Friday, 22 June 2012

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.  

Wednesday, 20 June 2012

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.

Monday, 11 June 2012


The problem in housing
It helps to be clear about the problem in housing.  This is simply that prices are too high.  What do I mean by too high?
  • The average age of a first time buyer is now approaching 40!
  • In the period 2001 - 2010, nominal average earnings rose by 34%, but nominal house prices rose by 94%!
  • National Averages disguise how the situation is worse in major cities, particularly London.
This last point is more important than it sounds.  Among the modern couples trying to get on the housing ladder, both partners will (hopefully) work.  This limits the geographical choice they will have.  It is only in the major cities that they can guarantee that they will both be able to find work in their chosen careers.

Many might be forgiven for feeling that the music has to stop some time and they should wait until a crash before they buy.  Unfortunately this is wishful thinking.  While easier credit has certainly been a factor in the house price boom of the late 20th and early 21st centuries, the way prices (especially in the cities) have held up during the credit crunch, indicates that they are being driven by scarcity.  

To correct the housing market, we must understand the housing market
The problem in the housing market is the severely constrained growth in the supply of new housing.  Population growth has outstripped housing growth by a rate of two to one.  Furthermore, while the population is growing, the number of households is growing even faster than the population.  This is a result of young people waiting longer before they marry and put down roots.  Although it is an open question which trend begets which.  It is entirely possible that young people wait longer because of the high cost of housing.  They are reluctant to start families when they can only afford small quantities of housing.

In economic terms, the supply of housing is not adjusting with the price.  We can represent this with a vertical supply line.  The demand for housing however responds to the price of housing.  We can represent this with downwards sloping line.  That line will shift upwards as the population increases; as people get richer; and as credit becomes easier to access.  In the last thirty years or so, the population has increased; people got richer (for most of it); and credit became easier to access.
In that time the housing stock has remained virtually static.  So the entire change in the housing market comes through in a price increase.

With this simple model in mind, we can see how some measures designed to help those who have not yet brought houses, might actually exacerbate the problem.  Policies to help home buyers have included reduced stamp duty for first time buyers and government guaranteed mortgages for some buyers.  However such policies will only shift the demand curve further up.  They will not alter the number of houses, neither will they alter who gets the houses.  Indeed a policy such as this is merely a transfer of wealth from tax payers to home owners disguised as a measure to help those who don't  yet own homes.

The real question then is why has the supply remained fixed?  There are only a few possible answers.  Basically one of the things required to build houses must be in fixed supply.  In order to build houses, one needs: labour; land; and materials.  Over the period in which house prices rose so dramatically, labour has not been in short supply.  The period encompasses the accession year when the former Eastern Bloc countries joined the EU and their citizens gained the right to come and work in the UK.  Neither has there been a particular shortage of materials.  Land has been in short supply.  This may come as a surprise to anyone who has ever flown over the UK in daylight hours.  There seems to be a lot of land available.  The problem is that one is not able to build on it.  Planning law essentially makes it very difficult or expensive to build more houses.  Indeed the more desirable a place is to live, the more difficult it is to build there.  Our major cities are protected by a so-called "Green-Belt" that was put in place around 50-60 years ago.

While the government is (at the time of writing) trying to reform planning law, cutting more than 1,000 pages from the rule book, it is doubtful whether:
  1. the reforms will actually go ahead; and
  2. they will actually go far enough.

What kind of change is needed?
Let's go back to basics.  Why might someone think that planning law is needed?  Essentially there is what economists call an externality here.  If I own the plot of land next to your house, then what I do with land will affect you.  Your enjoyment of your house will be affected if I build a tower block of flats on the patch next door.  The price of your house will also be affected. The result is that if I want to make any change to my land, I must seek the permission of the local government and this process gives you the right to object.

With this in mind, from a political economy perspective (this is the branch of economics that considers the incentives of policy makers), it is not difficult to see why house building has been so sluggish.  Bear in mind that there is no one single housing market in the UK.  There are a collection of more or less linked but separate markets.  Building new houses in any town will increase the supply of housing in that town and so lower the price of houses in that town.  The people who's permission must be sought in order to increase the local hosing stock are answerable to the people who already own houses in the area.  The economic losers out of development effectively have a veto.  No one speaks for the economic winners from proposed development (who are typically poorer than the losers).

However there is another way to take the externality into account.  Let ownership mean ownership, but create a vehicle for  owners to commit not to develop.  Such vehicles already exist in property law in the form of restrictive covenants.  This is best illustrated through an example.  Suppose I am a loss making farmer with a field near a village.  I could sell the field.  The only person who would be interested in buying is a developer.  The village is a short commute from London where there are lots of well paid jobs but housing is expensive.  Because of this proximity to London, housing is expensive in the village too, just not as expensive as London.  If the developer buys the field they will build more houses and the price of housing in the village will fall.  The current system effectively gives the villagers a veto on the development of the field.  Instead we should give the farmer the ability to sell the right to develop the field to the highest bidder, whether that be the developer or the villagers.

The development will go ahead if the villagers value a lack of development less than the developer will get from developing the land.  The developers profits from developing the land represent the benefits to those currently without housing from getting housing.  The development will not go ahead if the benefits to the villagers from keeping the land vacant exceed the benefits to those without housing from being able to move to the village.  These are precisely the situations in which we want development to go ahead or not go ahead.  Such a system could be achieved by allowing owners to enter five year restrictive covenants with their neighbours.  The covenants would be tied to the land rather than the person.

There is one difficulty with this system which I must admit. There will be a common action problem among the villagers in terms of buying a restrictive covenant from the farmer.  Indeed in order to reduce opportunities for corruption, I believe the local council must be prevented from buying restrictive covenants from owners.  Otherwise there will be too many opportunities for local politicians to enrich their chums by preventing "ghost" developments that the voters actually would not mind.  This actually makes the common action problem worse as people will not have access to the organising technology afforded by local government.  However preventing the system from being used corruptly must surely take precedence.  Furthermore, after such a long period of too little development, it would take a long while before any reforms led to too much development.