David Bell: Scots need to put some spark into the economy

IN THE near future, the Scottish Parliament may gain full control of the levers of economic governance. Even if some form of normality returns to the world economy before Scotland acquires these powers, the Scottish Government will have to confront many tough decisions.

The Scottish economy will have to grow if living standards and public services are to improve. There are no “silver bullets” for achieving growth. Countries start with different sets of resources and with different economic, cultural and political histories. It is usually those countries that can quickly increase the productivity of a large pool of previously untapped labour that experience sustained growth spurts. China is the most obvious current example, but the same argument applied to Ireland in the 1990s. Scotland already has 70 per cent of those aged 16 to 64 in work, putting it close to countries like Germany and Japan, and significantly above the United States. A sudden improvement in growth performance is unlikely.

The 19th-century economist David Ricardo argued that the key is to find those areas of production in which Scotland has already, or can develop, a “comparative” advantage – goods and services that Scotland can produce relatively efficiently. A Scottish government with added powers will inherit a business environment that is focused on an existing set of behaviours and trading relationships.

For example, data on exports suggests that the relative contribution of the “tradeable” sector in the Scottish economy has fallen in recent decades. This means the focus of production has changed from markets outside Scotland and instead has been increasingly directed towards domestic demand.

For an independent Scotland, unless it had substantial overseas investments, this would not be sustainable if it continued to consume a high level of imports. In 2007, Scotland exported £34 billion to the rest of the UK and £19bn to the rest of the world. It imported £44.2bn from the rest of UK and £21.5bn from the rest of the world. This left it with a deficit on the non-oil current account of £12.6bn – around 12.5 per cent of Gross Value Added – very high by international standards. With such a large deficit, the Scottish economy would be dependent on a depleting resource to fund its consumption. Estimated oil reserves at the end of 2010 were 4,196 million tonnes, of which 3,446 million tonnes have already been extracted. Oil might provide a breathing space, but it is not a long-term solution.

Perhaps a recovery in manufacturing would help refocus the Scottish economy away from domestic production. Given past trends, this would be a difficult task. Employment in Scottish manufacturing declined massively since the middle of the last century. Between 1951 and 2008, Scottish manufacturing employment fell by 70 per cent to just over 200,000 – around 10 per cent of the current Scottish workforce.

There was a sharp fall in the 1980s, when many of Scotland’s heavy industries vanished. There was a partial recovery, partly as a result of the rapid growth in electrical engineering and electronics – the so-called “Silicon Glen” phenomenon. Most of the employment in electronics was low-skill assembly work that was susceptible to lower cost competition from the developing economies of eastern Europe and Asia.

Nevertheless, Scotland still has some very good manufacturing firms, both indigenous and foreign-owned. And there are strong social as well as economic arguments for helping this sector to grow.

Yet rebalancing towards manufacturing takes time and will only occur if industrialists believe that Scotland has the skills and infrastructure to make their products competitive on world markets. In general industrialists would take the view that our costs are too high, our technology is not good enough and our business environment is less attractive than elsewhere. There are exceptions: Scotland does still receive some inward investment, but not at a rate that would transform the economy even in the medium term. So if manufacturing employment has fallen, which industries have expanded to keep Scottish employment levels so high? The data reveals that 85 per cent of the growth of 213,000 jobs in Scotland between 1995 and 2008 was in three sectors – health and social work; education and administration; and defence and social security. Most of these jobs are in the public sector. High levels of public sector employment are only sustainable if the rest of the economy is generating substantial tax revenues. On the other hand, if such jobs are debt-financed, whether the debt is incurred in London or Edinburgh, such employment expansion cannot be part of a sustainable long-run growth path for the Scottish economy.

The profound change in Scotland’s industrial make-up has had an impact on whether occupations have been growing or contracting. Occupations that involve routine manual or administrative operations have lost out. There are a lot fewer assemblers and routine operatives, clerks, fitters etc. These changes came about not only due to a loss of competitiveness, but also due to the impact of information technology, which has made many routine skills redundant.

Rapidly growing occupations include those where high-level skills are required, such as IT and management. But employment has grown fastest among those involved in child care, healthcare and social care – occupations where threats to employment from foreign competition and from information technology are weak.

Manufacturing employment in countries such as Switzerland, Italy and Germany has fallen much less rapidly than in the UK even though their wage costs are as high or higher than the UK and their corporation tax rates are close to, or above, the UK rate. These countries are better at identifying and exploiting niche markets in manufacturing than the UK.

The decline in manufacturing employment in Scotland has been even more rapid than in the UK as a whole. In 2010, Scotland only accounted for 6.6 per cent of UK manufacturing employment, well below its population share of 8.8 per cent. While it might be nice to imagine a swift return to historic levels of manufacturing employment (or tradeable production which also encompasses tradeable services), this will not happen. The Scottish Trades Union Congress objective of maintaining existing levels of manufacturing employment is more realistic, but even that may be difficult to achieve.

Is it desirable to reverse the decline in Scottish manufacturing? The danger in not doing so is that Scotland slips into independence with a dangerously unbalanced economy. The decline in the manufacturing sector has gone further and faster than almost anywhere else in Europe. The decline of the last two decades has perhaps been the unintended consequence of a belief that allowing economic activity to focus on financial services in the south-east of England would not have adverse effects on the economy of other parts of the UK. With some notable and unfortunate exceptions, other European countries have been less willing to allow their economies to be dominated by financial services and adopted tighter regulation or other measures to keep its growth in check.

One way to reinvigorate manufacturing is to revitalise Scottish entrepreneurship. In 2008, Scotland had 26.5 enterprises per 1,000 population. Denmark, Norway, Sweden and Finland had 43.4, 57.1, 67.3 and 61.2 respectively. High tax rates do not seem to deter Scandinavian entrepreneurship and partly explains why these countries are able to support high levels of social welfare. In Spain, the Basque Country and Catalonia also have a much larger population of enterprises and manufacturing enterprises than Scotland. Out of 349 European regions recorded by Eurostat, Scotland comes 267th in number of enterprises per 1,000 population. Scotland has an enterprise deficit.

But increased entrepreneurship will not be sufficient to revive Scotland’s manufacturing sector. Tradeable activity will only expand if employers have access to a competitive skills base. Developing a radical approach to skills formation has to be another key component in the revival of Scotland’s comparative advantage and the rebalancing of the Scottish economy.

• David Bell is professor of economics at Stirling University