The Scottish Government

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B. WHAT IS THE CHALLENGE THAT WE FACE?

This section sets out the scale of the challenge faced in putting Scotland on a higher sustainable growth path and the targets that have been set to help meet the challenge.

Figure B1 highlights the key components of increased growth - increased productivity, participation and population. For each of these components, this section outlines Scotland's performance, the gap between our performance and the performance of other economies and the target that will help drive improvement.

Figure B1 also identifies this Government's desired characteristics of growth - solidarity, cohesion and sustainability. For each of these characteristics, this section outlines the challenge Scotland faces, performance relative to other economies and the target that will help drive improvement.

Figure B1

B.1 GROWTH

Scotland's economic growth has underperformed relative to both the UK, and other small European countries, in recent decades. Over the last thirty years (1975 to 2005), Scotland's annual average growth in Gross Domestic Product ( GDP) was 1.8 per cent, well below that of comparable small European countries, and significantly below the UK average of 2.3 per cent. Scotland's growth has lagged that of the UK, in nine out of the past ten years. Growth in Ireland has been three times higher over the same period and, in Norway, nearly twice as high as in Scotland.

Figure B2: Scotland's long-term GDP growth performance (1975-2005)

Source: Eurostat, OECD, Scottish Government

Decades of relatively poor performance have led to missed opportunities for Scotland compared to neighbouring countries. We now clearly lag behind small independent EU countries in terms of GDP per capita, wages, living standards and public services.

Our growth targets. We are now setting a new level of ambition and a sharper aspiration for the future. We are establishing a growth target to which we will aspire over the medium to long-term and a more immediate target for the life of this Parliament.

Our aspiration. Over the long-term with access to a full set of economic and fiscal levers, a Scottish Government would be in a better position to achieve a step change in economic performance and match the levels of growth attained by small comparator European countries. Consistent with this belief, the new Government is setting a long-term growth target:

• to match the GDP growth rate of the small independent EU countries by 2017.

Our immediate target. As Scotland's historical performance shows, achievement of this target will require considerable improvement in Scotland's economic performance. We have therefore set an immediate target:

• to raise Scotland's GDP growth rate to the UK level by 2011.

Diagnosing Scotland's poor economic growth performance. In the long-term, there are three means by which the sustainable rate of economic growth in Scotland can be accelerated and by which per capita incomes will be raised:

• increasing the level of labour productivity and competitiveness;
• increasing the participation rate and so the number of people actually working; and
• increasing Scotland's population and the supply of potential workers.

These effects can be mutually reinforcing. By making Scotland a more prosperous place to live and work, for example, we are more likely to attract highly skilled people to contribute to, and share in, that prosperity; higher wages make work a more attractive proposition increasing participation in the workforce; and higher economic growth can increase the attractiveness of Scotland in a world where mobile businesses look to invest in successful places with a critical mass of knowledge, skills and connectivity.

B.2 PRODUCTIVITY

If Scotland is to become a more attractive destination for investment, offer higher wages and increase exports, it will need to improve its productivity and international competitiveness. Labour productivity (as measured by GDP per hour worked) provides an effective, internationally recognised and comparable measure of competitiveness. Scotland outperforms a number of our competitors, including Canada, Switzerland and Japan. However, the UK's labour productivity is 2.8 per cent higher than in Scotland and productivity is significantly higher in, for example, the US (20.5 per cent higher), France (22.2 per cent) and, among the Arc of Prosperity, in Ireland (25.5 per cent) and Norway (66.6 per cent).

Figure B3: GDP per hour worked (Index: Scotland =100) 2005

Source: Organisation for Economic Co-operation and Development ( OECD) (2007), Office for National Statistics (2007)

Low labour productivity translates into low wages and poor living standards: profitable businesses will pay workers no more than they produce. Consistent with poor productivity performance, average gross weekly earnings in Scotland are 3.3 per cent lower than the UK average, although this is mainly due to the relatively high levels of earnings in London and the South East ².

Our productivity target. Increased competitiveness will be at the heart of a faster growing Scotland. At present, we sit in the lower half of the second quartile of the OECD economies in terms of productivity as measured by GDP per hour worked.

The Government has, therefore, set a long-term target:

• to rank in the top quartile for productivity amongst our key trading partners in the OECD by 2017.

Diagnosing Scotland's poor productivity performance. There is compelling international evidence that higher levels of investment, skills, innovation and enterprise can generate improvements in productivity.

Investment. Whilst evidence is limited as to the effects of investment in physical capital on Scotland's labour productivity performance, research ³ exploring why UK productivity lags behind that of the United States, France and Germany, identified that different levels of investment in physical capital stock accounted for the largest proportion of the productivity gap. It accounted for 51 per cent of the gap with the United States, 80 per cent of the gap with France and 81 per cent of the gap with Germany. How resources are used also has a considerable impact on productivity performance - this is often due to differences in management practices, production processes, and the role of complementary investments and innovations. In particular, evidence suggests that part of the productivity gap between the UK and the US is due to differences in how information and communication technology ( ICT) investment has been utilised, as opposed to differences in the actual levels of investment in ICT⁴. There are also emerging opportunities for productivity improvements to be achieved through better resource efficiency, including greater energy efficiency and improved waste management.

Skill levels. Scotland's people are our greatest asset and this is borne out by Scotland's relatively strong performance in international benchmarking exercises on skills and qualification levels. Many indicators show that Scotland's labour quality is within the top tier of comparator countries ⁵. However, we can do even better. In particular, we must address the considerable proportion of the Scottish population aged 25-64 which has not reached at least an upper secondary education (31 per cent). On this measure, Scotland outperforms a number of the Arc of Prosperity countries, although lags behind Norway, Denmark and Finland ⁶. Scotland also faces the challenge of providing more choices and more chances for young people. In 2003, Scotland had the third highest proportion of young people outside of education, employment and training among OECD economies ⁷.

Our strong performance on skills and qualifications does not feed through effectively enough to productivity. It is essential that we empower our current and future workforce to use their skills creatively and innovatively in our economy. This can be achieved by focusing on a range of higher level core skills such as enterprise and controlled risk taking, collaborative skills, conceptual and creative thinking skills and research skills. This can make a decisive difference in driving productivity growth and transforming how our businesses operate. This is a key challenge to our schools, colleges, universities and employers. Recent research, ⁸ for example, has highlighted that despite rising skill levels over the past twenty years, there has not been an accompanying rise in the level of influence which employees report they can exercise over their jobs. This is in contrast to the reported findings of similar surveys in Germany, Sweden ⁹ and Finland ¹⁰.

Research & Development and Innovation. Scotland's total gross expenditure on Research and Development ( R&D) as a proportion of GDP is slightly lower than the UK rate and considerably below levels prevailing in Finland and Denmark ¹¹. The rate of patents filed ¹² in Scotland is also low relative to other parts of the UK - in 2004, 2.1 patents were filed per 10,000 population in Scotland, compared to the UK average of 3.1. While the rate of expenditure on R&D in Higher Education is in the top quartile of OECD economies and government R&D spend is above the average EU 25 and OECD rates, business expenditure on R&D in Scotland is less than half the UK rate. Scotland's business R&D statistics, however, do not take into account all of the innovative activity undertaken in the Financial Services sector. Moreover, R&D statistics provide only a partial view of Scotland's performance on innovation as the focus is on 'technical R&D' rather than a wider concept of innovative activity that would include process and service design innovation. Scotland ranks in the second quartile of EU members in the Community Innovation Survey ¹³, which reported that the majority of Scottish firms (56 per cent) were engaged in some form of innovation activity during 2002-2004, broadly in line with the UK average.

Enterprise. Scotland's enterprise performance can also be improved. In 2005, the rate of VAT registrations in Scotland was well below the UK average. The Global Entrepreneurship Monitor's ( GEM) Total Early-Stage Entrepreneurial Activity ( TEA) Index ¹⁴ allows for international comparisons of entrepreneurial activity. In 2006, TEA in Scotland was 4.2 per cent of the working age population. This is below the rates found in the Arc of Prosperity countries. Norway and Iceland had particularly high rates at 9.1 per cent and 11.3 per cent, respectively.

B.3 PARTICIPATION

Scotland's labour market is currently strong compared to its historic position, with an employment rate of 77.2 per cent and an International Labour Organisation ( ILO) unemployment rate of 4.5 per cent ¹⁵. In relation to both these indicators, Scotland outperforms the UK average. However, Scotland continues to lag behind the strong regional economies in the South of England. For example, the South East has an employment rate of 78.6 per cent and an unemployment rate of 4.2 per cent.

Figure B4: Scotland's employment rate versus UK employment rate, 2000-2007

Source: Office for National Statistics

Scotland's employment rate is around 8 percentage points higher than the EU27 average and recent improvements suggest a healthy trend ¹⁶. Scotland's participation record is mid-range among the Arc of Prosperity countries. While there are statistical issues around comparability, Denmark's employment rate is currently 6 percentage points higher than Scotland's, and Norway's more than 4 percentage points higher. ¹⁷

Over 600,000 people in Scotland are classified as economically inactive, with 285,000 people of working age - 9 per cent of the working age population - on Incapacity Benefit in 2006 ¹⁸. Almost 30 per cent of those who are economically inactive report that they want to work ¹⁹. It is vital that there are more employment opportunities in Scotland and there are more opportunities in particular for our young people to get good jobs and rewarding careers.

Our participation target:

• to maintain our position on labour market participation as the top performing country in the UK and close the gap with the top 5 OECD economies by 2017.

B.4 POPULATION

Population growth is not an end in itself. It is a key contributor to, and consequence of, a more vibrant society and a more dynamic economy. From the 1950s to the mid 1990s, Scotland's demographic trends reflected its economic performance, resulting in substantial net out-migration. Scotland's population stands today at just over 5 million people, and population growth has lagged significantly behind the UK over the last ten years. Indeed, despite benefiting in the last few years from the substantial influx of people from Central and Eastern Europe, Scotland's population grew by less than 1 per cent over this period ²⁰.

This contrasts with the Arc of Prosperity countries, where, for example, between 1997 and 2006, Ireland and Iceland witnessed population growth of roughly 15 per cent and 11 per cent, respectively.

Figure B5: Population growth, 1997-2006, Scotland, the Arc of Prosperity and UK

Source: Eurostat, General Register Office for Scotland

Looking ahead, consistent with most European countries, Scotland is projected to experience a significant demographic shift, leading to an increase in average age, with only the over 60 age group projected to grow over the period to 2031. This highlights the importance of increasing healthy life expectancy in Scotland. Without increasing labour participation among older people or attracting more people of working age to Scotland, adverse economic impacts are likely. Among the Arc of Prosperity countries, Ireland stands out with population growth of over 20 per cent projected for the period to 2031 ²¹.

Our population target. Previous approaches have acknowledged that Scotland's demographic challenge must be addressed. It is clear that Scotland requires a more ambitious target for population growth. Therefore, our target for Scotland is:

• to match average European ( EU-15) population growth over the period from 2007 to 2017, supported by increased healthy life expectancy in Scotland over this period.

B.5 SOLIDARITY, COHESION AND SUSTAINABILITY

Solidarity: improving social equity. The Arc of Prosperity countries are both wealthier per person and have lower levels of income inequality than the UK. The recent experience of our neighbours shows that Scotland will do better when more people in Scotland do better.

In 2005-06, around 14 per cent of income in Scotland was held by the bottom three income deciles, and around 52 per cent was held by the top three income deciles. Over the period 2000-01 to 2005-06, the share of income accounted for by the bottom three deciles has remained relatively unchanged. As a group, the bottom three income deciles capture the people in Scotland who are living in relative poverty. ²² There is, therefore, a continuing problem of the persisting level of inequality.

Our solidarity target: Previous approaches have adopted a wide range of targets aimed at increasing opportunities for the vulnerable and disadvantaged. However, there has not been an explicit target to reduce disparities between richest and poorest. In order for Scotland to be fairer, increases in wealth must reach those on the lowest incomes.

Therefore, our target will be:

• to increase overall income and the proportion of income earned by the three lowest income deciles as a group by 2017.

Cohesion: improving regional equity. As well as high levels of inequality in Scotland between income deciles, there are serious inequalities between the performance of our regions. The proportion of people claiming unemployment benefit ranges from 0.8 per cent in Aberdeenshire to 5.3 per cent in Glasgow ²³.

Economic inactivity rates (the proportion of the working-age population who are neither in employment nor looking for employment) vary even more dramatically across Scotland. Persistent pockets of multiple deprivation remain. In Scotland's most deprived communities (accounting for 15 per cent of the population), 35 per cent of the working-age population were economically inactive in 2006. At the higher spatial level of local authorities, economic inactivity rates vary from less than 15 per cent in Midlothian to 20 per cent or above in much of west central, central Scotland and Dundee, peaking at nearly 30 per cent in Glasgow ²⁴.

Figure B6: Economic Inactivity Rate by local authority area, Scotland, 2006

Source: Scottish Government

As at the national level, the number of people on Incapacity Benefit is a key factor in determining economic inactivity in local authority areas. Again, the degree of regional inequality is reflected in the gap between the three local authority areas with the lowest and highest percentage of their working age population on Incapacity Benefit:

• Lowest: Orkney (5.1 per cent), Aberdeenshire (5.2 per cent) and Shetland (5.2 per cent);
• Highest: North Lanarkshire (12.7 per cent), Inverclyde (12.8 per cent) and Glasgow (14.4 per cent).

Earnings also vary significantly across Scotland's local authority areas, with more remote rural areas suffering lower wages than average. The lowest waged local authority area in 2006, the Scottish Borders, registered median gross weekly earnings 30 per cent below those in East Dunbartonshire, the highest waged local authority area ²⁵.

Our cohesion target:

• to narrow the gap in participation between Scotland's best and worst performing regions by 2017.

Sustainability: improving intergenerational equity. The challenge is to improve Scotland's environment today and for future generations, while significantly reducing Scotland's negative impact on the global environment. The global imperative to address climate change demands a focus on harmful emissions. Scotland outperforms many of the Arc of Prosperity countries in both the level of net greenhouse gas emissions and in rate of reduction since 1990. While Scotland's greenhouse gas emissions fell faster between 1990 and 2005 than in most other EU15 countries, in 2005, Scotland still emitted more greenhouse gases per person than the EU15 average. These are, moreover, only the emissions we produce, not all the emissions resulting from the goods we consume (many of which are produced elsewhere). One way of measuring this is our ecological footprint, an estimate of the land and sea area needed to provide all the energy, water, transport, food and materials that we consume. The average Scot has an ecological footprint of 5.4 global hectares, significantly higher than the global average. If everyone on Earth lived the same way,
it is estimated that three planets would be needed to sustain us ²⁶.

Our sustainability targets:

The Scottish Government intends to consult on a proposed Scottish Climate Change Bill ²⁷ which will set the ambitious target:

• to reduce emissions by 80 per cent by 2050.

In addition to this statutory target, to ensure the Government's short-term growth target is met sustainably, we will set an accompanying target:

• to reduce emissions over the period to 2011.

We are determined to improve and meet our ambitious sustainability targets. Meeting these targets while increasing economic growth will be a major challenge. However, there are growth opportunities from improving the environment and moving towards a low carbon economy. For example, Scotland has a comparative advantage in alternative energy technologies, and, with 25 per cent of Europe's wind potential and vast renewable reserves, Scotland can be an international leader in this critical sector.

Figure B7: Greenhouse Gas Emissions per capita (2005) and change (1990-2005)

Sources: National Atmospheric Admissions Inventory ( UK); European Environment Agency; UNFCCC National Inventory Submissions; Eurostat.

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