More pain to come for Scottish economy, warns Ernst & Young Scottish ITEM Club - Ernst & Young - United Kingdom

Edinburgh 29 November 2009: Scotland is starting a slow and patchy recovery from the deep recession of the last 18 months, but will continue to underperform the UK for the next year as a result of some ‘disturbing weaknesses’ in its service sector economy, according to research released today by the Ernst & Young Scottish ITEM Club.

In its annual forecast, the Scottish ITEM Club says that the private services sector will drag down the relative performance of Scotland‘s economy, which will contract by 4.9% this year, and predicts that GDP growth in 2010 will be just 0.7%. In contrast, UK GDP is expected to contract by 4.6% in 2009 and grow to 1.1% next year.

The recession has been more aggressive than Scottish ITEM Club was predicting even six months ago, having forecast in June that Scotland’s GDP would fall to just 3.1% this year.

Dougie Adams, senior economic advisor to the Ernst & Young Scottish ITEM Club comments: “Scotland has a diverse economy and there are some areas, including crucial parts of the manufacturing sector, which are weathering the recession better than in the UK as a whole. However, you cannot escape the fact that the recession has exposed a number of areas where there are disturbing weakness, not least financial services, business services and the hotel & catering sectors, which have all significantly underperformed compared to the rest of the UK.

“The slower recovery of these ‘private services’ is expected to hold back the growth of the Scottish economy for at least the next twelve months”, he added.
Scotland’s financial services sector has been the biggest underperformer since the onset of the recession, due to the major fall-out from the banking crisis – in the year to June output in the sector shrank by 8.4% compared to 0.8% in the wider UK. The picture is just as dismal for business services, also contracting by 8.4% in Scotland and just 6.3% in the UK. Manufacturing in contrast is performing in line with the UK and is expected to be Scotland’s fastest growing area of private sector activity in 2010 – with output increasing by 1.5%.

Scottish economy faces a period of adjustment
According to the report, Scotland’s future economic growth will be dependent on a shift towards a more export led economy, and the ability of Scottish businesses to exploit the opportunities afforded by global recovery and the lower level of sterling. But the fundamental structure of Scotland’s economy will not change dramatically over the next few years.

“It would be wrong to argue that the Scottish economy will have to change out of all recognition over the next few years to sustain recovery”, says Adams. “Rather there will be an adjustment that will see an expansion of Scotland’s export industries and businesses competing with imports in the home market.

“Sustainable recovery will require Scottish firms to up their game in the export markets.  For example, even the buoyant drinks sector, which accounts for over 20% of Scotland’s overseas manufactured exports, lagged behind the fast growth in world trade in the earlier part of the decade. The low level of sterling presents a real opportunity for Scottish businesses to expand their market share and to help offset the impact of depressed domestic demand,” he adds.
 
Job losses set to continue until 2011
The very slow return to growth will have a detrimental impact on employment levels in Scotland.  The report says that further job losses in the short to medium term are inevitable and forecasts that Scotland’s unemployment rate will reach 8% in 2010 - compared to 8.6% for the wider UK. “We won’t see the beginnings of a reversal in the levels of unemployment until 2011,” says Adams. “Scotland’s unemployment rate among those eligible for benefits has almost doubled since spring last year and there is undoubtedly more pain to come – particularly if this period of economic weakness drags on.

“There is a real risk that companies may have held onto their employees during the downturn in anticipation that business conditions would improve relatively quickly. If Scotland’s economic recovery is prolonged, the employment shake out may only have been delayed rather than avoided.”

Worse still to come for Scotland’s financial services sector
However, while the unemployment figures for Scotland are high, job losses in the financial services sector have, to date, been less savage than many expected – 4,300 in the 15 months to June. But Scottish ITEM indicates that the sector could see an additional 3,000 jobs go over the next year as bank restructuring continues.

“Recent announcements by the banks suggest that the process of rationalisation is yet to get into full swing”, says Adams. “However, we remain hopeful that the location of activity by some of the new players in the sector in Scotland will soften the loss of employment from the changes in the banking sector,” he adds.

Hywel Ball, Ernst & Young’s managing partner in Scotland continues: “The last 18 months have been some of the toughest on record for Scotland’s economy but it looks like we may have hit bottom. There are some challenging days ahead as we go into the new year and with government spending cuts around the corner and the likelihood of deeper and more aggressive regulation – that could carry an expensive price-tag for business – it is going be a bumpy ride. 

“However there are some pockets of optimism for Scotland The asset management industry in particular continues to grow from strength to strength. Over the last few years there has been a significant increase in the number of fund administration businesses that have moved to Scotland, which is becoming a global hub for the industry.”

Public sector retrenchment 
Scottish ITEM Club warns that there will be an extended period of contraction in public sector employment from 2010, as the government seek to address the funding gap – despite the needs of a growing and ageing population.

Whilst the nature of a public sector retrenchment – the mix between spending cuts and tax increases – is still uncertain, ITEM is forecasting 14,000 fewer Scottish public sector jobs in 2014 than in 2010. However the report says that the scale of job losses will be dependent on the ability of the public sector to implement some of the flexible approaches to pay and working hours that have been adopted by the private sector during the recession.

Adams says: “Curtailing public spending in the face of a rising and ageing population is going to be painful, hitting households right across Scotland.  However there is one potential silver lining. Public sector wages are currently an average 11% higher than their private sector equivalents in Scotland, compared to just 2% higher in the rest of the UK. If this pay differential is eroded in Scotland by moves to place public finances on a sounder footing, it may make it easier for the business community to compete for talent. It will be part and parcel of the post-crisis adjustments that have to be made.”

Skilled work force offers hope for the future
The extent of public sector cost cutting, a general election on the horizon, and the impact of global market forces, represent significant risks to the Scottish ITEM Club’s economic forecast and threaten to prolong Scotland’s return to growth. However amid the gloom of a long, deep recession, Adams says that it is easy to overlook aspects of the economy that will aid Scotland’s recovery.

“It is important to remember that Scotland’s highly educated workforce possess skills that will always be attractive to potential employers and that will allow individuals to transfer across sectors as the economy adjusts to the new market conditions ,” concludes Adams.

Read the report  2.5Mb, November 2009