Europe 2020: Scotland's National Reform Programme 2019

Chapter 2: Sustainable Economic Growth

Scotland's Economic Performance

The overall purpose of Europe 2020 is to deliver, smart, sustainable and inclusive growth. The Scottish economy continued to grow in 2018, despite uncertainty regarding the UK's withdrawal from the EU remaining a key risk to the outlook.

Scotland's economy grew 1.3% in Q3 2018, down slightly from the previous quarter, however continuing the pattern of stronger growth experienced over 2017-18. Growth over the year was broad based across the Services, Production and Construction sectors.

Scotland's labour market also continued to perform strongly in 2018. The latest data for September to November 2018 shows that unemployment fell to its lowest rate on record (3.6%), with the number of people unemployed below 100,000 for the first time, while the employment rate remained high, rising to 75.3%.

The continued positive economic performance over the past year has been underpinned by stronger global growth, alongside the lower value of the British Pound. The increase in confidence and activity in the oil and gas sector and its supply chain has also been supportive.

Independent forecasts reflect the stronger performance in Scotland's economy over the past 18 months. However, the pace of growth is expected to remain below its long run trend rate. GDP is forecast to grow by between 1.3% and 1.6% in 2018, with potentially slightly lower growth in 2019 between 1.0% and 1.5%. All forecasts assume some form of smooth and orderly transition regarding Brexit.

Uncertainty surrounding Brexit is raised as a key factor affecting the economic outlook across all the forecasts alongside weak productivity, growth and slow population growth representing long-term challenges.

Over the short-term, some business surveys signal that business optimism has weakened over the past year, reflected in fragile business investment intentions and increased stockpiling. Alongside this, pressure on household finances and ongoing weaknesses in Scottish consumer sentiment also feature as risks to growth over the coming year.

A regular assessment of conditions in the Scottish economy is provided in the Scottish Government's Chief Economist's State of the Economy publication.

Scotland's Economic Strategy

The top priority of the Scottish Government is to support Scotland's economic resilience and to protect jobs, investment, long-term prosperity and growth prospects across Scotland. Scotland's Economic Strategy sets out a vision to create a more cohesive and resilient economy that improves the opportunities, life chances and wellbeing of every citizen in Scotland. At the core of the Strategy is the Government's Purpose, as outlined previously, which is underpinned by two key pillars - increasing competitiveness and tackling inequality.

This is illustrated in Scotland's economic framework as presented in Figure 1.

Figure 1: Scotland's Economic Framework

Within Scotland's Economic Strategy there are four priority areas which the Scottish Government continues to take action across to grow Scotland's economy, and ensure it remains resilient. The four priority areas are:

• Investing in our people, our infrastructure and our assets in a sustainable way;
• Fostering a culture of innovation and research and development;
• Promoting inclusive growth and creating opportunity through a fair and inclusive jobs market and regional cohesion;
• Promoting Scotland on the international stage to boost our trade and investment, influence and networks.

Economic Action Plan

The Economic Action Plan, launched in October 2018, sets out the actions the Scottish Government is taking to achieve the vision set out in Scotland's Economic Strategy. This includes key interventions to increase sustainable and inclusive economic growth across Scotland. The Plan also responds to many of the recommendations made in Scotland's business-led Enterprise and Skills Board's first Strategic Plan as well as reflecting key themes from our National Council of Rural Advisors. The Plan also reflects ongoing engagement with business and will enhance Scotland's economic support to business, places and people across Scotland.

The Economic Action Plan also sets out some key new measures:

• Establishing a £18 million Advanced Manufacturing Challenge Fund to ensure all parts of Scotland benefit from developments in advanced manufacturing.
• Responding to the rapidly changing skills needs of business and employees, by enhancing the opportunities for upskilling and reskilling for those already in work.
• Working with business to pilot two 'Productivity Clubs' to support businesses to help each other to improve managerial capability and diffusion of technology and innovation
• Expanding the role of the Can Do Business Innovation Forum to take action on the economic opportunities and challenges of new technologies.

Scotland's National Performance Framework

Progress towards the ambitions set out in Scotland's Economic Strategy is measured through the new National Performance Framework (NPF). The NPF sets out a collective purpose for Scotland, a values statement and 11 interconnected National Outcomes for creating a more successful country through increased wellbeing, and sustainable and inclusive economic growth. It includes 81 national indicators which underpin the outcomes and track progress in achieving these outcomes over time. The Framework's Outcomes are aligned with the UN's Sustainable Development Goals, and meaningful action under the NPF will allow Scotland to play its part in achieving these Global Goals by 2030. The National Outcomes include:

• Having a globally competitive, entrepreneurial, inclusive, and sustainable economy;
• That we are open, connected and make a positive contribution internationally;
• That we have thriving and innovative businesses, with quality jobs and fair work for everyone.

Figure 2: National Performance Framework

CSR 1: Fiscal Outlook

This recommendation calls on the UK to take action to strengthen the ongoing recovery and to ensure the sustainability of the UK public finances. While macroeconomic and monetary policy, and the overall public expenditure control framework, are matters reserved to the UK Government, the Scottish Government will continue to manage Scotland's finances in a competent, responsible and balanced way.

The Scottish Government has implemented a number of new fiscal powers in recent years, on which further details can be found in our May 2018 publication, "Scotland's Fiscal Outlook: the Scottish Government's five-year financial strategy".

This document explains the fiscal framework and funding arrangements that the Scottish Government now operates within; outlines our approach to financial management and fiscal rules; sets out a range of possible funding scenarios for the Scottish Budget over the next five years; and details our key policy priorities and approach to supporting Scotland's economy.

The Fiscal Framework gives the Scottish Government access to a number of levers that can support budgetary stability and management of the volatility associated with greater revenue-raising powers, including additional borrowing powers and permission to operate a (limited) Scotland Reserve. Further details on the use of these powers are set out in our five‑year financial strategy and in our Fiscal Framework Outturn Report.

In addition, we are committed to the sustainable use of revenue financed investment methods to ensure we do not overly constrain our choices in future years. Prior to the Scottish Budget in December 2018, the Scottish Government had a self-imposed revenue finance investment limit of 5% of the total Scottish Government budget. To ensure our National Infrastructure Mission will be delivered in a fiscally prudent way, and continues at a sustainable level, we are tightening this limit to 5% of the Scottish Government resource budget, excluding social security.

On 4 September 2018, the First Minister announced in her Programme for Government speech, the adoption of a National Infrastructure Mission. This commitment will increase annual investment by 1% of current GDP by the end of the next Parliament. This will mean that annual investment in our hospitals, schools, houses, transport, low carbon technology and digital connections, will be around £1.56 billion higher by 2025-26 than 2019-20. The Scottish Government has set the 2019-20 baseline of £5,195.8 million which will steadily increase so that it reaches £6,750.8 million of infrastructure investment in 2025-26.

The Scottish Government will achieve its national mission through a balance of approaches including capital borrowing, revenue finance, guarantees and growth accelerator. The Scottish Futures Trust has been asked to examine new profit sharing finance schemes, such as the Welsh Government's Mutual Investment Model, to help secure both investment and best value for the taxpayer.

A new Infrastructure Commission, chaired by Ian Russell, has been established to provide long-term strategic advice to the Scottish Government on national infrastructure priorities, based on evidence and learning from good practice and to align investment with long term inclusive economic growth and low carbon objectives. It will advise on the National Infrastructure Mission by identifying key strategic investments in Scotland to be made to boost economic growth and support public service.

As set out in the budget plans for 2019‑20, the Scottish Government will support infrastructure investment of £5 billion in 2019-20 through a combination of capital grant, borrowing powers, Financial Transactions revenue financed methods, including hub, growth accelerator, and Tax Incremental Financing.

Why EU Funding Matters

Funding from the EU supports the implementation of the Scottish Government's economic policy in a number of important areas. EU funding benefits Scotland significantly, supporting jobs, delivering infrastructure, sustaining rural communities, providing valuable support for the farming and fishing industries and delivering research funding for universities.

EU funding is expected to benefit Scotland by around £5 billion over the current EU budget round (2014-20) across the European Social Fund (ESF), European Regional Development Fund (ERDF), European Maritime and Fisheries Fund, and European Agricultural Fund for Rural Development.

The ESF and ERDF, in particular, play an important part in helping to grow Scotland's economy in support of sustainable economic growth and the five Europe 2020 targets.

European Social Fund and European Regional Development Fund in Scotland

• The current programmes are worth over €870 million (£828 million) which, together with match funding, delivers projects worth up to £1.8 billion.
• To date £490 million of funding is now approved under the 2014-20 ESF/ERDF programmes, continuing to deliver the goals of the Operational Programmes, including the Europe 2020 targets.
• The benefits are not only monetary; the funds promote innovative solutions and partnership working across sectors and Member States for the benefit of those in our communities who need it most.
• Projects supported by ERDF deliver investments in infrastructure, innovation and R&D, support for businesses and the environment.
• ESF supports investments in skills and social inclusion, aimed at accessing employment or up-skilling workers through training. This allows the programme to support the most deprived individuals and communities as well as developing skills for the future.
• EU membership has brought significant investment into Scotland, including investments in infrastructure, business and training. During the 2007-13 programmes, this totaled €740 million, which supported 96,000 people into work and helped create almost 50,000 jobs.

The 2014-20 programmes are targeted to support the Scottish Government's priorities as outlined in the Economic Strategy, Economic Action Plan and National Performance Framework and deliver across all five areas of Europe 2020 framework.

European Social Fund

The ESF programme targets the Employment, Education and Poverty and social exclusion targets under the Europe 2020 framework and the country specific recommendation of "Addressing skills mismatches and providing for skills progression". To date, over £196 million of ESF grant has been awarded to projects across the programme.

The programme invests in skills through the Developing Scotland's Workforce projects delivered by Scottish Funding Council, working with further education colleges, and Skills Development Scotland. This has seen the introduction of the Foundation and Graduate Apprenticeship programmes, which enable participants to gain on-the-job training, skills and qualifications, and an increased number of Modern Apprenticeship and further education college places, with a total of 30,000 individuals benefitting from the activity so far and plans being developed to continue and expand this over the remainder of the programme.

The approved projects under the employability priority have already supported over 30,000 individuals towards a target of almost 90,000 people to gain skills and improve their chances in the labour market. This targets individuals with multiple barriers limiting their opportunities, including many of those furthest from the labour market, often with long periods away from work. Alongside this, the Youth Employment Initiative aimed to support 18,000 young people by the end of 2018 in the south west Scotland NUTS region to progress towards education, training and work.

The combating poverty and promoting social inclusion priority aims to deliver against the shared Europe 2020 and Scottish Government goal of reducing poverty. So far, the approved projects under the priority are expected to fund projects to support 17,000 disadvantaged people, invest in close to 200 communities across Scotland and to support more than 100 social enterprises.

European Regional Development Fund

The ERDF programme targets the Employment, Research and development, and Climate change and energy targets under the Europe 2020 framework and the country specific recommendation of "raising GDP". To date, over £293 million of ERDF grant has been awarded to projects across the programme.

The SME growth priority has awarded over £100 million of grant to support business growth. This is predominantly delivered through two strands: improving access to finance through financial instruments, and increased specialist support delivered through Scotland's enterprise agencies and the Business Gateway network across the country. Altogether, this is expected to support 15,000 businesses, including close to 2,000 new enterprises.

Innovation and the transition to a low carbon economy are supported by two of the programme priorities, which will invest a further £100 million to support hundreds of firms introduce new products, hundreds more develop and implement new low carbon technologies, and enable low carbon transport through new travel hubs and cycle paths.

Alongside this, the programme will also support the roll out of broadband in Scotland's most rural areas, invest in urban green space and promote the highlands and island's natural and cultural heritage.

Brexit: What's at stake for Scotland's Economy?

At the time of publication significant uncertainties remain as to the form and timing of Brexit. As such, there is potential for widely different outcomes, including the potentially catastrophic economic impact of the UK leaving the EU without a transition agreement toward a future relationship.

Brexit threatens Scotland's access to the single market and international markets negotiated by the EU. The European Single Market is one of the world's biggest marketplaces, which gives Scotland access to over 500 million consumers.

The UK's departure from the EU means we may not share in the economic gains from future developments in the trade in services and completion of the digital single market. As the European Single Market continues to deepen new opportunities for high-value trade will emerge - particularly in the services sector, the energy sector, and the digital economy. These are sectors of key strategic importance to Scotland's future prosperity, the loss of such opportunities threatens our ability to deliver sustainable economic growth.

The Scottish Government's analysis Scotland's Place in Europe: People, Jobs and Investment, published in January 2018 demonstrates the benefits of the Single Market to Scotland and sets out the adverse economic consequences of a hard Brexit.

The Scottish Government believes the best option for Scotland is to continue being a member of the EU reflecting the wishes of the people of Scotland who in the 2016 referendum voted overwhelmingly to remain

The economic case for a closer relationship with the EU is backed by an overwhelming body of evidence, including Scottish Government economic modelling^[3]. Should the UK pursue a WTO-style relationship, Scotland's GDP would be around 8.5%, or £12.7 billion (in 2016 cash terms), lower by 2030, compared to continued full EU membership. This is equivalent to a loss of around £2,300 per year for each person in Scotland. A Free Trade Agreement relationship would mean Scotland's GDP would be 6.1% (£9 billion in 2016 cash terms) lower by 2030.

Should the UK remain in the Single Market by participating in the EEA this impact could be significantly mitigated, with Scottish GDP estimated to be around 2.7% (or £4 billion in 2016 cash terms) lower.

In a more recent report for the Scottish Government by Ernst and Young (January 2019) Scottish businesses identified six key risks to Scotland's Economy as a consequence of Brexit:

1. Tariffs and non-tariff barriers that will disrupt the frictionless and tariff-free movement of goods between Scotland and the EU.

2. Sourcing and supply resilience - trade frictions, corresponding disruptions to supply chains, and potential changes in the value of Sterling will impact Scottish companies and their supply chains.

3. Legal and regulatory compliance - leaving the EU will result in the UK leaving a number of regulatory regimes which otherwise help trade to flow.

4. Workforce - the end of free movement will exacerbate the challenges Scotland already faces to attract and retain talent in the context of an ageing population. A weaker British Pound may create disincentives for workers to come to the UK and Scotland.

5. EU funding and finance - Scotland will no longer benefit from EU funding beyond 2020.

6. Foreign Direct Investment (FDI) - Brexit may also reduce the attractiveness of Scotland as a destination for FDI; however, a weaker Sterling may increase Scotland's attractiveness for FDI.