Is This a Tax or a Subsidy I See Before Me?

So Edward Samuel Miliband, the leader of the Labour Party, has finally promised to abolish the spare room tax, or should that be the spare room subsidy?  I’m not entirely clear.  Every Labour party politician assiduously refers to this as the spare room tax and every member of the Conservative party assiduously refers to the spare room subsidy. Their various supporters in the press follow suit, so which is it?  In essence, this is about the use of language to bias a debate.

• If it is a tax being imposed on poor people, then that is more evidence that the people imposing it are heartless Tories.
• If it is a subsidy being withdrawn, then that is further evidence that people who oppose the policy just want to spend money and would explode the deficit if they got power.

This kind of labelling is an old (and quite transparent) trick, and one that I have already used twice in this post alone (although you may have to know what my own political bias is in order to spot one of them).

Technically speaking, I have more sympathy with the Conservative description of the policy as what is happening is that a subsidy is reduced if the family living in subsidised accommodation is judged to have more than sufficient living space.  I suspect some quick witted Conservatives will start saying “there he goes again making promises he can’t keep: You can’t abolish a tax that doesn’t exist.” 

Although withdrawal of a subsidy can have effects similar to the imposition of a tax.  Indeed, a subsidy is simply a negative tax rate, and so there is a point that if a subsidy is reduced, that is mathematically the same as increasing a tax. This often leads some people to cast a reduction in tax rates, or a refusal to tax a good they think should be taxed as subsidising the good in question.

The problem with using this logic to cast the failure to impose taxes you like as a subsidy and the failure to give out a subsidy you like as a tax is that it is highly vulnerable to reductio ad absurdum.  A friend and I were once discussing an article which referred to the withdrawal of a tax on mortgages (which happened about 20 years ago) as a subsidy for private home owners. At the time we were sitting in Oxford’s economics department which is one of those buildings where all the external walls are made of floor to ceiling windows, so I had to point out that the abolition of the Window tax in 1851 meant we were in the most subsidised building in Oxford.  Indeed, under that view, the Shard of Glass in London is receiving an eye wateringly large subsidy (adjusting the taxes that were charged for inflation).

To go one step further into the absurd, before breakfast, I could claim that books have been heavily subsidised by the government’s failure to tax them at £1,000 per book. After breakfast, I can claim that books have been heavily taxed by the government’s failure to subsidise each book by £1,000. The only thing that has actually changed while I was having breakfast is my reference price, not the policy.

So there must be some reference where we can refer to the good as either being taxed or subsidised.  One extremely convenient one would simply be to look at whether the government is paying out money (in which case we should probably refer to a subsidy) or whether the government is taking in money (in which case we should probably refer to a tax).  The key advantage of this way of labelling things is simplicity, to know whether a policy is a subsidy or a tax, you just need to look at what happens to the government’s budget. Under this convention, the Conservatives are correct and the housing benefit changes constitute a reduction in subsidy rather than an increase in tax.

However there is another way of looking at this which allows us to be more sympathetic to Labour. We could say that a policy is a tax if it raises the price above the market price that would prevail if there were no market imperfections, and that it is a subsidy if it lowers the price below the one that would prevail if there were no market imperfections. One attractive property of this way of labelling policies is that we can refer to the refusal to tax petrol in a manner that takes the price of the carbon externality into account as a subsidy.  In this labelling scheme, any policy that involves any kind of subsidy or tax is per se inefficient. Since the price of housing in the UK is kept artificially high by imperfections in the housing market, this would allow us to cast the benefit changes as a tax and say that Mr. Miliband is correct to talk about abolishing the bedroom tax.

If this labelling scheme appeals to you, then I just have one question for you and Mr. Miliband: So you are going to be taxing those who are ineligible for housing benefit how much?

I thought so. It is probably best if we just stick with the definitions of tax and subsidy that refer to the effect on government spending and income. 

None of this makes any comment on whether reducing housing benefit in this way is the correct policy, it is just about whether we should call it a tax or a cut in subsidy. Now might be a good time to start openly discussing the merits of this particular subsidy and whether it should be reduced or not; and if it should be reduced, is this the right way to go about it?

Pampered or Rational?

So a recent post about why Generation Y is so miserable caused a bit of a fuss recently, and a response can be found here. I’m not going to try and endorse or deny the stuff about entitlement. For one thing I am of Generation Y myself, so if I bite on that bait, I will only be providing evidence for the other comment about Generation Y that they don’t respond well to negative feedback. My main point is simply as follows: The trends identified in the “waitbutwhy” article are actually rational responses to a changing work environment. In particular pensions used to provide incentives which dramatically increased the financial value of careers which would give rewards only after many years’ hard work. I don’t want to get drawn into too much of the institutional detail here, if for no other reason than that those details differ on different sides of the Atlantic, so I’m afraid it is going to be pretty broadbrush at this point.. 

While institutional details differ, the general pattern is similar.  In the immediate post-war years, with greater faith in what the state could achieve, many Western countries set up “pay as you go” pension systems, where each generation would pay the pensions (and other retirement benefits) of the one that preceded it through the tax system. A bit of nominal ring-fencing goes on, but ring-fencing like that is normally just window dressing.

There is nothing wrong in principle with a pay as you go system.  Indeed, it can be an important way to ensure that the generations alive and approaching retirement when the pension system is set up do not miss out.  However when there is a baby boom (as there was in the immediate post war years), the system can be put under a great deal of strain.  When the baby boomers reach working age, there are a lot of them to spread the burden of supporting the older generations. When they retire, there will be a lot of them who need to be supported by the subsequent generations.

But there has been another trend, which means that each retired baby boomer will be an even larger burden for subsequent generations than the pensioners they supported in their working life.  The baby boomers will live much longer, their lives being preserved by expensive medical treatments (courtesy of the tax payer again), but retire at virtually the same age. In the UK, the age at which people most commonly die has increased by 10 years for men and by 5 years for women since 1980. This means that the typical man enjoys twice as many retirement years today as the average baby boomer did. There is nothing wrong with extra longevity, but it does mean that there are more pensioners whose pensions and other benefits need to be paid for by a relatively smaller population of workers.  That means a larger burden for each worker to bear.

Most of the solutions to this problem amount to moving the stable door from wide open to ajar once the entire team of horses have got out into the wild and are well on the way to producing more horses. Broadly speaking, the plan among those countries that are planning to do anything is to slightly raise the retirement age long after the baby boomers have retired. As with any “solution” to a problem which fails to go far enough, this simply means that more drastic actions will be required later, probably just as Generation Y is nearing retirement age. That age will probably be substantially raised, and the retirement benefits they will enjoy have already been drastically reduced compared to those that will be enjoyed by the baby boomer generation.

However this offers some insight into one of the differences highlighted between generation Y and their parents. Their parents expected to work until they were 65 and then enjoy a good 20 years of retirement. In those circumstances it is rational to look for a career purely on financial criteria. Generation Y’s parents will also, for the most part, benefit from pension schemes based on their final salaries.  This dramatically increases the financial benefits of a career which sees very large salaries right at the end, because that has a huge effect on pension income.

Generation Y is probably expecting to live to about 90 and retire at 86 (yes I am exaggerating, but the point is they will work longer and enjoy fewer years of retirement). The closure of most final salary pension schemes also means that sudden salary rises at the end of their careers will not have such a dramatic effect on their lifetime incomes as it did for their parents.

All this adds up to two things:

• Rationally the early financial rewards to their careers are more important to Generation Y than they were to their parents; and

• Rationally their careers will be a much bigger part of their lives and so Generation Y should be looking for a career where they can follow their passion rather than one that merely provides a living.

So maybe the feelings of frustrated expectations and the desire for earlier rewards from their career, and a career that provides a lot more job satisfaction are more than simply the selfish demands of a pampered generation. They might simply be rational responses to the environment they face.

Olympic Touts

First, I have been informed that "tout" is something of a British - English word, so I'll start by explaining that a tout is someone who hangs around sporting venues selling tickets.  Normally someone else's unwanted ticket that they bought.

I have to confess something here.  I am an Olympic Refusenik.  The only "benefits" of the games I have seen so far are: 

• It is much more difficult to get on the tube.  
• One only has to spend 5 minutes or so at a major train station before Boris Johnson's irritating voice comes up telling us that "This is… The big one" and advising us to go to an utterly useless website to re-plan our journeys.

However one Olympic story has grabbed my interest.  (OK, two stories if you count Boris and the zip wire!)  The twin outrage at empty seats in the arenas and ticket touts making money off the games.  As a friend pointed out on Twitter, it is wrong to draw too much of a connection between these two issues.  Most of the empty seats are, in fact, those that were reserved for the "Olympic family" of VIPs and dignitaries associated with the games.  If this is the case, it is highly unlikely that these would be the seats that touts are able to sell on.

However the attitude to touts is interesting in itself.  People do get genuinely very angry about touts, even those selling genuine tickets, and this often drives some economists crazy!  From our perspective, touts who sell genuine tickets are fulfilling an important economic function, moving goods and services from people who don't value them very much to people who place a great deal of value on them.

Let's go back to the point where tickets were being sold.  People were getting up very early in the morning to enter a "lottery" where they said which events they wanted to go to and would then "win" their tickets or not.  If you "won" the tickets, you still had to pay for them, but this way the tickets themselves could be priced below the market price so that the games could be enjoyed by everyone.  The fear is that otherwise the games will be a rich person's pleasure.

Naturally some enthusiasts entered the lottery for many events and ended up with nothing.  Others entered the lottery and won almost everything they said they'd want to go to.  People who won tickets to nearly everything they entered the lottery for would be spending far more money on Olympic tickets than they wanted. 

This is a prime example of an allocation mechanism that will create the conditions for a thriving secondary market.  On one side of the market we have people who really wanted to go to some Olympic events but ended up with tickets to far too many.  On the other side of the market we have people who wanted to go to lots of Olympic events but ended up without any tickets.  We should find some way to get excess tickets on one side to people who really want tickets on the other side.

If someone came along and offered to coordinate this process, giving of their time to match ticketless sports fans with over-ticketed sports fans and broker a deal, would we say that they were doing something wrong?  Is that something that should lead to an arrest, conviction and criminal record?  If they are doing it for free, then I, and I suspect a great many people, would say no.  It is only when they are making money from this activity that people seem to have a problem with it.  I have to admit to being puzzled as to why.  The process of brokering takes time.  Furthermore, if the tout reallocates tickets by purchasing them from those who don't want them and selling them on, then they are taking on considerable risk if they cannot find a buyer.  People need to be compensated for taking risks.

Tim Worstall suggests that it is a Victorian attitude to the grubby business of trade.  True wealth ought to be inherited rather than made.  There is something not quite right about this explanation being applied to modern Britain.  Two of the most popular television shows in the UK today are The Apprentice and Dragon's Den, where participants show off their business acumen, and these have propelled the businessmen involved to a celebrity status.  On the whole, Britain today is more comfortable with wealth creation than it has been in a long time.

I suspect that the explanation lies elsewhere.  I suspect the issue is the source of the wealth that is being generated by touts.  Tickets were sold in the primary market below market price and assigned via a lottery to ensure that the Olympic games were for everyone and could be enjoyed by everyone, not just the rich.  Had the tickets been sold at the market price, the games organisers would have made more money and the return on the investment in hosting the games for UK Plc. would be higher.  A similar argument could be made about touts at football matches and other sporting events.  The tout's profits are the profits that organisers decided to leave on the table so that the events would be "for everyone".  I suspect that this is the real source of the anger felt towards touts and it is why touting is illegal.  However, just because this is the source of the anger does not necessarily mean it is rational or sensible to make touting illegal.

While this argument may apply to other sporting events, it does not quite work for the Olympics.  The Olympic organisers chose (in the form of a lottery) an extremely inefficient means of allocating tickets that was always likely to create this secondary market.  There were alternative mechanisms that would have ensured tickets were initially held by enthusiasts for the sports involved.  Tickets could have been given away to the relevant sporting clubs across the country.  For example tickets for Olympic Judo could have been given away to local Judo clubs who would then have decided how many to sell; how many to allocate to members and so on.  If you want to find out who the e.g. badminton enthusiasts are, a badminton club is a good place to start.  Such an allocation mechanism would have been very good for the clubs allowing them to enthuse their members or raise cash for sporting equipment according to their own needs.  Such an allocation mechanism would not eliminate the problem of ticket touts, but it would have resulted in a smaller secondary market.

However, to an extent we have to accept that the premise of making the games something that was "for everyone" is a bit shaky.  We have the problem of touts because the people we are trying to "help" by giving them low cost tickets to sporting events would prefer to have the market value of the ticket rather than the ticket itself.  It is entirely possible that there are some people who lack sufficient disposable income to pay the market price of a ticket, but would not sell it at the market price if you gave it to them.  The question is how to distinguish them from the people who would sell their tickets at the market price.  Asking them to put their hands up does not seem to have worked.  

However, even if we could perfectly identify them, there would still be a secondary market.  Life happens and plans change, the events people thought they could make when the bought their tickets they can no longer get to.  Under these circumstances, it is understandable that they should want to get as much money as they possibly can for their ticket, and, in some ways, tickets like this should be reallocated through the price mechanism.  We could view this as redistributive - moving money from richer sports fans to (on average) poorer sports fans.  It might be better to accept that the secondary market exists and to start regulating it to protect punters from fraud rather than trying to stamp it out.

Unintended Consequences?

I am returning to the theme of Housing for this post, but will concentrate exclusively on the rental sector.  Oxford City Council have introduced new licensing conditions on what are called Houses of Multiple Occupancy (HMOs).  Nationally, an HMO needs to be licensed if it is "large" and is considered to be "large" if:

• There are five or more tenants.
• the house has three or more floors.

See the relevant part of DirectGov.  

However in Oxford, the Council has decided to tighten these regulations.  They will consider an HMO to require a license if:

• There are more than two tenants.
• The house has two or more floors.

The licensing system in Oxford is not being funded by the general tax payer, but by a system of fees on the HMO licenses themselves.  The fee is proportional to the size of the house in question, but can rise to around £500.

So what will be the economic effects of this policy.  First, in the short run, landlords who do apply for the license will actually be unable to pass the tax on to their tenants!  This might well be surprising for some, but the economic logic here is as follows.  The scarcity of housing means that landlords are effectively already extracting from their tenants the maximum willingness to pay of each tenant.  So there is no room to extract more.  However, in the longer run, landlords may decide that the bureaucratic costs of applying for the licenses and making any changes that the council requires as a result are just too great and stop renting their properties to multiple tenants.  Indeed, this is just what seems to be happening in this story from the Oxford Mail.

Once landlords start leaving the HMO market, then rents will rise as the (already too small) supply of rental housing contracts.  But what happens to the houses that were being rented as HMOs?  Will they be rented or sold to families and singletons?  Will this drive down the rents or prices that families and singletons have to pay?  Unlikely.  The fundamental problem of scarce housing still exists.  Indeed, high housing costs are one of the reasons that people delay starting families and live with friends in HMOs for longer.

It is more likely that in order to extract maximum value from their properties, landlords will instead divide them up.  They will turn each floor into a separate flat with its own toilet and kitchen facilities etc, so that they are not HMOs and rent out the floors separately.  In order to create the extra kitchens and bathrooms this will require, the total number of bedrooms will fall.  So the total housing supply falls leading to higher rents for the younger people starting out in life who will be renting these properties.  Naturally this process will take time; cost money; and require planning permission.  But if the council is serious about limiting HMOs (see below), it may well become the best option for those who own homes in Oxford.

For tenants forced out of their homes, this is a tragedy.  Such consequences of a policy are often referred to as "unintended consequences", this is the term used in the Oxford Mail story.  However in this case, the consequences are so transparently obvious that it is difficult to call them "unintended".  Indeed a brief perusal of Oxford City's website and the website of the local political party that controls it reveals that, far from being an unintended consequence, forcing out people like the tenants from the Oxford Mail's story is the point!  Note that Oxford City's website includes a section "Why are HMOs a problem in Oxford?"  The phrasing of the question itself reveals more information than the answer.  The controlling party boasts of having "... taken action to ensure local communities have a balance of housing, rather than HMOs taking over entire areas."  The prejudice against HMOs and the young people who normally live in them is clear.

Why is the local council trying to reduce the number of HMOs?  Oxford City's website highlights two general problems with HMOs.  To paraphrase:

• Across the entire country, the landlords can be a bit dodgy and neglect safety issues.
• There tend to be a lot of complaints about the people who live in them.

There is no satisfactory reason why we should expect that the first problem is unique to HMOs.  Indeed it shows a somewhat disturbing set of priorities in some respects.  If a dodgy landlord doesn't get the boiler checked we want to stop them renting to a group of young professionals or students and would rather they rented to a family?  Really?  Wouldn't it be better to ensure that all tenants knew their rights and that they could demand that the landlord get an annual gas safety certificate?  Wouldn't it be better to encourage tenants to report anything in their property that was unsafe?  (To align incentives, they could be encouraged to do so at the end of a tenancy during negotiations over return of the deposit).  If the point of these rules is really to help tenants, it strikes me that evicting them is an "innovative" strategy.

Regarding the second issue, the council are being exceptionally short sighted and this is possibly a case of unintended consequences.  From this perspective, the problem of HMOs is not the houses or the landlords, but the people who rent them.  The people who rent them are unlikely to leave Oxford and camp outside the ring road.  Rather it is more likely, in the long run, that they will be the people who rent the same houses again once they have been converted into flats.  In that event, I would expect the number of complaints to actually increase.  Currently entire houses are rented and people who live in them know each other.  Noise travels between the floors, but differences and arguments about this can be worked out between the various house mates who all know each other and are friends.  Friends are able to resolve these differences relatively amicably.  The noise externality is "internalised" in economics speak.  However once these houses have been converted into separate flats, noise will still travel between them, but the people who live in the different flats won't know each other and won't be friends.  They are therefore more likely to involve the council in disputes about noise and so on.  This policy will further reduce community cohesion rather than increase it!

I once thought National policy on Housing in the UK was misguided.  (See previous post on housing).  Compared to some local policies, it now appears positively insightful.  And that is saying something...

Cash in Hand

David Gauke, a minor Treasury Minister from the Conservative side of the coalition has said it is "morally wrong" to pay cash in hand seeking a discount.  This did not actually have the connotation of a pronouncement from on high that some of the later press coverage has imputed.  The minister was answering questions after a speech.  The phrase "morally wrong" was not chosen by the minister, it was chosen by the journalist asking the question.  The minister seems to have been saying (somewhat clumsily) two things:

1. People should not ask for a discount if they pay in cash in the knowledge that the tradesman will use the cash without declaring it; and
2. Stopping tax avoidance is important, but the "hidden economy" is a "very substantial" part of it as well.

One of these points is interesting; the other is mundane.  The attention each has received looks to me to be the wrong way around and that says something about us and our priorities.

The mundane point is that people should not say to their plumber or cleaner something along the lines of "I'll pay you in cash; you then don't need to report the income; and you can give me a share of the money you save on taxes through a discount from your usual rate".  As statements go, it is difficult to see why this has attracted the attention it has.  All it is really saying is that you shouldn't ask someone to commit a crime on your behalf, albeit a relatively minor one given the amounts involved.

Note that this is quite different from what I suspect usually happens when cash in hand payments go undeclared, which is where the tradesman offers a discount if you pay in cash.  This is a bit more of a grey area.  Not being a Philosopher, I think I'll leave off this point and move onto the second part of what the minister was (mis)communicating.

The minister was saying that stopping tax avoidance schemes at the top of the income distribution was important, but the hidden economy of tax evading plumbers and cleaners is just as important.  There was a sense in which the minister was equating the two and suggesting that if we are going to crackdown on one, we should also crackdown on the other.  Again, as I am not a Philosopher, I shall leave the ethical analysis to others and just consider the economics of this statement - in economic terms, this is palpable nonsense!

According to the HMRC, the median income is approximately £19,600 per year.  Whereas the income of the 99th percentile (this is the minimum income to claim membership of the top 1%) is £149,000.  The post-tax median income is £17,200.  The post-tax income of someone at the 99th percentile is £105,000.  A very rough and ready calculation (assuming the order of taxpayers remains the same before and after tax) suggests that the median taxpayer pays £2,400 per year in tax and the taxpayer at the 99th percentile pays £44,000 per year in tax.  So (on a very rough and ready calculation) catching a tax avoider or evader at the top of the income distribution will recover for the Treasury more than 18 times as much money as catching a tax avoider or evader in the  middle of the income distribution.  So the minister is right only if with the same effort and cost that it takes to catch one tax avoider at the top of the income distribution, we could catch around 20 tax avoiders in the middle of the distribution.  This may in fact be the case, and so there may be greater net benefit to the treasury from going after tax avoiders in the middle of the distribution, but that needs to be part of the discussion and it wasn't.

There are, of course, factors which should be considered but have been left out of this analysis for lack of data.  One example that would make the calculations even less favourable for the Minister is that we shouldn't be comparing the 99th percentile with the median, but the mid-point of the top 1% with the 25th percentile which might have a higher concentration of self-employed tradespeople.  That would put a much higher threshold on how much easier it would have to be to catch people at the lower end of the income scale in order to make targeting them worthwhile.  However, in the Minister's favour, there are a greater number of people at lower points of the income scale, and there may be economies of scale in targeting these groups that improve the economic argument for doing so.  There may be some reason to believe that tax evasion is more common at lower income brackets, though the Minister has not stated any reasons why we might think this, but if it were the case, that would change the analysis somewhat.  Some combination of these two points seems to have been what the Minister was driving at when he referred to "the hidden economy" being a "very substantial" part of the problem.  Although this does raise the question: If this part of the economy is "hidden", how do we know how big it is?

There is one final point to consider in all of this and I shall have to try not to sound too much like I am gloating.  The ideas of providing a "Nudge" to effect change described in the book of that name by Thaler and Sunstein have apparently been influential in Downing Street.  The idea is one that can work well when there is a behavioural bias to be overcome.  Increasing pensions savings by making pension schemes "opt-out" rather than "opt-in" is a good example.  One could (generously) read David Gauke's statement as an attempt to nudge the population into not accepting "cash in hand" discounts and even reporting tradespeople who suggest it.  If  that is the case, then it would seem to have backfired.  Nudges work best when they overcome a behavioural bias and point us in the direction of our own interest.  A Nudge will have a great deal of difficulty in getting us to take actions which run counter to our own interests.

Lies, Damned Lies, and...

An interesting story on the BBC today.  Apparently the last Labour government "got it wrong" on immigration.  What is as interesting as Miliband's shift is the reporting of immigration and the numbers.  Take the following from the story:

"But its [the Labour government at the time] estimates that only about 13,000 people a year would come to the country were soon proved wrong, with a peak net migration figure, from the EU and elsewhere, of 252,000 in 2010."

The estimate of the number of people who would be coming into the UK from the 8 extra EU accession countries who joined in 2004 is compared to the peak of net migration from everywhere that was taking place six years later.  Unsurprisingly, the net migration to the UK from the entire world six years after accession was considerably higher than the initial estimate of how many Accession Countries' citizens would exert their right to free movement by moving to the UK.  Comparing these two numbers in this way is simply dishonest!

It is worth taking a look at the actual figures.  As with all ONS data sites, it is unnecessarily difficult to find the data you might be looking for.  The spreadsheet titled "Provisional Long Term International Migration (LTIM) estimates September 2011 (Excel sheet 601Kb)" seems to contain some useful time series data, so let's start there.

The Accession Treaty came into force in May 2004, that is when citizens of eight Eastern European countries received the right to work in the UK.  The initial estimate was that around 13,000 people a year would come.  According to the data, 49,000 had come by December 2004.  In the first full year for which there is data, 71,000 arrived.  Did the government underestimate the number of people who would come?  Yes.  Did they underestimate the number as badly as the BBC's figures above would suggest?  By several orders of magnitude, no.  We should remember however that estimating the number of people who will move before they actually move is a very difficult thing to do.  One imagines one would conduct surveys, but it would be very expensive to conduct a proper random sampling exercise.  Any cost-cutting methodologies (eg. telephone / internet surveys) would risk over-sampling people with a better lot in life more likely to stay.

But how important is immigration from the EU Accession countries and how important was it overall.  The answer is, not very.  The graph below shows net immigration by source country.  The blue line shows the total net immigration to the UK of Non-British Nationals.  The red line shows net immigration from the Accession countries, and the green line shows net immigration from Non-EU countries.  While there is a spike in the Accession year, 2004, this seems to have been caused more by immigration from Non-EU countries than from the Accession countries.

What may be of more concern is the reason people are coming to the UK.  In the year to September 2011 (the latest for which I have been able to find figures) 50% of gross immigration to the UK was for the purposes of formal study.  In some ways this should not come as a surprise.  The UK has a strong presence in international academia and some very strong brand names in this area.  Education is actually a good export industry to the UK.  The really good news is that if we restrict attention to immigration from outside the EU, this number goes up to 62%.  That is good because non-EU students can be charged the full economic cost of their education while EU students have the right to study under the same conditions as domestic students.

The bad news is that the government has decided students coming for formal study is the area of immigration where they can get "results" quickly in terms of fulfilling their promise to bring immigration down to tens rather than hundreds of thousands.  It is almost as if they have decided to sacrifice a valuable export industry in order to fulfill a political promise.

I am not completely insensitive to people's concerns about immigration.  I understand that when the amount you charge for the services you provide is forced down because immigrants enter and offer the service more cheaply, that is distressing.  That it is better for the general public who can now afford more of those services is scant comfort, though it be the truth.  The economic arguments here are in fact very similar to those for free trade.  Yet the political argument for free trade has been fought and won in the past, and so I have hope that the political arguments about immigration can also be fought and won.  

One branch of the argument must emphasize the economic benefits of allowing more economic immigration.  Although lowering the price of some labour services is bad for the people who provide those services, it is good for the general public at large who consume those services.  Even if this argument is not accepted, it should be generally accepted that no one's lot in life will be improved by reducing the number of people who come to the UK to study.

While we have to acknowledge that more people put additional strain on the UK's already overstretched infrastructure, this is an argument for building more infrastructure rather than limiting population growth.  As an aside the UK's infrastructure would be overstretched without any immigration.  What population limiting strategies would then be suggested by those who want to solve the infrastructure problem by limiting immigration?

However there is another branch of the argument that has yet to be tried.  Positive net immigration is a sign that people want to live here rather than where they were born.  What better sign could there be of our success as a nation?  Positive net immigration is the best evidence available that the UK, for all its problems, is a good place to live.  As such, it is something we should, as a nation, be quite proud of.  

Executive Pay

So the government is going to introduce binding votes on pay. This is part of what has been referred to as a "Shareholder Spring" of recent years, which has seen shareholders vote against the remuneration packages of various large firms.  However, to date, these votes have been merely advisory.

I have to admit, I was truly gobsmacked when this proposal was first aired a few months ago. I am incredulous that it has ever been the case that shareholders’ votes on remuneration packages for senior management are only advisory. But then, that is what comes of being a theorist.  We know how these things are supposed to work, but are often surprised by what turns out to be "custom and practice".  


There is certainly a problem with executive pay. Over the last few years, executive remuneration has risen by around 50%, with no concomitant increase in corporate performance. It is too easy for executives to be rewarded for failure just as they would be rewarded for success. This may in part explain the poor performance of some firms over the past few years.


Nevertheless, when it comes to corporate pay, as the bard would say: “The fault, dear Brutus, lies not in our stars, but in ourselves...”

Given the shocking state of affairs, we should perhaps recap the relationship between managers and shareholders. What is the relationship supposed to be in theory, and what has happened in practice?

In theory, the manager is the servant of the shareholders. Think of the Earl of Grantham and the Butler, Carson from Downton Abbey. The shareholders do not have time to run the company that they own themselves. Even if they did, there may well be people who can do a better job of it than they can. The shareholders and the manager are both better off if the shareholders hire the manager to manage their firm. The manager gets a salary and the shareholders get the profits.

In practice things seem to have developed quite differently. Managers seem to have gained control of the firms they are running. To continue with the analogy, Carson is now upstairs being dressed by the Earl of Grantham. How has this happened? The answer essentially lies in the strength that comes from being one of a small number.

Think of the profits of the firms (before executive salaries are deducted) as a resource over which management and owners compete. A solution is negotiated between the two parties and the shareowners then have their say (which is not currently binding). Our experience of arguments and debates might lead us to expect that the group with the largest number will win more out of these negotiations. However we would be wrong. Indeed the greater number of shareholders is precisely what gives the managers the decisive advantage.

Among the shareholders, informing themselves about all the issues surrounding the executive pay within their firm and arguing about those issues with the management are costly actions. It takes a lot of time to find and understand all the numbers. There is a reward in higher dividends, and the total reward may well outweigh the cost, but that reward is dispersed across all shareholders. Remember that if a shareholder has sensibly diversified their portfolio, then they would ideally be doing this for a large number of firms. However the benefits of these activities are spread across a large number of shareholders.

Corporate governance activities are what economists would call a public good. The benefits are “non-rival” (one shareholder’s consumption of the benefit does not stop another shareholder from consuming the benefit) and “non-excludable” (it is impossible to exclude one shareholder from the benefit without excluding all). Corporate governance is like the washing up in a shared house. Everyone benefits if it is done, but no one actually wants to do it.

This is a problem unlikely to solve itself and only likely to get worse! In an egalitarian capitalist society, the ownership of capital should be widely dispersed. More people should own fewer shares.  But this will worsen the corporate governance problem and allow managers to get higher and higher remuneration which becomes less and less responsive to performance. As we get more shareholders, the benefits of exerting corporate governance become more dispersed.

The question then becomes what should be done. Giving shareholders a binding vote on remuneration is certainly a start, but the government may need to go further than this. Managers enjoy the privilege of “agenda control”, meaning that they would still get to decide what precise package the shareholders are voting on. A binding shareholder vote might simply become a costly veto where the shareholders face a choice between approving a pay package, or plunging the company (and its stock price) into uncertainty by wielding a veto. Shareholders should be choosing between two alternative remuneration packages, one put forward by management and one put forward by shareholders. The shareholders should also perhaps hold a vote to decide which package they put forward to compete with the management proposals.

The measures to increase transparency also provide a good start. What is needed is a way to ensure that when shareholders vote they are conscious that every penny they pay the chief executive is a penny less in dividends for them.  Simple reporting of total pay should help to raise this awareness.  Although I remain skeptical that managers will find ways of muddying the water here; probably through bonuses or shares issued as bonuses.

These are all measures that will make it easier for shareholders to re-assert control over their companies. However even these measures might still prove insufficient. Shareholders will still be blighted by what economists call a “common action problem”. Common action problems such as this can be resolved by the parties themselves, after all, they are the people with the biggest incentive to solve them. Better information and voting structures will help, but if they do not allow shareholders to solve the problem, other reforms to corporate governance measures may prove necessary.