EU immigration: how to maximise the benefits and minimise the costs

In welfare states, the economic benefits from immigration may be eroded by the additional costs of government handouts and public services. This problem has been particularly evident with some refugee populations. For example, according to one estimate, just one in ten working-age Somalis in the UK is in full-time employment, while the vast majority are dependent on subsidised housing, much of it in high-cost London. Indeed, the welfare system may be largely to blame for such poor outcomes, due to the high effective marginal tax rates imposed on those moving into work.

Outcomes for EU migrants have tended to be more positive, with northern and central Europeans in particular exhibiting high employment rates. Nevertheless, the large numbers in low-paid work that pay relatively little tax may still impose significant costs, particularly households with children that receive child benefit, child tax credits, possibly housing benefit and/or social housing, childcare subsidies, and state education, which costs taxpayers around £5,000 per pupil.

In addition, there may be significant ‘externalities’ from migration, such as increased congestion on transport networks, crime and anti-social behaviour, disruption to settled communities and difficult-to-predict long-term effects on culture (both positive and negative). The strong tendency for BME groups to support the Labour Party is an example of a long-term impact on the UK’s political environment.

However, the costs identified are to a large extent not the consequence of immigration per se, but result from its juxtaposition with an extensive welfare state and government provision of services. In a truly free society, by contrast, support for low-income households and services such as education would be provided voluntarily. Taxpayers would not be forced to pay for them. At the same time, property owners, whether individually or in voluntary communities, would be far freer to decide how their land was used and would also enjoy freedom of association or dissociation. In other words, they could decide who would be allowed to enter their property, which, as well as residences and workplaces, might also include roads and other ‘public spaces’ currently owned by governments.

Various rules of entry could be adopted (see these case studies). For example, existing residents might vote on whether to allow individual applicants to move into their community. Alternatively, restricted covenants could require residents or workers to meet certain requirements before gaining entry. In some cases, simple rules of thumb might be used in order to minimise transaction costs. A completely open policy would of course be another option.

Rather than a one-size-fits-all policy imposed by government, different models would compete with one another, allowing market segmentation. Such voluntary associations could therefore be tailored to individual preferences. Cosmopolitans preferring a diverse cultural mix would be free to choose a community with an open approach. Conservatives placing a high value on their own traditions might prefer a model with far more restrictive rules of entry. The latter approach could prove popular with religious and cultural minorities wishing to preserve practices under threat from the influence of wider society.

Under such a system, property owners and voluntary associations would bear the lion’s share of the costs of their policies towards incomers. A market discovery process would ensue, with successful models attracting more business and unsuccessful ones declining. In this way, rules of entry would gradually evolve, tending to increase the benefits of migration and reduce the costs, while adjusting to changing conditions.

Contrast this with the one-size-fits-all policies imposed by governments. Politicians cannot obtain the knowledge required to set efficient quotas or entry requirements (such as points-based schemes or charging immigrants a fee), and such measures cannot be tailored to suit the wide variation of preferences on immigration. The transaction costs of state systems may also be high, with poor incentives to reduce them. Moreover, immigration policy will tend to be influenced by concentrated interests, for example ‘key’ sectors seeking special favours.

Despite the obvious flaws of immigration policies based on central planning by governments, the prospects for a voluntary system are slim. In the UK, there are very strict state controls over land-use, most transport infrastructure is government-owned and in both the UK and EU there are strict prohibitions on freedom of association/dissociation. Given the dominant political culture, it is difficult to envisage that these constraints will be removed in the near future.

This raises the question of which immigration policies should be adopted post-Brexit if a free-market model is off the table. The most straightforward way of increasing benefits and reducing costs would probably be to reduce substantially migrants’ entitlements to welfare benefits, social housing and government services such as childcare and education, while at the same time removing barriers to low-cost private provision, which eventually could be adopted by the whole population. In addition, market pricing could be introduced on transport networks to address congestion issues. Other things being equal, this approach would be likely to cut numbers significantly, while addressing directly the issue of costs imposed on taxpayers and pressure on public services.

It would avoid the central planning problems, special-interest capture and high administration burden of points-based rationing. But it would also contravene current European Economic Area rules on equal treatment, with implications for the deal between the UK and the EU. Nevertheless, because it would maintain freedom of movement, EU institutions and member states might consider it less objectionable than the alternatives.

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Is there a free-market solution to overfishing?

Overfishing is often presented as a classic example of market failure. When individual fishing enterprises are competing, the benefits of winning the ‘race to fish’ accrue to the successful ones, while the costs of depletion are shared among all the fishermen in the fishery. There are therefore poor incentives for conservation – the so-called ‘tragedy of the commons’.

This is a simplistic interpretation, however. Market feedback mechanisms offer some protection to stocks. Declining yields will tend to force less efficient fishermen out of business, for example. Providing there is free trade in fish and substitutes are available in food markets, the combination of increasing costs and declining catches may not be offset by higher fish prices. The outcome will partly depend on the species in question. Its scarcity value, reproductive behaviour and migration patterns may affect the probability that overfishing leads to a collapse in stocks.

The history of the fishing industry shows overfishing has been hugely exacerbated by government intervention, in particular subsidies for uneconomic fishing businesses. These handouts have undermined the market mechanisms that would have helped to conserve stocks. The resulting overcapacity – too many vessels chasing too few fish – has strengthened the rationale for costly and bureaucratic regulation of the sector, as exemplified by the EU’s Common Fisheries Policy. As public choice theory would predict, such regulation has inevitably been subject to politicisation and lobbying by special interests, which has meant problems with overfishing have persisted. The creation of artificial property rights by governments, such as the Individual Transferable Quotas used in Iceland, has tended to deliver superior allocative efficiency compared with other forms of regulation, but has not been immune to special-interest influence or indeed discarding.

These problems raise the question of whether an unhampered market could solve the problem of overfishing. Clearly the removal of direct and indirect government subsidies would go a long way towards resolving the issue. However, it would not remove the tendency entirely and both yields and efficiency could still be suboptimal. While collapses would be less likely, they would not be impossible – and there are indeed examples that pre-date direct state subsidies to the industry.

There would therefore appear to be a trade-off between competition and efficiency. This is the case in many sectors, for example due to the ‘transaction costs’ resulting from competition, or because competition means economies of scale are lost (the rail industry is a classic example). Indeed it is a common misperception that unhampered markets inevitably produce a high level of competition. It depends on the characteristics of the sector concerned. One way markets can reduce transaction costs and capture economies of scale is through mergers and acquisitions.

In the fishing industry there are potentially major efficiency losses from competition in the form of the ‘race for fish’, both in terms of wasteful duplication of equipment, fishing effort and the depletion of stocks to suboptimal levels. There may therefore be strong incentives for fishing enterprises to merge or evolve into one large business (which could perhaps be some kind of cooperative) that held a near monopoly over fishing in a particular region. This dominant enterprise would then determine catch levels to maximise returns.

If fisheries remained ‘open access’, how could this structure be sustained? The market solution may be vertical integration. The dominant firm would merge with the harbours and/or the distribution operations in the region and perhaps even the fish processing industry, enabling it to exclude local competitors and to capture economies of scale that would act as a further market-based barrier to entry. Competitors from further afield would face much higher costs to reach the fishery. Nevertheless, initially the dominant firm might choose to deter them by deploying some of its vessels in a ‘race to fish’ in order to drive them elsewhere. Clearly there would be strong incentives to develop agreements between neighbouring firms not to stray into each other’s area of operation, to avoid the costs of such behaviour, and possibly also rules regarding migrating fish.

Subsidies from foreign governments to their own industries could upset this market outcome by artificially sustaining the ‘race for fish’, which raises issues regarding state protection of territorial boundaries within the current system of Exclusive Economic Areas. However, in principle there is no reason why these dominant firms or associations should not straddle existing national boundaries, with their geographical extent evolving according to market conditions.

This analysis also suggests that the state ownership/subsidy of fishing ports and associated distribution infrastructure (resulting again in substantial overcapacity) is likely to be a key factor in hindering a market solution to the problem of overfishing. In some countries there could also be problems with competition rules.

Finally it is important to consider the impact on consumers. The ‘market power’ of the vertically integrated firms would be severely limited. Under free trade they would be competing with fish suppliers from around the world, including produce from fish farms. Moreover, fish can be substituted for other foodstuffs and make up only a small percentage of the overall food supply. And the benefits would be substantial. A market solution to overfishing would deliver major benefits for consumers, with higher yields leading to lower prices and improved quality. At the same time, the inefficiencies, subsidies and special-interest influence associated with state-imposed fisheries policies would be avoided.

Why does privatisation sometimes go wrong?

The imposition of flawed privatisation models imposes economic losses far beyond the sectors concerned. Although the problems experienced in privatised industries have largely been the result of political interference and state regulation, their failure may be misused by ideological interventionists to undermine trust in markets more generally.

Both the public and opinion-formers have weak incentives to properly investigate why particular sectors have not performed well and this ignorance can be exploited. If the political culture turns against relatively free markets, the wider efficiency losses are likely to be substantial, as more and more economic activity becomes subject to high taxes and restrictive controls.

Privatisation is a political process and as such will be vulnerable to the problems afflicting political processes in general. Almost inevitably it will be influenced or even ‘captured’ by special interests. As a result, there is a risk that the outcome is not a dynamic free market, or even a lightly regulated sector. At worst, government will regulate the market to enable special interests to extract ‘rents’ from taxpayers and consumers. Such a model would protect favoured interest groups from new market entrants, competition and disruptive entrepreneurship, while participants’ profits might well rely on state subsidies.

As public choice theory would have predicted, many of the privatisations of the 1980s and 1990s did not produce anything approximating to free markets in the sectors concerned. In some industries at least, the period might more accurately be characterised as a shift from ‘state-capitalism’ Model A to ‘state-capitalism’ Model B. This raises the question whether Model B, consisting of heavily regulated markets under nominal private ownership, delivered economic benefits compared with the direct state ownership of Model A.

The answer is likely to depend both on the characteristics of a particular industry and the regulatory structure adopted post-privatisation. In an unhampered market economy, sectors characterised by major economies of scale and vast, inflexible, long-term capital investments – such as the rail industry – are likely to be dominated by large firms exhibiting high degrees of vertical integration. The ‘command economies’ within such firms will exhibit significant knowledge and incentive problems no matter what the ownership model. Thus, ceteris paribus, the benefits of privatisation are likely to be lower in such industries than in naturally more fragmented, dynamic and competitive sectors.

Nonetheless, there are particular problems associated with state ownership that are likely to apply across all sectors. These are explained in detail elsewhere, but include politicisation, producer capture, and poor incentives for entrepreneurship, innovation and cost-control. Where state regulation ensures monopolies, such pathologies may be exacerbated by an absence of competition. The poor results became apparent in the nationalised industries of 1970s Britain. Endemic misallocation of resources led to heavy taxpayer subsidies and poor quality services for customers.

However, some of the privatised sectors exhibit broadly similar problems today. The following (non-exhaustive) analysis therefore draws on theory and recent evidence to summarise some possible reasons why artificial post-privatisation markets could fail to produce efficiency gains compared with the directly state-controlled model that preceded them:

  • Politicisation – The propensity of politicians to interfere in a sector could hypothetically increase post-privatisation, resulting in increased regulation/taxation and concomitant efficiency losses. This outcome may be particularly likely in sectors with high political salience. Any change in the status quo creates risks for policymakers, providing incentives for them to intervene. The costs of such intervention are likely to be opaque and widely dispersed, leading to limited accountability.
  • Overregulation – Politicians may face fewer disincentives to impose costly regulations on a nominally privatised sector than under state ownership. In the former case, the negative effects can be blamed on private firms, whereas in the latter they are likely to be blamed directly on the government, creating higher political costs. Voters and ‘opinion formers’ have weak incentives to become well informed about such issues. Senior officials may benefit from the salary and status opportunities provided by expanded regulatory oversight, while key corporate players in the sector may welcome additional regulation if it serves their interests (for example, by raising barriers to market entry and protecting them from competition).
  • Flotation receipts – Short-term incentives to maximise flotation receipts may encourage the creation of heavily regulated ‘rigged markets’ that reduce the risks facing investors. Large, risk-averse institutional investors, such as pension funds, may prefer a model that effectively guarantees returns rather than entrepreneurial and disruptive freed markets that threaten incumbent players.
  • Transaction costs – Artificial post-privatisation markets may depart significantly from the organisational forms likely to evolve in an unhampered market economy. It is conceivable that in some instances such artificial structures increase transaction costs compared with direct state ownership, thereby reducing allocative efficiency.
  • Restructuring costs – Structural changes may weaken ‘social capital’ within a sector by disrupting working relationships, as well as losing specialist, often asset-specific knowledge and skills through the departure of long-term staff. Organisational cultures may also be weakened or destroyed. The role of such factors in efficient operations may be somewhat opaque to both policymakers and senior management.
  • Moral hazard – If sectors comprise ‘essential’ infrastructure then firms can be sure that governments will step in if they fail. Indeed, rules are typically in place that set out how this would be done. Limited liability laws and the use of special purpose vehicles also limit downside financial risks. These factors may encourage excessive risk-taking and a concomitant misallocation of resources.
  • Rent-seeking – A combination of heavy regulation and private ownership could potentially increase incentives for special interests to engage in rent-seeking activity. Profit-making businesses might have stronger incentives to lobby for regulations and subsidies that increase their profits than the less commercially minded managements of state industries. There is even a danger that ‘crony capitalism’ could emerge, as observed with privatisations in post-Soviet economies.

 

This is an edited extract from Without Delay: Getting Britain’s Railways Moving.

The future of the railways

This debate marked the launch of my new paper on rail privatisation, Without Delay: Getting Britain’s Railways Moving. The study is heavily critical of the 1990s privatisation model, in which politicians and officials imposed a complex and fragmented structure on the industry, ignoring the lessons of both transaction cost economics and railway history.

 

Ten rail capacity solutions that don’t cost the earth

  • Introduce more flexible pricing to flatten the peak. Passengers would have greater financial incentives to travel during the ‘shoulders’ of the peak, or indeed off-peak, thereby making more efficient use of existing infrastructure and rolling stock.
  • Phase out government subsidies and price controls so that fare levels better reflect industry costs.
  • Convert first class carriages into standard class carriages to accommodate more passengers.
  • Introduce high-capacity ‘economy class’ coaches with more standing room instead of seating (offering lower fare options).
  • Lengthen trains by adding more carriages and extending platforms. Double-length trains could even be used on busier sections and then split part-way through the journey.
  • Deploy improved signalling technology etc. to reduce the necessary gap between trains.
  • Consider using double-decker trains where the engineering costs would not be prohibitive.
  • Address bottlenecks by re-engineering junctions: relatively expensive but still much cheaper than building brand-new infrastructure.
  • Divert freight onto quieter routes, enhancing loading gauges where necessary. For example, intermodal traffic from Felixstowe to the Midlands and North can be sent via the Ipswich-Nuneaton route rather than the southern West Coast Main Line.
  • Allow full vertical integration to end the artificial separation between track and train, and between different franchisees and open-access operators. This would improve the financial incentives to make more efficient use of spare capacity.

Greek bailout fundamentally flawed

The original upload can be viewed here, together with comments.

 

HS2: subsidies breeding more subsidies

The rail industry depends on a very high level of state support. Much of the sector would not be viable without vast taxpayer subsidies and other special privileges.

The government supports the railways in several ways, including:

  • Providing direct subsidies from the taxpayer of about £6 billion a year (not including London Underground or light rail). This is equivalent to approximately 70% of fare revenue and represents a major distortion of the transport market.
  • Guaranteeing Network Rail debt, which has now reached an astounding £38 billion, larger than the national debt of Nigeria, a country of 180 million people. Big increases in such borrowing have enabled the government to hide the true level of taxpayer support by passing some of the costs on to future generations.
  • Imposing price controls on many rail fares, thereby increasing overcrowding, particularly on peak-time commuter services into London from satellite towns such as Milton Keynes.
  • Exempting rail fares from VAT. By contrast, tax is charged on road fuel at a rate of approximately 150%.
  • Adopting planning policies that push new development into areas adjacent to railway stations (for example, Stratford City), while restricting more spatially dispersed car-friendly growth. Also locating large public sector employers around rail hubs, including much of the civil service.
  • Funding ‘business’ rail travel by public sector workers and government contractors.
  • Suppressing competing modes such as road and air transport through high taxes, heavy regulation and restrictions on new capacity.

The artificial nature of the rail market raises uncomfortable questions for advocates of new rail infrastructure such as High Speed 2. Massive taxpayer support, regulated fares, discriminatory tax treatment and distortionary planning policies mean that the case for HS2 is grounded on levels of demand that have been hugely inflated by state intervention.

Existing subsidies are breeding future subsidies, with the UK’s transport sector and economic geography becoming ever more maladapted and distorted in the process.