Gary Becker was right, part four: Immigration
Gary Becker proposed a remarkable way of dealing with immigration. He suggested selling the right to live and work in the US or the UK. His proposal was that the countries should set a price ($50,000, for example), and admit foreigners prepared to pay it. Of course certain categories such as terrorists or criminals would be excluded, but otherwise the doors would be open to those prepared to stump up the money.
His reasoning was that this would lead to the type of immigrants of most value to the recipient country. Skilled people would be ready to pay because they would enjoy a bigger pay differential in moving from a poor country to a rich one than would poorer people.
Young people would be attracted because they would enjoy longer working lives in which to reap the benefit of their investment. And those intending to settle permanently and make a commitment to the host country would have a longer time there to enjoy the benefits than those who intended to return to their own country. All three categories make desirable immigrants.
Whether or not one agrees with the details, it is easy to agree with Becker on the principle that immigration should be encouraged where it is certain to make a positive contribution to the host country as well as to the immigrant. Several countries already have schemes in place to achieve this. St Kitts and Nevis offers citizenship as well as residence to those investing $250,000 in sugar industry diversification or $400,000 into real estate. Dominica offers citizenship for an investment of $100,000. The US will give a green card to someone investing $500,000 and creating 10 jobs for Americans, and Canada will let you in for 400,000 Canadian dollars.
The Becker proposal does deal with the objection that some raise about immigrants coming in and claiming welfare and health benefits. The objection seems unlikely, in that most immigrants are young and healthy and seeking work, but we can be reasonably sure that no claimants would be coming in under Becker-type rules. Many who oppose immigration are ready to make exceptions for skilled workers and those prepared to invest in their host country. International businesses might well stump up the money required for them to transfer in skilled workers with none of the hassle and delays of conventional applications.
Once again Becker has shown how economics can be applied to areas other than the economy.
Why we shouldn't let the prodnoses determine our diets
An amusing little coincidence of three stories that cross the desk here at Adam Smith Towers. Firstly, from Chris Blattman, the news that most published research is actually wrong:
Published medical science is deeply flawed. More often than not, when I’ve looked up a study claiming X, the statistics are deeply problematic. I suspect poor training and poor refereeing are proximately to blame, but there must be some deeper absence of incentives. It’s a shameful state of affairs.
The specific study that is being talked about here is the one that made everyone think that Omega 3 fatty acids were good for your heart. On hte basis that Inuit eaters of whale and seal blubber had less heart disease than everyone else. But they reached this conclusion without actually looking at the incidence of heart disease in Inuits who ate whale and seal blubber. something of a leap from evidence to conclusion there.
The second is about a new movie, "Fed Up", from the people who brtought you "An Inconvient Truth". Although Al Gore is a little porky to present this extravaganza, given that it's about how the modern food industry makes everyone obese.
The problem at hand, of course, is the standard American diet, especially in its current iteration, which took shape in the early 1980s after the commencement of the official “eat food lower in fat” recommendations. Those recommendations led to a 25 percent increase in the per-capita supply (and indeed consumption) of calories.
Yes, it is indeed a problem. But as Mark Bittman goes on, the rest of it is all to rail about the amount of sugar that is in the current diet. Which is again something of a problem, for here's our third piece of news:
Last week it fell to a floundering professor, Jeremy Pearson, from the British Heart Foundation to explain why it still adheres to the nutrition establishment's anti-saturated fat doctrine when evidence is stacking up to refute it. After examining 72 academic studies involving more than 600,000 participants, the study, funded by the foundation, found that saturated fat consumption was not associated with coronary disease risk. This assessment echoed a review in 2010 that concluded "there is no convincing evidence that saturated fat causes heart disease".
The sugar (and also the salt) is in all our foods because it's the only way to make it taste of anything if there's no animal fats around. So, let us assume that there is an epidemic of obesity (on the grounds that we should take peoples' arguments seriously, at the very least so that we can see where they lead) and that it is being caused by sugar in our food. Well, what caused that? The previous generation of prodnoses telling us all not to eat saturated fats.
At which point clearly we should tell them all to (mumble mumble) off and we'll get on with filling our bellies in our own manner, thank you very much. For they don't actually know what they're talking about.
Yes, that is my caramelised pork crackling over there......could you pass the butter? It's a tad dry...
Gary Becker was right, part three: Drugs
Last February Gary Becker wrote a post on the Becker-Posner blog calling for marijuana to be decriminalized. Ten months earlier he publicly called for the legalization of a wide range of drugs. He listed some of the advantages of decriminalizing marijuana, such as undercutting drug cartels, enabling those needing medical help to come forward, and saving costs on enforcement.
There is no doubt that the war on drugs has been a disaster. It has led to a huge upsurge in crime in both the producer and consumer countries. There have been murders by the tens of thousands, and the profits from the illegal drugs trade have corrupted the law in many countries. Drug use has not deceased. Any rational person would propose trying a different approach, yet most of those in legislatures and the media insist that we should do even more of what we already know does not work.
Becker is in accord with what the Adam Smith Institute has said. We have called for addiction to be regarded as a medical problem rather than a criminal one. We proposed that clinics be set up on High Streets manned by doctors and nurses. Addicts would be able to go in and, subject to undergoing medical examination and receiving advice, should receive free supplies to be consumed on the premises. Since people would not do this for recreational drugs, we proposed that cannabis, ecstasy and cocaine should be legalized.
The crime built up on the drugs trade would vanish. Teenagers would no longer shoot each other on the streets in drug turf wars. Prisons would find they had space again. People would no longer find their habits set them against the law, regarding police and the courts as their enemies. Control over quality would be established, and deaths from tainted doses or overdoses would diminish.
Yes, drug use might increase. More young people might be tempted to give it a try, just as many do today with tobacco and alcohol. But what we have at the moment is far worse. We have a situation with drugs approximating to America's stint on prohibition of alcohol, with criminal gangs flourishing like weeds and lawlessness prevailing. It is time to try it Becker's way instead.
Are the big banks simply paying efficiency wages?
We all know that top bankers at large banks get paid vast sums of money. But quite why is still a matter for discussion. It isn't, cannot be, simply because bankers are greedy. We know that everyone's greedy so that's not an explanation of why some and only some are getting the big bucks. An interesting piece of research gives us further insight:
The next step is to look at executive pay. Unsurprisingly, the chief executives of the big banks come out on top. Between 2010 and 2013, the median total pay, including cash and stock awards, of the CEO of a large bank was more than $57 million, $22 million above the median compensation for the chiefs of smaller firms, according to Mr. Cannon’s research. What drove these paychecks? Not performance but size. Mr. Cannon found no apparent links between compensation and shareholder returns, but he did discover a robust connection between a bank’s assets and its officers’ pay. “There is strong evidence that size has been the key driver of bank executive compensation since the financial crisis,” his note concludes.
People who run larger banks get more money than those who run smaller ones. And that's just about only connection to pay that we can see.
So, if you want to reduce top bankers' pay then reduce the size of the top banks: and since we want to do that anyway, to get rid of the whole idea of too big to fail, why not?
But what this is also telling us is that in the current system the banks are behaving entirely rationally. Or at least potentially so according to the idea of efficiency wages. This is often put forward by Chris Dillow, the thinking man's Marxist. The larger the organisation, and the less detailed oversight it is possible to have of the people running it, the higher the efficient level of wages to pay to those running it. Simply because there's more shareholder value for them to lose if they mess up, and there's more for them to steal if they're that way inclined. We could describe it as bribing them to stay attentive and honest and if that's the way you want to describe it then fine. But it is also efficient, which is why perhaps people do it.
Gary Becker was right, part two: Cuba
For many years Gary Becker wrote a blog with Richard Posner. In the last entry, shortly before his death at age 83, Becker wrote one entitled "The Embargo of Cuba – Time to Go." The US embargo of Cuba, began in 1960, was designed to put pressure on Castro's communist government, and if possible to persuade Cubans to overthrow it. It did not achieve that objective, but it did give Cuba a fig-leaf excuse to explain away the economic failure of communism.
In 1959 Cuban, exporting tobacco and sugar, was richer per head than Taiwan, exporting rice and sugar. Nowadays Taiwan has a modern, open market economy trading globally, and has a per capita income over five times that of Cuba, where tobacco and sugar are still important exports. Becker wrote:
Since Cuba no longer provides any significant threat to American interests, there is no sense in continuing to punish the Cuban people with an embargo on trade, nor to provide excuses to its leaders for the poor performance of the Cuban economy.
This is one of the main objections to embargoes: they punish the wrong people. General embargoes hit the living standards of poor people in countries subjected to them. Those people are denied access to global goods, and cannot sell what they produce on world markets. They also hurt the countries that impose them. The US International Trade Commission estimates that its embargo on Cuba costs America $1.2bn annually, largely through lost potential gains in tourism, agriculture and other industries.
Becker recommended that "free trade is a principle that the United States should follow except in extraordinary circumstances," a sentiment most free market supporters would endorse. Richard Cobden thought that free trade between nations would eventually lead to peace, and it is true to a large extent that nations which trade with each other learn to negotiate with each other and settle disputes peaceably. Furthermore, trading nations begin to see each other as partners, to depend on each other for goods, and for their peoples to learn more about each other.
Becker is right. Raising the Cuban embargo would bring immediate benefit to the people there, and would probably speed up that country's retreat from communism and its entry into the modern world.
Talkin' Bout a Revolution
Well, you know, if you say you want a revolution then you do need to understand what the others who might revolt with you are revolting against. And contrary to a popular misconception it isn't true that all who are willing to revolt against the current order are doing so for the same reasons you are. Or even trying to revolt in the same direction you are. We here at the ASI are of course in the vanguard of the neoliberal revolution, railing against the manner in which the State is captured by special interests, the way that regulatory capture depresses the economy, the way that civil liberties are whittled away in favour of a soft authoritarianism. I, Tim Worstall, am of course an extremist even by our local standards at Great Smith Street (one editor recently dismissed me from a publication on the grounds that I am a "hyperneoliberal" which by the genteel standards of American journalism I might well be). All of which is what makes this analysis in The Guardian so amusing to both I and us:
In the twilight of neoliberalism it's comics such as Russell Brand and Beppe Grillo who puncture establishment thinking.
It's entirely true that Beppe and Brand are railing against the current establishment.
Brand is not an isolated figure. In Italy the comedian Beppe Grillo has been the catalyst for the Movimento Cinque Stelle (Five Star Movement), a populist, anti-corruption organisation which has tried to position itself outside of the traditional left-right paradigm.
Quite so. But to lump Brand and Grillo together is to entirely misunderstand what each is attempting to say. As far as Brand is concerned we seem to have the standard Teenage Trotskyism that most of us grow out of around our 16 th birhday and the discovery of the opposite sex. Beppe Grillo is a far more complex and interesting phenomenon.
For Beppe has been known to tweet on to his followers (the Movimento 5 Star operates largely through social media) pieces from myself, that hyperneoliberal. And anything more than a cursory glance at the movement's desires and policies show that they wish to move Italian society in a more neoliberal, or even just a more classically liberal, direction. They wish to cull parts of the State, kill off some of those special interests, revive civil liberties and reduce the regulatory capture that plagues Italy.
Just because some ponderous theorists decry neoliberalism it doesn't mean that all revolting against the current order share that analysis. It can be, indeed it is, true that some similarly decry the current state of affairs but are arguing for more of what the theorists decry. Grillo is outside the traditional left/right divide in Italian politics just as we here at the ASI are outside that traditional divide in British. We're both arguing that classical liberal polity, that set of policies that doesn't actually have a home in any of the traditional parties.
We might all be talkin' 'bout a revolution but it's not necessarily the same tables that we want to turn.
Piracy deal ahoy!
After years of impasse, UK Internet Service Providers and the copyright holders of the entertainment world look set to sign off an agreement on internet piracy. According to the Beeb a 'voluntary copyright alert programme' is to be agreed. Under this, ISPs will identify the IP addresses of alleged copyright offenders and send them ‘educational’ letters on copyright violation and legal alternatives to piracy. Whilst a similar ‘six strikes’ scheme in America sees ISPs able to impose sanctions (such as slowed internet speeds) on persistent offenders, the UK scheme does not. The amount of letters that ISPs can send is capped, and no individual will receive more than 4 letters. Following these, no further action will be taken.
This voluntary agreement breaks a deadlock between content giants, the government and ISPs caused by the Digital Economy Act (DEA). Rushed through in the parliamentary wash-up of 2010, the DEA's copyright provisions instruct ISPs to keep a database of persistent downloaders, and to restrict then finally suspend internet access to those who ignore written warnings.
These provisions are deeply problematic. They force ISPs to police their own customers, burden the companies with compliance costs and ask them to protect another’s intellectual property. Punishing alleged copyright infringers without judicial involvement also undermines the rule of law. Criticized by many politicians, civil liberties groups and the ISPs themselves, none of the Act has been actually implemented.
On the face of it, it’s good that the new agreement is such a watered-down version of earlier proposals. It’s certainly a far cry from what the content industries really want: effective barriers to piracy and access to a list of infringers to hit with ‘compensatory’ legal action. Advocates of internet freedom should be pleased. That said, the agreement doesn’t change the power of copyright holders- they can still get infringing content removed and websites blocked under existing legislation.
Furthermore, skeptics might think that the entertainment industry’s acceptance of the new scheme is just them playing the long game. The programme is meant to run for 3 years but be regularly reviewed. Rights holders have warned that should the scheme prove ineffective they will push for the “rapid implementation” of measures in the DEA.
If the objective is to deter piracy it’s obvious that the scheme will be next to useless: sending ‘educational’ letters will do little to change the behavior of serial downloaders. What it does do, however, is let the entertainment industry claim that a soft approach doesn’t work, and gets ISPs creating a database of copyright infringers that rights holders might win access to in the future. Playing ball now gives the copyright giants credibility to push for more extreme measures later on.
This might seem cynical, but the established entertainment bodies are reluctant to let go of their increasingly outdated business models. Returning to the DEA also gets governments back in the picture, whom copyright bodies often have great success in lobbying. From the ‘Mickey Mouse Protection Act’ of 1998 to the recent EU extension of the copyright in sound recordings, entertainment groups have a knack of preventing their goods from falling into the public domain, and ensuring that governments favor their industry’s profits over actual economic sense.
Understandably, media groups want people to stop illegally sharing their stuff. But instead of lobbying for legislation and slapping fines around the most effective deterrent is to understand consumer’s preferences and offer them valuable alternatives to piracy. Whilst movie bodies get angry at Google for linking to copyrighted material without really tackling their problem themselves, Spotify’s quite probably done more to combat music piracy than blocking The Pirate Bay ever has. However, instead of evolving the copyright industry seems to go out of its way to antagonize consumers, rent-seeking and objecting to even the most eminently sensible of copyright reforms.
Given the entertainment industry’s determination to protect their intellectual property, it’s unlikely that efforts to tackle piracy will end with a voluntary alert system. Whilst innovating companies will continue to find new ways of sharing and monetizing content, for the time being the copyright-holding giants of the entertainment world will remain preoccupied with the wrong prescriptions for piracy.
Gary Becker was right, part one: Crime
Gary Becker famously applied economic thinking to whole areas of activity that lie beyond the realm of narrow economic transactions. One such area is crime. The prevailing thinking of the day was that criminal activity derived from mental aberration or from social repression, and might be tackled by measures to improve mental health or to upgrade social conditions. In his paper "Crime and Punishment – An Economic Approach" (1968) and in subsequent publications, Becker advanced the alternative view that criminals were basically rent-seeking, trying to secure more of the resources that others produced instead of contributing to economic growth themselves. He posited that criminals are rational, performing a kind of cost-benefit analysis in which they set the gains they stand to make from a crime against the likelihood of being caught and facing a penalty.
Society can alter that cost-benefit equation in two ways, by increasing the likelihood of detection, or by increasing the penalties faced upon conviction. Increased police presence is by far the costlier of the two options, while jacking up the penalties can be relatively less costly to do.
Becker's insights have altered the way in which authorities tackle crime. Zero tolerance, for example, proposes that pursuit of minor offences ("broken windows") can create a climate in which potential criminals feel they are more likely to be caught. The use of CCTV to identify criminals by recording them in the act is similarly intended to raise the stakes of crime by making its detection seem more likely. On the other side of the equation the use of longer prison sentences also increases the costs that the potential criminal has to set against the benefits.
It was entirely typical of Becker, and part of his great contribution, that he took economics out from the economy itself and into the activities and relationships in society at large. Crime was one such area.
There's plenty of brownfield land but perhaps we don't want to build on it
A standard trope in the current arguments about planning permission is that we don't need or want to build on green belt land, or even unproductive agricultural land, because there's so much brownfield land lying around and available. Well, yes, this could be true but why would we want to poison people by sticking houses ontocontaminated land?
Hundreds of homeowners have been told their £400,000 properties could have been built on 'contaminated' land - and it's not safe for their children to play in the area. Environment officers at Tunbridge Wells Borough Council have warned residents of three streets in Paddock Wood, Kent, they may be at risk. They say 'potentially dangerous' chemicals including asbestos and creosote could have seeped in to the ground. The substances could have 'an impact on human health', they added.
This is land that used to be a timber treatment works. And a great deal of such brownfield land lying around the place is contaminated with one thing or another that we now think isn't all that wise to have lying around in a garden.
Fortunately, we do have a solution to this sort of problem. It involves that complex thing called "price". Along with the mystifying to many interactions of "markets".
We could, for example, have a rational and sensible system of planning to allow low density building where people actually want to live, as we outlined in Land Economy. There would then be that magical "price" stuff happening. Brownfield land that was, by virtue of location or ease of cleaning up, worth more than more rural land for building upon would get built upon. That which is not worth more than the costs of clean up would not. And so, by that miracle of "markets" we would be creating the most value possible by creating that valuable housing at the least cost. And, of course, the synonym for "creating the most value" is "making us all richer".
Plus we'd avoid the possibility of poisoning an entire generation of children by insisting that they live in houses built on polluted land.
Amazing what markets unconstrained by ridiculous regulation can achieve really.
By George
Tim Lai argues that George Osborne's deficit reduction plan has been painful, but the right choice given the alternatives. The Conservative party’s prospective Chancellor of the Exchequer, George Osborne, faced a series of problems going into the 2010 general election: a deep and protracted global economic slump following the 2008 credit crunch, paralysed money markets, a spiralling budget deficit and rapidly rising national debt.
The credit crunch arose from the United States’ sub-prime mortgage market. From the mid-1990s, US government policy aimed to promote home ownership amongst middle and low-income groups. Regulatory lending standards were reduced, enabling riskier loans to be made. Separately, expansionary monetary policy after the 2001 dot.com crash kept US interest rates low from 2002 to 2004, encouraging borrowers into debt. As rates ‘normalised’ between 2005 and 2007, mortgage costs rose, house prices softened, over-extended borrowers on highly-leveraged loans became exposed, and mortgage defaults multiplied.
Financial institutions in the globalised secondary mortgage market caught a cold. Benign capital reserve regulations had allowed them to become over-exposed too, on the back of mortgage-backed securities and collateralized debt obligations funded by short-term inter-bank borrowing. These complicated bundles of debt were rated as safe by virtue of their diversity, but they proved catastrophically vulnerable to wholesale decline. Their value plummeted, leaving investment banks with unmanageable debt obligations and no-where to go. Unable to judge the survivability of existing or prospective counter-parties, they no longer dared lend to each other, and credit froze from August 2007, plunging the global finance sector into crisis. Government intervention followed on a massive scale, including in the UK, with a coordinated international response to prevent complete market failure; few institutions were allowed to collapse (Lehman Brothers), but many were taken over by rivals (Bears Stearns), bailed out by tax-payers (RBS, Lloyds-TSB, Northern Rock, AIG) or fully nationalized (Bradford & Bingley). Central banks also injected huge amounts of liquidity into the markets to restore the flow of credit, and they cut base rates to unprecedented levels – the Bank of England rate fell to a record low of 0.5% in March 2009.
Despite these large-scale responses, the crunch in inter-bank lending quickly spread to the real economy. Lenders retrenched, seized by institutional paralysis, reactionary risk aversion, and the need to repair balance sheets and meet new regulatory obligations to recapitalise. Faced with this credit squeeze, general uncertainty, stock-market volatility akin to the Great Depression, fragile cash-flow, household debt, negative equity, a coincident spike in commodity and food prices (which peaked in Summer 2008), and a growing risk of bankruptcy or unemployment, businesses and consumers reigned in as well.
Albeit for different reasons, the UK’s housing market had become dangerously inflated too, and became an important factor in the nation’s economic woes. Interest rates never dipped as low as in the US, but had nonetheless been attractive to borrowers since the mid-1990s at around 6%, half the 1970s / 80s average. Liberal lending criteria drew many into the net, tacitly encouraged by successive governments addicted to property-related revenues and the invigorating effect of apparently rising household wealth. Struck by contagion and credit blight, the UK housing sector crashed (prices fell by 12% from April 2008 to December 2009), followed by domestic consumer demand (spending fell by 4% over the same period). The effect was compounded from early 2009 by events in the Euro-zone, where the banking crash spawned a sovereign debt crisis in some nations, whereby over-spending governments struggled to refinance their debt or bail out their banks. These economies faired even less well than the UK, with knock-on effects upon trade. On the supply side, surviving companies turned increasingly inward, delaying new investment or hiring, cutting costs and hoarding capital, with adverse consequences for productivity and output; UK GDP fell by 6.3% between Q1/2008 and Q2/2009.
Predictably, government revenues fell in the economic downturn (from 36.3% of GDP in 2006-7 to 34.5% in 2009-10), whilst expenditures rose sharply (from 44.2% to 51.6%). Hence, in the run up to the 6 May election, the budget deficit sat at 11.2% of GDP, the fourth largest amongst OECD countries – smaller than Greece’s and Ireland’s but larger than Spain’s, Portugal’s and Italy’s (the so-called PIIGS) – and the national debt sat at 71.3% of GDP, the highest level since WW2.
Amidst this, the sitting Labour government’s expansionary pre-crisis spending plans had assumed strong economic growth, without which deficit and debt would rise further. In his April 2008 Budget, Alistair Darling, the Chancellor, was forecasting uninterrupted growth of 1¾–3% between 2008-2010, a rapid fall in inflation to 2% by 2009, a diminishing budget deficit of 2% of GDP by 2010, and national debt of less than 40% of GDP, also by 2010. Six months later, he acknowledged the extent of the UK’s fiscal challenge, but remained committed to a publicly-funded Keynesian stimulus programme, alongside expansionary monetary policy (cf Quantative Easing), low interest rates and falling commodity prices, to mitigate the effects of the ever-deepening recession confronting him. He explicitly deferred repairing the public finances to the medium-term. In his last Pre-Budget Report, in November 2009, he conceded that the economy had, in fact, contracted by 4.75% that year, he predicted above-target inflation, projected an in-year deficit of £178 billion or 12.6% of GDP, of which three quarters was structural, and he estimated that national debt would reach £1.3 trillion or 78% of GDP by 2014. But he only committed to reigning in government spending from 2011, and to halving the deficit over 4 years, with scant detail on how it would be achieved.
There was little here to worry the Keynesian devotee, for whom renewed growth would naturally close the deficit and pay down the debt. But disquiet amongst others was multi-faceted: that bureaucratically driven capital expenditure would allocate resources inefficiently, distort markets and displace private sector activity; that a globalised economy would dissipate the effect of any demand-stimuli on British productivity; that the inevitable prospect of fiscal consolidation, including through higher taxes, would dissuade consumers and businesses from being significantly stimulated; that incurring further debt rather than convincingly addressing the public finances would undermine the UK’s credit-worthiness and compound the crisis with higher borrowing costs for the government and a deeply indebted electorate (interest on the national debt stood at 4% of GDP in 2009/10, the fifth largest item of public expenditure); that a cumulative total of £25 billion in stimulus measures – which was all that even Darling felt was affordable in the circumstances – would make little impact (cf the $940 billion spent by the US federal government, the effect of which is also disputed). In short, whilst Darling’s ends may have been laudable, his Keynesian ways were questionable to many and the means he devoted were commonly held to be woefully inadequate.
Against this background, and in keeping with the Conservatives’ ‘small government’ instincts, Osborne adopted a more aggressive strategy that attacked the deficit immediately and aimed to eliminate it more quickly. His headline targets were to reduce government spending from 47% of GDP in 2009-2010 to 41% in 2015-2016, cut borrowing from 11% to 2% and begin bringing public debt down. A notable objective during the process was to preserve the confidence of bond markets and keep borrowing costs low. Ahead of the election, the Conservative Party’s manifesto had committed to: macro-economic stability founded upon savings and investment; low interest rates; effective prudential supervision of the financial markets and; at its core, a credible plan to eliminate the bulk of the structural budget deficit over the course of a single Parliament. The substance emerged on 22 June, in the new Chancellor’s emergency budget, where he described an ambitious strategy to cut public expenditure by 6.3% of GDP over four years, with more than three quarters coming from spending cuts and the balance from higher taxation. He also announced most of the major muscle moves for his strategy:
• An immediate in-year cut of £6 billion had been announced soon after the election as a nod to the markets. He supplemented this (whilst also leaving most of Labour’s pre-existing measures in place) with a public sector pay freeze, an accelerated rise in the state pension age, the elimination of middle class tax credits, a change from Retail to Consumer Price Index for calculating welfare benefits, better scrutiny of the Disability Living Allowance and restrictions on Housing Benefit. In subsequent budgets, he: cut Child Benefit for high-earners; increased public sector pension contributions; introduced ‘career average’ rather than final earnings as the basis for defined-benefit public sector pensions; placed an overall cap on welfare spending and; committed to running a balanced budget over an economic cycle. • On taxation, he increased VAT from 17.5% to 20%, introduced a bank balance-sheet levy, created a 28% Capital Gains Tax band for higher-rate earners (up from 18%) and signalled reviews on tax indexation and financial dealings as sources of additional revenue. Later, he also ramped up the Revenue’s anti-tax-avoidance operations. • To support growth, he lifted the threshold for employers’ National Insurance contributions, began a phased reduction in corporation tax from 28% to 24% (later extended and accelerated to reach 20% in 2015-2016), took steps to increase the personal income tax allowance from £6,500 to £10,000 (later raised to £10,500 – a flagship Liberal Democrat measure adopted by the coalition government), resurrected a previous link between the basic pension and earnings, and declared support to various regional infrastructure projects. This was followed by a suspension of above-inflation rises in petrol duty, the controversial reduction of Labour’s top rate of income tax from 50% to 45%, the introduction of ‘funding for lending’ and Help to Buy schemes aimed at encouraging banks to lend to small businesses and nudge developers into building new housing, and limited relief from green levies for businesses. • Finally, by way of oversight, he had already announced the creation of an independent Office for Budget Responsibility. In the Autumn of 2010, he also instigated an overhaul of the regulatory framework for the financial sector under the Bank of England, which gained wide-ranging powers for prudential regulation under its new Governor in 2013. This extensive catalogue of measures went a long way to addressing the deficit over time, but a gap remained for government departments to bridge during the Comprehensive Spending Review that followed his emergency budget. Having reaffirmed the party’s commitment to protect the health and overseas aid budgets, which represented almost 20% of all government spending, other areas faced eye-watering average cuts of 25% – up from 14% if nothing had been ring-fenced). This was later ameliorated by other savings (notably from Child Benefit), but nonetheless remained at 19%. In practice, the pain was unevenly spread, from 7.5% for Defence and 11% for Education, through 25% for the Home Office and Ministry of Justice, to over 60% for Communities & Local Government.
Osborne’s plan for fiscal consolidation was severe, and risky. Many feared it would kill off a weak recovery, plunge the economy back into recession and prolong the nation’s woes. Foremost amongst his critics was the Labour opposition. But his approach did gain the endorsement of the money markets, sovereign rating agencies and international institutions (including, initially, the International Monetary Fund), all key audiences. Subsequently, with a depreciating pound, stubborn inflation, rising unemployment, weak private sector investment, feeble productivity growth and, in 2011, the prospect of double-dip recession, he fought off strong pressure to reign back on his programme – and retrospective analysis later determined that a double-dip recession did not, in fact, occur. By the same token, he resisted further fiscal tightening in early 2013, when Moody’s removed the UK’s AAA credit rating, and when it became clear he would miss his key targets, such that the deficit will is not now expected to clear until 2018-2019, borrowing is forecast to remain above 2% of GDP until 2017-2018, and the national debt is unlikely to fall until 2016-2017.
But even as the UK’s credit-worthiness was downgraded, economic indicators began to improve, led by rising employment and followed by falling inflation, stronger growth and recovering house prices. By May 2013, the deficit had, at least, stabilised. A year later: unemployment is below 7% and record numbers have jobs; inflation is 1.6%, well below the Bank of England’s 2% target; incomes are rising faster than prices; the economy is expected to grow by 2.7% in 2014 (faster than any other major economy) and has all-but reached its pre-crisis level; and the budget deficit is down by a third and falling. In short, notwithstanding the delay in meeting his main targets, the ends to which Osborne committed himself in 2010 are largely realised or firmly in prospect. But does that make his strategy the right one?
Amongst the foremost strengths of Osborne’s approach, he maintained the confidence of the money markets and protected borrowing rates. It is improbable that the UK would ever have been unable to sell its bonds, as those nations bailed out by the troika of the European Commission, European Central Bank and IMF were unable to do during the Eurozone crisis, but a loss of confidence would almost certainly have raised the cost of government and personal borrowing, swallowing up the Exchequer’s scarce resources and compounding the financial difficulties of individual debtors and struggling businesses (the UK’s 10 year bond yield fell from 4.28% in February 2010 to a record low of 1.38% in July 2012, and stood at around 2.67% in late April 2014; by contrast, Spain’s peaked at 7.6% in July 2012 and was 4.29% in April 2014; Greece’s peaked at 48.6% in March 2012 and stood at 8.6% in April 2014). The creation of an independent OBR and the consolidation of responsibility for financial stability and prudential regulation under the BoE played to the same ‘confidence’ narrative by strengthening fiscal transparency and economic governance. The theorist (including the OECD and IMF) would also look favourably upon Osborne’s spending cuts as a more effective way to close the budget deficit than a higher taxes, and upon his increase in consumption tax as less distorting and constraining on growth than taxes on income, production or investment. But both spending cuts and higher VAT are regressive and, politically, they demanded to be offset. Raising the personal income tax allowance (and manipulating the higher rate threshold to limit the benefit to higher earners) did this, whilst also incentivising employment over welfare dependency. So, too, eliminating middle-class allowances and introducing higher-rate capital gains tax. Meanwhile, cutting corporation tax, employers’ National Insurance contributions and moderating rises in fuel duty will have supported private sector growth, albeit this effect was notably sluggish. In summary, Osborne’s package of measures seems balanced and well calibrated to deliver effect without breaking voters’ endurance. Whilst risky, it was also politically astute, underlining the Tories’ reputation for economic competence and forcing Labour toward fiscal conservatism in an attempt to shed their reputation for profligacy.
His approach has not been without its weaknesses, however. Most notably, the commitment to ring-fence health spending has severely exacerbated cuts elsewhere and distorted service provision across the board. It has also sheltered 20% of total government spending from the most rigorous examination. This may have been a political concession the Tories had to make to gain office in 2010, but it was constraining and unlikely to be repeated in 2015. Another commonly levelled criticism has been that universal pensioner benefits were left untouched. In view of dramatically improved health and life expectancy, and the less wearing nature of most modern occupations, many have also argued that Osborne should have gone further with raising the state pension age. But senior citizens are a growing constituency and the group most likely to vote. They cannot easily be ignored and, indeed, the Tories even reiterated their expensive commitment to protect the value of state pensions via the ‘triple lock’, which assures indexation by the greatest of inflation, wages or 2.5%. Elsewhere, Labour’s capital investment cuts, amounting to 1.5% of GDP, were left in place. Granted, new and important capital spending was subsequently announced (much of it using private sector money) but, amongst all else, it could sensibly have been disbursed earlier, helping to create economically conducive conditions for the recovery. In short, the government’s strategy has had its economic shortcomings, some of them quite serious, but most have been driven by political expedience or necessity; ever will it be thus.
The circumstances facing the government have also presented opportunities, some of which have been embraced more readily than others. For example, the chance to refashion and shrink government has been clear, but seems largely to have been taken ad hoc, without any central or overarching examination of what the state is for. The OBR forecasts that public sector employment will have shrunk by up to 1.1 million by 2018, spending has become more targeted and public services have been opened up to other providers; but this does not amount to a fundamental philosophical transformation. A root-and-branch overhaul of the UK’s complicated and behaviour-distorting tax code is overdue – for example, to remove the increasingly artificial distinction between income tax and National Insurance, to enhance rewards for investment and production, and to eliminate the most harmful forms of economic rent. Less punishing or stigmatising bankruptcy laws, akin to those of the United States, might encourage enterprise. And an examination of the energy sector could more faithfully price carbon emissions, evaluate the cost and maturity of emerging green technologies and agree sensible bridging strategies around nuclear generation and shale oil and gas.
But nor should the threats be underestimated that Osborne faced to his strategy. It seems likely that excess productive capacity, scarce credit, general uncertainty, risk aversion, and turmoil in the Euro-zone export market did, indeed, serve to dampen private sector investment and to delay the substitution of public sector spending that Osborne’s plan required. Faced with multiple challenges, banks also remained stubbornly reluctant to lend to business. Most indicators came to point strongly in the right direction, but his timetable had already been compromised by this earlier sluggishness. Inflation could have knocked things off track too; although fuelled by temporary phenomena, the cumulative and persistent effect could have forced an unwelcome rise in interest rates. Instead, deflation became the greater threat. Disappointing private-sector investment and a persistently fragile Euro-zone left exports weak, perpetuating a potentially destabilising trade deficit. A resurgent housing market raised the fear of a new bubble, and saving remained unattractive.
In summary, whilst imperfect, Osborne’s deficit reduction plan withstands scrutiny. At a time when others were reluctant to face (or publicly admit to) the economic challenge in prospect fro the nation, he described it as he saw it and was clear on his objectives from the outset, with respect to government spending, borrowing and debt; he laid out his timetable; and he deployed a strategy to deliver, balancing savings against revenues and using effective measures that, in many instances, had reinforcing secondary effects. But it is always difficult to prove cause and effect in real-world economics, where innumerable inter-dependent factors are at work, which cannot be evaluated in isolation. Hence, the extent to which Osborne’s actions were the cause of the positive economic outcomes that followed will always be debatable. But on the balance of rather extensive circumstantial evidence, it is reasonable to conclude that his strategy was successful.
Nor is it easy to contemplate alternatives in the absence of any meaningful counterfactual. Some present President Obama’s stimulus package in the US as the sort of Keynesian response advocated by Labour. But the effect of this federal spending was substantially diminished by the sharp cuts forced upon the states, most of which are required by law to maintain a balanced operating budget. The US, with the world’s reserve currency, also enjoys very different borrowing terms in the bond markets to the UK. At the opposite end of the spectrum, the much more severe austerity visited upon the PIIGS by the troika, in order to restore their fiscal credibility, is widely viewed to have prolonged recession and aggravated unemployment well beyond anything the UK endured (Greece, Spain and Italy remain in recession in May 2014, with Greek and Spanish unemployment still exceeding 25%). In short, George Osborne’s flawed offering may have been about as good as it could reasonably have been.