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Investment zones and the problem of displacement

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At last week’s ‘fiscal event’ the Chancellor set out plans for ‘Investment Zones’ as the part of the government’s renewed focus on growth.

The term ‘investment zone’ is a new name for an old concept. The previous government’s freeports policy – investment zones will apparently be a ‘full-fat’ version – are still in the process of being rolled-out. The coalition government brought in 48 ‘Enterprise Zones’ which gave tax and planning regulation incentives to businesses (you can read our 2016 evidence review on enterprise zones here) and the original enterprise zones first emerged in the UK under the Thatcher government in the 1980s.

A crucial question around all such area based initiatives, including enterprise and investment zones, and freeports, is the extent to which growth in the zone is due to displacement – the movement of economic activity from one area to another as a result of an intervention. When talking about enterprise and investment zones this mainly means the movement of businesses, relocating to take advantage of the zones.

Displacement is critical for thinking about investment zones because core to the debate around them is the extent to which they generate new economic activity as opposed to just moving existing activity around. The former would lead to overall growth of the UK economy, the latter won’t, although it could help with spatial disparities depending on what is being displaced to where.

What is displacement and why is it hard to measure?

When looking at where to set up, businesses will consider the costs and benefits of being based in a specific place. How expensive is land or property there? Will there be enough of the right kind of workers? What transport infrastructure is available? When two locations are very similar in terms of the costs and benefits to a business, then any intervention in one area – like a tax cut – that lowers the costs of being based there can tip the balance in favour of that area.

Creating an investment zone means laying down an imaginary border in an area that is otherwise fairly similar with the only real difference between one side of that border and the other the incentives available within the zone. This provides incentives to firms to move across that border to benefit. If that happens, the zone will have additional businesses as existing firms move, without any effect on entrepreneurs setting up new firms or inward investment into the UK.

This suggests that a lot of the growth we see in such zones could be due to displacement from other nearby areas. But some of the growth will be genuine – new activity created by firms facing lower taxes. The big controversy around such schemes comes down to one key problem: the extent of displacement versus new activity can be very hard to measure.

Seeing evidence of growth in the zone itself – the success stories that will always be highlighted by proponents – tells us very little if that activity is simply displaced from elsewhere. One option is to look at what happens in the larger area surrounding the zone. But this is not straightforward. Draw that surrounding area too tight – say a couple of miles – and we may miss displacement happening in the wider area. Draw the surrounding area too wide and it becomes very difficult to detect the beneficial effects of an investment zone which may only compromise a small part of that much larger geography. And both approaches ignore the question of displacement at larger spatial scales – for example at the wider regional level.

Why does this matter?

Given the difficulties, it’s not surprising that the evidence on displacement from past reviews on area based incentive zones is mixed. Not all the papers considered in our previous review look at displacement, but for those that do a majority find evidence of it. Because of the difficulties mentioned above it is still hard to say to what extent displacement happens, over what kind of distances it occurs, or what can be done to reduce it. But the underlying theory, and the evidence that we do have, should give us pause.

If we were talking about a drug with known side-effects the severity of which were hard to assess for any given patient, doctors would be rightly cautious. Economic policymakers need to be similarly cautious with investment zones when thinking about cutting taxes and regulations, given that displacement can play a significant role in any effects they have.

In this context, it is important for policymakers to think carefully about the costs of an investment zone, and whether these are proportionate to the potential they present for growth taking in to account the risks of displacement.

This isn’t to write them off altogether as a policy instrument, but it does mean that the government needs to be very clear – both with the public and with themselves – about what they want investment zones to achieve, and how they will be structured to ensure that they really do achieve it, not just look like they do. Be it levelling-up (in whatever form the new government pursues it) or pushing for growth, displacement matters.