Scotland’s economy has suffered a significant slowdown in its growth rate for more than a decade. From 1963 to 2006 it did not vary too far from its annual average of 2.3 per cent in terms of GDP per capita. However, from 2006 to 2016 there was next to no growth and little is forecast up to 2022. In GDP per capita terms, the growth rate has moved close to zero.
Last week the Scottish Fiscal Commission released a paper on forecasting the long-run potential of Scotland’s economy. Central to this analysis is our productivity performance which, barring a blip in 2010, has recorded only slow growth since 2004 – just 0.3 per cent a year. The one ray of light is its forecast that our productivity rate will return to an annual growth rate of one per cent by 2022-23.
To any high-flier setting out to explain productivity figures – let alone venture on a forecast four years ahead – a special bravery gong should be forged. We only need to look at recent data contradicting the grim prognostications of the UK Office for Budget Responsibility released with the Chancellor’s Autumn Statement to see how fraught an area this is. And time and again in Scotland, data underpinning productivity statistics in key sectors such as construction have come into question.
But persevere we must, because productivity is key to the performance of Scotland’s economy and well-being overall. And on present evidence, the long-term outlook – despite that SFC analysis – does not look good.
Just how problematic it is has been ably set out by Professor John McLaren in a Scottish Trends paper – Scotland’s Economic Growth and Productivity Slowdown: Explanations, Implications and Potential Solutions – essential reading for all involved in Scottish economic policy.
It opens by highlighting that our performance measured by labour productivity has been very slow for 14 years, with only 2010 providing any real fillip, due in part to a sharp decline in numbers employed in manufacturing. If this exceptional blip is excluded, “it could be claimed that the post-2014 productivity growth rate for Scotland is close to zero. Even including the 2010 boost, recorded post-2004 Scottish annual productivity growth is only 0.3 per cent.”
This bleak conclusion comes with caveats on how labour productivity in construction is calculated – concerns that could extend into other areas such as financial services.
This problem is compounded by several helpful ‘tailwind’ effects over the past 50 years disappearing or turning into growth-suppressing ‘headwinds’. These include changes to female economic participation, changes to education standards, demographic trends, North Sea activity, internationalisation, and political stability.
Potential solutions are not easy to effect. These may include increasing inward investment and entrepreneurship, increasing R&D spend, improving the diffusion of innovation across firms, and improving education and health standards.
The decline in productivity growth predates the decline in GDP per capita growth by two years, starting in 2004 rather than 2006. This was interrupted by a dramatic rise in construction productivity in 2010 – a huge increase in output which had next to no impact on employment or hours worked. This was connected to a surge in large infrastructure projects, some of which, like the second Forth crossing, involved highly specialised workers. These workers are often itinerant and may not be recorded in labour market surveys, hence the discrepancy between output and employment. This means that the increase in productivity in this sector may be an illusion, or at least overplayed.
McLaren is not persuaded by the SFC forecast of labour productivity recovering to one per cent growth – “well above any average measure recorded since 2004. Indeed it is equal to the average seen over the whole period from 1998 to 2017. As such … it may be over-optimistic and so too its forecasts for Scottish economic growth and future tax take.”
What countervailing policies could be pursued? OECD analysis suggests pro-competition reforms to product markets, especially in services to incentivise and spread new technologies and managerial performance; closer collaboration between firms and universities; a level playing field that does not favour incumbents over entrants; greater labour mobility and public investment in basic research.
But problems exist with these routes to improvement. First, the policies needed to increase inward investment or entrepreneurship are not obvious and have proved stubborn to effect. In addition, evidence that either approach would improve performance is scant. On R&D it may be better to incentivise innovation rather than provide investment subsidies.
According to the SFC, policies announced at the time of the last Scottish Budget are assumed to have no impact on future growth. The Scottish Government is placing much store by the creation of the Scottish Investment Bank – much heralded and benefits as yet unknown. And attempts by the UK government to ‘fill a hole’ in private sector investment have seriously under-performed against targets.
Other more diffuse policies suggested by the OECD include improving school education outcomes, increasing competition on health care provision (good luck with that in today’s climate) while other health improvements would help economic participation rates and Scotland’s woeful life expectancy record – one of the worst in the OECD.
The harsh truth, writes McLaren, “is that it no easy task to lift productivity and especially difficult to do so without negative knock-on impacts in other areas of the economy. “What can be said with some degree of confidence”, he adds, “is that if a return to productivity growth of one to two per cent per annum does not emerge, then wages, living standards and public spending are also unlikely to return to growth rates seen on anything like the historical average scale.” It is a conclusion that should concentrate minds at the highest levels of government policy.