Scottish Economic ReportJune

2002

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SCOTTISH EXECUTIVE Making it work togetherw w w . s c o t l a n d . g o v . u k

2002The Scottish Economic Report June

SE/2002/110: Laid before the Scottish Parliament by the Scottish Ministers, June 2002.

ContentsPage

Preface iv

Chapter1: Global, European and UK Economic Developments 1

1.1 Scotland in the Global, EU and UK Context 2

1.1.1 Integration with UK Economy and Rest of the World 21.1.2 Scottish Trade in the Global Environment 51.1.3 Inward Investment 6

1.2 Economic Developments and Prospects in the Global Economy 6

1.2.1 Recent Developments and Indicators 61.2.2 Economic Developments in the Euro Area 81.2.3 Economic Developments in the US 121.2.4 Future Prospects and Risks for the Global Economy 13

1.3 The UK Economy 19

1.3.1 Overview 191.3.2 Recent Developments and Risks 201.3.3 Current UK Monetary and Fiscal Indicators 211.3.4 Prospects and Forecasts for the UK Economy 221.3.5 Budget 2002: Announcements and Economic Impact 25

Chapter 2: Report on Economic Development Initiatives 29

2.1 Education 312.2 Support for Infrastructure 342.3 Enterprise Support and Skills Development 382.4 Rural Scotland 442.5 Social Justice 462.6 European Structural Funds 49

Chapter 3: The Scottish Economy: Recent Developments and Future Prospects 51

3.1 Summary 523.2 Output 523.3 Demand 583.4 Labour Market 593.5 Costs and Prices 623.6 Housing Market 623.7 Independent Forecasts 663.8 Assessment 68

Annex � Summary of Recent Business Survey Evidence 70

Chapter 4: Selected Economic Issues 71

A The Regional Employment Contribution of the Fisheries Sector to theScottish Economy 72

B Enterprise Fellowships: Stimulating Innovation and Entrepreneurship 81

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Preface

This is the sixth edition of the ScottishEconomic Report. It is published twice-yearly and incorporates a review of theprogress and prospects for the ScottishEconomy, together with a review of thebroader economic context in which theScottish economy is set. Additionally,there is a selection of summary articles onissues of key topical interest.

The Scottish Economic Report June 2002

This edition of the Scottish EconomicReport has four parts to it:

� Chapter 1: Global, European andUK Economic Developmentsprovides an overview of the importanteconomic developments in the Global,European, and United Kingdomeconomies and the economic contextfor Scottish economic developmentover the recent past; and the outlookfor future prospects;

� Chapter 2: Report on EconomicDevelopment Initiatives sets out asummary of recent policydevelopments in the economicdevelopment field, providing a follow-up to the Executive�s approach thatwas established in the Framework forEconomic Development in Scotland in2000;

� Chapter 3: The Scottish Economy:Recent Developments and FutureProspects provides an overview of theScottish economy. This sectionsummarises the recent developmentsand prospects for the Scottisheconomy;

� Chapter 4: Selected Economic Issuesprovides an opportunity for briefsurveys of selected economic issues to

be presented. The papers are intendedto review or summarise moresubstantive documents or work ofvalue to the thinking of the ScottishExecutive, or to provide an opportunityto present new or different perspectivesto stimulate further debate in areas oftopical interest.

This edition incorporates two articles:

• The Regional EmploymentContribution of the Fisheries Sectorto the Scottish Economy: This articlesummarises the main results of a recentpaper that was compiled to examinethe contribution of the fisheriesindustry to the Scottish economy.

• Enterprise Fellowships: StimulatingInnovation and Entrepreneurship:This article outlines the public policycontext of this programme anddescribes its development since itsinception in 1996/97. It alsosummarises the results of a formalreview and evaluation, drawingconclusions for the public policy goals.

Other economic publications

This year has seen two other importantpublications in addition to the ScottishEconomic Report. Firstly, the publicationof Scottish Economic Statistics 2002occurred in March 2002, again presentingthe development programme for economicstatistics in the Scottish Executive for thecoming year and beyond � in the chapterentitled the Scottish Economic StatisticsProgramme � and the full range ofeconomic statistics that are currentlyavailable for the Scottish economy.

Secondly, we have established an internet-based Economic Discussion Paper Series,which is now disseminated through the

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Scottish Executive websitehttp://www.scotland.gov.uk. This providesa vehicle for making available some of theunderlying work that has either beencommissioned by the Executive fromexternal experts to inform the developmentof economic thinking within theExecutive, or has been undertaken byeconomic staff within the Executive itself.It will � where appropriate � be moredetailed than the work presented in theScottish Economic Report and moretechnical in nature. It will, generally,relate to the current policy interests of theExecutive and to the debate in these areaswhich the Executive is keen to promote.

Acknowledgements

Finally, in addition to those named authorsin chapter 4, I would like to acknowledgethe major contribution to the preparationand compilation of this report by RichardMurray, Assistant Economist in theScottish Executive. Chapters 2 and 3 alsoreflect the major contributions from StevenMcMahon and David Rennie, and from avariety of other contributors across theGovernment Economic Service in theScottish Executive.

Dr Andrew Goudie.Chief Economic AdviserJune 2002

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2002

chapter one: Global, Europeanand UK EconomicDevelopments

Chapter One: Global, EU and UK Economic Developments1

This chapter has three themes: the firstrelates to Scotland in the global, EUand UK contexts; the second looks atglobal and EU developments; and thethird considers UK economicdevelopments and prospects.

1.1 Scotland in the Global, EUand UK Context

The January 2002 edition of theScottish Economic Report outlined theimportance and influence of externalforces on the Scottish economy,focusing on Scotland�s main tradingpartners. This edition of the Reportgoes further to examine how integratedthe various sectors of the Scottisheconomy are in the global economy,including the importance of our maintrading partner � the rest of the UK. Inthis regard, it is important to examineboth trade flows and capital flowsbetween Scotland and the rest of theworld. Inward investment to Scotland,for example, not only createsemployment and boosts nationaloutput, but also brings new skills andproduction methods that benefit oureconomy as a whole.

Understanding the linkages betweenScotland and her trading partners iscrucial to ensure that Scotland remainswell placed to reap the benefits of theglobal economy. These linkages also

help us to understand the potential sizeof the impact of any external shocks tothe Scottish economy. The recentglobal slowdown, particularlydevelopments towards the end of 2001,highlighted Scotland�s susceptibility toexternal fluctuations.

1.1.1 Integration with UKEconomy and Rest of the World

Scotland, as a small open economy,has extensive trade links with not onlythe rest of the UK, but also with theglobal economy. These linkages can behighlighted through the use of theInput-Output Tables and Multipliersfor Scotland 1998.

The gross value of imports and exportsat basic prices between Scotland andthe UK, and between Scotland and therest of the world (RoW) is illustrated inTable 1.1. It is clear that the UKrepresents Scotland�s most importantmarket place: exports to the rest of theUK (RUK) account for just over 50 percent of total exports from Scotland,and imports from the rest of the UKaccount for around 64 per cent ofScotland�s total imports. Scotland�sbalance of trade with the rest of theworld is positive, implying thatScotland makes a positive contributionto the UK�s external trade position.

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The contribution of Scottish trade tototal UK trade is analysed using input-output tables for Scotland and the UKin Table 1.2. The table shows thecontribution of Scottish trade with therest of the world to UK exports andimports. Scotland�s agriculture,forestry and fishing makes the greatest

sectoral contribution to the UK total,accounting for 37 per cent of UKexports in that sector. With regards toimports, the financial services sector inScotland accounts for the largest shareof UK imports, with 14 per cent oftotal UK imports for the finance sector.

Table 1.1: Trade in Products, Scotland 1998

(£milion)

ProductImports

RUKExports

RUKImports

RoWExports

RoWTotal

ImportsTotal

ExportsAgriculture, Forestry & Fishing 456 725 568 718 1023 1443

Mining etc. 790 999 83 1439 873 2438Manufacturing & Construction 21101 10342 13918 17487 35019 27828

Energy 541 253 42 78 583 331

Distributive Trades 827 3440 524 0 1351 3440Transport & Communication 1553 2809 833 574 2386 3382

Financial Services 2041 1863 196 656 2236 2519Business and Other Services 3645 2344 1275 726 4920 3070

Total 30953 22774 17439 21677 48392 44452

Source: Input-Output tables and multipliers for Scotland, 1998

(per cent)

Product Imports Exports

Agriculture, Forestry & Fishing 10 37

Mining etc. 1 19

Production & Construction 8 11Distributive Trades 6 0Transport & Communication 7 5Financial Services 14 8

Business and Other Services 7 3Total 7 10

Source: Input-Output tables and multipliers for Scotland, 1998

Table 1.2: Scottish Trade with Rest of the World as a % of UK Trade, 1998

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The export and import intensities ofthe broad industrial sectors of theScottish and UK economies, based ontotal output at basic prices, areillustrated in Table 1.3. The first fourcolumns examine Scottish and UKtrade with the rest of the world, whilethe final two columns look at Scottishtrade with the rest of the world,including the rest of the UK.

Looking at Scottish trade in general, itis clear that the mining and production& construction sectors account for thelargest proportion of Scottish exportsas a percentage of total output.Production & construction alsoaccount for the largest proportion ofScottish imports. Overall, Scottishexports to the rest of the world accountfor 16 per cent of total output,compared to 13 per cent for UKexports to the rest of the world.However, the roles are reversedregarding imports, with imports from

the rest of the world to Scotlandaccounting for 13 per cent of totaloutput, compared with 15 per cent forthe UK. This implies that the UK andScottish economies have a similardegree of openness to trade with therest of the world.

However, it is important to realise thatScotland�s main trading partner � therest of the UK � is excluded from thesefigures. Therefore, by examining thefinal two columns of Table 1.3, it isclear that Scottish exports and importsto the rest of the world, including tothe rest of the UK, were 32 per centand 35 per cent of output respectively� both substantially higher than thecorresponding figures for the UK.Although this is not comparing like-with-like, this emphasises the greaterdegree of openness of the Scottisheconomy compared with the UKeconomy as a whole.

Scot Imports Scot Exports UK Imports UK Exports Scot Imports Scot Exports% output % output % output % output % output % output

Agriculture, Forestry & Fishing 17 22 27 9 31 44

Mining etc. 2 40 28 34 25 69Production & Construction 28 35 35 29 71 56

Distributive Trades 3 0 4 1 7 18

Transport & Communication 8 6 10 9 24 34

Financial Services 3 10 1 7 34 38Business and Other Services 3 2 3 4 11 7

Total 13 16 15 13 35 32

Source: Input-Output tables and multipliers for Scotland, 1998

Trade with RoW Trade with RoW & RUK

Product

Table 1.3: Imports and Exports as a Percentage of Output, Scotland & UK, 1998

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1.1.2 Scottish Trade in the GlobalEconomic Environment

The Scottish economy is relativelysmall and open, and highly integratedwithin the global economy through adiverse range of international linkages.Thus, Scotland is highly exposed tosignificant developments within theglobal economy. A prime example ofthis was the recent global slowdownand the subsequent negative impact onthe performance of the Scottisheconomy.

Except for Japan, most of Scotland�skey trading partners will experiencepositive output growth in 2002,according to the OECD, with quarterlygrowth expected to pick up rapidlytowards the end of 2002. The UKeconomy � Scotland�s main tradingpartner � is expected to grow stronglyin 2002, with a growth forecast of 1.9

per cent from the OECD. Thesedevelopments should have a positiveimpact on activity in Scotland, asexternal demand for Scottishmanufactured goods will be expectedto increase in line with the globalrecovery.

OECD forecasts of GDP growth inScotland�s key global trading marketsin 2002 are plotted alongside therelative importance of these marketsfor Scottish exports in Chart 1.1. Thedegree to which our trading partnersare in the upper right hand quadrant,the greater the impact on Scottishgrowth prospects. Here the onlycountry in this quadrant is France, withboth the US and Italy close by. This isparticularly significant as Franceremains one of Scotland�s principleoverseas trading partner, accountingfor around 14 per cent of Scottishmanufactured exports2.

Chart 1.1: GDP Growth and Distribution of Scottish Manufactured Exports

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1.1.3 Inward Investment

The rapid growth in foreign directinvestment over the past 30 years hasbeen an important aspect of theglobalisation process. Scotland inparticular has benefited from suchinward investment in terms of bothincreased output and employment, plusthe associated spill-over benefits ofskills and lessons learnt from foreigncompanies.

Recent trends in inward investmenthave shown a decline over the past fewyears, and initial figures for the middlepart of 2001 show that investment wasfairly subdued. This was hardlysurprising given the state of theinternational economic climate and theuncertainties as to market andinvestment intentions. This uncertaintywas exacerbated following the tragicevents of 11 September. In the latterpart of 2001, and in the early part of2002, there have been signs ofincreased investor confidence.However, it is important to note thatsuch levels of foreign direct investmentare still below the levels of previousyears. Despite this, the market forforeign investment is improving and itis hoped that Scotland will be wellplaced to benefit from this.

Ernst & Young�s European InvestorMonitor released in April 2002 reportsthat inward investment, based on thenumber of projects, fell by 12 per centacross Europe and by 34 per cent in theUK in 2001. Despite this, manyapplicant countries seeking EuropeanUnion membership (e.g. CzechRepublic and Hungary) recorded anincrease in inward investment. Ernest& Young expect growth in foreigndirect investment to return to previouslevels by the end of 2002.

1.2 Economic Developmentsand Prospects in the GlobalEconomy

1.2.1 Recent Developments andIndicators

Data for the first few months of 2002suggest that the global slowdown hasbottomed out, with the US and, to alesser extent, Europe and Asia,showing tentative signs ofimprovement. Nevertheless,uncertainties remain, notably in Japanand Argentina.

Although the economic implicationsassociated with the terrorist attacks of11 September had an immediateimpact on confidence and activity �particularly in the travel and aviationindustries � these were short-lived.Overall, it is becoming clear that thiswas a one-off shock to the globaleconomy and that it is not expected toprevent the global economy fromrecovering in the first half of 2002.

In addition to signs that output growthwill continue to accelerate in 2002,inflationary pressures within the globaleconomy are forecast to remainsubdued. The International MonetaryFund3 (IMF) forecasts that worldinflation will fall to 1.3 per cent in2002, the lowest level since recordsbegan in 1970. This has partly been areflection of weaker global activity,coupled with moderate wage increases.However, concerns over low inflationwill be eased as it is expected thatprices will rise as the recovery beginsto gather pace, with there being adecline in excess capacity and a rise incommodity prices, especially oil.Deflationary concerns still exist inJapan, however, which experienced its

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fourth successive year of an overall fallin general prices.

Interest rates for the main advancedeconomies have remained unchangedin the first half of 2002, and it is nowexpected that in the months aheadattention will need to turn towardreversing earlier monetary policyeasing. Interest rates in the US and theEuro area have remained at 1.75 percent and 3.25 per cent respectivelyduring the year, with interest rates inJapan remaining close to zero.

Unemployment in the US and Europeincreased throughout the second half of2001 and the first half of 2002, as theglobal economic slowdown, along withthe events of 11 September, promptedcorporate retrenchment and re-structuring in many industries. Theaverage unemployment rate foradvanced economies was 6 per cent in

2001, and is projected to rise to 6.4 percent for this year. Of particular concernhas been the continued rise inunemployment in the Euro area whichis currently averaging 8.4 per cent.

The rates of GDP growth andunemployment of the G74 economiesand the Euro area in 2001 areillustrated in Chart 1.2. The US and theUK were very close with respect tohaving high growth and lowunemployment. In contrast, theperformances of the major Euro areaeconomies were characterised bycombinations of high unemploymentand modest output growth. Japan was aunique case, exhibiting falling GDPand low unemployment (byinternational standards). However,unemployment in Japan has beenedging up over the past few years andis currently running at a historicallyhigh rate.

Chart 1.2: G7 Unemployment Rates and Growth in Real GDP for 2001

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As highlighted in the January 2002edition of the Scottish EconomicReport, the recent global downturn hasbeen more synchronised than pastrecessions. This was due principally toa number of factors:

� The commonality of shocks �notably, the bursting of theInformation and CommunicationsTechnology (ICT) bubble;

� The steady increase in oil prices in2000;

� Tightening of monetary policyfrom mid-1999 to end-2000.

A further factor could be the increasingscale and range of linkages betweenthe world�s economies, particularly inthe corporate and financial sectors.

There has been much debate aroundwhether or not the global recovery willbe as synchronised as the downturn.The IMF predicts that the recovery willtake hold in most regions in the firsthalf of 2002, with the US taking thelead. However, they expect the natureand pace of the recovery will varydepending on the depth of thepreceding downturn, the openness ofthe economy concerned, the extent ofpolicy stimulus, and country-specificfactors and constraints.

1.2.2 Economic Developments inthe Euro Area

The Euro area, having experienced adecline in output growth towards theend of 2001, recovered slowly in thefirst quarter of 2002.

The continued weakening in the globaleconomy, coupled with the events of11 September, contributed to a 0.2 percent contraction in GDP in 2001 Q4 -the first drop in Euro area output foralmost 9 years. For 2001 as a whole,

output grew by only 1.5 per cent. Thisillustrated vividly that Europe lackedthe strength required to take up theslack in the world economy once theAmerican boom had faltered.Furthermore, recent evidence tends tosupport the notion that it will beAmerica rather than Europe that leadsthe way in pulling the global economyout of its recent lull.

The Euro area recorded a slightimprovement in the first quarter of2002, with annualised growth of 0.1per cent. The European Commission�sSpring forecasts predict that outputwill grow by 1.4 per cent in 2002,recovering more strongly in 2003 withgrowth of 2.9 per cent.

Despite this prognosis, there are stillsome economies in the Euro areawhich have continued to prosper inrecent times, namely Spain, Irelandand Portugal. It is the fact thatGermany, France and Italy � the threelargest economies in the Euro area,accounting for 70 per cent of output �struggled towards the end of 2001 thathas led to the slow growth in the Euroarea. Problems in the Germaneconomy have been well documentedsince the middle of 2001, withforecasters predicting unspectaculargrowth in the future. German GDPgrew by a meagre 0.6 per cent in 2001,the lowest rate in the EU. However, theGerman economy, which was in atechnical recession for the second halfof 2001 with output falling in twosuccessive quarters, did grow by 0.2per cent (quarter-on-quarter) in the firstquarter of 2002, indicating that theGerman economy has moved out ofrecession.

So why has the Euro area failed torecover as quickly as the US?Commentators highlighted two main

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constraints on the Euro area economiesas being part of the explanation:

� European Monetary Union, with asingle interest rate for the entireEuro area, may have played a part.The European Central Bank (ECB)was widely criticised for not beingaggressive enough in cuttinginterest rates in response to theglobal slowdown. For example,the Federal Reserve cut interestrates by 4.75 percentage points in2001, while the ECB cut rates byonly 1.5 percentage points. TheECB would counter this byarguing that interest rates were setwith the sole objective ofachieving price stability in theEuro area in the medium term. Thepresence of inflationary pressuresin certain countries and theprospect of future price increases,were the main reasons behind theECB�s interest rate decision.

� The Stability and Growth Pactconstrains the ability of nationalauthorities within the Euro area touse fiscal policy to combat thethreat of recession. The Pact statesthat governments must strive tobring their budgets into balance,and they must not allow deficits torise above 3 per cent of GDPexcept in exceptional

circumstances. Therefore countrieswill be limited in the degree offiscal stimulus they can inject intotheir economy in order tostimulate growth. However, theEuropean Union would argue thatthe pact is essential in order tosafeguard sound and sustainablegovernment finances in themedium term.

While the factors above maypotentially impinge on how Euro areaauthorities respond to economichardship in the short-term, Europe�sunderlying economic problems arestructural. For many yearscommentators, and the UKGovernment, have stated that product,labour and capital market reform inEurope is needed. Freeing up certainmarkets, reducing legislation,increasing flexibility, and encouragingcompetition have all been advocated.In particular, it has been stressed thatthe more efficiently Euro area productand capital markets function, thegreater will the success be of labourmarket reforms in creatingemployment opportunities5. Althoughthere are signs of reform, it is stillbelieved that much more is needed ifthe Euro area is to perform asefficiently as the US.

The European Union�s stability and growth pact was set up in 1997 to ensure that EUMember States safeguard sound and sustainable government finances through the medium-term budgetary objective of �close to balance or surplus�. The use of this Pact to control thesize of a member state�s fiscal deficit was highlighted in February of this year when theEuropean Commission proposed that Germany and Portugal should receive a formalwarning over the size of their projected budget deficit.

Germany�s deficit for 2001 was 2.6 per cent of GDP, close to the 3 per cent limit set down inthe stability and growth pact. Similarly, Portugal�s continued budget deficit of 2.2 per centof GDP for 2001 also caused the EC some concern.

Box 1.1: EU Stability and Growth Pact

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Unemployment in the Euro area is stillhigh � averaging 8.4 per cent in 2001compared with 5.5 per cent in the USand 5.2 per cent in the UK. Thecontinued rise in the mismatch of skillsis of particular concern. Chart 1.3shows that the general rise inunemployment over the past 20 yearshas been coupled in the cyclical

process with a rise in the vacancy rate.As a result, the Euro area is left notonly facing the difficulty of findingwork for the large number of peopleunemployed, but also with thechallenge of re-training people in orderfor them to fill the increasing numberof vacancies.

Despite the Commission�s proposals formally to warn the two countries, the finaldecision rests with the European Union�s 15 finance ministers. They rejected theproposal and instead looked to seek assurances from both countries regarding the sizeof future budget deficits. Of particular significance, the German Government insistedthat Germany would bring its public deficit close to balance by 2004 � its previousforecast had been by 2006.

It has been suggested that the rejection of the Commission�s proposal marks asignificant step towards a less rigid interpretation of the stability and growth pact. TheUK has also been the subject of scrutiny by the Commission over its proposed budgetdeficit of more than 1 per cent of GDP until 2006-07. The Commission commented thatthis was �not in line with the requirements of close to balance or in surplus in themedium term (as) contained in the stability and growth pact.� However, as the UK isnot a member of the Euro Zone, it is not formally bound by the penalties contained inthe stability pact. The EU has no power to force the UK to cut public spending or putup taxes to balance the budget.

The UK government has continued to argue that the pact should take into account theeconomic cycle, the need for public investment, and the levels of national debt. Indeedmany commentators have also claimed that there should be a deficit ceiling explicitly incyclically adjusted terms. This would allow much more flexibility in acting to curbeconomic slowdowns whose effects are felt more severely in some parts of the EU thanothers. Certainly, the interpretation of the stability and growth pact remains subject to asignificant degree of uncertainty.

Chart 1.3: Evolution of Skills Mismatch in the Euro area

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After the initial increase at the start ofthe year, Euro area inflation fellthroughout the remainder of 2002. Therise in the Harmonised Index ofConsumer prices (HICP) at the start ofthe year was attributed largely to theintroduction of euro notes and coins(refer to Box 1.2) and the parallel�rounding up� of prices. The benign

inflation trend, along with the slowrecovery in output growth later in theyear allowed the ECB to hold interestrates unchanged at 3.25 per cent sinceNovember. Forecasters are predicting aslight rise in interest rates in the secondhalf of the year as the Euro areaeconomic recovery begins to gatherpace.

On 1 January 2002 Euro banknotes and coins were introduced and all prices in the Euro areawere converted into Euros. By February, only the Euro was the accepted currency in thetwelve countries participating in the European Monetary Union.

Much speculation around the launch of the Euro focused on how this would impact uponinflation in the Euro area. The European Central Bank has an inflation target of below 2 percent (based on the HICP measure) in the medium to long-term. However, commentators hadclaimed that the changeover period would affect the degree of price stability in the Euroarea. Pressure for general price increases would come from companies trying to increasetheir profit margins by rounding up to new attractive Euro prices. Similarly, there is a costassociated to firms when switching the price of goods to the Euro. Here firms would betempted to pass these additional costs onto the consumer.

Despite these apparent inflationary pressures, there are a number of factors that suggest thatthese pressures will be rather limited:

� Competition within most markets will be strong enough to limit any upward rounding;� The economic slowdown around the turn of the year resulted in a weakening in demand,

thereby limiting the scope for price increases;� The publicity given to the possibility of firms taking advantage of the changeover period

by increasing prices has encouraged consumers and consumer organisations to bevigilant and monitor prices;

� Several items in the HICP will remain largely unaffected by any rounding aspsychological price-setting or contractually fixed pricing will prevail.

Chat 1.4 illustrates how the various categories of the HICP have changed in the run up toand the immediate aftermath of the introduction of Euro notes and coins.

Box 1.2: Has the introduction of Euro notes and coins affected inflation in the Euro area?

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1.2.3 Economic Developmentsin the US

Towards the end of 2001, theeconomic prospects for the USeconomy did not look favourable. Thelong anticipated slowdown in 2001,exacerbated by the events of 11September, resulted in a 1.3 per centannual contraction of output in 2001Q3. During the same quarter,unemployment rose and consumer andbusiness confidence both fell.

GDP growth then rebounded toannualised growth of 1.7 per cent inthe final quarter of the year, a revisionupwards of 0.3 percentage points fromthe preliminary estimate. Morerecently, latest estimates for 2002 Q1show that output has continued to growrapidly, with annualised growth of 5.6per cent, the strongest annualisedquarterly figure for almost two years.These unexpectedly favourable outputfigures suggest the recent economic

Here it is evident that the Euro area has experienced a rise in inflation during and after thechangeover period. However, it is very difficult to identify how much of this rise in inflationcan be attributed to the changeover. For example, the price of non-processed foods increasedsignificantly at the start of 2002. Rather than being attributed to the changeover, this was due tothe unusually bad weather conditions in Europe.

Of greater significance is the long-term implications of the introduction of Euro notes and coinson inflation. Here it is more likely that downward price movements should dominate, as thephysical introduction of the Euro will increase price transparency and ultimately strengthenprice competition in the Euro area.

Chart 1.4: Components of HICP Inflation for the Euro area

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downturn may have been one of themildest in recent history.

The Federal Reserve�s aggressivemonetary policy loosening in thesecond half of 2001 undoubtedlycontributed to the shallowness of thedownturn. The Federal Reserve cutinterest rates on 11 occasions in 2001by a total of 4.75 percentage points,leaving interest rates at 1.75 per cent,the lowest for 35 years. However inMarch 2002 the Federal Reserveswitched from a loosening to a neutralstance, implying that they believe therisks to the economy are now evenlybalanced between recession andinflation.

Weak global activity forecast for thefirst half of 2002, coupled with theample domestic spare capacity andstrong productivity growth, shouldhelp ensure that US inflation remainsunder control as economic activity inthe US continues to pick up.

Despite strong growth and lowinflation in the US in the early part of2002, unemployment has continued torise since late 2001. Officialunemployment figures for April 2002showed that unemployment had risento 6 per cent, its highest level sinceAugust 1994. Forecasters6 predict thatunemployment will start to decline inthe second half of 2002 as employersare expected to recruit more workersonce their confidence in the economicrecovery strengthens.

The resilience of consumerexpenditure has underpinned USgrowth during the recent turbulenceand economic uncertainty of recentquarters, and is now a key ingredient inthe current economic recovery.Consumer expenditure grew by 6.1 percent (annualised) in the final quarter of2001, helping to sustain the level of

domestic demand in the US. Consumerexpenditure has continued to grow inthe first quarter of 2001 but at a moresustainable rate of 3.5 per cent.

The fiscal policy of the USgovernment has provided additionalsupport to the economy. The UScongress is discussing the possibilityof a further $25 billion in spending forthe current fiscal year (this is on top ofthe $50 billion announcement foremergency expenditure in theimmediate aftermath of 11 September).This is intended to ensure that the USeconomic recovery does not stall. Inthe longer term, the US governmentplans to cut taxes by $1.35 trillion inthe next 10 years. This will knock thebudget deficit back into the red, withthe deficit forecast to be $106 billionor 1.0 per cent of GDP for 2002/03.

The US economy still faces risks. Ofgreat importance, perhaps, are therising consumer debt (see Box 1.5 laterin chapter) and the current accountdeficit. Indeed, the latter is projected tobe 4.1 per cent of GDP for this year. Ifforeign investors become unwilling tofinance this deficit, and with the USbudget back in deficit, US growthwould necessarily slow. Commentatorshave suggested that this could prompta sharp and destabilising fall in the USdollar.

1.2.4 Future Prospects and Risksfor the Global Economy

The global economic forecasts of theIMF, as presented in the last twoWorld Economic Outlooks, aresummarised in Table 1.4. The trendthroughout 2001 was for forecasts tobe continually revised downwards formost of the world�s advancedeconomies. However, as the overallprospects for an economic recovery in

13

2002 have improved, there has been ageneral move towards revising

upwards growth forecasts for 2002.

World output is expected to strengthenin 2002, with growth of 2.8 per centforecast (up from 2.5 per cent in 2001),before gathering further pace in 2003as growth rises to 4.0 per cent. Worldtrade volumes are expected to expandby 2.5 per cent and 6.6 per cent in2002 and 2003 respectively � a markedimprovement on the slight 0.2 per centcontraction in 2001.

These forecasts underline the expectedreturn in trading confidence following

the uncertainties associated with theglobal slowdown and the events of 11September. However, there areincreasing fears about global traderelations in light of the recentrestrictions placed on steel imports tothe US (see Box 1.3). Should the USgovernment�s action prompt anexpanded trade war, the IMF�sforecasts for trade growth might thenprove overly optimistic.

2001 2002 2003 2001 2002

World Output 2.5 (2.4) 2.8 (2.4) 4.0 0.1 0.4

United States 1.2 (1.0) 2.3 (0.7) 3.4 0.2 1.6Euro Area 1.5 (1.5) 1.4 (1.2) 2.9 0.0 0.2Japan -0.4 (-0.4) -1.0 (-1.0) 0.8 0.0 0.0Germany 0.6 (0.5) 0.9 (0.7) 2.7 0.1 0.2UK 2.2 (2.3) 2.0 (1.8) 2.8 -0.1 0.2Italy 1.8 (1.8) 1.4 (1.2) 2.9 0.0 0.2France 2.0 (2.1) 1.4 (1.5) 3.0 -0.1 0.1Canada 1.5 (1.4) 2.5 (0.8) 3.6 0.1 1.7

Developing Countries 4.0 (4.1) 4.3 (4.5) 5.5 -0.1 -0.2

Source: IMF World Economic Outlook, May 2002

May 2002 Projections (December 2001 in brackets)

Difference from December 2001 forecasts

Table 1.4: World Output Trends and Projections, Percentage Growth 2001 - 2003

On the 20th March 2002, President Bush introduced a stream of tariffs for steel imports to theUS, ranging from 8 per cent to 30 per cent, lasting for 3 years. The introduction of such ameasure was described as a temporary safeguard to enable the US to restructure their steelindustry. Indeed the US industry has struggled recently to compete with cheaper productsfrom abroad, and the US government has argued that this is primarily caused by subsidiesfrom foreign governments.

The European Union, along with a number of other countries including China and Japan, hasdenied the use of such subsidies and has filed a formal complaint against the US action withthe World Trade Organisation. The EU also argues that US steelmakers are inefficient,burdened by wasteful pay and pension agreements, and have been shielded from the marketforces which have led to much consolidation in the steel industry elsewhere in the world.

Box 1.3: Trying to �steel� an advantage?

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The OECD�s latest forecasts,7 like theIMF�s, predict that the global economywill rebound in 2002, with growth of1.8 per cent expected for the OECDarea. This recovery will gather pace inthe second half of 2002 and into 2003,with growth of 3 per cent forecast forthe OECD area in 2003. The OECDexpect the pace of recovery will varyacross the major OECD economiesand, while the downside risks havediminished since last Autumn, policymakers continue to be faced by asubstantial degree of uncertainty.

Inflationary pressures are expected toremain benign in 2002 and 2003, withworld inflation averaging 1.3 and 1.8per cent respectively. Unemployment,

however, is expected to remainrelatively high in 2002 and 2003, withthe major European countriescontinuing to have the highest rates ofunemployment amongst the advancedeconomies.

Among the major emerging markets,the outlook is very mixed. Althoughcountries in Central America areexpected to grow most strongly, thesituation in other countries, particularlyArgentina (see Box 1.4), remainsextremely difficult, with a substantialfall in output in the foreseeable futureappearing increasingly likely. Inemerging Asia, growth in China and,to a lessor extent, India, is expected toremain robust.

In the short term, it is the indirect rather than the direct implications of the tariffs whichare of particular concern to the European Union. At the moment only 5 per cent of EUsteel production is exported to the US. However, the indirect implication of the tariff isthat large volumes of steel exports will be re-directed from the US to elsewhere in theworld. This has serious implications and has led to the EU approving a package of tariffsintended to protect the European steel producers from this expected upsurge in imports.

It is important to recognise that the US tariffs will also have serious implications for theUS economy. Although steelmakers in the US will benefit from these measures, it isargued that the economy as a whole will suffer. Some have claimed that these tariffs willpush up the cost of steel, leading to an overall rise in production costs. This could lead tojob losses in many industries which use steel. This line of argument is furtherstrengthened by the fact that the US consumes more steel than it produces.

Of greater significance is how this will impact upon future global trade relations. It ispossible that the current dispute could stall or even derail the progress on the Dohaagreement to liberalise free trade. This could have implications for issues as varied asEuropean farming subsidies and cheap medicines for developing countries. Therefore itis essential that such specific trade disputes do not affect the overall goal of liberalisingtrade throughout the world.

Five presidents since December 2001, increasing debt burden, an economy which has almostground to a halt, public mistrust in the current government, and a freeze on most bankaccounts, leading to public unrest: the first half of 2002 has been a traumatic time forArgentina.

Box 1.4: Argentina � A Country in Crisis?

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Despite the generally favourableoutlook presented by the IMF andOECD, significant risks were stillidentified. The primary one, perhaps, isthe possibility that the recovery in theUS will be delayed/or weaker thanexpected, due to a prolonged decline ininvestment spending or a sharpweakening in private consumption.The extent to which any upswing in theUS would be transmitted to the othereconomic regions of the world is alsouncertain.

A more likely, albeit less threatening,risk to the global economy is theeconomic future of Japan. The world�ssecond largest economy is showingfew signs of recovery from the periodof economic stagnation that hascharacterised most of the last 12 years.While quarter-on-quarter output grewby 1.4 per cent in the first quarter of2002, analysts still expect Japaneseoutput to contract in 2002 as deepstructural weaknesses, with thepotential to hold back the Japanese

The economic recession in 2001 provided the backdrop to Argentina�s latest crisis, andsparked the outflow of funds from the Argentine banking system in late 2001. Thereasons for this outflow include:

� The central bank ordered a maximum interest rate of 7 per cent on peso loans, in amisguided attempt to instil confidence. The predictable result was a further reductionin credit;

� Political uncertainty within Argentina had led to increasing uncertainties over thefuture of the Argentine economy;

� Most importantly, the International Monetary Fund (IMF) withdrew its support forthe proposed recovery plan. The IMF had helped Argentina with loan arrangementsamounting to $48billion in 2001. However the IMF�s worries arose partly becausethe shrinking economy and the consequent slump in tax revenues meant that therewas little chance of the Government reducing its fiscal deficit to zero, as previouslypromised.

Many commentators have stated that any recovery, both economic and political, isdependent on the Government�s success in freeing its currency without triggering hyper-inflation. The Argentine economy is no stranger to hyper-inflation and a return to such ascenario would undoubtedly trigger further unrest.

After a decade in which the peso was fixed at par with the US dollar, the Governmentintroduced a duel exchange rate. Here some exports, �essential� imports and capitalpayments were fixed at 1.40 pesos to the dollar, while for most other purposes there hasbeen a market rate. This prompted, as expected, a depreciation in the peso. However,time will tell whether or not this will lead to hyper-inflation, or whether the economy�sdeep recession will restrain the inflationary pressures.

Restoration of the banking system in Argentina is also crucial if its economy is to getback on track. This will be inextricably linked to the success of the Government�sattempts to run a duel exchange rate system. Indeed, without a steady currency, there willbe little incentive to either invest or save money in Argentine banks. Furthermore, unlessthe peso remains at a steady rate, the government will not be prepared to lift its corralito:limiting the amount of money people can withdraw from their bank accounts to $1000per month. However, until the citizens of Argentina can spend their own money, it seemsunlikely that the economy will recover from its current recession. That is the Catch 22situation which the Argentine government currently faces.

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economy, remain. For example,institutional and financial weaknesswithin the banking and corporatesectors suggests that investmentspending may remain subdued for theforeseeable future.

A further risk to the size of the globaleconomic recovery is the continuedrise in corporate and household debt.Historically, recessions have beenassociated with a decline in both

corporate and household debt, and it isnot generally until economicconditions begin to look morefavourable that both types of debtbegin to increase. However, the recentglobal recession � one of the mildest inrecent times � has followed acontinued rise in both household andcorporate debt. This could provide adrag on the economic recovery aspeople�s ability to continue to borrowwill be restricted.

Recent history has highlighted that any period of economic �boom� is characterised by anincrease in consumer and business debt, while a recession prompts a decline in debt asconsumers/companies rein in their expenditure. However, the recent global economic recessionhas bucked this general trend, with consumers in particular continuing to borrow money inorder to maintain consumption levels. This has been one of the main contributing factors to therecent recession being one of the mildest in modern history.The root cause of the US recession � which quickly spread to the global economy � was thebursting of one of the biggest financial bubbles in history. However, the depth of the economicslowdown has been limited due to the continued strength in consumer expenditure. This was inthe face of large numbers of job losses, weakening consumer confidence, and great uncertaintyover the timing of the economic recovery. The consequence of this was a further rise inconsumer indebtedness in the US.More generally, there has been a substantial rise in the degree of household debt in many of theworld�s leading economies (see Chart 1.5). The UK has followed a similar spending trend to theUS and has experienced a sharp rise in household debt. The Japanese � traditionally the world�sbiggest savers � are now the world�s biggest borrowers, with debts accounting for 132 per centof their income. Germany has also witnessed a steady rise in household debt, although Francehas managed to keep their household debt under control in recent years.

Chart 1.5: Household Debt as a Percent of Disposable Income

Box 1.5: Implications of Increased Household Debt Throughout the Global Economy

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The continuing unrest in the MiddleEast, the military tensions betweenIndia and Pakistan, and the possibilityof expanded US military action in thewar on international terrorism, posefurther risks to the global economy.These could impact upon the globaleconomy through a variety of differentchannels. For example, the trouble inthe Middle East could spark a sharprise in the price of oil were the supplyof oil to be disrupted or threatened.

The rise in oil prices since the start ofthe year is illustrated in Chart 1.6.Many factors have contributed to thisrise, including uncertainty over theprospective supply of oil fromVenezuela, Iraq threatening to stopsupplying oil to the US, and, most

importantly, the possible implicationsfor the world�s supply of oil if thetensions in the Middle East continue.On the demand side, the continuedeconomic recovery in 2002 will createhigher demand for energy, thus placingfurther pressures on the price of oil.

Oil price movements have a directimpact on the global economy via theireffects on the costs of production,transport and, ultimately, byinfluencing price stability. The IMF�seconometric model, MULTIMODindicates that each $5 increase in theprice of oil leads to a 0.2 per centreduction in annual GDP growth,normally with a six to twelve monthlag8.

This general increase in household debt has serious ramifications for the global economy andcannot continue to increase in the long run. It is possible that excessive debt acts as a drag oneconomic growth, and can amplify the size of future downturns. Indeed many commentatorsbelieve that the current economic recovery will be modest as it started with balance sheets (forboth individuals and businesses) in a more fragile condition than during previous periods ofeconomic recovery. Consequently, there is little room for the increase in borrowing that usuallyleads an economy out of recession. This has been a potential downside to the fact that the recentrecession has been a mild one.

Furthermore, the continued increase in household and business debt will pose potentially biggerproblems in the next downturn as the pressure to re-structure balance sheets may then becomeirresistible. If households and companies try to push their joint net savings back into surplus,this could severely restrain investment and consumer spending, thereby stalling any possibleeconomic recovery.

To tackle this potential risk, commentators have argued that central banks should not only focustheir intentions on price stability, but should also try to control credit and asset prices. In someearlier periods monetary policy has had other objectives, for example that of minimisingunemployment in the 1960s and 1970s. This prompted a period of high inflation, causingmonetary policy to shift its focus to controlling inflation. However, if the continued rise in debtacts to hamper future economic growth, central banks maybe forced to set interest rates to curbexcessive borrowing as well as excess inflation.

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1.3 The UK Economy

1.3.1 Overview

The Chancellor of the Exchequerpublished his Financial Statement andBudget Report on 17 April 2002,setting out the current economicposition and the forecasts for futureyears. The forecasts for the UKeconomy were favourable, with totaloutput expected to increase by 2 to 2½per cent in 2002, rising to between 3and 3½ per cent in 2003. However, theChancellor cautioned that growth ofthe UK economy in 2002 would beaffected by the pace and timing of theglobal recovery.

Official data released since the time ofthe Budget have shown that activity inthe first quarter of 2002 was weakerthan expected by most commentators,including the Treasury: GDP wasunchanged; manufacturing outputrecorded a further sizeable contraction;

and exports fell further. Nevertheless,most commentators agree that theperformance of the UK economy willimprove in the second half of the year.

The UK government�s latest forecasts,as outlined in the Budget 2002, andother recent economic indicators showthat:

� GDP growth is forecast to bebetween 2 and 2½ per cent in 2002,rising to between 3 and 3½ per centin 2003;

� RPIX inflation is forecast to remainaround the UK government�s targetrate of 2.5 per cent for the comingyears;

� Public sector net debt is projectedto fall to around 30.2 per cent ofGDP by the end of 2002-03;

� The UK Government remains ontrack to meet its fiscal rules in theyears ahead, with the currentbudget surplus projected to be £3billion in 2002-03 (0.3 per cent ofGDP);

Chart 1.6: Two Month Future Brent Oil Prices for 2002

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� The Monetary Policy Committeeheld UK interest rates at 4.0 percent at their June 2002 meeting, thelowest rate in 37 years.

1.3.2 Recent Developments andRisks

Despite the difficult global economicenvironment, the UK economyperformed strongly in 2001,underpinned by the resilience ofdomestic household consumption andthe output of the service sector. Servicesector output grew 0.5 per cent in thefourth quarter of 2001, up 3.1 per centon the same quarter of the previousyear. The strength of this growth canbe explained partly by the modestcontribution of exports to UK servicesdemand. Total UK output expanded by2.2 per cent in 2001.

One of the main reasons behind theUK�s strong growth in 2001 was theresilience of household consumptionwhich continued to grow stronglydespite the large uncertainties whichsurrounded the UK economy at thattime. Strong household consumptionhelped to maintain employment at itshighest levels since records began,with unemployment also remaining atrecord low levels. This came at thetime when all major economiesthroughout the world were sufferingincreases in unemployment.

The UK economy could not, of course,escape the global slowdowncompletely unaffected. Thesynchronised world slowdown and thecollapse in demand for ICT-relatedgoods led to a marked contraction inUK manufacturing output and exports,and depressed business confidence andinvestment.

Output in the final quarter of 2001 andthe first quarter of 2002 was flat. This

was the first time the UK economy hasfailed to grow over two successivequarters since 1991. This developmentsuggests that there should be increasedcaution over the timing of the recoveryof the UK economy. The UK�s growthperformance in the first quarter trailedbehind that of many of the G7countries: Germany and France grewby 0.2 per cent and 0.4 per centrespectively, based on quarter-on-quarter growth; the US economy alsogrew strongly, with annualised growthof 5.6 per cent for 2002 Q1.

The manufacturing sector continued tostruggle in 2002, with output falling1.4 per cent in the three months toFebruary 2002, down 6.2 per cent on ayear earlier. However, there are signsthat this decline in manufacturingoutput is set to stabilise and forecastersare predicting a recovery in the secondhalf of 2002 as demand formanufactured goods increases.

The OECD suggest that the biggestrisk to the UK economy in the comingyears is the imbalance between internaland external demand which hasemerged over the past few years.Furthermore, they suggest that somedeep-seated structural problemsremain. In particular, OECDemphasises the importance ofstructural policy aimed at enhancinghuman capital and work incentives,raising competitive pressures andimproving public infrastructure.Overall, the OECD�s assessment is thatUK growth will return to a solid pacesoon, boosted by the expectedturnaround in international trade andthe substantial increases in publicinvestment already announced.

Although the increasing uncertainty inthe Middle East, and its associatedimplications for the world�s oil supply,is a particular threat to the global

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economy recovering in 2002, this willhave a relatively smaller effect on theUK. In general, the shock to the UKeconomy of a rise in oil prices will besmaller than on the US or the Euroarea, owing to the UK�s status as an oilproducing country. This has led toforecasters predicting that the recentrise in oil prices will pose relativelylittle threat to the inflation outlook,even if it were to be permanent.9

1.3.3 Current UK Monetary andFiscal Indicators

Monetary Indicators

RPIX inflation was 2.1 per cent in2001, and � apart from an erraticJanuary figure (2.6 per cent) � hasremained just below the UKgovernment�s target rate in the earlymonths of 2002. The main driver forinflation in recent months has been theincrease in seasonal food prices causedby the unusually bad weatherconditions throughout Europe over theWinter. However, housing costs, whichcontinue to increase as the housingsector remains buoyant, along with therising price of oil, are likely to be themain drivers behind any price rises inthe immediate future.

Against this benign inflationarybackdrop, UK interest rates haveremained at 4.0 per cent sinceNovember 2001, when the MonetaryPolicy Committee (MPC) acted toreduce interest rates in the light of theglobal economic slowdown and theevents of 11 September. Rates wereunchanged at the most recent MPCmeeting on 6 June.

It is useful to remember, however, thatthe MPC must look ahead to themedium term rather than target currentinflationary pressures when setting

interest rates. This is because of thelags associated with the operation ofmonetary policy, typically thought tobe around 18 months. The monetaryframework set up in 1997 ensures thatdeviations below the target rate are justas undesirable as deviations above thetarget rate. Consequently, there is noincentive for the MPC to keep interestrates high when there are lowinflationary pressures in the mediumterm.

The IMF�s inflation forecast10 is veryclose to the Budget 2002 projections,with inflation forecast to be 2.4 percent in 2002, rising slightly to 2.5 percent in 2003.

Fiscal Indicators

The slowdown in the world economyin 2001 has affected the fiscal balancesfor last year. Weaker external demand,lower equity prices and thedeterioration in financial corporations�profits depressed corporation taxreceipts in particular. Despite this, theUK government continued to meet itsfiscal rules11 and remains on track todo so over the next five years.

The forecast for government receiptsfor 2001-02 was revised downsignificantly in the November 2001Pre-Budget Report (PBR), and actualreceipts outturns since November havebeen about £1 billion below the PBRforecast. Despite this, the provisionalcurrent budget outturn shows a surplusfor 2001-02 of £10.6 billion (£0.3billion higher than projected in thePBR), reflecting lower than expectedspending outturns. The current budgetis expected to remain in surplus overthe period to 2006-07 (see Table 1.5),implying that the UK government willmeet its golden rule (i.e. borrowingonly to invest).

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Public sector net debt was 30.4 percent of GDP in 2001-02, and isprojected to fall slightly to 30.2 percent in 2002-03. Over the next fiveyears, public sector net debt is forecastto edge up to around 31 per cent ofGDP, comfortably meeting thesustainable investment rule.

The overall macroeconomic position ofBudget 2002 represents a slight fiscaltightening for this year and next,compared with the November 2001PBR, as growth gathers pace and theeconomy returns to trend. Theprojections indicate that the UK has abroadly sustainable fiscal position inthe long-term, with the impact of anageing population on public financesexpected to be both manageable and

less marked than in most other EUcountries.

1.3.4 Prospects and Forecasts forthe UK Economy

The UK government�s forecasts for themain economic indicators, includinggrowth and inflation, for the next 3years were published in the 2002Budget. The forecast range for outputgrowth for 2002 remained the same aspublished in the PBR in November,with growth of between 2 to 2½ percent forecast. However, the forecastsfor 2003 and 2004 were revised upslightly, indicating that the UKeconomy is expected to strengthenfurther into 2003 and 2004.

Item 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07

Surplus on Current Budget, £bn 21.6 (25.1) 10.6 (10.3) 3 (3) 7 (4) 9 (7) 7 (8) 9 (9)

Public Sector net borrowing, £bn -15.9 (-18.8) 1.3 (2.5) 11 (12) 13 (15) 13 (13) 17 (13) 18 (13)

Public Sector net Debt (per cent of GDP) (2) 31.3 30.4 30.2 30.4 30.4 30.7 31

Cyclically adjusted Net Borrowing (per cent of GDP)

-1.2 0.2 0.9 1.2 1.2 1.4 1.4

Maastricht deficit (3) -1.7 0.2 1 1.1 1.1 1.4 1.5

Maastricht debt ratio (4) 40.1 38 36.9 36.6 36.5 36.6 36.8

1 Including Windfall Tax receipts and associated spending2 Includes WTAS3 General Government net borrowing on an ESA95 basis.4 General Government gross debt on Maastricht basis.

Table 1.5: Summary of UK Public Sector Finances (PBR 2001 forecasts in brackets) (1)

2002 2003 2004

GDP Growth (per cent) 2 - 2.5 (2 - 2.5)

3 - 3.5 (2.75 - 3.25)

2.5 - 3 (2.25 - 2.75)

RPIX (Q4) (per cent) 2.25 (2.25)

2.5 (2.5)

2.5 (2.5)

Source: November 2001 Pre-Budget Report, Budget 2002 Report.

Table 1.6: Treasury Forecasts for UK Economy (PBR 2001 in brackets)

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The latest consensus of independentforecasts12 for the UK economy showsGDP growth of 1.9 per cent and 2.6per cent for 2002 and 2003respectively. This is slightly below theTreasury�s forecast range for 2002, andsignificantly below the Treasury�sforecast range for 2003. The IMF

forecasts are within the UKgovernment�s forecast range,predicting GDP will grow by 2 percent in 2002, increasing to 2.8 per centin 2003. The IMF�s forecast of UKinflation, at 2.4 per cent in 2002 and2.5 per cent in 2003 is also close to theUK government�s forecast.

Trade and Balance of Payments

The synchronised slowdown in theworld economy has inevitably affectedUK trade, with many of our tradingpartners facing economic hardship.

Weak growth in major export markets,along with the slump in demand forhighly traded ICT goods, contributedto a marked contraction in UK exportsin the second half of 2001. At the sametime, imports weakened much more

The rate of trend (or potential) growth is the rate at which the output of the economy can growon a sustainable basis without putting upward or downward pressure on inflation. Factors suchas changes in confidence, demand conditions in the UK�s trading partners, and the stance ofmonetary and fiscal policy, will all have temporary effects on economic growth. However it islonger-term factors, such as growth of productivity and the rate of growth and structure of thepopulation, which all have lasting effects which will alter the trend growth rate.

In the April 2002 Budget, the Treasury announced that it was revising upwards the UK trendgrowth rate from 2.5 per cent to 2.75 per cent. The trend rate of growth calculated by theTreasury is based on four main components: labour productivity; average hours worked; trendemployment rate; and population of working age. The Treasury forecasts the followingchanges to these components over the coming years:

� Labour productivity: projected in line with the evidence of recent years, implying trendproductivity growth of 2 per cent;

� Average hours worked: assumed to decline slightly, by 0.1 per cent a year, in line withthe trend over the 1986 to 1997 cycle;

� Trend employment rate: projected to grow by 0.2 per cent a year (less than has beenexperienced in recent years) through a combination of a decline in the inactivity rate andmodest further falls in the Non-Accelerating Inflation Rate of Unemployment (NAIRU);

� Population of working age: projections are based on the Government ActuariesDepartment assumptions. For the trend rate of growth, it is assumed that net migrationwill be similar to that of the last three years. This implies a contribution to the trend rateof growth of 0.6 per cent a year over the Budget projection period, slightly less than overrecent years.

However, the Treasury uses a different trend growth rate for the public finance projections inorder to take account of forecast risk. The UK Government deliberately uses a cautiousassumption for trend growth for the public finance projections that is ¼ of a percentage pointlower than its neutral view. Therefore, the annual trend growth rate used for public financeprojections will be 2.5 per cent, up from its previous rate of 2.25 per cent.

Box 1.6: UK Trend Growth

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sharply than projected in the 2001Budget, with the net effect being a

moderate widening of the deficit ontraded goods and services.

The UK economy has been growing strongly in recent years, although for the past four yearsthere has been imbalance between the different sectors of the economy. Much has beenwritten about the continued slump in the manufacturing sector, while the service sector hascontinued to grow strongly. The impact of the high value of sterling against the Euro, coupledwith the recent slowdown in the world economy, have exacerbated the long-run differencebetween the two sectors, or to be more precise, between the tradable and non-tradable sectorsof the economy.

Chart 1.7 illustrates the comparative performance of the UK manufacturing and servicesectors, along with the overall growth in output. From 1996 onwards, there is a cleardivergence between the two sectors, with the service sector on a continued upward trend,whilst manufacturing growth has remained static. Indeed, over the past year, manufacturinghas suffered a sharp decline in its output growth.

Chart 1.7: UK Output Growth in Manufacturing, Services and Total GVA

When looking at differences between sectors, it is important to view them in a long-runcontext. Productivity increases at a faster rate, on average, in manufacturing than in otherparts of the economy. Consequently, other things being equal, employment in manufacturingfalls as a share of the total. For example, at the start of the 20th century there were over 100blast furnaces along the banks of the River Tees. Today there is only one plant � Corus atRedcar � which produces more iron than all the 106 combined plants a century ago. Suchproductivity growth will increase the standard of living, but will also result in the share ofmanufacturing in total employment continuing to decline, unless demand increases, forexample from export markets.

Box 1.7: Two Speed Economy?

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The UK government forecasts that UKexports will pick up through 2002 asthe global economic recovery begins togather pace, but year-on-year growth isprojected to be negative for 2002 as awhole, contracting between 1 to 1½per cent. Imports are also expected toaccelerate this year, although theforecast moderation in householdconsumption growth, coupled with theincreasing share of final expenditureaccounted for by governmentspending, will limit import growthover the medium term.

The trade deficit is forecast to widenslightly in 2002 with the balance ofpayments current account deficit risingto 2½ per cent of GDP, from a deficitof 1¾ per cent in 2001. However, theTreasury forecast that the currentaccount deficit will stabilise at 2¼ percent of GDP, a level which is bothreadily financeable and which remainswell below past peaks.

1.3.5 Budget 2002: Announcementsand Economic Impact

The April 2002 Budget outlined themeasures and policy decisions taken bythe UK government to advance theirlong-term goals of:

� Maintaining economic stability,ensuring that the fiscal rules aremet, inflation remains low, and theUK has faster productivity growththan its main competitors;

� Sustaining a higher proportion ofpeople in employment than everbefore, while seeking to ensure fullemployment in every UK region;

� Eradicating child poverty andtackling pensioner poverty,extending opportunities for allchildren and providing security forall pensioners;

� Establishing world-class publicservices, delivering investment toimprove national healthcare for all,raise standards in education,modernise Britain�s transportsystem and tackle crime;

� Tackling global poverty andclimate change, helping to achievethe international community�sMillennium Development Goals by2015, and achieving the UK�scommitments under the KyotoProtocol.

The main announcements in the 2002Budget are summarised in Box 1.8.

Recently, domestic demand has been strong while the trade position has been weak. This yearnet trade is forecast to make a negative contribution to economic growth for the sixth year in arow. Therefore, it is important that such imbalances should be reduced in order for the UKeconomy to continue to grow strongly. The recovery in the world economy will help reducethe existing imbalance. However many commentators have suggested that any unwinding ofthe imbalance between domestic demand and output is likely to involve a slowdown ofconsumption growth in order to release resources that could be diverted to investment and animprovement in the trade balance. This, it is argued, may lead to a fall in the sterling exchangerate to a more sustainable level. However, when and how these adjustments will occur isextremely difficult to know.

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Total public spending13 is forecast toincrease substantially over the next 3years, rising from £392.1 billion in2001-02 to £454.6 billion in 2003-04.The Treasury forecast the tax burden to

increase modestly from 36.7 per centof GDP in 2002-03 to 37.6 per cent in2003-04, with further rises in 2004-05and 2005-06, leaving the tax burden at38.3 per cent of GDP.

� The Scottish Executive budget will increase by £224 million over 2003-04, and by acumulative extra £3.2 billion over the next 5 years, as a consequence of theChancellor�s spending announcements;

� New measures introduced to help small and large businesses: financial assistance forsmall firms� training needs; automatic relief for VAT on bad debts; plan to extendflat rate VAT to more small firms; corporation tax starting rate reduced from 10 percent to zero, with corporation tax for small firms reduced from 20 per cent to 19 percent; and volume-based R&D tax credit for large companies;

� Help for areas of high unemployment: further exemptions from stamp duty for non-residential property transfers in disadvantaged areas; and a new CommunityInvestment Tax Credit to promote enterprise and wealth creation in under-investedcommunities;

� A new Working Tax Credit will be introduced from April 2003 to provide workincentives and help reduce persistent poverty among working people;

� Basic credit on the Working Families Tax Credit will be increased by £2.50 a weekfrom June 2002, on top of the inflation increase;

� Extra 1 per cent of National Insurance Contributions (NIC) paid by employers,employees and the self-employed on all earnings above the NICs threshold of £89 aweek from 2003;

� In total, an extra £4 billion for public spending in the UK next year was announced,with the largest ever sustained increase in health spending.

Chart 1.8: Public Spending and Tax Burden

Box 1.8: Main Budget Announcements

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References

European Central Bank, MonthlyBulletin, April 2002

OECD (2002) Economic Outlook, May2002

IMF (2002) World Economic Outlook,May 2002

SCDI (2001) Survey of Scottish Salesand Exports in 1999

National Institute for Economic andSocial Research (2002), EconomicReview May 2002

Scottish Executive (2001), ScottishInput-Output Tables

HM Treasury (2002), Budget Report,April 2002

HM Treasury (2002), Forecasts for theUK Economy, March 2002

1 This chapter incorporates data available up to 14 June 2002.2 SCDI Survey of Scottish Sales and Exports in 2000.3 IMF World Economic Outlook, May 2002.4 USA, Japan, Germany, UK, France, Italy and Canada.5 European Central Bank, Monthly Bulletin, March 2002.6 OECD and IMF.7 OECD Economic Outlook May 2002.8 Department of Trade and Industry.9 National Institute for Social and Economic Research, Economic Review May 2002.10 IMF World Economic Outlook, May 2002.11 There are two fiscal rules: firstly, the �Golden Rule� means that over the economic cycle,the Government will borrow only to invest, not to fund current spending. Secondly, the�Sustainable Investment Rule� means that public sector net debt will be held at a stable andprudent level, with the upper benchmark being 40 per cent of GDP over the economic cycle.12 �Forecasts for the UK Economy�, HM Treasury March 200213 Total Managed Expenditure.

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28

2002

chapter two: Report on EconomicDevelopment Initiatives

Chapter 2: Report on Economic Development Initiatives

The Scottish Executive�s Frameworkfor Economic Development inScotland (FEDS), published in June2000, was designed to provide thefundamental structure within whichmore detailed policy programmes cantake place. The overall vision of FEDSwas to raise the quality of life for all ofthe people in Scotland throughincreasing economic opportunities in asocially and environmentallysustainable manner. It is vital thatpeople of all regions and social groupshave the opportunity to participate in,and benefit from, economic growth inScotland. Similarly, economic growthmust not be to the detriment ofScotland�s environment.

FEDS takes, as its starting point,several key principles:

FEDS shows the direction in which theExecutive wishes to see the economic

environment evolve and the prioritiesthat must be addressed. The Prioritiesfor Action identified in FEDS include:

Overall, FEDS identifies theenhancement of productivitythroughout all Scottish enterprises asbeing the critical element to improvingeconomic growth and living standards.These Priorities for Action are themain drivers to achieving this.

Importantly, FEDS must stimulatefurther action. While it is necessarilyset at a high level, and embraces thewide and complex set of elements thatdrive economic development, itexplicitly considers the processthrough which the Executive will movefrom the Framework itself to define asharper, more effective programme ofspecific initiatives. The last edition ofthe Scottish Economic Reportcontained the third update on theprogress the Scottish Executive hasmade in the field of economic

� Inclusive: FEDS is concerned withthe economic opportunities of allthe people of Scotland � throughoutsociety, and in all regions andsectors of activity

� Longer-term: FEDS looks beyondthe immediate towards a 5 to 10year horizon.

� Dynamic: FEDS embraces the fullrange of factors that togetherdetermine progress in economicdevelopment.

� Partnership: Economicdevelopment is ultimately driven bythe private sector, therefore FEDSseeks to enable and encourage thatdevelopment.

� Evidence-based: policy-makingneeds to be underpinned byevidence and rigorous analysis andnot by anecdotal and ad hocassessment.

� The strengthening of the basiceducation system to betterequip our children for thedemands of the globaleconomy.

� Ensuring we have theappropriate transportation andelectronic infrastructures.

� The approach to enterprisesupport, including encouragingan enterprise culture,supporting innovation, andassisting new businessformation.

� The contribution of economicpolicy to the continuingprosperity of the regions ofScotland and to the reduction ofsocial deprivation andimproved health.

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development. This chapter will gaugenew developments within existingprogrammes, along with covering newinitiatives the Scottish Executive hasundertaken since January 2002. Theseshall fall under the main Priorities forAction identified in FEDS. The policyjustification for these initiatives arereferenced throughout the chapter, asthe focus of the chapter is on the keyinitiatives which are currentlyunderway.

2.1 Education

One of the Priorities for Actionidentified in the Framework isstrengthening the basic educationsystem better to equip children for thedemands of the global economy,particularly through promoting theskills required for life long learningand the use of ICT. This reflects thecritical contribution education has tomake towards the enhancement ofproductivity and hence to thedevelopment of the Scottish economy.Education also has an importantcontribution to make to another two ofthe Priorities for Action, namely,encouraging a culture of enterprise andreducing social deprivation andimproving health by focussing on theopportunities, access and capacity ofall people to participate in economicactivity.

National Debate: The ScottishExecutive launched a National Debateon Education on 20 March 2002. TheNational Debate aims to provide avision and strategy for the long termfuture of school-age education. TheDebate focuses on high level issues forthe future such as why we educatechildren and young people and whatchildren should be learning, as well asexploring methods of delivery in termsof location, timing and the people whocan help young people to learn.

National and local organisations acrossthe country are holding discussionevents using support materialsproduced by the Executive, and peoplewith an interest in education candiscuss the issues that are important tothem in an environment which suitsthem. The debate continues until theend of June, after which the Executivewill formulate a vision and a strategyfor the future for publication early in2003.

A National Intranet for ScottishSchools: Following a majorconference in Edinburgh in December2001, the Executive has been workingclosely with the education authoritiesand other agencies to draw up detailedplans for a national intranet forScottish schools. This will provide alayered range of services and facilitiesto pupils, teachers and educationmanagers across Scotland through thevehicle of a secure intranet. It will alsooffer a broadband interconnect joiningevery education authority with eachother and with a range of nationalbodies. Procurement of the intranet islikely to get under way in the summer.This fits alongside the Executive�soverall strategy for broadband, whichinvolves aggregation of demand forbroadband connectivity across publicservices, including education andhealth, within geographical zones.

National Priorities in Education -Update: The last edition of theScottish Economic Report presented adetailed analysis of the NationalPriorities in Education. Theimplementation of the NationalPriorities is moving forward with thelaunch at the beginning of May 2002of a National Priorities Support Pack.This has been designed to helpteachers, Head Teachers and EducationAuthorities set realistic but ambitioustargets for improvements in

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achievement and attainment and otherdesirable outcomes. It also offers awide range of resources to supportschools and authorities when theyconsider the best way of securingimprovement for the young people intheir area. Academic achievement andattainment is just one of the NationalPriorities in Education. There is also afocus on values and citizenship, oninclusion and equality, and the skillsneeded to equip young people forlifelong learning, such as creativity andambition. There is recognition that inorder to play a full role in society,including contributing to the economicdevelopment of the nation, youngpeople need to acquire a wide range ofskills and knowledge.

New Community Schools: NewCommunity Schools (NCS) is a radicalinitiative which has the twin aims ofpromoting social inclusion and raisingeducational standards in Scotland. TheNCS approach embodies thefundamental principle that the potentialof all children can be realised only byaddressing their needs in the round,and that this requires an integratedapproach to the delivery of a range ofservices necessary to assist children toovercome the barriers to learning andpositive development - family support,family learning and healthimprovement. A pilot programme ofNew Community Schools wasintroduced in 1999/2000 and willcontinue until 2003/4. Evaluation ofpilot projects has shown that schoolsand other agencies are benefiting fromthe new ways of working and that theapproach can make significantimprovements in attainment. On 12November 2001, the Executiveannounced that additional funding of£30.6million over 2 years (2002/03and 2003/04) would be made availableto local authorities to support the rollout of the new community school

approach across all schools inScotland. This roll out process startedon April 1st 2002.

Assessment: The Minister forEducation has announced theestablishment of an action group totake forward developments inassessment, consisting of all keystakeholders and chaired by the DeputyMinister for Education. The aim is toimprove assessment, record-keepingand reporting in schools so that anydifficulties young people areexperiencing in learning andachievement can be promptlyidentified and addressed.

Education for Work and EnterpriseReview: Education for Work andEnterprise (EfWE) covers a wide rangeof activities and programmes which aredesigned to help prepare young peoplefor the transition from education towork. EfWE is key to the Executive�sProgramme for Governmentcommitment of promoting anentrepreneurial culture beginning inschools. A Ministerial Review Group,with representatives from business andeducation, was established inSeptember 2001. This group ischarged with identifying keyobjectives in EfWE, defining successand outlining the scope for its deliverywithin an outcome-focused curriculum.The aim is to maximise the high-levelopportunities available through EfWEwhich are available to both schoolstudents and business. As part of theReview, the Group has conducted amajor consultation exercise and hasundertaken focus group research togather views directly from youngpeople. It has also had direct interfacewith schools and business. The Groupwill report in Summer 2002.

Out of School Care: There has beenconsiderable expansion of out-of-school care services over the last few

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years. There are now about 800 clubs,compared with 500 in 1998, providingplaces for 40,000 or so children. Theseclubs enable parents to enter theworkforce, or to extend their workinghours, secure in the knowledge thattheir children are being well lookedafter. The expansion of clubs indisadvantaged areas is especiallyimportant in helping parents into work.

Education (Disability Strategies andPupils' Educational Records)(Scotland) Act: The new Education(Disability Strategies and Pupils'Educational Records)(Scotland) Act,established in March 2002, will requireeducation providers to prepare andimplement accessibility strategies.This will improve access to educationfor pupils with disabilities so that thesepupils can benefit from equalopportunities to achieve their fulleducational potential. It will alsoensure that more young people withdisabilities leave school with the rightskills and, as adults, go on to play anactive role in society and the Scottisheconomy.

Sure Start Scotland is a programmewhich is aimed at improving socialinclusion and achieving better lifeoutcomes for children. It is foundedon the notion that children will be ableto make the most of later opportunities,including pre-school education andbeyond, if they have a positive start inlife. Accordingly, Sure Start Scotlandtargets families with very youngchildren (0-3 years), particularly themost vulnerable and deprived families.The programme has 4 broadobjectives: to improve children�semotional and social development; toimprove children�s health; to improvechildren�s ability to learn; and tostrengthen families and communities.Joint working is an important factor inthe Sure Start programme: local

authorities, voluntary organisations,health services and parents areencouraged to work together to providea cohesive integrated service to meetthe identified needs of parent andchild. Examples of services fundedthrough Sure Start are: parent support;outreach services where workers visitfamilies in their own homes; childcare,including nurseries and playgroups;childminding; and support for specificmarginalised groups. £80m of fundinghas been allocated for the period1999/00 - 2003/04. A first stage ofevaluation, Mapping Sure StartScotland (May 2002), reportedpositively on the programme. Asecond stage of evaluation is beingplanned to begin to assess impact andto gauge whether children areachieving better outcomes, includinglearning outcomes, as a result of thisearly intervention approach.

Pre-school Education: There has beena major expansion in the provision ofpre-school education in recent years.The latest participation ratesinformation available relates toacademic year 2000-01 and showedrates of 80 per cent and 97 per cent forthree year olds and four year oldsrespectively. This compares with theearliest information available of 68 percent for three year olds in 1999-2000and 96 per cent of four year olds in1998-1999. It is now a statutory dutyfor local authorities to secure a freepart-time pre-school education placeavailable for all three and four yearolds whose parents want it.

Childcare: The Scottish ChildcareStrategy aims to ensure good qualityaffordable childcare for children aged0-14 in every neighbourhood. Wehave targeted additional resourcestowards areas of disadvantage throughthe child poverty package. Thisadditional funding will provide

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childcare grants for lone parents in fulltime Higher Education; allow FurtherEducation colleges to widen childcareprovision; and through ChildcareStrategy funding help local authoritiesto stabilise and sustain childcareprovision. In addition, the third roundof New Opportunities Fund childcarefunding, to be announced later thisyear, will support projects in deprivedareas.

Transitions from school: The BeattieCommittee was established in April1998. Following an extensive andwide-ranging consultation whichlooked at the participation andattainment of young people (16-24years) who require additional supportin post-school education and training,the Beattie Committee reported in1999 focusing on skills andemployability. The keyrecommendation of the Report was thatInclusiveness should be theunderpinning principle for all post-school learning and support and that itshould place the young person at theheart of provision. Funding of £22.6million has been made available toimplement the recommendations.

Beattie Implementation Programme� Update: The multi-partnershipInclusiveness projects, managed byCareers Scotland, are now operationalacross Scotland with approximately140 keyworkers employed within theprojects. These projects will be thesubject of performance monitoring andevaluation over the next 3 years.Three part-time National DevelopmentOfficers (Senior EducationalPsychologists) are taking forward thedevelopment of the specification for apost-school educational service.

2.2 Support for InfrastructureTransport Delivery Report: TheTransport Delivery Report Scotland�s

Transport: Delivering Improvementshas a two-fold purpose. Published on21 March 2002, the document detailsthe Executive�s vision for the future ofScotland�s transport, as well as settingout an impressive number of transportimprovements already accomplished,across Scotland and across all modesof transport. Of particular significanceis the fact that the Transport DeliveryReport contains Scotland�s firstnational transport strategy for overthirty years.

Scottish Executive-commissionedstudies predict road traffic to grow by27 per cent over the next two decades.80 per cent of this growth is forecast tobe in and around Scotland�s majormetropolitan areas � this is clearlyunsustainable. The Executive aims toreduce the impact of urban congestionby striving to stabilise growth at 2001levels by 2021. By increasinginvestment in the transportinfrastructure, the Executive willdeliver improvements consistent withits overarching vision.

That vision, outlined in the TransportDelivery Report, is to build asustainable, effective and integratedtransport system, meeting the needs ofall in society and appropriate to therequirements of different parts ofScotland. The Executive will take upthe challenge by investing in anintegrated package of measures:modernising and improving publictransport, promoting alternative modesof transport to the private car andtargeted trunk road improvements.

The Transport Delivery Report sets outthe Executive�s 10 priority projects fordelivery. These are major projects ofnational strategic significance, basedaround the interlinked aims of

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improving public transport andreducing urban congestion: -• letting of a new 15-year passenger

rail franchise;• the redevelopment of Waverley

Station;• the development of rail links for

Glasgow and Edinburgh airports;• tackling congestion in and around

Aberdeen;• delivering the top priority public

transport projects flowing out ofthe A8, A80 and M74 corridorstudies;

• progressing the central Borders raillink;

• from October 2002, free off-peakbus travel for elderly people andpeople with a disability; and

• improving and enhancingTraveline, the national publictransport information service, setup in January 2001, andencouraging local authorities toadopt through-ticketingarrangements on local buses.

The detailed sequencing of the 10priority projects will be a key prioritywhen decisions are taken in this year�sSpending Review. The clarity in theReport about what the Executive isseeking to achieve creates an explicitagenda for partnership with otherbodies. Such partnership is vital forthe Executive to attain the resourcesthat are needed to deliver. Workingwith local authorities and the voluntaryregional transport partnerships isfundamental if the vision is to beachieved. The Report cannot be theanswer to all of Scotland�s transportproblems. It does however clearlyarticulate what the Executive isstriving to achieve.

Energy, Water and Environment

Sustainable Development: On 30th

April 2002, the Scottish Executive

Environment Group published Meetingthe Needs�, a publication that markedthe start of the Executive�s ongoingprocess to define what we mean by asustainable Scotland and how weintend to achieve it. The Executive iscommitted to sustainable development(development that combines economicprogress with social and environmentaljustice) and the paper identifies themain priority areas that we will tackle.These areas are resource use(understanding where our materialscome from, how they are replaced,how they were transported, etc),energy (reducing our reliance on fossilfuels, increasing the amount of powergenerated from renewable resources,improving energy efficiency andreducing fuel poverty) and travel(better land use planning, anddeveloping sustainable transportsystems).

In order to measure and follow theprogress of sustainability, theExecutive has selected an initial 24sustainability indicators, which includeareas such as waste management,population structure, air & waterquality, energy, travel and fuelpoverty. Some of these indicators willbe used to set targets although manywill have their usefulness reassessed in2003 in light of emerging opinion.The Executive is committed toproviding regular reports on howScotland is performing in terms ofsustainability and on the progressbeing made taking forward the mattersset out in the Meeting the Needs�paper. A forum will also beestablished to contribute to thedevelopment of the strategy set out andto assist in driving forward sustainabledevelopment in Scotland. On a UKfront the Sustainable DevelopmentCommission, which includes twomembers who are particularly looking

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to Scottish interests, will take anoverview of progress in Scotland.

Footprints Study: The Five CitiesFootprint study, which has beencarried out as part of the Cities Reviewto examine the sustainability ofScottish cities, was completed at theend of May 2002. The study used theconcept of Environmental Footprints topromote understanding of theenvironmental impact of Scottishcities, and allow comparison with otherUK/European cities. There should beuseful application to other policy areas.The analysis is expected to informthinking on why cities perform in acertain way and should suggest waysof reducing the �footprint�, and sobecoming more sustainable. The WelshAssembly already uses footprints as anindicator. Best Foot Forward, whodeveloped the concept ofenvironmental footprints, undertookthe analysis for the Executive. Theresults from the study will bepublished in the Cities Review reportduring Autumn 2002.

Scottish Water: On 1st April 2002, allthe functions and assets of the threeexisting Scottish water authorities werepassed to Scottish Water as a result ofthe Water Industry (Scotland) Act,which was introduced in the ScottishParliament in September 2001, andreceived Royal Assent on 1 March2002. Scottish Water will become the4th largest water services provider inthe UK, as well as the 12th largestbusiness in Scotland by turnover.Through an extensive efficiency andbusiness improvement programme,Scottish Water will aspire to thestandard of world class serviceproviders. Scottish Water will play akey role in the Scottish economythrough its commissioning of 50 percent of the total contracts in theconstruction and engineering sector to

deliver an investment programmeworth around £2 billion between 2002-2006.

Water Framework Directive: The ECWater Framework Directive came intoforce on 22 December 2000 and hasbeen described as the most importantpiece of water legislation everintroduced. The Directive establishesa framework for the protection of allwater bodies and promotes sustainableuse of water resources. Member Statesare required to develop River BasinManagement Plans that set out theactions required to achieve good waterstatus by 2015 in the applicable waterbodies. Economics plays a significantrole in these plans, as the Directivecalls for a full economic analysis ofwater use to be carried out by 2004.As the Directive requires the status ofmany water bodies to be improved,then costs will obviously be involved.The economic analysis will help todetermine what actions should be taken(the most cost-effective solution) andwho should pay for them (the principleof the polluter pays). The Directivealso requires that a system of waterpricing be introduced that reflects thecosts, including environmental costs,incurred to provide the water. Thissystem should also provide incentivesfor efficient water use.

The second consultation paper, TheFuture for Scotland�s Waters:Proposals for Legislation, on theimplementation of the WaterFramework Directive into Scots lawwas published in February 2002. Theconsultation will lead to the WaterEnvironment and Water Services(Scotland) Bill being introduced to theScottish Parliament in May 2002.

Renewables Obligation (Scotland):On 1st April 2002, the RenewablesObligation (Scotland) (ROS) Ordercame into force. The obligation

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requires that by 2010, electricitysuppliers source 10.4 per cent of theirelectricity from �new� renewableenergy sources. Suppliers provide theregulator, OFGEM, with RenewableObligation Certificates (ROCs) toshow that they have met the obligation.Where suppliers fall short of theobligation, they have to pay a buy-outfee of 3p/kw. The buy-out paymentsare then collected into a fund andrecycled amongst suppliers whopresented ROCs. The buy-out fundacts both as an incentive to suppliers tomeet the obligation and as a cap oncosts to consumers.

The Scottish Executive has theobjective of increasing the amount ofelectricity generation from establishedand new renewable energy sources to18 per cent by 2010, but it now lookslikely that this target will be reachedearlier.

UK Energy Review: The Performanceand Innovation Unit (PIU) publishedthe Energy Review in February 2002.The review suggests that the overallaim of the UK government should bethe pursuit of secure and competitivemeans of meeting energy needs,subject to the achievement of asustainable energy system. Othersuggestions are that:• The immediate priorities of energy

policy are most likely to be metthrough the promotion of energyefficiency and renewable energy.

• There is no pressing problemconcerned with increasing UKdependence on imported gas.

• The options of investment innuclear power and clean coal needto be kept open.

• There should be support forinnovation in a broad range ofenergy technologies, aiming toestablish new sources of energy

that can be low cost and lowcarbon.

• The Government should useeconomic instruments to bringhome the cost of carbon emissionsto all energy users.

• A new cross-cutting SustainableEnergy Policy Unit should becreated to draw together alldimensions of energy policy in theUK.

• The Government should initiate apublic debate about sustainableenergy, including the roles ofnuclear power and renewableenergy.

The Report points out that several keyareas within energy policy aredevolved to the Executive, includingthe promotion of energy efficiency andrenewable energy, and consents fornew power station, electricity lines andgas pipelines. (Applications for allnew power stations in Scotland have tobe considered by Scottish Ministersunder these devolved consent powers).The Report recommends that theScottish Executive should remain fullyinvolved in the development of energypolicy.

Executive officials worked closelywith members of the PIU on energyissues of direct relevance to Scotland,particularly the scope for a hugeincrease in the production of renewableenergy, and the Executive submittedtwo papers to the Review. In view ofthe recommendations for new targetsfor renewable energy in 2020, theExecutive expects to consider thisissue in the near future.

The PIU report is now open to publicconsultation. There is an ongoingconsultation group, at which theExecutive is represented. The UKGovernment will consult on the issues

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raised and issue a response in anEnergy White Paper later on in 2002.

Review of National Planning PolicyGuidelines (NPPG) 2: In January ofthis year, the Executive consulted on adraft revision to National PlanningPolicy Guideline (NPPG) 2 EconomicDevelopment. This outlines the rolethat the planning system can play inpromoting economic development on asocially and environmentallysustainable basis. Following theconsultation, a finalised version of theguideline will be issued towards theend of this year.

2.3 Enterprise Support andSkills Development

Scotland's Economic Future

Scotland's enterprise strategy is basedupon consideration of evident globaleconomic trends. For most of the lastthirty years, growth in world trade hasoutstripped world GDP growth. InScotland we are embracing this trend.It is increasingly unlikely that we cancompete with developing countries interms of labour or commodity prices,and inward investment levels acrossEurope reflect this. The Executive isaware of the benefits to the economybrought by companies such as IBM orNCR. However, in order to fosterlong-term economic success, the focusof Scotland's Enterprise Strategy isrightly on Scotland's area ofcomparative advantage - high valueadded products and those sectors witha very high skill or knowledge content.

The Enterprise Networks were givenclear strategic guidance in January2001 with the publication of A Smart,Successful Scotland. This guidancereflects the Executive's widerenterprise strategy based on scienceand skills, and ensures that the

programmes of the EnterpriseNetworks work towards our strategicgoals. On the skills front LearnDirectScotland, Future Skills Scotland andCareers Scotland have been establishedto provide first class workforceinformation and to provide an all agecareers service. This has beenaccompanied by increased investmentin Further Education. In science theExecutive has put in place the firstscientific advisory committee, boostedearly stage funding forcommercialisation, built transatlanticlinks between Scottish universities andUS counterparts and modernisedRegional Selective Assistance towardsindigenous high growth companies.These achievements represent asignificant step towards economicsuccess, but the Executive realises thatultimately the engagement of theScottish business community, thedriver of economic growth, is anecessary condition in making theExecutive's enterprise strategy a long-term success.

The Joint Performance Team, a jointScottish Executive and EnterpriseNetwork body, published ameasurement framework for theEnterprise Networks in MeasuringScotland's progress towards a Smart,Successful Scotland in March 2002.This framework measures the successof the Enterprise Networks in the areasset out in A Smart, SuccessfulScotland. This document does not set"targets" for the Enterprise Networks.A Smart, Successful Scotland outlinesthose areas in which Scotland mustsucceed if we are to achievesustainable economic growth. TheJoint Performance Team'smeasurement framework detailsindicators that allow economicoutcomes to be measured in these areasof the economy in comparison withother OECD countries. The Enterprise

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Networks now have in place a clearstrategy iterated through A Smart,Successful Scotland, and a clearprocess and framework by whichsuccess in pursuing this strategy can bemeasured.

Business Support

Local Economic Forums: TheFramework for EconomicDevelopment in Scotland set theoverarching national policy frameworkfor economic development. One of themain priorities identified in theFramework is to support enterprisesand to help them face up to thechallenges of the global economy. ASmart Successful Scotland providesstrategic guidance to the EnterpriseNetworks and sets out the directionand priorities for Scottish Enterpriseand Highlands and Islands Enterprise.The ELL Committee proposed LocalEconomic Forums, comprising publicand private sector bodies, as a vehiclefor driving simplification in localeconomic development. The Forumsare a mechanism for better co-ordination of the delivery of localeconomic development services andfor the implementation of the broadthemes of both reports at a local level.

The Forums are beginning to make adifference by acting as a catalyst formore effective joint working andengaging the business community. InOctober 2001, each Forum producedan Action Plan to eradicate duplicationand improve economic developmentservices and significant savings arebeing identified, from implementationof the plans, for reinvestment inservice delivery. The ScottishExecutive is continuing to work withForums in delivering the changes inthe Action Plans. The key task is nowimplementing the action in the plans,

and the Forums have been invited toconsider and address issues of localstrategic importance in Year Two.

Business Gateway: At a nationallevel, the Executive is taking forwardthe options for a Business Gateway -encompassing all business support inthe Scottish Enterprise area - buildingon the success of the existing SmallBusiness Gateway and contributing tostreamlining access to information,while creating common branding ofservices. The work on the options fora Business Gateway is in hand, anddetails were published in May.Highlands and Islands Enterprise arealso considering a single entry pointapproach.

Business Birth Rate: The review ofScottish Enterprise's Business BirthRate Strategy (BBRS) addressed arange of issues relevant to Scotland�sbusiness start-up rate. Commissionedby Scottish Enterprise, the Fraser ofAllander Institute of the University ofStrathclyde completed the independentreview and reported in June 2001. Aconsultation on the review with theprivate sector and other interestedstakeholders further helped informconclusions. On 23 January 2002,Scottish Enterprise launched a newapproach to entrepreneurship:encouraging entrepreneurialdynamism1.

Science Strategy: The ScottishExecutive is currently implementingactions arising from A Science Strategyfor Scotland which was launched on 27August 2001. The document providesan overarching framework of policiesto guide the provision and use ofscience in pursuit of the ScottishExecutive's objectives as described inWorking Together for Scotland - AProgramme for Government. As partof the Strategy, the Executive

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undertook to appoint a newindependent Scottish Science AdvisoryCommittee (SSAC), under the auspicesof the Royal Society of Edinburgh(RSE), with an outstanding scientist asChair, who would also become theExecutive's chief adviser on science.On 17 December 2001, RSE appointedProfessor Wilson Sibbett, WardlawProfessor of Physics at the Universityof St Andrews, as Chair. The RSE hasalso conducted the recruitment processfor appointment to the Committee andthe first meeting of SSAC wasconducted on 7th May.

Review of Regional SelectiveAssistance: The Scottish Executive iscommitted to providing jobs for all andto tackling regional imbalances.Regional Selective Assistance (RSA)helps deliver this through providingdiscretionary grants to encouragebusinesses to invest in the AssistedAreas (AAs) of Scotland, both creatingand safeguarding jobs and contributingto the economic development of theseneedier areas.

An external review of RSA, chaired byGavin Masterton, former Chairmanand Managing Director of the Bank ofScotland was conducted last year andthe report was presented to theMinister for Enterprise, Transport &Lifelong Learning in December 20012.The Minister accepted itsrecommendations, in particular the re-shaping of the scheme to deliver morefocus on growing Scottish businessesand more focus on, and support for,quality projects. As part of the reviewof RSA, the Executive looked carefullyat how Scotland can further raise itsgame in the commercialisation of ourscience base and support morecompanies to reach their growthpotential. A number of new initiativeswere announced in this area.

• Venture Capital (VC) Funding:It is clear from recent studies thatsome SMEs continue to facedifficulties in accessing finance �particularly for small scale, earlystage equity. This reflects thehigh-risk nature of theseinvestments and thedisproportionate due diligencecosts relative to investment levels.Recent global economic trends andthe impact on technology stockshave further constrained equityinvestment. There is a crucial roletherefore for the public sector toaddress these market constraints ifwe are to improve our economicperformance. Minister forEnterprise, Transport and LifelongLearning announced on 12February 2002 the intention toestablish a £20m Fund of Funds tosupport a number of new privatesector equity funds in Scotland.Details will be announced in duecourse, but the intention is to:

� use this as a vehicle to draw insignificant private sector funding;

� support funds addressing the equitygap up to £250,000 but withsufficient scope to provide up to£500,000 where justified;

� include flexibility to address thespecific needs of particular sectors.

The funds supported will be privatesector managed and driven, withcommercial orientation, and willstrengthen the existing VC marketin Scotland.

• Investor Readiness: It is generallyrecognised that we do not haveenough companies with robustproposals able to attract equityinvestment. Ministers thereforeannounced in February 2002 that -

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in tandem with the VC proposal -Scottish Enterprise intend tointroduce a new, network wide,high quality investor readinessprogramme. This will provide thetype of support required to buildcompanies, and develop theirproposals to a stage and quality atwhich they are more likely tosucceed in attracting financialinvestment. This twin trackapproach is intended to help morecompanies to break throughinvestment barriers and reach theirtrue growth potential. Furtherdetails will be announced soon.

Following the review of RSA, anumber of changes have already beenmade to RSA and more are in-hand.For example, firms can now includesalary costs for new jobs where capitalinvestment is limited and the cost ofbuying intangible assets such as know-how, patents and IP. This is expectedto be particularly relevant to Research,Development & Technology andcommercialisation projects across allindustry sectors. Active marketing isensuring that Scottish businesses arefully informed about RSA while newstreamlining measures aim to halvedecision times for some 85 per cent ofapplicants: 10 working days for grantsup to £50k and 20 working days forgrants up to £250k. Scottish firms arealso benefiting from closer workingbetween the Scottish Executive andScottish Enterprise ensuring thatworkforce development needs areidentified at the outset and linked intoRSA projects. To help some of thelong term unemployed, since the endof May 2002, new premium RSApayments have been available toencourage RSA recipients to recruitand retain New Dealers.

Global ConnectionsScottish Development International�s

vision is to fully integrate Scotland'sinternational economic developmentactivities. Within this singleorganisation, there are three corespecialisms: attracting high valueeconomic activity to Scotland;internationalisation of Scottishcompanies; and a new capability basedon the exchange of skills, ideas and thenetworking of people.

Internationalisation of Scottishcompanies: The value of Scottishmanufactured export sales rose in 2001by 3 per cent over the previous yearreflecting the continuing success ofScottish companies in internationalmarkets. While we would not wish tounderestimate the impact of the effectsof the terrorist attacks of September11, and that the final quarter of 2001saw a drop in the level of exports overthe previous quarter, it would appearthat most companies envisage that theimpact on their business from theseevents will be mostly short term. Thiswas evident from the findings of asurvey commissioned by ScottishDevelopment International.

It is also clear that Scottish companieshave been particularly active in takingpositive steps to try and address anydifficulties that they have been facing.To further assist companies, ScottishDevelopment International announcedin March 2002 that it was increasingthe number of supported trade missionsto the US and reducing the costs tobusinesses using its ScottishTechnology and Research (STAR)centres and of joining its MarketAccess Programme (MAP) for the US.MAP provides companies with one toone assistance to develop new businessopportunities in key markets. In2001/02, Scottish DevelopmentInternational assisted 213 companies todo business internationally for the first

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time and introduced 816 experiencedcompanies into new markets.

Venture Capital: Engagement isbeing sought through ScottishDevelopment International to increasethe opportunities for young Scottishcompanies to access venture fundingfrom overseas and to, in turn,encourage indigenous VCs to fundearly stage companies.

Other international economicdevelopment initiatives underwayinclude the development by ScottishEnterprise of Globalscot, aninternational network of individualswho have an affiliation for Scotlandand who want to contribute to andshare in its economic success. Thenetwork is business and industryfocused, web enabled and aims topromote opportunity and developcollective ownership.

ATLAS (Accessing Telecoms LinksAcross Scotland): ScottishEnterprise�s ATLAS project aims toincrease the competitiveness of thetelecoms market in Scotlandspecifically for the benefit of high-endusers of bandwidth in Glasgow,Edinburgh and Aberdeen, through avirtual trading platform and acompetitive backhaul link tointernational networks. Future planswill extend these benefits more widelyacross Scotland. Scottish Enterprise isinvesting £6 million in the first stage ofATLAS (trading exchange andbackhaul) and up to £26 million (notyet approved) in the second phase toextend access via business parks.

Broadband Strategy: ConnectingScotland � our broadband future waslaunched by the Executive in August2001 with the aim of makingaffordable and pervasive broadbandconnections available to citizens and

businesses across Scotland. Scotlandwas allocated £4.4 million from a £30million UK fund for innovativeprojects to extend broadband networks.On the 19th March 2002, the Scottishprogramme was launched by theMinister for Enterprise, Transport andLifelong Learning at the Broadband forBusiness centre in Inverness.

Learning and Skills

Future Skills Scotland: Future SkillsScotland was established in July 2001with a remit to improve theavailability, quality and consistency oflabour market information andintelligence in Scotland, to align skillsneeds to relevant education andtraining provision, and to improve thematching of people to jobs. ScottishEnterprise, operating in associationwith Highlands and Islands Enterprise,manages the Unit, which will facilitatethe delivery of a faster and superior jobmatching service across Scotland. InJune 2002, Future Skills Scotland willpublish a Labour Market and SkillsReport and the results of the first-everScottish Employers Skills Survey.

Skills Development: The ScottishExecutive has established a ScottishSkills Fund to support the skills agendaby strengthening the role of the newSector Skills Council network inScotland. A total of £1.5 million hasbeen allocated, representing £500,000each year between 2001-2002 to 2003-2004. During 2001/02, the Fundsupported 33 skills projects run by theformer National TrainingOrganisations. A 2002-2003Prospectus has been issued invitingbids from Sector Skills Councils forRound 2 projects.

Scottish Union Learning Fund: TheScottish Union Learning Fund hasbeen established to promote activity by

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trade unions in support of the ScottishExecutive's lifelong learning and skillsdevelopment programmes andpriorities. The Fund has been allocateda total of £1.6 million over the four-year period 2000-2001 to 2003-2004inclusive. The aim of the Fund is tosecure effective and sustainableactivity by trade unions individually,collectively or in partnership withother organisations, to promotelearning in its widest sense. The Fundis presently supporting 12 projectsbeing run by trade unions for theirScottish members, with total fundingof over £500,000 committed. A 2002-2003 Prospectus was issued in Aprilinviting Round 3 bids by 14 June 2002.

Adult Literacy and Numeracy:Literacy and Numeracy are crucialunderpinning skills, affecting theemployability of individuals and thecompetitiveness of the economy. Lowbasic skills are estimated to cost theUK economy £4.8 billion a year. £22.5million of new funding was allocatedover 3 years from April 2001 to raisingskill levels. £18.5m of that is beinginvested in community learningstrategy partnerships to help at least80,000 people over the next threeyears. A national development unit isbeing established within CommunitiesScotland and a national training teamis developing a national trainingprogramme for tutors. Four pathfinderprojects are also being established.Three of these focus on improvingworkplace provision through workingwith the STUC, the road haulageindustry and local employers in NorthLanarkshire. A fourth pathfinder willhelp prisoners to improve their literacyand numeracy skills to assist theirprospects of securing employment ontheir release.

All Age Guidance Projects:Additional resources of £9 million over

three years were made available inSpending Review 2000 for thedevelopment of multi-agency All-AgeCareers Guidance projects in Scotland.The aim of the projects was to buildand strengthen delivery of adultlearning, information and guidance.Careers Scotland will now deliver thisservice and advice.

Careers Scotland: In response to theDuffner review, the Executivecommitted to the establishment ofCareers Scotland on 1st April 2002.Careers Scotland streamlines theprovision of help previously availablethrough a patchwork of over 80organisations and is managed by theEnterprise Networks. It provides aunified service with National serviceand quality standards, offering clients aone-stop shop approach to careerssupport services. Through CareersScotland, the people of Scotland canaccess �cradle to grave� careerssupport, assisting them to makeinformed decisions regarding thelabour market, education and training.

Modern Apprenticeships (MA): InMarch 2002 the Executive announcedthat the Programme for Governmenttarget of 20,000 MAs in training by2003 had been achieved one year early.As at May 2002, there were 23,025MAs in training, up from 5,000 in1997. This includes 4,374 who areaged over 25 and are benefiting fromthe Executive's decision to remove theupper age restriction to providelifelong learning opportunities toemployees of all ages.

New Deal: The New Deal is a series ofnational programmes run by JobcentrePlus - the new agency which bringstogether the Employment Service andthose parts of the Benefits Agencywith responsibility for working ageclients, to deliver these programmes.

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In Scotland, Ministers appointed aTask Force which advises on thepolicy and design of New Deal and theco-ordination with other Welfare toWork initiatives, particularlysupporting the Scottish Executive'sSocial Justice Strategy and otherdevolved initiatives.

Over the next year, changes will bepiloted which offer increasedflexibility across the New Dealprogrammes. To help clients of theNew Deal for Young People move intosustained work, Tailored Pathways arebeing piloted in Glasgow and Dumfriesand Galloway, offering a combinationof education, training, work experienceand subsidised employment to suit thespecific needs of individuals. Inaddition 'Step-up' is being piloted inEast Ayrshire and Dundee. 'Step-up' isa transitional employment initiative forthe very hardest to help, offering awaged job to those who have notsucceeded in New Deal. Mentoringwill be further developed andstrengthened, with specific approachesbeing piloted in Borders andLanarkshire. 'Progress2Work',targeted assistance for the clients withdrug problems which act as a seriousbarrier to job search and futureemployment, is being rolled out.Pathfinders have been established inDunbartonshire, Argyll and Bute,Glasgow, Tayside and Fife, with rollout to the rest of the country due by2003. The Glasgow EmploymentZone, which provides more help forthis group, has been extended to rununtil March 2004.

Sectoral Training: Demand-ledsectoral initiatives in Construction,Energy/Environment, Finance, IT,Public Sector/NHS Scotland, Retailand Tourism/Hospitality are ongoingwith employers providing input to thedevelopment and delivery of training.

To support this approach, LocalAccount Managers were introduced inOctober 2001 by Jobcentre Plus toengage employers and co-ordinatesector-based activities.

Individual Learning Accounts(ILAs): The introduction of ILAs hasbeen successful in helping to bringdown the financial barriers to learningand during its first year of operationthe scheme attracted nearly 270,000members with around 127,000 of themusing their accounts to undertakelearning. Although the ILA scheme inScotland was closed in December 2001as a precautionary measure to protectthe public purse and the interests oflearners, Scottish Ministers remaincommitted to encouraging the widestpossible participation in lifelonglearning and are keen to introduce anew scheme as soon as possible. Anynew scheme will build on theconsiderable success of the first ILAprogramme while tackling theconcerns raised. Consideration is nowbeing given to the future arrangementsthat might be put in place to supportindividual learning; and the views ofstakeholders and others on the shapeand details of any future programmeare being sought. An announcementabout future plans is expected later in2002.

2.4 Rural Scotland

Agricultural StrategyImplementation Group: A ForwardStrategy for Scottish Agriculture,launched in June 2001, represented thefirst ever strategic look at the role offarming in Scotland. The Strategycontains 54 separate action points fortaking forward the key messages andthemes, and invites all interestedparties across the industry to work with

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the Executive, the Enterprise Networksand other agencies to achieve this.

A 15 strong implementation steeringgroup held their first meeting on the 4th

March 2002 to monitor progress on thedetailed action points, identify ways ofmeasuring success and review theStrategy in the light of experience.This group is made up of a crosssection of rural interests, ranging fromfarmer to retailer and from financier toenvironmentalist.

Land Reform Bill: In terms ofbroader rural development, the LandReform Bill was introduced into theScottish Parliament in November 2001.The legislation will remove land-basedbarriers to sustainable development ofrural communities. This will beachieved via increased diversity in theway land is owned and used andincreased community involvement.The Bill has now completed Stage 1,with Parliament agreeing on March 20to the general principles of the Bill.Stage 2 is due to start in the middle ofJune and will carry on after summerrecess, and it is expected that the Billwill receive Royal Assent by the end ofthe year.

Poverty and Social Exclusion inRural Scotland: The Rural Povertyand Inclusion Working Group wascreated with the remit "to improveunderstanding of rural social exclusionin Scotland, including ensuring thatexisting indicators are appropriatelydeveloped for and measurable in ruralareas; and recommend ways ofpromoting social inclusion in ruralareas". As part of the follow up to theworking groups� Poverty and SocialExclusion in Rural Scotland report,Ministers hosted an event on Monday17 June 2002, to facilitate thedevelopment of local and national

strategies to address poverty and socialexclusion in rural areas.

Services in Rural Scotland: TheExecutive has continued to takeforward its commitment to improvingthe quality of life in rural Scotland byenhancing access to services. A sub-group of the Scottish National RuralPartnership (SNRP) is in the process ofmonitoring the implementation bypublic, private and voluntary sectorservice providers of therecommendations contained inServices in Rural Scotland (January2001). The sub-group will bereporting its findings to Ministers inthe summer.

In addition, a project is underway toacquire Geographic InformationSystems (GIS) data on a range of keyservices for rural communities. Theproject will both provide an evidentialbase with which to inform policydecisions and will be used to produce areport mapping access to key servicesacross rural Scotland.

Decommissioning: The Executive�s£25 million grant aid scheme for thedecommissioning of Scottish fishingvessels is well under way. The schemedeadline (originally 30th April) hasrecently been extended to 30th August2002 to allow further time for vesselsto be scrapped. As at 24th April, theowners of 97 vessels have been offereddecommissioning grants, of which 46have satisfactorily completed thedecommissioning process. The 97vessels represent over 12,000 grosstonnes of capacity - just over 18 percent of the capacity of the vessels thatwere eligible to apply fordecommissioning under the Scottishscheme.

Food Strategy: The Food Strategy,launched in 1999, set ambitious targetsfor growth in the food and drink sector.

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Schemes launched during 2001 have sofar helped to generate some £70million in new investment in theindustry. 2002 has seen the launch ofCHARIS, a joint venture between theHannah Research Institute and theScottish Agricultural College usingtheir complementary skills andresources. The scheme will offer a"business friendly" research anddevelopment facility providingtroubleshooting expertise quickly andeffectively for food and drinkcompanies throughout the country, aswell as an innovative service for newproduct development.

2.5 Social Justice

The pursuit of social justice lies at theheart of the Scottish Executive�s work.Breaking the cycle of deprivation,raising personal and communityaspirations and lifting children out ofthe misery of poverty are key aims ofthis government. The successfulimplementation of the Social Justiceprogramme will significantly increaseeconomic opportunities for all Scotsand contribute to the Executive�s statedaim of closing the opportunity gap.

The Executive measures its successthrough the Social Justice annualreport which details progress on socialjustice targets and milestones,including child poverty. The secondsuch report was published inNovember 2001 and it showed,amongst other things, that theproportion of children in relatively lowincome households had fallen everyyear since 1996/97.

Over the next twelve months one of theExecutive�s main priorities will be toimprove Scotland�s social housingstock through the successfulimplementation of the Housing

(Scotland) Act 2001 and encouraging,where appropriate, stock transfer tocommunity housing associations.

The largest such transfer in Europe isalready underway in Glasgow wherethe city�s 78,000 council tenants votedin April 2002 to transfer to the not-for-profit Glasgow Housing Association(GHA). Over the next ten years thisground-breaking decision will allow a£1.6 billion public investment inGlasgow�s social housing stock, with afurther £700 million coming from theprivate sector. Rents for transferringtenants will be guaranteed for eightyears � so stabilising the householdincome of some of the city�s poorestcitizens, and conservative estimatessuggest that 3000 jobs andapprenticeships will be created as theGHA embarks on Glasgow�s biggestpublic sector construction programmefor decades.

One of the starkest symptoms ofpoverty and economic exclusion ishomelessness. In February 2002, theSocial Justice Minister announced theallocation of an extra £11 million overthe next two years to help implementthe recommendations of theHomelessness Task Force. The TaskForce was set up in 1999 to review thecauses and nature of homelessness inScotland, and the 59 recommendationscontained in its final report were fullyendorsed by the Executive. Theseincluded changes to current legislationwhich will help achieve the ambitioustarget of offering every homelessperson permanent accommodation by2012 and bring an end to the use ofBed and Breakfast accommodation forfamilies.

Increasing the social and economicopportunities of Scotland�s poorestcitizens needs more than investment inbricks and mortar and the Executive

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plans to build thriving sustainablecommunities through initiatives suchas community planning and budgetingand support for Social InclusionPartnerships. In February 2002, theExecutive announced a further £120million investment package forScotland�s network of 48 SIPS. Overthe next two years this money willsupport community initiatives, such asprojects that improve access toemployment and education, providechildcare provision and promotehealthy living.

In June 2001, the Executive publishedits Community RegenerationStatement which moves forward itsstrategy for revitalising deprivedcommunities. The statement putscommunity planning firmly at the heartof future regeneration work. Itsimplementation will ensure thatmainstream public services,community organisations and thevoluntary sector work effectivelytogether, under the leadership of localauthorities, to close the economic andsocial gap which continues to blightmany of Scotland�s neighbourhoods.

Scotland�s cities are central to theeconomic well being of the country.Nearly two thirds of the populationlive in the five city regions, and 40 percent of employee jobs are located inthe four major cities. They also exhibitunique problems with over two thirdsof the ten per cent most deprivedpostcodes located in three cities andthree of our five city regions areexperiencing significant populationloss.

In June 2001, Scottish Ministers begantheir consideration of the year-longCities Review. Over the next fewmonths these findings will be used toinform the Scottish Executive�sthinking on how best it can release the

full economic and social potential ofthe five city regions, and a policystatement is expected in late Septemberof this year.

A national planning system that issensitive to the needs of both rural andurban Scotland is crucial to continuedeconomic growth. The next stage in themodernisation of Scotland�s planningprocess was completed in June whenthe findings of the Review of StrategicPlanning were announced.

If the Executive is to realise itsambition of a smart, successfulScotland, then it must close the digitaldivide. Scotland still lags behind therest of the UK in Internet use andnowhere is that more evident than inour most marginalised communities.The Scottish Executive�s digitalinclusion strategy � Open Scotland -will ensure that every individual has aconvenient, easy and reliable means oflogging on. In March 2002, two localauthorities, North Argyll and Bute andWest Dunbartonshire won the firstround of Digital Communitiesfunding and up to 4000 private homesin these areas will now get free PCsand Internet access. In April 2002, theExecutive announced £3.2 millionfunding for its public Internet accessprogramme which will bring freeInternet access to pubs, communitycentres and libraries.

For far too many Scots, povertyremains the single most intractablebarrier to them realising their fullpotential. Ending child poverty withina generation remains one of theExecutive�s primary objectives and itcontinues to work with the UKgovernment to realise this ambition,complementing fiscal measures such asthe new Child Tax Credit withsolutions shaped in Scotland. InNovember 2001 the Executive

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announced a £24 million programme tofund childcare for single parentswishing to take up further and highereducation programmes and in March2002 £3 million was released to fundmoney advice services acrossScotland.

Fuel poverty blights the lives ofhundreds of thousands of Scots and inJune the Executive published its FuelPoverty Statement which set out howit intends tackling the problem, with aview to eliminating it, as far as ispracticable, by 2016. This will build onexisting measures, such as Warm Deal,the home insulation programme andthe central heating Programme. ByJune 2002, more than 130,000 low-income households had been insulated� well in excess of the Programme forGovernment target of 100,000. And inthe year to 31 March 2002, 85,000homes had benefited from new centralheating systems.

A prosperous Scotland is also an equalScotland, one where cultural diversityis celebrated. In October 2001, theRace Equality Advisory Forum(REAF) published a report, Making itReal � A Race Equality Strategy forScotland in October 2001. And inMarch 2002, the Executive publishedits response to the REAF report,Committing to Race Equality, whichoutlined its commitment to tacklingracism in all forms of public life.

The Scottish Executive is committed totransforming the lives of people livingwith a disability. The introduction ofthe Education (Disability Strategiesand Pupil�s Educational Records)Act in March 2002 means thateducation providers now have a duty toprepare accessible strategies toimprove access to the schoolenvironment, the curriculum andschool information for pupils with

disabilities. In April 2002, theMobility and Access Committee forScotland was set up to act as advisorybody on all transport issues affectingdisabled people.

Despite many advances over recentyears, there is still a considerable paygap between men and women inScotland. Overall, the gap is 17 percent, but it widens to as much as 45 percent in some occupations. The ScottishExecutive, in partnership withorganisations including the EqualOpportunties Commission and theScottish Trade Union Congresslaunched the Close the Gap campaignin March 2001. Earlier this year, theScottish Executive, together with itsClose the Gap partners, secured ESFfunding of nearly £500,000 to takeforward new initiatives to target thepay gap. The project covers the wholeof Scotland, and will be cross-sectoralto reflect the diversity of its coremembers.

Domestic abuse is one of the mostdistressing aspects of modern Scotlandand it can condemn many families to alife of poverty and exclusion. In March2002, the Executive announced a £1.5million investment in projects acrossScotland which tackle the problems ofdomestic abuse, bringing the numberof Executive funded projects in thisfield to over fifty.

The voluntary sector has long beenrecognised as having a key role in theScottish economy, particularly inregeneration work and the ScottishExecutive invests almost £40 million ayear in this sector. In April 2002, theDeputy Minster for Social Justiceannounced new measures which willstreamline the application andmonitoring process for voluntarysector funding.

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2.6 European StructuralFunds

Current Programmes: By the end of2001, all five Programmes - theHighlands and Islands SpecialTransitional Programme, the Objective2 Programmes for East, West andSouth of Scotland and the Objective 3Programme - were fully up andrunning. Awards of around £257million have been confirmed to date.During 2001, incremental progress wasmade on developing better linkageswith other Scottish Executive policyareas, in particular in implementing thehorizontal themes of equalopportunities and sustainabledevelopment.

Annual Implementation Reporting(AIR): As set out in the StructuralFunds Evaluation Strategy3, a new AIRprocess has been established aimed atboth reporting on and reviewing theprogrammes, as well as providingbackground policy and socio-economicinformation. The Scottish Executive,in partnership with the ProgrammeManagement Executives, submitted thefirst AIRs for 2000, for each of the fivecurrent Programmes, to the EuropeanCommission in June 2001. These werewell received by the EuropeanCommission and work is currentlyunderway on the AIRs for 2001.

European Regional Policy: TheExecutive is actively involved in thedebate on the future of Europeanregional policy, which started with thepublication of the 2nd Cohesion Reportin January 2001 and the subsequentCohesion Forum in May 2001. TheMinister for Finance and LocalGovernment attended the informalcouncil in Namur4 in July 2001 and asa starting point for the discussion, theExecutive published an economist

group discussion paper5 in September2001, entitled "Scottish economicdevelopment in light of the CohesionReport". During discussions about theCommission's Second CohesionReport, Spain raised concerns aboutthe �statistical effect of enlargement�.In response the Commission undertookto produce an update of the SecondCohesion Report which was publishedin January 2002. In addition,following the priority issueshighlighted in the Second CohesionReport the Commission is holdingseminars on the territorial priorities(May), horizontal priorities (July), andsimplification (October). The ScottishExecutive will be represented at theseseminars and feed back information tointerested partners across Scotland.

Structural Funds and Enlargement:The Executive has also been assessingthe benefits and risks arising fromenlargement and continues to beclosely involved with the accessioncountries. On behalf of the UKGovernment, the Executive is leading aconsortium with France and Ireland tohelp the Czechs prepare for theeffective use of the Structural Fundsthey are likely to receive when theyjoin the European Union. This is thesecond Twinning Covenant6 with theCzech Republic and will run untilDecember 2002. The Executive willalso shortly be working with Estonia aspart of a Twinning Covenant led byFinland, and continues to receive studyvisits from many accession countriesthat are eager to learn from ourexperiences.

Nordic-Scottish Action Plan andINTERREG: The creation of a jointAction Plan by the Executive hascontinued the long history of Scottish-Nordic co-operation. The Action Planrepresents a commitment to continuedco-operation and proposes several

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potential projects that have beenlargely based on the INTERREG IIIBprogrammes. A Nordic-ScottishAction Plan Liaison Group has beenestablished and meets regularly todiscuss opportunities for collaborativework. Scotland participates in four

INTERREG IIIB programmes(Northern Periphery, North SeaRegion, Atlantic Area and North-westEurope) all of which have now beenapproved by the Commission and areconsidering potential projects.

1 Full text available on http://www.scottishenterprise.com/about/what/research/newapproach/2 Report available on www.scotland.gov.uk/who/elld.rsa.asp3 The evaluation strategy can be accessed at http://www.scotland.gov.uk/esf/evalstrat-00.asp4 See press release at http://www.scotland.gov.uk/news/2001/07/se1683.asp5 The discussion paper can be found at http://www.scotland.gov.uk/asg/cohesion.pdf6 See press release at http://www.scotland.gov.uk/pages/news/2001/09/SE3015.aspx

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2002

chapter three: The Scottish Economy:Recent Developmentsand Future Prospects

Chapter 3: The Scottish Economy: Recent Developmentsand Future Prospects1

3.1 Summary

The continuing weakness of the globaleconomic environment, exacerbated by theconfidence effects of 11 September, was amajor influence on the Scottish economyin the second half of 2001. Nevertheless,the Scottish economy grew modestly inboth the third and fourth quarters of 2001and recent evidence from business surveysindicates tentative signs of improvement inexternal demand and corporate sentimentin the early months of 2002.

The service sector remained the driver ofScotland�s growth in the second half oflast year, underpinned by the buoyancy ofconsumer demand and historically highlevels of employment. Retailing andfinancial services performed wellthroughout last year, while those parts ofservices most exposed to overseasdemand, such as tourism, fared less well.

In contrast to services, manufacturingoutput (which accounts for almost aquarter of Scotland�s GDP) declined in thesix consecutive quarters up to 2001 Q4.This trend was not exclusively to Scotland:manufacturing output at the UK leveldeclined over 2001 and the pattern wassimilar across most of the majorindustrialised economies. Industrial outputin the G7 economies fell by 3.2 per cent in2001 compared with an increase of 4.6 percent in 2000.

Scotland�s labour market held upremarkably well in the face of last year�sglobal uncertainty: employment remainedclose to its historical high and the rate ofclaimant unemployment stayed close to itslowest for over 25 years. In the three

months to April 2002, employmentincreased slightly and unemployment (ILOmeasure) was stable. The claimant countmeasure of unemployment, which hadrisen on a number of recent months, fell inMay and still remained lower than a yearago.

Looking ahead, all three independentforecasts monitored by the Executivesuggest that Scotland�s growth rate willincrease through 2002 and reach trendrates in 2003, with the possibility of abovetrend growth.

3.2 Output

The Scottish economy continued to exhibitpositive, albeit modest, growth over theyear to 2001 Q4, driven by the servicessector. According to Executive data, theScottish economy expanded by 0.1 percent in 2001 Q4 (compared with zerogrowth in the UK) and GDP increased by0.6 per cent in the year to Q4 (up 2.0 percent in the UK). These numbersencompass the immediate aftermath of theterrorist attacks in the United States,although it is difficult to disentangle andquantify the impacts of 11 September withany precision.

Scotland�s GDP aggregate conceals aconsiderable range of performance amongthe broad industrial sectors. In 2001 Q4,services output expanded by 1.4 per cent,construction output fell by 2.1 per cent andmanufacturing output fell by 3.8 per cent.The equivalent UK figures were +0.6 percent (services), +1.8 per cent(construction) and �1.9 per cent(manufacturing).

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Services

Scotland�s services sector outpacedservices in the UK in 2001, growing by 4.4per cent compared with an increase of 3.8per cent for the UK. Within services,growth was particularly strong in twosectors: real estate & business servicesand financial services.

Real estate & business services output roseby 2.0 per cent in the final quarter of 2001,taking growth in the year to 2001 Q4 to

9.8 per cent - well above the UK figure of5.6 per cent.

The output of financial services, a keycomponent of the Scottish economy,increased by 2.3 per cent in 2001 Q4,finishing the year 6.3 per cent higher thanin 2000 Q4. In comparison, equivalent UKgrowth in the year to 2001 Q4 was 4.4 percent. The financial services sector inScotland has grown its output by almost 50per cent since 1995 (equivalent UK growthhas been just over 30 per cent).

Chart 3.1: Index of Scottish and UK GDP

Chart 3.2: Scottish Financial Services/Service Sector GDP

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The Scottish Retail Consortium/RoyalBank of Scotland Retail Sales Monitor forApril 2002 showed that total sales grew by4.2 per cent on a year earlier. This wasdown from 10.2 per cent in March and

slightly behind the UK rate for April (asreported by the British Retail Consortium)of 5.0 per cent. The April figures mayhave been influenced by the early Easterholidays.

The GfK Consumer ConfidenceBarometer2 for Scotland for May 2002showed increases in four of the five key

measures. Expectations for the futuregeneral economic situation were at thehighest level recorded since January 2000.

Chart 3.3: Scottish Retail Sales Monitor � Growth in Total Retail Sales

Chart 3.4: GfK Consumer Confidence Barometer

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Manufacturing

In contrast to services, manufacturing inScotland trailed its UK counterpart lastyear: output fell 8.2 per cent in 2001,while the equivalent UK figure was minus2.3 per cent. The latest available data showthat Scotland�s manufacturing output fellby 3.8 per cent in 2001 Q4 (quarter-on-quarter) compared with a drop of 2.3 percent for the UK. These figures reflectseveral factors, including: global overcapacity in the production of Informationand Communication Technology (ICT)goods and the ongoing re-structuring ofICT supply world-wide; weakness ininvestment spending; the economicdownturn in many of Scotland�s key

markets; the weakness of the Euro; andstock adjustments.

Within Scottish manufacturing, themajority of individual sectors reporteddeclining output in 2001. For example, theoutput of the transport equipment andelectronics (electrical and instrumentengineering) sectors fell 12.3 per cent and20.2 per cent respectively (the UKequivalents fell 3.1 per cent and 8.1 percent). Some production sectors however,experienced growth in 2001. The output ofthe food & tobacco and drinks sectors rose1.9 per cent (UK was up 0.9 per cent) and2.6 per cent respectively (UK output wasup 3.9 per cent) in the year to 2001 Q4.

Survey evidence for manufacturingindicates that the significant drop inoptimism and demand recorded in thesecond half of 2001 appears to have easedsomewhat. Some surveys still showed afall in orders in the first quarter of 2002.However, they all indicated an anticipatedimprovement in trading conditions later in2002 and the recent Bank of Scotlandmonthly survey (May 2002) indicated

evidence of a marginal improvement inemployment trends.

Construction

The latest official statistics on the state ofthe construction industry clearly indicate adownturn in this sector. The output of theScottish construction industry fell by 2.5per cent in 2001 (UK output rose by 3.6per cent), having peaked in early 2000.

Chart 3.5: Scottish Manufacturing and Electrical & Instrument Engineering GDP

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The output picture was mirrored inconstruction employment (LFS �workforceestimate�, including self-employment),which fell 2.9 per cent in the year to 2001Q3 (UK equivalent rose 1.8 per cent). Thefall was even sharper excluding self-employment (down 6 per cent) as self-employment had edged up over the courseof 2001. This shifting employment/self-employment pattern is quite typical of theconstruction industry. A further indicatorof market conditions is information ontender prices for public sector constructionprojects in Scotland. In the 12 months to2001 Q3, tender prices generally rose inScotland yet the increases were relativelymodest in comparison to those beingachieved in England. This implies thattrading conditions are currently stronger inthe rest of the UK than they are inScotland.

Business survey evidence on theconstruction industry, however, provides aslightly more encouraging picture for thecurrent year. The Construction TrendsSurvey reported that a majority ofrespondents in Scotland experienced anincrease in output during the first quarterof 2002 with further increases expectedover the next 12 months. Similarly,employment was expected to pick up in2002 Q2. However, a majority alsoreported that new enquiries had fallenduring 2002 Q1 suggesting that theseexpected increases might not necessarilymaterialise. The Scottish ChambersBusiness Survey reported similar mixedmessages � a fall in both employment anddemand in 2002 Q1, but expectedincreases in both indicators during 2002Q2.

The evidence available strongly suggeststhat the construction industry has had quitea difficult year but that there are somesigns of a return to growth ahead.However, continued progress in terms ofoutput and jobs will ultimately depend onfactors in the wider Scottish Economy.

Agriculture and Fisheries

Total income from farming (TIFF) inScotland, as published by the Executive inFarm Income Estimates (2001), rose by 11per cent last year. TIFF represents farmers�combined return on their capital (land,buildings etc.) and labour (time engaged infarming activity). Increases in potato andmilk prices, and lower input andborrowing costs more than offset the fallsin the value of cattle and sheep productionthat resulted from the Foot and MouthDisease (FMD) measures. Last year�sTIFF increase would have been greaterhad it not been for FMD (the 2001 figuresdo not include the £165 million in FMDcompensation paid to Scottish farmers).

At the level of the individual farm, theExecutive forecast of net farm income(NFI) points to a 61 per cent rise in 2001/2(from a low base) to an average of £9,600per farm. Mirroring the TIFF sectoralresults, dairy and general cropping farmsappear to have seen the greatestimprovement in their finances, due tohigher commodity prices. The finances ofspecialist sheep farmers (in less favouredareas) however are likely to havedeteriorated again, with negative NFIs onaverage, due to depressed output followingthe loss of export markets for much of theyear (as a result of FMD) and reducedsubsidies.

The final results of the December 2001Sample Census, which were released inMarch 2002, showed that livestocknumbers and agricultural employment inScotland continued to contract last year.Regular staff fell by 3.2 per cent,contributing to a fall of almost 20 per centsince 1991; total cattle numbers fell by 2.8per cent; and total sheep numbers fell by8.3 per cent. The livestock contraction wasdue, in part, to FMD, but also continued alonger-term decline in cattle and sheepnumbers. Pig and poultry numbers, which

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contribute a lower proportion of Scottishagricultural output, did however showincreases of 11.1 per cent and 2.3 per cent,respectively. The crops picture wasmixed: the size of wheat and oats areasrose significantly, while barley and oilseedrape areas shrank.

Scottish-based fishing vessels landed £339million worth of sea fish in 2001 - £9million higher than in 2000 - with higheraverage prices offsetting the effect ofdeclining volumes. The sea fishingindustry continues to face stiff challengesdue to excess capacity, reductions inquotas, area closures, and fluctuatingstocks. The stocks of several key whitefishvarieties are in very poor health �particularly, cod and hake for which stockrecovery measures have been implementedand longer-term plans are beingdeveloped. The £25 million Scottishdecommissioning scheme, currently beingimplemented, will help to bring about abetter balance between fishing capacityand fish stocks.

The output of the farmed fish sector inScotland, which is dominated by salmonbut now also includes some whitefishspecies, increased further in 2001. Thisreflected increasing productivity and therecovery from Infectious SalmonAnaemia. The Executive is leading adebate about a future strategic frameworkfor the whole aquaculture industry.

North Sea Oil

Oil production in the three months to April2002 was 2.2 per cent higher than the sameperiod last year, although output in 2001was down 6.5 per cent on 2000 levels asproduction in some of the more maturefields fell back.

The fourth annual Royal Bank of ScotlandOil and Gas Survey assesses the currenthealth of the industry and was conductedbetween mid March and mid April 2002.

Overall the industry has benefited fromhigher investment levels and higher levelsof export activity over the past two years.The majority of respondents (58 per cent)reported that production volumes hadincreased in comparison with the previous12 months, and 39 per cent of firms expectvolumes to be up in 2002. Costs havecontinued to rise for the majority ofcompanies (59 per cent), mostly driven byshortages of skilled labour. High oil priceshave weakened the focus on cost reductionover the last two years but this remainscentral to the long term competitiveness ofthe UK Continental Shelf (UKCS).

The investment prospects for UKCS, asreported in the Department for Trade &Industry�s (DTI) Capital ExpenditureIntentions Survey (2000), are encouraging.The report shows that total intendedexpenditure (excluding exploration,appraisal and decommissioning) wouldrise from £3.0 billion in 2000 to £4.0billion in 2001. Comparison with theprevious DTI survey (1999) showed a risein optimism, with total intentions for thefuture five years around 30 per centhigher. The UK Offshore OperationsAssociation (UKOOA) estimated that theextra investment will support the creationof up to 25,000 jobs, in addition to the270,000 which UKOOA estimates arecurrently supported by the industry.UKOOA also estimates that oil productionwill increase for the next 3 years, reachinga peak in 2003.

Budget 2002 introduced important changesto the North Sea tax regime. With effectfrom 17 April 2002, companies pay a 10per cent supplementary charge on NorthSea profits and receive a 100 per cent firstyear allowance for capital expenditure inthe North Sea. The UK government�sintention is to strike the right balancebetween promoting investment and takingan adequate share of profits derived from anational resource. Subject to consultationwith industry, the UK government also

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intends to abolish Royalty. Royalty iscurrently charged at 12½ per cent of thegross value of oil and gas won in aparticular licence area.

In January 2002 the Minister for Industryand Energy invited applications forlicenses in the 20th Offshore LicensingRound. The 20th round opens up almost300 blocks of the southern, central andnorthern North Sea for competitive licensebids. The closing date for applications was16 April. The DTI has accepted 29applications for 36 Blocks or part-Blocks.The applicants will now be interviewedabout the technical basis of theirapplications, whilst the DTI also reviewstheir financial, technical andenvironmental suitabilities. Awards areexpected in mid-summer.

3.3 Demand

Exports

The value of Scottish manufacturedexports, revealed in Executive figures,stood at £4.333 billion in 2001 Q4 (atcurrent prices). In constant price terms,this represented an increase of 3.4 per centin the year to 2001 Q4. Compared with2001 Q3, there were declines in exportsales of 7.4 per cent in constant price termsand 5.3 per cent in current prices. Theevents of September 11th probably hadsome impact upon the figures for 2001 Q4but again it is difficult to quantify theexact impact.

Recent business survey evidence suggeststhat the outlook for Scottish manufacturingexports has improved. The CBI IndustrialTrends Survey (April 2002) and the Bankof Scotland Report on Scotland (May2002) indicated that export orders hadeither increased slightly or the rate ofdecline had eased. Export optimism forthe year ahead was broadly positive.

Chart 3.6: Scottish Manufactured Exports

58

Investment

The CBI Industrial Trends surveyindicated that investment intentions inplant and machinery for the year aheadweakened considerably from the previoussurvey. Expectations were at their lowestlevel recorded since January 1981.Investment intentions in buildings alsocontinued to demonstrate a decline withexpectations at their worst since October1980. Uncertainty about future demandremained the most likely factor to limitcapital expenditure.

The Scottish Chambers survey indicatedthat manufacturing investment intentionsin plant/equipment increased slightlycompared to the previous quarter. Withinthe construction sector, the percentage ofrespondents reporting plant/equipmentinvestment continued to rise and a positivenet balance was recorded. Wholesaleinvestment intentions increased over thequarter. Investment in retailing continued

to strengthen in the first quarter of 2002while decline in investment intentions intourism3 ended.

The Scottish Engineering survey showed adecline in capital investment planscompared to the previous quarter. Onlythe non-metal product, transport and oil &gas sectors reported an increase.

3.4 Labour Market

Although unemployment has increasedslightly in recent months and employmenthas fallen, the scale of the changes wasperhaps less than might have beenanticipated. The labour market remainsstrong by historical standards, perhaps dueto some firms continuing to hold ontoworkers as they anticipate the slowdownbeing fairly short-lived. Those job lossesthat have occurred appear mainly to be inmanufacturing; jobs continued to becreated in services.

Against the backdrop of modest economicgrowth, there is some evidence to suggestthat the Scottish labour market reached aturning point at its cyclical high towards

the end of the first half of 2001. Since thattime, employment levels have fallen backand ILO unemployment has risen.However, it should be noted that ILO

Chart 3.7: Longer Term Scottish Labour Market

59

unemployment was unchanged in the lastquarter (February � April 2002), whileclaimant count unemployment fell in Mayafter some increases in recent months.Employment increased in the three monthsto April and remains high in historicalterms.

Total Employment in Scotland rose by7,000 to 2,378,000 in the three months toApril 2002, although it was down 13,000in the year to April. The employment rate4

was 73.1 per cent, below the UK rate of74.6 per cent.

ILO unemployment (seasonally adjusted)in Scotland was unchanged over thequarter to April 2002 at 172,000, with therate at 6.8 per cent (UK: 5.2 per cent).Over the year to April, ILO unemploymentin Scotland increased by 25,000 with therate rising by 1.0 percentage point (UK: upby 0.2 percentage points). The ILOunemployment rate of 6.8 per cent remainsabove the UK average, but below the EUaverage (7.6 per cent, April 2002). Oneother Government Office Region - theNorth East of England (6.9 per cent) - hada higher ILO unemployment rate thanScotland.

The number of employee jobs5 inDecember 2001 was 2,203,000, down

25,000 from December 2000. Thiscomprised decreases in manufacturing(23,000) and other sectors (15,000) and anincrease in jobs in the service sector(14,000).

The number of claimants onunemployment-related benefits (seasonallyadjusted) in Scotland fell by 1,400between April and May 2002 to 102,700.The claimant count rate was 4.1 per cent ofthe workforce, down 0.1 percentage pointson the month. Claimant countunemployment was down by 2,400 (0.1percentage points) from May 2001. Theclaimant count unemployment rateremains around its lowest rate since 1975.

Chart 3.8: ILO Unemployment in Scotland and the UK

60

The number of economically active (inemployment or ILO unemployed) rose by7,000 in the quarter to February - April2002 (UK: up by 107,000). Among those

aged 16-59/64, the economic activity ratewas 78.5 per cent (UK: 78.8 per cent).Economic activity rose by 12,000 over theyear to 2,550,000 (UK: rise of 241,000).

Generally, survey evidence suggests thatthe manufacturing sector continues toexperience a decline in employment,although there may be some easing in therate of job losses. The recent Bank ofScotland survey (May 2002) showed the

first sign of some improvement inemployment trends, although moreevidence is required before any firmconclusions can be made. Regardingexpectations for the rest of 2002, there isno great expectation of increases. For

Chart 3.9: Claimant Count Unemployment in Scotland

Chart 3.10: Economic Activity Rates in Scotland and the UK

61

example, the CBI Industrial Trends Survey(April 2002) showed a decline inemployment for the fifth consecutivequarter, although the rate of decline easedslightly from that reported in the lastsurvey. This trend was broadly in linewith expectations. Over the forthcomingperiod the trend regarding employmentwas expected to remain negative, albeitshowing a lower level of job losses.

Official data published by DTI showedthat the number of company liquidations in2002 Q1 for Scotland was 240, 45 per centhigher than the corresponding figure for2001 Q1. However, these quarterly figuresare prone to erratic change. The totalnumber of company insolvencies in thefour quarters to 2002 Q1 was ten per centhigher than in the previous four quarters.

The number of bankruptcies in 2002 Q1was seventeen per cent higher than thecorresponding figure for 2001 Q1. Thefigure for the four quarters to 2002 Q1 wasan eight per cent increase compared withthe preceding twelve months. Datapublished by Dun & Bradstreet forbusiness failures show a broadly similarpattern 6.

3.5 Costs and Prices

The Bank of Scotland Monthly Report onScotland indicated that manufacturers'average input costs rose for the secondmonth running in May 2002, reflecting arise in oil prices. Although the rate ofincrease was modest, it still reached itshighest point for eleven months. Servicesector costs increased in May, with the rateof increase only slightly below the thirteenmonth high recorded in April. Higher fuelprices and rising labour costs were cited asthe main reasons. Average prices chargedfor services rose in May 2002 for the sixthsuccessive month.

The CBI Industrial Trends Survey reporteda sharp rise in average unit costs from the

January 2002 survey, in contrast toexpectations of a modest fall. A moderateincrease in costs was expected over theforthcoming quarter.

Results from the Scottish EngineeringQuarterly Survey (June 2002) indicatedthat there was some improvement in pricesfor a few sectors over the quarter. Themetal manufacturing sector reported anincrease in prices in both the UK and theexport market whilst the non-metalproduct and oil & gas sectors saw anincrease in the UK market. Price falls inthe UK and export markets were reportedby the electronic and electrical goodssectors. Sales margins decreased amongstall sizes of companies in both the UK andexport markets.

The Scottish Chambers survey showed thataverage pay increases ranged from 3.66per cent in manufacturing to 5.83 per centin tourism.

3.6 Housing Market

The housing market in Scotland has shownsome strong price growth over the lastyear, although in most areas of Scotlandthe market remains significantly �cooler�than the UK market as a whole. In theyear to 2002 Q1, Halifax-Bank of Scotland(HBOS) and Nationwide reported annual(mix adjusted) house price increases inScotland of 8.3 per cent and 8.5 per centrespectively, compared with 16.2 per centand 13.6 per cent respectively for the UK.The Council of Mortgage Lenders (CML)recently reported a different position withprice growth in Scotland in the 12 monthsto 2002 Q1 with it rising into the �double-digit� bracket (12.3 per cent). This growthoutstripped the corresponding CMLincrease at UK level (9.1 per cent) whichis the first indication since the early 1990sthat Scottish house prices may be risingfaster than UK prices. Further data willconfirm whether the above-averageincrease in Scotland is the start of a

62

genuine trend or whether the figures aresimply a one-off. Paradoxically, the mix-unadjusted data on Scottish property pricesfrom CML fell by 3 per cent in the 12months to 2002 Q1. Thus, despite themix-adjusted trend, it is not entirely clearthat there is significant inflationarypressure in the housing market in Scotland.

The strength of recent house price growthin Scotland owes much to the continuingbuoyancy of the Scottish labour market (afactor even more marked in the South Eastof England) and lower borrowing costs.The Monetary Policy Committee (MPC)cut base rates on 7 occasions in 2001 andrates have remained at 4 per cent since lastNovember - with average mortgage ratesmoving down to 5.5-6.0 per cent by theend of 2001. Further factors such as stableinflation and rising real incomes have alsoplayed a part in boosting housing marketactivity.

In the near term, it seems quite plausiblethat house prices in Scotland will continueto increase more quickly than the level of

general inflation, but at a steadier andmore sustainable pace than of late. As thestock of available housing can onlyincrease very slowly, price movementshave tended historically to be more closelycorrelated to wage inflation, reflectinghousehold budgets for mortgage payments,rather than changes in the level of generalprices.

Chart 3.11 sets the recent price changes intheir historical context. It is clear that thetrend in nominal house prices has beenvery much upward over the past 30 yearsor so both in Scotland and UK.7 In 1969,the average Scottish home could be boughtfor £4,500 (UK=£4,600); by 2001, theaverage price had risen to £76,500(UK=£115,700). This represents anaverage annual increase of 9.3 per cent.Over the same period, average pricesacross the UK increased by an annualaverage of 10.6 per cent. Therefore, recentannual house price inflation in Scotlandhas been below its long-term average,while the UK rate has been significantlyabove its long-term trend.

Larger local variations in house pricegrowth in Scotland seem to be developinghowever. Chart 3.12 gives average pricesin 4 local authority areas in Scotland. The

average price of dwellings (includingRight to Buy properties) in Edinburgh hasrisen by 107 per cent over the last 11years, compared with a 77 per cent

Chart 3.11: Average House Prices in Scotland & UK, 1969-2001 (mix adjusted)

63

increase in Glasgow, a 65 per cent increasein North Lanarkshire, and a modest 35 percent increase in Argyll and Bute. TheBank of Scotland report that averageprices in Edinburgh rose 32 per cent in the

year to 2002 Q18 and that the average first-time buyer was paying around £75,000 foran Edinburgh property - £23,000 above theScottish average9.

House price rises are very much a double-edged sword: for those already in this market, higherprices generate property-related wealth gains; but new entrants to the market find it increasinglydifficult to secure a home. Encouragingly, three of the four �affordability ratios� reported by theCouncil of Mortgage Lenders, shown in Table 3.1, point to significantly greater affordability inScotland than in the UK.

Scotland 2000 Q4

Scotland 2001 Q4

UK 2001 Q4

Average mortgage advance 52,894 56,431 75,301

Average property price 69,855 74,305 112,710

Average income of buyers 27,036 29,348 33,935

Annual mortgage payment 3,572 3,958 5,282

Affordability ratios

Advance as % of price 76 76 67Avance/income ratio 1.96 1.92 2.22

Price/income ratio 2.58 2.53 3.32Payments as % of income 13.5 (Q3) 12.0 (Q3) 13.5 (Q3)Source: Council of Mortgage Lenders

Chart 3.12: Average House Prices in Four Scottish Local Authority Areas, 1990-2001(mix unadjusted, including Right-to-Buy Property)

Box 3.1: Affordability of Housing

Table 3.1: Affordability Measures of Owner-Occupied Housing for Existing OwnerOccupiers and First-Time Buyers in Scotland & UK

64

Measuring affordability over time can, however, be problematic. Chart 3.13 looks at house price to

income ratios for first-time buyers in Scotland, the UK, South East England and London since

1969. By this measure, affordability in Scotland has worsened since 1990 (since 1983 in UK) but

the recent deterioration is much less pronounced here than in either the South East of England or

the UK as a whole. As Scotland’s affordability ratios have been consistently lower (i.e. more

affordable) than those for the whole UK, affordability for first-time buyers is less likely to be an

issue here – although the picture varies within Scotland (see above). The ratio of house prices to

incomes in Scotland shown in the chart is clearly higher now than at any time since the early

1970s, but this does not necessarily mean that first time buyers will struggle to raise the finance to

buy a home. Financial institutions seem now to be prepared to lend greater multiples of income to

first-time buyers than they have in past decades. This reflects the fact that today’s first-time buyers

are generally older than their predecessors and many can expect significant increases in real

earnings in future years.

The proportion of all first-time buyers’ gross incomes accounted for by mortgage payments, shown

in Chart 3.14, is an alternative measure of affordability. This chart, in contrast to Chart 3.13,

suggests that affordability ratios (in Scotland and the UK) have not risen recently and are well

below their peaks of the 1990s. Further, affordability ratios appear to be much lower in Scotland of

late than they have been throughout most of the last 30 years. The different profiles of affordability

illustrated by Charts 3.13 and 3.14 is accounted for by interest rate changes and demonstrates that

the conclusions to be drawn on affordability of housing in Scotland very much depend on the

choice of indicator.

Chart 3.13: Affordability (average house price to average gross income) Ratios for

First Time Buyers in Scotland, UK and South East England, 1969-2001

1.5

2.0

2.5

3.0

3.5

4.0

1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001

Aff

ord

ab

ilit

y R

ati

os

Scotland UK South-East London

65

3.7 Independent Forecasts

The Scottish Executive monitors theprojections of three independent economicforecasters that are published on a bi-annual basis. The forecasters and the datesof their latest projections are:

� Business Strategies Ltd (BSL)May 2002

� Cambridge Econometrics (CE)Feb 2002

� Fraser of Allander Institute(FAI) Mar 2002

The independent forecasters expect theScottish economy to continue toexperience positive growth in 2002, albeitbelow the long-term trend rate. The rate ofgrowth is expected to range from 0.9 per to

1.4 per cent in 2002, with growth expectedto pick up in 2003 with a range of growthfrom 1.5 per cent to 2.6 per cent.

The Fraser of Allander Institute (FAI)produced their latest forecasts for theScottish Economy in March 2002. Theystate that the Scottish economy remainsconsiderably weaker than its UKcounterpart, although electronics in theUK has suffered a more severedeterioration in production than Scotlandduring the last two quarters.

FAI forecast the rate of growth in Scotlandto be 1.2 per cent in 2002, unchanged fromtheir previous forecast issued in December2001. However, they have revised downtheir forecast for 2003, with the growthrate now expected to be 1.5 per cent. InDecember 2001, growth of 1.9 per centwas forecast.

Chart 3.14: Affordability (average mortgage payments as a % of average gross income)Ratios for First Time Buyers in Scotland, UK and South East England, 1969-2001

66

According to the most recent forecastspublished by Cambridge Econometrics,GDP in Scotland is expected to increase by0.9 per cent in 2002 compared with anestimated 1.7 per cent for 2001. Theypredicted that GDP growth in Scotlandwill accelerate strongly in 2003 to 2.6 percent.

BSL forecast that growth in Scotlandwould increase in 2003, helped by arecovery in the manufacturing sector andimprovements in the tourism sector.

With regard to claimant countunemployment forecasts, two of theindependent forecasters expect an increasein 2002 with the other expecting nochange. For 2003 BSL and CE expectunemployment to continue to rise whileFAI are expecting a decline.

Forecasts differ slightly on prospects foremployment. CE and BSL predictemployment will fall in 2002 with FAIpredicting a slight rise. For 2003, twoexpect a rise in employment.

Table 3.2: Independent Forecasts of GDP Growth 2001-2003 for Scotland and the UK

Scot UK Scot UK Scot UK

BSL (May 2002) 0.6 2 1.4 1.7 2.6 3.1

CE (Feb 2002) 1.7 2.2 0.9 1.3 2.6 2.9

FAI (Mar 2002)(2) 0.7 1.7 1.2 1.9 1.5 2.6

(2) FAI do not produce their own UK forecasts. FAI quote forecasts monitored by HM Treasury.

(1) FAI produces forecasts for GDP, whereas CE and BSL produce forecasts of GVA. UK excludes continental shelf.

200320022001

Table 3.3: Independent Forecasts of the Change in Employment in Scotland and the UK,2001-2003 (1)

Scot 000s (%)

UK 000s (%)

Scot 000s (%)

UK 000s (%)

Scot 000s (%)

UK 000s (%)

BSL (Nov 2001) -5 (-0.2) +134 (0.5) -23 (-1.0) -57 (-0.2) -16 (-0.7) -103 (-0.3)

CE (Feb 2002) +16 (0.7) +149 (0.5) -13 (-0.6) -56 (-0.2) -1 (0.6) + 67 (0.2)

FAI (Mar 2002) -8.4 (-0.4) n/a +6.3 (0.3) n/a +14.5 (0.7) n/a

(1) The BSL and CE data refer to total employment. The FAI data are for employees only.

2001 2002 2003

67

3.8 Assessment

The last Scottish Economic Report,published in January, discussed at somelength the possible impact on the Scottisheconomy of the terrorist attacks lastSeptember. Although the attacks are likelyto have impacted upon the economy, it isimpossible to determine their precise scale.At that time there was little hard evidenceon which to base any assessment. It is nowapparent that the Scottish economycontinued to grow in the second half of2001, though at a slower rate than earlierin the year. This was largely due todevelopments in the global economy,many of which were underway before 11September. Data released by the Executiveillustrated that GDP grew by 0.1 per centin 2001 Q4 (in contrast to zero growth inthe UK as a whole over the same period)when most commentators had beenexpecting a fall in output. Growth rates inScotland, however, remain below the long-run average rate and there remain issues ofthe longer-term structural performance ofScottish growth and productivity.

Manufacturing has been particularlyaffected with output falling in sixsuccessive quarters up to 2001 Q4. Thistrend has, however, also been apparent atUK and European level, reflecting global

restructuring in particular product markets.The service sector has continued to grow,notably the financial services and realestate and business services sectors. Otherparts of the service sector, where there isgreater dependence on overseas demand,have experienced some difficulties:tourism is the key example here. The retailsector has performed well and consumerexpenditure in general has been importantin maintaining positive growth.

Initial evidence from the early months of2002 suggests some improvement intrading conditions and external demand,although more evidence is required beforethis can be confirmed. The surveyevidence for Scotland in the first fewmonths of 2002 suggested that businessoptimism was improving, even inmanufacturing; demand continued to risein services although remaining relativelyweak in manufacturing with only minorimprovements; and employment prospectsremained broadly positive in servicesthough remaining poorer in manufacturing.

While it is undoubtedly the case that, byhistorical standards, the labour marketremains in good health, there were somesigns of a slight weakening in the secondhalf of 2001, continuing into 2002.

Table 3.4: Independent Economic Forecasts of Claimant Count Unemployment Ratesin Scotland & UK, 2001-2003

Scot 000s (%)

UK 000s (%)

Scot 000s (%)

UK 000s (%)

Scot 000s (%)

UK 000s (%)

BSL (Nov 2001) 4.2 3.2 4.2 3.2 4.5 3.6

CE (Feb 2002) 4.2 3.2 5.0 3.8 5.3 4.0

FAI (Mar 2002) 4.3 n/a 4.4 n/a 4.1 n/a

Note: The official average (seasonally adjusted) unemployment rate in Scotland in 2001 was 4.2 per cent (UK figure was 3.2 per cent).

2001 2002 2003

68

Overall, the picture remains mixedalthough the most recent data shows someencouragement: ILO unemployment wasstable over the most recent quarteralthough it increased over the year toFebruary-April 2002. Employment roseover the quarter, although it was also downover the year. Claimant countunemployment fell, after some increases inrecent months and was still down over theyear. In summary, the Scottish labourmarket has continued to hold up well inthe face of the significant challengeswhich have confronted the global economyover this period.

The economic fundamentals in the UKremain sound, with both inflation andinterest rates remaining very low by

historical standards. Although UK outputgrowth for the first quarter of the year wasweaker than forecasters had expected,there is general consensus that outputgrowth will resume in the second half ofthe year. This is highly relevant to theScottish economy, as the UK is our maintrading partner.

Looking ahead, independent forecasts allsuggest that Scottish growth in 2002, whileremaining positive, will probably be at orbelow the long-term average. Theforecasts for growth in Scotland rangefrom 0.9 per cent to 1.4 per cent.However, projected rates for 2003 suggestan increase in growth close to or abovetrend; the forecast range is 1.5 per cent to2.6 per cent.

1 This chapter incorporates data available up to 14 June 2002.2 Research carried out on behalf of the European Commission; data are not seasonally adjusted. Fieldworkcarried out between 04 May and 21 May.3 Within Scottish Chambers Business Survey the tourism sector has been categorised by large hotels.4 People of working age.5 Civilian Workforce Jobs series, seasonally unadjusted6 It should be noted that although both the DTI and Dun & Bradstreet data appear to measure the same thing,significant differences between the data sources exist. In addition, DTI data for company liquidations andindividual bankruptcies cannot be used for direct comparison between Scotland and England & Wales as aconsequence of institutional differences that exist between both sample areas.7 Data for chart 3.11 from Survey of Building Society Mortgage Completions, which was subsequently replacedby the Survey of Mortgage Lenders in 1993. These data are adjusted for changes in property mix over time.8 Bank of Scotland Scottish House Price Index, First Quarter 2002, April 2002.9 Bank of Scotland Press Release, 7 March 2002.

69

Annex � Summary of Recent Business Survey Evidence

Services ManufacturingBusinessOptimism

SCBS recorded rises in retailingand tourism although wholesalingcontinued to suffer.

SCBS and SEQR reported that optimism remainednegative in manufacturing

CBI-ITS found that business optimism amongstScottish manufacturers was positive for the first timesince January 2000. Export optimism for the year aheadwas also positive.

Orders andSales

BoS reported that service sectoractivity increased in May for theseventh successive month with therate of growth slightly up from thatreported in April.

SCBS reported that demand wasstatic in wholesale and tourismwhile an increase was recorded inretailing. For 2002 Q2, demandwas expected to increase in all threesectors � particularly in tourism.

SRC/RBoS RSM for April showeda year on year rise in total sales of4.22 per cent. This was well belowMarch�s figure of 10.2 per cent andbelow the but above the April 2001figure of 5.6 per cent. The non-food sector (3.9 per cent) performedless well than the food sector (4.5per cent) reversing the trend ofrecent months. Following somerecent months of recording retailsales figures ahead of the UK,growth in total sales in Scotland fellbehind the UK rate reported by theBritish Retail Consortium for April(5.0 per cent).

BoS found that manufacturing output rose for the fourthmonth running in May with the pace of growthincreasing to its highest level since June 2000.

SCBS reported a decrease in manufacturing orders overthe quarter despite expectations of a small rise.However, demand was expected to increase in 2002 Q2.

CBI-ITS found that the volume of total orders fell overthe quarter, with the rate of decline increasing slightlyfrom the January survey. However, total orders wereexpected to display a positive trend in the forthcomingquarter. Total output fell for the fourth consecutiveperiod, with a larger decrease recorded than in January.

LloydsTSB BM reported a positive trend in businessactivity and an improvement compared to the previousquarter and a year ago. Activity was slightly morepositive in production than for the service sector.Export activity was also positive for the first time in ayear.

SEQR reported an increase in output over the quarterrecovering from the all-time low in the previous survey.There was an improvement reported in demand. Exportactivity was positive.

Employment BoS reported that employment rosein May for the fortieth successivemonth with the rate of growthpicking up from April.

SCBS recorded downward trends inretailing and tourism althoughwholesale was unchanged over thequarter. Expectations were for arise in all three sectors in 2002 Q2.

BoS showed that employment increased for the firsttime in fifteen months although the rate of growth wasslight.

SCBS and SEQR reported a fall in manufacturingemployment. Over the forthcoming quarteremployment was expected to be unchanged.

CBI-ITS found that employment fell for the fifthsuccessive quarter, although the rate of decline easedslightly from January. Employment was anticipated tofall again over the next quarter, albeit at a slower rate.

Note: SCBS: Scottish Chambers Business Survey (Apr 2002); CBI-ITS: CBI Industrial Trends Survey(Apr 2002); BoS: Bank of Scotland Report on Scotland (May 2002); SCR/RBoS RSM: Scottish RetailConsortium and Royal Bank of Scotland Retail Sales Monitor (May 2002); Lloyds/TSB BusinessMonitor (Apr 2002); SEQR: Scottish Engineering Quarterly Review (June 2002)

70

2002

chapter four: Selected Economic Issues

Chapter 4: Selected Economic Issues � Section A

The Regional EmploymentContribution of the Fisheries Sector tothe Scottish Economy

Michael Thomson, Scottish Executive

Summary

This article summarises the main results ofa paper that was compiled to examine thecontribution of the fisheries industry to theScottish economy. As with any economicsector, the fisheries industry generates awide range of economic impacts. Theseinclude the contribution to output, incomesand employment. This paper focuses onemployment generated by the fisheriessector, as this is often of major interest topolicy.

At the Scottish level, the production andprocessing of fish directly accounts forabout 1 per cent of employment, and 3 percent in rural Scotland. However, theindustry is significantly more important forsome regional areas, particularly whenallowance is made for secondaryemployment impacts of fisheries activity.When these considerations are taken intoaccount, there are 13 coastal Travel toWork Areas (TTWAs) that are estimatedto have at least 10 per cent of theiremployment either directly or indirectlydependent on the fisheries sector, andseveral are estimated to have significantlymore than this.

Overview of the Fisheries Sector and theScottish Economy

The fisheries sector can be defined in anumber of ways. The definition used inthis article is based on the production offish products in Scotland. The three corecomponents are the fish catching sector,

fish farming, and fish processing. In 1998,the latest year for which comprehensiveproduction data are available, gross outputin Scotland was about £400 million for thefish catching sector, £700 million for fishprocessing and about £300 million for thefish farming sector. This compares withgross output in the Scottish productionsector of £45,279m in the same year.1

In 1999, the primary fish production sectoremployed about 9,400 people, of whomabout 7,800 were in the catching sectorand 1,600 in aquaculture. Primary fishproduction accounts for 0.4 per cent of allemployees in Scotland. Employment infish processing, at 10,400 employees, islarger than in the fish primary sector andaccounts for 0.5 per cent of employment2.The production of both primary andsecondary fish products (catching, farmingand processing sectors) thus employs19,800 people and accounts for about 0.9per cent of Scottish employment. Thiscompares with 1.6 per cent in the coastaldistricts as a whole and 3.1 per cent inrural Scotland. It is clear from both officialoutput and employment data that thefisheries sector is a very small componentof the Scottish economy.

However, these figures do not reveal theimportance of the fisheries sector to somelocal areas. This is because the fishingsector is highly concentrated in a fewcoastal regions. In these areas, thecontribution of the fishing industry issignificantly greater than for Scotland as awhole. Hence a more useful comparison isto look at the fisheries sector's contributionto employment in individual coastal TravelTo Work Areas (TTWAs). When this isdone a rather different picture emerges ofthe regional economic importance of thesector.

72

Regional Direct Employment in theFisheries Industry

Chart A.1 shows direct employment in thefisheries sector in Scotland by Travel ToWork Area (TTWA). All 3 industriesinvolved directly in the production of fishproducts (fish catching, fish farming andfish processing) have patterns ofemployment that are geographicallyconcentrated but the concentrations tend tobe found in different locations. OnlyShetland is ranked within the top 5TTWAs for all three industries, whilst theFraserburgh and Peterhead areas are in thetop 5 TTWAs for two of the industries(fish catching and processing) as is theWestern Isles (catching and aquaculture).

Catching Sector

Employment in the catching sector ishighly concentrated into a few areas. Thetwo TTWAs that contain the largestScottish fishing ports of Fraserburgh andPeterhead between them account for 22per cent of employment in the catchingsector in Scotland. Other TTWAs withmore than 500 catchers, or 6 per cent ofthe Scottish total, are Shetland, theWestern Isles and Banff. At the otherextreme, several coastal TTWAs(Dunfermline, Kirkcaldy, Dundee,Inverness, Lochgilphead, Dunoon &Rothesay, Greenock, Stranraer, NewtonStewart, and Dumfries) have fewer than 50fishermen. The general picture is forcatching employment to be concentrated in

north-east Scotland between Aberdeen andForres (38 per cent of the catchers), theislands of Shetland, Orkney and theWestern Isles (22 per cent), the mainlandand Argyll islands part of the HIE area (21per cent) and, to a lesser extent, in south-east Scotland from Fife to theBerwickshire coast (6 per cent).

Aquaculture

Employment in aquaculture is also highlyconcentrated. The 5 TTWAs of Shetland,Skye & Ullapool, Oban, Dunoon &Rothesay, and the Western Isles accounttogether for 70 per cent of theemployment. All of these areas havebetween 150 - 300 jobs in aquaculture,whereas all other TTWAs have less than50 jobs in aquaculture.

Fish Processing

In the case of fish processing, the largestconcentration of employment is found inthe Annan area with 16 per cent of thejobs. A further three TTWAs, all in north-east Scotland between Aberdeen andFraserburgh, each have more than 1,000jobs and account for a total 35 per cent ofthe processing employment. Three otherTTWAs (Dingwall, Shetland andBerwickshire) have between 500/700 jobsin fish processing and jointly account for afurther 18 per cent of jobs.

73

Chart A.2 ranks the TTWAs on the basis oftheir relative dependency on directemployment in the production of fishproducts. The chart shows that in 6TTWAs, the fisheries sector directlyaccounts for over 1 in 10 jobs. In another 8areas, the sector accounts for over 5 percent of employment. The areas with the

highest percentage of their localemployment directly provided by thefisheries sector are Fraserburgh (29 percent), Annan (17 per cent) and Peterhead(14 per cent), with the Shetland Isles,Keith & Buckie and also Berwickshireeach having around 11 per cent.

Chart A.1: Direct Employment in the Fisheries Sector by Coastal TTWA in Scotland, 1999

74

Total Employment Dependent on theFisheries Sector in Scotland

In addition to direct employment, firms inthe fisheries sector support furtheremployment as a result of their activities.Economic activity in the fisheries sectorgenerates a demand for goods and services

that are used as inputs in the production offish products. Such impacts are referred toas supply linkages, or indirect impacts.These support employment in those firmsthat supply the goods and services whichare used in the production of fish products.For instance, the catching sector requiressupplies such as ice, nets, boxes and fuel

Chart A.2: Percentage of Direct Local Employment Employed in the Fisheries Sector, 1999

75

whilst it may use local shipyards for repairand maintenance work or even newconstruction work. Aquaculture producersrequire inputs of smolts, fish feed andcapital equipment. Fish processors need topurchase supplies of fish as well as inputssuch as electricity and packaging material.In turn, businesses supplying products andservices to the producers of these inputsrepresent another round of indirect effects.

There is a further economic impact whicharises as a result of household spending bythose who earn their income either directlyor indirectly from the fisheries industry.For example, fish catching and fishprocessing workers spend their incomes onhousing, food, transportation, and otherconsumption. In turn, this supportsemployment in sectors producing thesegoods and services.

While there are no precise estimatesavailable for the total number of jobsdependent on expenditure from thefisheries industry, the indirect and inducedimpacts can be estimated through the useof multipliers. These are obtained fromInput-Output models which show theinterdependencies between differentsectors of the economy in a particularregion. Multipliers can be calculated forany geographical area although Input-Output data are only collected on a regularannual basis for Scotland as a whole. Onlya few studies have attempted to estimateInput-Output tables and multipliers forareas at a sub-Scotland level. In general,the scale of the multiplier will vary withthe size and economic diversification ofthe geographical area that is covered. Forexample, the multiplier effect for Skyewould be lower than for the Highlands,and in turn the latter's multiplier would beexpected to be somewhat lower than forScotland as a whole. This is because, for asmaller area, a lower proportion ofexpenditure from the fisheries sectorwould generally remain within the localarea.

Estimates of indirect and inducedemployment dependent on the fisheriessector in each TTWA would requiredetailed Input-Output data for each area.As such information is not available, themultiplier values that are used to producethe estimates in this paper are based onstudies that are available. There arelimitations to taking multipliers estimatedfor one area, and applying them to otherareas. Not only will multipliers changeover time, but differences in the economicstructure of each area will result indifferent multiplier effects.

There are further limitations to the use ofmultipliers that need to be borne in mind.For example, an increase in demand forfish supplies from fish processors mayhave no impact on catching employment ifthe catching sector is unable to expandoutput due to supply factors such asquotas. In such a case, the additionaldemand for fish inputs would be met fromimports, and there would be no directpositive impact on Scottish fish catchingemployment. Nevertheless, with theavailable data, the assumptions used areconsidered to be those which are mostappropriate under the circumstances.

The Scotland-wide figures, estimated fromapplying the Scottish and local fisheriesmultipliers, indicate that there may bearound 48,000 fisheries dependent jobs inScotland3. There are an estimated total ofaround 16,000 direct, indirect and inducedjobs generated by the catching sector.There are a total of up to 4,000 generatedby the fish farming sector, and 28,000generated by the fish processing sector.These estimates suggest that around 2.0per cent of Scottish employment isdependent on expenditure by the fishcatching, farming and processingindustries

The results derived from the inclusion ofthe estimated multiplier effects are shown

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in Chart A.3. The area with the highestpercentage of fisheries dependentemployment is Fraserburgh, where suchemployment, including indirect andinduced impacts, is estimated to accountfor over half of total employment in theTTWA. In addition, there are 5 TTWAswhere fisheries dependent employmentaccounts for between 20 � 35 per cent ofall jobs. In Annan, it is estimated toaccount for around one-third (36 per cent)

of total employment. In the Peterhead areathe figure is about 28 per cent, whilst ineach of Berwickshire, the Shetland Isles,and Keith and Buckie, it is about 22 percent. There are a further 8 areas (ArgyllIslands, Campbeltown, Western Isles,Skye & Ullapool, Newton Stewart,Kirkcudbright, Banff and Oban) wherefisheries dependent employment isestimated to account for between 10 � 16per cent of all local jobs.

Chart A.3: Percentage of Local Employment in the Fisheries Sector by Coastal Travel-To-Work Areas in Scotland, 1999

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The map of Direct, Indirect & InducedFisheries Related Employment (seeAnnex) provides a visual representation ofthe relative importance of fisheries relatedemployment in the different TTWAsaround the coast.

Conclusions

This article has presented estimates of thecontribution of the fisheries sector toemployment in Scotland. A total of 19,748workers were directly employed in thefisheries industry in Scotland in 1999. Ofthese, 7,774 were employed in thecatching sector, 10,405 were employed infish processing, and 1,569 were employedin fish farming. While in total this is lessthan 1.0 per cent of total Scottishemployment, and 3 per cent in ruralScotland, this figure understates theregional importance of the sector,particularly when allowance is made forlikely multiplier effects. The findings

confirm the impression that fisheriesrelated employment is highly concentratedinto relatively few areas, and for theseareas the fisheries sector is considerablymore important than for Scotland as awhole.

The employment estimates should,however, be viewed with caution as thereare various limitations to the multiplierapproach. Accurate local employmentmultipliers would require the generation ofInput-Output tables for each area.Applying common multipliers to all areas,as has been done here, will overestimatefisheries generated employment in someareas and underestimate it in other areas.Furthermore, the results do not indicate thelikely fall in employment if the fisheriessector were to decline, as most job losseswould be short term and, in the longer run,it would be expected that employmentwould be found in other sectors of theeconomy.

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References

Gillespie G., McGregor P.G., Swales J.K.and Yin YP, "An Input-Output Table andModel for the Shetland Isles, 1996/97),Fraser of Allander Institute

Greig G. (1999), "Multiplier Studies forthe Fishing and Fish Processing Industriesin the United Kingdom and Scotland - AnInput - Output Analysis", Sea FishIndustry Authority

McGregor P.G, Swales J.K, and Yin Y.P,(1995), "An Input-Output Table andModel for the Orkney Isles", Fraser ofAllander Institute

PACEC (1998), "The Economic Impact ofScottish Salmon Farming", The ScottishOffice

Roberts D., Thomson K.J and Snowdon P.(1999), "Modelling the Western IslesEconomy: Regional Accounts 1997",MLURI / University of Aberdeen

1 Scottish Census of Production2 The employment data that is used comes from the annual Scottish Sea Fisheries Statistics, published bySEERAD, and from the Annual Business Inquiry, collected by the Office for National Statistics.3 Published estimates, for the catching sector of Type I multipliers, which include direct and indirectemployment, range from 1.06 for the Orkney Isles (McGregor et al., 1998) to 1.66 for the Western Isles(Roberts, 1999). For the processing sector they range from 1.78, as estimated for the Shetland Isles (Gillespie etal, 1999), to 2.78 in for the whole of Scotland, reported in Greig (1999). For the aquaculture sector they varybetween 1.19 reported by the PACEC (1998) study for the Orkney Isles, to 2.1 reported by Roberts (1999) forthe Western Isles. Type II multipliers, which also include induced employment, range from 1.24 for the OrkneyIsles to 2.10 for the Western Isles, for the catching sector. For the processing sector, the only reported Type IImultiplier is provided by Greig (1999) at 3.33. The range for the aquaculture sector is from 1.68 for the OrkneyIsles to 2.26 for the Shetland Isles (PACEC, 1998). The estimates used in this paper are based on the mid pointsof the ranges reported in the published studies of local multipliers. To avoid double counting fish catchingemployment, the processing multipliers are adjusted downwards to exclude the catching sector.

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Annex

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Chapter Four: Selected Economic Issues � Section B

Scottish Enterprise/Royal Society ofEdinburgh Enterprise Fellowships:Stimulating Innovation andEntrepreneurship

Alison F. Graham, Scottish Enterprise

1 Introduction

The Scottish Enterprise/Royal Societyof Edinburgh Enterprise Fellowshipsprogramme was set up in 1996/97. Theobjective was to provide a route torealise the commercial potential ofexceptional research being conductedwithin Scotland's universities in theimportant fields of opto-electronicsand biotechnology and so contribute tothe development of the local industrybase.

Enterprise Fellowships are awardedthrough a rigorous, competitiveselection process to public sectorresearchers and industry personnelwho have identified a commercialopportunity addressing markets withthe potential to support substantialbusiness growth. Equally importantly,the recipients are judged to have thepotential to play a key role in anentrepreneurial start-up team.

The funding is provided to enable themto develop the business proposition,with the objective of forming acompany in Scotland that would nototherwise come into being, tocommercialise proprietary technologyand know-how. Where new firmformation is not in practice realistic,the projects should still aim to transferthe technology into new products andprocesses.

This paper outlines the public policycontext of this programme which

addresses particular goals of micro-economic intervention. It describes thedevelopment of the programme frominception to the present day andpresents a summary of the findings of aformal interim review and evaluation.It draws conclusions with reference topublic policy goals.

2 Policy context

2.1 Introduction

Current trends in policy analysis andimplementation address the conceptsof both market failure and systemicfailure. This applies internationally in arange of OECD countries and in recentyears has increasingly been applied inthe UK.

Scottish political and economicdevelopment policy recognises that therate of innovation occurring in themarket place is economically andsocially sub-optimal. Reducing barriersto entrepreneurship and enabling thecreation and growth of new technologybased firms is one route by whichgovernments and developmentagencies can intervene. The mainopportunities will be found where thereare low barriers to entry in fragmented,technically dynamic and fast growingmarkets.

The wider policy context (mapped inOECD (1998)) consists of all relevantmacro and micro economic policiesunder both UK national and Scottishdevolved powers, the degree ofentrepreneurial culture and the natureof the national and regional technical,business and educationalinfrastructure.

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The promotion of innovation coupledwith entrepreneurship is a widespreadgoal and, although by no means new, isincreasingly important in botheconomic and employment policy(Ploeger (2000), OECD (2001, 2002),CEC (2002)).

2.2 Rationale for Public SectorIntervention

Market failure rationale

Market failure arguments for micro-economic intervention to stimulateinnovation are typically framed round:� Imperfect markets in information,

for example on technology/marketopportunities relevant to both theexploitation of proprietarytechnology and the adoption ofnew technology with the objectiveof achieving productivity gains

� Uncertainty and risk, leading tosub-optimal economic activity incorporate venturing,entrepreneurship and investment

� Externality effects that inhibitinnovation and technologyentrepreneurship: for examplecompetitors inventing roundpatents and copying innovationsmay reduce or even precludereturns to the original innovator.

These arguments have resulted in awide range of direct public sectorinterventions at both the Scottish andUK levels aimed at stimulatingtechnology creation, exploitation,adoption, provision of seed and earlystage risk capital, andentrepreneurship. However, these havenot been sufficient to create theconditions for a substantialimprovement in Scotland'sperformance in the economicexploitation of new knowledge andtechnology, whether this is created inScotland or adopted from elsewhere.

Where a spin-out company is theappropriate route to transfer outputs ofpublicly funded research to thecommercial sector, the typical barriersto new firm formation remain:� Lack of business understanding,

experience and relevant contactsamong academic researchers, evenamong those with a track record ofindustrial collaborative research

� Lack of time/opportunity toinvestigate markets

� The incentive structures in thehigher education and researchsystem generally still do notadequately reward spin-out andknowledge transfer activity.

Prospective entrepreneurs from theprivate sector can also face significantbarriers even where their industryexperience potentially contributessignificantly to the proposed start-up.

Systemic failures

International policy analysis (OECD1999) now recognises that whilemarkets are a driving force ineconomic activity, interventions aimedat specific market failures may not besufficient to address fundamentalstructural or systemic issues.Piecemeal delivery is a common issuewhich also does not help matters.

It has been recognised for decades thattechnology development andexploitation is a UK wide failure. Thishas persisted despite publicintervention, demonstrating the casefor looking for approaches with thepotential to generate more fundamentalchange. However, on the positive side,the UK has strengths in scienceintensive industries, the prime examplebeing the case of pharmaceuticals.

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Technological change is systemic i.e.progress depends on both theperformance of specific actors (e.g.firms, universities, research institutes,entrepreneurs, financiers) and on howmarket and non-market institutionsinteract. Scotland has relative strengthin the size and performance of itspublic research base and relativeweakness in terms of the number andsize of companies with significanttechnological capability. It needs tostrengthen its industrial profile in thisrespect.

There is therefore a strong case forsetting as a policy priority the creationof sustainable technology basedbusinesses, in addition tocomplementary measures such asencouraging the location of corporateresearch, development and designfacilities by inward investors. Inparticular, public sector interventionaims firstly to increase the probabilityof promising companies being createdthat would not otherwise be founded,and secondly to increase theprobability of them achievingsignificant growth.

It is well known from studies (e.g.Scottish Enterprise, 1996),consultations and practical experiencethat the number and participation ofthe relevant actors is sub-optimal, asare the interactions between marketand non market institutions. Howeverin making regional comparisons,caution needs to be exercisedconcerning cause and effect indynamic growth regions. For example,entrepreneurial, technology orientatednew firms have undoubtedly been afeature of developments aroundCambridge for two decades, butanalysts reserve judgement withrespect to cause and effect (SegalQuince Wicksteed, 2000).

3. Scottish Enterprise/ RoyalSociety of Edinburgh EnterpriseFellowships

3.1 Programme Objectives andDevelopment

The SE/RSE Enterprise FellowshipsProgramme addressed the need tocommercialise the exceptional researchthat was being conducted withinScotland�s universities in the key areasof optoelectronics and biotechnology.Cluster development strategies forthese and other areas weresubsequently approved by the SEBoard.

The scheme was developed to targetnon-tenured researchers in theuniversities to give them the time,training and networks they needed tocommercialise their research,predominantly through new firmformation. Post-doctoral researchersare at a stage in their careers wherethey have had the opportunity todevelop significant capability andmaturity but also may be facing adecision on whether to continue inacademic research or whether topursue another route. EnterpriseFellowships make the spin-out route amore feasible option.

The funding approved for the pilot andmain programme allowed for up to 23Fellowships to be awarded on acompetitive basis in the period 1997-2002. The pilot areas wereoptoelectronics and biotechnology andthe first year outcomes wereencouraging. This led to the mainprogramme in which Fellowships wereoffered in the fields of opto-electronics, biotechnology, energy andcreative media. Provision was thenmade for a further 7 Fellowships incommunications technologies andmicroelectronics for 2001/03.

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The Royal Society of Edinburgh (RSE)administered the programme on behalfof Scottish Enterprise. Thisrelationship was considered veryappropriate given the credibility andtrack record of the RSE within theacademic establishment. GlasgowCaledonian University delivered thetraining element.

Early in 2001, Scottish Enterpriseundertook an interim review andevaluation of the outcome of the 13Fellowships completed at that stage.This gathered formal evidence for thepurposes of public accountability andfuture programme decisions. Thereview was commissioned externallyfirstly in order to obtain anindependent view, and secondly toposition Scottish Enterprise as one of arange of stakeholders, albeit the funderof the programme.

3.2 The Enterprise FellowshipYear

The main elements of the EnterpriseFellowships scheme are:� A rigorous competitive selection

process which is usually the firsttime the candidates have presenteda proposal for thecommercialisation of research to asenior panel including successfulentrepreneurs

� One year's salary and expenses,providing time to develop thecommercial opportunity, build thestart up team and raise first roundfunding

� Structured business training� Introductions to business and

investor networks� Experiential learning coupled with

intensive coaching and mentoring

The peer group adds a very importantdimension and the programme has now

got to a stage where new entrants alsobenefit from the example andexperience of those from previousyears.

4 Findings of the InterimReview and Evaluation

The objectives of the review (ScottishEnterprise, 2001) were� to identify qualitative and

quantitative outputs to date� provide an objective overall

assessment of the conduct andvalue of the programme and itscontribution to economicdevelopment

The review was based on an interviewprogramme with the Fellowsthemselves, their departments, mentorsand others involved in the cases.

At the review date, 13 researchers hadcompleted their Enterprise Fellowshipyear, a further 5 Fellowships wereunderway. Seven of these were inbiotechnology, 7 in optoelectronics, 2in energy, 1 in creative media and 1 incommunications technology.

The programme was found to be ontrack to award the planned 23Fellowships through a rigorouscompetitive selection process and toachieve (potentially to exceed) outputand impact targets.

Former Enterprise Fellows now holdpositions of CEO, Technical Directoror Product Manager, or are a keymember of the business start team inthe following technology orientatedcompanies: Intense Photonics Ltd;Photonic Materials Ltd; MicroemissiveDisplays Ltd; Kymata Ltd; SurfactantSolutions Ltd; Intrallect Ltd; andEdinburgh Biocomputing SolutionsLtd.

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The first three companies foundedwere in optoelectronics. The otherfour, founded more recently, are ineach of biotechnology, optoelectronics,energy and creative media.

While it must be acknowledged thatmany other factors, such as access tofinance, are crucial in new firmformation, the evaluators concludedthat:� In two cases it was highly unlikely

that a spin out company wouldhave been formed in Scotlandwithout the Fellowship.

� In three cases, the Fellowship wasa very important, possibly criticalstage in the formation of the firm.

� In one case the Fellowship wasjudged important but not the primefactor.

� In the seventh case, the Fellowshipyear made a contribution, albeitsmall relative to other inputs.

The impact on the Fellows themselveshas been substantial and in some casestransformational. The report quotessome of those who went on to play akey role in a new business:

'I started the year as an academic andended it as a businessman'

'I am light years away from where Istarted the year'

The confidence and personalcredibility required to operate in a newenvironment, the dramatic learningcurve and the wide range of contactsthat opened up during the Fellowshipyear were generally regarded as keyfactors.

The evaluators concluded that:

'There is therefore little doubt thatthose who are prepared to participatein the programme with the right spirit

in mind can indeed be stimulated andchanged by a dramatically differentenvironment compared to the one theyhave been used to'

The academic consultees contacted forthe review were very enthusiasticabout the programme as one of severaleffective approaches tocommercialisation. In almost all casesthe university department in which theFellow was based was supportive, andin some cases very much so.

Even where the projects did not resultin the formation of a new venture, theevidence indicates that undertaking aFellowship is still a valuabledevelopmental move providingenhanced skills relevant to bothacademic and private sector employers.Hence the risk to the individual inundertaking the year is likely to beacceptable to promising candidates.

The technical evaluation found that:� The net jobs created have each cost

£6,300, and this will fall to £1,700in three years time if the firms�projections are actually realised.

� The companies currently employ420 people, mostly in high qualityjobs. This is projected to increaseto over 700 in three years' timewith over 50 per cent directlyattributable to the intervention.

These estimates are based onconservative judgements of thecontribution of the EnterpriseFellowship year to the formation of thecompanies.

The value of private investment fundsattracted at the date of the review wasjust over £6 million. The firms hadalso attracted a further £1.5 million ofpublic funds, mainly grant fundingthrough competitive awards. Thesefigures exclude the £112 million

85

investment attracted by Kymata,quoted in published sources. Some ofthe companies have since raised furtherfunding, even in a more difficultinvestment climate.

The main hurdle a significant numberof the Fellows had to overcome relatedto time consuming and tensenegotiations concerning ownership ofintellectual property rights (IPR) andthe nature of the agreement with theuniversity to distribute the potentialfinancial returns. This type of problemby no means new nor unique toEnterprise Fellowships and a newguide has recently been issued for thestrategic management of intellectualproperty in the university sector(AURIL/Universities UK, 2002).

4.2 Conclusions of the InterimReview

The Interim Review concluded that:

�This has been an interim evaluationwhich has taken place while theprogramme is still up and running andthe businesses are still very young.Many of the benefits might be yet toemerge. Even so, economic impactperformance so far is very good, interms of business spinout fromuniversities, net job creation and costeffectiveness. This will be enhanced ifthe businesses established grow asthey are anticipating.

�The Enterprise FellowshipProgramme is shaping up to be anexcellent contributor to economicdevelopment in Scotland. It is enablingprogress to be made in thecommercialisation of universityresearch and the establishment oftechnology oriented new businesses.The programme is well-regardedamong those in the academiccommunity who have come into contactwith it and appears to have enhancedthe reputation of SE in this sector."

The conclusions of the review werevery positive and the principles of theprogramme judged to be correct.Nevertheless, the evaluators identifieda number of areas where developmentsand changes to the programme couldbring substantial benefits.

For example, they considered it shouldbe made more explicit that there are avariety of roles in which the Fellowcan make a leading contribution to anew business formed, although thereclearly are individuals who can emergeat the end of the year in charge of asuccessful business operating in acomplex technological area. Secondly,the current access to networks andsupport in finding partners to augmentthe skills of the Fellow should be amore explicit and open feature of theprogramme. This is illustrated in thefollowing diagram:

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The Enterprise Fellowship Year

4.3 Subsequent Developments

The findings of the review were verypositive and provided evidence thatthere was a strong case for extendingthe intervention along very similarlines. Further, it was closely alignedwith the latest Scottish Executive andScottish Enterprise policy frameworks(Scottish Executive, 2001). It was alsojudged that for the time being thereremained a significant opportunity tostimulate new firm formation thatwould not otherwise be driven by othermeans, in particular the participation ofthe private sector.

The work plan for development andappraisal for the extended interventioncovered:� Programme scale and scope.� Appraisal of future public and

private funding options.� Actions to reduce project risk

related to IPR� Development of the model and

programme processes, taking thedetailed findings of the review intoaccount.

Phase 2, launched in March 2002,provides for a further 80 Fellowshipsin 2002-2007. The range oftechnology/market areas has been

extended, determined by researchstrengths and areas of potential growthin world markets and in the Scottisheconomy.

5 Conclusions

The Enterprise Fellowshipsprogramme has proved to be effectivein a number of respects. Firstly, it hasbrought forward inventions andproprietary knowledge that otherwisewould be much less likely to reach themarket. Secondly it enables qualifiedand experienced researchers whowould otherwise have found itdifficult, if not impossible toparticipate in the formation of atechnology orientated new firm to dojust that. Thirdly, the training andsupport provided in this pre-start phaseis undoubtedly effective in enablingthe individuals to play a key role inthis process. Similar principles can be,and are being, applied elsewhere withdelivery adapted to localcircumstances. This provides thepotential to build up a wider body ofexperience and evidence.

Each Fellow undertakes to pursue ahighly ambitious goal. The majority todate have come from a universityresearch environment, so achieving

Candidate • salary• training• mentor support

• networking• securing partners

Spin-out businesswith Fellow as:• MD• Technical

Director• Manager, or• Otherwise

involved

87

that goal entails making the transitionto apply their technical expertise in avery different, and initially alien,environment. They also have tonegotiate difficult territory and makedecisions with far reachingimplications in both personal and inbusiness terms. Access to highlyexperienced, specialist advisers withno personal interest in any deal isextremely important. This must beavailable very early in the process.Further development and expansion ofthe programme needs to beaccompanied by sufficient capacity inthe specialised support provided.

From one point of view, EnterpriseFellowships are a pre-seed, hence highrisk investment largely supported bypublic funds. From anotherperspective, this approach bothstimulates, and reduces the risks of,participation by a range of public andprivate actors in terms of their input oftime and finance. The proportion ofpublic funding reduces dramaticallyonce the projects reach first roundventure funding. Hence theintervention works effectively with themarket.

Enterprise Fellowships have resulted inthe formation of new firms withinScottish Enterprise cluster policy areasand contribute to the delivery of theassociated action plans. This isreinforced by complementary

measures, both generic andcluster/industry specific.

Acknowledgements

The case material presented in thispaper draws substantially on theexperience and programme papers ofIain Ross (Scottish Enterprise), AndyMcNab (Scottish Enterprise), ProfessorD. Jane Bower (Glasgow CaledonianUniversity), and Anne Ferguson(Royal Society of Edinburgh).

The formal Interim Review andEvaluation of the SE/RSE EnterpriseFellowships Programme, 2001 coveredin Section 4 was conducted by SegalQuince Wicksteed Ltd on behalf ofScottish Enterprise. The review wassupervised by Iain Ross and the author.Scottish Enterprise greatly appreciatesthe detailed input to this review fromthe Enterprise Fellows, together withthe senior academics, professionaladvisers and business people who havemade essential contributions toimplementing the programme.

Further consultations withrepresentatives of UniversitiesScotland, the Royal Society ofEdinburgh, the Scottish Executive andthe Scottish Higher Education FundingCouncil continue to be very valuable inhelping to shape Phase 2 of theprogramme.

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References

AURIL, Universities UK and ThePatent Office (2002) 'ManagingIntellectual Property: A Guide toStrategic Decision-Making inUniversities' Prepared by SegalQuince Wicksteed Ltd with financialsupport from the Department of Tradeand Industry and the Patent Office.

Commission of the EuropeanCommunities, 2002. Third EuropeanForum for Innovative Enterprises,Stockholm, April, 2002.

OECD (1998). 'Technology,Productivity and Job Creation.'OECD Publications, Paris.

OECD (1999). 'Managing NationalInnovation Systems' OECDPublications, Paris.

OECD (2001). 'Fostering High-techSpin-offs: A Public Strategy forInnovation'. OECD STI Review No 26.

OECD (2002) 'LinkingEntrepreneurship to Growth'. STIWorking Paper 2001/02

Ploeger, R. (2000) 'Innovation andNew Entrepreneurship - A crossnational survey of policies in 13European cities'. Amsterdam StudyCentre for the MetropolitanEnvironment for Eurocities EconomicDevelopment and Urban RegenerationCommittee (EDURC).

Scottish Enterprise/Royal Society ofEdinburgh (1996) 'CommercialisationEnquiry'. Scottish Enterprise, Glasgow

Scottish Enterprise (2001). 'EnterpriseFellowships Interim Review andEvaluation - Summary Report'.[Programme evaluation report by SegalQuince Wicksteed Ltd]. ScottishEnterprise, Glasgow.

Scottish Executive (2001). 'SmartSuccessful Scotland'. Edinburgh.

Segal Quince Wicksteed (2000). 'TheCambridge Phenomenon Revisited'.Cambridge.

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This is the sixth edition of the Scottish Economic Report. It is published twice-yearly andincorporates a review of the progress and prospects for the Scottish economy, together witha review of the broader economic context in which the Scottish economy is set, as well as aselection of summary articles of key topical interest.

This sixth edition of the Scottish Economic Report has four parts to it:

• Chapter 1: Global, European and UK Economic Developments provides an overviewof the important economic developments in the Global, European, and United Kingdomeconomies, and considers the economic context over the recent past and outlook forfuture prospects;

• Chapter 2: Report on Economic Development Initiatives provides an outline of recentissues in the economic development field, providing a follow up to the Framework forEconomic Development in Scotland;

• Chapter 3: The Scottish Economy: Recent Developments and Future Prospectsprovides an overview of the Scottish economy. This section summarises the recentdevelopments and prospects for the Scottish economy;

• Chapter 4: Selected Economic Issues provides an opportunity for brief surveys ofselected economic issues to be presented. The papers are intended to review or summarisemore substantive documents or work of value to the thinking of the Scottish Executive, orto provide an opportunity to present new or different perspectives to stimulate furtherdebate in areas of topical interest.

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