By Graeme Roy, Professor of Economics at the Adam Smith Business School, University of Glasgow

Scotland’s public finances face considerable pressures both on the supply of public funds and the demand on those funds from rising inflation and a gloomier economic outlook.

In his Budget Review, John Swinney stated that "the financial situation facing the Scottish Government is, by far, the most challenging since devolution". This came on the day new data showed a fall in economic output in Scotland during August. A day later the Bank of England raised interest rates and hinted that further rises are likely.

Of course, Scotland and the UK are not alone in facing economic challenges. The Federal Reserve continues to talk up a more aggressive approach to raising interest rates in the US, whilst inflation in the eurozone is now tracking at nearly 11%.

We have of course, sadly, become accustomed to economic downturns over the last 15 years. Each one is, of course, different. The recession forecast by the Bank of England is projected to have a much smaller peak-to-trough decline than, for example, the financial crisis. But it may last for longer.

The most important difference this time around, however, is the real-world effect of high inflation. Few if anyone's pay award, benefit uplift, or pension increase will keep pace with the rising cost of living. Living standards for all but a very few will fall and may take years to recover.

Importantly, the impact upon public spending is also different. During the financial crisis and the COVID-19 pandemic, government spending actually rose in real terms. The UK’s fiscal consolidation post-2008, for example, did not start feeding through to real-terms falls in the Scottish Budget until around 2010/11 and 2011/12: by then, the economy was growing again.

This time however, because of inflation, John Swinney pointed out that his 2022/23 budget was now already worth around £1.7 billion less than when it was introduced in December last year. At the same time, in an effort to fund higher pay awards, "resource reprioritisation" or "resource savings" have had to be found from cutting back on other day-to-day spending commitments. In total, this in-year shifting of monies amounts to nearly £1.2 billion. A scale not seen with devolution.

Governments are no different from households in that if inflation is on the rise, the real-terms value of their spending power declines. Schools and hospitals cost more to heat and light, capital projects cost more to build, and the real-terms value of policy initiatives such as the Scottish child payment are lower than hoped.

So far, the government’s announcements cover just this year. In the coming weeks, we will have greater clarity for next year and beyond.

So, what are the key stages in that process?

First, the UK Government will set out its delayed Autumn Statement on November 17. This will include economic projections from the Office for Budget Responsibility and the Chancellor’s tax and spending plans for next year. Some of these, such as decisions on national insurance or an update on the energy price guarantee will impact directly on Scotland. But crucially, his announcements in areas that are devolved, such as health or income tax, will also give the Scottish Government clarity on its block grant for next year.

Four weeks later, on December 15, the Scottish Government will publish its Budget for 2023/24 and its spending and devolved tax plans. We in the Scottish Fiscal Commission will also set out our forecasts.

There will be much to digest. Even if inflation returns to its target of 2% within a couple of years, there will have been a "level-shift" in the cost of delivering public services that will not – unfortunately – disappear overnight.

Responding to that, not just over the next 12 months but in the medium term, is going to be a constant feature of budget negotiations across the public sector.

Policymakers in both the UK and Scottish governments will undoubtedly need to make some difficult choices, most likely at pace and with uncertain information. As a former civil servant, I have huge admiration for the teams involved in supporting their respective Ministers and parliamentarians through this important and challenging process.

This article was first published in the The Herald on 14 November 2022

First published: 14 November 2022

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