The National:

THE Scottish and UK governments are looking for growth in all the wrong places.

Last week, shadow chancellor Rachel Reeves said: “Economic growth only comes from businesses: big, medium and small. That's the model to grow the economy I believe in – and it's the only one that works." It is not the only way, and as we look ahead to the next decade, the evidence suggests that this approach will not work at all.

To grow GDP, a country can do only four things. It can increase government spending (G), public sector consumption (C), public sector investment (I), or net exports (X-M). The expenditure method of accounting for GDP is expressed as: GDP = G + C + I + (X-M). So let’s take each one, briefly in turn, to see where growth can come from.

GOVERNMENT SPENDING

A SIMPLE way to raise GDP is for the central government to significantly increase government spending. I maintain that the UK would still be in a recession without interest payments on government debt. Interest payments on government debt (now almost £200 billion since April 2022) are never questioned, but removing spending on public services must be judged by a very different set of rules.

We live in “fiscally frugal times”. Both main UK partners have agreed to live by the current fiscal rules that will reduce overall government spending over the next term. Let’s clarify: the UK Government will choose not to raise GDP with government spending.

The National:

UK Government spending on interest payments. Source: ONS

Scottish government spending does not boost GDP because all spending has to be funded by taxation. If Holyrood and Scotland’s councils raised taxes, that would reduce consumption by the same amount. This is the life of a currency user. Unable to create new net financial wealth, it cannot increase GDP.

The government sector could theoretically borrow to increase spending, but this would be risky as councils are currently more than £20 billion in debt. Increasing local government indebtedness is no way to increase GDP. Maxing out the available borrowing of £450 million per year for the Scottish Government would have a tiny impact on GDP.

So, what are other countries doing? In Q1 2022, US government spending was $8.25 trillion. Fast-forward two years, and we have a figure of $9.83 trillion. In Q1 2024, the US had 1.6% growth. Government spending is fuelling growth in the US. China's huge deficit spending undoubtedly contributed to its 5.3% Q1 2024 growth. The fiscally frugal UK (0.6%) and EU (0.3%) languished way behind in the growth figures.

CONSUMPTION

ACCORDING to neoliberals, tax cuts boost consumption. This is possible, although evidence suggests that many lower-income people pay off debt instead of consuming, and the wealthy tend to hoard the cash. And, of course, as tax falls, the government spends less, and G falls accordingly. Tax cuts certainly do not increase economic growth.

The other popular “tools” are removing business regulations and increasing labour productivity. Both Edinburgh and London strongly support this approach. I doubt that removing more regulations will increase GDP. And I am even more certain that expecting productivity gains to work will have even less success. The “Ending Stagnation” report from the Resolution Foundation said: “Labour productivity grew by just 0.4% a year in the UK in the 12 years following the financial crisis, half the [average] rate of the 25 richest OECD countries.” If there is a trend harder to change than the UK’s low GDP growth, it is productivity.

And yet, we pin all our hopes on these types of policies. The Scottish National Strategy for Economic Transformation, written for Kate Forbes in March 2022, outlines the Scottish Government’s approach to increasing GDP: “Stimulating entrepreneurship; opening new markets; increasing productivity; developing the skills we need for the decade ahead; and ensuring fairer and more equal economic opportunities” Apart from the last one, these are all classic neoclassical ideas. For Kate Forbes, please see Rachel Reeves.

INVESTMENT

GDP in the medium term will rise if the private sector invests more in capital (machines, factories, etc). But in the short term, you increase investment in the private sector at the expense of consumption. So no short-term fix there. And that’s not the really bad news.

Figures from the World Bank show the dire state of capital investment in the UK. Since 1992, the UK has averaged around 18% of GDP in capital and has one of the lowest rates in the OECD. For example, the UK hit that 18% mark in 2022, Australia and Canada invested 23%, Japan 26%, Sweden 27% and South Korea 32%.

The National:

The UK’s dire investment in Capital is a historic trend like GDP that will prove exceptionally difficult to reverse.

EXPORTS − IMPORTS

THE UK last had a trade surplus in 1997 (apart from the 2020 Covid year). I have used the figures for the UK as there are no completely reliable figures for Scotland. Still, I believe Scotland likely mirrors the UK, running a significant overall trade deficit each year.

The National:

Source: Microtrends

Increasing GDP through exports would have to reverse a long-term trend and overcome the handicaps of Brexit.

The Scottish Government lacks the economic levers to grow the economy, and it faces a global environment that is almost anti-growth. Its place in a Union where the party in power will keep the most important tool – increasing government expenditure – firmly locked in the cupboard almost certainly removes the chance for significant GDP growth.

In seeking economic growth, the Scottish and UK governments are looking in all the wrong places: deregulation, attracting foreign investment and embracing free-trade areas like freeports. Significant GDP growth is a mirage and will deeply damage the Scottish economy. Exactly how damaging will be the subject of our last article on GDP.