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Background Analysis to the Framework for Economic Development in Scotland
4 The Enabling Framework
4.1 Overview of the Enabling Objectives
Fulfilling the Executive's vision for economic development - and the key outcomes that this entails - rests heavily on putting in place the appropriate economic environment. The enabling objectives are central to generating the changes in economic behaviour upon which economic growth and prosperity depend.
In essence, these were summarised in chapter 1 as:
- a stable and supportive macro-economic environment
- a facilitating national economic context: encompassing the physical, human and electronic infrastructure
- a dynamic competitiveness in Scottish enterprises
- economic policies and programmes to secure the social, regional and environmental objectives
It is noteworthy that, while the key macro-economic powers and some microeconomic powers rest with the UK, Scotland does have major economic development powers enshrined in the Scotland Act. These encompass the key education and training policy levers, the powers in most areas of the physical infrastructure and those powers that relate to the support of the enterprise sector more directly. In addition, it is important to note the impact of Scottish fiscal policy in the wider sense of the influence that this significant expenditure has upon the economy as a whole and, thereby, on its future development.
In the remainder of chapter 4, we consider the important contribution of UK macro-economic policy to the Executive's economic strategy. In chapters 5 to 10, we then set out the Executive's strategic approach in key policy fields:
- The management of public finances
- The national economic infrastructure
- The dynamic competitiveness of enterprises
- The promotion of sustainable economic development
- Responding to demographic change
- The social and regional framework
4.2 The Contribution of UK Macro- and Microeconomic Policy
As an integral part of the UK, Scotland is highly dependent on UK macro-economic policy. The extent to which these policies provide the conditions for balanced and sustainable growth is therefore central to Scottish economic prospects. Scottish economic growth is dependent both on the UK macro-economic stance at any given time and on the high degree of convergence which exists between the economies of Scotland and rest of the UK.
Moreover, as an open economy, the UK's comparative inflation performance is important to Scotland's international competitiveness. In general, the avoidance of sharp swings in economic performance should promote and reinforce the sound underpinnings of the Scottish economy.
The UK's macro-economic policy is designed to promote economic stability through both monetary and fiscal policy frameworks. These frameworks have been clearly stated and set out in various publications. One motivation for this has been to provide transparent information to a range of economic agents (financial markets, businesses, trade unions and others) about how macro-economic policy is to be conducted. This strategy is intended to develop a culture of rational expectations and confidence in economic stability. This, in turn, has promoted greater certainty in the economy and constrained inflationary expectations.
Monetary policy framework: The UK Government's monetary policy framework incorporates a number of key elements:
- A symmetric inflation target - set by the UK Government - of 2 per cent annual growth in the Harmonised Index of Consumer Prices, and a requirement that monetary policy supports the wider economic policy objectives for growth and employment.
- Operational responsibility of the Bank of England's Monetary Policy Committee for setting interest rates to meet the inflation target.
- Mechanisms to promote openness, transparency and accountability, such as the publication of the minutes of the monthly Monetary Policy Committee meetings and the quarterly Inflation Report of the Bank of England.
There is also a regional dimension to the monetary policy framework, via the obligation of the Monetary Policy Committee to take account of regional and sectoral information in forming its interest rate decisions. Information in these regards are compiled by the Bank of England's network of regional agents, with whom the Scottish Executive consistently communicates.
The UK's inflation performance (RPI all items) has improved significantly in recent decades. During the 1970s, inflation was high and variable, reaching a peak of 24.2 per cent in 1975 and closing the decade at 13.4 per cent. Average inflation improved in the 1980s to 7 per cent, but remained variable. Over the 1990s, average inflation was 3.7 per cent. Since the introduction of the new monetary policy framework in 1997, monthly RPIX inflation (which was the target measure until December 2003) has averaged around 2.4 per cent and moved within a band of 1.9 per cent to 3.2 per cent. UK base rates stood at 6 per cent for most of 2000, and have been on a downward trend for almost all the intervening period. Rates were cut significantly to mitigate the economic effects of the terrorist attacks on 11 September 2001 and the consequent economic fallout, and reached a low of 3.5 per cent between July and November 2003.
Fiscal policy framework: the UK's primary objective for fiscal policy is to deliver medium-term sustainability in the UK public finances and fairness between generations. At the same time, it is acknowledged that fiscal policy can play a short-term role, for instance, through automatic stabilisers, whereby expenditure and revenue flows move to dampen the fluctuations emerging during the economic cycle. The UK fiscal policy framework itself is based around five central principles: transparency; stability in the policy making framework and in the way fiscal policy impacts on the economy; responsibility; fairness, including between generations; and efficiency, including in the design and implementation of policy. These principles were set out in the UK Government's Code for Fiscal Stability in March 1998.
Two UK fiscal rules are specified to provide benchmarks against which the performance of fiscal policy can be judged:
- The golden rule - according to which, over the economic cycle, the UK Government will only borrow to invest and not to fund current spending; and
- The sustainable investment rule - according to which, public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level.
In applying these two rules, the UK Government will be seen to meet the golden rule if, on average over the economic cycle, the current budget is in balance or in surplus. With respect to the sustainable investment rule, the UK Government believes that net public debt, other things being equal, of below 40 per cent of UK GDP over the economic cycle is desirable 5. The importance of setting the rules over the economic cycle is that it is intended to enable fiscal policy to play a short-term role if required. It allows, for example, UK net borrowing to vary between years, in keeping with the cyclical position of the UK economy.
Complementarity of UK and Scottish microeconomic policy
The Executive works in partnership with the UK Government on economic development issues. Devolved policies are complemented by UK reserved programmes to support growth and development in Scotland. These include such programmes as the DTI's Small Firms Loans Guarantee, improvements to the Treasury's R&D tax credit definition, and the Executive SEEKIT and SCoRe programmes to support R&D and knowledge transfer. The Executive strategy reinforces these programmes with further targeted support to business to increase productivity and competitiveness.
To ensure coherence across programmes and bring Scottish interests to bear on UK policy formulation, the Executive is engaging with UK departments in an active exchange of ideas. Joint Ministerial Conferences across all main subject areas allow for high-level consultations and the representation of Scottish concerns at a UK level.
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