Supply-side or demand-side?

23rd October, 2018

For local areas writing their Local Industrial Strategies (LIS), identifying the barriers to growth is essential. Once the state of the local economy and how it might develop have been assessed, it’s important to be clear about the underlying market forces at play before coming up with policy solutions. But the multitude of factors affecting local economies makes this a difficult task and it is easy to misidentify the true causes of poor economic performance.

Distinguish between supply and demand as explanations of under-performance

A common misdiagnosis comes from confusing supply side and demand side factors, as our recent report Developing effective Local Industrial Strategies explains. For example, cities wishing to improve students’ interpersonal and analytical skills through their LIS may consider how to raise participation levels in extra-curricular activities. But are these low rates due to a lack of activities being offered to children, or because the activities are unpopular and so take-up is poor? Supply-side problems (not enough classes on offer) warrant supply-side solutions (hold more classes), and vice versa, so getting the diagnosis wrong can mean that policy won’t work.

Take for example a city centre which lacks high-skilled jobs in service sector businesses and wants to attract in more of these well-paid jobs to benefit their residents. It is likely that there are barriers deterring businesses from locating in the city centre, and the first step to overcoming these is for the city to work out exactly what they are.

If the barrier is insufficient suitable office space, then policy needs to ask why the private sector is not building enough, and potentially step in to trigger development. But if the cause is instead the unattractiveness of the city centre as a business location then building more offices won’t necessarily solve the problem. In this case, an expensive policy to spur more city centre development might lead only to high vacancies.

Pay attention to market signals as a way of being realistic about market forces

So how can cities identify the underlying cause? Market signals, such as prices, can be a helpful indication of the market forces leading to underperformance.

If a place has high office rents and low vacancy rates, this suggests there is strong business demand to locate in a city centre but too few spaces available. In this case, building more should help attract more businesses. In contrast, if a place has low office rents and empty properties, the issue is more likely to be demand-side, meaning that policy needs to kick-start interest in the city centre from businesses. Simply building more offices on its own won’t entice firms in but addressing the core reasons why the city centre is unattractive might. For example, the low resident skill level in some cities deters businesses who need more qualified employees, pointing to a need for policy to improve educational attainment rather than focus on property development.

Of course, it is not always easy to decipher these market signals, which is why it’s important to carefully experiment with policy to reveal the true underlying causes of underperformance.

A previous Centre for Cities research report — Building Blocks — gives several examples of cities intervening in office development in a piecemeal and cautious manner. Bradford’s Chamber of Commerce developed a small but high-quality office building in the city centre as they suspected a lack of supply was restricting the number of firms locating there. They were proved right by high occupancy rates and this success meant they were able to expand. Huddersfield shares a similar story, where the city council’s first office development was quickly filled indicating a supply-side issue and giving them the confidence to build a second block. (This does leave open the question of where those firms came from and what happened to vacancies in similar buildings nearby, but that’s an issue for another day)

But at some point, supply will match demand and any further offices will struggle to find tenants. Then, if the city wants to attract more firms it’ll need to switch to boosting demand. This is why a step-by-step approach is vital, testing the water constantly to check the right factors are being addressed.

Diagnosing the causes of poor economic performance is a critical step towards designing effective local policy and applies to all policy areas, not just property development. Once it’s clear which supply-side or demand-side factors are at play, local areas can move on to identifying the policy options available to them to solve each development challenge.

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