GERS: A Story Told Through Graphs

Today saw the publication of the Government Expenditure & Revenue Scotland (GERS) report for the fiscal year 2015-16.

Regular readers of chokkablog will be familiar with my predilection for helping us get our heads around large quantities of data by plotting some graphs. Well buckle in.

Let's start with the simple headline fact: Scotland's GERS deficit was £14.8bn last year. It has remained at similar levels for the last four years but has slightly deteriorated in the last two¹.

As a percentage of GDP our deficit is now 9.5%. To place this figure in context, the EU's "excessive deficit threshold" is defined as 3.0%²

Of course we're not an independent country, we voted No. This means that the deficit that really matters to us is the UK's, because that's the one which we share. The UK's deficit, on the same basis, is 4.0% and improving steadily.

At this point somebody normally pipes up that this proves the UK's economic strategy is failing Scotland because the UK as a whole is improving but Scotland isn't. This is of course a rather daft observation. It's daft because it doesn't allow for the impact of North Sea oil revenue declining due to the global oil price crash and maturing North Sea reserves.

North Sea oil revenues are now effectively zero³, as the OBR and many of us predicted some time ago. This of course contrasts rather dramatically with the £6.8 - 7.9bn annual North Sea income that the Independence White Paper recklessly predicted. In fact - due to decommissioning costs and tax credits - the latest forecast is for the North Sea to represent a net fiscal cost for the foreseeable future.

We can easily exclude the impact of this North Sea decline by looking at Scotland's onshore economy only (the green line below).

This shows that our onshore economy has in fact been improving broadly in line with the trend for the UK as a whole⁴.

"But hold on Kev" I hear you ask, "if it's all about the loss of oil revenues, surely that's a problem for the UK as a whole as well?". The answer to this is simply that the North Sea is proportionately way less important to the economy of the UK than it is to Scotland. Here's that same graph on a total UK basis  -  makes the point pretty clearly I think.

So the apparent lack of progress on Scotland's deficit is really just due to the fact that we used to have oil and now we don't. The improvement in our onshore economy's performance is masked by the decline in our offshore revenues. But now oil's gone, why in relative terms is our deficit so much worse than the UK average?

This is easily explained by looking at Scotland's revenue generation and expenditure (on a per capita basis) versus the rest of the UK. Regular readers will be familiar with this graph⁵. The figures below are all in real terms (i.e. adjusted by the UK GDP deflator).

This graph shows us:

• Red line: we consistently receive about £1,300 higher expenditure per capita than the rest of the UK
• Green Line: we consistently generate about £400 per capita less onshore revenue than the rest of the UK
• Black line: when you include oil revenue, we've historically generated considerably more revenue than the rest of the UK, sometimes (most recently 2011-12) enough that our higher revenue more than compensates for our higher spend.

The difference between the red and the black lines is our per capita deficit gap, the amount by which our per capita deficit exceeds (or not) that of the rest of the UK.

Here's an updated plot of this gap - the trend is clear

The Independence White Paper assumed the same average level of North Sea oil income as generated on average between 2009 and 2012, implicitly in perpetuity. The recklessness of that assumption is glaringly apparent.

What these graphs tell us - and what this blog has frequently argued - is that there's long been an onshore deficit gap of about £9.0bn between Scotland and the rest of the UK. This was simply masked by surges in oil revenue. When the oil revenue goes (as it has now), that deficit is exposed. The idea that oil was ever just "a bonus" for the independence case is risible.

There are arguments to be made for calculating this deficit gap either on a per capita or percent GDP basis and versus either the UK as a whole (including Scotland) or versus rUK (the rest of the UK). If you really care, you can read the arguments here (> FFA For Dummies; Methodology) but all you really need to know is it makes little difference. The graph below shows the size of this onshore deficit gap over time, calculated in both ways

We can safely say that, for the last decade and more, there's consistently been an £8 - 10bn onshore deficit gap between Scotland and the rest of the UK and there's currently no sign of it going away. This is the "black-hole" that some of us keep banging on about.

Let's clear a common point of confusion: the "black-hole" doesn't mean the deficit. It means the amount bigger our deficit would be than that we now share with the UK ... if we were independent and still raising and spending public funds at the rate shown in GERS.

This matters in part because we could continue our trajectory of onshore revenue growth and slower spending growth and eventually we would eliminate (or at least reduce to manageable levels) our deficit - but we wouldn't close the gap with the rest of the UK unless we raise revenues faster or increase spending more slowly than them. As long as we perform on the same track that gap remains - a gap that translates into an effective fiscal transfer from the rest of the UK to Scotland of £9bn a year or £1,700 for every man, woman and child in Scotland.

Is it fair that we should receive that money? Well there are two ways of answering that.

Firstly you could argue that the principle of union is that we receive equal levels of service from the state (not equal levels of spending) and so if an area is high "cost-to-serve" it should receive more public funds. Think Scottish islands and rural areas being subsidised by Scottish cities. Scotland is high cost-to-serve relative to the rest of the UK because of low population density and dispersed communities, but also because we have health and demographic challenges (see Two Types of People). 

Secondly you could argue that it's the quid pro quo for the fact that when we have a windfall like North Sea oil, we share it. We definitely did share it of course - if you start the clock in 1980 (the most favourable point to do so from Scotland's perspective) we can see clearly that for a long time Scotland was a massive net contributor (black above red) to the UK's economy.

For what it's worth, if you sum up the total real terms net contribution by Scotland to the UK over this time period we are still "in credit" by just over £10k per capita (so at the current rate of transfer we'd still be in credit for another 6 years). Nobody in Scotland needs feel embarrassed by the fiscal transfer - we are pooling and sharing over time as well as geographically. Of course we could try and run this calculation from 1707, but that way madness lies.

Nobody is arguing that an independent Scotland wouldn't want to and indeed have to do things differently - but GERS does show us the starting point, the run-rate, the pro-forma accounts on which an independence case needs to be built. Those who champion independence have to make a credible for case for how and why and by how much we'd change the GERS figures by being independent. Just saying "the GERS figures tell us nothing" simply doesn't wash - they tell us what happens if we were to keep taxing and spending at these levels (and why we can't).

So let's look at where we spend the money today: here's our total managed expenditure in real terms over the last 17 years

Of course some of that money is controlled by Westminster. In the cases of debt interest and defence these cost are allocated to us on a per capita basis. The other main reserved expenditure is elements of social security, most notably pensions, which are allocated on an actual spend basis.

What strikes me is the fact that, despite the austerity rhetoric, our overall public spending has increased in the the last year by £650m or 1.0% in real terms (this compares to spending in the rest of the UK having risen by 0.8%)

If you strip out the reserved and per capita allocated (and highly contentious in terms of "value") categories of debt interest, defence & international services we still received £650m higher spending in real terms. 

Go a step further and strip out the world of pain that is accounting adjustments and the remaining categories have seen a spend increase of £1,420m or 2.5% (having been flat last year). We can debate how the pain has been spread, but the overall level of spending on key services has in fact risen as a result of the ongoing UK fiscal framework and the wonders of the Barnett Formula.

Remembering that the value of the fiscal transfer from the rest of the UK to Scotland is £9bn, it's worth noting that if you (ridiculously) assume no debt and no defence costs at all we'd still be missing £3bn a year if we were out of the UK and wanted to continue to spending these other sums.

You're probably wondering in what areas are we spending more than the rest of the UK on a per capita basis? Well we have a graph for that

The simple answer is basically "everywhere". We used to spend less per capita on 

Public order & Safety, but the centralisation of Police Scotland appears to have put paid to that. There has been a long overdue - but to be applauded - marked increase in Education and Training spend.

The only area where we spend less is "Accounting Adjustment" which needs a little explaining. In this graph this includes "EU transaction costs" which are broken out in GERS this year for the first time. Although EU membership is a net cost to Scotland (about £39 per capita) it's £85 lower than the cost for citizens in the rest of the UK. The other main source of difference is "English Housing Associations" which have been reclassified into the Public Sector in England and account for £132 per capita spend in England but zero in Scotland as they have not (yet?) been reclassified into public spending here⁶.

So we can see where we spend more and this adds up in total to £1,300 per capita (presumaby it will be more if ONS decide Scottish Housing Associations should also be classified as public expenditure). If we're to close the deficit gap - to reduce our dependence on Barnett - we could of course simply spend less. The figures above give you a starting point to try and find £9bn. Suffice to say a £9bn reduction in spend would be an order of magnitude greater than any cuts we've seen under "Tory austerity"

So let's look at the other side of the equation, our onshore revenue generation

This shows a very encouraging real-terms growth trend which is in-line with the UK as a whole⁴. The onshore revenue growth in the last year of £1.9bn is greater than the £1.8bn loss of North Sea revenue, so it's true that overall our revenue has grown. Of course we've already seen our spend has grown as well, which is why our deficit has very slightly deteriorated.

Now depending on the cut of your cloth you either see this as showing that Westminster's economic policies work for Scotland as well as they do for the rest of the UK or (if you aren't too busy arguing that GERS numbers show us nothing of value) that they show what a super job the SNP are doing. Given the SNP have refused to use our hard-fought-for tax raising powers to any meaningful degree, I find it hard to conclude that this is anything other than the UK's economic strategy working for Scotland's onshore economy.

Now I imagine you'll be wanting to know why we consistently generate less revenue per capita than the rest of the UK, so let me throw one last graph at you:

As noted before on this blog, we depressingly raise more per capita in sin taxes (tobacco, alcohol and gambling duties) and the corporation tax assumption is the one big "punt" in GERS: companies don't report profits split between Scotland and rUK so it's frankly a guess. The key point is that this guess is not a material factor in explaining the lower revenue generation we see - that's clearly down to lower income and wealth taxes. Basically, on average Scots are paid less and we are less wealthy than the rest of the UK.

I sense a grievance building, but as Nicola Sturgeon was at pains to point out today: "Scotland, in terms of economic output per head – and even excluding offshore revenues – remains the most prosperous part of the UK outside of London and South-east England"

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So I think we've understood the GERS figures through these graphs and they produce no surprises. If we'd have voted Yes the oil decline would still have happened and the gap that is being filled by fiscal transfers from the UK would have to have been filled from elsewhere - some combination of spending reductions, tax rise or even higher borrowing. That's before we even start to consider the immediate cost of independence, currency issues, business flight etc. We can safely conclude that those of us who voted No helped us dodge a bullet.

Even Yes voters can't deny that we now receive an effective £9bn fiscal transfer from the rest of the UK, that pooling and sharing works massively in our favour.

The question remains: how do we improve the economy of Scotland, how do we deliver not only onshore revenue growth in-line with the rest of the UK but revenue growth that's superior to the rest of the UK? Only by answering this question can we reduce the fiscal transfer without drastically cutting our public spending.

Well I have some thoughts. Obviously the way you grow public revenue is by growing the economy, creating jobs and paying people more (who then go out and spend more). That means creating an environment within which businesses can thrive.

The EU question is a thorny one and it's right that all options are explored to see how we can maintain our links with the EU whilst remaining within the UK. But any solution that proposes leaving the UK to join the EU has to address two major issues;

• Leaving the UK means leaving behind the £9bn pa fiscal transfer - the "black-hole" becomes very real and would have to be filled through tax rises, spending cuts, yet more borrowing or (hardly likely) the EU picking up the tab
• If the reason given for leaving the UK to join the EU is a fear that EU/UK trade will be hindered, that reason has a very simple logical flaw. If EU/UK trade is hindered as a result of Brexit, we lose far more being on the EU side of those borders than we do by being on the UK side (because we export four times as much to the rest of the UK than we do to the EU)

Investors don't like uncertainty. Continually threatening them with the disruption of yet another referendum and all of the contingent risks that entails (what currency, what tax regime, what trade barriers?) hinders investment and doesn't help our economy.

But I'd argue the cost of continual threats of indyref2 is more than just the effect on big business and investor confidence - it runs deeper than that.

Scotland is a country where our political leaders invest their energies into trying to break our Union rather than working to build our economy.  Our young people are bombarded with negative messages, provided with excuses not to succeed, hampered by reasons they can't instead of encouraged by reasons they can: it's Westminster's fault, its the UK's fault - we're cheated, hard done by, put upon - we can't succeed unless we break from the UK.

I can't think of a worse environment within which to try and encourage ambition, engender confidence, fuel entrepreneurial spirit and fill people with a sense of the possible - and yet that's surely what we need to do if we are to see our onshore economy out-grow the rest of the UK.

A parting thought. Consider how much of Scotland's population's time, energy and money has been expended fighting the UK and pursuing the dream of independence at any cost. Now imagine you could take just a fraction of that resource and invest it against positive, job creating, wealth building, economy boosting projects. Just think what we could achieve.

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Notes

1.As with every GERS release there have been some adjustments made to prior year figures. The most material of these for Scotland have been on the expenditure side - I haven't unpicked these
2. The EU uses a slighty different deficit definition than that in GERS, but it's not significant in this context
3. Actual North Sea revenues were £76m of which Scotland's geographic share was £60m
4. per GERS page 3: "Non-North Sea revenue in Scotland grew by 3.7% in 2015-16, similar to that for the UK as a whole, 3.8%."
5. I produced this graph way back when 2013-14 were the most recent figures available - I think it stack up pretty well compared to the actuals

6. See GERS page 2: "The ONS reclassified English Housing Associations (HAs)1
 into the public sector on 30 October 2015. In 2015-16, this increased UK public sector revenue by £6.9 billion and UK expenditure by £10.8 billion, resulting in a £3.9 billion increase in the UK net fiscal deficit. A similar impact is seen in earlier years. Scotland is apportioned none of this additional revenue or expenditure in GERS. The ONS have not yet announced a decision on the classification of Scottish Housing Associations". I haven't yet understood the implications of this