What’s Good for London Is Mainly Good for Britain

Is London good or bad for the rest of the Britain? I posed this question a few weeks ago and since then, perhaps by coincidence. there has been quite a lot on it.

Most notable was Vince Cable, the business secretary, who last month said London “is becoming a giant suction machine draining the life out of the rest of the country”. For a cabinet minister who constituency is in a London borough, albeit one whose constituents do not want to see a Heathrow expansion, that was brave.

Is he right? As promised, my answer, and I want to be methodical. So it comes in three parts. Does London distort monetary policy by imposing higher interest rates on the rest of the country than it needs?

Second, on fiscal policy, does London prop up other regions or drain fiscal resources from them? And finally, what are the dynamic and supply-side effects of London’s dominance: does the business it generates for the rest of the country outweigh the talent it draws from them?

London’s dominance is not in doubt. Its population exceeds the next 14 British cities combined. The Greater London built-up area, as defined by the Office for National Statistics, has more people, 10m, than the next six (Greater Manchester, West Midlands, West Yorkshire, Liverpool, South Hampshire, Tyneside) put together.

How does that affect monetary policy? The late Eddie George (Lord George) got into trouble in the 1990s after Bank of England independence for implying high north-east unemployment was a price worth paying for low southern inflation.

Monetary policy has to balance the different economic performance of regions in the area in which it operates. That task is a lot more demanding in the eurozone.

In the case of Britain, however, it is a stretch to say that monetary policy over the past two decades (including the period immediately before independence) has been too tight because of the London effect.

Most economists would agree interest rates should have been higher in the period running up to the crisis to curb demand for credit and cool housing and commercial property. It is hard to argue that the ultra-loose monetary policy of the past five years would or should have been any looser.

So London is not guilty on the monetary policy charge, with a caveat. This was sterling’s strength from 1996 to 2007, which helped cut manufacturing’s share of gross domestic product from nearly 20% to 11%.

That strength, we now know, was directly linked to overseas flows into Britain’s banking system, as banks expanded at breakneck pace. This was a period, admittedly encouraged by the then government, when London’s role as an international financial centre was in conflict with the success of manufacturing.

What about London’s fiscal position? It may surprise some people to learn that spending on public services per head in London, £9,757 in 2011-12, is above both the English (£8,618) and UK (£8,877) averages. Wales, Scotland and Northern Ireland all have higher spending per head than London but no other English region does.

Fortunately, London typically pays more into the Exchequer than it gets out. Professor Tony Travers of the London School of Economics estimates that surplus of revenues over spending to be between £10bn and £20bn in normal times.

He chaired Boris Johnson’s London Finance Commission, which argued for greater fiscal autonomy for the capital, not least to provide greater local incentives for, for example, more housebuilding. His report fell a long way short of calling for “city-state” independence for London, though there is a far stronger fiscal case for that than Scottish independence.

What about the trickier question: the “suction effect” of the London economy versus its ability to generate growth elsewhere in Britain? Costas Milas of Liverpool University has just done an exercise comparing growth rates in London and the rest of the country from 1997 to 2012.

Though growth rates vary between regions, they are always positively correlated. Growth in London is not, in other words, at the expense of the rest of the country, to the point where the regions experience a decline in economic activity.

The Centre for Economics and Business Research, under Doug McWilliams, came up with similar findings a few years ago, concluding that London, by providing demand for goods and services in the regions, and fiscal transfers, was good for the rest of the country.

This positive London effect can be seen in detailed data. Most of the jobs and orders for London’s Crossrail project are outside the capital. In 2012-13 the project supported 13.800 full-time jobs, 8,310 of which were outside London, as are 62% of the firms which have won orders on the project.

A study by PWC for London First found central London office developments are worth £1.7bn a year of economic output and 34,600 jobs, £1.1bn and 22,400 of which are outside London. The capital is sucking in goods and services from the rest of Britain, and that is a good thing.

Even financial and professional services, often thought to be a London-only thing, are regionally well spread. Of the combined employment total of just over 2m, slightly fewer than a third, 663,600, is in London and 41% of gross value-added.

It is not all one way. The CEBR’s McWilliams wonders whether what looks like a straightforward economic message – what’s good for London is generally good for the rest – fully picks up dynamic effects. When does London’s advantage become so great, that other regions become starved of investment, drive and talent to the point that they can never keep up? When does London become the cuckoo in the nest?

It may happen. In more normal times London could become the equivalent of Germany in the eurozone, and impose too high interest rates and too high an exchange rate on the rest. The brain drain from the regions could do irreversible damage. Some say it already has.

None of this means we should embark on a process to restrain London’s growth. That was the failure of post-war regional policy. Levelling-down leads to disaster.

London’s success is Britain’s success. It does, on balance, benefit the rest of the country. The key is to increase that success, by improving growth prospects in the regions. I’ll address that very big subject in a couple of weeks.

This piece is cross-posted from EconomicsUK.com with permission.