Centre for Cities

What’s good for Reading may also be good for Burnley - reflections on local government finance reform

The government’s latest thinking on the Local Government Finance Bill has prompted lots of reflections and commentary – much of it demonstrating little understanding of economics or the basic trade-offs that the new local government system has to consider. 

While we would welcome a Bill that had stronger incentives for growth including enabling local authorities to keep more than 50% of their business rate, we also recognise that legislation is devised in the context of a whole system and trade-offs have to be made.

It would be nice to be able to devise a local government funding system that maximises the incentive to pursue growth for some places whilst simultaneously providing an equitable system of redistribution and security for others. But with no additional funding on the table, this simply is not possible. 

Local authorities, pressure groups and other commentators could make a more useful contribution to the debate if they weighed up the pros and cons a bit more and evaluated their position in the context of the balance the whole system is trying to strike.  My reflections on the trade-offs involved within the proposed system are set out below.

Growing the size of the pie vs redistributing the existing pie

Much of the debate has been about winners and losers and who will get what under the new local government funding system. This downplays the real issue which is how to structure the new system in order to maximise growth and thus increase the total amount of money within the system so that everyone can get potentially get more. For example, if the incentive is sufficiently large so that Reading is encouraged to increase its business rates growth, then it will get to keep 50% of its resulting larger business rates pot. But Reading will also send 50% of this larger pot back to the centre to be reallocated to less successful places such as Burnley. The opposite is therefore also true.

Our research suggests that allowing authorities to retain a greater share of their business rate growth will create net economic benefits for the UK. If this plays out then there will be more money available via the central pot to redistribute to those places that are less able to grow their business bases. So what’s good for Reading should also be good for Burnley.

Safety nets vs growth incentives

For an incentive to work most effectively there must be a downside. In fact avoidance of the downside may provide a more effective incentive than the benefits of the upside. Therefore any safety net acts as a disincentive. If it is overly large or kicks-in very early it will reduce the effects of any growth incentive, particularly for those authorities that sit around the line between being top-up and tariff authorities. The system must work so that it always makes more sense for a city to go for growth than to rely on redistributive handouts.

Pooling vs competition

While much of the discussion has focused on the 50% retention rate, the government has also missed an opportunity in not providing incentives for pooling at the level of the functional economy. One of the likely effects of this will be increased tax competition between authorities as they vie to retain their existing businesses and attract new ones to their area. In some places this could result in a ‘race to the bottom’. If you’re in any doubt that this increased competition could happen, have a look at how authorities in the USA use their variable tax-system to do just this. If we want less competition, then we need to encourage more pooling. The new local government finance system should do more to encourage this – even if this is simply through explaining the benefits more clearly.

Because of the competing interests within this Bill — cities with stronger and weaker economies, central and local government, growth incentives and equitable redistribution — it was never going to make everyone happy. Understanding and respecting the notion of trade-offs is the framework in which discussion of the most effective local government system should be placed.

More money, more power: Now Government means business with business rates

Over a year in the making, the Local Government Finance Bill is finally taking some shape. Before everyone starts partying like it is Jubilee weekend, there are some really important details to consider.

First, I have some kudos to give for the Bill. There are some positive changes from earlier versions:

• Overall, there is more recognition that this Bill can be used to incentivise growth (among Government’s other goals).
• The Government has come forward with a rather large incentive of 50 percent retention of additional business rates, well in line with what the Centre for Cities has been suggesting.
• Local authorities will be able to pool their business rates, reducing volatility and giving more opportunities to fund cross-border infrastructure and skills programmes. There is also a greater emphasis on pooling across a functional economic area.

However, there are some issues we think still need some work.

• Clarity: The design of the system is complicated and unclear. It will be difficult for authorities (and voters) to understand just how much additional development will benefit them, which reduces the effect of the incentive.
• Certainty: The system is designed with an initial 7 year reset period, which can be changed at a later date. This means the most certainty of income an authority will receive for a new development is seven years, and this may lead to a delay incentive. I have previously argued that at least 10 years between resets—preferably 20—would provide the certainty needed for authorities to act on the incentive.
• Rewards: The system only rewards authorities for building new commercial property; it doesn't incentivise converting old properties to suitable uses or investing in the public realm. To ensure the policy encourages business growth everywhere, a more compreshensive system would reward different development improvements that increase property values.

Now, the onus is on cities. Given the complexity of the Bill, local government will need to understand how the system works and how their city can benefit from bringing forward new development (not an easy task).

Also, cities may have to work harder in the current economic climate to realise the benefits of rates retention, as building rates are lower outside London and the South East. But, those authorities which really take this on will see benefits to their cities, and that’s the point - rewarding places for taking difficult decisions and going for growth.

Note: Evidence demonstrating the potential effects of the business rates retention incentive have been published using supporting evidence from previous Centre for Cities research.

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The Queen’s Speech is not the answer to growth

Many commentators have noted the absence of specific measures on the economy in today’s Queen’s Speech.  Should we be surprised at this brief reprieve from a Government keen to convince the electorate – and the markets – that it’s on the right side of the argument on reviving the economy? Probably not.  Most of the choices facing the Government when it comes to growth are non-legislative and the strength of the economy in 2012/13 is not going to depend much on the Bills making their way through parliament. 

This is not to downplay the seriousness of the economic challenge ahead.  Weak demand is the major challenge facing the UK economy, and the relentless focus on reducing the deficit, and resulting squeeze on public spending and domestic demand, is simply making this problem worse. The Government needs to find ways to stimulate demand in the economy, and most of them don’t require legislation. Here are some key measures that would make a real difference to creating demand in the UK economy now, thus making a difference to city economies, and ultimately national growth: 

• More than HS2: Even if we accept the Government’s claim that there has not been a delay in HS2, the silence on other infrastructure projects is worrying.  Are all the Government’s eggs in one basket, and is it losing its nerve even on this? The Government intends to cut public infrastructure spending by a quarter in real terms over the next five years, yet we know that investment in infrastructure would create short term jobs in construction (which the latest figures showed was struggling) and has been shown to have long term benefits for growth. Northern cities could also benefit from investment in some local transport projects to unlock congestion, as well as benefiting from the local jobs.
• Triple the New Homes Bonus: To boost house building the Government should triple the size of the New Homes Bonus.  The Bonus is currently too weak to incentivise development in high demand areas. The Government should also review barriers to more houses being built in areas where there is greatest demand – we’ll be doing more work on this at the Centre.  
• Focus on the places with highest levels of unemployment:  Long term unemployment has a long term impact on demand as well as individuals; it means that people lose skills and tend to move into less productive jobs, which in turn makes it harder for local economies to grow and generate demand. More needs to be invested in policies to respond to the challenges of unemployment and they need to have more of a place-based focus. Some cities have seen much greater increases in unemployment than others and initiatives tackling unemployment – such as the Work Programme and the Youth Contract – should reflect this place-based variation.  For example, the value of the Youth Contract should increase in cities with the highest levels of unemployment.;  
• Deliver on City Deals: The City Deals confirmed so far – Manchester and Liverpool – both contain measures to stimulate demand, from the investment in infrastructure and Earn Back in Manchester to the Enterprise Zones in Liverpool. The Government must now move quickly on its negotiations with the remaining 6 Core Cities and ensure that these have a strong focus on jobs and economic growth. The Government must also decide how and when it will extend City Deal conversations with cities beyond the first round, and be clear about its approach to growth is post-mayors and local elections.   
• Stimulate local growth: The Local Government Finance Bill has the potential to incentivise local authorities to be more growth orientated.  We recommend that authorities should be allowed to retain at least 50 percent of the growth in the their business rates for at least 10 years.

The Government has already moved quite far from its 2010 "get out of the way" approach but it must and can do more.

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The double dip may be nothing new for some cities

Today’s GDP data release shows that the UK has officially re-entered recession. While this comes as somewhat of a surprise at the national level (consensus appeared to be predicting a small expansion of the economy), it is likely that some of our city economies re-entered recession before the first quarter of 2012.

Our most recent Labour Market Update showed that the claimant count has risen steadily over the last year in Derby. But it is not alone – its neighbours Nottingham and Mansfield have seen similar patterns, while Cardiff and Belfast have also seen steady increases. While the link between output and unemployment is not a straightforward one, it does suggest that these cities may have already been experiencing a double dip recession in the second half of 2011.

If the national economy is going to recover from a downturn that has persisted for four years now then it will require its cities to lead the way – they contain 58 percent of jobs and are responsible for 61 percent of output. The problem currently from a policy point of view is that very little is understood about where growth is going to come from, or how this will vary from city to city. This makes policy aimed at supporting economic growth more difficult to formulate. The Centre for Cities hopes to shed some light on this through research that we will release very soon looking at the make-up of the business bases of our cities, and setting out what this means for the policies that government and cities should be adopting to support stronger economic growth.

Watch this space.

A strategy for cities and growth go hand in hand

While the preoccupation with "pasty tax" rumbled on in the background, this morning we turned our attention to the bigger questions on the Budget: does the Government have a coherent strategy for growth and is the economic potential of cities being harnessed to full effect? 

Vince Cable set out his thinking on the Budget within the government’s economic growth strategy, highlighting the enormity of the economic “heart attack” that the economy is still recovering from, the importance of stimulating demand and the necessity of easing access to finance, especially for SMEs.  Sir Merrick Cockell, Chair of the LGA, spoke about the role of local government in driving economic growth and the importance of overcoming the culture of dependency that has sometimes characterised local government.

Sir Merrick made reference to the walls of Whitehall needing to come down between central and local government. To me it seems that the walls between Whitehall departments need tumbling down too.  In his speech to launch Cities Outlook 2012, Greg Clark set out clearly that the battle for growth will be won or lost in our cities. We’d agree, and it was disappointing to hear Vince Cable characterise cities by their concentration of deprivation without acknowledging their growth potential.  It is true that compared to their European counterparts England’s Core Cities  - with the exception of Bristol and also Leeds depending on what measure is used – lag behind the national average. But the Core Cities and London together generate 49.5% of the country’s GDP and the sheer scale of these cities means they have significant economic potential, which Government policy simply isn’t capitalising upon.

It’s also vital for Government to have a strategy that goes beyond the Core Cities: Cities Outlook 2012 identified the successes of smaller cities such as Cambridge, Milton Keynes and Aberdeen.  In all, cities generate 61% of UK GVA and the GVA per head of the top performing cities – Aberdeen, Edinburgh, Cambridge, London and Oxford – was at least 150% higher than the UK average in 2009.

There was agreement that there is more need for place-sensitive and flexible policy making. Vince spoke – as he has at Centre for Cities events in the past – about his time as a councillor in Glasgow and the creativity and energy that allowed local government at that time to flourish, and sometimes to make their own mistakes too.  Arrangements such as the tri-borough model in London and Manchester’s combined authority show local government innovation at its best. Giving cities the tools they need to cooperate, innovate and fulfil their growth potential has to be part of the solution to the challenges facing the national economy.

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A budget for growth?

As the UK economy staggers towards economic recovery, this year’s Budget was a big opportunity to demonstrate that the Government has a clear plan to support economic growth as well as manage the deficit. And despite the big news of the Budget being about tax, it’s very good news to see that cities, as drivers of the UK economy, were well represented. However, it’s also a Budget which missed some real opportunities to tackle the biggest challenges that UK cities face: investing in infrastructure, supporting private sector growth and dealing with rising unemployment.

So what was the good news for cities? Some of the measures announced are policies that the Centre’s research suggests will support economic growth. It’s great to see that Manchester’s City Deal involves devolution of tax to the city, and to hear that the Government is committed to City Deals with the remaining six core cities. And we welcome the commitment to invest in the Northern Hub rail scheme and to improve transport links between various northern cities: better transport links, combined with better skills, could have a substantial impact on northern city economies.

Progress on Tax Increment Finance - £150m for the core cities – is positive, as are measures such as £270m extra for the Growing Places fund, ultrafast broadband for 10 large and 10 small cities (which could help the shift from the ‘old’ to the ‘new’ economy) and a review of airport capacity in the SE. They all signal that the Government recognizes the importance of place to economic growth.

There’s also some interesting small print stuff about discounting loans from the Public Works Loan Board if local authorities can provide information on their long term borrowing and capital spending plans.

But there are some missed opportunities. We would have liked to see more spending on infrastructure: we know that this boosts economic growth in the short and longer term, and yet capital expenditure is still set to fall significantly over the next few years. We would have liked to see TIF funding extended to smaller fast-growing cities – and we’d like to see more money: even if it’s kept to the core cities, £150m won’t fund a great deal.

Our Budget submission also highlighted the importance of investing in skills and tackling youth unemployment, and ensuring that policies are place sensitive: while 1 in 100 young people in Cambridge are unemployed, it’s 1 in 10 in Hull. Measures to support job creation, particularly for young people through policies such as further enhancement of the Youth Contract, could help cities tackle a growing problem.

Finally, the Budget also raises some questions. Industrial policy appears to be back on the agenda with announcements of support for life sciences and the digital sector, as well as Lord Heseltine’s review of how the public sector can interact more effectively with the private sector. The question of what industrial policy should look like in a 21^st century economy will keep recurring – as will local questions about what role LEPs can play.

The Government has announced more Enterprise Zones, plus additional capital allowances – but the jury’s still out on how much impact this will have, particularly in the short term.

The detail of the National Planning Policy Framework will also remain a question until next Tuesday, although the Chancellor was clear that the presumption in favour of sustainable development would remain. But until we know what that means, it is not clear how the NPPF will change policy in practice.

And it’s worth noting that most of the policies announced today are focused on our largest cities. We would agree that large cities make an enormous difference to the UK economy, but Government also needs to think about how to support small fast-growing cities such as Milton Keynes to grow, as well as how to help former industrial cities like Hull.

Overall it’s good to see cities at the heart of the Budget, but questions remain about whether the policies announced today – many of them with impacts that will be felt only in the medium to longer term - will make a substantial difference to economic growth and job creation. 

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Budget 2012: live reactions

13:45: Budget reponse

“This year’s Budget was mainly about tax, but it’s still good to see that cities, as drivers of the UK economy, were so well represented. Support for superfast broadband, a £150m fund to invest in infrastructure, a boost for housing as well as a commitment to improve transport in the North and review airports in the South, will all make a difference to growing city economies. So too will steps towards giving cities more power over their tax base, as seen in the City Deal with Manchester.

But different cities face different challenges in an uncertain economy: while 1 in 100 young people in Cambridge are unemployed, it’s 1 in 10 in Hull. For cities to contribute to national economic growth, the Centre for Cities would have liked to see more place-responsive policies, in particular on youth unemployment, skills and enterprise in the Budget.”

13:17: We won’t know the full details of the National Planning Policy Framework until it’s published next Tuesday. It’s good news that the presumption in favour of sustainable economic development has been retained, as it will help fast-growing places under pressure to expand to build the housing and offices needed for their economies. And if the system is simpler, than that reduces transaction costs for businesses across the country. But the devil will be in the detail, and there are still questions about whether the presumption will help some of the slower-growing cities where planning simply isn’t the problem.

13:12: Youth unemployment is a major issue that needs to be tackled, but in different ways across the country: while 1.3% of Cambridge’s young people are claiming unemployment benefit, 10.1% of Hull’s young people are unemployed. It’s unclear that measures such as loans to young people to start up businesses will be enough to deal with the challenges facing young people in some of our former industrial towns.

13:05: It’s good to see cities mentioned so much in this Budget. We know that cities drive the economy: they contribute 62% of the UK’s GVA. Deals like the Manchester City Deal, which involves the city "earning back" tax where it has generated extra growth, are vital; that’s how the UK’s cities will catch up with their international competitors.

12:58: Enterprise Zones are being expanded – there will be more in Scotland and Wales, and London’s Royal Docks will have enhanced capital allowances. But lessons from the 1980s are that the jury is out on what they will deliver, and whether new jobs will be created or simply displaced from elsewhere. The news that there will be £150m of Tax Increment Finance money is likely to have a bigger impact on growth as it will allow investment in infrastructure required.

12:54: Investing in links between cities – like the links between Manchester and Preston just announced is exactly the way we should be trying to make the most of our cities. It increases the scale of cities like Manchester, and that’s what international investors want to see. It also helps people living in Greater Manchester and Lancashire benefit from a bigger labour market and more jobs.

12:51: It’s good that there’ll be more money for the Get Britain Building Fund – it’s an immediate, short term win for the labour market because of the jobs created by construction, as well as helping Britain’s long term housing shortage. But we still need longer term solutions to deal with the UK’s housing shortage.

12:38: Although the OBR expects the UK to avoid a technical recession and has revised its forecast for growth up, we’re still recovering much more slowly than we did from the last recession in the early 1990s. Four years on from the start of the 1990s recession, unemployment had been steadily falling for more than a year. Four years on from the start of the most recent downturn and unemployment has returned to 2009 levels. This main difference between now and then is that the 1990s recovery was accompanied by much stronger economic growth and, as a consequence, private sector job creation.   

Read the full 2012 Budget Submission from Centre for Cities: www.centreforcities.org/budget2012

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City Deal #2 – Manchester earning back tax

The second City Deal is signed and it’s a humdinger. Greater Manchester has agreed a Deal that means, for the first time, a city has the potential to ‘earn back’ some of the extra national tax revenue generated in the area.

My understanding of the Deal – although there is not much detail available yet - is that Manchester is setting up a £1.2bn infrastructure fund, to which Government is contributing revenue amounting to around £30m a year. The money being invested by both Government and Manchester means the city can borrow and create a substantial capital pot to invest in the next phase of big infrastructure projects. The plan is that these infrastructure projects will deliver extra growth. Manchester will then be able to keep the additional revenue it generates – ‘earning the money back’ – and recycle the money to invest further in growth. Other key elements of the Deal are here.

The Deal is bound to have its critics, concerned that the money from Government will set a precedent that all other cities will seek to follow. But Manchester is in an unusual position. Its Combined Authority gives it strong governance credentials, it has an Integrated Transport Authority dealing with transport across the wider city region, and it has already agreed a 3% levy on council tax to fund infrastructure projects in Greater Manchester. The combination means that Manchester is willing to bet its own money that the city can generate extra economic growth.

The Deal also paves the way for Greater Manchester to consider other options for raising finance over the long term – as financial services experts and those short of money at pay day know only too well, it’s much cheaper to borrow millions over a period of 10 or 20 years than it is to get £1000 for a week.

Without more details, it’s hard to know exactly how it will work and it will be years before we know how successful it has been. But this Deal does what the Centre always thought City Deals should do: it’s bespoke, innovative, and paves the way to cities being able to manage their own destiny. That’s exactly the kind of kickstart that the UK economy needs.

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Four years on and the road to recovery looks set to be a long one for many cities

Unemployment at the national level is showing tentative signs of stabilising; helping to allay fears about a double dip recession. Yet both the wider measure of unemployment (ILO unemployment) and the claimant rate are still up on last year, and there has been a large increase in part-time work.

The pattern of "recovery" contrasts with the recovery from the last recession in the early 1990s. Four years on from the start of the 1990s recession and unemployment had been steadily falling for more than a year. Four years on from the start of the most recent downturn and unemployment has returned to 2009 levels. 

Recession and recovery – changes in unemployment

So what’s different this time around? Unemployment figures have undoubtedly been driven up by the 270,000 jobs lost from the public sector over the last year, but the 1990s recovery also saw large scale public sector redundancies. The main difference between now and then is that the 1990s recovery was accompanied by much stronger economic growth and, as a consequence, private sector job creation. 

Recession and recovery – changes in GDP

No city is close to seeing unemployment return to pre-recession levels; in the majority of cities claimant rates remain twice as high as rates at the start of the recession. But recessions and recoveries are always uneven. For example, some cities are much more vulnerable to public sector job losses because of their greater dependence on public services for employment, and as a result unemployment is likely to remain much higher.

Take Hull and Reading for example, as highlighted in this month’s labour market update. Four years on from the start of the downturn in the 1990s, unemployment had been falling in both cities for over a year and it continued to do so at a steady rate until it fell back to pre-recession levels. Today, neither city has seen a significant fall in unemployment since the start of the downturn four years ago. But while rates have been relatively stable in Reading, unemployment in Hull is back on an upward trend, suggesting it is less resilient in the face of public sector cuts and global economic uncertainty. 

Claimant rates in Hull and Reading, 2008-2012

Next week’s Budget statement is an important opportunity to bolster the UK economy and get it more firmly on the road to recovery. But many national policies continue to be ‘spatially blind’, despite the fact that that cities face some very different challenges. There is a real opportunity for the Chancellor to use next week’s budget to give cities the financial resources and powers they need, not just to stem local unemployment rises but to drive the recovery for the UK as a whole. 

Pay for delay: The “delay incentive” in the draft Local Government Finance Bill

Just when the news is aflutter with stories of challenges with the planning system, Government’s proposed business rates retention system could introduce a new planning problem.

Andrew Carter and I have been paying close attention to the Local Government Finance Bill. My latest report, Urban Outliers, dives into the deep abyss of the Bill to explore two small issues which can have big implications for economic growth. I discuss one here.

It starts with the fact that business rates will now be the funding source for local social care, so the amount of business rates local authorities retain needs to be kept in line with local need. To do this, Government will ‘reset’ the amount of funding local Government retains in the proposed business rates retention system every 10 years.

At the same time, though, the retained business rates revenues have another goal of incentivising more development. Thus, the reset creates unhelpful uncertainty, as local government does not know how much of their rates they will retain after each reset to the system. This means that, for any given development, local government will only fully benefit from business rates retention before a reset, as any growth after that has the potential to be stripped out and sent to central Government.

In plain English: local government faces an incentive to delay developments until the beginning of a reset cycle. The benefits of pushing completion of a development back two years from year 8 in a cycle can be quite large, as local government is only guaranteed a portion of the business rates increase for 2 years, rather than 10 (if completed in the first year of a cycle).

The daunting part is that, if the incentive works, we could see waves of developments delayed across the country. This could bring instability to local government finance, treasury intakes, and businesses alike. These are not insignificant incentives authorities face; there is a real benefit to delaying development and business growth.

We do not argue that social need should be ignored at the expense of business growth. Rather, we argue that the mechanisms created by the resets to the system will create negative incentives for local government, business and the community at large, and they should be addressed. Now is the time to put our thinking caps on and work together to come up with clear and innovative solutions to these problems. Who’s with me?

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