Adam Posen is an American economist who currently sits on the Bank of England’s (BoE) Monetary Policy Committee (MPC). This is the committee that sets the UK’s interest rates in order to control CPI inflation, or at least that was the original idea behind the formation of the MPC in 1997 when Gordon Brown was Chancellor of the Exchequer. I mention this because a couple of weeks ago Mr. Posen was quoted in an article by Philip Aldrick in The Daily Telegraph as described British banks as “reluctant, risk-averse jerks”. He may be right, but is that such a bad thing, particularly given the reckless lending that preceded 2007? I thought we all wanted banks and bankers to be boring again. Obviously not!
It occurs to me, however, that one of the issues that both the Daily Telegraph article and Adam Posen’s recent comments apparently fail to highlight is the possible causal effect that low interest rates can have in reducing bank lending. The point that virtually no-one in economics and the political media has so far cottoned onto is this: when base rates are high banks are forced to lend virtually all the deposits they receive in order to pay the interest that they owe to their savers, but when base rates are low there is no such necessity. To understand why, consider this simple example.
In normal economic times bank base rates may be about 5%. So, suppose a bank receives deposits of £1m for which it must pay interest at a savings rate of 4.5%. If the bank is required to maintain a capital adequacy ratio of let's say 10%, it will only be able to lend out 90% of its deposits. But it must also lend sufficient money at a sufficiently high rate of interest so that it can bring in enough revenue through loan interest repayments in order cover the interest it owes to its depositors. At the very least that means it must lend all of the available deposits (£900,000.00) at a rate of 5% just to break even. It could of course lend out less (say £750,000.00) but then it would need charge a higher loan rate in order to make a profit (in this case over 6%).
When you add in the effects of competition between banks, that competition will have two effects. Firstly, it will force down loan rates (or force up saver rates); and secondly, that will then force banks to lend more and more of their available deposits in order to cover costs and maximise profit. This inevitably means that banks will be unable to sit on deposits. Instead they will be incentivised to make those deposits work as hard as possible, possibly to the extent where some banks try to circumvent the rules on capital adequacy. That of course was what happened during the credit boom with disastrous consequences. But that is not what is happening now.
Today base rates are anchored at 0.5% and look like staying there for several more years to come. As a result savers typically receive an interest rate of about 0.2% if they are lucky. Yet most loan rates still exceed 4%, while for credit cards and unsecured loans they are much higher still. Under circumstances such as these banks would only need to loan out about 5% of their total deposits in order to break even. The net result is that they can pick and choose with even greater selectivity than before who they choose to lend to, and how much they choose to lend. The credit market therefore becomes highly skewed in favour of the lender. So that would appear to explain, at least partially, why current levels of bank lending are apparently so weak. In which case is Adam Posen right to criticise the banks in this way? Or should some of the responsibility for this lack of lending also lie with Adam Posen and his colleagues on the MPC? After all, it is they who set the BoE's base rates and, as I have shown, it is those base rates that help to drive bank lending.
With UK interest rate policy set as it currently is, what has in effect happened is that lending rates have become decoupled from savings rates. Once you realize that then it becomes apparent that having base rates at 0.5% serves very little purpose as far as the wider economy is concerned. It certainly has no effect in stimulating increased loans to small businesses, and while that may not be the only reason for the poor lending record of banks, it is probably a contributory factor. The result is a credit crunch or liquidity trap where those with spare cash refuse to either lend it or spend it. The critical issue here is the same one you get in price deflation in a depression. Both are caused by the tendency of the rich to hoard cash when there is no financial penalty for doing so.
Normally, hoarded cash loses it value through inflation. That is why a small amount of inflation actually benefits the economy as it helps to drive the circulation of money through spending, investment and consumption. Similarly, un-loaned bank deposits normally lose value for the banks due to the costs of interest they incur that must be paid by the banks to their depositor customers. When inflation and interest rates are negative, however, these conditions no longer apply, and the cash or credit stops flowing. In short, when savings rates are close to zero the banks effectively have access to free money.
Of course there are other reasons for the general lack of lending to small businesses. One of the main ones is the competition for funds from house-buyers via the mortgage market. In the period immediately prior to 2007 over 75% of bank lending was on mortgages, with only about 6% being made available to small businesses. This represents a classic case of "crowding out". That is why part of the long-term solution has to be the establishment of a network of locally based investment banks in the UK based on the German model of financial support to its Mittelstand. What is clear is that the more choice banks have over where they lend their money, the less likely they are to lend it in support of the real economy. It is simply a question of reducing the number of options or degrees of freedom banks have. As Adam Posen is also quoted as saying: "We've got to change the competitive pressures on them, change the rules on them so they're forced to do the job right."
What the above statistics also show, though, is that like most of the UK's economic problems, the ongoing problem of underinvestment by UK retail banks in the rest of UK business is intrinsically linked to the perennial UK problem of property speculation and house price inflation. So you will never solve the investment problem unless you also solve the housing problem.
Tuesday, 21 February 2012
Saturday, 30 July 2011
Home ownership and economic mobility
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.
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.
Saturday, 2 July 2011
Time to auction work permits?
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.
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.
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