Area Cost Adjustment: A Response to the Department for Communities and Local Government's (DCLG) Recent Consultations

31 January 2010
By Dr. Richard Hern with Professor David Blanchflower of the Dartmouth College Department of Economics

A team led by NERA Director Dr. Richard Hern and former UK Monetary Policy Committee member Professor David Blanchflower was commissioned to review the recent consultation documents produced by the DCLG on the methodology used to calculate Labor Cost Adjustment (LCA) factors. LCA is the primary component of the Area Cost Adjustment (ACA) mechanism used to allocate funding to local authorities that takes into account regional differences in costs of delivering a common level of public services across the country.

The main component of the ACA is supposed to compensate local authorities for relative differences in regional labor costs. The rationale for this is that local authorities have to compete for staff with other potential employers in the wider labor market. To be able to hire and retain staff of a given quality, they are required to pay the local "going rate." This is calculated by studying wage evidence, on randomly sampled workers, in each ACA area. The DCLG has recently published a number of consultation documents that review the current ACA methodology.

In this report, the authors find that, in its current form, the ACA is not performing its job properly. They demonstrate that, in the latest data, there continue to be shortages of qualified local authority workers in high-wage areas. Hence, it cannot be the case that the ACA method is working efficiently: the whole rationale for ACA is to eliminate regional shortages and imbalances.

One of those areas most disadvantaged is West Sussex, which is an area that on average has relatively high employment and activity rates compared to the rest of the country as well as relatively high housing prices. The current local authority funding mechanism does not adjust properly for these factors in the case of West Sussex. The authors propose fundamental changes to the method of calculating the ACA factor to achieve a more efficient resource allocation of local authority funding.