Here’s the essential challenge with regional regeneration. To set up a business you need to have customers. But to have customers you need someone else to have a business to sell to – or at least to their employees. In the Midlands, nearly a quarter of businesses are retail, a sector which is reliant on local spending power. But local consumer spending power is below the national average, driven by relatively weak employment in other sectors. Closing this growth loop is not easy.
Some of this is true regardless of where you are based. Interestingly, if you set up a business today, the chance that it will still be running in five years is less than a third. Many businesses cease trading for positive reasons, but it does illustrate how unusual – and how precious – businesses which grow to provide significant long term employment are.
The traditional way of closing the growth loop in the regions of the UK has been to attract large-scale investment, or to distribute government employment more efficiently across the country. Swansea and its surrounding communities have benefitted greatly from the arrival of the DVLA, which employs 6000 people directly and many more through supply chains and the spending power of its staff. The Nissan plant in the North East is a vital tent pole employer in the same way. Successful industrial strategies by successive governments supported the expansion of the Sunderland plant to its current scale employing nearly 7,000 people. Barclays has several large employment sites in the Midlands including 3,000 staff in Northampton, and 1,500 in Birmingham.
These large investments will certainly be part of any successful economic strategy for the Midlands, but they can never be the whole story. Eventually you run out of government offices to relocate or large foreign investors to attract. So there is no doubt we also need to develop a diverse local business community, with the right balance of medium-to-large employers like the Jaguar Land Rover plant in Solihull which has 10,000 staff, small businesses and businesses who fit inside that magic 5-6 per cent with significant growth potential. It is diversity in scale, risk, innovation and stability which ensures long-term economic success.
The strategic approach to achieving it – in the Midlands or elsewhere – will be correspondingly broad. However, there are three things in particular which are clear necessities. The first is a diverse finance base. Banks are the principal lenders in the economy and the biggest banks between them have around
£100 billion lent to SMEs at any one time. But it is a common complaint that that the UK economy is funded excessively through bank lending, with insufficient risk bearing equity finance so crucial for innovation. This gap is particularly acute outside the South East.
While bank finance is a highly effective and low-cost channel for most financing needs such as working capital or revenue generation, it requires a strong expectation of repayment which does not allow for the uncertainty associated with high-growth business plans. Nor are banks always the best partners for a high-tech innovator. An average high tech firm has an eight-year period between the “eureka” moment to that innovation showing a profit. In those early years, the interest repayments of a loan can seriously reduce the money available for research.
This is why the long-recognised gap in the UK for risk-bearing equity finance remains so crucial. There are areas where banks can help, and Barclays’ own co-investment with the European Union’s InnovFin fund has supported lending to over 50 of most innovative UK companies. But ultimately, the fastest growing companies – that vital 6 per cent – needs a vibrant equity alternative to bank lending.
We tend to look to the US for an example of a strong equity market. The venture capital market in the US stands at around £26 billion, which is five times the size of the European market. It would be a mistake to try and replicate that just in the UK, and even more so to do it at a regional level. Instead the lesson to be drawn from the US is concentration. Three-quarters of total US venture capital is located in only three financial centres, while in the EU, 13 countries share similar levels of VC as a percentage of their GDP.
So what is the solution? Rather than trying to build highly localised pools of risk finance in each region, we should aim to create highly consolidated, full-scale venture capital markets in a small number of areas across Europe, large enough to be effective. The UK will certainly be one of those centres. In parallel, we need to create mechanisms to help regional high potential firms access those investment centres effectively. A couple of years ago the government legislated to require banks to refer businesses who are declined in their lending applications to an online platform where other lenders can find them. An obvious improvement would be to extend these to refer high-potential businesses to venture capital firms.
The second issue is improving infrastructure. Today, too many decisions about infrastructure are made at national level, which will always be less precise in identifying needs, and slower at fulfilling them. It is possible to devolve far greater discretion and direct fund raising powers to the regions. Investment banks are phenomenally effective channels for funding long-term, high value infrastructure projects from new roads, to new hospitals. Greater partnership between investment banks’ regional teams and regional leaders could improve the number of projects which get out of the ground.
And finally, trade is perhaps the most important way of closing the growth circle by allowing businesses to find customers outside of their immediate area. Small businesses have an advantage today that their predecessors didn’t have. Low-cost websites and shipping systems make it far easier to sell products internationally at an early stage, with far fewer risks and management time spent building customer networks. There is an increasing trend for businesses to make their first sale internationally.
However, we must not forget the central importance of larger exporters. The German “Mittlestand” network of mid-sized regional firms is often raised as a model for the UK to follow, and with good reason. What is so interesting about these firms is that there are relatively few of them, but they export at larger scale and to more diverse international markets than their British rivals. The lesson for UK exports is the value of a mid-sized exporter which can act as a local ‘tent pole’ firm, providing an efficient route to supply chain exporting. This is a natural model for the Midlands to adopt.
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