Council of Economic Advisers minutes: December 2018

The Chief Economist gave an update on key developments in the Scottish and UK economies in recent months, as well as an outlook for the Scottish economy: 

Part 1: Recent Economic Performance

• The Scottish economy has continued to strengthen in the first half of 2018. In Q2 2018, Scotland’s annual GDP growth was the strongest it’s been since 2014, and was also higher than the UK rate.
• Stronger growth has been underpinned by:
  •    Stronger confidence and activity in the oil and gas sector and its supply chain supported    by the higher oil price.
  •    Stronger global growth and lower Sterling supporting export growth.
• The Sterling exchange rate has fallen against the dollar and euro. Scotland’s international exports saw a downturn before picking up in 2016.
• Scotland’s labour market continues to perform strongly with unemployment falling to its lowest rate on record  and labour market tightness is reflected in slightly stronger nominal wage growth,.
• Stronger GDP growth is also reflected in a return to positive productivity growth in Q2 2018, with Scottish GDP growth forecasts for 2019 ranging from 1.0% to 1.5% and are broadly in line with UK rates. 

Part 2: Brexit and Economic Outlook

• In terms of forecasting Brexit impacts, it was noted that the nature and duration of a shock is difficult to calibrate due to uncertainty. Without an agreement or transition period economic dislocation is significant. In addition, sectoral and geographical impacts will differ. Three main Brexit scenarios have been modelled, as outlined in ‘Scotland’s Place in Europe’ publications.
• Brexit uncertainty continues to influence consumer and business confidence and investment planning. Investment activity is increasing, partly to secure supply chains.
• There is the potential for data volatility if businesses stockpile ahead of Brexit, however the longer term impacts of stockpiling on growth are negative. The short term impacts of stockpiling would result in a boost in 2019 Q1 before a decline in growth as companies wind down inventories.
• Household sentiment is positive concerning household’s own incomes – linking to strong labour market performance – but negative concerning the Scottish economy.
• The government response will remain focused on structural transition issues to ease constraints, but also looking to manage aggregate impacts. The government will continue to monitor the situation including looking at real time data for financial markets, sentiment and other measures to monitor supply and demand growth as well as identifying and monitoring communities and companies that will be acutely affected by Brexit.

The following points were noted during the discussion on this topic:

• Members recognised the extreme uncertainty in the current situation and therefore the constraints to modelling impact.
• Members noted the difficultly of modelling certain elements of Brexit including the changes to the cost of borrowing and the effects of political uncertainty.
• Members noted the potential decline of labour supply to companies, owing to a decline in EU citizens in the labour market. This would have varied impact across sectors.
• Members noted that a decline in demand - dependant on the final transition agreement - has the potential to last past the one year mark. The economic shock of leaving the EU differs significantly from the 2008 economic crisis in that it is expected and therefore a level of preparedness is possible. 
• Members noted that Brexit preparedness is constrained across SME’s, partly due to their level of leverage in the market. However, there are positive signs of household resilience as many SME owners pay themselves a low wage but are wealthier [than those not self-employed].
• Members were keen that the Scottish Government remain flexible in response to Brexit, and ensure that the increases in entrepreneurship and business start-ups that have been seen in previous crises can be achieved in the context of Brexit.

Update on Brexit current issues

The First Minister provided a brief update regarding Brexit. The Standing Council of Europe had met on Monday 17th December and so Anton Muscatelli, Chair of the Standing Council, provided a brief update on the discussions. 

The First Minister noted the upcoming potential situations including a no-deal exit, the deal being passed in the House of Commons or a second referendum. While it is not an easy solution, and many uncertainties remain in place, the Scottish Government’s preferred option remains a second referendum. In the absence of a second referendum, the Scottish Government believes that a Norway style deal is the least damaging deal that could be reached. However, the Scottish Government is heavily engaged in preparation for no-deal as this appears to be the default option – if no majority support can be found for any option, this option was most likely to materialise even in the absence of strong political support. This was frustrated for a number of reasons. For example, it has meant that resources needed to be dedicated to contingency planning for scenarios that may not happen rather than dedicated toward sectors of the economy that need support. The First Minister set out that supporting the supply of skilled workers into Scotland will remain a top priority in any of these scenarios. 

Anton Muscatelli noted that the scope for negotiation with Europe has become tighter. This may have implications for the preferred options being pursued by different actors. Where one option may have appeared to be preferable in the context of initial Brexit planning, the prospect of revisiting plans and prolonging uncertainty may now make these options less appealing. Referring to the First Minister’s concerns regarding the supply of labour to the Scottish economy, Anton Muscatelli reiterated that free movement of labour benefits Scotland and its removal will negatively affect the Scottish economy. 

Members queried the practicalities of an extension to article 50, with the First Minister commenting that unless the UK Government could commit to substantially changing its approach to Brexit, this could be difficult for the EU to accept. However, she thought that ultimately it would be agreed. Members also raised the issue of how to identify where resources should be directed to support business – ensuring that smaller businesses were not ignored in this process. 

Update on Public Finances and Fiscal Matters

The Cabinet Secretary for Finance, Economy and Fair Work provided an overview of developments in Scotland’s public finances, with particular reference to the Scottish Budget for 2019-2020. 

The Cabinet Secretary highlighted that on 12 December, the Scottish Fiscal Commission published its latest set of independent forecasts for Scotland; GDP growth forecast have been revised up in every year. The Cabinet Secretary noted the risk that Brexit may slow Scotland’s growth in future years. 

The Cabinet Secretary provided an overview of the main announcements in the Scottish Budget 2019-2020. There was a substantial uplift to funding for health delivered in the Budget, but all other portfolios see a real time reduction. Therefore the Scottish Government will use tax powers, resulting in a divergence from UK income tax rates, to support public services. In addition, this budget was designed to provide support, stability and certainty for business. 

Economic policies taken forward include continued investment in City and Region Deals; stability for public services including the NHS, but also promoting transformation, including across mental health services, and tackling the attainment gap. Local government has seen an uplift in capital and the overall budget and there was funding announced to support town centre regeneration. Across business taxation there is lower poundage in property taxes plus a business rates incentive scheme to encourage investment. 

The Cabinet Secretary asked the Council to undertake further analysis into the behavioural impacts of different rates of income tax, expanding upon the work that the Council have done regarding additional rate payers, to cover the whole tax base.. 

The following points arose during the discussion on this topic:

• Members were interested in the Scottish Government demonstrating the benefits of measuring wellbeing. Predictive analytics could be investigated for use at the government level.
• Members and Ministers recognised that there are benefits to living in Scotland that offset tax differences with the rest of the United Kingdom; and recommended further consideration of these should be articulated or demonstrated.
• Members also noted that international evidence regarding behavioural responses to income tax changes could be investigated, included between states in a federal system.
• Members agrees to continue the work investigating the behavioural responses to differential tax rates.

Workstream Review – Part 1 

The Chief Economist provided an update to Council members on the inclusive growth workstream, most recently the establishment of Scotland’s Centre for Regional Inclusive Growth, and the Wellbeing Economy Governments network. 

Building on the Council’s advice on Inclusive Growth, the principles learned in the North Ayrshire Inclusive Growth pilot were now being applied in other policy settings such as city deals and the South of Scotland agency. In order to ensure these lessons are widely shared and learned, Scotland’s Centre for Regional Inclusive Growth (SCRIG) was launched on 30 July and is a collaboration between government, industry and academia, offering a platform for practitioners, policy-makers and academic advisers to design, develop and support the delivery of inclusive growth within Scotland.  

The group of Wellbeing Economy Governments (WEGo) is an initiative led by the Scottish Government to deepen understanding of, and better embed in practice, the concept of economic wellbeing. The group consists of the Governments of Scotland, Iceland and New Zealand – with potential future involvement from the Governments of Finland and Canada. The Council have been updated on WEGo throughout the year, with Sara Carter and Harry Burns contributing to discussions. The group held its first public meeting on 28th November at the OECD International Forum in South Korea with participation from Joseph Stiglitz. Policy Lab discussions will begin in early 2019 with a view to hosting a meeting in Scotland in early summer 2019 to share progress and identify future areas of collaboration. 

The following points arose during the discussion on this topic:

• Members were content with the progress of both initiatives, and especially how well the Wellbeing Economy Governments has been received internationally.
• Members discussed that one of the key innovative aspects from Scotland is the framing of inclusive growth: not about redistribution, but about investment. The business pledge is an example of this, and looking at the production side of the economy. It was recommended that this kind of initiative is maintained and supported as part of a ‘just transition’ approach to a sustainable economic future. 
• Members supported the refreshed National Performance Framework as having inclusive growth and wellbeing at its core, and recommended that drawing together more data would make the narrative aligning wellbeing and inclusive growth more robust.

Workstream Review – Part 2 

The Chief Economist updated Council members on the progress in developing the Scottish National Investment Bank. The Scottish Government has committed to introduce legislation early in 2019 to support establishment of the Scottish National Investment Bank in 2020. The Bill is currently being prepared. A consultation focussing on the Bank’s objectives, purpose and governance, as well as its relationship with Ministers and stakeholders, closed on 31 October and responses were published on Citizen Space on 28 November. The responses will help shape the Bank’s Articles of Association and the draft Bill and accompanying documents 

The following points arose during the discussion on this topic:

• Members noted that the next stage is to get a more granular level of framework, and prepare for being active in choosing missions. To do so, the Scottish Government should draw on the expertise across the organisation regarding potential missions and investigating the impacts of selecting them.
• Members also queried and discussed capacity building in the context of the Bank – highlighting the need to ensure that proper expertise was included in the design and operationalisation of the Bank, but also that the Government built up capacity for innovation and the sort of specialist skills that being involved in the Bank would offer.
• Members also discussed the importance of clarity in respect to the role of the bank in relation to other government bodies, the importance of the bank providing guarantees to companies and the importance of having a significant initial level of investment, as well as the potential to raise money from bonds.

Future Look – Role of Council

The Chief Economist presented to the Council a short summary of progress across each workstream in the past year, against the 4 priority areas of Scotland’s Economic Strategy: investment, internationalisation, inclusive growth and innovation. The current model of the Council’s work is three workstreams. A new approach was presented to the Council which was to select three work themes and take forward individual projects under these themes. This would allow the Council to remain flexible to the changing economic conditions that are expected across 2019-2020. 

Therefore the potential themes going forward, and work contains therein are:

• Competitiveness: including the behavioural analysis of income tax disparities.
• Economic Resilience and Wellbeing: continued insight into wellbeing and the economy.
• Uncertainty and Responsiveness: including export analysis.

Council members were happy to move forward on this basis, with the view to being presented with a more detailed work theme proposal in 2019.

Summing Up / Any Other Business