Not many good tidings….

…in the productivity numbers that is.

Statistics New Zealand yesterday released the September quarter GDP data, including the revisions to the quarterly data that stem from the annual national accounts for the year to March 2016 that were published a few weeks ago.    Headline writers focused on the quite high rates of growth for the September quarter, while more sober observers allowed for the 2.1 per cent population growth in the last year and noted that in per capita terms real GDP growth remains pretty subdued.

I dug out the data to see if there had been any productivity growth.   As I’ve noted on several occasions, the labour productivity trend in recent years has been so weak it almost seems too bad to be true.  I wondered if the picture might look better with the new data.

In Australia, the ABS reports an index of real GDP per hour worked as one of the standard suite of published series.  In New Zealand, no such luck.  So I average the two measures of real GDP (expenditure and production) and divide by hours worked from the HLFS.  Unfortunately, Statistics New Zealand upgraded the HLFS earlier this year, and in the process introduced a break in the hours worked series.  There is a step up in hours worked that is partly on account of simply measuring things differently (and probably better).  Improvements in statistics are, of course, welcome but it is a little frustrating that the agency has made no effort to produce an official break-adjusted series.   In the June quarter, hours worked rose by 2.6 per cent.  As real GDP rose by 0.7 per cent, and there has been little sign of productivity growth in recent years, I’m going to assume in the charts that follow that 2 percentage points of that increase in hours was just a result of the change in methodology.  It won’t be quite right, but it doesn’t look likely to be seriously inaccurate either, especially against the measurement challenges and revisions we always face in looking at GDP/productivity.

So here is the resulting measure of real GDP per hour worked


And, even with the data updates, there is still no sign of any material productivity growth.  It has been 4.5 years now since this productivity index got to around the current level.

There was plenty of gloomy commentary around the recent Australian quarterly GDP outcome, but in productivity terms  even after a poor quarter (in a series with some noise), Australia continues to pull away from New Zealand.  Here are the two GDP per hour worked series, starting from 2007q4, just prior to the New Zealand (and global) recession and the Australian downturn.


Our dismal productivity performance really should be getting more attention, and raising more concern, than it seems to.  But today isn’t the day for a long post on the underlying problems and possible solutions.

I’ll be taking something of a break.  There might be a few posts in the next few weeks, but something like a normal flow won’t resume until the week starting 30 January when the kids start going back to school.

In the meantime, in honour of Sunday’s Feast of the Incarnation (aka Christmas) I’ll leave you with this from John Milton’s poem

On the Morning of Christ’s Nativity
Compos’d 1629


This is the Month, and this the happy morn
Wherein the Son of Heav’ns eternal King,
Of wedded Maid, and Virgin Mother born,
Our great redemption from above did bring;
For so the holy sages once did sing,
That he our deadly forfeit should release,
And with his Father work us a perpetual peace.


That glorious Form, that Light unsufferable,
And that far-beaming blaze of Majesty,
Wherwith he wont at Heav’ns high Councel-Table,
To sit the midst of Trinal Unity,
He laid aside; and here with us to be,
Forsook the Courts of everlasting Day,
And chose with us a darksom House of mortal Clay.


Say Heav’nly Muse, shall not thy sacred vein
Afford a present to the Infant God?
Hast thou no vers, no hymn, or solemn strein,
To welcom him to this his new abode,
Now while the Heav’n by the Suns team untrod,
Hath took no print of the approching light,
And all the spangled host keep watch in squadrons bright?


See how from far upon the Eastern rode
The Star-led Wisards haste with odours sweet:
O run, prevent them with thy humble ode,
And lay it lowly at his blessed feet;
Have thou the honour first, thy Lord to greet,
And joyn thy voice unto the Angel Quire,
From out his secret Altar toucht with hallow’d fire.

Labour on New Zealand Superannuation

Sometimes I wonder where Andrew Little gets his advice/ideas.

Yesterday, the Dominion-Post ran an article by Vernon Small reporting an interview with the Labour leader and his finance spokesperson Grant Robertson.   In it

Little reaffirmed his opposition to raising the retirement age – a policy he scrapped as leader – but he wants to resume payments to the “Cullen” fund that pre-funds some of the cost of the universal pension.

“Do we need to resume contributions to the Cullen Fund? Too darn right we do, (because) $14.5 billion of contributions not made in the last eight years would have been worth $20b to the fund.”

Other changes to superannuation were not being contemplated, although Little did not rule out other options such as changes to the current indexing, which is linked wage rates.

“Those are things you can have a look at. They are not big money-savers necessarily – over time they might be – but (I am) not certainly averse to looking at those sort of things.”

But New Zealand could be proud of its low level of elder poverty. “So why would you want to change that?”

I agree that the low level of poverty among the elderly is something New Zealand can be proud of.  So why would Labour want to put it in jeopardy?   Because that is exactly what changing the indexing basis would mean over time.   By contrast, raising the age of eligibility gradually –  the policy Labour previously campaigned on but has now abandoned – would be one of the best ways of securing the admirable record of keeping from poverty those unable to work because of advanced age.

At present, NZS payments are indexed to changes in average nominal wages.  That means that, over time, those on NZS share in the overall gains that wage earners achieve.  When productivity growth is low, neither wages nor NZS tend to rise very much in real terms, and when productivity growth is strong the elderly get to share in the gains.  It is easy enough to run an economist’s argument for an alternative approach:  index to the CPI instead (as some favour) and NZS is kept at a constant real level, regardless of what happens in the real economy.  If the current real level of NZS is enough to keep poverty at bay, that same level should keep poverty at bay in future –  at least if “poverty” is defined the same way.

Changing the indexing basis makes a huge difference over time.    In their recent Long-Term Fiscal Statement, looking ahead of 40 years, Treasury (perhaps optimistically) assumed annual labour productivity growth of 1.5 per cent per annum.  Only a couple of days ago, they tweeted the chart from the report highlighting just how much would be saved by indexing to the CPI instead of to wages.  But the flip side of moving to CPI indexing is that NZS payments received by individuals in the future would be much lower than they would be under the current rules.  In fact, on the Treasury productivity assumptions, NZS weekly payments 40 years hence would be only around 55 per cent of what they would be on the current, well-established, formula.   Adopting such a rule would almost certainly see a big increase in the number of elderly people measured as living in poverty –  and since community expectations, and regulatory minimum standards in a whole range of areas, tend to rise with economic growth it is almost certain that there would be an increase in real hardship.  Imagine if real NZS weekly payments had been held constant for the last 50 years.

There is nothing inherently right about the current real (absolute or relative) level of NZS.  It is the outcome of a series of political (com)promises.  Sure some money could be saved by moving to CPI indexing for a while, but CPI indexing would almost certainly be untenable and unsustainable in the long run, reopening intense debates every few years as to just what level of income superannuitants should receive.  Avoiding the bitter fights around NZS that characterised New Zealand politics from the mid 80s to the late 90s seems highly desirable.

What I found really puzzling about Little’s reported remarks is that changes in the indexing arrangements would affect everyone who receives NZS –  and would potentially adversely affect them for the rest of their lives.  By contrast, changing the eligibility age doesn’t affect those (a large number of voters) now receiving NZS at all.   And changing the eligibility age slowly, as New Zealand can still afford to do, is a very slight dislocation for most people.   Increase the age of eligibility by, say, two months a year until the age gets to, say, 68, and then index any future increases to future increases in life expectancy.  On that rule, someone who was 60 when the policy change took affect might have to work until almost 66, instead of until 65, to receive NZS.  From their perspective, of course it is a loss and unwelcome, but it isn’t a huge dislocation.  And it is a much slower pace of adjustment than we adopted in the 1990s and early 2000s, when the age of eligibility was raised from 60 to 65 at a rate of six months a year –  and governments managed to get re-elected nonetheless.  I don’t imagine there are many 50 year olds now who expect to collect NZS at 65.

Yes, there are some people who are physically unable to work by the time they are 65.  There always have been, and no doubt always will be.  We have working age people now who are physically unable to work.    And any compassionate society needs to make provision for those people.  But that needn’t mean a universal entitlement at age 65 indefinitely.

The other overdue change to the NZS system is to alter the rules of eligibility.  A residency requirement of only 10 years to claim a full NZS payment seems generous to the point of irresponsibility, prioritising those with a weaker natural claim on our support, over those with a greater claim.  That is especially  so as I pointed out again recently the rules mean that for many people (especially New Zealanders in Australia) they don’t need to have lived in New Zealand –  or paid New Zealand taxes – at all.    The Retirement Commissioner proposes a 25 year residency requirement.  One other possibility might be phased residency tests: perhaps after 10 years, a person might be eligible for 20 per cent of the standard NZS payment, and after 30 years might be eligible for 100 per cent.   But that residency test should involve actual physical residence in New Zealand.

I’ve long been meaning to write a sceptical post about the New Zealand Superannuation Fund.  It was a worthy wheeze in the days when Michael Cullen set it up –  discouraging his colleagues from spending all of the large surpluses –  but it has no natural place.  There is no good moral or economic ground for keeping a universal pension at 65, even as life expectancy continues to increase,  the ageing of the population is a permanent (welcome) feature not a temporary blip, and we don’t have large surpluses any more –  and haven’t had surpluses at all for the last decade.  Labour is quoted citing the investment gains that could have been had if only contributions had been continued for the last eight years –  but (a) the scale of those gains was inherently unknowable in advance, (b) if, as many believe, global asset markets are overvalued the gains may not even be permanent (the NZSF portfolio is structured in such a way that mean that returns will be highly volatile) and (c) the flip side to putting more into the NZSF would have been even larger increases in government gross debt than we have already incurred in the last few years.  Paying public servants to take big leveraged investment risks doesn’t seem a natural role for government (although I know some of my readers/commenters disagree).

I wonder what Labour’s private attitude is?  After all, Labour governments elsewhere in the world –  notably Australia –  have put in place policies to raise the eligibility age for the state pension.  Perhaps they really hope that in next year’s Budget Bill English and Steven Joyce will take the brave but responsible step of raising the eligibility age slowly.  If they did, it is hard to envisage responsible members of the Labour Party’s leadership opposing such a stance with any conviction.

Not bucking the longer-term trends

I was belatedly reading the speech given earlier this month by the Governor of the Reserve Bank.  His speeches often have had a strong tinge of cheerleading for the government –  either highlighting the positive indicators ministers and the former Prime Minister liked to cite, or highlighting as areas for concern only those aspects that the government itself had been raising (thus, for example,doing things about improving housing supply is regularly mentioned, but never the option of cutting back on the medium-term target level of immigration).

This speech was a little different.    The Governor took the opportunity to note that the current recovery –  itself interrupted by a double-dip recession in 2010 –  has been the weakest (in terms of average GDP growth rates) in New Zealand for many decades.  Under a heading “labour productivity growth has been particularly weak”, he explicitly drew attention to the estimate that “New Zealand’s trend rate of labour productivity growth is in the bottom third of OECD countries”, and also noted just how weak growth in total factor productivity growth has been.  The dismal record should be quite a challenge both for the new Prime Minister and Minister of Finance, and for opposition parties thinking about the policy proposals they will campaign on in the next year’s election.

But the paragraph that caught my eye in the Governor’s speech was this one.

New Zealand’s household net savings rate improved by 8 percentage points in the period 2008 to 2013 (from minus 6 percent to positive 2 percent of household disposable income (figure 5)).  Over this period, New Zealand’s overall savings rate (ie including savings by the business and public sectors) increased by around 5 percentage points, and this has been an important factor behind the improvement in New Zealand’s ongoing current account deficit and the decline in net external liabilities as a share of GDP (this ratio has declined from 84 percent of GDP in 2009 to around 63 percent of GDP currently).

It prompted me to go and have a look at the recent annual national accounts data (which will have been released just after the Governor gave his speech).

It was the comment on the overall national savings rate that surprised me.   Here is a chart of the net national savings rate as a share of net national income.

net national savings.png

There has certainly been quite a rebound in the national savings rate since the recessionary trough in the year to March 2008, but it does look mostly cyclical.  The latest observation is around the same level we saw in the year to March 2005.   There isn’t any sign that overall savings rates in New Zealand, averaging across the cycle, are any higher than they have been on average in recent decades.

Here is a shorter span of history for the household savings rate (also as a share of NNI).

household savings.png

The trough in this series was the year to March 2003, just before the big housing boom of the 00s got underway.   There was quite a recovery in the last years of the economic boom and during the recession and immediate aftermath.  But the steady fall in the household savings rate over the last few years also suggests nothing very different from history.    If the current household savings rate is higher than the earlier troughs, at the same time the government savings rate is lower than it was then.

Here is the chart for the same period of government and private savings rates.  “Private” includes –  and is typically dominated by –  business saving.

govt and pte savings.png

For a variety of reasons, when government savings rate rise private savings rates tend to fall, and vice versa.  The really sustained recovery since 2007 has been in business savings –  a component of savings that is typically too little analysed.

The Governor’s comments focused on changes in the savings rate(s).  But the other side of the equation –  particularly as it affects the interpretation of the current account –  is investment.

Here is the long-term chart of investment (national accounts definition –  gross fixed capital formation) as a share of GDP.

gfcf dec 16.png

Again, as I’ve illustrated previously, we’ve had a cyclical rebound in investment rates.  But it isn’t an impressive rebound.  The latest observation –  this in an economy which the Bank thinks has perhaps a small positive output gap – is well below the peaks in 1976 and 1986, and around the same level as the peak in 1996.   The economy went into the 1990s recovery with a massive overhang of commercial property, so it perhaps wasn’t surprising that overall investment didn’t surge to really high levels.  By contrast, in this cycle earthquakes destroyed quite a lot of commercial, residential and government capital stock –  necessitating a lot of gross fixed capital formation just to restore the capital stock to what it was pre-earthquakes.

In many other OECD economies, a gradual decline in the investment share of GDP over time wouldn’t seem odd, as the population growth rates have been trending downwards.  In many cases those countries now have flat or slightly falling populations, and just don’t need as much new investment to maintain capital/output ratios.    But that isn’t the story of New Zealand.  Over the period of that GFCF chart there has been no trend decline in New Zealand’s population growth and in the last year or two, our population has grown as rapidly as at any time since the 1950s.  This chart is a few quarters old, but it illustrates the point.


I wouldn’t want to make very much of the narrowing in the NIIP position.  Again, the Governor referred to a trough in 2009 and compared it to the current position.  But the NIIP position tends to cycle, and over 25 years there hasn’t been much change in the trend level.

But if anything, one could run a slightly contrarian position that a better-performing New Zealand economy over the last few years –  one where more firms wanted to invest more –  the current account deficit would have been wider and the negative NIIP position somewhat larger.  Overall, weak investment looks to be a symptom of weak demand –  both domestic and external.  Firms simply haven’t seen many great opportunities for investment and so, even with all the rebuild and repair work, overall investment levels have been pretty subdued.

And it isn’t as if the economy has been fully employed during that period.  The Governor notes in his speech that the unemployment rate is below the 20 year average. But it is above official estimates of the NAIRU and has been for eight years now.  It isn’t as if there has been an inflation problem either: core inflation has been below target for years now.  And the exchange rate has been extraordinarily high.

There are limits to what monetary policy can do, but stimulating demand –  all else equal –  is what it can do; in fact, it is the reason why we have discretionary monetary policy at all.    The data –  current account, investment rate, as well as the inflation and unemployment rates –  suggest that monetary policy should have been doing more over the last few years.  That it hasn’t is a choice the Governor has made, but having made those choices –  consistently mistaken in my view –  he shouldn’t be trying to sell as a virtue one of the key symptoms of the persistent weakness of demand.

The Morgan immigration policy: appealing to MBIE and Treasury?

Gareth Morgan’s The Opportunities Party last week released their immigration policy, in a reasonably substantial eight page document, long on words and light on pictures.  I’m a classic floating voter, with absolutely no idea who I might vote for at next year’s election, and a nerd too, so I like the idea of a party coming out with some serious discussion of important issues perhaps nine months before the election.  On immigration policy in particular, it is more than we have seen from any other party.

The TOP immigration policy strikes me as one that the bureaucrats in MBIE and Treasury might quite like.  Perhaps some of the more thoughtful ministers might be inclined to agree (quietly) as well, but it is an approach that is in quite striking contrast to the gung-ho assertions that the current system is working just fine, and benefiting all New Zealanders, often heard from the new Minister of Finance.

TOP’s policy document begins

“We are strongly pro-immigration as another tool in the box to improve the prosperity of New Zealanders”

Which seems to fit very nicely with MBIE’s claims that New Zealand’s non-citizen immigration is a “critical economic enabler“.    TOP go on to note/claim that

“Migration enlarges our economy and has a small but real positive impact on our living standards”


Net immigration puts a small upward bias to economic growth which is good for keeping confidence and encourages investors to take the risks necessary to underpin growth in per capita incomes.

There are certainly plenty of claims along those lines, and it has been easy enough for academics to generate models showing how such gains to living standards might arise, in principle.    But there is no evidence advanced by TOP –  or by MBIE, Treasury, Steven Joyce, Michael Woodhouse, Business New Zealand or the New Zealand Initiative –  to demonstrate that in the specific circumstances of New Zealand large scale non-citizen immigration has actually improved the living standards of New Zealanders.

The focus of the TOP immigration policy document is on some of the specifics of what is wrong with the current policy approach.  In many respects, there has been a lot of continuity in policy whatever party has been in government over the last 20 years.  But the current government has gone further than its predecessors in debauching the system, a point made in the TOP document with Gareth’s customary vigour:

“The Government’s craven desire for economic growth at any cost – even if incomes of New Zealanders aren’t rising –  has seen it make Permanent Residency far too easy for migrants who add nothing.”

And here I can agree with a lot of the TOP specifics.  The way the student visas policy has been run is a disgrace, and should be an embarrassment to any New Zealander –  at least perhaps other than those running private training enterprises.  As TOP put it

“There have been numerous instances of dishonest behaviour by NZ providers and their foreign and local agents. There are many sotries about conflicts all along the supply chain from the finders in India, right through to shonky qualifications being granted in New Zealand.  The real issue is that too many involved in the supply chain don’t care much about the education anymore, it’s become an Underground Railroad for aspiring but modestly skilled folk of modest means to gain permanent residency in New Zealand.

The Government, with its obsession in seeing foreign education as a winning growth sector has sold the integrity of our immigration policy down the river.”

Probably no one would argue against an approach that gave points towards residency to people completing, say, a Master’s degree in a core academic subject from a well-regarded New Zealand university.  New Zealand PTE qualifications are quite  another matter.

They go on to criticise the plethora of new working holiday visa schemes –  themselves often put in place more for foreign policy reasons than based on a hardheaded analysis of the economic impact on New Zealanders (especially perhaps less skilled and lower income New Zealanders) –  and the clearly inadequate way in which the points scheme is working.

As TOP note, in dealing with economic immigration

“we only desire people who make us more prosperous.”

There is little sign of that in how current policy rules are working.

Among the specifics on the TOP list of policy proposals there are ones I can agree with:

  • “remove the need for highly-skilled migrants to have a job to come to”.  If we are serious about bringing in highly-skilled migrants, we shouldn’t be putting them through the hoop of compelling them to find a job here from offshore, and potentially move their families to the other side of the world unsure if they will eventually get residency.  Yes, language tests probably have an important role, and there is no point bringing in people with qualifications that simply won’t be recognised here, but if there are long-term gains from immigration they almost certainly arise from the quality of the people we attract, not from the ability to match up with a specific job from the first moment they arrive in  New Zealand. The policy change to favour, in granting residency, people already in New Zealand on temporary visas, was well-intentioned but hasn’t worked to benefit New Zealanders.
  • “reform the study-to-work-to residency regime for foreign students so that only jobs that meet a genuine skill criteria are recognised for residency points”.  I’d go further than that –  removing the right of students to work here while studying, and granting points only for recognised post-graduate qualifications –  but what TOP proposes would be an improvement on where we are now.
  • “reform the points system to reflect the importance of salary level, English language skills, and the ability of migrants to contribute to the economy”.  That last provision worries me a little –  it can cover a multitude of sins –  but the direction seems right.  Again, I would go further and remove the additional points available for job offers in the provinces –  that scheme simply reduces further the average skills level of the migrants we do get.

It is also good to see that TOP endorses the increasingly popular view – even the Retirement Commissioner has belatedly come out in favour  of it – that the residential qualifying period for obtaining New Zealand Superannuation should be extended from the current 10 years to (in their case) 25 years.

I’m less sure I could be enthusiastic about “applicants for Permanent Residency must demonstrate an understanding of our Constitution and the status of the Treaty of Waitangi”.  I sympathise with the apparent intent, but would “uncertain” be an acceptable answer –  in one of the few countries without a formal written constitution and where the status of the Treaty is more a matter of political debate than of law?

Thus far, I think the TOP policies, if adopted, would represent quite an improvement on what we have now.  But, as I noted earlier, I suspect that Treasury and MBIE officials might well agree.

I’m less convinced that the points system itself is a bad way to ration whatever quantity of non-citizen migrants we want to allow in.  Gareth argues

And at the heart of this question [who should we allow in] is – who should decide?  Some bureaucrat adding up eligibility points in a dark room at the back of an earthquake-prone building in Wellington? Or the market?  Obviously the market needs to.  There needs to be either a job offer at a wage that reflects the skill shortage or a track record of the employee having what it takes to add value.”

But it sounds a lot like a points system to me.    The real question is what we should issue points for, not whether to have something like that sort of scheme.  If one is an open-borders libertarian, or even someone who thinks that almost our migrants should come on refugee or family reunification grounds, things might seem different.  But TOP –  rightly in my view –  argues for an explicit economic orientation for most of our immigrant inflow, and if that is the framework someone needs to devise a rationing device.  We could auction places subject to various minimum criteria but, to my knowledge, no one has proposed such a scheme (and no other country with a substantial immigration programme has operated an auction scheme).

Many of these points are about detail.  The big area in which I disagree with TOP is around the overall level of non-citizen immigration we should be aiming for.  They observe

“our immigration policy then, is all about improving the levers.  A 1% contribution to annual population growth from net immigration is a good ceiling”.

As I noted a few months ago in writing about the Green Party’s new immigration policy, an annual ceiling on net immigration is all but impossible to manage.   The flows of New Zealand citizens into and out of the country are large, variable and very hard to forecast.  By contrast, we have fairly tight control on the flows of non-New Zealand immigrants.

I’m not entirely sure how to read the TOP target, but given that for the last 40 years of so there has been a net outflow of New Zealand citizens almost very single year, presumably TOP would be aiming at a net inflow of non-New Zealand citizens of around –  or perhaps slightly more than –  1 per cent of the population per annum.    At present, that would be a net inflow of non-citizens of around 47000 per annum.  By contrast, the gross residence approvals target now is centred on 45000 per annum, and the typical net inflow of non-citizens over the last couple of decades has been a bit lower than that (some of those granted residency don’t end up staying long).     In other words, in terms of overall numbers TOP seems to proposing inflows a bit less than those of the last year or two, but something quite similar to the average outcomes of the last 15 years.

That makes some sense on their own terms.  As I quoted earlier, they believe that high levels of immigration can improve the long-term prosperity of New Zealanders.   And I’m with them (at least most of the way) when in their FAQs they say


How big then should the inflow of foreigners be?


The simple answer is the levels beyond which migration ceases to contribute to raising per capita income of Kiwis.

But where is evidence that anything like the sort of inflows of non-citizens we’ve had in recent decades –  or most of the time since World War Two – is contributing to “raising per capita income of Kiwis”?

It all seems to rest on the same underlying belief –  without evidence specific to the circumstances of New Zealand –  that now guides Treasury and MBIE: the current rules aren’t working very well, but if only we reorient them we can bring in at least as many people and we’ll finally –  decades on –  start seeing the gains of the large scale immigration programme.  Tui’s “Yeah right” springs to mind.

One of the real problems we face is that, attractive as New Zealand is to poor people and people of middling skills in poor countries, we just aren’t that attractive to many really able people.   By advanced country standards, we aren’t that wealthy or productive.  We are a long way from anywhere, including from the cultural and economic centres of the world.  And for all the talk about New Zealand’s wonderful lifestyle, I doubt there is an advanced economy that doesn’t offer very attractive lifestyles in one form or another.  Really ambitious and able people will typically aim for other countries first if they can get in there.  I’m a New Zealander and am at home here, but why as an able ambitious skilled foreigner would you come to New Zealand if you could get into the UK, the US, Canada, Australia, Ireland, or even –  so long as you are happy to learn another non-English language –  most of Europe?  All those countries have problems.  So does New Zealand.

The constant desire, repeated in the TOP document, to bring in lots of foreigners seems fated to be an approach that constantly disappoints.  We  could attract some really able people, and rule changes could help to attract more than the low number we get now.    But we shouldn’t fool ourselves about how desirable New Zealand is –  especially its long-term underperforming economy.  TOP associates itself with the recent strange call from Richard Dawkins for New Zealand to invite the world’s top academics to settle here.  I wouldn’t really have a problem with us doing so, but people need to stop and ask how likely it is to succeed.  When your country is remote, not that well-resourced economically, and when your universities are no better than middling, it simply isn’t very likely that many ‘top academics” would want to come, and in doing so cut themselves off from the funding, the networks etc that help make top tier research possible on a long-term basis.

Perhaps it does no harm to try, but in a way the real problem with the constant focus on trying to get lots of really skilled migrants is that it risks turning into a cargo cult.  Instead of looking to our own people, skills, institutions and energies to produce and sustain prosperity, we constantly look abroad. Other people aren’t the answer to our economic underperformance –  exchanging our people for some mythical superior group from abroad.  It is past time that New Zealand political parties, including TOP, started recognising this.


Gareth Morgan’s tax policy

Economist and commentator, Gareth Morgan, has begun releasing the policy platforms that his new party, The Opportunities Party, plans to contest next year’s election on.  Fairness seems to be his watchword and –  within limits –  who can argue with that aspiration?  But whatever “fairness” means, it doesn’t automatically translate into an obvious set of policy prescriptions.

The first policy he announced was that on tax (document here, and lots of FAQs here).  The centrepiece of the tax policy is to apply a deemed rate of return to  (the equity held in) all productive assets (including all houses) and tax that deemed rate of return at the owner’s marginal tax rate.  Own a million dollar house freehold and if the deemed rate of return was 3 per cent, you’d have an additional $30000 added to your assessed annual taxable income and those on the top marginal tax rate would have to pay, for example, an additional $10000 per annum.   The promise is that any revenue raised from this tax would be fully used to cut income tax rates, with a focus on those on below-average incomes.  In their own words, they expect this policy would

a. Make the tax system fairer;

b. Make housing more affordable over time;

c. Lead to more sensible investment of capital (everyone’s savings);

d. Make capital more readily available for productive businesses that create jobs  and pay wages;

e. Encourage a lot more “trickle down” from those who have stockpiled wealth courtesy  of this loophole; and

f. Reduce New Zealand’s reliance on foreign investment and debt to finance our growth.

I’m sceptical.

No doubt tax accountants and lawyers will have their own detailed concerns (some interesting issues were raised in this post from former Treasury and IRD tax adviser Andrea Black).

At the heart of the policy is a concern that the returns on houses are not appropriately taxed.    There are two strands to that.  The first, and most important in their thinking, is that the imputed rents on living in your own home aren’t taxed.  Everyone will, more or less, accept that that is something of an anomaly.  After all, if you rent an equivalent house and put your equity in a bank deposit, the returns to that deposit will be taxed.    The second is that capital gains typically aren’t taxed (and capital losses typically aren’t deductible).    There is much more room for debate about even the theoretical merits of taxing capital gains –  to say nothing of the practical problems.  But over the last 15 years in most of the country there have been large capital gains associated with housing.  Many rental property owners have not been declaring positive net taxable income, but have still made good overall returns through capital gains.

TOP eschew a capital gains tax –  rightly in my view –  but they appear to believe that their deemed rate of return policy will make future (untaxed) capital gains –  house price booms – less likely.

The idea of a deemed rate of return approach to taxing asset income isn’t new in the New Zealand debate.  Such an approach is already applied to holdings of foreign equities, and only a few years ago the government’s Tax Working Group reviewed the option as an approach to changing the taxation of housing.

Here are some of the reasons why I’m sceptical.

First, Gareth claims that a big part of the economic problem in New Zealand is an over-investment in housing, and that imposing a heavier tax burden on housing will reduce that.  As a result, so it is argued, more resources will be attracted towards business invesment.

This is old ground, but there is simply no evidence of systematic over-investment in housing.  Real investment (gross fixed capital formation) in housebuilding has,if anything, been less –  over recent decades- than we might have expected given our rate of population growth.  Countries with lots more people need lots more housing.  Most indications are that we haven’t built enough new houses.  And perhaps the best indication of that is the high price of houses and urban land.  Over-investment in something is usually consistent with low prices over time, not high prices.

But perhaps TOP have in mind something other than a national accounts meaning of “investment”?  They hint at a belief that houses make up more of household overall asset portfolios than is the case in other countries.  First, that factoid has been substantially discredited since the Reserve Bank last year introduced new and more comprehensive household balance sheet data.  Second, even to the extent it is true it partly reflects (a) overall modest rates of total household savings (people still have to live somewhere), and (b) the extent to which our tax system does not work to bias the ownership of the housing stock towards corporate or funds management entities (often tax-preferred in other countries).  And third, for every housebuyer there is a seller –  typically, from within the household sector.

Is there reason to think that New Zealand in some sense devotes “too many” real resources to housing.  The only one I can think of is that the average size of New Zealand houses –  like those in Australia and the United States – is quite large (much larger than in Europe).  Perhaps there is something in that, although since TOP argue that we need this policy partly because other countries (including the US and Australia) already deal with the distortions in other ways, it isn’t overly compelling.  Nor is it probably great politics to suggest smaller houses –  as we get richer – rather than more houses.

TOP claim that their tax policy will “reduce New Zealand’s reliance on foreign investment and debt to finance our growth”.  They don’t explain what they have in mind here.  Since, as I’ve pointed out, we already devote fewer real resources to building houses than one might expect given our population growth rate, it can’t really be through a channel of less housebuilding.  All else equal, less investment would reduce the current account deficit but……the TOP policy document argues we would see more business investment if their policy was adopted, so it isn’t even obvious why the current account deficit would narrow.

I think they must have in mind a wealth effect from high house prices onto consumption.  If high house prices encourages more overall consumption then, all else equal, that will widen the current account deficit –  although, contrary, to Gareth’s speaking notes at the launch of the policy, not since 1984 have these deficits involved “our political leaders trotting round the world with the begging bowl out”.    But as I have noted on various occasions previously, the evidence for a material wealth effect from higher house prices just isn’t very strong.  Here is a chart from a post I ran a few months ago showing consumption as a share of GDP over the last 30 years or so.

household C to GDP

Almost dead-flat (the red line is the full period average), and if anything edging slightly downwards, even as house prices have gone crazy.   That isn’t surprising: high house prices don’t make New Zealanders as a whole richer, they just redistribute wealth from one group to another (and in most cases –  since people want to stay living in the same house –  even the redistribution is more apparent than real).

In principle, of course, taxing an asset more heavily will tend to reduce its value.  Adopting the TOP policy could be expected to reduce house prices, to some extent.  But it won’t change the fundamental imbalances in the housing and urban land market (regulatory restrictions on land use the most important, but running head on into sustained government-induced population pressures).   And I wonder quite how much there is in the TOP policy proposal.

When the Tax Working Group looked at these issues a few years ago, they could talk loosely about a deemed rate of return of 6 per cent, something like the 10 year government bond rate at the time.  These days, having rebounded somewhat in the last few months the 10 year government bond rate is not much above 3 per cent.  And the Reserve Bank assures us that its modelling of long-term inflation expectations shows that they are firmly anchored around 2 per cent.    Real interest rates –  the real risk-free benchmark rate of return in New Zealand are very low.  And even then, our interest rates are still materially higher than those in most countries abroad –  and, as everyone accepts, that isn’t because productivity growth and real opportunities here are so much better than those abroad.  In the UK for example –  with a better long-term productivity record than New Zealand, much more government debt, and a similar inflation target –  the 10 year bond yield is around 1.3 per cent.

One of the problems with the TOP policy document is that there are no details.  They say that is all to be negotiated once they get into Parliament, but it makes a lot of difference whether they plan to use a real or nominal risk-free interest rate, or even a short or long-term rate.  Much discussion has tended to assume that a nominal long-term rate should be used.  I could make a strong –  stronger I think –  case for using a real short-term interest rate.

One of the flaws of our tax system –  or at least its interaction with our monetary policy inflation target –  is that all of nominal interest is taxed, and where interest is deductible all of nominal interest is deductible.  That is so even though the portion of the interest that simply compensates for inflation  –  maintains the real value of the asset – is not (in economic terms) income at all.  As a parallel, inflation raises the nominal value of your human capital to maintain the real value of that asset, but it is only the returns to that higher nominal asset value (any increase in annual wages) that is taxed.  Economists tend to quite like the idea of inflation-adjusting the tax system, while tax administrators hate it (for practical reasons).  It is already more of a problem in New Zealand than in most countries (because we fully tax –  and thus double tax –  all interest income).  But it would be a major new distortion, on a much more serious scale, to impose a nominal deemed rate of return across a much much larger stock of assets (than just fixed income assets that are already over-taxed).

So to me if the TOP policy were to be adopted the logic of using a real interest rate as the deemed rate of return (or fixing the zero lower bound and lowering the inflation target) seems pretty clear.

What about the short-term vs long-term rate issue?  No doubt, defenders of using a long-term rate would note that these are typically long-term assets.  But… has to assume that the deemed rate of return will change over time (even long-term bond rates do).  And it seems unlikely that if I buy a house today, Gareth’s policy would offer me tax certainty –  say, using today’s 10 year bond rate for the next 10 years.  If not, and if the deemed rate of return is subject to, say, annual review at each Budget, then using something like a one year government bond rate would seem a reasonable approach.    But the one year government bond rate is around 1.9 per cent at present, and year-ahead inflation expectations aren’t much lower than that.  A real risk-free government bond yield in New Zealand at present is around 0.5 per cent. And it is even lower in other, generally more successful, economies.

Now a reasonable rejoinder might be that the times are exceptional, and that these rates can’t last for ever.  If I were a betting man, I would probably agree.  But……our interest rates are higher than those in the rest of the world, and one of the goals of the Business Growth Agenda is to see that gap close.  And we aren’t in the depths of a recession: best estimates are that the output gap might be somewhere near zero, and yet our Reserve Bank expects no change in the short-term policy rate for the next few years.  If one is taking a policy to the electorate over the next 12 months, one surely has to work on the basis that the interest rates we have now might be around for some time.

If real short-term interest rates are the conceptually and practically appropriate rate to use in a deemed rate of return model, the tax on that million dollar housing equity would be around $1666 per annum, even for those on the top marginal tax rate.  That would be an annoyance to homeowners but –  especially with some income tax relief on the other side –  hardly likely to materially transform the housing market.   From Gareth’s perspective, that could have an upside –  an unthreatening introduction, and then when/if real interest rates return to “normal” it begins to bite much harder semi-automatically.  But it is a hard sell to make big changes in the tax system for such small potential payoffs at anything like current interest rates.

What else makes me uneasy (more briefly):

  • one of my objections to a practical CGT is that it tends to make government revenue even more highly pro-cyclical, encouraging unsustainable spend-ups as asset booms go on.   The deemed rate of return approach seems to face very similar problems.  Because a lot of housing assets are leveraged, the equity in housing changes more than proportionally with changes in houses prices.  A 20 per cent annual increase in house prices –  perhaps at a time when interest rates were rising anyway  –  might induce a 25 per cent rise in annual revenue from this tax.  While it is all very well to talk of full offsets in income tax reductions, it is very unlikely that would happen year by year –  or else, there will be material increases in income tax rates in the middle of asset busts, which again seems highly unlikely.  So, it looks like a policy that will tend to undermine spending discipline just at points of cycles when it is most needed, and undermine government revenue just at the point of the cycle when it is most valuable.
  • it is a systematic tax on Aucklanders  (most of the asset-based revenue will be raised in Auckland, but income tax rates are national and low income people aren’t concentrated in Auckland).  As a Wellingtonian that might not unduly bother me, and as an economist there might be a plausible argument for it, but there are awfully large number of voters in Auckland.
  • Valuation issues seem more substantial than TOP allow for.  In their FAQs there are blithe descriptions of how house values might be triangulated, but if I am facing a large annual tax on the imputed rent on my house I will likely care much more about the assessed value being used than I will in respect of local body rates.  The compliance costs seem non-trivial –  and that is before getting into business assets.
  • There is a reasonable economic case for a pure land tax. The quantity of unimproved land is fixed, and so taxing that value doesn’t change the supply of land.  But this isn’t a land tax.  It would apply to business assets as well, as –  in effect –  an underpinning minimum tax (if existing income tax liability is lower than the deemed rate of return).  But many businesses fail –  they never succeed in making much taxable income.  And while we want a strong stream of highly profitable businesses, one of the ways one gets there is to have plenty of entrepreneurs take risks, and often enough fail.   The TOP document talks about the ability of firms to   “allow those businesses facing a temporary or cyclical earnings downturn to defer their minimum income tax for a period of up this to 3 years (use of money interest to be charged)”.  But that doesn’t seem to deal with businesses that never succeed at all.  Imposing a fixed minimum tax, even if it can be deferred for a few years, is an increased tax on entrepreneurship.  What you tax, you get less of.    And yet TOP talk of encouraging more “productive” business investment and more entrepreneurship.

In the end, I think my assessment of the TOP policy is that a very high level it isn’t necessarily inappropriate, but would be hard to make work well, doesn’t offer very much in a low (real) interest rate world, and is misconceived as a structural answer to either our housing price problems or our sustained economic underperformance.

Next week I will write about TOP’s new immigration policy, which I strongly agree with parts of, while being quite sceptical of other parts.  To their credit, it is a more serious engagement with the issues than we’ve seen from other parties to date.


I was participating in a debate the other day with a prominent economist and a leading business person.  Both seemed keen on actively growing New Zealand’s population further –  the economist in particular calling for a “population policy”, and appearing to argue that a much larger population was a critical element in improving New Zealand’s productivity outcomes.  The principal channel that he appeared to have in mind was better physical infrastructure, notably (because he explicitly mentioned them) high speed trains between our major cities.  Both my interlocutors seemed keen on a much larger population for Auckland –  to which my response was along the lines of “what, and dig an even deeper hole than we’ve already dug”, given the economic underperformance of Auckland relative to the rest of the country over the last 15 years.  None of this advocacy for an active policy role in growing population further appeared to give any recognition at all to

  • the economic underperformance of Auckland
  • the lack of any evidence that countries with smaller populations tend to be smaller or less productive than those with larger populations, and
  • the lack of any evidence that small countries have been achieving less productivity growth than large ones.

As far as I can see, the only OECD country where there might –  just might –  be a strong case for an active government role in trying to grow the population is Israel, surrounded by much more populous hostile states.  And even then, Israel’s survival so far  –  I remain a little sceptical that it will last longer than the Crusader states of earlier centuries – is more down to technology, organisation, institutions, and embedded human capital than to numbers of people.

But what prompted this post was a comment from the economist that not only should Auckland’s population be markedly further increased –  and the residents urged into apartments –  but that governments should be actively aiming to increase the population of our other cities and regions.  The specific aspiration that caught my attention was the suggestion that our second biggest city –  at present, Wellington and Christchurch have similar populations –  should have a population around half that of Auckland.  I was somewhat taken aback and responded “but that isn’t typically how things are in other countries”, to which the confident response was “oh yes it is”.  So I thought I had better check the data.

I set aside very large countries, and extremely small ones.  Most of Malta, for example, is Valetta.  Even among the large countries there is quite a range of experience: Britain, France and Japan have single dominant city, while Germany, Italy, and the United States don’t. But I found 22 advanced (OECD or EU) countries each with a total national population of between 1.3 million (Estonia) and 17 million (Netherlands), and I dug out the data, as best I could, for the populations of the largest and second largest urban areas in each of those 22 countries.  20 of the 22 countries are in Europe, and Israel and New Zealand are also in the sample.

Here is the share of the total national population accounted for by the largest city in each country.


Among these smaller advanced countries, our largest city’s share of total population is a bit above the median, but nowhere near the highest share.  Of course, as I have noted previously, except for Israel (Tel Aviv), our largest city has grown faster than any of these countries’ largest cities in the post-war decades.

But what about the specific point at issue: the size of the second largest city relative to the largest city.  Here is that chart.

cities 2.png

There is huge range of experiences even among this group of relatively small advanced countries –  from Latvia and Hungary where the second city is tiny relative to the largest, to the Netherlands and Switzerland at the other end.  In those two countries, the largest city is quite small relative to the total population.  There isn’t an obvious correlation between economic success and the relative size of the second largest city.  Ireland and Denmark are much richer than New Zealand, but so are the Netherlands and Switzerland.  And Latvia, Hungary, Slovakia, Portugal and Bulgaria are poorer than us.  New Zealand’s number isn’t much different from the median country’s experience.

One thing worth bearing in mind in this sample is that in most of these countries, the largest country is also the capital.  That isn’t so in New Zealand, Israel, or Switzerland – or, for practical purposes, the Netherlands.  All else equal, one might hypothesise that Wellington would be smaller if it were not the capital –  but that might just have left Christchurch as the clear-cut second largest city.

Since there is a wide range of experiences across similarly wealthy countries in the relative size of largest (and second largest) cities, it might be wise to be rather cautious in concluding that government policy should be actively directed to altering the relative size of some or other groups of cities.  Patterns across countries are likely to reflect some mix of history, geography, and economic opportunities.  In some countries, outward-oriented economic activity is heavily concentrated in big cities (one might think of London), in others it derives largely from non-urban natural resources (one might think of Norway).

As it happens, as a matter of prediction rather than prescription, I do think that a successful reorientation of policy in New Zealand would increase the relative size of second and third tier cities relative to Auckland.  But it would do so because (a) Auckland’s population would no longer be supercharged by an aggressive immigration policy, and (b) because, as a result, overall population growth would be lower, there would be less pressure on real interest rates and the real exchange rate, and the outward-oriented economic opportunities, which are at the heart of the provincial economies, would be more attractive, and would see more business investment taking place.

If, instead, governments persist with large non-citizen immigration programmes then, for all the talk of the attractive lifestyle the regions offer, it is a recipe for even more of the same.   Why wouldn’t that happen –  doing the same thing again and again and expecting a different result doesn’t, to put in mildly, make much sense.    For the last few decades, Auckland’s population has grown rapidly relative to that of most of the rest of country.  And its relative economic performance appears to have languished –  there is  certainly lots of activity to keep up (more or less) with the needs of a growing population, but little productivity growth.  Indeed, the large productivity margin one might normally expect to see in the data for largest cities is quite small in Auckland, and has been shrinking further.  There is no sign of some critical tipping point being reached in which –  say – high speed trains are about to transform our economic prospects.

As for the regions, one hears enthusiastic talk from time to time of encouraging migrants to the provinces –  and last year the rules were further tweaked in that direction.  But that is simply a recipe for further undermining the quality of the migration programme –  less able people who are desperate to get in will go to the provinces, to pick up the additional points on offer.  We want people to move to Invercargill or Napier –  if they do – because the business opportunites there are sufficiently good to attract people, not because the government puts points “subsidies” on offer, which simply mask the serious structural imbalances in the economy.  The best path to better provincial performance –  not an end in itself, but probably part of a more successful New Zealand –  is likely to be the removal of the distortions and policy pressures that have given us such a persistently overvalued real exchange rate for so long.  Using policy to simply bring in lots more people won’t do that –  any more than it has for the last 25 years.

Brexit, Trump and all that

Last week, The Treasury hosted a guest lecture featuring two visiting academics under the heading Brexit, Trump & Economics: Where did we go wrongOne of the visitors –  Samuel Bowles, now a professor at the Santa Fe Insitute -had been around long enough that in his youth he had served as an economic adviser in Robert Kennedy’s presidential campaign,  and at other times as an economic adviser to the Castro government in Cuba.  The other –  Wendy Carlin –  is a professor of economics at University College, London.

When the invitation went out, I was rather puzzled by the title?  Who was this “we” that apparently “got things wrong”?    After all, I was –  and remain –  keen on Brexit, and will recall for a long time the thrill of that June Friday afternoon as the results rolled in.  And if I wasn’t a Trump supporter, I wasn’t a Clinton one either.  There is a fascinating question as to how Trump became the Republican nominee, but once that had happened one of two unattractive candidates was going to become president.

“We” turned out to be economists.  And by getting things wrong, Bowles and Carlin didn’t mean simply getting eve-of-polling-day forecasts wrong (after all, that late in the day even some pretty prominent Leave figures didn’t expect to win).  Instead, economists were held to blame for these otherwise unthinkable, apparently lamentable, events occurring in the first place.  If only economists had done a better job, the deplorable events would never have happened.  Or so the story went.  The tone was one that surely no right-thinking person could have wanted such outcomes (Brexit was even described as a “gloomy event”).    As this was the second Treasury guest lecture in recent months deploring Brexit, I start to wonder if the organisation now has a quasi-official view (or perhaps it is just the British CEO)?

I’m still not entirely persuaded that either event –  Brexit or Trump –  is quite as earthshattering as the liberal elite seem to make out, or even that they are very closely connected.  UK voters chose to leave the EU by a margin of 52:48.  That is a large enough margin not to require recounts, but hardly an overwhelming margin.  And the same voters only a year early had re-elected (this time with an absolute majority) David Cameron and Conservative Party, on a not-remotely-radical platform.  And today, Cameron and Osborne are gone, and Britain still has a not-remotely-radical (perhaps only slightly more reforming than John Key) Conservative government, with a massive lead in the polls – albeit, the latter is as much about the problems with the Labour Party as anything else.  The government is charged with implementing Brexit, and there seems to be not the slightest sign of some turn inwards, or reversion to protectionism, on goods and capital flows.

Of course, if your vision was one of ever-closer-union, and a mental model in which there was only a one-way door to the EU, perhaps it is a great shock.  After all, if Brexit works more less okay, it might suggest to other countries’ citizens that there are reasonable alternatives to being part of the EU.  And that simply isn’t so radical –  after all, most of the world’s people show no interest in becoming citizens of multi-national superstates.  And the tendency of the last 100 years has been towards more sovereign states not fewer.  Lower barriers to international trade help make that possibility more economically viable.

And it is not as if the public in the United Kingdom has ever been very enthusiastic about subsuming sovereignty into some quasi-democratic entity based in Brussels.  The technocratic elites may have been enthusiastic, but the public seem never to seen anything very wrong about being British.  When your country has been free, and on the right side of the major conflicts of the last 100 years, it is hardly a surprising stance.  Citizens of Spain or Austria might see things differently.

I wrote a post earlier in the year about the fascinating polling data from the early 1970s I stumbled across in a book reviewing UK entry to the EU in 1973.    For all the talk that it was poorer, unskilled, older people who voted to Leave –  as if somehow that changes the character of the decisions –  in the early 1970s, when overall opinion was pretty closely divided on entering the EU, it was those same groups who opposed joining.  And of course the same people who were young in 1972, are old in 2016.  As I noted in that earlier post, what was striking from the polling data (comparing the early 1970s and the 2016 exit polls), is the change in attitudes among the more highly educated groups.    Among the AB group (professional and managerial occupations), in the early 1970s there was a huge margin (50 percentage points) in favour of joining the EU. In the 2016 exit polls, there was a margin of only 14 percentage points  (57:43) in favour of remaining in the EU.   Poor and unskilled changed their minds (as a cohort) less than did the more highly educated groups –  and those more highly educated groups became much more opposed to staying in the EU.

But for Bowles and Carlin, economists had failed the world.  They presented familiar data showing that most economists thought that Brexit would come at some economic cost (and of course, the great and the good –  the OECD, the IMF, the Bank of England, and the UK Treasury shared that view).  And yet the voters had the temerity to ignore these experts.   When I pushed them on the point, they did –  somewhat reluctantly –  accept that it wasn’t necessarily unreasonable for voters to make decisions on grounds other than economic ones (as I noted, most colonial independence movements  –  even the Irish one – probably came at an economic cost).  But it was a reluctant concession –  these were people who could really only see one end in view, less national sovereignty, more global rulemaking, and they could only lament the choices of British voters –  blaming economists for championing policies which had “made the backlash inevitable”.

(The second half the guest lecture was a presentation about a new approach to teaching introductory economics.  It looked quite promising, but the connection between a possible better approach to teaching basic economics and voters in future “being more willing to take advice from economists” seemed tenuous at best.)

As for the Trump phenomenon, I’m also not sure quite how big an event that should be seen as.    The last count I saw gave Hillary Clinton 48.2 per cent of the popular vote, and Trump 46.3 per cent.    Four years ago, the Democratic candidate scored 51.1 per cent of the popular vote, and the Republican candidate 47.2 per cent.   Presidential elections aren’t decided by national popular vote totals (any more than, say, UK parliamentary elections are) but these aren’t big shifts in the overall vote share.  Yes, the presidency changes hands –  as it was going to do anyway –  but a few hundred thousand votes in a few key states and things could easily have been different.  Are economists really to blame for the fact that the Democratic Party chose such a weak candidate –  who largely ignored many of those tight rust-belt states, despite the advice of her own husband?  And whoever is to blame for Wikileaks I doubt it is the economics profession?

In 1984 Ronald Reagan took 58.8 per cent of the popular vote, in 1972, Richard Nixon took  60.7 per cent, in 1964 Lyndon Johnson took 61.0 per cent and in 1956 Dwight Eisenhower took 57.4 per cent.  Those were landslides (in a New Zealand context, electoral landslides –  1972, 1975, and 1990 involved perhaps seven percentage point gaps in overall vote shares).   This was a very tight election, fought between two deeply flawed candidates.  And if Trump’s success may have helped some Republicans in the House and Senate, very few were campaigning on some Trumpesque policy ticket –  whatever the specifics of such a ticket might actually have looked like.  Like them or not, the appointees to the Trump cabinet announced so far, don’t seem a million miles from many of the sort of people who might well have been appointed to serve in any Republican president’s cabinet.  And being a democracy, parties tend to alternate in office.

What was pretty clear as the Treasury guest lecture went on was that the speakers were mostly just pushing a social liberal ideological agenda (as they characterised their concern it was about a “a revolt against liberal tolerance”.  Things were wrong when their side didn’t win and somehow –  weirdly – economists were to blame.  That isn’t just my interpretation of the event –  it was a proposition put to them at the lecture by Professor Jonathan Boston, himself proudly socially liberal.  What wasn’t clear was why our Treasury was aiding and abetting their cause.   (Or for that matter, how  the ascendancy  –  voted in by US voters, well aware of most of his flaws – of such a symbol of the decadence of modern culture as Trump even represents a defeat for the social liberal project.)

In passing, there was one truly fascinating snippet in the lecture.  Bowles is adamant that a much higher level of economic equality is “not hard to create” –  and he treats such outcomes as highly desirable.  According to his research, the level of economic inequality in modern Denmark and Sweden is about the same as that found in ancient hunter-gatherer societies.  It was almost worth venturing into town for the afternoon just for that.

In the same vein, I came across an interesting report from a conference held in the UK last month under the title “Brexit and the economics of populism”.  The conference was attended by a cast of 50 or so academics, journalists, and some leading market economists from across Europe.    There were some very able participants and it looks to have been a fascinating day’s discussion.  The 12 page conference report is well worth reading for anyone with an interest in Brexit, Trump, modern macro and micro policymaking –  and in the attitudes of the (non-political in this case) elites.

What was perhaps striking –  and this is the real link to the Bowles/Carlin lecture here last week –  is that there is no sign in the entire report that anyone who spoke had themselves been a Brexit supporter (even though 43 per cent of the ABs had favoured Brexit). The report captures one questioner noting that it is not unreasonable for people to vote on non-economic grounds, and that is about it.  And the report is full of references to those ill-defined and pejorative phrases “populism”, “xenophobia”, “nativism” and –  heaven forbid –  “nationalism”.  I had to look up “nativism” –  it isn’t a term that pops up much in New Zealand debates.  According to Wikipedia

Nativism is the political position of supporting a favored status for certain established inhabitants of a nation (i.e. self-identified citizens) as compared to claims of newcomers or immigrants

One might play around at the margins with the precise wording, but it looks like a definition that probably describes the overwhelming bulk of voters.  And there will be few elected politicians  (ie people who have actually persuaded people to vote for them) who seriously think that the interests of foreigners rank equally with the interests of citizens.

Next thing people will be having a go at “familism” –  the belief that the interests of one’s own family might rank more highly in one’s own concerns than those of other people’s families, domestic or foreign.

The conference report suggests participants thought governments needed to do better.  And, of course, there are areas in which that is no doubt true.  Often enough, that might involve avoiding hubristic schemes –  like the euro, or the EU on current scale –  in the first place.  Or respecting the principle of subsidiarity –  pushing decisions back to national governments (and perhaps even lower levels of government) whenever possible.  And respecting public preferences and choices.  And acknowledging the sheer limitations of the knowledge of experts in so many areas –  including economics.

But that wasn’t the focus of the attendees at this conference.  Instead, it was a recipe that seemed to have three broad dimensions:

  • a more active role for government, in particular in discretionary fiscal policy (as if debt levels in many of these countries were not already uncomfortably high),
  • putting more decisions at an arms-length from elected politicians (whether delegating more fiscal policy to independent agencies, or promoting international regulatory alignment), and
  • convincing the public that there really were significant benefits from large scale immigration.

In fairness, there was some recognition that dysfunctional housing markets are a major problem, but no speaker or questioner is reported as having favoured extensive land use liberalisation.  Instead, more roles for active government were in view.

The immigration stance, of course, caught my eye.  As the report writer noted there is an “academic consensus that wealthy countries benefit from migration from developing to developed countries”, but most of the comment was devoted to trying to play down the potential costs to relatively unskilled native workers.  I’m sure these people are quite sincere in their beliefs that there are benefits to advanced countries (and their existing citizens?) but I can’t help thinking that if the gains were that real, and it were that important an issue, the advocates would find it much easier to demonstrate the benefits (to the rest of us) than they do.  Perhaps quite often large scale immigration doesn’t do much harm to natives, but there isn’t much sign that does much good either.  In fact, support for large scale immigration –  whether in Europe or Australasia – is often more of an ideological proposition than one grounded in robust evidence.  It seems as much about a desire to change a society –  in ways which natives often don’t want –  than to lift overall economic prosperity for citizens.    (But in defence of the Europeans, at least no one in this conference is reported as advocating for immigration on the specious grounds –  invoked often by our business leaders and the incoming Minister of Finance –  that immigration is needed to fill “skill shortages”.)

If you got this far, you might be wondering what the point of this post was.  I feel somewhat that way myself. But it was partly about getting a few things off my chest, partly about passing along the link to the interesting conference report, and partly about thinking through my reaction to those who ominously go “could it –  Trump, Brexit –  happen here?”       Could what?  A couple of close votes  –  one of which leaves in place a very moderate centre-right government, and the other of which installs a President who seems to have very few fixed views.  In the specific sense, clearly not. We aren’t part of some multi-national entity like the EU, and our electoral system is very different from that of the US.  Then again, perhaps there could be a revolt against decades of economic underperformance, decades of elite indifference to that underperformance, and an extraordinarily high target rate of immigration which changes the character of the country without doing anything apparent to improve its economic performance.  It could happen, but frankly it doesn’t seem very likely right now.  Easier just to keep on pretending everything is fine.



Immigration and the macroeconomy

Eric Crampton, the strongly pro-immigration head of research at the strongly pro-immigration New Zealand Initiative drew attention to a nice summary (on a high profile portal for the wider dissemination of economic research) of a new empirical paper by a couple of researchers at the Norwegian central bank looking at the macroeconomic implications of immigration in Norway.    It looks as though a draft of the paper may have been presented in New Zealand, and at very least the authors thank a couple of Reserve Bank researchers for comments, and cite a couple of  Reserve Bank research papers.

Unlike most European countries (apparently) but like New Zealand, Norway has good quarterly immigration data.  Historically, Norway had quite low rates of immigration, but over the last 15 years or so there has been a substantial increase, mostly stemming from the liberalisation of migration flows within the EU (and closely associated countries, including Norway).  By New Zealand standards, the net inflows are still modest, and annual population growth peaked at around 1.3 per cent, compared with a 2.1 per cent peak recent annual increase in New Zealand.

Figure 1 Annual change in Norway’s population (%)furlanettofig1

One of the challenges in assessing the economic impact of immigration is assessing which bits are a response to domestic economic developments, and which are more genuinely exogenous.  There aren’t easy or foolproof ways of doing that (after all, even when there are discrete policy changes –  as with the recent change in New Zealand’s target level of residence approvals –  those changes aren’t made in a vacuum, and may be influenced by the actual or perceived state of the economy).

The latest paper uses a particular empirical “identification strategy” to try to distinguish endogenous from exogenous changes in the immigration  flows.  It looks a plausible enough approach, but it is hardly the last word on the subject.   There are two other features of the paper to note, both of which should make it more likely that the authors will find positive results.

The first is that the authors look only at immigration from “western countries” (EU/EFTA, North America, Australasia and Eastern Europe).   As they note, in Norway “immigrants from non-western countries exhibited an employment rate substantially lower than natives, and migrated to Norway mainly because of family reunification or as asylum seekers”.  The second is that the analysis uses “mainland GDP” –  which excludes oil production and associated transport.  Doing so is common in short-term macroeconomic analysis in Norway, but tends to skew the results towards finding positive results from immigration –  since the oil resource is a fixed factor, and a major contributor to Norway’s overall economic prosperity.  Every increase in the population spreads that particular fixed resource across more people, lowering the average per capita output from that sector per person.

So what do the authors’ find as a result of their modelling?  Using quarterly data, they examine the response of a number of variables over periods up to 36 quarters (9 years) after the initial immigration shock.  Here is their chart.

Figure 2 Responses to an exogenous increase in immigration


When the grey shaded area encompasses the red (zero) line, there is no statistically significant effect found.

The results largely rang true to me, and are consistent with the longstanding approach of New Zealand economists to the short to medium term impact of immigration.    Unsurprisingly, an immigration shock boosts GDP –  to a statistically significant extent –  over the first year or so.  The new migrants (particularly these western migrants) are both workers and consumers, and generate a need to additional private and public infrastructure.  But interestingly, the effect doesn’t last.  On this modelling, there is no permanent increase in GDP –  let alone GDP per capita.

And consistent with the New Zealand stylised facts –  over decades, but including Reserve Bank research in the last few years –  a positive shock to immigration typically lowers the unemployment rate in the short-term (in this case two to three years), and in the long-term immigration makes no difference to the unemployment rate. That all makes sense –  typically the demand effects of additional immigration exceed the supply effects in the short-term –  after all, new arrivals need to eat (and do all or most of the normal consumption spending natives do), but they also create a demand for new houses –  which might last 100 years –  and other public and private additions to the capital stock.   In the longer-term, of course, the basic institutions of the labour market (regulations, unemployment benefits etc) determine the unemployment rate.

What about the fiscal impact?  On this modelling, it was found that additional immigration –  and recall that this study focused on western work-oriented migrants, not refugees or people coming on family reunification –  made no difference to public finances in the long-run.  There was a “slightly positive” effect in the short-term, which again shouldn’t be surprising, since –  as we saw earlier-   demand effects tend to exceed supply effects in the short-term, and strong demand tends to boost government finances.

These Norges Bank authors seemed to have started from a position of being relaxed about the economic impact of immigration to Norway.  They focus on the widely-heard arguments that increased immigration will raise unemployment and put additional strain on the public finances, and note that

Our research did not find any support for the macroeconomic arguments that have recently been used against immigration. In our model, immigrants do not limit job opportunities for native workers, and an increase in immigration has no negative effects on the fiscal balance (if anything, we find a small positive effect). It is important to stress, however, that our results refer only to immigration from western countries, and so largely capture job-related immigration.

However, reassuring (and unsurprising) as those results might be, the authors did find some more concerning results.  Specifically, GDP per capita (even just the mainland measure) appears to fall as a result of positive immigration shocks –  recall that in the long-term GDP didn’t rise and the population did –  and GDP per hour  worked also fell.   In their results, this arises from

This decline in productivity was mainly driven by a strong drop in capital intensity reflecting the adoption of less capital-intensive and more unskilled efficient technologies

As they note, laconically, in concluding their note

This may be a worry for long-term growth.

I wouldn’t want to make too much of these results. It is just one paper, and there are plenty of other papers with different research strategies and modelling techniques, that claim to find more positive results for other countries.    I’m not even sure this is the best approach to trying to sort out the long-term effects.  Then again, by focusing on only western immigration, and by looking only at mainland GDP (ignoring the fixed quantity of oil/gas), this paper gave itself the best possible shot at finding economic gains from immigration and –  at least on this methodology –  didn’t.  And these are results for a small country that – while not exactly located as favourably as Belgium or the Netherlands –  suffers nothing like the penalties of distance New Zealand does.

But there is a tendency in the New Zealand debate to (a) wipe from the memory banks all record of the longstanding scepticism of New Zealand economists about the value –  in gains in GDP per capita to New Zealanders –  of large immigration flows in the post-war decades (I wrote about one leading, and early, example of such scepticism here), and (b) discount any scepticism about the economic value of immigration to New Zealand as flying in the face of all serious literature.

The modelling approach in the Norwegian paper doesn’t really allow the authors to offer much insight on why mainland real GDP per capita, and real GDP per hour worked, in Norway might be being adversely affected by immigration, even though –  as in New Zealand –  the short-term effects on GDP and unemployment are typically positive.

As a reminder, while I am somewhat sceptical of the likelihood of large benefits to natives from immigration pretty much anywhere in the world –  unless people from a clearly more productive economic culture/set of institutions move to, and largely swamp the people of, a less successful place (the uncomfortable, but not seriously inaccurate summary of the 19th European migration to New Zealand).  Generally, I suspect immigration doesn’t make that much (economic) difference to natives.  But in some cases, it is likely to be materially harmful.  Give Wales, Nebraska, Tasmania or Southland control of their own immigration policies, and it is very unlikely that large scale immigration would leave the people of those places better off.  I suspect that New Zealand as a whole –  remote islands with control of its own immigration policy –  is also such an example.

I suspect there are two main channels through which this effect occurs here:

  • the first mechanism is the pressure that persistent large immigration inflows put on real interest rates and the real exchange rate.  The economy is skewed towards meeting the physical needs and demands that arise from a rapidly growing population, and away from outward-oriented business investment.
  • the second mechanism is through the dilution of natural resource endowment.  New Zealand’s exports remain overwhelmingly natural resource oriented (be it dairy, or coal, or wine or tourism), and there has been little sign of any dramatic transformation of that picture.  There are individual firms that succeed here simply on the quality of their people and ideas, not tied to any particular location-specific resources, but there simply aren’t many of them.   The persistent pressures on the real exchange rate make it less attractive than otherwise to develop them here, but in any case, New Zealand just doesn’t look like a natural location for lots of such businesses.  If so, we will remain very reliant on the fixed natural resources –  and ever more people, induced by immigration policy –  just makes it ever harder to keep up with, let alone catch up to, incomes and productivity in other more economically fortuiutously located countries.

It is a narrative that fits a lot of the stylised facts about New Zealand.  Of course, it doesn’t fit the prevailing “ideology” or mindset of our economic and political establishment – past and present Prime Ministers, key economic government departments, or (heavily non-tradables oriented) think tanks like the New Zealand Initiative.  But decades on there is still no evidence that their approach –  favouring lots of immigration to New Zealand, as some sort of “critical economic enabler” –  is producing economic gains for New Zealanders, and making New Zealand a more productive place.



Debt to income limits: some questions

One of the jobs of the new Minister of Finance will be to decide whether or not to accept the Governor of the Reserve Bank’s request to add some sort of debt-to-income limit tool to the list of direct regulatory interventions that the government gives the Reserve Bank political cover to use.  It does this under the Memorandum of Understanding on (so-called) macroprudential tools.  I phrase things in that slightly awkward way because Parliament has delegated so much power to the Reserve Bank –  probably without fully realising the import of several legislative changes over the years –  that one unelected official, the Governor, does not actually need approval of the Minister of Finance, or of Parliament, to impose such intrusive direct controls.

To give some credit to the outgoing Minister of Finance, the Memorandum of Understanding framework, while legally non-binding, does more or less ensure that the current Governor would not use such a regulatory intervention without at least the political cover provided by allowing the inclusion of a debt-to-income limit on the list of approved tools.  Longer-term, reform of the governance and regulatory powers of the Bank should include making decisions on the application of such controls formally a matter for the Minister of Finance, on the recommendation of the Reserve Bank.

The Reserve Bank has been at pains to claim that their successive waves of LVR controls have improved the resilience of the banking system.  That claim is less well-founded than they would like people to believe.  For example, shifting a large group of borrowers from say 81 per cent LVR mortgages to, say, 79 per cent LVR mortgages won’t make any material difference to the expected losses a bank might face in a severe downturn, but might actually modestly reduce the ability of a bank to withstand those losses (since loans with less than an 80 per cent LVR typically have lower risk weights).   This risk is one my former colleague Ian Harrison has drawn attention to.  In addition, the Bank has never presented any sort of analysis, not even impressionistic in nature, of what banks are doing instead of making high LVR housing mortgages.  If their risk appetites haven’t changed, and the capital invested in the business hasn’t changed, the risks are likely to be developing somewhere else, perhaps somewhere rather less visible, on banks’ books.  There are also ongoing questions about the evidence base behind the regulatory discrimination against those borrowing to buy a house for residental rental purposes.  Before giving his imprimatur to the possibility of further Reserve Bank regulatory interventions, the new Minister of Finance might reasonably ask some harder questions about what has already been done.  He might also ask some questions about when the drift towards ever more direct intervention –  initially sold as quite temporary back in 2013 –  might end.

Before approving the addition of any sort of debt to income limit tool to the approved list, it would also be worth the Minister insisting that the Bank’s background papers get public scrutiny.  No doubt Treasury gets to see them and Treasury has had some serious questions in the past about proposed Bank interventions.  But since the Governor says there is no urgency about using a debt to income tool, there can be no good grounds for not putting the background material out for wider scrutiny now, before the Minister makes his decision, not sometime –  if ever –  afterwards, when (with luck) the OIA finally gets the papers out of the Bank.

In particular, it would be good to see a careful assessment of the empirical evidence the Bank is using in support of its case for a DTI limit, on both soundness and efficiency dimensions (both important in the Reserve Bank Act).  Along those lines, there was an interesting post out earlier this week on the blog of Richard Green a professor (in housing, real estater economics etc) at the University of Southern California.

In that post, he reports some interesting empirical work on a sample of 281000 fixed-rate mortgages purchased by Freddie Mac, one of the US quasi-government “agencies”, in 2004.  He runs a regression model across two-thirds of these mortgages, using a range of variables to model the probability of subsequent default, including through the largest shakeout in the US housing market in many decades.  His DTI term is not actually the ratio of debt to income, but the ratio of debt service to income, but clearly the two will be highly correlated, especially for these relatively high quality mortgages (ones that met US agency standards –  “qualifying”), looking at all the mortgages across the same period of time.

The equation results are in Green’s post.

Note that while DTI is significant, it is not particularly important as a predictor of default.  To place this in context, note that a cash-out refinance is 5.2 percentage points more likely to default than a purchase money loan, while a 10 percentage point change in DTI will produce a 1.3 percent increase the probability of default.

To be clear, increasing the total service burden from, say, 40 per cent of income to 50 per cent of income –  a huge increase – produced a 1.3 per cent increase in the (always quite low) probability of default.

One reason he notes is measurement

First, while DTI is a predictor of mortgage default, it is a fairly weak predictor.  The reason is that it tends to be measured badly, for a variety of reasons.  For instance, suppose someone applying for a loan has salary income and non-salary income.  If the salary income is sufficient to obtain a mortgage, both the borrower and the lender have incentives not to report the more difficult to document non-salary income.  The borrower’s income will thus be understated, the DTI will be overstated, and the variable’s measurement contaminated.

More generally, and in the US context

The Consumer Financial Protection Board has deemed mortgages with DTIs above 43 percent to not be “qualified.”  This means lenders making these loans do not have a safe-harbor for proving that the loans meet an ability to repay standard.  Fannie and Freddie are for now exempt from this rule, but they have generally not been willing to originate loans with DTIs in excess of 45 percent.  This basically means that no matter the loan-applicant’s score arising from a regression model predicting default, if her DTI is above 45 percent, she will not get a loan.

This is not only analytically incoherent, it means that high quality borrowers are failing to get loans, and that the mix of loans being originated is worse in quality than it otherwise would be.  That’s because a well-specified regression will do a better job sorting borrowers more likely to default than a heuristic such as a DTI limit.

He tests this by applying his model to the one third of the sample of loans held back in the initial estimation.

To make the point, I run the following comparison using my holdout sample: the default rate observed if we use the DTI cut-off rule vs a rule that ranks borrowers based on default likelihood.  If we used the DTI rule, we would have made loans to 91185 borrowers within the holdout sample, and observed a default rate of 14.0 percent.  If we use the regression based rule…… we get an observed default rate of 10.0 percent.  One could obviously loosen up on the regression rule, give more borrowers access to credit, and still have better loan performance.  

And extending the point

Let’s do one more exercise, and impose the DTI rule on top of the regression rule I used above.  The number of borrowers getting loans drops to 73133 (or about 20 percent), while the default rate drops by .7 percent relative to the model alone.  That means an awful lot of borrowers are rejected in exchange for a modest improvement in default.  If one used the model alone to reduce the number of approved loans by 20 percent, one would improve default performance by 1.4 percent relative to the 10 percent baseline.  In short, whether the goal is access to credit, or loan performance (or, ideally, both), regression based underwriting just works far better than DTI overlays.  

The current focus in the US isn’t on responding to a house price boom, but on access to finance (in a market still dominated by the government).  But the sorts of questions posed by these sorts of results are just as relevant here as they might be in a US context.  Perhaps here too, high debt to income borrowers might generally be better quality borrowers?     How confident can the Reserve Bank be that an actual debt to income limit –  as distinct from a pure hypothetical –  will actually improve the resilience of banks –  not just on the housing book, but overall?  And even if there is some improvement in resilience, at what cost –  recall the statutory efficiency mandate –  in terms of access to credit would that gain come at?

Perhaps there are good answers to all these sorts of questions.  Perhaps the Reserve Bank has access to other careful studies that produce different, and robust, results.  But these are the sorts of questions the new Minister of Finance, and the public, should be asking in response to the Governor’s request for political imprimatur for adding another tool to his kit of potential interventions.     And, more broadly, how confident can we be of any sustained gains from such interventions, as compared to the sure increases in resilience that would result from either higher risk weights on housing loans more generally, or higher overall capital requirements for banks (and non-banks regulated by the Reserve Bank)?


Two main parties with new leaders hasn’t happened often

Idly reflecting this morning on the change in the leadership of the National Party, I started trying to work out how often the two main parties have both gone into a general election with a new leader.

The National Party was formed in 1936.  Here are the names of the leaders of the National and Labour parties at each election since then.

Main party leaders
Labour National
1938 Savage Hamilton
1943 Fraser Holland
1946 Fraser Holland
1949 Fraser Holland
1951 Nash Holland
1954 Nash Holland
1957 Nash Holyoake
1960 Nash Holyoake
1963 Nordmeyer Holyoake
1966 Kirk Holyoake
1969 Kirk Holyoake
1972 Kirk Marshall
1975 Rowling Muldoon
1978 Rowling Muldoon
1981 Rowling Muldoon
1984 Lange Muldoon
1987 Lange Bolger
1990 Moore Bolger
1993 Moore Bolger
1996 Clark Bolger
1999 Clark Shipley
2002 Clark English
2005 Clark Brash
2008 Clark Key
2011 Goff Key
2014 Cunliffe Key
2017 Little English

New leaders for both main parties hasn’t happened often.  The most recent previous occasion was 1975, and the  only other time before that was 1943.  On both occasions, the incumbent Prime Minister had died during the previous electoral term, and the opposition party (in both cases National) had experienced a thumping defeat at the previous election.