Adam Hawksbee is the Interim Director of Onward.
A month ago I co-wrote an article with others from the centre-right offering ten practical ideas to boost economic growth. Many ideas were familiar: reform planning, invest in skills, support R&D, streamline regulation. One proposal produced a bit of backlash: devolving power. “Fine idea”, some said, “but that’s not really about increasing growth”.
Not true. What is so often missed in the case for devolution is that it is more than just politics. Yes, there is a strong case for empowering local communities and leaders by giving them more of a say about their area. But the strongest centre-right case for empowering mayors and council leaders, and holding them accountable for results, is centred on hard-nosed economics and addressing market failure. And that should be at the core of Conservative economics – making markets work.
A leading economist, Ricardo Hausmann, has made a career of diagnosing barriers to growth in countries around the world. Through a series of cascading questions, his team at the Harvard Growth Lab identify the binding constraints to growth: those factors holding back investment and entrepreneurship. A lot of those constraints are familiar to those thinking about the UK’s growth problem, including small business finance, physical infrastructure, and human capital. But two areas leap out that are not discussed enough in the UK context: the somewhat confusingly named “information externalities” and “coordination externalities”.
In simple terms, “information externalities” occur when different parts of the market aren’t communicating with one another. One start-up might have developed a great new way to automate a process, but a business in another sector isn’t aware of it. Traditionally, competitive markets push firms to seek out these new ideas and adopt them, in order to succeed and grow. This constant process of discovery and diffusion is where long-term productivity growth comes from.
So markets don’t work when ideas don’t flow properly. Work by Dani Rodrik and others have shown that as economies get more complex and technologies more advanced, individual firms underinvest in this “self-discovery”, meaning markets don’t grow as they should. Stian Westlake and Jonathan Haskel have written on why the rise of intangible capital exacerbates this sort of market failure, because large spillovers mean businesses don’t capture as much of the benefit of new ideas themselves so underinvest.
Markets also don’t work when actors can’t coordinate. “Coordination externalities” are failures of different parts of the market to work together. Economic growth rests on thousands of interactions that are impossible to centrally plan and coordinate, which is why market mechanisms are so important. But the best markets have institutions that support these interactions. Some of these are foundational frameworks like a consistently applied rule of law or competition regimes. Some are cultural, like the shared norms observed in the Nobel-winning work of the economist Elinor Ostrom that help communities to self-organise in areas like agriculture. Others are sector specific – such as Germany’s Fraunhofer institutes which support the translation of scientific discovery into industry.
Devolution addresses these twin market failures. Put simply, transferring power to local leaders boosts growth by accelerating the sharing of ideas and improving the coordination of different actors.
The transmission of ideas that drives economic growth has often been a local endeavour. Think Birmingham’s Lunar Society during the Industrial Revolution, where scientists and industrialists across the Midlands met by moonlight to share their latest discoveries. Or Silicon Valley’s Homebrew Computer Club, started by Steve Jobs and Steve Wozniak in 1975 to swap ideas about computing. Jane Jacobs and later Ed Glaeser explored how cities are the perfect forum to support the emergence of these ideas and their adoption in productive economies.
Britain today doesn’t have enough of this growth led by new, homegrown ideas. That’s partly because our cities aren’t dense enough, our transport too unreliable, our skills pipelines underdeveloped, and our regional economies not specialised enough to support agglomeration. Better delivery through devolution can help solve these challenges. A cross-country study by the OECD found that decentralisation is positively associated with GDP growth, particularly where local leaders retain local revenues because it incentivises better investment.
But the true power of local leadership is in supporting the process of discovery and diffusing new ideas through industrial policy. Local leaders from politics, business, and the public sector can come together and identify areas of comparative advantage to prioritise. These will differ from place to place. In Pittsburgh local leaders focussed on capabilities in robotics to turn a struggling rustbelt economy into a globally competitive city. In Milwaukee local leaders turned capabilities in brewing into a cluster focussed on water technologies. Italy’s Emilia-Romagna secured its place as one of Europe’s most productive regions through a focus on small, artisan manufacturing.
Government has tried this process before, through Local Industrial Strategies. But these processes were still driven from the centre, with Ministers setting the scope and marking the homework of local leaders. No new powers or resources came attached with the finalised plans, so they secured limited buy-in from businesses and faltered when it came to execution. A genuinely local industrial strategy needs real local control and responsibility.
This process of discovering and diffusing ideas doesn’t mean anything unless local leaders have the levers to execute industrial strategies. This is where coordination externalities come in. Today, mayors rely on Whitehall to execute their plans, causing two major problems. First, interventions from Whitehall are disconnected, with separate and complicated pots to bid into for transport, housing, and skills funding. Second, Whitehall policy chops and changes all the time, limiting business confidence in contrast to a more stable policy environment at the local or regional level.
Economic coordination is often driven by the market. Complex supply chains develop and countless transactions occur without any involvement by the state. But there will be moments when state coordination can enable growth. Universities and FE Colleges can ensure a steady supply of workers for growing firms. Local Authorities can grant planning approval and contribute public land for developments. Trade advisors and UK Export Finance can open up international markets. All of these things need joining up to ensure that they provide a comprehensive offer to investors.
Other countries already have the governance to address these market failures. US Governors, the German Länder, and Israeli Mayors all wield significant economic development powers to tackle these information and coordination externalities in pursuit of growth. Only two countries – Ireland and Hungary – are more fiscally centralised than the UK and are becoming more so.
At its core, devolution is about bringing our approach to economic governance up to the standard of the world’s most productive countries. We desperately need to catch up.