Scottish Government's Medium Term Financial Strategy: May 2019

Part I – Funding Context - 1. Economic Outlook

1. Economic Outlook

Overall, 2018 was a positive year for the Scottish economy, with growth relatively broad-based across the economy; the labour market delivering record levels of performance; and further growth in exports.

Alongside this, the most recent data on business research and development trends and inward investment underline the attractiveness of Scotland as a place to do business.

All of this has been achieved against a backdrop of intensifying uncertainty regarding the UK’s exit from the EU, as well as continuing structural challenges for particular firms and sectors of the economy.

Scotland’s economy grew 1.3 per cent in 2018, continuing a pattern of stronger growth compared to 2015 and 2016. Growth was similar to that of the UK (1.4 per cent). On a per-person basis, however, Scotland’s growth rate outpaced the UK by 0.9 per cent to 0.7 per cent, respectively.

Scotland’s labour market has continued to perform well in the first quarter of 2019, with unemployment falling to a record low of 3.2 per cent. Alongside this, the number of people in employment has risen by 23,000 over the past year and the employment rate (75.4 per cent) remains close to its record high of 75.8 per cent in 2017. 

The continuation of more robust output growth, alongside the strength in the labour market, is reflected in Scotland’s productivity performance. Scottish labour productivity grew by 3.8 per cent in 2018, its fastest pace since 2010. Looking at the longer-term picture, Scottish productivity has grown faster than the UK’s over the past decade. Since 2007, Scotland’s labour productivity has expanded by 10.8 per cent, compared to 2.7 per cent in the UK.

A number of drivers underpinned Scotland’s strengthening output growth in 2017 and 2018. Firstly, stronger global economic growth, combined with the depreciation of sterling, provided a boost to Scottish exports. Scottish exports of goods increased by six per cent in 2018, faster than the other UK nations and the UK as a whole which rose by three per cent. Secondly, the rise in the oil price since 2016 and restructuring in the North Sea industry have provided a boost to confidence and activity in the sector. 

Scotland remains a highly attractive location for Foreign Direct Investment (FDI). In 2017, there were 116 new foreign direct investment projects in Scotland, up from 108 in 2016. Scotland has maintained its position as the top UK region for FDI, outside London, for five of the past six years. Such investment is key to Scotland’s future economic performance, providing an important source of employment, much of which is highly skilled.

However, Scotland continues to face an uncertain outlook as a result of the UK’s planned exit from the EU. Whilst leaving the EU without a deal is the worst outcome, even an orderly exit will result in economic loss compared to remaining in the EU. In its report published alongside this Strategy, the Scottish Fiscal Commission (SFC) is clear that uncertainty related to leaving the EU – which, according to a range of surveys, is causing both business and consumer confidence to fall – will have a negative effect on the Scottish economy in the near term. More broadly, there are also some signs that the global economy may be slowing, with the IMF revising down their outlook for growth in 2019. 

Against the background of these challenging headwinds, Table 1 sets out the SFC’s headline economic forecast. The Commission forecasts that, over the next five years, Scotland’s employment will rise further, unemployment will remain at near record lows, and earnings will accelerate.

However, the impact of leaving the EU is clear from the short-term economic forecasts for Scotland, with growth forecast to fall from 1.3 per cent in 2018 to 0.8 per cent in 2019. The SFC relates this anticipated slowdown directly to the ongoing uncertainty created by the UK’s EU negotiation process. Indeed, it highlights that this uncertainty has prevented it from revising up its outlook for the Scottish economy. 

Table 1: Headline Economy Forecasts

	2018	2019	2020	2021	2022	2023	2024
GDP (per cent growth)	1.3	0.8	0.9	1.1	1.2	1.3	1.3
Employment (millions)	2.67	2.68	2.68	2.69	2.69	2.69	2.70
Unemployment (per cent)	3.9	3.8	4.0	4.0	4.0	4.0	4.0
Real Average Annual Earnings (per cent growth)	0.2	0.4	0.8	0.9	1.1	1.2	1.2

1.1 Achieving Inclusive Growth in Adverse Conditions

Global economic conditions are particularly challenging at present, with the world economy in a ‘delicate moment’, according to the IMF’s chief economist. Not only that, but the UK is poised to leave the EU at the end of October 2019 at the latest. 

The Scottish Government’s overarching economic ambitions were set out in Scotland’s Economic Strategy in 2015. The strategy focuses on the two mutually supportive goals of increasing competitiveness and tackling inequality, through sustainable inclusive growth, fostering innovation, increasing investment, and promoting internationalisation. 

Inclusive growth is growth that combines increased prosperity with greater equity; that creates opportunities for all; and that distributes the dividends of increased prosperity fairly. The Scottish approach to inclusive growth centres on both the pace and pattern of growth across the country, and across different groups within our society. Emphasis is placed on building a strong labour market to achieve inclusive growth through the creation of more good-quality jobs, and ensuring people can access these jobs.

To facilitate the delivery of inclusive growth across Scotland, Scotland’s Centre for Regional Inclusive Growth (SCRIG) was launched in July 2018. SCRIG will deepen the evidence base on what works in regional inclusive growth, and will promote best practice policy and decision making through Regional Economic Partnerships and other stakeholders. 

Economic Action Plan

The Economic Action Plan sets out the actions that will build a strong, vibrant and diverse economy to deliver sustainable, inclusive growth; improve wellbeing; and attract investment across Scotland. 

Key elements of the Economic Action Plan include:

• City Region and Growth Deals, which unlock investment in our regions, cities, towns and rural economy. Over £1 billion of investment has so far been committed over the next 10 to 20 years. The aim is to ensure that every part of Scotland benefits through 100 per cent coverage.
• Responding to the rapidly changing skills needs of business and employees, by enhancing the opportunities for upskilling and reskilling for those already in work. 
• Maintaining a stable and competitive tax regime, as part of a supportive business environment.
• Setting up the Scottish National Investment Bank, which has the potential to transform Scotland’s economy, providing capital for businesses at all stages in their investment lifecycle and important infrastructure projects to catalyse private sector investment. 
• The Scottish Growth Scheme, which has already supported over £106 million of investment in 82 companies. We are confident it will support £500 million of investment over the three years to June 2020.
• Establishing an Advanced Manufacturing Challenge Fund of up to £18 million to ensure all parts of Scotland benefit from developments in advanced manufacturing.
• Investing £48 million in a National Manufacturing Institute for Scotland (NMIS) in Renfrewshire, with Strathclyde as anchor university. 
• Developing ‘A Trading Nation’, backed by £20 million of investment, to help boost the value of our overseas exports.

Infrastructure Investment

Investment in infrastructure is vital to supporting and delivering a prosperous and successful Scotland. Evidence from a range of international organisations, including the International Monetary Fund, the World Bank and the European Union, demonstrates a strong positive relationship between infrastructure investment and long-term economic growth.

In the 2018 Programme for Government, the First Minister set out the Scottish Government’s commitment to a National Infrastructure Mission (NIM). The adoption of the NIM will provide economic stimulus and boost international competitiveness by raising Scottish infrastructure investment to internationally competitive levels.

The NIM commits the Scottish Government to increase annual infrastructure investment by one per cent of 2017 Scottish GDP by the end of the next parliament in 2025-26, compared to 2019-20. Annual infrastructure investment will therefore be £1.56 billion higher in 2025-26 than the £5.2 billion baseline in 2019-20.

As part of the NIM announcement, the First Minister asked Scottish Futures Trust to “examine new profit sharing schemes such as the Welsh Government’s Mutual Investment Model, to help secure both the investment we need and best value for the taxpayer.” Scottish Futures Trust (SFT) has now published a report on its recommendations.^[1] 

It recommends that the Scottish Government adopts a Scottish version of the Mutual Investment Model (MIM). It confirms that the model provides the best value-for-money option which conforms to current Eurostat rules on private sector classification, and that with an appropriate investment pipeline there should be sufficient market interest to invest. SFT notes that, “should greater borrowing powers be made available to the Scottish Government, this would provide a lower cost financing option to deliver additionality.” SFT’s report assumes that the current borrowing powers remain and examines new investment models over and above the current approaches that would require to be classified to the private sector to count as additional investment.

The Scottish Government has reviewed and agrees with SFT’s recommendations. The MIM will be used, alongside a range of other available infrastructure investment tools including capital grant, public borrowing and other forms of revenue finance, to deliver additional infrastructure investment as part of the NIM. These tools currently include using Design, Build, Finance and Maintain (DBFM) contracts through the Hub programme. Whilst these had received a private classification from ONS, Eurostat has concluded a further review and we are not now planning for this arrangement to be able to deliver additionality of investment in the future. Consequently, the time is right for a new approach. At this stage, the use of the MIM model will be reserved for central government assets where access to borrowing is more restricted. The intention would be to deploy other levers first, including the use of capital borrowing in line with our fiscal rules and principles.

During 2019-20, the Scottish Government will invest more than £5 billion in infrastructure projects across Scotland, including:

• Over £825 million in the Affordable Housing Supply Programme.
• Progressing our £320 million commitment to construct five new NHS elective care centres in Clydebank, Inverness, Aberdeen, Dundee and Livingston.
• £187 million in City Deals across Scotland.
• £175 million in Early Learning and Childcare facilities.
• Over £145 million funding available through Energy Efficient Scotland.
• £120 million into the precursors of the Scottish National Investment Bank.
• £80 million in active travel to build an Active Nation.
• £50 million for a Town Centre Fund.

The Scottish Government also has a number of significant future capital investment projects including:

• A £600 million programme to deliver 100 per cent coverage in Scotland of superfast broadband (R100 Programme).
• £121 million for Early Learning and Childcare facilities in 2020-21 as part of the Scottish Government’s commitment to invest £476 million between 2017-18 and 2020-21.
• A multi-stage commitment to dual the A9.
• A substantial rolling programme of rail electrification across Scotland, delivering economic, social and environmental benefits.
• Investing £2 billion over 10 years to capitalise the Scottish National Investment Bank.