What are some of the big policy challenges facing Scotland’s new first minister?

On Monday, Scotland’s new first minister will be announced. Nicola Sturgeon’s successor faces a number of economic challenges related to growth, an ageing population, regional inequality and the transition to net zero.

This week, the new leader of the Scottish National Party (SNP) – and consequently the new first minister of Scotland – will be announced. The chosen successor to Nicola Sturgeon 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

The new first minister and their 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.

We have seen increases in income tax since powers were devolved and these have raised revenues. But the uplift in resources available to the Scottish government has been much less than the increase in the tax burden would suggest.

This year, instead of raising an additional £1,000 million from income tax as the Scottish government intends, the net gain is only around £300 million. The reason for this is that the Scottish tax base has been growing more slowly than that of the UK as a whole.

Figure 2 illustrates the gap that is opening up between the revenues that the policies would have raised had the tax base in Scotland matched the performance in the rest of the UK, relative to what has and is forecast to be raised.

Figure 2: The net tax position

Source: Scottish Fiscal Commission

A key challenge facing the new first minister is that average nominal earnings as a share of the UK have been weaker since 2014 (see Figure 3). Under the fiscal framework, this has a real effect on the resources available to fund public services in Scotland. One reason for the weak growth of incomes is the set of challenges facing the economy of the North East of Scotland as it makes the transition away from oil and gas.

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 has set some ambitious targets to reduce its emissions. But as analysis by the Committee on Climate Change shows, the nation is set to miss these targets unless urgent action is taken (see Figure 4).

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 – 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 this 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 differences 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.

Perhaps the longest-running delivery issue relates to the devolution of social security powers agreed as part of the Scotland Act 2016. While some of these devolved powers have been made fully operational in a devolved context – and implemented through a new agency called Social Security Scotland – a number of them remain in the hands of the UK government with no date set for some to be taken on by the Scottish government.

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, neither is set to enter service until 2024 at the earliest. This is despite the first steel being cut on one of the vessels (which will service the route between Arran and the mainland) in 2017. In addition to the ferries being over five years behind schedule, they are also expected to cost over three times the original amount.

Similarly, we are only a matter of months away from the Scottish government launching its ‘deposit return scheme’ to encourage recycling by levying a 20p deposit fee on every single-use container. This means that a six-pack of soft drinks cans will now require a £1.20 deposit, refundable when the containers are returned. A two-litre bottle of the same soft drink will incur a deposit charge of 20p.

The scheme’s laudable intentions have been somewhat overshadowed by the difficulties in moving the scheme to operation (due later this year). The civil service Gateway Reviews of the scheme have documented these challenges.

The review of May 2022 rated the scheme ‘amber/red’, meaning that ‘the project is in doubt with major risks or issues apparent in a number of key areas’. In the most recent review, it has improved slightly and is now rated 'amber’, indicating that ‘successful delivery appears feasible but significant issues already exist requiring management attention’.

Big concerns remain, including criticism from businesses and industry bodies about the design and feasibility of the scheme. Questions about whether the scheme is compliant with the UK Internal Market Act and whether the scheme needs (and if so, can get) an exemption to operate also persist. Given that the scheme is set to go live with consumers on 16 August 2023, this is an immediate policy issue facing the new first minister.

Conclusion

There is no shortage of policy issues facing whoever is chosen as first minister next week. But it would be naïve to think that there will be a radical policy overhaul once the new team takes office.

No doubt there will be new measures – indeed, some have already been announced by the candidates – but the broad policy stance will remain similar.

On economic policy, it is only a year since the Scottish government published its new National Strategy for Economic Transformation (NSET). It would seem strange to abandon that at this stage, although delivery in this area remains a concern.

But there will be significant scope for the 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.