Unfortunately, work subsidies don't actually work

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Within the autumn statement, one proposal in particular caught attention, and it was a policy earlier announced by the Deputy Prime Minister Nick Clegg. The UK government wants to subsidize businesses in hiring young unemployed workers, precisely from the ages of 16 to 24, by offering £1bn to the private sector to take young workers into apprentice schemes.

Under a typically political decision and explanation, youth unemployment is supposed to be tackled by offering money to private sector firms to take on temporary workers so that the young might get more experience. How this is supposed to create value for the private sector and how is such a policy sustainable in the long run, no one in the government knows or cares about.

The coalition is obviously desperate to cut youth unemployment as it fails to see the paradox in its claim that a subsidy to employ a young person is a way to create “lasting” jobs in the private sector. A temporary subsidy will be of just that effect – it will be temporary. Even if it does produce some youth jobs this won’t be due to an increase in real demand for workers, but due to an artificial increase in demand for workers.

A private sector business will be able to assess by itself the best whom to hire and how long to keep them. By creating a distorted incentive the government is directing the firms’ employment policies. In a crisis of confidence with many lay-offs it is natural that the young suffer the most. They lack the experience older laid-off workers possess and cannot compete with them. By creating a subsidy to employ only the youth, the government discourages hiring of older workers and distorts the labour market against them (discriminates against them). These are not just too old workers, but all those older than 24, meaning that younger workers, university graduates, still may get discriminated against. A subsidy, wherever it is enforced, will always yield similar effects – it will distort the market in favour of the subsidized and against every other market participant. In addition, the effect is always temporary and works only if the subsidies carry on indefinitely, which is of course extremely costly.

Subsidies create a political market for the companies to compete on. The difference is they don’t compete for customers, they compete for bureaucrats, or more precisely the favourability to bureaucrats in extorting funds.

A far better idea would be to create incentives for hiring temporary workers, not via subsidies but via decreased taxes and cutting employment regulations to encourage businesses to start hiring again. An NIC holiday for small businesses (actually proposed by the Chancellor) or removing it altogether, lower income taxes for the young, removing any regulatory confinements for hiring temporary workers and those on zero based contracts, reducing the rigidity of dismissal rules, removing financial repercussions for employers and further reform of the employment law. These are just some of the policies that would work much better than a subsidy.

First of all, they will cost less to implement. There will be no need to increase public spending and waste resources. Second, a tax cut creates a completely different incentive to the private sector business. Instead of competing for public money, it will decrease its costs by hiring another worker. It will lead to lowering of the entire unemployment rate and create more scope for businesses to make higher revenue. This will eventually decrease youth employment as well, as it will go down once the economy starts recovering with a higher pace.

In addition, if they really want to help the young get more working experience there is a particular policy decision preventing the young to do so – minimum wage. By removing the minimum wage for young workers the government will make it much more affordable for the private sector to offer them temporary jobs and work placements. The young are willing to work for a lower rate than the market rate to get some work experience. This is why they engage into internships and volunteering, hoping to get more experience and be more competitive on the market. Removing the minimum wage would yield exactly the effect Nick Clegg is hoping for – it will offer more jobs to more young people and help them get more experience. The subsidy, on the other hand, will fail to result in the same effect and is a prime example of wastefulness of the taxpayers’ money.

The planned chaos above us

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The House of Commons Transport Committee has called for evidence on the government's draft Civil Aviation Bill.

Well, here's my opinion. The first thing to note is that in a desperate bid to look 'green' for some reason, the government has decided not to go ahead with an extra runway at Heathrow but instead waste billions carving new high-speed rail lines through rural England (which doesn't seem to be too environmentally friendly either). And if you want to know what a bad proposition high-speed rail is, you need look no further than Nigel Hawkins's excellent ASI report on it, High Speed Fail.

Get real. London both needs and benefits from having a 'hub' airport at which people who are on their way to places – from the US to Europe and the Middle East, for example – can simply change planes without hassle. Sure, they are not coming into the city and spending vast amounts in the shops, but the business of handling all those planes and passengers is a nice little earner. Heathrow always occupied this hub-airport role in Europe. But now this business is moving out to other airports in France, Netherlands and Germany. London airport expansion has happened piecemeal, so as not to offend too many locals – and so we have Healthrow, Gatwick, Stansted and City Airport (and maybe even Luton if you like) rather than one big hub. And getting between them is a nightmare, so changing planes in London is becoming simply impossible on many journeys. So the first step is to build the new runway at Heathrow, to give breathing space while a new Thames Estuary airport is developed.

What the Bill won't say, of course, is that we should use the market to sort out the problem of congestion over London. Take-off and landing slots at Heathrow should simply be auctioned to the highest bidders. Then, the airlines and services that really needed to be at this full-to-capacity airport would get to be there, while others to whom the Heathrow location was marginal would up sticks and move to one of the other airports. Right now, British Airways occupies 40% or more of the take-off and landing slots at Heathrow, and will acquire even more if they acquire BMI through Lufthansa. Why should anyone pay good money for a heavily loss-making business like BMI? It makes no sense unless you can acquire more take-off and landing slots.

But at present, the whole business is opaque. We are not told what airlines pay for take-off and landing slots at Heathrow. Why not? The fact that British Airways moves heaven and earth to acquire new ones by buying decrepit airlines, and that it tries so hard to keep out other operators, and that it resists the idea of auctioning the slots so furiously, all suggests that the slots are worth many billions of pounds. If you can raise £22.5bn from auctioning mobile telephone licences, how much do you figure airport slots are worth?

The unions strike again

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The public sector strike today will be an inconvenience to many people – schools will be shut, university lecture halls will be even emptier than usual and most public servants’ jobs won’t be done. The reasons for striking are understandable – many people in the public sector will have to wait six years longer for their occupational pensions than they expected – but not exactly defensible. There’s no reason that public sector workers should, by default, have an easier ride than private sector workers. Being a nurse in a public hospital is difficult work, but surely no more difficult than being one in a private hospital.

Under current rules, working for the state brings with it quite a few benefits already: the biggest one is probably that your employer isn’t likely to go out of business. But the other big benefit is that the things your employer does are subject to public approval. Whereas a private company can lay off workers as it needs to, and negotiate benefits on a case-by-case basis without a huge worry about the PR impact it will have, the government’s actions are almost entirely driven by a quest for popularity. Argos can sack people as it has to in order to stay profitable, but sometimes governments prefer to go broke than do the unpopular but necessary thing.

For public sector unions, a strike is a great way of taking advantage of this strange situation. I have a bit more sympathy for the people marching today than, say, tube drivers on £50,000 a year demanding more or people marching against layoffs in general, because this pensions change will force a lot of people to reconsider their life plans. The change needs to be made, though – there isn’t any money left, and there’s no reason public sector workers should get an easier ride than private sector ones.

Really, the system is to blame: it is madness to have a pensions system that’s funded out of current expenditure. For that to work, it requires a constant influx of people either through immigration or fertility. Neither appear to be on the cards. A far better system would be one like Chile’s, where people save throughout their lives for their own pensions, which they own and can invest as they like. That’s robust to demographic changes and makes people less dependent on government as well. The real challenge is figuring out how you get from here to there – maybe that’s what the unions should be thinking about instead of spending their time trying to squeeze the current system for all it's worth.

Thumbs-down for the autumn statement

"We will explore all the options for maintaining the UK's aviation hub status, with the exception of a third runway at Heathrow."

So said George Osborne in his Autumn Statement today. And with that single sentence, he encapsulated the problem with government infrastructure projects – whatever the rhetoric, they are motivated by politics, not economics.

Clearly, it is feasible that new and improved infrastructure will boost economic growth by making us more productive. But that depends on the right projects being undertaken. And when you've got a government that says it wants to maintain the UK's aviation hub status, and then in the same breath refuse point-blank to let the private sector expand our existing hub airport, how much faith can you really put it their judgement?

Undoubtedly, most of the money the Chancellor is funnelling towards infrastructure spending will end up being wasted on projects that make no economic sense whatsoever. HS2, anyone? This is not a recipe for recovery.

The other problem with the government's infrastructure plan is that it rests on getting private pension funds to invest in infrastructure projects. But there are good reasons why pension funds haven't invested in infrastructure before, so it's hard to see why they'd leap at the opportunity now. Moreover, who is George Osborne to tell private pension funds that they should be investing more in infrastructure? Can he really say with confidence that this is going to give them a better return than the other possible investments? Quite frankly, the day the government starts directing private investment decisions is the day I'm switching to a SIPP and doing it myself.

All in all, I struggle to find anything nice to say about today's Autumn statement. For me, no amount of headline-grabbing initiatives can obscure the broad sweep of the statement. We're borrowing more money. The government is subsidising lending and attempting to direct private investment. And they're clearly trying to reestablish an activist industrial policy and plan the country's economic development. As I said on CNBC this lunchtime, it's like being back in the 1970s. Just without decent music.

Our view on the autumn statement

Eamonn Butler, Director: A £40bn business loan scheme, mortgage guarantees, £5bn of infrastructure spending, 'youth contract' apprenticeships, start-up tax reliefs, new R&D tax credits, extending free child care – these are all Gordon Brown-style tinkering measures that look good in the papers but end up being bureaucratic and wasteful. Far better to leave the money in people's pockets and cut taxes, which will boost confidence.

The most surprising thing in today's autumn statement was the Office of Budget Responsibility analysis that the Brown Boom was far bigger than anyone thought. That means the inevitable bust that followed it has been bigger too. There's still light at the end, but the tunnel's got longer. The government won't actually stop adding to its debts until maybe 2017.

It's good that the government will explore tearing up national public-sector wage agreements and move to local bargaining. Then, wages will fit local conditions. At present, the public sector pays so well in the most depressed areas that the private sector is priced out – accelerating the decline of the wealth-creating sector in those regions.

It's good that public debt will peak at 78% of GDP in 2014/15. As we have seen from across the eurozone, it's when public debt breaches the 80% limit that real economic problems begin.

It's also good that people's right to buy their council houses will be invigorated, with discounts up to 50%. This is a good way of getting capital into people's hands, and helping them take charge of their own future.

Extending the business rates holiday, the 1% cut in company tax next April, the changes on industrial tribunals and the freeze in fuel duty certainly will help business. That's vital, because the only way out of a debt trap this big is to grow our way out.

Sam Bowman, Head of Research: Heavy on detail, light on content. There's still no supply-side growth plan, but there are worrying signs that the Chancellor is a closet Keynesian who really does believe that spending is what makes the world go 'round.

Credit easing is a repeat of the US's subprime mortgage practice, where risky borrowers were packaged together and given a tacit government guarantee. Doing this for businesses is just as dangerous as doing it for home buyers. It risks creating a repeat of the 2008 crisis and will do nothing good for British business. Furthermore it adds £20bn to UK contingent liabilities and will cost £1bn directly.

Using taxpayers' money to underwrite 95% mortgages is immoral – it will draw people into home ownership who will be unable to afford their loans when interest rates eventually rise again. And it risks setting off the same sub-prime events that got us into this pickle in the first place. Banks are sitting on huge reserves of money already – they aren't lending because the fundamentals of the economy are so weak. A brute-force treatment like credit easing does nothing to solve the economic disease, little to alleviate the symptoms, and may ultimately kill the patient.

With growth as anaemic as it is, more cuts are desperately needed to stave off crisis. Freezing public sector pay for longer is a good step in this respect, but the money saved is going to be going on wasteful infrastructure projects, which are probably more designed to improve the government's electoral standing than the country's economic health. "Stimulus" projects do nothing of the sort – widening motorways here and there isn't going to revitalize the economy. Going Keynesian in marginal constituencies is a reckless waste of money.

ASI view: Instead of Osborne’s disappointing plans outlined in the autumn statement, the government should have considered the following:

  • Scrapping the minimum wage for under 25s
  • Abolishing 50p tax rate and lowering the 40p tax rate to 35p
  • Scrapping mandatory retirement age
  • Abolishing employer national insurance contributions
  • Speeding up the raising of the personal allowance to get the poorest out of tax entirely
  • Reviewing government spending, cut out what doesn't need to be done, contract out whatever possible, think afresh on delivering what's left
  • Bringing forward and deepen the cut in corporation tax
  • Getting to grips with the quangocracy

The good, the bad and the ugly in the autumn statement

THE GOOD

1. UK’s commitment to eliminating its deficit remains credible. However, the growth figures that the initial deficit reduction plan was based on now look overly optimistic, which means that cutting the deficit will almost certainly require additional cuts to current expenditure before the next election. But so long as the government commits itself to eliminating the deficit by reducing expenditure – and not threatening growth by raising taxes – we should be able to avoid a Euro-style meltdown.

THE BAD

2. Spending on infrastructure is an accountancy trick. It might boost GDP numbers, but it won’t do much for the real economy – in fact, it might make things worse. A recession is a period where investors reallocate their capital and people reskill to produce things that consumers want to buy. Infrastructure spending delays this, by creating unsustainable demand for skills that the private sector doesn't want. That might make the economy appear to be improving in the short term, but in the long term it gives mixed signals about where people should reskill and move, and makes sustainable recovery even tougher to achieve.

3. The lack of pro-growth tax cuts is worrying. If the last year has proved anything, it is that economic growth won’t come from nowhere. Entrepreneurs are paralysed by employment and business regulation, with high taxes making retirement a more attractive option than reinvestment for many successful businesspeople, and credit markets are reluctant to lend in such a sclerotic business environment. If the Chancellor wants to make the Eurozone crisis into an opportunity for Britain, he should be trying to make Britain the best place in Europe to do business. That means cutting taxes and regulation across the board.

THE UGLY

4. Credit easing is a deeply misguided policy that utterly ignores the lessons of the last decade. Packaging together small business borrowing into a government-backed security gives a false illusion of safety to investors. If and when some of those businesses start to fail en masse, bonds that looked completely safe are revealed to be worthless, creating financial havoc. It’s a re-run of the US subprime mortgage policies that led to the 2008 financial crisis. All credit easing does is set us up for another crash in a few years time.

Dr Madsen Pirie, President of the Adam Smith Institute, adds:

“It is good that 'Plan A' to cut the deficit is now 'Plan A-star,' stressing the importance of growth as well. The measures are small beer compared to the things that could really lead to growth. We must be careful not to tread in Gordon Brown's footsteps, trumpeting small-scale schemes by loud announcements.

What is needed is for government to be serious about removing the obstacles to growth posed by high taxation and over-regulation. Small businesses, which provide two-thirds of all new jobs, want to hear that their tax burdens will fall, and that they will be freed from many of the regulations designed for large firms.” 

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A guaranteed mistake

I rejoice in UK Business Secretary Vince Cable's ability to believe in two contradictory things at the same time. One is that the banks should strengthen themselves by putting more money into reserves. The other is that they should lend more to small businesses in order to kick-start economic recovery. The logical problem, of course, is that money which the banks keep in their vaults isn't then available to lend out to businesses – or anyone for that matter.

In his Autumn Statement (or soon after), Chancellor George Osborne is expected to resolve this dilemma by providing government guarantees on loans that the banks make to certain businesses. It parallels his announcement last week that the government would provide guarantees on loans made to first-time house buyers.

Guarantees are cheap. You don't have to shell out the money unless things go wrong. That doesn't stop them being immoral and counterproductive. With the government guaranteeing 95% mortgages, and with interest rates so low, I wonder how many people will be seduced into taking out home loans which – when interest rates rise – they won't be able to afford. Encouraging such sub-prime mortgages is surely immoral. And taxpayers bailing out banks when such loans go wrong…well, haven't we been here before?

The business loan guarantees being planned by George Osborne pose the same moral hazard. And they are bad for business, too. Sure, credit is tight. Curiously, that might be because interest rates are too low, not too high. Why would anyone lend money when the interest they earn doesn't even keep pace with our 5.2% RPI inflation rate? Inasmuch as the new guarantee scheme encourages businesses to borrow – which might be marginal, given the gloom that infects nearly all businesses right now – it will encourage people to make more bad investments. It's surprising, but business failures are lower at the moment than they have been in decades: it's simply cheap credit that is propping them up.

Some time, businesses have to grit their teeth and write off all the over-optimistic investments they made during the Brown Bogus Boom years. Then perhaps their investment cash can be put into things that have a better prospect of returning a profit. Painful, but better than living in a fantasy world underwritten by taxpayers. But giving them cheap credit, and more of it, just prolongs the the illusion, and the slow agony.

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Bank-bashing for pensioners

What’s more satisfying than bashing bankers to help pensioners? There is something to the Occupy movement’s outrage at the rewards enjoyed by the banking industry but the hue and cry for higher bonus and income taxes and a financial transactions tax misses the point.

The ASI has already explained why a financial transaction tax, aka Robin Hood or Tobin tax, is simply wrong and we won’t go over the details. Suffice to say that bankers are too smart to actually pay it. They’ll either move elsewhere or pass on the tax (like any other corporate tax) to their customers, ie. pensioners and other savers.

A more promising route for dealing with seemingly high-flying bankers is to figure out why they make so much money in the first place, not how to tax it after they’ve made it.

Step forward, David Norman, chief executive of TCF Investment. In an open letter to Prime Minister Cameron, Mr Norman calls for “an urgent and holistic review of the UK retail fund sector.” His literal bottom line is that the retail fund industry is ripping off savers through a complex and opaque system of fees and hidden charges.

Mr Norman is continuing a crusade whose beliefs were spelled out in a paper published over a year ago. It detailed all the charges borne by saversfrom the upfront Annual Management Charge down through admin fees, FSA fees, stamp duty and trading costs, to name just some. He has calculated that an average UK stock market fund investment of £100,000 over 20 years at 7% a year will generate £227,695. Of this total, though, £159,272 goes on all the various charges, not to the saver. (A Robin Hood tax would simply be another component in this overall bill.)

Now, Mr Norman’s figures may be extreme and he has been challenged on many of them by Mark Dampier, head of research at Hargreaves Lansdown. Of course, the two would differ: TCF markets itself as a low-cost investment provider while Hargreaves Lansdown is introducing a new monthly fee on index tracker funds.

All of this is way beyond the comprehension of most so Mr Norman has a solution: “The publication and wide communication of sound research into the total cost impacts on funds would empower self-motivated consumers and act as a standard to hold adviser recommendations to account. It should be an imperative for FSA to publish tables of Total Costs of Ownership (TCO) for all funds sold in the UK.”

For free and open market types like us, a thorough review of the sector may be a good idea as long it does lead to price transparency to foster competitive markets - the only sure route to the best quality at the lowest possible price. The risk is the unintended consequences of letting politicians start poking about. For the government, it really doesn’t require much except a bit of “nudge” work. But will they be able to stop there?

In the meantime, can we persuade the Occupy movement to swap their logo from “I am the 99%” to “I am the TCO”?

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Praising democracy in Africa

Or praising democracy anywhere in fact. An interesting but not surprising finding from Africa:

Africa is poor and its urban population and industrial centers are small, while its rural population and agrarian sectors are large. In the absence of party competition… we should therefore expect economic interests to seek to influence public policies through lobbying by interest groups. Insofar as this is the case, we expect economic policies to be “urban biased.” But when there is a change to party competition… electoral majorities acquire political weight and those seeking office will therefore begin to advocate measures designed to attract rural voters. They should therefore begin to support policies that favor agriculture.

Any ruler must favour the interests of those that keep him in power. A military dictator has to take good care of the Army and everyone, even Roman Emperors, is afraid of the urban mob. And what we saw in Africa after independence was that the urban masses, although only a small fraction of the country, were those who had the political power. Ghana's insanely over valued currency for example, which killed off the cocoa plantations in favour of cheap manufactured imports for the urbanites. And as that first flirtation with democracy faded then things only got worse.

But when the majority of the population is rural, engaged in farming, it's only right that economic policy should be determined by the needs and desires of that majority. Which, with the return of democracy, is what we're seeing happen.

And there's a lesson for us oh so moderns here too. Allowing power, decision making, to float off into the technocracy (at any level, UN, EU or just Whitehall) is going to cause exactly the same problems. As the power base, the support, will come from technocrats to technocrats policy will be decided with the aims and desires of technocrats in mind, not with our.

Which is really why we don't want political power to accumulate in the centre but to keep it close, by us. Doesn't matter which centre, if it gets there it will be deployed to benefit the centre whereas if we have it then we get to exercise it for ourselves.

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Home truths

houseOh, dear. A few days ago, worried about flatlining or falling house prices – always bad for politicians – the UK government announced a whizzo new scheme to underwrite 95% mortgages. We warned that this was encouraging just the sort of over-borrowing that got us into this mess in the first place.

Now the Centre for Economic and Business Research predicts that house prices will rise by 15% over the next five years, with the average three-bedroom semi-detached going up over £25,000 to £202,000. But that's nothing to do with the government's latest price-boosting mortgage initiative. No, it is simply because of a shortage of property on the market (planning controls), rising demand (immigration, demographics) and the fact that the banks are starting to lend again thanks to all that money the Bank of England has injected into them by way of Quantitative Easing. And the buy-to-let sector will boost the market too, as worried savers look for hard assets to put their money into.

So – if that is right – the net effect of the government's mortgage-guarantee plan will be to boost a market that is already about to rise. Rather than preventing prices (and the government's electoral prospects) from falling, it will add further to price increases.

The government should read its Milton Friedman. The Nobel economist researched the effects of 'stimulus' packages as a supposed way of smoothing out economic cycles, and concluded that they did more harm than good. By the time government realise business is declining, work out what to do, pass the legislation, and wait for it to have its effect, the trough is usually over and the policy ends up reinforcing the cycles. Today's house-price situation looks much the same: reinforcing the boom, which will mean we will suffer even more painful adjustment in the long term.

 

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