Focusing on Human Capital has failed to level up Britain. We should change course.
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In late 2021, the Chief Executive of Centre for Cities Andrew Carter interviewed three academics with jobs in East Germany. They spoke about that country’s experience of reunification and the levelling up of the former DDR that followed it. I listened to it at the time and I thought it was good. I must have been tired or in a bad mood back then because I listened to it again recently and now I think it’s brilliant.
The three Germans start by going back to 1990 and describing North England.
Infrastructure built a century ago and barely maintained since the war. Towns reliant on single industries still using century-old technologies. Depopulated cities constrained by continued political dispreference and disempowered by political centralisation.
Just kidding, they were describing East Germany. But it felt a bit too familiar.
Of course, East Germany had it much worse than us here in North England. And while we don’t know how much worse, we can be sure that East Germany upon reunification had a much weaker economy.
Communism is bad.
Communism is really bad and after forty years of trying to make it work, the people of East Germany voted overwhelmingly for parties who promised to give it up quickly. Reunification was not a merger, it was the rapid imposition of West Germany’s economic and political model on the East.
State-owned industries including the housing stock were quickly privatised. Infrastructure was transformed — electrical grids and sewage systems were upgraded, railways were electrified, new train stations were built, metro systems were extended, trams were replaced, and motorways were built from scratch where necessary. Research institutes were improved and added to.
Importantly, West Germany’s model of federalism was imposed. The six states that had been abolished and replaced with central control from East Berlin (and Moscow) under communism were re-established. These New States were given substantial freedom to raise taxes, get those taxes generously topped up by solidarity funds from the rest of the country, and helped to spend much of their money as they felt best.
The results have been astounding.
From well behind in 1990, the economy of the new states overtook North England’s in 2010. By 2016 this was true even ignoring Berlin, whose status as a national capital probably gives it some economic advantages.
This has involved hard choices and difficult trade-offs. Deindustrialisation that had taken two decades in North England happened in less than a decade in East Germany. A very similar social pain was experienced even more deeply.
In a dash for growth and modernity, all of Germany’s new states focused their energy on the large cities which had been suppressed under communism. East Germany’s large city economies have all enormously outperformed North England’s. Their success is why East Germany is richer today.
But small cities and towns in East Germany have fallen well behind and shrunk rapidly. The socialist model town of Hoyerswerda today has less than half the population it did in its centrally-planned prime. Unemployment and out-migration have left many of the people who remain there miserable and ignored.
In the 2021 German federal elections over a third of the people in Hoyerswerda’s constituency voted for the far-right Alternative for Deutschland (AfD). The party easily won the seat, just as they had in the previous election. This week they even more strongly backed AfD in the European Elections.
Skills.
Back to the podcast. We’re just about to reach the 30 minute mark. We’ve heard about a hugely successful example of levelling up where regions with a weak economy outperform and close the gap with regions with stronger economies. We’ve heard about huge investment in infrastructure, huge investment in science and technology, and tax raising powers backed up by large fiscal transfers to powerful local units of democratic government with lots of freedom to create and carry out local plans for growth.
No-one has mentioned skills yet. Nor has anyone mentioned human capital, the economics jargon which means more or less the same. This is astonishing.
In a 2023 Spectator podcast with Tyler Cowen, after a day of conference discussions with some of Britain’s top London-based thinkers on economic growth, it takes just three minutes for him to suggest to Kate Andrews that North England’s economic weakness could be due to persistent Human Capital issues. In the UK government’s 2022 levelling up white paper, Human Capital is listed top of the six capitals we need to consider to get levelling up right. Back in 1997 when he was preparing for government Tony Blair famously said that his three priorities were “education, education, education,… because nothing matters more to the future prosperity of the country”.
In over a decade of experience at conferences and roundtables working on levelling up strategy and industrial policy in Britain I’ve found that skills is almost always promoted as the top thing to invest in to achieve economic growth in lagging regions of Britain.
No doubt shell-shocked, Andrew Carter intervenes at the half hour point. What about human capital? he asks.
Dr Matthias Brachert at IWH Halle explains that “in the first period there was more investment in physical capital and now we are trying to shift policy in favour of investing in human capital”.
Carter, relieved, says — “we hear this a lot in Britain that one of the ways we’re going to level up is large investment in physical capital whether it’s land or buildings and transport and actually as we all know it’s investment in human capital that makes a material difference over time”.
But we just heard that Germany’s success at levelling up its new states in the East following reunification was based on a focus on physical capital, not human capital. Why do we think it is human capital that makes the material difference when the opposite seems to be the lesson here?
I don’t often hear the focus on physical capital that Andrew reports. Much more often I hear the importance of physical capital talked down, often sneeringly, and the focus shifted to human capital and investment in skills. I don’t agree that it’s investment in human capital that makes the material difference.
Focusing on human capital has failed.
I am often quite a lonely voice in arguing against a focus on human capital. Andrew’s statement is the dominant opinion in the large number of meetings and conferences I’ve attended on regional development, economic growth, and levelling up in Britain, especially in South East England.
And as a result we are a country which spends more on education than our more prosperous neighbours.
We achieve a lot with this investment.
According to recent PISA results, our schools outclass France, Germany, the Netherlands, Denmark, and many other countries of Northern Europe. We have accumulated more human capital in terms of graduates than our neighbours too. Far more of our workforce, both young and old, possess a tertiary (university equivalent) education for example.
These strengths are not just reserved for our prosperous regions. By our best estimates, North England has just as high a graduate population percentage as the Netherlands and a far higher graduate population percentage than Germany. By international rankings North England’s universities are better than the best in those nations.
North England certainly has a much higher intensity of graduates than East Germany. And again, if we trust international rankings, vastly better universities.
And yet it is Denmark, the Netherlands, Germany and the rest of Northern Europe who are economically well ahead of North England and Britain as a whole. And it is East Germany that from a starting position well behind us has caught, overtaken, and is now pulling away economically from North England. They haven’t done this by reindustrialising either, but rather by beating us in a high value services world with a high value service economy.
Why? I’ve long argued it’s because while North England was trying and failing to level up with a human capital approach, those places did things that worked better.
Better transport, spending on research and development, and replacing central planning with local power.
An outsider’s perspective.
I have made myself sound more alone in my pushback against what I see as a British over-emphasis on human capital as the route to levelling up than I am. And Andrew and I agree on this much more than I’m suggesting. I won’t name people who share my opinions in local government and academia, mostly in North England and Scotland, without their permission. But I will name a researcher whose work I hope could mark a turning point in British thinking on levelling up.
In Anna Stansbury’s “Tackling the UK’s regional economic inequality: Binding constraints and avenues for policy intervention” paper in 2023, she and her co-authors argue that British second cities have unusually poor transport infrastructure, enjoy unusually low public spending on science and technology, and are unusually disempowered by their central governments.
This is useful but not groundbreaking. More innovatively, they show in findings since reproduced by the Resolution Foundation that the graduate premium in these cities is falling and is now well below the level in London, suggesting that further increases to graduate levels in the cities will deliver diminishing returns.
I don’t think it is a coincidence that Anna wrote that paper at MIT, outside of the UK national policy circles that I feel overweigh human capital as a route to levelling up.
If our current approach to levelling up of focusing on human capital isn’t working what should we do instead?
Doing what works.
A good place to start would be to do something similar to what East Germany did. Of course we would do it in our way, I am not a simplistic “copy Germany” person and indeed many other countries in Europe were achieving similar success to East Germany well before it. I think we could do even better in many ways, especially given our significant advantage of proximity London, Paris, and Amsterdam. But we should move in the direction that we have seen work. Instead of education, education, education, we should pick the three priorities that worked. Infrastructure, research, and local power.
We should invest in physical capital, especially in better transport systems, with a strong focus on our big cities. East Germany has twice as many metro stations, eight times as many tram stops, and high speed railway lines — both new and upgraded — connecting its cities. It has nearly completely electrified its mainline railway. It has built new underground railway stations of the kind we have had cancelled.
Meanwhile North England is home to the largest city in Europe without a metro (Manchester), the largest city in Europe without any mass transit system (Leeds), the largest city in Europe except Tirana, the capital of Albania, without a single electric rail service (Sheffield), and probably the largest pair of neighbouring cities in the rich world not connected by a motorway of some form (Sheffield and Manchester).
We should set up lots of research institutes and triple public spending on R&D to fund them. In 2018 UK public spending on R&D in North England was €2.2bn. In East Germany in 2019 it was €8bn. This is not an appeal for reindustrialisation. East Germany beats North England with a service economy, not a manufacturing one. It is an appeal for a more efficient allocation of research funding in Britain.
We should reduce central control and central planning by the UK government and decentralise power to more local levels of government. In Germany, 34% of total tax is raised locally: 25% by states and 9% by local government. This is the same percentage as in the USA. Meanwhile in the UK, all local government combined raises less than 5% of total tax and has correspondingly limited freedom to plan for growth and fund its plans.
We shouldn’t abandon the brilliant work we’ve done as a country on education. There may be some parts of education, especially around further and adult education, where there’s still a lot of work to do. But we should probably be judging how good our plans for levelling up are by how low down the list of priorities education comes. And we should be mindful that our great success on education has delivered poor economic results for much of our country.
Why change course?
Where we have tried this approach, it has worked. Scotland’s economy has rapidly outgrown North England and the Midlands since it voted for and achieved devolution in 1999. It did this by following quite a lot of the East German playbook. We should expect similar outcomes here if we try something similar.
But my feeling is that most of England doesn’t want to level up its North like Germany wanted to level up its East. Not really. Our desires often feel closer to East Germany before reunification.
There, the arguments of Marx and Engels against agglomeration meant that central planning was used to promote towns instead of cities. When Rishi Sunak vetoed the Treasury’s recommendation to place a Northern outpost in Manchester or Leeds and insisted on Darlington instead, he was doing the same.
In the old East Germany, local and state government was replaced with central planning from East Berlin. Where Britain’s levelling up funds are deliberately designed to circumvent existing local governments and deliver money directly to new smaller units such as Towns Boards via competitive bids or micro-managed dispersal of central funds they are doing something very similar, but from London.
Much of our national discussion on the topic of levelling up assumes that North England, and the people of North England, lack some necessary features needed to prosper that East Germany and East Germans have. With a varying mix of solidarity and condescension we are told that we would be better off quietly enjoying decent public services paid for with Southern money as our relative decline is managed.
I reject this evaluation and this vision of the future emotionally. But even for those with cooler heads, there is a problem with continuing on that course that seems increasingly insurmountable; the cost of economic failure in North England and the Midlands is more and more unaffordable.
Upon reunification huge amounts of money started flowing from West Germany to the East. A new solidarity tax was set up to make such flows more visible. The fiscal transfers within Germany at the time were almost certainly far higher than those within the UK.
But by 2010, the success of the East German economy meant that fiscal transfers there had shrunk to be lower than those within the UK. At the time that East Germany’s economy was overtaking North England’s it was receiving about the same inward transfer of money from the rest of the country.
Since 2010, East Germany’s economy has closed the gap further on the rest of Germany and its need for fiscal transfers from the West has decreased as a result.
In Britain we have moved in the opposite direction. As places like North England and the Midlands have fallen further behind the rest of the nation’s economy, and especially far behind London’s economy, their needs for fiscal transfers to maintain public services has increased.
Without levelling up North England and the Midlands, home to nearly half of all Britons and Europe’s third largest metropolitan area, I doubt that we have a plan to reverse this trend. London’s success will increasingly have to support public spending across the whole country. And while many people in and around power in Britain seem happy to continue flying the economy on only one engine, it is unclear for how much longer that engine can support the ever-increasing fiscal weight.