Economy, Energy and Tourism Committee, 25 Jun 2008

Meeting date: Wednesday, June 25, 2008

Official Report 116KB pdf

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Research

Item 3 is consideration of a paper that SPICe has prepared for us on the overall economic situation, especially the impact of the credit crunch on the Scottish economy. Jim Dewar from SPICe is here. Good morning, Mr Dewar. I invite you to provide us with an introductory overview of your paper before answering questions from colleagues.

I will make a few brief points. The media have picked up on our conclusion that the evidence to date suggests that the impact of the credit crunch on the Scottish economy has been mixed. In my view, forecasting is a bit of a mug's game. All the resources that are available to Governments, banks and consultants failed to predict the timing or scale of the credit crunch or the rise in commodity prices that has taken place, so I will not second-guess what those organisations have done.

I offer members some updates on and slight modifications of the paper's contents. According to the latest information in the Case-Shiller home price index, which appeared yesterday, American house prices continue to fall. They are now down by 17 per cent in money terms and 21 per cent in real terms from the peak in the summer of 2006. In the paper, we say that house building in Scotland has not been particularly responsive to the rise in house prices. It may not be responsive when house prices rise, but it can be quite responsive when they fall—there is some evidence of decline in house building. I am happy to answer questions from members.

Would you like to comment on the proposition that in recent years the whole United Kingdom economy has been fuelled by house price inflation, that any change in the economy as a whole will have an impact on Scotland, and that it is a matter of judging what the impact will be?

It is undoubtedly the case that the UK economy has been buoyant, but the phenomenon has been fairly global, rather than confined to the UK. However, house price inflation has been a feature more of the UK and America—the Anglo-Saxon economies—than of European economies. It is not the sole factor, but there is no doubt that, because of the wealth effect that people have felt from it, they have been happy to incur debts and to buy big cars and replacement furniture. There is evidence that they are now tightening their belts. However, every time we think that that is happening, lo and behold, retail sales hold up.

That is interesting.

I have a specific question about the construction industry. As you know, I chair the cross-party group in the Parliament on construction. Any reduction in house building will have an impact on the number of people who are employed in the industry. How will that affect the construction industry as a whole, given that major projects such as the Commonwealth games and the new Forth crossing will—I hope—come on stream? We have a commitment to social housing, but there are skills shortages.

A problem for the construction industry is that it can be cyclical. Projects are cancelled when there is the prospect of a downturn in the economy. However, major public sector infrastructure projects are coming along in Scotland, which I hope means that fair demand for construction workers will be maintained.

There are many reports of workers in the house building sector being laid off. Not long ago, people were expressing concern about where we would find the people who would carry out the work that is needed for the Olympic games, so some pressure should be relieved in that regard. When the cost of future projects has been considered, it is interesting that assumptions about inflation in the construction industry have been quite high. Inflation of the order of 6 per cent has been assumed, although general price inflation is about 2 or 3 per cent. There might also be a reduction in inflationary pressure.

I am concerned about training and modern apprenticeships, particularly in areas in which there are skills shortages. If people are laying off staff, will there be an impact on the number of trainees, or will numbers remain stable?

I do not know enough about the sector to be able to give an informed answer, but I think that there is bound to be some effect. Even if people are not laid off in the middle of a training course, the number of new places that are offered will decline.

Many house builders, certainly in the Highlands, have tended to concentrate on the top end of the market and build large houses, because they can make a greater profit if they do that. Is there any indication that the credit crunch will have a greater effect on such builders and encourage them to build houses in the middle or bottom of the range?

I have not seen statistics on such matters, but my impression from anecdotal evidence is that many of the big houses that are built in rural areas are built by small-scale builders, rather than the likes of Barratt. Such builders tend to keep going—if perhaps not quite as quickly. If the owner of a small enterprise is to make a living, he must carry on, even though he might not make as great a profit as he used to make. I do not think that small builders will scale back their operations to the extent to which some of the larger firms will.

Many house builders in the north build four-bedroom houses that sell for £250,000 or £300,000. What will be the impact on such builders?

There is bound to be an impact, but I would have thought that it is still quite profitable to build such houses, because the construction cost is still substantially less than the selling price. That is what makes it profitable to get planning permission to build on a site. The price of the land can come down a long way before people will say, "It's not worth building a house yet."

I propose that we take evidence on the matter in the autumn. In fairness to Jim Dewar, I should say that we have asked him about a number of issues on which he cannot give an immediate answer. It might be useful to hear from a panel of witnesses from the house building sector and other interested parties, such as economic bodies.

The briefing paper was excellent and well put together. I know that Jim Dewar thinks that forecasting is a mug's game, but will he elaborate on the buy-to-let market? You say in the paper that it is difficult to forecast what will happen, but you describe factors that will

"combine to make buy to let investors more vulnerable to falls in house prices."

In Glasgow, there has been a lot of speculation in the buy-to-let market. How might large-scale developments be affected, such as Glasgow harbour, where there was much speculation?

Judging by what has happened in some cities in England, particularly Leeds, where a surplus of inner-city flats seems to have been built on spec with the buy-to-let market in mind, I suspect that Glasgow and Edinburgh are not totally immune to that. On the other hand, a report in The Times today said that quite a lot of buy-to-let owners are quite comfortable and are not being forced to sell. Rents are going up and they can afford to hang on to their properties. There is no suggestion that there is a huge amount of distress selling. The situation is not like it was in the early 1990s.

So, based on the information that you have just now, you do not anticipate that the buy-to-let market in Scotland will be affected in quite the same way as the market south of the border.

I confess that I am not enough of an expert to say authoritatively what will happen, but the pattern seems to be that Scotland is not as vulnerable as the rest of the UK. To the extent that things change in Scotland, they tend to lag behind, so people can anticipate what will happen.

David Whitton will be asking next whether Germany is going to beat Turkey tonight.

I thought that the paper was useful and helpful. Opinions vary, but most people seem to think that the effects of the credit crunch could last for a while—some think that it could be 12 to 18 months—and positions will change over time. Some of the information that is captured in the SPICe paper will be captured in SPICe's quarterly economic indicators report. Is there a way of incorporating some of the other movements that happen into that paper or into something different? It would be good for the committee to get updates as they happen.

As we did the paper, it occurred to me that it contains things that we could usefully include in our economic indicators quarterly briefing, and we will do that.

That was a good suggestion.

I have a couple of queries on the house price and rental income figures that you have uncovered. Price growth in Aberdeen and the north-east is running at double that in the rest of Scotland. I assume that you take that to be a reflection of the different economic sectors in the area.

Yes.

I was struck particularly by the fact that Perthshire and Stirling, an elderly, prosperous and growing part of the economy, has a very low rate of house price growth compared with that of the north-east. Is there any particular explanation for that?

There is a ripple effect in house price rises. It tends to start in the south-east of England and spread out to the rest of the country. Edinburgh has a similar role in Scotland. If you were to look at the figures from a few years ago, they would show that Edinburgh had the fastest rate of growth, followed by Fife, Stirling and Perth, and then by the further parts of Scotland.

Maybe too much should not be read into one year's figures for annual change.

Sure. The other thing that struck me was the sharp increase in rental income from properties in Aberdeen compared with Edinburgh and Glasgow. Has any feature of that caught your attention?

The fact that oil is $130 a barrel must be having an impact.

That is a fair comment.

I had a conversation with Bill Keegan of The Observer in October 2006, during which he said of economic peril, "You ain't seen nothin' yet." He was expecting a major bankruptcy in the banking sector, which we have now seen with Northern Rock. Going by what we see in today's papers, I think that there might be more to come. Does the closure of such a large sector, which provided huge profits for years, not suggest that, over the next year or two, public works projects could be funded more economically because contractors will not have the comparison of the gains from the housing sector? Could we not do some public works with cheaper financing than has been the case up to now?

I would not disagree with that.

As I said, we will aim to have a hearing on the issue in the autumn, given the interest that the committee has in it. Jim Dewar might reflect on some of the suggestions that colleagues such as Gavin Brown have made this morning about other areas of research. We will try to pull that together for the first or second week back in the autumn and see where we are then. I thank Jim Dewar for his helpful paper.