It all comes down to money

Toby Blume’s essay from “Changing the Debate: The Ideas Redefining Britain”

The policy agenda has shifted significantly since the general election with a consensus emerging across all the main Parties on the need to devolve power to localities and to give citizens the tools to play a more active role in civil and civic life. And whilst there are differences over how best to address the immediate fiscal challenges in the short term, the direction of travel appears to be generally accepted.

If we are now witnessing a more ambitious attempt to place power in the hands of citizens, then it is critical to ensure that communities are given the appropriate opportunities to determine what happens in their area. Big Society and Localism – or more significantly, the principles that underpin them, if those particular labels are not universally supported – focus predominately on social and political reform. We have seen moves to reform public services and stimulate social action which are welcome. However to truly empower localities you also need to devolve economic control to communities. Wealth retention and creation, poverty and income inequality, asset building and resilience are central to the challenges that local areas face and intrinsically linked to the ambitions of localism. In many instances (and particularly in more deprived communities) these are stubborn, complex and deep-rooted issues that have not been successfully addressed despite waves of regeneration and renewal programmes from successive governments. 

If we are to realise the ambitions of the political consensus on community empowerment and devolution, we need a new model of economic localism to support political and social reform. 

The case for economic reform 

To date, none of the main political parties have provided a clear and compelling narrative on economic reform. There are signs that the government have dipped their toes in to the waters of economic localism, with the establishment of Local Enterprise Partnerships and the Regional Growth Fund, but these are fairly limited when set against the ambition of broader social and political reform. We may yet see further progress being made with the review of local government finance but even this is too limited in its scope to transform our macro-economic architecture. Economic reform must be the focus of the next phase of localism if the ambition to transform the relationship between citizen and state is to be realised. 

If we aspire to give local areas – and communities – more control over what happens in their areas, then we must ensure they have the proper levers to do so. Social and political reforms are wholly interrelated and mutually-dependent on economics. If our economic architecture is designed for an older, more centralised, way of doing things, then our efforts to build locally-determined solutions will at best, be inhibited and at worst completely stymied by a lack of control over our local economies. 

Economic localism is not, however, solely a means of achieving other political objectives. It is an essential response to the shockwaves that have swept through our communities as a result of events like the global banking crisis and environmental disaster. If we are to avoid the huge pressures that these shocks create on local areas, it is increasingly important to ensure our communities are more resilient and better able to withstand external shocks. 

 Reconnecting capital to place 

A good example of how a centralised economic architecture causes problems is the contraction in access to capital, and financial service provision more generally. The fallout from the global banking crisis is well documented, but one of its lasting effects is the tightening of access to capital, particularly for SMEs. Since the financial crisis, government, business and civil society have almost constantly been bemoaning the problems of access to capital to support enterprise. Part of the problem with our banking system is the consolidation we have seen over recent years, with banks becoming ever larger global institutions. The risks of these institutions deemed by some to be ‘too big to fail’ have become more or less unmanageable and they have also become ever more distant from local areas. 

Banks have become ever more reliant on formulaic risk -mode ling process to take decisions about loans that are frankly unable to take account of subtleties that people understand (at least until we develop genuine artificial intelligence). Once upon a time a local bank manager would have known the person applying for a loan, understood the market and have made a pretty good assessment of someone’s ability to repay. Risk-based loan pricing creates a perverse incentive for banks to make riskier loans – since they attract higher rates of return and therefore greater profits. 

A more localised banking system – which is common in other countries but we don’t have in the UK – provides a way to connect surplus capital with productive purpose (for the mutual benefit of savers/investors and borrowers). That’s what banks were set up to do. How many of us that have private pensions really know where our money is invested? Even if you take care to choose the funds you wish your savings to be invested in, in broad terms, you’re unlikely to know which companies or areas you’re putting your money into. Perhaps, if there were stronger links between capital and places, it might even encourage people to save for their retirement – if it were to change the way we look at pension funds as more than ‘something for when I’m old’ and be seen as an opportunity to invest our surplus capital in enterprise. 

How to deliver economic localism 

It’s important to distinguish between specific programmes or policies that can be locally implemented in order to support local economies, with the economic infrastructure, or architecture, that governs the way our economy is organised. Progress is being made in some policy areas where local authorities and their partners can support the local economy. Local energy production is one example, with plans to reform feed-in tariffs and reduce some of the obstacles to community-based microgeneration. And there are also a number of small providers of financial services – credit unions and community development finance institutions – who are successfully linking capital and place. However these examples happen in spite of the current economic architecture, not because of it. 

If we are to respond to climate change, peak oil and global financial crises, as well as the opportunities for localism then we need a system that encourages, rather than hinders, this type of provision. It is the need for radical systemic economic reform that is most lacking at present in our political discourse and which is my focus here, rather than wide range of activity we can undertake to strengthen local economies. 

The idea of devolving control of local economies is not new and the UK has a long tradition of economic localism, despite its current absence.  Regional Stock Exchanges – one idea that would offer significant support to reconnect capital and place – were in existence in the UK up until 1973, when they were absorbed into the London Stock Exchange. In fact the Liverpool stock exchange operated up until 1991. At their height, in 1914, there were 22 stock exchanges across the UK in places such as Bristol, Halifax and Cardiff. The idea, which was a Liberal Democrat manifesto pledge at the last general election, would help improve the supply of affordable capital from local investors to SMEs. Given the huge variation between regional economies, it is surely no longer appropriate to think that a single entity can effectively reflect markets and serve needs. 

Local areas also need to be given wide-ranging power over taxation, in particular Income Tax, where local needs and capacity are very different and ought to be reflected in practice. By giving local areas greater control over revenue raising and taxation, they will be far better equipped to reflect differing local needs (not just between local authorities, but also at a neighbourhood level). With this power local areas would be able to use tax incentives more effectively to stimulate enterprise in deprived areas and reward local economic benefit. 

Other ideas to support economic localism that might be woven into our economic architecture include Local Enterprise Funds and Bonds, internalis ing the environmental costs of activity (in procurement and in taxation) and reframing competition laws to favour the development of local economies. The introduction of a locally determined Land Value Tax to replace Council Tax and Business Rates, like that proposed by the Green Party [1] , would also benefit local economies and reflect their differences. This would have the added advantage of creating a deterrent against speculative development and land-banking, which stifles regeneration. The introduction of a general power of competence for local authorities may mean that councils will be able to take this agenda forward, but this route risks being too piecemeal and inconsistent. And I do not accept the argument that localism is inherently inconsistent, as central government sets the framework for localism to operate within, which should establish consistent expectations and standards. 

 Transforming banking into a driver of economic localism 

A key barrier to economic localism at present is the state of our banking sector. Whilst more localised stock exchanges will help connect capital to places outside London, we also need to see far greater appetite for radical reform of financial services regulation. Aside from the small, though potentially significant, community banking sector, we have hardly any local banks in this country – unlike in the past. Most of our Building Societies have de-mutualised and a succession of mergers and acquisitions has seen our retail banking sector consolidated into an oligopoly. The barriers to entrance for new banks are so high that despite repeated calls from successful governments (and Parties) for ‘more competition’ within the banking sector, little progress has been made. 

Local financial institutions offer (like other local businesses) considerable benefit to the area – as the well evidenced LM³ methodology [2] has shown. They recycle a significantly higher proportion of capital and retain more wealth within an area than national or multi-national institutions. Banks, with their very specific role as brokers of capital, have an even greater significance on local economies and it is crucial that we create the necessary regulatory framework and infrastructure for this to flourish. 

There is huge potential to grow the currently small and immature community banking sector – credit unions, community development finance institutions and microfinance providers. Credit Unions and CDFIs account for only a tiny proportion of the financial services sector as a whole. In 2007 the value of the entire CDFI sector was less than 10% of Royal Bank of Scotland’s profits in the same year [3] . We should also be careful not underestimate the time and investment needed to get close to universal coverage of community-based financial service provision. 

One of the most effective ways to stimulate the growth of local community-based finance provision – as evidenced by the US experience – would be to introduce legislation along the lines of the US Community Reinvestment Act (CRA). In addition to encouraging more socially responsible banking, the CRA has led, albeit indirectly, to substantial private sector investment in community lending. The US Treasury’s research estimates that for every $1 of public investment into CDFIs, $27 of private finance has been leveraged [4] . 

The growth of the community finance sector was a positive but wholly unintended consequence of the CRA. Despite widespread misconception, all the CRA does within the US banking regulatory system is require banks to report on how they are serving local communities. These reports are then rated by the regulators, with an excellent rating affording banks certain permissions or privileges. The consequence of this has been to create a commercial incentive for banks to improve their performance in serving deprived communities, as the benefits that come with the top rating are greater than the costs of achieving that mark. 

The reason this has indirectly led to substantial investment in local community finance institutions is because the banks have deemed it easier and more efficient to support these institutions than to serve that community directly. So, rather than have the expense of setting up a branch in a community, they put their money into local provision. This approach could easily be adapted to the UK – taking account of the very different context, but retaining the underlying principles. 

 Unlocking latent resources within communities 

The ambition that underpins the localism agenda – for communities to have control over what happens in their areas – provides real opportunities to address deep-rooted social problems. However without redesigning the fundamentals upon which our economy is based we will continue to undermine the efforts of civil society, local authorities, private sector and communities to deliver local benefit and improved outcomes. The future of localism must focus far more on economic reform and provide local people with the levers to take advantage of emerging opportunities. 

This a chapter from ResPublica’s collection of essays, entitled “Changing the Debate: The Ideas Redefining Britain”.

ResPublica is publishing chapters from the collection on The Disraeli Room blog, encouraging other thinkers, politicians and members of the public to join the debate and contribute to the development of ideas.

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[1] See: http://policy.greenparty.org.uk/ld 

[2] For example research by new economics foundation in Northumberland found that every £1 spent locally was worth 400% more than £1 spent outside the area. (see http://www.neweconomics.org/press-releases/buying-local-worth-400-cent-more) 

[3] CDFA’s 2007 ‘Inside Out’ survey measured CDFI assets and loan portfolios at £856m. RBS posted pre-tax profits of £9.2bn in March 2007. (see http://www.cdfa.org.uk/wp-content/uploads/2010/02/Inside-Out-2007.pdf) 

[4] The CRA After Financial Modernization: A Baseline Report, US Treasury (2001) 

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