Nationbuilding?

Whenever I hear the term “nationbuilding”, and particularly when calls come for this or that programme in the name of “nationbuilding” I shudder somewhat. I spent some time working in southern Africa in the 1990s, and after-effects of the disastrous “nationbuilding” programmes of people like Kenneth Kaunda and Julius Nyerere were already apparent.  Since then, the sheer awfulness of Hastings Banda and Robert Mugabe have also become increasingly obvious.   “Nationbuilding” has a ring of something post-colonial, whether in Africa or Latin America, and (to me) a ring of persistent failure.

New Zealand has had its share (perhaps more than its share) of “nationbuilders”, people who seek to use the power of the state and its (our) resources to pursue one or another vision of what the country could become. There was Julius Vogel with the massive debt-fuelled expansion.  And Sutch/Savage/Nash, financially fairly austere perhaps, but with a vision of an insulated New Zealand with a large manufacturing sector (those 22 TV factories). We’ve had NZ Steel and Tasman Pulp and Paper –  and the Raspberry Marketing Council.   We’ve had those who actively encouraged (and even subsidized) large-scale immigration.  We’ve had the Think Big strategy of Muldoon and Birch.  And latterly another wave (of decades-length) of large scale (supposedly) skills-based immigration, supposedly as a “critical economic enabler” –  as if somehow the people we have aren’t really “good enough” for those holding the levers of power.   And there are all sorts of other programmes that fly a bit further under the radar –  film subsidies for example, or grants to those who capture the imagination of bureaucrats –  or which simply never managed to command enough public support in time (the slightly younger Roger Douglas’s call for sixteen state-funded carpet factories).  Each of these programmes that has been implemented made a difference, but how many of them were for the good is, at very least, an open question (my provisional answer is none of them).   And if they weren’t good, there was almost no effective accountability for any of the designers.

I pulled off my bookshelf this morning Brian Easton’s 2001 book The Nationbuilders, 15 profiles of people Easton saw as having “shaped the New Zealand nation in the middle years of the twentieth century”.  They are mostly political and bureaucratic figures, or people whose contribution was around politics and policy.  None was particularly market-oriented (Coates and Muldoon appear, both from the activist ends of their respective centre-right parties).  One major business figure was profiled –  James Fletcher – but even his success was in no small measure down to the huge government construction projects.  Oh, and there was Dennis Glover, who founded Caxton Press.

Which is a somewhat longwinded introduction to an article in the Dominion-Post a few days ago in which Shamubeel Eaqub called for this week’s Budget to be a nation-building one.  It wasn’t simply a line in passing –  the phrase appears three times in a not-overly-long column.  In this case, “more public debt” is the call –  in this case to build houses (30s revisited), public transport, and “rail in critical infrastructure corridors” (1870s revisited).

He continues

The reality is that the current expenses or lost revenue could be easily redirected into debt repayment to fund some serious amounts of new investment.

If we raised a 100 year bond, as Ireland has done recently, we could probably borrow about $30b for every $1b in debt repayment. Incidentally we spend about $1b a year on accommodation assistance. Redirected to borrowings, we could perhaps build about 82,000 houses on existing Housing New Zealand land in Auckland.

Set aside for the moment the long track record of poor quality government capital investment –  not just here but abroad – and then consider a key difference between Ireland (and Belgium which also recently issued a 100 year government bond) and New Zealand.

First, both have very high levels of government debt (general government gross debt in excess of 100 per cent of GDP) and so the idea of locking in some of that debt for a very long time must seem quite attractive to the respective debt managers.  Neither country seems to be launching an expansionary fiscal policy with the proceeds.

And second, there is quite a difference between the price of Irish or Belgian debt, and that issued by the New Zealand government.   Belgium issued its 100 year bond at a nominal yield of 2.3 per cent.  Ireland issued its at 2.35 per cent.  The ECB has an inflation target of just under 2 per cent, and inflation in last 25 years has averaged 2.2 per cent in Ireland and 2.0 per cent in Belgium.   At most, a reasonable estimate of the expected real interest rate over 100 years is perhaps 0.5 per cent.   That should represent quite cheap borrowing (although whether it is really cheaper than a succession of 10 year bonds only time will tell).

What of New Zealand?  We don’t have a 100 year bond.  But the New Zealand government does issue quite long-term inflation indexed bonds. A bond with 14 years to maturity has a yield of around 1.82 per cent, and one with 19 years to maturity yields around 1.93 per cent.  The implied 5 year rate in 14 years time (ie the last 5 years of the 19 year bond) is around 2.2 per cent.  Who knows at what yield the New Zealand government could issue 100 year bonds (having taken all the inflation risk back on itself) but it seems unlikely that it would be less than 2.5 per cent.   That is a huge difference in likely real borrowing costs from those European sovereign issuers.  And yet Eaqub proposes we borrow to spend (“invest”) at those high yields, even though the real productivity performance of the New Zealand economy over decades has been far inferior to that of either Belgium or Ireland.   In our case, a 2.5 per cent real interest rate not only materially exceeds past and likely future productivity growth rates, it may even exceed the likely future rate of real GDP growth.

For the government to borrowing at 2.5 per cent real might look reasonably attractive if the benchmark is New Zealand interest rates over, say, the last 25 years.  But being in debt at all, as a government, should have been extremely unattractive during that period given how high New Zealand’s interest rates have been (and, laudably, successive governments markedly lowered our public indebtedness).  Perhaps a long-term real borrowing rate of around 2.5 per cent real might be borderline attractive if we could count on excellent governance and disciplines and an assurance that projects would be subject to rigorous cost-benefit analyses.  The track record on that score isn’t promising.

On a perhaps-related issue, Treasury last week released a series of blog posts on the financial return to the Crown from its investment in Air New Zealand, from the time of the Crown bailout in 2001.    As a purchaser of last resort (in late 2001, post 9/11, no one was keen on airline shares), the Crown should have got quite good entry levels.  And Air New Zealand remained listed on the stock exchange, with minority private interests throughout the subsequent 15 years, ensuring some level of ownership-based market discipline.  Air New Zealand is widely regarded as a very well-managed successful airline, and for now is riding the back of relatively low oil prices and an upsurge in inbound tourism.

Over the period since 2001, the nominal 10 year government bond rate has averaged 5.3 per cent.  And yet the internal rate of return the Treasury analyst calculated on the Crown’s investment has been 8.4 per cent per annum –  and much of that is unrealized, and dependent on the current, still relatively high, Air New Zealand share price.    Buy the entire equity index and I suspect few investors would regard a 3 percentage point equity risk premium as reasonable (from memory, historic market estimates are typically in a 4- 7 percentage point range).  But Air New Zealand is not as risky as the index as a whole –  it is far far more risky.  Government debt financed that Air New Zealand investment, and taxpayers don’t seem to have gotten a remotely adequate compensation for the risk they assumed, even in an industry with lots of competition and market disciplines.  It isn’t clear why advocates of large scale borrowing now – in a country with still quite high real long-term interest rates –  think they would do better in generating economic returns.

So-called “nationbuilding” projects have usually been a way of wasting (with a fairly high degree of confidence) the nation’s resources in pursuit of some politician’s or economist’s pet vision.  Government don’t –  or perhaps rather shouldn’t –  make nations, and in particular they certainly don’t make the wealth of nations.  That is down to individuals, firms, and the networks of society.  There is an important role for government –  and whatever government does needs to be done as well (or least badly) as possible – but “nationbuilding” as a call seems no more likely today to result in a good, high-yielding, projects, than it did in 1870 or 1980 or 1935 or……

17 thoughts on “Nationbuilding?

  1. Ask Robert Inglis or Ewan Wilson what they think of the Govt return on Air NZ. They targeted Origin Air’s routes until it went under and then banged up the price. Perhaps they should sell their shares and put the money into bolstering the Commerce Commission? Swiss Govt never rescued Swiss Air and they have plenty of money.

    Like

  2. And therein lies the Keynsian takedown: governments invariably spend money on politically motivated rubbish to benefit its constituents. And it doesn’t have an incentive to spend that money responsibly or productively.

    The macro statement of ‘we should be building infrastructure projects’ simply doesn’t translate into an identifiable actual project, because invariably the details of the actual project in front of you aren’t that appealing.

    These conclusions seem obvious, but then lots of people are incentivised to spend that cash unproductively.

    Like

  3. Air NZ is a prime example as to why we should sell all our national assets. We sold it for a premium, and then we opened up the floodgates with landing rights to every other airline to competition. That decimated Temasek Holdings share price and the government comes in and rescues the airline and now owning majority stakes. Sell high and buy back low and then now we should sell it off again whilst prices are at their peaks. Sell Sell Sell now.

    Like

  4. I am expecting Mr Equab to announce his candidacy for a safe Labour seat at the next election. Nations are built by risk takers and people – not prescribed Govt largesse… next thing it will be about vision… well Pol Pot had a vision…

    Air NZ is an interesting example of the Govt’s IRR… 8.4% still handily beats 5.3% an on a 15 yr compounded basis the actual $ difference is quite material. Although if your cost of capital is 8.5% then maybe not such a good return…

    Like

      • I’ve never heard anyone talk about a government cost of capital before (which makes this very revealing indeed) – but I’ve also never seen anyone talk about the governments WACC when determining the appropriate required return for a proposed project.

        Every one that I ever saw used a standard view of the long term bond rate, with a few high and low ranges, with a real discount rate of around 6%-10%. Which didn’t really move with changes in the current risk free rate either (up or down). (See the Department of Finance’s handbook for cost benefit analyses.)

        Required returns were never adjusted for differences in project risks either: a risky property development was treated with the same discount rate as a vanilla replacement capex infrastructure project.

        Like

      • Assume you mean cost of equity?? Pre or post tax?? seems quite high for the current environment none the less… Although it is an airline…

        Like

      • Sorry, yes cost of equity. Here is the extract from their post.

        “A better benchmark than the cost of borrowing would be to consider market estimates of Air New Zealand’s cost of equity. This is the return that market analysts think that shareholders in a company would need to receive, to compensate them for the risks of investing in that company. A few years ago, market estimates of the cost of equity for Air New Zealand were between 12% and 16%, somewhat higher than the calculated IRR.”

        Given the riskiness of an airline, it doesn’t seem out of the line with the RBA survey results I discussed here
        https://croakingcassandra.com/2015/08/22/what-price-should-be-put-on-proposed-government-projects/

        Like

      • You would have to add the increased value of the share price plus the dividend yield. The government was picking the shares at 20c per share if I recall so that has been quite a substantial increase in the share capitalisation value.

        Like

  5. I think you could argue that much the same applies to Councils and various other Local body outfits infested upon us.
    Helen Clark managed to give councils an open right to fund anything they “feel good” and while it might make for a nice town it is rorted from the ratepayer and not users or very citizen that live in the area.

    Roading and Transport seems to be moving to the right funding model i.e.paid for by the users via fuel tax and road user charges. (except for Simple Simon’s stupid approach to exempting electric cars from that tax. See no reason why any other road user should subsidize these cars. Taxi’s for example can save $10-15K per year by avoiding these charges.).
    Currently I understand that for local roads council funds 50% and the Ratepayer funds 50%. The question is why should the rate payer fund any at all? NZTA collect the tax and should dish it out 100% for council roads. If the tax needs to rise to meet the cost well so be it, and it should allocated in a proportion to the income and population.
    NZTA then has a borrowing role and could use long term bonds if necessary without either the taxpayer nor the ratepayer having to add this to their debt mountain.
    Remember council debt is a charge against a private property owned by the ratepayer. ( as the kaipara people have found out).

    Like

  6. There is a very funny ABC show called Utopia about a “Nation Building Authority” that never builds anything. Anyone who has worked for the Australian public service or academia will tell you it cuts pretty close to the bone.

    Like

    • I must check it out. Probably better that it never builds anything – bureaucrats are quite cheap compared to the loss of real resources in actually building – and operating – such things. HIgh speed rail anyone….

      Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s