A wager for the Minister of Finance to consider

In the speech I linked to in yesterday’s post, I noted that

…from all appearances, our leaders (political especially, but also bureaucratic) have largely given up, perhaps idly hoping that something will turn up. And occasionally inserting “higher productivity” into a speech isn’t evidence of serious intent – if anything, it seems more like a substitute.

and

Judging by the inaction of our leaders in tackling the persistent productivity failure it seems that when it comes to crunch ours (regardless of party) care much less about the kids – of this generation and the next – than the cheap rhetoric of election campaigns might suggest. Giving up on productivity – in practice, and whatever the rhetoric – is a betrayal of our kids (and their kids). And most especially it betrays the children towards the bottom of the socioeconomic scales, those who typically end up paying the most severe price of economic and social failure.

I’d written that a few days ago, but if anything events of the last few days just confirm my concern.

I gave the speech the first time over breakfast on Thursday morning.  I’d just read Amy Adams’ pre-Budget op-ed on Stuff.    There was nothing in that at all about productivity (word or idea), only self-satisfied comments about the allegedly wonderful economy National had bequeathed labour.  That, you’ll recall, was the one with 1.5 per cent productivity growth in total over the past five years.

I didn’t listen to her boss’s speech in Parliament, but I get Simon Bridges’ emails and this was his post-Budget line

This Government was gifted an incredible legacy by hard working New Zealanders and by National. They inherited a strong, growing economy improving the lives of New Zealand families. They inherited a much more prosperous and outward looking country.   

Yet today they’ve delivered a Budget that is strewn with broken promises. No universal cheaper doctor’s visits, 1800 extra cops that aren’t coming anytime soon, no money to build Dunedin Hospital, not to mention a raft of new taxes from a Government that promised ‘no new taxes’ in its first term.

Again, nothing at all about productivity, or the possibilities that it can offer all of us.  This was, after all, the man of whose first economics speech as leader, I noted

500 initiatives [something he’d boasted of in the speech] and we still had barely any productivity growth in the last five years.  And, as I recall, one of the BGA goals was a big increase in the export (and, presumably, import) share of GDP: those shares have actually been shrinking.  Productivity levels languish miles behind the better advanced economies, and the gaps showed no sign of closing.

But what of the current government?

Sure enough, there were quite a few references to productivity, and lifting it, in the Minister’s material.    Eight (to “productive” or “productivity”) in the speech alone.  In the Minister’s Fiscal Strategy Report (with the subheading “Foundations for the future”) there were 17 references to productivity (quite a few of them mentions of the Productivity Commission) and another fifteeen uses of “productive” (often prefaced by the aspiration “more”).

Which is fine and good as far as it goes.  But what backed it up?  Not much.

On the very first page of the Fiscal Strategy Report, the government’s priorities are described

The Government’s priorities were set out in the Budget Policy Statement in December 2017. They are:

• Building quality public services for all New Zealanders and improving access to core services, such as health and education.
• Taking action on child poverty and homelessness.
• Supporting families to get ahead and sharing the wealth generated by our economy with a wide range of New Zealanders.
• Sustainable economic development and supporting the regions.
• Managing our natural resources and taking action against environmental challenges, such as climate change.

That document outlined the Government’s ambitious plan to reduce child poverty, protect the environment, create decent jobs, and build more affordable houses.

And not a word, not even an allusion, to beginning to close those productivity gaps.  The Budget material as a whole looks as if referring quite often to lifting productivity was a substitute for actually doing anything serious about it creating a better climate for it.

If I recall correctly, there were a couple of references to things that might help.  For example, there was mention of tax reform flowing out of the Tax Working Group’s recommendation.  We all assume a limited capital gains tax will emerge at the end of the process, and not much more (land taxes, for example, became infeasible once the land under the family home was ruled out).  There might be a decent case for a limited capital gains tax, at least on grounds of (apparent) equity, but no one thinks a CGT is going to make any material difference to New Zealand’s productivity performance.  If the Minister really did, he’d be making the case, documenting the evidence etc.

There was also mention of the new R&D tax credit.  I guess reasonable people can differ on how much impact that will have –  my doubts are here and here – but I don’t know anyone who thinks it is a big part of changing the overall picture of productivity performance in New Zealand.

And then, of course, there is the Provincial Growth Fund. I guess the Minister’s party is in a coalition with New Zealand First, so he has to talk up the benefits of spending all that money.  Everyone else recognises that it is no part of a serious growth (in productivity) strategy.

And, on the other hand, there is not a mention of the (real) exchange rate, one of the more pressing imbalances in the New Zealand economy.

But don’t just take it from me.  The Treasury does the  economic forecasts.   They do expect a bit more productivity growth in the next few years than in the last few years, but (a) mostly that looks like an assumption that things just get back to less-bad “normal”, and (b) the assumed rates of productivity growth aren’t going to make any inroads at all on the huge gaps to the rest of the advanced world.   And although an increasingly open economy –  trading more with the rest of the world –  is usually part of any successful catch-up strategy, as I showed yesterday the Treasury forecasts suggest no reversal in the decline in the export/GDP share that took place over the last few years.

Treasury does its forecasts on the basis on government policy, but that doesn’t take account of things that are still just political promises (even if quite likely to be), like the capital gains tax.

So perhaps the Minister of Finance –  like his colleague the Minister of Housing – thinks The Treasury has it all wrong, and is far too pessimistic.  Perhaps he’s really convinced that his government will successfully turn round our productivity performance, and get us on the track for catching the OECD top-tier.   As I noted in my speech, with the sorts of productivity growth rates various catch-up OECD economies have managed over the last 15 years (crisis, recession, and all) we could halve that gap in fifteen years, and close it altogether by 2050.

US economist Bryan Caplan encourages people who really believe an argument to express it in the form of a wager (typically for reasonably modest amounts, of around $100).  Doing so forces the parties to identify clearly what they do and don’t believe, and think carefully about the probabilities.  In that spirit, I’d be happy to offer a wager to the Minister of Finance (and/or his colleagues, the Prime Minister, or the Minister for Trade and Export Growth).

Conditional on them remaining in government, I’d expect that, if they are really serious about productivity –  lifting the possibilities for our kids –  and believe they have the strategy to do it (even if not all the bits are yet on the statute books), they would be willing to wager that New Zealand will average annual labour productivity growth over the next six years of at least 2 per cent.  I’d be only too happy to take the other side of such a bet, because I see no sign in government policy of anything that will substantially turn around our productivity performance.  No doubt, there will be the odd good year –  some of which might just be measurement –  but I’d be very surprised if we manage total labour productivity growth of anything close to even 5 per cent in the next five years.  Of itself, that wouldn’t be disastrous –  it would be quite a bit better than the last five years –  but, once again, it would mean no progress in closing those gaps.      (Of course, if I were to lose such a bet, I’d mostly be delighted –  better prospects for all of us and our kids.)

In fact, I’m sure the Minister of Finance knows his strategy won’t make any material difference to New Zealand’s dismal productivity performance.  If so, the words are just a substitute for action, and the betrayal of our kids stretches on through yet another government.

 

29 thoughts on “A wager for the Minister of Finance to consider

  1. In a way the should always have to own their policies. Instead they spray and walk away.

    When will someone from the Media Party explain “outward looking country”?. Don’t they mean selling land to foreigners?

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    • No they mean bringing in more Muslim refugees and giving away $750 million to poorer nations which could have easily housed all our street beggars especially on this raining day today.

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      • $750 million Pacific Aid

        18 May 2018
        Caller “allocate” on TalkbackZB at 4:55 am on Bruce Russell’s segment reckons the Islands are playing NZ off against China. NZ should call their bluff, cease all aid and advise them to obtain aid from China, Next time they need hospital treatment go to China for it, and they can send their populace to China for temporary agricultural jobs, and send their students to China for their education, and China can set up its own immigration Pacific Quota scheme

        Liked by 1 person

      • Sorethumb from your link: “”Most notably, the Australian media derive a large part of their advertising revenue from developers and real estate agents. And like the housing industry, the media have a limited capacity to export their products so an expanding domestic market suits them well. Media proprietors have supported immigration for a long time.””

        Liked by 1 person

      • A couple of interesting links here:

        there is in general an expansionary bias in the politics of immigration in liberal democracies such that official policies tend to be more liberal than public opinion and annual intakes larger than is politically optimal.

        https://business.highbeam.com/437042/article-1G1-17801339/modes-immigration-politics-liberal-democratic-states

        and here

        Title Immigration and the election of Donald Trump: Why the sociology of migration left us unprepared…and why we shouldn’t have been surprised

        http://csdc-cecd.ca/wp-content/uploads/2017/07/Waldinger-presentation2.pdf

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      • Sorethumb: like this quote from ‘Modes of immigration politics in liberal democratic states.’
        “”As it turns out, those who benefit from immigration in direct and concrete ways are better placed to organize than are those who bear immigration’s costs. Immigration tends to produce concentrated benefits and diffuse costs, giving those who benefit from immigration greater incentives to organize than persons who bear its costs. “”

        However productivity does not correlate positively or negatively with immigration. With no immigration some aspects of well being in NZ would (or might) improve or at least would improve given time to assimilate those who like myself arrived in this millennium. NZ would still require specific policy changes to make us more productive. I’m currently in the UK which I left 23 years ago. Anecdotally the UK (Bradford this weekend) is conspicuously wealthier than Auckland and I wouldn’t have said that during my first visit to NZ in 1996. This article is correct – in terms of productivity NZ is treading water while other countries (UK, France, Belgium) are swimming ahead and worst of all our govt of whatever party doesn’t notice it.

        Liked by 1 person

  2. Michael,
    I have been reading your commentary for a year or two now and admire your attempt to get a conversation going on increasing Productivity.
    A question to me is ‘what actions to take’ that would do this?’
    I have always thought that getting a lower exchange rate would increase exports and hence employment in those industries. How to do this. Is QE a no-no? How else?
    How about the Fiscal Responsibility rules that ‘must be followed’? Would a release from these help?
    I despair that anyone has any ability to even suggest some starting points for the process.

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  3. Hi Mike,

    I agree with David’s point. If you were Finance Minister, what would be the, say 10, policies you’d implement to raise productivity ?

    I’m guessing curtailing some parts of inmigration would be one…

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    • For any given process one could say there are 4 options to improve productivity,

      1) Reduce the cost & retain the process quality & time

      2) Reduce the time & retain the process quality & cost

      3) Improve the quality & retain the process cost & time

      4) Throw away the process completely as it can be replaced with a new process which is more productive.

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      • Cost reduction does not improve productivity. Cost can be reduced by using cheaper labour alternatives which is why we keep using immigrant labour if available in abundance. However once we start to close off immigration then migrant labour will start to become quite expensive.

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    • Peter/David

      I might come back later in the week attempting to respond to the “10 policies” challenge. When asked in the wake of my speech what one policy I would adopt if I were given that freedom, my response was to cut the residence approvals target from 45000pa to 10000 to 15000 pa. Other issues I touch on briefly in the speech are land use reform and capital income taxation, but one also has to think of whole packages, balanced short-term sacrifices, and sometimes compensation for losers. Some ideas were touched on in this post I wrote when Ardern first became leader
      https://croakingcassandra.com/2017/08/03/a-fresher-approach-for-ordinary-new-zealanders/

      David: on your specific points, things around monetary policy or the fiscal rules won’t make a material difference. In economists’ lingo, it is the real exchange rate that is probably a key issue, and that is about removing roadblocks that have driven the price of non-tradables so far up relative to the price of tradables (another post i hope to do later in the week)

      Liked by 1 person

  4. I think increasing our productivity is tough, and I’ve never really heard any suggested strategies that I’ve been 100% convinced will work. The thing is, governments shouldn’t repeatedly talk about how they are going to improve productivity if they haven’t got a plan. Maybe this is a defeatist attitude, but perhaps NZ should accept that our productivity isn’t going to be that high in the near future and that most of our income is going to continue to come from exporting our natural resources. We should give up on the failed strategy of trying to import economic growth and productivity via immigration since it hasn’t worked, but has created real issues with the housing market and infrastructure. NZ has enough wealth to give its citizens a modest lifestyle, and with some significant changes to immigration and tax, perhaps more capital could flow into export oriented industries (as opposed to housing or building infrastructure for a growing population).

    Liked by 2 people

    • I have suggested many times that we need to change our industry focus back to making leading edge products that the world can buy. Tourism and international students is a $15 billion industry and highly subsidised in the roading and transportation, the cleaning up and the public facilities. Also we need to change our focus from primary industries like milk and meat which are already at 10 million peak cow numbers. NZ economists need to get their heads around the fact that 10 million cows is not highly productive. NZ economists cannot just ignore the 10 million cows just because they are not people.

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  5. Presumably the productivity solution in a pre-Civil War American cotton farm was another shipload of slaves. Low wage immigration is unlikely to help NZ’s productivity whatever the so called skills. Maybe an argument for high wage immigration can be made but some evidence would help.

    NZ govt should consider how to motivate those who are responsible for increasing productivity. These are mainly the young to middle aged experienced adults. I am visiting a successful couple who are in their forties with no children. They have a lovely house, fine cars, frequent holidays and they seem to work for about six months a year. They told me yesterday that “there is more to life than work”. In my era they would have had double their productivity byworking 12 months a year; they would have had children and been well-paid full-time employees instead of self-employed contractors who only work when they choose to. So the productivity solution should be incentives to have children (universal child benefits, tax deductible child care, ability to transfer income between cohabiting adults with children for minimising income tax) and disincentives to being self-employed (reduce all the costs of time and money for employing workers).

    Another issue is how to keep the productive Kiwi in New Zealand. Nothing wrong with a OE for a student but we lose our best people in the prime of their life. Owning your own home is a strong incentive for staying put along with making it less profitable to rent it out. Another incentive to stay in NZ would be superannuation linked to more than 10 years work.

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    • Kiwis are highly trained. My daughter, 6 months in her new job after graduation has already received a number of top performance awards from the company she works with but already feels that her talents are constrained in the small NZ business economy. Already she is planning to leave for Melbourne or Sydney within the next 2 years as she outgrows her job in NZ.

      Liked by 1 person

      • Good point. Rather similar to Steven Adams choosing to play basketball in the USA; he didn’t move overseas for money but for the opportunity – he was successful but if he had failed he could have returned to NZ. There was little NZ could have done to keep him here. Compare that with rugby players where NZ is the highest standard but any player just sub-All Black goes to Japan or Europe with money being the attraction. There a return of NZ to top OECD GDP per capita would have meant our watching Dan Carter rather than French fans.
        Would your daughter still be attracted to Sydney if it meant a reduction in salary? If she moves will she ever return? What size would Auckland have to so she would not feel constrained, 2 million, 4 million, 8 million? Fifty years ago she would still have been attracted to the big cities – probably a year or two in London but with no student debt and cheaper housing and less traffic congestion she would have returned to Auckland, married, had kids, bought a house and then a bach and lived the Kiwi dream.
        If stopping people like your daughter going overseas is the solution to NZ’s productivity problem then our govt needs to consider some serious policy changes – policies that improve quality of life for talented young adults.

        Liked by 1 person

    • Yes, John Key’s economic solution was the ‘Antebellum solution’ – think big via labour not capital and import more people… it was very similar to the model adopted by the agrian South pre-Civil War. Worked well if you were at the top of the pyramid…

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  6. Michael
    A tangential point on this topic on which Id welcome your views.
    There is a debate going on at present as to whether government should borrow $10 billion to invest in infrastructure. The theory being that such money could be had for about 3%pa. and with the economy growing (nominally) at 4-5%pa. presto, you don’t have a debt/gdp problem.
    My reservation about this idea is that interest rates could jump a lot from such an initiative. Not because NZ would get downgraded by S&P, but because a further $10B being rammed into an already congested construction sector would be inflationary.
    US 10y bond rates have risen from circa 1.5%pa. to 3.0%pa. over the last couple of years. Coincidentally US inflation expectations have risen from 1.1%pa. to 2.2%pa. So it seems that 1.1% of the 1.5% bond yield rise reflects inflation expectations, and presumably the other 0.4%pa. comes from the end of QE, increasing supply etc.
    My view is that NZGB yields will be at least as sensitive to CPI expectations.
    With that preamble, my question.
    If government decides to spend up big on construction and the country’s capacity is already strained, what are the ways to avoid cost pressure and which of these ways constitutes “improved productivity”?
    They could…Allow immigration of lots of workers? Import lots of machines? Import low cost materials? Use empowering legislation rather than going through consenting processes? Lower the cost of capital?
    When we talk about “productivity”, which of the above are productivity related and what is the difference between an initiative that has lifted productivity versus one which has allowed something to get built for a lower cost without improved productivity?
    Tim

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    • Increased productivity equates to less people to generate increasing levels of GDP. Infrastructure spending like rail is very marginal addition to productivity because our largest city Auckland or any other city is spread too far and too wide. With the new Waterview connection, traffic on Dominion Road is now much much better. It takes me 15 minutes to drive from Dominion extension to Mt Eden when previously it would have taken 45 minutes to an hour. Monorail as proposed by labour along Dominion will not improve travel times beyond this if that monorail has to stop at every low density suburb along the route.

      The $10 billion should go towards new technology companies that can produce leading edge high tech products like Rocket Lab which became a US company for a paltry sum of a couple of hundred million even though they have to continue to manufacture and launch rockets from NZ. The government should never have allowed this NZ incubation tech to fall into US ownership and NZ National Security should have prevented that.

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      • Even if we had paid to keep the Nestle choc factory running would hav kept productivity higher than the current tourism based scenario. This choc factory was considered a well run factory and efficient but was still shut down. Nestle has instead relegated the factory to now a tourist attraction. In this case profitability won out against productivity. NZ gained profitability but lost productivity. That’s the difference.

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      • Sorethumb, but in the case of Rocket Lab, they have a need to be in NZ and will continue to manufacture in NZ. Due to NZ isolation, the Gisborne site offers a weekly launch window which makes it highly competitive in the Space race and the Electron engine allows a much cheaper launch cost compared to US based rockets have a 6 monthly launch window. Apparently the Gisborne launch pad is the only privately owned launch pad in the world. Now US owned.

        In the case of Nestle, the Choc factory mainly supplies the local NZ and Australian market.

        It is not so much about scalability because you can scale up in NZ. Don’t forget that we do manufacture milk and Fonterra does export most of the $11 billion to markets around the world. So we can scale up and transportation and isolation is not a factor. But because we have chosen to focus our billions of investment and subsidies into Primary industries and tourism we have lost our focus on leading edge mass market products.

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      • 22,000 cows will have to be culled soon due to the disease mycoplasma bovis. This cull will be paid for by the NZ taxpayer of around $60 million and could be as much as $100 million. That is a subsidy. If that $100 million had gone to Rocket Lab it would remain a NZ company rather than now a US company.

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    • Tim

      Re your preamble, two additional observations:

      – it isn’t only the cost of debt that matters to these sorts of calculations, but the overall cost of capital. After all, any of these projects expose taxpayers to risk. For a reasonably well-analysed project (ie not just election-driven), that might be nearer 10 per cent.
      – you note how much US inflation expectations have risen. Our implied expectations, from inflation bonds, are still around 1.3%.

      But on your main question, much of the answer probably depends on a short vs medium term distinction. In the short-term all infrastructure spending is an increase (net) in inflationary pressures: real resources have to be diverted to building whatever the project is, actual capacity doesn’t usually increase until the project is finished. In that sense(eg) enabling legislation to speed up the process could even further intensify the near-term resource and inflation pressures, even though it would presumably also bring the new capacity on stream earlier. I’d count that as a productivity gain (even tho the short-term pressures don’t go away)

      Of your other options
      “They could…Allow immigration of lots of workers? Import lots of machines? Import low cost materials? Use empowering legislation rather than going through consenting processes? Lower the cost of capital?”

      Presumably almost all big machines are already imported anyway, so that option is largely moot.

      In general, higher immigration only exacerbates short-term resource pressures, since the workers need to live somewhere. It is a standard result in NZ economics that the short-term demand pressures typically outweigh the short-term supply pressures, all else equal. Perhaps there are ways thru on occasion – eg the Manapouri power station workers were housed on passenger liner brought in specially – but most migrants don’t bring their own houses (and money isn’t the issue here, it is about real resources).

      What of lowering the cost of capital? Well, of course, that is a

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    • Tim

      The other problem with the 3% vs 4.5% comparison is that it allows nothing for an equity risk premium. Seems prudent to me to work on a WACC of rather nearer 10 per cent in evaluating govt projects.

      Pretty much anything is going to put more short-term pressure on real resources, and inflation (which isn’t entirely a bad thing with inflation below target). SOmething like enabling legislation would bring the new capacity on stream earlier than otherwise (a genuine gain) but at the price probably of intensifying short-term demand pressures.

      Of the other options you mention, almost all large machines are already imported. As for foreign workers, since they all need to live somewhere, immigration tends to boost short-term demand pressures more than supply. Few migrants bring their own house – and the issue is about real resources, not money.

      What of lowering the cost of capital? Well, of course this is central to my arguments. Cut the trend rate of population growth and the domestic average risk-free rate (and cost of capital) will fall. On the other hand, we will also need a lot less new infrastructure in such a world, leaving space free for my investment to occur in outward-oriented tradables sectors.

      We should be wary of letting short-term considerations drive long-term choices. If immigration policy was really boosting long-term productivity materially I’d probably favour it, despite the inevitable short-term pressures. Perhaps the same could be said for infrastructure spending.

      On your final question, I think it is a false dichotomy. Getting a (economically viable) new road built sooner and more easily will be (directly) a cost-saving measure, but that cost saving enables the rest of the economy to work more efficiently, enabling some businesses that might not otherwise exists. Those gains will count as productivity. You could think of a world in which we put tariffs on importing big machines: take them off and the cost of building new infrastructure falls (a fairly direct effect) but the indirect effect – the productivity gain – is enabling the whole economy to work better.

      In short, none of the items in your list are productivity gains per se, but well-used they can be means towards that end. Badly-used, of course, they work in the opposite direction.

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  7. Michael
    Thanks for the full reply. Reading it, and thinking about my own experience, it feels like regulatory reform is the low hanging fruit if productivity gains are the goal. I suspect Wellington’s traffic congestion would long ago have been ameliorated but for a long series of regulatory interventions.
    This Government seems inclined to have more regulation not less. That may make us all safer, healthier, etc. But not more productive
    Tim

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    • Tim

      I generally agree with you about the creeping paralysis of regulation. My caution is that the best indicators suggest that on that count we aren’t particularly awful by international standards. We could do a lot better – and there would be real gains for us all if we were to do so – but it is unlikely to be a material part of the answer in closing the productivity gaps to place like France, Belgium, or even the US (think of the pervasive occupational regulation there, as just one example.

      Like

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