Month: July 2016

Immigration is “a good thing”, and that is all we need to know

Michael Reddell Immigration, New Zealand economic performance

I’ve been struck again over the last few days by the determination of our “elites” –  whether from the left-liberal end of the spectrum, or the (rather smaller) libertarian end – not to actually engage with the data on New Zealand’s experience of large scale immigration.

In their amusing tongue-in-cheek simplified retelling of English history, 1066 and all that, Sellars and Yeatman had most things classified as “a good thing” or “not a good thing”.

There seems to be a world view, straddling National, Labour and the Greens, and ACT as well, that in some sense “immigration is a ‘good thing'” and that is really all that needs to be said on the matter.  Much the same goes for the media.  The plebs just need to get with the programme –  perhaps having it explained to them again, slowly and clearly this time, that immigration is a “good thing”.   Any skepticism is too often deemed to reveal more about the character of the sceptic, than the merits of the economic case.

There is a respectable theoretical argument (at least within the narrow confines of economics) to be made for an open borders policy.  But the fact that no political party I’m aware of –  here or abroad –  actually argues for such a policy is probably quite telling.  Within the EU, there is a particularly respectable case for open borders –  the EU-enthusiasts see the countries of Europe as being on a transition to a political union.  Only brutal authoritarian countries –  think China – want to control migration of citizens within their own country.  But, as it happens, most Brits didn’t want to be part of an EU political union, preferring to govern themselves.  Polls suggest citizens in most other EU countries also don’t want such a union.

Even without political union, there can be a reasonable case for an easy flow of people across borders.  New Zealand and Australia are two different countries, and that doesn’t seem likely to change.  And yet there have never been direct immigration restrictions on people moving among the various colonies (pre 1901) or between the Commonwealth of Australia and New Zealand (since then).    In practical terms, the barriers to moving – especially from New Zealand to Australia –  have been getting higher in the last few decades, as Australian welfare provisions etc and citizenship have become progressively less readily available to New Zealanders.  On my reckoning, New Zealanders have gained considerably from this ability to move to Australia, especially as the large income and productivity gaps have opened up in the last 50 years.  Some New Zealanders relocated and took direct advantage of the higher incomes and better opportunities abroad.  The rest of us benefited –  at least in principle –  because the departures from this land of (apparently) diminished opportunities eased the pressure on living standards here.   Whether Australians have benefited from the easy flow of people across the Tasman is more arguable.  There are reasonable arguments (and, thus, models) for small gains, small losses, and not much difference at all.

Even within the context of a system of immigration controls, there can be a variety of motives for allowing immigration.  There is the humanitarian perspective that governs refugee policy.  We don’t take refugees because it is good for us, but because it is good for them –  people whose homelands have become impossibly difficult.  If the refugee intake ends up benefiting us economically that is a bonus, but it isn’t –  or shouldn’t be –  what drives us.   And, of course, we allow New Zealanders who marry abroad to bring their spouse home, and to become a New Zealander.  Again, there isn’t an economic motivation behind those provisions.    And some countries have real problems controlling their borders, and get stuck with people they never intended to allow in.

But we do control our borders and the bulk of New Zealand’s non-citizen immigration programme has an economic focus.  MBIE, and the government, have described the immigration programme as a “critical economic enabler” for New Zealand –  a phrase which sounds sillier, and emptier, each time I write it, but which is at least honest.  We take migrants   –  lots of them (three times the per capita inflow in the US) – on the hypothesis that doing so will help New Zealanders economically over the medium to long-term.  We certainly needed “critical economic enablers”, so poor has our economic performance been over the post World War Two decades.  And there are plausible hypotheses for how immigration can help, at least in the abstract.

But several decades on, surely the advocates, administrators, and cheer leaders of the programme should be able to point to economic gains for New Zealanders? It doesn’t seem an unreasonable request, given the economics-based case made for the programme.   The presence of a wider range of ethnic restaurants, or the success of the All Blacks, are all very interesting –  although, to be honest, I hadn’t seen too many new English restaurants (the UK is still the source of more new residents than any other country)  – but that isn’t the case that has been made.  New Zealanders are supposed to have been made better off economically by large scale immigration.  And if there is evidence of those gains, the champions of the programme are strangely reluctant to cite it.

And so we have Liam Dann in the Herald this morning

Australians have been panicking about immigrants and to some extent their loss has been our gain.

Migration-driven GDP growth through a period of commodity price downturn has been a timely break for our economy.

….

There are risks that high immigration disenfranchises those at the bottom of the social ladder.

We need to ensure we have social policy to protect people from losing out and turning their anger towards migrants. We need to remember the current surge is not driven just by the more highly visible arrivals of different culture and ethnicity.

It is being driven by New Zealand passport holders.

History tells us this wave will not last. And that when it passes it will have left this country richer and stronger.

It is a strange argument.  After all, had the economy of our largest trading partner been doing better, presumably that would have helped our economy not hurt it.  And if demand had been weak here –  as actually it has been –  we could have had lower interest rates and a lower exchange rate, the latter in particular would likely to have been helpful.

And then, apparently confusing the variability in the NZ citizen immigration with the baseline large inflow of non-citizen migrants, he worries about people at the bottom “losing out”.  But this appears to be only about perceptions because he knows that when the current immigration surge ends “it will have left this country richer and stronger”.    That is, certainly, the logic behind the immigration programme.  But where is the evidence?  There is no sign that the income or productivity gaps between New Zealand and Australia are closing.  They haven’t closed after the previous waves of immigration either.  It seems to be based on little more than a wish  – and that same underlying belief that somehow high immigration is a “good thing”.

The Prime Minister on Q&A yesterday was no better.   Corin Dann put to the Prime Minister the case recently made by leading businessman (and economist) Kerry McDonald that high rates of immigration to New Zealand are quite damaging.  The Prime Minister responded that he “didn’t think the evidence bears that out”.   But he offered no evidence at all.   He mentioned wage increases in New Zealand, but when the interviewer pointed out that there was still a very large gap to Australia, all the Prime Minister could offer was the defensive “well, we’ve trying to close that gap for a long time” (really?) and “most New Zealanders would say we are making some progress”.  If the numbers supported his case, presumably he’d have quoted them.  They just don’t.  As I illustrated on Saturday, the gaps to Australia have just continued to widen –  not by large amounts in any one years, but little by little.  There is still a net outflow of New Zealanders to Australia, and if it isn’t as large as it was that seems to be mostly because the Australian labour market is tougher than it was, rather than that New Zealand is doing well.  (Again, as I illustrated on Saturday, both New Zealand and Australia have relatively high unemployment rates at present, and the gap in our favour is no larger than it was on average over the last couple of decades).

The Prime Minister was challenged on political spin in the interview, and he acknowledged that both governments and oppositions do it.  It was certainly on display in the answers on immigration.  The Prime Minister likes strong immigration because it is a “vote of confidence in New Zealand”.  Which might sound good for the first five seconds, until one remembers that for New Zealanders not leaving it is mostly that Australia isn’t doing that well either right now, and for those coming from emerging countries, New Zealand is richer than, say, India, China or the Philippines.  None of that tells one anything about whether New Zealanders are gaining from the large scale programme.  Similarly, the PM fell back on the “house prices are a quality problem” type of argument –  suggesting that Auckland was no different than cities around the advanced world with population pressures.  Perhaps he could check out Atlanta and Houston some time.

In a serious interview, on a major issue, the Prime Minister was simply unable to offer any evidence –  or even good arguments –  for how New Zealanders were actually benefiting from the immigration programme that he continues to run (the same programme his predecessors ran).  It should be a clue that there just aren’t such benefits.  With all the resources of the state at his disposal, including state-funded research programmes for advocates of the current policy, and he can’t articulate the benefits for New Zealanders.  Something seems wrong.

This week’s Listener –  house journal for the left-liberal establishment – had a lot of advocacy material on (the perils and woes of) Brexit –  epitomized perhaps in the column of the Otago university professor who concluded

Enough is enough. The British Government must halt its plans to proceed with Brexit and organize a second legally binding referendum to determine Britain’s future relations with the EU.

Vote again –  and again –  until the people deliver the approved answer.

Political columnist Jane Clifton dealt with immigration issue.  She observed

But the bitterest Brexit realisation is the damage that ensues when governments fail to “sell” immigration.  That’s the most urgent lesson for our MPs to swat up, because anti-immigrant sentiment is seldom far from the surface here. A sizeable bloc of British voterdom simply does not believe that immigrants enrich their country and stoke economic growth and job opportunities. And who can blame them, since in many long-term depressed areas, there’s precious little evidence of it.

Here, immigrants are increasingly copping referred anxiety about Auckland’s growing pains. Rather than document and illustrate the benefits of migration, the Government simply refuses to engage on any other level than to call the anxious xenophobic or racist

I’m not sure that last phrase is correct.  So far, to the extent there has been a discussion, it has mostly been free of that sort of thing.  [UPDATE: That was before I saw these comments from the Minister of Immigration.]   But the more general point holds.  The government simply does not, and perhaps cannot, illustrate the benefits of the programme for New Zealanders as a whole.  The alternative approach seems to be instead to whistle to keep spirits up, and attempt to spin the problems into a story of some sort of success.  If there really is now a robust case to be made for current policy, it should be beneath our government to rely on such feeble assertions.   Clifton herself, of course, seems unable to recognise the possibility that there may not be such benefits to New Zealanders –  that it might just be an economic experiment that has failed.

These days, we have serious figures from the centre-right, such as Don Brash and Kerry McDonald, arguing that our immigration policy is flawed, and probably damaging to the fortunes of New Zealanders, but our media and political elites remain enthralled with an “immigration is a good thing” mentality, unwilling or unable to engage with the specifics of New Zealand’s circumstances, location, and general ongoing economic underperformance.

And it carries across to housing policy.  In the last week, there have been a couple of serious contributions to the debate as to “what should be done” about housing, from, Eric Crampton and Arthur Grimes (and here). I agree with a fair amount of Crampton’s piece, and disagree with a fair amount of Grimes’s –  which is notable for wanting to ride roughshod over the rights and interests or existing residents.  But where they unite –  from the left-liberal end of the spectrum and the libertarian end –  is in avoiding any serious discussion about the high baseline target rate of immigration.  Now, I’ve always argued that as a first best we should try to sort of our housing supply issues –  Atlanta and Houston have –  and ideally have a separate conversation about immigration (since my arguments about the damage immigration policy seems to be doing are not at all reliant on house price stories).  And if there were any evidence that rapid inward migration was in fact boosting the fortunes of New Zealanders as a whole that might be a particularly robust case.  But…..there is none, or certainly none that the advocates have advanced.  Instead, we know that Auckland’s GDP per capita has been falling relative to that in the rest of the country for 15 years (as far back as the data go) and the margin by which GDP per capita in Auckland exceeds that in the rest of the country is now very low by international standards.  And if there is no sign that rapid immigration-driven population growth is helping lift New Zealanders’ income, while the political difficulties of fixing housing supply remain large, the  case for cutting back the target inflow is strong.  Doing so would immediately ease house price pressures  –  and without riding roughshod over property rights through use of compulsory acquisition powers that the government and economists now seem to favour –  and at worst not harm our medium-term income prospects.

As a reminder, the OECD produced new data only last week suggesting that the skill levels of adults in New Zealand are among the very highest anywhere (and that, as in most advanced countries, the skill levels of the average immigrant are a bit lower than those of the native-born.  To the extent we’ve managed to grow our exports –  the foundation of long-term prosperity  –  it has mostly been in natural resource based industries (complemented by the heavily subsidized film industry and the subsidized export education industry) where numbers of people just don’t help much, if at all.  There is no compelling economic case –  and recall it is economics that supposedly drives our immigration policy –  for using policy to deliver lots more people to New Zealand.  The Prime Minister, the leader of the Opposition, the Greens leaders all seem to disagree, as do the media establishment, but none of them can offer a clear simple straightforward data-driven explanation for why.

I’m not sure if there is a risk of a serious social/political backlash of the sort senior lawyer and former ACT MP Stephen Franks talks of.  But I certainly hope there is an economic backlash before too long. The alternative is, most likely, that our long slow relative decline continues –  and any other decent policies we adopt, and the skills and capabilities that our people possess, are constantly battling up hill, in face of an ideology (no doubt mostly well-intentioned) convinced that “immigration is a ‘good thing’ for New Zealand”.  In economic terms it doesn’t seem to have been so for a long time.

In a Listener article a few weeks ago, my former colleague (and New Zealand historian) Matthew Wright was writing about the early pre-1769 history of New Zealand.  One line in particular caught my eye:

New Zealand was the last large habitable land mass on Earth reached by humanity. The long journey of our species from Africa’s Rift Valley into the wider world ended, it seems, on the Wairau Bar.

New Zealand has produced pretty good living standards, at such great distance, for a small number of people.  In the halcyon days  –  when our relative performance was at its best –  we had a quarter the population we now have.  New Zealanders saw something going wrong decades ago and started leaving in large numbers –  in outflows that, as a share of the population, are really large by past international standards –  and haven’t yet seen fit to reverse that judgements.  Distance isn’t dead, but our government’s immigration policy –  in thrall to the ideology –  seems to assume that wishing it so can make it so.  We need to be much more cautious, and evidence/experience driven, in continuing to pursue an economic case for an ever-larger population

 

 

 

NZ and the UK: strongest performers in their blocs?

Michael Reddell Australia, New Zealand economic performance, UK

An article in yesterday’s Herald caught my eye. In a double-page feature on Brexit, it was headed “Options beyond the EU” and featured some comments from the former New Zealand Minister of Finance, Ruth Richardson.  I was a bit puzzled by the article, which didn’t really seen like a New Zealand article, but wasn’t attributed to any foreign newspaper or wire service.  When I checked it out, it turned out that it was a backgrounder that had run as part of a series in the Telegraph three months ago looking “at four non-EU economies to see if they could provide a model for Britain’s post-Brexit future”.  One was New Zealand.   (The Telegraph had gone so far as to described Richardson as  a”great economic reformer”, although the Herald quietly deleted the “great”.)

Several passages interested me:

Ruth Richardson, a former New Zealand finance minister and a great economic reformer, believes there is a clear parallel between the two nations, and the choice that each will face. “When Britain decided to become very closely connected [with the EU], Britain was regarded as the sick man of Europe,” she says, with the UK “almost on the brink of the International Monetary Fund dictating policy” to it. Similarly, “when New Zealand decided to explore closer economic relations with Australia, we were clearly the sick man of Australasia”.

However, Richardson says, “nations ought not to be trapped by historical perspective”. She believes that the arguments behind a once sensible decision may have shifted. As in business, decisions over a country’s political future should be made on the basis of what will work best in the here and now, Richardson says.

Both the UK and New Zealand have risen to become the strongest performer in each of their respective blocs, and the reasons to pivot towards emerging markets have become clear.

And

A pair of radical politicians helped New Zealand through this difficult period. Richardson was the finance minister in a Right-of-centre National party government from 1990 to 1993, and her efforts, combined with those of her predecessor, the Labour party’s Roger Douglas, transformed the economy from one at the bottom of the pile to something far more dynamic.

Shaun Goldfinch, a New Zealand-based academic, says that the country moved from being “one of the most hidebound economies outside the former communist bloc, to among the most liberal in the OECD”.

I wasn’t entirely sure that I recognize the pictures being drawn here.

In both cases, it is a picture of economies transformed –  the UK and New Zealand having ‘risen to become the strongest performer in each of their respective blocs’ (the EU and the CER respectively).

The UK entered the (then) EEC on 1 January 1973.  The initial six members of the EEC had been France, (West) Germany, Italy, Belgium, Netherlands, and Luxembourg.  I’m going to ignore Luxembourg in subsequent comparisons, and focus on the five reasonably large initial EEC economies.

For the UK the path to the EEC was pretty slow.  The first de Gaulle veto had occurred in 1963, and the second in 1967.    Over the 1960s, annual UK inflation  was around 1 percentage point above the median of the five EEC countries.  In 1972, just prior to joining the EEC, that gap was 1.4 percentage points.   Things got a lot worse in the following few years, but even then there was only one year –  1975 –  when the UK had the highest inflation rate of these six economies. Italy was typically worse.

And in the 1960s, real GDP per hour worked in the UK is estimated –  using the Conference Board data – to  have been almost exactly equal to that of the median country of the EEC-5.  Britain’s unemployment rate had been slightly below the median of the unemployment rates of those other European economies.

Of course, Britain had its challenges –  economic, and the psychological/political hurdles of the end of empire –  but it was hardly a basket case.

And nor has it, very obviously, gravitated to top of class since then

Here is real GDP per hour worked.

uk gdp phw

The decline in Britain’s GDP per hour worked, relative to those of the EEC-5, ended in around 1980.  And it has gone almost exactly sideways ever since.   Of these five European countries, Britain now only matches the real GDP per hour worked of Italy.  In the other four countries, labour productivity is around a quarter to a third higher than that in the UK.  Perhaps entering the EU staunched the decline, but there were probably a variety of other factors including financial liberalization (financial services being a huge chunk of British exports), the Thatcher reforms, and the end of the post-war catch-up phase.  But……Britain now has a lower level of labour productivity than all but one of these five European peers: it does no better than 80 per cent of the median of these other countries.  Not exactly a “top of class” performance.

One area where they have done better is unemployment.  The following chart shows the UK unemployment rate and the median rate for the same five European countries.  It combines official current OECD data (on harmonized definitions) since 1983, and several years of earlier OECD data from their Historical Statistics: 1960-1988 publication.

uk unemployment rates

Over the last 20 years or so, the UK has clearly done materially better than these five European countries.  Each of the other five is in the euro, but that shouldn’t explain any difference given that these five countries include four of the larger euro-area economies.  But even among those other five countries, the Netherlands has typically had a lower unemployment rate than the UK’s –  although that isn’t so right now.

And what about the New Zealand/Australia comparisons.  Negotiations on the CER agreement began in 1979, and the agreement was signed in early 1983.  Given that there are only two countries in Australasia, I won’t dispute the description of New Zealand by then as the “sick man of Australasia”.  Our economy had been very severely hit by the post-1973 fall in the terms of trade.   The large outflow of New Zealanders to Australia really gathered pace in the 1970s.  Neither country was running macro policy –  or micro policy –  that well, but New Zealand was generally accepted to be lagging somewhat behind Australia.  We compounded the problems with the Think Big energy projects programme in the early 1980s, which temporarily boosted demand, but simply threw away some of the nation’s wealth.

But the story wasn’t totally bleak.  Our unemployment rate, while rising, had been consistently below that of Australia. And over the years when CER was being negotiated, New Zealand’s real GDP per hour worked was about 79 per cent of that of Australia –  alert readers might notice that that is about the same ratio as that between UK GDP per hour worked today and that of the EEC-5 (see chart above).

I’m not about to dispute that lots of worthwhile reforms were done here during the subsequent years.  And I think it is likely –  although hardly certain –  that CER was helpful to both countries (although trade diversion effects were probably material in some sectors).  And there are whole sectors of the economy where I think policy  in New Zealand could reasonably be judged better, at least in terms of encouraging resource utilization, than that of Australia.  The labour market is one of them –  we don’t need elections called on the ostensible grounds of breaking the power of corrupt trade unions.  I know some readers disagree, but I think our approach to retirement income policy is superior to Australia’s.  And I often like to mention that taxi industry, where deregulation has given us a much better outcome than Australia has.

But has it made us the strongest performer in our little two country bloc?  Not really.

Take the real GDP per hour worked comparison, again from the Conference Board.

nz au real gdp phw

The late 1970s were a very bad period, as reflected in these data.  But on this measure things improved a bit of the 1980s –  partly no doubt the unsustainable boom that bust after 1987 –  before tailing off again.  Today, New Zealand’s GDP per hour worked is a little worse, relative to Australia’s, than it was when the CER negotiations got underway.  Perhaps the exam paper was upside down when that “best in class” grade was being awarded?  Of course, both countries are richer, and more open, than they were back then, but Australia has kept on doing a bit better than us.

And a significant part of the liberalization and reform process in both countries was the opening to external trade (not just bilaterally).  Here is the data for exports as a share of GDP.

exports nz and ausNew Zealand’s export share of GDP hasn’t changed in 35 years.

Of course, there are some area in which we do better –  and we have the distinct attractions (to New Zealanders at least) of no snakes or crocodiles.  As I noted earlier, the labour market tends to be one such area.  Here are the unemployment rates for the two countries back to the 1960s (prior to 1986 the New Zealand data are estimates, but good enough to be used by the OECD).  I have taken account of the revised data Statistics New Zealand published earlier this week.

u rates back to 60s

Our unemployment rate has been below that of Australia most years since 1967.  Only on two occasions was our unemployment rate higher – the first episode was in the wake of the post-1976 share and commercial property crash, and the second was in the couple of years after 2009 when Australian commodity prices –  and the associated business investment boom – were at their peak.  We should, of course, welcome the fact that our labour market typically generates less unemployment than Australia’s does, but it is worth mentioning that the gap in our favour is smaller than it was pre-liberalization.

No doubt our economy is rather more “dynamic” than it was –  although it is fair to wonder quite what that words mean specifically –  but it isn’t obviously much more successful., not even relative to Australia.  Compared with the late 70s, both countries now have low and stable inflation –  but their inflation rate is nearer target than ours.  Both countries have low levels of public debt, but in flow terms at present our government accounts are roughly balanced while theirs are still in deficit.    We have a slightly larger reliance on foreign capital (larger net IIP position as a share of GDP) than Australia does, but perhaps they have a slightly more compelling story about the new business investment (tradables sector) that capital has financed.  Both countries have seriously dysfunctional housing markets – it is hard to tell which of two bad performers is worse.  Oh, and New Zealanders are still (net) moving to Australia, not coming home again.

It is election day in Australia.  I was amused when Malcolm Turnbull became Prime Minister and talked about wanting to emulate New Zealand’s approach to economic reform.  In the intervening period, there hasn’t been much sign of reform in Australia –  any more than there had been in New Zealand –  but for all Australia’s challenges, it has still managed more productivity growth in recent years than New Zealand has.

real gdp phw nz and aus

As I noted earlier, the United Kingdom has hardly been a top-of-class performer in Europe in recent decades.  The sobering thing is that over the last few decades, Australia –  with all its newly developed mineral wealth –  has managed to do no better on the productivity front than just about keep pace with the UK.  New Zealand, of course, couldn’t even manage that.

real gdp phw nz aus uk

If Britain is searching for lessons and models in a post-referendum world, New Zealand might offer a model of good intentions.  As for outcomes, not so much.

 

 

 

 

 

 

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What the Board might (but surely won’t) say

Michael Reddell Reserve Bank

Yesterday was the end of the year for the Reserve Bank, and attention will be turning to the annual accounts and the Annual Report.  There are two relevant Annual Reports, required by law. The Bank itself is required to produce an Annual Report, but so is the Bank’s Board.

The Reserve Bank’s Board is quite different from a corporate board, or from boards of other statutory bodies.  The Board has no responsibility for running the institution – whether in a managerial sense, or setting strategic direction or policy.  The Board, in effect, selects the chief executive, but there the similarities largely end.  The Board isn’t charged to work with the Governor to collectively deliver the Reserve Bank’s goals.  Instead, it is explicitly charged with holding the Governor to account for his stewardship of the Bank.  In that role, their primary responsibility is to the Minister of Finance and to the public.   They are given privileged access to information, but are expected to be willing to stand at arms-length from management generally, and the Governor in particular.

Of course, structural flaws in the model make this hard to do effectively.  When a Board appoints someone as Governor, they naturally have a strong desire to see their choice validated, and hence a natural instinct to “back their man”.  The superficial similarities to corporate boards probably don’t help –  since many of the Reserve Bank Board members sit on other private or government boards.    I’ve also been critical of the Board for allowing itself, over the years to get too close to management – repeatedly making former staff chair of the Board for example –  and for seeing one of its role as helping sell the Bank’s messages.    But again, under-resourcing (the Board has none) tends to reinforce this dependent relationship

Last year, for the first time, the Minister of Finance sent a Letter of Expectation to Rod Carr, the chair of the Reserve Bank’s Board, setting out what he expected from the Board (I wrote about it here). In that letter, the Minister was quite explicit in drawing attention to the different nature of the responsibilities of this Board, and he outlined some clear expectations for what he thought the Board should report on.  He certainly wasn’t just interested in a list of meetings attended or papers received –  as past Board reports have often been.  He also explicitly noted that “greater visibility of the Board’s activities would also be welcome”.

So as the Reserve Bank’s Board begins to think about how it might shape and phrase this year’s Annual Report, bearing in mind the Minister’s written expectations, I thought I’d have a go at a version of the Board’s Annual Report that I think would be more consistent with (a) the data and evidence, and (b) the Board’s actual responsibilities.    Sadly, I will be surprised if any of these points are made, or even if the issues are treated in a substantive and balanced way, while reaching different conclusions.   But here goes:

Annual Report of the Board of the Reserve Bank of New Zealand
Year ended 30 June 2016

The Board of the Reserve Bank of New Zealand has quite different roles and responsibilities than boards of most other statutory bodies, let alone those of private sector companies.  Following receipt of the letter of expectation from the Minister of Finance in November 2015, we have taken the opportunity to reflect again on how best we can fulfil the role provided for us in the Act.  That role is primarily about holding the Governor to account for his stewardship of the Bank, on behalf of the Minister of Finance and the people of New Zealand.  Doing that well involves striking a difficult balance.  We are provided with privileged access to information, and the ability to engage with and question the Governor and his staff.  But we need to maintain a considerable distance from the management of the Bank, and ensure that we are exposed to, and consider, alternative perspectives on the Bank’s performance, in reaching our own assessments.   We are not here to be cheerleaders for the Bank, and regret that at times in the past we have allowed ourselves to become part of the Bank’s outreach efforts –  which compromises our subsequent ability to evaluate management, and to be seen to do so in an objective fashion.   And equally we need to bring a professional detachment to our evaluation, and not allow ourselves to be unduly influenced by the part we or our predecessors had in appointing any particular Governor.

We are also conscious that the Board has limited resources.  The role of Board member is a part-time position, remunerated on the basis that members will typically spend no more than perhaps two days a month on Bank matters.  Few of us are experts in the subject matter the Bank in responsible for, and we have no independent budgets or staff resources.  The Governor  –  whose performance we are charged with evaluating – controls the papers that come to the Board from the technical experts on staff.  Indeed, we are dependent on the Bank for even secretarial and administrative support.  We do not think that is an adequate model to enable the evaluation task to be done well, and we have written to the Minister of Finance suggesting that the Board be provided with a limited amount of independent resource (including the ability to commission external advice) to be better able to fulfil the role that he, and others, rightly expect of us.

The Reserve Bank has a wide range of tasks and statutory responsibilities.  That breadth of functions, and the extent of the powers delegated specifically to the Governor, is unusual –  both in New Zealand public agencies, and among central banks and financial regulatory bodies internationally.  We work within the framework Parliament has given us, but we are uneasy about how different the Reserve Bank framework now looks.  We would encourage the Minister to consider establishing a process to review whether the design of the institution and its governance model is the best possible model for New Zealand in coming decades.

The Reserve Bank has a substantial body of high quality staff.  We thank them for their dedicated input over the last 12 months.

As we reviewed the Bank’s performance over the last 12 months – and particular that of the Governor, who we are specifically charged with holding to account –  we have found a number of areas of concern.

The most obvious is the way in which inflation has undershot the midpoint of the target range –  the midpoint having been specifically identified as the focus as recently as the 2012 Policy Targets Agreement.    Many –  although not all –  advanced country central banks have been grappling with persistent surprising weakness in the inflation rates in their respective countries.  Of course, unlike many of those central banks, the Reserve Bank of New Zealand still had ample tools at its disposal –  the OCR has been consistently above 2 per cent, while in most advanced countries rates close to, or even below, zero have been more common.

We also recognize that many of the more prominent local commentators had similar, or even more optimistic, views on inflation, than the Reserve Bank did.  Perhaps there is comfort in a crowd, but unlike the other commentators, the Reserve Bank has been charged with delivering inflation at or near target.  It hasn’t done so over the last year, and unfortunately that followed several years of undershooting.  We disagree with the senior Bank manager who was recently quoted as suggesting that six years was too short a timeframe to evaluate monetary policy performance over.

It isn’t our place to second-guess specific monetary policy judgements made by the Governor.  But it is our duty to stand back and consider lessons from the patterns that start to emerge over time.  We are concerned that the Bank may have allowed itself to become too inward-looking, and too reluctant to foster or engage with alternative perspectives –  whether internally, or externally.  In an area in which there is so much uncertainty, this would be a serious weakness in the institution.  In most institutions, any such reluctance stems from signals –  deliberate or inadvertent –  sent from the top.  In this respect, we have been concerned that the Governor has not been willing to openly admit that mistakes were made in the setting of monetary policy in recent years.  To err is human.  To wish to deny error is also, perhaps, human, but unhelpfully so.  “He Knew Was the Right” is the title of one of Anthony Trollope’s novels. That character’s certainty did not end well.

We have already drawn attention to the well-known fact that most advanced countries now find themselves having exhausted their conventional monetary policy capacity.  If policy interest rates can still be cut at all, it is only by very small amounts by the standards of past cycles and shocks.  New Zealand is fortunate in that respect that the OCR is still some way clear of zero.  But that is no basis for complacency, and unfortunately we have seen little sign of the Reserve Bank taking steps to address the risks.  In typical past downturns the Reserve Bank has often had to cut interest rates by 500 basis points.  In a future downturn that can’t be done.  And yet there is no sign –  including in the latest Statement of Intent –  of any work programme to anticipate these risks and to, for example, seek to remove the near-zero lower bound on nominal interest rates.  With so much advance notice, New Zealand should not find itself unable to use monetary p0licy sufficiently in the next serious downturn.  As the Governor has rightly noted, risks abound globally.

We note, with some concern, issues that have been raised over the last year about the consistency of the Reserve Bank’s monetary policy communications.  We would expect management to take these concerns into account, but we recognise that inconsistent communication (or at least perceptions of it) has also been an issue facing some other central banks, including the Federal Reserve.  Our assessment thus far is that the communications problems are mostly a reflection of the underlying issues central banks have had with correctly reading and interpreting inflation, and inflation risks.  In the Reserve Bank’s context, they have probably been amplified by the lack of clarity around the role of house prices in the way the Bank has been conducting monetary policy.

The Reserve Bank’s second main area of policy responsibility is the regulation and supervision of various institutions in the financial sector, under a mandate of promoting the efficiency and soundness of the financial system.

As the Bank has noted in its own reports, New Zealand’s financial system is sound.  Demanding stress tests suggest that there is no credible threat to the soundness of the system, based on the lending patterns and standards observed in recent years.  Those patterns can change, and quite quickly, and the Bank needs to be closely monitoring developments, especially in the banking sector.

In recent years, however, the Governor has articulated concerns that house price developments, especially in Auckland could –  if left unchecked –  develop in ways that could pose a systemic threat. In turn, the Bank has used several unprecedented regulatory interventions –  unprecedented in New Zealand, even in the decades of direct controls – to attempt to influence access to housing finance.  In recent months, the Bank has signaled the possibility of yet more controls, when only three years ago it was explicitly talking of the first wave of controls as “temporary” in nature.

In his letter of expectation, the Minister indicated that he expected us to explicitly address both the soundness and the efficiency dimensions of the Bank’s responsibilities.  We are concerned that the Bank has not been giving sufficient attention to the way in which direct controls impede and impair the efficiency of the financial system. Recent FSRs, for example, have given efficiency little or no attention.

In a wider sense, we are uneasy that the Bank has been adopting successive waves of controls with too little robust analysis or research underpinning them.  Here we have in mind two particular types of research. First, the Bank has published nothing in recent years looking carefully at the experiences of the countries which did, and did not, experience financial crises or systemic stresses following the last credit boom prior to 2007.  And there has been nothing looking carefully at New Zealand’s own experience during that period –  a a huge, widely spread, credit and asset boom, and no serious or systemic stresses followed.  For an institution provided with a substantial amount of research resource, we don’t think that is a satisfactory state of affairs.  And second, we have seen no research from the Bank reviewing literature on government failure, or examining the various regulatory failures and knowledge gaps that plague well-intentioned efforts to use regulatory restrictions in all sorts of sectors.

Again, we do not see it as our role to reach different conclusions than the Governor on specific interventions.  But we are concerned at signs that the institution is insufficiently skeptical and self-critical.  That is often a recipe that leads over-confident regulators into sub-optimal policy responses.  We think the Bank, and those monitoring it, would also benefit from some more structured published research around its wider financial regulatory activities.

Relatedly, we would urge the Bank and the Governor to recognize that, under their current mandate, house prices are not something the Bank is responsible further.  That is quite clear in respect of monetary policy –  the Policy Targets Agreement charges the Bank with focusing on the CPI, and the Bank has long been of the view that house prices should not be in the CPI.  But it is also true of the financial stability responsibilities.  The current level of house prices appears to be a serious national issue, but it isn’t one of the Reserve Bank’s responsibilities.  We have not been presented with evidence over the last year, and nor has such research been made public, that direct interventions in the housing finance market are a better response –  better balancing soundness and efficiency concerns, and the knowledge problems facing all regulators –  than, say, requiring larger buffers through higher capital requirements and more demanding leverage ratios.

The Board’s responsibilities do not simply involve the Bank’s prime policy roles, but also involve monitoring the handling of administrative and management matters. Two in particular have come to light during 2015/16.

The first was the OCR leak that occurred at the March 2016 Monetary Policy Statement.  The  inquiry into this, established expeditiously by the Governor, highlighted not just that there had been a deliberate leak, but that the Bank’s system were sufficient weak (reliant on trust) that it was almost inevitable that at some point a leak, deliberate or accidental, would occur.   We endorsed the decision to discontinue lock-ups –  a practice adopted in few other central banks now –  and believe that the penalty imposed on the culprit (MediaWorks) was appropriate, if belated.  We are concerned, however, by evidence that the Bank’s senior management, and our own Chair, allowed apparent personal animus to colour their reaction to the events, and how they were brought to light.  We appreciate the actions of the person who alerted the Bank to the possibility of a leak.

The second relates to the Reserve Bank staff superannuation fund.  The Board is required to approve rule changes to this scheme, and appoints two of the five trustees (the Governor is a third). We have been seriously disconcerted to learn about substantive errors and at least one breach of the law that occurred around rule changes undertaken some time ago.  The trustees have already had to apologise to members for one breach of the law, and we are now aware that one major rule change –  which benefited the Bank financially, potentially at the expense of members –  was done illegally.  That would be concerning enough in itself, but we have now learned that this information was known to trustees (including senior Bank management) 25 years ago and it was neither acted on nor were members informed.  In fact, members were asked to consent to other subsequent rule changes – which did materially benefit the Bank financially – where knowledge of that past error would have been material information for some members in deciding whether to consent.  Other important rule changes appear to have been made without member consent; changes which could have materially disadvantaged members.  These are not standards of management or governance which we find acceptable, especially in a scheme dealing with the life savings of many of our former (and current) staff.  We apologise for the mistakes of our own predecessors in this area, and we have urged the Governor, and the other trustees whom we appoint, to act expeditiously to remedy past wrongs.

All New Zealand institutions are small by international standards, but the concentration of expertise on matters macroeconomic and financial (unparalleled anywhere else in New Zealand) and the Bank’s typically high standards in recruiting staff should enable the Bank to be at the forefront of engagement on the relevant policy and analytical issues, shaping the debate by the quality of the research and analysis, and unafraid to engage, including openly, with alternative perspectives.  Unfortunately, that has often not been the case in recent years.  We don’t think that is because the quality of the staff has deteriorated.  We note concerns that have been expressed in some quarters about the Governor’s apparent reluctance to participate in serious searching interviews.  Given the extensive powers the Governor wields, we think this choice has been unwise, and would encourage the Governor to adopt a more open approach.  Similarly, the Bank’s reputation for being highly obstructive in handling Official Information Act requests seems neither good policy consistent with the law, nor consistent with the approach to forward-looking transparency in monetary policy that the Bank has done so much to foster over the years.  Transparency can’t just involve telling people what the powerful want them to know.

In recognition of some of the weaknesses in how the Board has fulfilled its role in recent years, we have decided that it is time for a change of Chair. The Board will shortly elect a new Chair. In future we will aim to ensure that the role is not held by former Reserve Bank staff.

The Reserve Bank is a powerful and important organization in New Zealand.  But it has fallen short of what the public should expect from it in a number of major areas.  The Governor recognises this and has committed to work to lift performance over the remainder of his term.  We appreciate that.  As we move towards the appointment of a new Governor next year, we are committed to identifying candidates who would continue to lift the performance of the institution, producing the right blend of sound judgement, analytical excellence, operational efficiency, and a commitment to transparency and accountability and two-way engagement, of the sort the country deserves.

Rod Carr, Chair

Keith Taylor, Deputy Chair

 

As I say, I don’t expect to see even a substantive discussion of these issues in the Board’s actual report.  But time will tell.

In the meantime, while I’ve been writing this post and in and out this morning, responses from the Board and the Bank to several longstanding OIA requests about the OCR leak have turned up, on the very last day of the long extension the Bank gave itself.  I haven’t yet looked at the contents (now available here), but the lengthy delays just reinforce the point about the Bank’s lack of any serious commitment to institutional transparency.