by Adam Leaver, Manchester Business School
“You can’t revive the regions just through handouts from Whitehall…Revenues from the financial services sector were recycled round the rest of the country through the long arm of the state, creating the illusion of strong, national growth. Jobs were created but in an unbalanced way, over-relying on the public sector, funded by tax receipts from the City of London. And we’ve seen what happens when the conveyor belt breaks, as it did spectacularly in 2008. Those tax receipts fall, the money stops flowing and the whole country feels the consequences as the public sector contracts and jobs are lost. This nation is made up of 100,000 square miles. It cannot rely so heavily on one.” (Nick Clegg, October 2012)
Nick Clegg’s explanation of our current malaise is a seductive one in these times of austerity. The idea of an unsustainable cross subsidy form London’s vibrant financial services sector to the regions public sector jobs appeals to the prejudices of a metropolitan political elite who draw on this central perception. Such a view undoubtedly informed Osborne’s attacks on public sector wages and employment which he believed were ‘crowding out’ the private sector. It is also the bedrock upon which Boris Johnson now lobbies for London to ‘keep more of its own tax’.
Clegg’s paragraph tells us little about the pre-2007 world. Finance never contributed more than around 9% of total UK GDP and 11% of tax, even on the broadest interpretation of what activities constitute the sector – and that’s before we factor in the bailout money which exceeded the total taxes paid by the industry in the five years before 2007. Clegg and his fellow parliamentarians know this – this is ideology in its very old fashioned sense. But what he and others have done is to establish a new moral language around the regional economy, which talks about ownership, earnings and deserve on the one hand and dependence, subsidy and inefficiency on the other.
Such discourse abstracts from the sheer diversity of flows in any national economy. Global cities like London do attract capital, but they do so because they are a kind of conversion machine, taking national and international assets, converting them into revenue streams from which well-placed individuals skim high pay. London attracts capital because it is also extractive in other words. This can be seen from investment banking to private equity to infrastructure PFIs. This process of extraction requires an active state, through bailouts and subventions in the banking system to the underwriting of risks in infrastructure PPPs and PFIs. This implies the centrality of the state to a proportion of the UKs private sector.
PPPs and PFIs are a good example of where ‘extraction’ has distinct regional effects. The decomposition of activities around a contracted-out infrastructure project leads to a fragmentation of corporations around specialised functions, so that one company may provide the finance, another may build the school or hospital, another may manage the asset etc etc. In theory some of these functions need not be located on the site of the project. And certainly the revenue streams do not all circulate regionally: the finance company probably has its operating office in London, as might the asset management office. Even the operations might be co-ordinated from London using local contractors on site. Overseas companies that invest in PPPs/PFIs are likely to have an office in London, and those senior workers are likely to be extremely well paid.
Before PPPs and PFIs, projects that were State funded had revenue streams that would congeal in the regions where those projects were based, kicking in multipliers that would further benefit the local economy. The fragmentation of activities has led to a concentration of certain functions like financing and asset management in London. This has diminished capacity in the regions through the withering of broad competences, the fragmenting of supply and project chains, and skills drift as talent is forced to relocate down South to find a job. State-sponsored investment projects across the country have benefited private sector growth in London and the South East.
But infrastructure projects are not just about where the revenues go, but what liabilities are taken on to generate those revenues; and crucially who assumes responsibility for those liabilities when things go wrong. Many PPP/PFI schemes are highly levered: before the crisis projects were financed on around a 90/10 split debt to equity, though this has now levelled down to around 70/30. Even so, leverage produces interest payments that require servicing and a manifest risk of default. So the flipside to the revenue streams clipped by metropolitan elites is a tower of hidden contingent liabilities that may be passed onto the State, as when NHS Trusts cannot repay their PFI loans. Similarly on the operations side, contracts which allow companies to exit their obligations (designed to attract initial bidders) may leave the State with unexpected costs. This is what First Group did when it walked away from the backloaded premium payments on its First Great Western franchise, costing the taxpayer an estimated £800m in lost receipts. On the contracting side, unwieldy contracts can produce inefficiencies and exorbitant penalty clauses which are costly to renegotiate. And this is before we discuss the many contracts that overshoot their original estimates. All of these interventions should be thought of as State subsidies; received mainly by private subsidiaries operating in the capital, and paid for by taxpayers the length and breadth of the country.
This quiet cross-subsidy from North and West to South East has been running un-noticed for a long period of time. Its unanticipated result is a kind of regional moral hazard: the metropolitanisation of gains, and the nationalisation of losses. Perhaps by looking at the regional distribution of these corporate subsidies we might be able to challenge the simplistic picture mobilised by Clegg, Osborne and Johnson?