Sorting out the public finances Part 2 – Every part of the UK to pay its own way

The only thing more depressing than looking at the hard economic facts about our lowest performing regions is listening to the debate about how to solve the problems. There are two strands to this current debate. Firstly, there is a repetitive list of non-radical solutions (e.g. building new R&D facilities) to be found in all the Local Enterprise Partnership plans submitted yesterday to the Government. My reaction to these sort of solutions is the same as when an acquaintance told me that she was rejecting the normal treatment for cancer (aggressive surgery, chemo, radium, etc) and opting for the much more pleasant route of homeopathy. I wished her well and understood her horror at the thought of radical treatment. But I knew the statistics were against her. Such is the depth of the challenges in our low performing areas that only radical treatment will work. Secondly, there is a near universal clamour now for more devolution of power and money to the local level in the low performing areas. But this usually means devolving decisions on how to spend public money and how much to borrow, assuming that the tab will stick be picked up by others. Credible devolution has to based on requiring local areas to balance their budget locally. The problem underlying these two issues (avoidance of radical treatment and disbelief that low performing areas could ever balance their budget) is the lack of political leadership at a local level: the ability to own and explain the scale of the problem, to act swiftly and fundamentally to find solutions and to get people on board with the changes necessary. Oncologists have learnt how to do this. How could we rapidly help political leaders to be able to bring the right medicine to their areas? And, given it’s hard, do we really need to confront the problem?

At the height of its recent crisis, Greece had a fiscal deficit of 15%. This drew worldwide attention, threatened the European banking system and required an international bail-out in exchange for a brutal turnaround plan, supervised by the Troika of the IMF, the EU and the ECB. The UK’s deficit was also unsustainable, standing at 10% in 2011. However, this national average hid the fact that half of the UK had deficits which were as bad as Greece, or much worse. This meant that almost 3 times as many people in the UK lived in regions with worse deficits than Greece, with its population of just 11m. Three parts of the UK stand out, with 2011 deficits which were more than twice the level reached by Greece – Northern Ireland (39%), Wales (36%) or the North East (32%). But the rest of the North of England (NW and Yorkshire & Humberside) and the Midlands had higher deficits than Greece. By contrast, in 2011 London and the South East were in surplus, whilst Scotland, the East of England and the South West had UK average levels of deficit, albeit it at c10% they were high. A recent study suggests that Greater Manchester, one of the more successful cities in the North, is currently running an annual deficit of £5 billion per year, which would require local people to earn 30% more in wages and profits to break even. Whilst the deficit areas of the UK are now (rightly) asking for more devolution of power and financial responsibility, it is important to note that, ironically, it is only our highly centralised system of government which has stopped these areas going completely bust. Not only would 20-40% deficits have been unacceptable to lenders being asked to fill the gap in regional finances, but if these areas had had to do their own borrowing then the weakest of the areas (running a 20% deficit over 30 years) would find that the majority of their spending today would be on debt interest payments, leaving only 3rd world levels of funding for pensions, health, education, etc. Of course, the lenders would have called time on this situation many years ago, causing a collapse of Argentinian proportions.

There is a lot to do to solve the long-term problems we face. But I propose 3 things which I think are big enough to be game changing:

1. Legislate so that public spending and tax balance in each and every part of the UK within 15 years

We can’t just take regional fiscal deficits for granted – and we don’t need to. Given that the UK needs to balance its budget, it’s no way to run a country if half of it can’t pay its way – particularly if the situation is going to get worse. The main lesson of the Great Financial Crisis for the West was that someone always has to pay. At the moment the deficit areas of the UK have relied on income transfers from London and the South East. But clearly this isn’t enough, which is why the country still has one of the highest deficits in the developed world, in spite of tough cuts over the last few years. Even when the national deficit is eliminated in 2018, this will disguise the ongoing structural deficits in half of the country, some of which will remain in excess of Greece’s deepest crisis. Even if the south of the country could afford to subsidise the rest (which I doubt), it is a very risky strategy for the UK as there are many competitive threats to London and the South East. We all know what happened when we relied on the City of London to pay for the rest of the country’s public spending – it was great whilst it lasted and disastrous when global events turned against us.

So, my proposal is that every nation (Scotland, Wales, NI) and every region of England is required by law to balance its spending and revenue by 2030 and make prescribed progress every 3 years to this 15 year goal. This would include all spending – pensions, health, education, benefits, policing, local authority services, etc – with the exception of capital spending on economic infrastructure. The latter is lumpy (e.g. a high speed railway happens once in a generation) and a genuine investment in economic growth. The taxes (and other revenues) collected in the area would need to cover spending – eliminating any structural deficit. Rules would be set to allow for the economic cycle – small surpluses in good times, small deficits in bad times. Tough rules would also be set to force local areas to sort out their balance sheet – e.g. selling off their social homes given that market rents and social rents are similar in these areas, releasing tens of billions of pounds to reinvest in economic infrastructure like rapid transport links between Northern cities. The nation or region would be given a high level of fiscal devolution, as the only way to balance the budget is to increase taxes or reduce spending. This would be a dramatic step for the UK, which has about the lowest level of sub-national fiscal devolution of any developed country. But it’s necessary. And it’s also obviously possible, as we are going in that direction with Scotland. Irrespective of the independence vote, Scotland already controls the majority of public spending and is about to take on responsibility for the levels of income tax collected in Scotland, taking on the risk and reward of them rising or falling.

My law gives power and accountability to the national governments, but insist that the UK Secretary of State for each nation was equally obliged to achieve the fiscal balance. The national governments and the relevant SoS would be obliged to produce a 15 year plan, with 3 year milestones towards balancing the budget. This would need to be validated by the Office for Budget Responsibility (OBR). There would need to be a rolling 3 year budget, which is on track to hit the 3 year milestone. This would be validated by the relevant National Auditor. It is not so immediately easy to choose who should be in charge in the English regions. Ideally, there would, as in London, be strong Mayors leading the metropolitan city regions (Greater Manchester, South Yorkshire, etc). But there aren’t. There is lots of current debate about this. Well, maybe, we just need to bite the bullet and do it. One answer would be say that unless a city region chooses to have a Metro Mayor, then a Government Minister would be put in charge of balancing the budget in each city region. He or she would be democratically accountable, but clearly it’s less attractive than a directly elected local politician.

The UK Government would still play a vital role in tax and spend. Firstly, it would still have key national responsibilities, like defence and national security, national transport, economic regulation, etc. Secondly, it would put the financial might of the whole of the UK behind each nation and region’s fiscal position, issuing national bonds, managing the cash flow of spending and revenues, dealing with shocks to the system. Thirdly, it would do much of the administration for nations and regions, such as collecting taxes, paying pensions, etc – but they would pick up the tab in their locally balanced budget.

This fiscal devolution is tough medicine. But it also treats people like grown ups. We have seen how local government and the police have responded in the last few years to having to make large cuts in spend, in exchange for more freedom to make the best local fist of it. At the heart of this devolution is local political leadership and its ability to engage local people in the difficult choices in making the books balance. Much of this is about who pays what tax (e.g. more freedom on council tax rates or National Insurance charges), what levels of entitlement can be afforded (e.g. whether benefit rates or public sector pay should be regional rather than national) and which types of public spending are the real local priorities. But of course, the big opportunity to change the deficit lies in improving the local economy. My other proposals focus on the best ways to do this.

2. Double the number of 25-34 year olds in the designated regions within 15 years

There is a demographic crisis in the deficit areas. Overall population levels are predicted to be either static or have modest growth. But this disguises the problem. On the one hand, the population is growing because people are living longer. And this is what drives public spending – on pensions, on health care, social care, etc. On the other hand, in many areas, the working population is declining. And this is what causes tax revenues to decline. This is the worst possible vicious circle for a future deficit, let alone the local economy. We can see this clearly by looking at the Old Age Support Ratio, i.e. the ratio of the working age population to the retired population. In Leeds, for example, this is currently 3.2 (i.e. 3 times as many working age people as retired). But in 20 years time it will fall to 1.7. Even putting up the retirement age to 70 is not enough to maintain the current ratio. (It would need to be 72).

But why isn’t there a demographic crisis in the South? The answer is simple, if politically uncomfortable. More than a third of London’s residents were born overseas – compared to 1 in 20 in the North East. Indeed, there are now more foreign born people in London than there are residents of any description in the North East! London and the South East have about a quarter of the UK’s overall population but more than half of the foreign born residents. The pace of this divergence between the South and the rest of the UK has really accelerated in the last 15 years. A telling statistic is that until 2001, the North West had a bigger population than London. Now London has 1m more people. It has grown. The North West has been static (like the North East and Wales). 1m more foreign-born residents moved into London in this period. Merseyside, for example, attracted just 29,000 additional foreign born residents between 1995 and 2012. Its working age population will fall by up to 15% over the next 20 years.

It’s very hard to see how the deficit areas can turn themselves around without a major inward migration of working age people. The critical group to attract is the 25-34 year olds. These are the wealth creators, who have turned around many cities in the world – including London. Given the challenges facing the deficit areas, there is a need for a massive increase in the size of this group and it is urgent. Therefore, I propose a target of doubling the size of the age group in the deficit areas within 15 years. That would add about 10-15% to the total population in each of the areas. This is the sort of growth that London and the South East have experienced in the last 15 years. Starting in 2015, this could be a “15 in 15 from 15” strategy.

Where will all these people come from? Well, it’s too late to start breeding, as today’s new born won’t join the labour force in the next 15 years. So it means attracting young people from elsewhere. Partly this can be from other parts of the UK, especially the South. We could adopt a number of targeted policies to achieve this. For example, many of the deficit areas attract large numbers of students, but then struggle to retain them once they graduate. Perhaps we should offer a 5 or 10 year holiday on repaying student loans for those stay in the area to which they moved to study? Perhaps we could offer government backed mortgages for first time buyers who relocate into the area, where payments start low and rise in line with inflation over 25 years (rather than the current opposite which undermines home ownership aspirations for all)? But a large part of the increase will probably have to come from immigration. Let’s save a full argument about immigration for another post. Suffice to say here that I think we need high levels of immigration for 2 reasons – our ageing population and our need to attract the world’s best to the UK – but it needs to be the right immigration, so we need much more control of who comes to the country. In this spirit, one answer to the problems of the North would be offer location-specific visas, entitling people to live and work in a named city or region. This isn’t as impractical as it may first sound. We already do this for the largest group of visa holders – students. A visa is tied to a particular course at at a particular university – if the student fails to attend or leaves the university, the visa is revoked. So it’s entirely feasible to do this for designated areas of the country, perhaps attaching a visa to a job / running a business and payment of Council Tax in the area. This doesn’t just mean offering visas to non EU countries (e.g. to the young Australians, Canadians and South Americans) and seeing what happens. It should also mean investing very heavily in head-hunting the best in the world. Silicon Valley is what it is in large part due to the active recruitment of India’s best software engineers. Why don’t our deficit areas employ headhunters and offer incentives to the world’s smartest 25-28 year olds – the products of the world’s best universities in design, business, applied science, etc and those trained by the world’s best corporations. They aren’t hard to find, but they need a hard sell … and visas.

There is clearly also a hard sell needed within the deficit areas to convince people, who feel that there aren’t enough jobs or public services for those who already live there and believe, wrongly but passionately, that more people moving into the area will just make everyone worse off. It’s not easy to explain the complexity of labour market economics or fiscal sustainability. Let’s try a one word explanation – “Suarez”. The immigration of a Uruguyan into Liverpool has transformed the fortunes of the football club and the morale of at least half of the city. It has also lifted the global status of the city. (The other half of the city has been cheered by the genius of their new Spanish manager.) As Liverpool are poised to win the Premier League, I haven’t heard many local voices calling for South Americans to be sent home so a local lad can have the job! We need the same attitude to the economy as we have to football – busting a gut to get the world’s best people to come, in large numbers, to our deficit areas.

3. Create a bigger private sector in the deficit areas

In half of the country, less than half of working age adults work in the private sector economy. In South East, the richest region, two-thirds of working age adults work in the private economy. In South Wales, it less than a third. Throughout our northern cities (and the largest cities in the Midlands), 6 out of 10 working age adults are not working in the private sector. This includes major business centres like Manchester and Birmingham.

How can we possibly balance our national budget if this continues? One-third of the population is retired, the school leaving age has been raised to 18 … so how can we pay our way if less than half of the working age adults are employed in the private economy? The first problem is simply that in the deficit areas not enough people work, irrespective of who they work for. In the most prosperous parts of the country 9 out of 10 working age adults are in employment. In some of biggest Northern and Midlands cities, this falls less than 6 out of 10. The second problem is that not enough people work in the private sector. The average UK ratio of private to public jobs is 3:1, i.e. three-quarters of jobs are in the private sector. In the most successful areas of the UK, there are 6 private sector jobs for each 1 in the public sector. In the deficit areas many areas struggle to achieve 2:1. In Cardiff and Swansea, for example, there are only 3 private sector jobs for every 2 in the public sector. The problem is not too many public sector jobs. It’s a shortage of private sector jobs. Often the areas with a high proportion of jobs in the public sector have the lowest levels of people working in any sector. One rapid answer to this problem is to move the public sector into the private sector. This is not ideology, but pragmatism. Local public bodies rarely bring any income into the area – they just meet local need. But turn them into real businesses and they will be incentivised to draw business into their area (e.g. taking over the back office functions of public bodies in the high cost South East; attracting overseas private patients into local hospitals; diversifying from public revenues to win private sector business like the Teachers Pension Agency in Darlington has done by winning work from the life insurance industry in London; etc). One would expect the deficit areas (with lower costs and slack labour markets) to have attracted a lot of outsourced activity from higher cost, tighter labour markets. However, the opposite is true. London and the South East earn twice as much income (wages and profits) from outsourced businesses as the North West, Wales and Northern Ireland. Not only does privatising public services offer the chance to bring in external revenue, it also gives a unique opportunity for a dramatic shift in culture in the deficit areas from a public sector focus to a new entrepreneurial era. But this won’t come by simply asking large, Southern based corporations to take over public bodies. My proposal is that we mandate, within 3 years, the transfer of public services (apart from the police) to new employee-owned businesses. The models for this in the private sector are outstanding – world class organisations like John Lewis and Arup. Having our teachers, doctors, nurses, social workers, highways engineers, etc owning their own company and having to compete for contracts every few years would mark a historical change in the economy and culture of the deficit areas.

Conclusion

This is radical treatment. And probably no more popular with many people than being told they need radical medical treatment! But balancing the books, importing a workforce that can pay for the ageing society and turning millions of public sector staff into business owners are the sort of measures which could change the survival rates of our struggling areas and, just as importantly, ensure that the whole country can pay its own way. I am not naive about how hard this is for any politicians. And before my radicalism is dismissed as Southern arrogance, I would note that I spent the first 25 years of my life in the North West. When I was little my dad and grandad both worked on the Liverpool docks, then as they were closing we moved for a new job in a factory in the false dawn that was Skelmersdale New Town, where within 15 years most of the new factories closed down too. So I know this is a tough assignment, but I also feel passionately that it must be grasped.

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