The Scottish referendum has been and gone, and attention has turned quickly to the prospect of another referendum, on Europe. Surveys suggest that the Scots are more pro-EU than the English, so the ‘no’ vote has increased the chances of staying in, other things being equal. Things do not feel equal at the moment: UKIP seems to have been boosted by the result. There is a difficult time ahead for the two main parties. Defections to UKIP from the Conservatives give the impression that the political right is most vulnerable to resurgent little Englandism, but the revival of territorial politics presents difficulties for Labour too.
One of the strangest parts of the Scottish campaign was the debate over the currency. The nationalists apparently feared the prospect of their own currency. They also feared the euro, and so rushed into the arms of the pound. The travails of the euro area are, we are told, the consequence of the folly of bringing disparate countries into the ambit of a single currency. But if that is the folly of the euro, then it is the folly of the pound too. The single currency is, inevitably, managed primarily with a view to economic stability in the core regions of London and the Southeast. Credit conditions cannot be tailored to regional needs. The policy needed to stimulate the Portuguese or Scottish economy need not be consistent with that needed to rein in a housing bubble emerging in Munich or London. By embracing sterling, the nationalists embraced an economic future dominated by the financial services sector in London and – no doubt this was crucial – its small sibling in Edinburgh.
The sterling area should be more resilient than the euro area, in the face of regional divergences, because of its common fiscal institutions. By contrast with the euro area, these mean that there are substantial net transfers between regions of the UK in response to shifting demographics and variable economic fortunes. But this fiscal mechanism is being weakened, while the government in London is declaring the success of its strategy of complete reliance on monetary policy to produce an economic recovery. The Bank of England has managed to talk down the house price boom that rolled through London in the early summer, but it is apparent that the Southeast will recover more quickly on the back of cheap money than the rest of the country. Access to lending for small businesses restricted to local sources of funds (specifically, local branches of banks) remains poor, even while liquidity swills around the City. One explanation is that banks’ assessment of the safety of a loan depends heavily on the collateral offered. Borrowers in the parts of the country where property values are high have more collateral to offer and are therefore less constrained. Even if this collateral is a bit bubbly, it supports lending and promotes growth.
While Edinburgh may thrive on the back of London’s recovery, other parts of the country languish. This United Kingdom is a startlingly disunited place. Inequality between the richest region (London) and the poorest (west Wales and the valleys) is greater than in any other EU member state. While London often emerges from the statistics as the wealthiest region in Europe, some of the UK’s peripheral regions are among the poorest. The current stance of fiscal policy is exacerbating this regional inequality. Take social security. Social security systems can be effective mechanisms for regional rebalancing. Payments are made ‘on demand’ on the basis of individual entitlements. The automaticity of these payments and their low visibility makes them a robust way of responding to variable regional fortunes. But now the social security system is under sustained attack as part of the policy of fiscal austerity. Already-depressed parts of the country with high rates of reliance on social security payments are disproportionately affected. The long-standing policy of moving parts of the civil service to depressed regions has also been ended by austerity, with some specific localities badly hit by public sector employment cuts.
There is a view, particularly on the right, that fiscal mechanisms for regional redistribution are counterproductive: that relatively well-paid public sector jobs crowd out private sector development in the regions, and that social security benefits have created a dependency culture affecting whole communities, not just individuals. Thus the UK’s poorest regions have become laboratories for testing the theory of ‘growth-friendly fiscal consolidation’. This means putting faith in monetary policy, and therefore in the financial sector, to lead the way out of recession, but it is becoming evident that the financial sector will lead the way back up the path already travelled: underpriced risk, emerging asset bubbles and regionally unbalanced growth.
In most of Europe, secessionist movements are led by the richest region in the state: Catalonia, Flanders, Lombardia. The UK has a different dynamic because the richest region dominates politically as well as economically. Both main parties have located the median voter in the Southeast, and they pitch their policies accordingly. This regional bias sits oddly with the constituency system of representation, which is susceptible to localised and regionalised politics. We see this tendency only rarely because the party system counteracts territoriality by proposing policies for the whole of the UK and maintaining party discipline in support of those policies. So long as each party had a clear class basis that cut across regional differences, they were able to do this easily: so easily that they have become complacent. They have never really had to build coalitions of support across the UK or use their party structures to resolve regional conflicts.
This is likely to change. Devo-max has been promised to Scotland, which will require a new financial settlement. Inevitably, that settlement will affect Wales, and it is also likely to trigger a debate in the regions and major cities outside London about how power and resources are distributed in the UK.
Muddling through with the Barnett formula is not really an option. The formula provides a back door way of reducing the differences in per capita spending between the UK nations. However, it narrows the gap fastest when public spending is rising strongly. Austerity is disabling the process of convergence and locking in the historic allocation. In any case, it is not clear that we should converge on identical per capita spending by region. Some countries do use population-based distributions – VAT revenue is distributed among the German länder by population, for example – but other mechanisms are still needed to pick up the pieces of regional inequality, and fiscal crises occur periodically.
Respected commentators like the Institute for Fiscal Studies argue for a needs-based financial allocation to replace Barnett, but the more different the political preferences of the nations or regions, the harder it is to achieve agreement on a needs-based formula. A broad consensus about the nature of the welfare state has to underpin the formula, because agreement is required on which needs should be recognised. Policies oriented towards low-income households suggest a needs formula heavily weighted by income; policies to promote educational opportunity imply that the needs weights should reflect the youthfulness of the population, and so on. Negotiating a new formula in a climate of general austerity and deep disagreement about the maintenance of key pillars of the welfare state will be an immensely challenging task.
Another answer is to devolve more revenue-raising power along with spending obligations. The political left has sometimes toyed with this policy, attracted by a rhetoric of local empowerment. This is an illusion: financial autonomy for small units of government fundamentally weakens their ability to provide public goods and avoid fiscal competition. More financial autonomy means more beggar-thy-neighbour policies, as the unedifying example of Ireland’s low corporation tax and hidden subsidies to capital shows. It also means more exposure to economic instability. To balance the books with self-financed spending, each nation or region would have to cut expenditure in recessions, in response to falling tax revenue. The only way out of this procyclicality would be to borrow. If borrowing was allowed but the Bank of England did not stand behind sub-UK governments, there would be a risk of Greek-style debt crises. More likely, borrowing would not be allowed. That leaves countercyclical policy in the hands of the government in Westminster, and we are back at the root of the problem.
A political settlement becomes more difficult, the more intense the claims from the English regions. While UKIP’s pattern of support is currently weighted towards areas that perceive a threat from EU migration, the party is aiming to widen its appeal by invoking English nationalism in the regions against the cosmopolitan elite in London. As the Guardian put it on 26 September: ‘After the near-death experience of the UK political class in Scotland last week, Mr Farage is offering to do in England what Alex Salmond so nearly did in Scotland.’ This gambit exposes the weakness of both Labour and the Conservatives as unionist parties. MPs today have to think about how to win in constituencies which are alienated from national party politics. The party machines still carry a good deal of weight, but they do not bring the resources they once did. We see MPs go into battle for their constituencies and their regions on every major infrastructure project. Pork barrel politics, where seats are won or lost by the central government spending that the candidate pulls into the constituency, are likely to become a more persistent feature of the political landscape.
The union is not in a happy state. A favourable fiscal settlement and a substantial financial services industry encouraged Scotland to stay in. Other parts of the UK do not enjoy these benefits from integration, and we should not be surprised if they respond by voting for candidates who promise to focus on constituency interests and deride Westminster. UKIP may turn out to be more important for the disintegrative pressures it places on the UK than for its stance on Europe. The two are linked, not only by a common thread of alienation from remote power, but also by the failure of central government in the UK to share the costs of economic integration and spread the benefits.