Emissions, population growth and the NZPC inquiry

Early tomorrow morning the Productivity Commission will be releasing its draft report on how New Zealand can transition to a low emissions economy.   The report was commissioned by the previous government, but this will be the first real test for the Commission in dealing with the new government –  for whom this is an issue dear to the heart.   The Commission has been trailing the report, with links to a recent presentation.   Like most Commission reports it will, presumably, be long, and full of lists of findings and recommendations.   My main interest is whether they again –  as they did in their earlier issues paper – manage to entirely avoid the elephant in the room:  the role that deliberate (immigration) policy has played (and continues to play) in driving up the population, and driving up emissions, in a country that is pretty widely-recognised as having some of the highest marginal abatement costs anywhere.

On that latter point, don’t just take my word for it.  Here was the Ministry for the Environment –  official advisers on these things –  in their report last year.

mfe

(not, it appeared, that MfE had done any more thinking about it than that)

Bear in mind too that Statistics New Zealand project that New Zealand’s population will increase by another 25 per cent by 2050 –  the date by when the current government aims to have net carbon emissions to zero – and all (net) that projected population increase is due to immigration policy.

One key indicator around emissions is total emissions per unit of GDP.  On that measure, New Zealand has the second highest emissions of any OECD country, just behind Estonia.

nz and estonia

But we seem to be heading for number 1.   That our emissions per unit of GDP are high isn’t that surprising, given the large role that pastoral farming plays in our economy.  It may even be that New Zealand –  temperate climate and all – is a relatively efficient place for such farming emissions to occur.

As the chart shows, emissions per unit of GDP have been falling in New Zealand.  Even if that first chart might suggest a modest fall, in fact it only illustrates how energy-inefficient much of the former Soviet bloc actually was.   Here is a chart showing the reduction in total emissions per unit of GDP from 1990 to 2015 (the latest OECD data) for all the OECD countries for which there is complete data.  There are four countries missing, but looking at their incomplete data, it doesn’t as though including them would change the picture.

emissions 2

On that metric –  the change in intensity – New Zealand hasn’t done badly at all.  Of the countries to the right of us on the chart, six were former Soviet-bloc countries (formerly highly resource –  including energy –  inefficient).   And the Irish numbers are badly distorted by the way in which GDP  in the last 20 years has been increasingly artificially boosted by aspects of their corporate tax regime, counting as GDP stuff that doesn’t actually happen –  or generate emissions –  in Ireland (details here).  Relative to most of the old OECD, New Zealand emissions per unit of GDP have fallen more than most –  which is all the more striking because our productivity performance has been so poor.

And yet, for the OECD as a whole gross emissions increased by only 2 per cent from 1990 to 2015, while in New Zealand they increased by 24 per cent.  The big difference isn’t that somehow New Zealand has become relative more carbon-inefficient –  we haven’t (see previous chart) – but simply that we have a whole lot more people.  And the overwhelming bulk of that population growth is due to New Zealand’s immigration policy (natural increase – itself boosted by immigration – offset by the net outflow of New Zealand citizens would have given us a population increase of only around 250000 from 1990 to 2015).

There seems to be a real squeamishness about confronting this, pretty straightforward, series of facts:

  • production here is more carbon-intensive than elsewhere among advanced economies,
  • marginal abatement costs here are higher than those in most other parts of the advanced world,
  • more people drive up total emissions, all else equal, and
  • in New Zealand trend population growth –  over the last 25 years, and in the projections to 2050 –  is mostly due to active non-citizen immigration policy.

(In fact, you might have supposed that emissions/climate issues might have featured in the Fry/Wilson book on a multi-dimensional approach to thinking about immigration policy, but no.)

And here a few of the cross-country charts of the relations between population growth and gross emissions.  This one is for all energy sectors (including transport).

emissons 3

New Zealand is very close to the line (and the line remains upward sloping even if one excludes rapidly industrialising Chile, Turkey, and Korea –  the three dots at the top of the chart).

The relationship shouldn’t be a surprise: more people means, all else equal, more requirement for power, more need for transport, and so on.  Over time, production processes tend to become more efficient, but for any given production technologies, more people will tend to mean more emissions.

Much the same relationships is present (again unsurprisingly) for total gross emissions.

total emissions

and even, more to my initial surprise, for agricultural emissions

ag emissions

In fact, as I noted in an earlier post

Somewhat to my surprise there is actually even a (weak) positive relationship between population growth and per capita emissions and emissions per unit of GDP.  I’m not quite sure why that would be, although in New Zealand (and Australia’s) case, the migrants are moving to some of the OECD countries with, already, the highest emissions per capita and per unit of GDP.

The apparent relationship between agricultural emissions and population growth (even across advanced economies) is both interesting, and particularly germane to New Zealand.  As I’ve argued elsewhere, it is plausible that if New Zealand had had much lower immigration (and thus lower population growth) and, thus, a lower real exchange rate (according to the Reddell model), the political constraints on tightening water-quality standards (especially affecting dairy industry competitiveness) and on introducing agriculture to something like the ETS would have been less intense.  The lower exchange rate would have provided a competitiveness offset.  So it is likely that, all else equal, our immigration policy has even driven up our agricultural emissions.

None of which might matter much if

(a) there was compelling evidence that very high rates of non-citizen immigration had been boosting domestic productivity, or

(b) if the marginal abatement costs for emissions in New Zealand were low.

But neither appears to be so.   And thus, if one cares at all about minimising the cost to New Zealanders of a forced policy adjustment towards a net zero carbon emissions world –  as distinct from simply forcing us all to don a hair shirt and feel the pain –  rethinking our immigration policy really should be high on the list of options for responding to the carbon goals the new government (and, less ambitiously, its predecessor) have set for themselves.  I hope  –  but am not optimistic, based on the “part preview” I linked to above  –  that the Productivity Commission, who are supposed to be politically neutral analysts, have recognised this in their report.  But perhaps I’ll be pleasantly surprised.  We’ll see tomorrow.

It isn’t as if the issues haven’t been raised with them.   Here is the link to my brief submission to their inquiry.

World War One and the New Zealand economy

Earlier this week, in the lead up to ANZAC Day today, The Treasury drew attention to an interesting conference paper written a few years ago by Brian Easton on “The impact of the Great War on the New Zealand economy”.   From the opposite end of the political spectrum, Eric Crampton described it as “really great”.  I’m not sure I’d go that far, but for anyone interested in aspects of New Zealand’s economic history –  especially bits on which there are few systematic treatments (and often only patchy data) – it is certainly worth reading.

Easton’s focus is less on the details of how the economy did during the war than on supporting

my contention that the war experience fundamentally affected the way we governed New Zealand.  I shan’t be surprised if economic historians from other countries come to similar conclusions about their economies.

As Easton notes, the war itself took up a lot of resource.

How much diversion of resources? We dont know with any precision. During the war the troops overseas at any time, plus those in domestic training – amounting to at least 65,000 and even 100,000 men, over a fifth of the labour force – were not available for civilian production, but they were still consuming. Similarly there were workers diverted to producing war goods. There are no annual labour force figures at this time, so we don’t know the precise impact of having so many workers unavailable for domestic production. Some of the labour deficit would have been made up by running down the unemployed (although that was not a huge reserve), by drawing women into the labour force (although we dont know how many) and by working longer hours.

Other authors note that the number of women drawn into the labour force actually wasn’t that large.   In the 1916 Census, for example, there were 100000 women in paid employment, up from 90000 in the 1911 Census –  an increase as a proportion of the total female population, but not much of one (given the underlying rate of population growth). But it does appear that those people (male and female) in employment were  working a lot of overtime –  although data were only collected on female and youth overtime.

Easton surmises that resources equal to perhaps a third of GDP were diverted to the war –  similar to estimates of the resources devoted to World War Two.   Rich countries –  and New Zealand was then one of the very richest –  could afford to devote a large share to the war (since pre-war living standards were so much further above subsistence than in poorer countries).   One thing that made the New Zealand experience of World War One very different from that of World War Two, is that in the first war we had nothing like the massive influx of American troops seen after 1941 (our war was entirely overseas).

The war was financed by a mix of taxes and debt.

One of the most radical changes in our tax system occurred over the six years to 1919/20. Income tax made up just 9 percent of total tax receipts in 1913/14, behind customs duties (58%), land tax (13%) and death duties (10%). Six years later income tax was the single largest source of tax revenue at 39%, with the other three behind: customs 30%, land tax 9% and death duties 6%.

As for debt, here is a chart of the estimated public debt as a share of GDP.

ww1 debt

The level of debt – mostly domestic debt – roughly doubled, but there was so much inflation (despite, as Easton notes, resort to price controls) that the debt ratios themselves didn’t increase that much (nothing like the extent experienced in, say, the UK).  That didn’t stop our government claiming –  and securing –  a small portion of German reparation obligations after the war.

And that the demand impetus was led from the public sector rather than the private sector is evident in the ratio of trading bank advances to deposits.  There was plenty of deposit growth but pretty subdued growth in private credit.

adv to dep ratio

One aspect not touched on by Easton is that such rapid inflation was made possible by one of the very first New Zealand policy initiatives  –  the suspension of the Gold Standard.  In a very early post I wrote about that here, including the fact that gold convertibility was never resumed in New Zealand, and for the next 20 years (until the Reserve Bank was established) our monetary arrangements were idiosyncratic, and not really anchored at all.

But as I noted, Easton’s main concern in his paper is with the legacy of World War One for our economic management.    He argues, of the rehabilitation polices for returned servicemen

There is rarely a single event which initiates what proves to be a major policy, although there can be steps which accelerate its development. The rehab policies after the Great War might be thought of as starting the practice of widespread home ownership. Similarly the war’s broadening of the role of income tax was on the way to today’s dominant role of income tax in the revenue system. It seems likely that the administration of veterans’ pensions was part of the basis for the social security one set up in 1939.

And of the state control of exports during the war

….. by 1917 New Zealand had an agreement with the British Government that all the supplies available for exports would be requisitioned for the British market.

At the end of the war there was a considerable quantity of meat and wool in store. As shipping became available it, plus the normal annual production, was unloaded on the British market, as were South American supplies. Prices collapsed. Private enterprise seemed to have fail again, and the farmers turned to the public sector. In February 1922 the government, with dirigiste (‘Farmer Bill’) Massey at the forefront, passed legislation which established the Meat Producers Board with very wide powers. Although interrupted by the 1922 election, the Dairy Board was created almost as quickly.

We may ponder whether these producer boards would have been established as early – or at all – had there been no commandeer, had there been no Great War.

Perhaps more dubiously Easton argues for other longlasting legacies

This was most evident in the draconian wage and price freeze which the government of Robert Muldoon introduced in May 1982. The earlier war administrations would have been admiring. Of course, in ways that Muldoon never fully appreciated, New Zealand had moved on. The unwinding of centralised economic control that the successor government – the Rogernomes – undertook might be said to represent the end of the centralised Second World War approach to economic management of forty years earlier, itself a response to the Great War approach to economic management a further twenty-five years back.

Frankly, all of that seems a stretch in a New Zealand specific sense.   As he notes “I’m not sure that New Zealand was particularly more centralised than many of the other war economies”, and cross-country comparisons are often enlightening.  Ireland, for example, was long even more inward-looking than New Zealand.

Which isn’t to suggest that wars don’t have longlasting consequences –  economic, as well as political, social and personal.  Many scholars would ascribe the severity of the Great Depression in significant part to the conduct of policy (perhaps inevitable –  inflation, build-up of debt etc) around World War One.  Perhaps more locally, we wouldn’t have had a central bank as early as 1934 without the earlier war, and then the Depression.  Taxes and government spending seem permanently higher –  but who is say that that wasn’t an almost inescapable outcome of the worldwide lift in prosperity (and there is little sign that taxes are lower, or regulation less pervasive, in countries that stayed out of both wars).

On which note, perhaps I can end with the famous quote from John Maynard Keynes from The Economic Consequences of the Peace about the way in which global markets worked in the years prior to World War One.

The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages; or he could decide to couple the security of his fortunes with the good faith of the townspeople of any substantial municipality in any continent that fancy or information might recommend.

He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality, could despatch his servant to the neighbouring office of a bank for such supply of the precious metals as might seem convenient, and could then proceed abroad to foreign quarters, without knowledge of their religion, language, or customs, bearing coined wealth upon his person, and would consider himself greatly aggrieved and much surprised at the least interference. 

But, most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable.

And not a preferential trade agreement, attempting to reach behind borders and control this, that or the other aspects of other countries’ policies, in sight.

If anyone is interested, here is an early (surprisingly frequently read) post on New Zealand’s economy in World War Two.    There certainly seems to be a gap in the market for a good modern treatment of New Zealand economic history, and the history of economic policy, from say 1914 to 1945, encompassing the two wars.

For various other countries’ economic experience in World War One, I recommend Broadberry and Harrison’s The Economics of World War 1.

 

Immigration policy and wellbeing: Part 2 (aggregate economic outcomes)

Last week I wrote some brief introductory remarks about the new book by economists Julie Fry and Peter Wilson, Better Lives: Migration, Wellbeing and New Zealand.  

Unfortunately, like so much of the current bureaucratic and political enthusiasm in New Zealand for focusing on “wellbeing”, the book seems to be built on a straw man.   To listen to Treasury’s champions of the “living standards framework”, or Cabinet minister championing the proposed “wellbeing” framework for the Budget, you would suppose that all key decisions in the past have only ever been made on the basis of the impact on GDP (per capita) or some similar national accounts indicator.   That that notion is just nonsense takes no time at all to demonstrate: no one seriously supposes that we have a huge welfare system because governments have believed that by doing so GDP per capita will be maximised.   Raising the NZS eligibility age would most likely increase GDP per capita (and maybe even GDP per hour worked) but as a society we’ve chosen to leave it at 65.  And so on.   Advocates of almost any policy will try to argue for some material economic benefits (or to minimise the costs), but public support for this, that or the other policy is only occasionally directly dependent on expected real GDP per capita gains.

It is the same straw man that suffuses the Fry/Wilson book (and the various associated articles or interviews I’ve seen).    Their claim is that immigration policy has been driven by a near-exclusive focus on boosting real GDP per capita (or, again, some variant –  eg real net national income (NNI) per capita) –  economic considerations, and that they are preparing the way for something richer and better.  Here is the last two sentences of the book.

We are confident that using a wellbeing approach is the right way to think about migration.  It enables us to consider important broader issues that a simple focus on per capita GDP allows us to ignore.  The result should be a more effective and more sustainable immigration policy for New Zealand.

But in the entire book, not once did they seek to demonstrate that anyone individually (or New Zealand governments as a whole) has been driven solely by a focus on something like real GDP per capita.  That isn’t surprising.   Here is a summary table of residence visa approvals in 2016/17.

Category Number
Skilled Migrant         24,140
Residence from Work           2,353
Investor           1,418
Entrepreneur              594
Business Immigration Policy – Other*              141
Subtotal  (Skilled/Business)         28,646
Partner         10,914
Parent           1,820
Dependant Child           1,937
Sibling and Adult Child              346
Subtotal  (Family)         15,017
Refugee Quota           1,218
Samoa Quota           1,121
Pacific Access Category              655
Convention Refugees and Protected Persons              236
Refugee Family Support              302
Other special residence policies              489
Subtotal (International/humanitarian)           4,021
Total        47,684

I’m sure that in the first category (the Skilled/Busines sub-total) policy is driven primarily by economic considerations, perhaps encapsulated in a goal of lifting productivity and real GDP per capita.   But nobody supposes that parent or sibling visa policies were motivated by national economic considerations, let alone the two Pacific quotas or the refugee and related policies.  We take refugees because it is the sort of people that we are, and doing so captures or reflects things we care about, without too much consideration for economics.

Even in respect of the people here with short-term work rights, national economic benefit has never been the only consideration.  We didn’t enter a plethora of new Working Holiday visa schemes to maximise the GDP per capita of New Zealand, but through some mix of benevolence (its good for young people to see the world) and (so it seems) a pursuit of other countries’ votes for a Security Council place for New Zealand.  Even the recognised seasonal employer (RSE) scheme bringing temporary workers from the Pacific, is as much about aid to those countries and their people, and boosting political relationships with those countries, as it is about possible economic gains to New Zealanders.

And yet the authors claim that they are offering a whole new way of seeing immigration policy issues, thinking of dimensions other than the economic implications.    They know it isn’t so –  I heard one of the authors interviewed on Newshub Nation explicitly note that “of course politicians look at many of these things now” –  in which case you have to wonder what the fuss is about.  They seem to be arguing that if it were developed their framework (which is really no more than a concept at present –  a bid for consultancy contracts from government departments to flesh it out?) might enable a greater degree of transparency around the considerations guiding immigration policy decisions.  But you can’t help wondering what they have to offer that the release of Cabinet papers and regulatory impact statements, and the availability of speeches/interviews of relevant ministers does not already provide.   There is, perhaps, a bureaucrat’s appetite (and both authors are former bureaucrats) for tidiness –  boxes to tick, and perhaps a common agreed evaluation framework –  but not much of life is like that.

The authors adopt a list of 12 other considerations that they think immigration policy should take into account –  11 from the OECD, plus a Treaty of Waitangi dimension.  One could debate the relevance or role of many of them, but equally I could throw in five quite different factors.  No doubt, at one extreme, the National Front, and at the other extreme open borders globalists could throw in their own five distinctive angles.  There is no aggregation framework, no way for officials or “expert” advisers to decide which factors should count and to what extent.  What there is is the political process, messy as it often (perhaps inevitably) is.  As it is, Fry’s and Wilson’s own political worldviews –  if rarely directly stated –  suffuse the book (although they might be hard for many bureaucratic and political readers to recognise, since so many of them share that sort of worldview).

Perhaps all the Fry/Wilson (conceptual)framework might be useful for is reminding fellow economists on the odd occasion when some might be tempted to think that immigration policy is, or should be, only about aggregate economics (GDP and all that).  If some economists ever fall into that trap –  and I doubt many do –  few others do.

In some ways, the most interesting part of the book is an attempt to suggest thinking about New Zealand immigration policy through a Treaty of Waitangi lens.  I’m sceptical –  and think they avoid most of the hard issues – but want to come back and devote a separate post to that material.

Today I wanted to focus on the bit of the book that bugged me, and puzzled me, most.

There are repeated claims –  in the book text itself, and in associated articles/interviews – that New Zealand’s immigration policy has produced good economic outcomes for New Zealanders (at least in aggregate).    One chapter starts this way

“Migration is good for economies.  But is it good for people?”.

The final chapter beings

“But despite its economic benefits, migration remains a controversial topic”

In their presentation at Treasury a couple of weeks ago, Fry asserted that

“Immigration is economically beneficial, but the public is not fully comfortable”

And in a Newsroom column the other day they note that

“justifying high levels of migration by the fact that it boosts GDP or even GDP per capita has done little to resolve debates about migration”

To be clear, the authors aren’t championing a claim that there are large economic benefits (and they are focused on per capita gains, or lifts to productivity, not headline GDP effects).  In fact, they explicitly claim that

“The available evidence suggests that in modern times, the economic effects of immigration to New Zealand are likely to be positive but modest at best.”

But, remarkably, they offer no evidence for the claim that the effects have been positive at all (lifting economywide productivity –  and as they note, our productivity record has been pretty woeful –  of lifting the per capita incomes of New Zealanders (as distinct from the gains, reflected in average GDP, to the migrants themselves.     They make no attempt to engage with the stylised facts of New Zealand’s economic performance –  or even the huge scale (relative to most other countries) of our migration programme (permanent and temporary).

For “evidence” they seem to refer readers on several occasions to Julie Fry’s previous book (with Hayden Glass) Going Places: Migration, Economics and the Future of New Zealand.  In that book (which does touch on some of my arguments about rather worse results –  described as “a plausible idea but difficult to prove or disprove”) the authors have no sustained discussion of the New Zealand experience – poor productivity growth, despite huge immigration inflows, weak tradable sectors, limitations of geography –  and also adduce no empirical evidence of the economic benefits of large scale immigration (as it has actually been run) for New Zealanders.    That latter omission isn’t surprising as –  as even advocates of high immigration acknowledge –  there are no such papers.  But, if anything, in Going Places Fry and Glass seemed more cautious  –  noting the importance of the quality of the migrants, and doubts about how well New Zealand has been doing on that score –  than Fry and Wilson are in Better Lives.

It is all doubly perplexing because on the one hand they repeat standard lines about how immigration, even of the unskilled, probably hasn’t made much differences to wages, while at the same time arguing that large inflows of unskilled migration (notably in the US) had, by lowering the cost of various household services (childcare, gardening etc) enabled many more women (in particular) to move into the labour force.  You really can’t have it both ways.

I’m not sure why in the latest book they seem so confident that New Zealand’s large scale planned immigration programme (three times the size per capita of the US programme –  under such nativists as Clinton and Obama –  and larger, per capita, than those of any other OECD country) over the last quarter century or more has been economically beneficial.

There seemed to me at least three possibilities:

  • the first was that they had made a rhetorical or positioning choice.  After all, if they had taken a stance that our immigration policy, as run, had actually been costly to New Zealanders, most of their other list of “wellbeing” considerations would fall away.   We might still want to take some refugees, but there would be any other very compelling case for large numbers of other migrants –  open borders ideology aside.  Moreover, since their target audience is typically pretty pro-immigration (officials, National/Labour/Greens politicians, and other “urban liberals”) casting doubt on whether there had been any economic gains might have led those people to simply refuse to consider their arguments, and the framework they were touting.
  • the second was that they had just taken the international economics literature –  which tends to produce results suggesting gains in productivity and per capita income (often implausibly – incredibly – large estimates) from immigration, and assumed that (a) these estimates were valid, and (b) they applied to New Zealand, without any specific consideration of New Zealand’s actual experience, or
  • third, that the authors had themselves thought hard about the New Zealand experience, including its overall economic performance in the context of a large scale immigration programme, and had come to an independent view that there had been gains to productivity etc here (and perhaps didn’t have space in this book to write up those views –  arguably, the economic effects are the focus of the book).

And so I asked the authors. Of the third bullet I noted

If the latter, I’m a bit puzzled as to how you deal with such stylised facts as the persistently high real interest and exchange rates, the decline in the foreign trade shares of GDP, and the long-running weakness of business investment.   Where do you turn for evidence –  formal statistical or the marshalling of other material –  of the gains you proclaim?   And how, for example, do you grapple with the fact that (true) fixed factors –  land and natural resources –  appear to play a much larger role in NZ than the (almost non-existent) role in typical models, or than in many norther European economies.
A few days later I got a response.

On your specific question, we didn’t write the book to resolve the issue of the effects of migration on GDP or any of its components or derivatives, like TFP.  Indeed, the core element of the book is that GDP and its derivatives are poor metrics of welfare, both generally and in relation to migration.   If you are using a wellbeing framework, what matters is the capabilities that people have to lead the lives they value, not their command over commodities. So the effect of migration on GDP, GDP per capita or TFP isn’t the focus.

Which might be fine in the abstract, but really rather avoids the specific issue.  If they didn’t think productivity or real GDP per capita outcomes were meaningful –  and most will beg to differ –  why would they keep on repeating a claim that there have been gains to New Zealanders on exactly these counts?  And if they do believe there have been gains –  as they state repeatedly in the book and associated media material –  where are the New Zealand specific arguments and evidence for those claims?  It isn’t as if there is a single mention made only in passing: the proposition that New Zealand immigration policy has been economically beneficial to New Zealand suffuses the book.

A garrulous Governor

We’ve had talkative new central bank Governors previously.  Shortly after Don Brash took office people took note of the way he was commenting pretty freely on a lot of issues.  Tom Scott captured it this way.

brash 3.png

If the latest new Governor is really keen on transparency and openness on things he has responsibility for, I could readily offer a list of suggestions (well short of webcasting MPC deliberations).  He could, for example, publish (with a short lag)

  • the minutes of the Governing Committee meetings in which he makes his OCR decisions,
  • a summary of the written advice (recommendations and risks) he gets from his internal Monetary Policy Committee, and
  • the background papers generated internally in the process of deciding on his forecasts and OCR decisions.

On the latter point, I’m still engaged in an appeal to the Ombudsman to get hold of the analysis the Bank used last November in making written (but not substantiated) Monetary Policy Statement comments about the macroeconomic impacts of various of the new government’s policy initiatives.   To be clear, there was no problem with them making comments –  things like Kiwibuild should affect demand pressures and thus the near-term inflation outlook – the issue was the lack of detail, and the refusal then to release the background papers.

Perhaps the new Governor will take steps along these lines.  We have not yet seen an OCR decision on his watch, and journalists must already be relishing the first scheduled Orr press conference next month, given his readiness to comment at length on all matter of things that are no part of the responsibility of the Reserve Bank.  It is great that he is fronting up to the media –  in a way quite unknown during Graeme Wheeler’s term –  but is there anything about which he will say, if asked, “well, that isn’t really something that would be appropriate for me, as central bank Governor, to comment on”?  There has been no sign of such restraint so far.

I wrote on Friday about the Governor’s interview on Radio New Zealand.  In a comment to that post, one of my former colleagues described it as

I thought it was rather a good one – compared with many of the media beat-ups about this and that with which we seem to be currently afflicted. And refreshing to hear interesting perspectives about the need for coherent approaches to our strategic directions, and the risks associated with longer term structural adjustments in several dimensions.

As I noted in response, if you didn’t know who the interview was with, there was no particular problem with the content (reasonable people can have quite different views on the substantive issues and we benefit from debate).  Had it been an interview with think-tank person, an academic, a journalistic commentator, or even a retired Governor or Secretary to the Treasury, it might have been a welcome addition to the ongoing dialogue on important economic and social issues.

But it was the independent Governor of the central bank, banging the drum for a whole lots of causes where his words will have been music to the ears of the current government, on issues where (even if he may have some personal expertise/experience on some of them) the Reserve Bank has no responsibility, and no institutional expertise.   It would have been almost as bad if he had been taking the opposite position on those issues, or advocating a bunch of right-wing causes.  And I only say “almost as bad”, not to take a view of the merits of those issues, but simply because at least if Orr was overstepping the mark on the right-wing side, there would have been no suggestion that he was trying to butter-up the current government – championing many of their causes –  in a year when he has a lot of turf battles to fight and win.  There are all the legislative details of the Stage 1 changes to the Reserve Bank Act, and the subsequent provisions of the Charter, let alone Stage 2 where if things go badly for the Governor he could find his powers very greatly reduced –  or indeed find the regulatory/supervisory functions split out of the Reserve Bank altogether.   The decisions the government finally makes are more likely to go the Governor’s way if the government finds him useful, supportive, and generally agreeable.

I don’t suppose that there is anything dishonest in what the Governor is saying.  I presume he is quite as left-liberal (“a passion for issues such as social equality, diversity and the environment”) as his comments and journalists’ accounts of interviews suggest.  But the personal politics –  views on all manner of other issues –  of the Governor shouldn’t be relevant to his conduct in office, and shouldn’t be on display at all.  It isn’t just the Governor: the same goes for the Commissioner of Police, the Chief Justice, the Chief Electoral Officer, the Ombudsman, the Parliamentary Commissioner for the Environment, the Auditor-General, the Inspector-General of Intelligence, or whoever (let alone heads of government departments).  When the personal politics of any of these people is on display – on issues for which they have no official responsibility – it degrades the office, and diminishes the likely general respect for the office-holder (even as the groupies of one side or the other mostly welcome the support).  It also complicates the ability of the office holder to serve a government of a different stripe: Orr, for example, has a five year term, only half of which is before the next election.  It isn’t a role where the holder simply serves at the pleasure of the government of the day.

The Governor’s garrulity was on display again yesterday in a fairly short pre-recorded interview on TVNZ’s Q&A programme.  This time the topics weren’t climate change, sustainable farming, or infrastructure finance.  Instead, this interview covered capital gains taxes and the Australian banking royal commission.    Whether or not a capital gains tax is a good idea isn’t really a matter for the Reserve Bank.  It is a (highly) political choice, with various technical tax policy perspectives offering reasons why one might favour such a tax or oppose it.  As the Bank itself has previously noted, there is no evidence that whether or not one has a CGT makes much difference to the housing market or house prices.   Now, to be fair, the Governor didn’t specifically say he favoured a CGT, but at the end, having attempted to suggest that there were relevant financial stability dimensions, he observed “we need a more efficient level playing field around tax”, to which Corin Dann responded –  with no objection from the Governor – “I’ll take that as a yes”.   Perhaps he should have gone on to ask the Governor whether the “level playing field” he favoured –  with no actual responsibility for tax policy or the housing market –  included the family home in his CGT.    (Incidentally, in both the Q&A and Radio NZ interviews I heard the Governor suggest that 90 per cent of household net worth is in housing.  He is quite wrong about that.  The numbers are on his own institution’s website.)

Then there was the matter of the Australian Royal Commission into banking, and the question of whether such an inquiry was required here.  To be clear, the Australian Royal Commission was ordered by the Australian government, under intense political pressure.  It had – and has –  almost nothing to with the financial soundness of the banking system, or any of the sorts of issues the Reserve Bank of New Zealand has responsibility for in New Zealand.  It seems to be mostly about consumer protection (and abuse) issues.  So what possessed the Governor to declare that we don’t such an inquiry in New Zealand?  It isn’t his responsibility –  either formally (it is for the government to set up Royal Commission) or even covering the Bank’s policy ground (the “soundness and efficiency of the financial system’).  He went on to declare that the banking culture in New Zealand is “infinitely better than in Australia” –  one might hope so, but given that they are mostly the same banks, and several are or were until recently headed by New Zealanders, you have to wonder what evidence he has for that belief.   The substance of the issue –  abuses in the Australian banking system etc –  isn’t one I focus on, and so I don’t have a view on whether we need an inquiry or not (although the final Australian report could shed light on that).  But quite how, three weeks into the job, the Governor can express so much confidence in the Reserve Bank, the FMA, and MBIE in dealing with such issues – “all over them, every day” was the flavour –  is a bit beyond me.  Perhaps he could look into the approach to such things of his own Deputy.

There are, of course, plenty of cases where central bank Governors overstep the bounds in their comments –  it is common enough to prompt Willem Buiter to write the paper I linked to on Friday –  but few with quite the degree of abandon of our new Governor.  For his own good, and that of the institution and New Zealand public life (avoiding the politicisation of key institutions), he needs to be reined in.   In one of the Stuff profiles on the new Governor he observed

The problem was finding something which suited his temperament.

“I am certainly attracted to wanting to make a difference.”

He is also attracted situations involving drama and excitement.

“Being a ginger, I tend to run towards the fire, rather than away from the fire.

Sounds like the sort of character that would suit many roles.  It doesn’t naturally sound like a Governor of a central bank.  Central banking –  monetary policy and financial stability –  done well should be boring (and not very politically divisive).  The image I often used to use was of the fire brigades at airports.  In an ideal world, if you ever give it a thought you take comfort from knowing they are there, but you don’t expect to hear from them, and hope they are never needed to do much.  The parallel isn’t exact, but I’d argue it is closer to the ideal than a garruous Governor sounding off on every policy question some journalist happens to ask.  If he continues as he is starting, the value of his words will be greatly devalued.  And that would be a shame.

The Governor and the Minister of Finance should also give some thought to how the communications style the Governor is adopting fits with the approach to communications that the Minister announced a few weeks ago.    In that announcement, the Minister indicated that he would be legislating to establish a statutory Monetary Policy Committee, in which the Governor would have a majority of insiders, a role in appointing the outsiders, and in which

The Governor will chair the MPC and will be the sole spokesperson on its decisions.

Other MPC members are not be allowed to give speeches or interviews offering their own perspectives.

The Reserve Bank’s stance has been that if individual members were free to speak (as they are, say, in the US, UK, and Sweden) and are individually accountable for their advice and votes), it would be a “circus”  (though as Bernard Hickey points out, this example is hardly evidence of something wrong with the system).  At present, legally, the Governor is speaking only for himself –  as the sole lawful decisionmaker –  but soon, at least on monetary policy matters, he will become no more than first among equals.  Even at present, there is a real risk that the Bank’s messages on monetary policy and financial stability –  including the crucial ones about the limits of what Bank policy can do –  will be drowned in a cacaphony of comment on all manner of things, that commentators will come to assume it is normal for the Governor to comment on.  I’d welcome the open contest of ideas, and evidence of a range of views, on the appropriate path of interest rates, or how best to build monetary policy space for the next recession.  I’m not sure it would wise to have one –  let alone six – members of the MPC all offering their thoughts on climate change, the merits of a CGT, or whatever.  It is time for the Governor to stop and reset –  and for the Board and Minister to have a quiet chat, and encourage the Governor to think again.

 

Inflation still looks pretty subdued

The latest CPI data were released a couple of days ago.  Perhaps the only real news was that nothing much seemed to have changed, here or abroad, in the last few months’ data.

Here is a chart of OECD core inflation rates

oecd core inflation apr 18

I’ve shown a few different indicators.  Whichever you prefer there isn’t much sign of inflation picking up in the rest of the advanced economies.

Here is the Reserve Bank’s preferred core inflation measure.

sec fac model april 18

If there has been some hint of inflation picking up a little, it remains as excruciatingly slow as ever.   In a series with lots of persistence, the 2 per cent target midpoint seems a long way away.   And although the Reserve Bank and some outside analysts like to suggest this is all about tradables inflation (a) the gap between the core tradables and non-tradables inflation at present is just around the historical average, and (b) tradables inflation, in New Zealand dollar terms, is at least in part an outcome of monetary policy (the exchange rate directly influences it).

Here are a couple of non-tradables series I’ve shown before.

NT inflation bits

This measure of core non-tradables remains persisently below the rate (somewhere near 3 per cent) that would be consistent with overall core inflation remaining around the 2 per cent target.    The extent to which construction cost inflation has been falling away again is now quite marked: it doesn’t just look like noise.

And what of market implied expectations of future inflation from the government bond market?

IIB breakevens Apr 18Nowhere near 2 per cent, and if anything a bit lower than they were three months ago when the last inflation numbers were released.

Pictures like these should be a challenge for the new Governor as he ponders his first OCR decision and associated communications.   After all these years, there still isn’t much sign of (core) inflation getting back to 2 per cent, and there doesn’t seem much impetus from either domestic demand (for which construction cost inflation is often an important straw in the wind) or foreign inflation.

Some who have previously been “dovish” now point to higher oil prices as a reason –  either directly, or just as a straw in the wind – why perhaps core inflation will finally pick up.  Perhaps, but it is hardly been an infallible indicator historically.  Others note that our exchange rate has fallen.  That’s true too, but at present the TWI is about 2-3 per cent lower than the five-yearly average level (not much more than noise), and historically falling exchange rate have often been associated with falling non-tradables inflation (depending what drives the particular exchange rate move).

Time will tell, but in his RNZ interview the other day I heard the Governor praising the “courage” of central banks internationally for having held interest rates so low for so long, despite very strong growth, to help get the inflation rates back up to target.  I wasn’t sure I recognised any element of the description –  in the advanced world, central banks have mostly been reluctant to have interest rates low, and growth has rarely been particularly strong (both caveats seem to describe New Zealand).  But perhaps the Governor needs to consider displaying some of courage he says he has admired and take steps to get New Zealand inflation securely back to target.

 

A mis-step by the new Governor

Seventeen years ago, in August 2001, then Reserve Bank Governor, Don Brash gave a speech to something called the Knowledge Wave conference, sponsored by Auckland university.  The speech had the title Faster growth? If we want it (at the link  for some reason it says the speech was given by Alan Bollard, who was Secretary to the Treasury at the time, but it was certainly a Brash effort –  here is the link to the version on his website ).   The speech drew a great deal of flak.  It was two years into the term of the Labour-Alliance government, and it had nothing much to do with monetary policy or financial stability (the Bank’s responsibilities), and instead offered the Governor’s views on what could or should be done to lift New Zealand’s economic performance.

According to the Governor, our culture was a big part of the problem

we seem to have some deeply-engrained cultural characteristics which are not conducive to rapid growth – surprisingly widespread disdain for commercial success, no strong passion for education, and a tendency to look for immediate gratification (as reflected in our very low savings rate and strong interest in leisure) – and it usually takes years, and perhaps generations, to change such cultural characteristics.

and the welfare system

does the present welfare system – with largely unrestricted access to benefits of indefinite duration, and with a very high effective marginal tax rate for those moving from dependence on such benefits into paid employment – provide appropriate incentives to acquire education and skills and to find employment?

we will not achieve a radical improvement in our economic growth rate while we have to provide income support to more than 350,000 people of working age – 60,000 more than when unemployment reached its post-World-War-II peak in the early nineties – to say nothing of the 450,000 people who derive most of their income from New Zealand Superannuation.

 

Could we, for example, drop all benefits to the able-bodied and scrap the statutory minimum wage, so that pay rates could fall to the point where the labour market fully clears, but simultaneously introduce a form of negative income tax to sustain total incomes at a socially-acceptable level? Could we introduce some kind of life-time limit on the period during which an able-bodied individual could claim benefits from the state? Could we, perhaps, gradually raise the age at which people become eligible for New Zealand Superannuation, reflecting the gradual increase in life expectancy and improved health among the elderly? One of my colleagues has suggested the idea of abolishing the unemployment benefit but introducing some kind of “employer of last resort” system, perhaps run by local authorities with support from central government, under which every local authority would be required to offer daily employment to anybody and everybody who asked for it.

and our schools

It must be a source of grave concern that so many of the people coming out of our high schools have only the most rudimentary idea of how to write grammatical English; and that while Singapore, South Korea, Taiwan, and Hong Kong occupied the top four places for mathematics in the Third International Maths and Science Study, New Zealand ranked only 21st (out of the 38 countries in the study). It can not be good for our economic growth, or for the employment prospects of many of our young people, that, according to an OECD report released in April 1998, nearly half of the workforce in New Zealand can not read well enough to work effectively in the modern economy. It must be a matter for particular concern that 70 per cent of Maori New Zealanders, and about three-quarters of Pacific Island New Zealanders, are functioning “below the level of competence in literacy required to effectively meet the demands of everyday life”.

and excessive regulation

Businesses saw the biggest single problem as the way in which the Resource Management Act was being implemented, and described dealing with that legislation as being “cumbersome, costly and complex”. It should not require two years to get all the approvals needed to set up an early child-care facility catering for only 30 children, or ministerial intervention to cut through the red-tape involved in setting up a boat-building yard. Most of us know similar horror stories.

and our tax system

Another matter relevant to how we might encourage more investment in physical capital is the tax regime. Do we need a substantial change in the tax structure to encourage investment in New Zealand by New Zealanders, by immigrants, and by foreign companies? And if so, what might that change look like? This isn’t the place to go into detail, but it would probably involve a significant reduction in the corporate tax rate (it is disturbing that New Zealand’s corporate tax rate is now the highest in the Asian region). The rate of company tax is rarely the only factor determining the location of a new investment, and indeed it is not often even the dominant factor. But it is a relevant factor, and is one of the issues to look at if we are serious about encouraging more investment in New Zealand.

There were some interesting ideas in the speech. I probably agreed with quite a few of them (I was one of those who gave comments on the draft text, which was even more radical and provocative).  It brought to mind comments about ‘save it for your  retirement”, or “stand for Parliament and make your case” –  which of course Don did a few months later.  But whether you agreed with him or not, whether the government of the day agreed with him or not, it just wasn’t appropriate for an incumbent Reserve Bank Governor.

The Governor is entrusted with a great deal of discretionary power in a limited number of areas.  Citizens need to be confident that the Governor is operating in the public interest, and not to come to suspect the Governor or the Bank of using a very powerful position –  and the pulpit it provides –  to advance personal agendas for policy in other areas.  Same goes for all sorts of key officeholders –  the Commissioner of Police, the Chief Justice or whoever.

That isn’t a novel perspective.  A few years ago Willem Buiter –  chief economist of Citibank and formerly an academic and external member of the Bank of England Monetary Policy Committee –  wrote a useful paper in which(from p286) he urged central bankers to “stick to their knitting”.

The notion that central banks should focus exclusively on their mandates and not be active participants in wider public policy debates, let alone be active players in the negotiations and bargaining processes that produce the political compromises that will help shape the economic, social and political evolution of our societies is, I believe, sound. Alan Blinder described this need for modesty and restraint for central bankers as sticking to their knitting.

As Buiter notes, central banks have often not followed that advice, but

Although always inappropriate, central banks straying into policy debates on
matters outside their mandates and competence is less of a concern when there is little central bank independence and the central bank functions mainly as the liquid arm of the Treasury. It becomes a matter of grave concern when central banks have a material degree of operational independence (and sometimes of target independence also).

Of one example of such straying he writes

Chairman Bernanke may be right or wrong about the usefulness of this kind of fiscal policy package at the time (for what it is worth, I believe he was largely right), but it is an indictment of the American political system that we have the head of the central bank telling members of Congress how they ought to conduct fiscal policy. Fiscal policy is not part of the Fed’s mandate. Nor is it part of the core competencies of the Chairman of the Federal Reserve Board to make fiscal policy recommendations for the US federal government.

And of another

Draghi’s recent address at the Jackson Hole Conference organised by the Federal Reserve Bank of Kansas demonstrates how broad the range of economic issues is on which the President of the ECB feels comfortable to lecture, some might say badger, the political leadership of the EA (Draghi (2014)). Regardless of the economic merits of Draghinomics, there is something worrying, from a constitutional/legal/political/legitimacy perspective, if unelected central bank technocrats become key movers and shakers in the design and implementation of reforms and policies in areas well beyond their mandate and competence.

All of which came to mind when I listened this morning to the interview with new Reserve Bank Governor, Adrian Orr, undertaken yesterday by Radio New Zealand’s Kathryn Ryan.   The interview went for half an hour, and had all of Orr’s accustomed fluency (and not terribly searching questions), but probably half of it was on matters that had really no connection at all to the statutory responsibilities of the Reserve Bank.

He talked at length about climate change and what governments and firms did or didn’t (in his view) have to do.  Some of this no doubt built off his former role with the New Zealand Superannuation Fund –  including the (untransparent) shift in the portfolio away from carbon-intensive assets –  but he is now the Governor of the Reserve Bank, which  has no responsibility for, and isn’t particularly affected by, such matters.  And these are all highly politicised issues.  “The transition needs to start today” he insisted: many people might agree, while others will reasonably take a quite different view, valuing the option of waiting.   The developed world had “gorged on fossil fuel” for 300 years, and now we needed to offer resources to the emerging world.  Probably conventional wisdom at a Green Party rally, but this is from the Governor of the Reserve Bank.

The Governor urged everyone – firms, societies, banks and (presumably) governments to “think and act longer-term”, lamenting the failure of society to take heed of his strictures (and offering no evidence to support his case).   When was the Governor gifted foresight beyond that available to mere mortals? Most humans find the future uncertain, and the far future very much so –  just check out prognostications and concerns from 50 years ago –  and have to plan accordingly.

He seemed to lament the fact that Western societies were growing older –  surely one of the great successes of economic development –  and then declared that it was “fair enough” that the “have-nots” should want structural change now.  How can this possibly be appropriate for the Governor of the Reserve Bank?  (Even if the government of the day happened to agree with him, he is (a) an independent actor, and (b) may well still be in office when the other side of politics once again takes over.)

And, putting a stake in the ground in a hugely contentious issue he declared himself a “huge believer that the country has underinvested in infrastructure”, claimed that our mindset around infrastructure finance was 30 years out of date, and lamented our reluctance to embrace PPPs (while addressing none of the risks of downsides of such structures).

Returning to the Green Party type of narrative, the Governor declared that in his travels he found that the world was looking to New Zealand to show leadership in transitioning to “sustainable agriculture”, declaring how “fantastic” it was when individual farmers had made such a shift.

You might agree with him or some, all, or none of that (I’m in the “none” category myself) but that really isn’t the point.   It would have been quite as inappropriate if he’d been making the opposite points, or repeating the sorts of lines Don Brash was running in 2001 –  championing large company tax cuts, or vocally opposing R&D tax credits.   He has simply gone miles off reservation, nailing his colours to political masts that will make it very hard for him to gain respect as someone operating as an non-political powerful regulator (for now, until the Act changes, the single most powerful unelected official in New Zealand). Perhaps it was a rookie error, and recognising his mistake he can pull his head in, and concentrate on the tasks Parliament has given him, and the need –  acknowledged in his Stuff interview yesterday –  to markedly lift the Bank’s own game.  If not –  if it was conscious and deliberate –  it was a dangerous lurch in the direction of politicising one of the more important offices in our system of government.

I’m not suggesting central banks should never comment on other areas of policy, but they need to be very modest and self-effacing in doing so, and need to tie their comments, and the issues, chosen, very carefully to the Bank’s own areas of responsibilities.  It isn’t, for example in my view the Bank’s place to advocate land use liberalisation, but it is quite appropriate for them to highlight the way that policy choices in that area affect house and land prices, and thus influence the risks on bank balance sheets.  It generally isn’t appropriate for the Bank to take a view on the merits, or otherwise, of particular fiscal or structural policies. But at times the Bank will need to point out the implications of such choices for, say, the mix of monetary conditions.   We should value a good independent central bank, but the legitimacy of the institution –  and its ability to withstand threats to that independence –  will be compromised if Governors play politicians or independent policy and economic commentators.

(Of the bits of the interview dealing with Reserve Bank issues, I didn’t have much to disagree with –  although he seemed far too complacent about the ability of monetary policy globally to cope with the next recession.  There was one proposal that sounded eminently sensible, if challenging to operationalise.  Remarkably the interviewer asked him almost nothing about lifting the Bank’s own game, or the results of that New Zealand Initiative survey on the Bank’s conduct as regulator and supervisor.)

R&D tax credits: more ill-considered corporate welfare

In the minds of members of our new government, much of whatever hope they have of transforming New Zealand’s economic performance (productivity, foreign trade and so on) seems to rest on the proposed R&D tax credit.

Don’t just take my word for that.  Yesterday, they released a discussion document on details of the new tax credit, which is scheduled to take effect next year.  The document is headed Fuelling Innovation to Transform our Economy” .  In the Foreword, ministers gush

This Government’s vision is to build a better New Zealand for all our people and we see an incredible opportunity ahead of us to do this.

That means a country with affordable, healthy homes; an environment we can be proud to leave to future generations; and a diverse, sustainable, and productive economy that delivers for our people.

This vision can’t be delivered with the same old approaches. We need new ideas, new innovations, and new ways of looking at the world.

And that is where science, innovation and research can play an important role. That is where we see our innovators, our scientists, our entrepreneurs and our visionaries building a better New Zealand.

In the view of the government, businesses don’t spend enough on research and development.  They need to spend more.   Knowing better than businesses apparently, the government is to fling another subsidy into the mix.  My mind is carried back to bad old days of export incentives, and other patchwork attempts to avoid addressing the real issues (in those days, heavy import protection and a (typically) overvalued real exchange rate).

As far as I can see, the only thing released yesterday was the discussion document.  There was no officials’ advice on the economics of the proposal, no Cabinet paper, no regulatory impact statement. Not really anything at all, other than few assertions and then straight to the details of the proposed scheme –  the only bit they seem actually interested in consulting on.  Not once –  in yesterday’s document, or in anything else the government has published –  have I seen any considered analysis of why profit-maximising firms might have not regarded it as worthwhile to do more R&D spending here.   If you don’t understand that, it is unlikely that any proposed remedy is a serious well-structured response.  Much seems to rest on the fact that most –  but by no means all – OECD countries also offer these subsidies.

There is quite a reasonable argument to suggest that research and development spending is already rather favourably treated by the tax system.   Purchase a physical asset as part of your firm’s production, and you can only deduct it against taxable income through depreciation, over the expected economic life of the asset.  But research and development spending is really just another form of investment –  it is even in the national accounts (GDP numbers) as such.  But most of that spending is immediately deductible for tax purposes.   The R&D spending that Boeing did to come up with the 747 generated sales and profits over decades, but instead of that spending being offset against those profits in the  years they were earned, it would all have been deductible up-front.  The time-value of that favourable treatment is considerable (huge when the R&D leads to a product with a long period in the market).  And since New Zealand has now one of the higher company tax rates in the OECD, the value of that standard ability to deduct is already larger here than in many other OECD countries (and before people start invoking our imputation scheme, it is the company tax rate that matters for foreign investors and in the document the government says “We also want to attract large
international R&D intensive firms to New Zealand”).

In the discussion document there is a full page graphic highlighting gross R&D spends in a variety of advanced countries.  For some reason, even though the R&D credit is aimed at businesses, they don’t quote business R&D expenditure, so in this table I’ve added that column as well, using data from the OECD.

Total R&D Business R&D
% of GDP
United States 2.8 2
United Kingdom 2.9 1.1
Canada 1.7 0.9
Ireland 1.5 1.1
Finland 2.9 1.9
Denmark 3 1.9
Israel 4.3 3.6
Switzerland 3.4 2.4
Australia 2.8 1.2
New Zealand 1.3 0.6

Which is interesting, but it is perhaps worth pointing out that of those countries, Finland, Denmark, and Switzerland (as well as New Zealand) don’t have R&D tax credits.  As I’ve pointed out in other posts Germany doesn’t either –  and business expenditure of R&D there is about 2 per cent of GDP.    On OECD estimates, the value of the US tax credit is also very small.

R&D tax credits aren’t the only form of government spending to subsidise business R&D – in fact, the government’s new scheme involves doing away with the current grants.   And as it happens, OECD numbers suggests we already spend more (per cent of GDP) on such subsidies than Germany (DEU), and quite a lot more than Switzerland (CHE).

Direct government funding and tax support for business R&D, 2015

All of which might suggest taking a few steps back and thinking harder about why firms themselves don’t see it as worth undertaking very much R&D spending here.  But given a choice between hard-headed sceptical analysis and being seen to “do something”, all too often it is the latter that seems to win out.

In an earlier post, I pointed out

Formal research work done previously suggests that the rate of business R&D spending in New Zealand partly reflects the sort of stuff we produce.  One way to see that is to look the OECD’s commodity exporting countries, and compare them with seven economies at the heart of advanced Europe.  These are simply different types of economies.

BERD (% of GDP) BERD ( % of GDP)
Australia 1.23 Austria  2.03
Canada 0.93 Belgium  1.58
Chile 0.14 France  1.44
Mexico 0.17 Germany  1.96
New Zealand 0.57 Netherlands   1.10
Norway 0.87 Switzerland   2.05
Denmark   2.oo
Median 0.72 Median 1.96

In passing, it is also perhaps worth highlighting Israel –  an economy with very high business spending on R&D, and yet not only an economy with GDP per capita around that of New Zealand, but with a similarly poor longer-term productivity record.  They make and sell different stuff –  some of which clearly needs lots of R&D –  but not, overall, any more successfully than we do.

A reasonable counter to this sort of line of argument might be “ah yes, but we want to be Denmark –  after all, in some sense they once were New Zealand (agricultural exporter etc)”.     But if the opportunities are really here for such a transformation, has the government and its advisers stopped to think about why firms don’t seem to see investing in more R&D as offering a worthwhile expected return?  Danish firms didn’t seem to need an R&D tax credit to get there.

Personally, the 2025 Taskforce’s approach to the issue seems more persausive

The 2025 Taskforce addressed some of these issues in their 2009 Report (around p 70).  They argued that more attention should be given to the possibility that high levels of business R&D spending might reflect more about where particularly economies are at (near the frontier or not, differences in product mix) rather than being some independent factor explaining the success or failure of nations.  In their view, a highly successful New Zealand was likely to be one in which more business research and development spending was taking place, but as a consequence of that transformation rather than an independent cause of it.  That still seems like a pretty plausible story to me –  although New Zealand is long likely to be primarily an exporter of commodities, and richer commodity exporters (Norway, Australia and Canada) don’t have particularly high levels of business R&D spending.

And part of the transformation in New Zealand seems almost certain to involve a much lower real exchange rate for a prolonged period.  It was an important message in the 1980s –  when officials actually took it seriously –  and remains no less important today, even if ministers and officials now seem to ignore the issue.

I don’t want to spend time on the detailed issues of the design of the new tax credit.   But I did notice this

A business will need to spend a minimum of $100,000 on eligible expenditure,
within one year, to qualify for the Tax Incentive. The rationale for setting the threshold at $100,000 of eligible expenditure is to filter out claims that are not likely to be genuine R&D. $100,000 of expenditure is roughly the cost of one full time employee’s salary and related overhead costs.

It isn’t clear why small claims should be less likely to be all genuine R&D than large ones. But then juxtapose the planned threshold with this chart

BERD by firms NZ

In other words, a large proportion of the companies doing R&D won’t be eligible for the new subsidy at all, while the “big end of town” can gobble up generous subsidies from the taxpayer.  It is corporate welfare, deliberately skewed to the bigger firms.

An interesting feature of the proposed new tax credit is that there is no attempt to structure it to incentivise increased levels of R&D spend.  The tax credit will apply to the first dollar of R&D expenditure (for firms above the $100000 threshold) –   much of it spending the firm would have done anyway.  No doubt there are arguments for such an arrangement in practicality and minimising compliance costs.  But it also means that the returns to whatever additional R&D spend might take place as a result of the tax credit will have to be very high, to cover the cost of the whole programme.  And yet there is no attempt at any sort of cost-benefit analysis (actually not even an estimate of the fiscal cost) in the discussion document –  or even a hint that one has been done elsewhere.  It is as if the government believes that any increase in recorded deductible gross R&D spending will offer gains in material living standards for New Zealanders.   Perhaps, but it would be nice to see the case rigorously made, and the detailed assumptions exposed to scrutiny.