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Can one money suit all regions?

Some people find one economist bad enough- but 155 of them in Germany have just spoiled Chancellor Helmut Kohl's pre-election digestion by calling for delay in his pet project for the Euro. Herr Kohl, who makes a habit of referring to economics as 'that silly stuff' and similar put-downs, is not about to be shouldered away from his last big triumph by even a thousand of such silly-billies. But the German people also seem to be noticing that he has ruined their economy; and we shall see if his or their views are shared by Germany's Constitutional Court in Karlsruhe, where four more economists are challenging the euro's constitutionality. The show is not over, as we all know, until the fat lady sings.

What those economists are all worried about is whether Europe is yet up to turning 11 or more states into mere regions, all under the aegis of one money. It is difficult enough running a country like the UK under one money, with its relatively well-integrated regions- a topic some readers have asked to hear more about.

Successful regions in the UK get there pretty much regardless of their monetary arrangements. Clwyd in North Wales has grown about the fastest of any UK region; its secret is superb communications, available sites, a lightly-unionised and flexible labour force, and efficient pro-business local authorities. Just across the border is not-so-successful Merseyside, thankfully now turning over a newish leaf; the not-so-secret reasons for its long decline and then relative stagnation are its poor communications, derelict sites, highly-unionised (frighteningly so at times) workers, and some local authorities that made the Light Brigade look intelligent.

It used to be put about in the 1970s that regions grew if the state gave them resources. Nearly the opposite is the truth; regions grow because they are organised well for free market initiative, and state resources (other than emergency aid) can too easily encourage attitudes of dependency hostile to such initiative.

But monetary policy is another matter. It is hard to be a region on the periphery of a monetary area, when interest rates are set on the basis of what happens at its centre. Let us compare Huddersfield or Runcorn with London and the South East. The first two have large manufacturing sectors, whereas the South East is dominated by services, most of them not traded internationally. Productivity growth is faster in manufacturing than in services; this means that for given wage increases across the economy prices of output will rise faster in the South than in the North.

Then the North has systematically been facing manufacturing decline or `deindustrialisation' whereas London has been basking in the glow of expanding demand for services, whether traded ones like tourism and the City, or the non-traded ancillary sectors (shops, entertainment) that always do well when trade does well. Since the country has a unitary benefit system, the resulting relative decline of Northern wages pushes them closer to benefits and produces more unemployment, aggravating the loss of prosperity all round.

Now how do you set interest rates? In relation to conditions in London or in Huddersfield? That is not an academic question. We have just seen in the latest figures a rise in unemployment in parts of the North- the first for some years- against continued falls in the South. We will soon see more layoffs in manufacturing as the effects of the high pound and then of the Asian fall-out from super-cheap imports feed through. Yet services output and employment is growing quite strongly, around 4% and 2% respectively.

There is a theoretical answer: set interest rates so that the average consumer price level across all regions is stable over the long term, and in the short term vary them to stabilise the average country-wide unemployment rate around its `normal' or `natural' rate- this is the rate at which the economy would eventually settle through market forces. In other words operate on averages across the whole currency area.

But in practice it is not easy to do this because inflation measures differ so much, by area and also by type of index, as do unemployment rates. The chart compares unemployment rates in the South East and Merseyside. My research team calculates national unemployment, now 5%, can come down to 2.5% without average inflation pressure. But tell that to people in Reading. They will try to chill your blood with tales of skilled labour shortages, price gouging and outrageous wage demands.

The Bank's Monetary Policy Committee will then worry that a wage-price spiral will begin in Reading and be transmitted nation-wide. Its argument would go: the Reading shortages will not be relieved by inward movement of workers so wages there will rise and rise, and this will prompt trade union demands for matching rises across other areas and industries. Prices would then be driven up.

The counter-argument is that unions do not have that power any more; also spare labour in other areas can move to relieve shortages in Reading. This may take a little time but it happens- helped greatly by the liberalisation of the private rented sector in the late Nicholas Ridley's 1988 Housing Act. Merseyside's unemployment rate has fallen to 10% today from nearly 20% ten years ago and yet its employment has also fallen by 13% over that time. This means that its work force has contracted by one fifth through emigration. Many of these people appear to commute (weekly, monthly or even yearly) to where there is work, rather than move their families.

These arguments will run on until the evidence from this recovery is fully in. But at least now we have some mechanisms to alleviate the Bank's regional mistakes; if Runcorn gets a cold bath because Reading is in a sauna, the labour market is flexible enough to prompt both wages to fall in Runcorn and its workers to move to London. And then if all else fails they can go to their MPs and complain.

Pity the poor workers in the South of France if Herr Kohl rolls over those hundred-odd economists; stuck with 16% unemployment, with a labour market unable to respond, and with no channel for their complaints about the all-powerful Euro Bank.

Patrick Minford is professor of economics at Cardiff Business School and visiting professor at Liverpool University.
 
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