The Labour Party may have won the Glenrothes by-election this week, partly on the back of the Prime Minister’s handling of the financial crisis, but Gordon Brown’s Scotland is predicted to suffer more than the rest of Britain during the economic downturn.

Scotland was named European Region of the Future for the second time in four years by the Financial Times’ fDi (foreign direct investment) magazine this year.

But figures show its growth is likely to lag behind the rest of the UK during the oncoming recession.

According to the Scottish Item Club’s 2008 Economic Prospects report, the Scottish economy is estimated to have grown 1.8 percent in 2008, 0.3 percent less than the UK’s rate. By 2009, this gap will have worsened to 0.6 percent. 

The main reason is the Scottish economy’s vulnerability to a weakening financial services sector.

This sector has been the driving force behind the country’s growth during the past decade, providing tens of thousands of jobs. Since 1998, its output has represented more than 8 percent of total Scottish GDP, and it has grown at an average annual rate of 7.3 percent.

But the result of a more cautious banking sector is likely to be a drop in financial services growth to only 2.9 percent in 2008. 

The situation has not been helped by the likely takeover of HBOS, which includes the Bank of Scotland, by Lloyds TSB, with an expected swathe of jobs cuts in its Edinburgh head office.

The banking sector accounts for more than 10 percent of Britain’s financial services employment, the Item Club said.

Secretary of State for Scotland Jim Murphy told Reuters the sector faced “specific challenges” because of the economy’s concentration in that area.

“That sector is feeling the most,” he said.

“But Gordon Brown has said he will do everything it takes to support it.”

Other factors are likely to worsen the situation, the report added, such as a slowing down in the growth of public spending, the lagged impact of interest rate rises since August 2006, persistently high real oil prices and slowing U.S. and European economies.

Construction, another area of relative strength in Scotland in recent years, has also been growing more slowly than its UK counterpart.

Investment is forecast to drop sharply over the coming year, CBI Scotland said last week, and manufacturers are reporting problems accessing internal finance, the Financial Times reported.

“In the coming year economic conditions in the UK will provide a much tougher backdrop for the Scottish economy as the impact of the credit crunch ripples out to other sectors of the economy,” the report added.

“If a return to sluggish growth is confirmed, then it raises questions on how Scotland will perform in a much less benign environment, with financial services in the developed world at the epicentre of slowing growth and public spending growth under much more pressure than at any time in this decade,” the report went on to say.

People living in Brown’s constituency, a former coal mining area, have felt a decline for the past 20 years, including the decade of economic growth Brown presided over as Chancellor.

William Anderson, a 52-year-old psychiatrist nurse, said the motto in Kirkcaldy was “home, dole, giro” - referring to the reliance on the state in the area.

“Shops and pubs are closing,” he said. “The social scene is disappearing.

“You now get two and three generations of families unemployed. There is rough housing and crime. My parents don’t go out after 6pm anymore. There is generally a bad feeling, a negative feeling since the 80s.”

The Scottish National Party, which has a majority in the Scottish Parliament, has devised a six-point plan to help Scotland avoid the worst effects of recession, the Financial Times said.

These include bringing forward capital projects to stimulate construction and the housing industry, boosting energy efficiency and improving advice to businesses and streamlining the planning process.

But the sense of a recession has already hit Glenrothes.

Murray Pearson, a retired company director, shopping in one of Scotland’s biggest indoor retail centres, said most people were only looking, not buying.

“There are plenty of people about,” he said. “But they are not spending, and they are going to cheaper places.

“We are definitely cutting back on Christmas — everything is so expensive.”

They were widely accused of dithering earlier this week but Gordon Brown and Chancellor Alistair Darling have now finally caught up with events and have tried for the first time to overtake them by unveiling a 50-billion pound rescue package for the banks.

The aim is to bolster their balance sheets, increase confidence in them and get them lending again so ordinary financial life can start anew.

Newspapers have generally welcomed the fact that action has finally been taken, though some feel the package on its own is not enough.

Sector analysts have more specific questions about future bank dividends or who will make use of the rescue money.

What do you make of the rescue package? Do you feel more reassured now?

Newspapers generally praised the government move to shore up the banks, saying that whatever the prospects for the success of the “stability and reconstruction plan,” to have done nothing would have been infinitely worse.

They noted how fleeting the effect of the far larger U.S. bank bailout has been so far and called for the UK plan to be accompanied by cuts in interest rates by the Bank of England and concerted action on an international scale.

This weekend’s World Bank/IMF meeting in Washington needs to take a stand-back look at the entire post-war structure of global finance, some suggested.

“This is the right course of action,” the Financial Times  says of the package. “By recapitalising these banks, the government is making a strong statement to the markets that existing British banks will not disappear and will continue to meet their obligations.”

It says the deal must be designed to avoid participating banks appearing to be marked out for vulnerability. All the big banks should be encouraged to use the facility in some form.

The FT calls for the Bank of England to cut rates by at least half a point this week.

The Times thinks only a full point reduction would be enough. “With confidence plummeting, this is the time for bold moves, not incremental changes,” it warned. “In the past year the Bank has continued to play doggedly by the rules at a time when rule books around the world — on competition law, on deficits, on moral hazard — are rightly being ripped up.”

The Independent  sees wider forces at work behind the current liquidity crisis and demanded wider international action to solve it.

“Two tectonic plates are beginning to meet and grind on top of each other,” it says — namely the liquidity crisis and the accelerating pace of recession in nearly all the major Western economies.

“There is simply no point in hoping that individual measures in any one sector or any one country are going to break this visious circle,” it says. “An EU-wide safety net and a scheme to mop up toxic assets is needed. There is a simple message from the past few days: the picemeal won’t do.”

The right-leaning Telegraph and Daily Mail attack the government for what they call dithering in the run-up to Wednesday’s package and demanded assurances about how it will work.

“The government should make explicit what is already implicit — that it will guarantee all bank deposits, businesses as well as private, without limit, for a fixed term, perhaps two years,” says the Telegraph. “No other single measure would do more to restore public confidence in the banks.”

The Mail calls for banks to cut their “outrageous” loan charges to small businesses and to start lending to home-buyers again. “We demand that no City slicker gets another obscene bonus until we get every penny of our money back,” it adds.

The biggest-selling daily, The Sun, says: “This is the only show in town — the alternatives are horrific. All we can do now is hold our breath and hope it works.”