State of the Economy: June 2019

Overview

The Scottish economy has continued its recent pattern of strong performance at the start of 2019 with the unemployment rate falling to record lows and strong growth in exports and output.

In both Scotland and the UK as a whole, output growth increased in the first quarter to 0.5%, driven by a notable up-tick in the manufacturing sector. However, growth was driven in part by temporary factors such as stockpiling and firms completing orders in anticipation of the original end March Brexit deadline. UK business survey evidence suggest some manufacturing firms have subsequently reversed these activities and are unwinding stocks following the extension to the Withdrawal Agreement. This is consistent with recent weaker UK manufacturing data and we would expect similar impacts in Scotland over the coming months.

Brexit uncertainty has impacted business investment with companies pausing key investment programmes and instead focussing on immediate Brexit-related spend - including stockpiling, warehousing, logistics, supply chains and alternative trade options. As a result, business investment has fallen in Scotland (and the UK) for a number of quarters, and since the EU referendum investment has lagged well behind the growth observed in other G7 countries. Similarly, the number of foreign direct investment projects into the UK and Scotland in 2018 was also down, reflecting Brexit-related uncertainty. These trends pose a significant risk for future output growth and productivity if they persist.

Whilst investment has remained subdued, Scotland’s labour market has seen record high levels of employment and historically low levels of unemployment. This Brexit paradox has been driven by two factors. Firstly, at a time when companies need to respond quickly to changing events, some are increasing staff numbers rather than boosting capital investment, to maximise flexibility. Secondly, labour supply remains tight given demographics and the impact of Brexit on EU labour. Both however are combining to drive real wage growth in Scotland (and the UK), supporting consumer demand and household sentiment.

In this context, growth of 1.4 per cent observed over the past year is strong with many encouraging trends within the economy, particularly international export sales, and many sectors (digital, business services, energy, tourism, food and drink) performing more strongly. This underlying resilience is important as the economy is under a period of change with sectors transitioning both in relation to Brexit and wider technological and cultural factors which are impacting business models.

Finally, the short term outlook for the economy continues to be dominated by Brexit uncertainty and the form any exit takes. This is reflected in the modest growth estimates for an orderly transition to the negative impacts of a No Deal exit. Until the fog of Brexit is lifted, growth in the Scottish (and UK) economies will remain subdued and potentially more exposed to any downturns in international demand and growth.