The 'North-South' Divide
The grass must be made greener

Soaring house prices in the South of England were evidence that market forces work, Patrick Minford argued at a lunchtime meeting on 25 September. They increased business costs in the South and encouraged firms to expand in the North: this reduced unemployment, particularly among non-manual workers. The evidence indicated, however, that for manual workers the housing and labour markets performed less effectively. Most manual workers lived in council housing or in private regulated tenancies. In addition, Minford argued, the benefit system created a floor below which their wages were unlikely to fall. As a result, wage differentials between North and South were unlikely to grow large enough to encourage firms to expand employment in the North or to compensate Northern workers for the increased costs of migrating South. As a result large regional differences, persist between the unemployment rates of manual workers. Minford's research suggested that the abolition of all rent restrictions would have reduced aggregate unemployment by 1.8 percentage points in 1979.

Patrick Minford is Edward Gonner Professor of Applied Economics at Liverpool University and a CEPR Research Fellow. The opinions Minford expressed were his own and not attributable to the Centre, which takes no institutional policy positions.

Minford considered the effects on non-manual workers of a shift in demand from the industries of the North to those of the South. These effects will depend on the availability of land in the South. If land with planning permission is plentifully available in the South (at some constant price of farming land), then wages will fall in the North and rise in the South. This will cause migration southwards until wages are equal again; housebuilding expands in the South and contracts in the North, but land prices are unaffected. In reality, however, the supply of land for housing is limited. In this case attempts to migrate only drive up the price of scarce land in the South. As house and land prices rise, business in the South has to pay more for its own land and premises. Wage bills rise as well in order to compensate workers for higher housing costs. Conversely business costs, including wages, fall continuously in the North.

Minford emphasized that in both cases the net marginal product of labour (after allowing for the costs imposed on the environment as reflected in planning restrictions on land) is equalized across regions, and there is no regional misallocation of resources or unemployment. In one case, regional equilibrium is restored through migration, and in the other through shifts in relative costs in the two regions. Although evidence was limited, Minford concluded that the labour and housing markets for non-manual workers functioned in this manner: unemployment rates among non-manual workers show much less regional variation than those among manual workers, businesses starting up in the North are tending to employ non-manual rather than manual labour, and regional differentials in non-manual earnings exceed those among manual workers and may well compensate for higher housing costs in the South.

Minford argued that manual workers found themselves in a very different situation, in which markets functioned less effectively. These workers tend to live in rented accommodation, mostly as council tenants or in private regulated tenancies. Their productivity is lower, he argued; they are typically eligible for benefits and if unemployed will receive not much less than their normal pay. Minford traced the effects on such manual workers of a shift in demand from businesses in the North to those in the South. As wages start to rise in the South, local labour becomes more fully employed, but there is a limit beyond which wages rise with little corresponding reduction of unemployment. As wages fall in the North, however, they quite quickly reach the 'benefit floor', below which they are unattractive compared to benefits. There is little countervailing pressure on firms to create jobs to offset the ones lost because of the fall in demand, so unemployment rises in the North by more than it falls in the South.

Migration does not occur in this labour market, largely due to the nature of the housing market. The regulated or council tenant requires a substantial wage differential to compensate for the difference between the rent on the black market lodgings available in the South and the sitting-tenant rent in the North. Such a differential is unlikely to develop, however, since wages in the North are held up by benefits. In the manual labour market, therefore, nothing offsets the inequality in real wages and unemployment between North and South. This causes a severe inter-regional misallocation of resources as well as a rise in national unemployment.

The evidence overwhelmingly supported this interpretation of the manual labour market, according to Minford. He pointed to the large regional disparities in manual unemployment rates and to the disparities in manual wages, which were clearly neither eliminated by migration nor large enough to eliminate concentrations of high unemployment.

Minford's recent research with Paul Ashton and Michael Peel, reported in Discussion Paper No. 191 , provided other evidence of the importance of housing and other distortions on regional unemployment. Minford and his co-authors constructed a regional 'housing mobility index' to measure the extent of each region's housing subsidies, based on the disparity between the level of rents charged for both private and public sector housing in the region and the rent that might be charged in a free housing market without rent restrictions and subsidies (based on national estimates). This index was used to estimate an equation, using regional data for 1963-79, in which unemployment in a given region and in a given year depended on variables that include the mobility index as well as national unemployment, regional demand, regional union power and regional property taxes (or rates). The housing mobility index was found to be significant in the regressions, confirming to Minford the importance of housing distortions in explaining regional unemployment. The estimates also indicated that regional levels of unionization and rates were significant in explaining regional unemployment.

Minford's calculations based on these estimates suggested that if all rent restrictions had been abolished, national unemployment in 1979 would have fallen by 1.8 percentage points, though he warned that this estimate was based on extrapolating well beyond experience in the sample. Minford concluded that effects of this order should be sufficient to motivate political interest in the deregulation of the housing market. He argued that in the case of non-manual workers, the markets should be left alone, but that policy changes were urgently needed in the markets affecting manual workers. These included supply-side reforms to the benefit, rent and rate systems, such as those the government is currently pursuing.