Options for the next serious recession: fiscal policy

August 22, 2018August 22, 2018 Michael Reddell Fiscal policy, Monetary policy, zero lower bound

I’ve run various posts over the last few years urging the authorities (Reserve Bank, Treasury, and the Minister of Finance) to get better prepared for the next serious recession (and lamenting the relative inaction on this front in other countries too, many of whom are worse-positioned than New Zealand is).

As a reminder, we went into the last recession with the OCR at 8.25 per cent, while the OCR now – years into a growth phase, with resources (on official assessments) fairly full-employed – is 1.75 per cent. In that last recession, the Reserve Bank cut interest rates a long way, the exchange rate fell a long way, there was really large fiscal stimulus cutting in as the recession deepened, and there were lots of other interventions (guarantee scheme, special liquidity provisions) and it was still as severe as any New Zealand recession for decades, and took years to fully recover from (on official output and unemployment gap estimates perhaps seven or eight years). Lives were blighted, in some cases permanently, in an event where there were no material constraints on the freedom of action of the New Zealand authorities. In fact, our Reserve Bank cut the OCR (over 2008/09) by more than any other advanced country central bank.

Next time, whenever it is, it seems very unlikely that the Reserve Bank will have that degree of freedom, particularly around monetary policy. On current policies and practices around bank notes, it seems unlikely that the OCR could be usefully cut below about -0.75 per cent. Beyond that point, most of the action would be in the form of people shifting from bank deposits etc to physical currency, rather than buffering the economic downturn.

Our Reserve Bank has long appeared disconcertingly complacent about this issue/risk. The latest example was comments by the new Governor and his longserving chief economist following the latest Monetary Policy Statement. They talk blithely about the unconventional policy options other countries have used, but never confront the fact that almost no advanced country could have been comfortable with the speed of the bounceback from the last recession. Output and unemployment gaps of eight or nine years (the OECD’s estimate for advanced countries as a whole) aren’t normal and shouldn’t be acceptable.

Quite why the Reserve Bank is so complacent is something one can debate. My hypothesis is that it is some mix of assuming we will never face the problem (recall that they have spent years hankering to get the OCR back up again) and of noting that other people/countries will most likely face the problem before New Zealand does. They also like to remind us that New Zealand has a floating exchange rate as if this somehow differentiates us (as a reminder so do Australia, Canada, Norway, Sweden, the US, the UK, Japan, Korea, Israel, and even the euro-area as a whole). Whatever the explanation, robust contingency planning, and building resilience into the system, is what we should be expecting from the Reserve Bank (and Treasury). There is no sign of it happening. Meanwhile, the Governor plays politics in areas (eg here and here) that really aren’t his responsibility.

In my post on Saturday, I touched again on the desirability of doing something – specific and early, consulted on and well-signalled – about removing the effective lower bound on nominal interest rates. That would tackle the issue at source. Monetary policy has been the primary stabilisation tool for decades for good reasons. Among other things, it is well-understood and there is a fair degree of (political and economic) consensus around the use of the tool. And confidence that the tool is at hand in turn proves (somewhat) self-stabilising, because people expect – and typically get – a strong monetary policy response.

Perhaps the other reason why authorities – perhaps especially in New Zealand – have been so complacent is the view that “never mind, if monetary policy is hamstrung there is always fiscal policy”. After all, by international standards, public debt here is low (on an internationally comparable measure from the OECD, general government net financial liabilities, about 1 per cent of GDP, which puts us in the lower quartile – less indebted – among OECD countries.)

The implicit view appears to be that, with such modest levels of debt, if and when there is another serious recession, New Zealand governments can simply spend (or cut taxes) “whatever it takes” to get economic activity back on course again. After all, the upper quartile of OECD countries have net general government liabilities in excess of 80 per cent of GDP.

I’m sceptical for a variety of reasons.

One of them is the experience of the last recession. For this, I had a look at the OECD data on the underlying general government primary balance as a per cent of potential GDP:

general government = all levels of government
underlying = cyclically-adjusted (ie removing the impact of the fluctuating business cycle on revenue (mostly), and adjusted for identified one-offs (eg recapitalisations of banking systems)
primary balance = excluding financing costs, so that comparisons aren’t affected by changes in interest rates themselves
as a per cent of potential GDP = so that a temporary collapse in actual GDP doesn’t muddy the comparison

The numbers aren’t perfect, and there are inevitable approximations, but they are the best cross-country data we have. Changes in this balance measure are a reasonable measure of discretionary fiscal policy.

Here is how those underlying primary balances changed from 2007 (just prior to the recession) over the following two or three years. I’ve taken the largest change I could find, and in every case that was over either two years to 2009, or over three years to 2010.

fisc stimulus

Some countries (Hungary, Estonia) were engaged in severe fiscal consolidation from the start. Several others experienced almost no change in their structural fiscal balances.

Quite a few countries saw 5 percentage point shifts in their underlying fiscal balances. Spain – a country with no control over its domestic interest rates – is recorded as having gone well beyond that. I don’t know much about the specifics of Spain, but for those who are upbeat about the potential scope of discretionary fiscal policy I’d take it with at least a pinch of salt – on the OECD numbers, the Spanish primary deficit dropped again quite sharply the next year (and Spanish unemployment didn’t peak until several years later).

Note that both Australia and New Zealand are towards the right-hand end of that chart. In Australia’s case, most of the movement resulted from deliberate counter-cyclical use of fiscal policy (the Kevin Rudd stimulus plans). In New Zealand, by contrast, the change in the underlying fiscal position was almost entirely the result of discretionary fiscal commitments made by Labour government at a time when Treasury official forecasts did not envisage a recession at all. From a narrow counter-cyclical perspective, those measure might have been fortuitous, but they were not deliberate discretionary counter-cyclical fiscal policy measures. In fact, at the time they were seen in some quarters as exacerbating pressure on the exchange rate, and limiting the scope of any interest rate reductions.

Perhaps it is worth stressing again that in not one of the OECD countries did the reduction in structural fiscal surpluses (expansion in deficits) last more than two years. In every single country, by 2011 structural fiscal policy (on this measure) had moved – sometimes modestly, sometimes quite sharply – into consolidation phase. In most countries, either conventional monetary policy limits had been reached or (as in individual euro area countries) there was no scope for conventional monetary policy. And it was to be years before output and unemployment gaps closed in most of these countries.

What is my point? Simply, that it looks as though the political limits of discretionary fiscal stimulus were reached quite quickly, even in countries where there was no market pressure (any of the established floating exchange rate countries other than Iceland), and even though the economic rebound in most was anaemic at best. That is why so many countries needed more conventional monetary capacity than in fact they had (and QE in various forms was not much of a substitute).

The OECD table on underlying primary balances only has data going back a few decades. No doubt experiences in wartime were rather different – in those circumstances huge shares of the nation’s resources can be marshalled and deployed in ways which (incidentially) stimuluate demand and activity. But looking across the OECD countries over several decades, I couldn’t any examples of discretionary fiscal policy being used as a counter-cyclical tool materially more aggressively than happened over 2008 to 2010. In Japan, for example, the structural fiscal balance worsened by about 6 percentage points over seven years after 1989.

So from revealed behaviour patterns, I’m sceptical as to just how much practical capacity there is for fiscal policy to do much, and for long, in the next serious recession, even in modestly-indebted New Zealand. The limits aren’t technical – they mostly weren’t last time – but political. Perhaps people will push back and run some argument along the lines of “oh, but we’ve learnt the lessons of unnecessary premature austerity last time round”. To which my response would be along the lines of “show me some evidence, or reason to believe that things would, or even should, be much different next time”. When – outside wartime – has it ever happened? And what about our political systems makes you comfortable that it is likely to happen next time? We could probably run large structural deficits for a year or two, but pretty quickly the pressure is likely to mount to begin reining things back in again (especially if, for example, the next recession is accompanied by heavy mark-to-market losses on government investments – eg NZSF).

And recall that here in New Zealand we had almost as much fiscal stimulus last time as any country, and even supported by huge cuts in interest rates (and without a home-grown financial crisis), we had a nasty recession (even a double-dip in 2010) from which it took ages to recover.

And all of this is without even examining how effective realistic fiscal policy is likely to be. The easiest fiscal stimulus is a tax cut (or even a lump sum cash handout). You can do clever ones, like the UK temporary cut in GST, which not only put more money in people’s pockets, but actively encouraged them to shift consumption forward – only to then create problems as the deadline for raising the value-added tax rate loomed. But putting money in people’s pocket – in a recession, and often explicitly temporarily – doesn’t guarantee they spend much of it. The most effective demand-stimulating fiscal policy (supply side measures are another issue – but lets just agree that deep cuts in company tax and related rates will not happen in the depths of a recession) is direct government purchases of goods and services. Most talked of is government capital expenditure, infrastructure and all that.

But, approve or otherwise, no government has a reserve list of projects, designed and consented, just waiting to get starting the moment it is apparent the next deep recession in upon us (that moment usually being several months after the recession has begun). It is almost certainly politically untenable for them to do so – if the project is so good, so the argument will run, why not do it when times are good? And so realistic government fiscal stimulus through the capital expenditure side will take months and years (more probably the latter) to even begin to get underway. Faced with the actual physical destruction in Christchurch, look how long it took for major reconstruction to get underway.

What of income tax cuts? Either the cuts are focused on those who pay the most taxes (in which case there is quickly one form of political pushback) or perhaps they take the form of a tax credit paid as a lump sum to everyone (in which case there is likely to be pushback of another political type – ideas around “everyone becoming a welfare beneficiary). I’m not attempting to defend either type of response, just to anticipate the risks.

By contrast, monetary policy – the OCR – can be adjusted almost immediately, and often begins to have an effect before the central bank even announces its formal decision (market expectations and all that). And if monetary policy changes don’t affect everyone equally, they affect the entire country – a borrower/saver/exporter in Invercargill just as their counterparts in Auckland. In the line from a US Fed governor, monetary policy gets in “all the cracks” (although he was contrasting it with regulatory interventions). Government capital expenditure is, by its nature, very specific in location. There probably isn’t a natural backlog of major (useful) capital projects in Invercargill or Dunedin.

I’m not saying fiscal policy has no useful place in the stabilisation toolkit – although my prior is that it is better-oriented towards the medium-term, with the automatic stabilisers allowed to work fully – but that we should be very cautious about expecting that it is any sort of adequate substitute for monetary policy in the real world of politics, distrust of governments and so on, in which we actually dwell. It is well past time for the Reserve Bank and the Treasury, led by the Minister of Finance, to be taking open steps towards ensuring that New Zealand has the conventional monetary policy capacity it would need in any new serious recession.

The Minister of Finance champions an economic strategy

August 21, 2018August 21, 2018 Michael Reddell New Zealand economic performance, Productivity, Uncategorized

Longstanding readers will know that I was pretty critical of the previous government for the utter absence of any sign of a set of economic policies that might have begun to reverse the decades of relative economic decline. Worse, they and their acolytes too often seemed to make up stories about how well things were going when the data pretty clearly pointed in the opposite direction. I’m not sure I’d be quite as harsh as Kerry McDonald and Don Brash, who recently gave the Key-English government an overall score of 0/10, but I’d be close, especially around productivity (and also around housing).

What has become increasingly disconcerting is that the new government – now almost a third of the way through its term – also has no credible ideas about reversing the decline and little interest either. They seem increasingly reduced to making stuff up as well, and trotting out the same lines again and again without any sign of a really understanding the challenge, without any sign of a compelling analytical framework, and without any reason to think that the policies they talk of will make any material (helpful) difference.

I woke this morning to the news that the Minister of Finance had an op-ed in the Herald explaining how the government was going to restore our economic fortunes. With suitably low expectations, I tracked it down. Even with low expectations, I was struck by how weak it was, and left wondering why the Minister and his PR team thought the article was a good idea.

The Minister begins thus

The coalition Government is helping business modernise our economy to be fit for purpose for the 21st century.

Presumably he is aware that one sixth of the 21st century has already gone? And that his party was in government for half that time? But let that pass: as rhetoric it might be empty, but it is probably harmless.

This means being smarter in how we work, lifting the value of what we produce and export, supporting the environment, planning for future generations and giving everyone a fair shot at success. It means making sure that all hard-working Kiwis share in the rewards of economic growth.

All of which is hard to argue with, but isn’t exactly a) specific, or (b) new. I keep a copy of National’s 1975 election manifesto by my desk, and flicking through it – 43 years on now – I think I spotted all those points (actually, in light of Eugenie Sage’s announcement on Sunday, I also found a pledge to “discourage all forms of environmental pollution and encourage the recycling of materials. We will place a levy on difficult-to-dispose-of products’). Labour’s 1972 manifesto, or its 1984 one, or its 1999 one probably had them all too.

Most New Zealanders know we cannot go on relying on a volatile mix of population growth, an overheated housing market buoyed by speculation, and exporting raw commodities as our growth drivers.

Quite a bit of that was in the 1975 manifesto too. They are old lines, each trotted out by politicians of either main party for decades as the symptoms presented. Not always even very accurately – does anyone actually think an “overheated housing market buoyed by speculation” added to national prosperity? And not with much sense that the speaker had any sort of robust model of the New Zealand economy. Let alone serious policies in response: for example, if this paragraph is to be believed, the current government is apparently uneasy about rapid population growth, but continues to run the same immigration policy as both its predecessor governments for the last 20 years.

And despite all this, a few sentences later the Minister of Finance tries to assert that

the fundamentals fuelling the economy are strong

Quite which “fundamentals” he has in mind – presumably not those in the previous quote (above) – isn’t clear. In fact, all he offers in support of his view is

Last week, the Reserve Bank said growth will still average 3 per cent over the next three years. And Mainfreight managing director Don Braid said recently: “I think the business environment is good right now.”

A government agency whose forecasts seem to command increasing scepticism among other forecasters, and one prominent business person. Perhaps you are persuaded. I’m not.

But finally we get to some of the things the government is promising. First, what the Minister presents as a key component

Our plan to become more productive is built on getting our infrastructure sorted. This year, and for the next 10 years, we will invest more than $4 billion getting roads, rail and coastal shipping humming. We are sorting out Auckland’s congestion to save the $1b loss in productivity it causes each year.

Haven’t we heard these infrastructure stories (“we are taking steps to clear the backlog”) for 15 years now? But even if they are doing everything well in this area, look at the number in the final sentence. $1 billion – assuming the estimate is robust – is a great deal of money to you and me individually, but this is an economy with an annual GDP of $280 billion. On the Minister’s own numbers, fixing congestion would lift GDP by about 0.36 per cent. It would be very welcome, but it is tiny relative to the scale of the economic underperformance: with no productivity growth at all for the last three years, it might take 10 similar initiatives to just reverse the further slippage (relative to other countries) in the last few years. But this was the only hard number in the entire article.

So what else does the Minister have to offer in his economic strategy?

We are investing to improve the skills of our workforce so that workers can adapt to changing workplaces. New programmes like our Mana in Mahi/Strength in Work apprenticeship scheme will get young people off the dole and support employers with the costs of giving them an apprenticeship to help them grow their business.

As I’ve noted numerous times previously, on OECD data New Zealand workers are among the most highly-skilled in the OECD. And where the government is spending most heavily in the broad area of skills, it seems to be in providing fee-free tertiary education – a policy that will (a) mostly redistribute money to people (and their families) who would already undertake tertiary education, and (b) to the limited extent it encourages further participation, presumably do so mostly among those for whom tertiary education offers lower expected returns. It doesn’t have the feel of a productivity-enhancing policy, and the government has not (that I’ve seen) offered any numbers to the contrary. As for getting “young people off the dole”, it is (of course) a worthy objective but haven’t we seen many such initiatives in the last 50 years?

Other policies supporting small and medium enterprises to manage costs include greater access to training programmes, e-invoicing and cutting compliance costs.

There may well be some useful stuff in that list. But surely every government in modern times has talked of cutting compliance costs? And, in practice, haven’t most ended up increasing them overall? The previous government liked to boast of the 500 (?) items that comprised its Business Growth Agenda, but none of it (not even all of it) began to reverse decades of underperformance. It was symptom of the drive for action without analysis.

New Zealand was built on innovation. The best path for us to get richer as a country is to invest in new opportunities and find better ways of doing things. The coalition Government is supporting business to lift research and development investment, with $1b set aside in the Budget for R&D tax incentives.

Hard to disagree with the second sentence, but without some compelling analysis suggesting that the government and its advisers understand why firms haven’t regarded it as worth their while to spend more heavily on R&D, it is difficult to be optimistic that more subsidies are the answer. As I noted in an earlier post on the government’s proposals in this area

R&D tax credits aren’t the only form of government spending to subsidise business R&D – in fact, the government’s new scheme involves doing away with the current grants. And as it happens, OECD numbers suggests we already spend more (per cent of GDP) on such subsidies than Germany (DEU), and quite a lot more than Switzerland (CHE). [both of which have far far higher levels of actual business R&D]

All of which might suggest taking a few steps back and thinking harder about why firms themselves don’t see it as worth undertaking very much R&D spending here. But given a choice between hard-headed sceptical analysis and being seen to “do something”, all too often it is the latter that seems to win out.

But we are only stepping up to the big stuff

Our bold goal for New Zealand to have a net zero emissions economy by 2050 is essential as we face up to climate change. This goal creates economic opportunities. The business community is alongside us, with 60 of our biggest firms forming the Climate Leaders Coalition. The $100 million Green Investment Fund and the One Billion Trees initiative are key parts of this work.

Perhaps it is “essential”. Perhaps it even creates “economic opportunities” – big changes in regulation and relative prices always do, for some people. But the government’s own consultative document, and modelling commissioned for them from NZIER, suggests that once one looks at the entire economy, a serious net-zero emissions target by 2050 will result in losses of real GDP per capita of 10 to 22 per cent (relative to the baseline in which no such target is adopted by New Zealand). No democratic government is history has ever consulted on proposals that would lead to such a dramatic fall in expected future living standards and productivity. And, as a reminder, on the government’s own numbers, the costs would fall wildly disproportionately on the poorest New Zealanders. And, yes, there probably will be a lot more trees planted – many of them probably on good, easy to access and harvest, land – but just last week the government had to announce large subsidies to get even that programme underway. Subsidies have never been the path to improved economywide economic prosperity. Of course, few suppose the government proposes adopting a net-zero target for economic purposes, but they should at least stop misrepresenting the analysis on the economic effects from their own consultants.

We are also committed to ensuring no one is left behind in our economy. That’s why we have put in place the Families Package and lifted the minimum wage. It is why we have a $1b annual fund for regional infrastructure and economic development opportunities.

So the regions are so “stuffed” that only an annual subsidy scheme is going to help ensure they aren’t “left behind”? That seems to be the implication of what the Minister of Finance is saying there. And perhaps the Minister skipped over the likely tension between the laudable desire (see above) to get young people off the dole, and the really substantial increase in the minimum wage his government is putting in place (at a time when there is little or no economywide productivity growth)?

There are challenges in the world that are outside of New Zealand’s control. That is why we are running a surplus and being prudent with our debt levels. We are also diversifying our export markets to create new opportunities for our exporters.

There is no hint of what, specifically, the Minister has in mind with his final sentence. But there is a certain sameness to it, going back decades and decades (nice quotes – including about the potential role of forestry – in that 1975 manifesto I mentioned earlier). And, actually, taken over the decades there has been a huge amount of diversification of export markets – no single country takes more than a quarter of New Zealand firms’ exports – but it hasn’t enabled New Zealand to lift the foreign trade share of its GDP much. In fact, over the last 35 years that share has shrunk.

As Don Brash noted in his article the other day, the previous government had fine words too

Key spoke about the need to increase the export orientation of the economy, and set a target for exports of goods and services of 40 per cent of GDP, up from 30 per cent when he came to office. Today, exports are just 27 per cent of GDP

Just no policies to make a difference.

The Minister of Finance attempts to end his article on an upbeat note

We are committed to working with business, workers and communities to build a stronger, more productive economy that delivers the quality of life that all New Zealanders deserve.

A worthy objective indeed, but there is nothing in what he told his readers that is likely to address – and begin to reverse – the decades and decades of underperformance. If we take seriously the government’s own numbers around the proposed emissions goal, the relative underperformance could be even worse under this government (were it to win nine years in office) than under its two predecessors.

I presume (hope) the Minister believes what he says, but until he starts to confront the implications of charts like this he is unlikely to make any progress (except perhaps by chance)

With a real exchange rate now averaging 25 per cent higher than in the previous 15 years, in a country where productivity has dropped further behind, it shouldn’t be any surprise at all that foreign trade shares are falling, that the economy is increasingly skewed towards the non-tradables sector (where competition is often, and often of necessity) quite limited, or that firms don’t see the likely payoff to investing heavily in R&D. These are classic symptoms of a severely unbalanced economy. Most often they arise from misguided government choices. In our case, the biggest single misguided choice is the grim determination – or perhaps enthusiastic dream – to keep on rapidly driving up our population in such an isolated location where the opportunities to take on the world from here seem few – and all the fewer with such a severely out-of-line real exchange rate.

Really successful economies – ones with materially stronger productivity growth than their peers – tend to have strong, and rising, real exchange rates. But that strength is a consequence of success, an outcome of success, a way of spreading the gains. Driving up the real exchange rate has never been a part of successful strategy to lift the relative productivity performance of the economy. The reformers here in the 1980s recognised the importance of a sustained lower real exchange rate as part of a successful economic transition. It is tragic that today’s political and economic leaders seem to have almost completely lost sight of that.

We have – and will have – a 21st century economy. But the question is whether it will be a struggling upper middle economy, with hazy memories of glory days long gone, or one that once again matches many of the richer countries in the advanced world, something I’m pretty sure we could do, but for a small number of people. If the government really believes they have the answer for how they can do it with a population that they actively drive further up every year, they surely owe it to us to lay out their reasoning, their analysis, with much more specificity than the Minister of Finance has yet done. That might include explaining why their clever wheezes and proposed reforms will make the difference their predecessors also claim to have aspired to for decades now.

Then again, perhaps tangible achievement no longer matters. Under the government’s wellbeing approach perhaps warm feelings will substitute for world-leading incomes?

Reflecting on the government and the PRC

August 20, 2018August 20, 2018 Michael Reddell China, NZ politics

Early last month, the government published its Strategic Defence Policy Statement. That was the one that caused a bit of a flurry because of the inclusion of the odd, rather mild, honest statement that appeared to that put noses out of joint among the tyrants of Beijing and their representatives and advocates (not all PRC citizens) in Wellington.

And that was so even though early on the document reminded us that

New Zealand continues to build a strong and resilient relationship with China. Defence and security cooperation with China has grown over recent years, supported by a range of visits, exchanges, and dialogues.

It isn’t clear what values or interests the People’s Republic of China and New Zealand would share. We knew better 50 years ago when we didn’t do military exchanges and joint exercises with the Soviet Union.

The pandering goes on with talk of how “China is deeply integrated into the rules-based order” (one of those much-used but very ill-defined phrases that seems to bear little relationship to reality).

Moving along, the report gets a little more frank, but in repeating lines that are news to no one. China is not – and shows no sign of or interest in becoming – a liberal democracy, and its “views on human rights and freedom of information…stand in contrast to those that prevail in New Zealand”. The document notes also growing Chinese military power and a disregard for international fora in dealing with “the status of sovereignty claims” in “disputed areas of maritime Asia”. There is, rather brief, reference to attempts to “disrupt and influence Western nations’ political systems from the inside”, although those comments aren’t specific to China.

And (in a statement of what one would have hoped would have been blindingly obvious) there is this

Developments in Europe and Asia have crystallised a sense that non-democratic and democratic systems are in strategic competition, and that not all major powers’ aspirations can be shaped in accordance with the rules-based order [whatever the government means by that], in the way that had been hoped until recently.

And yet, if this is partly in reference to China, what have the presidents of both the Labour and National parties been doing praising Xi Jinping and the contribution of the PRC? There has been no sign of them recanting.

A little later on in the document, there are two paragraphs specifically about China. They are purely descriptive, with not a word of disapproval to be found among the descriptions of China’s aggression in the South and East China Seas, the construction of military bases on artificial islands in contested waters. Remarkably – but no doubt pleasingly to both Beijing and our Ministry of Foreign Affairs and Trade – there is apparently no mention of Taiwan, a key potential flashpoint, at all.

You could perhaps read the document more charitably than I have done – for example, hints of unease about Chinese activity in Antarctica – but it is still a pretty anodyne document. There is no explicit or outright criticism. Even China’s major geopolitical initiative, the Belt and Road Initiative, is described in positive terms.

But Beijing didn’t like it

At a press conference in Beijing on Monday, China Foreign Ministry spokeswoman Hua Chunying said the country had taken note of the defence policy statement and “lodged stern representations with New Zealand on the wrong remarks it has made on China.” …

“We urge New Zealand to view the relevant issue in an objective way, correct its wrong words and deeds and contribute more to the mutual trust and cooperation between our two countries.”

Quite telling that wording. Not a matter, apparently, where reasonable people might disagree, but rather “wrong words” (and “deeds”) that need correcting. New Zealand should abase itself. And the PRC sometimes wonders why it doesn’t have more genuine friends….

The document itself is now rather old news. But what struck me in the days and weeks after its release was that, anodyne as it was, it was made even weaker by the complete silence of the Prime Minister and senior Labour Party figures (and, for that matter, the Greens). Labour is by far the largest component of the government, and not a peep has been heard from the Prime Minister (conveniently on leave when the policy statement was released). But that is par for the course from the Prime Minister – I wrote here about a speech she gave earlier in the year to the China Business Summit in Auckland. There was no sign of any moral core to her views. Not surprisingly, since her own party president has been in Bejing, since she became leader, praising Xi Jinping. It is sickening.

Incidentally, for anyone inclined to look favourably on New Zealand First’s involvement in all this, I stumbled on an article on the PRC Embassy’s website about an event in Wellington a couple of weeks ago to celebrate the 91st anniversary of the People’s Liberation Army. Among the speakers were our Defence Minister, Ron Mark, and our new Chief of Defence Force, Kevin Short. Various other senior New Zealand officials also attended. Neither man published the text of his remarks, but the Chinese Embassy reported them.

Here was Ron Mark

The New Zealand Minister of Defence Ron Mark extended his heartfelt congratulations on the 91st anniversary of the founding of the PLA and expressed his admiration for the contribution of the Chinese army towards safeguarding world peace. The Honourable Ron Mark noted that China is New Zealand’s strategic partner and that the relationship with China is one of New Zealand’s most important and valuable relations with foreign countries. Over the past 30 years since Royal New Zealand Navy frigates visited Shanghai in 1987, China-New Zealand military-to-military relations have continued to develop on the basis of openness and mutual respect.

What planet is the man on? He’d probably have had a good word for the Wehrmacht and the Luftwaffe in 1938 as well.

As for the Air Marshal

Mr Short noted that over the past 91 years since its founding, the PLA has made tremendous contributions to China and the world.

A decades-long civil war, enabling one of the brutal and murderous regimes on the planet, and now – according to our own Strategic Defence Policy Statement

China’s military modernisation reflects its economic power and growing leadership ambitions. China’s growing military capabilities raise the costs of any potential internvetion against its interests and include stronger expeditionary capabilities, including a military presence in the Indian Ocean. China has expanded its military and coastguard presence in disputed areas of maritime Asia. It has determined not to engage with an international tribunal ruling on the status of sovereignty claims.

Perhaps all that had slipped the Air Marshal’s mind when he made the kowtow before the PRC Ambassador, presumably with the approval of his Minister?

Distasteful as the PRC regime is, at least there was a bit more honesty in some of their reported remarks

In his speech, Defence Attaché Li Jingfeng stated that as socialism with Chinese characteristics entering a new era, the building of the PLA has also reached a new stage. With the deepening of defence and military reforms, the entire army adheres to the absolute leadership of the Chinese Communist Party and resolutely implements President Xi Jinping’s thought on building a strong military. By constantly advancing the policy of developing the military through political work, strengthening it through reform, and governing it according to law, the PLA’s combat effectiveness has been significantly enhanced

Against what external threat, other than those generated by the PRC’s own aggression, one has to wonder?

As the PRC Embassy reported it

The atmosphere at the reception was cordial and friendly. The participating New Zealand guests spoke highly of the achievements made by the Chinese armed forces and their contribution to world peace,

I guess we can take such propaganda with a pinch of salt, but it clearly wasn’t a remotely awkward occasion for such an expansionist power just a few weeks after that defence policy document had been released. It should be a cause for shame among our ministers, officials and senior defence force officers.

And if I’m critical of our government and its officials, the Opposition is no better. After all, they still have former PLA intelligence staffer Jian Yang – the man who acknowledges he misrepresented his past to get into the country – as one of the lesser lights of their parliamentary caucus. Their leader was the man who, as a senior minister last year, signed New Zealand up to the Belt and Road Initiative, in a document full of nauseating and ingratiating rhetoric (next steps of which are due, in terms of the agreement, in the next six weeks). Perhaps worse, when the government came out with its rather mild Strategic Defence Policy Statement, mostly just stating – barely even criticising – the blindingly obvious, Simon Bridges was all of a flutter. The government couldn’t possibly say such things: it might upset Beijing. There would be consequences he ominously warned. Does the man have no respects for the values and systems of his own country at all? Is he only interested in the perspective of a few businesses (including universities) that want better trade terms, never mind the character of the regime they pander to? Never, ever, apparently must a disrespectful word be uttered.

There have been a few interesting articles around from abroad in recent weeks that are worth reading. Perhaps most directly salient was a substantial piece in the Australian magazine The Monthly by John Garnaut, formerly a senior Fairfax journalist (and long-term China correspondent), more latterly an adviser to the Australian government. His article is on the challenge PRC influence strategies pose in many countries – in Asia, the Pacific, Europe and the Americas.

Garnaut writes

The CCP’s international influence system is a complex, subtle and deeply institutionalised set of inducements and threats designed to shape the way outsiders talk, think and behave. The modus operandi is to offer privileged access, build personal rapport and reward those who deliver. It seeks common interests and cultivates relationships of dependency with chosen partners. The Party uses overt propaganda and diplomacy, quasi-covert fronts and proxies, and covert operations to frame debates, manage perceptions, and tilt the political and strategic landscape to its advantage.

Beyond the foundational assumption of a single, civilisational “China”, the specific demands of United Front work are framed by permutations of three narratives: China is inherently peaceful and beneficent, the growth of Chinese power is inexorable, and China is vengeful and dangerous if provoked.

These narratives are internally contradictory but consistent over time. The first two are delivered openly by leaders, diplomats and state propaganda. The third is usually delivered via back channels with plausibly deniable connections to the state: PLA “hawks”, specialist military hardware websites, academic forums, personal meetings with top leaders, editorials in the Global Times. Together, this messaging orchestra is designed to condition audiences into believing that the rewards are great, resistance is futile, and outright opposition may be suicidal.

The meta-narrative of Beijing’s ever-growing power is the drumbeat that accompanies China’s policies of territorial coercion across its southern and eastern seas. It is the subtext that persuades foreign governments to remain silent as Beijing abandons restraint in the restive borderlands of Tibet and Xinjiang. It is also the incentive for economic beneficiaries to avoid seeing, or to rationalise, or to even actively support the Party’s efforts to degrade the values and institutions of civil society.

That final sentence sounds a great deal like the New Zealand situation.

But Garnaut isn’t just writing about distant places like New Zealand and Australia. Of Taiwan he writes

In May I attended a closed-door forum hosted by the Taiwan Foundation for Democracy that was publicly opened by the deputy foreign minister, François Chih-Chung Wu. He set aside diplomatic platitudes to issue this plea for international help:

“In Taiwan, and in countries elsewhere, China moves from soft power to sharp power, and then to hard power. And it is becoming more brazen every day … In other countries, this process may begin with a Confucius Institute, scholarships, grants, but the next thing you know you must self-censor discussions China considers sensitive … In the face of this authoritarian onslaught of China’s misinformation, cyber hacking, bribery, economic coercion, theft of technology, and intrusion in internal politics – Taiwan is crucial. If it can hold on, other democracies will be able to hold on. But if it fails, there will be no security for the democratic governments of the world.”

He also writes about the Singaporean government’s expulsion last year of a resident Chinese-born US citizen, a reasonably prominent academic, for being an “agent of influence for a foreign country”. Garnaut writes

What is striking about this official statement is that it makes detailed allegations relating to a form of espionage that sits a long way from the traditional Western counterintelligence agenda. The intelligence officers who were allegedly behind this operation were not stealing secrets. And nor were they aiming to directly control any policy lever. Rather, they were allegedly planting or nurturing a series of words and ideas in order to tilt the strategic decision-making landscape in a particular direction. They didn’t want to force Singaporean policy makers to make decisions in their favour. Rather, they wanted to condition policy makers to make such decisions of their own volition.

He quotes a recent speech from a retired top Singaporean diplomat (reprinted in the government-managed media in Singapore)

“China does not just want you to comply with its wishes. Far more fundamentally, it wants you to think in such a way that you will of your own volition do what it wants without being told. It’s a form of psychological manipulation.”

As I read that, it brought to mind Beijing’s description of the New Zealand defence document: “wrong words”.

Garnaut reports his own experiences, and the attempts of the regime to suborn his reporting

At first, my exposure to United Front work was all about inducements, with an occasional warning to keep me on my toes. I was offered red envelopes, neatly packed with US$100 bills. And sounded out for a lucrative “consultancy” arrangement with a Hong Kong bank. In one encounter, I was offered air tickets, hotel accommodation, a five-star family holiday, a job, and a gift bag containing bottles of Bordeaux wine valued at up to US$2000 each. These were all reciprocity traps, to be avoided at all costs. Gradually, over time, the ratio of carrots to sticks was inverted.

Garnaut was recently the subject of legal action by one extremely wealthy PRC resident in Australia, put out by his open and sceptical reporting.

Another recent piece people might like to read was piece by Didi Kirsten Tatlow, long-serving (and then China-resident) journalist, and currently visiting fellow at the (German) Mercator Institute for China Studies, on some of the ideas, values, and language (often ancient) that seem to guide PRC actions today, including around the United Front activities (“Imperial philosophy meets Marxist orthodoxy in Beijing’s global ambitions”).

In one quote, resonant of Beijing’s descriptions of the defence policy document,

A direct consequence of this worldview is that, from the party’s point of view, China’s sovereignty applies everywhere in the world. The party-state reserves for itself the right to negate values such as freedom of speech anywhere if it feels these challenge its sovereignty.

This stance is often expressed in terse demands to “outsiders” to apologize for getting things “wrong,” such as classifying Taiwan as a nation, or referencing the Dalai Lama in an advertisement, as happened recently to western airlines, hotels and car companies. These demands are increasingly coupled to direct threat to trade, in a classic example of jimi.

Rarely is the rationale behind the demand spelled out, but it was, in January, in an article in Global Times. The article responded to a previous New York Times article that documented how Chinese diplomats and soccer officials were interfering in political and speech freedoms in Germany. (That article was by this author.)

Efforts in Germany to support the rights of Tibetans were not a question of free speech, wrote Zhang Yi in Global Times: “What the author fails to understand is that the Tibet question is a matter of Chinese sovereignty; the Tibetan separatists aimed at splitting China and they should not use freedom of speech as an excuse,” Zhang wrote.

In that quote the underpinnings of the democratic order are removed and the intrinsic value of free speech negated everywhere. This isn’t simply change. This is revolution, in the sense of overturning. While the Global Times is not the party or government, the sovereignty argument expressed by Zhang cleaves to official thinking.

Towards the end of her paper, Tetlow notes

How can an anti-democratic, universalist China be accommodated and managed?

Firstly, a mental reset is needed. In a time of system competition it is of utmost importance to understand one’s competitor. Chinese officials and official commentators often talk about “changing and improving” global governance – pluralist societies must assume they mean to do it. Open societies must stop seeing the People’s Republic of China as a paler copy of themselves, merely lagging in terms of democratic modernity. Such teleology is unjustified, barring major political change in China.

By seeing the threads that the party is picking from the past and weaving into the future, we see China as it is – human yet totalitarian, strong yet weak, defensive yet aggressive, and ultimately a great challenge to democratic nations. When China calls for a tianxia-esque, civilizational system such as the “commonwealth of human destiny,” we must listen carefully, analyze closely the historical context and development of the term, identify the techniques used to achieve it, and assume party leaders mean to implement it if they can.

And what of the vaunted Belt and Road Initiative, that local taxpayer-funded PR outfits like the China Council and the Asia New Zealand Foundation are constantly keen to talk up (and on which the New Zealand government soon has to make decisions)? I noticed a new short piece out of a US think-tank suggesting that all might not be well with the programme even inside the PRC.

the PRC’s policymaking apparatus appears to have already responded to concerns of BRI overreach by adjusting the scale of lending to limit possible financial risk. BRI lending by major PRC banks has dropped by 89% since 2015, and lending by commercial banks—who are dealing with their own financial issues domestically—has ceased almost entirely. Policy banks have also scaled back, despite their status as arms of PRC government policy.

What are these concerns?

On July 20, Sun Wenguang, a retired professor of physics at Shandong University, penned an open letter criticizing China for “offering almost CNY 400 billion in aid to 166 countries, and sending 600,000 aid workers” (Canyuwang, July 20). On August 1, as he expanded on his concerns in an interview with the US-based Voice of America, police forced their way into Sun’s apartment. As he was taken away, Sun could be heard saying, “Listen to what I say, is it wrong? Regular people are poor, let’s not throw our money away in Africa … throwing money around like this doesn’t do any good for our country or our society.” (VOA Youtube, August 2)

Ah, the character of the regime our politicians and officials pander to…..

As the author notes

Although a Western observer might dismiss a few professors’ unhappiness with the BRI as ivory tower grumbling, PRC academic critiques are worth noting, since outspoken academics are often the channel through which other PRC societal elites communicate their dissatisfaction with the CCP.

And draws atttention to one much-better-connected leading academic’s recent essay.

Although Sun has long been a government gadfly, he is also long retired, and resides far from the center of power in Beijing. But similar criticisms have found voice much closer to the corridors of power. On July 24, Xu Zhangrun (许章润), a professor at Beijing’s elite Tsinghua University, published an extraordinary essay entitled “Imminent Fears, Imminent Hopes” (我们当下的恐惧与期待). Among many other criticisms, Xu excoriates Xi’s government for its profligacy abroad, saying:

At the recent China-Arab States Cooperation Forum [on 10 July 2018], [Xi Jinping] announced that twenty billion US dollars would be made available for ‘Dedicated Reconstruction Projects’ in the Arab world, adding that [China] will investigate offering a further one billion yuan to support social stability efforts in the [Persian Gulf]. Everyone knows full well that the Gulf States are literally oozing with wealth. Why is China, a country with over one hundred million people who are still living below the poverty line, playing at being the flashy big-spender? (China Heritage, August 1)

Xu Zhungrun’s essay is a fascinating read (the readily available, and extensively quoted, translation was done by the Australian China scholar living in the Wairarapa). As the translator notes in his introduction

On 24 July 2018, Xu published a lengthy online critique of China’s present political and social dilemmas. In issuing his Jeremiad, Xu, who is something of a latter-day rú 儒, locates himself in the Grand Tradition by effectively addressing a Memorial to the Throne, 諫言 or 上書. Given the relentless police repression and intensifying ideological clamp-down in Xi Jinping’s China, this is a daring act of ‘remonstrance’ 諫勸.

The professor doesn’t pull his punches

Over-investment in international aid may well result in deprivations at home. It is said that China is now the world’s largest source of international aid; its cash-splashes are counted in billions or tens of billions of dollars. For a developing country with a large population many of whom still live in a pre-modern economy, such behaviour is outrageously disproportionate. Such policies are born of a ‘Vanity Politics’; they reflect the flashy showmanship of the boastful and they are odious. The nation’s wealth — including China’s three trillion dollars in foreign reserves — has been accumulated over the past four decades using the blood and sweat of working people, in fact, it has actually been built up as a result of successive policies and countless struggles dating from the time of the Self-Strengthening Movement [launched during the Tongzhi Restoration during the 1860s when, following its defeat in the Second Opium War, the court of the Qing-dynasty adopted the first modernising reform agenda in Chinese history. By saying this Xu, to an extent, indicates that he does not completely embrace the Communist narrative or its soteriology]. How can this wealth be squandered so heedlessly?

The era of fast-paced economic growth will come to an end; how can such wanton generosity be tolerated — a generosity which, in many ways, replicates [the vainglorious Maoist-era policies when China boasted that it was the centre of world revolution to] ‘Support Asia-Africa-Latin America’ [which meant that an impoverished China was generously giving aid to Third World countries in an effort to gain political advantage and counter the influence both of the American imperialists and the Soviet revisionists] that led to countless millions of Chinese being forced to tighten their belts simply to survive, and which even saw the corpses of those who had starved to death scattered in the fields.

Recall that New Zealand too – far richer than China per capita – is a recipient of this lavish PRC “foreign aid” – paying for language teaching assistance in numerous of our state schools, all encouraged by our government at the expense of poor Chinese.

Average Chinese are most frequently offended by the way the state scatters large sums of money through international aid to little or no benefit. China is still slowly making its way up the steep slope of development. In terms both of basic infrastructure and social facilities, as well as in regard to people’s ability to access welfare, we are confronting massive problems; our burden is great and the road ahead leads far into the distance. And I make this point without even mentioning the crisis in aged care, or issues related to employment opportunities and education.

Even the most commonplace international meeting organised in China involves extraordinary levels of expense. There is no regard for budgets; fiscal waste and the heedless loss of human work hours is considerable. Such activities are content-free and superficial. It’s all about pursuing ‘Vanity Politics’ not ‘Practical Politics’, let alone ‘Hard-edged Politics’. Such events have nothing to do with the so-called ‘venerable traditional of warmth and hospitality demonstrated by the Chinese people from ancient times’; only the most vain and self-serving [leaders and bureaucrats like to] indulge in such things. If foreigners were to copy what we ar constantly doing here, then the VIP-filled headquarters of the United Nations in New York would be on police lock-down 24/7, and the headquarters of the numerous international organisations based in Geneva and Paris would perforce have to stage nightly fireworks displays with their personnel expected to be decked out in all their finery all the time.

One might think of cocktails to celebrate the 91st anniversary of the PLA. But more tellingly one might think of PRC gifts to PNG (a fancy convention centre and a new six lane highway for example) to enable it to host APEC this year.

An emergency brake must be applied to the unfolding Personality Cult. Who would have thought that, after four decades of Reforms and the Open Door, our Sacred Land would once more witness a Personality Cult? The Party media is going to extreme lengths to create a new Idol, and in the process it is offering up to the world an image of China as Modern Totalitarianism. Portraits of the Leader are hoisted on high throughout the Land, as though they are possessed of some Spiritual Mana. This only adds to all the absurdity. And then, on top of that, the speeches of That Official — things previously merely to be recorded by secretaries in a pro forma bureaucratic manner — are now painstakingly collected in finely bound editions printed in vast quantities and handed out free throughout the world. The profligate waste of paper alone is enough to make you shake your head in disbelief.

Didn’t former Labour leader Phil Goff pay for a large chunk of his mayoral campaign auctioning off collected works of Xi Jinping, to PRC-based donors?

It is a bracing read, and one can wonder at the likely fate of the courageous author.

Meanwhile, our Prime Minister – and her Opposition counterpart – refuse ever to utter a critical word about the regime, or what it represents here (Jian Yang, the infiltration of Chinese community groups, control of the Chinese language media), abroad (South and East China Sea), or back home. The most egregious recent example is around the mass concentration camp (actual detention, and extreme surveillance for those not detained) in Xinjiang. What would it take for Jacinda Ardern, Simon Bridges, Winston Peters, Ron Mark, James Shaw, Marama Davidson to speak up and speak out. Does nothing but a dollar matter in their world nowadays? It looks a lot like civilisational decadence taken to whole new levels. So well-schooled it doesn’t even occur to them to speak up. Another cocktail party perhaps? Pass the canapes, and quietly ignore the great evil Beijing and the CCP are responsible for – not just in decades past, but (in more refined, and perhaps unnerving) forms right now.

These were parties that once prided themselves on standing against (variously) apartheid South Africa, French nuclear testing, the Soviet Union, Nazi Germany, mass murder in Cambodia or Rwanda, and so on. Is there anything left they believe in enough, or care about enough, to speak up, take a stand, or do something?

Towards a (physical) currency auction

August 18, 2018August 18, 2018 Michael Reddell Monetary policy, zero lower bound

A week or so back, at the Monetary Policy Statement press conference, veteran Herald economics journalist/columnist Brian Fallow asked the Governor about how well-situated New Zealand was to cope with the next recession, given how low the OCR is now (1.75 per cent, as compared with 8.25 per cent going into the previous recession).

As I recorded in a post the same day, the Governor and his offsiders responded with a degree of confidence that wasn’t backed by much substance. It all smacked of a worrying degree of complacency.

Fallow also apparently wasn’t persuaded, and returned to the issue in his weekly Herald column yesterday. I wanted to pick up today on just one of the topics he touched on in that column.

The key issue is the effective lower bound on nominal interest rates. The Reserve Bank has indicated that it believes the OCR probably couldn’t usefully be taken lower than -0.75 per cent (I agree with them, and that assessment of the effective lower bound is consistent with the lowest any other country has set its policy interest rate). Beyond that point, it seems likely that an increasing proportion of holders of short-term financial assets would transfer into holdings of physical cash. There is no direct cost of conversion, although there are storage and insurance costs for physical cash (which is why large scale conversion doesn’t occur at, say, -5 basis points).

When official interest rates were dropped below -0.75 per cent it still probably wouldn’t affect very much much (or how) little cash you hold in your wallet/purse. If you hold much cash at all, it is probably for convenience (or privacy), balanced against (say) risk of loss/theft. And a secure physical storage facility for even $10000 of cash would be much more inconvenient – and probably expensive – than holding a short-term bank deposit. You might well, grudgingly, live with an interest rate of -2.0 per cent per annum (as it is, since the last recession, marginal term deposit rates have been well above the OCR anyway). Or you might seek to shift your money to riskier (potentially higher-yielding assets) – in which case the lower policy interest rate would still be somewhat effective.

But the big issue here isn’t so much what the ordinary householder does. Most don’t have that many financial assets that could be converted directly to cash anyway. The bigger issue is institutional investors (resident and foreign, including – for example – Kiwisaver funds). The funds management market is pretty intensely competitive, and (risk-adjusted) yield-driven (as an example, I was in a meeting yesterday where we looked at a restructuring option to save perhaps 3 basis points). So if the Reserve Bank tried to cut the OCR to, say, -2.0 per cent (and it was expected to remain at least that low for a couple of years), there would be big incentives to find alternative assets yielding a less-negative (or positive) return. The most obvious example is physical cash. And if there are incentives for fund managers to find such alternative options, there are incentives for trusted operators to provide them (secure physical storage for large quantities of physical currency). Willing buyers and willing sellers usually find a way to get together, at least if regulators don’t come between them (in this case the regulator – the Reserve Bank – actually creates the problem. People sometimes talk about a lack of secure storage facilities, but $1 billion in $100 bills doesn’t take much space (nor, really, does $100 billion). (On US note dimensions, the calculations are here.) If conversions of this sort happened on a large scale, a lower OCR won’t have any material effect – other than encouraging remaining asser holders to convert to cash. It wouldn’t lower retail interest rates (much) and wouldn’t lower the exchange rate (much).

These sorts of conversions wouldn’t happen overnight. Probably most funds managers and the like won’t have physical cash in their list of approved assets. Some will be able to change that faster than others. Those that can will be able to offer better returns than those that don’t. And such conversions would be much more likely in the next recession precisely because the starting point – initial low interest rates – is so bad. It is quite likely that official rates could be negative for years. Or perhaps the conversions will just never happen because central banks (here the Reserve Bank) just don’t lower their official rates far enough to make conversion economic. But, if so. they will have made the point: conventional monetary policy will have very quickly exhausted its capacity.

And so various people, including me in the New Zealand context, have been arguing for some years now that something needs to be done – and needs to be done early, to condition expectations about the next recession – about the effective lower bound. Brian Fallow refers to this in his article

Overseas experience suggests that at most, a negative policy rate might move the effective lower bound for interest rates 75 basis points into the red. Moving it lower still would require, economist Michael Reddell suggests, imposing a fee on banks switching from virtual to physical cash.

It wouldn’t be difficult. There are more complex models on offer – see Miles Kimball or Citibank’s Willem Buiter – but the desired results looks to me to be able to achieved quite simply by setting a cap on the regular holdings of physical currency (say 10 per cent above current levels). It might need to be a seasonally adjusted cap (currency demand rises around Christmas and the summer holidays, and then falls back again). The cap would need to rise through time (currency demand rises with the size of the nominal economy). But the key point is that any net issuance beyond that level would be auctioned (perhaps fortnightly or monthly). Any creditworthy entity – the sort of institutions the Reserve Bank deals with routinely – could participate in the auctions, and the marginal exchange price between settlement cash and wholesale volumes of physical cash would then be established quite readily, and could alter through time. If the state of the economy and inflation meant the Reserve Bank needed to cut the OCR to -5 per cent (and in the US context, there are estimates that such a – temporary – rate would have been desirable in 2009), there would be a lot of demand for physical currency, and no more supply. The market-clearing price would rise, perhaps sharply.

Of course, banks supply currency to retail customers on demand, mostly through ATMs. Banks would be free to respond to the rise in the marginal cost of obtaining new notes by passing those costs onto customers (retail or wholesale). A (say) 5 per cent conversion cost of obtaining cash would encourage retail customers to economise on cash holdings (using EFTPOS etc instead), while allowing those who put most value on having physical currency to pay the price. These days very few domestic transactions strictly require much cash.

Perhaps there are pitfalls in such a scheme. If so, now is the time to be identifying them, not in the middle of the next serious recession. Now is the time to be socialising – including with the public – possible solutions, not in the middle of the next serious recession (when putting a premium price on physical currency suddenly announced might actually be seen as a negative signal about the soundness of banks – ie discouraging people from holding cash). Perhaps there even legislative obstacles – I’m not aware of any, but all sorts of obscure issues can arise when one looks into anything in depth. But, again, now is the time to identify those issues and fix them, not in the middle of the next serious recession. There would probably need to be an override mechanism to cope with a genuine financial crisis driven run to cash.

And if there are better, workable, models, now is the time to identify them, and to test the alternative models in open dialogue, to ensure things are easily pre-positioned to cope with the next serious downturn.

Unfortunately, there is no sign of any of this sort of preparation occurring. Certainly, nothing has been signalled by the Reserve Bank or by the Treasury or by the Minister of Finance. If they aren’t doing the work, it is (complacent) negligence. And if they are, but simply aren’t telling us, it would be quite unwise.

After all, as I noted in the earlier post, a key consideration the authorities need to be addressing is expectations (about inflation and policy). In a typical serious downturn, inflation expectations fall but not too much, as all market participants expect that the downturn will be relatively shortlived, partly because of aggressive cuts to official interest rates. But going into the next recession – whenever it happens – it seems increasingly likely that few central banks will have the interest rate adjustment capacity they would like. And all economists and market participants will recognise the constraint, and are likely to factor it into their expectations are seen as a downturn in underway. A rational response would be to cut inflation expectations (actual or implicit) much more sharply than usual – in turn, driving up real interest rates (for any given nominal rate), worsening the downturn, and worsening the reduction in inflation. This issue doesn’t seem to get the attention it deserves even in the international discussions of these lower bound issues, but it looks to me like a pretty straightforward implication of the current situation.

Since none of us knows when the next severe recession will hit – it could be years hence, but it could be next year – this isn’t the time to let the issue drift. Too many people paid the (unemployment) price of central bankers reaching their limits last time around to contemplate with equanimity going into the next recession starting from a situation where current low official interest rates are still only consistent with inflation at or below target in most countries, including New Zealand. Dealing with the lower bound issue should be treated a matter of urgency.

(For those who are quite relaxed because of fiscal policy options, I might do a post next week on why it shouldn’t be very much consolation at all.)

Exchange rate moves: trivial in historical context

August 17, 2018August 18, 2018 Michael Reddell Exchange rate, inflation

I saw a curious story the other day which reported the Minister of Finance and the National Party spokesperson on finance arguing over who was to blame (or who could take the credit) for the fall in the exchange rate that followed the Reserve Bank’s Monetary Policy Statement. From one side there seemed to be talk of the fall being part of the much-vaunted (but little seen) economic transition – the Prime Minister herself has claimed this – and from the other talk of loss of confidence in the economy, combined with some inflation risks.

Mostly it seems to be a difference about almost nothing. Here is one of the OECD measures of New Zealand’s real exchange rate, for which data are available back to 1970. Obviously, we don’t have Q3 data yet, but I’ve taken the fall in the nominal TWI measure of the exchange rate for this quarter to date (latest observation for the RB website today) and applied it to the Q2 data to proxy a current observation.

RER ULC aug 18

Over almost 50 years, there have been lots of ups and downs in the series, even in the period (up to early 1985) before the exchange rate was floating. Some have been the start of something pretty sustained – see the falls in the mid 70s, or after 1987. Others have been very shortlived (see for example the fall in 1986 or 2006 – times when, for example, markets got a bit ahead of themselves in thinking our economy was slowing and interest rates would be falling). Over the full period (and this is quarterly average data, which takes out some of the noise anyway) there have been at least eight episodes when this real exchange rate index has fallen by at least 10 index points (roughly 10 per cent). The last occasion was in 2015, as markets somewhat belatedly realised – not quite as belatedly as the then Governor – that the Reserve Bank’s OCR increases weren’t going to be sustained.

This episiode isn’t one of them. The latest (estimated) observation is a mere six per cent below the most recent peak (18 months ago). And the latest observation is nowhere near the low reached in the second half of 2015.

In fact, the current level of the TWI is 2.4 per cent below the average level for the June quarter. Over the entire life of the series (fixed and floating periods) the average quarterly change (up or down) has been 2.7 per cent. Taking just the floating period (since March 1985), the average quarterly change has been 3.1 per cent per quarter, and if we take just this decade (which, eyeballing things, has been a bit more stable, at least as regards big sustained moves) the average quarterly change has been 2.4 per cent.

Perhaps the fall we’ve seen so far this quarter (or even since the MPS last week) will be the start of something more. If there is a serious global risk-off event, or a serious New Zealand downturn, that probably would happen. But all we’ve seen so far is a change that is about the size of the change one sees, on average, each and every quarter – some up, some down, and most not implying anything very much for the economy.

The idea that the fall foreshadows some promised rebalancing in the economy is pretty laughable. There have been no policy changes to bring about any such rebalancing (any more than there were with the other – larger – falls in the previous 20+ years). Then again, so is the notion that a lower exchange rate – a modest fall at that – is a material inflation risk. The Reserve Bank itself published research a few years back suggesting noting that, in fact, a lower exchange rate has tended to be associated with lower non-tradables inflation, and often – notably when commodity prices are also fallling – with lower overall inflation.

How poorly have Australians done?

August 16, 2018 Michael Reddell Australia

Much of this blog focuses on the dismal long-term performance of the New Zealand economy. A common benchmark is to compare our performance against Australia: once (and for a long time) we more or less matched them, these days we languish well behind, and as a result a huge number of New Zealanders have left for better opportunities abroad, notably in Australia – still, fortunately, a place where New Zealanders are relatively easily able to move, if not (any longer) to securely settle.

But how has Australia itself done?

Here is how things were 100 years or so ago, in 1913 – the eve of World War One, the end of the first great age of globalisation. And Australia itself had finally recovered from the devastating crash, financial crisis etc, after 1890. The data are real GDP per capita (in 1990 dollars) from the Maddison database.

1913 GDP

Australia (and New Zealand), far from the industrial heartland of the North Atlantic (recall that the Industrial Revolution had spread out from the UK, and then places like Belgium, Netherlands and northern France), in 1913 had per capita incomes twice those of places like Norway and Italy, 50 per cent more than France and Germany, 25 per cent more than Belgium and the Netherlands. Only the United States matched us (some years a touch higher, some a touch lower).

And here are the top 25 countries from the latest IMF WEO database.

2017 GDP pc

You could toss out some or all Macao (tiny, and really just past of China), San Marino (really tiny), Hong Kong (China), Ireland (numbers not really reflective of Irish incomes because of the corporate tax system) or Luxembourg (much GDP is produced by people living in neighbouring countries but working in Luxembourg) if you want, and Australia would still only just get into the top 15. Australian per capita is now less than that of most of the countries in the first chart – only just edging out Taiwan.

Comparable productivity data going back a long way are scarce. The Conference Board data on real GDP per hour worked start in 1950. There is only data for about 30 countries for 1950 (mostly the advanced countries). But of those countries, only the US and Switzerland were ahead of Australia.

2017 real GDP phw

Again, you could safely ignore the Irish number, but doing so doesn’t change the story. Australia has slipped a long way back, and is now nowhere near (say) that bracket of Germany, Denmark, Netherlands, the US, and Belgium. (Taiwan – see previous paragraph – is just behind Italy on this measure).

Here is one way of looking at the performance over decades. Both Australia and Norway abound in mineral resources (in Norway’s case mostly oil and gas, in Australia’s a huge range). Belgium, Netherlands, and Denmark are three high-performing European countries, where the data aren’t complicated by tax systems (Ireland), absorbing a failed communist state (Germany) and the like.

aus norway 2

Back in 1970, both Australia and Norway (before the minerals booms really got underway) had slightly higher average levels of productivity than the average for those other three northern European countries. In Norway, the development of the oil and gas resources from the 1970s seems to have contributed to a marked widening in average productivity (and incomes) in Norway’s favour. That margin has narrowed a bit in the last decade – oil itself is past its peak in Norway – but there is a still a large margin (over Europe’s other high productivity economies). And what of Australia? Even now, after a decade with the challenges of the euro crisis, the marked slowing in productivity growth at the global frontiers, and with the huge new mineral resources that have been opened up and brought to market by Australia, Australian average productivity still languishes a long way behind. Even now – after their reforms (80s and 90s) and their new resources – the margin between Australian productivity and that of these northern European countries is only about where it was in the mid-80s. At that time, there was a great deal of angst (similar to NZ) about Australian’s relative decline. In fact, Paul Keating’s “banana republic” line dates from then. There has been no reconvergence since then.

With staggering volumes of newly-economic resources able to be brought to market, it is really a quite remarkably mediocre economic performance. One might quibble about things like Australian labour market laws, but Australia is a functioning market economy that still scores quite highly on economic freedom indices. This is no Venezuela.

And yet, for all its riches – and you see (in the second chart above) the difference natural resources can make – Australia is no better than a middling performer among the (old) OECD countries it once mostly far-outstripped.

I’m not here to scoff – New Zealand has, after all, done so much worse, and the embarrassing exodus stems from that – but to analyse and learn. I’ll offer some thoughts on reasons why in another post, probably next week.

Not very useful data at all

August 15, 2018 Michael Reddell Uncategorized

This dropped into my email inbox today from Statistics New Zealand (full release here)

The gender pay gap was 9.2 percent in the June 2018 quarter, Stats NZ said today.

This is the second-smallest gap since the series began 20 years ago. In comparison, the gender pay gap was 9.1 percent in 2012 (the lowest on record) and 9.4 percent last year.

The gender pay gap shows the difference in median hourly earnings for men and women. For the second year in a row, the gap reflected that median hourly earnings for women, from wages and salaries, increased faster than for men, up 3.2 and 2.9 percent, respectively.

“The gender pay gap is a useful measure when trying to understand differences in pay between men and women, due to its simplicity. But this measure is limited. It doesn’t account for men and women doing different jobs or working different hours. It also doesn’t account for personal characteristics that can influence pay, such as qualifications and age,” Mr Broughton said.

In other words, it is almost certainly of very little use at all.

There does seem to be an increasing trend for our supposedly independent statistics agency to be working in league with government departments championing particular causes. This seems to be another example. Thus on the SNZ email we read this advert

Renee Graham, Chief Executive of the Ministry for Women, discusses the gender pay on YouTube from 11am.

It is to be expected that the Ministry for Women will have a view on such data, and causes to champion. But what is Statistics New Zealand doing promoting the views of an advocacy agency? Doesn’t it risk compromising confidence in SNZ’s statistics? No doubt the Governor of the Reserve Bank has a view on the CPI numbers, or indeed the GDP or employment numbers, but it would be a worry if SNZ were using their platforms to promote the Governor’s efforts to spin things his way.

But as it is, surely the chart above points to something quite important. There is next to no difference in the average hourly wages of men and women in the under 24 age group, and even the gap in the 25-29 age group is probably barely statistically significant (look at how much the measured gaps in individual age categories can jump around from year to year). Not much sign of the much-vaunted conscious or unconscious discrimination. It seems quite likely that the subsequent gaps mostly reflect (the lagged effect of) intra-family choices about childcare etc, which have no obvious policy implications. In such a context neither a widening nor a narrowing of the gap is something to be welcomed; it just is.

But I guess that wouldn’t fit the desired political and bureaucratic narrative.

A British visitor championing free trade and open borders

August 15, 2018August 16, 2018 Michael Reddell Immigration, New Zealand economic performance, New Zealand Initiative

Last Thursday British journalist and economist Philippe Legrain gave a lunchtime address at Victoria University (of Wellington). Legrain was apparently in the country mainly to talk about some work he does on refugees and employment, but this particular event (hosted by the New Zealand Initiative) was on the topic “How our open world is under threat, and why it matters”. He is a Blairite (ie active government) globalist (a term I don’t mean in any pejorative sense) – favouring, it appears, as much open trade, open investment, and open migration as possible, and then some. For anyone sufficiently interested, the Initiative has now posted a video of Legrain’s talk.

I found it a strangely unsatisfying talk on a number of counts. Perhaps it worked for those already converted to his cause, but even then there wasn’t anything new, or any fresh arguments or evidence. And it didn’t greatly help that despite being an obvious fan of New Zealand (or at least of the fourth Labour government) he didn’t know much about it, despite speaking to a central Wellington audience probably largely made up of policy wonks and junkies.

In his younger days, Legrain had worked as an adviser to Mike Moore in his time as head of the WTO. There, I presume, he had picked up stories about the sheer dreadfulness of New Zealand 35 years ago, and heard tales of the subsequent reforms. We were, he claimed, in some respects the “birthplace of globalisation”, which still – reflecting on it days later – seems a very odd claim. The reformers of the 1980s mostly saw the reforms as being about bringing New Zealand policy back more into line with the mainstream of advanced country practice (even if, with a small single chamber parliament, some reforms could be pushed through in more elegant and intellectually appealing ways than some other countries managed). Lamenting (quite rightly) the insanity of the days when New Zealand assembled television sets (and cars) here from disassembled kits, Legrain (again, fairly enough) observed that New Zealand needed to do more international trade.

But then his tale became rather more detached from reality. We were told that New Zealand had “flourished” since the early 1980s, we were “richer, freer, more diverse, better connected”, we’d found niches in world markets (he mentioned film-making, apparently oblivious to the subsidies so generous they’d have made an early 80s sheep farmer blanch), had better economic growth, and higher living standards. All because we’d opened to the world.

All of which would have been a good story. It was, after all, the way things were supposed to be. But what of the evidence?

Foreign trade for example? Successful small economies tend to do a great deal of it, and there is no doubt that the protective structures we wrapped around the economy for 40 years or so tended to reduce both exports and imports as a share of GDP. But here is how the export and import shares of the New Zealand economy look, for the first four years of the 1980s and for the last four years.

foreign trade

I think I am pretty safe in saying that no one involved in the reform process 30 years ago envisaged our foreign trade shares shrinking.

And what of the “richer” claim? Well, certainly real GDP per capita and real productivity measures are higher than they were, but that is true almost everywhere (Venezuela perhaps excepted): there are common global forces, technological innovation etc, at work. What matters, in assessing the success of New Zealand policy, is how New Zealand has done relative to the rest of the world, and in particular to the other advanced economies we’d been falling behind for several decades. Since 1983, New Zealand’s productivity growth (real GDP per hour worked) has been in bottom quartile of the 25 countries the OECD has complete data for. If you prefer simple GDP per capita comparisons, then despite a big sustained gain in New Zealand’s terms of trade – almost totally beyond our control – we’ve fallen further behind the G7 industralised countries on that score over the same period.

It isn’t even as if things went badly worse for a few years and are now coming right: trade shares are still trending down, we’ve had almost no productivity growth in recent years, and so on. If New Zealand really was the “birthplace” of globalisation, advocates such as Legrain should be looking to bury the evidence – or, more to the point, think more deeply about what aspects haven’t worked well, and whether some things matter here in ways they mightn’t matter elsewhere.

He was a bit hazy on his geography too. In (fairly) noting that trade deals between a post-Brexit Britain and New Zealand won’t make much difference for either country, he launched into the old line about New Zealand’s future being in Asia, and our great good fortune in being on the doorstep of the fastest-growing part of the world. It probably escaped his attention but Wellington and London are each about the same distance from Shanghai, and London is much closer to Delhi or Mumbai than Wellington is.

Legrain’s misconceptions about New Zealand continued to the present. He is a big fan of immigration – having written a whole book about it under the heading Immigrants: Your Country Needs Them – and lamented that New Zealand was slashing its immigration numbers by a third. I presume this was an allusion to the Labour Party’s policies in last year’s campaign, which might (on their estimates) have reduced the net inflow by about a third for one year. But perhaps he hadn’t caught up with the fact that the government seems to be following through on very little of that, and (more importantly) that they never promised, or even suggested, any reduction in the annual target for new permanent migrants. That target remains probably the highest, per capita, anywhere in the world. But never mind; don’t let troublesome details get in the way of a rhetorical flourish.

Perhaps my description of Legrain as a “globalist” was best-exemplified by one of the items on his list as to how the world is going to pot. He was, he noted, disturbed that New Zealand had a party in government whose name was “New Zealand First”. I’m no fan of the party itself – any more than any of our parliamentary parties – but precisely whose interests does he suggest that governments should govern in? He didn’t elaborate, but pursuing first and foremost the interests of your own citizens (or even residents) seems pretty basic to me. And not very contentious among most citizens – here or abroad. Quite often, of course, what is good for us is good them (and vice versa) – free trade in goods and services is generally the prime example – but the case for any New Zealand government action should be that it advances the interests, attitudes and values of New Zealanders. Sometimes those decisions will be altruistic in nature – taking in refugees for example – reflecting the values of New Zealanders. But most of us want our governments to respond to, and promote, the best interests of New Zealanders. Legrain clearly doesn’t.

Now, I should make clear that I am a strong supporter of free trade in goods and services. I’ve long argued, for example, that we should remove all our remaining tariffs unilaterally. Legrain hates Brexit, but the fact remains that the current difficulties are mostly arising because the EU does not believe in, or practice, that sort of free trade. I’m also a supporter of a pretty open approach to foreign investment, at least when it doesn’t involve state actors (and even Legrain noted that, thus, China should be something of an exception). Actually we also apparently share a view that trade agreements among advanced countries – if we must have them at all – are not a place for things like ISDS agreements or intellectual property rules.

Where we differ quite strongly – and this would be particularly so on New Zealand, although the point generalises – is probably around immigration. Because in his paean to globalisation he draws no distinction between free movement of goods, of capital, and of people. But voters appear to, and often for good reason. Legrain, unlike many voters, doesn’t appear to have much time for concepts of nationhood, or cultures which bind societies together. As the child of immigrants (French and Estonian) himself, perhaps that isn’t overly surprising, but most people have a different, more localised, background.

10 years or so ago, Legrain wrote a book in praise of immigration, an excerpt from which is available on the web. In it he declares himself scandalised that a politician can win an election on the promise that “we will decide, and no one else, who comes to this country” or that people would think it “normal and reasonable” to control migration flows. He laments the fact that migration policy is largely decided on national grounds.

It was a book written just before the 2008/09 recession, when Blairite globalists of his sort were in the ascendant – things felt rather good, especially if you were a successful middle class person in a major financial centre like London. He captures some of that in this extract

the debate that is at the heart of this book: should we welcome or seek to prevent the unprecedented wave of international migration that is bringing ever greater numbers of people from poor countries to rich countries like Britain, Spain and the United States? Fear of foreigners versus the dynamism of multicultural London: a microcosm of the wider debate about immigration that is raging around the world.

As if these are the only choices; the only (or best) way of framing any debate.

He didn’t actually use the word “xenophobia” there, but that is what “fear of foreigners” is: apparently the only grounds why anyone might be sceptical of large scale permanent immigration. But however things might have looked in 2007 – when the UK and Spanish economies were indeed booming – the subsequent decade isn’t necessarily such an advert for Legrain’s open border approach (the UK, for example, having had almost no productivity growth at all since then).

And although Legrain continues, as he did in his lecture the other day, to champion the view that countries need migrants, he offered very little in support of such a view. The potential for relative prices to change – whether to attract aged care workers or strawberry pickers, or substitute technology – never seems to enter his calculus. You might suppose his own country would be a prime illustration of his point: if relatively open immigration really offered the large gains to recipient countries’ own nationals as Legrain claims, a country that had very little immigration for a long time, and then opened up quite a lot should be a great case study. That was the UK experience after 1997. And yet, a couple of decades on, where can people like Legrain find the whole-economy evidence of how Britons have benefited to any great extent (and this in a country in a very favourable geographic location, with foreign trade heavily dominated by services and other intangibles)? If there are macroeconomic gains, they look pretty hard to find even there (and even if one simply abstracts from the house price disaster – as Legrain does with an wave of the hand, and a simple “well just build more houses”. Would that it were politically that easy, there or here.)

And New Zealand, of course, should be able to be his other showcase economy. After all, we’ve had high levels of target non-citizen immigration – much higher per capita than the US and the UK – for a long time now. But, beyond the handwaving and the pretty trivial (Legrain mentioned an apparent choice of Cambodian restaurants in Wellington), even the defenders of the current policy approach find it difficult to demonstrate the economic benefits to natives, and often seem left falling back on a “well, it would have been even worse otherwise” type of assertion. Legrain’s world doesn’t seem to have much place for geography or natural resources – perhaps not that surprisingly when you come from London – and, as already noted, he seemed oblivious to the failure to grow the trade sector of the economy, or the continued heavy dependence on natural resources, not obviously enhanced by simply bringing in lots more people to one of the most remote places on earth.

I think the New Zealand arguments are, or should be, different from those in countries nearer the centre of affairs. But even in those countries, the advocates of relatively large-scale migration – and actually in all European countries the numbers (per capita) are modest by New Zealand, Australian or Canadian standards – struggle to demonstrate that citizens of recipient countries are benefiting. Perhaps some of the middle classes do so – cheaper nannies or strawberry pickers (the sort of complementarity story Legrain advances) – but as I’ve noted before, to the extent this argument has force, it explicitly involves a redistribution in which poorer or less skilled natives are further disadvantaged. If we should expect our governments to govern first and foremost in the interests of their own people, I’d argue that it is also important that governments govern with a particular eye on the interests of the most vulnerable or disadvantaged of their own people. And there is no real evidence of the sorts of economic gains people like Legrain, or international agencies like the IMF have touted. Of the IMF modelling, as I wrote a while ago

…the model also implies that if 20 per cent of New Zealanders moved to Australia (oh, they already have) and an equivalent number of Australians moved to New Zealand, we could soon be as wealthy as Australia is now, simply by exchanging populations. Believe that, as they say, and you’ll believe anything.

As it is, large-scale non-citizen migration has skewed the entire structure of the New Zealand economy against producing competitively with the rest of the world (the real exchange rate has got quite out of line with the productivity performance and opportunities here). We are reduced to living with sustained underperformance (often while our leaders pretend otherwise), with subsidies for trees (lots of them), trains, and other provincial baubles to attempt to buy off simmering discontent in parts of the country that should be doing really well.

Globalists like Legrain seem reluctant to accept that large scale immigration is mostly oversold as an economic instrument (if there are gains to natives, even in the North Atlantic countries, they appear small) or that the angst that he worries about (in lamenting Trump, Brexit etc) about it is often cultural and national in nature at least as much as it is economic. For people like him, the world is made up of autonomous individuals, in which people of a country are united by, if anything, only a common passport and the authority of a common government. Most voters in most countries see it as more than that – they put a value, not just sentimental but practical, on common cultures, shared history and experiences and so on. My own arguments about New Zealand immigration don’t really go along those lines – I’ve repeatedly made the point that all our migrants could be from Bournemouth, Brisbane, Buffalo or Banff and the economics still wouldn’t work out well – but people who champion an open economy, and the real gains on offer from foreign trade, risk losing that battle if they don’t wake up to the fact that people movements are different in all sorts of ways, and support for free trade has no natural or inevitable implications for a view on appropriate immigration policy.

The Governor and the PM

August 14, 2018August 14, 2018 Michael Reddell New Zealand economic performance

I hadn’t been going to write any more about last week’s Monetary Policy Statement and associated comments from the Bank’s senior management, but then I heard the Prime Minister on Radio New Zealand this morning invoking the Bank in support of her story that everything is just fine in the economy and that we are in the midst of some transition or rebalancing of the economy towards one that is more productive, less driven by immigration etc etc.

The Governor was interviewed on TVNZ’s Q&A programme, broadcast on Sunday night. He was remarkably upbeat – in line no doubt with the rather glib claim in his press conference last Thursday that he thought the New Zealand economy was in a “wonderful spot”. While acknowledging that economic growth had slowed – and how could he not with even rather lagged hard data like this

gdp pc to mar 18

he claimed there was only “a very low risk” of the economy “stalling”. The Governor didn’t attempt to define “stalling” and nor did the interviewer push him to do so. To me, “stalling” doesn’t sound disastrous – not the economy going off a cliff into a deep recession – but perhaps zero or negative per capita GDP growth might qualify? If so, the data suggest we were already there months ago and the Governor’s own forecasts don’t suggest that June quarter was any better (forecast GDP growth of 0.5 per cent, at a time when population growth is about 0.4 to 0.5 per cent per quarter).

Another dimension of “stalling” might be something around productivity growth. There has been none – at all – for the last three years. And the Governor’s forecasts suggest productivity growth will have been negative in the most recent quarter (GDP growth of 0.5 per cent, and hours worked – average of the two measures – up 1.2 per cent).

Of course, the Reserve Bank predicts that things turn up from here. But that is almost par for the course. In their August MPS last year, they predicted real GDP growth of 3.8 per cent over the four quarters to June 2018. Now – with three quarters of actuals in the bag – they reckon that growth rate will have been more like 2.2 per cent. Perhaps they’ll be right this time – they now reckon 3.5 per cent for the three quarters to June 2019 – but the recent track record isn’t encouraging.

Actually, even the Bank’s chief economist seems a bit uneasy. He was quoted in an interview the other day suggesting that really people just needed to think more positively

“Animal spirits in an economy matter,” McDermott said. “It is possible to talk yourself into a recession. You can generate self-fulfilling expectations, we recognize that. The more that happens, the more we’ll try and lean against that. The economic fundamentals say it should be okay, but there’s a psychological problem that sits there.”

without seeming very confident that it would happen.

“In the September quarter we’re expecting things to be more back to normal, the fiscal policy starting to get some traction at that point, the net exports to start picking up,” McDermott said. “If we don’t hit that one, it’s like oh, have we got it wrong? That will be a real test.”

But back to the Governor. What can he cite in support of his story? Not very much as it happens. He listed a lower exchange rate, world growth that is “strong”, fiscal stimulus, private consumption, and the fact that in his view “business investment should be increasing”. A little later in the interview he went on to elaborate his investment story, asserting that with capacity constraints, demand very strong, and the labour market very tight, it was a good time to invest. What’s more, he suggested, interest rates were low and firms “should be investing”.

It always seems a bit rich of public servants to be trying to tell businesses, with their own money on the line, what they should and shouldn’t be doing, but even setting that to one side, there isn’t very much in the Governor’s claims.

For example, the Governor knows better than to suggest that interest rates are low for some random reason unrelated to the economy. On his own reckoning neutral interest rates have come down quite a bit, and (again on his own reckoning) the actual OCR is far below the neutral OCR because there just isn’t enough aggregate demand, or inflationary pressure, to support higher interest rates.

What about world growth? Well, we can all read the headlines around Turkey and other emerging markets, but even putting those to one side for now, the most recent IMF numbers suggest world growth this year and next much the same as that last year (the world backdrop to New Zealand’s mediocre performance), and the IMF observes

Global growth is projected to reach 3.9 percent in 2018 and 2019, in line with the forecast of the April 2018 World Economic Outlook (WEO), but the expansion is becoming less even, and risks to the outlook are mounting.

There is a probably bit more fiscal stimulus in New Zealand than there was last year, or than there might have been under previous projections, but the differences of magnitude are pretty second order (government operating surplus forecasts are about half a percentage point of GDP lower than the forecasts the Reserve Bank published a year ago).

What of business investment?

bus investment aug 18

It has been pretty subdued right through this decade. That has also been true in a number of other advanced economies, but three things most other countries didn’t have should have been supporting business investment here: the earthquakes (commercial buildings needed replacing/repairing too, and these are gross measures), a strong terms of trade – another thing the Governor likes to quote – and very rapid population growth. Oh, and we had huge opportunities to catch-up with the OECD productivity leaders. But businesses – looking to their own bottom lines – just haven’t seen the opportunities here. It isn’t clear why that is about to change to any great extent. Sure, the labour market is a bit more in balance (on the Governor’s own NAIRU estimates, not “very tight”) but on the other hand population growth is projected to slow, the global environment doesn’t look overly propitious, and there is a great deal of uncertainty about various aspects of domestic policy, and some measures which are simply hostile to business investment.

Incidentally, the Governor’s business investment forecasts don’t back his rhetoric. Here are projections (for growth in real business investment) from the latest MPS

bus investment projection aug 18

Growth in the next few years is projected to be less than in the last few years.

Both the Prime Minister and the Governor like to talk up the fall in the exchange rate, but again it is a case of nothing much there. The Governor knows that, and having now been in office now for almost a year, the Prime Minister should too. Despite headline talk of a sharp fall in the exchange rate, the TWI at its current level (71.6 this morning) is less than one standard deviation below the average level for this decade to date: a decade which, notwithstanding the high terms of trade, has seen the share of exports/imports in GDP shrinking. The TWI was lower than the current rate only three years ago. Morever, no small part of the fall in the TWI over the last year is likely to have been because markets have become less optimistic about the (relative) performance of the New Zealand economy (see, for example, those downward revisions in even the Bank’s own growth forecasts). The Governor talks often of some other countries moving to tighten monetary policy (although really only the US has done so to a significant extent), but his own stance is no change is likely here for some considerable time, and that a cut is as likely as an increase (the McDermott comments above suggest he thinks a cut in perhaps more likely). Were the Governor’s rhetorical upbeatness (“wonderful spot”) etc prove to be correct, it isn’t likely that the exchange rate would remain low for long.

And, unsurprisingly when dealing with such modest exchange rate moves, the Bank’s projections don’t really back up again sort of “reorientation towards exports” story. In the latest set of projections, the Bank expects export volume growth over the next three years of around 10.5 per cent in total (about 3.5 per cent per annum). Over the previous three years, actual export growth was about 10.3 per cent.

And, finally, what of the Governor’s story (or that of the Prime Minister) that we in the process of transitioning away from an economy that just has more people to one based on…well…something else. Here are the Reserve Bank’s net migration projections from the latest MPS

net migr aug 18

and here are their projections from 12 months ago

net migr aug 17

About the only difference is the scale (the top chart is annual, the bottom one quarterly).

For better or worse, the current government’s immigration policy is all-but identical to that of the previous government. There may well be a cyclical fall-off in the overall net inflows, but they won’t be because of any change in immigration policy, but because the Australian labour market is doing better.

Asked explicitly in his TVNZ interview the other day whether he bought the government’s line about the economy being in the midst of a transition, the Governor agreed. But it wasn’t a very compelling answer. He noted that we were moving away from a post-recession recovery phase – but the recession itself ended 9 years ago – and that we were moving beyond the Christchurch repair and rebuild process – which peaked several years ago. And, as I just noted, it isn’t as if immigration policy has changed to any material extent.

So it isn’t clear what this “transition” towards some better tomorrow, that the Prime Minister keeps talking of, really consists of. The real exchange rate remains very high, years of high terms of trade haven’t translated into a business investment boom, and the economic strategy still seems to depend largely on just bringing in lots more people, mostly not overly skilled, every year, to a land where opportunities were (a) always constrained, and (b) are in the process of being made more constrained by conscious government policy (eg oil exploration ban, net-zero carbon targets). And for all the talk of somehow moving away from housing investment towards “more productive” investment, a key element of government policy is Kiwibuild, which is supposed to build more houses.

As for improved productivity, the Reserve Bank’s forecasts certainly assume it. But then they always do. Three years ago, they thought total trend productivity growth for the three years to March 2018 would be 2.1 per cent; they now think actual trend growth over those years was -0.1 per cent. Two years ago, they forecast trend productivity growth for the three years to March 2019 would be 2.0 per cent. They now think it will have been 0.3 per cent. And so on. The Bank doesn’t have a strong focus on productivity, and tends to assume some sort of return towards longer-run averages. We must hope they are right this time, but if so it is likely to be only by chance, rather than because the Governor and his staff have any particularly strong insight on what might improve the longer-term structural performance of the New Zealand economy.

If one tries to work out the mental model the Governor is using, it seems to come down to not much more than that house price inflation has slowed, and that that in itself will put the economy in a better place. But there is little robust foundation for such a story – welcome as the slower house price inflation is likely to be to potential entrants to the market. After all, it isn’t as if the household sector in aggregate has been on some sort of wild spending spree in recent years, backed by the illusory “gains” to real wealth from rising house prices.

household C

It is hard to avoid thinking that both the Prime Minister and the Governor are engaged more in spin (trying to keep spirits up) than in hard-headed economic analysis. We should expect better, especially from the Governor, but then he still has lots of turf battles to fight, and it pays to keep onside with the political masters who will make those decisions.

And to be clear, the deep-seated problems with this economy were already there – and increasingly apparent – under the previous government. Nothing much the current government is doing (or talking of doing) suggests that any of them are likely to fixed under the present government, and the risk remains (seems quite high) that – even cyclical ups and downs aside – the real underperformance just continues to worsen.

10 years ago we had a new government that talked of catching up with Australia by 2025. Perhaps they never quite believed it, perhaps it would have been a stretch to have actually done it by then. But I don’t recall anyone – National or Labour – 10 years ago talking up the prospect of material further widening in the productivity gaps. But that is what happened, and now we start out even further behind.

aus nz productivity

And yet the Governor can continue to tell us we are in a “wonderful spot”. In what alternative universe?

Plastic bags

August 13, 2018August 13, 2018 Michael Reddell NZ politics

There is a reason why we do not let primary school children make policy or vote. They are children, precious and growing but prone to all the enthusiasms of children, easily influenced, and not responsible (as taxpayers or anything else) for their expressed preferences. And yet, as the Prime Minister was reported, it seemed that the fact that lots of school children had written to her about plastic shopping bags was almost enough in itself to justify a decision to ban them. And how many of those letters in turn were subtly – or not so subtly – prompted by teachers, themselves disproportionately likely (at least based on the sample I’ve seen over 10 years and four schools) to be Labour and Greens supporting? Has a child in central Wellington ever came home enthused by a teacher regaling them with the creative wonders of the market, of innovation, or prosperity? (Let alone any other traditional virtues.)

Having now read the government’s consultative document on the planned ban on plastic shopping bags, I was pretty staggered by how bad it was. Since the document is actually released under the name of the Ministry for the Environment, has the New Zealand public service now sank to such a low level of “analysis” and evaluation? Or were they simply overruled by ministers with an agenda, and no analysis? Either way, there is little positive that can be said for it.

Just for clarity – since this didn’t really come through in the media reporting I saw – this is what it is proposed to ban:

A new plastic bag (including one made of degradable plastic) which has handles and is below a maximum level of thickness. The terms ‘plastic’ and ‘degradable’ (including ‘biodegradable’, ‘compostable’ and ‘oxo-degradable’) would be defined in regulations with reference to international standards.

Thus, oddly, of the 31 bags I brought home from the supermarket the other day, only 15 will be outlawed. But there is no hint in the document as to why one sort of bag – that one might put beans or apples in, or in which bread rolls might come wrapped – is less problematic environmentally than the bags (with handles) that I might then carry the groceries home with.

Since one tends to notice these things once attention is drawn to them, I’m also relieved to find that the two newspapers a day that arrive at our house will still be able to be wrapped in plastic (definitely never re-used after it is ripped open), and that the various magazines that arrive each week wrapped in plastic will also still be okay. But why? What is the difference? Will the bag my newspaper was in be less likely to blow round than the bags the groceries were in? No evidence or argument is offered.

It is a simply incoherent approach, apparently grounded on no analysis whatever (at least none they have sufficient confidence in to expose to scrutiny – perhaps it will biodegrade in sunlight?)

As it is, the document highlights just how small a problem – if “problem” they are – plastic bags are. Here is total use

Industry estimates of current consumption in New Zealand of standard supermarket single-use shopping bags are 154 bags per person per year. This is about 750 million bags per year, or about 0.01 per cent by weight of total waste in levied landfills.

0.01 per cent of landfill waste.

There is more

Published urban litter count data does not differentiate plastic shopping bags from ‘unclassified packaging’, which makes up 10.8 per cent by count in ‘visible litter’. Takeaway food and drink packaging makes up an estimated 40.2 per cent, and non-packaging litter makes up 42.4 per cent.

And recall that the proposed ban isn’t going to ban all plastic shopping bags, only the ones with handles, which must make up quite a small proportion of even that 10.8 per cent of total “unclassified packaging”.

Or take these (unverified) estimates from various “coastal clean-up events”

Figure 1: Coastal clean-up data, New Zealand, top litter categories by … weight

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(the orange bars are items wholly/largely made of plastic).

So even if you were wanting to focus policy on the potential impact of plastic litter on marine life etc, it is far from clear why you would make a start on plastic bags (again, recall that the class of plastic bags the government proposes to ban is only a fraction – no estimates from them as to what fraction – of total plastic bags). Rope and buoys/floats do rather stand out, as do plastic drink bottles. As I read the consultative document, it is all plastic, and will also break down over time into stuff that might do bad stuff to marine life or even humans. But the government is just coming for our shopping bags.

I used the word “might” a couple of sentences back. I don’t claim any expertise in the science: here instead I’m quoting the Associate Minister for the Environment, Eugenie Sage in her Message at the front of the consultative document.

There is early evidence of the toxicity of these plastic particles to marine species, and potentially the human food chain.

I was quite surprised by her rather modest claims (“early evidence”, “potentially”). Surely that uncertainty would then be reflected in the cost-benefit analysis for any regulatory intervention? Oh, silly me. That assumes there is a cost-benefit analysis, but in this document there is nothing even remotely resembling such a standard part of the policy analysis toolkit. And that is even though they explicitly acknowledge of what evaluation they did do

This assessment was based on information from overseas experience, which has many gaps in relation to these goals.

So what is the rush? Why not do your evaluation rigorously and robustly, clearly identifying your assumptions when there is (as there always is) inevitable uncertainty? And how about pricing the option of waiting, or incentivising the development of genuinely biodegradable bags?

But actually the clue to what is going here is actually repeated several times in the document, this from the Executive Summary.

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In other words, we want to be in your face about it, and we can inconvenience almost everyone.

It isn’t about marine pollution or the potential toxicity of plastics, but a stake in the ground for a strategy which, if pursued, would up-end the way we do things across the spectrum of economic life, all based on the new dogma known as “the circular economy”.

I’d noticed a reference to this concept a few months ago in a speech by a senior Labour minister (this stuff isn’t just Greens flakiness) but hadn’t paid it much attention. But here is what the government says in the latest consultative document.

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With not a single reference, at all, to the role of the price system in signalling the best uses for resources, best productive processes etc etc, it looks a lot like economic illiteracy hallowed by a major government ministry. There is, for example, no hint in any of this – presented as some easy alternative – about the labour costs in each of these approaches. No one doubts that the earth has finite resources – heck, even the sun will burn itself out one day – but on this standard of analysis, government would never have let the Industrial Revolution (or all the huge improvements in material living standards that flowed from it) occur.

If there are unpriced externalities, identify them, estimate the significance of them, and look at the options for pricing them. That would be pretty standard economic analysis. You might even focus first on the most significant sources of marine pollution, not the feel-good ones, deliberately designed to inconvenience almost everyone.

Because this isn’t just some new analytical framework for academics to play with. It seems to be a policy agenda

Actions to phase out aspects of a linear ‘throwaway culture’ are part of a transition to a circular economy.

If the Prime Minister, James Shaw, Eugenie Sage and the rest of them haven’t come for your water bottle, your disposable coffee cup, your newspaper wrapper, your fresh produce bag at the supermarket, the tray supermarket meat comes on, or the carton your Chinese takeaways come in, this document suggests it is only a matter of time. Standard economic analysis would suggest that provided the true economic cost of landfill provision is charged for (eg) these are cheap and efficient technologies improving the living standards of New Zealanders.

As I’ve already noted, there is no cost-benefit analysis in the document. Specifically, there is no overall summary estimate. But there is also no attempt to put a dollar value on any one of the various potential costs and benefits (some identified, others ignored completely). How do we value the potential reduction in the poisoning etc from marine life? I have no idea of the appropriate number, and the documents suggests (by silence) that MfE and the government have no idea either. Since that is, purportedly, the main benefit of the policy, it seems like quite a gap.

And if there is no cost-benefit analysis, there is also no decent distributional analysis. But there is this stark statement

Some consumers on low incomes may nonetheless find the up-front cost of multiple-use bags unaffordable. One possibility is to provide support, such as offering discounted bags to holders of Community Services Cards and Gold Cards.

So yet another policy proposal – from the party the campaigned that it was on the side of the poor and the marginalised – that will hit the poorest hardest (as the net-zero climate proposal will). And that on the government’s own reckoning. But it does rather highlight the point about why supermarket shopping bags with handles exist: because they are cheap and efficient.

Strangely, there is also no real analysis of where the savings to retailers (from not providing bags) are likely to go. Again, from a left-wing government, the first option listed in a “windfall profit” to retailers – transferring value from poor people to supermarket shareholders? My starting point would be that, over time, any savings to retailers would be competed away, but I know that serious people have concerns about the degree of competition in the New Zealand supermarket sector. On which note, it would be interesting to know – and tempting to OIA – whether the supermarket chains have lobbied for this ban, including in its very particular form. Quoting again from the Associate Minister,

Government working alongside industry can be very powerful

No doubt, but there should be no presumption – perhaps especially from left-wing parties, if they seriously care about consumers and the poor – that such working together will generally be in the public interest.

I have noted already that some costs are not even identified at all. At present, if I go to the supermarket I give no thought to what I will bring my purchases home in. Supermarkets provide plastic bags (as do many other retailers). If every trip to the supermarket were in future to involve 30 seconds to collect reusable bags before heading out, then across tens of millions of trips to the supermarket each year, the value of that time alone will be non-trivial.

The authors of the consultative document also seem conveniently oblivious to how people actually live. This is from a post by Eric Crampton this morning.

We have a few reusable bags at home. The ones we have get reused a lot, because we use them on planned trips to the store. But most of our trips aren’t like that. Most of them are grabbing a few things on the way home after getting off the bus. Maybe other people are happy to carry around reusable grocery bags every day on the off chance that they might need to grab milk, bread, eggs and butter on the way home. I’m not. On those trips, we use the disposable plastic bags. Because what else are you going to do? Walk home, get a bag, walk back to the shop? It’s absurd.

Or my own experience as a semi-retired suburban homemaker. I go for an hour-long walk most days. About three-quarters of the way round, I pass the local supermarket, and perhaps most days I pop in and get one or two things. A light supermarket shopping bag, with handles, equips me for the walk back up the hill home again. Zealots will no doubt argue that I should carry a reusable bag with me all the way round my walk. By why would I want that inconvenience? Or this morning, when I went out I planned to pick up just one small thing, that I might have carried home without a bag at all. But passing the supermarket I noticed a generous discount on something I stock up on whenever it is on sale. I bought five of that item. With a supermarket shopping bag, with handles, it was not a problem. Without that option, I am more likely to use the car and drop back down to the supermarket later in the day, extra carbon emissions and all. All these sorts of forced changes of behaviour should be identified, and efforts made to price them, weighed up against serious estimates of any possible benefits.

The consultative document does, at least, include a table showing estimates of how many times different types of alternative bags have to be used to have less environmental impact (over 14 different measures) than a standard supermarket shopping bag. At the absurdist end of the spectrum – and yet these the sorts of options Greens like to talk up in other contexts – an organic cotton bag would, we told, need to be reused 20000 times: roughly once a day for each of 60 years. In a sense that difference is one of the marks of how much progress society has made in identifying products as cheap and useful as the supermarket shopping bag. Organic cotton, after all, was all the cotton there was a few hundred years ago.

Lest you be unable to believe that there is no evaluation framework at all, MfE do offer one up in the document. It is captured in this subset of their table.

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This framework is not designed to assess whether there is a policy problem that can be cost-effectively addressed. Rather, it assumes there is a major policy problem (note that triple-weighting on the first criterion, and how broadly and loosely defined it is) and then it set up to demonstrate the superiority of the option the government plans to ram through. There is no obvious reason (from a public perspective) why the ability to impose a ban without new legislation should be favoured over an option that requires new legislation (in fact, rather the contrary given the pervasive – deliberately so – effect on this proposed ban). And on the other hand, the evaluation framework gives no weight at all to issues around personal freedom and choice. Thus, some of the other options – tax or mandatory-charge based – would be likely to generate substantial reductions in plastic bag use, while allowing those for whom use of such bags was particularly convenient or valuable to continue to do so. It is, for example, the approach adopted in the UK. The consultative document offers no good economic reason not to take that path here.

Finally, it is perhaps worth noting that some media outlets have reported there being 104 countries to have adopted such a ban. In fact, the consultative document is quite clear that there are 104 jurisdictions – anything from local councils to national governments. Recall that there are 70 odd territorial local authorities in New Zealand alone. And that local councils – here and (no doubt) abroad – do all sorts of daft and damaging things without adequate scrutiny and evaluation (see, for example, our housing markets). Going by the table in the document, the number of countries that have actually and enforced imposed bans (especially as far-reaching as our government plans) seems able to be counted on the fingers of one hand. We deserve much better analysis; it is not a case of New Zealand simply copying what every other advanced economy is already doing.

It is a shockingly poor document, perhaps summed up best in this question for submitters

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Perhaps it is mostly a fair enough question, but given all the analytical resource and money (from taxpayers) the government and MfE have at their disposal, surely they could have at least made a stab at estimating the costs and benefits themselves, setting down their workings as a basis for submitters to agree or not.

But that perhaps assumes that this is a real consultation. I suspect the school children can be counted on to write in assuring the Prime Minister and her colleagues that it is a wonderful plan and everyone will feel better for it. Such a sound way to make policy.

croaking cassandra

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

Month: August 2018