Macaulay Land Use Research Institute
with the University of Aberdeen

December 1999

Executive Summary

1. Introduction

1.1 This study was undertaken during 1999 for Comhairle Nan Eilean Siar in collaboration with Western Isles Enterprise, Highlands and Islands Enterprise and The Royal Bank of Scotland (together, the sponsors). Although there has been previous input-output (I-O) analyses of the Western Isles (and of the Orkney and Shetland Islands), this report represents the first study of its kind in Scotland.

1.2 The study had the following principal objectives (study brief, September 1998):

"To construct (in a manner consistent with recognised I-O accounting conventions and formats) a comprehensive set of up-to-date regional accounts for the Western Isles in the form of an I-O table

To compile a Western Isles occupational employment-by-industry matrix compatible with the core I-O table

[By] utilisation of relevant I-O data and systems, to undertake a number of analyses relating to the structure and performance of the Western Isles economy

To provide the project sponsors with an operational model 'package' of the Western Isles economy for in-house use."

2. Methodology

2.1 The study adopts a Social Accounting Matrix (SAM) approach, which presents comprehensively and consistently the flows of incomes and expenditures around the regional Western Isles economy. In particular, the SAM constructed in this study includes:

· 26 industry sectors, including (separately) sea fishing, fish farming, textiles, land transport, sea transport, air transport, education and health

· "factor" income from employment (occupation) and business profits etc.

· household income receipts separately from wages and salaries, self-employment, investments, pensions, and social security payments

· three separate accounts for Western Isles households, relating to those with no dependants, those with dependants, and those consisting of retirees only

· income and expenditure by local government, as well as flows to and from central government

· tourist expenditures in the Western Isles

· imports and (non-tourist) exports to the rest of Scotland, the rest of the UK and the rest of the world (separately).

2.3 The Western Isles SAM was constructed with a base year of 1997, using a mixture of primary (survey-based) and locally published information, external (e.g. Scottish) information, and professional judgement. The final balanced SAM was used to produce a series of different coefficients, including sectoral and household multipliers, showing the overall "impact" of an external "shock" on the Western Isles economy. The SAM wasthen used as a basis to calculate the economic effects of a number of "scenarios", i.e. envisaged situations which were selected by the sponsors and study team for their likelihood or interest.

3. Core Regional Analysis

3.1 The size of the Western Isles economy as a regional unit of production is conventionally measured by the Gross Regional Domestic Product (GRDP). Total GRDP at factor cost of the Western Isles in 1997 is estimated as £221 million, or £7,827 per head (of Western Isles residents). This level of per capita GRDP is approximately midway between other (but cruder) recent figures for the Western Isles. It is 65% of the equivalent GDP figure for the UK, and is significantly lower than the equivalent figures for Orkney and Shetland. Comparison with the 1989/89 Western Isles I-O study figure suggests a relatively high rate of economic growth over the intervening period, but the earlier figure may be low due to lack of oil-related construction activity at that time.

3.2 An alternative measure of the economy is Gross Regional Domestic Expenditure (GRDE), which measures expenditure by Western Isles residents, and thus indicates the level of economic welfare or the standard of living of the region's people. The 1997 estimate of Western Isles GRDE is £287.30 million, or £10,173 per head, which is 78.6% of the UK level. The substantial difference between the levels of GRDP and GRDE is due mainly to the direct and indirect receipt by many Western Isles households of public-sector transfers such as social security payments. The difference is reflected in a large trade deficit for the Western Isles.

3.3 There have been changes in the relative importance of different sectors, though dependent on how this is measured. Employment in the economy has become slightly more evenly distributed between the production sectors since 1988/89, when the five most significant sectors in terms of employment (local government, other services, distribution, extraction/construction and transport/communications) provided jobs for 74.2% of the Western Isles workforce. By 1997, transport/communications sector had become a relatively less important source of employment, while health employment had become more important. Together, the top five sectors in 1997 accounted for 70.8% of employment, a reduction from 10 years before.

3.4 In 1988/89, the five most significant contributors to regional value added earnings, i.e. local government, distribution, fishing and fish farming, extraction/construction, and transport/communications, provided 61.0% of total value added (wages, profits, etc.) in the region, while the same sectors accounted for 74.2% of total value added in 1997. Thus income-earning in the Western Isles economy has become more specialised or reliant on the performance of a few particular sectors. Moreover, in aggregate, the public sector (health, education, public administration and other public services) has grown in importance, accounting for 28% of employment and 35% of the total value of output in the Western Isles.

3.5 When compared to the economic structure found in the previous 1988/89 study (though differences in classification should be noted), the relative importance of household and local government final consumption in the Western Isles has stayed roughly constant, while central government expenditure has increased. Most significant has been the increase in trade-related flows with imports, exports and tourism both increasing in importance, the latter contributing 14.4% to GRDP as compared to 4% in 1988/89. The economy appears to have become more reliant on trade and more open to economic influences outside its territory.

3.6 Western Isles households derive a higher proportion of their total income from self-employment than in Scotland or the UK, and 16% of those in employment have more than one job. The value of household income received from sources other than local production sectors (i.e. from investments, pensions or social security) substantially exceeds the magnitude of value-added payments flowing out of the region (i.e. wages and profits to non-residents). In terms of their expenditures, Western Isles households spend proportionately more on necessities, in particular food and drink, fuel and light, than their Scottish or UK counterparts but spend less on motoring and travel costs.

3.7 In 1997, the Western Isles had an external trade deficit of £98m. Fish farming and fish processing provided the greatest value of net exports, followed by construction (with large exports but also large imports) and land transport (including haulage). Western Isles households spent a total £71.3m on imported goods, 23% of which are purchased either outside the Western Isles or by mail order. Compared to 1988/89, the economy has become more open, with both import and export levels increasing.

3.8 In 1997, tourism contributed an estimated £32m towards Western Isles GRDP. Of this £32m, £22.4m accrued to goods and services provided by Western Isles businesses, indirect taxes accounted for £2.5m, and £6.7m was spent on imported goods. Tourism in 1997 accounted for an estimated 14% of GRDP, compared to only 4% in the 1988/89 study. Tourists staying in hotels spent, on average, the highest amount (£309.10 per person per trip), not only on accommodation itself but also on items such as gifts and entertainment, compared to £211.17 by visitors staying in other accommodation (guest houses and/or caravan sites), and £87.75 for those staying with friends and relations.

3.9 Tourist expenditure is dominated by payments to sectors where the import content of the goods and services is low, for example transport (which received £5.5m as income from tourists), accommodation and catering. This suggests that tourism has good potential for stimulating local economic activity. However, the low level of wages, salaries and value added in the sectors directly involved in tourism dampen the magnitude of multiplier effects.

4. Multiplier Analysis

4.1 Several types of multipliers were calculated for this study, including:

· Open IO or Type 1 output multipliers, which measure the effect of a change in final demand (e.g. an increase in export demand) for one sector on the output of the whole economy, taking into account the inter-sectoral purchases of input goods and services

· SAM output multipliers, which, in addition, take into account the distribution of income and the spending behaviour of local households as more (or less) income is available as a result of the initial injection

· SAM household multipliers, which measure the total effect of a unit change in income of a particular household type on the incomes of all households in the economy.

· Employment coefficients, which measure the amount of employment (measured in full-time equivalents, FTEs) required per unit output of each sector, and employment effects, which measure the amount of employment generated in the whole economy as a result of a unit increase in demand for output from a particular sector.

· Employment multipliers, which measure the total number of jobs created in the economy as a result of an increase of employment in one sector.

4.2 The largest Type 1 multiplier effect in the Western Isles economy is possessed by Agriculture, at a value of 1.9. That is, a £1000 (say) increase in demand for farming output would generate an additional £900 in the output of all sectors of the local economy, as agricultural expansion increases demand for inputs and services in the Western Isles economy. The next largest multiplier coefficients are possessed by Food and Drink Manufacturing and Processing (1.8), Fish Processing, Preserving and Wholesaling (1.72) and Sea Fishing (1.66). These results demonstrate the still-important role of primary sectors in the Western Isles economy: although some have declined significantly in relative or absolute size, fluctuations in demand for their products (which are mainly exported to the mainland and beyond) have unusually high effects on the Isles economy. When SAM output multipliers are considered, Agriculture again has the highest value at about 2.07, followed by the same group of primary sectors.

4.3 The SAM household multipliers show that retired households generate the largest knock-on effects for other household groups. If these households spend an additional £1000 (due, say, to an increase in state pensions), then an additional £238 of income is generated amongst Western Isles households in total.

4.4 As regards employment, Public Administration has the highest coefficients, with 0.118 FTE jobs required per £1000 of own "output". Agriculture leads the rest of the sectors, with 0.075 FTEs per £1000 of output, followed by Catering, and Other Services. Amongst the employment effects, the general ranking of sectors is maintained, though Food and Drink Manufacturing, which would generate 76 FTE jobs following a £1m (say) increase in demand for its output, rises to fourth place.

4.5 The highest values of employment multipliers, with over 2 FTE jobs generated for every one in the initial sector, are shown by Fish Processing, Air Transport, Food Processing, Other Public Services and Fish Farming.

4.6 Of all the different types of final demand identified in the model, analysis showed that export demand was by far the most significant. Taking into account direct, indirect and induced effects, demand for exports from the Western Isles generated 42% of total factor earnings in 1997, and 45% of Western Isles employment. Central Government final demand was found to be the second most important source for stimulating economic activity in the region.

5. Scenario Analysis

5.1 After discussion with the sponsors, the following impact scenarios were chosen for analysis:

· a 20% increase in tourism activity from 1997 levels, including changes in visitor types

· continued trends in ageing and numerical decline in the Western Isles population

· a 25% increase in local processing of output from the sea-fishing sector

· the closure of the company Lewis Offshore

· a 25% change in the cost of sea transport on the price of outputs from all other sectors.

5.2 The effect of a 20% increase in tourist activity, assuming the same proportion of each visitor type as observed in 1997, is estimated to generate an increase of £6.7m in value of output produced in the Western Isles plus an additional 416 FTE jobs, or 4.25% of current (1997) employment. The greatest increase in the type of employment generated is in the "personal services" category (which includes many hotel employees), and managers and sales occupations also show relatively high increases. Further analysis showed that different types of visitors have differing potential for stimulating the economy although the differences are perhaps small.

5.3 Changes in population levels and structure between 1997 and 2007 were based on the most recent census-based projections, i.e. a population drop of 4.65% overall but over 10% amongst the under-25 age groups. This was translated into an estimated 2% fall in total expenditure by regional households. The economic impact of this fall is not very significant, because the major proportion of household expenditure is "leaked" from the local economy through import demand, savings, etc. Total factor income drops by 1.8% over the decade as a result of demographic changes. About 136 FTE jobs are lost (about 10% of the population decline), but disproportionately amongst the professional and associated occupations.

5.4 The impact of a 25% increase in Western Isles processing of landed fish on factor earnings (wages and profits) is nearly £7m or 3.1% of the Western Isles total, with a relatively large effect on capital earnings (profits) rather than employment income. The increase in fish processing would bring about another 270 FTE jobs, or 2.8% above the 1997 level, mainly in the "other occupations" category, and in management.

5.5 The total turnover of Lewis Offshore in 1997 was £23m, and total factor earnings of the company were £6.28m. The results of simulating the disappearance of this company from the Western Isles economy show that the overall fall in Western Isles economic activity would be higher than this, due to the indirect and induced effects stimulated by the company. Overall figures suggest that the company contributes 6.1% to Western Isles gross output levels, 3.7% to factor earnings, and 5.7% to employment. Lewis Offshore itself employed 450 people in 1997, and the results suggest that the total economy-wide loss in employment would be an additional 105 FTE jobs.

5.6 The final scenario involves a 25% increase or decrease in the cost of sea transport, and measures the impact on the price of outputs from all other sectors in the Western Isles economy. An increase in the cost of sea transport has two effects. Firstly, it increases the costs of sea transport used by each sector, and secondly, and more significantly, it affects the cost of imported inputs used in the production process. Three alternative scenarios were run, involving 5%, 10% and 20% increases in the total costs of imports respectively. The results suggest that these rises in transport costs would increase the prices of output from all sectors, with output from agriculture increasing most, by 4.8% more than in 1997 under the most conservative assumptions. Since direct expenditure on sea transport by each sector was fairly small, the impact on the cost of imports was by far the most important determinant of the price changes, with sectors with high direct import propensities having large price increases. Due to the model's construction, the same estimated changes hold in reverse, i.e. reduction in ferry prices would have the same percentage price effects.

5.7 The SAM matrix, methodology and software made available in this study will enable a number of other scenarios to be analysed along similar lines as those in this report. These might include the impact of new industries or large-scale developments in the Western Isles, upturns or downturns in various other sectors, changes in existing policies (e.g. the Common Agricultural Policy), or alterations in local and/or central government arrangements (e.g. funding, activities). Various other economic developments and issues, e.g. the impact of new technology (e.g. IT) or human resource development (e.g. training, or higher education) might also be tackled, though in addressing these more endogenous and/or dynamic scenarios the limitations of the SAM data and method should be appreciated.

6. Final Remarks

6.1 This study has applied SAM technique to the analysis of the Western Isles economy in 1997, based on a variety of data sources including extensive primary survey work as well as secondary sources. The SAM approach has enabled a wide-ranging analysis to be pursued within a comprehensive and internally consistent economic framework, but its limitations should be recognised. In particular, new technologies, new products and market pressures and new behaviour by Western Isles enterprises and people have not been explored in detail. Nevertheless, the method offers opportunities for a number of further scenario analyses to be carried out relatively easily.

6.2 The traditional problems of the Western Isles economy include: remoteness (high transport costs), high dependence on a relatively few basic economic sectors and on the public sector, and the loss of economically active population. This study has not attempted to analyse the private and public attempts to address these problems, except in an aggregate sense. Nor has the geographical dispersal of economic activity within the Western Isles been analysed.

6.3 For the future, increased consumer concern is likely for products and services involving traditional skills, a clean productive environment, and a recognised "local identity". In addition, both physical and telecommunications are continuously improving. In all these respects, the Western Isles can hope to make maintain and increase its competitive advantage. However, relevant changes in the British and global economic environment include greater environmental (and other, e.g. food) regulation, more careful exploitation of natural resources, and "globalisation" of basic commodity and manufacturing production, leading to fierce competition in markets for undifferentiated and low value added products.

6.4 Locally, the drive for increased community involvement in land development, and for further devolution of political and public-sector activity may be expected to intensify, leading to new regional initiatives. The transport cost issue will remain of special importance to the Western Isles. Given their high environmental and cultural significance, the Western Isles will remain attractive as a place for some to live and for many to visit, leading almost inevitably to high imports of goods and services, and hence to a continued trade deficit. Moreover, these pressures, and local demographic patterns, suggest high demand for local public services which will require maintained expenditure from central government. Overall, the economic future of the Western Isles depends on the commercial competitiveness of their enterprises in the wider national and international economy, and on pro-active engagement with policy decision-makers elsewhere.