Policy Priorities in 2018: Boosting Productivity

Across the Western World, there is a growing sentiment that capitalism isn’t working. Productivity growth has stalled and inflation has outpaced wages. This has led to voters backing protectionists (Trump) and socialists (Sanders and Corbyn). In response, conservatives are becoming more interventionist, backing counterproductive policies such as price caps and curbs on executive pay. Worse still, sluggish growth hurts the government’s fiscal position making important reforms harder to implement.

Public consent for free market capitalism relies on rising wages and living standards. If the pie isn’t growing, then it’s only natural that politicians will win by promising to slice it up more evenly. To mount a robust defence of free-market capitalism, it is essential to develop policies that raise average income growth to, at the very least, historical norms and address rising living costs.

Our key policy priority for 2018 will be to address the housing crisis through planning reform. It is a real testament to the work of Sam Bowman and Ben Southwood that the housing crisis is now the key issue in politics today, and that it is widely accepted (at least on the centre-right) that the cause is restrictive planning laws.

High housing costs not only eat in into pay packets (that in many cases haven’t kept pace with inflation) but they also create barriers to mobility. By making it more expensive to where the best paying jobs are (productive cities like London, Oxford and Cambridge), they lead to people staying put in lower paid work elsewhere. Research by Hsieh and Moretti finds that this effect is responsible for a 13% reduction in GDP in the US and there’s reason to believe that this effect would be even greater in the UK.

It is also important for our limited housing supply to be allocated as efficiently as possible. This is why we will continue to advocate in favour of abolishing stamp duty, which prevents people from moving.

The rise in house prices driven by supply-side constraints is to blame for the rise in wealth inequality identified by Piketty. Importantly, the focus must be on increasing affordability: not just ownership. It is a mistake to state (as many commentators and politicians have) that one must own capital to support capitalism. If capitalism only benefited the owners of capital, then we would be socialists. As a result, we will continue to oppose demand-side interventions such as Help to Buy which fail to address the underlying supply-side problem.

The only way to resolve the housing affordability crisis is by increasing supply through planning reform. Building on our work last year with John Myers, we will work hard on developing politically feasible policies to radically boost housing supply.

Another priority will be removing barriers to investment within the tax system. Over the past seven years, reducing the corporate tax rate has made the UK an attractive destination for overseas investment. However, the corporate tax rate cuts were partially funded by reducing the value of deductions for machines and industrial buildings, making domestic investment less attractive. This effectively increased the marginal tax rate on some investments and blunted the potential of the rate cut to boost domestic investment.

Evidence from the UK (Maffini, Devereux and Xing) and US (Ohrn) found that shortening depreciation schedules or allowing for immediate deductibility can significantly increase investment leading to higher wages and employment levels. Moving to a system of full instant deductibility, where businesses can deduct the costs of capital investment immediately, would be a strong move to sustainably boost wages. Furthermore, this could be funded in part by removing the deduction for corporate debt interest. This would not only boost investment but would also end the bias of debt over equity.

Business Rates present another barrier to investment as they are calculated on the value of the property rather than the underlying land value. Firms that invest in building improvements increase the rateable value of their property. Business Rates are, on average, one of the less harmful taxes, as the incidence falls primarily on the landowner, because planning constraints limit the ability of owners to invest in their property. Still, shifting the burden solely to the landowner by replacing business rates with a tax on imputed land rents would be a pro-investment change.

Immigration reform will be another key factor in ensuring productivity growth remains high. Remaining open to foreign talent as Britain leaves the European Union is essential. The effect of high-skilled immigration on wages, revenue and investment is unambiguously positive, but the process for hiring skilled workers is bureaucratic and prevents many talented individuals from coming to the UK. Furthermore, the economic impact of EU migrants is, on net, positive. Freedom of movement may have lowered wages in the short term for unskilled workers (by about a penny an hour), but for the vast majority of workers it has boosted incomes. This minor harm is far outweighed by the positive contribution EU migrants make to the public finances; while the average Brit in the decade up to 2011 was a net drain on the public finances, EU migrants paid in £1.5bn a year more than they took out.

To keep Britain open throughout the Brexit process, we will work with The Entrepreneur’s Network to set out a liberal immigration agenda. We will make the case for ending the skilled migration cap, ending the net migration target, and ensuring that international students are not penalised in attempts to control migration. We will advocate maintaining open to migration from the EU, expanding migration from CANZUK nations and streamlining non-EU migration by investigating visa auctions to ensure market demand (and not central planning) determine who comes to the UK.

We won’t stop there though. Housing, Tax and Migration may be our top priorities, but we’ll also work to boost productivity through a number of other policy channels.

  • Energy: All major political parties are committed to cutting carbon emissions, but disagree on the most cost-effective way to achieve it. The Helm Review on the Cost of Energy found that there were 13 different interventions in the energy market, including guaranteed pricing contracts, that rely on notoriously unreliable projections. The free-market solution is to simply tax carbon and let individuals and firms figure out the best way to cut back.

  • Infrastructure: Investments in transport (commuter-rail, roads, and airports) will contribute to faster growth and reduce pressure on housing. But, infrastructure funding is currently biased towards London and the South-East. Devolving infrastructure and allowing local government to use land value capture to fund it could deliver massive benefits.

  • Road Pricing: Congestion imposes significant costs on individuals. By underpricing roads, we encourage overuse. Politicians mistakenly call for expensive road-building projects, but they regularly fail to cut commute times as the number of road users increases proportionately. The only solution is to dynamically price the externality of congestion. London’s Congestion Charge was a step in the right direction but it’s priced too low, fails to shift journeys away from peak times, and fails to distinguish between a day driving in central London with a single trip.

  • Broadband: Another aspect of infrastructure is broadband. Many rural communities are still not connected. This problem is exacerbated by the EU’s Net Neutrality regulations which ban ISPs from charging edge providers for priority access to digital fast lanes. This deters ISPs from investing, leading to marginal investments (in rural communities) being cut. Rather than spending money or imposing a Universal Service Obligation, scrapping internet regulations outside the EU will boost access to broadband.

  • Agriculture: Direct payments to farmers raise food prices and lead to higher taxes. Leaving the European Union is an opportunity to rethink this harmful policy. Similarly, tariffs protect British farmers from competition, raising prices and encouraging environmentally harmful farming. We should follow New Zealand’s lead in embracing free trade and eliminating subsidies. Some support to farmers should continue for the provision of environmental services, but payment must be by results.

This is the first part of our Policy Priorities in 2018 series. Next we'll be tackling permissionless innovation and the ways we can support practical liberalism