5 regional funding(1)

EC-111Topic 5: UK Regional Funding

Dr John MoffatRichard Price Building, Room F49Email: [email protected]

Office Hours: Tuesday & Friday, 1:30-2:30pm

mailto:[email protected]

Topic 5: UK Regional Funding 2

Learning OutcomesStudents should be able to answer the

following questions:What impact will increased levels of

expenditure have on regional income?How is funding distributed to the devolved

regions of the UK?Explain why many people regard this funding

mechanism as unfair.


ReadingsArmstrong & Taylor, chapter 2Holtham Commission (2010), Fairness and

accountability: a new funding settlement for Wales, Available from: http://wales.gov.uk/docs/icffw/report/100705fundingsettlementfullen.pdf

Oxford Economics (2008), Regional Winners and Losers in UK Public Finances, Available from: http://www.isitfair.co.uk/Reports/Public/OE%20UKPublicFinance.pdf

http://wales.gov.uk/docs/icffw/report/100705fundingsettlementfullen.pdf

http://wales.gov.uk/docs/icffw/report/100705fundingsettlementfullen.pdf

http://www.isitfair.co.uk/Reports/Public/OE%20UKPublicFinance.pdf




Keynesian Income-Expenditure ModelThe importance of regional funding is explained by the

regional multiplier which shows the impact of an increase in government expenditure (and other types of expenditure) on regional income

To provide the intuition behind the multiplier, suppose the UK government decided to pay workers in Wales to electrify the railway line between Cardiff and Swansea:This increases the income of these workersThese workers spend a proportion of this income in WalesThis is income to other workers in WalesThese workers spend a proportion of this income in WalesAnd so on


Keynesian Income-Expenditure ModelThe national income identity is:

(1)where C=consumption; I=investment; G=government expenditure; X=exports; M=imports

Assume for the moment that:(2)

And that:where (3)

(4)where c=marginal propensity to consume; m=marginal propensity to import; t=marginal rate of taxation

MXGICY

000 ;; XXGGII

dcYCC 0 tYYY d dmYMM 0


Keynesian Income-Expenditure Model Substituting (2)-(4) into (1) gives:

(5)

Or:

where:(6)

is the regional multiplier

The impact of changes in autonomous expenditure can be calculated as follows:

(7)

tmc

MXGICY

11

)( 00000

00000 MXGICkY

tmck

11

1

00

GkYkG

Y


Keynesian Income-Expenditure ModelTo calculate the regional multiplier, we need

estimates of (c-m) which is the marginal propensity to consume locally produced good and services

This will typically be smaller when:The regional economy is smallerThe regional economy is more specialisedThe regional economy is closer to other labour

marketsFor Scotland, using information from input-output

tables, Harris (2009) estimates that (c-m)=0.39. If we assume that t = 0.2, then the simple Keynesian multiplier equals 1.45


Keynesian Income-Expenditure ModelBut treating investment and government

expenditure as exogenous is unrealisticMore realistic specifications for

investment and government expenditure are as follows:

where i<1(8)

where we assume that g<0(9)

diYII 0

dgYGG 0


Keynesian Income-Expenditure ModelSubstituting equations (8) and (9) along with (2) –

(4) into (1) gives:(10)

so:(11)

Using this more realistic version of the multiplier, and having estimated that i=0.17 and assumed that g=-0.1, Harris (2009) calculates that k=1.58 in Scotland

0000011

1MXGIC

tgimcY

tgimck

11

1


Crowding-outThe Keynesian income-expenditure model

assumes that increased government expenditure does not cause an offsetting reduction in consumption or investment

This assumption will not hold if increased government expenditure is financed by borrowing which in turn causes a rise in interest rates

This is what is referred to as ‘financial crowding-out’


Crowding-outThe Keynesian income-expenditure model also assumes

that the supply curve is horizontal and that there is therefore no impact on prices of increased expenditure

This assumption will not hold if the economy is at or near full capacity

In these circumstances an increase in public expenditure will increase aggregate demand which in turn will increase wages and prices

This moves the economy to a new equilibrium with higher nominal wages and prices but unchanged real wages and output

This is referred to as ‘resource crowding-out’


Crowding-outBut crowding-out is unlikely to be a problem in

the context of regional policyIn relation to resource crowding-out, the

regional economy is unlikely to be at or near capacity or it would not be a target for regional policy!

Financial crowding-out will be a problem for the region only if the region rather than the central government has to borrow to fund the increased expenditure or if the region is a very large part of the country


Barnett FormulaThe devolved authorities receive their

funding for spending on devolved areas through a block grant allocation from Westminster

Increases/decreases in the size of the block grant are allocated to devolved regions through the Barnett formula on the basis of:the size of the increase/decrease going to

Englandpopulation shares


Barnett FormulaThe change in the size of the Welsh block grant is

given by:

where ΔG denotes the change in nominal expenditure on services and W and E refer to Wales and England respectively

α is given by:

where POP denotes populationUsing ONS mid-year population estimates for 2010, an

increase in expenditure of £1 billion on a devolved area in England leads to an increase in expenditure of ((3/52) x 1 billion=) £58 million in Wales

EW GG

E

W

POP

POP


Barnett Formula• As spending increases, the Barnett

formula should eventually lead to the following outcome:

• Wales will receive a share of expenditure that is equal to its share of population

• In other words, spending per head will be the same in Wales and England

E

W

E

W

P

P

G

G


Barnett FormulaAs spending per head in the devolved regions

is currently greater than in England (see next slide), this implies that spending per head relative to England will fall if spending in England increases

This is the so-called ‘Barnett squeeze’But if spending falls, as it is forecast to do

over the next few years, spending per head relative to England will rise in the devolved regions


Identifiable Expenditure Per Head, 2006-2010 (£)

2006-7 2007-8 2008-9 2009-10 2010-11

North East 7,833 8,235 8,889 9,459 9,501

North West 7,636 8,093 8,631 9,267 9,386

Yorkshire and the Humber 7,033 7,332 7,867 8,462 8,512

East Midlands 6,527 6,875 7,385 7,950 8,098

West Midlands 7,097 7,502 8,015 8,613 8,679

East 6,241 6,534 7,067 7,690 7,834

London 8,352 8,806 9,355 10,146 10,198

South East 6,208 6,524 7,091 7,513 7,529

South West 6,531 6,896 7,481 7,977 8,096

England 7,042 7,414 7,962 8,553 8,634

Scotland 8,588 9,045 9,424 9,945 10,165

Wales 8,260 8,609 9,144 9,726 9,947

Northern Ireland 8,963 9,540 10,044 10,550 10,668

UK 7,288 7,671 8,203 8,785 8,884

Source: PESA (2011)


Regional ExpenditureConsiderable anger surrounds current levels of

expenditure per head across the regions of the UKMuch of this anger is directed at the fact that

Scotland receives higher expenditure per head than Wales (and many English regions) in spite of having, by most measures, a stronger economy (see previous lecture)

But, as shown above, the Barnett formula, if rigorously applied, should eventually lead to convergence of spending per head across the devolved regions and England


Regional ExpenditureBut is convergence of spending per head

desirable?Many people advocate the distribution of

public expenditure on the basis of a needs-based assessment (as in, for example, Australia)

A needs-based assessment would take account of different levels of demand for public goods and differences in the cost of providing a minimum standard of public goods across the country


Regional ExpenditureThe Holtham Commission (2010) undertook a

needs-based assessment and calculated that Wales was underfunded by £400 million in 2010-11

This calculation was based on the six measures of need shown in the next slide

The weighting attached to each measure of need was determined by a statistical analysis of their influence in determining relative levels of expenditure across areas within the other countries of the United Kingdom


Regional Expenditure

Holtham Commission (2010)


Regional ExpenditureWhat does Lord Barnett think of the formula

that he devised in 1978? He said the following:

“I do not consider it is successful. I do not think it is fair… I thought it might last a year or two before the government would decide to change it. It never occurred to me for one moment that it would last this long” (House of Lords Select Committee on the Barnett Formula, 2009)

http://www.bbc.co.uk/news/uk-politics-11970598


Regional RevenueIt may be argued that, when judging whether

the current distribution of expenditure across the UK is fair, the amount of revenue raised in each region should be taken into account

Information on tax receipts is not collected on a regional basis by HMRC so the tax revenue from each region needs to be estimated

The table in the next slide was calculated by subtracting (estimated) revenue per head from (estimated) expenditure per head for each region


Net Regional Fiscal Balance Per Head, 2006-7

Oxford Economics (2008)


Expenditure AllocationThe total amount of money available for

expenditure by the devolved parliaments is determined by the Barnett Formula

But the distribution of expenditure across those areas for which they have responsibility is determined by the devolved parliaments

In other words, the ‘Barnett consequentials’ from an increase in expenditure on, for example, health in England do not have to be spent on health in Wales


SummaryThe Barnett formula determines the size of the

budget for the devolved parliaments of the UKMany people regard the Barnett formula as

unfair and argue for a needs-based assessment to determine the distribution of expenditure throughout the regions of the UK

The devolved parliaments are free to spend their allocations in whatever way they like across those areas for which they have responsibility

5 regional funding(1)

Education

regional economy

importance of regional

regional winners andlosers

national income identity

uk public finances

devolved regions ofthe

autonomous expenditure

marginal propensity