Analysis | Investment Zones Are No Silver Bullet for the UK

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Once upon a time, a once-great power impoverished by fantasies of self-sufficient isolation put its faith in a visionary leader who sought to reverse its decline and reawaken entrepreneurial spirits by setting up special economic zones. The rest is history, as they say.

But enough of Liz Truss. While Britain’s shortest-serving prime minister didn’t last long enough to push through her version of the Deng Xiaoping policy that helped ignite China’s economic rise, the UK is still enamored of the concept.

The 12 new investment zones announced in Wednesday’s Budget are a dramatic scaling back of Truss’s plans for as many as 200 of the enclaves, where special tax incentives, planning rules and funding support for infrastructure apply. It’s a sensible refocusing that, besides being about £11 billion ($13 billion) cheaper than the Truss proposal, increases the chances of achieving the stated aim: creating “clusters” of innovation in industries such as advanced manufacturing, green technologies and life sciences.

However, anyone who thinks this is likely to “supercharge” economic growth, in the words of the UK’s finance minister, Jeremy Hunt, is likely to be disappointed.

That’s not to say that Hunt’s policy is wrong. The world has moved on a long way from the 1980s and 1990s when special economic zones — an umbrella term covering any geographically defined area freed from ordinary regulation — were best known as tools for developing countries to attract foreign investment and increase their share of international trade. The number of SEZs exploded to almost 5,400 as of 2019 from fewer than 200 in 1986, according to a report from the United Nations Conference on Trade and Development. Developed economies accounted for 374 of them.

The free-markets ethos of the globalization era has given way to an age of industrial policy. When everyone else is flinging around carrots to attract investment, you don’t want to be the only one left out. The UK is currently squeezed between subsidies offered by the US, Europe and other competitors, observes Neil Lee, a professor of economic geography at the London School of Economics. “We have to prioritize, and a smaller number of larger investments would probably have a greater chance of success,” he said.

It’s still questionable whether investment zones — and their close cousins, the free ports championed by Prime Minister Rishi Sunak — will make a tangible difference to growth in the only Group of Seven member where the economy remains smaller than before the pandemic. The argument against such strategies is that they displace investments that either already exist or would have taken place anyway. Companies may move factories to special zones to take advantage of the perks on offer, but that won’t necessarily lead to a net increase in economic activity.

Investment decisions for coveted high-value industries depend on more than subsidized land or tax breaks. Far more important are the availability of a skilled workforce, a nearby network of suppliers, and the size of the market.

Greater flexibility to offer incentives after Britain’s withdrawal from the European Union — claimed as a key advantage for free ports in a 2016 paper by Sunak — is insufficient to compensate for the loss of unfettered access to such a large market, as shown by the UK’s struggle to attract battery and electric-vehicle manufacturers. BYD Co. is the latest to rule out building a car factory in the UK because of Brexit: The Chinese company’s European president said Britain didn’t even make its top 10 list of possible locations, the Financial Times reported March 12.

None of this makes investment zones a bad idea. The distributional effects are valuable socially and politically if not economically. The comforting notion that market forces can be relied on to rebalance growth across economies has broken down. We are living in a world of agglomerations: Innovation industries create a self-reinforcing, “winner takes all” (or most, at least) loop in which rewards increasingly accrue to clusters of companies and high-skilled workers. Once, relocation by manufacturers to areas with cheaper wages and land values would have helped to reduce disparities between regions. These days, not so much. That’s because cost isn’t the primary factor for the innovation economy.

It’s a problem across the world including in the US, where technology gains have helped spawn a growing gap between dynamic metropolitan areas such as Silicon Valley and Boston, and the rest. A 2019 paper from the Brookings Institutions called for the nation to designate eight to 10 new regional “growth centers” across the heartland. That’s likely to have influenced the approach in Britain, where the challenge is to address the widening gulf between London and the rest of the country.

Hunt said that, in England, the following areas had the potential to host a zone: the West Midlands, Greater Manchester, the Northeast, South Yorkshire, West Yorkshire, the East Midlands, Teesside and Liverpool. There will also be at least one each in Scotland, Wales and Northern Ireland.

In cases of market failure, it makes sense for the government to try acting as a catalyst to create new innovation clusters. Focusing on sites close to universities where there is already an industrial base will maximize the chances of success. Free-market purists may chafe, but in the words of one economic reformer once criticized for ideological heresy: It doesn’t matter whether the cat is black or white, as long as it catches mice.