Contraction underlines Scottish and UK economic divergence

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by Alex Porter, Economy Editor

Britian’s GDP contracted by 0.6% in the last quarter of 2010 according to the Office of National Statistics (ONS).

Scotland UK comparison

Although the same figures are not available specifically for Scotland, the UK numbers do nevertheless provide evidence of divergence between the Scottish and the UK economies.  The contraction in UK numbers takes place against a backdrop of falling Scottish unemployment and rising employment.

Recently enterprise minster Jim Mather, comparing job market statistics, alluded to the divergence of the two economies saying: “For three consecutive monthly labour market statistics releases, we have seen falling unemployment and rising employment in Scotland compared to rising unemployment and falling employment across the UK.

“Scotland’s total employment rate is at its highest level since the three months to December 2009 – and Scotland has a higher employment rate and lower economic inactivity rate than the UK as a whole.”

This latest economic data serves to underline existing evidence which shows that the Scottish economy is in robust shape whilst the UK economy is in trouble.  According to the most recent Government Expenditure and Revenues Scotland (GERS) report the Scottish economy was running a surplus as recently as 2008-2009.

Having factored in interventions in the financial sector in 2008-2009, Scotland’s financial position was a current budget surplus of £1.3 billion, or 0.9 per cent of GDP, including a geographical share of North Sea oil revenues.  At the same time, the UK was in current budget deficit of £48.9 billion, or 3.4 per cent of GDP, including 100 per cent of North Sea revenues.

Given that UK government borrowing has escalated, standing at £23.3 billion for the single month of November 2010, one would expect an economic contraction in Scotland leading to job losses.  However the opposite is true.

This is good news for SNP Enterprise Minister John Swinney as his party goes into the Holyrood elections.  By being able to point to Scotland bucking the trend the SNP will impress upon the Scottish electorate that where their parliament has powers over the economy success ensues, and so more powers will mean more economic success.

Low interest rates bitter-sweet

According to received wisdom the ONS negative growth figures will lend authority to those seeking to keep interest rates low.  Low interest rates, we are often told, makes it easier for companies to borrow and so stimulate economic activity.

However the reality is that although lending to main street banks from the Bank of England (base rate) is only 0.5%, the banks aren’t lending to main street.  Instead, it seems, they use the almost free money to buy and sell financial products to and from each other, triggering commission on each transaction and therefore bonuses.

In the City of London this almost free money sloshing around gives the impression of buoyant underlying economic activity.  The commissions and bonuses ulitimately derived from devaluing the pound have a ripple effect and so in the South-East there is a general sense that recovery is never far away.  Devaluation is felt more severely outwith the South-East where increased prices are squeezing family budgets and an increasing number of homeowners now need to use credit cards to meet mortgage payments.

Prices rise as a devalued pound means importers will have to pay more for products and components coming into the UK.  These costs are passed on to the consumer creating price inflation.

It is not clear what the economic benefits of devaluation are to the UK economy as a whole.  Despite the pound losing value against key trading partners, unemployment is rising in the UK whereas it has never been lower in Germany.

Currency devaluation does benefit exporters but as the UK is an importing economy the trade deficit widens and so the government receives less in taxation.  Consequently to pay for public services the government must turn to borrowing on the markets in order to finance its increasing deficit.  This in turn leads to the case being made for austerity cuts.

Monetary policies which benefit the City leads necessitate austerity cuts.  Yet those who use public services most tend not to be the City bankers or shareholders.  Any benefits homeowners have from lower interest rates on mortgages are offset by higher prices and public sector cuts.  Once interest rates do rise it will be clear to homeowners that their low mortgage payments were bitter-sweet.