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Claims that a low tax, low regulation UK would be a disaster are rubbish

Claims that a low tax, low regulation UK would be a disaster are rubbish

Dame Minouche Shafik, Deputy Governor of the Bank of England, is leaving to become Director of the London School of Economics.  Last weekend, she gave her final interview wearing her Bank hat.

Shafik issued what was described in the media as a “thinly veiled warning” to the Chancellor, Phillip Hammond.  She stated that it was an “illusion” to believe that transforming the UK into a low tax, low regulation economy would give it a competitive advantage.  Indeed, Shafik went further and offered the opinion that such polices risked “hugely disastrous consequences for the economy”.

We have heard such prognostications before. In the run up to Brexit, the Treasury claimed that unemployment would rise by 500,000 by the end of 2016 in the event of a leave vote.  It actually fell.  The Bank signalled a similar opinion, that Brexit would be bad.  Doom and gloom was prophesised by the OECD and the IMF.

These institutions seem permeated by what we might call “Davos liberalism”, the sorts of opinions which would be congenial to George Clooney.  Of course clever, well meaning people can design policies and regulations which will benefit ordinary people, who after all cannot be expected to understand these things and might hold incorrect views!

Shafik claimed that the UK economy has lost 16 per cent of GDP relative to trend because of the financial crisis. Looser regulation would run the risk of an even bigger loss in future.  But the French economy is much more highly regulated than that of the UK.  It has lost at least 20 per cent of GDP relative to trend, some £80 billion more than the UK.  And France has at least 1 million more people who are unemployed.

Shortly after the Shafik statement, the government announced a major review of how the UK can become the world leader in artificial intelligence (AI) and robotics.  We can take with a pinch of salt the unnervingly precise estimate that £654 billion can be added to the British economy by 2035 if the growth potential of AI is achieved.  But we are clearly already a world leader in this area and, equally clearly, if we succeed in capitalising on this, GDP will be boosted by a very big number.

An essential ingredient for success is to attract the innovative thinkers who will push out the frontiers of the science, and the entrepreneurs who will help turn the ideas into practical tools.  It is of course possible that a system of high personal and corporate tax rates could succeed in attracting such people.  But it seems plausible that low tax rates are more likely to do the trick.

The high taxes imposed by President Hollande in France illustrate the point.  Young French people have flocked to the UK.  London is now the sixth largest French city in the world in terms of the population of native French speakers.

Our borders need to remain open to highly skilled individuals.  But we need policies which continue to attract them rather than drive them away.

Image: French President François Hollande by Foreign And Commonwealth Office is licensed under CC by 2.0
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The people of Burnley and Bradford have a point about the impact of immigration

The people of Burnley and Bradford have a point about the impact of immigration

The scenes as the migrant camp was cleared in Calais once again provoked bitter divisions in British society. Metropolitan luvvies and liberals tweeted their virtue and called for no restrictions on immigration. In more traditional areas, there is active resentment at the possibility of even further inflows of foreigners.

When New Labour decided in the early 2000s to allow large-scale immigration from new EU member states, we were seriously invited to believe that an influx of immigrants on a scale unprecedented in our history would only have positive economic effects and would boost economic growth.

Economics certainly suggests that an increase in labour supply can increase growth in output. But in the so-called neoclassical growth theory of economics, even in the post-endogenous variety made notorious by Ed Balls in his previous incarnation, by far the most important source of sustained growth is innovation.

A truly modern economy does not rely on more and more capital and labour being fuelled into the machinery of production. That was the old Soviet model.

A modern economy relies instead on innovation. So there are at best limited benefits from importing more and more labour. True, immigrants can bring new skills, found innovative new businesses and, as they tend to be younger, they can slow down the ageing of society. But they, too, get older eventually, so this is not a long-term solution.

The anxieties about immigration are not couched in the arcane language of economic theory. But a fuller appreciation of the theory does enable us to understand why people worry so much. Underlying the theory are the assumptions that supply and demand balance in labour markets, and that the prices of the various kinds of labour – in other words, wages – are set at appropriate levels.

A recent paper in the Journal of Economic Perspectives by Christian Dustmann and Uta Schönberg of University College London shows that large-scale migration in fact creates serious imbalances and mismatches in labour markets.

They provide extensive evidence of what economists call “downgrading”. “Downgrading” occurs when the position of immigrants in the labour market is systematically lower than the position of natives with similar education and experience levels. The authors calculate that, in Germany, recent immigrants have wages which are on average 17.9 per cent below those received by natives with similar age and skill profiles. In the US, the figure is 15.5 per cent and in the UK 12.9 per cent.

Dustmann and Schönberg illustrate the disruption which mass migration can cause even more starkly. They calculate that while 69.7 per cent of immigrants in their samples can be classed as high skilled in terms of their education, only 24.6 per cent are in high skilled jobs. In their dry terminology, this means that “immigrant arrivals to the United Kingdom were a supply shock in the market for low-skilled workers”.

Mass migration has not simply meant more people competing for jobs. It has meant that people with higher skill levels are competing for your job. In other words, the people of Burnley and Bradford have been right all along, and the metropolitan liberal elite completely wrong.

 

As published in CITY AM on Tuesday 1st November

Image: Calais Jungle by malachybrowne is licensed under CC by 2.0

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Why economics can prevent Europe’s refugee crisis from becoming even worse

Why economics can prevent Europe’s refugee crisis from becoming even worse

Emotions are running high over the refugee crisis, with heart-breaking images arousing waves of compassion across Europe. As ever, however, economics lurks in the background. The tragic stories of refugees coming to Europe rightly elicit a call to help those in need, but we must understand the underlying realities to truly do something about this crisis.

We can contrast the general composition of the refugees fleeing Syria and those already encamped at Calais, for example. The Syrians are mainly family groups, whereas in Calais young men predominate. Incentives help explain their choices of destination. As they trail across Eastern Europe, the Syrians chant “Germany!” At Calais, however, everyone wants to get into the UK. The political situation is highly fluid, but Germany has had a policy of open borders for such refugees. Other European countries are less easy to get into.

Many of those in Calais speak fluent English and have high skill levels. They would make a much more positive contribution to this country than, say, relatives imported from the poorest parts of Pakistan and Bangladesh. Their families have invested large amounts of money in their journeys, made with the specific purpose of getting into the UK. The lighter regulatory burden imposed on the British labour market than in much of the rest of the EU is in many ways a great strength. But it does mean that it is much easier to work illegally here. In theory, employers can be prosecuted for employing illegal immigrants, but in practice this doesn’t always happen. Skilled young people can thrive, which is why they want to come – not to sponge off our benefits, but to work.

Incentives feature strongly in the highly emotive issue of the boat crossings too. Since the EU took the decision to rescue the boats, the numbers crossing have soared. The demand has increased after an important component of the price of the voyage, that of the chances of being turned back, has fallen sharply. But the consequences of this misguided liberalism have been to place more lives at risk. Indeed, there is increasing evidence that the so-called boat captains are now not even bothering to get on board themselves. They simply take their large fees and let the refugees steer as best they can. After all, why put your own time and effort into a task when the EU will, or least purport to, do it for you? So the crossings have become even more dangerous.

The role of incentives is misunderstood and so, too, is the most fundamental feature of economics – the allocation of scarce resources. “Saint” Bob Geldof may be able to accommodate refugees in his large underutilised homes, but for local authorities there is a real trade-off. Every refugee housed is a person already on the waiting list who has to stay on it. Not just that, but they tend to be allocated to the poorer parts of the country where property is cheap. Simon Danczuk, the leading Labour moderate, points out that his Rochdale constituency has already been made to accept more asylum seekers than the whole of the South East of England.

Economics may often seem harsh, but keeping its principles in mind can avoid outcomes being even worse.

As published in City AM on Wednesday 8th September 2015

Image: Un jove de Kobane (Síria) refugiat a la frontera turca. by Jordi Bernabeu Farrús is licensed under CC BY 2.0. 

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Open borders or fair wages: the left needs to make up its mind

Open borders or fair wages: the left needs to make up its mind

As published in the Guardian on Tuesday 24th March 2015 as part of their ‘Economics – Immigration Special’

Mass immigration increases inequality. This is the unpalatable fact the liberal left in Britain refuses to accept. Markets are imperfect instruments. But it is not necessary to subscribe to free market economic theory to believe that large increases in supply tend to drive down the price. And the price of labour is the wage.

Last Friday, the Guardian front page carried a report from the Office for Budget Responsibility, claiming that higher net immigration increased the UK’s economic growth rate. According to the mainstream theory of economic growth, this is undoubtedly true. Higher growth can be created by sustained increases of either capital or labour.

But underlying the theory is the assumption that supply and demand balance in these markets, that the prices of the inputs are set at levels such that all available capital or labour is in fact employed and does not remain idle. So this “flourishing modern economy” with high immigration celebrated by the Guardian is based on persistent large wage inequalities.

A powerful force in the global economy is driving the increase in inequality that has been seen in western economies over the past few decades. In essence, there has been a massive increase in the effective supply of labour. Over the past three decades or so, China and India have gradually been absorbed into the network of international trade.

This puts pressure on European labour markets. Many call centres, for example, have been relocated to India. But much of the impact of this is indirect, operating via trade flows, and is only really felt by certain sectors of western economies.

Closer to home, the opening up of eastern Europe in the early 1990s has had a strong effect, especially on countries that are their immediate neighbours, such as Germany. Employers soon realised that economies such as Poland and the Czech Republic possessed educated labour forces, whose productivity potential had been suppressed by the gross inefficiencies inherent in planned economies. German companies opened up new production plants in the old Soviet bloc countries in Europe, rather than at home.

The impact on wage rates of this increase in competition was dramatic. Christian Dustmann at University College London has provided clear evidence on the evolution of wage rates in the former West Germany. The 15th percentile of the wage distribution is the level at which only 15% of wages are lower. In West Germany, at the 15th percentile, real wages have fallen almost continuously since the mid-1990s. At the 50th percentile, where half get more and half get less, the reduction has been less sharp.

But the fall had set in by the early 2000s. At the 85th percentile, the mirror image of the 15th, real wages grew strongly, reaping the benefits of the recovery of the economy created by the increase in competitiveness.

It is against this background that New Labour opened up Britain’s borders in the late 1990s. It was a major betrayal of the very people the party purported to represent.

In addition to the global competition from countries such as China, in addition to competition closer to home from the economies of eastern Europe, New Labour allowed direct competition to enter the UK labour market on a scale unprecedented in our history.

Not surprisingly, the distribution of wage rates has evolved in very similar ways to those of West Germany. It is the relatively unskilled in the bottom half of the distribution who have lost out. The liberal elite do not suffer.

Indeed, they benefit because many of the services they consume are provided at lower prices than would have been the case without mass immigration. It is sometimes argued that immigrants do jobs that native British workers are unwilling to take.

Very well then, without mass immigration, employers would be obliged to raise the real wage rate to induce these people to take the jobs.

The effects of this extend to benefit levels. With at least half the population facing at best stagnant and often falling real wages, basic political economy requires benefits to be squeezed as well. Hostility to benefits is strongest precisely in the bottom part of the wage distribution. It is political suicide to increase real benefits in this context, regardless of who is in power.

In the so-called neoclassical growth theory of economics, whether of the pre- or post-endogenous variety, by far the most important source of sustained growth is innovation. The age structure of immigration means that it does make a change to per capita economic growth, but one that is barely perceptible. Moreover, immigrants themselves age eventually, so eventually even this tiny benefit disappears.

A truly modern economy does not rely on more and more capital and labour being fuelled into the machinery of production. That was the old Soviet model.

A modern economy relies instead on innovation. This should be the focus of policy. The potential gains are huge, not marginal and ephemeral.

Image: Budget by Simon Cunningham under license CC BY 2.0

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