22 September 2014

Anti-market policies are not the solution to high living costs – they’re the problem


Since the Great Recession, UK household incomes have been squeezed significantly. Median household incomes were still 6.2 per cent below their pre-crisis peak at the end of 2013/14. If the financial crisis had never occurred, households might have expected to have real incomes 20 per cent higher than they do now.

This squeeze on real incomes has rightly brought policymakers’ attention to the high cost of living. In particular, prices of many goods and services one might consider essential – housing, energy, childcare and food, for example – were rising even prior to the financial crisis. These items take up a higher proportion of the incomes of those on low incomes, meaning that rising prices can worsen poverty. Policymakers are therefore under pressure to find policies which can ease this living cost squeeze, whilst accepting the fiscal constraints of the UK’s deficit reduction programme.

One might think of two broad approaches to thinking through the related ‘high cost of living’/’low pay’ problem.

One approach would be to examine each of the product markets and the labour market in turn, analysing why prices are high in certain markets before assessing whether there are any supply-side policies which might enable a structural lowering of costs for goods and services or improvements to the productivity of labour.

An approach like this would find that the UK’s extremely tight planning laws – particularly ‘greenbelt’ zones around some of the most successful cities like London, Oxford and Cambridge – are a key structural reason for high house prices. It would show that the UK’s approach to carbon mitigation has led to more expensive energy for consumers (beyond that necessary to achieve international carbon reduction targets).

In childcare, it would observe how UK costs are high on an international basis – both in terms of taxpayer subsidy and ‘out of pocket costs’ for families. Government policies encourage the use of formalised, pre-primary education care settings, but also extensively regulate informal care suppliers, driving up costs. Though recent food price increases have mainly been driven by international forces, it would also highlight how the Common Agricultural Policy and biofuels policies at an EU level put upward pressure on prices.

Taking this approach, one would likely conclude that there are significant pro-market supply-side reforms which could be undertaken to reduce the cost of living. Unfortunately, the UK political parties take a very different approach – which seems predicated on the idea that high prices in these markets are a result of ‘market failure’, necessitating further government intervention in the form of the government controlling prices and wages or subsidising certain activities.

The Labour party leader Ed Miliband, for example, in his agenda for tackling the ‘cost of living crisis’ has articulated the need for a state-imposed energy price freeze, a mild form of rent controls and lower regulated rail fares. The Coalition government has increased childcare subsidies and restrained tariff competition in retail energy markets. Both have articulated the desire for higher minimum wage rates.

All of these policies attempt to treat the symptoms of high prices in product markets and low wages, rather than addressing the underlying causes of them in the first place. But populist, simple solutions could have profoundly negative economic consequences without resolving the underlying problems. The history of price and wage controls of this type is not pretty, whilst subsidies merely transfer the high prices from users to taxpayers.

Why then are politicians drawn to the interventionist approach? In part it’s because of the voter demand to act – ‘doing something’ brings electoral gain, whilst uninformed voters are unlikely to link interventionist policy action with delayed negative consequences. But the key problem here appears to be that a host of anti-market myths, fallacies, red herrings and straw men dominate debates, facilitating misguided policy actions.

From claims that ‘the market has failed to build houses, so the state has to step in’ to the argument that privatisation is to blame for high energy and rail fares; from the idea that ‘childcare subsidies are good for the economy because they facilitate maternal employment’ through to the idea a higher minimum wage is needed to offset the effect of ‘tax credits subsidising employers’, faulty analysis is driving bad policy prescriptions for the UK’s low pay/cost of living problem.

In a paper released today, my colleague Kristian Niemietz and I show how all of these arguments and more are either red herrings or fallacious. By analysing each claim in turn, we hope our paper can be the starting point for informed debate – and the acceptance of the sort of supply-side approach which could bring significant gains to those on modest incomes through substantial reductions in living costs.

Ryan Bourne is Head of Public Policy at the Institute of Economic Affairs. He is a co-author of ‘Smoking out red herrings: the cost of living debate’, which was released today.