Paul Ormerod: Our Friends in the North are trapped in a monetary union

Michael Heseltine’s report on economic growth came out last week. It contains 89 recommendations. A mere 57 varieties, to recall the famous Heinz slogan, might have connected it more with popular culture.

The report has already attracted a lot of comment, mainly that Lord Heseltine seems nostalgic for things like the Regional Development Agencies and the decades of the 60s and 70s. The report does at least have the merit of stating a list of possible policy actions to deal with a serious problem.

But what is to be done about the regions of the UK? The first thing to note, of course, is that there are very marked differences within each of the individual regions. Towns like Hexham, Harrogate and Wilmslow are every bit as prosperous as the Home Counties. So talking about the problem of the regions is an over-simplification. Yet the fact remains that there is a problem. Incomes per head are much higher in London and the South East than in any other region taken as a whole, and average unemployment rates are lower. If anything, the gaps are widening over time.

In a nutshell, the regions suffer from the fact that they are in a monetary union with two very dynamic and productive areas, London and the South East. The monetary union in this case is the sterling area. We are not accustomed to think of it in this way. But the underlying problems of Greece and Spain are the same as those of Yorkshire and Wales. They are uncompetitive in their respective monetary unions.

Britain’s regions do not face such acute problems as Euro zone countries, for two reasons. First, they have lacked the autonomy to take decisions which have bankrupted some of the states of Southern Europe. Second, until now, the prosperous South of Britain has been happy to hand over large sums of money to keep the regions afloat.

Essentially, our regions are running large balance of payments deficits with London and the South East. They are not sufficiently competitive to produce enough goods and services which we want to buy. In a monetary union, a balance of payments deficit translates into lower growth and higher unemployment, something which standard trade theory, one of the best bits of economics, shows clearly.

The coalition’s policy of regional pay is therefore a Good Thing. Paradoxically, Britain’s regions are poor because they pay themselves too much. They cannot devalue their currency against London to make themselves competitive, so they need to price themselves back into the market.

But they also need more trade, and this means more links, more connections with London and the South East. Modern network theory has been used to provide exciting new perspectives on the structure and patterns of world trade. The same principles apply within a country. More connections through infrastructure like HS2 gives the regions an chance to transform themselves, and become prosperous areas again, as they were in the 19^th century when they led the world.

Paul Ormerod is an economist at Volterra Partners LLP, a director of the think-tank Synthesis and author of Positive Linking: How Networks Can Revolutionise the World

Guardian: http://www.guardian.co.uk/politics/2012/oct/31/unions-business-lobby-back-heseltine

BBC news video: http://www.bbc.co.uk/news/business-20150603