How can Scotland’s economy navigate economic turmoil?

What does “economic turmoil” really mean? Change lies ahead for Scottish businesses; higher borrowing costs for homeowners and the Government are just the first hit. Previously, big currency moves have re-shaped the Scottish economy over a generation. What can we expect now, and is Scotland’s economy flexible enough to react?

Volatility in the 1970s in energy, currencies and interest rates led to significant de-industrialisation in Scotland in the ‘80s. Politics drove some of this, but global forces saw many other economies moving in line. Although this paved the way for a boom in higher value-added services and technology-based sectors, it removed many manufacturers and assembly plants from towns around Scotland. That upheaval brought great strains in terms of dislocation, unemployment and re-training. Are we better placed now to cope?

A lower Pound certainly plays to Scotland’s strengths in tourism and hospitality. But over the last three years, the proportion of visitors from other parts of the UK has grown, meaning that the UK consumer squeeze is a bigger factor than arrivals from overseas. The pressure on real incomes from energy costs will cut discretionary spend on hotel stays, restaurants, pubs and coffee shops. And, while the focus is on Pound weakness, there has been little change in the value of the Pound relative to the Euro. Travellers from the Eurozone are facing a similar currency fall versus the US Dollar: the Euro is at a 20 year relative low, something overlooked amidst the headlines of a crashing Pound. Tourism involves lead-times and may not come through for the Scottish economy as early as 2023, with the shorter term being dominated by pressures from energy and the labour market. Scottish consumers may cut back on foreign travel and spend more at home, but an overall downturn is likely.

One sector that does have competitive advantage and has been gaining traction internationally, is higher education in Scotland. Our universities have continued over the last three years to invest in their campuses and technology. The winners have been Scotland’s longest established universities, climbing up the world rankings. Lockdowns forced a re-evaluation of the university business model as they developed online learning delivery. That experience has helped, even as most teaching has moved back onto campuses.

But it is questionable whether the biggest universities can readily scale-up further to take advantage of the currency opportunity. Already, in Scotland’s largest cities and St Andrews, a significant shortage of student accommodation has developed. Growth during the pandemic, combined with a quick return to physical attendance, has brought pressure on accommodation. The private rented accommodation market has gone into reverse whilst demand for student rooms has grown. The uncertainty in economic outlook combined with some renting restrictions are encouraging many private landlords simply to sell. Students come from overseas to experience internationally-renowned education, but in some cases are ending up bussed in from other locations or staying in hotels. This does not look sustainable, never mind poised for growth.

While the UK’s turmoil looks self-inflicted and unplanned, more experimentation in economic policy is likely internationally as the world economy slows. Even China - a centre of strong growth this century - is facing great challenge. What may follow is a series of competitive devaluations, with a number of countries trying to grab a bigger share of an ex-growth global economy.

The pressures globally are particularly in manufacturing nations such as China and Germany, where shortages in raw materials, semi-conductors and energy have hit production. After two years of strong inflation in manufactures such as cars, consumer interest may not be quickly revived by small currency moves or price cuts. Price sensitivities are not clear.

In general, devaluations hit consumers while typically favouring businesses. But many business sectors may struggle to take any advantage from the potential to boost exports or for import substitution. The UK has become more of a service economy, sectors that often lack open markets internationally. Price is less of a factor than in manufactures. In Scotland, for example, the financial services sector is unlikely to see any business boost from a lower Pound.

Scotland has higher value-added activity in food and drink, including whisky, but may lack the flexibility to really benefit. Brexit raised new challenges in selling to the European Union markets and input costs have risen. For premium products, it is important in a devaluation to capture some of that potential gain by repricing internationally to the extent that markets can bear.

That is, there is little point in merely giving overseas consumers cheaper prices, when the supplier must try to recapture some of that as profit. Usually, that price benefit will matter more than volume increases at a lower customer price. This is well recognised by Asian and North American suppliers of consumer electronics to the UK, who typically charge higher prices here than their product retails at in their home market. It can be difficult to maintain pricing consistency amidst currency volatility, but Scottish producers of premium products should not allow a fall in the Pound to devalue their products in export markets.

Does Scotland now have the labour mobility to re-engineer its economy? Although the strategy is for inclusive growth, economic change and pandemics have knocked the plan off course. It can be attractive politically to support industries hit by input costs and currency volatility, but that can only be an interim measure. The challenge now is to identify the potential winners with sufficient innovation and technological edge to maintain growth against this difficult backdrop. Devaluation is a way of discounting, but Scotland needs to position itself internationally as a quality offering. Coupled with this, thought needs to be given to questions of transition and flexibility. Smaller economies can adapt more quickly, focus now must be on how to support that transformation.

A version of this article was published in The Herald on 21.10.2022.

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