Europe's regions must specialise to survive

The most unfair thing about the pain inflicted by the strong pound is that it falls most heavily on those least able to bear it - on the least competitive companies and regions. It is the manufacturing heartlands of the Midlands, the North and Scotland that are suffering the worst economic damage.

Yet Britain's north-south divide cannot be entirely the fault of the over-valued exchange rate. For every country within the eurozone has its own equivalent regional divide as well. A full third of the EU's budget is spent addressing the problems of economically weak, deindustrialising regions, and member countries match the expenditure.

At first glance there is a puzzle in this European problem of regional inequality. Industry in the EU is significantly more dispersed, less clustered in a few centres of production, than is the case in the US. The motor industry is one of the most extreme examples. Despite the cloud hanging over Longbridge and Dagenham, Europe has many more car plants than the US. The pattern is repeated in almost every other broad industry sector, as the chart shows (paper and pulp is an exception).

Yet income inequalities between US states are less extreme than those between EU regions. A recent report published by the Centre for Economic Policy Research* notes: "[US] regions are more specialised, but most regions have proved quite capable of specialising in something."

A second key difference is the mobility of the population. American regions with a concentration of economic activity also have a concentration of people. Incomes per person are therefore less unequal than in Europe. And before dismissing this as a peculiarity of America's federal system and common language, it is worth noting that the mobility of labour in Europe is lower now than it was during the 1960s.

The puzzle is a genuinely regional one. The report makes it clear that, looking at national-level data, GDP per head has converged over time, thanks in large part to the progressive liberalisation of trade between members and the single market. In other words, per capita GDP in countries like Portugal or Greece has caught up to a great extent with Germany and France. Yet the poorest regions are as far from the richest as ever; incomes remain lower and unemployment higher than the average, and the inequality is as great as ever despite all that expenditure.

So the question is whether Europe can attain the more equal US regional picture, and if so how.

There is good reason to believe that European industry is becoming more concentrated, on the US model. The degree of industrial clustering is the result of the play of two forces. The most important centrifugal ones are the need for access to markets, especially if transport costs are high, and trade barriers. Barriers in the EU have been coming down thanks to the single market and now, for the 11 members, the single currency. The centripetal forces are access to a pool of skilled labour and supplier base, and a high quality of life for that labour force. The more sophisticated the industry, the greater the need for that skill pool. That is a pressing need for virtually every industry in a modern economy, where every branch of production is becoming more specialised than ever.

In other words, there is every reason to believe that the map of Europe's economy will rapidly become much more like that of the US. That is a dramatic change. After all, in the American auto industry, there isn't really anywhere other than Detroit and its hinterland. With half of the EU-15 still hanging on to at least one national centre, and often more, making cars, the potential for transformation of the industrial map is dramatic indeed. It is a sobering thought for anybody working in the British car industry.

Yet America's concentration of production is not marked by greater regional inequality; on the contrary, regions in the US are more equal. According to the report, the variation in GDP per head between America's regions is about half that in Europe.

The research suggests that this is thanks to the development in American states of clusters of something; if it can not be cars, then something else. And in the successful development of these industrial clusters, two things really matter. First, there is a very strong magnetism for other companies once a cluster gets going. Inward investment to regions is powerfully boosted by the presence of other firms in the same industry.

Secondly, the presence of a skilled workforce is crucial. According to the CEPR report, a 10 per cent increase in average years of schooling in the local workforce increases employment by between 22 per cent and 45 per cent. This result, too, is depressing for UK regions. Britain had fallen from top of the EU league for education spending per head in 1960 to near the bottom by the mid-1990s. Although the present boost to education spending will improve matters, there is a long way to catch up to the leaders.

The policy prescription is very familiar. What any region needs more than anything is a highly-educated and adaptable workforce. A helpful regulatory and planning regime will help too, as will any measure to boost labour mobility. In short, regions, like nations, need the flexibility to develop what they will be expert at in future rather than preserve what they were good at in the past. In a summary which goes to the heart of the pain now being suffered by Britain's manufacturing regions, the report concludes: "Misguided regional policies, which try but fail to freeze existing patterns of economic activity, can paradoxically increase the likelihood of the very polarisation they seek to prevent."

"Integration and the Regions of Europe: How the Right Policies Can Prevent Polarisation" by Pontus Braunerhjelm, Riccardo Faini, Victor Norman, Frances Ruane and Paul Seabright, CEPR. Details from http://www.cepr.org/

d.coyle@independent.co.uk