Scottish economic insights: November 2023

Overview

Scottish Economic Insights is a new biannual report which provides more in depth economic analysis and insight on the key themes presented in the monthly Scottish Economic Bulletin and highlights some of the technical economic analysis being undertaken within Scottish Government. This edition of the report provides further analysis on three key themes: inflationary pressures, the weakness in economic growth, and labour market resilience. It also showcases two pieces of technical analysis on deflators and Gross National Income.

The economy has faced a succession of significant shocks in recent years from EU exit, the pandemic and most recently the inflation shock arising from the war in Ukraine. Collectively, they have led to a range of economic risks which have evolved over the past year as the economy has continued to recover, adjust and adapt to these persistent challenging conditions and elevated uncertainty.

The sharp rise in inflation in 2022, largely due to the war in Ukraine and its impact on energy and wider commodity prices, has eased over 2023. While inflationary pressures have been widespread across goods and services, the significance of energy and food within the budgets of both households and businesses has been a particularly challenging aspect of this cost crisis.

While inflation is now on a downward trend, it remains notably higher than in recent years and businesses and households are continuing to adjust to such a permanent upward shift in price levels, alongside the rapid shift to a higher interest rate environment. Furthermore, the latest forecasts indicate that the ongoing reduction in inflation will be more gradual and will remain above the 2% target until the second half of 2025. This edition considers the latest drivers of inflation within the Consumer Prices Index basket and also the Scottish GDP deflator which provides insights on labour costs and gross operating surplus, which includes company profits.

During this inflationary shock, economic growth has remained subdued and broadly flat since the start of 2022 as cost pressures and weak demand have slowed. While economic output has largely recovered to its pre-pandemic level at the Scotland level, parts of the economy, particularly in production, are significantly below, emphasising how the succession of shocks continue to impact differently across sectors.

Looking ahead, independent growth forecasts remain subdued for 2024, with downside risks arising from weak global growth and ongoing cost pressures and uncertainty expected to continue to dampen consumer spending and business investment. However, the economy has remained resilient, in the face of these challenges and there is strong possibility that growth will surprise on the upside given both the opportunities for external investment in Scotland and also the performance of key export sectors.

Alongside the analysis of GDP, this edition also presents the latest Gross National Income Data for Scotland up to 2021, which provides insights into the flows of income from and to Scotland and provides an estimate of Scotland's domestic economic wealth.

The labour market has remained resilient during 2023 with low unemployment and indications that businesses are continuing to add to their headcount going into the final quarter of the year. The underlying tightness in the labour market has eased slightly as the pace of recruitment activity has slowed during the year. However, nominal earnings growth has remained robust and, coupled with the fall in the inflation rate, this has seen a return to real earnings growth. The report looks at the latest earnings data split by public and private sector, which indicate a narrowing in growth rates and a narrowing in the gender pay gap.

Finally, while the return to positive real earnings growth is good news for household incomes, the ongoing weakness in consumer sentiment and lower demand for labour mean that consumption is unlikely to drive growth in the near term. With inflation expected to remain above target for longer, economic growth is likely to be driven by external demand in Scotland, and will be a gradual process.