Levelling up: what might it mean for public spending?

This may be a budget dominated by the coronavirus but the government’s priority to “level up” across the UK is still likely to be a theme. This promise has so far been rather light on details, but the ultimate goal of a ‘levelling up’ agenda would presumably be to reduce the disparities in productivity and earnings across the UK. Recent IFS research has documented these regional inequalities, showing for instance that in London both productivity and earnings are more than 30% higher than the national average, but that in Wales they are 15% lower.

There is no single policy lever that can be pulled to reduce these disparities and address the complex underlying causes, and it could take years – or decades – for policies to have meaningful effects. For instance, one factor driving higher productivity in London is the fact that it has a more highly educated workforce than other parts of the country. 47% of working-age adults living in London are graduates, versus 24% in the North East. This is unlikely to change fast and for as long as this disparity remains, differences in earnings and productivity are also likely to remain.

One thing that the government can exert control over in the immediate term, however, is public spending.

Targeted investment in particular sectors or areas of the country could be one way to deliver improved productivity growth in the medium-to-long term. Currently, investment spending per head is higher in London than anywhere else in the country: £1,456 per head in London, versus an average of £891 in the rest of the UK, and just £621 per head in the East Midlands (see Figure 1). Transport, which will be of particular importance for productivity growth, is a key driver of differences in spending across the country: at £653 per head, transport investment is 2.5 times higher in London than the average £260 per head in the rest of the UK.

Rewriting the rules that govern which projects receive funding to place greater weight on regional equity could be one way of rebalancing government investment away from London and the South East, and towards other parts of the country. ‘Levelling up’ in this respect could come with a hefty price tag: raising transport investment per head across the UK to the current London level would mean spending an extra £19 billion per year. That would require the government to almost double the budget. This figure is purely indicative and not prescriptive – there are clear reasons for investment in public transport to be greater in London than in rural Cornwall, for example – but it gives a rough idea of how much ‘levelling up’ would cost on that definition. It also highlights that we should not be surprised if in five or ten years’ time per capita investment spending is still higher in London than elsewhere in the UK. And, in any case, this could be justified given that the financial returns to investment are likely be greater in densely populated, higher productivity areas such as London.

Figure 1: Investment spending per head in 2018−19

Source: Author’s calculations using HM Treasury ‘Country and regional analysis: 2019’ and ONS mid-year population estimates. London transport figures include Transport for London.

Investment is of course important, but it represents only a small part of total government spending and is not a panacea. The vast majority of the total spending pot is ‘current’ in nature, and goes towards things like employing public sector workers, the day-to-day running costs of government departments and public services, and paying social security benefits. And, of course, it is not just investment spending which matters for ‘levelling up’. Spending on education will have benefits for local economies in the long-run, while spending on health, social services and benefits helps in the immediate term. So one should also look at how total public spending varies by region.

This is illustrated in Figure 2, with total spending split between current (day-to-day) and capital (investment). The variation in total spending is considerably less pronounced than the variation in investment spending, but differences remain. Total spending per head in Northern Ireland is 25% higher than it is in England (£11,590 versus £9,295). Total spending per head in England is 18% higher in the North East (£10,182) than it is in the South East and the East Midlands (£8,601). Much of this is driven by variation in current spending across the nations and regions of the UK.

Figure 2: Total identifiable spending per head in 2018−19

Source: Author’s calculations using HM Treasury ‘Country and regional analysis: 2019’ and ONS mid-year population estimates. Figures are for identifiable spending only, and therefore exclude spending outside of the UK, non-identifiable spending and accounting adjustments. Capital identifiable spending per head corresponds to the figures shown in Figure 1.

Within the current budget, for instance, health spending is £1,932 per head in the South East of England, £2,338 in the North East, and £2,642 in London. Education spending per head is £1,046 in the South West, £1,196 in Yorkshire and the Humber, and £1,430 in Scotland. Benefits spending per head varies from £2,360 per head in London to £3,233 in the North East. Such variation in current spending arises for two main reasons.

First, the cost of providing public services varies across the country: it is more expensive to employ a nurse in London than in Liverpool, and it is more expensive to collect household rubbish on the Outer Hebrides than it is in central Glasgow.

Second, the regions and nations of the UK differ in their need for various types of spending. We’d expect health spending to be higher where the local population is older or less healthy, we’d expect police spending to be higher in areas with more crime, and we’d expect benefits spending to be higher in regions with higher unemployment rates. In practice, then, a blunt approach to ‘levelling up’ spending on public services would mean delivering additional spending to the parts of the country with the least need for it. That would hardly represent efficient targeting of scarce resources. To give a concrete example: one consequence of the government’s promise to ‘level up’ schools spending is to provide additional resources to schools in wealthier areas with fewer disadvantaged pupils and fewer pupils for whom English is not a first language. Applying a similar principle across the board would likely mean delivering a funding boost for areas like the South East and East of England, not for the ‘forgotten’ or ‘left behind’ towns that the Prime Minister and government seem to have in mind.

In all of this, it is important to remember that there are already big fiscal transfers from London and the South East to the rest of the country, largely because tax revenues are much higher in those two regions than elsewhere. One objective of a long-term ‘levelling up’ agenda might be to reduce the magnitude of these fiscal transfers and to reduce the reliance of the UK public finances on London and the South East. But, in the short-term at least, a rebalancing of spending towards the rest of the country could see them widen.

As it stands, we have few details of what policy tools the Government intends to use in its ‘levelling up’ agenda, or even what ‘levelling up’ actually means. The Spending Review later in the year should fill in some of the gaps. Government spending is an obvious and readily available tool for the Chancellor to deploy, but applying the Government’s approach to ‘levelling up’ schools spending to other public services would likely mean delivering additional resources to the areas that need them least. Rebalancing investment spending across the country could sensibly form part of the Chancellor’s toolkit, but carries risks of its own. This is a policy problem that will require careful thought and even more careful delivery.