Geoff Mawdsley, The Scotsman
18 March 2008
In the current climate of global uncertainty, it is more important than ever that Scotland fulfils its potential on the world economic stage.
But there is no doubt that unless we create a new framework for growth, Scotland will continue to lag behind not only her foreign competitors but other parts of the UK. Today, Reform Scotland – a new, independent think tank – publishes its first report, Powers for Growth, in the hope this will stand as a signpost to a new road of economic stability and strength.
The starting point is a comparison of the Scottish economy\’s long-term trend rate of economic growth (measured by GDP per capita) with that of other countries and parts of the UK.
The trend rate of growth is the most reliable indicator of economic health as it measures the capacity for growth within an economy.
The results are worrying. Scotland\’s economy lags behind many of the leading world economies as well as the economies of countries of a similar size to Scotland. It also trails the UK as a whole and particularly successful parts such as London and the South-east.
Scotland\’s long-term growth rate of 1.8 per cent a year compares badly with a number of smaller European countries which have grown by an average of 3.5 per cent over the last ten years. Indeed, the gap between the economic growth rate in Scotland and in countries such as Ireland and Iceland has grown over the past decade.
We then looked at why the economy in Scotland is under-performing. One reason is that the productivity rate in Scotland is declining and well below the EU average. Ultimately, economic growth is driven by growth in productivity, which in turn relies on investment in infrastructure, human capital, knowledge and equipment.
The evidence from successful economies around the world is that the private sector must play the central role in this investment, as when governments try to replace the private sector they misdirect funds and do not add to productive capacity.
Governments cannot improve productivity directly. Instead, in successful economies, they concentrate on creating the right fundamental framework for growth. When the right environment is in place, it is more rewarding to save and there is less uncertainty about future returns. This leads to individuals and companies putting aside money for investment and growth picking up.
The right framework for growth encompasses many areas including the protection of property rights, the ease of doing business, the openness of an economy to trade and investment, as well as levels of taxation and public spending. These are largely decided at the UK level and in many ways the UK economic policy framework provides an environment conducive to growth. However, in two key areas – taxation and spending – it is moving in the wrong direction.
The tax burden of the UK, including Scotland, as a percentage of GDP is 37 per cent, whilst in Ireland it is 31 per cent. Our research shows that a low tax burden has a positive impact on economic growth by encouraging long-term investment and new business generation which in turn leads to greater employment and productivity. This is backed up by the fact that Ireland\’s GDP per capita is some 26 per cent higher than Scotland\’s.
At the same time, public spending as a proportion of GDP is 55 per cent in Scotland. It is not only one of the highest levels in Europe, but it is rising. Of other EU countries, only the UK as a whole and Portugal are in the same boat.
There is a clear link between a falling share of public spending and faster growth, as shown in Ireland where public expenditure has fallen from 52 per cent of GDP in 1987 to 34 per cent today.
This appears to be a large fall, yet its public sector has far more money than in the 1980s because its economy has grown so much.
Ireland is an excellent illustration of the benefits of a lower overall tax burden and a falling share of public spending. However the trend is also repeated in many other countries.
Matching the trend rate of growth in the most successful economies will require an average growth rate of 3.5 per cent sustained over ten to 12 years.
It is an ambitious target. We need to start by reducing the tax burden in Scotland. A more favourable UK tax regime would help and we should push for that. But we must also use the existing tax-varying powers of the Scottish Parliament to reduce the tax burden and boost growth.
Equally, we need to reduce the level of public spending in Scotland as a share of GDP. That requires public spending to grow more slowly than the economy as a whole, although as growth increases so will revenues. The key to achieving this is reforming public services in Scotland so that they deliver better value for money.
Greater financial powers for the Scottish Parliament could also help to create a platform for higher economic growth in Scotland. The current UK policy environment does not work well for many of the nations and regions of the United Kingdom, where growth lags behind that in the South-east.
Additional powers could be used to further reduce the tax burden in Scotland. There would be a greater incentive to do so, too, because the higher revenues resulting from faster economic growth would stay in Scotland.
Raising more revenue in Scotland would also provide an incentive for greater control of public spending. At present, spending in Scotland is largely governed by a block grant from Westminster and any money not spent simply goes back there.
Such measures are not the full answer to improving Scotland\’s long-term growth rate. However, they are an essential starting point and are necessary to lay the foundations for the greater prosperity and higher living standards which will benefit everyone living and working in Scotland.
Geoff Mawdsley is the director of Reform Scotland, an independent, non-party think tank.