Sunday, August 17, 2008

Are cities limited?

The recent instalment (PDF) of the Policy Exchange 'Cities Unlimited' series has provoked quite a reaction.  There has been predictable fury from Northerners who don't take kindly to being told that we should accept their cities' decline.  Southerners don't exactly see further expansion of the towns in their densely populated region as much of a reward for their economic success.  Some of them rather dislike the idea of a deluge of Northerners.  Those two reactions left little doubt about what the political response would be and sure enough both Conservative and Labour politicians have condemned the report in colourful terms.



Cities Unlimited deserves a more thoughtful reception.  None of the 'rebuttals' offered by various politicians and commentators really stand up to scrutiny.



Some cite new investments as a sign that cities are regenerating.  If they read the report they would see that the central case the authors are making is that investments haven't translated into lasting economic progress.  An example they cite is the billions of pounds of Nissan investment in Sunderland.  Citing more investments without showing those translating into increased prosperity, best measured through value added per person is pretty meaningless.  All you're doing is strengthening the report's case that the cities have received substantial investment but failed to translate that into sustained greater incomes.



Others have pointed to an improving employment record in some areas, which creates more questions for the apologists for recent Northern economic performance than it answers.  Why has a strong employment record not translated into higher incomes?  An obvious answer would be that the employment is all being created in low value occupations, perhaps because the workforce in these cities doesn't contain enough high skilled workers.  Unemployment figures are also easily distorted by the switch to incapacity benefit and employment figures by large scale immigration.



Challenging the report by arguing that regeneration policy has been a brilliant success isn't going to work.  The empirical case in the report is solid.  We've been spending a fortune for years and the income gap between the regions is expanding rather than contracting.  There isn't really any way of talking around that.



To put all this in perspective, there is another case of a region that, over more than fifty years, failed to catch up with a richer rival's 25% greater income per head, with the gap actually widening to 27%.  Eddie Hunt in 1986 studied historical pay for agricultural workers in different parts of Britain (the study is behind the academic firewall, I'm afraid).  Agricultural pay isn't a perfect proxy but should give us a reasonable idea of general incomes in those areas as agriculture had to match levels of pay in other industries in order to attract workers.  In 1976-1770 Buckinghamshire was 23% richer than Lancashire.  With the advent of the Industrial Revolution, by 1794-1795, Lancashire overtook its Southern rival and between 1833 -1845 and 1898 the gap in incomes between poor Buckinghamshire and rich Lancashire actually rose by 4 s. 2 d.



C19regionalincomes



Clearly something has changed the economic fortunes of the two counties not once, but twice.  It certainly wasn't regeneration spending.  First, Buckinghamshire lost its old lead with the advent of the Industrial Revolution and Lancashire was richer for the best part of two hundred years.  After that, we know that Buckinghamshire joined in the success of the South East of England in the twentieth century while Lancashire became one of the poorer areas whose problems Cities Unlimited is addressing.
The report puts those changes down to economic geography.  The period of Lancashire's success coincided with the importance particularly of coal and ports that could bring in cotton.  Buckinghamshire now does well thanks to, particularly, its proximity to London.



The report establishes pretty conclusively that current policy isn't effectively addressing regional inequalities.  Its case that some areas of the country have failed to replace the old staple industries is also clearly correct.  The argument that new policies cannot be more effective in turning these areas around is, I think, less convincing.  I don't think that the fortunes of areas are determined by the geographical hand they are dealt to the extent the report suggests.



Eastern Europe lost its old economic raison d'etre in the early nineties as the Eastern bloc fell to pieces and its manufacturing base collapsed.  Estonia's success would, I think, be hard to predict from its geography.  Equally, Ireland's economic geography hasn't fundamentally changed recently to turn it from a perennial no-hoper to the Celtic tiger.  In both Eastern Europe and Ireland it isn't economic geography that has changed but policy.  In particular, market reforms in Eastern Europe including the flat tax and cuts in corporate tax in Ireland (Benjamin Powell, for CATO, sets out how it wasn't EU subsidies that made Ireland rich).  In 1993 GDP per capita in Britain was 28% higher than in Ireland, today the situation is reversed and Ireland enjoys a GDP per capita 20% higher than we do in Britain.

Those two examples suggest that it is eminently possible for policy reforms to turn regions around, even those like Eastern Europe with few obvious geographical advantages.  In order for us to accept the Policy Exchange report's analysis that some regions decline is essentially irreversible we need to ask whether it is plausible that new policies can create a radical turnaround.



David B Smith, in a paper (PDF) for the Economic Research Council, sets out the status quo:  Many of Britain's poorer regions can hardly be considered market economies.  Public spending is 58% of the North East's GDP, against 31% in the South East.  24% of the workforce in the North East works in the public sector against 18% in the South East.  Thanks to the black market it is thought that the state only controlled about 75% of the economy in the Soviet Union.  In terms of the importance of public spending, Sunderland has more in common with the Soviet Union than Kent.

Other government policies also weigh more heavily on poorer regions.  If you scaled the £5.35 minimum wage in 2006 to median earnings it would be £4.78 in the North East and £6.90 in London.  This means that the minimum wage will have far more of an effect on employment in poorer areas.  Italy's Mezzorgiorno and East Germany have had similar problems as labour market regulations and non-wage labour costs that richer regions can sustain do far greater harm in poorer areas.



Entrepreneurial activity is directed towards politics rather than capitalist enterprise.  As David B Smith says, the high government spending regions "seem to produce large numbers of political entrepreneurs, who live off and lobby for a large state, but few of the traditional wealth creating kind".



Welfare dependency has nasty effects on people.  Psychology has found it encourages the pursuit of instant gratification.  This plays into high levels of drug and alcohol abuse in populations with large numbers of people on benefits.  That might be one reason for the large number of incapacity benefit claimants in struggling towns.



Private sector employers have to compete with the public sector for staff.  Centralised pay bargaining means that in poorer areas private sector firms struggle to compete with public sector salaries funded by the rich South.



Beyond that, the relatively high burden of personal and corporate taxes makes the North a more expensive place to do business.  In particular, our corporate taxes are now above the average in the OECD.  This stops the South, with its many advantages, fulfilling its full economic potential.  Worse, it could clearly have a crippling effect on the North that more often competes with developing countries, which tend to have lower corporate tax rates.



The essence of the Policy Exchange report is that regeneration efforts have failed to resuscitate the economy in many old Industrial towns.  That regeneration policy is premised on the idea that the market economy is failing, and needs help from the state.  If we accept the reality of the situation, that a combination of massive state intervention and taxes that discourage private investment has left an economy that is more public than private sector, then we might start from a very different premise.



Cities Unlimited suggests that some Northern towns now don't have a raison d'etre.  I disagree.  There are plenty of ingenious people in even the most struggling towns and they'll find something to do, some reason to be.  The problem is that the massive Southern subsidy, combined with taxes and regulations that choke business enterprises, channels the ingenuity of the North's brightest into lobbying for greater funds from the government.  That is now the North's economic raison d'etre.  A mind blogging array of government bodies has the ability to disperse lucrative grants and chasing them can be far more lucrative than plugging away at building a business.  William Baumol wrote that the growth miracle of capitalism was founded on channelling entrepreneurship to productive ends, to enterprising activity that would make us all better off.  An array of taxes, regulations and subsidies may have ended that in the North, is it any wonder that the region's economic performance has been poor?



If we want to see real improvements then we need to change that.  Fiscal decentralisation, as the report recommends, could encourage regional self-reliance and, if done properly, allow enterprising towns to slash taxes and show others the way.  You could scrap the RDAs (PDF) and cut 4% off the small business rate.  That would do a lot of enterprising souls some good and make setting up a new firm seem like a significantly better idea.  You could make phased, pre-announced cuts of 2% to the 12.5% corporate tax rate (PDF) they have in Ireland.  The economic effects across the country would be incredible, boosting incomes, investment and, over time, even corporate tax revenue.  The boost to competitiveness would be particularly welcome in poorer parts of the country.  It would be a swine to get past the unions but ending centralised pay bargaining would save lives in the South and make it easier for the private sector to compete for workers in the North.



All those policies would create more room for the private sector to grow in the North.  They would increase the rewards to enterprising souls who decided to found businesses instead of trying to seize on the taxpayers' chequebook.  They might make it possible for the North to join the long list of regions from around the world that have turned their fortunes around and gone on to become incredible success stories.



The steady increase in population in the South and decrease in the North causes a series of strains.  Political institutions can't keep up and various services wind up under or over resourced in different parts of the country.  There is additional pressure on the countryside in an increasingly densely populated South of England which can only be partially alleviated by some of the sensible steps Cities Unlimited recommends, such as allowing industrial land to be used to build residential property.



No one wants to give up on turning around the decline of old Industrial cities if we don't have to.  While the authors of Cities Unlimited have done a good job of illustrating the weaknesses of current regional policy, I'm not convinced that there aren't better policies that could see the Northern cities prosperous again.

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