The prospect of deflation is not entirely doom-laden, and is a much-needed wake-up call, writes Bill Jamieson
IN BARELY four months, Scotland has gone from a surge of confidence about prospects to the depths of gloom. Has Scotland just gone bust – or is the plunge in the oil price the wake-up call we have long needed?
Life looked good last year with oil at $115 a barrel and the prospect of more powers, if not outright independence. Tens of thousands were fired up by hopes, not just of an end to austerity but real increases in public spending, better welfare provision and programmes to reduce inequality. And all this from a natural endowment gifted by nature: no need for productivity drives, harder work, innovation and enterprise.
Today that optimism has all but gone. The economy is slowing, the election campaign has immediately sunk into claim and counter claim on “NHS in crisis” and rows over debt and deficit reduction.
And the oil price has not just fallen. It has crashed to almost half the level of last summer – yesterday Brent crude tumbled to just $49.92 a barrel, the lowest since 2009.
For the North Sea oil industry this is deeply worrying. Many fields are simply uneconomic at this level. Capital investment plans have already been cut and headcounts reduced.
But for Scottish aspirations, it is catastrophic.
The economics of independence critically hinged on oil prices staying above $110 a barrel, with the campaign fuelled by claims that cash from North Sea oil could pay for not only Scandinavian-style public services, but an oil fund too.
But according to projections from the Office of Budget Responsibility (OBR) last month – when the oil price was above $60 a barrel – oil revenues in an independent Scotland would have slumped to one fifth of the SNP’s prediction. The OBR reckons oil revenues would come to just £1.25 billion in 2016-17 instead of the £6.9bn predicted by the SNP. With the price now at $50 a barrel, these projections have been reduced to rubble. It has also smashed into the UK government’s projections, and this shortfall will have to be made good – by spending cuts elsewhere, higher tax, or more borrowing.
Little wonder that a Labour tribal war broke out this week over how the proceeds of its proposed Mansion Tax would be spent. Such a tax would raise between £1.7bn and £2bn annually – well short of the hole left by lower oil tax revenues. Every scrap will have to be fought for and we can expect much more of this as the election campaign intensifies.
Nor does the oil price wrecking ball stop there. Many fear the greatest damage will be done by the effect of lower oil in driving the economies of Britain and Europe into deflation.
Figures yesterday showed that prices last month were 0.2 per cent lower than a year ago. The principal cause was a 6.3 per cent fall in the price of energy.
Deflation is one of the scariest words in economics. It conjures up visions of a Japan-style “lost decade” – or more accurately two of them; low to zero growth and consumers reluctant to spend in the expectation that prices will be lower in six months’ time. Arguably most worrying of all is the effect of falling prices on increasing the real burden of public and private debt. If inflation takes the pain out of debt, deflation adds mightily to it.
But I am not at all convinced that deflation is wholly negative. It can work to stimulate innovation as manufacturers can no longer resort to the traditional “remedy” of jacking up prices.
And deflation has not always been a cause for misery. Over the past 15 years, dramatic falls in the price of electronic hardware and information technology have brought immense computer power into tens of millions of homes. We have enjoyed, too, cheaper clothes and falls in prices of consumer durables. Few wrung their hands in despair. Today we are seeing significant falls in the price of petrol, putting money back into the pockets of households and businesses alike. So long as the lower oil price is passed on, this should see a genuine stimulus to the wider economy, beyond anything that political parties could credibly promise.
And it is catalysing wider benefits for consumers. Supermarket giant Sainsbury’s has announced it will cut the prices of 1,000 of its most popular products as part of a £150 million programme, with rival Asda announcing similar plans, saying it would invest £300m in the first quarter of 2015 on cutting prices.
Given all the attention focused on stagnant incomes, household poverty and food banks, this is surely news to be welcomed. Indeed, our grumble is not that prices are falling but that they are not falling as far or as fast as we would like. As it is, pump prices have already fallen from 135p a litre to 109p – a near 20 per cent reduction.
And the impact of deflation on central bank policy may well prove as benign. In the eurozone, the spectre of deflation is piling pressure on the European Central Bank to pull the quantitative easing trigger at its 22 January policy meeting and boost the region’s economy. A bad outcome? We’ve only been waiting three years.
Whether inflation is just above or below zero barely signifies in the greater picture – one in which it has been not “falling oil” but the lamentable failure of Europe’s politicians and its central bank to act that has brought about low growth entrapment and appalling levels of unemployment.
Tellingly, the fall in the oil price – and in the value of the euro on expectations that action may finally be at hand – has helped business confidence across the eurozone to pick up from the lows seen last autumn.
Now the downside, of course, is the prospect of massive geopolitical instability, both across the Middle East as well as Russia, if the oil price remains at this level or falls further. Here, too, I am not convinced that oil much below $80 will prove permanent, though the game of chicken between Saudi Arabia and America’s shale oil producers may have some way yet to run. The price is as likely to see a bounce in the coming months.
In the meantime, it is this broader stimulus – both at home and in critical export markets overseas – that will make a greater contribution to the health and vibrancy of Scotland’s economy than oil staying at $115 a barrel. Scotland will not “go bust”.
But it has just been given a shuddering wake-up call.