Disposable Income in Scotland: How Does It Compare? David Bell

Disposable Income in Scotland: How does it compare? David Bell Introduction The OECD has recently been putting its considerable statistical muscle behind collecting consistent measures not only for its member states, but also for the sub-central governments (provinces, regions, territories etc) that make up its members. It has produced a dataset which provides information on household disposable income per capita (HDIPC) for 362 sub-central governments within the OECD, covering 1.2billion inhabitants. This is an important indicator of the ability of households to meet their consumption needs. Household Disposable Income Per Capita (HDIPC) Household disposable income is the amount of money left with a household to spend on goods and services after taxes on income have been deducted and state benefits (e.g. housing benefit, the state pension) added. HDIPC is this measure expressed on a per capita basis. Dividing household disposable income by the average household size to give a per capita measure ensures comparability at the individual level because it corrects for country differences in the average size of a household. The OECD’s estimates of HDIPC therefore provide a useful comparator for the spending power of the average Scot relative to residents in other parts of the OECD. Other comparisons are available. Scottish Government estimates place Scotland 14th in the ranking of GDP per capita among OECD countries. This is based on Scotland being an independent state and therefore receiving a geographically based share of North Sea oil revenues. Disposable income is strongly correlated with GDP and with Gross National Income (GNI)12. But the correlation is by no means perfect. GDP includes elements, such as profits, which have no direct effect on the spending power of households. The linkage to Gross National Income is even more indirect, because, for example, profits generated in Scotland are repatriated to the owners of capital – the ultimate beneficiaries – wherever they are based. Thus, for example, profits generated in the North Sea or in the whisky industry benefit mainly foreign companies who return these profits to their largely foreign shareholders. The direct benefits to Scottish households come from the incomes earned by employees working in these industries and from the taxes levied on their profits or turnover. Both influence HDIPC. Wages increase household income directly, while taxes on oil and whisky may reduce taxes on income and so indirectly boost disposable income. Arguably HDIPC is more relevant to the understanding of the circumstances facing the average Scottish household than is either GDP per capita or GNI per capita. The great advantage of the OECD data on disposable income is that they are collected on the same basis in all of OECD members, allowing comparisons to be made across 300 separate territories. No 1 The Centre for Public Policy for Regions (CPPR) has done useful work on Scotland’s Gross National Income 2 See, for example, Boarini, R., Å. Johansson and M. Mira d'Ercole (2006),“Alternative Measures of Well-Being”, OECD Economics Department Working Papers, No. 476, http://dx.doi.org/10.1787/832614168015 such breakdown exists for either GDP or GNI. Not only is the HDIPC data adjusted to US dollars by applying the appropriate exchange rate, they are further adjusted to take account of differences in purchasing power across countries. Variations in purchasing power are often illustrated by the Big Mac index, which is calculated by the Economist magazine, and which shows how the cost of a Big Mac varies across countries, even after its price has been converted to dollars at the correct exchange rate. Some countries are systematically more expensive than others. Turning now to the estimates of HDIPC, the estimate for Scotland from the most recently available data is $19,365 after adjustment for purchasing power and after adjustment to constant 2005 dollars. However, the absolute amount of disposable income is of less interest than the comparisons that can be drawn between Scotland and other parts of the OECD. So how does Scotland compare? We group the data in four ways for comparison purposes. Specifically, our comparisons are between Scotland and: (1) OECD sub-central governments (2) Sub-central governments in Scandinavia and Ireland (3) OECD member states (4) Other parts of the UK We deal with these in turn. (1) Other OECD Sub-Central Governments Scotland comes 114th out of the 367 sub-central governments for which the OECD has compiled data. This places it at the 69th percentile of the distribution – 69 per cent of the states and territories in OECD countries have lower HDIPC than Scotland on average. Figure 1 shows the household disposable income per capita for all states/regions ordered by size of HDIPC. It shows where Scotland is positioned within this list and also shows its position relative to the overall average for OECD sub-central governments, which is $16,493 per annum. Scottish households have more purchasing power than most other parts of the OECD, but average HDIPC in Scotland is well below that of the most affluent parts of the OECD. Figure 1: Household disposable income per capita for states/territories/regions within the OECD (2) Sub-central governments in Scandinavia and Ireland The OECD includes countries such as Turkey, Mexico and Chile, which are much less developed than Scotland. They do not form part of the set of the usual comparators for Scotland. Given the prominence of other small northern European states in the referendum campaign, a more appropriate comparator group currently may be the Scandinavian states and Ireland. Figure 2 shows HDIPC values for Denmark, Finland, Ireland, Norway and Sweden. Scotland ranks 8th of the 28th areas on this list, being surpassed by several Norwegian regions but only by Stockholm among the other countries: None of the regions of Denmark, Finland or Ireland have as high HDIPC as Scotland. High productivity economies, such as those in Scandinavia may be characterised by relatively high prices3. One way to check this out is to look at the Big Mac index. According to the Economist4, compared with the UK, Big Macs are overvalued by 69 per cent in Norway, 36 per cent in Sweden and 12 per cent in Denmark. Although disposable income in Scotland (and the UK as a whole) may appear relatively low when measured at market exchange rates, the gap narrows (or disappears) when purchasing power is taken into account. For the same reason, almost all US states have higher HDIPC than Scotland: this is one reason why Scotland comes relatively far down the overall ranking of HDIPC within OECD territories – almost all of the 50 US states have higher HDIPC than Scotland. This reflects the USA’s relatively low price level compared with other parts of the OECD. 3 This is known as the Balassa-Samuelson effect. See: http://en.wikipedia.org/wiki/Balassa%E2%80%93Samuelson_effect 4 The Economist Big Mac Index (July 9th 2014) : http://www.economist.com/content/big-mac-index An analogous argument can be used to explain why prices are relatively low in Scotland compared with, say, Scandinavia. Melitz and Ottaviano (2008) 5 suggest that “competition is tougher in larger markets as more firms compete and average prices are lower” (p 7). They also suggest that trade liberalisation increases competition and drives down prices. Scotland is part of a more comprehensive free trade zone than are the Scandinavian countries or Ireland. The EU single market is not yet complete, and its currency arrangements are complex. On the other hand, Scotland’s trade with rUK is facilitated by the absence of any trade barriers and a shared currency. Competition with producers in rUK may keep prices relatively low in Scotland. Norway is outside the EU and therefore its domestic producers are less open to external competition than is the case with EU member states, which may explain its high prices, even within Scandinavia. Figure 2: Household Disposable Income Per Capita for Scandinavia and Ireland Oslo and Akershus Agder and Rogaland Western Norway Stockholm South-Eastern Norway Trøndelag Northern Norway Scotland Hedmark and Oppland Åland Southern and Eastern Helsinki-Uusimaa West Sweden East Middle Sweden Border, Midland and Western South Sweden Småland with Islands Upper Norrland Central Norrland North Middle Sweden Southern Finland Capital (DK) Western Finland Eastern and Northern Finland Zealand Central Jutland Southern Denmark Northern Jutland $0 $5,000 $10,000 $15,000 $20,000 $25,000 Household Disposable Income Per Capita (US$, PPP, 2005 Prices) Next consider how Scottish disposable income per head compares with other countries within the OECD rather than with the OECD regions. Figure 3 shows Scotland would come 10th in this list. This compares favourably with the 14th place which Scotland reaches in terms of GDP per head (adjusted for purchasing power) according to the Scottish Government. Why the discrepancy? Again, it must reflect differences in the share of GDP that finds its way into household spending in different countries. This depends on taxes on income, on benefits and on the size of those parts of GDP that do not help boost household’s spending power. Interestingly, while Sweden, Ireland and Denmark rank higher than Scotland on the GDP per capita measure, while the UK is lower, these rankings are reversed for HDIPC. The UK as a whole has marginally higher HDIPC than Scotland, but lower GDP per head if Scottish GDP includes a 5 Melitz, Marc J., and Gianmarco IP Ottaviano. "Market size, trade, and productivity." The review of economic studies 75.1 (2008): 295-316. geographic share of North Sea oil. This may seem paradoxical, but there is a straightforward explanation. The main way in which North Sea oil affects average spending by Scottish households is through the incomes received by oil workers.

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