Update: what big policy challenges face Scotland’s next first minister?

Humza Yousaf, Scotland’s first minister has recently stepped down. His successor, John Swinney, faces a number of economic challenges related to growth, an ageing population, regional inequality and the transition to net zero.

The next leader of the Scottish National Party (SNP) – and consequently the new first minister of Scotland – has just been appointed. John Swinney, the successor to Humza Yousaf, will face a number of pressing policy challenges across areas of devolved responsibility.

Here, we sketch out what they are and the broader context for policy-making.

Growing the economy

Overall economic growth in Scotland has been weak since the global financial crisis of 2007-09. But a key difference with the rest of the UK has been much slower population growth: on a per capita basis, GDP has grown by more in Scotland than in the UK as a whole.

Figure 1 shows where output per person would have been had Scotland and the UK remained on their pre-2007 trend.

While many of the short- to medium-run economic levers that can shape the economy are not devolved, powers that are key to shaping the economy over the longer term are.

Figure 1: GDP per capita, Scotland and UK

Source: Scottish government, Office for National Statistics

The new first minister and his team will want to consider what more can be done to address some of the longstanding economic challenges facing the Scottish economy.

Growing the tax base

The resources that the new first minister will have available to support their policy priorities are, since the devolution of additional fiscal powers to the Scottish parliament, partly a function of the performance of the Scottish economy.

While the overall budget envelope is still determined by the Barnett formula (the mechanism by which devolved budgets were calculated before fiscal devolution), it is adjusted at the margin to take into account how devolved revenues in Scotland have performed relative to equivalent revenues in the rest of the UK.

A useful way to think about this issue is through what is known as the net tax position. This is the difference between Scottish income tax revenues and what is called an income tax block grant adjustment.

The block grant adjustment is an estimate of the tax revenues forgone by HM Revenue and Customs (HMRC) because of tax devolution. In simple terms, this is an estimate of the tax revenues that HMRC would have collected if UK income tax policies applied in Scotland and the tax base had grown at the same rate as in the rest of the UK.

In the latest forecasts from the Scottish Fiscal Commission (SFC), the net tax position is expected to be positive and growing over the forecast horizon (through to 2028/29). This means that devolved income tax revenues are expected to increase the resources available to the Scottish government relative to what they would have had under the old block grant system.

But as the SFC set out in its December 2023 report, there are a number of reasons to be cautious about this outlook, including the uncertainty around the determinants of income tax revenues in both Scotland and the rest of the UK. This means that there can be big revisions to these estimates as new data become available.

Indeed, relative to its assessment the year before, there have been substantial revisions to the net tax position for this reason. This represents a risk for future budgets as these revisions can generate reconciliations that increase or decrease the resources that the government has to spend on public services in the years ahead.

Figure 2: The net tax position

Source: Scottish Fiscal Commission

Another important factor is what happens to earnings growth between Scotland and the rest of the UK – under the fiscal framework, this has a real effect on the resources available to fund public services in Scotland.

On a practical level, this means comparing the outlook from the SFC for earnings in Scotland with the Office for Budget Responsibility’s (OBR) assessment for the UK. In the latest forecasts, the SFC is forecasting faster earnings growth in Scotland than the OBR is for the UK.

This has the effect that average earnings in Scotland as a percentage of the UK are forecast to increase (see Figure 3). Nevertheless, it is worth cautioning that the SFC notes in its latest report that its ‘judgement [is] that for estimates of the income tax net position from 2025-26 onwards, there is an asymmetric downside risk. If Scottish and UK earnings growth are more closely aligned than the latest SFC and OBR forecasts suggest, the income tax net position will be materially lower’.

In short, if, in reality, earnings growth is closer than these two forecasts suggest, the net tax position will look less favourable for the Scottish government than it currently does.

The current forecasts for average earnings in Scotland and the UK contribute to a more positive net tax position in future years. But it is important to stress that these are forecasts and are subject to updates and revisions as new data emerge.

It is only when we receive data on tax revenues collected that we will get a full picture of the net tax position. Given the operation of the fiscal framework, growing income tax revenues in Scotland is a key priority for any Scottish government.

Figure 3: Scottish average earnings as a share of UK

Source: Scottish Fiscal Commission and Office for Budget Responsibility

The transition to net zero

Climate change remains a major global challenge – and Scotland had set an ambitious target to reduce its greenhouse gas emissions by 75% by 2030. In its December 2022 report, the Committee on Climate Change described meeting this target as ‘extremely challenging’ and made clear that Scotland was set to miss it unless urgent action was taken (see Figure 4).

In its latest report, published in March 2024, the Committee on Climate Change made clear that: ‘the acceleration required in emissions reduction to meet the 2030 target is now beyond what is credible’. The Scottish government announced in April that it was dropping its 2030 target while retaining its goal of being ‘net-zero’ by 2045.

A major challenge for the new first minister will be how to deliver on these commitments. This means developing a credible and deliverable plan to tackle emissions across areas of devolved responsibility, including in agriculture, buildings, transport and land use.

Figure 4: Scotland’s emissions and targets

Source: Committee on Climate Change

At the same time as an energy transition takes place in the whole economy, there is also an economic transition required for the North East of Scotland, which has relied on and supported oil and gas activity in the North Sea for decades.

Having grown far faster than the Scottish economy between 2005 and 2014, the challenges in global oil and gas markets have led to a collapse in economic activity in the region since 2014 (see Figure 5).

Tackling climate change has to occur alongside supporting an economic transition of the North East. Otherwise, there is a risk that some of the mistakes of previous periods of deindustrialisation may be repeated.

Figure 5: GDP, chained volume measures (1998 = 100)

Source: Office for National Statistics (ONS), HMRC

Demographic pressures

Like many advanced economies, Scotland’s population is getting older, and this ageing is expected to increase over the coming decades.

This raises a series of challenges for the Scottish government. These include the effect on its own budget revenues – having fewer working age individuals implies a reduction in income from taxes – as well as on the design and delivery of public services, as an ageing population is likely to increase spending on heath and social care.

Figure 6: Scotland’s changing population

Source: National Records for Scotland

There is also a notable rural dimension to population ageing, with the population of rural areas already older than urban areas. This represents a significant challenge for rural economies and is putting additional pressure on public service delivery in these parts of Scotland.

Regional inequalities

Regional inequalities have been a persistent focus of successive Scottish governments since devolution, most recently articulated in terms of ‘regional inclusive growth’. Despite this policy attention, regional differences in economic experience have persisted and, in some cases, worsened.

One way to think about these regional variations is by examining the evolution of total pay in different parts of the nation – in contrast to looking at average or median pay for people in these areas. This enables us to think more about how the overall size of the local economy is changing.

Figure 7 shows total payroll in each of the NUTS3 regions of Scotland – generally equivalent to council areas – since 2014. While payroll income is only one element of total income, it is the most common form of income and it illustrates the diversity of economic performance across Scotland.

Figure 7: Aggregate pay growth by NUTS3 regions

Source: Office for National Statistics, HMRC real-time information

The prosperity of Edinburgh, East Lothian and Midlothian has increased far faster than it has in, say, the city of Aberdeen and Aberdeenshire over this period.

While there are other dimensions of prosperity that are important, the differences on this measure are notable and relate directly to economic conditions in these areas. As highlighted in Figure 7, some regional inequalities across Scotland are expanding.

Delivery, delivery, delivery

There are several policy areas where challenges exist, not because of a lack of (good) ideas or a lack of will, but because of weaknesses in policy delivery. This includes progress to deliver net zero, discussed earlier, but also closing the attainment gap – the difference in educational performance between children in the most deprived communities compared with their peers in the least deprived areas – and delivering ‘the promise‘ to children and young people who have been in care.

Even relatively straightforward projects, such as making the A9 between Inverness and Perth a dual carriageway, have not been delivered. This is now expected to be completed by 2035, ten years after the initial target date.

There have also been persistent challenges around replacement ferries to link Scottish island communities to the mainland. These services are vital to the islands’ local economies. Of the two new ferries that have been commissioned, the first is undergoing sea trials at the moment, with the hope that it will finally enter service this summer.

This is despite the first steel being cut on this vessel (which will service the route between Arran and the mainland) in 2017. In addition to the ferries being over six years behind schedule, they are also expected to cost three to four times the original amount.

The outgoing administration shelved a number of contentious policies that were in Humza Yousaf’s inbox when he became first minister. These included the deposit return scheme, a ban on alcohol advertising and plans for highly protected marine areas.

In an attempt to reset relations with the business community, some members of which had been critical of these policies, there was also a ‘new deal for business’’ announced under the outgoing first minister. Time will tell what happens to this initiative, and any broader reset in relations with the business community.

Conclusion

There is no shortage of policy issues facing Scotland’s next first minister. But it is unlikely that there will be a radical policy overhaul once the new team takes office. No doubt there will be new measures, but the broad policy stance is expected to remain similar.

The exact shape of any policy agenda will become clear in the coming weeks, starting with any announcement about resuming or not working closely with the Scottish Green Party (formally and in government as they were until a few weeks ago, or informally and outside government).

There is significant scope for the new first minister to support a renewal of activity and action in economic policy and beyond. Tackling some of the longer-term issues set out in this article would be a useful starting point.