The Council of Economic Advisers has been created to advise the First Minister on how to increase Scotland's sustainable economic growth rate. This was the last meeting of the current Parliamentary session.
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Introductions, Minutes and Actions
1. The Chair welcomed all members of the Council to the tenth meeting.
2. The Chair referred members to the minutes and matters arising from the ninth meeting. Council members indicated that they were content.
Update on the Scottish Economy
3. The Chair invited Dr Andrew Goudie, the Scottish Government's Chief Economic Adviser, to provide an update on the Scottish economy.
4. In recent months, the global recovery has exhibited some signs of weakening - apart from in the Far East where growth remains robust. This reflects several factors, including: the continued repercussions of the credit crunch - the IMF, for example, estimates that a third of banks' bad debts have yet to be fully managed - and the transition of the principal effects of the financial crisis from private financial markets to government finances and sovereign debt.
5. In Scotland, the recession came to an end in the final quarter of 2009 but economic recovery remains fragile. Scottish GDP was unchanged in first quarter of 2010 and recent labour market data show that Scottish unemployment rose to 8.9 per cent over the period May to July 2010. This is the highest rate of unemployment in Scotland since 1997 and follows a period of around five years when the Scottish labour market outperformed the UK as whole. Employment in Scotland is showing some signs of improvement with a rise in the last quarter, but the rate of increase was insufficient to absorb all the inflows into the labour market.
6. The Bank of Scotland's PMI survey has been positive for the past 13 months suggesting growth in private sector output, particularly in manufacturing and engineering. Services output has been less strong and more volatile. Business confidence appears to have dipped somewhat since the UK Government's Emergency Budget in June.
7. The Emergency Budget accelerated the deficit reduction process considerably, with the aim of eliminating the UK budget deficit by 2014/15. The newly-created Office for Budgetary Responsibility (OBR) updated its forecasts for UK economy after the Emergency Budget with a sharp downward revision to GDP growth for 2011, which fell to 2.3 per cent, significantly down on the December 2009 Pre-Budget Report forecast of 3.5 per cent.
8. The public finance estimates presented in the Emergency Budget implied that expenditure, in real terms, controlled by the Scottish Government would decline for 6 years. According to these plans, the average annual real reduction in resources available to the Scottish Government would be about 3 per cent - with accumulated real cuts in capital expenditure of 40 per cent and a fall in revenue expenditure of 12 per cent by 2014/15. For next year, the Scottish budget would be expected to shrink by 6 per cent in real terms or £1.2bn in cash terms compared with this year - approximately half from revenue and half from capital budgets.
9. Updated analysis from the Chief Economic Adviser showed that the UK Government's Emergency Budget plans would increase the scale and duration of spending cuts in Scotland. Furthermore, the analysis suggests that it may take 16 years for levels of public expenditure to get back to previous peak, with an cumulative loss of resources to the Scottish Government of around £42 billion.
10. This analysis is obviously sensitive to a range of assumptions. For example, if UK trend GDP growth increased from 2.1 per cent to 3.1 per cent, then the expected timescale of adjustment would reduce to 12 years and the cumulative loss of resources would shrink to around £32 billion. The Chief Economic Adviser noted that the analysis does not take account of other pressures on public services, such as additional demand arising from demographic change.
11. Discussion followed around the main themes of the presentation, particularly the economic implications of the UK Emergency Budget. The timing, speed and depth of the accelerated UK fiscal consolidation is a clear source of risk while private sector output remains fragile and this could threaten recovery in the Scottish economy over the next 12 months. Despite the sluggishness of the economy as whole, there are some encouraging signs at the company level with the attraction of new investment and employment into Scotland, including recent announcements by Barclays, Hewlett Packard and Virgin Money, that demonstrate the work of the enterprise agencies in promoting Scotland as location for inward investment.
Independent Budget Review
12. Crawford Beveridge, Chair of the Independent Budget Review (IBR), reviewed the key themes of the report and discussed the initial reaction it had received. Council members had had an opportunity to discuss the emerging themes of the Review and to offer contributions at the previous meeting in June.
13. The IBR report, published on 29 July, had been received very positively across the political spectrum and had attracted much coverage in the written and spoken media.
14. The Review was not intended to be a line-by-line examination of the Scottish budget; instead, it considered dispassionately the key choices that exist around the future of public services in Scotland - and their financial implications. The Review touched upon a wide range of specific issues but focussed attention on four main areas:
- Efficiency - The Scottish Government had made progress in recent years in generating savings that have been recycled within Portfolios. At a minimum, these efforts would need to be maintained in future years to create additional headroom and the Government would need to consider whether all future savings should be recycled in the same way as now.
- Capital - The future budget for capital projects would be cut to a much greater extent than the resource budget. Given estimated needs for new infrastructure and maintenance, the capital shortfall poses clear short-term risks for growth and employment in the construction sector and longer-term risks to the economy's growth potential.
- Universal Services - The Review recognised the advantages of universal provision, such as concessionary travel, free care, prescriptions, eye tests etc., but raised issues of affordability and targeting. In some cases, entitlement changes could provide significant savings and a range of possible options for change is presented in the report.
- Remuneration & Workforce - Pay represents about 60 per cent of the budget of the public sector in Scotland. The UK Government had proposed a freeze on public sector pay except for those earning less than £21,000, which represents around 20 per cent of public service employees (47 per cent in Scotland). Even in the absence of wage rate rises, progression payments would still see the Scottish public sector pay bill rise by some £180m next year. Greater flexibility on pay rates would help to preserve workforce numbers.
15. In the course of the discussion that followed, Government plans to introduce a Scottish Water Bill were mentioned. The intention of this Bill would be to provide Scottish Water with the flexibility to develop a broader range of commercial opportunities and access different sources of income than current legislation permits.
16. The Scottish Government had welcomed the publication of the findings of the Review and its formal response would be presented in the next Draft Budget, which was due to be laid before Parliament in mid-November. Before then, the Government would use the IBR as the basis for dialogue with political parties and the general public. The Government is determined that any budget options which are pursued must be consistent with its Purpose by supporting economic growth and positive social development.
Planning
17. The CEA Lead reviewed the key actions the Scottish Government has taken in response to the Council's recommendations on planning, as outlined in its First Annual Report.
18. Council members recognised that the Scottish Government had achieved a great deal in terms of planning reform, particularly around the treatment of national-scale developments and improvements in the speed and predictability of planning decisions. Such reforms have enabled around 86 per cent of written appeals to be dealt with by Ministers within 12 weeks, up from only 7 per cent prior to 2008/9.
19. Whilst recognising the genuine value of these improvements, Council members felt that more could be done to re-balance the financial incentives for local authorities in order to stimulate high quality development. At present, planning approvals often generate additional up-front costs for local authorities (e.g. for road improvements) but do not produce much by way of additional revenues in the short term.
20. The Council endorsed plans to pursue tax increment financing (TIF), which is currently being piloted in three areas of Scotland, as a means to address the issue of financial incentives and urged the Government and local authorities to continue working together to improve planning performance.
Banking
21. The Council discussed a range of issues relating to the competiveness of the banking industry in Scotland following the financial crisis and the difficulties some Scottish companies, particularly SMEs, experience in accessing working capital and finance to support expansion.
22. Anecdotal evidence suggests that the terms and conditions being attached to some lending by the banks dominant in the Scottish market may be dampening the volume of business in Scotland's financial and business services sector. In situations where Scottish firms have responded by moving their banking business to overseas banks, there has been a negative knock-on impact on the demand for related legal and accounting services in Scotland.
23. A broader range of financing options (e.g. equity and bond issuance) is available to businesses of large scale seeking to access large sums than is available to many small and medium-sized companies pursuing smaller investments. There is a common perception too that the restructuring of the banking sector has led to further concentration of senior decision-making staff in London and this may be weakening the important personal relationships that help to underpin the flow of borrowing to Scottish businesses.
24. The original objectives and future intentions of the UK Government with respect to its holdings in the banks was discussed. One objective of the UK Government in providing capital and taking stakes in the UK banks in the wake of the credit crunch was to ensure the maintenance of an adequate supply of financial services to businesses on reasonable terms. Questions were raised about how well this objective was being met and how ultimately the disposal of these shareholdings would be handled.
25. The Council considered the kind of structures that would be of most benefit to the wider Scottish economy in terms of providing competition in banking services and supporting the future growth of the financial & business services key sector in Scotland, including the retention of highly-skilled staff. The eventual disposal decisions of the UK Government, coming on top of recent decisions by European competition authorities, will yield major implications for the structure of the banking industry in Scotland. The Council urged the Scottish Government to play a full part in influencing the outcome of these decisions in the long-term interests of the Scottish economy.
Annual Report
26. A draft of the Council's Third Annual Report was discussed. The Annual Report will provide further recommendations from the Council to the Government when it is published in December.
Retrospectives
27. To close the final Council meeting of this Parliamentary session, both the First Minister and Sir George Mathewson offered their thanks to all members for the commitment and expertise they have brought to the Council's work over the past three years.
28. The Council has played an important role in shaping the Scottish Government's response to the recession, particularly recommending accelerating capital spending and the pursuit of further economic and borrowing powers.
The following members of the Council were present:
First Minister
Sir George Mathewson (Chair)
Mr Crawford Beveridge
Professor Andrew Hughes Hallett
Professor John Kay
Professor Alex Kemp
Sir James Mirrlees
Mr Jim McColl
Lord Robert Smith
Apologies were received from:
Ms Frances Cairncross
Professor Finn Kydland
Professor Frances Ruane
Also present:
John Swinney, Cabinet Secretary for Finance and Sustainable Growth
Dr Andrew Goudie, Chief Economic Adviser
Jennifer Erickson
Lucy Proud
Dermot Rhatigan
Scott Rogerson