Universities,export education and immigration

I’ve made a few passing comments in recent weeks about New Zealand universities, mostly in the context of discussions and debates around immigration.  Export education is one of the key emphases of the current government’s economic strategy; they and their MBIE advisers appear to believe that somehow we boost the incomes of New Zealanders by making it relative easy for people who come to study here to gain residence.

I’ve been a bit skeptical about this argument.  If there are economic benefits to New Zealanders from immigration to New Zealand, they probably arise mostly if we are able to attract particularly high-skilled, able and innovative people.  In a US context, people often talk of the benefits of having a top tier university system, which attracts top-flight students to do PhDs in the US and can help encourage some of those people to settle in the US, with possible spillover benefits to the wider economy.  It all sounds good in principle, and there is some evidence of those sorts of gains for the United States.

But what about New Zealand?  Well, I noticed that one set of international rankings of universities (the QS rankings) had been released earlier this month, and I started digging round in their data.  There are a number of different rankings systems, and they all produce slightly different results, emphasizing slightly different things.

On the QS rankings, here are the top 10 world universities

2 Harvard
3= Cambridge
3= Stanford
5 Caltech
6 Oxford
7 University College, London
8 Imperial College. London
9 Swiss Federal Institute of Technology
10 Chicago

New Zealand universities just aren’t in the same league as these sorts of places.  But how do our universities compare with those of other small advanced economies?

I painstakingly went through both the QS rankings and the Times Higher Education rankings for New Zealand and all the smaller OECD and EU countries, plus Singapore.  “Small” in this context meant fewer than 11 million people (Greece, Belgium and the Czech Republic are all just below that population).  There is quite a gap to the next smallest country, the Netherlands, with almost 17 million people.  New Zealand’s population is around that of the median country.

I took the average ranking for each of the universities in each of these countries, for both the QS and Times rankings.  Across the two sets of rankings, New Zealand’s universities turn out to be right on the median among these small advanced economies. The really lowly ranked systems are those of the former Eastern bloc Communist countries (notably Bulgaria, Croatia, Hungary, Latvia, Lithuania and Slovakia).

But New Zealand’s economic performance is also less impressive than most of these advanced economies.    There is a reasonable correlation between the two.  Here I’ve shown the average university ranking for each of these small advanced countries against real GDP per hour worked for 2014, taken from the Conference Board’s database.  New Zealand is highlighted in red.


New Zealand doesn’t seem to do too badly, but we don’t stand out.  (The outliers on the right are Luxembourg and Norway).

If we don’t stand out, it is a little hard to see why top-tier foreign students would be keen to come and do PhD (and subsequent post-doc) study in New Zealand.   We will always attract some people –  and being an English language country helps us attract more foreign students than one might expect given our size and distance –  but not many of them will be from the top tier of potential students. It is those top tier students from whom the strongest contributions are later made –  and usually only from a relative handful of them.  And for almost all of those people, the top universities in the US or the UK (and a handful of others, in Switzerland, Singapore, or perhaps even Australia) will overwhelmingly be the destination of choice.

Perhaps for some these sorts of numbers suggest a strategy: “lets make our universities great, and then we’ll attract top tier students, who in turn might stay and help lift New Zealand’s economic performance”.  I suspect that if there are any causal relationships here, they are mostly the other way round.   Top universities are as much consumption goods as production ones, and luxury products tend to be found in the richest and most successful countries.  The United Kingdom and the United States have long been the richest and most successful countries and they have university systems that reflect that (the UK isn’t that large a country but has around 15 universities in the top 100).  Among the smaller countries, Switzerland and the Netherlands  have  also long been among the most prosperous countries, and also stand out with relatively high-performing universities.

No doubt, causation runs both ways –  top universities are a magnet for talent and in some cases that talent can be part of the process of innovation and economic advancement –  but it seems most unlikely that one can first  create the top tier university and then see the prosperity follow. That is perhaps especially so in somewhere as small and remote as New Zealand.   What would make top tier foreign academics, in large numbers, want to come and stay in New Zealand?  Perhaps money might do it for some, but even if governments were to make the money available, backing this as some new “growth strategy”, I rather doubt it could be a sustainable strategy.  Distance is simply too formidable an obstacle.

As I was playing around with this material, I was thinking of the New Zealanders who had worked at the Reserve Bank in my time there who had gained PhDs.  A few have pursued them at New Zealand universities –  several are at present – because it enables part-time study and fits with family commitments etc.  But I jotted down a list of 14 people I could recall who had done PhDs overseas, mostly after leaving the Bank.  Most went to the US or UK, and all of those went to top tier universities (LSE, Cambridge, Berkeley, Stanford, Chicago, Yale, Princeton, Harvard, NYU).  Even the two who did PhD study in Australia did so at universities rated materially higher (overall, and in economics) than any of New Zealand’s universities.  These were all very able people, and the revealed preference in their choices suggests that universities of the quality of those in New Zealand (middling by international standards) are most unlikely ever to attract any material number of the sort of exceptionally talented creative people from abroad around whom one might reasonable begin to build an immigration policy.

PhDs aren’t everything, and lots of highly creative people have no interest in that particular sort of field of endeavor, but it just helps illustrate the point about how difficult it is more generally for a small remote country, with mediocre incomes, to attract the world’s best.  In my view, we are much better focusing on building a prosperous and successful society around our own people, as capable and hardworking as any in the world.

But, by all means, put in place a facility akin to the US one for people of ” extraordinary ability”. Here are the requirements for one set of fields:

Proving extraordinary ability in science, education, business or athletics:

The applicant can submit evidence of receipt of a major international award such as the Nobel Prize, Olympic Gold Medal or at least 3 of the following:

  • Receipt of nationally or internationally recognized award
  • Membership in organization that requires outstanding achievement
  • Published materials about the applicant in professional or major trade publication
  • Judgment of the work of others
  • Original scientific or scholarly work of major significance in the applicant’s field
  • Evidence of authorship of scholarly work
  • Evidence that he or she has been employed in a critical or essential capacity at an organization with a distinguished reputation
  • Has commanded or will command a high salary in relation to others in the field
  • Other comparable evidence

If we can attract these sorts of people, New Zealanders might well benefit.  We probably wouldn’t get many, but who knows.  And large numbers aren’t really the path to prosperity; mass moderately-skilled immigration hasn’t been any sort of successful economic lever in New Zealand in the last 25 (or 70 ) years.





I’m still puzzling over the academic who told Radio New Zealand’s listeners yesterday that he didn’t agree with me that New Zealand was remote: “we are, after all, in the middle of this great ocean, the Pacific”.    I keep looking at the globe, conscious that perhaps I have a eurocentric view of the world, but….we still look about as remote as they come.  And it is a sort of remoteness which, historically, hasn’t been conducive to really high levels of economic performance for lots of people (see Tristan de Cunha, St Helena, Bouvet, and even Samoa, Kiribati, or Fiji).  Henry Kissinger is reported to have described Chile as “a dagger pointed at the heart of Antarctica”.  Much the same could be said of New Zealand, one of the Antarctic Rim countries.

But, on another topic, I noticed that Kiwibank and NZ Post were in the news this morning.

Late last week, Radio Live was reporting a story that Kiwibank was being prepared for sale, and they asked for my thoughts on that.  That interview is here.

There was never a good economic case for setting up Kiwibank.  Our banking market was, and is, pretty competitive, and there were few material regulatory barriers to new entrants.  And the historical track record, here and abroad, is that government-owned banks are more prone to getting into costly trouble than private-owned banks (and some of them cause quite enough trouble).  In a modern New Zealand context, think of the Bank of New Zealand, DFC, and the (different sort of case of the) Rural Bank.  Overseas, examples abound.

But, of course, the case for Kiwibank was never mostly about economics.  It was mostly about nationalism, and some mix of political product differentiation and the political circle turning. Jim Anderton has resigned from the Labour Party in 1989, having been suspended from Labour’s caucus when he refused to vote for the sale of the Bank of New Zealand (then still predominantly government-owned).   And now Jim Anderton was back, as Deputy Prime Minister in a Labour-Alliance government.  Not only could the government own businesses, but it could –  so it was claimed –  build good new ones.  This speech by Jim Anderton captures the flavour.  This centre-left government would be different from its predecessor, and the establishment of Kiwibank would be one important marker of that difference.

The Reserve Bank and (more importantly) Treasury opposed the establishment of Kiwibank.   There weren’t obvious gaps in the market that other new entrants couldn’t fill, and establishing any new business is risky.

The National Party opposed the establishment of Kiwibank, but has never been willing to commit to selling it (in full or in part), even when Don Brash was leader in the 2005 election.

The actual track record of Kiwibank has been less bad than many of the opponents feared.  NZ Post was able to recruit some capable people who have built a reasonably substantial bank, that now has around $19 billion of assets.  Kiwibank grew very rapidly in its early years, and when institutions –  especially new entrants –  grow rapidly, it is wise to worry about the credit standards: it is most easy to write loans to people whom other lenders are reluctant to lend to.  Kiwibank had a few ill-judged forays into particular market segments, but appears to have built a reasonably self-sustaining bank, which came through the recession of 2008/09 with little more damage than the larger banks sustained.   My own reaction to that record was that, as taxpayers, we should be thankful for small mercies, and take the opportunity to sell before something went wrong.

But it has never been quite clear how much money Kiwibank has really made, and in particular whether it has ever sustainably succeeded in covering the cost of the taxpayers’ capital invested (and reinvested) in the bank.  Banking is a highly leveraged business, and since the government’s finances are already heavily directly exposed to the overall health of the New Zealand economy, there were no obvious diversification gains for it in establishing a bank in New Zealand.  We needed a good rate of return to justify the risk.

One of the reasons it has never been clear just how profitable Kiwibank has been is that Kiwibank and its parent NZ Post were intertwined, operating (most obviously) from the same physical locations.  During the early years in particular, there was a lot of incentive for NZ Post (with its government appointed Board) to help ensure that Kiwibank was a success, and to err in favour of Kiwibank in any allocation of costs or charging for shared services.  I got involved with these issues briefly in my time at Treasury and even then it seemed impossible for outsiders to know whether costs were being allocated appropriately.  Several years on one might have hoped all these issues were adequately resolved, so I was a little surprised to see this comment from Bill English in the Herald this morning.

He said there had been discussions over whether NZ Post was subsidising Kiwibank.

“Certainly through the start-up phase it has been but NZ Post can’t afford to keep cross-subsidising the bank,” he said.

Which doesn’t give one a great deal of confidence that, even over the last few years, the Kiwibank accounts give a full representation of the returns from a standalone banking business.  I don’t read the literature as suggesting that the economies of scale in retail banking are huge (so a small bank could be profitable) –  and we have both big and small banks co-existing in the New Zealand market –  but I doubt it could be shown that Kiwibank had been a good investment for the taxpayer.  Fortunately, it hasn’t been a disastrous one.

So I’d be all in favour of Kiwibank being sold.  There is just no good reason for the government to be involved in the business of retail banking.  Even today, the barriers to new private sector entrants are quite low, and even if there is some independent concern  about New Zealand-owned banks, then we have SBS, TSB, Co-op, and Heartland.

One key strand in New Zealand’s approach to banking is the idea that no institution, and no depositor/creditor, is totally immune from failure and the risk of losing one’s money.  I don’t think that is a politically tenable stance, and am among those who favour New Zealand adopting some form of deposit insurance (as most other countries have done).  But it is a particularly difficult model to sustain in respect of a government-owned bank.

Yes, governments have been willing to allow creditors of SOEs to lose money –  the banks who had lent to Solid Energy most notably among them –  but a handful of banks, mostly foreign, is a rather different matter than hundreds of thousands  (800000 apparently) of retail depositors (and voters).   Governments can say all they like that no one is guaranteed, but it isn’t obvious why anyone would –  or should –  believe them.  After all, a standard element in the Reserve Bank’s approach is that if a bank gets into difficulties, the Reserve Bank will look to its shareholders to recapitalize the bank concerned.  The  New Zealand government owns all the shares in NZ Post, the immediate (struggling) parent of Kiwibank.   The credit rating agencies also take that view: S&P, for example, noted last year that

we consider that Kiwibank has a “high” likelihood of receiving extraordinary support from the New Zealand government, reflecting the bank’s “very strong” link and “important” role to the government.

The unpriced implicit support Kiwibank has from the government skews the domestic banking market and undermines the efficiency of the financial system, all while continuing to pose material financial risks for the New Zealand taxpayer.

And it is not as if the governance of Kiwibank looks particularly strong either.  I was quite surprised to find, looking through the list of directors, that not a single one of them has a background in retail banking.

At very least I think it would make sense to restructure the NZ Post group, removing Kiwibank and making it a standalone SOE in its own right.  Going by the comments from the Minister, if the story Radio Live ran had anything behind it, that was the mostly likely form.

A sale would also make sense, but I don’t see any chance of it happening under the current government.  One could conjure up all sorts of imaginative options that might mitigate the political uproar –  recall the size of the petition around the partial sales of the government stake in three power companies –  but I can’t see why this government would regard it as worth the political risk.  And no potential coalition partner really cares enough to want to make a sale a “bottom line” in any deal –  while NZ First might well care enough on the opposite side.

Kiwibank shares could, for example, be distributed to all adults –  on current book value that might be around $300 each –  so that it was truly the “people’s bank”.  But then there would no single dominant shareholder, and the rating agencies would get nervous, and so would the Reserve Bank.  It would have quite high direct costs, and the opposition parties would no doubt sell it (accurately) as prelude to those individual parcels being bought up by one or another of the other banks.

I’ve seen suggestions that perhaps the New Zealand Superannuation Fund should become a key shareholder in Kiwibank.  I reckon that would be even worse than direct state ownership, since the NZSF faces neither market nor political disciplines.

I don’t really like the idea of a partial privatization, with the government retaining the majority shareholding.  It still has most of the moral hazard/bailout risks associated with the current ownership model, with more risk that the private shareholders would seek to aggressively (and quite rationally) exploit such advantages.  It was, more or less exactly, the model used with the Bank of New Zealand in the late 1980s.

In truth, the best value for the taxpayer probably lies in what is the least politically attractive option: a straight trade sale, probably to one of the existing large participants in the market. That was how the previous Postbank was sold, back in 1988.  It is what happened to Trustbank in 1996, and to Countrywide a couple of years later.  And, of course, Lloyds concluded that the best value from the National Bank was through a trade sale to ANZ.  The government might get a price well above book value in such a sale, even recognizing that banks are less inclined to aggressive expansion than they were a decade ago, and that some of the Australian banks might be uneasy about overweighting their exposure to New Zealand.  But even to propose such a sale would surely be seen by the government’s political advisers as an unadulterated gift to the Opposition.

And so it seems likely that, for the foreseeable future, the government will not just be the largest owner in New Zealand of dairy farms, funds managers, trains and planes, power companies, and legal firms, but will remain the owner of a modest-sized, not outstandingly successful, retail bank.

UPDATE:  In casting around for any summary analysis that has been done/released on Kiwibank’s long-term performance, I found this chart of return on assets (not equity) in a Treasury report from a couple of years back.

bank roa.png

The results shouldn’t be very surprising, but they do reinforce the point that even if Kiwibank is currently earning reasonable rates of returns (eg in the most recent year), it has a long way to go to deliver the sorts of cumulative returns to taxpayers that private sector shareholders might have expected (especially as none of the private comparators were start-ups).


Switzerland of the South Pacific: cargo cult thinking?

One of the odder articles to appear in the local media over the holiday weekend was Fran O’Sullivan’s piece in Saturday’s Herald, headed “Key’s vision: Switzerland south”.  I’ve been critical of the Prime Minister in a few posts recently, but when I first saw the O’Sullivan piece I wondered if she was really reporting the Prime Minister or building up a creation of her own.  But after several re-readings, I think she must really be reporting the views of our Prime Minister.

Of course, we have been this way before.  In the midst of the 1980s reforms, before the commercial property and equity bubble burst leaving us with a serious financial crisis, people like Michael Fay and David Richwhite used to give speeches talking of building a Switzerland of the South Pacific here in New Zealand.  Implausible as it may have been, my memory was of a positive vision – a liberalized economy would stimulate investment and entrepreneurship (and probably a large financial sector led by Fay, Richwhite?), enabling us to generate once again per capita incomes more akin to those in Switzerland(we’d matched or exceeded them as late as the 1920s).  In the climate of the times, in the early post-ANZUS days, Switzerland’s armed neutrality probably added to the appealing imagery.  Of course, it all came to pretty much nothing.  Switzerland remains one of the most prosperous advanced economies, while we languish as the slightly embarrassing poor relation.  Fay and Richwhite, as it happens, ended up relocating to Switzerland.

But John Key’s image is a much less positive one – New Zealand as a “beautiful and wealthy bolthole for high net-worthers seeking to escape from an unstable world”.

We are told that

Key believes that free-flowing terrorism is here to stay. To the Prime Minister, this simply makes New Zealand more attractive and will result in more high net-worth consumers wanting to come here


But Key contends it is the fear of terror – which has been happening over a long time – which is the driver for Europeans to up sticks and leave.

complete with talk of

If Donald Trump is elected President (assuming he first gets the Republican nomination) there may be a new outflow if his political bombast becomes reality.

Haven’t we heard all this before?  People allegedly about to flee the US if, say, George W Bush was re-elected.  Or people fleeing to New Zealand in the 1980s to escape the nuclear peril of the late Cold War tensions.  And where are we today?    Our per capita incomes and productivity relative to the rest of the world just keep on drifting slowly further behind.

And what about terrorism?  Tyler Cowen included a link the other day to this chart of annual terrorism-related deaths in Western Europe since 1970


Hardly a pattern suggesting that the rich and powerful  –  with much better protections than the masses – should flee to little old New Zealand.  If New Zealand didn’t prosper through a century in which Europe went through two savage wars and a prolonged Cold War, an exodus of the elites seems unlikely to be our path to renewed prosperity now.

The great age of European emigration was in the 60 or 70 years prior to World War One, not now.

Ah, but O’Sullivan points out, then there are the Chinese

New Zealand has also become an attractive destination for Asian high net-worthers who have invested in property here – particularly Auckland. Chinese investors are relatively open that they are seeking to de-risk their own exposure to the China market, get capital out and buy residential property in a pollution free environment.

Auckland, and Sydney, and Vancouver, and London and Houston and…..anywhere more or less safe without heavy tax and regulatory restrictions.  The Chinese capital outflow story is a real one, and a historically anomalous one –  about fear, corruption, and lack of secure property rights in China.  But there is little no basis for thinking that it will a basis for transforming New Zealand’s specific economic prospects.  We don’t have difficulty attracting foreign capital, but we haven’t (it appears) created a climate in which business investment here is sufficiently attractive to begin to lift our relative productivity and income performance.  And as China’s own GDP per capita is about a third of ours, it isn’t obvious that one would look to mainland Chinese as a source of sustained domestic prosperity. (Taiwan or Singapore might be different, but then those countries have rather more respect for domestic property rights and, not unrelatedly, more success in generating  domestic prosperity).

And if foreigners really were wanting to build a top-notch global business (as distinct –  and it is an important distinction – from protecting what one already had), you almost certainly wouldn’t start from here if you had any other choice.  No serious observer ever pretends that New Zealand is better than fifth choice even among the Anglo countries: try the US, the UK, Canada, or Australia, and if you can’t get in there, then there is always New Zealand.  For a similar population, higher incomes, and rather better location I’m never quite sure why Ireland doesn’t appear in those lists.

O’Sullivan also tells us tax plays a part.  We don’t, she tells, us compete with Switzerland’s (now somewhat attenuated) banking secrecy laws

But it is notable that one of the reasons why New Zealand has yet to follow Australia and bring in rigorous laws to clamp down on multinationals which are not paying significant tax here is because this country is competing for investment.

Perhaps, but this is the same Prime Minister who, interviewed by TV3 a week earlier, reckoned that the tax paid by multinationals in New Zealand was “not fair”, and whose government is part of the OECD-facilitated BEPS process.

If we were really serious about promoting business investment in New Zealand, and in turning lifting our incomes and productivity performance, one of the best things we could do is to remove taxes on capital incomes altogether.  Taxes on business incomes are, largely, taxes on wages, precisely because they discourage the business investment that, for example, New Zealand has been so short of.  This isn’t a popular line to run in New Zealand, or perhaps anywhere, but a government that was serious about creating the conditions under which its own people could prosper, and in which foreign investment would assist us in that process, would not still be presiding over a company tax rate of 28 per cent and talking of finding ways to raise more money from foreign companies operating here.

[This is not the post for a lengthy treatment of tax issues, but a standard response is that much lower company tax rates would be a windfall gain to existing foreign investors, with no benefit to New Zealand.  That might be so if most foreign investment here were in tradables sectors (since selling prices of tradables are largely determined in international markets), but in fact the largest components of foreign investment here are in the non-tradables sectors, where lower company taxes would be expected to result in lower domestic selling prices (eg for banking or telecoms services), benefiting New Zealand consumers and businesses.  I outlined some thoughts on tax a few years ago here.)

As the O’Sullivan moves towards her conclusion she notes

If the Key Government keeps its nerve, the wealth transition will continue. For instance, New Zealand is becoming a magnet for high net-worth Chinese tourists and for students from Saudi Arabia – markets which are growing rapidly. That interest will bring with it investment in hotels, airports, and housing.

Both –  Chinese tourists and Saudi Arabian students –  are surely welcome, but is there any reason to think they are a probable basis for a reversal of our decades of income decline?  Our universities aren’t exactly Harvard or Oxford –  or even on a path to getting there –  and although I’m loathe to criticize tourism (we want holidays, so do foreigners), there is no advanced country of any size that has managed to support or sustain top-tier incomes based on tourism.  France is perhaps the most-visited country in the world, but it isn’t tourism that keeps it rich.


Annual net migration reached an all-time high of 68,840 people. And net migration from Australia was positive for the 11th consecutive month. These positives underline that John Key’s vision of New Zealand as a Switzerland of the Asia-Pacific has indeed the potential to become reality.

Key won’t be doing anything to destroy that wealth effect.

It gets boring to keep pointing it out, but over the last year around a net 4000 New Zealanders left New Zealand.  If we can’t even persuade the New Zealanders to stay, let alone create conditions that make the huge diaspora population want to come back,  it is a pretty unpromising foundation for the creation of a Switzerland of the South Pacific.

As for that “wealth effect”, O’Sullivan repeats the claim that the Credit Suisse Global Wealth Report demonstrates that New Zealand households are the second wealthiest (behind only Switzerland).  If she got this from Key (with all his advisers) it is inexcusable: the claim was widely reported at the time, but Credit Suisse themselves acknowledged that they had made a mistake, using the wrong exchange rate to convert New Zealand data in to US dollars.  I suspect someone else has pointed this out, as the detailed reference in the hard copy edition of the Herald has disappeared from the online version of the article.

It was, in any case, an odd statistic to trumpet.  Even on the corrected basis, New Zealand household wealth looks quite high.  But it does so because (a) our exchange rate is very high (they use market exchange rates, not PPP ones) and (b) because house prices, especially in the third of the country that is Auckland, are ridiculously high.   The average middle-aged homeowner in major cities such as Houston or Atlanta probably has a better house than the average middle-aged Aucklander, but it does not have a $1m price tag attached to it.

Which brings me to my final comment on the article itself.  The Prime Minister is reported as

He is frankly unapologetic about the massive increase in Auckland residential property values, which has resulted in many established Aucklanders becoming relatively rich, but younger people being locked out of the market. It is a trend which is not going to stop anytime soon, given the immigration figures.

They aren’t presented as direct quotes but if these lines are representative (and they are consistent with what he said in his TV3 last week) it is surely a disgraceful indictment of a failed government.  The sheer indifference to the plight of ordinary New Zealanders is breathtaking.    While his government continues to preside over land-use restrictions that limit the ability of Auckland’s physical footprint to grow, then continued high immigration would continue to hold up Auckland house and land prices.  But those land-use restrictions could be changed, and should be, especially if we are going to continue with anything like recent population growth rates.

The breathtaking indifference might be slightly less inexcusable if there were any sign that the Prime Minister’s Switzerland “strategy” (or just “this week’s talking point”?) was working.  If, for example, incomes were growing rapidly and steadily closing the gap on the rest of the advanced world.  But they aren’t.  New Zealand continues to do badly, and recent data suggest that over the last 15 years Auckland has done worse than the country as a whole (per capita incomes growing less rapidly).

The Prime Minister is surely mostly right when he says

“They look at us and think it is a highly developed first world economy, unbroken democracy, stable government, independent judiciary

But in Switzerland they get all that, and more.  Beauty and stability, rule of law and wealth, and all that in the heart of one of the largest and most populous regions of  prosperity and innovation anywhere on earth.    Boltholes tend to be places of comfort and luxury but not of great economic dynamism and entrepreneurship.  And I’m pretty skeptical that it is “bolthole” tendencies that have enabled Switzerland to get, and stay, rich –  that is more down to the innovative products and services of its firms and peoples – but there seems no more basis for thinking that New Zealand is on any sort of path towards being a Switzerland of the South Pacific than there was when Fay and Richwhite were championing the idea 30 years ago.

Countries get and stay rich mostly on the skills and talents and energies of their own people.  Natural resources can help.  Really remote countries, even with able people and natural resources, face considerable challenges.   But to keep on looking for our salvation to come from abroad –  as the Prime Minister seems to in this article –  seems no more promising than the Melanesian cargo cults.


Inquiry into possible leak: for the record

It came to my attention that the weekly political newsletter Trans Tasman has commented on the Reserve Bank’s inquiry into the possible leak of the OCR decision.

They noted “the markets didn’t move until after the cut….so no harm was done and Reddell now says it may not have been a leak”.  The “now” in that sentence is what bothers me, with a suggestion that I have walked back from some earlier position.

So, to be clear:

At 8.04 am on 10 March I received an email from a person in a media organisation saying

We have just heard that the Reserve Bank is cutting by 25 basis points.

At 9.08 am I sent the following email to Reserve Bank Assistant Governor John McDermott and to Head of Communications, Mike Hannah

For what it is worth, I received an email an hour ago from someone telling me that they had just heard that the Bank was going to cut by 25bps this morning.  I have no idea whether it was a well-sourced “leak” or just speculation, but I have no reason to doubt the person who told me, who in turn (as far as I’m aware) has no reason to pass on simple speculation.

There were a couple of brief follow-up emails in which I told them the exact time of the email I’d received and made clear that it had not come from anyone inside the Bank.

Later that day, in my post about the Monetary Policy Statement, I included this brief concluding paragraph

And finally, as I have noted to them, the Reserve Bank might want look to the security of its systems.  I had an email out of the blue at around 8 this morning-  most definitely not from someone in the Bank –  telling me that the sender had just heard that the OCR was to be cut by 25 basis points.  I have no way of knowing if it was the fruit of a leak, or just inspired speculation, and was relieved to see the foreign exchange markets weren’t moving, but it wasn’t a good look.

A week or so later I wrote a post about possible improvements in the way the Reserve Bank handles and releases information about the OCR.

In that post I noted

I went into town this morning to talk to the Reserve Bank’s inquiry looking into the possible leak of last week’s OCR announcement (see last paragraph here).  I still have no idea whether there really was a leak, but it seems likely, and if so it seems likely to have come from one or other of the lock-ups the Bank runs, for analysts and for the media.

It “seems likely” to me mostly because if there was another explanation for the email I received, it would have been easy for the sender to have got in touch, either with me or with the Bank, to explain.  Perhaps someone had misunderstood something they’d been told.  Perhaps they were just testing me.  Or whatever.  Perhaps the sender has approached the Reserve Bank directly, but they certainly haven’t approached me.

The whole episode got a surprising amount of media coverage last week, on the back of this story by Hamish Rutherford.   That story quoted a Reserve Bank spokesman as saying

“We are aware of an allegation that information may have been leaked ahead of the OCR announcement on 10 March,” a spokesman of the bank said.

In a clarifying post, I noted that I had made no “allegations” (see paper trail above), but had simply passed on, unprompted and as a concerned citizen and former employee, the information (the email) I had received. I noted:

I have been consistently clear that the email in its own right is not confirmation that a leak occurred,  but it is troubling nonetheless, and raises the serious possibility of a leak.  When I drew the matter to the attention of the Reserve Bank, they also expressed immediate concern and appropriately moved to initiate an inquiry.


I still fervently hope that the investigation is able firmly to conclude that no leak occurred.

And that is the last thing I have said on the matter.  As readers will recognize, there has been no change in my account/arguments, and no allegations.  There is one piece of evidence from me, and the Bank is inquiring into what, if anything, they can conclude from that, and from anything else they can gather.  If there was in fact a leak of some sort, it may be a little like looking for a needle in a haystack  (and it is hard to prove a negative, even if no leak occurred) and so it may be difficult from them to conclude anything very confidently one way or another.

I presume that, in due course, the Reserve Bank will release the results of its inquiry.  Whatever it concludes about the specific event, the focus really should move quickly to reforming the procedures to materially reduce the risks of any leaks occurring.



Surrounded by Rongotai conservatives?

When you are both a social and institutional conservative, and someone who believes in the central role of private markets in generating prosperity and supporting freedom, and yet live in one of most left-liberal electorates in the country you get used to being in a rather small and embattled minority.

In 2014 Rongotai had the fifth highest Labour+Greens share of the party vote (56.9 per cent, in an election in which those two parties together managed only 35.8 per cent across the whole country).  And it was the second-best electorate for the Greens, typically rather more radical and subversive of society’s established institutions and symbols (“progressive”) than Labour:  they polled 26.4 per cent of vote here (no wonder we got a dreadful cycleway), only a little behind their vote in neighbouring Wellington Central.

Out of curiosity, I went onto the Electoral Commission’s website yesterday to check out the Rongotai results in the flag referendum.  Somewhat naively, I think I was assuming that perhaps 60 per cent of people here would have voted for the alternative flag.   In fact, 62.6 per cent of people in Rongotai had voted to retain the current flag.   The left-liberals must, in quite large numbers, have joined with the residue of conservatives to support retaining a flag that has been a symbol of our nation since 1902 (a time when we were governed by Dick Seddon, who deferred to no one in his assertion of our nationhood).

Or perhaps it was mostly just party politics.

Here are the 15 constituencies with the highest percentage vote for retaining the current flag

69 – Te Tai Tokerau 78.5%
67 – Tāmaki Makaurau 77.5%
66 – Ikaroa-Rāwhiti 76.9%
71 – Waiariki 75.8%
65 – Hauraki-Waikato 74.2%
68 – Te Tai Hauāuru 73.6%
23 – Māngere 70.8%
70 – Te Tai Tonga 67.8%
24 – Manukau East 67.4%
25 – Manurewa 65.4%
21 – Kelston 64.8%
8 – Dunedin North 64.1%
46 – Rongotai 62.6%
53 – Te Atatū 61.9%
9 – Dunedin South 61.4%

Not a single one is held by the National Party, or would even by marginal between National and Labour.

And here are the 15 constituencies with the highest percentage vote for the alternative design.

49 – Tāmaki 51.9%
48 – Selwyn 51.7%
2 – Bay of Plenty 51.4%
11 – East Coast Bays 51.1%
18 – Ilam 50.8%
6 – Clutha-Southland 50.4%
12 – Epsom 49.8%
52 – Tauranga 49.7%
33 – North Shore 49.4%
59 – Waitaki 49.4%
32 – New Plymouth 49.1%
57 – Waimakariri 48.9%
3 – Botany 48.3%
42 – Rangitata 48.2%
50 – Taranaki-King Country 48.0%

And not one of those seats is held by Labour, or would have been particularly marginal between National and Labour.   (In case you are wondering, in John Key’s seat of Helensville, the vote for the alternative design was virtually right on the national average at 43.3 per cent).

Somehow the image of the voters of Selwyn or Clutha-Southland as radicals, keen to ditch symbols of nationhood, seems about as implausible as that of my Rongotai neighbours (or the students of Dunedin North) as conservatives.

Here is a scatter plot showing the Labour+Greens vote share in 2014 against the support for retaining the current flag, by electorate.

flag 1

The outliers are the Maori seats, where (a) opposition to changing the flag was particularly strong, and (b)  where the Maori Party vote matters.

But I was also fascinated by the turnout patterns.  This chart shows turnout in the referendum and percentage support for retaining the current flag, again by individual electorate.

flag 2

I was struck by how strong the downward relationship was.  Electorates where people favoured the current flag were also those where people did not participate to anywhere near the extent they did in the electorates voting for change.

Some of that is no doubt just established voting patterns.  Older richer whiter electorates tend to have higher turnout rates than younger, poorer, browner ones, and on this occasion this correlated with the pattern of votes on the flag.    If the people who didn’t vote had much the same characteristics as those who did (and we have no way of knowing that on this occasion), then if the turnout had been similar across all electorates the margin for the current flag would have been larger (perhaps more in line with the handful of published opinion polls).

All in all, it ends up rather unsatisfactory.  Decisions on symbols of nationhood –  once in a hundred, or five hundred, year decisions –  shouldn’t really split along party lines.  Party votes shares come and go, but flags are pretty permanent.

On this occasion I’m fairly sure an underlying majority wasn’t in favour of changing the flag in the first place, and even among those who did really favour change many didn’t like the alternative design.  So the final decision probably reflected underlying preferences, even if the actual debate/process did end up all too party-politicised.

I guess we have to blame the politicians for the politicisation.  David Cunliffe first promised a referendum, and then John Key copied him, and went on to make the process as much about him as about us, New Zealand.   He lost, despite having turned the conservatives radical and the radicals conservative.  Very odd.

Perhaps now he could turn his attention to serious issues which really do require a lead from politicians, such as turning around our decades of relative economic decline.

“Alice laughed. ‘There’s no use trying,’ she said. ‘One can’t believe impossible things.’


A not very straightforward reversal by the Reserve Bank

Back on 27 August 2015, I wrote about the Reserve Bank’s refusal (having taken almost two months to consider the matter) to release anything material from the extensive work it had been doing on possible reforms to the governance of the Reserve Bank.

Somewhat frustrated by the obstructionism, I commented then

If the Official Information Act really provides protection for every single one of the papers covered by my request, including the titles of those papers, the Act is even more toothless than most had realised.  In fact, I suspect that this is a case of instititutional arrogance and over-reach by the Governor, who doesn’t really seem to regard himself as accountable to the public.  Perhaps the Governor is embarrassed, or frustrated, that the Minister of Finance or Treasury were not convinced by his particular arguments?  Perhaps he had staff simply look at one option, and ruled out of court any serious consideration of the wide range of options used internationally and elsewhere in the New Zealand public sector to govern powerful public agencies?  Whatever the explanation, he doesn’t want us to know.


As I’ve said previously, the Reserve Bank is much less transparent than it likes to make out.  This is just another example.  We’ll see whether the Ombudsman agrees with their interpretation of the Act.  Whether or not she does, this decision by the Governor is not the hallmark of an open and accountable public institution, committed to scrutiny and debate and to improving policy and institutions through the contest of ideas.

I had also requested information on any work on Reserve Bank governance from The Treasury.  With their accustomed more positive approach to the Official Information Act, they released a reasonable amount of material, which I wrote about here.  A paper dated 5 June 2015 confirmed (what I already knew) that the Reserve Bank work programme had ceased, and Treasury’s advice to the Minister (in a note on the Reserve Bank’s draft Statement of Intent) that work should be continued apparently went nowhere.

Several times since then, I have highlighted the Reserve Bank’s refusal to release any of the material on governance, despite it being a completed project.  I had lived in hope that one day the Ombudsman’s office would get to my complaint, and that the Bank might be compelled to release at least some of the material.

And then, out of the blue this afternoon, an email arrived from the Bank (apparently released simultaneously, and before I had even had a chance to read it, on the Bank’s website).  Here is the heart of their letter

At the time we responded to you in August 2015, we withheld information under section 9(2)(f)(iv) of the Act, on the basis that advice was being considered by the Minister and had been tendered to him.  In September, Associate Minister of Finance Steven Joyce told Parliament that the government had no plans to reform the governance structure of the Reserve Bank – meaning the advice to the Minister was no longer under active consideration. This is a change in circumstances that provides an opportunity for the Reserve Bank to revisit its decisions on your request. The Reserve Bank considers it now appropriate to release to you the following documents:

The Reserve Bank holds other information within the scope of your original request that we are continuing to withhold, as provided by the following sections of the Act, for the reasons described:

  • 9(2)(g)(i), to maintain the effective conduct of public affairs through the free and frank expression of opinions by or between or to members of an organisation or officers and employees of any department or organisation in the course of their duty;
  • 9(2)(h), to maintain legal professional privilege; and
  • 8(d) – the information is publicly available here – www.rbnz.govt.nz/research-and-publications/reserve-bank-bulletin/2014/rbb2014-77-01-02.

Back in September I had written about those comments from Steven Joyce, answering questions for the Minister of Finance from Greens spokesperson Julie Anne Genter.

I welcome the Bank’s change of heart.  But I doubt it is entirely sincere.  After all, it is now March, and the Associate Minister’s comments were made in September. I know the Reserve Bank is busy, but really…..   Moreover, they are not being straightforward in claiming that the matter had been under active consideration by ministers up to that point.  As the Treasury document, from June, already showed, the Bank had already ceased work on governance, and we can be pretty confident that cessation had occurred when the Minister of Finance had told them some time earlier still that he did not want to do anything about Reserve Bank governance. To reinforce the point, when they originally withheld all this material, back in August last year, they did not seek to invoke the argument that the material was under active consideration by the Minister (even though they included a laundry list of reasons for withholding).

I suspect the Ombudsman may finally have gotten round to investigating my complaint, and the Reserve Bank has decided to try to minimize its reputational losses by releasing this material now (and just prior to a long weekend etc), rather than wait for the Ombudsman to compel them to do so.  Even having done so, the Ombudsman will still have to decide on the other material which they have withheld.

I haven’t had a chance to read the papers the Bank has released.  They are all available at the link above.  I will probably write about the contents at some stage next week.

Meanwhile, Reserve Bank governance still needs reform, and  it is disappointing that the  current government has been so reluctant for the Treasury and the Reserve Bank to continue work on reforming an outdated model, that doesn’t align well with (a) the current functions of the Bank, (b) international practice in the governance of monetary policy and financial regulation, or (c) the governance of other entities in the New Zealand public sector.


A dairy stress test

I’ve been a bit slow to get around to writing about the material the Reserve Bank released last week about the dairy stress test it conducted with the five largest dairy-sector lenders late last year.

I’ve long been of the view (and on record here) that, almost no matter how severe the dairy situation becomes, dairy loans would not represent a threat to the soundness of the New Zealand financial system.  That is a top-down analysis based on

  • the size of capital of the New Zealand banking system (around $36bn),
  • the overseas ownership of all the main dairy-lending banks, and the absence of correlated exposures in most of them (dairy loans aren’t a big part of the Australian parents’ books),
  • the fact that any losses on the dairy book will crystallise gradually, allowing other retained earnings, or outside injections of new capital, to buttress the overall position of the New Zealand banks, and
  • that while dairy losses could in time be a part of a wider set of banking system losses (eg if severe losses also mounted on the housing portfolio), it is almost inconceivable that in such a scenario New Zealand’s exchange rate would not fall a lot further.  A NZD/USD exchange rate of, say, .39 (where it got to in 2000) covers over quite a lot of weakness in the international prices of whole milk powder (in turn mitigating the severity of the dairy losses themselves).

There are counters to each of these points, but in the end I think they come down to this: if the Australasian banks ever face really large losses on their housing loans, the banks could be in trouble.  I think that is very unlikely: house prices are held up by a combination of regulatory land use restrictions and population pressures, and vanilla housing lending has rarely if ever collapsed a banking system (as the Reserve Bank itself has acknowledged).  You might disagree, but my real point is that dairy loans themselves aren’t going to threaten the soundness of the system. Much wealth will be lost.  And many of the individual loans may have been ill-judged (by borrower and lender) but that is a different issue, and almost in the nature of a market economy operating under (the real world) conditions of uncertainty.

That is all top-down perspectives. But the stress test was useful precisely because it aims to be a bottom-up approach: working with the banks on how their actual dairy portfolios would behave under two pre-specified scenarios.  Note what the exercise wasn’t: it didn’t look at the implications for loans to dairy companies themselves, or to suppliers to the dairy industry (companies or farmer), and also didn’t look at the impact on loan losses elsewhere in the portfolio resulting from the stresses on the dairy sector itself (eg retailers or builders or residential mortgages or… in dairy-dependent towns).  Note that it was also only a rather provisional exercise, indicative more than definitive, and a basis for ongoing discussions between the Reserve Bank and individual banks.

stress test extract

That does tend to suggest we should use the higher loss estimates rather than the lower ones (since banks have fewer incentives to overstate the loss implications than to understate them).

Here are the scenarios the Reserve Bank specified.

stress test scenariosI’m largely going to ignore Scenario 1 from here on.  As the long-term average real milk price is probably only around the assumed 2017/18 level, Scenario 1 doesn’t represent much of a stress test at all.  The banks and the industry would have to be have been very rickety for a scenario like that to have presented a banking system problem.  I think the Reserve Bank should also have discounted these results, rather than highlighting them in their press release.

Scenario 2 does look much more like a real stress-test.  But even if one thought the series of payout assumptions might be reasonable (2015/16 won’t have been that low, but some of the out years could still be lower than assumed here), I was surprised by the dairy land price assumptions.  Despite a really severe adjustment in the payout path (absolutely, and probably relative to farmer expectations), dairy land prices are assumed to fall by just under 40 per cent (the cumulative effect of those three annual falls).

That might sound like a lot, but:

  • when the Reserve Bank did its housing stress test, it assumed a 50 per cent fall in Auckland house prices.  People still need to live somewhere, while they don’t need to farm cows.
  • we’ve already a dairy land price scare not long ago.  Here is a chart of the (“hedonic”)dairy land price index the Reserve Bank developed for REINZ (despite which, we don’t have general access to the series).

dairy farm pricesIn a single year, dairy land prices fell by more than 30 per cent –  and that was a severe, but very short-lived, fall in milk prices, and a rise in dairy non-performing loans that was still moderate compared to what we see in Scenario 2 in the current stress test.   Perhaps deliberately, the Reserve Bank’s stress test does not seem to have taken account of a second round of selling (forced or voluntary), and the potential for that to drive land prices well below what might be a longer-term equilibrium level.  Overshoots routinely happen in such markets, where liquidity is thin to non-existent, uncertainty is rampant, and potential buyers are few.  As Eric Crampton’s discussion highlights, one difference between now and 2009 will be that potential buyers are probably much more aware of how significant the barriers are to any offshore buyers (who might otherwise be a stabilizing force in the market).

Loan losses evaluated on total dairy land prices falls of perhaps 60 per cent might be a more realistic stress test –  recall, that stress tests aren’t central predictions, they are a scenario to test robustness against.  Loan losses went up by 5 percentage points on the move from the (not very stressful) Scenario 1 to Scenario 2.   The pattern of losses on loans should rise non-linearly as the test gets more stressful, and moving from a 40 per cent land price fall scenario to a 60 per cent scenario is a bit more of a land price adjustment than moving from Scenarios 1 to 2.

There are lots of other points of detail I could question (some things in the article just aren’t made as clear as they could be), but will just highlight one.

The Reserve Bank has long emphasized the desirability of having a capital framework for banks in which risk weights (whether imposed by the Bank, or flowing from the internal models of the major banks) do not have the effect of making capital requirements pro-cyclical.  If capital requirements fall in asset booms and rise in shakeouts, the capital requirements will tend to amplify credit and asset price cycles (an existing stock of capital will go ever further as the boom proceeds, and ever less far – encouraging banks to rein in lending even more –  as the bust proceeds).  And yet the stress-testing article suggests that pro-cyclicality is deeply embedded in the modelling, at least for the dairy portfolio –  itself the largest single chunk of banks’ commercial lending.

Here is what I mean.

risk weights dairy

This chart shows the average risk weight for the banks’ dairy portfolios under Scenario 1.  Recall that Scenario 1 was not very demanding at all, and yet the average risk weight on dairy loans increases by 60 per cent  (eg, from, say, 70 per cent to 112 per cent).  No doubt deliberately, the Bank does not reveal how much further risk weights increase in the much more onerous Scenario 2.     Even if it is not that much further, this sort of highly pro-cyclical pattern of risk weights looks like a bug that needs some serious attention.

To recap, in Scenario 2, bad debt expenses average 8 per cent of dairy exposures.

dairy bad debts

But, as the Bank noted (see extract above), not all banks were as conservative as others.  If we take the pessimistic end of the Scenario 2 range, we would have bad debt expenses of perhaps 11.5 per cent of dairy exposures.  But, as noted above, the near-40 per cent fall in land prices  in Scenario 2 still looks too shallow for such a fully-worked-through scenario.  If land prices were to fall 60 per cent would it be implausible that in such an scenario, with all the second round effects accounted for and allowing for the non-linear loss profiles, the banks could face losses not of the “3 to 8 per cent of their total dairy exposures”  that the Reserve Bank highlighted, but something more like 20 to 25 per cent of their total loans to dairy farmers?    I deliberately pose it as a question, rather than a confident assertion, and it is –  deliberately – the result of a stressed scenario, but it is probably a question people should be posing to the Reserve Bank.