There's no reforming the EU without understanding it

Once again the Daily Telegraph (“Brussels plots fresh City of London power grab”, 8^th August) and like-minded media have become irrationally frenzied by EU moves that are wrong but nevertheless entirely rational.  London has been reminded that the three UK financial regulators will have to give up their regulatory powers to Brussels and become merely supervisors. As this Institute pointed out in our letter to The Times in June 2009, the UK governmentagreed that the previous March.  It was President Sarkozy’s price for attending the London G10 Summit in April.   The necessary legal framework was agreed by Parliament before that summer’s recess. The government and the City were silent at the time and in the five years since.  It is no use yelping now.  Brussels is only implementing what we agreed.

The worry now is that the City and the government ignorance of Brussels and its processes make EU reform all the less likely.  One needs to understand and then work the system to succeed.  The UK negotiators’ failure is demonstrated by the 55 occasions on which we have sought to block some new Brussels initiative or other and been over-ruled each time.  The French and the Germans know how to garner support for what they want done; the British government clearly hasn’t a clue.

If the past five years, during which the EU financial regulation issue has been ignored by City and government, show anything, it is that the Foreign and Commonwealth Office and HM Treasury have been asleep at the wheel.  The FCO lacks backbone and is notoriously pro-EU. We need a new team.

Obviously some of the existing team do have some understanding of the EU.  Perhaps we need an exam, supervised by Michael Gove, to sift out the good ones and then complete the new team with our finest negotiators first to understand what has to be done and then to prepare the way.  It will make little difference to the UK’s position in the EU if our involvement, for the few years preparation will take, is little more than keeping bums on seats.

The Coalition has at least done some of the preparation in asking and thinking about what reforms Britain would like but that is no more than a Santa Claus wish list without a plan to achieve any reform.

A final thought along these lines is to put the new team under John Major’s charge.  He is the last British Prime Minister successfully to have negotiated any substantial matter with the EU.

A new ASI report finds a foreign player crackdown would do nothing to help England's football team

A new report released today by the Adam Smith Institute blasts the FA's proposals to crack down on foreign players, finding:

• No link between native play time in the Premier League and performance of English national team
• No link between amount of minutes played by Englishmen ten years ago and performance today
• A strong link between foreign players and Premier League quality

The FA's plan to crack down on foreign players in the Premier League would damage the league's quality and success in European club competitions, without any benefit to the English national team's performance, according to a new study from the Adam Smith Institute, an economic think tank.

In the first research of its kind, there was no link found between the time English players get on the pitch and the performance of the national team.

The report, "Sweet FA - Why foreign player crackdowns hurt English football", found this to be true for performance measured in FIFA points, world ranking, or placing at major championships—i.e. the World Cup and European Championship. This also goes for the other major leagues in Europe—Spain's La Liga, Germany's Bundesliga, and Italy's Serie A.

The report also rejected as baseless the claim that a reduced amount of playing time for English players five or ten years prior affected English international performance.

But the report did find evidence of a strong link between a league's UEFA coefficient and the prevalence of foreign players—leagues with more non-natives are stronger, and stronger leagues have more non-natives.

This suggests that Greg Dyke's scheme to tighten up work permit rules for foreign (or just non-EU) players would harm the English Premier League—the world's most popular and successful league—without any concomitant benefit to the English national team.

Paper author Ben Southwood, Head of Policy at the Adam Smith Institute, said:

"It is widely believed that England's perceived underperformance at recent international competitions owes something to the reduced fraction of minutes English players are playing in the Premier League—but up until now no one's really studied the question with any kind of rigour.

"My numbers are not final but they suggest there is no real link between the amount of football English players play in the Premier League (or across the top four European Leagues) and English international performance.

"If the reduced quantity of experience is a problem, then it is being balanced out by the massively improved quality—or something else".

For further comments or to arrange an interview, contact Kate Andrews, Communications Manager, at kate@old.adamsmith.org / 07584 778207.

The Adam Smith Institute is an independent libertarian think tank based in London. It advocates classically liberal public policies to create a richer, freer world.

Boris's BOGOF

Boris Johnson’s putative return to the Commons overwhelmed any publicity for his, or rather Gerard Lyons’s, strategic analysis of the UK’s in/out EU options: The Europe Report: A Win-Win Situation, released 6^th August.  Four possible outcomes are envisaged: staying in either a largely unreformed EU or one reformed to the UK’s liking.  The two departure options are seen as (a) good EU relations and pro-growth UK reforms and (b) poor EU relations and an inward-looking UK. Lyons makes the good point that “the UK can only achieve serious reform if it is serious about leaving, and it can only be serious about leaving if it believed that is better than an unreformed EU.”  The title would have you believe both staying in a reformed EU and leaving are “Win Situations” that we can either choose one or use it to achieve the other, i.e. Buy One and Get One Free.

Lyons has produced an important review of the issues facing each sector but, at the end of the day, his conclusions are based on simple assumptions of the economic outcomes from each option.  We do not need 108 pages of report, and 130 pages of appendices, to be told that the two high growth scenarios are more attractive than the two low growth ones.  Furthermore, the conclusion that the two high growth scenarios are economically equivalent is similarly based on heroic assumptions. Lyons’s Panglossian vision of the UK outside the EU and reforming itself begs a great number of questions.  The world is not ordered according to the way we order ourselves: trading with the EU will still be governed by EU regulations, likewise the US.

The paper has a number of failings: in particular it is not specific about the EU and UK reforms that would be needed, still less how they could be achieved and how likely that would be.  For example, the only hope of securing the EU reform the UK seeks is for the UK to show benefit for EU as a whole, not just the UK.  UK proposals to improve the EU market for financial services looks, to the rest of the EU, like UK self interest.  We know that the rest of the EU does not accept the UK arguments because it is outvoted every time.

How would, as Lyons suggests, the UK leave the EU whilst at the same time improving the UK’s EU relationships?  The chilling legal issue is EU Article 50 under which the remaining members decide the terms of the separation with no involvement of the departing member.  Obviously there would be negotiation so that may not be as ugly as it seems.  Trade would continue and we import more from the rest of the EU than we sell them but that is beside the point: could the UK protect its EU exports better than it could reduce its EU imports?  De Gaulle reckoned that the UK needed continental Europe more than vice versa and the 1960s proved him right.

We should welcome this report for its discussion of many of the issues but we cannot rely on its findings.  The City really does need to come up with a plan to protect its future but this is not it.

Time for a human rights review?

The Times law report (15^th July) concerned a Muslim school-age immigrant, granted asylum in France, who had come to the UK instead on the grounds that she was not permitted to wear the burka in French schools. She claimed that to be a human right and therefore the Home Secretary was wrong in seeking her return to France. The rights and wrongs of human rights and clothing indicating religion are not my concern.  The issue here is the extent to which foreigners are entitled to legal representation to fight their cases at UK taxpayers’ expense.  Some lawyers claim that justice has no price but can that really be so?

In this case, Mr Justice Hickinbottom refused a judicial review of the Home Secretary’s decision.  On 24^th June, the Court of Appeal, being the Master of the Rolls and two other Lord Justices, resoundingly supported the earlier judgment.  The appellant needed to show that there was a “flagrant violation” of the European Convention on Human Rights.  In this case, there was no violation at all, never mind flagrant.

Although the report does not say so, it is hard to believe that this school-age asylum seeker had the funds to cover the original hearing, still less the appeal. Perhaps we will be paying for a further appeal to the European Court of Human Rights itself even though the ECHR has already ruled several times that France is entitled to ban the burka in schools so long as it does not do so in general.  Other forms of education are available, e.g. distance learning.

Some will feel that an asylum seeker is lucky to be accepted at all and such acceptance should not entitle them, free of charge, to the full panoply of rights built up and paid for by the citizens.  Obviously as time goes by and they integrate, so their rights should build up but not immediately and certainly not before they have gained admission.

One solution would be to require asylum seekers as part of their acceptance to sign, with legal advice, a binding agreement that they are not entitled to legal aid until assimilated into the country as defined by learning the language to conversational level, paying UK taxes for, say, five years and not being found guilty of a crime normally punishable by a prison sentence.

Some will say that the last is both unfair and inefficient.  In effect they would be deemed guilty before being judged and self-defence by someone without the language would clog up the courts.  But the present system lands the UK taxpayer with the not inconsiderable cost of prison followed by a failure to expel them, as we legally can, because deportation is appealed and the Home Office is overwhelmed by cases.  The UK taxpayer funds not only the legal costs of asylum seekers’ “rights” but all the associated civil service, police and imprisonment costs.

Time for a review?

Steel tariffs to save a few jobs doesn't work if steel tariffs cost more jobs elsewhere

The Obama Administration has decided to impost steel tariffs over in the US. This is because, horrors, foreign companies were willing to sell steel to US consumers at prices they wanted to pay. The argument is that this will save jobs in the steel industry. And quite possibly it will: On Friday the Commerce Department imposed duties on hundreds of millions of dollars in annual trade with South Korea and eight other countries, including India, Vietnam, Turkey and Taiwan. As punishment for allegedly dumping steel into the U.S. market at unfair low prices, South Korea's exporters will face tariffs of about 10% to 16%, while smaller players from other countries face rates up to 118%.

As we all know, if some foreign wallah turns up offering you a deal, even if that deal has been funded by gouging foreign taxpayers, the correct answer is to say "Thank you , may I have some more?" But such is the power of the steel unions in the US that the authorities have caved and made steel more expensive for all Americans to please that one interest group.

If only people remembered a bit more of history, eh? Bush also imposed steel tariffs and the effects were:

The Consuming Industries Trade Action Coalition (CITAC) Foundation requested a formal examination of the impact of higher steel costs on American steel-consuming industries,1 and in particular, a quantification of employment losses at those companies. This study employed straight-forward and widelyaccepted regression analysis using a variety of price and employment data to maximize the reliability of the results.2 We found that: • 200,000 Americans lost their jobs to higher steel prices during 2002. These lost jobs represent approximately $4 billion in lost wages from February to November 2002.3 • One out of four (50,000) of these job losses occurred in the metal manufacturing, machinery and equipment and transportation equipment and parts sectors. • Job losses escalated steadily over 2002, peaking in November (at 202,000 jobs), and slightly declining to 197,000 jobs in December.4 • More American workers lost their jobs in 2002 to higher steel prices than the total number employed by the U.S. steel industry itself (187,500 Americans were employed by U.S. steel producers in December 2002).

That's not exactly an impartial report, this is true. But losing more jobs as a result of tariffs than there are in the entire industry you're supposedly protecting doesn't sound like a very good idea really.

Probably better to have let the steel industry shed a few jobs, offer retraining to those affected and allow the rest of the economy to expand off that cheap steel being subsidised, if subsidies there really were, by Johnny Foreigner.

City Regulation and the EU

Last month Business for Britain published research on the potential damage to the City from EU financial regulation.  This is an excellent report, full of content, and deserving of careful Whitehall consideration. It did, however, call fundamentally for the City to be regulated by the UK. 54 top City figures wrote to the Sunday Times (22^nd June) supporting this recommendation.  Business for Britain is right about the danger but their solution does not take enough account of the realities of the EU, whether the UK remains in or out. After explaining why their proposal is, frankly, unachievable, an alternative solution is advanced. EU control of financial regulation was President Sarkozy’s price for attending the London G10 Summit in April 2009. To save the Summit, or perhaps his own prestige, Gordon Brown agreed that Brussels would set future regulations, with member states (such as the UK) merely enforcing them. We highlighted the dangers of this in a letter The Times published in June 2009 and a report called Saving the City, but City bosses then seemed unconcerned.

The EU’s position is logical: a single market requires a single set of regulations, and as the main proponent of the single market in financial services, the UK should accept that. Against that, the EU’s lawmaking system is undemocratic and corrupt, and the City, the world’s second-largest financial market, will be at the mercy of 27 other states – most with no interest in its future success, and some that are openly hostile to it.  The UK with far the largest financial services market will have just one vote in 28.

The extent to which George Osborne has enabled the UK to claw back from that, and whether the claw back applies only to banks, is unclear.  As the Business for Britain report (p.19) says “Facing new regulations which it believes are prejudicial to the interests of the UK, the government is so far failing to shape regulation before it is proposed to the point where it supports that regulation; failing to stop the progress of the resulting regulations which it does not support; and then failing to win the resulting legal cases when it attempts to challenge them in the courts.”

A solution which would give comfort to Business for Britain and those of similar persuasion would be to allocate votes on the EU financial regulation committee pro rata to the skin they have in the financial game.  The UK would have about 75% of the votes but as other member states increased their financial services, they would also increased their share of votes. In effect it would still be a single EU market but the regulators would have a genuine interest in the health of the EU financial services market for the long term and its global competitiveness.

The naysayers, citing the 2008 crash, would say that the financial services people cannot be trusted with their own regulation but that is not what is proposed.  The UK financial services market has regulators independent of the traders and that would still be true for the EU.  To have regulation decided by member states that know nothing about it, as envisaged by the current arrangements, makes no sense.  One might as well have the dentistry regulator setting the rules for horse racing.

Leaving the EU is no solution as UK financial services would still be governed by EU regulation when trading in the EU (our largest customer) just as they are by the US when trading in the US.

Achieving this EU reform would not be easy but then none of the reforms we seek will be easy to negotiate.  Given the importance of the City, it should be a priority.

The EU's purpose may depend on tariffs

What does business want from the European Union? One answer is that of the Confederation of British industry, in its report Our Global Future, which I came across recently. That answer is that business wants to remain in – but ideally, in a reformed EU.

One reform they would like is open trade. The UK is well placed to trade with developing countries, but the high tariff (and non-tariff) external barriers that we sign up to as EU members make this nigh-impossible. Also, the CBI wants the single market to be completed. At present there is a single market in most goods (though often it is very much harder to export to other EU countries than it should be under the rules). But we are still waiting for a single market in financial services, in which the UK has a particular strength.

Will the CBI get the reforms they want? Unlikely. There are just too many vested interests wanting to prevent the UK's financial sector from getting in to their markets. And if the EU were to drop its barriers against foreign trade, why would anyone want to remain an EU member? They could quit and still get the free trade benefits. The EU would have no members left, except the ones living on its subsidies.

People dream of other scenarios. A Norway solution where, as an EFTA member, it enjoys access to the EU market. The downside is that it also pays a contribution to the EU despite getting no say over how its rules are made. But then the UK gets no say in how its export markets in the US, China and elsewhere set their rules either. The Switzerland arrangement has been mooted. It has negotiated scores of bilateral trade deals with the EU. But it is a very complicated set of arrangements. Another model is Turkey, part of a customs union with the EU. But again, it faces non-tariff barriers and has no say in things.

Sadly the EU cannot grant any such arrangement to anyone – otherwise the whole membership, led by the UK, would be queuing up to demand the same concessions. So I remain skeptical that the EU can be reformed in any meaningful way. Of course, if you believe it has a mission in promoting ever-closer political and cultural union, it still has a purpose. But economically, it can only stick together if it keeps its trade barriers high. That is not good for the EU, nor the world.

The costs of a government-sponsored crisis

Accusations of child neglect are surfacing in the United States as leaked photos from Arizona and Texas border patrol processing centers show hundreds of migrant children sleeping in razor-lined cages. Thousands of unaccompanied minors, who have narrowly escaped from dangerous, cartel-infested areas of Central America and Mexico, have been brought into federally-run boarder patrol centers, only to receive further inhumane treatment. The photos reveal that minors – many young girls under the age of twelve – are left unsupervised, crowded into caged cells along with hundreds of their peers, and forced to sleep on the ground.

Since the leak, new regulations have come into effect. According to Patrol Agent Charge Leslie Lawson’s memo obtained by Townhall, steps were taken on June 6th to change procedures at one of Arizona’s border detention facilities:

Effective immediately, the use of personally owned cellular phones, cameras, or recoding devices in the Nogales Dentition Facility and Nogales Processing Center is strictly prohibited.

Forget the living standards of the kids; Patrol Lawson decided to get tough with the whistleblowers instead.

Despite (tragically) popular belief, millions of illegal immigrants residing in the U.S. are hard workers, adding net value to the U.S. economy. Roughly 11 million illegal U.S. immigrants are providing nearly $11billion worth of revenue per year through state and local tax payments – an amount that is estimated to skyrocket by billions if more immigrants earn a legal status (not citizenship – just a legal status). Furthermore, over half of illegal immigrants voluntarily choose to pay income tax, knowing they’re very unlikely to see a social security paycheck or Medicare subsidies down the road.

Meanwhile, the U.S. spends over $18 billion a year on immigration enforcement to keep their young counterparts locked in cages.

Yes – we can debate the specifics of immigration reform; but U.S. citizens and illegal immigrants alike can probably agree that $18 billion is far too much to be spending on a government-sponsored humanitarian crisis.

The eurozone is in dire need of nominal income targeting

It may well be that, in the US and UK, nominal GDP is growing in line with long-term market expectations.* It may well be that, though we will not bring aggregate demand back to its pre-recession trend, most of the big costs of this policy have been paid. And so it may be that my pet policy: nominal income/GDP targeting, is only a small improvement over the current framework here in the UK or in the US. But there is one place that direly needs my medicine. As a whole, the Eurozone is currently seeing very low inflation, but plenty of periphery countries are already suffering from deflation. And this is not the Good Deflation of productivity improvements (can be identified because it comes at the same time as real output growth) but the Bad Deflation of demand dislocation. The European Central Bank could deal with a lot of these problems simply by adopting a nominal GDP target.

When it comes to macroeconomics, the best analysis we really have is complicated econometric models on the one side, and highly stylised theoretical models on the other. Both are useful, and both can tell us something, but they rely on suspending quite a substantial amount of disbelief and making a lot of simplifying assumptions. You lose a lot of people on the way to a detailed theoretical argument, while the empirical evidence we have is really insufficient to conclusively answer the sort of questions I'm posing.

In general, I think that very complex models help us make sense of detailed specifics, but that "workhorse" basic theoretical models can essentially tell us what's going on here. Unemployment is a real variable, not one directly controlled by a central bank, and a bad thing for the central bank to target. But in the absence of major changes in exogenous productivity, labour regulation, cultural norms around labour, migration and so on, there is a pretty strong relationship between aggregate demand and unemployment. Demand dislocation is almost always the reason for short-run employment fluctuations.

Unemployment rose everywhere in 2008-9. But it nudged down only marginally post-crisis in the Eurozone, whereas in the UK and US it soon began to steadily fall toward its pre-crisis rate (the red line, though not on this graph, has tracked the green one very closely). In the meantime the Eurozone rate has risen up to 12%. This is not at all surprising, given the almost complete flattening off of aggregate demand in the Eurozone—this means a constantly-widening gap with the pre-recession trend (something like 20% below it now).

Although intuitively we'd expect expectations to steadily adjust to the new likely schedule, three factors mean this takes a while: firstly the ECB is very unclear about what it is going to do (and perhaps unsure itself), secondly some plans are set over long horizons, and thirdly the lacklustre central-bank response to the 2007-8 financial crisis is unprecedented in the post-war period.

1. We have a huge literature on the costs of policy uncertainty—the variance of expected outcomes has an effect on firms' willingness to hire, invest, produce, independent of the mean expected outcome.

2. Many firms invest over long horizons. It may have become clear at some point in 2011, when the ECB raised interest rates despite the ongoing stagnation and weak recovery, that the macro planners, in their wisdom, were aiming for a lower overall growth path and perhaps a lower overall growth rate in nominal variables. And so, after 2011 firm plans started to adjust to this new reality. But many plans will have been predicated on an entirely different 2009, 2010, 2011, 2012, 2013, 2014, and so on. And as mentioned before, the gulf between what was expected for the mid-2010s back in 2007 and what actually happened is actually widening.

3. Thirdly, and finally, the period 2008-2010 is unprecedented and will have slowed down firm adjustment substantially. As mentioned above, even if firms set plans with a fairly short-term horizon (a few years) they wouldn't have been able to adjust to the new normal in 2008, 2009 and 2010 unless they really expected the ECB's policy of not only not returning to trend level, but not even return to trend rate!

All of these three issues are convincingly resolved by nominal income targeting. It's very certain—indeed the best version would have some sort of very-hard-to-stop computer doing it. It promises to keep up to trend. And it is very stable over long horizons.

Recent evidence reinforces the view, implicit in our models, that (unconventional) monetary policy is highly effective at the zero lower bound, even through the real interest rate channel (!) All the ECB needs to do is announce a nominal income target.

*This reminds me: isn't it about time we had an NGDP futures market so we could make claims here with any kind of confidence?

Why Labour's rent controls will do more harm than good

Now that we have more detail, Labour’s new ‘rent control’ policy is not quite as bad as I'd initially feared. Instead of the old school price ceilings that destroyed parts of New York City, Labour are proposing ‘second-generation rent controls’, which limit the ability of landlords to renegotiate rents during tenancies, and ‘make three-year tenancies the norm’.

The real-world effects of this are likely to be that expected rent increases over the three-year lease will be priced in to the starting rent, so it’s unlikely to actually make anyone better off unless there’s an unexpected increase in rents. If rents fall below expectations, this would hurt tenants.

Since landlords are bound within tenancy agreements, rises in rents are likely to be sharper than they currently are for new tenants. This means that housing mobility is likely to be reduced – tenants locked in to a relatively low rent will find it more costly than they otherwise would to move. This is very important: it looks as if lowered housing mobility causes higher unemployment, because people are less able to move to find new jobs.

Rent controls of any kind are likely to decrease the supply and quality of available housing. ‘Second-generation’ controls are less tight and so less harmful than classical rent controls, but as Hopi Sen has pointed out, the German experience does not seem encouraging. There, rents have risen far more quickly over the past decade than they have in Britain, as new construction has slowed.

There is also evidence to suggest that second-generation rent controls have a similarly negative impact on housing quality as classical rent controls. A 1985 study by the Richmond Fed found that controlled housing units were 7.1% lower in quality in 1974, and 13.5% lower in 1977, pointing to a cumulative negative effect. If classical rent controls are only worse than bombing, second-generation controls may be close to petty vandalism.

One interesting aspect of this announcement is that it may affect supply now, as would-be investors in new housing are discouraged by the prospect of stricter controls on their investment. If the measures are actually brought in – crossing the rent control Rubicon – an expectation of tighter controls may reduce supply even more.

It’s not clear what mechanism Labour is proposing to make three-year tenancies ‘the norm’, but it’s hard to imagine any effective measure that would not end up hurting tenants who want shorter leases. This probably means young people.

As we say virtually every day, the best way to reduce the cost of housing is to build more. Labour’s proposals seem counter-productive, but they’re nothing compared to the harm caused by the planning system.

We recently learned that more of Surrey is covered by golf courses than by houses. Rolling the green belt out even a bit – by, say, a mile outside London – would create space for hundreds of thousands of new homes, relieving pressure on existing housing stock, reducing rents and – a nice bonus – creating lots of jobs and adding a few percentage points on to GDP growth. We can dream.