Economy, Jobs and Fair Work Committee

Meeting date: Tuesday, November 1, 2016

Official Report 584KB pdf

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Economic Impact of Leaving the European Union

Good morning. Agenda item 3 is our round-table discussion on the economic impact of leaving the European Union. I welcome the witnesses and point out that you do not have to press your request-to-speak buttons. If you indicate to me by raising your hand that you would like to come in on a question or to the discussion, I will bring you in and the broadcasting staff will deal with the microphones.

This is a sort of formal yet informal setting—an informal round-table set-up is meant to facilitate discussion between committee members and witnesses. Starting with Graeme Roy on my right, we will go around the table introducing ourselves and indicating the organisation from which we come. Jenny Stewart from KPMG can take the opportunity to explain a small bit about her role in that organisation, as she has been added to the list of witnesses slightly later than the others and has not had the opportunity to put in a written statement.

Thank you very much for the invitation to come along this morning. I am the director of the Fraser of Allander institute at the University of Strathclyde.

I am an economist with a small independent consultancy called 4-Consulting that is based in Kirkcaldy.

I am the chief economist at the Royal Bank of Scotland.

I am chief executive and chief economist at the European Policy Centre, which is an independent Brussels-based think tank. I am also on the Scottish Government’s standing council on Europe.

Good morning. I am the director of a business start-up called GenAnalytics, which focuses on equality and diversity in the workplace.

I am a partner at KPMG. I run our Government business in Scotland and I am part of a group that runs our UK public sector business. As you do not have a paper from me, I will do a quick one-minute introduction.

KPMG took the EU referendum vote very seriously, prepared for both eventualities and, within two days of the vote, appointed a head of Brexit. We have been gathering intelligence from across our very diverse client base and we have been working with clients to help them respond to the Brexit vote. I will pick out some key points that people might want to pick up on later.

First, the immediate impact has not been as severe as was predicted, so I spend a bit of my time explaining to clients why that has not been the case. The quick one-second answer is that there are three bits to the economy: consumer spending, which accounts for 60 per cent; business investment; and whatever the Government and the Bank of England do. In effect, consumer spending has held up; on business investment, instead of thinking, “We will stop until we know more,” generally businesses are thinking, “It is so uncertain and we don’t know what is happening, so we will just carry on as usual”; and the intervention by Mark Carney and the Bank of England to reduce interest rates was pretty helpful.

On Brexit itself, every business will have a different exposure and, given the economic and political uncertainty at the moment, businesses are doing scenario planning—that is what we are doing with businesses. That involves saying, “We don’t know and we can’t possibly predict what it is going to be like, but what kind of broad scenarios are likely to emerge and how will we respond and deal with those?”

The key issues that businesses are picking up on at present include people—namely, businesses’ exposure to EU27 nationals. At KPMG, we knew before the vote exactly how many of our 700 staff are EU27 nationals. We ensured that we contacted those individuals after the vote and reassured them of their value to the company as individuals. We also set up arrangements to provide advice to them.

Another issue is strategy. With the significant drop in the value of the pound, there is a lot of foreign direct investment coming in and a number of companies have become acquisition targets. Equally, some businesses in the UK are revisiting their acquisition strategy in the light of the drop in the pound.

Also, given the issues around exchange rates, inflation and so on, businesses are reviewing their medium-term financial planning assumptions to see whether they breach their banking covenants in any of the potential scenarios.

The other issue is tariffs. If we end up in a World Trade Organization situation, how is that likely to impact on each particular business, and what are the costs?

Those are the key business issues. Clearly, individual sectors are affected differently and different countries in the EU are making it clear that they have a competitive offer. For example, the automotive sector in Slovakia is stressing its competitiveness—Jaguar Land Rover has just made a big investment there—and Dublin, Frankfurt and Luxembourg are making a play for financial services institutions.

Regarding sectoral issues, specific sectors such as higher education, agriculture and financial services are affected, but for most businesses it is really about what will happen to the economy.

My last point is about what this all means for public policy. In Scotland, public spending accounts for about 40 per cent of GDP, the public sector directly employs about 20 per cent of the workforce and even more people are indirectly reliant on the sector. What happens on tax and spending will have a big impact on the economy, and the fiscal framework will need to be reopened in the light of changes to things such as the common agricultural policy.

Across our client base, questions are beginning to be asked about future policy in key areas such as agriculture, fishing, research and development, the social fund and regional policy, which are all policy areas that the Scottish Parliament and the Scottish Government will take over post Brexit. People are already starting to think about what the policy choices are and how their individual businesses will be affected if there is a significant policy shift.

I apologise if that was too long by way of introduction, but I hope that it was helpful.

Thank you very much.

I welcome Dr Matias Margulis, who is a lecturer at the University of Stirling—thank you for joining us. We have a round-table format today. Members will ask questions and if you want to come in on a discussion topic, simply indicate by raising your hands—sorry, not both hands; one hand will do. Once that is noted, I will seek to bring you into the discussion.

Thank you. My apologies for being late.

Not at all.

I will start with a question specifically for Richard Marsh, from 4-Consulting, who has submitted a paper to us on the contribution of EU citizens to Scotland’s economy and society. As the paper says, it gives a snapshot rather than setting out what may or will happen, because it does not address the way in which policy changes will affect what people do or do not do.

On page 2, you say:

“It is difficult to measure the number of EU citizens living in Scotland and their social and economic contribution.”

I have a few questions about the numbers. In paragraph 1.5 on page 2—that is by the numbering in our paper 5, although I am sure that you will be familiar with your own paragraphs—you say:

“There are around 209,000 people who were born in EU28 countries ... accounting for around 4% of Scotland’s total population.”

The First Minister has talked about 173,000 EU nationals living in Scotland. Can you clarify the difference between those two figures?

Absolutely. As you have kindly pointed out, it is actually quite difficult to measure even the number of such people. One of the big differences, which we set out in our submission, is between people who were born in other EU countries and people who are citizens of those countries. We refer to a paper from the Office for National Statistics that neatly summarises that. The ONS thinks that around 16 per cent of people across the UK who are from other EU countries have actually become UK citizens. That would account for some of the difference between the number that the First Minister cited and the number in our submission.

The other thing—

Sorry to stop you, but 83 per cent of 209,000 is roughly 173,000.

I was trying to do the maths in my head, but that is roughly about right.

Does that explain the discrepancy between the figure in your report of 209,000 and the First Minister’s figure?

It might. I am at pains to say that the figure that we have given is from a survey of a very small part of the overall population. All the figures in our report are estimates, and there is a margin of error in them of plus or minus a few thousand, or possibly tens of thousands.

Am I correct in thinking that your purpose in the paper is to show the contribution that EU citizens make to the Scottish economy?

Yes. I originally submitted the paper to the then European and External Relations Committee and I was asked to pass on a slightly updated version to this committee. The paper’s aim was to answer the two specific questions in the call for evidence from the European and External Relations Committee, to show the economic and social contribution of EU workers.

11:15  

You will be aware that EU citizenship is not based on where a person is born. A person does not necessarily possess the nationality of the country in which they were born, and the European Union framework is based on rights for European Union citizens. Therefore, a European Union citizen is such a citizen because they are a national of a member state of the European Union.

In our report, we have made it fairly clear that we are looking at people who were born in EU countries. We have not really gone into the issue of citizenship. The labour force survey includes some questions that allow us to interrogate whether people would classify themselves as a European citizen. However, it is a self-response survey, so we rely on people providing accurate information.

It does not necessarily give us an indication of the number of people who have a right to be here on the basis of their European Union citizenship.

No, absolutely not. The survey looks purely at the number of people who were born in EU countries outside the UK.

Under the common travel agreement, would some EU citizens who were not born in the United Kingdom, such as Irish citizens, have a right to live and work in the United Kingdom that was unrelated to their EU citizenship?

You are pressing me on an area in which I am not an expert.

I talked about EU27 nationals because we recognise that the Irish would have a different status.

The status of Irish citizens is unaffected by whether or not the United Kingdom is in the EU, because they have rights under the common travel agreement that pre-date European Union rights.

That is our understanding.

Did you look at the number of Irish citizens who are living and working in Scotland who, on that level, would be unaffected by the United Kingdom leaving the European Union?

We could do that. I had a quick look at the number of people who were born in Ireland who are living and working in Scotland. The problem is that the sample sizes get quite small when we begin to look at people from individual countries and ask what proportion of those populations are working and how much they get paid. The sample sizes would not allow us to produce credible results.

But if we are talking about the number of European Union citizens who will be affected, in the sense that there is a question about whether they will be allowed to remain here after the UK leaves the EU, you would have to take out the Irish citizens, because they will not be affected in that way.

If you wanted to look at that population, we could almost certainly take them out and the numbers presented in the report would be lower.

EU citizens who have been in the UK for five years or more have a right to permanent residency in the United Kingdom. What percentage of the people in Scotland to whom you refer in your figures fall into the category of EU citizens who have been resident here for five years and who therefore face no question about whether they have a right to remain when the UK leaves the EU?

The labour force survey is a useful source of information that includes the year in which someone arrived in the UK. We could do analysis and filter out those who have arrived in the past five years. The problem is that that would require a more in-depth piece of research that might take a little longer. We could ask what country a person came from and whether they arrived here in the past five years—that would be entirely doable. If you wanted us to address a policy question instead of taking a snapshot, we could try to amend the data slightly to get closer to answering the question that you wanted to ask.

If the Home Office has figures that suggest that more than 80 per cent of EU nationals living in the UK fall into that category, could that be extrapolated to Scotland in the same way that I think you have extrapolated the 16 per cent and 83 per cent figures from the ONS figures?

If we took the route of using the ONS figures, we would simply ask a slightly different question: “Are you a citizen of another EU country?” We could also take away certain countries, or we could try to cross-tab with the tables and add another dimension, by asking: “Have you arrived in the last five, 10, 20 years?”. All of that is doable.

My understanding is that we have not done that for the purposes of this paper.

No.

I take it, then, that you have not looked at the question of EU nationals who have been resident in the UK for fewer than five years but who have a right to remain because, for example, they have children who were born here and who are British citizens.

We could extend the analysis even further if we chose to do so and ask: “Do you have children who were born here in the UK?”

Also, you have not looked at the question of dual nationality. Someone can be born in a European Union country and have British nationality or be born in Britain and have the nationality of a European Union country. They would be unaffected by the changes.

Yes. We have focused on those born in other countries and we have not touched on citizenship and nationality.

Do I take it from what you are saying that you accept that the paper shows the contribution that people born outwith Scotland in EU countries and who are resident and working here make to the country, but it does not address the question of who would have a right to remain upon the UK leaving the EU?

Absolutely.

Thank you. Let us move on.

I have a quick question that is relevant to your paper. Scotland, similar to western Europe, has an ageing population and we need young workers and people who want to come to this country and put down roots.

Yesterday, I visited a food manufacturing company, which highlighted that 41 per cent of its production staff and some of the office staff were eastern European people who had been there for up to 10 years.

The Home Office might put down an agreement that people have a right to remain, but what will happen in future years when we require a workforce and we still have an ageing population? How will we attract workers if we suddenly have a barrier in place?

Is that question for me?

Yes.

I point you towards the table that we produced that looked, as best we could, at some broad sectors of Scotland’s economy. In manufacturing, the proportion of people employed from other EU countries was slightly higher and the wages paid to those workers was much higher—perhaps there are more full-time workers, or perhaps they are working slightly longer hours or are paid a higher wage rate; we could not go into that. Almost 12 per cent of the wage bill for employees in manufacturing in Scotland is paid to people who were born in other EU countries.

I recognise the situation that you describe; and in manufacturing, it is a particular concern. I do not want this response to sound flippant, but if it is more difficult to recruit people from other EU countries that have traditionally been important sources of labour, it will become more difficult to find the workers that are needed.

Gil Paterson wants to come in on this subject. I suggest that we open the discussion out; I do not want Richard to be put on the spot on his own.

My experience is in the automotive industry in Scotland, not the UK—I am not talking about big plants manufacturing cars in England. The number of EU nationals in that industry now in Scotland is quite substantial and they are very highly qualified.

My question also relates to the private and public parts of the health sector. What is the panel’s view on the long-term future economic situation for Scotland if part of the workforce is removed? That is about the long-term issue, rather than the immediate issue of the five-year threshold, which might be removed at any time by the Government.

You start to allude to one of the key issues and challenges in thinking about what the future might be in a world where Scotland and the UK are outside the European Union. The key thing is to hold everything else constant and assume that nothing else changes. We know that we have an ageing population in Scotland and that most academic studies show that attracting skilled migrants to the country is good for the long-term health of the economy. We then start to get into questions about what we do to respond to that. If everything else remains equal, Brexit gives us a headwind into the future. The institute encourages the committee and policy makers to start to think about what you might do in domestic policy and in the future negotiations on the terms of Brexit to tackle what we know is a genuine long-term challenge that Brexit will not help with.

To pursue the point that Graeme Roy has just made, let us assume for a moment that, at some point, the existing arrangements that allow people to move freely come to an end and that migration falls very sharply from current and recent levels to much lower levels. We know that, as the Fraser of Allander institute’s work points to, that will mean slower growth in the Scottish economy, other things being equal. That points us to a question about what other measures we have at our disposal and what other things we could do in a circumstance where the labour supply becomes constrained.

I would turn quickly to the fact that, in Scotland, a very large proportion of the working-age population is still outside the job market. By all means focus on the actions that you can take to try to secure a good deal on the free movement of people, but it is at least as important to try to draw more people back into the job market, because that is in a sense a form of internal migration that you could think about drawing on.

I am looking at the long term, but there might be quite a sharp cut-off. How do we square that circle? How long does it take to train people in those highly skilled jobs and how will that impact on the economy?

I will reach the limit of my knowledge on the issue quite quickly, but I think that the answer is that it depends hugely on what the occupations are. It will be much easier and quicker to do the training that is required for some jobs than it is for others. My guess—it is no more than that—is that, for some automotive trades, that might take a considerable period, whereas it could be done more quickly for other industries and occupations. If we have a cliff-edge reduction in labour supply, that would mean a wrenching adjustment for a lot of employers and it would push up labour costs sharply.

I do not know whether anyone else has an opinion. I referred to the automotive industry, but other people might be more familiar with the health service and the impact on it—it is just that I know all about the motor industry, I am sorry to say.

Gillian Martin wants to come in with a question, and then I will come to Jenny Stewart.

We have heard reports of various dispensations or calls for dispensation in relation to the potential effects of Brexit. There has been an agreement with Nissan and calls for the City of London to be excluded from certain implications of Brexit. In particular, there has been a call for access to the European single market. I would be interested to hear people’s views on whether certain sectors in Scotland should have a similar exemption from some of the implications of Brexit and what that might mean.

11:30  

We will start with Jenny Stewart because she wanted to come in on the previous point. She can answer Gillian Martin’s question as well if she would like. We can then open things up to other guests.

I will leave Gillian Martin’s question to others—I have spoken quite a lot. On the point about the workforce, clearly, we do not know what the immigration policy might be or what constraints or what kind of visa system there might be. That is one issue that will impact on the future economy.

My other point is more of a short-term one about how attractive Britain will be to people thinking about moving here. The pound has dropped quite sharply—we may discuss that later. If people are being paid in pounds and they want to send money back home, it will become less attractive to come to the UK than to go to Germany or France, for example. Equally, it will be an issue for non-EU people coming here. One of our very bright economists was being paid in pounds but still has student loans in the US, so suddenly her costs spiralled. She was thinking about her career anyway and has moved to Australia.

One needs to think about how attractive we will be as a place to move to and the pound is a big issue in that context.

On Gillian Martin’s point about internationalisation and the exporting agenda, as an overview it is probably important to look at the challenges that the Scottish economy faces in terms of our low levels of internationalisation. It would be quite useful for the committee to consider that, as Graeme Roy mentioned, in relation to what the forward projections and policy making should look like for the Scottish economy.

We know the statistics on Scotland’s trade with the EU. How that trade will be impacted by Brexit we do not yet know. Jenny Stewart referred to the WTO and potential tariffs. If we are looking at the future success of Scotland’s economy longer term, we need to be much more open to our businesses exporting beyond the EU. Our exports to Asia remain very low. Recent exports to China were £530 million. Recent exports to India were £228 million. China and India are two of the fastest-growing economies in the world and our export levels to them remain very low.

In our forward policy making, we need to look at Scotland’s export strategy as a whole and ask why over 50 per cent of our exports are still being generated by 50 companies. It would be interesting if the committee could look at how many of those 50 companies are foreign owned and at the risks to the Scottish economy if those businesses decide to leave Scotland, whether or not that is due to Brexit.

That is not answering your specific question on trade agreements. However, it is important to have an overarching look at the current export situation for Scotland and ask why we still have very low levels of exporting among our business base, particularly among our small and medium-sized enterprises business base, which remains the key driver of Scotland’s economy.

To pick up on Gillian Martin’s point about individual sectors, there are probably four ways to look at this. One is to start to think through the different trade-offs that might happen from different trade agreements and the different outcomes from the UK’s exit from the EU. The whole debate about the membership of the European economic area model, the WTO model and so on becomes quite important and the models will have quite unique implications for individual sectors. It is important to understand that. A model where the UK is in the EEA could be quite different for an individual sector from a model where the UK is in the WTO, and understanding the potential implications for individual sectors is quite crucial.

The second way is to broaden that out into asking how different sectors might be impacted by, for example, changes in migration rules. We know that certain sectors of the economy are more dependent on inward migration than other areas are: tourism, the automotive industry—which Gil Paterson mentioned—and the national health service. Therefore, it is important to understand the potential implications for those sectors.

The third way is to move into asking what policy opportunities open up from no longer being part of the European Union. That is much more controversial and takes us much more into the political sphere. However, we know that the Scottish Parliament will get further powers as a result of Brexit and that further elements might even come through the fiscal framework. In which of those areas could the Parliament use policy differently? That might have implications for different sectors as well.

The final way is to broaden that out to ask what policies and strategies the Scottish Government—also the UK Government, but let us focus on the Scottish Government at the moment—is implementing to deliver economic strategy. The delivery of the economic strategy cannot be exactly the same prior to Brexit as afterwards. There will be new challenges and opportunities, so it becomes crucial to reassess the economic strategy when we are no longer part of the European Union. What levers does the Scottish Government have at its disposal at the moment that it can use differently to have an impact on certain sectors?

To come back to Gillian Martin’s general question, aside from considering the headline impact, our analysis and modelling for the Culture, Tourism, Europe and External Relations Committee started to consider what sectors are most exposed to the European Union and can be identified as ones about which we might need to be quite worried or on which we might have to think about our response. It also examined what other sectors might have further opportunities, such as greater scope to move into wider international markets. Our policy response for them might be quite different. It might be less about protecting and more about nurturing and supporting a sector. How can we help such sectors to use the future growth in the global economy to tap into wider markets?

The situation is quite complex. There are quite a lot of factors but they all need to be examined if we are going to have a comprehensive response.

I will shamelessly borrow some research that I did with Fabian Zuleeg a long time ago. The point about what sectors might be involved is interesting. We have had some brilliant work from the Fraser of Allander institute on that.

The single market is much more than just workers and trade. If the committee looks at the Financial Times today, it will see that the biggest company in America is Apple. In the American top 20, there are six companies that were not there 10 or 20 years ago, including Google, Microsoft, Facebook and Amazon. However, there are no software companies in the top 20 for Europe. The single market is bringing together a series of disparate countries and trying to ask how we can have common rules for digital services and signatures; it is bringing all the difficult things together. In the United States, which has a fully integrated single market, that has produced world-beating global companies.

It is good and proper that we think carefully about the Scottish economy as it is and how we can protect the sectors that are thriving now but we must ask what we need to put in place to ensure that some of the smaller, creative, technology-based companies in Scotland that are doing well but which do not yet have the scale can still trade and integrate online with the rest of Europe and the rest of the world.

I will address the so-called special deal for Nissan that has been in the news a lot. We do not have a full picture of the assurances that the UK Government has made to Nissan but one of the suggestions that has been made in the news is that the Government would pursue zero-tariff entry for British automobiles into the EU market post-Brexit. That would make sense on paper, given that EU tariffs on automobiles can be as high as 22 per cent. However, special sectoral deals are not likely to be WTO compliant.

The only way to have that kind of arrangement is under a comprehensive free-trade agreement—in essence, the single market and customs union. Outside such an arrangement, duty-free entry cannot be provided for specific sectors and trade partners. The likelihood of such an option being WTO compliant is very low, so the idea that we can have special sectoral deals with the EU is not likely to fly with international trade.

I want to pick up on Jane Gotts’s point. There are undoubtedly challenges to do with exports, but there are also opportunities. I am struck by an agenda that says, first, that we need to lift exports overall and, secondly, that we do badly in the rest of the world. Given that we know the hierarchy—we export more to the rest of the UK, then comes Europe and then comes the rest of the world—I am curious to know whether Jane Gotts thinks that it makes sense that the Government’s strategy is to expand exports to Europe and not to take on the bigger issue of the rest of the world, where the opportunity lies. Should Europe be the priority or should the Government do something else?

The Scottish Government is to be commended, because its reach in international markets is very good. There is representation in all trading businesses through the UK, but Scotland itself has offices throughout Europe and in Asia and the USA. There was a recent announcement about increasing the Scottish presence in Berlin, which is a good thing, because the German market offers a lot of opportunities for Scotland, particularly given Germany’s strong SME base. Trade between Scotland and Germany that focuses on SMEs is a positive.

The infrastructure is there, but Scottish businesses do not seem to be taking advantage of it to the extent that they should be doing if they are to grow exports. The challenges are to do with not the infrastructure but getting Scottish businesses to internationalise, for a host of reasons, whether we are talking about access to finance or awareness of opportunity. The Scottish Chambers of Commerce did a lot of research and found that some Scottish businesses do not think that their product can be sold overseas. However, businesses that are selling into England or Ireland are, in effect, exporting; it is just about getting a more international mentality.

I can understand that the pressures of day-to-day business are such that it can seem challenging and expensive to do business in overseas markets. However, the more that can be done to allay such concerns, the more positive the result for the economy.

May I push you a little further? Should the priority be to expand in Germany, or should it be to expand in the rest of the world?

It is difficult to give a yes or no answer at this stage. The Scottish Government expanded its offices in India and China in recent years, so it obviously has priorities and plans in relation to the markets. I understand that the Government has expanded its approach into South America. I mentioned the recent announcement about Germany, which I think is a good thing, given the current German economy.

Dr Margulis, do you want to come in on that point? You talked about the car industry and sectoral deals. As you rightly said, we do not know what assurances might have been given. The United Kingdom imports billions of pounds-worth of cars from Germany. If the Japanese continue to build cars in the United Kingdom after we leave the EU, those cars can be sold in the UK. The continued popularity of German cars in the UK might depend on the tariffs that are imposed, so the issue might be more to do with tariffs between the UK and Japan. I am speculating, but perhaps you will comment on that and respond to Jackie Baillie’s question.

11:45  

First, on the point that Jane Gotts made, we need to distinguish between trade promotion and market access. No matter what the scenario is, Brexit will reduce market access for British exports, so we have to look at whatever strategy is chosen in the context of reduced market access. The final option for the nature of Brexit will determine exactly how much market access will be lost. We are talking about the degree of disintegration. That needs to be part of the discussion rather than just trade promotion, which is about the promotion of products. If access to markets is more restrained, the incentives for exporters will change.

In response to the convener’s question, I note that the Nissan cars are British made but are assembled with parts from all over the world. Several factors will influence the export of automobiles, and one will be the tariff rates that are set. Under the WTO option, we would go to most favoured nation tariff rates, which are significantly higher than those that the UK faces at present when it exports to the EU, but there are also rules of origin, so the content of the automobiles will determine the tariff rates.

When we talk about exports and production, we must remember that most things are globally assembled. They are not primarily built here; they are assembled here with parts from everywhere. Where this gets complicated is with the non-tariff barriers—such as rules of origin—that determine the tariffs that will be applied to the exported goods. It is not so much about the EU’s tariff rates with Japan. It is about the terms of the British exit from the EU and its tariff agreements with the EU market, but also with the rest of the world, because those will affect all the inputs and outputs in relation to the automobiles.

I take your point. My question might have been too simplistic. I was thinking more about which cars British people would be buying. If tariffs were introduced on German automobiles, there might be a growing appetite for Japanese cars that are built in Britain, which might deal with the issue.

Perhaps we can move on. Gil Paterson wants to come in on some of the points that have been made. After him, Andy Wightman wants to come in, and I will then bring in some of our guests who have indicated that they would like to comment.

I hope that you will indulge me if I comment quickly on the previous subject, convener. I understand that the tariff for automobile parts is substantially lower than that for the finished articles. That is a worldwide phenomenon.

My main question is about the statistics on exports. There is a view that a substantial amount of Scottish exports are recorded as English exports because they leave from English ports. Is that the case or is it imaginary? As I said last week, one of the problems that the committee has is the lack of reliable statistics that are peculiar to Scotland. It seems that, often, such statistics do not exist and we rely on people such as those who are sitting round the table this morning to produce information. Businesses provide information to the Government, but information never comes back that is peculiar to Scotland.

Dr Margulis, do you want to comment on that? I will then bring in Dr Zuleeg.

It is an astute observation. One of the problems is that British statistics are national and they are not broken down internally, which makes it difficult to know the extent of the Scottish economy. Most of the statistics that I see are based on surveys, so they are to some extent limited data.

The committee and the Government should be thinking about the fact that there are not great Scottish statistics. What kind of data do we require in order to make decisions? I know from my former experience as a trade negotiator that we cannot decide on appropriate strategies unless we have a hard picture of what our economy looks like, which is currently missing for Scotland. It is a significant information gap.

I will pick up on a couple of the points that have been made.

It is clear that there is still a significant amount of uncertainty about timing, transition and the final outcome. It is also clear that the harder and the quicker Brexit is, the higher the costs will be. The key question is whether the UK continues to be in the single market, which is qualitatively different from negotiated access to the single market. It is a binary choice. The single market is much more than a free-trade agreement.

If there is a free-trade agreement, rather than membership of the single market, it will depend on when that is negotiated and it is likely to be way into the future. We are not talking about having a free-trade agreement on exit; we are talking about having one at some undefined point in the future.

There are a lot of questions, including what will happen with the UK and the WTO. The UK does not have a WTO schedule and it will have to negotiate one—again, there is the question of transition arrangements. All of that will impose costs: short-run costs, medium-run costs and long-term dynamic costs—which is where the really significant costs will come in.

There are some considerations about whether there can be special deals. If the UK leaves the single market, I think that it is highly unlikely that any part of the UK will get a special deal to remain in the single market. The big question with special deals is whose gift they are in. Who will be the one to decide on those special deals?

With international trade, there is a game of negotiation that involves give and take. The big question is always what the UK Government will give. What will be on the table to rescue some of the special provisions that there are? It should not be forgotten—it has already been mentioned—that that takes place within a framework that has already been set. WTO rules will prescribe certain things for the UK. For example, it is quite difficult to see how some agricultural subsidies or preferential trade deals will work under WTO rules.

It is not just the relationship between the EU and the UK that will change fundamentally, but the relationship between the UK and the rest of the world. Should Scotland aim for the rest of the world, rather than for the rest of the EU? It is about both, rather than either. It is about taking into account the uncertainty that will exist under WTO rules with the rest of the world. There is also an economic proximity factor: the closer a country is, the more you trade with it. Generally, that holds true regardless of the institutional arrangements. In the Nissan case, we do not know what has been promised, but the key thing is that we should not assume that UK car makers produce for the UK market. UK car makers produce for the European market, so it matters a lot whether there are tariffs for cars that are exported from the UK to the continent. That will also determine car makers’ long-term decisions about whether to continue to invest here. There are possibilities for trying to mitigate some of that, but those possibilities are costly—state aid, for example—and again we come back to the question of what is WTO compatible and what is not.

Following on from discussions about special deals and so on, I note from 4-Consulting’s paper that Edinburgh’s economy is reliant on financial services to an even greater degree than London and, from a European perspective, it is second only to Luxembourg in that regard. Given that financial services are a key UK export, what are the implications for the Scottish economy—and, in particular, the Edinburgh and Lothians economy—of whatever deal might be reached for financial services? Do financial services have a different profile in Scotland? Are they likely to be more or less impacted by exit from the European Union, or are they the kind of services that would benefit to the same degree as those in the city of London if it secures any special deals on the future of passporting?

Does Stephen Boyle have any comment on that? I am happy for other guests to comment.

I will do my best, convener. I do not carry precise numbers around in my head but, if I recall correctly, exports of Scottish financial services to the rest of the UK are between 10 and 20 times the value of Scottish financial services exports to outside the UK. The UK market matters to Scottish financial services to a considerably greater extent than the non-UK market does.

My expectation is that that is quite different from the position that applies in the City of London, for which the non-UK market is likely to be much more significant than it is for Scotland.

I would not necessarily assume that there will be a special deal for financial services in London. We have to look at what the EU 27 might want out of the negotiations, and there is relatively little incentive to give competitors good access to the market without any kind of give from the UK. If the UK wants to keep passporting for UK financial services, my question is: “What will the give be? What will the UK offer?” It will not be an easy ride.

I want to reinforce Stephen Boyle’s point about the make-up of the financial services sector in Scotland and its links into the UK, which are quite crucial. For example, RBS has largely been a domestic bank, for which service to the rest of the UK is crucial. That is the same with a number of other big financial players in Edinburgh, such as Standard Life, that are very much linked to the rest of the UK market.

I guess there is a second issue there about the companies that are much more open and trading internationally. They create large amounts of GVA and turnover, but in terms of employment the levels are slightly lower than they are in some of the companies that are more focused on the domestic side of things. There is a great distinction between the potential impacts on employment and other measures.

That starts to get into the point that Jackie Baillie was making on what markets we should go for. Fabian Zuleeg is entirely right: we should not forget that, although trade deals and access to the single market are important, proximity is one of the most important things. One of the big focuses for the Scottish Government in future policy rounds should be integration into the rUK market and what it can do to support expansion into it. One of the reasons why Scotland has struggled with all this in the past is about growing small businesses into medium-sized businesses. Access to the local market is quite crucial there.

I return to my point that differences by sector will be crucial. Take a product such as whisky, for example. Yes, the whisky industry exports a lot of goods into the EU, but it exports a lot more globally. That is an example of where there are opportunities to focus on other markets. However, if we take a product such as fresh fish, we see that we cannot export that to Australia. A free-trade deal with Australia is all well and good, but we are not going to export our west coast fish or langoustines over there. That is an important point to think about. The actual results will be determined by individual sectors.

I will pick up on Gil Paterson’s point about data. It is easy to knock the data, which is not perfect and is based on surveys, but the numbers that we have for Scotland are the best that we have. They are national statistics and they are based on questions to companies about where their end markets are and where they are exporting to. Ultimately, that relies on companies knowing where they are exporting to. For the most part, they are pretty accurate at finding out where the final export market is. Where it becomes much more interesting and difficult is where companies are part of a supply chain. They might be involved in an element that is going to the UK and then will be extended over into the EU. That is why our modelling was quite careful to look at the potential shock to not just Scotland but the rest of the UK. If I am a firm in Edinburgh that is producing a good that is part of a supply chain going to a company in Leicester and then into the EU, understanding the supply chain becomes crucial.

We need to think about the potential impacts of Brexit for not just exporters but people in the Scottish economy who are part of a much bigger supply chain into the European Union. That is also quite important.

12:00  

I am trying to make sure that everyone gets in. Gordon MacDonald has a quick question.

I will build on Andy Wightman’s point about the importance of financial services to the Edinburgh economy. Anthony Browne, the chief executive of the British Bankers Association, recently said:

“Many smaller banks plan to start relocations before Christmas; bigger banks are expected to start in the first quarter of next year.”

When Mark Carney was asked about that last week in the House of Lords, he said:

“we are aware of the contingency plans that are in varying stages of readiness at those institutions.”

What would be the impact in Scotland if some of the larger players started to relocate? Is there an opportunity for Scotland if we decide that EU membership should be retained?

Jenny Stewart and Jane Gotts both want to respond; I do not know who is best placed to answer the question that Gordon MacDonald has put into the room. Stephen Boyle may also want to respond.

As others have said, there is a big distinction to draw, because different parts of the financial services sector will be affected differently. Of the 90,000 jobs in Scotland that depend directly on financial services, a large number are probably in retail banking and there is, in effect, no single market in retail banking between us and the EU, so that sector will not be affected. A paper was produced recently at the University of Strathclyde by Owen Kelly, the ex-chief executive of Scottish Financial Enterprise, and by Jeremy Peat, which goes into quite a bit of detail about how the different elements on the investment side might be affected and who is more exposed to the EU or the UK. It might be worth reading that paper.

There are contingency plans for relocation for those that are based in the City of London. I will explain the passporting requirement. We have talked a lot about freedom of movement, but there is also the issue of freedom of capital and being able to invest in other countries. If we come out of the EU and do not get passporting, the financial services institutions will have to set up subsidiaries in the EU and capitalise those subsidiaries in order to continue to provide services. That is a significant issue for them to address, and it impacts on what their ownership structures and so on ought to be.

Potential relocation activities might involve headquarters but might also involve particular groups of staff. Investment banking will be more exposed, so activity might involve considering how many people an institution needs to put in Luxembourg by quarter 1 next year to be ready to deal with the relocation. The issue is slightly more complex than just the relocation of headquarters.

I agree with Graeme Roy that the statistics that the Scottish Government produces on exports are the best that we can access from company information. It is interesting that Scotland’s biggest export market is the USA, despite its distance—we export £4 billion of goods to the United States, which is over £2 billion more than we export to its nearest rival. According to the statistical information, our biggest market in the European Union is Holland, to which we export £1.9 billion of goods. However, we know that a lot of that trade goes through Holland and out through the ports. That goes back to Graeme Roy’s comments about the final destination of our exports.

To look at the potential impact on the Scottish economy, we should if possible get more detail on which companies generate the bulk of those exports. Are exports to the USA primarily determined by USA-owned businesses in Scotland? That information is not necessarily available, but it would be welcome, as it would allow us to understand more the potential risks and opportunities for the Scottish economy.

The food and drink sector has experienced growth of more than 12 per cent in exports to China. Demand is growing for Scottish products that are at the high end of the market, which is another interesting area that should be explored in more detail. How do we take advantage of growing economies and growing wealth in markets throughout the world? We need to consider what niche Scottish products could go out to those markets.

To return to Gordon MacDonald’s point, my first observation is that it is exceptionally rare for headquarters to relocate. Other than in the event of takeovers, it is very rare for headquarters to change where they are. Therefore, I do not expect to see much by way of the movement of headquarters, either in or out.

To be fair, I did not refer to headquarters.

Okay—thank you.

I will come on to the nature of the tussle or the trade-off. You referred to financial services. Depending on the terms of the agreements that are struck, I expect the costs of doing business from the UK to be higher than they are now and barriers to trade to be greater than they are now, which will cause some functions to leave the UK. However, at least two factors are pulling against that. One is that there are substantial agglomeration economies, particularly in London, from which businesses benefit. The fact that businesses are part of a richer labour market and an extensive supply chain means that the costs of going somewhere else are not negligible. That is the trade-off that businesses will be making.

On the point that Jenny Stewart made, if a business decided that it needed to be in a European Union member state to conduct its business, among the options that it would consider would be establishing an operation in that country specifically for that purpose, rather than taking its operation wholesale from London to that country.

Dean Lockhart has a question. Is it on that financial point?

It is on another point.

I will call you in due course, then, because John Mason has been waiting to get in with a new point.

My question is on a different point, although it has been touched on. We have talked about exports quite a lot, but I will go back to Jenny Stewart’s point about the change in the exchange rate, because that has actually happened. It strikes me that a lot of people seem to be relaxed about that. If the exchange rate goes down, does that automatically mean that export levels go up? Can we just sit back and watch whisky exports go up and up?

What really is the impact? Jenny Stewart mentioned people who make remittances to other countries. What happens with foreign investment? Does the change make it more or less likely that people will invest in Britain? Has the pound stopped going down or will the fall continue?

When I was younger, we laughed at Italy and Greece because their currencies were worth thousands to the pound. It strikes me that the exchange rate is important because it reflects the strength of the economy and creates an image round the world. People seem to be surprised that the price of tea is going up, but I have not noticed any tea growing here, so of course the price of tea is going up—I presume that the price of quite a lot of things is going up. Where are we going with that? Is that a factor?

It is clear that the change in the exchange rate and the fall in the pound have been significant. There have been a couple of direct implications of that. I think that people were surprised by the initial fall in the pound; then equities rose, and people did not really understand why the stock market was going up while the pound was falling. That reflected the fact that for a lot of companies—for example, a lot of the oil and gas industry—income is denominated in dollars. A fall in the pound was pretty helpful to them and, as a result, share prices went up.

That meant that, if someone sold a barrel of oil for so many dollars, they automatically got more pounds. They had not actually sold anything more or done anything more.

That is right.

I am with you.

Moreover, there is potentially a positive impact on exports, although we have not seen the data to find out whether that is feeding through significantly. However, it is important.

The other impact relates to inflation, which you touched on. Because we as an economy import an awful lot more than we export, the expectation is that the situation with the exchange rate will feed through to increased inflation. The Bank of England’s inflation report is coming out on Thursday, but the bank has suggested—and others have said—that inflation, which is sitting at about 1 per cent, could go up to 2.5 or 2.6 per cent over 2017 and might even hit 3 per cent in 2018.

The inflationary effect of the drop in the pound might take a while to come through, but it all depends on what the Bank of England does. As its monetary policy remit is to target inflation, it is in a bind; it wants to keep interest rates low, but it also wants to control inflation. That is why the value of the pound is such a fundamental issue not only for the whole economy but for individual businesses.

Do the timescales that you have suggested for the effects to feed through arise partly from the fact that energy companies, supermarkets and so on have bought ahead and can therefore fix the price for a period?

That is partly the case but, for other goods, the effects will be almost instantaneous. We will have to see how all that feeds through.

Stephen Boyle, Dr Zuleeg, Richard Marsh and Dr Margulis all want to come in, so I will take them in that order.

To go back to John Mason’s point about the impact of the exchange rate reduction, I believe that the pound has gone down by about 15 per cent since the referendum and by closer to 20 per cent over the year. There has already been a substantial adjustment in the exchange rate.

Let us assume for a moment that the adjustment is sustained and that there is no recovery. On the face of it, it might represent a substantial gain to exporters, because they could take higher revenue for the same volumes or adjust their prices and take higher profits. However, as Jenny Stewart explained, there is another dimension. Input costs are rising—we have already seen in the UK as a whole a sharp increase in input prices as a consequence of the really quick fall in the exchange rate.

Who wins and who loses in such a context depends on the balance between dependence on export revenues and imported costs. Some sectors such as the drinks industry have limited imported costs but can gain substantial export revenues. More generally, it looks to me that the companies that will gain are those in the service sector, for which imports and inputs are not a big part of what they do but which have some export activity. Because of the nature of supply chains, the losers look predominantly to be those in the manufacturing sector who might be exporting but who also have a substantial amount of imported input content.

There are other winners and losers, too. Jenny Stewart talked about what the average increase in inflation might be. Different households are affected in different ways by the change in the exchange rate. So far, the input cost rises have been greatest in energy, food and clothing, which constitute a higher proportion of the spending of the country’s older and poorer households. Such households are likely to be disproportionately adversely affected.

We might not see changes in, for example, import and export volumes manifest themselves quickly, because businesses hedge their currency risks so that they are protected against movement in the exchange rate for anything up to a year.

12:15  

I will make a couple of points. Export performance depends on many factors. The exchange rate is one factor, but—depending on the sector—it is often not the most important factor. That is easily demonstrated by the experience in Europe. Before we had the euro, a number of countries periodically had competitive devaluations of their currencies, and that did not solve their export problems—certainly not in a sustainable way.

Another important factor is how responsive demand is to price, both abroad and in Britain. If the price changes, will there be a big effect? In general, at least for consumer prices, there tends to be quite inelastic demand, which means that the exchange rate loss will be passed on to consumers in a relatively short time.

It is important to note that volatility itself imposes a cost. The issue is not necessarily whether the pound is high or low; rather, it can be difficult, especially for SMEs, to deal with the costs of a fluctuating currency. Stability has a value in itself. There is still a threat in that regard, because the exchange rate still moves predominantly with events in the political sphere—whenever it is considered that Brexit might be harder, the pound deteriorates further, and whenever people think that there is a chance that the UK or parts of the UK will remain in the single market, there is an improvement.

Much depends on the politics and on the final outcome. If we are truly moving towards a very hard Brexit, I expect the pound to fall even further.

We are in danger of finding that we have several economists in the room who agree with each other.

I will follow up Stephen Boyle’s point. There is some data out there. The Scottish Government’s input-output tables look at the balance between what we import and what we export, so we can look at the winners and losers. I quickly made a list and towards the top are—absolutely as Stephen Boyle said—food and drink sectors, with whisky at the top of the table, because it exports a great deal of its output and uses natural resources in Scotland. It is intuitive that whisky is potentially a big winner.

Towards the bottom of the list are sectors to do with energy, as Stephen Boyle said. In addition, sectors such as health and public administration make significant purchases of specialist equipment and plant from outside the UK, and such sectors export very little, because they are public services.

It is quite difficult to say whether Scotland is a winner or a loser, but I note from the stats that there are significant winners in specific sectors of Scotland’s economy and that some sectors have to source things from outside the UK—they have little choice about that, as Fabian Zuleeg said, because adjusting the supply chains would require fairly significant changes in the economies of Scotland and the UK.

Much of what I wanted to say has been said. The issue reiterates the importance of having a better understanding of where Scotland fits in global supply chains. We cannot really understand how the change in the currency will affect exports until we know what the global supply chains look like and understand how those changes might play out within sectors.

Do any of our expert witnesses have examples of existing companies that are making contingency plans? Jenny Stewart has mentioned companies having to act as early as quarter 1 next year and Fabian Zuleeg talked about the potential for disinvestment over time. Jane Gotts spoke about the extent to which some of the commanding heights of the Scottish economy are now foreign owned, which one would expect potentially to lead to a branch plant approach and possible retrenchment.

Does that make it even more compelling that we have an industrial strategy that looks at how to plug the gap in medium-sized enterprises, develop the indigenous industrial base and become less reliant on foreign direct investment as a way of transforming the economy?

It is very difficult to say when the disinvestment will happen. I would be astonished if, at least among larger companies, there is no contingency planning. It would be a failure towards their shareholders if they were not doing some contingency planning at the moment. Whether that means that they will plan to leave is a different question.

In the long run, we will see an effect on investment. There will be more reliance on indigenous growth. How that can best be promoted is a big question. Both technically and from an economic perspective, the kind of industrial strategies that we have seen in some countries have not worked particularly well in growing medium-sized companies. Also, it is generally the case that the international market is very important for medium-sized companies; they are not just oriented towards the national market. If one looks at successful countries such as Germany, their medium-sized businesses are very international. The question is how one can internationalise those kinds of company.

On top of that, a big question is what kind of industrial strategy will even be possible, within both the UK framework and the WTO framework. There are big questions about what kind of instruments could be used and what the response would then be from other countries, which will react to the kind of industrial strategy that Scotland or the UK puts into place.

The question is too difficult to answer, but it is important to have a blend. Scotland has been phenomenally successful in recent years in attracting foreign investment. Scotland has the best foreign investment in the UK outside London in terms of attracting overseas businesses. It should be a priority to maintain that.

At the same time, we need to look at where the potential gaps in our economy are and where there are opportunities for indigenous businesses. On John Kemp’s point about where the opportunities are, we have not talked much about the tourism sector—we mentioned it briefly—but, with the drop in the pound, there is huge potential to grow our tourism sector. Of course, it is a double-edged sword, because we know that there are a lot of European citizens working in the sector in Scotland; therefore, how can we manage a potential boom in tourism, because of a falling pound, at the same time as making sure that we have enough people to service the industry? Those are not questions that we can answer now, but they all have to be on the table for consideration.

Professor Roy, in your submission, you rightly challenged policy makers to examine the policy opportunities that may open up as a result of Brexit. I have two questions for you. First, am I right in thinking that the report that you prepared for the then European and External Relations Committee a couple of months ago looked at only three Brexit scenarios—the Norway model, the Swiss model and the World Trade Organization model—and that it did not take into account the potential upside of new trade deals with countries such as India, China and the US?

We have heard about the potential opportunities for exports that exist in different sectors across the Scottish economy. It is incumbent on policy makers to address not just the challenges but the opportunities that arise from Brexit. What steps do you recommend that the committee takes to explore those opportunities?

Your first question was about the modelling. The modelling looks at the potential impacts of different trade models for Scotland and the UK in a post-Brexit world. It isolates the impact of Brexit—in other words, it considers the implications of having less trade integration with our largest international market.

You are entirely right. We then get into questions such as what the policy responses might be and what other things could flow from that. We do not model that because there is no clarity about what Brexit will be, let alone what policy opportunities might come from it.

In addition, we need to consider the issue in context. It is entirely possible that we could have trade deals with countries outside the European Union, but we must put those numbers into context. There are ways in which trade with those countries could be improved. Let us take the example of Australia, because there have been hints about potential trade deals with Australia. If we were to increase our exports to Australia by a third, those exports would equate to less than 2 per cent of our total exports to the EU. It is true that we could expand trade and get trade deals with other countries, but we must put that in context and take account of the relative size of that expansion.

As has been touched on, there is quite a difference between a single market and free-trade deals or arrangements with other countries. A single market provides a level playing field for trade. It means that there are rules to stop exploitation of workers and to harmonise product regulation and so on. It would be possible to enter into a trade deal with China, for example, but what would be the rights of the Chinese workers on the goods that were being exported to the UK? Would we want to enter into a trade deal with China? We have seen all the challenges around the transatlantic trade and investment partnership and the concerns that people have had about American companies seeking to provide public services.

Dean Lockhart’s point is entirely correct: we are encouraging people to start to consider the policy opportunities—because we know that Brexit will create headwinds to growth rather than be growth enhancing and consideration needs to be given to how to mitigate the worst of the effects and to the opportunities that exist to do things differently. We need to start to get creative and to think about what policy levers the Scottish Government has to do things differently and about the policy opportunities that might come from the greater devolution that might come down the line. For example, in the past we have been prevented from having powers over VAT and excise duties because of EU regulations, but what could happen if those powers were devolved to the Scottish Parliament? What might we do differently if we had a greater suite of fiscal powers? What might we do with the powers in agriculture and so on?

However, it is necessary to put the opportunities in context. Even with all those opportunities, Brexit will still be a headwind to growth, but if Brexit is happening, we must consider what we should do about changing policy in response.

Earlier this week, in your blog, you mentioned that we should not let Brexit overcloud everything else and that some of the challenges that the Scottish economy faces have been there for years. I welcome that. Do you agree that, although Brexit is a possible headwind, there are structural issues with the Scottish economy that have been there for years and which we need to deal with?

I agree with everything in that statement apart from the phrase “a possible headwind”—I would probably say that Brexit is a headwind.

You are entirely right to say that we have had structural challenges in the Scottish economy around internationalisation and the growth of small and medium-sized companies. Brexit will not help us to address those, but it is a potential opportunity to take a fresh look at, and to make a frank assessment of how we start to address, the structural challenges that we face.

12:30  

Before I bring in some of our guests, I will give Ash Denham an opportunity to ask a question about the short-term implications rather than the long-term implications, which the previous question addressed.

My question may have been partially covered, but I want to highlight a couple of points. The Fraser of Allander institute has focused on short-term considerations, and we will all no doubt have seen newspaper headlines in the past few weeks crowing about the fact that the predictions of economic doom that were forecast have not quite come to pass. We have touched on the sharp fall in sterling, which would probably fit into that category.

The Fraser of Allander institute states:

“we should be wary of expecting to see any immediate changes.”

The full impact of Brexit has perhaps not yet come to pass, but that does not mean that it is not coming. When do you think that we might see some more impacts?

The short-term challenges are really quite complex. If you speak to most economists, you will find that there is relative consensus about the impact of the long-term headwinds of Brexit in relation to the areas that we have discussed such as trade, investment, access to skilled migration and so on.

What happens in the short term is much more complex. As we have heard, businesses tend to wait to see what is happening. In the short run, they tend to be driven very much by issues around day-to-day supply and demand, such as what their orders are like and what is happening to interest rates and the exchange rate—those issues dominate in the short term. A lot of things are happening on the positive side that will help to boost the economy, and a lot of things are happening on the negative side that may turn out to present more difficulties.

If you look at the average forecast for the outlook over the next wee while, you will see that most people said that the economy would be slower in 2016 as a result of Brexit because of the uncertainty. The data that we have had so far has been surprisingly on the upside, although I caution that we have data for only the first three months after the referendum and a lot of the forecasting is based on model data.

However, most economists have predicted that the real challenges will come in 2017 and 2018, when the decisions on investment start to kick in. If a business made the decision to invest in 2016, it is unlikely to throw everything out immediately; it will wait for greater clarity. The issue is what happens with the next decision—for example, a business may cool its expansion plans slightly. One would expect that effects would begin to trickle through next year and the year after.

That is why we forecast that 2017 will be slightly more challenging than 2016 for Scotland. Most independent forecasts, rather than the ones that the Treasury produces, are predicting that 2017 and 2018 will be slightly more challenging than 2016.

The key issue is what happens with inflation, which has already risen to 1 per cent. The Bank of England, in its report in August, referred to the possibility that inflation would rise to 2.4 per cent in 2018. That is when the effect on household consumption will really start to kick in as we move forward.

Stephen Boyle made the point really well about the impact on different types of households, but we have not spoken about the potential impact on the poorest households. We know that, typically, they face the highest increases in food and energy prices and so on, but we need to also think about what might happen in the autumn statement and about the outlook for welfare. We know that there are plans for a number of benefits to be frozen. If inflation rises, potentially that will make the challenges for people on welfare benefits all the more difficult.

A public sector pay award of 1 per cent is challenging, but it still represents a real-terms increase when inflation is 0.5 per cent. However, if inflation rises to 2.5 or 3 per cent, a pay award of 1 per cent suddenly starts to present many more difficulties. In 2017 and 2018, we will start to see the potential challenges coming through not only for investment but for consumption.

Are there specific helpful measures that either the Scottish or UK Government could implement in the short term? For example, the Bank of England has cut interest rates and the Scottish Government has launched its £500 million growth scheme. Do our panellists have any other suggestions?

Perhaps people could answer that question as part of their closing remarks.

We have talked about the short-term impacts not being as significant for business investment as was thought, but there is so much that can still change. As Graeme Roy said, we are looking at reduced improvement next year, so things are changing. The forecasts for 2017 have gradually been shifting upwards a little, as more positive data have been coming through. In the weeks post-Brexit, the consensus was that the UK economy would grow by between 0.3 and 0.5 per cent next year, whereas now the consensus is hovering around 0.7 to 0.8 per cent. If the growth forecasts continue to be relatively positive, that is a good starting point for next year.

I want to go back to Richard Leonard’s point about business investment. I would not want to give the impression that it is suddenly about to fall off a cliff. Businesses will be thinking things through and making contingency plans, but we will need to see what happens, particularly the impact of the autumn statement.

There are some other points that I want to throw in that the committee might want to consider. We have not talked about skills yet. That has been a significant issue in the Scottish economy. We have some significant skills gaps, particularly around construction and technology—we touched on the digital agenda earlier—which may be made worse by Brexit.

The discussion has also not touched on the higher education sector, which will potentially be significantly affected by the freedom of movement issue. As I understand it, something like 16 per cent of staff and 25 per cent of researchers come from other EU countries. The higher education sector is worth considering, because it contributes significantly to the economy.

It is important to emphasise that Brexit has not happened yet and is not scheduled to happen for two and a half years, so the effects that we are seeing are based on what people are anticipating rather than Brexit itself. Its effect will be felt only after Brexit has happened, and then it is the long-term dynamic effect that will be much more important. The interplay between innovation, freedom of movement and foreign direct investment will have a significant, long-term, growth-reducing effect on the UK as a whole.

At the moment, there is still quite a bit of speculation that there will be, for example, parts of the UK that remain in the single market—there have been questions around passporting and so on. If the suggestions on those turn out not to be true, we will see a further effect. As the markets start to anticipate a harder and harder Brexit, the costs will be bigger. That is what we expect.

One of the issues that tends to be neglected in the discussion is the relationship between the UK and the rest of the world—not the UK-EU relationship, but what happens in foreign trade. There is very high uncertainty about what will happen after Brexit, so there is huge potential for damage to trade. Some people are assuming that there will be free-trade agreements with all those places around the world, but although that might be the case, it is quite a big ask to negotiate them, it will take a lot of time and the UK side will require to give up quite a lot in order to secure those trade deals.

If you look at the trade deal that the EU has just concluded with Canada, you see that it is a huge, 2,600-page book, because that is the big difference between being in a single market, where you have a level playing field, and having to negotiate access on every individual point. That is a huge issue on which the UK Government needs to be pressed more. It must say what the contingency plans are for day X—the day after Brexit—because all of the current trade deals and the schedule of the EU will no longer apply.

Dr Margulis, could you and Stephen Boyle address the question of what the Scottish Government can be doing at this stage?

I want to echo how much of a Herculean task it will be for the British Government to renegotiate its trade relationship with not only the EU but the other 50 countries with which the EU has preferential free-trade agreements that the UK currently enjoys. On a safe estimate, we are looking at it taking several decades just to renegotiate the access that the UK currently enjoys.

There is an idea of there being an upside to this, down the road, but that would be decades away, because the reality is that the UK has not negotiated a trade agreement since the late 1970s and has no capacity to negotiate such agreements. The UK has a much smaller economy than the EU and so does not have the same leverage, which means that when it strikes new deals, they are likely to be not as good as the deals that it currently has. Furthermore, nobody is getting in line to sign trade deals with the UK—globally, it is not such an important economy and the UK is not the country that most other countries are lining up to trade with. There must be some realism about where the UK sits in the global picture.

On what the Scottish Government can do, it is important to start a consultation process with stakeholders across sectors to get a better sense of their concerns and to identify the kind of measures that will need to be put in place in the interim to replace the supports and benefits that the UK currently enjoys as part of the EU and that might disappear when it leaves, such as agricultural subsidies and state aid. We cannot assume that we will be able to use the same things going forward. As an interim measure, it is important for the Scottish Government to figure out what kind of mitigation capacity it has.

In a very narrow sense, one thing that we can do is to stop obsessing about Brexit. I say that because what the work of Graeme Roy and his colleagues shows is that, at its heart, Brexit presents a growth challenge: it makes the growth prospects of Scotland’s economy poorer than they otherwise would have been. However, for a long time, we have been on a journey to try to improve Scotland’s rate of growth, and Brexit provides a further, stronger justification for doing so. In practice, that means that when decisions are being made, the Government should continue, at the margin, to change the balance of spending towards investment, which means away from consumption. That is difficult to do, but that investment will pay off in terms of longer-term growth.

On the narrower Brexit-related issues that arise, my judgment is that if we have a fixed pot of money for the purposes of promoting internationalisation, that money will likely be more productively spent on export promotion than on the attraction of foreign direct investment.

Thank you, we will wind up there because we are at the end of the time available and we would not want to be accused of obsessing about Brexit. Thank you to all our guests.

12:44 Meeting continued in private until 12:58.