Reform Scotland

The Recovery – Professor Sir Donald MacKay

In the October blog, I argued that the “Great Recession” from 2008 was a result of two failures -first, the failure to implement the “Golden Rule” that fiscal policy should be counter-cyclical and, second, to regulate the financial sector successfully. After the crash, the Coalition Government struggled to halt the continuing rise in total national debt until near the end of its period in office. It still faces a struggle to reduce national debt to an appropriate level. Yet, to the continued surprise of many “macroeconomists,” the economy recovered due to a strong supply side response in the labour market – a response which is evident in Scotland as well as the UK as a whole.

The following text updates an earlier paper submitted in 2014 to the Scottish Parliament’s Economy, Energy and Tourism Committee. The basic argument remains the same and is depicted in Figures 1-2 below.  Figure 1 shows that, contrary to the normal historic record, the Scottish employment rate lagged the UK employment rate in to the “Great Recession” and led it out of the recession. The unemployment rates tracked each other fairly closely over the period shown. The latter is also true for the 16-64 total and male activity shown in Figure 2. However, from the beginning of this decade, the Scottish female activity rate rose more rapidly than that for the UK as a whole.

Labour market flexibility is important to the performance of any economy. In a downturn, it can help toward stabilising employment. In an upturn, it can help push forward a more sustainable recovery. Over 2008-10, the fall in GDP was greater than the fall in employment. There was, indeed, a “cost of living crisis” – real wages were falling because, for many, money wages were static or declining and inflation remained above the Bank of England target rate. This is what can happen in a recession when the government reduces the rate of growth of public expenditure to restore some order to the public finances.

Over 2008-10, many employers, particularly those in the private sector, chose to “hoard” some labour against the day when they could respond to an increase in demand. This shows up as a reduction in productivity and profitability, but many employees stayed with the devil they knew because they had no better alternative to hand. In Scotland, the 16-64 employment rate bottomed out in Q3 2010 and has risen relative to the UK, particularly since end-2012.

At this point, it is important to emphasise that there are different ways to measure an economy and the behaviour of the trade cycle through time. For example, it is often said that the UK is the fifth richest economy in the world. If you measure this in total GDP it certainly is. If you measure it in terms of GDP per capita it has a lower ranking! God may be on the side of the big battalions in war, but not in terms of the per capita income of its citizens or employment as a % of the population of working age.

This is particularly relevant to discussing the response of the UK and the Scottish economies through the “Great Recession” and the Recovery. The supply side changes in the labour market were relatively greater for the UK as a whole than for Scotland, because the rate of net immigration was much greater for the UK. The French economist JB Say coined the dictum “supply creates its own demand,” and, where immigrants are mainly economic migrants, it can be expected that they will be active in seeking and obtaining work. Supply can create its own demand in both the medium and the longer term.

Economic historians consider that a long history of the UK as a welcoming host country has been influential in increasing employment and income generation. Yet, the high level of immigration and the UK’s reduced capacity to control its own borders, have created both social and economic problems, particularly in areas of high immigration. The main adverse impacts have been on those with fewer skills and lower incomes. They have faced greater competition in both social and economic terms, as levels of recent immigration have been much higher than historically. Again, in recent years, there have been many more immigrants from eastern European countries who are more likely to compete directly for lower skilled jobs.

Scotland has been relatively fortunate in that, after a long period of declining population, the population is again increasing, but at a more modest rate than in the UK. Moreover, the ubiquitous Poles have been widely welcomed especially in the north of the country. My own experience of a very small Highland town during the war was that a few hundred Poles in a town of less than a thousand people rebuilt the Catholic Chapel to our great delight, although we were rather over-endowed with religious establishments in the form of the Chapel and two Presbyterian Kirks! In short, both the scale and the composition of the immigration in the modern period provided supply side changes in the labour market which helped the recovery without creating some of the social tensions evident in countries with high net inward migration.

The largest sea-changes in the labour market have been:

  • the shift from public sector to private sector employment
  • within the above, a substantial increase in self-employment
  • the increase in female employment is a continuation of a secular trend and has been particularly apparent in Scotland from around 2000 (see Figure 2).

From Q2 2008 to Q2 2015 there has been a marked shift from public to private sector employment in both the UK and Scotland. The shift has certainly been greater in the UK, but this difference may be eroded through the next few years if the Chancellor pushes through the return of the RBS to the private sector. I shall look at the data in more detail in the December blog, but Scotland has long been a home of high levels of public sector employment, with a concern that this has had an element of “crowding out” private sector employment. This has always been difficult to measure precisely. Yet the squeeze on public sector employment from 2008 has been a “push” factor in the increase in private sector employment, even in circumstances where many in the private sector were facing stagnant or falling real wages. Of course, most people would prefer both rising real wages and employment, but there was also a pressing need for a major restructuring of the economy, this including a shift from public sector to private sector employment.

The criticism that public expenditure cuts under the Coalition Government were “too deep, too fast,” is misplaced. Like all post-war UK governments, the Coalition found it difficult to check the growth of government spending. Reduction in the total national debt will require serious restraint of current public expenditure and much improved targeting of welfare support if the recovery in the UK and Scottish economies are to be continued. Above all, the most recent evidence is that the recovery in the UK and Scottish economies occurred much more quickly than previously thought (GDP per capita recovered 2008 levels in 2013 and not in 2015 as the data previously suggested) and the bulk of the evidence seems to point to a strengthening growth rate.

Yet it would be a serious mistake to assume that these trends can be extrapolated for a long forward period. The strength of the recent recovery has surprised many and I count myself as one of that number, but there remain serious concerns as to whether the pace of the recovery can be sustained beyond the medium term. In Scotland, the most recent labour market statistics are not encouraging, but it still looks likely that the employment levels will remain high by historical standards. Nonetheless, Gordon Brown’s girlfriend, Prudence, would be saying we should fix the roof now while the sun is shining and that requires the defeat of the deficit deniers.

In the next blogs I will look in more detail at the change in the private/public sector mix, trends in self-employment and other facets of a more flexible labour force.

Figure 1: Scottish & UK employment rates                         Figure 2: Scottish & UK male & female activity rates

sir donald graph 1 sir donald graph 2