Section 1: Economic Context
Scotland has strong economic foundations
We have a highly-skilled workforce, substantial natural resources, a long-standing reputation for innovation, internationally recognisable brands and products and companies competing successfully in global markets.
We have thriving energy, life sciences, and creative industries and social enterprise sectors, while Scotland's tourism and food and drink are internationally renowned.
Our universities are also amongst the best in the world with four universities in the world's top 200 - more per head of population than any other country except Switzerland.
Our Economic Strategy will build on this strong starting point. It will focus on the dual and reinforcing objectives of boosting competitiveness and reducing inequality through our four priorities for sustainable growth - investing in our infrastructure and people, fostering a culture of innovation, encouraging inclusive growth and promoting Scotland on the international stage.
The Scottish Economy - Recent Trends
Despite challenging economic circumstances, since 2007, Scotland's economic performance has improved, relative to the UK, across a range of economic indicators.
Long-standing gaps between Scotland and the UK in terms of productivity, labour market participation and earnings have been reduced as outlined in Table 1.1. Scotland also has the highest employment rate, lowest unemployment rate and lowest economic inactivity rate of all four UK nations. 
Further information on Scotland's recent economic performance is provided in Scotland's National Performance Framework, as discussed in Box 1.2.
Table 1.1: Key Economic Activity Indicators - Performance since 2007 
|Indicator||Value in 2007||Rank
(12 UK countries/ regions) in 2007
|Most recent value||Current rank
(12 UK countries/
|1. GDP per head ||£22,505||4th||£25,065||3rd|
|2. Productivity ||£24.60/hr||6th||£29.10/hr||4th|
|3. Disposable income ||£13,851||5th||£16,267||5th|
|4. Average full-time weekly pay ||£442||4th||£519||3rd|
These statistics relate to the onshore economy. Scotland's onshore GDP was worth £134 billion in 2013. Including North Sea oil and gas production total Scottish GDP stood at £151 billion.  The North Sea oil and gas sector remains a key part of Scotland's economy. Whilst the fall in oil prices at the end of 2014 has had an impact on the sector, it is clear that with an appropriate tax regime and supportive policy environment the sector will make an important contribution to Scotland's economy for decades to come.
Scotland has also continued to perform well on the international stage. The value of our international exports increased by around 40% between 2007 and 2013.  This growth has been achieved despite challenging conditions in key export markets, particularly in Europe. We have also maintained our strong performance in attracting international investment. In 2013 international investment to Scotland was at its highest level since 1997 and Scotland remains the top UK region outside London for such investment. In fact, of the 11 UK countries and regions outside London, Scotland has ranked 1st or 2nd every year since 2006. 
There is therefore much to be positive about in terms of economic performance. Nevertheless, Scotland's economy still faces a number of challenges. Some of these are linked to the recent recession and are likely to unwind as we progress further in the recovery process, as discussed in Box 1.1. Others are more structural in nature and will require a dynamic change in Scotland's long-term economic performance.
The 2008 financial crisis resulted in the deepest global recession in over 50 years. As with virtually all other advanced economies Scotland experienced a severe recession in 2008-09 with output contracting by 6%.
Research into previous financial crises has cautioned that, as well as being particularly severe, recessions that follow financial crises typically entail a long recovery time. This was the case in the majority of advanced economies after 2008 and Scotland was no exception. As the chart highlights, by 2011 more than two years after the end of the recession, output, employment, and wages in Scotland were still well below pre-crisis levels.
Four years on, the economic context is now different. We have seen a period of sustained growth in Scotland's economy. As a result, many key economic indicators are close to, or above, pre-recession levels, see Figure 1.1.
Scotland's labour market has strengthened significantly since 2011, with the headline unemployment rate falling consistently and now approaching its pre-recession average. The number of people in employment is now at a record level with around 2.6 million in work.
Nevertheless, the legacy of the recession remains evident. For example, the number of people underemployed, though falling, currently stands at 248,000, this is 32% higher than in 2008.  Real wages in Scotland, in common with many other advanced economies remain substantially below pre-recession levels.
It is important to note that these economic improvements have occurred against a backdrop of significant public spending cuts as a result of the UK Government's austerity and fiscal consolidation agenda. As a result, the Scottish Fiscal DEL budget has been cut by the UK Government by nearly 10% in real terms between 2010-11 and 2015-16, with the risk of further cuts planned over the course of the next Spending Review.
The UK economy recorded one of the weakest recoveries from recession compared to other major international economies. This reflected a number of factors - the impact and size of the financial sector, level of household indebtedness and the UK Government's policy response relating to austerity.
Our response to the economic and social challenges we currently face must go further than simply aspiring to ensure a return to pre-recession levels of economic performance. The challenges of underemployment, youth unemployment, low pay growth and weak productivity, all relate to, and in some cases are exacerbated by, patterns of inequality in Scotland.
It is therefore important that we take a wider view that encompasses action to tackle inequality and ensure that economic growth is inclusive.
Scotland's National Performance Framework ( NPF) underpins delivery of the Scottish Government's priorities and monitors the delivery of the Scottish Government's purpose.
The framework contains a number of indicators which monitor improvements in a range of socioeconomic indicators across Scotland. The latest results show that Scotland has improved its performance in many of the key areas identified in this strategy:
- Productivity - Productivity in Scotland has risen relative to the UK. The gap in productivity between Scotland and the best-performing countries in the OECD has also been reduced since 2006 - the baseline used in the NPF.
- Participation - Scotland has the highest employment rate among the four countries of the UK.
- Population - The population of Scotland is now at its highest ever. Since 2007 Scotland's population has grown by 0.5% a year on average, faster than in the EU-15 as a whole (0.4% a year).
- Cohesion - The gap in labour market participation between Scotland's best and worst performing regions has been reduced between 2012 and 2013 - although the gap remains larger than it was prior to the recession.
- Solidarity - Overall levels of income in Scotland are rising, however, the proportion of income received by the bottom three income deciles has remained largely unchanged since 2006-07.
- Sustainability - In 2012, total Scottish greenhouse gas emissions were 26% lower than the 1990 baseline used in the NPF.
The NPF will be central to monitoring our progress against the objectives set out in this strategy and is currently being updated to reflect our new strategic approach. As part of this work, the Scottish Government, in conjunction with the Council of Economic Advisors, will be developing an improved set of measures of Scotland's performance across a wider range of dimensions of economic prosperity.
These measures will reflect our ambition to rank in the top quartile of the OECD in terms of productivity, wellbeing, inequality and sustainability.
Ensuring that the benefits of economic growth are shared more equally across society is just as important as boosting overall growth. Poverty levels in Scotland are too high and many people still face poor economic prospects.  The inequalities that exist between households and between different regions across Scotland prevent individuals and communities from maximising their potential.
As part of the UK, Scotland has been tied to an economic model that has exacerbated inequalities. Of the 34 OECD countries, the UK ranked 29th in terms of income inequality - in other words, the 6th worst as outlined in Figure 1.2. Whist income inequality in Scotland is closer to the OECD average than the UK, Scotland is still more unequal than many other countries and would rank 20th.
Figure 1.2: Gini-Coefficients in the OECD 
These are not new trends. Income inequality among working age people increased faster in the UK between 1975 and the late 2000s than in any other country in the OECD. 
In 1997-98, the richest 1% of income taxpayers in Scotland earned nearly 7% of total pre-tax income. This share increased to over 8% in 2010-11 meaning that the top 1% of income taxpayers in Scotland had an income greater than the bottom 20% of taxpayers put together. This is illustrated in Figure 1.3.
Figure 1.3: Change in share of total income among taxpayers, by percentiles of taxpayer income, 1997-98 to 2010-11, Scotland 
Rising income inequality plays a key role in determining a household's ability to accumulate wealth. In Scotland, as in almost all advanced economies, the distribution of household wealth is even more unequal than the distribution of income. During the period 2008 to 2010 the wealthiest 30% of households owned 76% of all private household wealth in Scotland. The least wealthy 30%, in contrast, owned less than 2% of wealth.  Forthcoming analysis of data from 2010-12 suggests little change in the extent of wealth inequality in Scotland and in wider Great Britain.  This trend has been mirrored internationally and evidence suggests wealth inequality is increasing at a faster rate than income inequality. 
Such patterns of inequality have a negative impact on long-term economic growth and prosperity. The IMF found that lower income inequality is correlated with faster and more durable growth.  Work by Professor Joseph Stiglitz also concluded that countries which are more unequal, grow more slowly and are less stable.  Professor Stiglitz's analysis suggests that a concentration of income can restrict the economy in the long run by limiting the potential of people to contribute in a productive way; whilst inequality may also restrict government investment in the infrastructure, education, and technology that is required by a modern economy.  There is also evidence on the impact of public sector investment on growth. Mazzucato (2013) finds that public sector investment has an important role in supporting private innovation. 
A recent working paper by the OECD drew similar conclusions, estimating that rising income inequality in the UK reduced GDP per capita growth by 9 percentage points between 1990 and 2010.  The OECD analysis argues that the key driver behind this finding is that income inequality undermines the education opportunities available for disadvantaged individuals, hampering skills development and reducing social mobility.
Figure 1.4: UN Human Development Index ( HDI), 2013 
International experience demonstrates that it is possible to perform better on measures of equality and wellbeing whilst also having a strong economic performance.
For example, many northern European countries have achieved lower levels of income inequality than the UK whilst also performing better on key measures of economic performance. For example the United Nation's Human Development Index ( HDI) is a composite index based on indicators of life expectancy, educational attainment, and income. The top-ranked country in the 2013 HDI was Norway, in addition Switzerland (3rd), the Netherlands (4th), Denmark (10th), Ireland (11th), Sweden (12th) and Iceland (13th) all ranked above the UK (14th). As well as having lower levels of income inequality, all these countries, with the exception of Ireland, had higher levels of Gross National Income per capita than the UK in 2013.
Income and wealth inequality are only a small subset of overall inequalities in society and the economy. However, they are strongly associated with - and indeed determinants of - wider inequalities across a range of social outcomes, such as health and education. These have a significant impact on people's wellbeing, as well as on their future opportunities.
For example, health inequalities and poor health outcomes reduce people's economic opportunities and have a negative impact on the country's overall economic performance.  They can also place additional pressures on the public sector. Across the European Union it is estimated that health inequalities resulted in economic losses of between 1.5% and 9.5% of EU-25 GDP per year. 
Scotland's health is improving with many people living longer, healthier lives. Nonetheless, significant health inequalities persist, particularly in our most economically disadvantaged communities.
Addressing inequalities in educational outcomes also improves employment opportunities and living standards for individuals, as well as the skills of Scotland's workforce.
Gaps in educational attainment between disadvantaged children and their peers are often apparent in the early years, and are likely to persist and widen through school and beyond. For example, evidence from the Growing Up in Scotland  study finds lower cognitive ability among children from disadvantaged backgrounds as early as age 3. Students from the most deprived fifth of our communities only account for one-seventh of our university undergraduates. 
Ensuring that all regions and communities can prosper is important for both overall economic performance and ensuring that all areas have the opportunity to fulfil their potential.
Significant variations exist in levels of economic activity across Scotland. For example, output per person in Edinburgh is £38,000 compared to £12,000 in East and North Ayrshire, see Figure 1.5.  This reflects, in part, the nature of growth in cities, which benefit from a concentration of economic activity, also drawing in workers from surrounding areas. In addition, some areas of Scotland still suffer the legacy of past industrial decline - for example, the management of the decline in industry and manufacturing in the 1980s by the UK Government which has contributed to concentrations of deprivation in some parts of Scotland.
Figure 1.5: Regional GVA per head 2013 
Whilst output per head varies by region in Scotland, these differences are smaller than those in the UK and many other EU countries, see Figure 1.6. However, progress is needed. Countries such as Finland and Sweden have smaller regional differences in GDP per person than Scotland.
As well as differences between regions, there is also a high level of variation in income and economic activity within regions.
The Scottish Index of Multiple Deprivation incorporates a variety of different aspects of deprivation including employment, income, health, education, skills and training, crime, housing and access to services, and assesses these at smaller local levels. 
Whilst some characteristics of disadvantage in rural communities are not all picked up on this measure, communities in rural areas can face other types of challenges such as accessibility and connectivity.
Future Economic Challenges
Our ability to both increase Scotland's competitiveness and reduce inequalities will be influenced by the challenges currently facing virtually all modern advanced economies.
A more detailed analysis of Scotland's performance on these key measures, and on Scotland's wider economic performance is provided in the Scottish Government's State of the Economy report and in the National Performance Framework. 
Improving our productivity is about making better use of all our resources - whether they are our people, infrastructure, or natural assets. It is the principal long-term driver of economic growth. More productive economies can produce greater quantities of goods and services for a given set of resources, typically leading to higher incomes, living standards and wealth.
The historic gap between levels of productivity in Scotland and the UK has been reduced in recent years. However, when seen in an international context, there is a clear need to improve Scotland's economic performance. Amongst the OECD countries Scotland currently ranks around the average but below many other Northern European economies such as Germany and Denmark.
Rebalancing the Economy
If we are to be successful in our ambitions for a more competitive and fairer Scotland we must consider how we want the structure of the Scottish economy to evolve.
We want to move Scotland onto a more balanced growth path, with a greater contribution to economic growth from investment and net trade, rather than consumption. This will allow our economy to better withstand economic shocks and help ensure that everyone in Scotland can contribute to, and benefit from, growth.
Key challenges for Scotland in this regard are the need to continue to grow and to diversify the business base, reindustrialise, strengthen the role of export-generating sectors and focus on encouraging firms to invest and to export.
- Scotland has a relatively small business base with lower rates of business start-ups than the UK as a whole (see Figure 1.7). Although progress has been made in recent years growing the business base remains an important issue to improve upon as a key driver of growth and competition.
- Recent data from the Global Entrepreneurial Monitor ( GEM) shows improvements in the level of entrepreneurial ambition in Scotland in recent years, now similar to UK levels and other major economies, but we will need to build on this improvement by supporting entrepreneurship across the entire Scottish economy. 
- Rebalancing the economy will require a stronger role for exporting companies and sectors to increase sales in products and services. A strengthened role for manufacturing will be a key part of this. Manufacturing firms are more likely to export and to invest in research and development;  whilst increasing the scale of the manufacturing sector can help with wider equality objectives in terms of addressing regional imbalances through local spillovers, while providing jobs that are typically high skilled and well paid. 
- Increasing exports is also key to rebalancing Scotland's economy. As well as having positive implications in terms of the resilience and sustainability of economic growthw, there is evidence that companies that are exposed to international investment and competition become more productive.  Scottish exports have increased by 20% in cash terms between 2010 and 2013 marking good progress toward our target of boosting exports by 50% over the period 2010 to 2017.
Labour Market Participation
Greater participation increases an economy's potential output and is essential to supporting sustainable economic growth. Bringing more people into the labour market is key to tackling poverty, inequality and social deprivation and improving health and wellbeing.
- The participation rate in Scotland has been on an upward trend for the past 20 years, as outlined in Figure 1.8. Female participation rates in particular have seen a marked increase. As a result, Scotland has a similar or higher female participation rate than many advanced economies.
- However, a gap remains between the female labour market participation rate in Scotland and the best-performing countries in the OECD, such as Iceland, Norway and Sweden. Employment rates among disabled people, some ethnic minority groups and older workers in Scotland also remain well below the national average. 
- Youth unemployment in Scotland, whilst lower than in most European countries, also remains above the overall unemployment rate in Scotland, as discussed in Box 1.3.
- The number of people underemployed, though falling, currently stands at 248,000.  Reducing levels of underemployment and fully utilising the skills of the Scottish workforce are also key to supporting sustainable economic growth.
Figure 1.8: Labour Market Participation Ray 
Youth employment outcomes have important implications in terms of competitiveness and reducing inequality.
They are of particular relevance given the long-term impact unemployment at a young age can have on individuals and the economy as a whole, in terms of productivity and future participation in the labour market. There are also wider implications, for life satisfaction and long-term health outcomes.
Rates of youth unemployment tend to be higher than in the wider population. Higher youth unemployment is due, in part, to young people having fewer demonstrable skills and less work experience which can make it harder to find employment. These challenges have been magnified in recent years as a result of the recession.
Whilst youth unemployment remains above the pre-recession levels, significant progress has been made in recent months, with Scotland's youth unemployment levels and rates now at their lowest in five years. Youth unemployment  in Scotland is currently 14.5% - and is currently less than half the level observed in some European countries. 
However, whilst it has fallen by 6.8 percentage points over the year it remains higher than the overall unemployment rate in Scotland, currently at 5.4%. Similar trends are observed in other countries.  For example, in Denmark and Finland youth unemployment rates are 10.7% and 17.9% while overall unemployment rates are 6.4% and 8.9%.
Our target is to reduce youth unemployment by 40% by 2021.
Adapting to External Changes in Globalisation and Technological Change
Globalisation and technological change are external trends which have impacted the Scottish economy over the long term and shape the structure of demand.
Technological change is one of the key drivers of productivity and long-term growth. Innovation and the role of transformational (or destructive) technology has been crucial for driving economic growth and there is a clear link between previous periods of above trend growth and the advent of such new technologies. It has also been one factor which has changed the composition of the labour market. The process where labour is substituted for technology in many countries, including Scotland has tended to impact on semi-skilled jobs that are medium-paid. This has resulted in the share of people employed in high-paid and low-paid jobs increasing relative to those in medium-paid jobs, creating ' job polarisation'.
Technological progress has been one of the main factors driving increasing income inequality across countries.
Adjusting to these changes in the economy requires a flexible and skilled workforce that can adapt to new technologies and markets.
Population and Demographic Trends
Growth in the working age population plays a key role in underpinning sustainable economic growth.
- It increases the labour force and with it, the total amount the economy can produce.
- It also increases demand for goods and services, creating business and employment opportunities.
- In addition, a healthier and more active population with a longer life expectancy, as well as improving overall wellbeing, also further improves a country's productive capacity.
Between 2010 and 2035, the Scottish population is projected to increase by 10.2%,  above the EU average  and significantly faster than many other European countries, see Figure 1.9. Within this, the working age population is also projected to increase. 
However, this increase in Scotland's population is expected to be accompanied by an increase in the dependency ratio which is forecast to rise as the number of older people in the population increases. This will present a number of challenges in terms of both the structure of the economy, and the way we innovate to deliver public services to meet these demands.
Figure 1.9: Projected population, 2010 to 2035 
Resource Efficiency and Climate Change
In the decades to come, climate change will continue to be a key challenge that all economies face and will only increase in importance.
All countries will have to adjust to a more resource-efficient and sustainable economic model. The Scottish economy is particularly well placed to benefit, both from the development of the low carbon economy and from using Scotland's natural resources more efficiently.
In 2012, Scottish greenhouse gas emissions were 26.4% lower than in the 1990 Base Year, used in the EU Emissions Trading System ( EU ETS). As a result, Scotland is more than halfway towards its Climate Change (Scotland) Act 2009 target of achieving at least a 42% emissions reduction by 2020. As Figure 1.10 illustrates, on an internationally comparable basis, the reduction in emissions in Scotland has also been greater than in the EU-15 as a whole.
Scotland has faced a challenging economic climate over the last eight years, with the most severe recession in living memory. The Scottish economy has, however, shown resilience in responding to these challenges.
We want to achieve more than simply return to pre-recession levels of economic performance and the resultant outcomes that this model delivered. That is why our Economic Strategy has a greater focus on tackling inequalities to ensure long-term sustainable and inclusive growth.
The next section sets out the priorities for Scotland's Economic Strategy.
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