This week the Scottish Government released the monthly estimate of GDP for July, as well as revisions to its estimates for June. We had positive news in that the economy is now estimated to not have contracted in June – contrary to previous indications – as well growing by a healthy 0.3% in the first month of the third quarter.

While looking at month-to-month fluctuations can make it hard to discern underlying trends, the level of GDP is now 2.5% above pre-pandemic levels and has grown by 1.1% relative to 12 months ago. While these are hardly spectacular numbers, they aren’t terrible either. They point to an economy that has decisively recovered from the pandemic and the inflation shocks, and offer hope that this momentum might be maintained as the effects of the Bank of England’s first rate cut start to flow through the economy.

Looking at the underlying sectoral data also shows a pattern of dual performance in Scotland’s economy. Real output in the production sector is still significantly below its level at the end of 2019, by around 6%, with all growth since then coming from services. Agricultural and fisheries output is also below 2019 levels, though nowhere near as much as in production. Within services, output has been particularly increasing rapidly in IT and professional services, where cumulative growth relative to 2019 is 30% and 29%, respectively.

As we move further away from the pandemic, the apparent permanence of these effects raises the spectre of these being more long-lasting shifts in the structure of the Scottish economy. Of course, it wasn’t just the pandemic that happened in 2020 and 2021 – Brexit happened too, and there will be a process of adaptation to the new trading paradigm. But there is a broader process of employment and output continuing to transition into services which is long-standing, and which the data suggests is continuing at pace.

Please can I have some more fiscal headroom?

The Chancellor appears to be on the hunt (a few months ago this would have been a great pun) for some largesse that the current fiscal rules would not allow. Much has been made of ‘treating investment differently’ – in some ways, this was also addressed by Labour in opposition, by changing the other main fiscal rule to allow borrowing to invest (or more formally, to only target the current budget to be in balance).

But as we wrote a few months ago, Labour’s decision in opposition to commit to debt falling as a share of GDP as one of its fiscal rules meant that all other tweaks were essentially meaningless – this is the fiscal rule that would in any case be closest to being broken, and therefore the binding constraint for an Autumn fiscal event.

We also suggested at the time that a broader definition of debt – one which includes Bank of England debt and therefore doesn’t create artificial separation to do with who pays for losses on quantitative tightening – would be a sensible change, and one which would allow the Chancellor an additional c.£15 billion. Add in another year’s growth to the denominator from rolling the forecast a year, as the OBR always does, and this might add another £7-10 billion.

People often find comfort in things that withstand the test of time, and so they might find comfort in the fact that despite the keys to No. 11 having changed hands, the building is no more leakproof than when the Conservatives were in charge. This time it’s been all about how the Chancellor is exploring options that would redefine the target of the main rule. One option reputedly under discussion is one that was all the rage a few years ago – public sector net worth, or PSNW. Net worth is a more comprehensive measure of the government’s balance sheet, and which takes into account both liabilities and all the public sector’s assets and the contribution they make.

While attractive conceptually, PSNW is riddled with complexities, especially to do with non-fungible assets and how they are valued – and how responsive the data can be for some broader metrics. Opinions differ as to whether it would improve incentives, by essentially giving credit to the government for spending on capital, or whether it would lead the government to spend more on things on which rules for measuring are beneficial rather than considering the actual impact of the spending. Ideally these would be aligned, but experience shows that’s not always the case. I am personally sceptical that it would improve incentives, and some of the data challenges don’t seem to me to be surmountable.

The other option on the table is public sector net financial liabilities (PSNFL), which can broadly be defined as the sum of all public sector net borrowing (PSNB), or the deficit. This would seem to be similar to net debt, and conceptually it is – but PSNFL includes non-cash items such as funded public sector pensions or depreciation, whereas debt is purely a cash measure. While cash and accrued borrowing are correlated, they can differ significantly.

PSNFL is a better measure of the overall economic impact of the government’s borrowing on the economy – these effects are real changes in the economy, even if they don’t necessarily involve the government spending actual cash.

Should we really ignore debt? And what else can be done?

But the question must be what risk should the government really worry about. Net debt is a quantity actually transacted in financial markets – the government issues gilts, which are promissory notes of repayment plus interest in exchange for hard cash today, and so net debt is a useful metric for measuring market risk. PSNFL can move around for all sorts of non-cash reasons that would in theory allow the government to then issue more cash borrowing – but because the government can’t pay back debt in non-cash items, having a metric that focusses on cash is useful for market participants, and guards against making decisions that could make markets turn their noses even if the PSNFL was being complied with.

There is general consensus that the UK should not cut back on spending, particularly investment spending, for the sake of meeting seemingly arbitrary fiscal rules – something expressed rather well by Álvaro Santos Pereira, the OECD’s chief economist, earlier this week, and by Nick Macpherson on BlueSky, who compared them more to a central bank’s inflation target, which can be missed for perfectly good reasons.

That reminded me of something I once heard a Treasury official who shall remain nameless say in a meeting, which was that the probability of the Treasury meeting the fiscal rules was essentially 100%, because the Treasury would always do what was necessary to make sure they were hit. This sort of attitude is the fiscal equivalent of the ‘inflation nutters’ that Mervyn King worried about when setting explicit inflation targets – the idea that central bankers would try and hit the target to the detriment of any other policy outcomes – and the sort of thinking that would be best eliminated from fiscal policymaking.

The slightly disconcerting fact in all of this is that the government is effectively behaving as though it only has one lever over the path of debt, that being spending. Of course in reality it can also decide how much it brings in through tax revenues, and it could change rates or the tax base in many other ways and in an array of taxes. The Chancellor might come to regret having ruled out any changes to the main taxes – it’s hard to see why 20p in the pound must be the correct basic income tax rate for all of eternity, for example.

Milton Friedman once described the behaviour of central bankers as that of a ‘fool in the shower’ who keeps adjusting the taps and either getting burned or doused in freezing water because of the lag it takes for adjustments to come through. Sticking with a similar metaphor, the government at times appears to be emulating the behaviour of a person who insists on only controlling the amount of water in the bath by changing the flow of the tap, all the while ignoring the option of removing the plug.

Councils withdraw support for the National Care Service – what next?

COSLA announced earlier today that council leaders had voted to withdraw support for the National Care Service. The introduction of the service, which originally would have moved responsibility for commissioning social care from local authorities to a central body, had been delayed already until 2028-29 due to concerns with rising costs. The centralising principle had already been watered down by the Scottish Government to cut costs, as outlined by the Social Care Minister in December in a letter to the Finance Committee.

This vote could potentially put its introduction altogether at risk, after two unions – GMB and Unison – had already withdrawn their support earlier in the month.

This is also the latest conflagration of the difficult relationship between COSLA and the Scottish Government, and which has continued despite the Verity House Agreement. Such a transfer of power should happen with consent, and therefore if the Scottish Government is serious about implementing it, it will require addressing the concerns of local authorities.