George Osborne is reportedly looking for £13 billion of savings from government expenditure. That’s no small potatoes. As they used to say in the USA, “A billion here, a billion there, and pretty soon you’re talking real money”. Especially with large spending departments like Health and Education – and Foreign Aid – ring-fenced, this inevitably means huge pressure on the government’s massive welfare budget.
In turn, pundits expect the axe to fall on Gordon Brown’s pet project – tax credits. Wages too low? Never mind. Uncle Gordon will give you a top-up. This was a very clever policy in two ways. First, it makes many millions of people effectively clients of the state, and therefore (in the Brown view) more likely to vote Labour. Second, it is very difficult for the next government to reverse, without being seen (at least by the left) as brutal and heartless and committed to child poverty.
It is also another example of the left’s failure to think a policy through, to analyse the knock-on effects, the perverse incentives, the unintended consequences, the moral hazard.
What Gordon was effectively saying to employers was “Look guys, you can pay really low wages. Don’t lose any sleep worrying whether your workers can afford a decent breakfast. There’s no need for you to pay a living wage – the government will top it up”. In a very real sense, the tax credit is not a benefit to low-paid workers. It’s a subsidy directed to bad employers.
(An aside – you can see the same effect with the Common Agricultural Policy. Those clever Tesco buyers know exactly what it costs to grow a ton of wheat, or produce a pint of milk. And they also know just how much Single Farm Payment each farmer is getting. They negotiate accordingly. So what we intended as a subsidy for farmers, which I’m quite comfortable about, becomes a subsidy to Tesco).
But there’s a deeper question on low wages. How is it that low wages are endemic in the UK? There’s a basic principle of economics that when there is an excess supply of any product or service, prices fall. If you get a good harvest, the price of wheat tumbles. If the world is awash with oil, the price of oil dives. And if there’s a surplus of unskilled and semi-skilled labour, wages fall – or are compressed and fail to rise. That’s what we’re seeing now.
And the reason for the glut of labour? EU Free Movement policies. With wages in the UK many times higher than those in Bulgaria, or Croatia, or Romania, we’re getting exceptional levels of immigration, which are causing wage compression. Gordon’s tax credits are, indirectly, subsidising the EU’s free movement policy – another hidden cost of EU membership.
Then there’s productivity. Economists constantly wring their hands about the UK’s poor productivity record. But one major factor affecting automation and investment – and therefore productivity – is the availability of cheap labour. There’s a clear trade-off between labour costs and investment in automation. Put simply, if labour is cheap, and looks likely to stay cheap, there’s less incentive to invest. I believe that this must be at least a significant factor behind the UK’s productivity problems.
When we eurosceptics debate against the other side, they often say, dismissively “Oh, you eurosceptics simply blame everything on the EU”. True. We often do. And often, as in this case, we’re right to do so.
We need to leave the EU, to control our borders, control immigration, allow wages to rise to a realistic level, and against that back-drop, start phasing out Gordon’s superficially attractive, but ultimately destructive, tax credits.