The Productivity Commission’s story

Some months ago I ran a post about some of various attempts to explain New Zealand’s decades-long relative economic decline, and to propose remedies that might reverse this performance.  The first major piece along these lines that I’m aware of was by the Monetary and Economic Council in 1962.  Since that was the year I was born, and economic outcomes now, relative to those in other countries, are worse now than they were then, despite all the various policy reforms and all the ink spilt in trying to make sense of the situation, I find that all rather depressing.  A lifetime, and more, of relative economic decline.

In that earlier post I noted that the Productivity Commission, or more particularly its Director of Economics and Research, Paul Conway, had been at work for some time on a “narrative” of New Zealand’s economic underperformance, offering some combination of diagnosis and prescription.      Earlier versions have been presented at various conferences and seminars here and abroad, and this week the finished product was released.  (In the interests of full disclosure, I should note that the Commission paid me to provide some comments and suggestions on a relatively advanced draft of the paper, imposing no  restrictions on me writing about the finished product.)

The paper, Achieving New Zealand’s Productivity Potential, is issued under Paul Conway’s name.  There is no disclaimer, of the sort often seen on public sector agency research, that the paper represents only the views of the author and not necessarily those of the institution.  I asked Paul about the status of the paper, and he suggested that my description, that it was his paper but that the Commission was “not unhappy with the content”, sounded about right.

The paper is well worth reading, and should be read by anyone with a serious interest in these sorts of issues.    It should be reasonably accessible for most potential readers, and –  at least by Productivity Commission standards – at 80 pages it is quite short.    There are lots of interesting charts, and a variety of interesting issues/possibilities are dealt with (including some of the arguments I’ve been raising).  It is a balanced and fair-minded report, and a really useful contribution to the debate that needs to be had.   Even if the Prime Minister apparently no longer cares much about it – the recent statistics are just too bad for political comfort – productivity growth is the basis of any future long-term prosperity prospects.

The paper isn’t the last word on the issue by any means.  That isn’t just meant as an observation that I disagree with some of it.  As Conway notes, there are many issues where not enough research has been done, whether by academics, core policy agencies, or bodies such as the Commission.  Some of the paper is inevitably a bit speculative.  One goal of the paper might be to stimulate further debate, and prompt a demand for more serious research in a number of areas.

The Commission appears to be keen to be read by the government and its acolytes.  That is perhaps understandable –  only this week, the Prime Minister was dismissing out of hand theTreasury’s long-term fiscal projections, and much the same fate befell the 2025 Taskforce a few years ago.  But on my reading, the desire to not immediately lose all readers from the current government has led them to over-egg the pudding in a few places, in writing up the story of the last few years.  It isn’t central to the story, but the suggestion that New Zealand has materially closed the income gap to other advanced countries in recent years just isn’t supported by robust data, and praise for the Business Growth Agenda and regulatory reform both seem to go beyond the substance of what has been achieved.   There is at least an arguable case that the quality of regulation has deterioriated further in recent years.  Where it counts –  productivity –  at best New Zealand has not lost more ground relative to other OECD countries in the last decade or so. But the large gaps simply aren’t closing.

Even though he began his career at the Reserve Bank, these days Conway’s focus has tended to be on microeconomic issues, and often on firm-level research.  New Zealand is particularly well-positioned for such research, because of the creation by Statistics New Zealand of the Longitudinal Business Database, which enables (a small tightly controlled group of) researchers to conduct studies using anonymised detailed data on individual businesses.  Various researchers, at Treasury, Motu, the Commission etc, have produced a series of interesting papers looking at various aspects of firm behaviour in New Zealand.  Some more results in that vein are included in Conway’s narrative paper.  Indeed, this firm-level approach dominates the early part of the paper –  he argues that “this approach puts firms at the centre of the analysis”.

Interesting as the results of these papers often are, I’m less convinced that the firm level analysis is very helpful for understanding long-term trends in overall economic (and productivity performance).  Some of that may just be about short runs of available data.  Thus, the paper begins with some international evidence about the differential labour productivity performance of leading and laggard firms over the last 15 years or so.  There is a big difference.   The Commission produces some evidence suggesting something similar for multi-factor productivity in New Zealand.  But fascinating as that is, we have no way of knowing whether it is normal behaviour, or whether something unusual and new has been going on in the last 15 years.  And, at least on this score, we don’t even know whether New Zealand has been doing more or less well than other advanced countries, even over this relatively short period.  My concern has been that the availability of the data –  itself a wonderful thing –  is shaping the research agenda more than is really warranted.   Perhaps that is inevitable –  researchers will follow data, as water flows downhill –  but even if so, we need to recognise that the questions that data can help answer aren’t necessarily the ones policymakers should be most concerned with.

None of this is to suggest that firms aren’t important.  Most market economic activity takes place in firms.  But firms, and managers and workers within them, respond to incentives, and should typically be presumed to do so in a rational way, that best serves their own interests.    That includes choices to enter the market, to expand or cut back, or to leave it.  Or simply never to set up at all.    After the 50 or so years of our relative decline, it is likely that the structure of our economy, and the firms within it, look quite different than if a more successful path had been found.  And firm-level analysis simply can’t look at the firms that never came into being –  the exporting firms, for example, that might have developed if repeated aspirations to lift the export share of GDP (as in most other advanced countries) had been met.  So, it isn’t entirely clear to me what we learn, that sheds light on overall productivity performance, from an analysis of the firms that happen to be here now. The firm level data, for example, suggest that the labour productivity performance of our leading firms is perhaps 30 per cent below that of advanced country peers.  But that is, surely, just what we would expect.  GDP per capita is –  roughly –  30 per cent below that in many other advanced countries, and firms (and workers) will adjust so that, at the margin, resources earn their marginal product.  Production structures will, typically, look different in poorer countries than in richer ones.

And so one of my criticisms of the Conway/NZPC paper is that while it is strong on highlighting symptoms, it is much weaker on analysing and understanding incentives (eg the reasons why firms, and governments, behave as they do).  There is a tendency in the firm-level literature to treat firms as the cause of the problems –  firms don’t invest enough in R&D, aren’t very good at management or what ever –  without taking as a prior (perhaps to be tested) that individual firms and the people within them typically make decisions that appear rational, and indeed (on average) optimal for themselves.  There is sometimes a sense that if only firms were as smart as the researchers studying them, the problems would be solved.  The Conway paper largely avoids that tone, but it is still weak on the incentives/opportunities issue.    If, as one study suggests, New Zealand firms’ management capabilities really are weak –  on some measure –  why has that happened?  What makes it rational for firms to ‘under-invest” in such capability?  Is it, perhaps, that what counts as high level capability in these surveys is, in fact, more of a luxury consumption product, that tends to accompany –  rather than independently cause –  economic success?  I’ve previously posed similar questions about R&D.   My own story –  unproven – tends to be that firms would be likely to invest more in (genuine, not just classified for tax purposes) R&D, if the overall business environment (expected returns) were less unfavourable.  Similarly, business investment in New Zealand (especially that in the tradables sector) probably isn’t low because businesses are badly run, or because business people are failing in some duty to their country, but because the expected risk-adjusted returns to much higher levels of investment just haven’t been there.

Another concern about the paper is that, for all the interesting paragraphs (and charts), I still came away from it uncertain quite how the author (or the Commission) would summarise the story.  For example, as between the various firm-level “failures” and the big picture macro environment issues,  there is no overall summary that gives me a good sense of which issues they think were really important, and which are rather less so, in explaining how we got to the poor outcomes we have today.  The same is true of the way ahead: what initiatives have the potential to make a real and substantial difference and which, while perhaps nice to have, probably don’t matter that much.   I suspect there is still a tension in the author’s own mind.  His own micro-orientation comes through strongly in the final paragraph of the whole paper.

The broad policy considerations for lifting productivity offered in the paper highlight the importance of regulation that promotes knowledge diffusion into and throughout the economy and increased competition to improve resource allocation. Synergistic investment in skills, innovation and organisational know-how (including managerial capability) and other forms of KBC [knowledge-based capital] are also important. Flexibility, openness and receptiveness to new technology are also key and carry important implications across a range of policy areas.

This is a quite different tone than comes through at the start of the document (Foreword, Key Points, and Introduction).  But more importantly, it has a strong whiff of “more of the same”, even though Conway reproduces the OECD’s chart that suggests that on a standard OECD set of micro-structural policies, New Zealand should already be much richer and more productive than it is.     And it doesn’t really engage at all with the sense in the second half of the paper (which I think the author comes to perhaps rather late and a little grudgingly, or which he perhaps just struggles to fit with his firm-based focus) that macroeconomic conditions –  whatever has caused persistently high real interest rates in particular –  may, in fact, be a material part of the overall story of why the economy has systematically skewed away from growth in the tradables sector, and why it has managed such weak overall productivity growth for such a long time.

In fact, Conway comes a long way towards the view I have been espousing in recent years that the best explanation for persistently high real interest rates (relative to those abroad), which best fits other relevant stylised facts such as the persistently strong exchange rate, is a series of (insufficiently recognised/understood) demand shocks (see discussion on pages 39 and 40).  He also recognises the likely connection between these persistently, and unexpectedly, high real interest rates and the way in which the real exchange rate has stayed high, even though productivity differentials have suggested that we should have seen a material depreciation in the real exchange rate.   Nonetheless, when it comes to discussing the overall economic performance, and particularly the policy path forward, the real exchange rate tends to get only passing mention.  By contrast, I think it is likely to be central to the story.  It is a key part of the business environment that firms considering establishing or investing here have to take into account, and over which they have no control.

For my money, Conway also underemphasis the importance of New Zealand’s extreme geographic isolation.  He notes OECD research that suggests distance represents perhaps a 10 per cent penalty on New Zealand’s GDP per capita, and recognises that –  in some ways counterintuitively –  distance may, if anything, be more of problem/constraint now, especially in knowledge-based industries, than it was in decades gone by.  But I suspect he doesn’t take the issue sufficiently seriously.  On my reading of the paper, most of it would be almost exactly the same if New Zealand was conveniently located in the Bay of Biscay, rather than in a remote corner of the South Pacific, distant from markets, suppliers, key networks etc.  The continuing natural resource base of the overwhelming bulk of our exports doesn’t get a mention either, even though it might raise questions about whether New Zealand is a natural place to put ever more people –  ever more people exposed to the “tax” of distance –  if we hope to generate top tier first world living standards for New Zealanders.

Perhaps somewhat relatedly, there is a lot of discussion in various places of the potential challenges, including for individual firms, that being a small country –  a quite different point from being a distant one –  might involve.  Small domestic markets, and the inevitable limits on the amount of competition in, eg, domestic services markets are real factors facing people considering investing here.  And yet, it was puzzling that throughout the paper there were very few systematic comparisons across small advanced economies.  After all, evidence tends to suggests that small countries have not, in fact, achieved less productivity growth than large ones.  And it is a well-known stylised fact that small countries engage in much more international trade (exports and imports) than large ones do.  Thus, while a firm in a small country might face the “need” to move into exporting earlier than a peer in Japan or the USA might, and face hurdles in doing so, actually the evidence suggests that they do it, and do so in ways that, taken together, generate high incomes and high levels productivity for their home nations.  On my read, being a distant country is a problem –  and one we can do nothing to change –  but being a small country isn’t.  Keeping on trying to become a slightly bigger, still very distant, country doesn’t look like a path to success.  If, in fact, it is, the case isn’t made in the Conway/NZPC paper.

In fact, on that score, I was pleasantly surprised by where the author has got to on immigration policy.   My impression is that his bias, and that of the Commission, would naturally tend towards favouring non-citizen immigration –  it is, after all, fairly standard OECD orthodoxy.  But, as I have consistently argued, the issue has never been a high-level issues of first principles –  at some times and in some places, immigration may benefit all those involved, movers and natives – but one that requires a specific assessment in the New Zealand context.

But as Conway notes

It is difficult to conclusively assess the impacts of migration on the economy.

On the demand side

More broadly, and as discussed in Section 4, Reddell (2013) argues that demand-side pressures driven by strong migration inflows are part of the reason for high real interest and exchange rates in the economy, which supress investment and encourage resources into the low-productivity non-tradables part of the economy.


On the supply side, migration may generate small productivity increases via agglomeration.

Note the “may” and “small”


A supply of high-skilled migrants may also lift productivity in other ways, including improvements in the skill composition of the labour market, diversity effects and knowledge transfer.

And while they note that, relative to other OECD countries, our immigrants aren’t that lowly-skilled, the picture isn’t all rosy either

Recent evidence from the OECD’s Survey of Adult Skills shows that the skill level of the total overseas-born population in New Zealand is higher than for the overseas-born population of any other OECD country (Figure 5.8). This indicates that the migration system has done comparatively well at attracting high-skilled migrants. However, migrant skills are still lower than the skills of the New Zealand-born population, suggesting that migration inflows may be part of the reason for small decreases in the average quality of workers outlined in Section 3.

(Note that, as I have written about previously, the same OECD survey shows that our native workers are among the most highly-skilled in the OECD.)

Before concluding

Although up-to-date research on the impact of migration on employment and wages is lacking, it is possible that recent inflows of low-skilled migrants have restricted wage growth and the employment of low-skilled New Zealanders. In turn, this would encourage a reliance on cheap labour by some firms and industries. In conjunction with any macroeconomic effects on real interest and exchange rates, this may suppress investment and productivity improvements, and work against efforts to increase the employment of lower-skilled New Zealanders.

The Government’s objectives around migration for labour market purposes should be clearly focused on improving the skill composition of the workforce to improve international connection and the flow of new technology into the economy. New Zealand is currently a very attractive destination internationally and policy needs to use that advantage to target very highly skilled and well-connected migrants. Any reduction in the total number of migrants coming to New Zealand as a result of this sharper focus may help address New Zealand’s macro imbalances outlined in Section 4.

I couldn’t really disagree  (but anyone who read only the Key Points or the Conclusion wouldn’t have sensed that there might be an issue in this area).

One last substantial issue also relates to labour.  For a couple of decades now, at least since the labour market liberalisation in the early 1990s, there has been a story put around that perhaps our labour productivity growth (and MFP?) was lagging because we had put in place highly flexible labour markets which were able to absorb many people (typically lower productivity people) who would simply miss out on jobs in many other countries.  If so, society as a whole might be better off, even if measured average productivity was a bit lower than it might otherwise be.  There is quite a bit of that sort of flavour in the Conway/NZPC paper.  Indeed, it even pops up in the call-to-action Conclusion of the entire paper.

The paper argues that New Zealand needs to shift from a development model based on increasing hours worked per capita to one in which productivity growth plays a more important role in driving growth in GDP and incomes per capita.

It is certainly true that average hours worked per capita are higher than in the median OECD country.  And employment as a share of the adult population is higher here than in the median OECD country too.  But that was true decades ago too.  Our HLFS data only go back to 1986, but that isn’t such a bad starting point –  it was before the bulk of the reforms of the late 80s and early 90s had taken effect, and before the very large, but temporary, disinflation and structural change increase in the unemployment rate occurred.    In fact, New Zealand’s unemployment rate in 1986 (4.2 per cent) wasn’t much lower than the current unemployment rate.

But how do we compare against OECD countries?


Our employment rate has increased slightly over the 29 years to 2015, but  the median employment rate in other OECD countries has increased a little more than that in New Zealand.  Increased labour participation/employment rates cannot be part of the explanation for why over that same period we have continued to lose ground against other advanced countries, whether one looks at GDP per hour worked or at total factor productivity.    And while it is hypothetically possible that the high level of the employment rate might be depressing the level of productivity, it is worth remembering that the three OECD countries with higher employment rates than New Zealand (Iceland, Sweden, Switzerland) also have higher GDP per capita and GDP per hour worked than New Zealand does.

There are plenty of other aspects of the paper I could write about, and I could touch on some of those here in more depth.  One or two I might come back to next week.  But to close, I would note that I was struck by this line from the final paragraph

With low productivity so entrenched in New Zealand, lifting this presents a monumental challenge for policymakers, business owners and workers.

Unlike most of the rest of the paper, it presents business owners and workers as part of the problem.  But I don’t think the paper offers any evidence to that effect.  Instead, we should generally assume that business owners and workers respond rationally to incentives, and to the climate they face.    Governments shape so much of that climate.    On my telling, governments have (perhaps unintentionally) consistently skewed the economy away from paths that could have allowed much better productivity and GDP per capita outcomes.

The issues are important and the paper is a valuable contribution.  I encourage people to read it, and hope it stimulates some more debate on how New Zealand might best, in the paper’s closing words, achieve its productivity potential.


Thoughts prompted by Cuba

Fidel Castro is dead.  Sadly, the same can’t be said for the brutal regime that has controlled Cuba for 57 years now –  the regime that suppresses speech, religion, and the exercise of democratic freedoms that we take for granted; the regime that executed thousands of its political opponents and which, to this day, imprisons many of those brave enough to stand against it; the regime that suppresses free economic activity; the regime that actively tries to stop its own people leaving.  There have been plenty of awful Latin American regimes in the last 100 years or so, but fortunately most of the worst have now passed into history.  But not the Cuban regime.  I won’t rejoice in anyone’s death, but consider what type of man this was:  Fidel Castro had enthused about the idea of a nuclear attack on the United States, and had to be put in his place, in no uncertain terms, by Khrushchev.

Last week I happened to be reading Stephen Ambrose’s history of the Eisenhower presidency –  the last non-politician to become President of the United States.  Never having read that much about Cuba, I was surprised to learn that US government agencies –  and this at the height of the Cold War –  were genuinely uncertain what to make of Castro at first, were reluctant to conclude that he was a communist, and (in parts of the government at least) were initially reluctant to see him toppled, for fear that others, notably his brother (the current President of Cuba) would be worse.

But this blog is mostly about things economic.  I knew that pre-Castro Cuba had been a reasonably prosperous place by Latin American standards.  The southern countries (Chile, Argentina and Uruguay) were richer, and so was oil-abundant Venezuela.  But Cuba in the 1950s is estimated to have had real GDP per capita higher than, for example, that in Bolivia, Brazil, Paraguay, Honduras, El Salvador and Ecuador.    Most Cubans –  including Castro –  were descendants of Spanish migrants, and in the mid to late 1950s, real GDP per capita in Cuba is estimated to have been around 75 per cent of that in Spain.

What has happened since then?  Like all countries, Cuba has had its relatively good and relatively bad periods –  the latter, notably, after the fall of the Soviet Union.  And data sources for such a controlled economy aren’t that abundant, or probably that reliable.  However, Angus Maddison’s international database does have real GDP per capita estimates (all on a PPP basis) for Cuba from 1929 through to 2008 (the successor Conference Board database doesn’t include Cuba).

Here are estimates comparing real GDP per capita estimates for Cuba with those for other various other countries/groupings.  Here I’ve shown averages for (a) the thirty years prior to the Castro takeover, (b) the 1950s immediately prior to the takover, and (c) the forty years from 1968 to 2008.   And I’ve shown comparisons between Cuba and the United States, Spain, and New Zealand and also those with Maddison’s Western Europe measure and his measure for the eight largest Latin American countries for which there is annual data all the way back to 1929.     Using these averages masks the shorter-term volatility, but in looking at the Castro period the picture wouldn’t be much different if, say, I’d used just the 2008 observation rather than the 40 year average.  The big decline in Cuba’s economic fortunes took place in the 10 years after Castro’s revolution.


Against all these countries/groupings, Cuba’s performance in the Castro period has been worse than it was previously –  dramatically so when compared to the Latin American grouping, Western Europe, or to Spain, the former colonial power.

Having said that, I was a little surprised that the deterioration had not been even more marked.  If the numbers are roughly reliable –  and that is a significant caveat – then in 2008, Cuba’s real GDP per capita was still higher than those in El Salvador, Honduras, Nicaragua, and Paraguay.

Looking around for something a little more up-to-date, I found the World Bank had data showing PPP-adjusted current price per capita GDP estimates for the period 1990 to the present.  In Cuba’s case, “the present” only being up to 2013.

This is how Cuba has done relative to New Zealand over that period.  I’ve just set both countries’ GDP per capita equal to 100 in 1990 and so shown the relative growth since then.

cuba 2.png

It is a little depressing.  1990 was just before the collapse of the Soviet Union, and you see the subsequent sharp fall in Cuba’s performance in the early 1990s.  But over the entire 23 years, on this measure, there has been no change in New Zealand’s performance relative to that of Cuba.

(Here is a link to a post that puts Cuba’s economic performance in a rather more gloomy overall light.  I think it is a little unfair to compare any country’s performance to world GDP over recent decades, given that China is a significant chunk of the world and China had –  and has – so much ground it had to make up after the self-destruction over much of the 20th century.)

Of course, one of the other salient features of Cuba’s experience since Castro took power was the emigration to the United States.  Cuba’s population in 1958 was around 6.8 million.  Current estimates are that the Cuban-American population is around 1.2 million.  That outflow –  which would, presumably have been much larger if the Cuban government had not put tight exit controls in place –  was large enough that Cuba’s population growth in the 50 years after the revolution was the second lowest of all the Latin American countries Maddison reports data for (only Uruguay –  with its own large scale emigration-  had a lower rate of population growth in that period).

New Zealand is, of course, another country that has experienced a large scale net emigration of our own citizens.   Since 1958, it is estimated that 975000 New Zealand citizens (net) have left New Zealand permanently (and in 1958 our population was only 2.3 million).

I don’t want to make much of the Cuba/New Zealand comparisons. They can be crass, and risk trivialising the appalling oppression, persecution, and suffering of the people of Cuba, many of whom had –  and have – no way of escape.  And I’m not sure I believe the Cuban GDP numbers anyway –  and I see Tyler Cowen also highlights that issue.

But, equally, it is too easy to come to simply take for granted the massive outflows of our own people over recent decades, and the disappointingly poor relative economic performance.  Freedom is a great blessing, as is democratic choice (and legitimate exit options likewise), but our democracy –  and decades of chosen leaders –  has kept on failing our people.  We really should have been able to do a great deal better.

UPDATE: Various people have commented on the possible achievements of the Castro regime, especially in literacy and health.  Tyler Cowen had a link to this post, which I found useful in making sense of the merits of the case in that area.

What Wellington house prices have come to

A real estate agent yesterday sent me a PDF showing all the recent house sales in southern and eastern Wellington.

This one caught my eye

rintoul st.png

It is tiny, by almost any New Zealand standards.

It caught my eye because it is almost over the road from the school one of my daughters goes to, and because a fellow parishoner had spent her adult life in the almost identically small next door house.

Not only is the house tiny, but the section is pretty small by any standards.  No great redevelopment opportunities, unless (I suppose) someone managed to buy up the whole row of tiny houses.

Berhampore isn’t such a bad location I suppose.  It is an easy walk to the hospital or to Massey’s Wellington campus.  And I guess one could walk to work in town. The distance from this house to, say, Unity Books in Willis St is about the same as the distance from the Mt Eden shops to the Auckland Unity Books in High St.   But…….Berhampore is not Mt Eden.  It is slowly rejuvenating, and is apparently very popular among Green Party voters, but it will always have small houses, tiny sections, and rather a lot of council/state housing (oh, and the Satan’s Slaves are almost over the back fence).

And yet this tiny property went for $633,500.

Out of curiosity I checked out the real price I paid for my first house in 1989.  It was another couple of kilometres out of town, but the house was bigger, it was a couple of blocks from the beach, and the section was about three times the size of the Berhampore one.  In 2016 dollars, that house cost me $282000.

People in central and local government –  ministers, mayors, councillors, relevant officials – should really be hanging their heads in shame, at having so badly messed up housing and land supply markets to have produced such an atrocious situation.  Sadly, shame now seems like a foreign concept to those who do so much (always well-intentioned, but good intentions are never enough) damage to the prospects, and reasonable expectations, of our younger generations.

The Treasury on Auckland and immigration

The Treasury yesterday released its latest Long-Term Fiscal Statement.  These documents, in some form or other, are now required under the Public Finance Act to be published at least every four years.  I was once a fan, but I’ve become progressively more sceptical about their value.  There is a requirement to focus at least 40 years ahead, which sounds very prudent and responsible.    But, in fact, it doesn’t take much analysis to realise that (a) permanently increasing the share of government expenditure without increasing commensurately government revenue will, over time, run government finances into trouble, and (b) that offering a flat universal pension payment to an ever-increasing share of the population is a good example of a policy that increases the share of government expenditure in GDP.  We all know that.  Even politicians know that.  And although Treasury often produces an interesting range of background analysis, there really isn’t much more to it than that.  Changes in productivity growth rate assumptions don’t matter much (long-term fiscally) and nor do changes in immigration assumptions.  What matters is permanent (well, long-term) spending and revenue choices.     And from a purely technocratic perspective – and Treasury are supposed to be technocrats, not politicians – the headline out of yesterday’s release should probably really be “there is no great urgency about doing anything much over the next 20 years”.  In this chart, from the report,  in 2035 spending as a share of GDP, on historical patterns and existing laws, is only around where it was in 2010.   ltfs

John Key –  the Prime Minister who refuses to do anything about NZS – almost certainly won’t be in office that long.

There were several interesting background papers Treasury released yesterday.  If I get time over the next few weeks, I might write about some of them here.  For now though, I simply wanted to highlight some interesting material in the main report on a couple of my favourite topics: Auckland’s economic (under)performance, and immigration policy.   I’m not entirely sure why either section was included in the report –  which is about fiscal projections – but there they are.

First, Auckland.  Here there are some encouraging signs that Treasury is finally recognising the problem.  A few months ago I was quite critical of a cheerleading speech about Auckland given by the Secretary to the Treasury.  And in the LTFS, the text starts off quite upbeat

akld text.png

I was drumming my fingers at this point, but then I got to the second half of the paragraph.


There was much more that could have been said, but for Treasury to acknowledge quite openly –  the plain statistical fact –  that Auckland incomes have been falling relative to those in the rest of the country, despite the huge infusion of additional people (“most skilled migrants anywhere in the OECD” as I heard Steven Joyce say again this morning) should be seen as pretty damning.  There is something very wrong with the model: as they add “this suggests we are not seeing the agglomeration effects we would expect from Auckland’s size and scale”.  Perhaps there is no guarantee –  or even reason to think –  that putting an extra million people or so (the increase in Auckland’s population in the last 50 years or so)  in a remote corner of the South Pacific would generate particularly favourable productivity results.

As I’ve noted previously, not only is Auckland’s GDP per capita less high relative to the rest of the country than it was even 15 years ago –  the point Treasury now acknowledges –  but that margin is small compared to what we see in other countries.  I ran this chart, looking at other large cities, in a post a few months ago.

gdp pc cross EU city margins

Auckland does poorly.  To me, that isn’t surprising.  This is a strongly natural resource based economy.  There is no sign –  and no sign Treasury points to –  that it has needed lots more people, and especially not in Auckland.

But Treasury, while clearly a bit troubled, isn’t willing to abandon the faith just yet.  The section on Auckland goes on.   There are a couple of anodyne paragraphs on Auckland as gateway (people and goods), and Auckland’s transport system,  and then we are right back to credal statements.


Perhaps diversity does bring advantages, but in the specific case of Auckland, there is just no evidence of solid economic gains.  As Treasury notes, Auckland has a fast-growing population, a young population, a culturally diverse popuation, and a very high proportion of people born overseas.   But it has a disappointingly poor-  and worsening –  relative economic performance.  In my hard copy of the report I had scrawled next to the comment about London “just a shame, we don’t have their GDP performance”.  In the chart above, you can see the contrast between London and Auckland.    We really should expect more than faith-based claims from the government’s premier economic advisory agency.  As Treasury knows, for example, there is no evidence of a causal relationship between immigtration to New Zealand and growth in innovation, productivity or exports.

(For those interested in the Auckland underperformance issues, the October issue of North and South magazine had a nice article on  The Delusions of Aucklanders (and perhaps those advising governments). The article is now available on the new Bauer Media website, Noted.)

Some pages on from the Auckland discussion, Treasury has a page on immigration.  It also starts off with a strongly credal tone –  keep the faith.


After finishing guffawing at the rather desperate “Auckland as a city of global significance” –  had the 9th floor of the Beehive requested that touch, or did they not need to ask? – we might simply ask for some evidence.  You might think it would trouble Treasury, even a little, that with one of the largest immigration programmes in the world –  of people who, by world standards, are not that badly skilled –  we’ve had 25 years of one of the lowest rates of productivity growth in the world.  Even Treasury acknowledges that failure.  Perhaps there isn’t a causal relationship.  Perhaps the productivity performance would have been even worse without the immigration.  But not a hint of doubt is allowed into this discussion from our premier economic agency.

But then the drafting gets a little more cagey.

akld 5.png

Note very carefully the “can”.  Yes, in principle, a good immigration policy can support productivity etc in the right places/circumstances.  But Treasury can, and does, advance no evidence that it has, in fact, done so in New Zealand.   They really want the public to believe in the programme, while being skilful enough drafters not to allow themselves to be pinned down to have made claims that the economic performance of New Zealanders is actually better as a result of the large scale immigration programme.   There is no hint of any evidence that using immigration policy in “addressing short-term skill shortages” makes any difference to longer-term per capita growth and productivity (and I’ve seen no literature on that point internationallly either).  And actually, Treasury’s own scenarios suggest that immigration also makes very little difference to the longer-term fiscal challenges.

They conclude, perhaps a little uneasily, reverting to rather more jargon-ridden text.


Be very wary of bureaucrats proposing “integrated system responses”, when markets have ways of dealing with issues.  Typically, when demand for additional labour and human capital is high, returns to that sort of labour rise, which attracts more people into those jobs, and to developing those skills.  “Skill shortages” –  or even “workforce planning” – just aren’t some sort of a chronic problem governments need to address.  Excess demand for labour is either a sign that monetary policy is a bit loose, or that wages (for that sector or industry, or across the board) should be rising.   And if Treasury –  or MBIE or ministers –  could produce strong evidence that our immigration policy really had boosted productivity and the material living standards of New Zealanders, that would be one thing.  But they can’t –  and don’t.   And don’t forget, that the same OECD survey Steven Joyce was citing again this morning shows that native New Zealanders already have some of the very highest skill levels in any OECD country.

Overall, I guess one gets a sense that Treasury is slowly losing confidence in bits of its story.  They now are prepared to acknowledge (at least part of) the sustained underperformance of Auckland.  They have raised some doubts about excess reliance of some industries on immigrants.  And they still can’t cite any real evidence of sustained gains in the living standards of New Zealanders from the large scale non-citizen immigration programme.  But rather than openly addressing the genuine uncertainty – and in what seems a slightly desperate attempt to keep spirits up, and encourage people to “keep with the programme”  – we are left with what are little more than slogans, simply asserting the alleged economic gains to New Zealanders from diversity and high rates of non-citizen immigration.  A reasonable response should be “well, show us the evidence”.

At the session Treasury hosted yesterday for the release of the LTFS, we were informed that the Productivity Commission is releasing next Monday its “narrative”, in which they will attempt to explain why the New Zealand economy has underperformed for so long, and (presumably) some thoughts on how best to reverse that.  I will look forward to that document –  there aren’t enough developed competing narratives around a really important issue – and I will no doubt be writing about it here.  Given the Productivity Commission’s statist tendencies, I’m not optimistic, but I will be particularly interested in how they deal with the immigration policy and Auckland issues, both in explaining the underperformance of the last few decades, and in contemplating a better way ahead.

Monetary policy leeway for the next recession

A chart of short-term nominal interest rates over the last thirty years looks something like this.


It looks dramatic for two reasons.  First, I’ve started the chart from almost the historic peak in New Zealand’s interest rates, and secondly because in the late 1980s inflation and inflation expextations were still quite high.  It wasn’t until around the end of 1991 that inflation got inside the then target range of 0 to 2 per cent annual inflation.

Here are the same two series adjusted for inflation expectations –  the Reserve Bank’s two year ahead measure, from a survey that began in the September quarter of 1987.


It is a less dramatic picture of course but –  as in most other countries –  the trend is pretty strong downwards.  In previous posts I’ve shown that over the last 25 years or so there has been no sign of New Zealand interest rates converging on those in other advanced countries.

For some purposes, thirty years just doesn’t provide that much data.  There might have been 10000 calendar days, but there have only been two or three big cycles in interest rates, and a few smaller ones.

What has troubled me for some time –  perhaps the more so as the years since the last recession have accumulated-   is what happens when the next recession comes.  We know that most advanced countries ran out of conventional monetary policy capacity in responding to the 2008/09 downturn.  That, almost certainly, slowed the recover in demand and activity in many of those countries (even recognising the underlying productivity growth slowdown that was already underway before that recession).

Back in 2009, this might not have looked like much of an issue for New Zealand.  After all, in 2009 the OCR troughed at 2.5 per cent and the time pretty much everyone –  market pricing included –  expected a fairly quick and substantial rebound.   Despite a couple of ill-fated policy attempts at a tightening cycle, it just never happened.  And years on now, inflation is still materially below the target midpoint, and the nominal OCR is even lower than it was then.

Views differ about the current position of the economy, but they are probably bounded quite tightly around an output gap estimate of zero.  I emphasise that the unemployment rate is still above the NAIRU, suggesting a modest (and unnecessary) negative output gap, and even the most optimistic forecasters/commentators don’t see much sign of a materially positive output gap.  There aren’t huge amounts of spare resources lying idle, but equally there isn’t massive overheating either.  For better or worse, we should probably be treating current interest rates as something like “normal”  – not perhaps in some very long-term sense, but certainly in terms of the sorts of macro conditions we’ve experienced in recent years.

And if interest rates are in some sense around normal/natural at current levels, we can’t prudently assume or plan on the basis that they are highly likely to rise from here (any time in the next few years).  They might, but it looks as though it would take some material new development for that to happen.  But it must be almost equally likely that the next material move is a fall.  This isn’t a debate about where the next 50 basis point move comes from –  reasonable people could probably differ over that range about where the OCR should be right now.  Instead, it is about the next multiple hundred basis point move will be.  They aren’t that uncommon –  we’ve had three in the last 30 years.

I think there is a tendency –  partly a recency error, partly the dramatic headlines of the times –  to think of the interest rate adjustments over 2008/09 as unusually large.  But they weren’t, especially not in New Zealand.  There were some very big individual OCR adjustments  –  twice in a row the OCR was cut by 150 basis points-  but in total they didn’t add up to much more than usual for a New Zealand downturn.  Retail interest rates fell by 400 to 500 basis points.    Over the short sample we have, that looks to be about the typical amplitude of New Zealand interest rate cycles.

Dramatic as the events of 2008/09 were internationally, when one looks at the New Zealand real economic data, 2008/09 simply doesn’t stand as an extraordinary downturn (although the subsequent weak recovery stands out more).  Here is a chart of annual average real GDP growth (using an average of the expenditure and production measures).

real gdp aapc.png

The recession wasn’t quite as deep as the 1991 episode (which came after several years of pretty sluggish growth and not much sign of a positive output gap), and the slowdown in the growth rate wasn’t much larger than the slowdown from around 1996 to 1998.

And here is a chart of the employment and unemployment rates.


Again, neither the change in the unemployment rate nor the change in the employment rate over 2008/09 particularly stand out.

It is a small sample of events, but on the basis of that limited sample, it looks as though we should be planning on the basis that in the next material downturn we’ll need to lower retail interest rates by 400 to 500 basis points.  And, we should be planning for the possibility that such a downturn happens before economic conditions warrant raising interest rates much, if at all, from current levels.

But 90 day bank bill rates today are around 2 per cent, and term deposit rates are a bit above 3 per cent.  The OCR itself is 1.75 per cent. There is a pretty clear consensus that, on current technologies and institutional practices, a rate like the OCR probably can’t be reduced below about -0.75 per cent –  if it was attempted large holders of short-term assets would find it more economic to convert those holdings into physical cash.  The Reserve Bank of New Zealand might have policy leeway of perhaps 2.5 percentage points, but they can’t safely assume they have leeway beyond that.  And among the scenarios they have to plan on is that in the next downturn there could be a renewed widening of the spread between retail and wholesale interest rates –  and it is retail rates that influence consumption and investment behaviour.

It is easy to say “oh, but we can just bring fiscal policy into play”.  But, on the one hand, the Reserve Bank has no control over fiscal policy, and can’t just assume that the political imperatives driving/constraining fiscal policy will neatly fit with the Bank’s stabilisation (inflation targeting objectives).  And, on the other, while New Zealand’s overall fiscal policy isn’t bad by international standards, it isn’t stellar either. The Crown balance sheet is in nowhere near as good shape as it was in 2008.  It can take a lot of fiscal stimulus to compensate for the absence of monetary leeway –  and of the numerous countries that deployed discretionary fiscal stimulus in 2008/09, I can’t think of any where it made a decisive difference (we can debate Australia).  And, relative to the situation in 2008, we’ve since been starkly reminded over the last few years how (physically and financially) vulnerable to earthquakes New Zealand is, reinforcing the case for fiscal prudence (eg a positive net assets position as the norm).

In the next big downturn, there might be some scope for discretionary fiscal policy support (beyond the relatively weak –  in New Zealand –  automatic stabilisers) but no one –  and certainly not the Reserve Bank –  should be counting on it much.

The other reason to be uneasy is that the limited policy leeway is no secret.  In typical downturns inflation and inflation expectations fall to some extent, but everyone recognises that the central bank will cut interest rates as much as necessary, to help support a recovery in demand, and keep inflation near target.  Countries as diverse as the US and NZ could cut by 500 basis points in 2008/09 and did, and everyone knew in advance they had that potential.

But if the next material downturn were to occur in the next couple of years –  and typical expansion phases in New Zealand haven’t last much longer than that – everyone will know that (abroad as well as here) central banks just don’t have that sort of leeway.  The Fed might be able to cut by 1.5 percentage points, and the RBA and the RBNZ by as much as 2.5 percentage points.  But that will be about it.  Rational agents –  firms, households, markets, will assume that inflation, and inflation expectations will fall further.  That will make it even harder to stabilise activity and inflation.

(I’m not going to spend a lot of time on QE, but outside extreme crisis conditions, I think it is fairly common ground that it would take a great deal of QE to compensate for even 100 basis points of conventional monetary policy leeway.)

This isn’t a trivial, or abstruse technical, issue.  At the heart of the case for discretionary monetary policy –  the model advanced countries have run with since the 1930s –  is the ability to adjust monetary conditions as much as it takes, to assist in stabilising the economy when it faces significant shocks.  In the next downturn, there is increasingly unlikely to be enough leeway.

That should be concerning the Minister of Finance, the Secretary to the Treasury, and the Reserve Bank –  not just in some idle handwringing sense, but commissioning work to respond to this threat.  Perhaps there are secret projects underway in the bowels of the Reserve Bank and Treasury, but this isn’t work that should be kept secret; rather, it should be part of an open and ongoing conversation to help reassure the public and markets that the authorities have the capacity to respond decisively if and when the next serious downturn happens.  There are solutions.

At the extreme, central bank physical currency could be withdrawn and completely replaced with electronic central bank liabilities, on which (say) negative interest rates could be paid.  But that would take legislation and considerable organisation, and would be an unnecessary over-reaction, while there is still a considerable revealed demand to transact (in the mainstream economy) in cash.  Better options might be to, say, cap the total issuance of Reserve Bank physical currency and allow an auction mechaism to set a variable exchange rate between physical and electronic Reserve Bank liabilities.  Banks themselves could be allowed to issue currency again –  on whatever terms they chose.  Or the Reserve Bank could simply put in place an administered premium price on access to new physical currency (eg a 2 per cent lump sum fee would be likely to introduce considerable additional conventional monetary policy leeway).  Each of these possibilities has potential pitfalls and possible legal issues. It would therefore be highly deisrable if an open consultative process was got underway, enabling a range of perspectives to be considered and debated in the cool light of day, rather than in the urgency of an unexpected recession.  If, in the end, it all proved too hard –  which I’d be reluctant to believe –  the case for an increase in the inflation target would be strengthened.  As the PTA needs to be renegotiated next year, now is the time to have this work underway. (And as the Reserve Bank has just given itself, somewhat unwisely, a three month holiday from reviewing the OCR –  the next review is not til February –  now would seem a particularly appropriate time to assign some joint Treasury and Reserve Bank resources to this work.)

What is particularly disconcerting is that there has been no hint that this is even considered an issue, whether in comments from the Minister, in speeches from the Secretary to the Treasury (including those commenting directly on monetary policy), in the Reserve Bank’s Statement of Intent, or in the increasingly rare speeches from the outgoing Governor.  We should expect more.

(And in case anyone thinks otherwise, this issue is not an argument against the OCR cuts of the last year or so.  Without them, inflation and inflation expectations would be likely to have fallen further, only increasingly the severity of the “lack of leeway” problem if a new recession were to strike a year or two down the track.  The best way to maximise the limited remaining leeway is to keep interest rates low enough now that inflation is at, or even slightly above, the midpoint of the target range.)

Another disheartening Makhlouf speech

I’ve written previously, and quite critically, about various speeches given by Gabs Maklouf, Secretary to the Treasury (including here, here, here, and here) .  I continue to be surprised that we have someone that poor as head of the government’s premier economic advisory body –  for that I guess we should blame Iain Rennie and the State Services Commission.  It was perhaps even more disappointing that Makhlouf was reappointed for a further term earlier this year –  for that both SSC and the Minister of Finance must surely be held responsible.  And, since I assume he does have some strengths even if economic and policy analysis is not among them, I remain surprised that he does (is allowed to do?) so many on-the-record speeches.    This year, for example, he has done many more public speeches than the Governor of the Reserve Bank, even though the Treasury’s prime role is to advise the government, while the Reserve Bank Governor has extensively discretionary policymaking powers affecting directly or indirectly a large proportion of New Zealanders.  In some other countries – Makhlouf’s native United Kingdom for example –  the Secretary to the Treasury is generally not seen or heard by the public.

There was another Makhlouf speech a couple of weeks ago, headed Growing our Economic Capital: Investing in Sustainable Improvement in our Wellbeing.

There is a lot in the speech I could comment on.  There is the notion that “we are in a new era of policy frameworks and I’m proud to say the Treasury’s Living Standards Framework is at the forefront of economic thinking” –  which would be laughable, if it were not that Makhlouf, head of the government’s principal economic advisory agency, appears to take this claim seriously.  Bryce Wilkinson of the New Zealand Initiative wrote an excellent critique of the Living Standards Framework here (pages 6 and 7) , and I’m not going to try to improve on that piece.

And there is the rank cheerleading – that probably went over okay in the Beehive – in Makhlouf’s opening description of the economy

The New Zealand economy has been performing well over the past 4 years, relative to both the potential growth rate of the economy (of around 2.7%), and to most advanced economies.  Over this period, our economic growth rate has averaged 2.8% while the average growth rate of OECD economies has been around 1.7%.

in which he goes on to suggest that the results are commendable, to be celebrated, and something to “feel good” about.   And yet there is not even a hint of the fact that:

And all this on the back of 15 years of no growth at all in per capita real output of the tradables sector.

Sure, things could have been worse, but there isn’t much to celebrate.  Makhouf included the unemployment rate is that list of good things, and yet his own department estimates that the NAIRU is now around 4 per cent, and the unemployment rate hasn’t been that low this decade.

Of course, I largely agree with Makhlouf that

We need to look as much to lifting the economy’s long-run average growth rate, one of the main sources of a sustainable increase in our collective wellbeing, as we do on worrying about whether the economy is operating at or close to its short term potential growth rate.

Indeed, one might think that the Treasury should put a lot more emphasis on how to lift long-term productivity growth.  The short-term stuff is mostly the Reserve Bank’s job.  And yet there is nothing at all in the speech, and nothing in anything else the Treasury has published, to suggest that the organisation has any real idea what it might take to reverse the staggering decades of relative economic decline in New Zealand.  Instead, the Living Standards Framework seems to function in part to distract attention from that failure: providing robust advice to governments on how to reverse long-term relative economic decline has become all too hard, so we’ll burble on instead about bureaucrats’ personal agendas for how society and government should be organised.   Hiding under that broad heading of “economic capital” that Makhlouf wants to build, for example, is “social capital (including culture)”.  It is far from clear that the Treasury has anything useful to say on building culture, or that the views of its staff have any greater merit than those of the first 1000 voters in the Auckland telephone directory.    That is what we have political processes for:  Midwest evangelicals and New York liberals (and their New Zealand counterparts) have quite different and conflicting visions of culture and society.

There is also the staggering hubris and faith in governments (officials I suspect more than the elected ones) that pervades the speech. And, on the other hand, signs of an agency that (at least at its head) has totally lost sight of how prosperous stable societies develop and maintain themselves.  I searched through the speech and the word “markets”, for example, appears only in reference to financial markets –  nothing at all about competitive processes, private sector innovations (products and institutions) and so on.   And, on the other hand, almost nothing on the limitations of knowledge that all of us face –  perhaps governments most of all.  Surely only a bureaucrat  –  and a not very introspective one at that – could say this

Government strives to take a system view.  A system approach underpins the direction the public service has been moving in following the Better Public Services report in 2011.  It reflects the fact that central government is well-positioned to observe and monitor the system dimensions that influence our collective wellbeing.  It also has system-level instruments that can help make a difference, some of which are about devolving power and using the energy of communities.

At the centre, technology enables us to collect and share information on what various communities are doing to improve their lives.  We also have the analytical capabilities to assess what works and does not, but we need to do the hard work of converting that potential into practical initiatives through appropriate investments in economic, environmental and social infrastructures.

The frightening thing is that he doesn’t seem chastened at all by the repeated failures, here and abroad, of well-intentioned government interventions in so many areas.  In a week when attention focuses on the inability of central government to effectively operate something as relatively basic (and close to a public good) as a tsunami warning system, it is a reminder that we are really owed much more humility from our senior public servants. Rather than imperial visions of reshaping society, or even just championing yet more “smart active” interventions that all too often prove to be anything but, in part because too rarely do the advisers take into account that humans design and run these systems, not angels, we’d be better with a Treasury constantly focused on what governments can’t do well.  Plenty of people criticise the 1980s and 1990s Treasury, but one thing the institution certainly knew then was that government failure was as pervasive as market failure, and that institutions had to be built on and around the limitations of flawed human beings.  At least at the top of the organisation, that conception now seems long lost.

I could go on –  I quite enjoy the occasional rant – but I wanted to focus specifically on some of Makhlouf’s comments about macroeconomic policy and financial regulation.  Bear in mind that he has no known background in either subject.

He starts with the 2008/09 international financial crisis.

For example, one of the main events of the last ten years has been the global financial crisis.  This was system failure par excellence.  It showed us that a combination of placing too much weight on the wrong indicators, guided by mis-specified models, could lead to disastrous policy decisions being made in many countries and outcomes affecting millions of lives.  These models ignored the critical role of financial markets and networks.  The policy prescriptions they led to misjudged how complex systems work.  They resulted in coordination and communication failures, among other things.

Which might sound impressive, but in fact there is much less there than meets the eye.  No one seriously thinks that the limitations of formal macroeconomic models –  typical models didn’t have an explicit financial sector –  explain the crisis that hit several countries in 2008/09.  Among other things, government agencies in countries that didn’t have domestic crises –  New Zealand, Australia, and Canada among them –  used exactly the same sorts of models.      Having said that, you might have thought this paragraph would give Makhlouf pause for thought –  if really smart people in governments around the world could get things so wrong (the British bureaucracy included, where Makhlouf held quite senior positions) what gives him confidence that things will turn out better next time?  Limitations of knowledge are frustrating, but profound.

Makhlouf looks to the future

People are still trying to understand the lessons from the GFC. One area of learning which has had international attention is the critical role of better coordination of fiscal, monetary, financial and broader macroeconomic policies in order for those policies – whether fiscal, monetary, financial and broader macroeconomic – to be implemented effectively when one of them faces constraints. It can be the difference between a well-conducted orchestra playing a symphony and ninety disorganised musicians creating a cacophony. This area has been a focus of the G20 and IMF since 2008.

Maybe, but it is difficult to spot much visible change in how macroeconomic policy is conducted, or in how macroeconomic policy institutions are designed and organised.

What of New Zealand?

I should emphasise that New Zealand was one of the countries that coordinated fiscal and monetary policy effectively over the course of the GFC.  Fiscal policy supported monetary policy through the crisis by being stimulatory when needed and then contractionary once the economy was recovering.  But that doesn’t give us an excuse to cut class when experience delivers useful lessons and poses questions, including on policy coordination. And we should also make sure we learn the lessons of putting too much weight on simplified economic models.

Makhlouf wasn’t in New Zealand during that 2008/09 period.  Perhaps that explains what is simply a mistaken description of how things worked here.  In fact, New Zealand was one of the few advanced economies where there was no discretionary fiscal stimulus undertaken during the recession.  On the assumption that the good times would last, and on explicit Treasury advice to that effect, the previous Labour government had been putting in place quite expansionary fiscal policies anyway, and by chance some of those measures were still taking effect when the recession hit, but there was no coordination on those matters across The Terrace.  In my observation, the two agencies (the Reserve Bank on the one hand, and Treasury/Minister) got on well enough –  and worked closely together on specific interventions like the guarantee schemes –  but there was no fiscal/monetary policy coordination.  Rather fiscal policy had set its medium-term course, and monetary policy took that into account in setting and adjusting the OCR with the aim of meeting thre inflation target.  The system worked as it should –  and it helped that New Zealand interest rates didn’t get to zero  –  but that isn’t the sort of thing people have in mind when they talk about policy coordination.

And –  minor cosmetic changes aside – the legislation fiscal and monetary policy operate under today is the same as it was in 2008/09. If Makhlouf thinks something different is needed, he should tell us –  and advise the Minister accordingly.

Makhlouf seems to favour change or –  perhaps –  just wants to sound as though things are different now.

Building on what I said earlier, my first example relates to the coordination of monetary, financial (including prudential) and fiscal policies towards not only keeping the economy operating close to its current growth potential, but doing so in a way that does not cause harm to the growth potential of the economy. Indeed it can enhance it.

International experience over the past 10 years and maybe more casts increasing doubts about the effectiveness and efficiency of monetary policy alone in managing the economy’s performance relative to its current growth potential when it is adjusting to a large structural shock.  In fact, relying on monetary policy alone to do that job risks the longer term growth potential of the economy as well, by leading to the misallocation of resources towards investments such as residential investment that are comparatively less productive in terms of generating wealth and well-paid jobs.

It is certainly true that to the extent that some hubristic economists came to believe (consciously or otherwise) that serious recessions were now a thing of the past, they were simply wrong.  And, of course, plenty of people are asking questions about whether there are better ways of running policy in relevant areas –  although doing that well surely depends on a clear and compelling explanation for the 2008/09 recession and aftermath (without it, policy change risks being as unrelated to the causes of the problem as many of the post-Depression policy changes in the 1930s, here and abroad, were).

But if people are asking questions, what is surely striking is how little institutional change there has been in the years since that severe recession.  As the Governor of the Reserve Bank often, and rightly, points out, no country has even switched from inflation targeting to some other nominal anchor.  No country I’m aware of has made any material changes to institutionalise the coordination of fiscal and monetary policy.  And although various countries –  including New Zealand –  have been making a bit more use of direct controls of bits of the financial system, it is hardly some integrated coordinated approach to policy –  if anything, it looks a lot more like assigning a new tool to a new target.  Some argue at present for tighter monetary policy in various countries even though inflation is low, in the belief that doing so would assist longer-term financial stability and growth prospects.  But it doesn’t seem to be an approach that governments (or central banks) are signing on to.  Of course people are dissastisfied with the economic outcomes globally over the last decade, but there isn’t any sign yet that greater macro policy coordination within countries is a material part of the answer.

I’m not sure what Makhlouf really thinks about inflation targeting.  He has been on record suggesting that he doesn’t think major change in the PTA is warranted next year.  But then it seems strange for the Secretary to the Treasury to be undermining a macroeconomic policy framework that has worked quite well for New Zealand –  macro policy can’t solve long-term productivity problems, but we’ve avoided serious economic and financial crises for the 25 years of the current fiscal and monetary regime.  That is something to appreciate.

And before I leave that section of Makhlouf’s speech, he talks about the risk that inflation targeting (in isolation?) can  lead to “the misallocation of resources towards investments such as residential investment that are comparatively less productive in terms of generating wealth and well-paid jobs”.  Just two points in response: the first is that houses are to live in, not to generate “wealth and well-paid jobs”, and second, surely everyone now accepts that one of the biggest issues –  policy failures, but not macro policy –  in New Zealand (and Australia, the UK, Canada, and large chunks of the US) is that far too few houses were built, on land made artificially scarce by regulation.  We simply do not have a problem of over-investment in housing, however that concept is defined.    Surely the Secretary to the Treasury knows this?

I could go on but won’t –  tempting as his central planners’ approach to tourism is, for example.  The overall quality is just depressingly poor.  Lots of virtue-signalling, and little sign of really hard-headed analysis and engagement with the specifics of New Zealand, or the limitations of government.

In conclusion, Makhlouf observed

It’s about being prepared for the unknown unknowns. And I should add that part of this preparation is making sure our institutions are fit for at least the next 25, 30 or 40 years.

That sort of timeframe is probably unrealistic –  elections come by every three years after all –  and the deeper-seated institutions of our society and culture shouldn’t be lightly tampered with anyway.  But it is hard not to be concerned that our Treasury is not now fit for even the next decade. Even a centre-left government –  to whom things like the Living Standards Framework might be appealing –  should expect (and will probably need) something more rigorous than seems to be on offer at present.  Perhaps even more unsettling is that the weakness at the top of the Treasury don’t seem counterbalanced by strengths in any of the main economic policy or advisory agencies.


New Zealand and the Great Depression

It is a trifle unsettling to check out the Geonet pages, notice the large cluster of continuing aftershocks around “25kms east of Seddon”, and then to realise that looking out my window I can more or less see that spot.  It surprises me quite how much damage and disruption Wellington has already had despite being several hundred kilometres from Culverden and the site of Sunday night’s major quake.

US politics and a good book make worthwhile distractions.

I’ve just been reading The Broken Decade: Prosperity, Depression and Recovery in New Zealand 1928-39, by the local historian Malcolm McKinnon.  It is, as far as I’m aware, the first substantial scholarly history of the depression years in New Zealand.

The Great Depression was a tough time for many people in many countries, New Zealand not excluded.

Whereas for the UK, the fall in real per capita GDP wasn’t much larger than the experience in the 2008/09 recession (and the 1930s recovery was faster), in New Zealand real GDP per capita is estimated to have fallen by almost 20 per cent.

nz-great-depressionNo wonder there was a net migration outflow during the Depression –  small, by the standards of some we’ve seen since, but then the travel costs back to the UK were much greater than today’s three hour flight to Sydney, Brisbane or Melbourne.

What made it so tough for New Zealand?  We went into the Depression with staggeringly high levels of debt – high government debt (perhaps around 170 per cent of GDP just before the Depression), and a highly negative net international investment position.  Most of the external debt was owed by the government (central and local), and most government debt was external.  And within New Zealand there was a huge level of farm debt –  mostly not owed to banks (which didn’t do that sort of long-term finance) but to government agencies, non-banks, relatives, and to other individual private sector entities.  Many farmers bought their farm, and the seller (whether family or other) left mortgage funding in the farm to be paid off over the subsequent decades.

When export prices, and consumer prices, fell very sharply, the debt overhangs became much more pronounced.  In respect of the farm debt, wealth was reallocated among New Zealanders (lenders better off, borrowers worse off, at least if debt servicing was maintained).  In respect of the public debt, the servicing burden became much more difficult, and a larger proportion of New Zealand’s nominal GDP has to be devoted to servicing that debt.  Nominal GDP is estimated to have fallen by a third between 1929 and 1932 –  and export receipts fell 40 per cent.  The additional servicing burden was particularly severe on the foreign debt which still had to be serviced in sterling, as New Zealand’s own newly-emerging currency gradually depreciated against sterling.

The extent of the fall in activity in some cyclically-sensitive sectors was pretty stark: building permits issued for new houses and flats fell by almost 80 per cent.

But, no doubt as ever, it wasn’t all contraction and decline.  Electrical appliances were becoming ever more widely adopted, and with it electricity generation continued to expand right through the Depression years.


Perhaps even more striking was dairy sector production and exports.  Sheep numbers in 1935 were almost unchanged from the level in 1929, but the number of dairy cows in milk was 42 per cent higher than in 1929.  And here is total dairy production.


I’m not sure I understand quite what was going on in that sector: presumably some combination of new technology, the desperation that came from the high levels of debt hanging over these farmers, and low  direct marginal production costs (family labour) made it worthwhile to markedly increase cow numbers and overall milk production despite the low international prices for dairy products.

And substantial as the overall drop in real per capita income was, the fall was spread very unevenly across the population (as is no doubt the case in every recession).  Unemployment was high –  estimates vary, but even among adult males the unemployment rate probably peaked near 15 per cent (I’d give you 1991 comparisons if only the Statistics New Zealand website were not down in the earthquake aftermath). And there was a lot of resistance to wage cuts during the Depression, but for many of those who kept their jobs –  and especially those in salaried jobs, not affected by cuts in overtime hours – real purchasing power actually increased during the Depression.  My own grandfathers were in their mid-late 20s when the Depression began –  both were in work throughout, and both bought new houses in the early 1930s.  As McKinnon highlights, as much through his large selection of photos as from the text, “life went on”: society ladies graced race meetings, the All Blacks still played, and so on.

McKinnon’s book advertises itself as focused on the politics of the period, rather than the economics, and although there is a lot of economic-related material in the book, New Zealand is still lacking its first book-length economic history of the era (although of course it is treated to some extent in the few economic histories of New Zealand). Putting New Zealand’s experience systematically in cross-country comparative perspective (eg New Zealand, Australia, Canada, Ireland –  and perhaps Uruguay and Argentina –  and, say, the United States and the United Kingdom) would be fascinating.

It is a richly documented book, but with some gaps.  For a book avowedly focused on the political side, it was surprising that the author had made use of New Zealand official archives, but not those of the UK –  key export market, key source of finance in a stressed period, and of course key international relationship more generally.   And even locally, although the book covers the whole period 1928 to 1939, there is very little attention to developments on the right of politics after 1935, including the formation of the National Party.

In terms of policy responses to the Great Depression, my own sense is that the politicians did about the best they could.  With hindsight it was clear that a substantial currency deprecation would have been a helpful remedy –  perhaps the single most potent response New Zealand could have deployed in the face of a severe global downturn.  But in 1929 there still wasn’t a strong sense of New Zealand even having its own currency, let alone it being something that our government could control the value of.  As time went on, the option of a more structured devaluation became a centrepiece of the policy debate –  advocated by many economists –  but even then the dividing lines weren’t clear cut.  Export industries generally welcomed the idea, but workers and unions –  focused on the expected rise in the cost of imports – didn’t.  And for a government with a massive foreign debt, the additional servicing burden from a currency depreciation was a certainty, while the expected increase in tax revenue over time was no more than a hypothesis.  When the government finally acted in early 1933 to formally depreciate the exchange rate, it prompted the then Minister of Finance, William Downie Stewart, one of ablest figures then in politics, to resign in protest.  For several years afterwards, the devaluation remained a point of political contention (and even scholarly contention –  at the time the US academic Kindleberger, later famous, argued that our devaluation had largely just pushed down the international price of dairy products).

Of course, the standard Keynesian line is that countries should have used fiscal policy more aggressively to attempt to maintain demand through the Depression years.  Sadly, New Zealand was already debt constrained, and external debt markets were fragile at best.  Additional public spending (even if totally domestically financed) might have boosted demand, but it would also have put more pressure on the balance of payments (in a non floating exchange rate world).    A few years ago, in Paul Goldsmith’s book on the history of the New Zealand tax system, I stumbled on what should surely be the last word on the possibility of New Zealand borrowing and spending more back then, from Keynes himself.

Visiting London in late 1932 (after the worst of the disruption to the UK external capital markets was over), Minister of Finance Downie Stewart met Keynes.  Stewart recorded in his diary:

“I asked him if he would borrow if he was in New Zealand in order to get through the crisis.  He said, “Yes, certainly if I were you I would borrow if I could, but if you asked me as a lender I doubt whether I would lend to you.”

By that time, the fall in the price level had taken the level of government debt to well over 200 per cent of GDP.

The servicing burden of high levels of public debt was a major issue in many countries during the Depression.  In some cases, it led to direct defaults: Germany, for example, simply ceased paying reparations (and New Zealand, as a small recipient, was a loser from that).   The UK, and various other European countries, ended up defaulting on their war debts to the United States (the UK also suspended some of our war debts to them).  In other cases –  not just involving government to government debt – the approaches were more subtle, but they involved effective defaults nonetheless.  In the United States, for example, government bonds had typically been payable in gold.   The Roosevelt administration had those clauses revoked, and at much the same time went off gold, effectively depriving holders of a large proportion of their contracted returns.

In New Zealand (and Australia) there was a different approach again.  In respect of domestic government bonds, holders were simply forced to accept a lower interest rate on existing debt than they had contracted for  –  as part of the legislation, if they didn’t accept the exchange, they would face a punitive tax to achieve the same effect.  I wrote about that interesting episode in a Reserve Bank Bulletin article a few years ago.

What was interesting, in both countries, was the reluctance to do anything about the foreign debt (much the largest component of both countries’ public debts).  The unexpected fall in the price level, and in nominal incomes, had massively increased the burden of the debt.  But both countries still needed access to those funding markets, to rollover maturities at very least.  Neither country defaulted on central government external debt, focusing instead on the goal (about which they could do nothing much directly) of raising the world price level, so as to lower the effective servicing burden.  That finally happened, although in New Zealand’s case market unease about New Zealand’s external debt remained a serious concern –  much more so than anything in the last 30 years –  right down to the outbreak of the war.  Had it not been for the war, external default might well have happened in 1939/40.

This has been a fairly discursive post.  There are a lot of other aspect of the Depression in New Zealand I could write about –  especially the handling of distressed farm debt –  but I’ll save those for another day.  For anyone interested in New Zealand’s experience of the Depression, I’d recommend McKinnon’s book.  It is a sobering remind of an event that still shapes perceptions, and where –  among the now very old –  memories are still often seared by the experience.  Never again, people hoped for decades.  And then there was 21st century Greece.

Still reluctant to lower interest rates

I was a little late to the Monetary Policy Statement. The actual OCR cut yesterday was very well foreshadowed, and I wasn’t expecting much else.  And in fact there weren’t many surprises in the document.  But that is shame, because the Reserve Bank still seems trapped in much the same mindset that has delivered inflation below the midpoint of the target range (the explicit required focus of policy since 2012) for the last five years or so.  And it isn’t just headline inflation –  thrown around by petrol prices, tobacco taxes, ACC levies etc –  but whichever one or more core inflation measures one cares to focus on.  At present, the median of half a dozen core inflation measures is around 1.2 per cent.

And despite the rather self-congratulatory tone of the document, and particularly of yesterday’s press conference with the Governor and Assistant Governor, even on the Bank’s latest projections it is still another two years until inflation is expected to be back around 2 per cent.  And, of course, we’ve heard that line before, repeatedly.  As everyone knows, a lot can happen in two years, and it is most unlikely that things will unfold as the Bank (or any other forecaster expects) but there is nothing –  not a word, sentence, or paragraph –  in the latest MPS to explain why it is more likely today that inflation will now track back to settle around 2 per cent than it has been for the last five years.   Why should we be comfortable that the Bank has it right this time?

The Governor continues to repeat the line favoured by the government, emphasising recent annual GDP growth of around 3.5 per cent.  He does so in a way that suggests that all is pretty rosy, and my goodness if we were to do anything more there would be real risks of nasty overheating and intense volatility.  But like the government, the Governor rarely bothers to mention per capita growth.  Here is the chart of annual average growth in real per capita GDP (using the average of expenditure and production GDP).


At its brief best, several years ago, real per capita GDP growth never got anywhere near the rates of previous recoveries.  At something around 1 per cent now (1.5 per cent of an apc basis) it not anything to be encouraged by.  Sure, some of the weaker growth reflects the deteriorating productivity growth trend –  which the Governor can’t do much about –  but not all of it by any means.  With 2 per cent population growth, we probably should be getting a bit uneasy if over GDP growth were at 6 per cent –  and the unemployment rate was falling quickly below the NAIRU –  but that just isn’t the way things have been in New Zealand in the Wheeler years.  And the disconcerting thing is the Graeme seems to think that is a good thing.  Monetary policy could have done more, but consistently and consciously chooses not to do so.

Instead he repeats, over and over again, the point that tradables inflation has been negative for several years, making his life oh so hard (hard to get overall inflation back to 2 per cent).  From a New Zealand consumer’s perspective, low tradables is a good thing.  And from a New Zealand producers’ perspective it is typically should be quite a good thing as well.  Persistently weak tradables inflation creates room for the Reserve Bank to cut New Zealand interest rates further, in turn lowering the exchange rate (relative to the counterfactual).  A lower exchange rate would raise tradables inflation a bit, but also increase domestic economic activity and raise returns to our own tradables sector producers.    The headline inflation rate would rise as, over time, would core measures.

It is one of aspects of Graeme Wheeler’s stewardship that I don’t purport to adequately understand.  In almost every statement he repeats the plaintive line “a decline in the exchange rate is needed” but isn’t willing to do much about the one thing in his control that really makes some difference: lowering interest rates.

You might think that is a little unfair.  After all, the OCR has been cut by 175 basis points in the last 16 months.  But then it was unnecessarily raised  by 100 basis points over 2014.  Overall, the nominal policy interest rate has fallen over the last three years, but once one takes account of the fall in inflation expectations, there has been hardly any fall in the real OCR at all.  And that despite three more years of inflation persistently undershooting the target (and three more years of an unemployment rate above the NAIRU).

And they aren’t even providing much to boost domestic demand and activity.  The Bank ran this chart in yesterday’s MPS


It isn’t that easy to read, but just focus on the top and bottom lines. The top line is an estimate of the weighted average cost of new bank funding (retail, wholesale, onshore, offshore).  The bottom line is the OCR.  That marginal funding costs measure hasn’t fallen much at all this year, despite the continuing falls in the OCR.  Over the last three years taken together, the fall in marginal funding costs has not even quite kept up with the fall in inflation expectations.  Is it any wonder that core inflation has stayed low, and if there is any sign of some lift in inflation, it is at a very sluggish rate?

The Governor devoted a paragraph in  his main policy chapter to a discussion of the helpful things (in terms of lifting resource pressure and inflation) lower interest rates are doing.  There was a striking omission: frustrated as he no doubt is with the level of the TWI, it is almost certainly lower today than if the Bank had not cut the OCR.  But no mention of the exchange rate connection at all, even though it is probably one of the most important monetary policy transmission mechanisms in New Zealand.

But I was also struck by one of the observations the Governor did make.  He noted that low interest rates “are encouraging businesses to undertake investment they may not have done otherwise”.  So far, so conventional, and I wouldn’t disagree at all.  But here is a chart of investment (excluding residential investment) going back almost 30 years.


Investment in things other than building new houses is certainly off the recessionary lows, but it is still a considerable way below the typical share of GDP seen in the mid-late 1990s and the pre-recessionary 2000s.  And that is (a) with some considerable activity related simply to rebuilding in Christchurch following the earthquakes, and (b) the most rapid population growth rate we’ve had for decades.  Many more people should mean a lot more investment (simply to maintain the capital stock per person).  With current rates of population growth, and the Christchurch effects, perhaps we might be a little uneasy, concerned about overshooting, if the investment share (ex housing) was much above say 18 per cent (around the pre-recession peak). But it isn’t, and there is a little sign of business investment accelerating.

Monetary policy doesn’t make that much difference to an economy in the long run.  But in the short to medium term it can make quite a difference.   If a central bank is reluctant to cut policy rates further when

  • core inflation is well below the target focus (and has been for years),
  • when the unemployment rate is falling only slowly and is still well above the NAIRU,
  • when per capita GDP growth remains modest at best,
  • when the exchange rate is well above appropriate long-run levels, despite a languishing exports/GDP picture,
  • and when business investment itself is pretty modest, especially given the unexpectedly rapid population growth

it is leaving New Zealanders poorer, and more of them unemployed, than is necessary, or desirable.

Perhaps the bit of yesterday’s press conference that frustrated me most was the response by John McDermott, the Bank’s chief economist and Assistant Governor to a question.  The questioner asked about whether the Bank had given any thought to the idea Janet Yellen had openly toyed with, of deliberately aiming for a period of above-target inflation –  whether to in some sense “make up” for the period of below-target inflation and cement in slightly higher inflation expectations, or just to “give growth a chance”, including the chance that additional demand growth might stimulate new supply and productivity growth.   As the next recession –  and the next need to cut rates –  can’t be that many years away –  whether by accident, exhaustion or unintended trade war – the “overshoot” approach might just be prudent risk management in the current circumstances.

There are a number of problems with the idea.  In a US context, I don’t find that argument that weak demand has held back productivity growth that convincing –  and they managed very rapid productivity growth during the Great Depression –  and there are questions as to whether a central bank could credibly commit to overshoot its target for a time (aren’t the incentives to renege as soon as inflation actually starts getting near the target?).  And in the US, the unemployment rate is already back to around pre-recession lows.

But the Bank’s chief economist simply didn’t address the question.  Perhaps he didn’t hear it clearly, or misinterpreted what was being asked, but he simply gave the rather self-satisfied response that if one looked at the Bank’s projections, inflation was heading back towards target, and that “sounds like the plan being implemented”.

It is nothing of the sort.  What the Bank is doing is pretty mainstream inflation targeting, on the assumption that their forecasting models and understanding of the economy is roughly correct.  And it is surely exactly the same approach they’d take if the target was, say, centred on 5 per cent, and core inflation measures were around 4.2 per cent.

It is also exactly the approach they’ve taken throughout the Wheeler term, when they have proved to be consistently wrong.  Inflation has simply kept on undershooting.

The approach that was asked about, at least as I heard it, was whether the Bank should not cut more aggressively now, actively aiming to get (core) inflation up to perhaps around 2.5 per cent for a time.  If the Bank’s forecasting models are still wrong –  and they’ve given us no basis to believe something has changed and they now have it right –  perhaps actual core inflation would turn out around 2 per cent.    But if the models are right, we’d have a few years where inflation was a bit above target.  There would be few obvious downsides to that.  The next recession –  whenever it is –  would be likely to see inflation fall again.  But we’d see inflation expectations pick up –  from the current 1.6 to 1.7 per cent – to something more like 2 per cent, and we’d see a phase of stronger real GDP growth (per capita), stronger business investment, and the unemployment rate might finally –  eight years on from the recession –  get back to something like the NAIRU.  Indeed, perhaps it might undershoot the NAIRU for a year or two, likely a welcome outcome for the people concerned.

And then there is the looming issue of the near-zero lower bound on nominal interest rates. The Bank has just cut the OCR to a new record low of 1.75 per cent, and projects that it will remain at that level for the next three years.  They think the economy already has a small positive output gap.  So if the next recession comes in the next few years, there will be only around 250 basis points of leeway to cut the OCR if required.  In past cycles, the Bank has often needed twice that capacity.  And yet the Bank has shown no sign of having any preparations in train to make the lower bound less binding.

Far better to take a more aggressive path now.  Actually push real interest rates well below where they were in the years when inflation has consistently undershoot.  Get inflation up sooner, and perhaps even overshoot for a time.  Get growth in real GDP per capita up, and drive unemployment down.  And in the process, get inflation expectations –  what people treat as normal –  up again. The best way to preserve capacity for the next recession is to get inflation expectations up –  at or above target midpoint –  now, while there is still discretionary capacity.

There are counter-arguments to this sort of approach –  no doubt, many would mention house prices –  but the Bank simply ignored the quite reasonable question.  It is as if they really just don’t care.  Not, I’d have thought, ever an appropriate response from a body given such great delegated power, but perhaps less so than ever in a week when voter rebellion against the elites, perceived not to have the interests of ordinary people at hear, hog the headlines.

As a final thought, while I welcomed the move to publish the interest rate projections in terms of the OCR (rather than the 90 day bill rate), given that the Bank adjusts the OCR in increments that are multiples of 25 basis points, it is rather odd to give the interest rate projection to only one decimal place.   Over the next few months, the OCR will either be 1.5 per cent, 1.75 per cent (as presumably the Bank thinks), or 2 per cent.  It won’t be 1.8 per cent or 1.7 per cent.  The Governor seemed to suggest yesterday that 1.7 per cent was implying a 20 per cent chance of a further OCR cut.  But, even if so, how do we know whether 1.8 per cent is simply 1.75 per cent rounded, or is intended as a 20 per cent chance of an OCR increase?  The move to using the OCR was designed to improve clarity.  They could do a little more in that direction (and in ways that might reduce the temptation to micro manage market expectations).


Still here

I had a post half-completed the other day when my computer failed –  a failure that proved terminal.  Add in an egregious decision by the Reserve Bank to leave trustees of its pension scheme potentially personally liable for some really bad past calls by the Bank (a decision that has already contributed to the resignation of our most eminent trustee) and a worsening cold, and my energies were elsewhere.  And, of course, for the last 24 hours, the US election has been much much more interesting than anything New Zealand-related that I might have written about.  Even my 10 year old came home from school yesterday telling me that her class had been following the early results intensely, even if (she reported that) some of the offspring of liberal Island Bay had apparently somehow become convinced that Donald Trump would soon be bombing New Zealand.

I wasn’t a Trump or Clinton supporter going into the election, and am pretty sure that if I’d been American I’d have voted for neither of them (although one of the interesting things in the last few weeks had been the collapse of the third party candidates’ vote share).  I laid out some of my reasons on my other blog.  So unconfident was I in either candidate that I thought a least bad outcome might be one in which one party controlled Congress and the other had the presidency, and (as I noted somewhere else a few days ago) the numbers suggested that if that was going to happen, that probably meant Clinton in the presidency.

But, of course, we now know that hasn’t happened.   Donald Trump will become President on 20 January 2017.  None of my reservations has gone away.  Character matters, temperament matters.  And Trump doesn’t have either of those in any sort of form that makes me think him fit to be President.  I suspect he will be a poor President.  Then again, with what we know now John F Kennedy and Lyndon Johnson wouldn’t pass the character test.  Nor Bill Clinton, nor Hillary Clinton.

For all the media vapours in the last 24 hours, the polls were always relatively close –  as late as yesterday morning I noticed that two new polls on the RCP presidential polls site had a slight lead for Trump –  and the popular vote (not, of course, the basis of the election) looks set to end quite close.  Towards the end of the campaign detached analysts had been saying that Trump had perhaps a 30 per cent chance of victory.  This outcome was always a serious possibility –  the more so perhaps as no one had adequately understood Trump’s surprising success since he first declared his candidacy in the middle of last year.  Perhaps in the end it was a bit like Brexit.  The polls were always close but (a) most of the media and political elites were appalled at the idea of Brexit, and (b) even supporters ( I was one) couldn’t quite believe, despite the polls, that a Brexit victory could actually happen.

Of course, as regards the US election, those sorts of sentiments were accentuated among elite observers outside the US.  According to polls New Zealanders (and Australians) overwhelmingly favoured Obama (in 2008 and 2012) and then Clinton, and that predilection will have been even more marked among our media and political and opinion leaders.  And so the subsequent coverage has been marked more by incomprehension and abuse than anything else –  although in a breath of commonsense the Prime Minister did note that New Zealand is unlikely to be one of the new President’s concerns.  Between the Dominion-Post and Morning Report (and a quick glance through the Herald),  the coverage has been so one-sided that it can only have appealed to the emotional uncomprehending side of liberal readers/listeners, offering little in the way of analysis.

I’m a free market-oriented, small government, social conservative.  There aren’t many of us in New Zealand.  Even if it weren’t for the character and temperament issues, much of Trump’s policy/rhetoric makes me deeply uneasy.  I believe in free trade –  although not preferential trade agreements of the sort of TPP –  and I’m very sceptical of the sort of infrastructure spending programmes that Trump and Clinton were falling over themselves to champion.    And if China has a hugely distorted economy, that mostly disadvantages China –  the idea of officially deeming China a “currency manipulator” isn’t appealing at all (and to extent it is an accurate description, it was truer 15 years ago than it is now).

Then again, there are some things I’m unambigiously happy about in last night’s result:

  • seeing the back, surely finally, of the Clintons (all of them).  Failings of character, a strong sense of entitlement, a strong whiff of corruption, and so on.   As someone noted, probably not many foreign governments will be donating to the Clinton Foundation today.
  • the probable death of TPP.  That agreement had very little in common with “free trade”.  ISDS provisions, which provide foreign investors access to different dispute resolution procedures than domestic investors or ordinary citizens have access to, should have no place in a democracy governed by the rule of law.  And the intrusion of international agreements into trying to set parameters for eg domestic labour market regulation should be firmly resisted.  Domestic laws should be argued over in domestic political debate.
  • the likelihood that new Supreme Court justices will be people inclined to read the Constitution as it was written, rather than as individual judges might wish it to be written.  There is an established procedure for amending the Constitution, and further politicising the Court isn’t that procedure.
  • a halt in the relentless push towards normalising abortion (the Democrats campaigned on restoring federal funding for abortions).
  • a pause –  though probably only a pause –  in the relentless push by federal authorities to compel private people and entities to accept/endorse policies that are anathema to their traditions and religious beliefs (eg same-sex marriage and transgender issues).
  • less risk of a hawkish interventionist foreign policy, and especially the serious risks that would have surrounded Clinton’s preference for a Syrian no-fly zone.

And others where there is some –  perhaps small –  hope of better policy:

  • smart people on both sides of US politics recognise there are serious flaws in the US corporate tax system. This means it is one possible area of serious reform, especially with the Republicans in control of the House and the Senate.  Lower capital income taxation, and a more conventional tax treatment of the offshore earnings of US companies, would be material steps forward, lifting the prospect of stronger private business investment,
  • steps towards a rather better healthcare policy, perhaps including much greater scope for innovation in the healthcare and drugs sectors, and perhaps a step towards comprehensive catastrophic risk cover (the latter a stance favoured by many Republicans pre 2008).
  • perhaps even Trump and a Republican Congress could be the vehicle towards a viable long-term solution for the huge number of illegal immigrants in the US.  In parallels with Nixon to China, perhaps only someone like Trump has the political positioning to be able to resolve the issue. I don’t have strong view on what the “right” outcome should be, but the existing legal limbo can’t be good for the illegals, or for confidence in the US system of government.

And in the last 15 years or so –  perhaps especially under Obama –  there has been a huge increase in the discretionary use of the powers of the administrative state, rather than relying on Congress.  No doubt each side of politics dislikes many of the uses the opposite side’s presidents have made of such powers –  and there are some serious challenges around the legality of some of those interventions (including, for example, Obama’s on immigration), but  in general, the heavy use of such power isn’t really consistent with visions of a democracy in which legislatures make laws and the executive carries them out. No doubt, Trump and the Congressional Republicans will have differences –  often large ones –  on many things, and it still takes 60 votes to get major things through the Senate –  but there must be more scope for relying on legislation rather than executive orders than there was in years when the presidency and Congress were controlled by different parties.  To me, whatever the specific policies, that is an unambigously good thing –  superior process.  And as the Republicans aren’t defending many Senate seats in 2018, if anything the Senate majority could actually increase a little for the last two years of the presidential term.

Am I very optimistic? No, not really.  It was always extraordinary that a great country was reduced to such a bad set of presidential options.  And no doubt the political environment for the next few years will be at least as toxic as the last few have been.  But from a small government social conservative perspective, even a deeply flawed vessel might still end up being agent for some modest gains (even amid the substantive and rhetorical dross).

Weak productivity growth: can composition effects explain it?

One of the charts I’ve run a few times in the last few months has had a bit of extra coverage in the last few days.


It is a pretty straightforward chart (although it would be a little easier if SNZ followed the practice of the ABS and reported the series routinely, rather than leaving it for people to calculate).  I simply averaged the expenditure and production measures of real GDP, and divided the results by the total number of hours worked (from the HLFS).  And real GDP per hour worked itself is a pretty standard measure of labour productivity.

The interest, of course, has been in the now four years or so of no growth in labour productivity.  On the face of it, it is a pretty poor performance and tends to act as something of a counterpoint to a focus by the government (and its business and media cheerleaders) on headline GDP numbers –  which are high largely because the population has been growing so rapidly, rather than because resources are being used more productively.  Productivity is, in the long run, almost everything when it comes to improving material living standards.

I would add a few caveats around the chart, some of which I’ve made here before.  The first is that the very final observation should be heavily discounted or ignored.  SNZ introduced a revised HLFS methodology in June, which has resulted in a step up in the number of hours recorded (perhaps by around 1 to 1.5 percentage points).  At some point that might be reflected in a slightly higher level of GDP, but for the moment there is just an inconsistency.  (And, of course, there is always some quarter to quarter volatility in the data too.)

The second caveat is the old warning that when a number looks particularly interesting it might well be wrong.  Four years of no productivity growth at all is not unprecedented here or abroad (on current data, for example, GDP per hour worked in the UK now is only around 2007 levels) but….these series are prone to revision, and while they could be revised either up or down, it shouldn’t greatly surprise us if the picture for 2012 to 2016 looks a bit different when we review the data a few years hence.

The big revisions tend to happen as a result of the annual national accounts.  Statistics New Zealand gets a lot more detailed data, produces full annual data once a year (including revisions to earlier years), and then updates the quarterly series that have already been published.  The annual data for the year to March 2016 are out later this month, and the revised quarterlies will presumably be available with the September quarter GDP release next month.  Expect changes (including in the chart above).

But for now, the data is as it is.  Bernard Hickey gave the chart some prominence, with the editorial comment “We’re just pumping more low wage workers in the economy and working more hours”, and observing “Jobs soaked up by net migration & more >65 yrs working”

That prompted Eric Crampton of the New Zealand Initiative, writing on his Offsetting Behaviour blog,  to produce a post asking whether compositional changes in the labour force might account for some or all of the weak productivity growth in recent years.  As he quite rightly notes, if a lot of very unskilled people started working lots more hours (in total), while higher skilled people worked the same number of hours, at the same real output, average real GDP per hour worked would fall even though no one individually was less productive.

First, Eric noted that the number of people on welfare benefits has fallen quite a bit over the last few years.  If –  as seems reasonable –  those people had been of below average productivity, that might tend to lower overall productivity somewhat.

But here is my problem with that story.


Working age beneficiary numbers have certainly fallen over the last few years, but they rose a lot during the recession.  There is seasonality in the data so I’ve only shown one observation per annum (June), but in June this year the share of the population of working age on welfare benefits was almost exactly equal to the share as the recession was getting underway in 2008.  People moving on and off benefits might affect average labour productivity to some extent, but absent any sign of an upward surge in productivity over, say, 2008 to 2010 it is difficult to believe this effect explains much of the recent absence of productivity growth.  (And, of course, the decline in beneficiary numbers doesn’t appear to have been in the faster than in the five years leading up to 2008).

Eric also includes a graph showing changing employment rates for different age cohorts, observing

The youngest workers are least productive. They hugely dropped out of the labour market with the changes to the youth minimum wage, but that decline’s since reversed a bit. There’s been a long trend growth in hours worked among older workers, but typical wage patterns over the lifecycle have wages flattening out from the early 50s or thereabouts. Big increases in employment rates among cohorts with lower than average productivity, or at points in the life cycle where wage profiles (and presumably productivity) flatten out, will both flatten or worsen GDP per hour worked.

What to make of that?  Here is a chart of the changes in employment rates for each age group, both since 2012 (when productivity seems to have gone sideways) and since 2007, just before the last recession –  and it isn’t a misprint/error; we’ve had no change in the employment rate over the full period from 2007 to 2016.


Over the last four years, the least productive age group (15 to 24) had the largest increase in employment rates,  and the 65+ employment rate has kept on growing quite a bit.  But….employment rates for 25 to 44 years olds increased quite a lot too (more than the over 65s).    And if we take the full period (Sept 07 to Sept 16), we’ve had a big drop in the employment rate for the lowest productivity age group.  That fall was, of course, concentrated in the first half of the period, but there was no obvious corresponding surge in average productivity at that time (granting that one never knows the c0unterfactual).

And by New Zealand standards, there is nothing very obviously unusual going in the 65+ employment rates.  Between 2007 and 2016 the 65+ employment rate rose by 8.7 percentage points. In the previous nine years, it has risen by 8.1 percentage points.

Perhaps one could dig deeper (if the data existed) and the impression might change, but it isn’t obvious that the changing age composition of the workforce can explain four years of no labour productivity growth.

Sometimes people suggest that perhaps our labour market is performing so much better than those of other advanced countries which might in turn explain the poor productivity growth.   But here is a chart showing employment rates for New Zealand, Australia, and the median OECD country.


There might be something in the story relative to Australia over the last few years.  But comparing New Zealand with the OECD median, our employment rate fell about as much as that median did during the recession, and has rebounded only slightly more since.  Compare New Zealand and the typical employment rate just prior to the recession and almost half of OECD countries have had more of an increase than (the slight rise) New Zealand has had.

Eric also suggests that we need to think about the role of immigration

And, obviously, net migration’s increased over the last few years. New workers getting settled in New Zealand might take a bit to find their feet as well, while still being better off than they were before.

Just two thoughts.  First, around half the huge swing upwards in net inward migration has been the result of the sharp decline in the number of New Zealanders leaving.  They won’t have taken “a bit of time to find their feet”.    Second, for the other migrants, there might be something to the story (although there hasn’t been much variability in the number of actual residence approvals) through, for example, the increased number of foreign students working and people on working holiday visas.  But….the New Zealand Initiative and other business lobby groups can’t really have it both ways. They often tell us it is imperative that we have the sort of immigration policy we have now, because (for example) New Zealanders just can’t, or won’t, do the work (at a price firms can afford). There is a strong hint in that sort of argumentation that immigrants are on average actually quite highly productive relative to natives (even though the data show that for most immigrant groups it can take decades for the earnings to reach those of similarly qualified, similarly experienced New Zealanders).

I wouldn’t rule out the possibility that the compositional effects resulting from immigration are part of the explanation for the latest productivity slowdown (although we didn’t see something similar when Australia had its huge surge) but….if the Initiative is right about the general economic payoff to high immigration, we should be expecting a pretty big lift in average labour productivity (the more so to make up for four years of no growth) really quite soon.

One other lens on the composition issue is offered by our own official annual productivity data (for the “measured sector” rather than for the whole economy).   SNZ produces both labour productivity and multi-factor productivity estimates, and they also produce both series using both total hours worked and an estimate that attempts to adjust for the changing composition of the labour force.   The latter isn’t precise by any means, and won’t pick up all the sorts of issues that have been touched on in this post, or Eric’s, but they are just another angle on the question.  The MFP numbers are valuable because they help get round the question of whether, say, labour productivity is just poor because firms have substituted away from capital towards abundant labour.  Any such substitution would be less troubling if the result was showing strong MFP growth.

Unfortunately, the most recent data are for the year to March 2015.  In the labour productivity data, SNZ weren’t detecting any sign that a worsening average quality of the labour force was explaining the productivity slowdown – they reported much the same improvement in the average quality of the labour force as in earlier years.  And here is the MFP chart.


On this measure, of labour-quality adjusted MFP, there has been no productivity growth at all since around 2006.    There is some modest growth over 2012 to 2015 (a bit over 1 per cent over three years).

Where does all this leave us?

I remain a bit uneasy about the prospects the data could be revised, but then data revisions are always a risk.  But if the average real GDP per hour worked data are roughly right – and there really has been no average labour productivity growth for perhaps four years now –  I think we should be more inclined to believe that it is telling us something about overall economic underperformance, than that it is simply, or even largely, reflecting compositional changes in the labour force. To repeat:

  • the share of working age welfare benefit recipients has fallen gradually over the last few years, but then it rose in the previous few years, and there was no obvious associated productivity surge,
  • over the last few years the employment rates of the low productivity young age groups have risen, but not noticeably faster than those for, say, the rather large 25 to 44 age group.  Over 65s employment rates are rising more than those for other age groups, but that change has been underway for many years.  There was no obvious associated productivity surge (at least in the reported data) when youth employment rates dropped sharply.
  • there is nothing in cross-country comparative data suggesting employment rate changes here have been unusual, in ways that might help account for unusually weak productivity growth here.
  • compositional effects resulting from increased immigration of non-citizens (especially  working students and working holidaymakers) could be part of the story (averaging down real GDP per hour worked, even if no one individually is less productive), although it would be worth testing that story against other episodes in other countries.  If higher immigration is playing a role in dampening productivity growth, I suspect it isn’t mostly a compositional story, but one about overall pressures on domestic resources, which have contributed to holding up real interest rates (relative to those in other countries) and the real exchange rate.
  • and overall MFP growth –  whether SNZ estimated for the measured sector, with some labour composition effects accounted for, or the Conference Board’s estimates that I showed the other day – also seems to have been weak to non-existent.