Success breeds success, and failure breeds failure. This seems to be the trend in the UK’s regional inequalities, as pointed out last week by Andy Haldane, chief economist at the Bank of England. The division in growth rates and income levels between London and the South East, and the North, are particularly stark. Only in the former are income levels now above those before the Great Recession, which began more than eight years ago, while the latter has fallen further behind.
This regional divide is not a new phenomenon. It has been the result of decades of uneven economic development in the regions of the UK. The almost relentless decline in the share of manufacturing output and jobs for the UK as a whole, particularly since the 1980s, hit the North of England and parts of Wales hard. Private sector dynamism has tended to be concentrated in London and the South East, particularly in the service sector, which makes up the majority of GDP and employment.
Successive governments have responded in different ways to regional inequality. Under the Conservatives during the 1980s, the emphasis was on encouraging Foreign Direct Investment (FDI) into areas of high unemployment and industrial decline through fiscal (tax and spending) incentives or what has proved to be malign neglect. This proved insufficient to make a major difference.
Under the Labour government that followed, a large expansion of public sector employment dominated regional policy. Since 2010 with the Conservatives back in power, much of this has been undone under the mantra of austerity, with cuts to public employment and services. There has been a large rise in private sector employment, including self-employment, but wages and working conditions have necessarily been worse than in the public sector jobs that they have to some extent replaced.
This latest intervention by Haldane is important. The new Prime Minister Theresa May has said repeatedly that her government wants an economy that works ‘for all’. This is a lofty ambition and an attempt to rebrand the Conservatives as the party of working people, as opposed to the ‘nasty party’.
Any solution to the problem of regional inequality must first address the causes in order to be able to formulate an effective policy.
Post-Keynesian economist Nicholas Kaldor, who advised Labour Governments in the 1960s and 70s on regional inequality and the policy response, drew on the ideas of Adam Smith, Gunnar Myrdal and Allyn Young to formulate a theory of unequal economic growth between regions. He suggested that rich countries were usually industrialised, with a significant share of economic activity in manufacturing. The latter is characterised by economies of scale, so that average costs for firms and for the sector as a whole will tend to fall as output expands. A growing division of labour will also be part of the process so that growth will involve increasing specialisation in production, both between and within firms and sectors.
These processes will tend to result in a process of ‘circular and cumulative causation’, so that successful firms, sectors and ultimately regions, will become more competitive as rising output promotes productivity growth and falling average costs, allowing them to capture larger shares of the available market demand by cutting prices.
By contrast, firms, sectors and regions that fall behind their rivals will find it increasingly hard to catch up, as slower growth in output leads to slower productivity growth, slower falls in average costs and output prices, and declining market share.
This process may apply to parts of the service sector as well as manufacturing. It may however be offset somewhat by the environmental costs of rising production. The more successful regions will tend to create more jobs and experience net immigration as a result. Rapid population growth will lead to greater congestion, pollution and strains on public services, so that social costs within that region may rise ahead of the private costs born by firms. This will act as a constraint on economic growth, until the scope and quality of public goods and services ‘catch up’ with private economic outcomes.
The theory of circular and cumulative causation can also be applied to international development as an explanation of divergent economic growth experiences between rich and poor nations. Inequality between nations was fairly low before the advent of capitalism and industrialisation in Europe. Since then, some countries have forged ahead, followed by others which have ‘caught up’. But the list of countries where most of the population faces grinding poverty is still long. The countries that have caught up are usually those which have industrialised successfully. Huge natural resource endowments do not seem to be necessary, as the cases of Japan, South Korea, Taiwan and Singapore illustrate.
So in the case of regional inequality in the UK (and elsewhere), what to do? The UK case shows that both the laissez-faire (leaving it all to the private sector) and the public employment route by themselves are not a long term solution. But some sort of government intervention may well be necessary if Kaldor’s theory of success breeding success is right. Leaving significant parts of the country to manage decline is a dead end economically and is likely to breed resentment and division, both socially and politically.
Policies which encourage the development of a dynamic private sector will need government support in providing decent infrastructure, education, training, and promoting links between universities and firms as well as between firms themselves. Sources of finance for Small and Medium-sized enterprises and start-ups which have a potential for rapid growth should also be promoted. There is nothing particularly new about these ideas, and some of them are already government policy. But their practice has tended to wax and wane with changes in government.
Macroeconomic policy could also be more supportive. In particular, the maintenance of the current (or even a lower) value of the exchange rate would encourage growth in net exports. The share of manufactured goods in exports remains significant and is higher than their share in overall GDP. Macroeconomic policy has for decades allowed the pound to be periodically overvalued against its trading partners, which has damaged the UK’s export performance, particularly in manufactures. Some UK regions have never fully recovered from such policy outcomes, and need something of a revival in manufacturing to potentially benefit from the processes of economic development.
Political and institutional reform may also be part of the policy package, and this has been much discussed by policymakers too. Devolution which gives more power and resources to local government could allow the introduction of policies better tailored to those who stand to gain.
A reinvigorated regional policy at the microeconomic level, a supportive macroeconomic policy, and institutional reform, as described above, could help to revive the neglected regions of the UK. It will take a real push over many years to turn around their fortunes, but if they could catch up with the richer areas of the country in terms of productivity and incomes, there would be huge benefits.