Thursday, 30 April 2015

Immigration helps the natives

At some point in the middle of 2014, opinion polls in the UK revealed that immigration became the most important issue in Britain (see graph below), surpassing even the debates on the economy (probably because the economy is now in a better shape than before, with 2014 growth around 2.6%). What best showed this change in sentiment was the homepage of the British Office for National Statistics (ONS) during the autumn of 2014, where the first figure you could see was that of net migration (which was around 300,000 in 2014). During the 'good old times' of the stagnant recovery (2009-2013), the first thing you could see when you entered the ONS website were the GDP growth estimates, followed by numbers for the CPI, budget deficit, business investments, etc. For quite some time the main page didn't even feature data for the debt and deficit. You had to dig around to find them.

Obviously the Britons are bemused with the popularity of the UK Independence Party, particularly after their unprecedented triumph at the EU Parliament elections in May 2014. They are a party which was originally focused on a single goal - get Britain out of the EU. To that goal they have added a plea to "take back control of our borders", or in other words, limit immigration. And they've landed in a gold mine. As mentioned before, according to survey data, Brits consider immigration the most important issue facing Britain, overtaking even unemployment, NHS (always an important topic in Britain) or the economy. Notice how these issues correspond to varying historical periods. Back in the 80-ies and the 90-ies unemployment was the biggest issue, followed by the NHS and immigration in pre-crisis times, overtaken completely by the economy during the crisis and the recovery, until last year when immigration started gaining momentum. The recent opinion polls confirm this trend - immigration is still the hottest issue in the country, just a few weeks before the elections. 
Source: The Economist. Click to enlarge.
The Conservative government was quick to respond to these trends. But not for reasons one would immediately think of. The Conservatives were simply afraid of UKIP's growing popularity, afraid that in the national elections UKIP will take many of their own voters thus causing them to lose the elections to Labour (although these fears have receded lately, as the race became neck and neck, and as the Tories are looking to UKIP as partners in their new government). Two Tory MPs have already defected away from the party, gaining two seats for UKIP in Parliament (UKIP has never held seats in Parliament before). This only further increased their popularity and their presence in the media, where their ideas to curb immigration (among other things) are gaining more and more political clout.

As a response the PM David Cameron has announced a tougher stance on immigration, and has even promised an in-or-out EU referendum for Britain if elected as Prime Minister once again. He has also announced changes in restrictions on EU migrants as a point of further negotiation between UK and the EU, aiming to restrict even the EU incoming migrants. Under current EU laws this would be prohibited since it would violate the assumption of freedom of movement and equal status of all EU citizens. Which is exactly why UKIP is calling for an EU exit, stating that "Britons must leave the EU if they want to cut immigration." 

"They took 'r jobs!"

It's hard to tackle such an issue in purely economic terms. Politics has to be involved. You will hardly find an economist opposing immigration, just as you will hardly find an economist opposing free trade, or promoting rent control. However this doesn't prevent politics from imposing immigration restrictions or tariffs and quotas. All for the - supposed - protection of domestic jobs. But in economic terms it is fairly obvious that protection of jobs steaming from immigration restrictions causes much more problems than benefits. 

The anti-immigration argumentation suffers from the typical fallacy that the demand for work is limited so that by giving a job to one person means you're taking it from someone else. Even though this seems quite intuitive at first (higher supply simply implies the price going down if demand stays the same), the fact is that immigration doesn't just increase the supply of labor, it also increases the demand for labor, since immigrants earn salaries they spend in the city they reside. They pay rents, buy food, clothes, cars, houses. They add to the demand for other goods and services out there, thus increasing the overall demand for labor. The exact same thing happens when a young graduate enters the job market - they don't steal a job from anyone, they simply increase the demand for jobs. Firms expand, economies grow. More people can only be a good thing for an economy over the long run. Think about why countries facing depopulation are in big problems. Those facing net immigration surely aren't. At least in economic terms.  

An article in the New York Times sheds some evidence on this 'Lump of Labor' fallacy: 
"The single greatest bit of evidence disproving the Lump of Labor idea comes from research about the Mariel boatlift, a mass migration in 1980 that brought more than 125,000 Cubans to the United States. According to David Card, an economist at the University of California, Berkeley, roughly 45,000 of them were of working age and moved to Miami; in four months, the city’s labor supply increased by 7 percent. Card found that for people already working in Miami, this sudden influx had no measurable impact on wages or employment. His paper was the most important of a series of revolutionary studies that transformed how economists think about immigration. Before, standard economic models held that immigrants cause long-term benefits, but at the cost of short-term pain in the form of lower wages and greater unemployment for natives. But most economists now believe that Card’s findings were correct: Immigrants bring long-term benefits at no measurable short-term cost."
Political implications 

Economics isn't the only part of the equation. An even bigger concern about immigration than job losses for domestic workers are benefits being taken by immigrants. The usual accusation is: "they've contributed nothing but are taking away from the system". This is particularly troubling in Britain which has universally accessible health care and welfare services, which according to the prevalent opinion of the British population, tend to be overcrowded by immigrants.

A further issue is the problem of assimilation of immigrants. There can exist entire neighborhoods where no one even speaks the language of the country they're in. This is a problem both the US and Europe are increasingly facing. Many immigrants cluster in certain neighborhoods where apparently the same rules don't apply. By doing this they self-select themselves out of the domestic society and it becomes very hard for them to assimilate. Particularly for the first-generation immigrants. There is always an issue of respecting one's culture, but in some cases this may go too far where the minority fails to respect the culture of the host nation. As crime rates increase in such areas, that's when the issue truly becomes political. And then it's quite difficult to use economic reasoning to solve the immigration issue. No one wants to hear about the long term benefits of net immigration, or how they increase domestic productivity, if violence is escalating (just think of France). If the benefits are not immediate and quite obvious, no one really takes them into consideration. It's easier to make inferences on our immediate observations. After all, we have a tendency of highly discounting the future. 

However the most interesting thing about surveys of opinions about immigration is the location and the relative exposure to immigrants. For example in London, one of the most multicultural cities in the world, its citizens share the most liberal views about immigration. As you move further down the line, the less immigrants a constituency has, the more likely it will see immigration as a crucial issue. People like to exaggerate as well. In the same survey measuring sentiment towards immigration, the people were asked how many foreign-born immigrants are there in the UK. The answer on average was 31% of the population. The actual number is 13%.

In the next text I'll present some more evidence on immigration vis-a-vis job creation, labor market performance and education. 

Sunday, 19 April 2015

Graph of the week: Happy, happy Europe

From the Economist, calling upon a report from Eurostat: what drives happiness in Europe and how heterogeneous European countries tend to be when it comes to the satisfaction with their living standards. 

Source: The Economist
"ONE frequent stumbling block for the European project is the fact that different countries want different things. Recent Eurostat polling on self-reported happiness highlights those divergences. As usual, Scandinavians are the happiest people in Europe and retired Danish women are the cheeriest among them, reporting a happiness score of 8.5 out of 10. In general, geography is the best predictor of merriness, followed by pay. At all income levels a step up one quintile on the income scale makes people more content. Yet the poorest 20% of Danes are more joyful than the richest Greeks."
Bear in mind that the data on happiness is self-reported, which can make it a bit biased. However, even with all the problems of self-reported survey data, the story is quite clear and actually well-known: Scandinavian nations - the leaders in economic freedom rankings, competitiveness, doing business, and prosperity rankings - by far outweigh the rest. Their economic model is based first and foremost on efficiency. There's no ideology attached to it, only pragmatism. If something works, apply it. South European nations, namely Spain, Italy, Greece and Portugal, should take note. 

Notice another interesting fact; usually life in the South of Europe is portrayed as relaxed and easy-going, implying its people are quite content with their lives. Warm climate in the South must mean that its citizens are much happier than their Northern counterparts, consumed with heavy rains and cold weather. The data on happiness consistently fails to show this. Regardless of the effect of the crisis, Northerners were always much happier. Climate has nothing to do with it. The economy (read: institutions) does. 
Source: The Economist
"Where one lives within a country is also important. Around the Mediterranean people prefer towns, while near the Arctic Circle rural life is best. Procreation affects cheerfulness too. In southern Europe families with children are happiest, whereas the British and Irish are the only people to become sadder when little ones arrive. Ageing draws out differences. Everyone is happiest when young and less so in middle age. But in old age the British and Scandinavians cheer up while in the south retirement is a miserable affair. Debt crises and financial woes are not the only reason life within Europe is so often frowned upon."
The last part is the most interesting: "in old age the British and Scandinavians cheer up while in the south retirement is a miserable affair". The British and the Scandinavians (I would add the Germans as well) understand the value of life-long savings. Their institutional arrangements make it so. This is another crucial North-South European divide. The more care-free the citizens are at the start of their careers (see happiness in ages 16-24), the worse off they get when they are retired (notice the movement of the yellow circle across age groups in the second figure). Tough news for the youth unemployed of Spain, Greece, Italy and Portugal. Will they ever get to enjoy their lives? Or is this the beginning of a truly lost generation in Europe?

Tuesday, 7 April 2015

Rent-seeking explained: Removing barriers to entry in the taxi market

The taxi market is undoubtedly one of the best examples of something economists like to call rent-seeking. What does this phenomenon stand for and why do economists (particularly political economists) devote a lot of attention to it? 

The classical definition was given by Gordon Tullock back in his 1967 seminal paper "The welfare cost of tariffs, monopolies and theft", even though the phrase itself was coined by Anne Krueger in 1974Rent-seeking is a process of gaining private benefits through the political process (by lobbying or logrolling for example). It implies gaining protection for a certain privileged group, which in return promises political support, large campaign contributions, or even bribes. This protection varies from giving a monopoly status to a certain company, regulating market entry than hampers competition (such as introducing licences to specific occupations), imposing tariffs to import goods to protect the domestic industry, handing out subsidies to politically chosen "winners"; etc. Rent-seeking most precisely paints the picture of how politicians, when they follow their self-preservation incentives, create outcomes that reward special interests, very often at a huge cost to the 'public interest'. It is therefore a term that co-exists with the political economy analysis of interest group behavior. Interest groups are formed to seek (i.e. lobby for) rents; privileged benefits for the few at the expense of the many. 

Rents are thus the inevitable monetary or non-monetary outcome of rent-seeking (quite different from the rents one pays to their landlord, which is the first thing that comes to mind). They are always created via the political system willing to hand out monopoly status or special privileges to certain businesses. It’s hard to achieve monopoly status in a competitive marketplace, as there will always be someone to offer a more efficient or customer friendly way to exploit the price differential and take over a portion of demand. So, governments, not markets, create monopolies. 

Governments are the ones handing out licences that limit the supply and thus increase the price of the good/service. They are based on negative signals that allow a business to prosper simply because this business had enough money to pay for its privilege of being the only service provider. If you go back in history you will find out that most big corporations were founded as state monopolies (e.g. the British East India Company), or were founded as so-called natural monopolies (telecommunications, railways, power grids, water supply, sewers, public transportation, etc.). These companies were public to begin with, but very often in many countries their privatization didn't imply they got striped off their monopoly status. Herein lies the problem as these companies carry on with their legal (and legitimate) rent extracting behavior, all regulated under the state, and with multiple corruption incentives arising in the process. The outcome is of course mass inefficiency. 

Licences for taxis 

But let's stick to the licencing issue. The text started by referring to the taxi business and how they seem to be an excellent example of rent-seeking. Before I lay out how this works, consider the following paragraph from the Krugman and Wells "Economics" textbook (a very good Econ 101 textbook, if I may add): 
"New York City is a place where you can find almost anything - that is, almost anything, except a taxicab when you need one or a decent apartment at a rent you can afford. You might think that New York's notorious shortages of cabs and apartments are the inevitable price of big-city living. However, they are largely the product of government policies - specifically, of government policies that have, one way or another, tried to prevail over the market forces of supply and demand."

Housing shortages are a natural consequence of rent control (something, I believe, Hayek was the first to write about in "The Constitution of Liberty"), while the problem of the taxi market is serious lack of competition that's pushing the price up and limiting the supply.

Here is how it works on the taxi market. Drivers of taxis decide to set up an interest group (a lobby organization, sometimes even a union), to lobby City Hall (since this is usually a local market), for the introduction of a taxi licence. This licence would restrict market access to any competitor that wishes to freely enter the market. The justification for introducing the licence is market regulation (setting up standards that only a selected handful of drivers can concur to), safety, etc. But the real logic behind it is to gain monopoly power, in order to be able to charge a high price for a sub-par quality service. This is what rent-seeking is all about. Seize a unique opportunity to charge a high premium for your low effort (picking the low-hanging fruit, as Tyler Cowen would say). Furthermore because of the licence supply is limited (read: inadequate to satisfy the market), which necessitates the drivers to charge high prices (low supply + high demand = high price). 

There is another side of the story as well. The politicians. Why would such a scheme be worth it to them? Because they care for having the market regulated by licences in order to provide high standards to the customers? Certainly not. If this is the rhetoric they use to justify the licence, it's certainly not the reason why they do it. The reason is much more superficial - the opportunity for bribes. In order to give out a licence the city politicians establish a Commission (like this one in NYC). The Commission (or even a city legislature committee) oversees the distribution of licences and decides who gets to enter the market. The taxi drivers then lobby this committee to grant them the special privilege and in the process bribes can be made. As a spilover effect legislators try very hard to get placed in the licence committee (it works like this in Congress/Parliament as well - some committees are simply more attractive than others; it's not always due to bribes, it's also to do with power and the size of the budget at their disposal). Furthermore, the overall welfare effect of the licence is negative (a deadweight loss) since higher prices of taxis imply people spend less in other markets. The relative prices get distorted (the same thing happens with taxation or tariffs, there is always a welfare loss for the consumers and for the society as a whole). It's a classical monopoly story:

Source
How to fight this?

In theory, easy - liberalize the taxi market. In practice, much harder. It involves the politicians to willingly reduce some of their own benefits (bribes or power). For the taxi market example these need not be very high (which is why we do in fact observe liberalizations of taxi markets in some countries), however in general, curbing rent-seeking and monopoly power of state enterprises can be very difficult. It rests upon first and foremost reducing political power and therefore their inherent ability to extract rents. This is the difficult part, particularly since there is a large veil of informational asymmetry operating on such markets. 

The second problem relates to the other actor on the market - the drivers (i.e. the monopoly). And while it's easier to get public support to dismantle a public monopoly, it's harder if this includes protests. It's quite logical to expect protests - the people are protecting their jobs. After all, no one likes competition, particularly if you're operating as a monopoly. 

But as in most breaking up of monopolies, the taxi market should follow the same pattern. Making barriers to entry smaller and licences cheaper would increase the size and the efficiency of the market. The oligopolists would be hurt. But this is a signal to them as well to reallocate and respond properly to the market forces. If in this process some taxi drivers lose their jobs, they will get hired by the competition. This is what usually happens in a skills-specific occupation such as this one (not that it's a very unique skill, but it's a specific type of job), once the licencing monopoly is broken. It happens with the break-up of other monopolies as well. People with a specific set of skills get hired by the new entrants to the market (who need these types of skills), while some re-specialize in another line of work. This very often leads to the rise of entire new industries and entire new careers. Nothing proves as a better example of this than the UK, and more specifically London, in the 1980s and 1990s

What about political rents and the limit of political power? In my political agency research I call for the limit of political power. Politicians play a repeated tit-for-tat game with the voters in which they try and conceal their true type and the amount of their rent-extraction to get re-elected. Their success depends on their patience (one might even say greed), i.e. on how much are they willing to decrease their rent-extraction temporarily in order to win office for the next term. Their decisions determine the amount of rent-extraction and the amount of waste within a society. If this is too high, they lose office, if it's too low, then it's not enough to satisfy the basic needs of the voters. The trick is to balance between the right amount they would like to extract for themselves and what would keep them further in office. This implies the existence of an optimal threshold above which it isn't profitable to extract rents (in terms of utility maximization). 

Therefore the only way to constrain and prevent the politicians from wasteful spending is by limiting their power. Here is where a number of factors need to be accounted for. The separation of power is one, the media is another. It matters to which extent those holding legislative or executive office can influence those holding judicial office or the media. If this power is substantial, then the voters are on a loss, as it will be hard to remove a wasteful politician from office. If liberties are restored and the media is not captured, then it will be much easier and the power of politicians will be substantially limited. So the problem of rent-extraction and rent-seeking can be solved in an institutional environment that will disable politicians from misusing it. How to achieve this is a bit more trickier. But that's another issue, left for another blog post. 

Tuesday, 17 March 2015

Graph of the week: Returns to education

Is higher education worth it? According to the latest report from PayScale (HT: The Economist), the answer is: it depends on what you study. An obvious answer, but let's look at the data nonetheless:

Source: The Economist
 Here's the main result:
"Engineers and computer scientists do best, earning an impressive 20-year annualised return of 12% on their college fees (the S&P 500 yielded just 7.8%). Engineering graduates from run-of-the-mill colleges do only slightly worse than those from highly selective ones. Business and economics degrees also pay well, delivering a solid 8.7% average return. Courses in the arts or the humanities offer vast spiritual rewards, of course, but less impressive material ones. Some yield negative returns. An arts degree from the Maryland Institute College of Art had a hefty 20-year net negative return of $92,000, for example."
You can check out the distribution of all occupations in more detail on the following link. The data is for US universities.

This is a topic I've covered on several occasions on the blog. Mostly in terms of the new trends in education and how the IT revolution is changing everything, particularly in the demand for (and consequently supply of) jobs. In addition there is an increasing trend of enrollment into college, so that too is placing a dent in demand, and is, in one way, affecting the inequality problem as well.

So what should we conclude from data such as these? Well, most obviously, it's not getting any easier for those studying arts and humanities. Their negative return to education adds to the widening of the inequality gap, particularly if you account for the student loan bubble. To return a student loan once you get a job is hard as it is, imagine how difficult it can be if your return to education is actually negative. 

However, I don't think this situation will persist for too long. The supply and demand of programs in humanities and arts will eventually adjust downwards. As they did so many times before for so many different occupations. As this ineviatble trend keeps on going universities will have to ajdust their supply of such programs and enroll less studnets, or substitute the student intake from arts and humanities with the programs for which the demand is high (or higher). This doesn't mean that there will be no more students studying arts and humanities, it just means there will be less of them since there are less such jobs available. 

Universities and the labor market must work hand in hand. If the demand on the market changes so must the supply of university programs. Otherwise you're only creating a new flock of unemployed, thus adding to the negative picture of the labor market. This is particularly noticable in Europe, whose public universities tend to react even slower to any changes in demand on the labor market. Data like these are important precisely because they show the universities how to adjust the supply of their programs. It's not the only thing they should look at, but it's an important parameter nonetheless. 

Sunday, 1 March 2015

The Greek reform plan: an epilogue of the Greek tragedy?

It's been a rough few weeks, but Europe and Greece have finally reached an agreement. Or to be more precise, the Greeks have caved in to the demands of the financial markets, just as I predicted they would in my last blog post. Again, I hate to blow my own horn (but let's be honest, I need to); I was right once again in predicting the outcome in Greece. This aligns well with my track record of being correct on Greece in 2011, 2012, 2013 and, well, 2015. Just saying. 

So what was in the new deal? In a nutshell here is what the Greek government has pledged to do in return for the extension of the Eurogroup bailout program (much needed to maintain solvency of the Greek government):
  • Combat tax evasion (new tax policies): broadening the definition of tax evasion and fraud, while disbanding tax immunity. This includes reforming the collection of VAT (introducing technology), modernizing the income tax code, and altogether creating a new culture of tax compliance. Keep in mind that the Greek finance ministry fails to collect 30bn euros each year due to tax evasion (that's 10% of their gross public debt! Annually!)
  • Reform public sector wages to avoid further wage cuts, without increasing overall wage bill
  • Improve government efficiency and cut spending this way: more control over all forms of spending in the central and local government, in the health system, and particularly at cutting benefits for non-eligible beneficiaries (i.e. fraudsters)
  • Fight corruption: the government plans to make this a priority. Particularly in its aim to curb money laundering and smuggling of fuel and tobacco products.  
  • Continue with privatization: they've made a commitment not to halt the already introduced privatization schemes and even to review the privatizations not yet implemented with an aim to maximize the government's short term benefit (Wow! How's that for a leftist political platform?)
  • Labour market reform: they plan to introduce a new way of collective bargaining, stopping short of raising the minimum wage immediately, with an approach aimed at balancing flexibility with fairness (now isn't this something you can read in a standard economics textbook?)
  • Tackle Greece's "humanitarian crisis" with housing guarantees and free medical care for the uninsured unemployed (plus things like food stamps for the poor, and even an experimental minimum income scheme), but with no overall public spending increase
  • Pension system modernization: achieving pensions savings by consolidating funds and eliminating incentives for early retirement, however without cutting payments (this is an incomplete measure which should be re-considered since Greek pensions tend to be among the highest in Europe, and in some categories the average pension is higher than the average salary!)
  • Reduce the number of ministries from 16 to 10, cutting special advisers and fringe benefits for officials, in an aim to further cut down government inefficiency, and hence spending. This includes an overhaul of spending across every ministry, with an aim to reorganize non-salary and non-pension spending (which tends to account for 56% of total public spending!)
A more detailed list, with some measures not mentioned above, is available here in a letter from Varoufakis and summed-up here.

All of these sound really good actually. And very, very far from something a left-wing government would propose (which isn't too surprising). Christine Lagarde of the IMF even calls them "too optimistic". Even if this is true and even if it does take a long time for some of these measures to take effect (such as the new culture of tax compliance), there is no doubt this is exactly the reform package Greece needs. Too bad it didn't start doing it back in 2011.

Europe (read Germany) accepted the plan and extended the bailout deal for another four months. How did the Greek voters react? Violently, as usual. At least those voters who felt betrayed. Which is, again, exactly what I predicted would happen: Tsipras will follow the rules of the financial markets, which his voters will interpret as a betrayal and a renege of his campaign promises (at least on the promises he made in the beginning of the campaign). Luckily once you come to power and face the consequences you start realizing reality, even though the same cannot be expected of your voters. 

The tax evasion issue

The most interesting reform proposal is surely the one on clamping down tax evasion. A welcomed policy indeed. But the number I stated earlier (30bn euros) doesn't even begin to describe the extent of this problem.

First off, just take a quick look at the picture below: 

The source is this great paper from Artavanis, Morse and Tsoutsoura on tax evasion in Greece. Their main finding is that contrary to popular belief that only the super-rich are avoiding to pay their taxes, it is actually the middle classes (the upper middle classes to be precise) which are dodging their taxes. This makes a lot of sense, as 30bn euros is too much to link it only to the super rich. The problem must be more widespread. And it is. Basically across the Greek society. In the map above, you can see that tax evasion is even almost evenly distributed geographically (I don't know too much about Greece to comment on the geographical heterogeneity; there must be a reason why the Peloponnese peninsula, the greater Athens area and the island of Crete have the highest number of tax evaders). But the interesting area is the one circled. As the authors note, this is Larissa, "an area...that has the largest number of Porsche Cayennes in Europe". Talk about feeling sorry for the middle classes, huh?

The authors note that the primary tax evaders in Greece are doctors, engineers, private tutors, accountants, financial service agents and lawyers. Not surprising is it? But more problematic is this: "Testing the industry distribution against a number of redistribution and incentive theories, our evidence suggests that industries with low paper trail and industries supported by parliamentarians have more tax evasion." 

It gets better:
"On average, self-employed Greeks spend 82% of their monthly reported income servicing debt. To put this number in perspective, the standard practice in consumer finance (in the United States as well as Greece) is to never lend to borrowers such that loan payments are greater than 30% of monthly income. ...
... Take the examples of lawyers, doctors, financial services, and accountants. In all of these occupations, the self-employed are paying over 100% of their reported income flows to debt servicing on consumer loans."
As you might have figured it out this doesn't mean that the Greeks in all these occupations spend their entire income on servicing debts, but that their incomes are massively underreported.

As I've said countless times before, the Greek problem really is systemic. There is nothing ideological about it. Which is why ideology has to be removed when designing the remedies for Greece. In the current reform plan this seems to be the case, more or less. Let's hope they stick to it.