This document summarizes the Scottish Economic Report published in June 2002. It discusses Scotland's integration with the global, European, and UK economies through trade and investment. It notes that Scotland trades most significantly with the rest of the UK, but is also exposed to external economic fluctuations globally. The report reviews recent economic developments and forecasts for Scotland's key trading partners and finds mostly positive growth expected in 2002. It also discusses trends in foreign direct investment. Overall, the report examines Scotland's economic linkages and dependence on external factors as a small, open economy.

1. Scottish Economic Report
June
2002
SCOTTISH EXECUTIVE Making it work together

2. 2002
The Scottish Economic Report
June
SE/2002/110: Laid before the Scottish Parliament by the
Scottish Ministers, June 2002.

3. Contents
Page
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 2
1.1.2 Scottish Trade in the Global Environment 5
1.1.3 Inward Investment 6
1.2 Economic Developments and Prospects in the Global Economy 6
1.2.1 Recent Developments and Indicators 6
1.2.2 Economic Developments in the Euro Area 8
1.2.3 Economic Developments in the US 12
1.2.4 Future Prospects and Risks for the Global Economy 13
1.3 The UK Economy 19
1.3.1 Overview 19
1.3.2 Recent Developments and Risks 20
1.3.3 Current UK Monetary and Fiscal Indicators 21
1.3.4 Prospects and Forecasts for the UK Economy 22
1.3.5 Budget 2002: Announcements and Economic Impact 25
Chapter 2: Report on Economic Development Initiatives 29
2.1 Education 31
2.2 Support for Infrastructure 34
2.3 Enterprise Support and Skills Development 38
2.4 Rural Scotland 44
2.5 Social Justice 46
2.6 European Structural Funds 49
Chapter 3: The Scottish Economy: Recent Developments and Future Prospects 51
3.1 Summary 52
3.2 Output 52
3.3 Demand 58
3.4 Labour Market 59
3.5 Costs and Prices 62
3.6 Housing Market 62
3.7 Independent Forecasts 66
3.8 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 the
Scottish Economy 72
B Enterprise Fellowships: Stimulating Innovation and Entrepreneurship 81
iii

4. Preface
This is the sixth edition of the Scottish
Economic Report. It is published twice-
yearly and incorporates a review of the
progress and prospects for the Scottish
Economy, together with a review of the
broader economic context in which the
Scottish economy is set. Additionally,
there is a selection of summary articles on
issues of key topical interest.
The Scottish Economic Report June 2002
This edition of the Scottish Economic
Report has four parts to it:
§ Chapter 1: Global, European and
UK Economic Developments
provides an overview of the important
economic developments in the Global,
European, and United Kingdom
economies and the economic context
for Scottish economic development
over the recent past; and the outlook
for future prospects;
§ Chapter 2: Report on Economic
Development Initiatives sets out a
summary of recent policy
developments in the economic
development field, providing a follow-
up to the Executive’s approach that
was established in the Framework for
Economic Development in Scotland in
2000;
§ Chapter 3: The Scottish Economy:
Recent Developments and Future
Prospects provides an overview of the
Scottish economy. This section
summarises the recent developments
and prospects for the Scottish
economy;
§ Chapter 4: Selected Economic Issues
provides an opportunity for brief
surveys of selected economic issues to
be presented. The papers are intended
to review or summarise more
substantive documents or work of
value to the thinking of the Scottish
Executive, or to provide an opportunity
to present new or different perspectives
to stimulate further debate in areas of
topical interest.
This edition incorporates two articles:
• The Regional Employment
Contribution of the Fisheries Sector
to the Scottish Economy: This article
summarises the main results of a recent
paper that was compiled to examine
the contribution of the fisheries
industry to the Scottish economy.
• Enterprise Fellowships: Stimulating
Innovation and Entrepreneurship:
This article outlines the public policy
context of this programme and
describes its development since its
inception in 1996/97. It also
summarises the results of a formal
review and evaluation, drawing
conclusions for the public policy goals.
Other economic publications
This year has seen two other important
publications in addition to the Scottish
Economic Report. Firstly, the publication
of Scottish Economic Statistics 2002
occurred in March 2002, again presenting
the development programme for economic
statistics in the Scottish Executive for the
coming year and beyond – in the chapter
entitled the Scottish Economic Statistics
Programme – and the full range of
economic statistics that are currently
available for the Scottish economy.
Secondly, we have established an internet-
based Economic Discussion Paper Series,
which is now disseminated through the
iv

5. Scottish Executive website
http://www.scotland.gov.uk. This provides
a vehicle for making available some of the
underlying work that has either been
commissioned by the Executive from
external experts to inform the development
of economic thinking within the
Executive, or has been undertaken by
economic staff within the Executive itself.
It will – where appropriate – be more
detailed than the work presented in the
Scottish Economic Report and more
technical in nature. It will, generally,
relate to the current policy interests of the
Executive and to the debate in these areas
which the Executive is keen to promote.
Acknowledgements
Finally, in addition to those named authors
in chapter 4, I would like to acknowledge
the major contribution to the preparation
and compilation of this report by Richard
Murray, Assistant Economist in the
Scottish Executive. Chapters 2 and 3 also
reflect the major contributions from Steven
McMahon and David Rennie, and from a
variety of other contributors across the
Government Economic Service in the
Scottish Executive.
Dr Andrew Goudie.
Chief Economic Adviser
June 2002
v

6. 2002
chapter one: Global, European
and UK Economic
Developments

7. Chapter One: Global, EU and UK Economic Developments1
This chapter has three themes: the first
relates to Scotland in the global, EU
and UK contexts; the second looks at
global and EU developments; and the
third considers UK economic
developments and prospects.
1.1 Scotland in the Global, EU
and UK Context
The January 2002 edition of the
Scottish Economic Report outlined the
importance and influence of external
forces on the Scottish economy,
focusing on Scotland’s main trading
partners. This edition of the Report
goes further to examine how integrated
the various sectors of the Scottish
economy are in the global economy,
including the importance of our main
trading partner – the rest of the UK. In
this regard, it is important to examine
both trade flows and capital flows
between Scotland and the rest of the
world. Inward investment to Scotland,
for example, not only creates
employment and boosts national
output, but also brings new skills and
production methods that benefit our
economy as a whole.
Understanding the linkages between
Scotland and her trading partners is
crucial to ensure that Scotland remains
well placed to reap the benefits of the
global economy. These linkages also
help us to understand the potential size
of the impact of any external shocks to
the Scottish economy. The recent
global slowdown, particularly
developments towards the end of 2001,
highlighted Scotland’s susceptibility to
external fluctuations.
1.1.1 Integration with UK
Economy and Rest of the World
Scotland, as a small open economy,
has extensive trade links with not only
the rest of the UK, but also with the
global economy. These linkages can be
highlighted through the use of the
Input-Output Tables and Multipliers
for Scotland 1998.
The gross value of imports and exports
at basic prices between Scotland and
the UK, and between Scotland and the
rest of the world (RoW) is illustrated in
Table 1.1. It is clear that the UK
represents Scotland’s most important
market place: exports to the rest of the
UK (RUK) account for just over 50 per
cent of total exports from Scotland,
and imports from the rest of the UK
account for around 64 per cent of
Scotland’s total imports. Scotland’s
balance of trade with the rest of the
world is positive, implying that
Scotland makes a positive contribution
to the UK’s external trade position.
2

8. The contribution of Scottish trade to
total UK trade is analysed using input-
output tables for Scotland and the UK
in Table 1.2. The table shows the
contribution of Scottish trade with the
rest of the world to UK exports and
imports. Scotland’s agriculture,
forestry and fishing makes the greatest
sectoral contribution to the UK total,
accounting for 37 per cent of UK
exports in that sector. With regards to
imports, the financial services sector in
Scotland accounts for the largest share
of UK imports, with 14 per cent of
total UK imports for the finance sector.
Table 1.1: Trade in Products, Scotland 1998
(£milion)
Product
Imports
RUK
Exports
RUK
Imports
RoW
Exports
RoW
Total
Imports
Total
Exports
Agriculture, Forestry
& Fishing
456 725 568 718 1023 1443
Mining etc. 790 999 83 1439 873 2438
Manufacturing &
Construction
21101 10342 13918 17487 35019 27828
Energy 541 253 42 78 583 331
Distributive Trades 827 3440 524 0 1351 3440
Transport &
Communication
1553 2809 833 574 2386 3382
Financial Services 2041 1863 196 656 2236 2519
Business 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 11
Distributive Trades 6 0
Transport & Communication 7 5
Financial Services 14 8
Business and Other Services 7 3
Total 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
3

9. The export and import intensities of
the broad industrial sectors of the
Scottish and UK economies, based on
total output at basic prices, are
illustrated in Table 1.3. The first four
columns examine Scottish and UK
trade with the rest of the world, while
the final two columns look at Scottish
trade with the rest of the world,
including the rest of the UK.
Looking at Scottish trade in general, it
is clear that the mining and production
& construction sectors account for the
largest proportion of Scottish exports
as a percentage of total output.
Production & construction also
account for the largest proportion of
Scottish imports. Overall, Scottish
exports to the rest of the world account
for 16 per cent of total output,
compared to 13 per cent for UK
exports to the rest of the world.
However, the roles are reversed
regarding imports, with imports from
the rest of the world to Scotland
accounting for 13 per cent of total
output, compared with 15 per cent for
the UK. This implies that the UK and
Scottish economies have a similar
degree of openness to trade with the
rest of the world.
However, it is important to realise that
Scotland’s main trading partner – the
rest of the UK – is excluded from these
figures. Therefore, by examining the
final two columns of Table 1.3, it is
clear that Scottish exports and imports
to the rest of the world, including to
the rest of the UK, were 32 per cent
and 35 per cent of output respectively
– both substantially higher than the
corresponding figures for the UK.
Although this is not comparing like-
with-like, this emphasises the greater
degree of openness of the Scottish
economy compared with the UK
economy 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 69
Production &
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 38
Business 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
4

10. 1.1.2 Scottish Trade in the Global
Economic Environment
The Scottish economy is relatively
small and open, and highly integrated
within the global economy through a
diverse range of international linkages.
Thus, Scotland is highly exposed to
significant developments within the
global economy. A prime example of
this was the recent global slowdown
and the subsequent negative impact on
the performance of the Scottish
economy.
Except for Japan, most of Scotland’s
key trading partners will experience
positive output growth in 2002,
according to the OECD, with quarterly
growth expected to pick up rapidly
towards the end of 2002. The UK
economy – Scotland’s main trading
partner – is expected to grow strongly
in 2002, with a growth forecast of 1.9
per cent from the OECD. These
developments should have a positive
impact on activity in Scotland, as
external demand for Scottish
manufactured goods will be expected
to increase in line with the global
recovery.
OECD forecasts of GDP growth in
Scotland’s key global trading markets
in 2002 are plotted alongside the
relative importance of these markets
for Scottish exports in Chart 1.1. The
degree to which our trading partners
are in the upper right hand quadrant,
the greater the impact on Scottish
growth prospects. Here the only
country in this quadrant is France, with
both the US and Italy close by. This is
particularly significant as France
remains one of Scotland’s principle
overseas trading partner, accounting
for around 14 per cent of Scottish
manufactured exports2
.
Chart 1.1: GDP Growth and Distribution of Scottish Manufactured Exports
5

11. 1.1.3 Inward Investment
The rapid growth in foreign direct
investment over the past 30 years has
been an important aspect of the
globalisation process. Scotland in
particular has benefited from such
inward investment in terms of both
increased output and employment, plus
the associated spill-over benefits of
skills and lessons learnt from foreign
companies.
Recent trends in inward investment
have shown a decline over the past few
years, and initial figures for the middle
part of 2001 show that investment was
fairly subdued. This was hardly
surprising given the state of the
international economic climate and the
uncertainties as to market and
investment intentions. This uncertainty
was exacerbated following the tragic
events of 11 September. In the latter
part of 2001, and in the early part of
2002, there have been signs of
increased investor confidence.
However, it is important to note that
such levels of foreign direct investment
are still below the levels of previous
years. Despite this, the market for
foreign investment is improving and it
is hoped that Scotland will be well
placed to benefit from this.
Ernst & Young’s European Investor
Monitor released in April 2002 reports
that inward investment, based on the
number of projects, fell by 12 per cent
across Europe and by 34 per cent in the
UK in 2001. Despite this, many
applicant countries seeking European
Union membership (e.g. Czech
Republic and Hungary) recorded an
increase in inward investment. Ernest
& Young expect growth in foreign
direct investment to return to previous
levels by the end of 2002.
1.2 Economic Developments
and Prospects in the Global
Economy
1.2.1 Recent Developments and
Indicators
Data for the first few months of 2002
suggest that the global slowdown has
bottomed out, with the US and, to a
lesser extent, Europe and Asia,
showing tentative signs of
improvement. Nevertheless,
uncertainties remain, notably in Japan
and Argentina.
Although the economic implications
associated with the terrorist attacks of
11 September had an immediate
impact on confidence and activity –
particularly in the travel and aviation
industries – these were short-lived.
Overall, it is becoming clear that this
was a one-off shock to the global
economy and that it is not expected to
prevent the global economy from
recovering in the first half of 2002.
In addition to signs that output growth
will continue to accelerate in 2002,
inflationary pressures within the global
economy are forecast to remain
subdued. The International Monetary
Fund3
(IMF) forecasts that world
inflation will fall to 1.3 per cent in
2002, the lowest level since records
began in 1970. This has partly been a
reflection of weaker global activity,
coupled with moderate wage increases.
However, concerns over low inflation
will be eased as it is expected that
prices will rise as the recovery begins
to gather pace, with there being a
decline in excess capacity and a rise in
commodity prices, especially oil.
Deflationary concerns still exist in
Japan, however, which experienced its
6

12. fourth successive year of an overall fall
in general prices.
Interest rates for the main advanced
economies have remained unchanged
in the first half of 2002, and it is now
expected that in the months ahead
attention will need to turn toward
reversing earlier monetary policy
easing. Interest rates in the US and the
Euro area have remained at 1.75 per
cent and 3.25 per cent respectively
during the year, with interest rates in
Japan remaining close to zero.
Unemployment in the US and Europe
increased throughout the second half of
2001 and the first half of 2002, as the
global economic slowdown, along with
the events of 11 September, prompted
corporate retrenchment and re-
structuring in many industries. The
average unemployment rate for
advanced economies was 6 per cent in
2001, and is projected to rise to 6.4 per
cent for this year. Of particular concern
has been the continued rise in
unemployment in the Euro area which
is currently averaging 8.4 per cent.
The rates of GDP growth and
unemployment of the G74
economies
and the Euro area in 2001 are
illustrated in Chart 1.2. The US and the
UK were very close with respect to
having high growth and low
unemployment. In contrast, the
performances of the major Euro area
economies were characterised by
combinations of high unemployment
and modest output growth. Japan was a
unique case, exhibiting falling GDP
and low unemployment (by
international standards). However,
unemployment in Japan has been
edging up over the past few years and
is currently running at a historically
high rate.
Chart 1.2: G7 Unemployment Rates and Growth in Real GDP for 2001
7

13. As highlighted in the January 2002
edition of the Scottish Economic
Report, the recent global downturn has
been more synchronised than past
recessions. This was due principally to
a number of factors:
§ The commonality of shocks –
notably, the bursting of the
Information and Communications
Technology (ICT) bubble;
§ The steady increase in oil prices in
2000;
§ Tightening of monetary policy
from mid-1999 to end-2000.
A further factor could be the increasing
scale and range of linkages between
the world’s economies, particularly in
the corporate and financial sectors.
There has been much debate around
whether or not the global recovery will
be as synchronised as the downturn.
The IMF predicts that the recovery will
take hold in most regions in the first
half of 2002, with the US taking the
lead. However, they expect the nature
and pace of the recovery will vary
depending on the depth of the
preceding downturn, the openness of
the economy concerned, the extent of
policy stimulus, and country-specific
factors and constraints.
1.2.2 Economic Developments in
the Euro Area
The Euro area, having experienced a
decline in output growth towards the
end of 2001, recovered slowly in the
first quarter of 2002.
The continued weakening in the global
economy, coupled with the events of
11 September, contributed to a 0.2 per
cent contraction in GDP in 2001 Q4 -
the first drop in Euro area output for
almost 9 years. For 2001 as a whole,
output grew by only 1.5 per cent. This
illustrated vividly that Europe lacked
the strength required to take up the
slack in the world economy once the
American boom had faltered.
Furthermore, recent evidence tends to
support the notion that it will be
America rather than Europe that leads
the way in pulling the global economy
out of its recent lull.
The Euro area recorded a slight
improvement in the first quarter of
2002, with annualised growth of 0.1
per cent. The European Commission’s
Spring forecasts predict that output
will grow by 1.4 per cent in 2002,
recovering more strongly in 2003 with
growth of 2.9 per cent.
Despite this prognosis, there are still
some economies in the Euro area
which have continued to prosper in
recent times, namely Spain, Ireland
and Portugal. It is the fact that
Germany, France and Italy – the three
largest economies in the Euro area,
accounting for 70 per cent of output –
struggled towards the end of 2001 that
has led to the slow growth in the Euro
area. Problems in the German
economy have been well documented
since the middle of 2001, with
forecasters predicting unspectacular
growth in the future. German GDP
grew by a meagre 0.6 per cent in 2001,
the lowest rate in the EU. However, the
German economy, which was in a
technical recession for the second half
of 2001 with output falling in two
successive quarters, did grow by 0.2
per cent (quarter-on-quarter) in the first
quarter of 2002, indicating that the
German economy has moved out of
recession.
So why has the Euro area failed to
recover as quickly as the US?
Commentators highlighted two main
8

14. constraints on the Euro area economies
as being part of the explanation:
§ European Monetary Union, with a
single interest rate for the entire
Euro area, may have played a part.
The European Central Bank (ECB)
was widely criticised for not being
aggressive enough in cutting
interest rates in response to the
global slowdown. For example,
the Federal Reserve cut interest
rates by 4.75 percentage points in
2001, while the ECB cut rates by
only 1.5 percentage points. The
ECB would counter this by
arguing that interest rates were set
with the sole objective of
achieving price stability in the
Euro area in the medium term. The
presence of inflationary pressures
in certain countries and the
prospect of future price increases,
were the main reasons behind the
ECB’s interest rate decision.
§ The Stability and Growth Pact
constrains the ability of national
authorities within the Euro area to
use fiscal policy to combat the
threat of recession. The Pact states
that governments must strive to
bring their budgets into balance,
and they must not allow deficits to
rise above 3 per cent of GDP
except in exceptional
circumstances. Therefore countries
will be limited in the degree of
fiscal stimulus they can inject into
their economy in order to
stimulate growth. However, the
European Union would argue that
the pact is essential in order to
safeguard sound and sustainable
government finances in the
medium term.
While the factors above may
potentially impinge on how Euro area
authorities respond to economic
hardship in the short-term, Europe’s
underlying economic problems are
structural. For many years
commentators, and the UK
Government, have stated that product,
labour and capital market reform in
Europe is needed. Freeing up certain
markets, reducing legislation,
increasing flexibility, and encouraging
competition have all been advocated.
In particular, it has been stressed that
the more efficiently Euro area product
and capital markets function, the
greater will the success be of labour
market reforms in creating
employment opportunities5
. Although
there are signs of reform, it is still
believed that much more is needed if
the Euro area is to perform as
efficiently as the US.
The European Union’s stability and growth pact was set up in 1997 to ensure that EU
Member 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 the
size of a member state’s fiscal deficit was highlighted in February of this year when the
European Commission proposed that Germany and Portugal should receive a formal
warning 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 in
the stability and growth pact. Similarly, Portugal’s continued budget deficit of 2.2 per cent
of GDP for 2001 also caused the EC some concern.
Box 1.1: EU Stability and Growth Pact
9

15. Unemployment in the Euro area is still
high – averaging 8.4 per cent in 2001
compared with 5.5 per cent in the US
and 5.2 per cent in the UK. The
continued rise in the mismatch of skills
is of particular concern. Chart 1.3
shows that the general rise in
unemployment over the past 20 years
has been coupled in the cyclical
process with a rise in the vacancy rate.
As a result, the Euro area is left not
only facing the difficulty of finding
work for the large number of people
unemployed, but also with the
challenge of re-training people in order
for them to fill the increasing number
of vacancies.
Despite the Commission’s proposals formally to warn the two countries, the final
decision rests with the European Union’s 15 finance ministers. They rejected the
proposal and instead looked to seek assurances from both countries regarding the size
of future budget deficits. Of particular significance, the German Government insisted
that Germany would bring its public deficit close to balance by 2004 – its previous
forecast had been by 2006.
It has been suggested that the rejection of the Commission’s proposal marks a
significant step towards a less rigid interpretation of the stability and growth pact. The
UK has also been the subject of scrutiny by the Commission over its proposed budget
deficit of more than 1 per cent of GDP until 2006-07. The Commission commented that
this was “not in line with the requirements of close to balance or in surplus in the
medium term (as) contained in the stability and growth pact.” However, as the UK is
not a member of the Euro Zone, it is not formally bound by the penalties contained in
the stability pact. The EU has no power to force the UK to cut public spending or put
up taxes to balance the budget.
The UK government has continued to argue that the pact should take into account the
economic cycle, the need for public investment, and the levels of national debt. Indeed
many commentators have also claimed that there should be a deficit ceiling explicitly in
cyclically adjusted terms. This would allow much more flexibility in acting to curb
economic slowdowns whose effects are felt more severely in some parts of the EU than
others. Certainly, the interpretation of the stability and growth pact remains subject to a
significant degree of uncertainty.
Chart 1.3: Evolution of Skills Mismatch in the Euro area
10

16. After the initial increase at the start of
the year, Euro area inflation fell
throughout the remainder of 2002. The
rise in the Harmonised Index of
Consumer prices (HICP) at the start of
the year was attributed largely to the
introduction of euro notes and coins
(refer to Box 1.2) and the parallel
“rounding up” of prices. The benign
inflation trend, along with the slow
recovery in output growth later in the
year allowed the ECB to hold interest
rates unchanged at 3.25 per cent since
November. Forecasters are predicting a
slight rise in interest rates in the second
half of the year as the Euro area
economic recovery begins to gather
pace.
On 1 January 2002 Euro banknotes and coins were introduced and all prices in the Euro area
were converted into Euros. By February, only the Euro was the accepted currency in the
twelve countries participating in the European Monetary Union.
Much speculation around the launch of the Euro focused on how this would impact upon
inflation in the Euro area. The European Central Bank has an inflation target of below 2 per
cent (based on the HICP measure) in the medium to long-term. However, commentators had
claimed that the changeover period would affect the degree of price stability in the Euro
area. Pressure for general price increases would come from companies trying to increase
their profit margins by rounding up to new attractive Euro prices. Similarly, there is a cost
associated to firms when switching the price of goods to the Euro. Here firms would be
tempted to pass these additional costs onto the consumer.
Despite these apparent inflationary pressures, there are a number of factors that suggest that
these 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 be
vigilant and monitor prices;
§ Several items in the HICP will remain largely unaffected by any rounding as
psychological 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 to
and 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?
11

17. 1.2.3 Economic Developments
in the US
Towards the end of 2001, the
economic prospects for the US
economy did not look favourable. The
long anticipated slowdown in 2001,
exacerbated by the events of 11
September, resulted in a 1.3 per cent
annual contraction of output in 2001
Q3. During the same quarter,
unemployment rose and consumer and
business confidence both fell.
GDP growth then rebounded to
annualised growth of 1.7 per cent in
the final quarter of the year, a revision
upwards of 0.3 percentage points from
the preliminary estimate. More
recently, latest estimates for 2002 Q1
show that output has continued to grow
rapidly, with annualised growth of 5.6
per cent, the strongest annualised
quarterly figure for almost two years.
These unexpectedly favourable output
figures suggest the recent economic
Here it is evident that the Euro area has experienced a rise in inflation during and after the
changeover period. However, it is very difficult to identify how much of this rise in inflation
can be attributed to the changeover. For example, the price of non-processed foods increased
significantly at the start of 2002. Rather than being attributed to the changeover, this was due to
the unusually bad weather conditions in Europe.
Of greater significance is the long-term implications of the introduction of Euro notes and coins
on inflation. Here it is more likely that downward price movements should dominate, as the
physical introduction of the Euro will increase price transparency and ultimately strengthen
price competition in the Euro area.
Chart 1.4: Components of HICP Inflation for the Euro area
12

18. downturn may have been one of the
mildest in recent history.
The Federal Reserve’s aggressive
monetary policy loosening in the
second half of 2001 undoubtedly
contributed to the shallowness of the
downturn. The Federal Reserve cut
interest rates on 11 occasions in 2001
by a total of 4.75 percentage points,
leaving interest rates at 1.75 per cent,
the lowest for 35 years. However in
March 2002 the Federal Reserve
switched from a loosening to a neutral
stance, implying that they believe the
risks to the economy are now evenly
balanced between recession and
inflation.
Weak global activity forecast for the
first half of 2002, coupled with the
ample domestic spare capacity and
strong productivity growth, should
help ensure that US inflation remains
under control as economic activity in
the US continues to pick up.
Despite strong growth and low
inflation in the US in the early part of
2002, unemployment has continued to
rise since late 2001. Official
unemployment figures for April 2002
showed that unemployment had risen
to 6 per cent, its highest level since
August 1994. Forecasters6
predict that
unemployment will start to decline in
the second half of 2002 as employers
are expected to recruit more workers
once their confidence in the economic
recovery strengthens.
The resilience of consumer
expenditure has underpinned US
growth during the recent turbulence
and economic uncertainty of recent
quarters, and is now a key ingredient in
the current economic recovery.
Consumer expenditure grew by 6.1 per
cent (annualised) in the final quarter of
2001, helping to sustain the level of
domestic demand in the US. Consumer
expenditure has continued to grow in
the first quarter of 2001 but at a more
sustainable rate of 3.5 per cent.
The fiscal policy of the US
government has provided additional
support to the economy. The US
congress is discussing the possibility
of a further $25 billion in spending for
the current fiscal year (this is on top of
the $50 billion announcement for
emergency expenditure in the
immediate aftermath of 11 September).
This is intended to ensure that the US
economic recovery does not stall. In
the longer term, the US government
plans to cut taxes by $1.35 trillion in
the next 10 years. This will knock the
budget deficit back into the red, with
the deficit forecast to be $106 billion
or 1.0 per cent of GDP for 2002/03.
The US economy still faces risks. Of
great importance, perhaps, are the
rising consumer debt (see Box 1.5 later
in chapter) and the current account
deficit. Indeed, the latter is projected to
be 4.1 per cent of GDP for this year. If
foreign investors become unwilling to
finance this deficit, and with the US
budget back in deficit, US growth
would necessarily slow. Commentators
have suggested that this could prompt
a sharp and destabilising fall in the US
dollar.
1.2.4 Future Prospects and Risks
for the Global Economy
The global economic forecasts of the
IMF, as presented in the last two
World Economic Outlooks, are
summarised in Table 1.4. The trend
throughout 2001 was for forecasts to
be continually revised downwards for
most of the world’s advanced
economies. However, as the overall
prospects for an economic recovery in
13

19. 2002 have improved, there has been a
general move towards revising
upwards growth forecasts for 2002.
World output is expected to strengthen
in 2002, with growth of 2.8 per cent
forecast (up from 2.5 per cent in 2001),
before gathering further pace in 2003
as growth rises to 4.0 per cent. World
trade volumes are expected to expand
by 2.5 per cent and 6.6 per cent in
2002 and 2003 respectively – a marked
improvement on the slight 0.2 per cent
contraction in 2001.
These forecasts underline the expected
return in trading confidence following
the uncertainties associated with the
global slowdown and the events of 11
September. However, there are
increasing fears about global trade
relations in light of the recent
restrictions placed on steel imports to
the US (see Box 1.3). Should the US
government’s action prompt an
expanded trade war, the IMF’s
forecasts for trade growth might then
prove 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 1.6
Euro Area 1.5 (1.5) 1.4 (1.2) 2.9 0.0 0.2
Japan -0.4 (-0.4) -1.0 (-1.0) 0.8 0.0 0.0
Germany 0.6 (0.5) 0.9 (0.7) 2.7 0.1 0.2
UK 2.2 (2.3) 2.0 (1.8) 2.8 -0.1 0.2
Italy 1.8 (1.8) 1.4 (1.2) 2.9 0.0 0.2
France 2.0 (2.1) 1.4 (1.5) 3.0 -0.1 0.1
Canada 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 the
US, ranging from 8 per cent to 30 per cent, lasting for 3 years. The introduction of such a
measure was described as a temporary safeguard to enable the US to restructure their steel
industry. Indeed the US industry has struggled recently to compete with cheaper products
from abroad, and the US government has argued that this is primarily caused by subsidies
from foreign governments.
The European Union, along with a number of other countries including China and Japan, has
denied the use of such subsidies and has filed a formal complaint against the US action with
the 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 market
forces which have led to much consolidation in the steel industry elsewhere in the world.
Box 1.3: Trying to “steel” an advantage?
14

20. The OECD’s latest forecasts,7
like the
IMF’s, predict that the global economy
will rebound in 2002, with growth of
1.8 per cent expected for the OECD
area. This recovery will gather pace in
the second half of 2002 and into 2003,
with growth of 3 per cent forecast for
the OECD area in 2003. The OECD
expect the pace of recovery will vary
across the major OECD economies
and, while the downside risks have
diminished since last Autumn, policy
makers continue to be faced by a
substantial degree of uncertainty.
Inflationary pressures are expected to
remain benign in 2002 and 2003, with
world inflation averaging 1.3 and 1.8
per cent respectively. Unemployment,
however, is expected to remain
relatively high in 2002 and 2003, with
the major European countries
continuing to have the highest rates of
unemployment amongst the advanced
economies.
Among the major emerging markets,
the outlook is very mixed. Although
countries in Central America are
expected to grow most strongly, the
situation in other countries, particularly
Argentina (see Box 1.4), remains
extremely difficult, with a substantial
fall in output in the foreseeable future
appearing increasingly likely. In
emerging Asia, growth in China and,
to a lessor extent, India, is expected to
remain robust.
In the short term, it is the indirect rather than the direct implications of the tariffs which
are of particular concern to the European Union. At the moment only 5 per cent of EU
steel production is exported to the US. However, the indirect implication of the tariff is
that large volumes of steel exports will be re-directed from the US to elsewhere in the
world. This has serious implications and has led to the EU approving a package of tariffs
intended 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 the
US economy. Although steelmakers in the US will benefit from these measures, it is
argued that the economy as a whole will suffer. Some have claimed that these tariffs will
push up the cost of steel, leading to an overall rise in production costs. This could lead to
job losses in many industries which use steel. This line of argument is further
strengthened 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 is
possible that the current dispute could stall or even derail the progress on the Doha
agreement to liberalise free trade. This could have implications for issues as varied as
European farming subsidies and cheap medicines for developing countries. Therefore it
is essential that such specific trade disputes do not affect the overall goal of liberalising
trade throughout the world.
Five presidents since December 2001, increasing debt burden, an economy which has almost
ground to a halt, public mistrust in the current government, and a freeze on most bank
accounts, leading to public unrest: the first half of 2002 has been a traumatic time for
Argentina.
Box 1.4: Argentina – A Country in Crisis?
15

21. Despite the generally favourable
outlook presented by the IMF and
OECD, significant risks were still
identified. The primary one, perhaps, is
the possibility that the recovery in the
US will be delayed/or weaker than
expected, due to a prolonged decline in
investment spending or a sharp
weakening in private consumption.
The extent to which any upswing in the
US would be transmitted to the other
economic regions of the world is also
uncertain.
A more likely, albeit less threatening,
risk to the global economy is the
economic future of Japan. The world’s
second largest economy is showing
few signs of recovery from the period
of economic stagnation that has
characterised most of the last 12 years.
While quarter-on-quarter output grew
by 1.4 per cent in the first quarter of
2002, analysts still expect Japanese
output to contract in 2002 as deep
structural weaknesses, with the
potential to hold back the Japanese
The economic recession in 2001 provided the backdrop to Argentina’s latest crisis, and
sparked the outflow of funds from the Argentine banking system in late 2001. The
reasons for this outflow include:
§ The central bank ordered a maximum interest rate of 7 per cent on peso loans, in a
misguided attempt to instil confidence. The predictable result was a further reduction
in credit;
§ Political uncertainty within Argentina had led to increasing uncertainties over the
future of the Argentine economy;
§ Most importantly, the International Monetary Fund (IMF) withdrew its support for
the proposed recovery plan. The IMF had helped Argentina with loan arrangements
amounting to $48billion in 2001. However the IMF’s worries arose partly because
the shrinking economy and the consequent slump in tax revenues meant that there
was little chance of the Government reducing its fiscal deficit to zero, as previously
promised.
Many commentators have stated that any recovery, both economic and political, is
dependent 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 a
scenario would undoubtedly trigger further unrest.
After a decade in which the peso was fixed at par with the US dollar, the Government
introduced a duel exchange rate. Here some exports, “essential” imports and capital
payments were fixed at 1.40 pesos to the dollar, while for most other purposes there has
been 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’s
deep recession will restrain the inflationary pressures.
Restoration of the banking system in Argentina is also crucial if its economy is to get
back on track. This will be inextricably linked to the success of the Government’s
attempts to run a duel exchange rate system. Indeed, without a steady currency, there will
be little incentive to either invest or save money in Argentine banks. Furthermore, unless
the 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 $1000
per month. However, until the citizens of Argentina can spend their own money, it seems
unlikely that the economy will recover from its current recession. That is the Catch 22
situation which the Argentine government currently faces.
16

22. economy, remain. For example,
institutional and financial weakness
within the banking and corporate
sectors suggests that investment
spending may remain subdued for the
foreseeable future.
A further risk to the size of the global
economic recovery is the continued
rise in corporate and household debt.
Historically, recessions have been
associated with a decline in both
corporate and household debt, and it is
not generally until economic
conditions begin to look more
favourable that both types of debt
begin to increase. However, the recent
global recession – one of the mildest in
recent times – has followed a
continued rise in both household and
corporate debt. This could provide a
drag on the economic recovery as
people’s ability to continue to borrow
will be restricted.
Recent history has highlighted that any period of economic “boom” is characterised by an
increase in consumer and business debt, while a recession prompts a decline in debt as
consumers/companies rein in their expenditure. However, the recent global economic recession
has bucked this general trend, with consumers in particular continuing to borrow money in
order to maintain consumption levels. This has been one of the main contributing factors to the
recent recession being one of the mildest in modern history.
The root cause of the US recession – which quickly spread to the global economy – was the
bursting of one of the biggest financial bubbles in history. However, the depth of the economic
slowdown has been limited due to the continued strength in consumer expenditure. This was in
the face of large numbers of job losses, weakening consumer confidence, and great uncertainty
over the timing of the economic recovery. The consequence of this was a further rise in
consumer indebtedness in the US.
More generally, there has been a substantial rise in the degree of household debt in many of the
world’s leading economies (see Chart 1.5). The UK has followed a similar spending trend to the
US and has experienced a sharp rise in household debt. The Japanese – traditionally the world’s
biggest savers – are now the world’s biggest borrowers, with debts accounting for 132 per cent
of their income. Germany has also witnessed a steady rise in household debt, although France
has 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
17

23. The continuing unrest in the Middle
East, the military tensions between
India and Pakistan, and the possibility
of expanded US military action in the
war on international terrorism, pose
further risks to the global economy.
These could impact upon the global
economy through a variety of different
channels. For example, the trouble in
the Middle East could spark a sharp
rise in the price of oil were the supply
of oil to be disrupted or threatened.
The rise in oil prices since the start of
the year is illustrated in Chart 1.6.
Many factors have contributed to this
rise, including uncertainty over the
prospective supply of oil from
Venezuela, Iraq threatening to stop
supplying oil to the US, and, most
importantly, the possible implications
for the world’s supply of oil if the
tensions in the Middle East continue.
On the demand side, the continued
economic recovery in 2002 will create
higher demand for energy, thus placing
further pressures on the price of oil.
Oil price movements have a direct
impact on the global economy via their
effects on the costs of production,
transport and, ultimately, by
influencing price stability. The IMF’s
econometric model, MULTIMOD
indicates that each $5 increase in the
price of oil leads to a 0.2 per cent
reduction in annual GDP growth,
normally with a six to twelve month
lag8
.
This general increase in household debt has serious ramifications for the global economy and
cannot continue to increase in the long run. It is possible that excessive debt acts as a drag on
economic growth, and can amplify the size of future downturns. Indeed many commentators
believe that the current economic recovery will be modest as it started with balance sheets (for
both individuals and businesses) in a more fragile condition than during previous periods of
economic recovery. Consequently, there is little room for the increase in borrowing that usually
leads an economy out of recession. This has been a potential downside to the fact that the recent
recession has been a mild one.
Furthermore, the continued increase in household and business debt will pose potentially bigger
problems in the next downturn as the pressure to re-structure balance sheets may then become
irresistible. 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 possible
economic recovery.
To tackle this potential risk, commentators have argued that central banks should not only focus
their intentions on price stability, but should also try to control credit and asset prices. In some
earlier periods monetary policy has had other objectives, for example that of minimising
unemployment in the 1960s and 1970s. This prompted a period of high inflation, causing
monetary policy to shift its focus to controlling inflation. However, if the continued rise in debt
acts to hamper future economic growth, central banks maybe forced to set interest rates to curb
excessive borrowing as well as excess inflation.
18

24. 1.3 The UK Economy
1.3.1 Overview
The Chancellor of the Exchequer
published his Financial Statement and
Budget Report on 17 April 2002,
setting out the current economic
position and the forecasts for future
years. The forecasts for the UK
economy were favourable, with total
output expected to increase by 2 to 2½
per cent in 2002, rising to between 3
and 3½ per cent in 2003. However, the
Chancellor cautioned that growth of
the UK economy in 2002 would be
affected by the pace and timing of the
global recovery.
Official data released since the time of
the Budget have shown that activity in
the first quarter of 2002 was weaker
than expected by most commentators,
including the Treasury: GDP was
unchanged; manufacturing output
recorded a further sizeable contraction;
and exports fell further. Nevertheless,
most commentators agree that the
performance of the UK economy will
improve in the second half of the year.
The UK government’s latest forecasts,
as outlined in the Budget 2002, and
other recent economic indicators show
that:
§ GDP growth is forecast to be
between 2 and 2½ per cent in 2002,
rising to between 3 and 3½ per cent
in 2003;
§ RPIX inflation is forecast to remain
around the UK government’s target
rate of 2.5 per cent for the coming
years;
§ Public sector net debt is projected
to fall to around 30.2 per cent of
GDP by the end of 2002-03;
§ The UK Government remains on
track to meet its fiscal rules in the
years ahead, with the current
budget surplus projected to be £3
billion in 2002-03 (0.3 per cent of
GDP);
Chart 1.6: Two Month Future Brent Oil Prices for 2002
19

25. § The Monetary Policy Committee
held UK interest rates at 4.0 per
cent at their June 2002 meeting, the
lowest rate in 37 years.
1.3.2 Recent Developments and
Risks
Despite the difficult global economic
environment, the UK economy
performed strongly in 2001,
underpinned by the resilience of
domestic household consumption and
the output of the service sector. Service
sector output grew 0.5 per cent in the
fourth quarter of 2001, up 3.1 per cent
on the same quarter of the previous
year. The strength of this growth can
be explained partly by the modest
contribution of exports to UK services
demand. Total UK output expanded by
2.2 per cent in 2001.
One of the main reasons behind the
UK’s strong growth in 2001 was the
resilience of household consumption
which continued to grow strongly
despite the large uncertainties which
surrounded the UK economy at that
time. Strong household consumption
helped to maintain employment at its
highest levels since records began,
with unemployment also remaining at
record low levels. This came at the
time when all major economies
throughout the world were suffering
increases in unemployment.
The UK economy could not, of course,
escape the global slowdown
completely unaffected. The
synchronised world slowdown and the
collapse in demand for ICT-related
goods led to a marked contraction in
UK manufacturing output and exports,
and depressed business confidence and
investment.
Output in the final quarter of 2001 and
the first quarter of 2002 was flat. This
was the first time the UK economy has
failed to grow over two successive
quarters since 1991. This development
suggests that there should be increased
caution over the timing of the recovery
of the UK economy. The UK’s growth
performance in the first quarter trailed
behind that of many of the G7
countries: Germany and France grew
by 0.2 per cent and 0.4 per cent
respectively, based on quarter-on-
quarter growth; the US economy also
grew strongly, with annualised growth
of 5.6 per cent for 2002 Q1.
The manufacturing sector continued to
struggle in 2002, with output falling
1.4 per cent in the three months to
February 2002, down 6.2 per cent on a
year earlier. However, there are signs
that this decline in manufacturing
output is set to stabilise and forecasters
are predicting a recovery in the second
half of 2002 as demand for
manufactured goods increases.
The OECD suggest that the biggest
risk to the UK economy in the coming
years is the imbalance between internal
and external demand which has
emerged over the past few years.
Furthermore, they suggest that some
deep-seated structural problems
remain. In particular, OECD
emphasises the importance of
structural policy aimed at enhancing
human capital and work incentives,
raising competitive pressures and
improving public infrastructure.
Overall, the OECD’s assessment is that
UK growth will return to a solid pace
soon, boosted by the expected
turnaround in international trade and
the substantial increases in public
investment already announced.
Although the increasing uncertainty in
the Middle East, and its associated
implications for the world’s oil supply,
is a particular threat to the global
20

26. economy recovering in 2002, this will
have a relatively smaller effect on the
UK. In general, the shock to the UK
economy of a rise in oil prices will be
smaller than on the US or the Euro
area, owing to the UK’s status as an oil
producing country. This has led to
forecasters predicting that the recent
rise in oil prices will pose relatively
little threat to the inflation outlook,
even if it were to be permanent.9
1.3.3 Current UK Monetary and
Fiscal Indicators
Monetary Indicators
RPIX inflation was 2.1 per cent in
2001, and – apart from an erratic
January figure (2.6 per cent) – has
remained just below the UK
government’s target rate in the early
months of 2002. The main driver for
inflation in recent months has been the
increase in seasonal food prices caused
by the unusually bad weather
conditions throughout Europe over the
Winter. However, housing costs, which
continue to increase as the housing
sector remains buoyant, along with the
rising price of oil, are likely to be the
main drivers behind any price rises in
the immediate future.
Against this benign inflationary
backdrop, UK interest rates have
remained at 4.0 per cent since
November 2001, when the Monetary
Policy Committee (MPC) acted to
reduce interest rates in the light of the
global economic slowdown and the
events of 11 September. Rates were
unchanged at the most recent MPC
meeting on 6 June.
It is useful to remember, however, that
the MPC must look ahead to the
medium term rather than target current
inflationary pressures when setting
interest rates. This is because of the
lags associated with the operation of
monetary policy, typically thought to
be around 18 months. The monetary
framework set up in 1997 ensures that
deviations below the target rate are just
as undesirable as deviations above the
target rate. Consequently, there is no
incentive for the MPC to keep interest
rates high when there are low
inflationary pressures in the medium
term.
The IMF’s inflation forecast10
is very
close to the Budget 2002 projections,
with inflation forecast to be 2.4 per
cent in 2002, rising slightly to 2.5 per
cent in 2003.
Fiscal Indicators
The slowdown in the world economy
in 2001 has affected the fiscal balances
for last year. Weaker external demand,
lower equity prices and the
deterioration in financial corporations’
profits depressed corporation tax
receipts in particular. Despite this, the
UK government continued to meet its
fiscal rules11
and remains on track to
do so over the next five years.
The forecast for government receipts
for 2001-02 was revised down
significantly in the November 2001
Pre-Budget Report (PBR), and actual
receipts outturns since November have
been about £1 billion below the PBR
forecast. Despite this, the provisional
current budget outturn shows a surplus
for 2001-02 of £10.6 billion (£0.3
billion higher than projected in the
PBR), reflecting lower than expected
spending outturns. The current budget
is expected to remain in surplus over
the period to 2006-07 (see Table 1.5),
implying that the UK government will
meet its golden rule (i.e. borrowing
only to invest).
21

27. Public sector net debt was 30.4 per
cent of GDP in 2001-02, and is
projected to fall slightly to 30.2 per
cent in 2002-03. Over the next five
years, public sector net debt is forecast
to edge up to around 31 per cent of
GDP, comfortably meeting the
sustainable investment rule.
The overall macroeconomic position of
Budget 2002 represents a slight fiscal
tightening for this year and next,
compared with the November 2001
PBR, as growth gathers pace and the
economy returns to trend. The
projections indicate that the UK has a
broadly sustainable fiscal position in
the long-term, with the impact of an
ageing population on public finances
expected to be both manageable and
less marked than in most other EU
countries.
1.3.4 Prospects and Forecasts for
the UK Economy
The UK government’s forecasts for the
main economic indicators, including
growth and inflation, for the next 3
years were published in the 2002
Budget. The forecast range for output
growth for 2002 remained the same as
published in the PBR in November,
with growth of between 2 to 2½ per
cent forecast. However, the forecasts
for 2003 and 2004 were revised up
slightly, indicating that the UK
economy is expected to strengthen
further 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 spending
2 Includes WTAS
3 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)
22

28. The latest consensus of independent
forecasts12
for the UK economy shows
GDP growth of 1.9 per cent and 2.6
per cent for 2002 and 2003
respectively. This is slightly below the
Treasury’s forecast range for 2002, and
significantly below the Treasury’s
forecast range for 2003. The IMF
forecasts are within the UK
government’s forecast range,
predicting GDP will grow by 2 per
cent in 2002, increasing to 2.8 per cent
in 2003. The IMF’s forecast of UK
inflation, at 2.4 per cent in 2002 and
2.5 per cent in 2003 is also close to the
UK government’s forecast.
Trade and Balance of Payments
The synchronised slowdown in the
world economy has inevitably affected
UK trade, with many of our trading
partners facing economic hardship.
Weak growth in major export markets,
along with the slump in demand for
highly traded ICT goods, contributed
to a marked contraction in UK exports
in the second half of 2001. At the same
time, imports weakened much more
The rate of trend (or potential) growth is the rate at which the output of the economy can grow
on a sustainable basis without putting upward or downward pressure on inflation. Factors such
as changes in confidence, demand conditions in the UK’s trading partners, and the stance of
monetary and fiscal policy, will all have temporary effects on economic growth. However it is
longer-term factors, such as growth of productivity and the rate of growth and structure of the
population, 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 trend
growth rate from 2.5 per cent to 2.75 per cent. The trend rate of growth calculated by the
Treasury is based on four main components: labour productivity; average hours worked; trend
employment rate; and population of working age. The Treasury forecasts the following
changes to these components over the coming years:
§ Labour productivity: projected in line with the evidence of recent years, implying trend
productivity growth of 2 per cent;
§ Average hours worked: assumed to decline slightly, by 0.1 per cent a year, in line with
the trend over the 1986 to 1997 cycle;
§ Trend employment rate: projected to grow by 0.2 per cent a year (less than has been
experienced in recent years) through a combination of a decline in the inactivity rate and
modest further falls in the Non-Accelerating Inflation Rate of Unemployment (NAIRU);
§ Population of working age: projections are based on the Government Actuaries
Department assumptions. For the trend rate of growth, it is assumed that net migration
will be similar to that of the last three years. This implies a contribution to the trend rate
of growth of 0.6 per cent a year over the Budget projection period, slightly less than over
recent years.
However, the Treasury uses a different trend growth rate for the public finance projections in
order to take account of forecast risk. The UK Government deliberately uses a cautious
assumption for trend growth for the public finance projections that is ¼ of a percentage point
lower than its neutral view. Therefore, the annual trend growth rate used for public finance
projections will be 2.5 per cent, up from its previous rate of 2.25 per cent.
Box 1.6: UK Trend Growth
23

29. sharply than projected in the 2001
Budget, with the net effect being a
moderate widening of the deficit on
traded goods and services.
The UK economy has been growing strongly in recent years, although for the past four years
there has been imbalance between the different sectors of the economy. Much has been
written about the continued slump in the manufacturing sector, while the service sector has
continued to grow strongly. The impact of the high value of sterling against the Euro, coupled
with the recent slowdown in the world economy, have exacerbated the long-run difference
between the two sectors, or to be more precise, between the tradable and non-tradable sectors
of the economy.
Chart 1.7 illustrates the comparative performance of the UK manufacturing and service
sectors, along with the overall growth in output. From 1996 onwards, there is a clear
divergence between the two sectors, with the service sector on a continued upward trend,
whilst manufacturing growth has remained static. Indeed, over the past year, manufacturing
has 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-run
context. Productivity increases at a faster rate, on average, in manufacturing than in other
parts of the economy. Consequently, other things being equal, employment in manufacturing
falls as a share of the total. For example, at the start of the 20th
century there were over 100
blast furnaces along the banks of the River Tees. Today there is only one plant – Corus at
Redcar – which produces more iron than all the 106 combined plants a century ago. Such
productivity growth will increase the standard of living, but will also result in the share of
manufacturing in total employment continuing to decline, unless demand increases, for
example from export markets.
Box 1.7: Two Speed Economy?
24

30. The UK government forecasts that UK
exports will pick up through 2002 as
the global economic recovery begins to
gather pace, but year-on-year growth is
projected to be negative for 2002 as a
whole, contracting between 1 to 1½
per cent. Imports are also expected to
accelerate this year, although the
forecast moderation in household
consumption growth, coupled with the
increasing share of final expenditure
accounted for by government
spending, will limit import growth
over the medium term.
The trade deficit is forecast to widen
slightly in 2002 with the balance of
payments current account deficit rising
to 2½ per cent of GDP, from a deficit
of 1¾ per cent in 2001. However, the
Treasury forecast that the current
account deficit will stabilise at 2¼ per
cent of GDP, a level which is both
readily financeable and which remains
well below past peaks.
1.3.5 Budget 2002: Announcements
and Economic Impact
The April 2002 Budget outlined the
measures and policy decisions taken by
the UK government to advance their
long-term goals of:
§ Maintaining economic stability,
ensuring that the fiscal rules are
met, inflation remains low, and the
UK has faster productivity growth
than its main competitors;
§ Sustaining a higher proportion of
people in employment than ever
before, while seeking to ensure full
employment in every UK region;
§ Eradicating child poverty and
tackling pensioner poverty,
extending opportunities for all
children and providing security for
all pensioners;
§ Establishing world-class public
services, delivering investment to
improve national healthcare for all,
raise standards in education,
modernise Britain’s transport
system and tackle crime;
§ Tackling global poverty and
climate change, helping to achieve
the international community’s
Millennium Development Goals by
2015, and achieving the UK’s
commitments under the Kyoto
Protocol.
The main announcements in the 2002
Budget are summarised in Box 1.8.
Recently, domestic demand has been strong while the trade position has been weak. This year
net trade is forecast to make a negative contribution to economic growth for the sixth year in a
row. Therefore, it is important that such imbalances should be reduced in order for the UK
economy to continue to grow strongly. The recovery in the world economy will help reduce
the existing imbalance. However many commentators have suggested that any unwinding of
the imbalance between domestic demand and output is likely to involve a slowdown of
consumption growth in order to release resources that could be diverted to investment and an
improvement in the trade balance. This, it is argued, may lead to a fall in the sterling exchange
rate to a more sustainable level. However, when and how these adjustments will occur is
extremely difficult to know.
25

31. Total public spending13
is forecast to
increase substantially over the next 3
years, rising from £392.1 billion in
2001-02 to £454.6 billion in 2003-04.
The Treasury forecast the tax burden to
increase modestly from 36.7 per cent
of GDP in 2002-03 to 37.6 per cent in
2003-04, with further rises in 2004-05
and 2005-06, leaving the tax burden at
38.3 per cent of GDP.
§ The Scottish Executive budget will increase by £224 million over 2003-04, and by a
cumulative extra £3.2 billion over the next 5 years, as a consequence of the
Chancellor’s spending announcements;
§ New measures introduced to help small and large businesses: financial assistance for
small firms’ training needs; automatic relief for VAT on bad debts; plan to extend
flat rate VAT to more small firms; corporation tax starting rate reduced from 10 per
cent to zero, with corporation tax for small firms reduced from 20 per cent to 19 per
cent; 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 Community
Investment Tax Credit to promote enterprise and wealth creation in under-invested
communities;
§ A new Working Tax Credit will be introduced from April 2003 to provide work
incentives and help reduce persistent poverty among working people;
§ Basic credit on the Working Families Tax Credit will be increased by £2.50 a week
from 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 a
week 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
26

32. References
European Central Bank, Monthly
Bulletin, April 2002
OECD (2002) Economic Outlook, May
2002
IMF (2002) World Economic Outlook,
May 2002
SCDI (2001) Survey of Scottish Sales
and Exports in 1999
National Institute for Economic and
Social Research (2002), Economic
Review May 2002
Scottish Executive (2001), Scottish
Input-Output Tables
HM Treasury (2002), Budget Report,
April 2002
HM Treasury (2002), Forecasts for the
UK 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 and
prudent level, with the upper benchmark being 40 per cent of GDP over the economic cycle.
12
“Forecasts for the UK Economy”, HM Treasury March 2002
13
Total Managed Expenditure.
27

33. 28

34. 2002
chapter two: Report on Economic
Development Initiatives

35. Chapter 2: Report on Economic Development Initiatives
The Scottish Executive’s Framework
for Economic Development in
Scotland (FEDS), published in June
2000, was designed to provide the
fundamental structure within which
more detailed policy programmes can
take place. The overall vision of FEDS
was to raise the quality of life for all of
the people in Scotland through
increasing economic opportunities in a
socially and environmentally
sustainable manner. It is vital that
people of all regions and social groups
have the opportunity to participate in,
and benefit from, economic growth in
Scotland. Similarly, economic growth
must not be to the detriment of
Scotland’s environment.
FEDS takes, as its starting point,
several key principles:
FEDS shows the direction in which the
Executive wishes to see the economic
environment evolve and the priorities
that must be addressed. The Priorities
for Action identified in FEDS include:
Overall, FEDS identifies the
enhancement of productivity
throughout all Scottish enterprises as
being the critical element to improving
economic growth and living standards.
These Priorities for Action are the
main drivers to achieving this.
Importantly, FEDS must stimulate
further action. While it is necessarily
set at a high level, and embraces the
wide and complex set of elements that
drive economic development, it
explicitly considers the process
through which the Executive will move
from the Framework itself to define a
sharper, more effective programme of
specific initiatives. The last edition of
the Scottish Economic Report
contained the third update on the
progress the Scottish Executive has
made in the field of economic
§ Inclusive: FEDS is concerned with
the economic opportunities of all
the people of Scotland – throughout
society, and in all regions and
sectors of activity
§ Longer-term: FEDS looks beyond
the immediate towards a 5 to 10
year horizon.
§ Dynamic: FEDS embraces the full
range of factors that together
determine progress in economic
development.
§ Partnership: Economic
development is ultimately driven by
the private sector, therefore FEDS
seeks to enable and encourage that
development.
§ Evidence-based: policy-making
needs to be underpinned by
evidence and rigorous analysis and
not by anecdotal and ad hoc
assessment.
§ The strengthening of the basic
education system to better
equip our children for the
demands of the global
economy.
§ Ensuring we have the
appropriate transportation and
electronic infrastructures.
§ The approach to enterprise
support, including encouraging
an enterprise culture,
supporting innovation, and
assisting new business
formation.
§ The contribution of economic
policy to the continuing
prosperity of the regions of
Scotland and to the reduction of
social deprivation and
improved health.
30

36. development. This chapter will gauge
new developments within existing
programmes, along with covering new
initiatives the Scottish Executive has
undertaken since January 2002. These
shall fall under the main Priorities for
Action identified in FEDS. The policy
justification for these initiatives are
referenced throughout the chapter, as
the focus of the chapter is on the key
initiatives which are currently
underway.
2.1 Education
One of the Priorities for Action
identified in the Framework is
strengthening the basic education
system better to equip children for the
demands of the global economy,
particularly through promoting the
skills required for life long learning
and the use of ICT. This reflects the
critical contribution education has to
make towards the enhancement of
productivity and hence to the
development of the Scottish economy.
Education also has an important
contribution to make to another two of
the Priorities for Action, namely,
encouraging a culture of enterprise and
reducing social deprivation and
improving health by focussing on the
opportunities, access and capacity of
all people to participate in economic
activity.
National Debate: The Scottish
Executive launched a National Debate
on Education on 20 March 2002. The
National Debate aims to provide a
vision and strategy for the long term
future of school-age education. The
Debate focuses on high level issues for
the future such as why we educate
children and young people and what
children should be learning, as well as
exploring methods of delivery in terms
of location, timing and the people who
can help young people to learn.
National and local organisations across
the country are holding discussion
events using support materials
produced by the Executive, and people
with an interest in education can
discuss the issues that are important to
them in an environment which suits
them. The debate continues until the
end of June, after which the Executive
will formulate a vision and a strategy
for the future for publication early in
2003.
A National Intranet for Scottish
Schools: Following a major
conference in Edinburgh in December
2001, the Executive has been working
closely with the education authorities
and other agencies to draw up detailed
plans for a national intranet for
Scottish schools. This will provide a
layered range of services and facilities
to pupils, teachers and education
managers across Scotland through the
vehicle of a secure intranet. It will also
offer a broadband interconnect joining
every education authority with each
other and with a range of national
bodies. Procurement of the intranet is
likely to get under way in the summer.
This fits alongside the Executive’s
overall strategy for broadband, which
involves aggregation of demand for
broadband connectivity across public
services, including education and
health, within geographical zones.
National Priorities in Education -
Update: The last edition of the
Scottish Economic Report presented a
detailed analysis of the National
Priorities in Education. The
implementation of the National
Priorities is moving forward with the
launch at the beginning of May 2002
of a National Priorities Support Pack.
This has been designed to help
teachers, Head Teachers and Education
Authorities set realistic but ambitious
targets for improvements in
31

37. achievement and attainment and other
desirable outcomes. It also offers a
wide range of resources to support
schools and authorities when they
consider the best way of securing
improvement for the young people in
their area. Academic achievement and
attainment is just one of the National
Priorities in Education. There is also a
focus on values and citizenship, on
inclusion and equality, and the skills
needed to equip young people for
lifelong learning, such as creativity and
ambition. There is recognition that in
order to play a full role in society,
including contributing to the economic
development of the nation, young
people need to acquire a wide range of
skills and knowledge.
New Community Schools: New
Community Schools (NCS) is a radical
initiative which has the twin aims of
promoting social inclusion and raising
educational standards in Scotland. The
NCS approach embodies the
fundamental principle that the potential
of all children can be realised only by
addressing their needs in the round,
and that this requires an integrated
approach to the delivery of a range of
services necessary to assist children to
overcome the barriers to learning and
positive development - family support,
family learning and health
improvement. A pilot programme of
New Community Schools was
introduced in 1999/2000 and will
continue until 2003/4. Evaluation of
pilot projects has shown that schools
and other agencies are benefiting from
the new ways of working and that the
approach can make significant
improvements in attainment. On 12
November 2001, the Executive
announced that additional funding of
£30.6million over 2 years (2002/03
and 2003/04) would be made available
to local authorities to support the roll
out of the new community school
approach across all schools in
Scotland. This roll out process started
on April 1st
2002.
Assessment: The Minister for
Education has announced the
establishment of an action group to
take forward developments in
assessment, consisting of all key
stakeholders and chaired by the Deputy
Minister for Education. The aim is to
improve assessment, record-keeping
and reporting in schools so that any
difficulties young people are
experiencing in learning and
achievement can be promptly
identified and addressed.
Education for Work and Enterprise
Review: Education for Work and
Enterprise (EfWE) covers a wide range
of activities and programmes which are
designed to help prepare young people
for the transition from education to
work. EfWE is key to the Executive’s
Programme for Government
commitment of promoting an
entrepreneurial culture beginning in
schools. A Ministerial Review Group,
with representatives from business and
education, was established in
September 2001. This group is
charged with identifying key
objectives in EfWE, defining success
and outlining the scope for its delivery
within an outcome-focused curriculum.
The aim is to maximise the high-level
opportunities available through EfWE
which are available to both school
students and business. As part of the
Review, the Group has conducted a
major consultation exercise and has
undertaken focus group research to
gather views directly from young
people. It has also had direct interface
with schools and business. The Group
will report in Summer 2002.
Out of School Care: There has been
considerable expansion of out-of-
school care services over the last few
32

38. years. There are now about 800 clubs,
compared with 500 in 1998, providing
places for 40,000 or so children. These
clubs enable parents to enter the
workforce, or to extend their working
hours, secure in the knowledge that
their children are being well looked
after. The expansion of clubs in
disadvantaged areas is especially
important in helping parents into work.
Education (Disability Strategies and
Pupils' Educational Records)
(Scotland) Act: The new Education
(Disability Strategies and Pupils'
Educational Records)(Scotland) Act,
established in March 2002, will require
education providers to prepare and
implement accessibility strategies.
This will improve access to education
for pupils with disabilities so that these
pupils can benefit from equal
opportunities to achieve their full
educational potential. It will also
ensure that more young people with
disabilities leave school with the right
skills and, as adults, go on to play an
active role in society and the Scottish
economy.
Sure Start Scotland is a programme
which is aimed at improving social
inclusion and achieving better life
outcomes for children. It is founded
on the notion that children will be able
to make the most of later opportunities,
including pre-school education and
beyond, if they have a positive start in
life. Accordingly, Sure Start Scotland
targets families with very young
children (0-3 years), particularly the
most vulnerable and deprived families.
The programme has 4 broad
objectives: to improve children’s
emotional and social development; to
improve children’s health; to improve
children’s ability to learn; and to
strengthen families and communities.
Joint working is an important factor in
the Sure Start programme: local
authorities, voluntary organisations,
health services and parents are
encouraged to work together to provide
a cohesive integrated service to meet
the identified needs of parent and
child. Examples of services funded
through Sure Start are: parent support;
outreach services where workers visit
families in their own homes; childcare,
including nurseries and playgroups;
childminding; and support for specific
marginalised groups. £80m of funding
has been allocated for the period
1999/00 - 2003/04. A first stage of
evaluation, Mapping Sure Start
Scotland (May 2002), reported
positively on the programme. A
second stage of evaluation is being
planned to begin to assess impact and
to gauge whether children are
achieving better outcomes, including
learning outcomes, as a result of this
early intervention approach.
Pre-school Education: There has been
a major expansion in the provision of
pre-school education in recent years.
The latest participation rates
information available relates to
academic year 2000-01 and showed
rates of 80 per cent and 97 per cent for
three year olds and four year olds
respectively. This compares with the
earliest information available of 68 per
cent for three year olds in 1999-2000
and 96 per cent of four year olds in
1998-1999. It is now a statutory duty
for local authorities to secure a free
part-time pre-school education place
available for all three and four year
olds whose parents want it.
Childcare: The Scottish Childcare
Strategy aims to ensure good quality
affordable childcare for children aged
0-14 in every neighbourhood. We
have targeted additional resources
towards areas of disadvantage through
the child poverty package. This
additional funding will provide
33

39. childcare grants for lone parents in full
time Higher Education; allow Further
Education colleges to widen childcare
provision; and through Childcare
Strategy funding help local authorities
to stabilise and sustain childcare
provision. In addition, the third round
of New Opportunities Fund childcare
funding, to be announced later this
year, will support projects in deprived
areas.
Transitions from school: The Beattie
Committee was established in April
1998. Following an extensive and
wide-ranging consultation which
looked at the participation and
attainment of young people (16-24
years) who require additional support
in post-school education and training,
the Beattie Committee reported in
1999 focusing on skills and
employability. The key
recommendation of the Report was that
Inclusiveness should be the
underpinning principle for all post-
school learning and support and that it
should place the young person at the
heart of provision. Funding of £22.6
million has been made available to
implement the recommendations.
Beattie Implementation Programme
– Update: The multi-partnership
Inclusiveness projects, managed by
Careers Scotland, are now operational
across Scotland with approximately
140 keyworkers employed within the
projects. These projects will be the
subject of performance monitoring and
evaluation over the next 3 years.
Three part-time National Development
Officers (Senior Educational
Psychologists) are taking forward the
development of the specification for a
post-school educational service.
2.2 Support for Infrastructure
Transport Delivery Report: The
Transport Delivery Report Scotland’s
Transport: Delivering Improvements
has a two-fold purpose. Published on
21 March 2002, the document details
the Executive’s vision for the future of
Scotland’s transport, as well as setting
out an impressive number of transport
improvements already accomplished,
across Scotland and across all modes
of transport. Of particular significance
is the fact that the Transport Delivery
Report contains Scotland’s first
national transport strategy for over
thirty years.
Scottish Executive-commissioned
studies predict road traffic to grow by
27 per cent over the next two decades.
80 per cent of this growth is forecast to
be in and around Scotland’s major
metropolitan areas – this is clearly
unsustainable. The Executive aims to
reduce the impact of urban congestion
by striving to stabilise growth at 2001
levels by 2021. By increasing
investment in the transport
infrastructure, the Executive will
deliver improvements consistent with
its overarching vision.
That vision, outlined in the Transport
Delivery Report, is to build a
sustainable, effective and integrated
transport system, meeting the needs of
all in society and appropriate to the
requirements of different parts of
Scotland. The Executive will take up
the challenge by investing in an
integrated package of measures:
modernising and improving public
transport, promoting alternative modes
of transport to the private car and
targeted trunk road improvements.
The Transport Delivery Report sets out
the Executive’s 10 priority projects for
delivery. These are major projects of
national strategic significance, based
around the interlinked aims of
34

40. improving public transport and
reducing 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 of
the A8, A80 and M74 corridor
studies;
• progressing the central Borders rail
link;
• from October 2002, free off-peak
bus travel for elderly people and
people with a disability; and
• improving and enhancing
Traveline, the national public
transport information service, set
up in January 2001, and
encouraging local authorities to
adopt through-ticketing
arrangements on local buses.
The detailed sequencing of the 10
priority projects will be a key priority
when decisions are taken in this year’s
Spending Review. The clarity in the
Report about what the Executive is
seeking to achieve creates an explicit
agenda for partnership with other
bodies. Such partnership is vital for
the Executive to attain the resources
that are needed to deliver. Working
with local authorities and the voluntary
regional transport partnerships is
fundamental if the vision is to be
achieved. The Report cannot be the
answer to all of Scotland’s transport
problems. It does however clearly
articulate what the Executive is
striving to achieve.
Energy, Water and Environment
Sustainable Development: On 30th
April 2002, the Scottish Executive
Environment Group published Meeting
the Needs…, a publication that marked
the start of the Executive’s ongoing
process to define what we mean by a
sustainable Scotland and how we
intend to achieve it. The Executive is
committed to sustainable development
(development that combines economic
progress with social and environmental
justice) and the paper identifies the
main priority areas that we will tackle.
These areas are resource use
(understanding where our materials
come from, how they are replaced,
how they were transported, etc),
energy (reducing our reliance on fossil
fuels, increasing the amount of power
generated from renewable resources,
improving energy efficiency and
reducing fuel poverty) and travel
(better land use planning, and
developing sustainable transport
systems).
In order to measure and follow the
progress of sustainability, the
Executive has selected an initial 24
sustainability indicators, which include
areas such as waste management,
population structure, air & water
quality, energy, travel and fuel
poverty. Some of these indicators will
be used to set targets although many
will have their usefulness reassessed in
2003 in light of emerging opinion.
The Executive is committed to
providing regular reports on how
Scotland is performing in terms of
sustainability and on the progress
being made taking forward the matters
set out in the Meeting the Needs…
paper. A forum will also be
established to contribute to the
development of the strategy set out and
to assist in driving forward sustainable
development in Scotland. On a UK
front the Sustainable Development
Commission, which includes two
members who are particularly looking
35

41. to Scottish interests, will take an
overview of progress in Scotland.
Footprints Study: The Five Cities
Footprint study, which has been
carried out as part of the Cities Review
to examine the sustainability of
Scottish cities, was completed at the
end of May 2002. The study used the
concept of Environmental Footprints to
promote understanding of the
environmental impact of Scottish
cities, and allow comparison with other
UK/European cities. There should be
useful application to other policy areas.
The analysis is expected to inform
thinking on why cities perform in a
certain way and should suggest ways
of reducing the “footprint”, and so
becoming more sustainable. The Welsh
Assembly already uses footprints as an
indicator. Best Foot Forward, who
developed the concept of
environmental footprints, undertook
the analysis for the Executive. The
results from the study will be
published in the Cities Review report
during Autumn 2002.
Scottish Water: On 1st
April 2002, all
the functions and assets of the three
existing Scottish water authorities were
passed to Scottish Water as a result of
the Water Industry (Scotland) Act,
which was introduced in the Scottish
Parliament in September 2001, and
received Royal Assent on 1 March
2002. Scottish Water will become the
4th
largest water services provider in
the UK, as well as the 12th
largest
business in Scotland by turnover.
Through an extensive efficiency and
business improvement programme,
Scottish Water will aspire to the
standard of world class service
providers. Scottish Water will play a
key role in the Scottish economy
through its commissioning of 50 per
cent of the total contracts in the
construction and engineering sector to
deliver an investment programme
worth around £2 billion between 2002-
2006.
Water Framework Directive: The EC
Water Framework Directive came into
force on 22 December 2000 and has
been described as the most important
piece of water legislation ever
introduced. The Directive establishes
a framework for the protection of all
water bodies and promotes sustainable
use of water resources. Member States
are required to develop River Basin
Management Plans that set out the
actions required to achieve good water
status by 2015 in the applicable water
bodies. Economics plays a significant
role in these plans, as the Directive
calls for a full economic analysis of
water use to be carried out by 2004.
As the Directive requires the status of
many water bodies to be improved,
then costs will obviously be involved.
The economic analysis will help to
determine what actions should be taken
(the most cost-effective solution) and
who should pay for them (the principle
of the polluter pays). The Directive
also requires that a system of water
pricing be introduced that reflects the
costs, including environmental costs,
incurred to provide the water. This
system should also provide incentives
for efficient water use.
The second consultation paper, The
Future for Scotland’s Waters:
Proposals for Legislation, on the
implementation of the Water
Framework Directive into Scots law
was published in February 2002. The
consultation will lead to the Water
Environment and Water Services
(Scotland) Bill being introduced to the
Scottish Parliament in May 2002.
Renewables Obligation (Scotland):
On 1st
April 2002, the Renewables
Obligation (Scotland) (ROS) Order
came into force. The obligation
36

42. requires that by 2010, electricity
suppliers source 10.4 per cent of their
electricity from “new” renewable
energy sources. Suppliers provide the
regulator, OFGEM, with Renewable
Obligation Certificates (ROCs) to
show that they have met the obligation.
Where suppliers fall short of the
obligation, they have to pay a buy-out
fee of 3p/kw. The buy-out payments
are then collected into a fund and
recycled amongst suppliers who
presented ROCs. The buy-out fund
acts both as an incentive to suppliers to
meet the obligation and as a cap on
costs to consumers.
The Scottish Executive has the
objective of increasing the amount of
electricity generation from established
and new renewable energy sources to
18 per cent by 2010, but it now looks
likely that this target will be reached
earlier.
UK Energy Review: The Performance
and Innovation Unit (PIU) published
the Energy Review in February 2002.
The review suggests that the overall
aim of the UK government should be
the pursuit of secure and competitive
means of meeting energy needs,
subject to the achievement of a
sustainable energy system. Other
suggestions are that:
• The immediate priorities of energy
policy are most likely to be met
through the promotion of energy
efficiency and renewable energy.
• There is no pressing problem
concerned with increasing UK
dependence on imported gas.
• The options of investment in
nuclear power and clean coal need
to be kept open.
• There should be support for
innovation in a broad range of
energy technologies, aiming to
establish new sources of energy
that can be low cost and low
carbon.
• The Government should use
economic instruments to bring
home the cost of carbon emissions
to all energy users.
• A new cross-cutting Sustainable
Energy Policy Unit should be
created to draw together all
dimensions of energy policy in the
UK.
• The Government should initiate a
public debate about sustainable
energy, including the roles of
nuclear power and renewable
energy.
The Report points out that several key
areas within energy policy are
devolved to the Executive, including
the promotion of energy efficiency and
renewable energy, and consents for
new power station, electricity lines and
gas pipelines. (Applications for all
new power stations in Scotland have to
be considered by Scottish Ministers
under these devolved consent powers).
The Report recommends that the
Scottish Executive should remain fully
involved in the development of energy
policy.
Executive officials worked closely
with members of the PIU on energy
issues of direct relevance to Scotland,
particularly the scope for a huge
increase in the production of renewable
energy, and the Executive submitted
two papers to the Review. In view of
the recommendations for new targets
for renewable energy in 2020, the
Executive expects to consider this
issue in the near future.
The PIU report is now open to public
consultation. There is an ongoing
consultation group, at which the
Executive is represented. The UK
Government will consult on the issues
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43. raised and issue a response in an
Energy White Paper later on in 2002.
Review of National Planning Policy
Guidelines (NPPG) 2: In January of
this year, the Executive consulted on a
draft revision to National Planning
Policy Guideline (NPPG) 2 Economic
Development. This outlines the role
that the planning system can play in
promoting economic development on a
socially and environmentally
sustainable basis. Following the
consultation, a finalised version of the
guideline will be issued towards the
end of this year.
2.3 Enterprise Support and
Skills Development
Scotland's Economic Future
Scotland's enterprise strategy is based
upon consideration of evident global
economic trends. For most of the last
thirty years, growth in world trade has
outstripped world GDP growth. In
Scotland we are embracing this trend.
It is increasingly unlikely that we can
compete with developing countries in
terms of labour or commodity prices,
and inward investment levels across
Europe reflect this. The Executive is
aware of the benefits to the economy
brought by companies such as IBM or
NCR. However, in order to foster
long-term economic success, the focus
of Scotland's Enterprise Strategy is
rightly on Scotland's area of
comparative advantage - high value
added products and those sectors with
a very high skill or knowledge content.
The Enterprise Networks were given
clear strategic guidance in January
2001 with the publication of A Smart,
Successful Scotland. This guidance
reflects the Executive's wider
enterprise strategy based on science
and skills, and ensures that the
programmes of the Enterprise
Networks work towards our strategic
goals. On the skills front LearnDirect
Scotland, Future Skills Scotland and
Careers Scotland have been established
to provide first class workforce
information and to provide an all age
careers service. This has been
accompanied by increased investment
in Further Education. In science the
Executive has put in place the first
scientific advisory committee, boosted
early stage funding for
commercialisation, built transatlantic
links between Scottish universities and
US counterparts and modernised
Regional Selective Assistance towards
indigenous high growth companies.
These achievements represent a
significant step towards economic
success, but the Executive realises that
ultimately the engagement of the
Scottish business community, the
driver of economic growth, is a
necessary condition in making the
Executive's enterprise strategy a long-
term success.
The Joint Performance Team, a joint
Scottish Executive and Enterprise
Network body, published a
measurement framework for the
Enterprise Networks in Measuring
Scotland's progress towards a Smart,
Successful Scotland in March 2002.
This framework measures the success
of the Enterprise Networks in the areas
set out in A Smart, Successful
Scotland. This document does not set
"targets" for the Enterprise Networks.
A Smart, Successful Scotland outlines
those areas in which Scotland must
succeed if we are to achieve
sustainable economic growth. The
Joint Performance Team's
measurement framework details
indicators that allow economic
outcomes to be measured in these areas
of the economy in comparison with
other OECD countries. The Enterprise
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