Alternative narratives

From time to time people who are persuaded by my story about New Zealand’s economic underperformance ask why it hasn’t been more widely accepted, and the policy implications adopted.

And, of course, there is a variety of good reasons.  They include:

  • my own story/analysis is quite recent and is continuing to evolve.  I’ve spent over 30 years as an economist, but central bankers mostly focus on the short-term.  It was really only two years spent at Treasury from 2008, and my involvement there in helping the 2025 Taskforce, that energized me to start thinking hard, and reading widely, on the issues around New Zealand’s long-term economic underperformance.   The first time I wrote anything down on any of this was 2010, and it hasn’t exactly been a fulltime occupation since then.   The presentation I gave last Friday has quite different emphases in some important aspects than the first public presentation  of related ideas that I gave in 2011.
  • it is a competitive market in ideas, and there is a variety of competing narratives around to help explain our underperformance, and what (if anything) might be done to remedy it.   Some have had considerable resources put into them, and others are less formal.  Some are produced under important and influential ‘brands”.
  • it is not as if the problems are new.  It is now more than 50 years since the first major reports were published on New Zealand’s relative economic deterioration (eg the Monetary and Economic Council in 1962).   Many stories have been told, and explanations attempted, in the subsequent decades.  Various strategies have been tried since then –  some well-founded, and others daft –  and the decline has not been fully arrested, let alone reversed. In some ways, I think that experience leaves people a little jaded, disillusioned, and perhaps rather wary.

What are some of the alternative narratives?

Treasury is probably the organization that has put the most resources into exercises of this sort (and, of course, it is the New Zealand organization with the most resources).  Prior to the last election they put a lot of effort into a disciplined process reviewing the arguments and evidence in a range of areas, including getting contributions from people elsewhere in the public sector in particular.  The public face of what they produced was Holding On and Letting Go, part of their post-election advice to the Minister of Finance.  There was also a substantial (60 pages) and more specific paper for the Minister of Finance done in late 2013, (which has been released to me under the OIA but does not appear to have been put on the Treasury website with their other OIA releases), which grouped policy recommendations under nine headings.   Treasury has come and gone a bit on what it emphasizes but savings, public pensions, and problems with macro policy loomed large back then.

One could also think of the 2025 Taskforce’s reports in a similar vein.  With a lot fewer resources, those reports represent a story about what could, and should, be done to reverse New Zealand’s economic decline.  The Taskforce itself summed up the essence of its approach

 The key elements of the Taskforce’s approach are:

  • Significantly cutting government spending and tax rates.
  • Finding better, more effective, ways of ensuring the delivery of services the government does fund. „
  • Substantially improving the rigour with which government spending proposals are evaluated.
  • Substantially improving, across the board, the quality of economic regulation. „
  • Getting government out of the ownership of business assets

It was a “smaller and better government” prescription.  When I read through the specifics again this morning, I don’t find many I disagree with, and there is much I would strongly endorse.  But when the work of the Taskforce was over, I was left with a sense of “important as some of these issues may be, it doesn’t seem quite enough”.  Whatever one’s judgement on the appropriate size of the state, for example, that in New Zealand doesn’t seem unusual.

The Productivity Commission, mostly focused on specific inquiries assigned to them by Ministers, has also been turning its attention to trying to answer the question of how to lift New Zealand’s productivity growth.  Paul Conway, the Commission’s director of research, gave an oral presentation to last year’s NZAE conference, and it will be interesting, in time, to see where the Commission as a whole lands, in both diagnosis and prescription.

And no doubt there are others.  Roger Procter, the thoughtful  former (recently-retired) Chief Economist at MBIE had some interesting analysis and views on appropriate policy to reverse New Zealand’s underperformance.  Philip McCann’s analysis created significant interest a few years ago (and my own views are probably less far from his than I realized at the time), and the New Zealand Initiative –  while not, that I’m aware, having a fully worked-out framework for thinking about our underperformance –  would also probably emphasise smaller government and more open markets (people and capital).

And there are also the overseas prescriptions, notably the biennial advice of the OECD.  The OECD has long been somewhat puzzled by the underperformance of New Zealand –  we were somewhat embarrassing because in some respects by the early 1990s we were almost their best pupil.  Their analysis and prescription tends to be a modern social democratic one (open markets and lots of smart active government), and in my judgement hasn’t really got beyond treating New Zealand as if it were another small northern European country.

I’m not going to go through each of these diagnoses or prescriptions here  today (let alone ones from decades past, like the major World Bank report on New Zealand in 1968), Having said that, I always used to stress to staff that it was no use beating a caricatured straw man version of an opponent’s argument –  one had to engage with the strongest and best arguments that people could mount on the other side.  So perhaps I will spend some time as the year goes on working through some of these other documents and explaining why I haven’t yet been persuaded by their (often quite different from each other) stories.  I might also highlight the aspects of my own story that I’m relatively less comfortable with.

All of which is a long-winded way of saying that it is not as if my ideas, or those of any new contributor, are coming into a vacuum.  Able people have been trying for a long time to develop stories, and prescriptions, that best fit the collection of New Zealand economic stylized facts.  Different people emphasise different subsets of those stylized facts, which can often mean that it feels like quite different, unrelated, conversations are going on.  Each perspective probably has some useful policy presciptions to offer, but most probably won’t make a difference on the scale that is required.  Will mine?  I think so, but advocates of some of the other approaches no doubt think that is true of their models as well.

And it is also worth recognizing that any set of existing policies in place gathers vested interests in support.  That will be quite a mix: in some cases it might just be people who benefit financially (as those with import licenses in earlier decades were reluctant to see that policy changed), but more often it will probably be about the emotional and intellectual investment in a way of seeing the problems, and remedies.  We are all prone to those sorts of biases, and they are hard to overcome –  I wrote, with some conviction, the section of the first 2025 Report on why size and distance were cop-out explanations and I wince a little now when rereading that.  In respect of my own analysis, a “bigger New Zealand” mentality has pervaded political and economic life in New Zealand for a very long time. If it is misguided, as I think, it is not likely to be a sentiment that is abandoned readily, at least absent some sort of crisis.

On a slightly different note, I’d recommend people read (economist and economic historian) Deirdre McCloskey’s piece from the Wall Street Journal the weekend, ‘How the West (and the Rest) Gor Rich’, drawn from her new book Bourgeois Equality, the final in her massive trilogy of works in this area.  I rather liked the last few paragraphs, which remind us that politicians –  and policy analysts –  don’t generate our prosperity.  But they can –  and too often have –  got in the way of such prosperity.

What public policy to further this revolution? As little as is prudent. As Adam Smith said, “it is the highest impertinence…in kings and ministers to pretend to watch over the economy of private people.” We certainly can tax ourselves to give a hand up to the poor. Smith himself gave to the poor with a liberal hand. The liberalism of a Christian, or for that matter of a Jew, Muslim or Hindu, recommends it. But note, too, that 95% of the enrichment of the poor since 1800 has come not from charity but from a more productive economy.

Rep. Thomas Massie, a Republican from Kentucky, had the right idea in what he said to Reason magazine last year: “When people ask, ‘Will our children be better off than we are?’ I reply, ‘Yes, but it’s not going to be due to the politicians, but the engineers.’ ”

I would supplement his remark. It will also come from the businessperson who buys low to sell high, the hairdresser who spots an opportunity for a new shop, the oil roughneck who moves to and from North Dakota with alacrity and all the other commoners who agree to the basic bourgeois deal: Let me seize an opportunity for economic betterment, tested in trade, and I’ll make us all rich.

 

14 thoughts on “Alternative narratives

  1. I have been in NZ now for 30 years. Like any new migrant I was keen to grow my assets and to become wealthy. I worked hard and saved every penny and bought a house to live in. Property as an investment was never in my psyche. I then started saving and started to do a small business in my spare time and as that business grew I went full time and as I did not have the capital I had to borrow from the bank to fund my small business. As business improved, I started a share portfolio. However, my business kept getting knocked back by an overly aggressive and hawkish reserve bank. I could not grow my business as the margins quickly got eroded as the business environment started to improve the cost of funds kept rising faster than the sales margins from so called inflation.

    The Reserve Bank kept raising interest rates as petrol prices rose providing a double whammy in cost increases. Both my business and my shareportfolio was decimated as the reserve bank drove the NZ economy into a recession time and time again, under Don Brash and subsequently under the watch of Allan Bollard.

    I then started investing in property as the value of my home kept increasing, through the bad times the decline in value was relatively short term, it dawned on me that property was fairly resilient in the face of rising interest rates that decimated my business and my share portfolio.

    In 2002, I put every cent and borrowed up to my eyeballs to invest in investment property as I noticed that there was a structural issue of supply in Auckland. Initially I started as a part time speculator and bought and sold a couple of properties. I quickly realised that buying and selling property was a mugs game ie there was no profit. The real money was in long term investment ie 10 year cycles.

    It is the persistently high interest rates and the rapid increases that drove me into property as a business contrary to what the economists ideology indicates.

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    • interesting angle. of course, an economist’s response is to ask why interest rates were so high. You seem to take it as a fruit of central banker misjudgement (repeatedly), while I see it as a response to some forces that generated the demand and inflation pressures that made the higher int rates necessary (in terms of the mandate the RB was given).

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      • I repeat because you make the same mistakes in your base assumptions like most economists.

        Interest rates are driven by the 90 day bank bill rate. The RB is a key influencer of that 90 day bank bill rate as evidenced by how closely matched the 90 day bank bill rate is with the OCR. The treasury takes it’s cue from those same rates when they set the government bond rate.

        Contrary to what some conspiracy theorists believe, banks creates lending from savings that they are able to source. They make their profit from the margin between debt and savings and the lag time between raising interest rates between falling interest rates. That is why interest on loans is calculated monthly(ie monthly compound) and interest on term deposits are paid at the end of the term.

        Banks make the most money from falling interest rates because they can move the interest on deposits down very quickly on their deposits and they can lag the interest rates payable on loans. Banks in NZ are most stable in a falling interest rate environment making record profits. Banks become more unstable as interest rate rises and if interest rates rise too fast, savings start to increase which starts to impact on a banks net asset position and increase its cost of funds.

        The other side of the equation is local savings. I was under the presumption that NZ were poor savers and high net borrowers as we were always told by economists until I bothered to look at the RB stats on the Household Balance Sheet. It dawned on me that NZ household debt was very closely balanced with NZ household deposit savings. We were therefore being badly mislead by the RB because they persistently excused themselves that in order to control consumption spending you have to raise interest rates to dampen inflation as we were a net borrower. Interest rates do not affect the average NZ household because higher interest rates mean savers start to spend and borrowers stop but if interest rates were to fall the reverse occurs. Interest rates whether higher or lower do not affect general consumption. Savings and debt of NZ household is a fine balance.

        In our current interest rate environment interest rates are too high compared to many of our major trading partners and again as you have repeatedly pointed out that Wheeler is keeping interest rates too high. You are therefore very inconsistent with your base assumptions. He is either responsible or he is not.

        I am of the opinion that the OCR is high in the global context but I do not want the RB to intervene. The problem with the RB is that they have a tendency to panic. The minute we start to see a bit of inflation they start cranking interest rates up and it goes up too fast. Better they find normal and just do nothing. I think 2.25% is just about right, perhaps little too low.

        At this rate the RB stops being a key influencer. At this rate of interest rates our banks are seeing savings hit record levels of $153 billion as it is still very high from a global context. This puts our banks under pressure to lend. If they are prevented from lending to property and I do like the 30% LVR restrictions on Auckland. It means that we would start to see more lending towards higher risk areas ie the small business and the funding of other so called productive activities eg our newest space industry in Gisborne etc.

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  2. One day I’ll deal with the more substantive argument you (often) make, but just on the consistency point, there is no inconsistency. Individual Governors will make mistakes from time to time: Don Brash did during the MCI phase of 1997/98 and Graeme Wheeler has over the last couple of years. But even if GS adopted my advice now, the OCR might be at 1.5 per cent – still well above those in most other advanced countries. It is that longer-term averages level that reflects the underlying pressures in the economy (or whatever), not the whim and (mis)judgements of individual Governors.

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    • That is why my preference is for the RB just to do nothing at this stage and allow the banks to set interest rates in accordance with their flow of funds. This means we start to see the OCR and 90 day bank bill rate start to move apart as it should in a normal market. Banks margins will predictably come under pressure as the weight of record savings put their record profits under pressure and in effect forcing them into higher risk lending which is the so called more productive sector at lower and more reasonable interest rates. Unfortunately interest rates on deposits would also be under pressure to fall but if the RB holds OCR at 2.25% banks would have no excuse to drop interest rates on deposits.

      In 2004 to 2008 as interest rates started rising rapidly, banks were desperate to lend to maintain their profit margin to the extent that low documentation loans was actively issued and bank managers had sole discretion to lend up to as high as $2 million credit approval authority without credit department review. Lending to property just went nuts as banks loosened up their lending risk controls. Nothing to do with exuberance. It was from panic from margin erosion and declining balance sheets.

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    • I disagree with the second half of your comment. If I buy your house for twice what it was once worth, all it does is encumber me with a large debt, and gives you a large windfall deposit. It doesn’t divert real resources, just makes houses impossibly expensive.

      Of course, some individuals might decide to focus on property buying/selling instead of doing other activities, but that doesn’t create any more houses – one new buyer squeezes out another.

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  3. Hi Michael, I’m not an economist but disagree.

    At the aggregate level it has diverted resources. We have substantial wealth now tied up in appreciated land value. This land is not “marginally productive, ie. adds no additional value beyond putting a roof over our heads” and much of the land value increase is purely due to artificial planning constraints & excess immigration rates. Take both these away and our excessive housing “wealth” disappears. (Although I note some of the increased land value can be attributed to agglomeration effects & is probably real.)

    In the counterfactual case, in aggregate NZer’s would have nearly no mortgages and all the capital ploughed into making the Australian banks rich could have been used to create wealth in more potentially more productive areas (albeit at potentially higher risk).

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  4. David

    Of your first main para, I agree with all but the first sentence. It is an artificially overstated wealth, and could disappear again if those structural distortions were unwound.

    But it is your counterfactual I disagree with. As I said, if I buy your house for double what it was previously worth I (typically) end up with a very large mortgage and you (typically) end up with a large deposit, both with a bank. There is some gain to the banks – and to that extent wasted/diverted resources – but it doesn’t alter the real resources (labour, physical capital) devoted to housing vs other things. Indeed, to the extent that the house prices are a symptom of underbuilding (given the population pressures) there is a plausible case for saying NZers have diverted too few real resources to housing.

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  5. To take the argument further.

    1) If the capital went into productive enterprise interest costs would be tax deductible. With mortgages they are not unless we are all house investors. Simply via this mechanism the use of the capital would be more productive (everything else being equal).

    2) “There is some gain to the banks” – I would say more than some. The interest payments on mortgages almost all go to the 4 big banks which are Australian owned. We effectively have a large pipe of capital constantly flowing to Australia which we then have to pay to borrow again.

    “there is a plausible case for saying NZers have diverted too few real resources to housing” – agreed but we both agree NZ’s immigration rate is too high.

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    • You forget that house prices started rocketing when net migration was negative ie when more kiwis left for Australian in abundance.

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  6. Just on point 2, remember that is only the (additional) margin between the lending and deposit rates that flows to bank shareholders, and that is in part a recompense for the additional capital bank shareholders have to put up to support/sustain the larger balance sheets that have resulted from absurdly inflated house prices.

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  7. Hmmm… The comments on the value of land are really off the point from an economic point of view. one of the most puzzling issues is the relatively weak performance of NZ productivity growth compared with similar countries. As a country NZ works hard as measured by working hours but has little to show for it in a productive sense.

    Two thoughts spring to mind which are not easy to model but bear thinking about.

    The first is the relative ease of live in NZ. We do no have, compared to many many other countries, true poverty. We have relative poverty, better known by that media beat up called inequality, but not the grinding destitution of elsewhere. It is a relatively easy place to live. But NZ is expensive and anyone who argues against this has not traveled.

    Secondly, capital intensity is low – we have relatively less invested in capital productive assets than other countries of a similar size, so most of the productivity growth is on the labour market. Now one could argue that that is an issue for capital markets, banks and the like, but these function reasonably well; not perfectly, but not awfully either.

    And given the timeframes outlined, maybe the problem is also cultural? People live here, have a lowish standard of living via international comparisons, but have a great lifestyle – who needs the $$ when a swimmable beach is less than 30 minutes on public transport from the centre of our largest city? Maybe true in Sydney but other large cities? Maybe we still think this is ‘Godzone’?

    Its a curly one…

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    • Interesting possibilities. I’ve always been a bit skeptical about the lifestyle/culture story. after all, for at least 50 years we had whatever the NZ lifestyle offers, and among the very highest material living stds in the world. It is partly why I keep making the (otherwise obscure) about the attractive beaches of Montevideo.

      People talk up access to beaches and bush, but never seem to talk about what people in other countries experience as lifestyle. Living in the suburbs of London, for example, might make beach access an issue, but access to museums, galleries, superior newspapers, or Paris 2 hours away on the train count as a different sort of attractive lifestyle. And – among smaller countries – Norway and Sweden and Finland look to have good lifestyles, and easy access to water etc.

      On capital intensity, I think we should always see it as a symptom, and so pose the question as to what aspects of the NZ economic environment made it unattractive for firms to invest more heavily (my story: largely the persistently high real interest rates, and a persistently overvalued real exchange rate)

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