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Cut Red Tape to Boost Growrth? Start With Immigration

23/08/2012 10:00 BST | Updated 22/10/2012 10:12 BST

With the economy persistently weak, there is a growing consensus among economists that premature austerity has done considerable unnecessary damage, and that there is a strong case for slowing fiscal consolidation - at least to restore some of the unnecessary and damaging cuts to public investment (which have been the source of most of the deficit reduction so far). However, others have instead argued that the problem is not on the demand side, but on the supply side, and that what is needed is a radical programme of deregulation - "cutting red tape" - especially in the labour market.

The argument to focus on the supply side to boost growth is both wrong and right. It is wrong because in the short term, the main thing holding the economy back is lack of demand, the result of misguided macroeconomic policy, both here and globally (especially the eurozone). As the IMF put it it its latest report, upfront and in bold:

"The recovery has stalled... with current policy settings the pace will be insufficient to absorb significant slack in the economy, raising the risk of a permanent loss of productive capacity. Demand support is needed."

But just because the main short-term problem is lack of demand does not mean that we should not worry about the supply side. Indeed, almost all economists would agree that over the medium to long term, what really determines growth, jobs and prosperity is indeed the health of the supply side of the economy. So, even while recognising that they will not be a panacea in the short term, the ideas of the supply-siders should nevertheless be examined on their merits. Increasingly, they focus on the labour market. Liam Fox, for example, said:

"To restore Britain's competitiveness we must begin by deregulating the labour market. Political objections must be overridden. It is too difficult to hire and fire and too expensive to take on new employees."

Subsequently, an independent report commissioned by the government from Adrian Beecroft addressed Fox's point by proposing (in addition to some fairly minor changes) the introduction of a form of no-fault dismissal. It was deservedly mocked (if you haven't read Richard Lambert's brilliant parody, do so!). More generally, numerous more informed commentators (including, commendably, Vince Cable, commenting on the report his own Department had commissioned) have pointed out that the Fox/Beecroft line of argument is remarkably difficult to justify with any actual evidence.

However, this didn't deter everyone: for example, Bruce Anderson argued that the government should implement the Beecroft Report in full, because:

"rights without jobs are a mere mockery, and the excessive emphasis on rights has deterred employers from taking on new workers, unless they are Eastern Europeans, who proclaim their willingness to work with every molecule of their being."

As I explain here, this is utterly ludicrous; perhaps 85% of new hires are British workers. In fact, overall the UK labour market has performed extraordinarily well of late. Hiring - given economic conditions - is surprisingly healthy, and employment is rising, despite weak or no growth . Labour market economists, and international organisations like the OECD, agree that three decades of successful reform have given the UK a flexible and generally well-functioning labour market, by international standards. There is no reason to believe regulation is currently a significant barrier to job creation. This suggests that - while doubtless there are improvements that could be made around the edges - there is little to gain from further wholesale deregulation. Spain and Italy need radical labour market reform; we don't.

But that doesn't mean we should stop looking for areas where we could improve the supply side. And indeed there is one aspect of labour market regulation where sensible deregulation is urgently needed, and could genuinely boost UK growth. This is immigration. Now immigration rules are not generally what either economists or policymakers think of when they talk about labour market regulation. But of course restrictions on those who want to come here, or stay here, to take up employment or to look for a job are exactly that: they are government regulations that change the way the labour market functions.

So the changes to skilled migration introduced by the government - a set of new burdensome and bureaucratic rules and regulations, including a quota on skilled migrants - are new labour market regulations. Indeed, in contrast to almost all other such regulations, which are at least designed with an eye to ensuring that the benefits to employers and employees outweigh the costs, these changes were designed expressly to make it more difficult for businesses to employ the workers they want.

As a consequence, they will reduce growth and make us poorer. And these impacts - áccording to the government's own estimates - are potentially very large. As I said in my testimony to the Treasury Select Committee after the 2011 Budget:

"The extra employment regulation that the Government has imposed on employers wishing to employ migrant workers--the cap on skilled migration--will, using the Government's own methodology, reduce UK output by between £2 and 4 billion by the end of the Parliament."

This is not just be a result of the reduced size of the population; since the regulations are designed to exclude skilled migrants, who tend to be more productive, they also reduce average productivity and hence GDP per capita, as the Home Office Impact Assessment states.

None of this is news to economists; most of us, wherever we are on the political spectrum, think that well-functioning markets usually do a pretty good job of allocating resources. That goes for the labour market too, so it is no surprise that liberal (in the true sense of the word) immigration policies are good for the economy, and restrictive ones are not. So simply reversing the new regulations introduced by this government, let alone further deregulation, could yield large gains. Moreover, in contrast to some other policy changes that might promote growth, the fiscal impact would be positive, not negative; the deficit would be some hundreds of millions of pounds lower.

It is worth comparing these figures with the impact of changes to other forms of labour market regulation. The government's proposed changes to employment tribunals, for example, are designed precisely to reduce burdensome labour market regulation (in the ordinary sense). But the official Impact Assessment estimates the net benefit to be about £70 million per year; trivial by comparison.

More radical changes to immigration policy might have even larger impacts. A recent paper by one of the leading US researchers on the economic impact of immigration suggests that, looking across countries, the impact of openness to immigration on per capita income is large and positive - indeed, larger than the impact of openness to trade. They conclude:

"We interpret these results as consistent with the idea that immigration enriches the skill and idea variety of countries, increases their productivity and efficiency and, in the long run, it is an important contributor to their economic success."

So there is an obvious target for those commentators and politicians who talk about freeing up the UK labour market. If they really want to cut red tape, why not start with the red tape that directly prohibits employers from hiring the skilled workers they want? If they want a more liberal, market-oriented approach to economic policy, why not reduce the most damaging and illiberal restrictions on the operation of the labour market? And if they think that the UK benefits by being "open for business", then act in accordance with the evidence that to realise those benefits means being open to labour mobility as well as free trade and capital mobility.

Of course, changing course on immigration - even in the direction of deregulation and free markets - is politically difficult for the government. But fully a year ago, the Chancellor argued:

"this crisis provides an opportunity to make some difficult trade-offs in favour of growth that might get parked in the "too difficult" box in calmer times."

This is surely exactly what he meant. Now that he's promised to devote "110% attention" to boosting growth, this would be a good place to start.