Regional Economic Disparities

A Failure of Policy

By David Starkie, University of Buckingham

The United Kingdom of England, Scotland, Wales and Northern Ireland, forms a single polity for major policy issues including defence, foreign affairs and higher level economic matters. For the latter, the UK operates also as a common market with a shared currency and monetary policy, together with a fiscal regime that is fundamentally uniform. These institutional characteristics transcending as they do state boundaries, generally are taken for granted and discussed relatively little. During the fraught Scottish independence debate just over a decade ago, whether an independent Scotland should have its own currency was far from agreed upon. Even the National Party (SNP) promoting political separation, accepted a position of sharing Pound Sterling, until a new political and economic architecture was developed.

Nevertheless, the existing, economic framework of the Union begs an important question. Does it comply with critical criteria laid down in the seminal 1960s work of Robert Mundell on optimal currency areas (OCAs). Mundell’s suggested that if shocks, both endogenous and exogenous, emerged at a regional level, differentials in the market price of factors of production (labour, raw materials etc) should emerge, in turn encouraging their movement into or out of the region concerned, thus gradually lubricating, and equilibrating the overall economy of a common currency area through the mechanism of differential prices. If these differences were impeded in some way, disparities in regional incomes, employment and wealth would continue thus placing a strain on the currency union and, ultimately, on the shared polity.

Superficially, the UK appears to comply with the tenents of an OCA, (arguably more so than in the European currency union where a single market allowing free trade in services has yet to be fully implemented). Throughout the UK labour, capital, goods and services are permitted to flow freely. Despite which, contrary to theoretical expectations, there are (very) long standing regional economic imbalances. Before, and particularly in the decades following WW2, governments of all persuasions, sought to respond to the problem with often elaborate regional policies seeking to nullify spatial imbalances. These policies, usually transient, were hugely varied and at different times involved extreme restrictions even limiting office development in south east England, and payroll tax-subsidy scheme that discriminated in favour of regional manufacturing (the Selective Employment Tax). There were also many more mundane, run-of-the-mill type measures including subsidising the provision of factories in lagging regional economies and providing generous transport infrastructure in peripheral areas.

Regional assistance policies, in their varied forms with varying emphasis, have been applied for well over 75 years, and have had some success in equilibrating core rates of economic activity. However, for good reason, the ‘levelling up’ agenda remains a strong policy goal in Westminster. Economic activity rates continue to lag significantly the national average in Wales, Northeast England, and in N.I. (See Table 1). Scotland, on the other hand, once considered a markedly lagging regional economy, was boosted particularly by the discovery and development of a natural resource, hydrocarbons in the 1960s onwards. Its activity rates converged on the English average albeit after substantial fiscal transfers, largely through a block grant.

Table 1: Headline estimates for regions of the UK, seasonally adjusted, July to September 2024.

Source: Adapted from Labour Force Survey, the Office for National Statistics

Notes:

1. Calculation of headline employment rate: number of employed people aged 16 to 64 years, divided by the population aged 16 to 64 years. Population is the sum of employed, plus unemployed, plus inactive. 

2. Calculation of headline unemployment rate: number of unemployed people aged 16 years and over divided by the sum of employed people aged 16 years and over plus unemployed people aged 16 years and over.

3. Calculation of headline economic inactivity rate: number of economically inactive people aged from 16 to 64 years divided by the population aged from 16 to 64 years. Population is the sum of employed plus unemployed plus inactive.

The continuation of regional imbalances elsewhere should not come as a surprise, however. There is a basic flaw in the design of policy, indeed, a fundamental contradiction, taking with one hand whilst giving with the other. Although economic agents are permitted to flow freely throughout the UK, the essential control mechanism directing this flow, the differentiated level of prices, is severely compromised and distorted, particularly by state intervention in labour markets. The State confuses and confounds the system of price signals that are essential for the efficient working of the equilibrating process.

It does this, for example by setting public sector pay nationally thus in some regions renumerating employees to an extent that is in excess of broadly private sector equivalents, and vice versa as shown in a recent carefully considered analysis of hourly pay rates undertaken by the Institute for Fiscal studies (see Figure 1). Although the public/private wage disparity is much reduced compared with two decades ago, the differences remain marked, being more than 5 per cent higher in Scotland and the North East region. In addition, there are other job attributes, such as pensions and job security, to consider which also tend to favour public sector employment.

Figure 1: Public sector pay differential conditional on workers’ characteristics, by UK region and nation

Source: IFS

Note: The differential is calculated controlling for age, education, experience and region, all interacted with sex, and interactions between education and experience. Figures are for hourly pay and exclude pension contributions.

Given that public employment accounts for a sizeable proportion of regional totals, generally between one-fifth and a quarter in the afore mentioned regions, when public sector wages exceed those in the private sector, the effect is to benchmarks wage rates for the latter. Consequently, private sector renumeration is inflated above its naturally occurring level. In turn, the overpriced labour market deters inward private investment and thereby reduces regional economic growth. It is a market distortion which cannot be corrected by exchange rate movements in view of the common currency area throughout the UK. Although It can be argued that inflated public sector wages boost local spending-power and thus regional economies a better way of achieving such an outcome for the same level of expenditure is to add to the block grant leaving wage rates generally at market clearing levels.

Figure 2: Installed and planned wind power generation.

Source: Wikipedia

Labour market intervention is an important but far from the only way in which the state distorts regional pricing signals. Another example is its control of the electricity transmission system and a strong inclination to uniform wholesale electricity prices despite the growing importance of northerly located wind generation in the electricity mix (see Figure 2). An alternative zonal pricing approach is more likely to attract energy intensive manufacturing, and services such as power-hungry data centres, to the English north and Scotland. As matters stand the natural resource advantages of the north (potentially cheaper labour and electricity) are nullified by contradictory labour and energy policies that for the purposes of the ‘levelling up’ agenda resemble trying to push water uphill.