This week’s figures report substantial (and welcome) growth of +0.8% in the Scottish economy in Q1. Not only does this mean that the economy avoids falling into the technical definition of recession – defined as two quarters of falling output – but it means that it has made up some of the ground lost last year (when it did not grow at all).
An earlier report by the Fraser of Allander Institute, Scotland’s foremost independent analysts, is summarised below in six bullet points but clearly under-estimated the – surprising – bounceback in manufacturing output, driven by the resumption of steelmaking in Dalzell and a huge (12 percent) increase in refined petroleum products from Grangemouth. But, first, the latest FAI analysis.
Relative to the UK
Growth of +0.8% in Scotland in Q1 is above the equivalent growth of +0.2% in the UK economy as a whole in Q1. However, as the following chart shows the UK economy has grown far faster than the Scottish economy since 2015.
Drivers of growth
The first obvious question is why – with all indicators of business activity and confidence suggesting relatively weak growth at best – do the GDP statistics produced by the Scottish Government suggest such a substantial pick-up in activity in the first three months of 2017?
The explanation lies in the sectoral split of growth, summarised at a high level in the following chart.
For services and construction, which together make up over 80% of the economy, growth was good but relatively unspectacular. Services grew 0.3% (slightly below trend of 0.4%) whilst construction output actually fell 0.7%.
Taken together these would have led to growth overall in the economy – indeed spot on with what our Nowcast is telling us about the Scottish economy’s performance.
But what has driven the scale of the upswing was the massive growth in production of 3.1%! This is the first time production sector activity has grown since Q1 2015.
To put this in context, the only other time that the production sector has reportedly grown faster than this – since the Scottish series began in 1998 – was in Q3 2009.
There appear to be four key reasons for this.
- Firstly, the figures show a substantial rise of over 7% in metals manufacturing, driven in part by the re-opening of the Dalzell steel plant.
- Secondly, as our latest Oil and Gas survey highlighted, there has been a growing return to confidence in the oil and gas supply chain. The data published today appears to indicate that this has actually now translated into a welcome degree of bounce-back in actual activity within the sector.
- Thirdly, the figures report massive growth of over 12% in refined petroleum output which is largely output from Grangemouth. We’d urge caution with this series as it’s especially volatile as the chart below highlights – usually around Q1- in contrast to the overall production series.
- Finally, other sectors of manufacturing have also bounced back from a weak 2016. Food and drink for example, also grew strongly by historical standards.
All these positive factors have happened to coincide with each other during this quarter, helping to pull up overall growth quite significantly. Whilst positive, it is entirely possible that a number of these factors will only have a (large) temporary impact on the quarterly results. Key will be how sustainable the pick-up is in the months ahead.
One thing to note is that unlike with previous one-off events impacting on headline GDP figures, for instance when power plants have closed, there is no explanation for these one-off events in the statistical publication accompanying today’s data; they are only picked up in the Scottish Government press release. This is unusual.
Finally, it is worth noting that these data also report substantial growth of 0.6% and 0.5% respectively in the Education sector and the Health and Social Work sector this quarter. These are large increases. This means that the data now show that the GDP contribution of the Health and Social Work is 2.1% larger, in real terms, than it was this time last year.
All this being said, as we outlined in our report last week, whether or not the quarterly figures are above or over the line is largely unimportant. What is much more important is the longer-term trend. In this regard, today’s figures are welcome progress but policymakers will be hoping for a few more quarters of growth at this pace before they are reassured.
For example, whilst production output is up over 3% this quarter, it is still down -4.2% over the past two years.
And taken with the contraction of -0.2% in the overall economy at the end of last year, and very weak growth during the earlier part of 2016, output in Scotland has still been weaker than the UK as a whole.
So on balance, these data do not change the fact that the Scottish economy still faces a fragile outlook – particularly when you factor in likely effects of possible higher inflation and any Brexit uncertainty in the months to come.
We continue to forecast that growth in the Scottish economy will continue through 2017.
And the latest figures are consistent with that outlook. So if Scotland can – over the remaining three quarters of 2017 – secure its average quarterly growth rate of 0.35% then this will bring in 4Q-on-4Q growth over 2017 of 1.2%. Identical to our June forecast.
Later on this month, we’ll get official data from the Office for National Statistics on earnings growth in Scotland which will give a further insight into how the performance in the wider economy is feeding through to living standards. These figures will be of particular interest to the Scottish Fiscal Commission as they get set to forecast tax revenues. They will also probably be interested in how measures of consumer confidence and business activity continue to perform and whether or not they give an alternative insight into how the underlying economy is performing in practice (and therefore how tax revenues might perform).
So all in all, whilst very welcome, we’d urge caution in dusting down the bunting and streamers just yet! There is much work still to be done if the Scottish economy is to fully make up recent lost ground.
Six earlier conclusions
- Overall, we expect growth in Scotland’s economy to pick-up over the next three years but to remain below trend. As we argued back in July last year, quarterly growth is likely to be quite volatile with further negative figures entirely possible. But on the whole, the latest indicators of activity suggest that there will be more growth in the economy than there has been over the past 12 months.
Central FAI forecast Scottish GVA growth (%) by sector, 2017 to 20190
In such uncertain times, we continue to recommend that just as much attention is given to the range of estimates that underpin this outlook as well as our central estimates.
Some sectors stand to do quite well – particularly those such as food & drink and tourism who will continue to benefit from the low value of the pound. Others, particularly those that rely on household spending, such as retail, are likely to face tougher trading conditions.
- The latest economic data has – on the whole – continued to be relatively disappointing. Scotland’s economy shrank in the final three months of 2016, with the slowdown evident across most key sectors.
Whether or not next week’s data confirms a ‘technical’ recession (defined by economists as two consecutive quarters of falling output) is in our view not especially important. On balance, we think that the figure will be positive. But of much greater importance is the longer-term time trend and the gap that has opened up between Scotland and the UK. With Holyrood’s Budget now dependent upon how Scotland’s economy performs relative to the UK as a whole, it is now even more crucial that this gap is closed.
Scottish & UK cumulative growth – since 2015
- The one bright spot has been the labour market, as our recent Scottish Labour Market Trends report highlighted, where unemployment is now at a record low.
Underemployment has continued to fall, whilst Scotland has better labour market outcomes for 16-24 year olds. The Government are right to point this out and that this is better than we forecast last year.
Scottish employment & unemployment rate
But we continue to urge caution when interpreting the recent labour market data.
Firstly, some of the fall in unemployment in recent years has been driven, not by people finding work but, by people leaving the labour market entirely – that is moving into inactivity. If these people had continued to search for a job, then the unemployment rate would be higher.
Scottish & UK inactivity rates since 2008
Secondly, almost all of the improvement in the employment figures has been in the form of self-employment. A concern that exists about this increase is that whilst, for some, the greater flexibility that self-employment brings is welcome, for others, it may come with less stable and rewarding opportunities and fewer protections.
Sharp rise in self-employment in Scotland
Finally, and much more importantly, with little growth in output and rising employment, this means that we’re producing less but with more people. In other words, productivity growth will continue to be poor. This explains, in part, why whilst employment has been growing, wages and earnings have seen very little in the way of real-terms growth.
Scotland’s productivity growth since 2006
- Global forecasts have improved in recent times – and this should help support Scottish exporters.
An improving global outlook – World growth forecasts (% change on a year earlier)
And overall, the outlook for the UK is better than most economists thought this time last year…
Evolution of UK forecasts for 2017
…but the effects of Brexit are expected to have an increasingly significant impact over the coming years, with most still predicting that growth –while positive- will slow down over the next few years.
Latest growth forecasts for the UK economy
- So what explains the gap between Scotland and the UK?
The downturn in the oil and gas industry clearly continues to have an impact.
Business activity in the north east – as a result of downturn in oil and gas – lagging behind Scotland
But the recent challenges appear to no longer be just limited to sectors tied to oil and gas. Construction has continued to fall, whilst services are growing at just over ½ the UK rate.
Weakness across sectors evident over the year in the Scottish economy
This is particularly evident in manufacturing, where sectors linked to the North Sea such as metals and metal products have clearly been badly impacted, but others such as Food and Drink and textiles have also weakened.
Downturn in manufacturing – not just oil and gas
And with the UK growing more quickly, it’s not entirely clear that this can be explained (yet) by a unique Brexit hit in Scotland vis-à-vis the UK.
Scotland vs. the rest of the UK: PMI
- Finally, what does all this mean in the real world? Unfortunately, it looks as though households will have longer to wait for a sustained increase in their living standards.
Earnings across the UK have fallen once again…
UK average weekly earnings: 3-month average on same time a year ago
…..and with inflation expected to pick-up in the coming months, household budgets are likely to continue to be squeezed.
Inflation rising (and likely to exceed 3% in the next few months)
First published by the Fraser of Allander Institute