Cantab83

Home ownership and economic mobility

2011-07-30T21:52:00.003+01:00

A couple of weeks ago James Gregory of the Fabian Society published an article on the Fabian Society’s Next Left blog where he discussed the impact of increased home ownership on the economy, and the labour market in particular. The central tenet of the article was that the continuous increase in home ownership seen in the UK over the last thirty years has reduced the capacity of the labour market to respond flexibly to economic changes. Rather than complementing and enhancing the legislative changes introduced by the Thatcher and Major governments that were supposedly designed to liberalise the labour market in this country and increase growth, his argument is that increased home ownership has instead acted, at least partially, to neutralise many of those changes and thereby presumably retard growth.

What I found surprising about the article though, were its starting assumption that most people (or perhaps only most of the current political class?) believe that home ownership increases economic mobility, and secondly what I perceive to be the article's failure to fully describe the true extent of the causes and impact of this immobility. As a result some of what I would consider to be potential remedies were neglected. For by omitting some of the causal factors, it is undoubtedly more likely that some of the most effective solutions will also be overlooked. However what the article does do is once again highlight the negative impact that current housing policy (such that any active policy actually exists in the UK) has on the British economy.

Given the well-known problems of transaction costs (estate agent fees, stamp duty, surveyor fees, re-mortgage fees, conveyancing etc) and the logistical problems associated with the home moving chain, I was more than a bit surprised that "popular opinion" was perceived to be as the article implied. I have certainly never been of the opinion that home ownership may actually make workers more economically mobile. In fact I suspect that most people are not, and do not even desire to be economically mobile. This conjecture is probably borne out by the average time between re-sales for domestic property in the UK (currently about 20 years). You can see the immobilising effect of home ownership by comparing this value with the average length of time most tenants stay in the same property (often for only a few months). Doubtless, much of this difference is due to what James Gregory referred to as "psychological attachment". Homeowners have a lot of emotional as well as financial capital invested in their homes that is generally absent for many tenants.

James Gregory also rightly points to the principal contradiction in UK economic policy: “why have we spent the past 20 years actively pursuing ‘flexible’ labour market policies whilst, simultaneously, seeking to push more and more households into homeownership?” The answer, he claims, lies partly in the myth “that owner-occupation is a vehicle of social and labour market mobility.” It may well be that owner-occupation advances the former. Unfortunately, it most certainly acts against the latter. In addition to the transaction costs described above, there are a number of other reasons why owner-occupation acts to reduce labour market mobility. James Gregory highlighted in particular the pressure some homeowners face to keep up their mortgage payments. Such pressure can often trap homeowners in jobs thereby reducing or removing their ability to change career or relocate. However, I think there are some other pressures that are perhaps even more problematic, not just for the individual, but for society as a whole.

The first is the rise in, and the impact of, double income households. The high cost of housing (both home-ownership and rental) is forcing more families to send both adults out to work. This in itself acts to reduce mobility even more as the probability of both adult partners with different careers being able to find suitable jobs in the same part of the country at the same time is always going to be less than the probability that each will find work independently.

This then leads to a second problem: an increased tendency for skilled labour to cluster in regions of high employment density such as the South East where both partners are more likely to find suitable employment. This in turn leads to greater regional inequality and overheating of some local economies. This positive feedback mechanism then further exacerbates the original effect (i.e. high house prices) that gave rise to the problems of low mobility and employment clustering (caused by a move towards double income households) in the first place.

This clustering then also impacts on employers. Many firms, particularly those that depend on highly skilled labour, have already recognised this problem. As a result they also tend to cluster in regions where the skilled labour is already situated, thus adding to regional inequality. Moreover there is a growing tendency for many of these firms to actively reject job applications from outside their local area because of worries about mobility and relocation problems, thereby adding to the imbalance.

The result of all of this is that regional disparities in house prices are exacerbated. This also acts as a further impediment on labour mobility, at least for those trying to move from poorer areas to wealthier ones.

Finally there are the issues of short-term and part time jobs. These may give employers greater flexibility, but the cost is borne by the worker (and to some extent the State). Just as it is more difficult for a family of two adults to move and find new employment for both of them than it would be for a family with just one wage earner, so it is also more difficult for an individual with several part time jobs to move and replace all of those jobs simultaneously than it would be to replace a single full time position.

These then are some of the additional problems that I would seek to highlight. Unfortunately I can see little reason why the remedies that James Gregory proposes would make much difference. For example, providing more advice and assistance to those with mortgage problems will at best only slightly ameliorate an already abysmal situation. In fact it could actually make the situation worse by giving artificial external economic support to home owners who having inflated the housing market are unfairly supported within it through taxpayer support. What is needed is a set of policies that tackle the underlying problems.

The first of these problems is excessive house prices that force families to work longer hours than is socially desirable and which have wider consequences that are economically undesirable. Until a government commits itself to delivering stable and reasonable house prices this problem will not go away. This requires an economic policy that delivers such stable and reasonable house prices (as I have previously outlined) so that families can reclaim a more socially desirable work-life balance, and more of their disposable income can be recycled within the productive economy rather than being sunk into unproductive fixed assets.

The second problem to be addressed is the issue of regional inequality. For this we need progressive tax rates for employers (NICs, land tax and business rates) that vary regionally and decrease with distance from London. We also need more investment in the regions that doesn't just increase employment, but provides high value jobs. For this we need to look to France and Germany and establish a network of research institutions akin to the Max Planck, Fraunhofer and Helmholtz Institutes in Germany (of which there are more than 150) or the CNRS in France (of which there are over 100 separate facilities). These policies would indeed attract high value jobs back into the regions and do so far more effectively and more sustainably than the current system of regional development grants.

Finally we need to actively reduce the number of part time jobs in the economy. Flexibility is OK in good measure, but the balance has clearly gone too far. There are currently about 1.2 million people working in part time jobs while actively seeking full time positions. Much of this increase in part time working is driven by the way employers' National Insurance contributions (NIC) are levied. Employer NIC exemptions for jobs that pay less than about £110 per week should be limited to companies with less than five employees. The purpose of these exemptions should be to help a very small company take on the one or two extra staff it needs to meet fluctuating demand. They should not be used by large chains of stores to reduce their tax bill. Large companies should already have sufficient employment flexibility by virtue of the size of their workforce. Currently too many are exploiting this tax loophole for their own financial advantage, but to the detriment of the wider economy.

These then are some of the solutions that the Left should be complementing. First, though, it needs to recognise the wider impact that the housing market has on the UK economy. Building more houses, or providing more social housing, is not enough. Neither is simply setting up a few advice networks for distressed home-owners. The problem is much wider and more entrenched than can be solved by such simplistic solutions.

Time to auction work permits?

2011-07-02T11:51:00.008+01:00

Once again the government is getting itself in a muddle over work permits and immigration. This week the Work and Pensions Secretary, Iain Duncan Smith, has been urging UK businesses to employ young Britons, rather than relying on foreign workers. This comes after a recent article by Frank Field MP for the Daily Telegraph highlighted that the majority of new jobs created in the UK both in the last year, and also over the last ten years, have gone to overseas workers. Yet such pleas from government ministers calling on business leaders to act are hardly likely to make much difference unless they are backed by legislation. After all, why should any business act against its own perceived interests in this way.

The usual response of employers to the immigration issue is that British workers 'lack skills' and have a 'poor work ethic'. They also claim that they are only employing foreign workers because they are looking to employ the very best international talent. The problem is that none of this is really true. It is difficult to argue that this country suffers from a shortage of talent when it has at least three of the top ten science-based universities in the world within its borders. It is also difficult to argue that there is a shortage of technical talent when the relative size of the industrial base in this country is so small compared to other top OECD countries. As for the question of work ethic, there is more than a suggestion that this is shorthand for people in this country being asked to work long hours for low pay. If this country needs to import talent, then surely it should be in the form of people with skills that are comparable to the best this country has to offer. Yet even in our universities you will struggle to find foreign academics from the best overseas universities such as Stanford, MIT, Caltech and the Ivy League. So we may be importing talent, but it is not generally world-class talent.

The problem with the current system is with the rules and how they are implemented. So if a government doesn't like the result that ensues then it should change the rules. Those rules were based on a points system linked to workers' skills. Now the government wants to cap numbers. Unfortunately both systems are flawed because neither is sufficiently based on quality, and neither places any incentive on the employer not to demand foreign workers over British ones. Nowhere is this more prevalent than in our university sector where there is an abundance of overseas graduates, but very few from the top ten research institutions in the world. However the same is true for much of industry. As there was no premium for a degree from a truly world-class institution under the points system, there was no incentive to import talent from those institutions in order to raise the average quality of talent in this country. As a result in many cases overseas graduates acquired a kudos that was undeserved and was used to displace domestic graduates from the UK jobs market.

Moreover the points system itself was deeply flawed. Not only did most university degrees from most countries carry more or less the same intrinsic points value, but additional points were added for existing earnings rather than for any future earnings from the intended UK-based job. For example, a Ph.D. graduate (worth 50 points under the points-based scheme) who was under 30 years of age (worth another 20 points) would only have to be currently earning over £25k under the old system to acquire the necessary 75 points for a Tier 1 visa. If they had a batchelor's degree (worth 30 points) and had previous UK experience (5 points) then they would need previous annual earnings of over £35k to qualify. Yet even this amount could be exaggerated by the 'uplift calculator' which artificially raised the earnings of applicants from low GDP per capita countries. The result of all this is that virtually any graduate qualified.

Nor is the capping system much better. Such a cap would also fail to distinguish between workers of different skill levels and quality. It would probably be implemented on a first-come-frst-served basis that would do little to improve the technical excellence of the UK. As a result places would end up going to hairdressers instead of nuclear physicists.

What is needed instead is a market system that is biased in favour of high quality talent over lower quality talent. One that forces employers to balance the cost of employing a foreign worker with the cost of not doing so. It also needs to be a system where the cost increases with demand in order to limit demand to the most valuable workers with the most valuable skills. The obvious solution is therefore one based on an auction mechanism where the quantity of work permits is constrained, but excess demand forces up the price so that they are only economically viable for the highest paid jobs. The question then is, who should pay? The worker or the employer?

In a recent article on the Institute of Economic Affairs (IEA) blog, Eamonn Butler of the Adam Smith Institute (ASI) suggested that work permits should be auctioned to the highest bidder. For once I agree with him. He also suggested that the immigrant employee should pay as they were the ones who were in line to benefit. That though is where he and I part company. The problem I have with many proposals that come out of both the IEA and the ASI is that they tend to place higher costs on the ordinary worker or citizen, while seeking to exempt the owners of business from similar costs.

The problem with asking the employee to pay for the work permit is two-fold. Firstly, in any free market the best workers will always migrate to countries with the highest incomes and the lowest cost of entry. If a country wishes to avail itself of the best talented labour from abroad, large immigration fees applied to those migrant workers would be self-defeating. They would drive the best talent elsewhere. After all, why would an immigrant worker be prepared to pay £30k or more to work in the UK, when they could get visas or work permits for similar jobs elsewhere in the EU and the USA for free?

The second problem with forcing the immigrant employee to pay is that it will not reduce immigration levels. If the price of the visa or work permit goes up then migration from richer countries will indeed go down. However it will almost certainly be replaced by migration from poorer countries (or less talented individuals from richer countries) where the wage differential with the UK is greater. Thus net migration will be unchanged, but the quality will be reduced.

Fundamentally though, this policy should be about internalising externalities. In this case the externalities are the adverse social costs that are currently passed on to the taxpayer and the State as a result of immigration. These can include higher unemployment, additional costs on public services (such as education and health), the lowering of domestic wage rates, and a reduction in workplace training.

The impact on workplace training is of particular importance. In this regard the UK’s record is lamentable, and immigration makes it even worse. It allows bad employers to undercut good employers by utilising low cost foreign labour instead of improving the skills of their existing employees. This lack of workplace training is not a new phenomenon in the UK. As Will Hutton pointed out in his book "The State We're In" back in 1994 (see p187), British employers in 1988 only invested about 0.15% of their turnover in training. Companies in Japan, France and Germany invested about ten times that amount. That was the main source of the UK skills shortage then, and it probably still is now.

The solution, therefore, should be to make employers pay more for immigrant labour than they would have to for retraining their existing UK workers. It is employers who should bid for these work permits in monthly auctions not the migrant workers. Perhaps then employers would be incentivised more to invest in their workforce instead of continually carping to government ministers about the supposed skills shortage in this country. To put it in simple terms, if migrant workers are really that essential to the well-being of the UK economy, then employers should be prepared to pay a premium for their services.

No doubt many employers will complain vigorously about this and claim it will make the UK uncompetitive. This is a poor argument, not least because most of the UK economy is based on services, and service industries in the UK cannot in general compete for custom against similar companies overseas. Their market is internal, and so their only competitors are internal. If higher wage costs push up their service costs then they are free to pass them on. Far from damaging the UK economy, such actions would increase GDP by increasing the spending power of the low paid, much as the minimum wage has done. Britain's future prosperity lies in being a high wage economy, not a low wage one. As for manufacturing, higher wage costs would be offset by a higher quality of employee and therefore a higher level of innovation and international competitiveness.

Feminism and social mobility

2011-04-03T20:09:00.002+01:00

The Universities Minister David Willetts (aka "Two Brains") has found himself in political hot water this week for daring to suggest that a lack of social mobility within the male population over the last 40 years is a direct consequence of feminism. His argument appears to be that greater equality between the sexes has led to women, who would otherwise have been housewives, taking university places and well-paid jobs that instead would have gone to ambitious working-class men. There may be some truth to this analysis, but is this an example of a decline in social mobility? I would argue not for two reasons.

Firstly, because I would argue that feminism IS a form of social mobility. Before feminism, a woman's only hope of social advancement was by marriage. Now with feminism she has at least a chance of improving her lot by virtue of her own ability, just as any man has.

Secondly, but more controversially perhaps, I actually see very little evidence that there has ever really been any real social mobility in this country. This may be a highly contentious view, but it is one that I believe is consistent with the analysis of David Willetts in regards to the effects of gender equality on the life chances of men.

The conventional view of Britain's recent social history is that in the immediate aftermath of WWII Britain experienced a period of sustained improvement in social mobility. During this period members of the lower classes were able to gain access to better paid jobs, and so move up the social ladder. This upward mobility has generally been attributed to the improved access to education for the poor and the raising of the school leaving age following the 1944 Education Act, and in particular to the role of grammar schools in allowing the brightest children of the poor to receive the same high quality education as the children of the rich. Consequently, the subsequent introduction of comprehensive schools in the 1970s at the expense of grammars, and the perception of a decline in social mobility in the years that followed, has been seen as evidence of the superior value of grammar schools in fostering improvements in social mobility, meritocracy, and egalitarianism. There is, though, an alternative argument: that social mobility never existed at all.

Under this alternative view the growth in social mobility that was allegedly observed in the 50's and 60's was instead a manifestation of an entirely different phenomenon: social expansion (for want of a better term). This period was characterized by massive technological changes, and therefore also a change in the nature of work. As more jobs were created that needed specialist skills and a high level of education, employers were forced to look beyond the confines of their existing and narrow pool of talent in order to fill these new posts. Thus the perceived rise in social mobility was a direct consequence of changes to the labour market, and the inability of the upper classes to breed fast enough to fill the growing numbers of prestige jobs that were now being created. Employers were, therefore, reluctantly forced to extend their recruitment policies to include the children of the hoi polloi and other assorted 'oiks' that had previously been overlooked as being wholly unsuitable for such lofty positions of responsibility.

Unfortunately, once the expansion in new places at the top table of society ground to a halt, then so too did social mobility. Thus, social mobility was not driven by merit in this instance, for if it were then it would have continued indefinitely and those moving up in society would have seen equal numbers of the upper classes passing them in the opposite direction. No, instead it was driven be a temporary expansion in places. That is why it would be better termed as 'social expansion'.

In this context, the impact that feminism has had on social mobility according to David Willetts can be seen as being nothing more than an extension of what has always happened. It has merely provided an additional pool of socially acceptable labour for the upper class elite to tap into before they countenance expanding their social horizons. So in this regard I agree with Willetts. Unfortunately, it does not follow that without feminism social mobility would have improved in this country. Perhaps the illusion of it would, but not the reality.

Of course the ultimate myth is that full social mobility can ever be achieved by improvements to education alone. How can a more egalitarian society ever be achieved if the best jobs are not given to people based on their ability, but rather on the wealth of their parents or on their political affiliations? Actions such as this can only lead to a society where the division of wealth and power is demarcated ever more strongly along class and party political lines.

20 questions for the next Labour leader - part 2

2010-06-17T04:13:00.002+01:00

Having just watched the Newsnight debate between the five contenders for the Labour leadership, I have to confess that I am still not much the wiser. With Jeremy Paxman seemingly more interested in trying to get the candidates to talk about the past (e.g. Iraq, Gordon Brown's leadership) than the future, there was precious little time for the candidates to outline future policy changes. Paxman's attempt to try and get Ed Balls to knife Alistair Darling over his last budget was particularly emblematic of much that is wrong with the way politics is conducted inside the Westminster/media bubble. Then Michael Crick had the audacity to claim that Ed Miliband had underperformed because he had "..failed to put forward the kind of visionary ideas..." that he had outlined at previous hustings. Well of course he failed, Michael, because he wasn't given the opportunity. In fact none of the candidates were.

In a previous blog I outlined five of the top twenty questions that I think need to be addressed in this leadership debate. Only the first of these (why you?) and the last (civil liberties) were really addressed in the Newsnight debate. The issues of housing, inequality and the candidates' own policy priorities were largely ignored. Yet the previous debate hosted by the Fabian Society seemed to be much more policy oriented. As a result it is slowly becoming apparent that there are some distinct differences between the various candidates, but we will only be able to fully appreciate what these are when we find out where each candidate stands on a range of different issues. Many of these critical issues will be in policy areas where the last government was found wanting, both by its supporters and by the electorate as a whole.

6) Clearly electoral reform is one such issue. The media think this is only of relevance to political anoraks, but it is becoming clear that it is central to issues of social justice and inclusion. It also impacts on the way political parties position and differentiate themselves and hence on amount of choice voters are given at elections. This was one of the key policies that was addressed at the Fabian meeting. It now appears that most of the candidates are signed up to electoral reform. Ed Balls is even in favour of a written constitution, which brings me on the the next point.

7) Constitutional reform.
One area where the last government lost trust was over its refusal to grant the people a referendum on the Lisbon Treaty. So would a future Labour government grant a referendum on all future EU treaties? This question is even more important given the role that such treaties appear to be playing in forcing the UK government to contract out public services and possibly privatise the Royal Mail.

8) Then there is the euro. Given the current problems in the eurozone it is imperative that we know under what circumstances (if any) each candidate would countenance the UK joining the euro. It is also important that we find out to what extent they each understand the potential economic consequences of doing so. One of the biggest economic consequences of joining the euro would be in the effect it had on the UK financial sector.

9) So would any of the candidates be prepared to reform the banking system to make it more competitive and reduce the risk of another financial collapse? Are they prepared to break up big banks? What other financial measures would they introduce? And how would they prevent the most disadvantaged in society being excluded from access to bank services as banks seek to increasingly make customer pay annual fees for bank accounts?

Of course it is not only our banking system that is prone to excessive executive pay and a disproportionate bonus culture. The same is true of much of British industry.

10) So how would each candidate improve shareholder democracy and Company Law in order to reduce corporate fraud, tax evasion and avoidance, and excessive executive pay and bonuses?

11) How would they regulate takeovers in order to maintain market competition, improve consumer choice and protect British businesses and jobs from unfair competition and commercial predators? There is no doubt that the takeover of Cadbury by Kraft cost Labour many thousands of votes, both around Birmingham and elsewhere.

12) Wealth and Mansion Taxes.
Which candidates would support a Mansion Tax of the type outlined by Vince Cable? Such a tax is far more redistributive than income tax and could generate up to £20bn, as I pointed out a few months ago. That is nearly ten times the amount that inheritance tax currently generates. It is also far more than is currently generated by stamp duty and CGT.

So, twelve down and eight more to go.

How to prevent a Euromess

2010-06-01T23:36:00.005+01:00

So, the euro is in turmoil. A crisis that started in Greece is now spreading to Spain, Portugal, and possibly even to France and Italy. However, as the Nobel prize-winning economist Paul Krugman pointed out on his New York Times blog a few months ago, the real story is in Spain, not Greece. This is partly because Spain is the much bigger economy. It is also because, for most of the first seven years of this millenium, Spain kept to the rules and maintained its budget deficit well with the 3% limit demanded by the Maastrict Treaty. In fact, over that period it actually ran a small cumulative budget surplus (see Paul Krugman's blog for details). That, though, did not save it from the effects of the credit crunch and the financial collapse of late 2007. Greece on the other hand is a totally different kettle of fish. Unlike Spain, it didn't even try to play by the rules, so it is hardly a surprise that it is in the economic mess that it is.

The lesson to be learned from the experiences of these two countries is that the problems of the Eurozone are two-fold. Firstly, there are some countries that were admitted to the club (probably for political reasons) that were fiscally irresponsible and failed to obey the rules. In short, they probably shouldn't have been there in the first place. Then there were other countries, like Spain and Ireland, that generally obeyed the rules, but suffered from what Krugman terms asymmetric shocks. It is how the euro deals with these asymmetric shocks in the future that will ultimately determine whether the euro can survive in its present form. In my view, the measures so far proposed do not address the real issues, or provide any real solution. In order to understand how these asymmetric shocks can be prevented you need to understand their cause. In the cases of both Spain and Ireland, the primary cause was (surprise, surprise!) a massive property boom, driven in part by large speculative capital inflows, which then led to excessive local price inflation. So, no stable solution will be found unless it addresses the problems of capital flows, and local inflation in wages and house prices.

The problems in Spain started with the property boom. This led to massive inflows of cash into the economy that meant that Spain ended up running a massive current account deficit. This inflow of cash also stimulated the economy to such an extent that it caused inflation in local goods and services, and particularly in wages. The critical factor, however, is that the property boom ultimately led to a boom in GDP and thence to a huge increase in government revenues. So the government was able to spend more without either raising taxes, or borrowing to fund a deficit. The problem was, this extra spending then fuelled the boom in GDP even more, thereby exacerbating the underlying problem. However, because the economy was expanding and the government was still balancing its budget while its spending increased, few people saw the impending crisis looming. Unfortunately, when the property bubble burst, as it inevitably had to, government revenues collapsed with GDP, while government spending rose even further to fund the consequences of rising unemployment. The result is a massive deficit of over 12% of GDP. That, then is the history, as Paul Krugman outlined previously on his blog. The question for the euro though, is how could it all have been prevented?

Of course, it is patently obvious that central to this whole mess is the inflation in asset prices that occurred during the boom, mainly in housing and other real estate property. Now it has been argued by some at the Adam Smith Institute (ASI) that the flaw in the whole euro project is the common interest rate set by the European Central Bank, and it was this that caused the property boom because the bank rate was set too low. Unfortunately there are two major flaws to this argument.

For a start, the argument that housing booms are, or can be, effectively controlled by changing interest rates is not well supported by historical economic evidence. Governments and central banks are generally reluctant to raise interest rates in order to dampen house price inflation for fear of strangling economic growth or strengthening the currency too much. As I pointed out a few months ago, the only way to effectively control house price inflation is by controlling mortgage lending. Secondly, Britain and the USA suffered from their own housing bubbles without being in the Eurozone. They had the freedom to adjust their interest rates upwards to counter their own housing booms, but chose not to. Finally, it should also be remembered that the property booms in Spain and Ireland started long before either country joined the euro.

An alternative possible solution currently being touted is to go for greater fiscal integration in the EU. This is the approach that was suggested by the German government recently. Unfortunately, such a policy would reduce the ability of member states to run their own domestic affairs. It could lead to outside agencies (like the European Commission) telling member states how they should spend their own money. It would inevitably lead to greater tax harmonisation across the Eurozone (something favoured by Germany), together with a reduction in democratic accountability and plurality. It would also make the EU more like the USA. Of course one way the USA deals with fiscal imbalances between member states is to tax nationally and then redistribute money to the different states via federal grants. There is, though, no political appetite in the EU for a similar strategy.

The USA is also a more integrated economic region than the EU, with greater geographical movements of people. Paul Krugman has suggested that one solution to the Spanish problem, and asymmetric shocks in general, is an increase in "fiscal and labour integration". In other words to make the EU more like the USA. The problem with this is that there are deep structural barriers in Europe to the free movement of labour: language, culture, education and recognition of qualifications. In reality, it is far more likely that companies will move jobs to regions of low wages and high unemployment, than people will move between countries to find jobs.

There is, however, a third option that has so far been ignored. Rather than the EU taxing all citizens, as happens in the USA, it could tax all member governments in the Eurozone. The tax rate would be designed to counter the capital inflows that Spain enjoyed, and which led to its inflation rate exceeding the Eurozone average. By using this rate of surplus inflation in Spain as the figure of merit (i.e. the difference between local Spanish inflation and the Eurozone average), and calculating the tax due by applying that rate to the current value of Spanish GDP, such a measure would effectively counteract the effects that the capital inflows had in distorting the economy.

For example, the data in Paul Krugman's blog shows that local inflation in Spain between 2000 and 2007 was on average about 4% more than in Germany (and the Eurozone average). At the same time the current account deficit varied between 4% and 10% of GDP. So, if the European Central Bank (ECB) were able to tax the Spanish government at a rate of 4% of GDP for that period, the Spanish government would then have been forced to pass on that tax to the population via tax rises, or spending cuts, in order to maintain its budget balance within the 3% Maastricht limit. Both of those measures would have acted as a dampener on economic growth in Spain, thereby counteracting the effects of the housing boom. Moreover, the tax revenues generated by such a measure, and thus acquired by the ECB, could then be used as bailout money for Spain in any future banking or economic crash. In fact such a policy would have resulted in Spain building up capital reserves at the ECB equivalent to around 25% of its GDP in the period up to 2007. That would have funded its current deficit for at least two years and thereby negated much of the economic crisis that it now finds itself in. This policy would therefore eliminate most of the potential for asymmetric shocks within the Eurozone while also providing the financial means to compensate for any shock should it ever occur.

There is, however, another issue that needs to be addressed if the euro is to work effectively, namely, how to regulate the banks. What this crisis also demonstrates is that EU member governments need adequate tools to be made available to them that allow them to regulate the lending policies of their local banks, and to the control the level of indebtedness of their own local populations. The problem is, the single currency zone of the euro and its single interest rate make that virtually impossible for any individual government. This though, is not just a problem with the Eurozone. It is also a problem that has its roots in how the European single market is constructed. You only have to look at the difficulties that Britain and the Netherlands had in regulating Icelandic and Irish banks to see that. As I have pointed out previously to those at the ASI, that can only be achieved if the EU allows member states to restrict lending of local banks to local customers, as at least used to happen in the USA.

The problems with the euro that I have described above, not only represent an important economic issue, but also an important political issue. The debate over whether Britain should ever join the euro may have been consigned to the cryogenic freezer now that Cameron is PM (given that the Tories will probably never agree to it), but it could still resurface as a major issue for the Labour Party, either in the forthcoming leadership contest, or in any future coalition with the Lib Dems. That is why it is important that the Labour Party has a coherent policy in this area. The question is, what should that policy be?

It is no secret that the issue of joining the euro strongly divided the last Labour government. It could also strongly divide the main leadership contenders. While large parts of British industry may be in favour of joining the Eurozone, that in itself is not sufficient justification. Moreover, part of the attraction of the euro is historical. It dates back to the 70's and 80's when Britain was a country of high inflation, and Germany was the epitome of monetary stability. That justification has now been rendered largely redundant. For the last twenty years Britain has enjoyed low inflation as well. In addition, because the Eurozone now includes fifteen countries, that is fourteen fewer currencies that British companies need to deal with, so the euro has already greatly simplified the problem of foreign exchange for British industry without the UK needing to join the euro, even if it has not completely eliminated it. What is clear, though, is that both the euro and the single market need substantial reform of the type I have outlined before Britain can even consider joining the euro. At the moment, that looks a long way off.

20 questions for the next Labour leader - part 1

2010-05-29T19:16:00.006+01:00

Last week Sunder Katwala of the Fabian Society posed the question on the Next Left blog site, "What are the difficult questions the leadership candidates need to answer?". The biggest surprise about this question is that no-one has asked it sooner. Many in the Labour Party who were unhappy with Gordon Brown's leadership may well have acted against him long before the last General Election if there had been a credible alternative candidate waiting in the wings. Unfortunately, one of the reasons that there was no credible alternative (even though there were plenty of potential candidates) was that no-one really knew what any of the possible leadership contenders stood for. The problem now is, we still don't.

There is a common misconception in the media that Labour lost the last election merely because of a failure of presentation, both in its policies and in the personality of its leader. I disagree. I believe Labour lost because it ran out of policy ideas and therefore appeared to many to be a spent political force. After 2001 it had exhausted the stock of policies it had built up in opposition, and any policies it came up with subsequently it had to invent on the hoof while running the country. Unfortunately most of them ended up sounding as though they were made up on the hoof. They lacked coherence and intellectual rigour, and alienated our core support. In fact many of them just didn't work. On top of that there was a total failure to address the issues that affected Labour voters the most (jobs, housing) or angered them the most (bankers bonuses, immigration, the economy). That is why before the Labour Party can choose a new leader, the members need to know where the candidates stand on the issues that matter to them.

Unfortunately, so far in this leadership campaign all we have seen is more of the same. It has been the same bland candidates with the same vacant policy agendas. So far the campaign has been about who has the looks to take on Cameron, and who can amass the biggest army of sycophantic backbench supporters. That is why Sunder is right to ask his question. I have already offered Sunder my initial answer on what those questions should be, but here I will outline my definitive top 20, starting with my top five. The rest will come later.

1) The first question any potential leader should have to answer is the BIG one. It is this: "Why do you want to be leader? "
This is the question that Roger Mudd of CBS put to Ted Kennedy when he ran for US President in 1980. His failure to answer it effectively ended his presidential ambitions. For that reason alone, it is a question that deserves to be put to all leadership candidates. The events of the last ten years demonstrate that if a party is to avoid electoral stagnation, it needs to have a leader with a vision, not someone whose sole aim is to manage things a bit better, or is driven by his own hubris, vanity and lust for power and status. That is the underlying importance of this question.

2) The next question is one that I think follows on naturally from Q1. It is, what is YOUR big idea? What do you see as the fundamental structural problems in British society and what would you do to correct them?

Then we need to get into specifics regarding what a future leader would do if they became PM. If there are three issues that define the failure of the Blair/Brown years, then they are probably the housing crisis, the continuing rise in inequality, and the attack by the last government on civil liberties.

3) Housing
First we need to know if the candidates fully understand the role the housing bubble played in causing this current recession. Do they appreciate the effects that shortages of affordable housing have on distorting the labour market and reducing the mobility of labour? Do they recognise that inequalities in housing inevitably lead to inequalities in health, wealth and education? Do they understand that booming house prices lead to underinvestment in productive industry, and therefore to stagnating GDP and excessive private sector debt? Do they understand that housing booms always end in housing crashes, and that that always leads to recession, or worse? If so, we need to know how they plan to address these problems.
Would they support the building of more Council Houses, or social housing? And if so, how would they ensure that house building occurred in sufficient quantities? More importantly, how would they prevent future housing booms from occurring? I have already argued that control of house price inflation is essential to our future economic growth, and I have already outlined how such price stability could be achieved. If you don’t know the answer then I suggest you look here.

4) Inequality
Despite many noble initiatives, inequality in Britain grew (by some measures at least) under the 13 years of the last Labour government. If the Labour Party stands for anything, then it must be for the promotion of equality and fairness in all sectors of society. I doubt that anything in the last election campaign angered Labour voters as much as seeing David Cameron continually trying to present himself as the new champion of the poor and dispossessed. So any new Labour leader must outline how they would reduce inequality and make Britain a fairer country?

5) Civil Liberties
Despite incorporating the European convention on human rights into UK law, the last government's record on human rights and civil liberties was far from exemplary. Allegations of collusion in torture, extraordinary rendition, unlimited detention without charge and ID cards all made it look repressive and authoritarian. Worse still, it appeared more authoritarian and pro-establishment that the Tory Party. That is hardly a favourable position to be in for a party that claims to be the champion of the working man.
The question then for the leadership candidates (some of whom were associated with many of these illiberal policies) is this. Which should take priority under the law: the civil liberties of the individual, or the right of the state to maintain its own security? To claim (as many politicians do) that one must always try and balance civil liberties against the need for security seems to me akin to arguing that a country should always try to compromise between democracy and totalitarian rule. It can never be about balance or compromise. It is always about principles. It is about which of the two viewpoints should take priority, both in government policy, and under common law. It is also about the balance of power between the establishment and the people: the rulers and the ruled. That is why Labour should always be on the side of civil liberties, because it is about protecting the disadvantaged from abuse of power by the privileged.

These then are the first five questions I would put to the leadership candidates, but they are not the only ones. It remains to be seen, though, if we manage to get any satisfactory answers to any of them.

Nick Clegg and the Tories - deal or no deal?

2010-05-08T14:23:00.006+01:00

So who should Nick Clegg and the Lib Dems do a deal with? And what should they seek to get in return?

Clearly their first priority must be electoral reform. This is clearly their best opportunity yet to secure a set of reforms that could completely change the dynamic of British politics. Unfortunately, there are a number of major obstacles standing in the way that could prevent them from achieving this.

The first problem is this. On issues of policy (tax, electoral reform, Europe, the economy) the Lib Dems are much closer to Labour than the Tories, and so are most Lib Dem activists. Unfortunately, the same cannot be said for most Lib Dem voters, particularly those in many of the seats in the South of England where the Lib Dems are the main opposition to the Tories. So while most Lib Dem party members and MPs would be much happier forming a coalition with the outgoing Labour government, they could face a backlash from some of their voters and the Tory press if they did. David Cameron may not have won the election last Thursday, but there is no doubt that Gordon Brown lost it. Therefore Nick Clegg would be committing electoral suicide if he was seen to be supporting a Prime Minister who had been rejected by the voters.

The alternative Lib Dem-Labour scenario is that a coalition between the two parties could be agreed, but with Gordon Brown stepping down as PM. But would Gordon Brown ever agree to that? I suspect not, but even if I'm wrong, who would replace him? No-one from within the Labour Party has the mandate, and a new leadership election would take too long. So how about if Nick Clegg were to be the new PM? That might be more popular with the electorate, but then the problem switches to the question of who would be his Chancellor of the Exchequer. The public would also want Vince Cable, but it is inconceivable that any coalition between the Lib Dems and Labour could be agreed with the Lib Dems holding both of the two top posts in Cabinet when they are by far the smaller party. And the alternative is that Gordon Brown might demand his old job back.

Finally there is the problem of stability. A Lib Dem-Labour coalition would still fail to command a majority in the House of Commons. It would need the additional support of the SDLP, the Greens, and either Plaid Cymru or the SNP or both in order to govern. Yet the greater the number of partners, the greater the risk of collapse. The question the Lib Dems should therefore be asking themselves is this. How long would such a coalition need to exist in order for it to deliver electoral reform in time for the next election? And how likely is it that it would happen? The doomsday scenario is that this coalition would collapse before any real reform could be enacted, and that at the ensuing general election the Tories went on to win decisively, with the Lib Dems routed. Electoral reform could then be off the political agenda for another generation.

So if a Lib Dem Labour coalition is fraught with difficulty and danger, how about a pact with the Tories? At first sight it is hard to see, though, how a pact between the Tories and the Lib Dems (whether in the form of a formal coalition or an informal one) could work given the massive differences in policy between the two parties and the mutual hostility of many of their respective MPs. Moreover, the Tories would never agree to electoral reform of the House of Commons. However there is one thing that the Tories could deliver that would be a total game changer - reform of the House of Lords.

David Cameron and the Tory Party claim to support a fully elected upper chamber, so now Nick Clegg needs to call their bluff. The outgoing Labour government has claimed that it was opposition from the existing Tory life peers and hereditary peers that blocked and delayed reform of the House of Lords in the final years of Gordon Brown's premiership. David Cameron on the other hand can deliver the necessary votes in the House of Lords needed to get reform through quickly. That should therefore be the price that Nick Clegg should demand for limited support of a minority Conservative government in the House of Commons. The critical factor here is speed. If reform of the House of Lords is not in place before the next general election, not just in legislation but in operation as well, it can always be repealed by a new (Tory) government in the House of Commons that may seek to break any promises and cancel any deals agreed previously. There is little honour in politics, particularly if it gets in the way of the exercising of unbridled power. However, once an elected House of Lords is up and running though, no House of Commons will be able to abolish it unilaterally. It would need a broad consent in The new House of Lords as well, and turkeys don't usually vote for Christmas. In short, once it is up and running, a directly elected House of Lords is here to stay. It is irreversible.

Now at first sight this might all seem like a small and insufficient concession for the Lib Dems to extract from the Tories given that most people see the House of Lords purely as a revising chamber. I believe, though, that reform of the House of Lords is the real key to total electoral reform in this country. It represents the small crack in the dam that will eventually bring down the whole structure. As the new House of Lords would be elected by PR, it would be more proportional, more democratic, and therefore more legitimate than the House of Commons. It could act as a block on extreme policies promoted by governments with Commons majorities but minority support from the electorate. In effect it would lead to coalition governments without the need to reform the voting procedure for the House of Commons, though that would surely follow. In short, it would totally change the rules of the game. That is why Clegg must seize the opportunity now. He may never get another chance.

Why is Labour afraid of a 'Mansion Tax'?

2010-02-24T05:18:00.003Z

Is there a causal link between the British obsession with property ownership and the reluctance of our government to tax it? I can only think there must be, because I can't come up with any other reason why a Labour government would have failed to endorse Vince Cable's proposal for a 'Mansion Tax'.

Ever since Vince Cable announced his proposal it seems as though it has been subjected to a barrage of venomous criticism from all sides. Not surprisingly, most of this criticism has emanated from the small sect of people that would have the most to lose from this tax: those that make up the wealthy core vote of the Tory party and their cheerleaders in the right-wing press. Nor is it perhaps surprising that many Lib Dems also appear rather bewildered by it, given that it totally contradicts and undermines their currently stated opposition to that other established property tax: the Council Tax. What I really don't understand, though, is why those on the Left, and particularly most of the Labour Party have not enthusiastically embraced this tax policy. After all, it goes to the heart of what most socialists believe in and are striving for: a fairer and more equal society with a fairer and more even distribution of wealth. It targets extreme wealth, inherited wealth, and the idle rich. Moreover, because it targets fixed assets it is impossible to avoid. People and businesses can move between countries and tax jurisdictions: property can't. Personally, I only have one problem with this tax: it doesn't go far enough.

The tax Vince Cable proposed was originally going to be set at a rate of 0.5% on the excess value of any property above a threshold of £1 million, and was expected to yield over £1bn in revenue. Unfortunately, Vince then appeared to lose his nerve and watered down his proposal by raising the threshold to £2 million. Presumably the Lib Dems were worried that the original proposal might lose them too many votes in their key marginal constituencies in and around London. As a result the tax is now worse than useless. Like Labour's 50% income tax band that I slated in my last post, this proposal doesn't raise sufficient revenue to make it politically worthwhile. It won't fill the fiscal black hole that we are currently staring into, nor will it either help rebalance the property market or contribute anything significant towards promoting greater wealth redistribution and a fairer system of taxation in this country.

Instead of a 0.5% tax above £2m, the tax rate should be set much higher and the threshold set much lower (and closer to the current Inheritance Tax threshold). In short, it should be set at a minimum of 2% on excess property values above £500k. Now that would be truly radical, and it would yield almost £10bn for The Treasury. If the tax were also to be levied on all second homes and buy-to-let properties below £500k, and all commercial land not already covered by business rates (such as speculative land banks etc.), the total could be closer to £20bn. Not only would such a proposal be both radical and progressive, it would also allow the Government to address the problem of the budget deficit without cutting services or raising taxes on income and consumption that could damage the fragile economic recovery.

Of course those that would be hit by this tax would claim it was both unfair and arbitrary. In fact it is neither. The rate at which this tax is set is consistent with existing property taxes. It is, therefore, the absence of this tax that is unfair. To understand why, we need to consider the other main property tax that is levied on the populus: Council Tax. It is the iniquity of this tax that demands the introduction of the Mansion Tax, and also helps determine the rate and threshold that should be imposed.

The average Council Tax in the UK is now nearly £1500, compared to the average property value of about £165k. For most people, this equates to a 0.9% tax on the asset value of the property they live in, irrespective of whether they actually own that property or not. Yet this tax is not levied in proportion to the actual house price, nor even the price back in 1991 when the last valuation took place. In fact, as the graph above illustrates, the relative burden of this tax falls disproportionately on those occupying houses valued in the lower bands (A-E) who would also be expected to have lower incomes and net wealth, while the rich end up paying a much lower rate of tax when measured either as a proportion of their income or their wealth (i.e. property value). This cannot be fair, and goes against all established principles of progressive taxation. It is because of this iniquity that the Mansion Tax is needed.

This then is the rationale behind such a tax. Currently most Council Tax payers (or at least those in bands A-E) are paying approximately 1% of the asset value of their property in tax each year. Yet coincidentally, this equates almost exactly to the amount they would pay in extra income tax (at 20%) from the typical maximum rental income (about 5% of asset value) that they could reasonably be expected to derive from that property. In other words, they are in effect being taxed on the potential income that the equivalent property investment might yield. So, applying the same principle to those living in more expensive properties (bands F-H), who are also likely to be higher rate (i.e. 40%) income tax payers, means that their tax rate should be 40% of the rental value (which in turn is 5% of the asset price), and this then equates to a property tax equal to 2% of the asset value. As for the level at which the threshold for this tax is set, well that should be determined by the point on the graph above at which the tax rate under the current system plateaus off in favour of the rich. This occurs at about band F/G, or 1991 property values of about £160k. Today these properties are valued at about £500k.

There are two main objections that critics of this tax usually try to raise to demonstrate, either its unfairness, or its impracticality.

The first objection is that the tax will prove far too difficult to collect because it is just not possible to value each property accurately enough, or the property values will change with time. If this were true, though, then surely the same problems should apply to the collection of Council Tax and inheritance tax, shouldn't they? So how is it that these taxes appear to work perfectly well? If it is possible to value a property for the purposes of levying Inheritance Tax upon it, then it should be equally possible to value the same property for the purpose of this Mansion Tax. Remember - the Inheritance Tax threshold is currently below the level at which I would propose levying the Mansion Tax. So every property that would be subject to the Mansion tax in the future is already potentially subject to Inheritance Tax now.

The second objection is equally spurious. It is based on a belief that all taxes should be based on the principle of a person's ability to pay. This in itself is a noble and just position to take. Unfortunately, those that seek to oppose wealth taxes like the Mansion Tax presume that one's ability to pay, as they define it, is determined solely by one's income, and not by one's accumulated wealth. Thus they invent the hypothetical case of a little old lady living alone in a vast mansion, with little or no income to support her, other than maybe her paltry widow's pension. This is supposed to highlight the gross unfairness of the tax. With little or no income, how can she pay the tax? An equally valid question though is, with no income how can she maintain the property at all, irrespective of whether it is taxed or not? How will she be able to pay for the roof to be mended, or the electrical wiring replaced, or the boiler repaired?

The fact is that this hypothetical old lady is just that: hypothetical. She doesn't exist because no-one with an ounce of common sense would ever take on the responsibility of the upkeep of such a property without having sufficient excess capital to maintain both the property and their own lifestyle. If though, by some one-in-a-million chance this old lady did exist then there would still be many ways for her to pay. She could sell her home, and downsize, by acquiring a smaller and cheaper property. The capital profit could then be used as income. Alternatively she could re-mortgage and use the capital lump sum to fund her lifestyle.

In effect this argument against this Mansion Tax actually reduces to one in favour of the landed gentry being allowed to live beyond their means. Contrast that with the outcry that would emanate from the same right-wing voters if a group of penniless squatters were to take over a property and expect to live in it tax-free.

The plain fact is that this Mansion Tax is both fair and necessary. With the UK's wealth now estimated to be in the region of £6 trillion, and an astonishing 55% or more of that accounted for by unproductive residential property, it is obvious that we need to rebalance our economy. We need a taxation regime that encourages people to invest in productive assets, not unproductive ones, and the Mansion Tax would do just that if its scope were extended to cover buy-to-let investments and other private property portfolios.

To put it simply, the Mansion Tax is the missing link in our tax system that would do far more to reduce inequalities of wealth than the 50% income tax rate or Inheritance Tax will ever do. It will also raise far more revenue than both these taxes combined, and could even replace them. It is also supported by both Polly Toynbee of The Guardian, and Martin Wolf of The Financial Times.

If we are serious about trying making Britain a more equal and less economically divided society, then the issue of wealth inequality in this country needs to be addressed. With the wealthiest 10% of Britons now owning more of this country's assets than the remaining 90% put together, and with that disparity widening further with each passing year despite the efforts of the current government, something needs to change. Up until now government tax policy has focussed obsessively on revenue raised from income and consumption. Yet, as I pointed out in my previous post, by using higher tax bands for income tax as its preferred method of wealth redistribution, this government actually risks damaging the wider economy by reducing the amount of entrepreneurial activity within the economy. Rather than taxing liquid wealth, the government would be better served by taxing accumulated idle wealth, and by far the largest and least-taxed component of that wealth is property.

Moreover, this tax, unlike many others (such as the recently announced disastrous rise in National Insurance or the abolition of the 10% income tax band) has no electoral downside for Labour. It will have no impact on Labour's core vote, and it will be invisible to swing voters in marginal constituencies, as neither group will be targeted by the tax. Nor does it have the negative economic consequences that recent rises in National Insurance and Income Tax could have, particularly in the midst of a deep recession, by reducing consumption and demand within the economy, and thereby endangering jobs and the speed and scale of the recovery. Instead it targets dead money: money that would otherwise either remain idle and unproductive, or would be used to boost speculative asset prices such as property values; i.e. the same asset prices that caused this very recession in the first place. In fact this tax would target the ill-gotten gains of those that made the most money during the last credit boom, and whose earnings and increase in wealth we now know were both in large part undeserved because they were based on fictitious or inflated profits in the financial sector during the economic boom years.

Why the 50p tax rate is bad politics and bad economics

2010-02-14T19:21:00.006Z

The issue of tax has long been a thorny issue for the Labour Party, due in large part to the suspicion that it was the one single issue that cost it both the 1987 and 1992 elections. Hence Tony Blair's pledge before 1997 not to raise income tax in the first term of a Labour government. However, last year Alistair Darling did indeed announce an intention to raise income tax for those earning over £150k by introducing a new 50% tax band for those high earners. The intention of the tax seemed clear: to increase wealth redistribution and to make Britain a fairer and more equal society. There is just one problem with this proposal. Any objective analysis of it suggests that it will probably fail miserably to achieve any of its aims. In short, it is a rubbish policy.

This 50% tax targets a miniscule proportion of the population, it is too easy to avoid, and so it will raise virtually no extra money. In fact by encouraging tax avoidance, it may even reduce the overall tax receipts by also decreasing the number of 40% tax payers in the economy. In addition, the level and threshold at which it is set are so arbitrary that the signals it sends out are entirely negative. To put it simply, if the Government can tax at 50% today, then why not 66% or 90% tomorrow? With no logical reason to doubt that the tax rate could go even higher in the near future such a policy completely destroys any confidence in Labour's future tax plans. Instead it raises the spectre of the bad old days of the 1970's and Dennis Healey's pledge to "tax the rich until their pips squeak." It therefore destroys confidence in the Government without even having the positive compensating effect of raising significant amounts of extra money. So, instead of a win-win scenario, we have a lose-lose one. Brilliant!

If the Government was going to raise the tax rate for high earners, it should at least have done so based on some underlying guiding principle. That principle should be one of equality or fairness. The questions then become, how can we justify such a higher rate of income tax for higher earners, and what should it be?

Historically, government expenditure has tended to hover around 40% of GDP, at least in recent decades. In the light of this one could reasonably argue that anyone who is paying less than 40% of their income in tax is clearly not paying their fair share. At first sight that might appear to encompass the majority of the population who only pay income tax at 20%. However, that argument doesn't account for the additional 11% they pay in National Insurance (soon to increase further), Council Tax (which averages out at another 4%) and the VAT and other consumption taxes that they pay on most other basic costs including transport, food and clothing. So in practice a person on an average income (which is currently about £25k) pays significantly more than 40% of their total income in tax, almost all of which is unavoidable.

As the average Briton is clearly being taxed at a rate that is greater than the overall taxation ratio of 40%, it is therefore only fair that those on higher incomes should also be expected to be taxed at an overall tax rate that is commensurate with the ratio of Government expenditure to GDP as well. However, any additional income that the richest 10% of the population earn in excess of the average household income (currently about £45k) is predominantly disposable income. It is income that is above and beyond that which is required to cover most daily living expenses. Therefore, it seems only reasonable that this should be taxed at the same overall ratio as the national average. That seems to me to be the justifiable rationale behind imposing a higher tax rate for the top earners in society, and perhaps why it has been set at 40% for most of the last few decades. However, there is now a problem. The current recession means that the ratio of Government expenditure to GDP is increasing above 40%, while tax receipts are declining. With public sector net borrowing (PSNB) predicted to exceed £175bn this year, and the bond markets getting increasingly nervous about the scale of our national debt, politicians need to come up with credible policies to tackle this problem. However both the solutions advanced so far have a dark side.

On the one hand is the spectre of tax rises, as exemplified by the recent announcement by Alistair Darling to raise National Insurance contributions, for both individuals and employers. This, though is a tax on both jobs and consumption, both of which could slow any economic recovery. On the other hand the Tories are baying for spending cuts. Yet this also risks prolonging the recession by increasing government spending on benefits even more while reducing government procurement and economic consumption. What is needed is a 'third way' that reduces the deficit without taxing jobs and reducing revenues from consumption. That way is to tax surplus wealth, and one such source is the disposable income of higher earners. I would therefore argue that rather than introducing a new 50% tax rate that benefits no-one, the Government should have raised the existing 40% rate.

My reasoning is this. Given that the ratio of Government expenditure to GDP has now increased to nearly 44% for this financial year (2009-10), and is expected to remain at such a level for the foreseeable future, and tax receipts have plummeted to only 33% of GDP due to the recession, gradually raising the upper tax rate from 40% to 44% would have represented a far better policy than the introduction of a new 50% rate. Not only would it have been fairer, it would have been based on a clear and transparent principle that would have reassured the public that such rates were not arbitrary and vindictive. It would have also raised ten times as much in tax as the 50p rate (£10bn versus £1bn). As such it would have made a significant impact on our underlying budget deficit (currently estimated at about £50bn), while having little or no adverse effect on either levels of employment or consumption (due to it being targeted at the disposable income of the affluent that would normally be invested in assets and savings). It would also be far less prone to the problems of tax avoidance as it is highly unlikely to cause a mass exodus of higher rate tax-payers from the country.

So the essence of this tax policy is this. Rather than having a fixed 40% tax band, or introducing a new 50% band, the current 40% band should 'float' with its level set by the current ratio of government spending to GDP. Under the current financial circumstances we find ourselves in that would mean gradually increasing the rate from 40% to about 44%.

There would of course still be great howls of protest from those with salaries in the top decile of the earnings league who would be the most affected by the raising of this tax level. However, these are to a large extent the very people who enjoyed the largest percentage growth in their earnings during the boom years, earnings that we now know (or at least suspect) were, in a large measure, based on fictitious or inflated profits, particularly in the financial sector. In which case, these were, in large part, salary rises that were unearned.

These are also the people who, more than any other sector of society, invested those earnings in the property bubble that caused the boom and the resulting crash in the first place. So, given that many of them were the largest beneficiaries of the credit boom, and partially responsible for it, isn't it fair that they should also be the ones who should contribute most towards restoring the economic stability of the country? Given that they are also the only ones with the spare cash to do so shows that they also have the means to do so. And if they don't like this policy? Well, they can always vote for a party that will promise to slash public spending in order to keep it below 40% of GDP. But then don't most of them do that already?

Hostile corporate takeovers - time to reform the rules

2009-11-21T20:22:00.000Z

The attempted takeover of Cadbury by the American multinational conglomerate Kraft has not, unsurprisingly, been greeted with universal cheering throughout the country. Workers at Cadbury are now anxious about possible job losses, and politicians are worried about the relocation of those jobs to outside the UK and the political fall-out that might then ensue. After all, in 1993 Kraft took over another prominent English chocolatier, Terry's of York, and look what happened subsequently. In 2005 it closed the factory in York and moved the majority of its production to eastern Europe. The questions many are now asking are: will the same thing happen with Cadbury? And if so, what can be done to prevent it?

The neo-liberal proponents of unregulated free-market economics would doubtless argue that corporate mergers and acquisitions are all just a part of life under globalisation, that the benefits of such takeovers outweigh the disadvantages, and that the ownership of any one individual company does not really matter in the grand scheme of things. However, the current Director-General of the Confederation of British Industry (CBI), Richard Lambert, clearly thinks it does matter. So much so that he wants to see restrictions in the voting rights of shareholders who have owned their shares for less than six months. This restriction appears to be targeted at hedge funds which, it is claimed, have now acquired over 12% of Cadbury shares, presumably on the basis that they expect the share offer by Kraft to be increased. However, hedge funds are only doing what most market investors and speculators have done countless times before over the years. I know because I was one of them.

Back in 1992 I bought shares in Midland Bank when it was being lined up as a takeover target by HSBC. At the time the market speculation was that a counter bid would be made by Lloyds and so the share price could only go higher. It did. So you can hardly blame hedge funds or speculators for trying to cash in on what looked like a one way bet.

The problem here is not the speculation. Even if the rules on share ownership were changed to limit voting rights for short-term traders, speculators and hedge funds would still bet on the likely outcome of any takeover battle. The real problem is actually the whole issue of corporate takeovers, and in particular the destructive impact that the threat of a hostile takeover can have on the long term stability of a publicly quoted company. Unfortunately this is a problem that corporate leaders like Richard Lambert either tiptoe around, or completely fail to address; yet it is one of the most economically damaging issues facing this country, and is fundamental to addressing the numerous shortcomings of current corporate governance.

My principal objection to corporate takeovers is not that they play into the hands of speculators; it is that they are fundamentally anticompetitive and therefore, rather than being the natural bedfellows of neo-liberal economic thinking, actually distort the free markets that neo-liberals are forever proselytising. The reasoning behind this view is fairly easy to outline.

If a company takes over one of its competitors, it effectively increases its market share without having to work for it through comparative advantage. This process therefore represents an easy and lazy way for a company to appear to be increasing its profits without having to grow endogenously. Consequently, it does nothing to increase market competition and will actually act against the interests of the consumer by reducing choice and increasing prices. In fact from the perspective of the consumer, the merger process is no different in its outcome from that of a price-fixing cartel. Yet as both British Airways and the UK construction industry have recently found to their cost, such price-fixing cartels are illegal. Takeovers, on the other hand, are not. Nor do mergers and acquisitions do anything to significantly increase the GDP of the country. These, though, are not the only problems with mergers and acquisitions.

One of the most insidious consequences of the current takeover rules is the effect that the threat of takeover has on the long term stability of a particular company and its ability to plan investment in the medium or long term. In order to fend off potential predators, vulnerable companies are scared into maximising their share price on a day-by-day basis by paying ever higher dividends at the expense of future investment. So instead of investing in future research and development, money is haemorrhaged from the company to placate short-term investors. Nowhere is this more apparent than in the UK which, with its liberal takeover rules, also has one of the worst records for investment in industrial R&D of all the major economies.

Moreover, there is also a growing trend for companies that merged in the past to de-merge at a later date. As a case in point you need look no further than the company at the centre of this recent takeover controversy: Cadbury. Last year Cadbury was de-merged from Cadbury Schweppes after the two entities had enjoyed nearly forty years together, and acquired numerous other acquisitions over that period. Yet other mergers are less long-lasting. The acquisition of Imperial Tobacco by Hanson lasted barely ten years, for example.

The suspicion therefore remains that this seemingly never-ending cycle of corporate merging and de-merging may often be about as economically productive as a dog chasing its own tail. This poses some obvious questions in regard to the real shareholder benefits that can accrue from them in the longer term. If both companies in a merger and de-merger eventually end up back more or less where they were originally, who really benefits from the entire process, other than a few management consultants, merchant bankers and corporate lawyers who are generally at the heart of the whole process, and often responsible for driving much of it?

Then there is the other big driver of takeovers - debt. This is best exemplified by the tactic of the leveraged buyout (LBO) that is often associated with the takeovers made by private equity funds. In this respect the proposed takeover of Cadbury by Kraft is another prime example of how the creation of debt can be used to acquire a target company. Yet, with a debt-to-pretax profit ratio of 3.6, Kraft is already heavily leveraged. This highlights some of the inherent dangers that can arise from LBOs, and you only have to look back at some of the biggest LBOs of the 1980s to realise the scale of the problems that can arise. Given what has happened more recently, however, how can it be considered beneficial for the economy as a whole for both it and its largest companies to be saddled with unnecessary debt? After all, haven't we just seen the consequence of such practices? Nor does this growth in debt help the wider society as the interest on it is usually offset against any profits, thereby reducing the company's tax burden and thereby the government's income.

The final criticism that can be levelled at takeovers is that they are bad for free enterprise. In extremis, they result in the formation of oligopolies and quasi-monopolies. In crude terms, they are nothing more than a form of corporate cannibalism. The proponents of takeovers claim that hostile takeovers, or the threat of them, are a way of keeping management on their toes and ultimately removing poorly performing executives. But isn't that what shareholders are supposed to do? If it requires the executives of one company to purge those of another, then that merely proves that shareholders cannot ultimately hold the executives of either company to account. Executives are in effect beyond the reach of those they claim to be beholden to. That is not just an argument in favour of reforming takeover rules, but also one in favour of reforming the entire basis of corporate governance.

So, given the numerous negative impacts of takeovers on the wider economy, perhaps the question the likes of Richard Lambert should be asking is; how should we reform the rules that govern takeovers?

The first step should be to outlaw hostile takeovers, once and for all. That would then allow companies the relative luxury of being able to plan their future investment without forever looking over their shoulder to see which corporate predator was preparing to strike. It would also attract companies to the London Stock Exchange (LSE) as the LSE would then be perceived as a safe haven from corporate attack. If we are to champion greater competition and stability in our economy, however, I believe we need to go further.

As well as outlawing hostile takeovers, we should also be looking to reduce the burden of debt on public companies. That means vetoing all takeovers where a significant proportion of the finance for the takeover is provided by the creation of additional debt.

The low visibility of the Competition Commission (CC) in the area of corporate regulation in the UK is a testament to its current weakness, and an over-compensation within government towards light touch regulation. We should be setting more stringent limits on the definition of quasi-monopolies that not only outlaw hostile takeovers, but also prevent any agreed takeover between companies if the market share of either company, or the combined company, in any sector of its business, exceeds a predefined limit. For the sake of argument, I would set that limit at 10%. This is in contrast to the current regulations where the market share required for a significant lessening of competition (SLC) is not explicitly or objectively defined. This could mean that some judgements of the CC may appear to the outside observer to be too subjective in their basis, and therefore potentially prone to political pressure or bias.

In summary, the current policy towards corporate takeovers does little more than pander to corporate executive machismo, and contributes little to improving growth in GDP. Too many takeover battles are played out as gladiatorial combat at boardroom level, with the heads of the losing companies served up as trophies. It is also worth noting the scale of these mergers and acquisitions in the UK. When the FTSE 100 Share Index was introduced on the 3rd of January 1984 it was set at a level of 1000.0 while the total market capitalisation of all the 100 companies listed was barely in excess of £100bn. Twenty-five years later the FTSE 100 stood at 4434.17 while its market capitalisation stood at £1083bn. So while the FTSE 100 had risen by a factor of 4.4, its market capitalisation rose by a factor of 10. The different between those two numbers is, in a large part, down to mergers and acquisitions.

House price inflation part 2 - a solution

2009-10-31T07:31:00.001Z

The thorny issue of house prices is once again back on the political agenda, or at least it is outside of Downing Street and the Westminster bubble.

Yesterday Rob Williams raised the problem once more on the Compass website. Now while I agree with much of his comment, there are a couple of criticisms I would make.

Firstly, while it is true that house prices are going up again, I don't believe this is predominantly a result of City bonuses, Russian oligarchs or the Cameron bounce. While these factors may have a strong effect in London, elsewhere there are other factors at play. Those are the reduction in the size of deposits that the banks are demanding for each mortgage issued, and the low interest rates that they are currently charging. As I pointed out in this blog last week, this fall in deposits has coincided with rising prices. I do not consider that a coincidence.

This issue of mortgage deposits now brings me to my second criticism. Rob has articulated the problem of house price inflation nicely, but like many before him, has failed to provide a definitive solution to it. Yet find a solution we must. It is no use saying something must be done unless you know what should be done. Unfortunately there are too many economists and political commentators who claim that either nothing can be done, or that the market should be left alone and allowed to correct itself, without intervention, whatever the economic cost. Needless to say it is partly this neo-liberal belief in intelligent markets that got us into this current mess in the first place.

Personally, I would argue that the only positive thing that can be said about the concept of intelligent markets is that they are probably more intelligent than some of the people that believe in them. Quite frankly, to claim that markets are intelligent is about as rational as claiming that gravity is intelligent, or that a bowl of water is intelligent because its surface is always flat and so that means that the water must always be capable of finding its own level.

The truth is that the surface of a bowl of water is flat because of the laws of thermodynamics. Markets find their own level because of the economic laws of supply and demand and competitive advantage. There is no intelligence involved in either, except by those that seek to understand and scientifically quantify the behaviour of each system, or by those that seek to intervene in the behaviour of each. And if we can intervene in the behaviour of natural water systems for our own social and economic benefit (such as by damming rivers and building reservoirs), then by the same token we should also be allowed to intervene in economic systems to improve their social impact.

So, the question remains: how should we intervene in the housing market?

As I again pointed out last week, house price inflation can only be brought under control if the sources of imbalance in supply and demand are tackled. So while many are arguing for increased house-building to increase housing supply, I would argue that that cannot solve the problem in the short term. Nor can it ever respond quickly enough to sufficiently dampen the oscillatory boom and bust cycle. What is needed is a lever that can be pulled that would have a smooth, rapid and proportionate impact on the housing market by reducing demand. Traditionally that lever has been interest rates, but this usually has an adverse affect on business investment, employment and the wider economy. A far better approach would be to regulate bank lending more strictly, and there are essentially three ways that this could be done.

The first would be for the Bank of England (BoE) to set an annual quota for total mortgage lending that would go up or down depending on whether house prices went down or up. This quota would then be divided amongst the various lenders. There are, however, a couple of problems with this approach. The first is that it requires the BoE to interfere in the lending policies of individual banks. This would not be popular, it could be very bureaucratic, and it might be difficult for the BoE to always be seen to be even-handedly in its treatment of different banks. The second problem is that some of those banks might also be less than even-handed in deciding which of their customers they choose to grant mortgages to, and which are sent to the back of the queue (where they will probably remain indefinitely). You don’t need to be a rocket scientist to work out which customers will be first in the queue and which will be last.

A better solution would be to set a fixed limit on the loan-to-earnings ratio for each mortgage applicant. Unfortunately this is one of the two mechanisms Lord Myners specifically ruled out a couple of weeks ago. Why? Who knows?

The third option, and the second proposal Lord Myners discounted, is setting fixed limits on the loan-to-value ratio for every mortgage. In my opinion this is probably the policy that would yield the greatest number of economic benefits.

The easiest way to implement such a policy is by introducing the concept of a Minimum Mortgage Deposit (MMD). This would be the fraction of the value of the house that the buyer must provide in cash that cannot be covered by the mortgage itself. This threshold should be set by the Bank of England’s Monetary Policy Committee (MPC) at the same time as they set base rates. The base rates will continue to control the CPI rate of inflation; the MMD will control house price inflation. A target for house price inflation should be set for the BoE by the Government, just as the target for CPI currently is, but the BoE will then be responsible for meeting this target using MMD. This is the first virtue of this policy. Its mode of operation is almost identical to the already proven mechanism by which CPI inflation is controlled.

For its part, the Bank of England should report annually to Parliament on the state of the housing market, and recommend what it regards as the optimum value for MMD under the current economic climate, and how many new houses need to be built (and where) in order to achieve this in the medium term.

The beauty of this system is that it includes a separation of powers between two potentially antagonistic institutions, the Bank of England and the Government. Each can impose demands on the other, but neither will be able to have control over the parameters under which they themselves are being asked to operate. The BoE has no control over what the house price inflation target will be, and the Government will be told how many houses to build in order to keep the the MMD threshold at an appropriate and acceptable level. Therefore neither can corrupt the system nor damage long term economic stability for their own short-term self-interest. The benefits will also extend beyond the confines of the property market.

This policy, unlike the loan-to-income approach, will force potential house buyers to save before they can buy. In the past that has been futile because house price inflation always meant that the deposit required would rise faster than most people’s capacity to save for it. The 125% mortgage was then introduced to overcome this, but actually made things worse. If house prices are stabilised first, the panic-induced dash to buy will no longer be there. The increased savings will decrease consumer debt, increase the country’s national saving ratio and help recapitalise the banks. With mortgage lending then effectively capped, banks will have more cash to lend to business. Therefore business loans will be more plentiful and cheaper. With housing no longer being the vehicle of choice for investors and speculators, money will flow more freely to other areas, such as the FTSE100 which has stagnated whilst house prices have boomed. That cannot be pure coincidence can it? After all, why would you invest in the stock market with a typical yield of 4%-10% when you can invest in a (seemingly) less risky asset (i.e. housing) that is generating yields that are two or three times as much?

The other advantages of the MMD policy are that it is easy to implement. Most of the necessary powers, people and institutions are already in place. The BoE MPC is already set up and could easily expand its role to cover MMD. Indices for average house prices are already measured by the Land Registry (and also by several banks and building societies). The FSA already has powers to regulate financial services and consumer products, and could therefore monitor the compliance of the banks. Moreover, the FSA has already suggested possibly abolishing 125% and 100% mortgages, so the precedent for this new policy has already been set, except of course that the FSA has now backed down over this approach. Perhaps that is because setting the precise limits on bank lending is not, or should not be, within the remit of the FSA. The FSA is in effect a financial police force. Its role should be to police the activities of financial institutions, not to set monetary and fiscal policies. Those roles should remain with The Treasury and the BoE.

So this policy also has the added bonus of reinforcing the separation of powers between the BoE and the FSA. While this separation of power and responsibility has been the source of much criticism during this financial crisis, it is not a criticism I share. Having two competing institutions does not necessarily mean that there will be cracks in the regulatory framework where no-one takes responsibility. If those two institutions are programmed to compete aggressively with each other for greater regulatory power then that will not happen. Such an outcome, though, depends on the exercising of strong leadership underpinned by positive political support, so any failure of regulation is ultimately the result of either a failure of leadership in the FSA and BoE, or a lack of political will from the Government.

Inevitably some people will look at these proposals and declare that the requirement for mortgage deposits will be impossible to sell to the electorate, because people have become accustomed to getting mortgages on demand. This may be true, but there are a couple of ways to overcome this problem.

The first is to allow banks to lend low value mortgages without large deposits, but only for much smaller loans-to-earnings ratios (say less than 1:3) with the BoE MPC also setting the value of this floating limit on the same monthly basis as they would for MMD and interest rates. Such mortgages would also be suitable for those who wish to re-mortgage when moving home. In effect they would be using existing equity in a property as a form of deposit. If buyers require larger mortgages with higher loans-to-earnings ratios (1:4 or 1:5) then deposits should be required on those mortgages. This has the added bonus in that it introduces an element of choice and diversity into the mortgage market.

The second solution is to introduce the policy gradually. If this is done then most people won't notice the change. For example we could introduce the policy now with the MMD rate set at 5% and it would make no difference to lending practices because currently virtually all mortgages require much larger deposits. If MMD were to subsequently vary by about 1% per year, then once again most people wouldn't really notice.

Ultimately all that is required is for this policy to become reality is for the Government to give the green light, to set the target rate for house price inflation (I would suggest keeping it between the CPI inflation rate and the average growth in earnings), and give the FSA some bigger sticks to beat bad banks with (e.g. fines, increased capital adequacy ratios). Other than that it is a question of timing, and I suspect we may need to wait for the economic recovery to occur first, in order to let all the fallout from the last crash get purged from the system, before it will be possible politically to implement such a measure. However, sooner or later, implement it we must.

The real issue is house prices, not bank regulation.

2009-10-23T19:18:00.000+01:00

This week the FSA published proposals to increase and improve the regulation of mortgage loans, principally by banning self-certification mortgages where applicants were not required to provide any proof of income. At the same time much of the wider political discussion has been about more general regulation of the banking industry. Unfortunately, both this strategy of the SFA and the wider discussion seem to me a bit weak at best. They are both based on the flawed assumption that the current economic crisis was caused by the reckless behaviour of banks and bankers, when in fact it was at least partly caused by an unregulated house price bubble that, together with the securitisation of debt, encouraged bad lending practices. To suggest otherwise is to put the cart before the horse. Banks like Northern Rock, HBOS and RBS did not collapse or require government intervention because they indulged in the reckless trading of derivatives. The problem was they borrowed in order to lend into an inflated property market, and it was the rate of inflation of that market that encouraged them to borrow so excessively.

The issue is this. Fundamentally, there are two distinct problems that need to be solved, not one. These problems are the risky lending practices of banks as they sought to inflate their profits, and the boom in house prices that both underpinned those policies, and was driven to even greater extremes by them. In this chicken and egg world, it is both of these failures that need to be addressed. Unfortunately our politicians and regulators so far only seem interested in tackling the first of these. They are only interested in saving the banks and the financial system while appearing quite happy for laissez faire free-market ideology to go on unchecked in the rest of the economy, and particularly in the housing market. This is partly because in doing so such actions reinforce the current received wisdom that all the current economic woes are the fault of nasty, greedy bankers, and not the way banks and bankers were (or were not) regulated, because obviously if it were the latter then politicians would also have to share in the blame, and that would never do.

So, one year on from the collapse of Lehman Brothers and the almost complete nationalisation of Scottish banking, and it seems it is not only bankers who have learnt nothing from the experience. Listening to the latest proposals from the FSA on the regulation of mortgages, it is clear that most politicians and regulators still haven’t got it either. What is worrying about the latest FSA announcement is not so much the proposals that are being advocated: it is the total disregard for the ones that were omitted. Fundamentally, though, it is about the complete failure to even acknowledge the elephant in the room that still no-one will talk about. That elephant is house price inflation and how to control it. The conventional wisdom is that such control is beyond the power of governments or regulators. I disagree. I believe it is both possible and essential that this rampant source of inflation is killed off once and for all time if we are ever to return to sustainable economic growth, or if Gordon Brown’s dream of no more boom and bust is ever to be realised. Moreover, I will demonstrate precisely how it can be done.

This antipathy towards controlling house price inflation also highlights the hypocracy of our politicians and leading economic thinkers. If economic stability is so critical to ensuring long-term economic prosperity, and if the control of inflation is so critical to maintaining economic stability, why is the control of house price inflation not sought with equal enthusiasm? After all, was it not the housing boom that ultimately caused our current economic problems? And it’s not the first time such a boom has been the cause of recession in this country, is it? So, unless we do something to change things, it won’t be the last either. So why the reluctance amongst so many politicians to do anything to change things?

Maybe the obvious answer is that there were too many vested interests in politics, business and the media that were benefiting from the boom, or at least thought they were. And with so many MPs using their second home allowance to play the property market themselves, perhaps it is understandable that there was little appetite amongst many of them to kill the goose that was (temporarily) laying the golden egg for the privileged few. Yet in 1997 we were told that things would be different. As Gordon Brown stated in his first budget speech as Chancellor: “I will not allow house prices to get out of control and put at risk the sustainability of the recovery”.

The mistake Gordon Brown made was the same one that many others continue to make. He tried to counter house price inflation through taxation. In 1997 he reduced mortgage tax relief and raised stamp duty. Unfortunately neither measure had any effect. Nor could they, because the plain fact is that you do not dissuade people from speculative behaviour merely by taxing a proportion of the profits of that speculation. That is why stamp duty doesn’t work, nor capital gains tax, nor a land value tax. In order to control inflation in house prices you have to get back to fundamentals and control supply and demand.

Many on the Left have been advocating house building as a solution, particularly the building of more social housing. While this supply-side approach would have many benefits, it is also very slow to implement. On average it takes between three and five years for a house to get built, so a supply-side solution will always lag behind the market and will always be playing catch-up. When the market turns, the change will be exacerbated and the boom and bust cycle maintained.

The only viable solution is to control demand. Traditionally governments have done this using interest rates with some limited success, but this approach also damages the wider economy, particularly with regard to business investment. What is needed is a lever that the State can pull that only affects the number of potential house-buyers. That lever is the one that controls the supply of mortgages. If you control this, you ultimately control the number of buyers in the market. Unfortunately, the Government and the FSA have just rejected the two measures that would do just that. As Lord Myners said last week, “...we’re not going to have a mandatory limit on loans to value or loans to income but rather a prudential limit...”

Yet it is only these policies of either a manditory limit on loans-to-value or loans-to-income that can ever work. They can, after all, be defined and quantified objectively within a legal framework. How do you define and quantify prudence? More importantly, however, by setting changeable limits on what people can borrow for a mortgage you can adjust those limits and thereby adjust the qualifying criteria for mortgages as economic circumstances change.

As the deposit required for a mortgage goes up, the number of people who can summon up such a deposit will decline until the balance between buyers and sellers shifts in favour of the remaining buyers. Therefore the price of housing will eventually stop rising and begin to fall. Similarly, if the criterion is the ratio of earnings to mortgage value, reducing the ratio removes lower income applicants from the bidding process for each house and also reduces the eventual sale price. Thus both mechanisms should result in lower house prices and a control of inflation in that sector of the economy.

No doubt the naysayers will ask, how do you know such a policy would work? Where is your evidence? Has it ever been applied anywhere?

Well the answer is yes, right here, right now.

Why do you think house prices have crashed over the last two years?

Was it because of higher interest rates? No!
Was it because of higher tax rates? No!
Was it because of increasing supply of houses? No!
Was it because of a shortage of potential buyers? No!
Was it because of a shortage of mortgages? Not exactly.

It was because the banks raised the deposits that prospective buyers needed to provide in order to qualify for a mortgage. A year ago this deposit was so large that most prospective buyers were forced out of the market. The result was that house prices crashed. Now, though, those deposits have fallen from over 20% last year to as little as 5% in some cases this month. And the result? Well over the last six months house prices have been on the rise once more as the buyers have returned. If that isn’t convincing what more evidence do you need?

The problem is that all this has happened by accident, or at least in a haphazard and totally indeterminate manner. Yet it needn’t be so. All that is required is for the Government to give the Bank of England (or some other independent financial authority) the power to set these deposit levels on a monthly basis, in much the same way as Bank of England interest base rates are currently set, and then house prices can be brought under control once and for all.

So if this Labour government is truly interested in delivering economic stability and a fairer society then it must commit itself to the control of house price inflation. Without such a commitment any housing policy it tries to implement in the future will at best be no more than mere palliative care, and any economic policy will ultimately be wrecked on the same rocks that scuttled the last policy.

Is it time for a new business model for Royal Mail?

2009-10-10T19:55:00.000+01:00

The latest strike vote by the CWU workers at the Royal Mail is sending a clear message that all is not well within that organisation.

Royal Mail is a business in trouble. It has some of the lowest staff morale, one of the highest strike rates, and one of the highest rates of staff turnover of any company in the country. The unions and workers appear to have no confidence or respect for the management, and given the damage these disputes do to Royal Mail in business terms, many of them seem to have very little sense of personal investment in Royal Mail either. Maybe that is part of the problem, and so should be seen as part of the solution?

The traditional solution for ailing nationalised industries is privatisation. However, there is a lingering worry that this would actually hasten the demise of the service the Royal Mail currently provides, not improve it. The universal service would be unlikely to survive the pressure to maximise corporate profits, and experience shows that any guarantees to the contrary given before flotation rarely survive the test of time, or a change of government.

Privatisation will also leave Royal Mail workers hopelessly exposed to the downward pressure on wages from the free market. Given the nature of its business, which will always involve large numbers of postmen and women delivering thousands of letters by hand each day, Royal Mail workers are always going to be amongst the lowest paid in the economy, and increasing deregulation and competition in the industry will continually reduce their collective bargaining power.

On the other hand, continued nationalisation leaves the Royal Mail umbilically tied to the current short-term political and financial interests of the Government. If history shows us anything it is that the Government is a bad owner of business. Its attention span is too short-term, and it is more interested in squeezing cash out of businesses to fund other services than allowing those businesses to invest for the future.

So, if nationalisation doesn’t work, and privatisation is a disaster-in-waiting, what third way is there?

It seems to me that all the problems at Royal Mail are indicative of an organisation where the workers feel undervalued, powerless, and marginalised. One way to change that would be to give the workers a greater sense of ownership of the company. The answer could be to turn the Royal Mail into a cooperative partnership along the same lines as the John Lewis Partnership (JLP).

The John Lewis Partnership is a cooperative venture that was set up in the interests of its workers (or partners) by its owner, John Spedan Lewis over an extended period from 1920 to 1950. The company is run by a tripartite system of company Chairman, Partnership Board and Partnership Council. The Council is directly elected by the workers based on constituencies. Each constituency is based around one store, or a group of stores, or part of the business, and returns one member. The Council then elects five members to the Partnership Board, with the Chairman nominating another five, and two external non-executives also being appointed. The Chairman and Board run the business, but are accountable to the Council, i.e. the workers.

As in most companies, the Chairman and Partnership Board take the day-to-day business decisions and decide what proportion of the annual profits should be reinvested in the business. But unlike PLCs, the rest of the profit is paid to the workers as bonuses in proportion to their salary and not to rentier shareholders. At the John Lewis Partnership these bonuses typically range from about 8% of salary in poor years, to over 25% of salary in good ones. For people on low incomes such large lump sums would be welcome windfalls and could provide enormous financial opportunities. In addition there are other corporate benefits such as pension provision and leisure discounts. The other major area where JLP differs from most private sector companies is in its commitment to social responsibility and local communities, a commitment that is enshrined in its constitution.

The positive consequences of this arrangement are that JLP has a much lower turnover of staff than most of its main competitors, better staff morale and good industrial relations. It is also renowned for its customer service and tends to be more resilient at weathering recession. And at a time when excessive executive pay is constantly in the headlines, JLP also rewards its senior managers less extravagantly in comparison to its shop floor workers than is the case for most of its competitors. In short, JLP has all the positive attributes that the Royal Mail currently lacks.

It seems to me that the business structure and employee demographic of JLP and the Royal Mail are very similar. So applying the business structure of JLP to the Royal Mail should be straight-forward, and should result in a new postal service without most of the problems that afflict the current one.

So why not turn the Royal Mail into a partnership, with each sorting office electing one member to its Partnership Council?

Under such a scenario the Royal Mail would become an independent company, but with no shareholders, only stakeholder workers. The management would be appointed by a board that is answerable to, and elected by, the workers. The benefits for the Royal Mail of this arrangement would be:

the company would be independent of government and so able to take its own long-term financial decisions.
It would give the workers a greater say over the way the organisation was managed and run, and a greater sense of ownership of any changes to working practices that need to be implemented.
The workers would reap the rewards that accrue from the sacrifices and compromises that they need to make. That would be a powerful incentive for workers to embrace business change, rather than continuing to resist it.
Industrial relations, service quality and reliability should all improve.

The benefit to the Government would be that it would no longer be responsible for the Royal Mail pension fund deficit, nor for overseeing the business. In return for the Government relinquishing its ownership rights, the Royal Mail could pay the Government a fixed annual dividend (let’s say 25% of the total staff bonus fund) but the Government would have no voting rights accompanying this dividend. The new Royal Mail constitution should commit the company to maintaining the current universal service and an external regulator should set the price of the standard second class stamp as this is the area in which the Royal Mail has the greatest monopoly. All other pricing should be left to the management of the Royal Mail.

The strategic position of Royal Mail means that most other businesses in this country are dependent upon it by using its services. Royal Mail is therefore critical to the economic prosperity of this country, and this means that the mail service that it provides must be reliable and adaptive to the needs of its customers.

The current policy of many on the Left including Compass is to keep the Royal Mail in public ownership. As I have also argued elsewhere, I do not believe this is viable in the long term, and sooner or later a Conservative government will pluck up the political courage to either privatise the Royal Mail through flotation, or sell it off completely to a competitor. The JLP solution has the added advantage that it would protect the Royal Mail from such a fate in perpetuity as well as leading to a better quality of service and better employment conditions for the workers.

AV or not AV? That is the question. Or is it?

2009-10-04T15:29:00.000+01:00

When Gordon Brown announced in his speech to the Labour Party Conference last week that a referendum on the alternative vote (AV) electoral system would be held after the next election (if Labour won), did he really mean AV? Or was the term simply a lazy shorthand for all possible flavours of AV+ (AV plus top-up seats to increase the proportionality) with the exact composition to be decided on later? Or more worryingly, was it another exercise in triangulation designed to kill off any real prospect of reform?

If it was the last of these then I can understand the anger of people like Neal Lawson of Compass who wanted the referendum to coincide with the next General Election. However, the problem with that strategy is that the issue of proportional representation (PR) could become subordinate to the other main issues at the election. Then there is the other problem of double jeopardy. Either scenario for a referendum will mean that two separate electoral hurdles must be overcome before electoral reform can become a reality. With four possible permutations available (YY, YN, NY, and NN) but only one (YY i.e. Yes to a Labour government and Yes to voting reform) that will actually deliver change, the odds are not good. So was that part of Gordon's cunning plan?

The issue of PR in our electoral system has long been a controversial one, particularly for those on the political Left. Maybe it is because some on the far left were never really true democrats in the first place, and only ever saw democracy as a means to an end, not an end in itself. For them it was about the acquisition, appropriation and maintenance of the reins of power, albeit for what they perceived to be the common good or the liberation of the working class. That position, however, is no longer tenable, if it ever was.

21st century Britain is crying out for a modern democratic system. You only have to look at the disaffection of many voters, and the lack of any real policy differences between the main parties to see that the current electoral system reduces the amount of pluralism within politics, rather than increasing it. It places 90% of electoral power in the hands of 10% of voters in the 100 most marginal constituencies and effectively disenfrachises most of the rest. It is therefore not fit for purpose, and is most certainly not democratic.

It is against that background that many of us in the Labour Party have long been waiting for Gordon Brown to take the initiative in this area. So when he finally broke cover, the relative modesty of his proposed reforms has left many of us underwhelmed. However, much of the criticism regarding Gordon's announcement and of AV in general has been about its perceived lack of proportionality. So while Simon Heffer writing in The Daily Telegraph thinks (wrongly) that AV is a form of proportional representation (PR), many others such as Neal Lawson and Mark Thompson at Left Foot Forward dislike it because it is more disproportionate than the current First Past The Post (FPTP) system. Meanwhile, back at The Daily Telegraph, Janet Daley seems to hate AV because she thinks the Tories would never be able to win under it (as incidently does Heffer given his apparent paranoia over the "threat to put a centre-Left coalition in power for perhaps decades to come"). Of course the point both Daley and Heffer fail to acknowledge is that if the Tories can't win under AV or PR (even in coalition) it is probably because more than 50% of the electorate hate them. In which case they don't deserve to be in power in the future just as they probably didn't for much of the recent past either.

The reality is that the proportionality or fairness of AV+ depends fundamentally on the number of top-up seats that are included. The greater the number, the greater will be the proportionality, at least for the three main parties. The argument that is then presented to counter this is that top-ups give too much power to the party leaders in their appointment, but this is another red herring. If the top-up candidates are selected from the highest placed runners-up in each constituency and ranked in priority based on their proportion of the first preference vote, only the voters can ultimately decide which candidates get chosen for the top-up seats, not the party leaders.

The advantages of AV+ are that it means that each candidate needs to garner the support of over 50% of the electorate relative to his/her nearest rival in order to win. So fewer constituencies will be safe seats and almost everyone's vote will count towards the final decision. This should help to increase voter turnout and improve the democratic credentials, support and legitimacy of whichever candidate is selected. However, there are three other important factors that most people tend to overlook when considering the merits of any type of electoral reform.

Firstly, you cannot judge the merits of a proposed electoral change for the House of Commons (HoC) without considering how such a change interacts with the electoral process for the upper chamber (assuming we ever get one). The two bodies should be designed to work in unison, with each complementing the other and each compensating for the deficiencies of the other, not merely reproducing the political balance or composition of each other. A bicameral system only serves any real purpose if it introduces a separation of power or powers, and creates constitutional checks and balances. If each of the two arms of the legislature is a carbon copy of the other then all you are doing is adding extra cost for no additional benefit.

Secondly, people wrongly assume that if electoral reform is implemented everything else will stay the same, that the constituency boundaries will be the same and the amount of tactical voting will be unchanged. Neither of these are true. If the voting system changes then the Boundary Commission will inevitably change the size, shape and demographic of the constituencies in order to make the outcome of any election fairer. People's voting strategies will then be influenced by both of these changes as they seek to maximise the impact of their vote.

Finally there is the elephant in the room that no politician will talk about. That elephant is the Parliament Act of 1911 and its 1949 amendments that give the House of Commons ultimate supremacy over the upper chamber. It's justification is the greater democratic legitimacy of the elected House of Commons (HoC) over the unelected House of Lords (HoL). But if the HoL is reformed into a democratic chamber elected by PR using the list system, and the HoC remains with FPTP or merely changes to AV or AV+, how can the Parliament Act continue to be justified? The reformed HoL will have at the very least equal democratic legitimacy, and so should have equal power and status. Unfortunately, many MPs will never countenance such a transfer of power, and presumably neither will many of them countenance any real electoral reform either. In that respect these MPs demonstrate their true anti-democratic credentials.

Perhaps the most worrying aspect of Brown's speech, though, was the one reform that was glaring by its omission. What exactly is the Government's policy on House of Lords reform? Until we know that everything else must be put on hold?

It is clear that real electoral reform requires a reform of both Houses of Parliament and of the constitutional settlement under which they operate. AV+ has many attractive attributes in this respect.

• It maintains the constituency link for most MPs as in FPTP. This will also help maintain the independence of local parties and their candidate selection.

• It means every vote will count in many more constituencies, so voter turnout should increase, and there will be more marginals.

• Marginal constituencies will be as attractive as safe seats to the winning candidate(s) because these constituencies will return two candidates, not one.

• It is more likely than PR to generate a House of Commons with a parliamentary majority for one of the major parties, and therefore avoid the constitutional messiness of ever changing coalitions.

But AV+ also has a number of drawbacks:

• It is still not truly proportional. A party will probably still end up governing with less than 50% of the popular vote.

• It still disadvantages the small parties.

• It fails to address the West Lothian question.

However all these drawbacks could all be compensated for with a reformed HoL elected on the list system. In such a chamber it is unlikely that any one party would ever achieve a majority of votes or seats. Therefore a coalition between the dominant party in the Lower House (i.e. HoC) and other smaller parties in the Upper House (i.e. HoL) would be necessary, provided of course that the Lower House could not steam-roller its legislation through using the Parliament Act. That is why the Parliament Act must eventually be repealed.

The constitutional settlement that I have arrived at could also be enhanced with a number of other refinements.

• Disenfranchising voters in Scotland, Wales and Northern Ireland from one of the two Houses (personally I favour the Upper House) effectively nullifies the West Lothian question.

• PR for the Upper House is more amenable for fixed term parliaments.

• Mid-term elections to the Upper House would increase democratic accountability. I would elect a third of members every two years.

• Term limits of six years for the Upper House would increase the independence of MPs and decrease the power of the party whips and the executive.

So, Gordon, if you really are committed to electoral reform I expect to see much of the above in the next Labour manifesto. After all, what have you got left to lose?