Whoever becomes Scotland’s new first minister will face no shortage of challenges. Lurking behind many of them lies a common cause: an economy that is not working. 

Data published this week shows that Scotland’s economy shrank by 0.3% in February, leaving the country on the brink of recession. Economic downturns rarely spell good news for voters or politicians. But if the new first minister is to turn Scotland’s economy around, they must look far beyond immediate GDP figures. In reality, Scotland’s economy is facing a profound series of interlinked challenges. Nowhere are the failings of the prevailing economic model more evident than in peoples’ paypackets. 

Although the ‘cost of living’ crisis only started to appear in the headlines following the Covid-19 pandemic, it is anything but new. For the past 15 years Scotland – like the rest of the UK – has experienced an unprecedented squeeze on living standards. As shown in the chart below, today real median weekly earnings for full-time workers (earning after adjusting for inflation) are £10 lower than they were in 2008. This means that, on average, people in Scotland are poorer today than they were 15 years ago. If average weekly earnings had instead grown at their pre-financial crisis trend of 2.2% per year, they would be £286 higher – equating to nearly £15,000 per worker per year. Such a prolonged period of stagnating living standards is unprecedented in modern times.  

How did we get here? The causes of Scotland’s economic malaise are multifaceted. Throughout the 2000s, Scotland’s economy was fuelled by an over-extended financial sector, a lucrative fossil fuel sector, ballooning house prices, and (often debt-fuelled) consumer spending. But each of these proved to be fundamentally unsustainable. 

The spectacular failure of Scotland’s banking giants has rendered the financial services sector a shadow of its former self. North Sea oil and gas is in decline, and extracting every last drop is incompatible with an inhabitable planet. Rising interest rates have brought the UK’s unsustainable housing boom to an abrupt end. And soaring prices and borrowing costs have weighed down on consumer spending. In other words: the economic model that sustained Scotland during the 2000s is broken.

These structural headwinds have been greatly exacerbated by the UK Government’s post-crisis turn towards austerity, which undermined productive capacity, squeezed living standards, and eroded public services and state capacity. Although the Scottish Government has taken steps to mitigate the impact of austerity in areas like welfare, the longstanding damage inflicted on Scotland’s economy and public services has been profound. This in turn was further exacerbated by the Covid-19 pandemic, which triggered the deepest recession on record and caused profound disruption in the labour market. The return of high inflation, fuelled by rising energy, food and fuel prices, has only intensified the squeeze on household budgets.

Despite these challenges, Scotland’s economy undoubtedly has many strengths. But today many of our largest sectors – whisky, oil and gas, financial services, petrochemicals, professional services – are either mature industries with limited prospects for expansion, or facing managed decline. Many are also owned overseas by international investors – a consequence of the Scottish Government’s longstanding drive to attract foreign direct investment (FDI). While attracting high-quality inward investment can be beneficial, relying on it too heavily comes with a cost. 

As Common Weal’s Craig Dalzell has highlighted, Scotland has experienced a net outflow of wealth every year since records began in 1998 – totalling around £277 billion between 1998 and 2021. Of this, £135 billion was extracted to the rest of the UK and £143 billion was extracted to the rest of the world. The only other advanced economies with similar levels of extraction are tax havens like Ireland, Luxembourg and the Cayman Islands. 

But while the Scottish Government boasts about the level of inward investment, the level of actual investment (gross fixed capital formation) remains among the lowest in the OECD, at 18% of GDP. For decades Scotland’s chronically low level of investment was papered over by exuberant consumption and rising asset prices. But if countries don’t invest, their economies can’t thrive in the long-term. Significantly raising domestic investment is therefore not only crucial for raising living standards and productivity – it is also the key to tackling the major challenges the country faces. To meet Scotland’s net zero target, annual low-carbon capital investment will need to increase fivefold – rising from less than £1bn per year today to £5-6bn per year by 2030.

However, in recent weeks Scotland’s aspiration to be a global climate leader experienced a major setback. But while the decision to drop the 2030 net zero target is disappointing, it was not surprising. While ministers showed commendable leadership in setting ambitious targets, they failed to take the decisive action needed to meet statutory targets. Going forward, it is crucial that the Scottish Government doubles down on efforts to decarbonise key sectors of the economy. Delivering net zero is not only a climate imperative – it is also Scotland’s greatest economic opportunity.

With an abundance of natural resources and a highly skilled workforce, Scotland is well placed to prosper from decarbonisation. However, we cannot afford to assume that this will happen automatically. To see why, we just need to look at Scotland’s burgeoning renewable energy sector. Although Scotland has more than doubled its renewable electricity generation over the last decade, this has not translated into large-scale job creation. In 2010 the Scottish Government projected that 28,000 workers would be employed in the offshore wind sector by 2020. However, today only 3,100 workers were employed in the sector – just 11% of the total that was projected. As the Scottish Trades Union Congress (STUC) has highlighted, the number of jobs for every £1m of turnover made by offshore wind companies has fallen dramatically in recent years – falling from 6.1 in 2018 to 0.7 in 2022.

As the Climate Change Committee has shown, the transition to net zero has the potential to create many more new jobs than will be lost. But this is far from guaranteed, and on current trends it looks highly uncertain. If Scotland is to maximise the job-creating opportunities of decarbonisation, the government must take proactive steps to nurture domestic industries, scale up supply chains and reskill and retrain workers. While scaling up nascent green industries is crucial, investing in so-called ‘foundational economy’ sectors such as care, retail, and hospitality is equally important. With many people employed in these industries, often with poor pay and conditions, supporting investment and skills would have a disproportionate impact on Scotland’s economy.

Importantly, Scotland is not just committed to achieving net zero – it is committed to delivering a just transition. This means much more must be done to ensure that the wealth created in Scotland’s economy is more broadly shared. After decades of privatisation and liberalisation, the UK’s economic model has become an engine for redistributing wealth upwards. Spiralling inequality has seen productivity gains captured by high earners and asset owners rather than being widely shared in the form of higher wages. Moreover, much of the wealth accumulated in recent decades has come not from genuine wealth creation, but from extracting wealth from others through economic rents. 

Not only is this unfair, it’s also inefficient. Funnelling more wealth towards the rich does little more than inflate idle bank balances and asset prices. In contrast, low and middle income households are far more likely to actually spend new money – circulating money throughout the economy. As such, tackling inequality is not just about fairness, it’s essential for creating a more dynamic, prosperous economy. This is not just about redistribution through the tax and benefit system – it is about rewiring the structure of the economy so that such large inequalities do not arise in the first place.

Does the Scottish Government have a strategy to overcome these issues? For the time being the answer is ‘no’. In March 2022, the Scottish Government published the grandly titled ‘National Strategy for Economic Transformation’ (NSET). But beneath the lofty rhetoric was an outdated strategy focused on attracting inward investment, in the hope that this will boost exports and innovation. Far from representing a strategy for transformation, it resembled a strategy for economic continuation. 

At a time when muscular industrial policy is making a return globally, Scotland cannot expect to transform its economy using the policy playbook from the 1990s. The key challenges of the 21st century – flatlining living standards, rising inequalities, and environmental breakdown – demand a fundamentally different approach. As the world changes in response to new challenges, Scotland’s economic strategy must adapt with it. However, it is not enough to simply talk the language of transformative change while making small tweaks to a broken system.  Scotland must match ambitious words with meaningful action. 

There are some signs that change is on the horizon. In February 2024 the Scottish Government announced it would be undertaking a refresh of the NSET, and in September 2023 the first minister pledged to develop a green industrial strategy for Scotland. If made bold and ambitious, this provides an opportunity to break with the status quo and set Scotland’s economic model on a more sustainable and equitable path. 

Whether or not this happens will depend on whether the new first minister embraces transformative change, or resorts to reheating old orthodoxies. Future Economy Scotland is currently undertaking a two year research project focused on developing the ambitious policies needed to deliver a just transition. We look forward to working constructively with Scotland's new first minister – whoever they may be.