The effects of regional inequalities and how they can be fixed
Levelling up is the UK’s plan to use government support to boost specific parts of the economy. It involves investment in infrastructure in poorer, more neglected regions. Such spending allows governments to target specific areas of the economy that suffer from a lack of investment, which could spur private sector investment. However, it can be costly, while it opposes Joseph Schumpeter’s principle of ‘creative destruction. Having two unequal areas of the economy significantly impacts productivity and the returns on investment in such areas.
Government support to boost certain parts of the economy allows them to target specific areas which suffer from a lack of funding. This can prevent these industries from falling behind, creating a diversified and robust economy. However, subsidising loss-making firms can be a government failure as resources are inefficiently allocated, which prevents ‘creative destruction’. The government must ensure that such spending is the proper use of the taxpayer’s money and will not be squandered by the beneficiaries.
Private Sector Investment
The provision of public goods and essential foundations for a prosperous industry may spur private sector investment. Providing transport links and broadband access may attract firms to the area, which boosts the surrounding economy and increases economic activity. However, if government spending goes too far, it risks crowding out private sector spending. This could cause unproductive investments that private firms would better install. Hence, opportunity costs would be stark. There is a fine line building too few foundations and too many.
Returns on Investment
Having two areas of the country which are unequal in terms of their prosperity can create the opportunity for high returns on investment. Marginal returns in neglected areas are likely to be higher as only minor improvements would benefit areas greatly, which would mean that taxpayers’ money is being used efficiently. However, if returns were so attractive, why hasn’t the private sector taken advantage of them? While this assumes perfect information, firms would likely have taken the opportunities for such high returns before the government would get to do so. The fact that they have not may suggest underlying faults with the area due to geographical or political constraints, for example. Although, initial spending by the government may make areas more favourable by improving transport links or building a local hospital. In the long run, such investments are likely to bring in significant returns in higher productivity, greater output, or increased economic activity. However, governments may not be enthused by these opportunities as they may clash with the political cycle. Short-term returns are more favourable for governments to achieve as this increases the chance of re-election, making long-term investments less desirable. Additionally, infrastructure projects are not overnight and can often take years to implement, meaning that by the time they are completed, if they overcome political opposition, it is likely that new political parties will be in power. Hence, while regional inequalities create profitable and worthwhile investment opportunities, political parties may be put-off by the lengthiness of such processes.
Having two areas of the country which are unequal in terms of their prosperity has implications on innovation. Agglomeration effects mean that cities in the UK such as London and Manchester are hubs for innovation, hives of highly skilled workers packed in a synergising environment. Such concentrated competition and diffusion of ideas help drive economies. Hence, regional inequalities may positively affect productivity as most of the country’s social capital is in one place. This also implies that divestment from these areas, channelling more money into the neglected areas, can cut cash flows that innovation desperately needs. Investing in more sparsely populated, less developed areas affects fewer people and its impacts it thus not so large. However, as previously discussed, it may spur agglomerations to form elsewhere, expanding the network of innovation hubs and leading to a net increase in total productivity when spending occurs. This could be enhanced further through financing infrastructure spending, not through cutting the budgets of developed areas, but through taxpayers’ money or borrowing. Borrowing in the current climate is particularly attractive due to such low interest rates and, despite fears of rising debt levels, could be a shrewd investment.
To conclude, government spending to support particular areas of the economy can uplift financially malnourished industries to create a diverse economic environment while unleashing the power of private sector investment as it does so. Spending should not go beyond the provision of public goods and essential foundations for a thriving society, such as education and healthcare. This risks crowding out and wasted resources if private firms do not invest further. Hence, the government should approach levelling up through providing essential goods and services across different areas of the economy: enough to make it attractive for private firms, but not too much to discourage investment. Get it right, and they will be rewarded through greater productivity and economic output.
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