Comment: Our economic forecast cannot be called ‘normal’

Ashcroft: "don't underestimate threats"
Ashcroft: "don't underestimate threats"
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PUT economists in a room to predict the growth rate and we are virtually guaranteed two sharply different forecasts. Thus it has proved in the past week with two heavyweight assessments on Scotland’s economy. From the University of Strathclyde’s Fraser of Allander Institute comes a warning – all too familiar from this source – that further “austerity” measures could threaten recovery.

It has downgraded its forecasts for GDP growth this year from 2.6 per cent to 2.5 per cent, while its prediction for 2016 is trimmed from 2.4 per cent to 2.3 per cent. Little by way of pick-up is seen for 2017 with growth marking time at 2.3 per cent.

With the volatility of inflation… a rise in interest rates may not now be far off

Brian Ashcroft, emeritus professor of economics at the University of Strathclyde, counsels that “we should not underestimate the threats to the recovery from rising household debt, little growth in real wages, the dark shadow of further austerity and the rising possibility of Greece leaving the euro”. Recovery, he adds, could be hit by the UK government “continuing, or even tightening, planned austerity measures” in the Budget on 8 July.

Now compare this with the altogether more upbeat tone of the latest Bank of Scotland Business Monitor. This shows the Scottish economy recovering from slowdown at the start of the year. Expectations for the next six months have improved to the fourth best level in seven and a half years.

It finds that in the three months ending May, 36 per cent of the firms surveyed increased turnover. The overall net balance (those reporting an increase minus those reporting a decrease) is +7 per cent, up from the zero per cent of the previous quarter.

Services firms showed an overall net balance for turnover for the three months ending May of +14 per cent, well up on the +4 per cent of the previous quarter – a welcome contrast to the “nil growth” reading in the fourth quarter of last year.

Services firms are now much more optimistic than production firms, showing an overall net balance for turnover for the next six months at +27 per cent compared to +14 per cent for production firms.

Expectation levels on new orders, says the bank’s chief economist, Donald MacRae, “suggest the private sector of the Scottish economy will show growth close to trend level in the second quarter of 2015, recovering from the slowdown at the start of the year. Expectations remain close to pre-recession levels suggesting that growth will pick up in the second quarter of the year.”

Now, we should note that these assessments are based on different perspectives and data and cannot fairly be compared. Fraser of Allander draws its conclusions from published macro-economic data while the bank survey is based on responses from individual businesses to questions on order levels, staff hiring, price movements, overall confidence etc.

But given its relatively more positive conclusions, need business readers worry that much about the institute’s findings? It has arrived at modest shadings of previous estimates, barely meriting the description of “downgrade”. And its forecasting record in recent years has tended to under-shoot, requiring subsequent upgrades.

Fraser of Allander has long been sceptical of the strength and sustainability of the upturn since 2012, firm in the belief that growth is largely the product of higher government spending. It did not foresee the economy growing as strongly as it did through a period of public expenditure restraint. It has been sceptical of the contribution of SME activity and the growth of e-business and the digital economy in recent years. At the same time, its sombre warnings on the debilitating effects of austerity are mitigated somewhat by a recognition that Scotland’s growth continues to be fuelled by infrastructure spending (Forth Crossing, M8 completion), 80 inward investment projects, and consumer spending! Indeed, it makes little of the latest lift in annual pay growth to 2.7 per cent – a four-year high.

However, all that said, its latest forecasts reflect evidence of a slight slowing of the recovery pace in the first half, weakness in exports and greater allowance for the downturn in North Sea oil activity.

And it highlights two issues in particular that should be of concern to an administration requiring a quantum leap in Scotland’s growth performance to realise its fiscal autonomy objectives.

The first is the persistent gap between the performance of the UK and Scottish economies. When oil and gas production is removed – to compare like with like, since offshore activity is included in the UK but not the Scottish GDP data – the gap in the strength of the recovery widens further in the UK’s favour. UK GDP stands 5.1 per cent above the pre-recession peak compared to only 2.3 per cent in Scotland. This, suggests the institute, could be due to the recovery in R&D activity being stronger in the rest of the UK after the recession than in Scotland.

In the UK, the service sector was by far the main driver of growth, while in Scotland the sector made no such contribution. The principal driver of growth in Scotland was the construction sector while the sector in the UK was a drag on growth.

As for exports, it notes that a more competitive price through a lower sterling exchange rate is insufficient to boost export demand. “Issues of product quality and marketing would appear to be at the root of this Scottish and UK problem.”

The second issue is the evidence of slowdown in the pace of job creation. Numbers seeking work rose slightly in the latest quarter and the reduction over the year, while sizable, is proportionately less than in the UK. By the end of the fourth quarter, Scottish jobs were 2.6 per cent above the pre-recession peak, while UK jobs were 4.6 per cent higher.

Finally, there is the looming inflection point of a rise in interest rates. For the past four years this has been booted into the long grass of “next year”. But with the volatility of inflation – a swing into deflation proving far more brief than many predicted – and the acceleration in pay growth, a rise in interest rates may not now be far off.

Some will hail it as a sign of a return to “normality”. But there is little in the potential impact of external events – a China slowdown, continuing enormous debt problems in Greece and a traumatic bond market sell-off – that can in any way be described as “normal” in the high-wire world of economic forecasting. «