Natural resources: Norway and the UK

March 31, 2017March 31, 2017 Michael Reddell New Zealand economic performance, Norway, Uncategorized

How natural resources contribute to the prosperity of nations is much-debated. There is little doubt that a) natural resources can be wasted, mismanaged etc, such that a country well-provided for by nature still ends up pretty poor (Zambia is my favourite example, partly because I worked there), and b) that it is perfectly feasible for some countries to do very well indeed with little in the way of natural resources (one could think of Singapore or Japan, but also Belgium or Switzerland). The quality of the human capital of the people in a place, and the “institutions” that are put in place or sustained, make a huge difference. Location looks as though it might matter too.

But equally, it is easy to think of countries where it is pretty clear that natural resources have made a great deal of difference indeed in lifting the economic prosperity of the nation. One could think of Saudi Arabia, Kuwait, Brunei, Equatorial Guinea and so on. It isn’t natural resources in isolation that makes them rich – Iraq and Iran still manage to mess themselves up – but in combination with some basic level of property rights, institutional quality, and human capital (native or imported) the natural resources have lifted living standards in such countries above levels that could otherwise readily be explained.

The quantity of natural resources in each country is fixed. That doesn’t mean that what can be done with those resources is fixed – able people and smart technologies find more efficient ways of extracting the resources or utilising them. We’ve seen that in New Zealand with the growth of agricultural sector productivity over 150 years or more. But the fact that the endowment is fixed means that each additional person added to the country reduces the average per capita value of that endowment. If the natural resource stock is small to start with, it isn’t a point worth bothering about (and so a lot of economic models largely ignore fixed factors). But if it is a large part of what an economy produces, and exports, it can matter rather a lot. It is why I’m unconvinced that rapid immigration policy driven population increase makes a lot of sense in New Zealand or Australia, where the overwhelming bulk of what we sell abroad is natural resource dependent. The point is more immediately pressing in New Zealand – where we haven’t uncovered major new natural resources for a long time – than in Australia, but is no less conceptually relevant there.

In this post, I wanted to illustrate the point by looking at the experience of Norway and Britain with North Sea oil and gas. The oil and gas were always there, but weren’t known about for most of history – and even if they had been known about, it wasn’t until offshore drilling and processing technology got to a certain point that the resources had much value. By the 1970s, Britain and Norway were beginning to get into oil and gas production.

Britain and Norway were both advanced economies in 1970, drawing on the skills and talents of their people and growth-friendly institutions and cultures. Natural resources probably matter a bit more in Norway, but oil and gas weren’t then among those resources. And in 1970, OECD data indicate that GDP per hour worked in the two countries (converted at PPP exchange rates) were about the same. As it happens, GDP per hour worked in New Zealand then was around the same level.

norway uk nom gdp phw These days, by contrast, GDP per hour worked in Norway is around 60 per cent higher than that in the UK (which is in turn quite a bit higher than New Zealand’s). Norway has among the very highest material living standards of OECD countries, and the UK is still in the middle of the pack.

Here are the charts for total oil and gas production in the two countries since 1970, using data taken from the BP Statistical Review of World Energy.

First oil

oil prodn

And then gas

gas prodn

Over the 40 years to 2015, the two countries each produced roughly the same amount of oil and the same amount of gas.

There are all sorts of differences between the two countries. I’ll come back to some of those, but the first I wanted to emphasise was population. Norway now has around five million people, and the UK currently has around 65 million.

Here is per capita oil and gas production for the two countries.

oil pc

gas pc

That “windfall” – the discovery of large recoverable oil and gas resources – made a big per capita difference in lightly populated Norway, and not much of one in heavily-populated Britain.

Determined sceptics might argue that it is all a mirage and that somehow Norway would have got to its current living standards anyway. If I was focusing on GDP per capita they could, for example, point out that in Norway a materially larger share of population is employed than in the UK. But, as it happened, I was focusing here on GDP per hour worked (and if anything, employing a higher share of the population should probably lower, at least a bit, average output per hour, if the less productive people are the last to be draw into the workforce). As it happens too, the employment/population gap between Britain and Norway is narrower than it was in 1970.

Perhaps too people might set out looking for areas in which Norwegian policy is superior to that in the United Kingdom. But there isn’t much to find. As a share of GDP, for example, government spending in Norway has typically been larger than it is in the UK.

gen govt spending uk and norway

And I went through the structural policy indicators released last week as part of the OECD’s Going for Growth. Norway isn’t badly run by any means, but on a majority of the indicators Norway scores less well than the UK.

Location probably favours the UK as well – the south of England is very close, and accessible to, the high productivity populous countries of France, Belgium, Netherlands, Germany. Norway isn’t remote – certainly not by New Zealand standards – but it isn’t quite as advantageously located for prosperity as the UK is.

In sum, don’t think any dispassionate observer would doubt that oil/gas – combined with the responsible management of the revenue – is what explains Norway’s rise over the last few decades to the top of the OECD league tables. And if, by some historical chance, there had been 65 million people living there, rather than the five million who actually were, it just wouldn’t have made very much difference. For the UK, the oil and gas were a “nice to have”. For lightly-populated Norway they made a great deal of difference.

For New Zealand, for whom extreme remoteness is a given, and where fixed natural resources make up so much of our export earnings, it is something to think about. There is a reasonable alternative story to tell under which the average New Zealander would have been better off – given the current state of global and local technology etc – if there were three million of us not 4.7 million. Perhaps that would have been the case, if we hadn’t restarted large scale immigration after World War Two.

Do big countries get richer (or more productive) faster?

March 30, 2017 Michael Reddell New Zealand economic performance, Productivity

The short answer appears to be “no”.

Much of the debate around the appropriate immigration policy for New Zealand seems to have as a sub-text (implicitly or otherwise) a sense that New Zealand population is just too small, and that if only we had more people we would be richer (per capita) and more productive. Those who run, or rely, on this line rarely seem to engage with the estimates that New Zealand’s GDP per capita was at its peak, relative to incomes in other countries, at a time (around 100 years ago) when our population was about a quarter of what it is now. (Of course, the population of other countries has also grown since then, but in most advanced countries the population growth rate has been much slower than in New Zealand – the UK had about 45m people 100 years ago and about 65m now.)

In their recent report in support of New Zealand’s immigration policy, the New Zealand Initiative joined the group of those arguing that a larger population would be good for New Zealand’s per capita income and productivity.

I wrote about this point in a post back in 2015, in which I observed

I’ve long been fairly sceptical of that proposition. A casual glance around the world suggests no very obvious relationship. The United States and Iceland co-exist, and Japan and Singapore. At the other ends of the income spectrum, India and Bhutan, and Brazil and Costa Rica. There are all sorts of arguments advanced around the economics of agglomeration, and that analysis seems to work quite well in describing what happens within countries. But it does much less well in describing economic performance across countries. And as I’ve pointed out to people previously, if the real economic opportunities in big countries were so much superior to those in small countries, large countries would tend to have (more high-yielding projects and) higher real interest rates than small countries. But they don’t.

Over recent decades we’ve also seen many more smaller countries emerging, presumably because the people in those places concluded they wouldn’t pay too much of a price to be independent.

In the earlier post, I included some scatter plots suggesting that there was basically no relationship at all between the size of country and the subsequent growth in its real GDP per capita or productivity (real GDP per hour worked). In this post I’m looking at much the same relationships, but this time just using the Conference Board’s Total Economy Database, which starts in 1950.

One of the challenges in any work in this area is that people tend to flow to rich and successful countries. Indeed, plausibly in a successful fast-growing country, people might even be willing have more children on average. The simplest way to correct for that is to take the population level at some historical point in time and then look at per capita growth subsequently. Here is a chart for 33 relatively advanced (and relatively free) economies showing population in 1950 (in logs) and total percentage growth in real GDP per capita over the subsequent 65 years to 2015.

1950 popn and subseqeunt GDP pc

The simple regression line is still slightly downward sloping even if the very fastest growing countries (Singapore, Taiwan and South Korea) are excluded. But note that I’m not arguing that higher populations are necessarily bad for subsequent growth, simply that there is little evidence (none in the simple bivariate relationships) that larger populations are good for growth. Small and large countries seem able to successfully, and prosperously, co-exist.

What about more recent periods? There has been a line of argument – associated in the context of the New Zealand debate with Philip McCann – that these issues have become much more important in recent decades as the nature of the global economy has changed (more reliance on ideas, trade in services etc).

Here is the same chart for the 25 years since 1990.

1990 population and real GDP pc

Take out the outlier (Singapore) and the bivariate regression line still slopes slightly downwards.

And for the same countries, here is the relationship between total hours worked in 1990 and subsequent growth in real GDP per hour worked.

1990 hours worked and subseqeunt productivity growth

And still no positive relationship.

My sample of countries in these charts excluded the countries of the former eastern bloc. Most of them have relatively small populations, and most have – not surprisingly – done quite well in the last 25 years or so, once the shackles of communism were removed. The quality of the data from 1990 might also be in some question.

But for completeness, here are two charts from 1990 to 2015 with various of the eastern European countries added in (those now in the OECD and/or the EU). This one for all the countries.

1990 hours etc - enlarged sample

And this one – as much for visibility as anything – just excluding Singapore, South Korea and Taiwan.

1990 hours etc - enlarged sample ex Sing, Taiwan, S Korea

There doesn’t seem to be any simple evidence that, across the relatively advanced world as a whole, a higher starting population has helped make for stronger subsequent growth in real GDP per capita or real labour productivity.

I concluded my earlier post this way

Charts of this sort are, of course, not conclusive. Lots of other things are going on in each country. In an ideal world, one would want a much fuller and formal modelling of the determinants of growth. But equally, the absence of a positive relationship between the size of the country and its subsequent growth shouldn’t be surprising, and there have been previous formal research results suggesting a negative relationship.

Of course, perhaps New Zealand is an exception. Perhaps real per capita incomes would really be materially lifted if we had many more people here, even though there has been no such relationship across the wider range of advanced countries in history. But in a sense we have been trying that strategy for 100 years and there is no sign that it has worked so far. Very few relatively advanced countries have had weaker real per capita growth than New Zealand in the last 100 years (only places like Argentina and Rumania).

Perhaps the next 25 or 100 years would be different. But I think the onus is now on the advocates of policies to bring about a bigger and more populous New Zealand to demonstrate where and how the gains to New Zealanders from a much larger population are occurring?

At that stage, I was putting less emphasis than I now would on two (probably related) factors that make it even less likely that such a beneficial relationship would exist for New Zealand even if it did – and these charts suggest it doesn’t – for other advanced countries:

our extreme distance from other countries (markets, suppliers, value-chains, competitors etc) in an era when, if anything, personal contacts seem more important than ever, and
our continued very heavy reliance on natural resources – and ability to apply new and better skills to those resources. Those resources are in fixed supply, our heavy reliance on such natural resources is now quite unusual (it isn’t so for most OECD countries), and there is little sign of the economy successfully gravitating away to any significant extent from a reliance on natural resources.

Playing to our strengths, and maximising the prospects for New Zealanders, looks as if it would be much better-served by an approach that didn’t seem determined to drive up the population, regardless of the 100 years (or 70 or 25 or whatever period you like) in which there has been no evidence that a larger population is enhancing the economic well-being, or productivity, of New Zealanders.

And here is one last chart, for completeness, including all the relatively advanced countries – eastern European and Asian alike – and showing population in 1990, and subsequent growth in real GDP per capita.

1990 population and real GDP pc extended sample

Still no sign of that vaunted upward-sloping relationship.

Comparing ACC investment returns to NZSF’s

March 29, 2017March 29, 2017 Michael Reddell NZSF

I’ve written quite a bit over the last few weeks about the New Zealand Superannuation Fund. My argument is not that they have done badly – indeed, some evidence suggests that over a relatively short period (since their own self-assessment benchmark is a rolling 20 year horizon) they have done rather well – but rather that what they do isn’t worth doing at all (for citizens and taxpayers). Total returns have been rather risky – interviewed on Radio New Zealand the chief executive called it a “high octane” fund – and don’t stack up that well against rate of return requirements the government generally expected over that period for discretionary investment projects, or with the sorts of hurdle rate private sector entities typically use in evaluating projects.

One reader has suggested several times that I show the data for the ACC investment performance. The value of ACC’s total assets is currently quite similar to that of NZSF.

To give credit to NZSF, their investment performance data is much more easily available (on their website) than that of ACC. But I did track down a couple of charts of ACC’s investment performance and ACC provided me with the annual data behind those charts, going back to the 1992/93 June year.

These are the headline numbers for the two government entities for the 12 full financial years in which both were operating.

acc and nzsf

What will no doubt stand out first is that ACC’s returns have been much less volatile – less risky – than those of NZSF. They are very different funds, with very different mandates and different appetites for risk.

The numbers the two agencies supply are not exactly comparable. The NZSF returns data are pre-tax and after costs. ACC is not liable for New Zealand tax, although they note that they pay a small amount of foreign withholding taxes. Their numbers are also reported before allowing for some investment management expenses. This is from their Annual Report

However, returns are shown prior to the deduction of other investment management costs of $42.4 million (including fees paid to external fund managers and the remuneration of our investment staff), which would have detracted 0.135% from investment returns in 2015/2016.

In the remaining calculations in this post, I have silently deducted 0.135 per cent per annum from the ACC returns to produce numbers more closely comparable to those NZSF provides.

Over the 12 years both agencies were investing, NZSF produced (geometric) average annual returns of 9.5 per cent. ACC managed 8.3 per cent average annual returns over the same period. But the big difference was in the volatility of those returns. For NZSF, the standard deviation of the annual returns was 13.9 per cent over that period, while for ACC it was only 4.8 per cent. That is pretty low level of risk. (I’m a trustee of the Reserve Bank’s superannuation scheme. We have historically been a deliberately relatively low risk fund, and over the same period the standard deviation of our returns has been similar to ACC’s.)

You can see in the chart above where it really makes a difference. Over 2008/09, at the height of the recession (here and abroad) and financial crisis, ACC had a bad year. Returns in that June year were -1 per cent. At NZSF, they lost 22 per cent of the value of the assets. Fortunately that was still 22 per cent of not that much.

In an earlier post, I looked at the Sharpe ratios – returns relative to the variance of those returns – for NZSF. It is a commonly used metric in looking at, andcomparing, funds managers.

NZSF’s official performance benchmark is the total returns of the fund relative to the (risk-free) Treasury bill rate. ACC doesn’t use that metric, but lets see how the two organisations compare on it anyway, again over the 12 financial years 2004/05 to 2015/16.

	Average return above T bill(percentage points)	Std deviation(percentage points)	Sharpe ratio
NZSF	5.7	14.6	0.39
ACC	5.2	5.8	0.90

And recall that NZSF’s own document suggest that over the long-term they don’t exepct anything like that level of returns: they aim to produce “at least” 2.7 percentage points above Treasury bill yields.

Both ACC and NZSF like to report on how they have done relative to benchmarks that they themselves have set (the “reference portfolio” in NZSF’s case). That can be useful in assessing their active management returns and allowing the respective managements and Board to assess whether active management is worth doing at all. It matters less to taxpayers, especially in the NZSF case, where there isn’t wealth that has to be managed, but rather we have to take a view on whether having the Fund – funded from taxes and borrowing – is worthwhile at all (and where the benchmark is designed in a way that makes it not too hard for the NZSF to beat). As I noted, the official performance benchmark for NZSF is performance relative to Treasury bill. But for what it is worth, here is the same sort of table for what both organisations might call their ‘active management”.

	Average annual active mgmt returns (percentage points)	Std deviation (percentage points)	Sharpe ratio
NZSF	1.8	3.2	0.56
ACC	0.9	0.8	1.13

ACC’s performance, even on this measure, is pretty impressive, both absolutely and relative to NZSF’s. ACC has a longer-run of data, and the performance over the full 24 years of data is quite similar to that for the 12 years for which we can compare ACC and NZSF.

I’ve tried to ensure that all my numbers are accurate, although there is always some risk of error in combining differently formatted numbers etc. But the key point really is in the headline numbers in the graph above. Over the 12 years to date – when NZSF has done better than they expected – ACC has earned average total returns a bit less than those of NZSF, but they have done so by taking on much less risk.

And as I”ve highlighted in the various NZSF posts, NZSF’s sort of investment strategy tends to lead to very big losses at just the times when Crown finances are put under greatest stress anyway (in severe economic and financial downturns). That is a distinctly unappealing feature, and a risk profile more akin to that adopted by ACC over the years also looks as though it would be a better approach to take to any other Crown investment management subsidiaries. Those with long memories will recall the intense fiscal pressures – some real some exaggerated – in 1984, 1990/91, 1998/99, and 2008/09. In future downturns, the last thing we need is huge investment losses amplifying pressures for politicians to “cut and cut now”. It is fine for technocrats to argue that markets will bounceback. Often they do, but it is a great deal of unnecssary risk for taxpayers to assume, or for them to rely on politicians and appointed technocrats to manage.

As a final note, I’ve been critical of the reshuffle of Kiwibank shares among various Crown agencies, which reduced NZ Post’s share, and resulted in NZSF and ACC owning around a quarter each of a retail bank. In neither agency’s case does that look particularly good. If things go well, both NZSF and ACC might do rather well financially – after all, they were the only credible and politically acceptable buyers. But neither ACC nor NZSF has any expertise in retail banking, and difficulties of handling any potential failure of Kiwibank – and the inevitable pressures for government bailouts – are only compounded by the dispersed non-expert ownership all still on the overall balance sheet of the Crown.

Time to wind-up the NZ Superannuation Fund

March 28, 2017March 28, 2017 Michael Reddell Superannuation

In their print edition last Friday, NBR ran a piece from me suggesting that it was now time to wind-up the New Zealand Superannuation Fund. For those with NBR subscriptions, it is now available on line.

I didn’t assign my copyright to NBR or anything of the sort, but I won’t reproduce the full column here. It was, largely, a much shorter version of a post I did here a couple of weeks ago (and in the process of generating it, I proved to myself again that one reason I write long posts is that short posts take much longer). But this was the final paragraph.

There is a political debate to be had about both NZSF and about the future parameters of New Zealand Superannuation. But the two simply aren’t very logically connected. What NZS policy we run in future depends on all manner of things, including the overall state of the government’s finances. But the performance of one part of the balance sheet simply isn’t a key consideration. If it makes sense for governments to run speculative investment management operations, it does so whether or not life expectancies are increasing. But short of Norwegian quantities of oil and gas being discovered here – which give the government cash that simply has to be invested – it is just isn’t a business the government should be in. Fortunately, the Fund hasn’t done badly over its life to date, but let’s bank the gains, and wind-back the considerable future risks by closing the Fund and using the proceeds to repay government debt.

In both my recent posts on NZSF (here and here) , I’ve tried to emphasise that those who run it probably haven’t done a bad job in the time they’ve been managing our money. (Here I should note that the NZSF have pointed out, via a response to someone else’s OIA, that in my first post I made a mistake in annualising the rates of return on the New Zealand stock exchange, a number I had mentioned in passing in that post. NZSF and I agree – on this if little else – that the New Zealand stock returns are not a particularly meaningful benchmark for these purposes.)

NZSF has been charged by Parliament with running a high risk fund, they’ve done that, and over a period in which global asset markets have done rather well, they’ve made quite a bit of money for the taxpayer. But if the relevant benchmark isn’t the NZSE50, neither it is (as NZSF and its chief executive keep claiming) the Reference Portfolio that the Fund Board themselves construct and adopt. The latter has some uses inside the organisation, but it is largely irrelevant for taxpayers and citizens trying to decide whether NZSF has (a) done a good job, and (b) should exist at all.

In their own official documents, the relevant performance benchmark is

It is our expectation, given our long-term mandate and risk appetite, that we will return at least the Treasury Bill return + 2.7% p.a. over any 20-year moving average period.

That expectation is hardly ever mentioned when, for example, the chief executive takes to the media. It didn’t appear in the OIA response I linked to earlier either.

As it happens, the returns to date have been (quite a bit) better than that benchmark – which is why I’m quite open about the fact that NZSF has probably done a reasonable job, perhaps as good as most other managers with their opportunities might have done. But after only 13 years, their own official documents tell us that we can’t yet know how much of those returns is down to luck, and how much down to skill. As they note, when you take as much risk as they do – really big year to year fluctuations – it takes a long time to tell. When global markets are rising strongly it isn’t hard to make money.

Over the life of the Fund, their total returns have averaged around 10 per cent per annum. As I’ve noted previously, over most of that period the Treasury required government agencies looking at investment projects to use a discount rate of 8 per cent real (or around 10 per cent in nominal returns). Of course, what discount rate one should use depends on how risky the proposed project is, and what it does to the risk profile of the whole of the owner’s business. A “high octane” (Orr’s words) investment management subsidiary is risky – it might not be Wellington aiport runway extension risky or INCIS risky, but it will be riskier than, say, a new school in a growing city. And these sorts of investment management returns tend to add to, rather than reduce, the variance of the Crown’s overall financial position – in particular, the biggest losses tend to become starkly apparent in periods when there is the greatest pressure on other government finances (ie in severe global economic and financial downturns). A 10 per cent (pre-tax) return over the period from 2003 to now – even though it is better than they expected – just isn’t that impressive. And NZSF tell us that even they believe those sorts of returns can’t be expected to be replicated in future – they tell us we should expect 2.7 per cent above the Treasury bill rate. Who knows what a “neutral” New Zealand Treasury bill rate is, but even if it is getting up to around 4 per cent, that suggests expected future pre-tax returns of less than 7 per cent. And there is no reason to think that the variances, or covariances, of the portfolio will be less in future than they have been. (In recognition of the lower interest rate environment, Treasury now encourages government agencies to use a real pre-tax discount of 6 per cent – or 8 per cent in nominal terms.)

I could add into the mix the point that few private companies will be using hurdle rates of return of less than 10 per cent in deciding on investment projects, or the acquisition of a subsidiary. And that is what NZSF is – a fairly aggressive investment management subsidiary of the New Zealand government (with deteriorating governance/transparency – eg when a large chunk of a government-owned local retail bank is in the portfolio).

And so my bottom line is that we should be thankful for the reasonable returns we’ve had from NZSF to now (through some mix of luck and skill), but that since we can’t count on anything like those sorts of returns in future (even NZSF say so), and even the returns to date are really only sufficient to compensate us for the risk run on our behalf, we’d be better off locking in the gains we’ve had, closing down the Fund, liquidating the assets over a couple of years, and using the proceeds to repay public debt. Our government does not need to be in this game – unlike, say, the governments of Norway or Abu Dhabi, with genuine wealth to manage and smooth – and the returns to doing so don’t look that attractive. As the Crown is already heavily exposed (both through the tax system and its other extensive asset holdings) to the ups and downs of the domestic economy and global markets, strategies that reduce risk, rather than increase it, seem intuitively more appealing. The NZSF logic is the opposite of that.

To accompany my NBR piece, they did an NBR Radio interview. The one question that got me thinking – and really the reason for this post, which to some extent is traversing old ground – was along the lines of “wouldn’t winding up the NZSF leave ordinary people worried about whether their NZS pension would be there for them when they got old?”.

That the question slightly rattled me probably just reflected the fact that I’m a macroeconomist not a political scientist. Perhaps it is also a testimony to Michael Cullen’s political skill in constructing the NZSF, initially to safeguard surpluses from spending ministers as anything else, and linking it to the NZS regime. But why shouldn’t people worry?

NZSF is only a small part of the government’s overall balance sheet,
Our government finances are – thanks to a succession of Labour and National led governments – among the stronger in the advanced world,
Even the staunchest advocates of NZSF never saw it contributing more than a moderate proportion of future NZS costs,
We’ve had a universal government pension since around 1940 – with brief interruptions in the means-testing years of the 1980s and 1990s – and a government old-age pension for those in need since 1898,
Our universal old-age pension is high enough to keep most old people out of poverty (even those who earned low enough incomes through their lifetimes that they’d have had little effective capacity to save), but doesn’t (of itself) deliver high incomes to people beyond basic needs (so it isn’t like some state schemes elsewhere in the OECD),
And there is nothing about NZS that is unaffordable in the long run, provided that sensible, well-foreshadowed, adjustments in the age of eligibility are made, in line with continuing improvements in life expectancy. Ideally, we’d have the age at 67 already, and be increasing (by statutory formula) a little each year as the life expectancy rises. Simply shifting the age to, say, 67 doesn’t resolve the issue, but a suitable resilient formula-based adjustment would.

In modern times, the greatest period of uncertainty – by far – about future state pension support was during the years from around 1985 to 1998 when a means-testing regime was instituted and then constantly revisited. That had to do with some combination of the overall stretched state of the government’s finances, as well as essentially ideological debates about universality vs targeting.

If one believes – as I, somewhat reluctantly (but for good second-best reasons) do – in a modest but universal state age pension, the best protections of that over the long-term, and the best way to provide predictability to individuals (avoiding jerky discontinuous policy adjustments) are

(a) sound overall government finances (low debt levels, and tax and spending shares of GDP that don’t push historical or international limits), and

(b) agreed, or at least broadly accepted across the main parties, statutory provisions that lay down well in advance how the age of eligibility will adjust in future as life expectancy increases.

NZSF really isn’t relevant to either. It is just a high-risk investment management business, and that isn’t a natural business of government.

And veering slightly further off topic, I’m still puzzled by that Labour-Green commitment I discussed yesterday to keep core Crown spending to around 30 per cent of GDP while doing nothing to alter NZS parameters. This was the chart from the Treasury’s long-term fiscal statement released late last year.

ltfs They would be okay for the next few years, but once you get even 10 years out from here, there would need to be a lot of other expenditure cut to keep spending to around 30 per cent of GDP, even if (a) the two parties resume NZSF contributions soon, and (b) investment returns proved to be pretty good. I’m genuinely puzzled how they propose to square that circle.

Labour/Green Budget Responsibility Rules

March 27, 2017March 27, 2017 Michael Reddell Fiscal policy, Greens, labour party

Grant Robertson, for Labour, and James Shaw, for the Greens, released on Friday a short document on the “budget responsibility rules” the two parties would adopt if they are in a position to form a government after the election.

As others have noted, it was PR win for the two parties, in what was in any case not a great week for the government (Afghanistan and all that). If one criticism of the left-wing parties in the 2014 election was that no one seemed sure what a Labour-Green government might look like, or how the key figures might get on, this is the sort of initiative that helps build confidence and makes people nearer the centre, or just tired of nine years of a government that has accomplished little, think harder about the possibility of voting for a change. Whatever their other specific policies, whatever their other limitations, in this release – and, for example, in the double-page spread in the Herald, – Shaw and Robertson looked and sounded like plausible responsible senior ministers.

On the substance, I think it is only fair to note that for 30 years or so there hasn’t been a huge difference between the two main parties on the overall approach to fiscal policy, and that has been to the credit of both parties. Roger Douglas and David Caygill broke the back of our record of fiscal deficits, and Ruth Richardson and Bill Birch finished the job. Both parties ran surpluses through much of the 1990s and the 00s. The budget was run badly into deficit late last decade, through some combination of poor official forecasting, the global recession and productivity slowdown, and the earthquakes. Policy played a part – Labour in government was responsible for a large increase in spending (advised by Treasury that it was sustainable). But had National been in government in 2005-08 it is difficult to believe that fiscal bottom lines would have been much different. They’d have been getting the same Treasury advice about revenue sustainability, although presumably they’d have done more about tax cuts than Labour did, and put through fewer spending increases. Since then both main parties have had a shared commitment to get back to surpluses – helped along by relatively favourable terms of trade, and unexpectedly strong population growth, which tends to flatter the fiscal position in the short-term.

Of course, the Greens have remained a bit of an unknown quantity in the broad area of economic management, not helped by for example the flaky suggestion from their former leader that New Zealand should have been adopting quantitative easing, at a time when there was still plenty of scope for conventional monetary policy. But that now seems to be in the past, and in this new agreement the Greens have pretty much signed on for an orthodox and fairly sensible approach to broad fiscal management. Perhaps they always were, but sometimes writing things down and stating them openly matters.

There are six points in the Budget Responsibility Rules document. I’m mainly interested in the sixth of them – the genuine and welcome innovation. My comments on most of the others are mostly around the margins, intended as constructive technical points rather than any very substantial disagreement.

The first two points are

1. The Government will deliver a sustainable operating surplus across an economic cycle.

An OBEGAL surplus indicates the Government is financially disciplined and building resilience to withstand and adapt to unforeseen events. We expect to be in surplus every year unless there is a significant natural event or a major economic shock or crisis. Our surpluses will exist once our policy objectives have been met, and we will not artificially generate surpluses by underfunding key public services.

2. The Government will reduce the level of Net Core Crown Debt to 20% of GDP within five years of taking office.

To give future generations more options, reducing government debt has to be a priority. By setting a target, provided that economic conditions allow, we will be able to make responsible debt reductions and invest in housing and infrastructure that strengthen our country and prepare us for future challenges.

On which I would make just two points:

if nominal GDP is growing at, say, 4.5 per cent per annum (say, 2 per cent inflation, and 2.5 per cent through some mix of population and productivity growth) then a stable debt to GDP ratio of 20 per cent is consistent with annual deficits of 0.9 per cent of GDP. I’m not opposed to the commitment to run surpluses in normal times – presumably offset by deficits in years with serious economic downturns – but since those severe downturns typically come less than once a decade, and a parliamentary term is only three years, they will need to do some hard thinking about how to operationalise these self-imposed rules jointly, as the 20 per cent target comes into view. There is a real risk of seriously pro-cyclical fiscal policy quite late in economic cycles, compounded by the fact that the commitment to run surpluses is not expressed in terms of a structural balance (ie stripping out the estimated budgetary effects of the state of the economic cycle).
what is a sensible debt target with, say, zero population growth would, all else equal, be too low a target if population growth was to continue at 1.5 or 2 per cent per annum. The Greens have announced a net immigration target which is consistent with population growth of on average around 1 per cent per annum. We don’t yet know what Labour immigration policy is. (I should add that this technical point is relevant to the current and past governments’ specification of debt targets as well – such targets typically arose more out of political framing etc than out of robust economic analysis.)

The third of the rules is

The Government will prioritise investments to address the long-term financial and sustainability challenges facing New Zealand.

The Government will prioritise responsible investments that enhance the long term wellbeing of New Zealanders – such as restarting contributions to the Super Fund. In addition we will invest in infrastructure to support our growing population, and reduce the long term fiscal and economic risks of climate change.

I’m not going to get into debates about NZSF here (the bigger fiscal issue is how much overall public sector saving there should be, not the institutional form it takes), and presumably no one is going to quibble with the high level of generality in the italicised commitment. All the arguments – including those within any future government – will be about the details of specific policies, values, and preferences, and about how hardnosed project evaluation and cost-benefit analyses should be.

The fourth rule is interesting and somewhat surprising

4. The Government will take a prudent approach to ensure expenditure is phased, controlled, and directed to maximise its benefits. The Government will maintain its expenditure to within the recent historical range of spending to GDP ratio.

During the global financial crisis Core Crown spending rose to 34% of GDP. However, for the last 20 years, Core Crown spending has been around 30% of GDP and we will manage our expenditure carefully to continue this trend.

Here is the chart of core Crown spending as a share of GDP.

core crown expenses

The average over that full period has been 30.8 per cent of GDP.

I’m more hesitant about this “rule” or commitment than you might expect. On paper it looks like a timely recognition of the cost to productivity and real future incomes of too large a state. But when, thinking about fiscal rules, it is really important to think about (a) how they might be gamed in future, and (b) how they might lead even the authors of those rules into decisions that might less than ideal. I’ve also not seen anyone ask Labour, in particular, how they square a semi-commitment to hold core Crown expenses to around 30 per cent of GDP with doing nothing about NZS. Even the most enthusiastic supporters of the NZSF recognise that it will make only a modest contribution to covering those ageing population costs – and probably none at all in the life of any Labour-Green government elected this year.

But even setting that specific issue to one side, this is a commitment around core Crown expenditure, but there are other ways to skin a cat. If a future government feels bound by an expenditure commitment, why not try regulation. There doesn’t appear to be anything comparable limiting future extensions of the regulatory state (thus, say, in a US context a statutory mandate compelling people to buy health insurance might be a substitute for more direct government spending on health). And it isn’t clear that this commitment by Labour and Greens would limit the use of tax expenditures. And people closer to the details of how governmemt activity is classified might want to pay attention to the possibilities in the distinction between core and total Crown. Finally, expenditure to GDP ratios can be flattered by the state of the cycle – a ratio of 30.000 per cent late in a big boom, can quickly transform into one of 32 or 33 per cent without any new discretionary fiscal choices if there is a serious recession.

These comments are, mostly, not intended to take away from the welcome overall thrust of the Labour/Greens commitments, but they are some details to think about when it comes to firming up what the commitments might mean if/when they are in office. Under pressure, ministers and smart bureaucrats find “outs”. For now, one should welcome the fact that the parties believe it is politically advantageous to commit to something like an expenditure (share of GDP) ceiling.

I’ll pass over the tax commitment quickly

5. The Government will ensure a progressive taxation system that is fair, balanced, and promotes the long-term sustainability and productivity of the economy.

The Government will ensure a progressive taxation system that is fair, balanced, and promotes the long-term sustainability and productivity of the economy.

Since no one – apart perhaps from one or two lump-sum taxers lurking under rocks somewhere – will disagree, it means very little in substance and constrains no practical choices. The substance of any tax reform will no doubt flow from the tax working group they propose to establish – where the terms of reference and the people they agree to appoint will matter rather a lot.

My main interest in the whole document is the commitment to establish a fiscal council.

Measuring our success in government

The credibility of our Budget Responsibility Rules requires a mechanism that makes the government accountable. Independent oversight will provide the public with confidence that the government is sticking to the rules.

We will establish a body independent of Ministers of the Crown who will be responsible for determining if these rules are being met. The body will also have oversight of government economic and fiscal forecasts, shall provide an independent assessment of government forecasts to the public, and will cost policies of opposition parties.

It isn’t in the official document, but in another interview with Robertson he confirmed that the body would not be located inside Treasury.

The establishment of a body of this sort would be entirely conventional for an advanced, open, economy. It is something the OECD, for example, has recommended for some time and (from memory) the Treasury’s own external reviewer a couple of years ago also favoured establishing one.

Early last year the Green Party came out advocating the establishment of an independent policy costing unit. I wrote about the proposal here. It was a well-intentioned, but somewhat flawed, proposal – including because, somewhat surprisingly, it had proposed locating the independent unit, to cost opposition party policies, inside the Treasury.

I noted at the time that

I reckon that if New Zealand is going to establish such a unit it should be done as an office of Parliament, and I wonder why the Greens chose not to take that option. Perhaps they took the view that such a unit would be cheaper if it operated within Treasury (drawing on the corporate functions of a larger organization). But even if that were true, I suspect it would be a false economy.

On the overall proposal, I noted

But is it worth going down this track? I’m still ambivalent. I don’t think there is enough thoughtful scrutiny of macroeconomic policy issues in New Zealand (and touched on some of that here), and before the Greens proposal goes any further it would be worth looking carefully at what is done in other countries.

Before concluding

On balance, I still think there is a role for something like a (macro oriented) fiscal council in New Zealand, perhaps subsumed within the sort of macroeconomic or monetary and economic council I suggested here (but perhaps that just reflects my macro background). And there is probably a role for better-resourcing select committees. But when it comes to political party proposals, if (and I don’t think the case is open and shut by any means) we are going to spend more public money on the process, I would probably prefer to provide a higher level of funding to parliamentary parties, to enable them to commission any independent evaluations or expertise they found useful, and then have the parties fight it out in the court of public opinion. The big choices societies face mostly aren’t technocratic in nature, and I’m not sure that the differences between whether individual proposals are properly costed or not is that important in the scheme of things (and perhaps less so than previously under MMP, where all promises are provisional, given that absolute parliamentary majorities are very rare). If there are serious doubts about the costings, let the politicians (and the experts each can marshall) contest the matter.

I presume Labour and the Greens are still some considerable way from pinning down all the details of how the proposed body would work. I remain a bit sceptical about the policy costing dimension of the proposal, for reasons outlined at greater length in the earlier post, and suspect that if they do get the unit up and running it will be a distinctly secondary function.

The main area where a fiscal council – or indeed, a broad macro policy advisory council – could add value is around the bigger picture of fiscal policy (not just rule compliance, but how the rules might best be specified, and what it does (and doesn’t) make sense to try to do with fiscal policy).

But there are still important caveats. For example, it is fine to talk in terms of the council having “oversight of government economic and fiscal forecasts”, but quite what level of resource would that involve? Does the proposal envisage that the core forecasting role, on which government bases its policies, would move outside Treasury? Even if there was some merit in that, it would be likely to end up with considerable duplication – since neither the Treasury nor the Minister is likely to want to be without the capability to have their own analysis done, or to critique the work of the fiscal council. The UK’s experience is likely to be instructive here, but we also need to recognise the small size of New Zealand and the limited pool of available expertise. Our population – and GDP – are less than a 10th of the UK’s.

Again, I think Labour and Greens are moving in the right direction here, so I’m keen to see a good robust institution created, not to undermine the proposal. The success of such a body over time will depend a lot on getting the right people to sit on the Council, and to keep the total size of the agency in check. Too large and it will be an easy target for some other future government – no doubt enthusiastically offered up by a Treasury keen to remove a competing source of advice. But make it too small, or with too many establishment figures on the Council, and people will quickly wonder what is the point. As it is, we don’t have a lot of independent fiscal expertise in New Zealand at present (as distinct, say, from specific expertise on eg aspects of the tax system). I presume that if they form a government later in the year, Labour and the Greens will be looking quickly to the experiences in this area of small advanced countries like Ireland and Sweden.

My other caveat isn’t a specific criticism of this proposal, but rather a more general one. It is always easy to establish new, small, government entities. Each on its own doesn’t cost much, but they all add up. Perhaps there would be something to be said for a one-in one- out “government entity budget”, to parallel the “regulatory budget” approach being tried in a few places. I wonder which entity Labour and the Greens would kill off to make way for a fiscal council? It would be easy for someone on the more sceptical side of the debate around the role of government, and the incentives/capabilities of government, to come up with a list. But that isn’t usually where Labour and the Greens are coming from and in time layer upon layer of marginally useful government entities provide lots of jobs for the boys (and girls). It has been a while since there was a good quango-hunt. Perhaps we are overdue for another?

What does the OECD really have to offer us?

March 24, 2017March 24, 2017 Michael Reddell New Zealand economic performance, Productivity

The Organisation for Economic Cooperation and Development (OECD) is often loosely described as “the rich countries club”. It isn’t an entirely accurate description – there are several high income oil exporting countries who don’t belong (as well as places like Singapore and Taiwan), and some countries that are members (notably Mexico and Turkey) aren’t particularly high income. But it is a grouping of mostly fairly advanced fairly open economies (New Zealand’s been a member since 1973). And the organisation claims to be able to offer useful advice to countries as to how to improve their economic performance. I’ve become increasingly sceptical of that proposition, especially as regards New Zealand.

On a biennial cycle the OECD’s Economic and Development Review Committee (EDRC) meets in Paris to review each member country’s overall economic performance, and offers some specific advice both on general economic management issues and on specific topics agreed in advance between the secretariat and the country concerned. I wrote about the process, which draws on extensive staff work, on the day New Zealand was last reviewed in April 2015.

The next review is almost upon us. The EDRC is scheduled to discuss New Zealand on 20 April, so the draft text is probably already in the hands of New Zealand government agencies. The final text will presumably be released in late May or early June. This year’s agreed special topics are “Increasing Productivity”, and “Labour Markets and Skills”. The latter topic apparently includes the New Zealand immigration system, and when the OECD team came to Wellington last year I participated in a meeting with them, along with various government agency representatives, on some of the strengths and weaknesses of our system. Historically, the OECD tends to be very strongly pro-immigration – without much evidence for its benefits, especially in remote places like New Zealand – and I expect their treatment this time will again reflect that presumption, probably with some suggested tweaks at the margins. But, as often, the OECD might be able to present some cross-country data on the issues in interesting ways.

Quite what they’ll come up with to increase productivity could be more interesting. In many ways, New Zealand is a test for whether the OECD has much useful to say. For a member that was once among the richest and most productive OECD economies and now languishes a long way down the league table, New Zealand has been a bit of an embarrassment to the OECD. After all, we did an awful lot of what they suggested 25 to 30 years ago.

I’m writing about the issue because a few days ago the OECD released one of their flagship cross-country publications, Going for Growth. These documents often contain a lot of interesting cross-country comparative material – data collection and presentation is one thing the OECD defintely does well. But they also get specific, and have a couple of pages of economic policy priority recommendations for each country. Since the OECD must already have written their full substantive report on New Zealand for the forthcoming EDRC survey, one might have expected that the recommendations for New Zealand would be particularly incisive and well-focused, offering suggestions which, if adopted, would clearly help reverse our long-term underperformance. As they note, labour productivity gaps between New Zealand and the other advanced economies have continued to widen over the last quarter century. As the OECD’s own chart illustrates, real GDP per hour worked is now about 37 per cent below the average for the countries in the upper half of the OECD (these are countries from Luxembourg and Norway at the top, to Italy and the UK at the bottom).

So what does the OECD propose for New Zealand?

Reduce barriers to FDI and trade and to competition in network sectors. Recommendations: Ease FDI screening requirements, clarify criteria for meeting the net national benefit test and remove ministerial discretion in their application. Encourage more extensive use of advance rulings on imports and improve the publication and dissemination of trade information. Sell remaining government shareholdings in electricity generators and Air New Zealand. Remove legal exemptions from competition policy in international freight transport.
Improve housing policies. Recommendations: Implement the Productivity Commission’s recommendations on improving urban planning, including: adopting different regulatory approaches for the natural and built environments; making clearer government’s priorities concerning land use regulation and infrastructure provision; making the planning system more responsive in providing key infrastructure; adopting a more restrained approach to land regulation; strengthening local and central government emphasis on rigorous analysis of policy options and planning proposals; implementing pricing to reduce urban road congestion; and diversifying urban infrastructure funding sources.
Reduce educational underachievement among specific groups. Recommendations: Better target early childhood education on groups with low participation in such education. Improve standards, appraisal and accountability in the schooling system.To improve the school-to-work transition, enhance the quality of teaching, careers advice and pathways, especially for disadvantaged youth, and expand the Youth Guarantee. Facilitate participation of disadvantaged youth in training and apprenticeships. Students from Maori, Pasifika and lower socio-economic backgrounds have much less favourable education outcomes than others.
Improve health sector efficiency and outcomes among specific groups. Recommendations: Increase District Health Boards’ incentives to enhance hospital efficiency, improve workforce utilisation, integrate primary and secondary care, and better managed chronic care. Continue to encourage the adoption of more healthy lifestyles.
Raise effectiveness of R&D support. Recommendations: Further boost support for business R&D to help lift it to the longer term goal of 1% of GDP. Evaluate grant programmes. Co-ordinate immigration and education policies with business skills needs for innovation.

The general goals seem fine, in as far as they go. And some of the specifics seem sensible enough too (others – more R&D subsidies, government encouragement of “more healthy lifestyles” – seem distinctly questionable). But could anyone with a reasonably in-depth understanding of the New Zealand economy and its performance over the last few decades, really think that that list, even if adopted in full, would really make a material difference in turning around New Zealand’s long-term productivity underperformance? I’m all for fixing the housing policy disaster, but when the OECD talks of the agglomeration gains that might make possible, have they actually looked at the dismal Auckland productivity performance over a period when Auckland’s population has already grown very rapidly?

It is also quite surprising what they don’t mention. Perhaps macro imbalances, such as our persistently high real exchange rate, or our (typically) highest real interest rates in the OECD, don’t easily fit in a structural policy document – although they are significant symptoms that a list of possible structural policy remedies needs to notice.

But the OECD does publish as part of Going for Growth quite a range of cross-country comparative data on various structural policy indicators. Even then there are puzzling omissions. There is nothing at all, for example, on immigration policy. And company tax is also missing. Here is the data from the OECD website on statutory company tax rates for 2016.

company tax rates

New Zealand is in the upper third of OECD countries – and with a company tax rate well above that group of countries (from the Czech Republic to Switzerland) at around 20 per cent. I’m all in favour of reducing FDI barriers, for example, but for many firms who might consider establishing here, the likely tax bill is probaly a more significant consideration. And I suspect it offers more payoff in improving productivity than the health system, whatever the merits of the specifics they propose there.

It was also interesting that the OECD does not mention our labour laws. It is well-known that our minimum wage is quite high relative to median wages/labour costs. In fact, the OECD again illustrate it in their indicator pack. This is their chart, and I’ve simply highlighted New Zealand.

min wage OECD

It is a quite a stark picture, but doesn’t seem to be a priority issue for the OECD. Actually, I doubt altering the minimum wage laws offers very much on the productivity front, but even if one is simply concerned about disadvantage (as they very much seem to be) we know that getting people into jobs is the best path towards longer-term economic security. One needn’t go to the US end of this spectrum, but places like the Netherlands and Belgium aren’t exactly known as bastions of heartlessness, small government or whatever.

Overall, I think the list still suggests the OECD has very little idea what has gone wrong in New Zealand, and hence has little more than a generalised grab bag of ideas to offer in response – many no doubt quite useful in their own way, but mostly likely to be tinkering at the margins.

Out of curiousity, I had a look at what they had to recommend for the previous country on the (alphabetical) list – the Netherlands. It is an interesting country too. Productivity – GDP per hour worked – is above that for the group of countries in the upper half of the OECD. Indeed for decades productivity levels in the Netherlands have been very similar to those in the United States. Per capita income lags a bit behind, because Dutch people on average don’t work long hours each year (although the participation rate is high). But it is, by most counts, a very successful economy. Real GDP per hour worked is about 65 per cent higher than in New Zealand.

What does the OECD recommend for them?

Lower marginal effective tax rates on labour income.
Ease employment protection legislation for regular contracts and duality with the self-employed.
Reform the unemployment benefit system and strengthen active labour market policies.
Increase the scope of the unregulated part of the housing market
Increase direct public support for R&D [even New Zealand spends more on this than they do]

Setting aside the OECD’s taste for R&D subsidies, it mostly seems sensible, plausible, and well-targeted. They seem to have a better idea what to offer an already rich and successful country in the heart of Europe, than they have to offer a once-rich now-underperforming remote one. For us, that is a real shame.

One can only hope that when the productivity chapter of the forthcoming New Zealand economic survey comes out, they can offer a more persuasive grounded set of recommendations as to what might make a real difference in reversing our decades of underperformance.

(For a more optimistic take on the OECD’s recommendations for New Zealand, see Donal Curtin’s assessment.)

In sort of, kind of, half-hearted partial defence of Wellington City Council

March 23, 2017March 23, 2017 Michael Reddell Wellington

That isn’t a stance that comes naturally. Wellington City Council wastes money with the best of them (convention centres, possible runway extension, bike stands outside our church, and so on – they even use ratepayers’ money to help fund the New Zealand Initiative) and presides over land-use restrictions that deliver increasingly high house prices. And then there are more localised gripes – but which have managed to get quite a bit of national coverage – like the Island Bay cycleway.

It was built without adequate consultation, and after it was built an overwhelming majority of participants in a well-run survey of residents conducted by the Residents Association told the Council they didn’t like it and wanted it gone. There was never an obvious reason for it in the first place – The Parade was one of the wider flatter safer streets in Wellington – but the then Mayor lived in Island Bay and liked to cycle to work. (It remains part of a grand vision of a cycleway all the way into the city – key bits of rest of the route currently serviced by roads that are barely wide enough anyway). And the only bit of the street I’d be a bit hesitant about cycling – through the shopping centre, with reversing angle parkers etc – is the only bit where there is no cycleway. It has been a fiasco all round. It is still relatively early days, but as someone who is mostly a pedestrian or a motorist, I suspect the overall environment is now more dangerous than it was (not very). As a pedestrian, one suddenly finds the cycleway merging with the footpath (to get round bus stops). As a motorist turning out of side streets it is materially harder to see oncoming traffic than it used to be. And I’m not at all sure how people who live on The Parade, backing out of their driveways, cope. It would probably matter even more if there were many cyclists, but on a nice autumn morning I just walked the length of the cycleway and didn’t see a cyclist.

The story is back in the news because a local dairy owner has decided to close his business, and blames the loss of short-term parking for a downturn in business (more than a few parks were removed to facilitate the cycleway). Perhaps so, but I’m just a little sceptical. Perhaps that is partly because it isn’t clear to me who uses dairies, even when parking is no problem, apart perhaps from school kids buying lollies. I’m in the neighbourhood all day, and I might have used a dairy twice in a year. But along the length of the cycleway – a distance I just walked in 14 minutes – there are six dairies (including the one planning to close soon) and a full-service supermarket (open from 7am to 10pm every day), for a population of around 7000. There were only one or two more when I first moved here 40 years ago. On one corner, two dairies face each other across the street – and somehow seem to survive. And actually, the dairy that is to close is the furthest from all the others, and the only one everyone has to pass coming into Island Bay from the city. It is a little hard to believe that the ill-considered cycleway is the only, or even dominant, factor. The Wellington City Council is guilty of many things, and a prima facie assumpton that they will be guilty of whatever they are charged with is often safe (don’t get me started on the walkway they currently have indefinitely closed to protect “heritage interests”), but perhaps not this time.

None of which excuses the inaction on the cycleway. It was kicked beyond the election last year, even after the survey results had been released, and now we are told to expect a decision in six months time. Meanwhile, of our two local councillors, one is off to become a member of Parliament – unless perhaps the Greens find a more dynamic candidate, in this one of their strongest party vote seats – and the other sees his future in Christchurch – he’s running for Parliament for the Greens in Ilam. The fear remains that the other councillors, the bureaucrats, and the cycling lobby – all keen on a whole network of cycleways – will just wait things out and the monstrosity will be with us forever.

Agreeing with the Governor

March 23, 2017 Michael Reddell inflation, Monetary policy

If I go on finding myself agreeing with Graeme Wheeler, there won’t be much point writing about OCR announcements. But, as it happens, he has only three more to deliver.

I could quibble about a few details in this morning’s announcement, but the only one I wanted to highlight briefly was this proposition

Monetary policy will remain accommodative for a considerable period.

In six months and a few days, the Governor will have moved on. We’ll then have an acting Governor, with no Policy Targets Agreement, for six months. And not until this time next year will we have in place a monetary policy decisionmaker, with an agreed target, who can make moderately credible statements about possible monetary policy decisions over the medium-term. So to be strictly accurate, that sentence should probably have read something like

“If the forecasts underpinning today’s decision are roughly right, and if my successors have (a) the same target I do, and (b) the same interpretation of that target, and the same reaction function, then monetary policy will remain accommodative for a considerable period.”

But in this post, I’m backing the Governor, and one line I was particularly pleased to see was this one (emphasis added)

Global headline inflation has increased, partly due to a rise in commodity prices, although oil prices have fallen more recently. Core inflation has been low and stable.

I made that point here a while ago, so I was pleased to see the Reserve Bank also highlight the point. Here is what I mean, using the OECD’s data on CPI inflation ex food and energy – the one readily available and consistently compiled core inflation measure.

OECD inflation ex food and energy

I’m using monthly data, to be as up-to-date as possible, and New Zealand and Australia don’t have monthly CPI data. But the comparable quarterly chart doesn’t look materially different.

I’ve shown two lines. The first is the median core inflation rate for all individual OECD countries (with monthly data). But that includes 19 euro countries (plus Denmark) that have only one monetary policy. So the second line is the median core inflation rate for the distinct monetary policy countries/areas – ie delete the individual euro area countries, and replace them with an inflation rate for the euro area as a whole. I’d probably tend to emphasise that measure.

But on neither measure is there any sign that core inflation has been picking up at all. And although the US has been raising its policy interest rate to some extent, there have been more cuts in policy interest rates in the last 18 months or so (the sort of time it takes policy to work) than increases.

Of course, that is only actual inflation outcomes. Perhaps there is more inflation just ahead of us – a story markets seem to have taken a fancy to.

For what it is worth, international agencies still thought there was a negative output gap across the advanced world last time they looked (the OECD thought it was -1.4 per cent last time they updated their published forecasts).

The unemployment picture – another read on excess capacity and resource pressures -is a bit different. For the G7 countries as a whole, the unemployment rate is now a touch below the troughs reached at the peak of the last boom. For the OECD group as whole – even including places like Greece – it is only around 0.7 percentage points higher than at the peak of the last boom. For the median OECD country, the unemployment rate now only about half a percentage points above the average for the last boom year (2007).

Here are the unemployment rates for the largest OECD economies

U rates big countries

The unemployment rates have been falling for some considerable time, and there has been no pick up in inflation yet. For each fall, of course, the respective NAIRUs must be getting closer, but it is probably safer to wait and see that core inflation has actually begun to rise – especially in view of the low starting level – than to simply assume that it must happen soon.

Of course, when one looks at unemployment rates what does tend to stand out is how little the unemployment rates in New Zealand and Australia have come down.

U rates NZ and Aus In both countries the current unemployment rate is around 1.5 to 1.7 percentage points higher than it was in the year or so prior to the global downturn. And neither country was troubled by a domestic financial crisis, nor did they run out of room to use conventional monetary policy. The monetary policy authorities should have been able to do better. If I look across the monetary areas in the OECD (again replacing individual euro area countries with the region as a whole), the only places with a worse record on this score – unemployment rates now compared to the pre-recession levels – are:

the euro area as a whole (visible in the first chart above) where they did run out of conventional monetary policy options,
Norway, and
Turkey, not a paragon of economic management or political stability.

Core inflation measures have been picking up a little here, as they should have after the sharp cuts in the OCR the Reserve Bank had to implement. But our unemployment record – at a time when much of the rest of the advanced world has been able to run unemployment rates back near pre-recessionary levels without (yet) seeing signs of core inflation rising – is one reason why I think the Governor is quite right not to express any bias about the direction of the next change in interest rates, however far away (and delivered by a person yet unknown) that might be.

Superior measures, but still no productivity growth

March 22, 2017March 22, 2017 Michael Reddell Productivity

Statistics New Zealand this morning released their best estimates of New Zealand productivity growth. They are annual only – so the new data is for the year to March 2016 – and cover only the “measured sector”, so excluding parts of the public sector in particular where productivity is just very hard to measure (there are few market prices for the services for a start). They also make an adjustment for the changes in the composition of the labour force – there is, in principle at least, a lot more human capital associated with an average worker now than decades ago when few people had a tertiary education.

Last week I ran this chart, showing an estimate of quarterly labour productivity growth (real GDP per hour worked)

real gdp phw dec 16 release

It isn’t an encouraging picture. In fact, the last five years have been so bad, I’ve been hesitant about believing reality was quite that bad.

But here is new annual data, showing labour productivity and multi-factor productivity, both indexed to 1998 when the data in this format start.

measured sector productivity mar 2017

The summary?

No multi-factor productivity growth, in aggregate, for a decade – the latest data point is very slightly below that for the year to March 2006.
And no labour productivity growth for the last four years – a picture very similar to the (differently measured, and more recent) real GDP per hour worked chart above. In the last 10 years, there has been only around 4.5 per cent labour productivity growth in total.

Different models, and different measurement bases, will produce different results. None of them suggest there has been much productivity growth in New Zealand for some considerable time. And to repeat Paul Krugman’s succinct summary

“Productivity isn’t everything, but in the long run it is almost everything.”

New Zealand Initiative on immigration: Part 10 Recommendations and Conclusion

March 22, 2017March 22, 2017 Michael Reddell Immigration, New Zealand Initiative

At last we get to the end of the New Zealand Initiative’s report on New Zealand’s immigration policy.

I don’t want to spend much time on the Conclusion page or so. Even in a short section, there is lots I could challenge or disagree with, but much of it is ground already covered. But I did want to highlight briefly the tone they adopt. It is not one that, say, respects the very wide differences in immigration polices found across time and across the countries of the world (even just among the relatively advanced countries). Or one that recognises that in some area men and women of goodwill and decency might have different preferences as to how best to organise or govern societies. It isn’t even one open to the possibility that not all state-facilitated immigration – to any place, at any time – will necessarily benefit the natives of the place. Rather, the only things that can possibly lead to different conclusions than the Initiative are fear, confusion, racism and so on.

This is what I mean.

Such is the intensity of the fear and confusion among the public that many opposition parties have seized on this narrative, some naively and some opportunistically. The pro-immigration Key government too has tightened policy settings to appease the public.

No one, presumably, has engaged in a thoughtful or considered reassessment?

Radical changes to policy settings simply to appease populist fears is misguided and even harmful.

The only reason anyone might apparently consider change is “to appease populist fears”.

Which is all a bit odd because a couple of paragraphs on they come to the economic aspects of immigration – economics being the core expertise of Initiative people. And there, writing about New Zealand, they say (emphases added)

Economic worries about immigration are overblown. There is no compelling reason to believe migrants are causing major detrimental impacts to the labour market. Although the empirical evidence is less than conclusive, there are good reasons to believe, as most economists do, immigration can make a positive contribution to economic growth.

Note how weak the actual claims are. It isn’t exactly a ringing endorsement of the contribution of New Zealand’s immigration policy to the economic wellbeing of New Zealanders. After all, I’m happy to sign up to the proposition that immigration “can” make a positive contribution to per capita economic growth, productivity, NNI per capita or whatever. Pretty clearly it did in New Zealand in the 19th century. It is just that the Initiative, at the end of a major report, can point to no evidence that it actually has done so in recent decades, or is doing so now, in New Zealand.

But what of their specific policy recommendations? For practical purposes, they endorse roughly the current scale and structure of our immigration policy (with no attempt to assess whether New Zealanders would be better off if, say, the programme were 50 per cent larger, or smaller, than it is). There are, broadly, four areas of reform they suggest. As they argue – noting again the loaded language

Most of the low-hanging fruit have been picked, but policy can still be improved. And there are less harmful ways to placate those who demand an exclusionist policy.

The first is “giving business more of a say”. In some areas, I agree with them. For example

Rather than let government decide what types of skills the market needs, let the market reveal it through the price system. A market-driven approach could be to adjust the points system to assign points to the salary ranges of job offers rather than the specific industries migrants are qualified in.

I would favour something similar for our short-term work visa rules. Set age-related salary thresholds, and set them quite high, and use that as the main tool to decide whether or not to approve a work visa. I’d have no real problem in offering work visas fairly freely for any position (genuinely) paying, say, $100,000 per annum or more, subject to a limit of, say, three years. After all, in the Initiative’s words – and ones I could have written myself

Skills ‘shortages’ can be rectified through higher pay rather than lobbying
government to add the skill requirement to the list.

Where I depart from the Initiative is when they fall back on comparing people with pineapples.

The free market is a much better decision-maker on how many imported pineapples or cars New Zealand needs. Likewise, the number and types of skilled workers New
Zealand requires is for businesses to decide without the strong hand of government.

What is being decided, in our medium-term immigration programme, is how many people, of what sort, will be able to come and join the polity that is New Zealand. Pineapples don’t vote, pineapples don’t come with cultures. People do. The Initiative seems largely indifferent to any notion of the state as agent of the collective preferences of its citizens, but most voters probably see it differently. I’d put their sentence the other way round:

“It is for the government, on behalf of the public, to make choices as to how many, and what type of, people to invite from abroad to become New Zealanders. Firms and employers will choose optimal production structures, remuneration patterns etc, in light of all the resources and constraints they face.”

The Initiative also explores the option of imposing a levy, “to limit the effects of migration on infrastructure costs”. One of the authors, Rachel Hodder, followed up this idea in an article on interest.co.nz. As she puts it

Our recommendation then also stands as a challenge to political parties that have been using infrastructure burden as justification for cutting immigration. If that is the genuine reason you believe immigration policy needs to be adjusted, then why not explore this option first?

It is an interesting idea, and I don’t think I’d have any objection in principle. It would increase the chances – although certainly not ensure – that large scale immigration would actually be benefiting New Zealanders in aggregate, although on its own it would do nothing to allay the distributional concerns (that relatively unskilled New Zealanders are losing out).

The Initiative proposes the idea of a levy without, as far as I can see, giving any sense of the possible size. One angle might be to look at the public sector capital stock, which presumably needs to be augmented, in much the same per capita amounts, for each addition to the population. As at last March, Statistics New Zealand estimated that the current value of the general government sector’s capital stock was around $41500 per person. But that is a depreciated value. Assume that all the capital was halfway through its life, and one could easily be looking at a per capita cost of putting in place the new public sector capital that new migrants require of $80000. Some of the public sector capital is already financed by user-fees, but most of it isn’t. I wonder if anyone is seriously willing to propose an $80000 levy for successful applicants for a residence visa in New Zealand – even if, say, it could be paid as an income tax surcharge over the following 10 years? In principle, it should raise the average skill level of the successful applicants to some extent. It would certainly deter migrants with children.

I don’t have a huge problem in principle with such a scheme but, rightly or wrongly, I suspect most people would judge that it was almost a “repugnant transaction” – they would prefer not to sell the right to become one of us. Is it different in character from inviting migrants in on the hypothesis that doing so will enrich us all (the current philosophy)? Perhaps not – and definitely not to the economist in me – but I can’t see it finding a great deal of public favour, among supporters or sceptics of the immigration programme.

The Initiative also seems to endorse proposals for New Zealand to sign reciprocal free movement agreements with any willing coountries, citing favourably ACT leader David Seymour’s suggestion to promote such agreements with Canada and the United Kingdom, complementing the arrangements we currently have with Australia.

Doing so with the UK in particular would, of course, restore the system that operated for more than a century after New Zealand was first settled. It was only in the 1960s and 70s that free movement between the UK and New Zealand was no longer legally permitted. At a political level, I find the idea quite appealing (but politicians in the two countries are unlikely to). At an economic one, I don’t. This simply harks back to my longstanding argument that the most important issue for New Zealand is the sheer number of immigrants we’ve been taking, not primarily what shills they’ve had or where they’ve come from. Most of our migrants in the early post-war decades came from the United Kingdom. At the time, material living standards here were better than those in the UK. But even now, decades on, no one has been able to produce studies – whether econometric ones or analytical narratives – demonstrating the productivity gains to New Zealanders from that large scale immigration. Economists at the time was pretty sceptical. Those now just seem uninterested in New Zealand economic and economic policy history, and the possible lessons it should offer.

These days, of course, New Zealand is poorer than the UK, but the UK is so much the larger country that even a small outflow from the UK to NZ (as a share of the UK population) would be materially disruptive to New Zealand, and would further set back the chances of lifting productivity and living standards here back to those in, say, the top half of the OECD. There is, additionally, the adverse selection problem, that the people most willing to migrate from a rich hub to a poorer, but perhaps more relaxed and spacious, country are hardly likely, on average, to be those with the greatest desire to succeed, and the strongest likelihood of offering the vaunted productivity spillovers.

The Initiative’s final suggestion for policy improvement is in the area of sponsorship for migrants.

A separate visa category could allow committed people to sponsor and support migrants in adverse circumstances, provided adequate checks and balances are in place. Canada allows community groups to sponsor refugees above the quota if they agree to be responsible for the basic care and support of the refugees, and New Zealand is laudably trialling this system for refugees here.

In principle, I’d have no particular problem with this suggestion. As they note

Requiring bonds from sponsors could ensure the sponsors are held to their commitment.

But I think it is an approach mostly best operated on a relatively small scale. Immigration policy is a collective decision about the number, and sort, of people we welcome to become future New Zealanders. I’m not sure we want motivated minorities – whether libertarians, evangelical Christians, Wahhabi Muslims or whatever – trying to skew the population balance over time by fundraising to bring in lots more of their own. Each group is, of course, welcome to evangelise and persuade, and perhaps if the libertarians ever persuaded enough of us we’d have open borders after all. But make it a contest of ideas, not of the power to buy more imported supporters.

In the end, it is a pretty modest list of suggested reforms. Much as they seem driven by a vision of open borders, in the end the Initiative is worried that New Zealanders might be getting uncomfortable with the grand Think Big experiment of New Zealand existing immigration policy over the last 25 or so years. It has delivered us a large increase in the population, and a lot more ethnic restaurants and higher house prices (to take the most obvious gains and downsides), but with little or no evidence that it has done anything to lift our overall economic performance. As the OECD noted again only the other day, for the last quarter century our productivity – already low – has just drifted a little further behind other advanced countries. Perhaps it is past time to rethink this key dimension of economic policy.

My own preferrred model would probably have these elements:

Reducing the residence approvals target from around the current 45000 per annum to, say, 10000 to 15000 per annum. In per capita terms, that would be about the rate of legal immigration the US has, and would be similar to the rate we had in the 1980s. Not exactly closing the door, but certainly pulling it over to some extent.
Within that reduced target I would look to focus much more strongly on demonstrably highly skilled people (who offer the best chance of fiscal and productivity gains) and thus would
- revisit, reduce and potentially eliminate the current Pacific access categories,
- permanently eliminate parent visas, except (and even then capped) where there is an enforceable, insured, commitment to full financial support from the parent, or their New Zealand citizen child.
- leave the refugee quota as it is
- eliminate the additional points provided for job offers in regional areas (a measure that is tending to lower the average quality of the accepted migrants)
- eliminate additional points for New Zealand specific qualifications,
- eliminate additional points for jobs in areas of “future growth” or “absolute skill shortage”
- more strongly differentiate points in favour of higher level qualifications,
- perhaps establish a category akin to the US visa for those with extraordinary ability
Eliminate the provision allowing foreign students studying here to work 20 hours a week. If New Zealand tertiary institutions really have a product worth buying – and some probably do – they should stand on their own feet, as other exporters are required to.
Reshape the work visa system with a view to (a) reduce the scope for lobbying and influence peddling, (b) reducing the total number of people here on work visas at any one time, and (c) provide much greater flexibility for employers to utilise work visa people for short specific periods in highly-skilled and well-remunerated roles. Since there would be many fewer residence approvals place open (see above) this path would in any case be much less popular with prospective migrants. Specific features might include:
- no one could have a work visa for more than two three year stints
- use an age-based matrix in which in normal circumstances no work visas might be issued to anyone under 30 for a role paying less than, say, (an inflation-indexed) $75000 per annum, increasing by (say) $25000 in each five year age window up to a cap so that for a person over 50 to get a work visas they would need to be in a role paying $200000 per annum or more.
- no doubt there would need to be some exceptions to this, and it would not apply to say approvals for roles of less than perhaps three months, but the point is to get the focus not on official judgements of “skill shortages” but on attracting people, if we do, who are capable of commanding high salaries (loose proxy for skill) on market.

Is it a perfect scheme? No, of course not. That isn’t a meaningful test for any human institution. Is it a scheme for other countries. No. Some might find it useful, but for others – where there might be clear evidence of gains to natives from large scale immigration – it might be quite inappropriate. But for the specifics of where New Zealand finds itself now, it would be a huge step in the right direction. For a very remote place, in an age when personal connections seem to matter more than ever, it would give us a much better chance of finally beginning to close the income and productivity gaps, and offer New Zealanders – the inevitably fewer number of future New Zealanders than under current policy – the chance of achieving world class productivity and living standard here in their own place.

croaking cassandra

Economics, public policy, monetary policy, financial regulation, with a New Zealand perspective

Month: March 2017

Natural resources: Norway and the UK

Do big countries get richer (or more productive) faster?

Comparing ACC investment returns to NZSF’s

Time to wind-up the NZ Superannuation Fund

Labour/Green Budget Responsibility Rules

1. The Government will deliver a sustainable operating surplus across an economic cycle.

2. The Government will reduce the level of Net Core Crown Debt to 20% of GDP within five years of taking office.

4. The Government will take a prudent approach to ensure expenditure is phased, controlled, and directed to maximise its benefits. The Government will maintain its expenditure to within the recent historical range of spending to GDP ratio.

5. The Government will ensure a progressive taxation system that is fair, balanced, and promotes the long-term sustainability and productivity of the economy.

Measuring our success in government