Sunday, 30 June 2013

Charging visitors to the UK, adverse selection, and moral hazard

A few months ago the Deputy Prime Minister Nick Clegg was expounding on the benefits of a security bond for visitors to the UK. The basic idea was that visitors to the UK would have to deposit some money with the government and they would get the money back when they left. I was hoping the plan would be quietly dropped, and it seemed to have been. But, unfortunately, the story is back and now looks worryingly likely to happen. Visitors from a select list of countries, including India and Nigeria, will be expected to deposit £3,000 with the UK government if they want to visit the UK. The government's policy on immigration has been a disaster for many years, but the idea of a security bond seems to be taking up a notch the level of stupidity. 
       To put this plan for a bond in context we need a bit of background. A large proportion of the UK electorate is anti-immigration. The current coalition government's answer is to bow to the electorate and promise a tough line on immigration. The message has gone out that Britain is closed to foreigners. Foreign students, for example, are no longer allowed to work in the UK for one year after their graduation. And universities find it ever tougher to hire foreign professors. The government's approach has catastrophically failed. It has not appeased the electorate, who have started voting for the UK Independence Party. And, more importantly, it has annoyed foreigners. Given that immigration is a good thing, this is not something to celebrate. Indeed, at the same time the government was closing the door to foreigners, the Prime Minister and others were trying to sell Britain's advantages in emerging markets, like India. Which doesn't make much sense! If the government would just get on with arguing the case for immigration rather than being trapped by public opinion we might see progress. Instead, we have the latest idea to annoy foreigners. 
       The logic behind the bond is simple enough: We have people who visit the UK and then illegally stay in the country longer than allowed. The bond is an incentive for people to leave when there supposed to. Unfortunately, this logic is fundamentally flawed. What we have here is a game of incomplete information. Suppose that there are two types of foreign visitors. Genuine visitors who want to visit friends and family. And illegal visitors who want to stay in the country indefinitely. The government wants to let in the genuine and block the illegal. But, it cannot tell which is which. That leads to the problems of adverse selection and moral hazard. 
        Adverse selection. Who do you think is going to be more willing to deposit £3000 to visit the UK, the genuine or the illegal? My money would be on the illegal. £3000 is a small price to pay to live in the UK and we know that many illegal immigrants pay a lot more than that to enter the country. Someone visiting friends, by contrast, may not have £3000 to hand. The government is, thus, likely to hand pick the very opposite of what it wants. This is a classic example of adverse selection: the least desirable are more likely to be willing to pay the bond.
      Moral hazard. Let's focus now on the people who paid the bond and have been let into the country. Will he £3000 bond change their behavior. My guess is that it will. We know that a financial payment can crowd out more pure incentives.* So, a genuine may decide to stay in the UK illegally. In other words, someone who may have returned home after they stay, because, say, they felt guilty at staying illegally, may now decide to stay. The bond removes their guilt. Again, this is the exact opposite of what the government wants to happen! 
         The security bond is a bad idea, even if the goal is to reduce immigration. So, hopefully, there is still time for the policy to be quietly dropped.

* Frey, B. S., & Oberholzer-Gee, F. (1997). The cost of price incentives: An empirical analysis of motivation crowding-out. The American economic review, 87(4), 746-755.

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