Economic and Political Challenges for Scotland’s Top Businesses

Professor David Bell

University of Stirling

• Depressed demand in some major markets

– European stagnation

– Asian slowdown

– Robust US growth

• But … – Lower oil prices!

Europe weak – UK/USA relatively robust in 2014

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But does GDP capture how well people feel about their circumstances?

90

92

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104

GDP

GDP Per Head

NNI Per Head

“RNNDI might be expected to have a close correlation with economic well-being.” (ONS, 2014)

Weak economy – investment stagnates - currency sinks …

Last six months

The pound has also weakened – poor trade performance

Last six months

• Countries with weak growth likely to have poor investment prospects

• Investors may shift in government debt to earn a stable return• Countries with fast growth have better investment returns.

Governments have to compete with industry for investment funds.

• Countries with high debt and concerns about default are unlikely to have high demand for their debt. Their debt loses value because investors don’t want to hold

• Yields increase.

Sovereign Bond Yields – Cost of Government Borrowing

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

Switzerland

Germany

France

Spain

Hong Kong

United States

Portugal

Australia

New Zealand

India

Sovereign Bond Yields as of 6/1/2015

The Oil Issue

• Lower prices good for:– Countries/regions that import oil

– Companies that use hydrocarbons for energy/manufacturing

• Lower prices bad for:– Oil exporting countries/regions

– Oil industry

• Oil price is highly volatile – difficult to hedge in the long-term

Oil price crash

Referendum

The Oil Shock – Demand Weakens, Supply Grows

The UK Perspective

• Strong growth performance in 2014, but slower growth from 2015 onward

• Price inflation undershooting its target– No scope for conventional monetary policy to increase prices– Unlikely that there will be any interest rate rise

• Weak nominal wage growth– Living standards for poorer households static or declining– Offset by increasing population

• Uncertainty over course of government deficit = taxes – government spending

Services dominate recovery so far …

OBR Forecast Dec 2014 – current growth consumer-basedPercentage change on a year earlier

Outturn Forecast

2013 2014 2015 2016 2017 2018 2019

Output at constant market prices

Gross domestic product (GDP) 1.7 3.0 2.4 2.2 2.4 2.3 2.3

Expenditure components of GDP

Household consumption 1.6 2.3 2.8 2.2 2.4 2.3 2.4

General government consumption 0.7 1.1 -0.4 -0.8 -0.9 -0.3 0.0

Business investment 4.8 7.7 8.4 6.3 6.3 6.3 6.3

General government investment -7.3 2.1 3.3 1.6 2.2 1.6 2.3

Net trade10.0 -0.2 -0.5 -0.1 -0.1 -0.1 -0.2

Source: OBR

The Next Five Months

PA/BBC

The Autumn Statement Proposals - cuts and more cuts …..

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2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20

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PPublic sector currentreceipts

Total managedexpenditure

Key Political Arguments Over Tax and Spending

• How quickly to reduce deficit?

• What level of borrowing is acceptable?

• Focus on spending cuts or introduce some tax increases?

UK Public Net Debt As Percent of GDP

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90

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Current Position

More or Less Debt?

• Debt should be reduced in the good times, so that in the bad times it can be increased in order to help individuals and firms adjust to shocks.

• Governments should only commit future generations to pay for spending that those future generations will benefit from themselves.

• There should be some limit to how much we pre-commit future taxpayers to, not only on fiscal sustainability grounds but also because it involves making a choice on behalf of people who have no power to resist.

Scotland Act 2012– Landfill Tax– Land and Buildings Transaction Tax

– Scottish Rate of Income Tax (SRIT)

– 2015-16 estimated receipts: • Landfill tax £107m • Land and Buildings Transaction Tax £413m• SRIT £4668m• Total £5188m

(Out of total budget of £37.5bn)

Scottish Rate of Income Tax

Income

Income TaxRate

£10k £42k £100k

20p

40p

45p

10p

Scottish Government

HM Government

= £4.7bn

Vertical tax competition within shared tax base?

Horizontal tax competition over mobile tax base?

15p

The Block Grant Adjustment (under the Scotland Act 2012)

Year 1

Less than £37bn?

SRIT

Reduced Block Grant

Year 2

£37bn

Size of reduction determinedby growth in UK tax base

Shortfall if Scottish incometax not growing as fast asUK income tax

Indexed DeductionMethod

The Smith Commission – Fiscal Powers

• Scottish Parliament gains control over all of income tax except the personal allowance

• Scottish Parliament to receive the first 10 percentage points of VAT raised in Scotland, but cannot influence the UK’s overall UK rate

• Air Passenger Duty

• Some welfare powers

• Can supplement existing welfare benefits

• More borrowing power to cover forecasting errors

Smith Proposal (example)

Income

Income TaxRate

£10k £42k £100k

20p

40p

23p

£40k

43p

Conclusion – Some Key Questions

• Will the powers be used?

• How will their use be influenced by business?

• How effective could the powers be in stimulating business?

• What other business-friendly policies could the Scottish Parliament introduce?