‘Levelling up’ has become one of the big agenda items for this government but how can it be helped by industrial strategy?
In recent decades the UK’s regions have diverged so much that we are now the most unbalanced economy in the industrialised world. London was the same size as the North of England as recently as 2004 but its GDP is now a quarter larger. Britain is home to both highly productive Cambridge and London, and places that are less productive than parts of East Germany before reunification.
The Conservative Government won last December’s election with a mandate to rebalance the economy and address this regional productivity gap. Whoever runs Downing Street, they must not forget that. But how should they achieve it?
We know that productivity increases partly because people innovate – and research and development is essential to innovation. Through R&D activities, businesses develop new products and services that not only generate private profit but create valuable knowledge and efficiencies that spill over locally and nationally.
Unfortunately, there is no clear correlation at the regional level between private sector R&D activity and public funding for innovative projects. This means that private innovation in poorer regions is often not being supported by the taxpayer, while other, already-productive parts of the economy receive considerable support.
The Government has already committed to increasing overall R&D intensity to 2.4% of GDP by 2027. The best way to spend this extra funding would not be to pile more subsidy into London and the South East but to use the Spending Review and R&D Place Strategy to increase support for business innovation in lagging regions.
Innovate UK, the UK’s innovation agency, should take explicit account of geography when allocating grants to bolster innovation. This would ensure funding more closely matches the spatial distribution of private sector R&D spend and give greater weight to the positive externalities that would follow in low-productivity areas, thus rebalancing the economy.
And the best bit? Because this is about better distributing new money, not redistributing existing budgets, it wouldn’t mean some places lose out.
Industrial strategy often sees the economy in terms of industrial sectors. But this view is incomplete. Urban economies with their local labour markets are the building blocks of the national economy.
Jobs are clustered in cities – although they account for 9 per cent of Britain’s land area, they contain 59 per cent of all jobs. This is most acute in city centres – they account for just 0.1 per cent of the country’s land area, but include 14 per cent of all jobs.
Although it’s difficult to predict which industrial sectors will grow and shrink in the future, we know that ideas and innovation depend on the benefits cities offer – namely access to skilled workers and other skilled businesses. And so the sectors that will drive growth in the future – whatever they will be – will be looking for a city that provides these businesses.
The problem for the UK – and a cause of its productivity problem – is that its biggest cities are not offering these benefits to the extent they should. While bigger cities are typically more productive in other countries, there is an annual £47 billion gap between the actual and potential output of the eight biggest cities outside London. Manchester, Birmingham, and Glasgow alone account for 70 per cent of this gap.
Focusing only on sectors wont address the reason why high-skilled businesses do not locate in sufficient numbers in certain parts of the country. And the UK’s productivity problem and levelling up challenge will persist.
This is why a new industrial strategy must focus on place. It must get our biggest cities, especially Manchester, Birmingham, and Glasgow, to play the role that the national economy needs them to play.
A lot of the policy chatter about how to level up has focused on shiny new infrastructure or high-risk, high-reward tech innovation – from the £600bn Rishi Sunak promised in March for ‘roads, railways, broadband and homes’ to the promise of a new ‘MIT of the North’.
All of these are worthy ideas that should contribute to narrowing the regional inequalities in economic performance that have seen London steam ahead and the Midlands and the North fall behind.
But these aren’t the only inequalities we need to address to truly level up. Stagnant pay and insecure, low quality work has led to a rise of in-work poverty across the country, and the chance of being trapped in poverty is highest in cities and towns in the Midlands and the North of England.
Looking into the data we found that higher local productivity is related to lower poverty rates but only weakly. Raising wages at the bottom of the income distribution and increasing the number of people with at least GCSE or equivalent skills are both key to levelling up living standards.
So, here are three things the industrial strategy must also do to deliver for people currently trapped in poverty:
We should not expect to a nation-wide ‘UK’ industrial strategy to ‘level up’ the country. Our country is made up of regions, towns and cities – these are the geographies that people and businesses use every day to grow the local, regional and national economy. All of these places are different and complex, beyond the imagining of Whitehall.
In recent months, we’ve had another reminder of how badly central government strategies work when they come into contact with reality on-the-ground. This applies to economic management as well as public health.
Expecting a national industrial strategy to support regional growth is back to front: instead, levelling up devolution will support the national industrial strategy. There are already local industrial strategies for much England, but central government won’t give places the power and resources to implement them effectively.
That’s why the government must deliver on longstanding promises to devolve important economic powers. They should let places that want more have more – there is no sense in going at the pace of the slowest, and holding back the ambitions of Greater Manchester, the West Midlands and London. Devolved funding and responsibility is long overdue for investing in innovation, delivering transport infrastructure projects, funding 16-19 education provision, and providing employment support.
Ultimately, we should have local, regional and national industrial strategies – implemented by accountable agencies at each level. That’s how economic policy works in other countries, and that is a major reason why similar countries like Germany and France are both more productive and more regionally equal.
From the Soviet Union to 1970s Britain, industrial strategy inevitably fails because the state is incapable of picking winners and losers. Its latest incarnation — an effort to force regional growth — will similarly end up misallocating scarce resources. It will lead to government-supporting zombie companies and failing industries, in the longer run leading to lower wages and more joblessness.
The Government should pursue policies that enable the economy to flourish while taking barriers away to levelling up. The focus should be on making it as easy as possible for businesses to operate and flourish. They can start by Abolishing the Factory Tax: allowing businesses to immediately deduct the cost of all capital purchases, encouraging investment in machinery and buildings essential to the levelling up agenda. In addition, lessening the burden on employers through lowering or removing National Insurance contributions would encourage more hiring and more growth in traditionally stagnant sectors.
R&D investment and infrastructure projects also form part of their industrial strategy. In this regard, the Government would do well to allow the private sector to pursue advances in technology based on permissionless innovation — only regulating should harm arise. In practice, this would mean pursuing a mammoth red tape cutting agenda to get rid of the regulation that strangles businesses. For infrastructure, the Government should scrap expensive, negative return projects like HS2 in favour of more regional and east-west transport links. It’s not as exciting as train lines, but express bus routes that take people from towns and villages into nearby cities are the missing link that could allow people to prosper.