Council of Economic Advisers: annual report 2015-2016

3. Inclusive Growth ^[3]

Inclusive growth is one of the four priorities for sustainable economic growth highlighted in Scotland's Economic Strategy. It is an area to which the Council has paid particular attention over the past year, as it is a central part of the Scottish Government's economic agenda, and an important link between improving the competitiveness of Scotland's economy and reducing inequalities.

The objectives of reducing inequalities and supporting growth are not new ones. However, there has been a growing recognition in recent years that persistent inequalities can have a deleterious effect on a country's wider economic performance. There has also been a recognition that actions that support the fundamental drivers of economic growth, and that help to reduce inequalities, can be mutually supportive. Developing approaches and ideas for economic and social policies that explicitly support more inclusive growth is a new challenge, not only for the Scottish Government, but for advanced economies more generally.

As inclusive growth is a relatively new policy concept within advanced countries, the Council's role has been to advise the Scottish Government on the development of this new approach to policymaking. The Council has concentrated on placing Scotland's experience in an international context; identifying areas where Scotland performs relatively well, and where it faces more significant challenges; advising on high-level policy actions that support both increasing long term sustainable growth and reducing inequalities; and helping the Scottish Government to develop the tools it needs to make its policies more supportive of growth and more inclusive.

Inclusive Growth - An International Perspective

Inclusive growth is increasingly being recognised as a common challenge internationally, owing to increases in income inequalities across countries, and the emerging picture around the negative effects that increasing inequalities can have on economic performance ^[4] .

The international evidence suggests that there are a number of global factors driving these trends, such as skill-biased technological change, but that countries' policy choices have also played an important role in reinforcing those trends, particularly through those policies that have an impact on labour and product markets, the financial sector, and tax and welfare systems ^[5] .

Consequently, a number of international organisations, such as the European Commission, the OECD, the IMF, the World Bank and the World Economic Forum, have focused on Inclusive Growth as a policy objective in recent years. These organisations' views of inclusive growth tend to centre on a vision of inclusive growth as being growth that increases a country's overall prosperity, but with a particular emphasis on who directly benefits from growth ^[6] . This represents a shift from a previous approach, focusing largely on tackling inequality through redistribution of the proceeds of growth, towards one where inclusive objectives are more central to the policy making process and better integrated with the processes that deliver economic success.

The international organisations have begun to develop evidence around policies that can support growth and inclusion. IMF researchers have suggested that, taking into account their impacts on reducing inequality, redistribution policies seem generally benign in terms of impacts on growth ^[7] . The OECD ^[8] have identified a number of 'win-win' policies that can impact positively on both economic growth and income inequality over the longer term. These include:

• Removing barriers faced by women who wish to participate in the labour force, including barriers resulting from the tax and welfare systems, whilst recognising the wider social impacts on women and families of greater participation;
• Strengthening and improving the effectiveness of Active Labour Market Policies, including those that assist with job search and re-skilling;
• Improving provision and quality of early, primary and secondary education; and,
• Improving outcomes and broadening access to higher education and training.

The OECD also identifies evidence on policy areas and actions where there may be potential for trade-offs between increasing growth and reducing income inequality to occur. These can include changes to welfare benefits related to unemployment, product market reforms that increase competition, and policies around increasing innovation or R&D intensity. While policies in these areas will not automatically result in trade-offs occurring, they highlight the importance of careful policy design to encourage positive effects on both growth and inclusion.

This shift means that inclusive growth policies are focused on the transformation of the economy towards sustainable and productive employment over the longer term, rather than on short-term income redistribution alone. This is influenced by a recognition that there are a number of causes behind 'exclusion', which may require different policy responses. For instance, addressing the consequences of economic change, particularly disengagement from the labour market, in individual parts of Scotland may require different policies than those for reducing economy-wide barriers to economic participation. It is also underpinned by the recognition that the private sector needs to grow, invest, and innovate in order for good quality jobs, tax-base and opportunities required for inclusivity to be created.

Principles for an Inclusive Growth Policy Approach

From the international literature, and the Council's discussions, there are a number of common principles that should underpin an inclusive growth policy approach in Scotland. These include:

• Recognising that economic growth and inclusion are mutually interdependent, rather than being separate concerns;
• Recognising that inclusive growth has both economic and social dimensions, and that improving social outcomes, such as educational attainment and health, are an important part of an inclusive growth approach;
• Understanding the positive links and trade-offs between different policies' effects on inclusion and growth, and their impact on the different groups across the income distribution and population as a whole;
• Recognising the importance of place and geography to inclusive growth outcomes, and the importance of regional and community groups in delivering these. In its discussions, the Council has highlighted the importance of recognising the potential implications of different geographical approaches towards improving inclusive growth.
• The need for policies to take a long-term approach to inclusive growth. In many respects, improving Scotland's performance around inclusive growth will involve broadening the economic opportunities available to people across Scotland, and many of the policy levers that the Scottish Government and its partners possess to influence these are long term in nature;
• The importance of focusing on inequalities in economic opportunities, rather than focusing solely on inequalities in outcomes and redistribution;
• Recognising that the emphasis on different facets of inclusive growth should vary across countries, depending on their circumstances: inclusive growth policies need to be country-specific. ^[9]
• The scope for using existing policy tools and levers to support growth and reduce inequality. This is particularly important given the levers that the Scottish Government possesses in areas strongly associated with inclusive growth, such as early years, education, skills and training, and health.

Inclusive Growth - A Scottish Perspective

Scotland has a reasonable record with regard to inclusive growth in recent years. Scottish GDP is 5.5 per cent higher than its pre-recession peak (2008 Q2) in real terms, and GDP per capita has recovered to 2.0 per cent above its pre-recession level. Productivity (in terms of output per hour worked) has grown by 4.4 per cent since 2007, compared to zero growth in the UK over the same period ^[10] . However, Scotland lags behind a number of international competitors with regard to productivity levels. Scotland would rank 19 ^th of 34 OECD countries in terms of output per hour worked ^[11] , just above Iceland and Japan and just below Spain and the UK overall.

Scotland's labour market has improved significantly since the recession, but has shown some signs of weakening in early 2016. The employment rate came close to its pre-recession peak early in 2015, but Scotland has since had lower employment rates and higher unemployment rates than the UK, with similar inactivity rates.

Scotland's gender gaps in employment and inactivity rates have fallen substantially in recent decades, from 14.9 and 19.3 per cent in March-May 1993 to 5.6 and 7.5 per cent in March-May 2016, ^[12] and Scotland has the second lowest female unemployment rate, fourth highest female employment rate, and eighth lowest female inactivity rate amongst EU 28 countries ^[13] . Scotland's youth employment rate and level has decreased slightly in recent months, however the youth employment rate is higher than the UK rate.

There have also been improvements in wider dimensions of inclusivity. There have been increases in proportions of school leavers entering 'positive destinations' - that is, entering employment, training of further learning - both overall and from school leavers from the most deprived quintile ^[14] . Life expectancy has continued to increase for both men and women since 1998, while relative poverty before housing costs has fallen over the last decade, with the percentage of individuals living in relative poverty before housing costs lower in 2014/15 (15%) than in 2003/04 (18%) ^[15] . However, after housing costs, poverty has not fallen to the same extent (from 20% in 2003/04 to 18% in 2014/15). This is particularly true for families with children. Housing costs have risen faster than income, combined with changes to housing benefit eligibility, meaning little improvement in living standards for low income families ^[16] .

Scotland is also mid-ranking in terms of income inequality among advanced economies, and would rank 19 ^th of 34 OECD countries in terms of the Palma ratio ^[17] . This places Scotland below the Republic of Ireland, but above France, Canada, Australia, New Zealand and the UK. There also remain significant inequalities across different social and economic indicators within Scotland. These occur both among different groups within Scotland (in areas such as labour market), different parts of the income distribution (for example, in early years), and in terms of geography (which may in part stem from long term changes in patterns of economic activity within Scotland). In a number of areas, such as educational attainment and health outcomes, there are differences in outcomes between income groups, which are spatially-based. Examples of inequalities across these indicators are set out in Table 1.

Table 1: Selected Dimensions of Inequalities in Scotland

Labour Market There is a persistent gender employment gap in Scotland, with recent employment rates are 76.8% for men and 71.3% for women [18] . Employment rates for those with disabilities (42.0%) and from ethnic minority groups (59.2%) are significantly lower than the Scottish average [19] . The gender pay gap for full-time workers in Scotland is currently 7.3 per cent [20] . 19.5 per cent of full-time employees were classed as low paid in 2011 [21] , almost 3 percentage points higher than the OECD average. There are considerable differences in labour market performance across different areas of Scotland.

Early Years At entry to primary school, children from the lowest income quintile are twice as likely to have developmental problems than those from the wealthiest income group. [22] On average, children from more advantaged households have better vocabulary and problem solving ability at ages 3 and 5 than children from less advantaged households. By age 5, the gap in vocabulary between children from low-income and high-income households is 13 months [23] .

Education [24] Around four in ten of school leavers from the 20% most deprived SIMD areas gained 1 or more Higher equivalent qualifications or better, compared with around eight in ten of leavers from the least deprived SIMD quintile. In March 2016, 86.3% of school leavers from the most deprived SIMD quintile were in learning, training or work 9 months after leaving school, compared with 96.3% from the least deprived SIMD quintile. School leavers from schools in the 10% least deprived SIMD areas are three times more likely to be in Higher Education 9 months after leaving school than those from schools in the 10% most deprived SIMD areas.

Health There is a long-standing gap between different areas of Scotland for both life expectancy and healthy life expectancy: men and women in the 10% most deprived areas live in good health for over 20 years less than those in the 10% least deprived areas [25] . Significant differences in premature mortality, and in mental health between the most and least deprived areas.

There are considerable differences in labour market performance across different areas of Scotland. In 2015, while Scotland's overall employment rate was 73.1 per cent, employment rates among Scotland's Local Authority areas varied from 87.3 per cent and 86.8 per cent in Shetland and the Orkney Islands, to 77.1 per cent and 72.2 per cent in Aberdeen City and City of Edinburgh, and 66.6 per cent and 63.3 per cent in Glasgow City and Dundee City respectively ^[26] . Significant differences in labour market performance across Scotland are long-standing: between 2004 and 2015, the gap in employment rates between the best and worst performing local authority areas has ranged between 14 percentage points and over 19 percentage points. Glasgow has consistently had one of the 3 worst employment rates in each of these years, with its employment rate not rising above 67 per cent.

There are also persistent geographical concentrations of deprivation within Scotland. For example, in the Scottish Index of Multiple Deprivation ( SIMD) 2012, 29.6 per cent of the data-zones ^[27] in the 15 per cent most deprived data-zones in Scotland were found in Glasgow City ^[28] . Disparities were evident across a range of outcomes, with the most deprived areas exhibiting substantially lower employment rates, higher economic inactivity rates, lower educational attainment, and worse general health than both the Scottish average and the least deprived areas in Scotland ^[29] .

Developing Scotland's Approach to Inclusive Growth

The Scottish Government's vision of Inclusive Growth is of, "growth that combines increases prosperity with greater equity; that creates opportunities for all and distributes the dividends of increased prosperity fairly" ^[30] . Scotland's Economic Strategy sets out the following broad dimensions of inclusive growth:

• Improving the quality of employment opportunities within the labour market and the quality of work within firms;
• Reducing barriers to labour market opportunities, particularly for disadvantaged and equality groups;
• Reducing cross-generational inequalities, through reducing inequalities in early years and educational outcomes; and,
• More equal growth across Scotland (cities, towns and regions).

The Scottish Government has also been looking to improve its approach to policymaking to support more inclusive growth. Building on the principles set out earlier in this chapter, the Scottish Government has been developing tools for improving government planning and policy across the different dimensions of inclusive growth. These tools are in development, and the Council has yet to fully review their outputs.

The Inclusive Growth policy framework, set out in Figure 1 below, has been designed to take more explicit account of wider economic and social objectives, including such things as well-being, and a greater acknowledgement of the redistributive effects and impacts on households. The framework can help to identify trade-offs and synergies between growth and inclusion in a systematic manner.

The framework assesses impact across three main dimensions:

i. Multidimensional policies aimed at tackling inclusion such as well-being and equality of opportunities;

ii. Growth policies aimed at boosting competitiveness such as investment and innovation; and

iii. The impact of policies, including redistributive impact on wealth or absolute/ relative poverty.

Following Council advice, the policy framework highlights the importance of geography and place in tackling inequalities; interactions of various Scottish Government policies with the labour market; and the need to assess impact differentiating between long-term and short-term impacts.

Figure 1: Scottish Government Inclusive Growth Policy Framework

The framework has been tested in several policy areas. Policy makers have indicated that the tool is useful for improving understanding of the potential impacts of policies. For example, in Housing Policy, synergies identified included the potential to support regional employment and output growth, reducing regional disparities. Trade-offs included disincentives to create new supply and the risk of deadweight loss if new buyers simply force others out of the market.

In addition to this, the Scottish Government is beginning to develop an Inclusive Growth Diagnostic for Scotland. Based on a methodology conceived by three Harvard Economists ^[31] , diagnostics are increasingly used in developing countries to identify the main constraints to growth and prioritise spending actions to unlock them.

The diagnostic's main purpose is to identify constraints and opportunities for driving inclusive growth in Scotland in order to prioritise actions to address them. The value of the diagnostic lies both in its systematic and evidence-informed approach to identifying and prioritising areas of concern and also its comprehensive breadth of coverage - tackling both economic and social drivers. The methodological approach is based mainly on the benchmarking of potential drivers with comparator countries (countries with similar characteristics to Scotland) to identify what the key gaps are.

To ensure that regional issues are taken into account, the Scottish Government is also undertaking analysis of inclusive growth drivers in North Ayrshire. This analysis is taking a person-centred approach to understanding inclusive growth in order to understand how drivers are impacting on real people and to bring the outcomes of the diagnostic to life.

The Council is encouraged by the development of these tools, and believes that if successful, these should be rolled out further. Exercises of this kind would be of value as the Scottish Government develops its inclusive growth approach and priorities, and the Council will look to continue to advise the Scottish Government on its application to Scotland as they develops further. This sort of 'whole systems' approach is important to ensure that policy actions are developed in a holistic, prioritised and complementary way. Ultimately, creating a more inclusive kind of growth in Scotland will depend on the success of actions at the local level.

The Scottish Business Pledge

During the course of its deliberations, the Council has been interested in issues relating to corporate governance and behaviour, as these are important influences on facets of inclusive growth such as workplace productivity and opportunity. With this in mind, the Council has paid particular attention to the development of the Scottish Government's Business Pledge initiative, which is potentially an important tool for encouraging private sector engagement in issues around inclusive growth. Overall, whilst the Council feels that the Pledge has potential, uptake to date has been relatively small in scale. In particular, the Scottish Government could do more to incentivise greater participation in this important initiative.

Background on the Business Pledge

The Scottish Business Pledge was launched in 2015. It is an agreement between the Scottish Government and signatory businesses, which aims to boost productivity, competitiveness, employment, fair work, and workforce engagement and development. By signing up to the Business Pledge, companies are committing to a set of shared values, and to delivering them through their actions and future plans.

There are nine components to the Business Pledge. Overall, these are aimed at improving business performance and supporting fair work. Those components aimed at supporting workforce engagement and fair work opportunities include:

• Paying the living wage;
• Not using exploitative zero hours contracts;
• Supporting progressive workforce engagement; and,
• Making progress on diversity and gender balance.

Those aimed at supporting wider social engagement include:

• Investing in Youth; and,
• Playing an active role in the community.

Those aimed more directly at improving business performance and competitiveness include:

• Committing to an innovation programme;
• Committing to prompt payment; and
• Pursuing international business opportunities.

In order to sign up to the Business Pledge, signatory businesses must meet the core commitment of paying the Living Wage, fulfil at least two other components of the Pledge at time of signing, and be committed to delivering all nine elements over the longer term.

Signatories also have flexibility in terms of how and by when they meet different components of the Business Pledge. Some components, such as the living wage, have a clear standard to meet. For other components, such as gender and diversity or investing in youth, there are more flexible parameters. This reflects the Business Pledge's overall approach - stressing business ownership and interpretation to reflect conditions in different sectors and industries, whilst holding up an aspirational standard.

Early Evidence on Uptake of the Business Pledge

Over 200 businesses have signed up to the Business Pledge. Analysis of early adopters ^[32] revealed the following characteristics of those who had signed up to the Business Pledge:

• The majority (69%) of signatory businesses were small. However, as small firms make up 96 per cent of firms within the Scottish economy, proportionately more medium and large firms had signed up to the Pledge than these firms' share of the Scottish business base. ^[33]
• Nearly half (44%) of all signatory businesses operated in two broad sectors: 'information and communication' (21%) and 'professional, scientific and technical activities' (23%). In the overall economy, these sectors make up 5% and 19% of firms respectively. This may be linked to the fact that higher quality working conditions already exist in these sectors ( e.g. better pay), making it easier to make the pledge.
• The majority of early signatories were fulfilling the majority of components of the Business Pledge. While around 11 per cent of signatories had fulfilled all nine components, around 76 per cent of signatories fulfilled at least six of the nine components. This implies that there may be more uptake from those businesses which already meet the conditions of the Pledge.
• There was variation in the components of the pledge that early signatories had fulfilled. All signatories fulfilled the components on paying the living wage and not using exploitative zero hours contracts. Over 70 per cent fulfilled the components around pursuing international opportunities, playing an active role in the community, investing in youth and committing to an innovation programme, while only around 37 per cent fulfilled the component on making progress on diversity and gender balance.

Avenues for Increasing Uptake

The Business Pledge is in its early stages of adoption, and its progress has been of interest to international bodies that are taking forward work on inclusive growth, such as the IMF and OECD.

In its discussions, the Council has emphasised the need for the Scottish Government to more proactively encourage greater uptake among businesses. The Council's considerations have therefore focused on understanding possible drivers of change and avenues for influencing greater uptake.

The Council's discussions suggested a number of possible avenues to consider to facilitate greater uptake, including:

• The importance of business to business interaction in raising awareness of the Business Pledge, and encouraging greater uptake. Engaging with business representative organisations such as Chambers of Commerce is a potentially important route in this regard.
• The need for the Business Pledge to have a wide degree of ownership. This is particularly important if the ambition for the Business Pledge is for it to help influence how business is done in Scotland.
• The importance of the Business Pledge being voluntary and business led. While conditionality might seem to offer a route to signatory businesses meeting more Pledge components, it would risk the Pledge being seen as something 'done to' businesses, rather than being a shared view of good business practice and encouraging behaviour change. It was also emphasised that more could be done to identify and encourage business community leaders to drive forward voluntary uptake.
• The importance of there being flexibility in how businesses can fulfil the components of the Business Pledge. As the conditions facing individual firms and sectors will differ, having an approach that is flexible and sensitive to business conditions could be more supportive of changing business behaviour.

Ultimately, businesses are likely to change their behaviour, and sign up to initiatives like the Business Pledge, if there is clear evidence around the benefits that adopting such an approach would create. The Council's considerations have therefore emphasised the need to develop the evidence base around the impacts that the Business Pledge, and similar initiatives, can have on business performance.

The Council is encouraged by the Scottish Government's willingness to explore and implement ideas like the Scottish Business Pledge. The Council believes that these have the potential to encourage Scotland's businesses to adopt a range of positive behaviours that benefit both their workforces, and their competitiveness. However, to encourage greater uptake within Scotland's business community, the Council also believes that the Scottish Government should encourage businesses themselves to take the lead in building momentum behind the Business Pledge - making it part of a business-led agenda.