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Scottish Economic Report: March 2004
3.2 Output
The Executive's provisional estimates show Gross Domestic Product in Scotland (seasonally adjusted and on the new chainlinked basis) rising by 0.3 per cent in the third quarter of 2003 and by 2.1 per cent in the four quarters to 2003 Q3. The figures for the UK show that GDP rose by 0.7 per cent in 2003 Q3 and by 1.6 per cent over the year to 2003 Q3.
The new methodology has the largest effect on the most recent data, as they were furthest removed from the relevant weights (i.e. we were using 1995 weights with the 2003 data), whereas, prior to 1999, no data were further than 3 years from the relevant year's weights. Table 1 shows the long term average annual growth rate of the Scottish economy (1974-2002) and the rate between 1995-2002, both prior to and after chainlinking. It can be seen that although there is an upwards revision to both, in the case of the long-term rate, it is a very minor increase of 0.02 percentage points, while even the change for the period between 1995 and 2002 is relatively small at 0.11 percentage points.
Although the impact of chainlinking and the application of a more up to date weighting framework to the GDP calculation has been to revise growth rates upwards, the sectoral analysis remains very consistent with previous estimates. In the year to 2003 Q3, annual output in the Scottish service sector grew by 3.5 per cent, compared with a 3.1 per cent drop in the production sector and a 4.4 per cent rise in construction. The UK figures showed 2.5 per cent growth in services, a 1.0 per cent drop in production and 6.1 per cent growth in construction.
Output in the manufacturing sector decreased by 0.6 per cent in 2003 Q3, and fell by 3.9 per cent over the year to 2003 Q3. The UK manufacturing index showed an increase of 0.2 per cent in 2003 Q3 and a fall of 0.7 per cent over the year to 2003 Q3.
Chart 3.1 compares the Scottish GDP index with that of the UK in recent years and also compares the previous estimates of GDP with the most recent. Before the new chainlinking methodology was implemented, Scottish and UK GDP estimates showed a clear divergence from 2000 onwards, with Scotland experiencing lower levels of growth than the UK. The new figures now show a different picture. Scottish growth since 2000 has been very similar to UK growth, with Scotland experiencing a slightly higher growth rate from late 2002 onwards. Over the longer term, UK growth can be seen to be stronger with an annual average growth of 2.7 per cent between 1995 and 2002 compared to 1.9 per cent for Scotland.
3.2.1 Demand
The Sc ottish Industrial Trends Survey from CBI Scotland, published in January 2004, indicates that Scottish manufacturing is showing signs of recovery, although the CBI reports that the pace of the pick up lags behind that of the UK. The CBI note that firms reported the first significant increase in output for nearly two years and now rising at the fastest rate since April 2000. Further, albeit more modest, growth in output is expected over the next three months. CBI also notes that Scottish firms did not consider their total order books to be below normal - the first time since September 1999.
The Royal Bank of Scotland Purchasing Managers' Index (RBS PMI) for January 2004 reported a seventh successive monthly increase in business activity. This was being primarily driven by growth of new business in both manufacturing
and services. Manufacturing output expanded for a seventh successive month in December, with further gains in new order books cited as the principal factor behind the expansion. Growth of business activity in the Scottish service sector was maintained for an eighth successive month in January, with Financial Services reporting the sharpest increases in activity. Solid gains in new work, increased marketing activity and new product launches were all frequently mentioned as contributing factors.
The Scottish Chambers' Business Survey released in January 2004 was headlined "More Signs of a Recovery in Scottish Manufacturing in 2004". The survey reported that the outturn in orders and sales was better than anticipated in manufacturing, construction and tourism, but weaker than expected in wholesale and retail distribution.
The Lloyds TSB Scotland Business Monitor covering the fourth quarter of 2003 shows the Scottish economy growing, with nearly half of the firms surveyed reporting increasing turnover in the three months ending November 2003. The survey states that recovery has picked up pace, with 'clear signs of manufacturing emerging from recession and returning to growth'.
Scottish Engineering's Quarterly Review published in December 2003 refers to "Improved Volumes Raise Hopes of a New Dawn", citing increases in output volumes and new orders.
3.2.2 Exports
The Scottish Executive published the results of Scotland's Global Connections Survey in February 2004. This was conducted on behalf of Scottish Development International and represents the most comprehensive study of Scottish exports and trading connections to date.
The results of this survey are considered in more detail in Chapter 1, but Table 3.1 and Chart 3.2 below summarise the principal findings. Total Scottish exports in 2002 were provisionally estimated to be 19 billion, of which three-quarters were attributable to manufacturing industries. An estimated 11 billion of Scottish exports were destined for the EU, with the largest share going to Germany (13 per cent of total exports).
Total Scottish exports do not include any exports of oil and gas extracted from the UK continental shelf. This is consistent with the approach taken in all Scottish economic statistics in that, following European System of Accounts (ESA 95) conventions, the National Accounts determine that these cannot be allocated to any one region of the UK. When analysing this data, it is also necessary to recognise that the most significant export market for goods and services produced in Scotland - the rest of the UK - is excluded.
The Global Connections Survey relates to 2002, so it is therefore necessary to look to business surveys for impressions of exporting activity in 2003.
CBI Scotland reported that manufacturers have benefited from a pick up in export demand in the third quarter of 2003 with new export orders increasing for the first time since July 2002, albeit modestly. Expectations for future export sales are stronger than at any time since October 1995. Respondents were more optimistic about export prospects than they were in the second quarter of 2003 - again for the first time since July 2002.
The RBS Purchasing Managers' Index has been particularly upbeat over the equivalent period, highlighted by manufacturers continuing to signal strong growth of export sales throughout the period from October 2003 to January 2004.
The results of the Global Connections Survey demonstrate the significance of exports to businesses in Scotland, but export demand is dependent on the economic climate in those countries Scotland exports to, as well as on exchange rates. Exporters to Eurozone countries have continued to benefit from a favourable exchange rate, with Sterling having depreciated significantly against the Euro over recent years. In February 2004, the exchange rate was 1 = €1.43, compared to around €1.64 in February 2002.
3.2.3 Costs and Prices
CBI Scotland reports that costs appear stable despite sharp rises in oil prices over the final quarter of 2003. Brent Crude averaged $30.06 per barrel in the January survey period, compared with an average of $27.20 per barrel in October, an increase of 10.5 per cent. However firms are optimistic that this is merely a "blip" and that costs will resume their downward path over the coming three months. Profit margins remain under pressure however. Average domestic prices fell for the sixteenth successive quarter, although the pace of decline was the slowest since April 2001.
The RBS PMI Scotland Report stated that inflation of input prices borne by both manufacturing and service sectors has been rising throughout the second half of 2003 and into 2004; driven largely by increased labour costs and rising supplier and raw material prices. Strong competition in product markets continued to limit companies' output pricing power.
January 2004's Scottish Chambers' Business Survey reported that expectations of price increases over the next three months rose in manufacturing and in wholesale and retail distribution. There was little evidence of pay pressures reported in the fourth quarter of 2003.
Scottish Engineering reported that both domestic and export prices remain depressed in all sizes of companies. Only the oil and gas sector reported an increase in sales margins for either market. No other sector reported any relief from the ongoing downward pressure on prices. Those suffering most were electrical goods and metal manufacturing. There are no increases predicted in the next three months in any sector or size of company for prices or margins.
3.2.4 Investment
CBI Scotland report that the upturn in confidence has brought about the first signs of a turn in the investment cycle. Plans for spending on product and process innovation turned upwards once again in January, and were stronger than at any time in the past five years. Intentions for investment in training were at their highest level since October 1999. However investment in plant & machinery and buildings is expected to be lower over the coming year than it was over the past twelve months.
The latest Scottish Chambers' Business Survey reported that approximately one third of respondents intended to change their investment plans, which suggests a modest strengthening on business activity. The only exception was tourism where a slight downward trend in investment was reported.
Scottish Engineering reported in December 2003 that plans for capital investments are mostly positive, with highs being machine shops and the electronic sector and lows being fabricators and oil & gas. Training investment plans feature heavily for non-metal products and oil & gas but not for fabricators or electrical goods.
RBS PMI reported that purchasing activity in the Scottish manufacturing sector rose for a fourth successive month in January, as firms continued to respond to higher new orders and increased output requirements. Respondents attributed increased input buying to recent significant rises in production requirement.
3.2.5 Business Confidence
CBI Scotland reported that the improved results for orders and output have combined with a more upbeat prognosis for the domestic economy as a whole to boost confidence. Thirty-one per cent of firms surveyed said that they were more optimistic about the general business situation than three months ago, while 16 per cent said they were less optimistic- the first improvement in confidence since April 2002.
Halifax Bank of Scotland compiles an index of Scottish Leading Economic Indicators. A seventh successive monthly rise in the Leading Indicator suggests accelerating growth of the Scottish economy well into 2004. They cite investor confidence as having steadied. The month-end average for the top 50 Scottish companies' share prices finished the year strongly in December, rising to the highest level since August. Equity prices have now been higher than levels of a year previously in every month since July. HBOS also report that there have been 'signs of decreasing pessimism amongst industry leaders'.
Lloyds TSB Scotland's Business Monitor reported that expectations for the next six months to end of May 2004 show the majority of firms expecting turnover to either increase or be maintained. This confidence is shared across both production and service sectors.
RBS PMI reported that the modest return to net recruitment suggests increasing confidence among Scottish companies regarding new orders from UK and overseas and the sustainability of recovery. They also point to positive balances within the New Economy New Orders Index as a signal of a further substantial increase of new work which is in line with the recent rise of general business confidence.
Scottish Engineering reported that although levels of optimism have risen, the balance of responses remains negative. When broken down to company sizes, small and medium are negative with large companies being positive. By sector, only electronics, transport and non-metal products have positive returns.
3.2.6 Consumer Demand
The Scottish Executive monitors two independent monthly reports in assessing consumer demand: the Royal Bank of Scotland Scottish Retail Sales Monitor (SRSM) and the Martin Hamblin GfK Consumer Confidence Barometer. The former measures the monthly change in retail sales while the latter measures the annual change in overall confidence levels.
The Retail Sales Monitor reported like-for-like sales (that is from the same outlets) growing by 6.0 per cent in December 2003 compared to December 2002 and 3.4 per cent in the previous month and a 3.0 per cent rise for December 2002 compared to December 2001. Total sales grew by 5.6 per cent in December 2003, a decrease in growth from 6.0 per cent in November but an increase from 4.9 per cent in the previous December. Retail sales in Scotland are much stronger than in the rest of the UK, which reported a 0.2 per cent decrease in like-for-like sales and an increase of 2.3 per cent in total sales. This comparison was highlighted by the SRSM in the accompanying press release where they refer to 'A year of Scotland's retail sales growth outstripping the UK's retail sales growth …with even further divergence from UK figures'.
The relative strength of the Scottish performance can be seen in Chart 3.3, which graphs the growth in total retail sales as measured by the Scottish Retail Sales Monitor in Scotland and the British Retail Consortium in the UK over the past thirteen months. Comparing December 2003 with December 2002 one can see nearly a one percentage point increase in the growth of Scottish retail sales. In the UK however, there has been a contraction in sales growth with a fall on the previous year of almost 2 percentage points. Although the series follow similar trends, over the second half of 2003 we see the gap between them widening as growth in Scotland has been falling at a much slower rate than in the UK.
The strength of the retail sector in Scotland is supported to a degree by the level of consumer confidence. The Consumer Confidence Barometer, carried out by Martin Hamblin GfK on behalf of the European Commission, reported that the New Year brought 'some consumer optimism for the economy in 2004'. However, the performance of Scotland over the past year has shown some signs of divergence from the UK, as shown in Chart 3.4.
During the period of active military conflict in Iraq, both Scotland and the UK dropped to record low levels of consumer confidence. However, this measure of consumer confidence shows a stronger and more sustained recovery in Scotland after these events than in the UK as a whole. Possible interpretations of this divergence in confidence as well as the departure from the trend in retail sales reported by SRSM (see above) remain uncertain.
One possible explanation is the speculation leading up to and reaction after the rise in interest rates in November. Indeed, this may well have had a more adverse effect on confidence sentiments where servicing UK mortgage debt is a bigger issue. Nevertheless, the more tangible recorded sales held up better - suggesting that what people say is more sensitive to market conditions than what people actually do.
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