British regional policy needs more government

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I found this week's Bagehot column in the Economist interesting. It complains that Westminster is brain-dead, but that elsewhere there are signs of innovative thinking. This helps to raise the question of how to address the imbalance of Britain's (and especially England's) imbalance towards London. But it betrays some rather stale thinking.

The article itself is lightweight. It shows enthusiasm after a visit to the University of Warwick, and witnessing its projects promoting industrial innovation, and in particular the efforts of Kumar Bhattacharyya to push back against the idea that Britain's future lies in financial services and not manufacturing. It contains no hard analysis. This is less disappointing for a political column that it was for an article a few months ago about what to do about the developed world's "left behind places". Towns and rural areas left behind by changes to the industrial economy. In spite of the promise of its headline, this article had very little to say about solutions. It instead seemed to encourage the further expansion of already thriving urban centres, on the grounds that this would clearly be good for productivity. This was another symptom of the the stale, conventional thinking that dominates the Economist's journalism.

But the issue is an important one. The gap between London and England's southeast, and other regions of England, Wales and Northern Ireland is problem for everybody. It is an obvious problem for the struggling regions, from Cornwall to Tyneside. It is also a problem in the prosperous regions, where the cost of housing is exacerbating social divisions. If economic prosperity could be distributed more evenly geographically, then it would be easier to distribute it more evenly between the classes and generations. Scotland, incidentally, is something of an exception, and a revealing one.

This has been obvious for a long time, but efforts by governments to do something about it have at best been only partially successful. Two things have been tried: money, and relocation of government agencies. There have been various initiatives to pump money into the poorer regions, a number of which are under the banner of EU aid. These clearly help, but the beneficiaries too often seem to be large corporations headquartered elsewhere, who simply manage to funnel the money back again. So many English regional towns are dominated by national and international brands at the expense of more local ones. The relocation of government agencies manage to disrupt local labour markets (the jobs tend to be quite well paid and put local businesses under pressure), but a bigger problem is that they fall victim to government efficiency drives which shrink them.

Where the Bagehot article is clearly right is that there needs to be more going on locally in these regions that central largesse. Centres like the Warwick Manufacturing Group clearly help. At the centre of thriving modern economies is brainpower. Universities and research are clearly part of this - as experience in other countries shows. But two points need to be made: political structures are vital, and we need to think about tomorrow's economy rather than today's or yesterday's.

The lack of interest in political structures was a big disappointment in the Economist's analysis. Political structures clearly affect the way economics is distributed geographically. Countries that are both quite large and politically centralised, like Britain and France, have more uneven economic geography than those that don't - like Germany and Scandinavia. I think this is for two reasons. One comes from network theory, which I have advanced before. Humans can manage only a couple of hundred connections with other humans efficiently, so at the heart of any organisation, however large, there is a small network of people within it, and people that the organisation does business with. Large organisations simplify management to reflect this, which means concentrating power geographically. When government power concentrates, corporate power tends to concentrate with it, as government has such an important effect of modern business. Superficially this looks efficient - the trap that the Economist falls into, because the concentrated power centres are efficient in themselves - but that is at the cost of hollowing out elsewhere. Scandinavia may not have a centre that compares with London or Paris, but you can hardly say it is not prosperous.

The second, and overlapping, reason that centralisation of government is bad for outlying regions is the sheer dead weight of government decision making. In England most decisions involving significant money find their way back to the Treasury in London. Decisions get stuck in queues, and when they come to be taken, risk aversion prevails unless huge political capital is expended. Human progress generally demands risk-taking. The fairly obvious idea that rail links between northern British towns should be drastically improved is bogged down in Westminster politics. If the north of England was an independent country it would already be finished.

So it is not surprising to see that developed countries with devolved political structures usually have better distributed wealth than ones that don't. Switzerland, a small country with highly devolved politics reeks comfort and prosperity almost wherever you go. As I have already alluded, it is no accident that Scotland, with its advanced level of political devolution, is the one British region that has been able to push back against the gravitational pull of the southeast. It doesn't always work. Political devolution allows regional governments to choose incompetence; Welsh devolution has an unconvincing track record. And what of distribution of wealth within regions?

The idea that political devolution needs to be part of any solution is very gradually taking hold in Britain. Most politicians play lip service to it. But there is long way to go to change the political culture. But we also need to think about how the economy is to develop. This is the biggest gap in the Bagehot article. It bangs on about manufacturing. Manufacturing still dominates the way most economists and policy makers think about economics. But we need to move on. Manufacturing is going the way of agriculture. There is only so much stuff we can consume, just as there is only so much food we can eat - and in both cases you can argue that we consume too much already. Consuming more stuff is not what will make our lives better (though it will for an important minority of us). The more productive manufacturing becomes, the less important it will be to the economy as a whole - the paradox outlined by the economist William Baumol.

Before I develop that argument further I must qualify it. Manufacturing is still important. It is changing radically in ways that mean that we should produce more locally, and rely less on global trade. This is partly technological, and partly because the economics of importing from less developed countries changes as they, and especially China, develop. There is plenty of scope for innovation and Britain needs to keep up it. Manufacturing innovation based in Warwick, Sheffield and other places needs to be kept going. But it won't be enough.

What we need to think about is services. The health economy will grow in relative terms, and not just because of demographics - prolonging life and reducing pain is what people want to spend money on when they get more of it. Public services such from social work to law enforcement also need to grow - or get radically better at solving problems rather than pushing them around the system. And there is care for the elderly. We shouldn't just be sponsoring research into manufacturing into the regions, but into all these other things and more.

And it will not be lost on my readers that this means more government and not less, which has been the prevailing wisdom of most of the last 40 years. But it needs to devolved and better at its job.

21 thoughts on “British regional policy needs more government”

  1. I have recently stopped running a regional company that had little to do with the local economy, and joined my local council where what you say is painfully relevant. The local public networks are beset by cost-cutting which can sometimes drive innovation, but there are no inventive, dynamic networks of the kind you are talking about in the public sector here as far as I can see. I feel the only way forward is government that talks positively about service innovation in the public sector, acknowledging that it is almost certainly the most important economic sector of the future, and drives it via small research institutions spread around the country. All current devolution initiatives should of course be pushed forward.

  2. The Lib Dems have pushed this concept for some time now. But the voters are sceptical. I seem to remember that the North East voted against setting up a regional government. I would argue they are right to be sceptical.

    Regional governments don’t have the the currency issuing capacity of central government. Their borrowing costs are therefore much higher. A regional government can default on any loan whereas central government cannot. By default, the economics of local government tends towards austerity. Budgets have to be balanced. Spending has to be tightly controlled.

    Lib Dems like to cite successful local government in countries such as Switzerland and Germany. These countries generally have large export surpluses. There is always more money entering the country than leaving so there isn’t the same need for deficit spending either at National or local level.

    In the UK this would probably only work in London and the South East of England. It wouldn’t work in the North East unless central government provided generous cash grants. That might happen to start with but unless we had a government in Westminster with the correct economic understanding it would be unlikely to continue.

    So when the cracks started to show in the regional NHS, the regional education system etc the voters would complain to their Westminster MPs. They’d be told that it wasn’t their problem any longer and that they should take it up with their representatives in the regional Assembly.

    Britain isn’t a huge country. We already have local government and National government. There’s no need for an additional layer of regional government.

    1. First I think your criticism of being a wasteful level of bureaucracy certainly applies to the Prescott proposal that the voters rejected all that time ago. Nothing substantive was devolved as the Treasury really doesn’t get this. The City regions of the coalition, and Scottish devolution seem to be going much better. Wales less so. I think as soon as a region gets much beyond 10m inhabitants diseconomies of scale in governance creep in. Britain is a big country in that respect.
      Second regional government is only part of the solution. There needs to be decent and competitive local government. And an appropriate fiscal settlement. Also investment needs to be in the right things, which is the other focus of my article.
      You raise a very interesting point about fiscal conservatism, which applies to regions that are fully independent with their own currencies like Sweden and Switzerland as well devolved regions. And the not unrelated issue that so many of my paragons of governance have trade surpluses. Well I don’t think that was always the case, and in the current international systems well governed places tend to move to trade surplus. This is not a virtue in itself, of course. It’s just what happens when so many countries apply fiscally loose policies. So I think you have cause and effect the wrong way round. Whatever the macroeconomic virtues of fiscal looseness, I think there are substantial micro benefits to being very careful with resources.

      1. On a world scale there is always going to be approx half of all economies which have a trade surplus and half which are in deficit. So if a characteristic of a “well governed place” is that they are in surplus, half of all countries are going to be disqualified.

        Every country, at least the major economies, which does have a trade surplus also has an exchange rate policy. It has to keep its currency low be able to continue to run that surplus. It’s easy enough to peg your currency at lower than market level. Easy enough, that is, as long as everyone isn’t doing it. Countries like the UK and the USA will then inevitably have a trade deficit if they allow their currencies to freely float. This attracts in inflow of foreign capital. If the capital account is in surplus the current account has to be in deficit. It’s just arithmetic.

        Another way of looking at it is to say that if countries like Germany, the Netherlands, Denmark, Singapore etc are determined to hold down their currencies and run large trading surpluses that they are going to create trading deficits in countries like the UK and USA.

        That would be fine, except that those trading deficits translate into budget deficits, which in turn cause many to worry that we are living “above our means” and start to apply austerity economics. There’s then “no money” for schools and hospitals! The buildings look tatty. The queues lengthen. There is also “no money” to even keep the place tidy and litter free! The whole country starts to look run-down and like its a failure. People then start to ask “why can’t we be more like Germany and Switzerland” and want copy their political structures.

        Again, the answer is that on a world scale, not everyone can be like Germany and Switzerland. So I’m afraid it just won’t work for the UK.

        1. Ha! A hardy perennial for you and me. The trouble with basing a narrative on accounting identities is the the logic is completely reversible. So a government decides to run a big budget deficit to help raise the overall level of consumption to make people feel happier. A trade deficit results because consumption moves ahead of production. So the currency appreciates in order that this comes about. Pure arithmetic as you would say. Meanwhile a country with a thriving private sector and thrifty government finds its export businesses pushing against an open door. Productivity rises to meet the extra demand that its relatively low exchange rate means. We get the trade surplus to balance the first country’s deficit.

          Which way round is it? I think you can point to evidence on both ways. But the point is that if some countries are determined to run a trade deficit other countries have to run a surplus. And no manipulation of exchange rates is needed. But a trade deficit is not necessarily a bad thing, and neither is a budget deficit. It depends on context. Whether or not austerity is the right economic choice likewise depends on context. I have argued that in the UK it was justifie in 2010 (I have a more nuanced view now). The situation in 2017 is more complex. We certainly need more resources in many parts of the public sector – but how far to balance this with extra taxes?

          1. Matthew,

            Yes you’re right, whilst accounting identities are important, they can’t be used to show causality.

            So you’re describing a simple interaction between two economies? Where I would disagree with your interpretation is that running a trade deficit causes an appreciation of the currency. If a govt is profligate in its spending and doesn’t set taxation rates correctly it can causes excessive inflation. A loose fiscal policy, therefore, is likely to cause a depreciation of the currency.

            Conversely if a government is running a tight fiscal policy and the manufactures in that economy find it more advantageous to export rather than sell in a recessed home market, that is likely to increase the net demand for its currency leading to an appreciation.

            So if we look around the world at the big net exporters they all have mechanisms in place to keep their currencies cheaper than they otherwise would be. Holland and Germany use the euro. If they had their own currencies they’d be more expensive. Denmark pegs its krone to the euro. If it removed the peg the krone would rise.

            It’s always a lot easier to keep a currency cheaper than the market would value it than keep it more expensive. Britain has come unstuck several times, the last time being Black Wednesday, trying to keep the pound at an unrealistically high value. The speculators move in and there’s only going to be one winner in that contest.

            So I’m basing my argument on what governments do with their currencies rather than the accounting identities.

          2. Yes you can certainly argue that Germany, the Netherlands and Denmark are keeping their currency artificially low, and that Switzerland has tried and failed. Though Sweden, another surplus country these days, floats freely. And China certainly used to undervalue even if it is a bit nuanced these days. All that is evidence in favour of your narrative. Whether the Euro as a whole is undervalued is an interesting discussion to have.

            But I am talking of real exchange rates, so if there was is inflation there may be real appreciation and nominal depreciation at the same time. Second it is my working hypothesis that if countries are well integrated into the global trading system with free capital flows, as Britain is, inflation is much less likely to be the outcome of excess demand. The exchange rate takes the strain, along with inflated property values. One day there may be a reckoning in the capital markets but nobody is likely to have seen it coming when it arrives. Less developed/integrated economies, like Turkey and Argentina still seem to conform to the old models.

          3. I’ve just checked on Investopedia and they say” the Swedish central bank, Sveriges Riksbank, maintains a managed float regime for the exchange rate”

            The Swedish krona has had an almost linear , ie slow and steady, increase of about 10% against the euro in the last five years which would indicate that it has indeed been “managed” to keep the exchange rate where the Swedish Govt/Riksbank wants it to be. So it’s not a peg but close to it.

            Incidentally the Swedish Govt is deliberately avoiding meeting the conditions for euro entry even though it hasn’t been granted a formal long term exemption.

            The Finnish economy, by contrast can’t control its exchange rate, having joined the euro at probably too high a level, and is suffering as a consequence.

            The ability of a country to control its exchange rate is obviously an important economic tool, but not everyone can do this! The international system does rely on at least some countries, such as the USA and the UK, allowing their currencies to genuinely freely float. This must mean that if everyone else “manages” their currencies to keep their trade in the black, that the UK and the USA are always going to be in trade deficit.

          4. Back in the Keynesian heyday almost everybody managed exchange rate. Some on the left remember this as the golden age before the neoliberal ruined everything. I do wonder, with the explosion of debt, rampant inequality and pointless activity in financial markets whether the breaking of Breton Woods was actually worth it. Most small countries seem forced to manage their exchange rates in some way.

            I had a quick look at the Economist estimates of current account balances. The overwhelming majority of them are positive and I’m sure they add up to a substantial net positive. Which tells you something about economic stats. The US and the Euro area more or less cancel each other out. So do China and Britian. But that leaves Japan (bigger surplus than China) South Korea, Taiwan, Singapore, and so on with big surpluses. Only South America goes in for deficits in a big way.

          5. “Back in the Keynesian heyday almost everybody managed exchange rate”

            Except the Americans! If everyone else was keen to run surpluses the USA had to run deficits. If they’d balked at doing that in the postwar period and had also tried to manage their currency to also keep their trade in balance the system wouldn’t have worked. We might well have had a rerun of what had happened previously. Trade wars broke out which could well then escalate to real wars.

            Keynes was aware of the potential problem and suggested the introduction of a new currency, the Bancor, plus a system of fines for countries wishing to be mercantilistic in their trade outlook. We used to be more aware of the problem of trade imbalances than we are now. Now we seem to imagine that floating exchange rates automatically take care of all that and so they don’t merit much discussion at all. The link between trade deficits and budget deficits isn’t discussed by the mainstream which likes to give the impression they are quite independent.

          6. I think it was the other way round. The US made trade surpluses after the war, as the world’s manufacturing powerhouse, while the rest of the world recovered from war damage, many helped by assistance provided by the US. That broke down when the US needed to run big fiscal deficits to fight the Vietnam war without raising taxes. So they broke Bretton Woods up. In those days too many countries wanted to run deficits no doubt.

            I agree with you about the linkage of trade and fiscal deficits. The difference these days is that exchange rates can move to reconcile the two, so we get fewer crises and the whole thing is less visible. Some mainstream economists, like Martin Wolf do talk about it though.

          7. https://en.wikipedia.org/wiki/List_of_countries_by_current_account_balance

            I added the top 20 in each list:

            The deficit countries: $936 bn
            The surplus countries: $1.3 tn

            I’m not sure what we’d get if we added them all up. It must be difficult to get a more than an estimate of the amount of money travelling in each direction. Some of the economists I follow would say it doesn’t matter in any case. All that does matter is keeping inflation under control, on the one side, and keeping the economy functioning at clsoe to full capacity on the other.

          8. All that does matter is keeping inflation under control, on the one side, and keeping the economy functioning at clsoe to full capacity on the other.

            Very much the pre-crash consensus. I sense that you aren’t so sure and neither am I. I think there’s a bit of Goodhart’s going on. As soon as you focus on one economic measure it loses its value. Happened to money supply, and now to inflation. Prices aren’t formed as they used to be. The pressure comes out in different ways. That should have been one of the learnings of the crisis. Unsustainable does not always correct through inflation. Financial bubbles and debt crises do the job too.

        2. I think you must know I don’t agree with the pre-crash consensus. That was that governments should keep their budgets as close to balanced as possible or at least not to allow debts to rise any faster than the growth in the economy. Interest rates were the main control lever to regulate the economy. That just led to an increase in the level of private debt and the creation of a a housing price bubble. We haven’t seen the end of that.

          But just to get back to the original point of the post, the Lib Dems must, if they want to stay in the EU, want 4 layers of government. On the top we’ll have the European Parliament. At some stage, if the EU survives, that will be the Parliament of the United States of Europe. Then we’ll have the National Parliament at Westminster. In England we will have a number of regional Assemblies with similar powers to the Scottish and Welsh Parliaments/Assemblies. Underneath all that we’ll still have our local councils!

          I know those of us on the left are supposed to like lots of Government but I’d just make the point that we can have too much of a good thing!

          1. Four levels is quite common in polities with highly devolved structures. In the US it would be town, county, state and federal, I think. Liberals tend to believe that political power should be dispersed, so that no single entity gets too much. Dispersion across levels of government is one way of doing it. Still it has to make sense with each level in charge of something appropriate and important. I have become persuaded that the regional level makes a lot of sense by the success of medium sized nation states in Europe. But the regions need to have coherence about them, unlike most of the official English regions. I am also mostly persuaded about elected mayors to run these new levels, though most of my Lib Dem colleagues disagree.

            And yes I get that your main critique of pre crash economic governance was its emphasis on monetary policy and disapproval of fiscal deficits. And I agree. But I also think there were deeper problems, including outmoded concepts of inflation, productivity and so on, and neglect of the role of financial markets.

  3. I quite agree with most of this – I had been thinking that, following the rediscovery of an industrial policy by Vince Cable and Theresa May, the next step should be the rediscovery of a regional policy for the sake of the ‘left-behind places’ which have been causing such political problems. As an article in the FT about retraining has argued, places as well as people need to be resilient when redundancies strike.

    To my mind the service sector /manufacturing sector distinction is not to the point because the former is so varied; what is relevant is the parts of the service sector which produce an output which is tradeable between different regions and countries, and where productivity between different places can vary widely. There is not much point in promoting, for example, the development of more retail corner shops in a depressed area. And care is needed to be realistic. It was noticeable that the banks that so spectacularly failed – RBS, Northern Rock – had their HQs outside London; I am pretty sure that their gross over-expansion on the basis of unsound business models was in part due to a somewhat uncritical enthusiasm locally for the development of these service sector companies. The UK Government picked up the tab. But , to take a more hopeful example, solicitors services can these days be provided at a distance , and thus traded across regions. London solicitors have done very well from selling their services internationally; could not the regions join in?

    Perhaps at this juncture I should declare an interest; during a varied career in DTI (as BIS was called then), I had a couple of spells working on what was then called regional policy – one on the rules on grants for companies creating jobs in depressed areas – the ‘Regional Selective Assistance’ which still exists in Scotland, another on technology and best business practice matters. As the Thatcher era took hold, the conventional wisdom became that grants were doing no real good. Critics pointed to the fact that regional disparities were not , in aggregate terms, reducing very much. Taken together with free market assumptions this implied that the boost to jobs from grants was only temporary, after which the market would return to its equilibrium; indeed, under free market assumptions, the grant might hold up a necessary movement of people to places of higher employment. But of course relatively lowly paid people who are being ‘left behind’ are not mobile in this way for all sorts of reasons; and meanwhile the extra regional jobs encouraged in one way or another by a grant, even if regarded as time limited, might provide economic benefits worth the extra expenditure.

    I would agree that there is a structure-of-government issue. Germany has its Lander; even the highly centralised France has its regional Departments; but England has no level of regional Government. An effort was made to create such a layer, starting in the North East where regional Government was enthusiastically championed by John Prescott; but a referendum in the region found that a majority of voters were against creating what was seen as another layer of Government. As a result, the DTI regional policy was administered for the most part though ‘Regional Development Agencies’ which to start with were effectively branches of the DTI; later they gained more independence; but they were abolished by central Government in 2010 as a cost saving measure. For my money I would aim for a Federal system of Government in the UK based on regions big enough to be sensible economic units but small enough that people within them can travel to meet each other and back in a day – eg the North West including Liverpool and Manchester would probably be one such unit; I would look for initiatives such as the Northern Powerhouse to provide for the start of such regions; and for the main level of local Government below that to lie in unitary authorities as in Scotland. Admittedly, some cities would be too large to form a single unitary authority, and might need to be tackled more on the London model. If there was a layer of Government at regional level with real tax raising powers, central government might be able to cofund initiatives with it, thus bringing in regional commitment and regional control, while also guarding against excesses fuelled by regional enthusiasm.

    And I accept, differing standards between differing regions would have to be tolerated (as Denmark tolerates its equivalent of our NHS being split into a number of regional units). Localities decide what they want and get what they pay for, though with cross-subsidies from more prosperous to less prosperous regions. This is what local decision making has to imply, and is what works elsewhere – the UK has a uniquely high share of tax revenues raised centrally. But I recognise, I speculate!

    Hugh

    1. Thanks Hugh. You raise a number of interesting issues there. I think the Labour effort to create a regional layer by stealth was deeply flawed. One issue was boundaries, as you touch on. Another was the lack of serious leadership opportunities. I think the Coalition’s efforts with the City regions is much more promising.

      I am not sure if I would focus on exports quite so much, or import substitution come to that. Exportable services tend to have high productivity and therefore, in 21st Century terms, relatively low impact (I.e. they don’t employ enough people). They are important but not enough. Instead I would be thinking about things that would encourage people to move in. World class medical research linked to a hospital, for example.

  4. Yes, I can recognise both these points. Working through existing power structures and existing loyalties, as does the city-regions initiative, does seem the best approach to devolving power at present, learning from the failure of the Prescott effort. And, granted , encouraging enterprises which export their output from the region is a demand-side measure which can usefully be complemented by supply side measures such as improving the transfer of know-how to a region. Mind you, getting a hospital to assist with the development of its region would be easier if there was more local control of the hospital concerned, – which may be coming with the city related initiatives, we will see,

  5. I’ve just read that Northampton council have just about “run out of money” and are “close to effective bankruptcy.”

    https://www.theguardian.com/society/2018/feb/02/tory-run-council-runs-out-of-money-to-meet-obligations

    This is very much the scenario that I would envisage for devolved government in the UK. Westminster will devolve responsibility but not power.

    Northampton council like any other council or devolved government can run out of money. Westminster can never run out. So, if we have to choose, who would we want to be responsible for our schools and hospitals?

    1. That is very much the danger, Peter. Without substantial revenue raising powers it will not be real devolution. It took the Scots a couple of decades to get anywhere close. There also need to be much looser borrowing powers (especially when there are assets such as housing available as collateral), with a clear resolution regime for when the locality is unable to pay its debts. HM Treasury will not want to do any of that, but, as the Scots have shown, I think it can be ground out little by little.

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