Scottish Economic Prospects: Slow Recovery in Prospect

1. 26th November 2011 Scottish Economic Prospects: Slow recovery in prospect Tom Vosa Head of Market Economics-Europe, Wholesale Banking National Australia Bank, tom.vosa@eu.nabgroup.com

2. Structural Overview • Scotland accounts for around 8.4% of the UK’s population and employment but only around 7.7% of its output. Therefore productivity is lower than the UK average. • The industrial structure includes a smaller share of private services (including financial & business services) and a larger share of public services than does the UK as a whole. Private services have been the main driver of UK growth over recent years. • The employment rate in Scotland (79%) is marginally higher than the UK average (77%) and the unemployment rate is lower. The region also outperforms the UK average in terms of qualifications. • Demographic picture remains weak, as both relatively slow population growth and demographic ageing act to restrict growth of working age population and labour supply. • The house-price to earnings ratio is substantially below the national average, and Scottish households are, on the whole, less indebted than those in other parts of the UK. • Key Infrastructure developments: Progress on the 10 Year Transport Plan will add substantial ongoing support to Scottish construction activity. • City performance: Edinburgh has been the star performer in recent years, with strong growth also in Aberdeen. Glasgow and (particularly) Dundee have suffered relative declines.

3. Scotland has underperformed the UK average since 2006… UK and Scottish GVA • And followed the UK through its deepest post-war recession almost one for one. • Output fell by 0.4% in the second quarter, around the same rate as the UK. • The annual growth rate remains higher at -0.4% versus -0.5% for UK, but this might unwind as England should disproportionately benefit from any Olympic Games effect. • Scottish nominal output worth £124 billion in 2011. Source: Scottish Executive

4. Construction has been the severely hit Contributions to quarterly Scottish GDP growth • Service and construction sectors contributed to growth. • Production saw a severe fall, probably Jubilee related. Source: Scottish Executive

5. PMI data insist economy is underperforming UK (but growing) Regional PMIs

6. Compared to UK, Scotland has smaller financial and government sectors 2007 Output shares Source: Scottish Executive

7. Mixed picture on insolvencies Scottish Personal Insolvencies • We have seen a sharp fall in personal insolvencies over the first nine months of the year. • Overall trend has been downwards since peaking in 2009 as the recession hit. • Improvement reflects lower household indebtedness (due to cheaper house prices). • But corporate insolvencies are still showing an upwards trend. The fall in compulsory liquidations in the third quarter was partly offset by an increase in voluntary liquidations. Scottish Corporate Insolvencies Source: The Insolvency Service

8. Corporate position relatively weaker than UK Rate of corporate insolvencies • The housing bubble was much more focused in England and Wales so it is hardly surprising that the rate of company liquidations was much higher. • But as the rate falls in the UK, it is rising in Scotland. • And we have seen a relatively worse performance. • Scottish firms are more likely to fail, which could reflect relatively smaller size or more operation gearing. Source: The Insolvency Service

9. Corporate position relatively weaker than UK % of businesses only paying interest on loans • A survey by R3 showed that 9% of companies were only able to pay interest on their debt but not payback the debt itself. • These have been described as ‘zombie’ companies in the press. • While not in as bad a position as Northern Ireland or Greater London, it seems that Scottish firms are vulnerable to a rise in interest rates. • We should therefore expect more insolvencies as the economy recovers and rates rise. Source: The Financial Times

10. Export bounce petering out Scottish manufactured exports • The sharp fall in sterling at the end of 2008 did little to help exports. • This is not surprising as global demand was collapsing at the time and it takes at least six months for any boost from exchange rate movements to start to feed through. • Recovery through 2011 now looks to have run out of steam. Source: Scottish Executive

11. Export structure Scotland’s goods exports by value (2011) • Exports of goods from Scotland in 2011 were valued at £17 billion, accounting for 7% of UK goods exports. • In only two commodity groupings: food and live animals and beverages & tobacco is Scotland’s share of UK exports greater than its share of GDP. • This is massively so in the whisky-dominated beverages grouping. Source: HMRC

12. Over time, drink exports have gained significant share Composition of Scottish manufactured exports Source: Scottish Executive

13. Drink sector looks to have run into global headwinds Scottish manufactured exports • Drinks exports fell by 5.8% in the three months to June. • Sector has now been contracting for six months, but we hope that this is a blip and resumption of global growth in 2013 will provide a boost. • Food and tobacco exports yet to recover from the sharp fall seen in 2008-9 as the global crisis struck. • All other sectors are showing a contraction. Scottish manufactured exports Source: Scottish Executive

14. EU debt crisis has affected markets Top 20 markets for International Exports • USA comfortably remains the largest export market. • Trade with the Netherlands reflects Europort, so other markets are probably understated (although this is true for all trade statistics). • France and Germany remain third and fourth respectively. Very little change at the top, but we have seen Ireland and Spain become less important as austerity bites. Source: Scottish Executive

15. Important not to overstate manufacturing Total International Exports by Grouped Industry Sector Total manufacturing £14.8 billion Total services £7.1 billion Source: Scottish Executive

16. Labour market weakened much more quickly than UK Employment growth • But has now bounced back much more quickly. • We are seeing much more volatility in employment data. Source: Office for National Statistics

17. Job market has yet to recover from earlier losses Scottish employment • Public sector hiring has stopped, hence flatline in the total number of women in employment. • Males have found jobs, we are still below the peak seen in 2008. Source: Office for National Statistics

18. Labour market weaker than UK Unemployment rate • The ILO measure shows the Scottish unemployment rate at 8.1% in August, compared with 7.8% for the UK. • The unemployment rate peaked at 8.9% in June 2010 so we have seen some improvement. • The economic activity rate was broadly in line with the UK during most of this year. • But we saw a very sharp fall in August, which suggests that workers have been discouraged from entering the labour market. Economic activity rate Source: Office for National Statistics

19. Service sector growth now recovering Scottish employment growth • Service sector had seen large job losses as the Global Financial Crisis struck, but we have seen some increases recently. • Construction jobs increased in Q4, but then fell back again in H1 2011 in line with GDP data. Since then, we have seen some stabilisation with a small increase in hiring in Q2. • Manufacturing continues to shed labour (although at a slower pace). Source: Office for National Statistics

20. With large falls in some surprising areas Scottish service sector employment growth • While the annual changes in most sectors have been volatile, the underlying position is much more stable. • We are seeing net hiring in wholesale and retail trade, which suggests that retail spending is holding up. • Financial intermediation jobs are still falling. Real estate looks to be flat, but it is only the Information and Communication sectors that are showing strong growth. Scottish service sector employment growth Source: Office for National Statistics

21. Public sector employment is still falling Scottish public sector employment Source: Office for National Statistics

22. Bulk of workers are in local government Breakdown of devolved public sector employment in Scotland, Q2 2012 • 282,000 or 57.8% of public sector workers are in local government. • NHS is second largest employer. Source: Scottish Executive

23. Shakeout in financial sector has seen pay fall for managers and senior officials Median full-time annual gross pay Scotland • Pay fell slightly in 2011 from 2010, which we suspect signals some loss of financial sector jobs. • With inflation averaging 3%, real incomes would have fallen more sharply. Source: Scottish Executive

24. Housing market is proving less volatile… DCLG House price index • On the official measure, Scottish house prices rose by 0.9%yoy in September 2012. • That contrasts with a 1.7% annual rise in the UK. • But, the Scottish housing market has been much less volatile and houses have held onto their value much better. • But lags might now reflect lower income levels and lack of mortgage availability. Source: Department for Communities and Local Government

25. And this has left Scottish households with lower debt burdens Household debt-income ratios • And followed the UK through its deepest post-war recession almost one for one. • Output fell by 0.3% in the fourth quarter against a 0.5% fall in UK, but the level of growth is still lower given earlier underperformance. % 300 250 200 150 100 50 0 Wales Scotland North East South East North West South West East Midlands West Midlands Greater London Northern Ireland Eastern England Yorkshire & the Humber Source: Experian

26. Retail sales weaker in H1 Retail sales volumes at basic prices • Retail sales volumes have held up a little worse in Scotland than in the UK. • Volumes rose by 0.5% in the March quarter versus 0.8% for UK and fell by 0.3% in Q2 versus a UK rise of 0.1%. • The latest BRC survey suggests that this underperformance has continued into the third quarter and remains one explanation why we expect Scottish GDP growth to be weaker this year. Source: Scottish Executive

27. Housing completions fell to record lows in 2011 Scottish housing completions • Private sector completions fell form 11,210 to 9,890 in 2011 the lowest rate since 1970. • With Registered Social Landlords and Local Authorities also cutting back, total completions fell from 16,920 to 15,150 a record low. Source: Department for Communities and Local Government

28. Lack of mortgage availability is sending households to private renting Scottish housing stock by tenure • Owner occupied housing peaked at 1,612,000 in 2009. • The number of homes occupied by owners had fallen to 1,595,000 by 2011. • The offset has been an increase in private sector renting which rose by 42,000 over the same time period. • A small fall in the number of houses rented from local authorities was offset by a rise in those rented from Registered Social Landlords so no change in the public sector. Source: Department for Communities and Local Government

29. Housing could become a significant problem Scottish population • The Scottish population increased from 1951 to 1974, before experiencing a steep decline. • Population fell by 164,000 to 5,077,000 in 1988, before reaching a trough at 5,055,000 in 2002. • But it looks as if population growth has now switched, helped by EU Accession 8 migrants from 2006 onwards. • Population is running ahead of 2006 projections, • Good news is that increased labour force should boost trend growth. Scottish population Source: Office for National Statistics

30. Conclusions

31. Conclusion • Scotland’s performance during the deepest recession in post-war history has been disappointing. • It is normally a low-beta economy which grows by less than the UK average (2% vs 2.75%) but with a much smaller variance in growth. • We would normally have expected it to outperform. • We suspect that the similar performance reflects the specific nature of the supply shock experienced overall. Also could reflect headquarters effects from Scottish banks. Further, public sector spending peaked earlier and so was on a downwards path much earlier. • Survey data suggest that the economy will struggle during the second half of this year and we would expect Scotland to receive much less benefit from any Olympics effect. • So growth set to be below the 0.2% contraction we expect for the UK as a whole. Growth in 2013 also expected to be lower (1.0% vs 1.3% for UK). Upside risks come from net trade. • Corporate sector looks to be relatively weaker and more vulnerable to rate increases, although personal sector is not. • Export growth has been over-dependent on the drinks sector, when this stumbled exports fell as a whole. More diversification is required. • There has been a switch away from the periphery towards Scandinavia but it is easy to do for specific sectors (oil industry) in particular and regions (Aberdeen) than for the economy as a whole so any trade switch will be piecemeal. • Service sector exports have grown much more quickly than manufactured goods. Education sector looks to be scalable and schemes to boost service sector could help boost employment growth. • The house-price to earnings ratio is substantially below the national average, and Scottish households are, on the whole, less indebted than those in other parts of the UK. • In longer-term, population growth should boost the labour supply and thus trend growth. However, this will also provide challenges in terms of housing, especially given the difficulty that potential homebuyers currently face

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