Give the North the power to experiment

Local decision-making on taxes and public sector rules would allow scope for enticing investment

How should the Government set about reviving the North of England? Ministers must be clear that the North’s economy will not be revitalised by a replay of the Sixties. Government-directed private investment and heavy local public spending did not work then and will not work now.

That is not to say that ministers are wrong to consider rewriting public spending rules that focus solely on economic return, as the Treasury is reportedly planning to do. There is undoubtedly a tension between investing in transport and other infrastructure in highly productive regions – such as London and the South East – which yield high returns, and investing in projects in less prosperous places. The truth is that there is great merit in investing in projects that will make a significant improvement to the communities involved – even if they would not maximise economic returns to the country as a whole. A significant programme of investment in disadvantaged areas can yield wider political and social welfare gains, not just to those areas but in terms of the cohesion of the nation.

What must be avoided is state intervention that slows down necessary economic change. This happened in the decades after the Second World War, leading to a backlog of reform and an economy that was stuck in the past. Instead of evolving gradually, the UK created the conditions for a structural economic crisis in the Seventies.

The great achievement of Margaret Thatcher was to make these necessary but difficult economic changes. During her time in office, when I was a special adviser to Nigel Lawson at the Treasury, there was a systematic reorganisation of businesses, industry and the economy. Nationalised industries, trade unions, the docks, the newspaper print industry and the labour market were reshaped. An economy that had underperformed for years began to deliver income, employment and growth of the sort expected of a major modern economy.

This huge change came at a price and at a cost to the people involved – especially to communities that had once depended on the manufacturing and mining industries. The modernising agenda was good at clearing things away, but not so good at replacing redundant economic activity with new local opportunities.

Conservative and Labour governments from the late Eighties used the economic success of the services and finance sectors to raise tax and transfer money to individuals and communities that experienced difficulty. But instead of helping matters, in many respects this increase in public spending had unexpected consequences. For a start, it created a growing public sector that crowded out private local economic activity.

A large part of the UK’S regional economic problems lie in the centralised character of economic decision-making in the UK and specifically in England. Public sector pay, benefits paid to people of working age, national insurance and tax – including corporation tax and local business tax rates – are set centrally. There is no scope to experiment, no scope for a community to set out its stall to attract businesses, investors or people to relocate and live there.

In the US, things are very different. State and local governments have much greater scope to alter their taxes to attract investment, change public sector procurement rules to enhance their local economies and to encourage local activity. The economic dynamism of Florida, Arizona and the revival of Pittsburgh are testimony to the freedom that local policymakers have to modify economic incentives.

Some states have dispensed with income tax altogether, such as Nevada, Texas and Florida. Most states have phased out inheritance tax and many states do not tax capital gains. The states with the highest combined income and sales tax burdens, such as Illinois and New York, have tended to be consistent in their relatively disappointing economic performance.

In the same way, after German unification in 1990, huge public investment in East Germany failed to create a dynamic private economy rich in jobs and pay. Nationally agreed pay and benefits prevented East German workers from competing in private markets. The public sector received investment, but it came at the price of sluggish local private markets. Buildings and historic monuments were regenerated, but the people living there were not empowered. In many respects there are parallels between the UK and German approaches to economic regeneration.

So the UK needs to strike a better balance. In the North, we need investment in transport, public spaces and in ensuring that derelict land is cleared and historic buildings are maintained. Less prosperous communities should be supported.

But, above all, local decisionmakers need to be given the economic instruments to make their local labour markets more responsive and competitive. That will involve an agenda that goes a long way beyond platitudes about greater public spending.

Warwick Lightfoot is head of economics at Policy Exchange