The left-behind economy and what to do about it

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The key fact about everything in contemporary politics, more or less everywhere, is that it happens in the context of an actual or potential takeover by illiberal populists. So from time to time, it’s worth pausing to think about the root causes of the populist insurgency in liberal democracies. Regular readers will know that I put one cause at the top of that list: the persistent rise in regional inequalities, which fuel what economic geographer Andrés Rodríguez-Pose calls “the revenge of the places that don’t matter”.

We are understanding the sources of regional divergence better and better — at least if we are willing to look for them. This week’s column surveys some recent findings worth your time. Spoiler: there is good news and there is bad news.

It has quickly become a classic exhibit of how the political economy of space matters: a paper on how competition from China affected industry in different parts of the US very differently, by David Autor, David Dorn, Gordon Hanson, Maggie Jones and Bradley Setzler. This paper found that:

. . . The adjustment of places to trade shocks is generational: affected areas recover primarily by adding workers to non-manufacturing who were below working age when the shock occurred . . . Contrary to standard models, trade shocks reduce geographic mobility . . . Although worker inflows into non-manufacturing more than fully offset manufacturing employment losses in trade-exposed locations after 2010, incumbent workers neither fully recover earnings losses nor predominantly exit the labor market, but rather age in place as communities undergo rapid demographic and industrial transitions.

The point here is that differences in economic structure mean big shocks hit places very differently. And that means historical economic specialisation can cast long shadows. Very long shadows: a fascinating new study shows that in Germany, places that had more steam engines per worker in 1875 (!) have higher wage levels today.

But although the US rust belt gets much of the attention, the general importance of regional differences applies everywhere and the mechanics of disruption can be a lot broader than just sudden import penetration from China. The political backlash from feeling left behind is also broad — a new study by Will Jennings at the University of Southampton shows how a sense of local decline and wounded pride contribute to eroded trust in political elites.

So it’s necessary to expand our focus. A recent symposium in the public economics journal Fiscal Studies contributes to that. The journal has published three research articles, each identifying different causes of the outsized levels of inequality between different parts of the UK.

One article reveals that, after the global financial crisis, banks perceived greater risks to lending outside London than in the capital (see chart below).

As a result, the risk premium — the extra interest rate charged on loans to non-London borrowers — expanded, presumably pricing some projects out of economic viability. It is easy to see how this could support a vicious cycle: banks perceive greater risks and lend less or at higher rates as a result, which ruins profitability and makes otherwise good projects riskier than they would otherwise be, vindicating the banks’ original worry.

Another article reports a very high rate of university graduates who leave their hometown: 44 per cent on average, although this varies, unsurprisingly, with the level of the graduate wage premium. In other words, the fewer opportunities there are that reward the time spent studying, the less graduates want to stay. While they may not then go on to stay in London forever, they tend to move to the surrounding suburbs while staying inside the London job market rather than returning to the towns they left behind. 

Finally, for the underprivileged or deprived, it really makes a difference where you live. A third article documents large regional variations in the degree of intergenerational mobility:

For example, among men who grew up in Hackney, the average gap in adult earnings rank [in the national distribution] between those from the poorest and richest neighbourhoods is about nine places, compared with nearly 30 places in Blackpool and Bradford.

I promised you good news. So here is one positive: what studies such as these show is that, long shadows of history notwithstanding, we need not be fatalistic about regional differences in growth. These findings also point to policies to improve regional inequality and raise productivity for left-behind places. For example, to address the lower supply of financing outside of London, you may want to look for differential regulation or tax policies that compensate or counteract the higher risk that banks perceive, or put in place public financial institutions that could fill the gap. Perhaps there is a need for a 21st-century version of the local savings bank, or an analogous institution that could also mobilise equity funding towards lifting local productivity.

To address the flight of graduates, you need policies that encourage more graduate-level jobs outside the capital. A few years ago, I wrote that the pandemic gave us all a crash course in remote working and that it would be a shame not to harness this into a concerted strategy to make companies spread out such jobs more widely. The third study shows that social mobility can be high, even in poorer places, and suggests we look at how to replicate the sources of mobility in those areas that lack them. If access to a large and dynamic labour market is the reason, then that can be automatic if you are a London borough, but otherwise requires transport links, educational investment and (again) policies to encourage remote working for advanced jobs. But the point is that we are not bereft of solutions.

It is also crucial to observe that these findings all point to domestic policy opportunities. There are clearly common dynamics at play since virtually every western country now has higher regional inequality than four decades ago. But even if the ultimate causes lie in deep technological and economic transformations over the entire rich world, there are plenty of solutions available at the national (or sub-national) level. Neither globalisation nor alleged international constraints (hello, Brexit) are any excuse.

And the fact is that regional challenges can be overcome. The Centre for Cities has just published a report focusing on British cities and towns that have grown faster than the national average over the past decade (some press coverage here). What they had in common was an ability to increase the share of knowledge-intensive business services jobs in the local economy. Governments could do a lot worse than look at such examples, see what they have got right and help replicate it across their left-behind areas. They may find that the politics get detoxified at the same time.

Other readables

● Emerging middle powers may welcome the end of the hypocrisy that came with the western-led liberal international order, but they should be careful what they wish for, I argue in my latest column on Mark Carney’s much-noted Davos speech.

● Should we really care about government debt-to-GDP ratios? Other indicators of public debt burdens show less cause for alarm.

● Electric vehicles outsell petrol cars in Europe for the first time.

● The Russian refinery that Berlin cannot afford to lose.

● Could Europe defend itself without the US?