The RB Financial Stability Report

November 11, 2015November 11, 2015 Michael Reddell Financial stability

This won’t be a long post. Today’s Financial Stability Report was pretty uneventful relative to May’s .

The body of the report had some interesting material, both on dairy exposures and housing lending.

But I had a number of concerns.

My most important was that the Financial Stability Report was, again, in breach of the Act. The Reserve Bank can write as much interesting analysis as it likes, and good analysis is always welcome, but they must comply with the Act. Section 165A says as follows:

A financial stability report must—

(a) report on the soundness and efficiency of the financial system and other matters associated with the Bank’s statutory prudential purposes; and

(b) contain the information necessary to allow an assessment to be made of the activities undertaken by the Bank to achieve its statutory prudential purposes under this Act and any other enactment.

Much the same words are in section 162AA as well. And this document simply does not comply. It hardly comments on the efficiency of the financial system at all, at a time when the Bank is imposing ever more-extensive and complex controls on the activities of banks.

These are the four references to “efficiency”:

The first, on page 52, is simply one item in a list in an Abstract, summarising the chapter
The second , page 54, is purely descriptive, and deals only with payment systems (“the Reserve Bank has an objective of efficiency”)
The third, on page 56, refers to a goal as part of the “regulatory stocktake”, to improve the efficiency of regulation of banks
And the fourth, on page 58, is also purely descriptive (“ The Reserve Bank acknowledges that appropriately robust outsourcing arrangements can improve a bank’s efficiency”)

Not one of these refers to the efficiency of the financial system, and none offers any analytical perspectives. But the Act is quite clear. I hope some MP chooses to ask the Bank about it when they appear at FEC, and that the Bank’s Board – legally charged with holding the Governor to account – poses the question, and perhaps chooses to highlight the omission when they next write an Annual Report. As it is, the accountability model is not working. The Governor is imposing more and more controls, taking us further from an environment of regulatory competitive neutrality (across institutions, across types of loans, across places of loans and so), and he simply does not provide the material that would enable us to assess the Bank’s activities against the statutory responsibility to promote the soundness and the efficiency of the financial system.

Somewhat related to this point around efficiency, the Bank continues to assert that its LVR controls are reducing risk in the financial system. But I don’t think I’ve seen analysis from them, either when the first controls were introduced, or with the latest extension, looking at how banks will choose to maximise profits for their shareholders if they are prevented from undertaking some classes of lending. There may be perfectly satisfactory and reassuring answer, but if banks are not able to undertake their preferred types of lending (which must be the case, or controls would not be binding) surely we should expect them to seek out other opportunities, which might – or might not – be just as risky as those the Reserve Bank is restricting? The concerning dimension is not just the absence of the analysis, but the fear that the silence might suggest the Governor has not even thought about the issue.

What else struck me?

The Bank’s continued obsession with “investors”. When pushed, the Governor will say that the Auckland housing situation is mainly a supply issue, but if supply remains severely restricted by regulation, and demand increases (eg with an acceleration in population growth) quite what would he expect, but some increase in people purchasing in expectation that tomorrow’s price will be higher than today’s? And in a city where the combination of policy failures has pushed the home ownership rate down so far, what is surprising or troubling (from a financial stability perspective) about around 40 per cent of mortgage loans being for rental property purchasers? They haven’t addressed these issues, which again makes it hard to assess their activities.

I was also struck by the mire the Bank has made for itself. The Reserve Bank is primarily a macroeconomic policy agency, and even in its financial stability role it has a systemic statutory focus. And yet we have the Governor and Deputy Governor being quizzed about housing developments in Hamilton and Tauranga (4 and 3 per cent of the country respectively) and the Governor responding in some detail about the nature of the demand in those two markets (although with no apparent sense of any model of equilibrium prices). Fortunately, they did say it was “too early” to be considering Hamilton or Tauranga specific measures. I hope it always is. The Bank, and those holding it to account, should be prompted to reassess and pullback from trying to run system-wide financial stability policy TLA by TLA. More and more they turn themselves into people doing inherently political stuff, with no political mandate, and soon no doubt (if it hasn’t happened already) they will be being lobbied by councils and other entities in Hamilton, Tauranga and who knows where.

It was good to see journalists asking about the Bank’s stress tests. The Governor and Deputy Governor now openly acknowledge that the banks, and the financial system, would be just fine if the system faced a shock of the size (very severe) the stress tests were done on. That really should be largely the end of the matter for them. Instead, they go on about how in a downturn banks might rein in their lending. Indeed, and it is surely up to them – the owners of private businesses – to make choices about whether, and to what, extent it is economic to lend, and (hence) whether to raise new external capital. We have monetary policy to deal with any associated economic downturns that lead to inflation undershooting the target.

Perhaps it is just me, but I continue to be struck by how little thoughtful cross-country or historical comparative analysis is provided in the FSRs (or in other associated documents, such as the Bulletin). No two situations are ever fully alike, across time or across countries, but those comparisons are often the most helpful benchmarks we have. And if the Reserve Bank can illustrate for us which comparators it regards as useful, and which not, and lay out the reasons for those judgements, it can help enable us to better assess how the Bank is handling its responsibilities in this area. One difficulty for people doing the assessment is that almost all the factual and analytical material in this document could have allowed the Bank to have reached quite different conclusions (eg high capital standards, strong liquidity buffers, moderate credit growth, all suggest that despite the rapid growth in Auckland house prices, the financial system is robust and efficient, and no further regulatory measures have been needed over the last couple of years). We know what the Governor thinks, but how are we to know – or at least have greater confidence – whether he is right, or whether the alternative story would have been better? The Bank needs to be doing, and publishing, more research in this area.

Oh, and finally, in the press conference it was hard not to conclude that the Deputy Governor looked rather more gubernatorial and on top of his material than the Governor did. And it no doubt helped that Grant actually looked at the camera and the questioners.

The social democrats from the IMF

November 10, 2015November 10, 2015 Michael Reddell IMF, New Zealand economic performance

The social democrats from Washington – the IMF – have been in town, and today released their preliminary report. It is quite strikingly different to the last one, released in March last year. The so-called Concluding Statement, at the end of the team’s 10 days or so in New Zealand, isn’t very long, and can’t cover lots of things in depth, so keep that in mind as you read the rest of this post.

The mission team will have spent a lot of time with Treasury and Reserve Bank staff. Indeed, the draft of the Concluding Statement will have been haggled over in a meeting with fairly senior officials from the two agencies, and it is pretty rare for the final product to contain anything that those agencies have much disagreement with. Indeed, Fund missions can get so close to staff in the host countries that even when two countries, reviewed by teams led by the same mission chief, have much the same circumstances, the policy advice will at times differ – seemingly to reflect what the authorities in the two countries want. A great example last time round was direct regulatory interventions in the housing finance market, which the IMF has enthusiastically supported here, but had been silent on in Australia. I’m not sure if the mission chiefs are still the same for the two countries, but checking the most recent concluding statement for Australia, I notice that the inconsistency has persisted.

Rereading the 2014 Concluding Statement the upbeat tone was unmistakeable.

“the economic expansion is becoming increasingly embedded and broad-based”

“with the economy set to continue to grow above trend in the near-term, pressures on core inflation should follow”

“we welcome the RBNZ”s shift toward a policy of withdrawing monetary stimulus, with the clear signal that it expects to increase rates steadily over the next two years”.

Oops.

(Although no doubt the Governor was pleased with the statement at the time.)

There is, of course, no hint in today’s Statement that the Fund might have misread things that badly last year. Space constraints I suppose.

But what about this year’s Statement?

I was interested to read that “inflation is projected to rise to within the RBNZ”s target range of 1-3 per cent in 2016, as the impact of the decline in oil prices drops out, and the depreciation of the New Zealand dollar passes through”. No mention anywhere, at least as far as I could see, of any rise in core inflation towards the mandated target midpoint. But I guess they are running the same lines the Governor always does – over-emphasising the one-offs (especially now that the exchange rate has rebounded) and quietly ignoring the persistent undershoot of core inflation.

But in some ways what really struck me about this year’s Statement was the wholesale leap into advocacy of a range of microeconomic and structural policies. It is a very different emphasis from last year. I know the Fund has changed mission chief for New Zealand, but surely there should be more continuity in the analysis and advice than this?

What do I have in mind?

Somewhat surprisingly, the Fund weighs in on immigration policy, noting that “continued high net immigration could pose challenges for short-term economic management, but in the longer run would boost growth”. Well, no one will really dispute the short-term demand pressures, but where is the IMF’s expertise in immigration? How have they concluded that our past immigration has boosted (per capita) growth? They might be right (or not) but how does it relate to the core macroeconomic and financial stability mandates of the IMF?

The Fund then suggests, in a paragraph on government finances, that “in addition, investment in infrastructure and housing (in high-quality projects) should be accelerated where possible to support higher housing supply in Auckland, and infrastructure improvements”. Where is the evidence of the central government infrastructure shortfalls? Government capital expenditure in New Zealand has been among the highest in the OECD, as a share of GDP. And what leads the Fund to think the government should be building houses itself (only high quality ones mind)? It all seems rather unsupported, and far from the principal mandate of the IMF.

They note too that “intensifying efforts already underway to boost higher density housing would be welcome”. What gives the IMF the basis for suggesting government policy should be skewed towards higher density housing? And how does it all connect to macroeconomic stability anyway?

Last year, the IMF was cautious about further regulatory prudential measures – tools should be “used sparingly and with caution”, but this year they are champing at the bit – no doubt reflecting the Governor’s new enthusiasm. After a perfunctory observation that “the impact of the new [prudential] measures to reduce financial stability risks will need to be evaluated”, they rush straight into “but the authorities should be prepared if further steps are needed”. I suppose that could be seen as just contingency planning, but there is no sense here at all that these interventionist measures could conceivably have costs, or that any benefits might be small.

Last year , there was no mention of tax issues at all, but now not only are “the newly introduced measures to deter speculative investment“ welcomed (those evil “speculators” at it again – can’t have them in a market economy) but “and further steps in this direction should be envisaged”. The Fund apparently favours “a more comprehensive reform to reduce the tax advantage of housing over other forms of investment“ [that would be unleveraged owner-occupiers they were targeting?] and “reducing the scope for negative gearing”. Many people might agree with the Fund, as a matter of tax policy, but where is the evidence, including the cross-country insights that (these issues are important that) the Fund is supposed to be able to offer? And where is the consistency from one mission to the next? If agencies like the IMF have substantive use – as distinct from a convenient echo of the preferences of the Reserve Bank or Treasury – it has to be keeping a clear focus on the longer-term issues that matter to macroeconomic and financial stability.

There are some odd features to the statement. In one place, they say that “stress tests indicate that the sector [banks] can withstand “a sizeable shock to house prices, the terms of trade and economic activity”, but then a page or so later they observe “financial system stress tests suggest it is able to withstand – at least in the short-term – adverse developments related to China spillovers, dairy prices and the housing market”. I think the final haggling session with officials must have missed something, and will be interested to see if the “in the short-term” caveat reflects something coming out in tomorrow’s FSR.

The other odd feature is this “on the one hand, on the other hand” paragraph

Monetary policy has been focused on the primary objective of price stability. Only if financial stability risks become broad based and prudential policy is insufficient to contain them, then using monetary policy to ‘lean against the wind’ could be considered as part of a broader strategy to rein in financial stability risks. Even in this case, the benefits would need to be weighed against the output costs and the risk of policy reversals.

They would have been better simply to have left it out. Monetary policy in New Zealand has no statutory basis for pursuing anything other than medium-term price stability, and it hasn’t even been doing that overly well. Having already had only an anaemic recovery, partly because of an overly cautious Reserve Bank, and two policy reversals – a record for the OECD – the IMF might have been better advised to simply urge the Reserve Bank to do its job – deliver inflation consistently around the middle of the target range. When they get back to the office, perhaps the mission staff could talk to Lars Svensson, currently at the IMF, about the attractions (or otherwise) of using monetary policy to “lean against the wind”.

The Concluding Statement wraps up with a discussion of Medium-Term Policies. Last time round, they had a balanced, but high level, discussion which noted structural imbalances between savings and investment (by definition, since the current account has long been in deficit], and noted that structural measures might be needed “to address the savings-investment gap”. Probably reflecting the IMF’s limited expertise in the area, it went no further, and did not even attempt a diagnosis as to whether any issues might more probably be found on the savings side than the investment side.

But this time round savings is confidently identified as the problem. We have, according to them “chronically low national saving” and “raising saving is the key to addressing this vulnerability”, “in particular household saving”. They don’t back any of this up, they don’t suggest reasons why private savings behaviour might be inappropriate, or identify policy distortions that are creating problems. Instead, they jump straight in to solutions

comprehensive measures to encourage private long-term financial saving should be considered, including through reform of retirement income policies. Options include changing the parameters of the Kiwisaver scheme—e.g., default settings, access to funds, and taxation—to increase coverage and contributions while containing fiscal costs, and adjustment of parameters of the public pension system. This could help deepen New Zealand’s capital markets and broaden options for retirement planning.

“Broadening options for retirement planning” fits how with the Fund’s mandate, or expertise? Did they recognise that New Zealand already has both a low elderly poverty rate and fiscal expenditure on public pension that, while rising quite rapidly, is not high by international standards?

Did they, for that matter, even attempt to back up the claim that New Zealand has “chronically low national savings”. If you are going to compare national savings rates, you really have to use national income as the denominator (ie savings of residents relative to the incomes of residents) . In this chart, from the OECD database, I’ve compared New Zealand’s net national savings rate (as a percentage of net national income) to the median for the other Anglo countries (Australia, Canada, Ireland, US, and UK).

Both lines are below the median for the OECD grouping as a whole – although in the most recent year we were almost bang on the OECD median – but over 25 years our net savings rate has simply fluctuated around the median of those countries most culturally similar to us. Where is the “chronic” savings problem? And given how strong our public accounts are – better than those of any of the Anglo countries other than Australia – how likely is that our feckless private sector is behaving as irresponsibly as the IMF mission staff suggest? Perhaps Treasury has updated its view again, but I was involved in an exercise a couple of years ago in which Treasury made a pretty concerted effort to look for areas where policy might be driving down private savings rates (relative to those in other countries). They looked hard, but it was a pretty unsuccessful quest.

And, finally, here is the IMF”s last paragraph

Despite the implementation of successful structural reforms in the 1980s, productivity levels have remained low compared to OECD peers. To raise productivity, the government’s business growth agenda has identified a number of policy priorities. Specifically, the Productivity Commission has highlighted the need to raise productivity in the services sector (which accounts for 70 percent of the economy). Measures include boosting competition in key sectors such as finance, real estate, retail, and business and other professional services; and leveraging ICT technology more intensively, including by enhancing skills.

I thought, and think, that most of the reforms of the late 1980s and early 1990s were in the right direction. But a sceptic might reasonably ask what is the definition of “success” when productivity gaps have not just remained large, but widened further since then. Perhaps more importantly, what is this paragraph doing here? Long-term income convergence issues aren’t really in the IMF’s remit, and the IMF doesn’t seem to have anything useful to offer on the subject. The paragraph is little more than an advertorial for the Business Growth Agenda – itself so far signally unsuccessful in lifting exports or closing productivity gaps – and the Productivity Commission.

We really should expect something better, and more authoritative and more focused, from the IMF. Perhaps it will come with the full report in a couple of months time, but I’m not optimistic.

Flexicurity: the way ahead for New Zealand?

November 10, 2015November 10, 2015 Michael Reddell labour party, unemployment

I finally caught up yesterday with Grant Robertson’s interview on The Nation.

There was the odd good aspect. It sounds as though the variable Kiwisaver policy, as a tweaky tool to supplement to monetary policy, is heading for the dustbin, joining the capital gains tax proposal. Other bits bothered me – in particular, the lack of any sense in Robertson’s comments of the importance of markets, competition, relative prices etc. He is clearly a believer in the power and beneficence of “smart active government”.

And I’m still a bit uneasy when I hear Robertson talk about changing the Reserve Bank Act to place a specific onus on the Reserve Bank to promote employment (or reduce unemployment). It will be important to see details. In principle, an amendment to section 8 of the Reserve Bank Act to say something along the lines of “achieve and maintain a stable level of prices, so that monetary policy can makes it maximum contribution to sustainable full employment and the economic and social welfare of the people of New Zealand” might do no harm. It would, in fact, be not dissimilar to words that have been in the Policy Targets Agreement in the past. On other hand, requiring the Bank to, say, actively target the lowest rate of unemployment consistent with maintaining price stability would be another matter. Right at the moment it might be quite good advice to this Governor, who seems particularly uninterested in the plight of the (cyclically) unemployed. But over time it would risk imparting a bias to the Reserve Bank’s choices that might well lead to persistently higher inflation outcomes over time. That wouldn’t help anyone.

But the bit of the interview I was most interested in was the discussion around a possible different approach to help facilitate people moving from one job to another, as technology and opportunities evolve and change. Robertson seems taken with the Danish “flexicurity” approach. I didn’t know much about it, but in my younger days the idea of active labour market policies had had some appeal, so I thought I would take a quick look. In some respects, Denmark’s experience is one to try to emulate: prior to World War Two it was largely an agricultural economy, heavily reliant on agricultural exports to the United Kingdom, but poorer than us. Now, while agriculture still plays an important part in the Danish economy ,other sectors have become much more important in the external trade and Denmark’s per capita income is far higher than New Zealand’s.

Here is how the Danish government describes “flexicurity”

A Golden Triangle Flexicurity is a compound of flexibility and security. The Danish model has a third element – active labour market policy – and together these elements comprise the golden triangle of flexicurity.

One side of the triangle is flexible rules for hiring and firing, which make it easy for the employers to dismiss employees during downturns and hire new staff when things improve. About 25% of Danish private sector workers change jobs each year.

The second side of the triangle is unemployment security in the form of a guarantee for a legally specified unemployment benefit at a relatively high level – up to 90% for the lowest paid workers.

The third side of the triangle is the active labour market policy. An effective system is in place to offer guidance, a job or education to all unemployed. Denmark spends approx. 1.5% of its GDP on active labour market policy.

Dual advantages The aim of flexicurity is to promote employment security over job security. The model has the dual advantages of ensuring employers a flexible labour force while employees enjoy the safety net of an unemployment benefit system and an active employment policy.

The Danish flexicurity model rests on a century-long tradition of social dialogue and negotiation among the social partners. The development of the labour market owes much to the Danish collective bargaining model, which has ensured extensive worker protection while taking changing production and market conditions into account. The organisation rate for workers in Denmark is approx. 75%.

The Danish model is supported by the social partners headed by the two main organisations – The Danish Confederation of Trade Unions (LO) and The Confederation of Danish Employers (DA). The organisations – in cooperation with the Ministry of Employment have also jointly contributed to the development of common principles of flexicurity in the EU, resulting in the presentation of the communication “Towards common principles of flexicurity” by the European Commission in mid-2007.

And here is a link to an accessible VoxEu piece from a few years ago on the flexicurity approach and Denmark’s experience after 2007.

The Danish “flexicurity” model has achieved outstanding labour-market performance. The model is best characterised by a triangle. It combines flexible hiring and firing with a generous social safety net and an extensive system of activation policies. The Danish model has resulted in low (long-term) unemployment rates and the high job flows have led to high perceived job security (Eurobarometer 2010).

….

The employment protection constitutes the first corner of the triangle. For firms in Denmark, it is relatively easy to shed employees. Not only notice periods and severance payments are limited, also procedural inconveniences are limited. The employment protection legislation index of the OECD for regular contracts is only 1.5. The Netherlands and Germany, countries with employment protection legislation, have an index of 2.7 and 2.9 respectively.

And here I started getting a bit puzzled. Denmark certainly makes it a lot easier than many European countries to shed employees. But it is even easier in New Zealand. On all 4 components of the OECD’s indicators of employment protection legislation, New Zealand ranks as less restrictive than Denmark – quite materially so by the look of it.

The OECD indicators on Employment Protection Legislation

Scale from 0 (least restrictions) to 6 (most restrictions), last year available

Protection of permanent workers against individual and collective dismissals Protection of permanent workers against (individual) dismissal Specific requirements for collective dismissal Regulation on temporary forms of employment

OECD countries

Australia 1.94 1.57 2.88 1.04

Austria 2.44 2.12 3.25 2.17

Belgium 2.99 2.14 5.13 2.42

Canada 1.51 0.92 2.97 0.21

Chile 1.80 2.53 0.00 2.42

Czech Republic 2.66 2.87 2.13 2.13

Denmark 2.32 2.10 2.88 1.79

Estonia 2.07 1.74 2.88 3.04

Finland 2.17 2.38 1.63 1.88

France 2.82 2.60 3.38 3.75

Germany 2.84 2.53 3.63 1.75

Greece 2.41 2.07 3.25 2.92

Hungary 2.07 1.45 3.63 2.00

Iceland 2.46 2.04 3.50 1.29

Ireland 2.07 1.50 3.50 1.21

Israel 2.22 2.35 1.88 1.58

Italy 2.89 2.55 3.75 2.71

Japan 2.09 1.62 3.25 1.25

Korea 2.17 2.29 1.88 2.54

Luxembourg 2.74 2.28 3.88 3.83

Mexico 2.62 1.91 4.38 2.29

Netherlands 2.94 2.84 3.19 1.17

New Zealand 1.01 1.41 0.00 0.92

And then I wondered about just how the unemployment rates of the two countries had compared.

At least for the last 15 years, our unemployment rate has hardly ever been higher than Denmark’s.

And what of the share of the population in employment. There the difference in recent years is quite startling, and all in favour of New Zealand. The sustained fall since 2007 in the Danish share of the population that is employed is among the largest in the OECD, matched only by Greece, Ireland and Spain.

Of course, the recent employment (and unemployment outcomes) aren’t just the result of employment protection legislation and active labour market policies. Demand is an issue too, and by pegging to the euro Denmark gave up the ability to use monetary policy to support demand (and the euro area authorities have largely exhausted their capacity). I guess the Danish unemployment rate isn’t too bad, but I wasn’t quite sure what the Danish labour market experience had to offer that should attract New Zealand.

I imagine that life on the unemployment benefit is a bit more pleasant in Denmark than in New Zealand, but it isn’t obvious that the Danish structure, as a package, is producing, over time, better outcomes than what we have here. And their model is vastly more expensive, and more heavily regulated, consistent (of course) with Denmark’s position as the OECD country with the third largest share of government spending as a per cent of GDP (57 per cent). New Zealand, by contrast, has total government spending of around 41 per cent of GDP

Perhaps more regulation and more spending was Robertson’s point. I guess we have elections to debate such preferences, but it seems a stretch to believe it would be an approach that would make our labour market function better. It isn’t obvious Denmark’s does.

A surprising clause in the TPP investment chapter

November 9, 2015November 9, 2015 Michael Reddell TPP

Article 9.6bis: Treatment in Case of Armed Conflict or Civil Strife
1. Notwithstanding Article 9.11.6(b) (Non-Conforming Measures), each Party shall accord to investors of another Party and to covered investments non-discriminatory treatment with respect to measures it adopts or maintains relating to losses suffered by investments in its territory owing to armed conflict or civil strife.

I was a bit surprised to find this one. Presumably this refers to cases where the state is not bound to provide compensation, but does so discretionarily? Why would countries sign up to a policy in which they have to treat the losses of citizens/residents the same as the losses of foreigners? And why only for cases of “armed conflict or civil strife” – but not, say, earthquakes, bank failures, or other vicissitudes of life? London was badly bombed in the blitz in 1940. Is this seriously suggesting that the British government, if it offered any compensation to any of the victims, had to treat, say, the owners of Swiss banks or factories the same as the owners of British banks or factories. Why would they want to pre-commit to that, in respect of ex gratia measures?

There might be plenty of occasions when a country might want to treat these two groups of people equally, but why should it sign up to committing in advance to such equality of treatment?

Public policy should be made primarily in the interests of the citizens (and perhaps residents) of the country concerned. In all manner of areas, we treat residents different from non-residents (eg access to public schools and the public health system, let alone voting). In some cases, we even treat citizens differently from non-citizens: both might go prison for a crime, but the non-citizen can be deported too. It isn’t always obvious where the lines should be drawn, but draw them we do. And sometimes we revise them in light of specific circumstances. But why pre-commit to treat any compensation for this particular class of losses equally between New Zealanders and others?

PS. On the off chance that “non-discriminatory treatment” only refers to how different countries’ overseas investors are treated, it still seems an odd and inappropriate thing to pre-commit too. In any “armed conflict”, some other countries will have been allies, other perhaps very friendly, and others neutral or perhaps mildly hostile. Why would we pre-commit to treating investors from each of those countries equally, in offering discretionary compensation for any losses resulting from armed conflict (or civil strife)?

Temporary safeguards, crises, and TPP

November 9, 2015 Michael Reddell TPP

I still have no idea whether the TPP agreement our government has reached is, on balance, a net benefit to New Zealanders. Without a proper independent assessment and analysis, undertaken by an agency that is both competent and independent (in the New Zealand case, think of the Productivity Commission), it is going to be difficult to know. Imposing more regulation, across a range of quite diverse countries, doesn’t have the same presumption of economic benefit that lower tariffs do. And the addition of yet more international meetings of officials and politicians seems like pure loss.

I’ve printed off, but not yet read, the modelling exercise done for MFAT – the government’s negotiators – that suggests annual benefits of as much as 1 per cent of GDP, at least for the subset of provisions they looked at. And on Saturday, a form email from Tim Groser dropped into my inbox, urging me to sign a National Party petition to show my support for New Zealand’s exporters back TPP as “vital” to our economic future. Frankly, it seems a little desperate when the Minister of Trade is having to generate his own petitions.

Some of the things I’m most uneasy about are matters of principle. I think it is simply wrong that foreign investors should have access to different courts than New Zealand firms and individuals do in respect of issues relating to their activities in New Zealand. Equal and common access to justice should be a foundational principle of our longstanding democracy – no doubt things might be different in the brutal and corrupt communist regime that is our new treaty partner Vietnam . This isn’t an argument about how many claims there will ever be against New Zealand (probably few), but simply about differential access to justice. Our Courts should be open to all who seek justice in New Zealand (and open more generally), and there should be no special jurisdictions for favoured parties. And New Zealand law should be made by the New Zealand Parliament, with any interested parties (domestic or foreign) free to make their cases in the public debate here.

Out of interest, I have dipped into a few of the chapters of the TPP is the days since the text was released. I wanted to focus this morning on bits of Chapter 29, Exceptions and General Provisions, and especially Article 29.3 Temporary Safeguard Measures. I had some peripheral involvement in New Zealand’s stance on these provisions, but here I just wanted to comment on what has finally been agreed.

The Article is only a couple of pages long, and the key points are here:

Nothing in this Agreement shall be construed to prevent a Party from adopting or maintaining restrictive measures with regard to payments or transfers for current account transactions in the event of serious balance of payments and external financial difficulties or threats thereof.

Nothing in this Agreement shall be construed to prevent a Party from adopting or maintaining restrictive measures with regard to payments or transfers relating to the movements of capital:

(a) in the event of serious balance of payments and external financial difficulties or threats thereof; or

(b) if, in exceptional circumstances, payments or transfers relating to capital movements cause or threaten to cause serious difficulties for macroeconomic management.

Since 1982 New Zealand has not had current account restrictions in place, and since the end of 1984 we have not had capital controls in place. I hope we never adopt such controls again. But it is the sort of decision that an elected government should be free to take.

New Zealand, for example, adopted current account convertibility controls briefly during the Great Depression, and then had both capital and current account controls in place from the foreign exchange crisis of 1938 until the early 1980s. There were legal limits in place on what you could import, how much you spend on an overseas holiday, and official permission was required for, for example, overseas magazine subscriptions. And that was before starting on the capital restrictions, on New Zealanders having money abroad, and on foreigners have money here. It isn’t a world I ever want to go back to.

But capital and current account controls have not gone from the face of the earth. In recent years, one OECD country (Iceland) and one EU country (Cyprus) have put new controls in place, and in the previous 15 years Malaysia and Argentina had also deployed such controls.

It is probably inconceivable to the US – a very large country, and home of a “reserve currency” – that such restrictions could ever be warranted outside wartime (unlike, no doubt, numerous other direct controls like FATCA or AML/CFT ones), but for small and highly-indebted countries it is another matter. If New Zealand were to face a severe outbreak of foot and mouth disease, at a time when financial stresses were heightened anyway, controls might be an option a New Zealand government would want to consider. Same might go for a severe flu pandemic, of the sort that so much planning was done for last decade, which closed down for a time world financial markets. There would be costs and benefits to adopting controls, but it should be a choice for New Zealand governments to make. It is about keeping a full arsenal of risk management options.

So I’m pleased to see that both 1 and 2 made it into the final agreement. After all, any controls need to be consistent with the Articles of the International Monetary Fund – which we’ve belonged to since 1961. The IMF articles don’t put any particular restrictions on capital controls, but require approval from the Fund for any current account restrictions. That approval is supposed to be provided in advance, but Iceland secured approval retrospectively in 2008, so these aren’t just abstract issues.

But the TPP articles goes further, and in some respects where they go are quite concerning.

Here are the main conditions controls have to meet

(c) avoid unnecessary damage to the commercial, economic and financial interests of any other Party;

(d) not exceed those necessary to deal with the circumstances described in paragraph 1 or 2;

(e) be temporary and be phased out progressively as the situations specified in paragraph 1 or 2 improve, and shall not exceed 18 months in duration; however, in exceptional circumstances, a Party may extend such measure for additional periods of one year, by notifying the other Parties in writing within 30 days of the extension, unless after consultations more than one half of the Parties advise, in writing, within 30 days of receiving the notification that they do not agree that the extended measure is designed and applied to satisfy subparagraphs (c), (d) and (h), in which case the Party imposing the measure shall remove the measure, or otherwise modify the measure to bring it into conformity with subparagraphs (c), (d) and (h), taking into account the views of the other Parties, within 90 days of receiving notification that more than one half of the Parties do not agree;

(f) not be inconsistent with Article 9.7 (Expropriation and Compensation);

(g) in the case of restrictions on capital outflows, not interfere with investors’ ability to earn a market rate of return in the territory of the restricting Party on any restricted assets; and

(h) not be used to avoid necessary macroeconomic adjustment.

4. Measures referred to in paragraphs 1 and 2 shall not apply to payments or transfers relating to foreign direct investment.

5. A Party shall endeavour to provide that any measures adopted or maintained under paragraph 1 or 2 be price-based, and if such measures are not price-based, the Party shall explain the rationale for using quantitative restrictions when it notifies the other Parties of the measure.

In principle, (c) looks fine – “unnecessary” damage should be avoided in the same way our Reserve Bank should avoid “unnecessary” exchange rate variability. But what is unnecessary and who defines it? And (d) too – responses should be proportional to the seriousness of the situation, rather than using a minor crises as a pretext of abandoning openness. I never really looked into (f) when I was involved in official discussions and I’m not starting now.

But here is where I start getting more uneasy. On my reading of (e), under no circumstances can capital or current account controls be in place for more than 2.5 years. New Zealand previously had them in place for 45 years, but more relevantly Iceland only this year announced plans to remove controls put in place, in response to a severe crisis, in 2008. This provision goes well beyond anything in, for example, the multilateral framework of the IMF Articles of Agreement, and even provides a veto power to (a majority of) the other countries on even having controls in place beyond 18 months.

It might seem unlikely that the veto would ever be exercised (such is international politics that rather than upset a partner one could just let the last 12 months of controls run out)…..but, unlike the IMF, disputes under this Agreement can (presumably) be dealt with through the ISDS process. So rather than mere political lobbying about whether extending controls is a good idea, interested private foreign parties could seek remedial action. Could they, for example, take a claim against another foreign government for failing to be stringent enough in evaluating whether any extension of New Zealand’s controls was really warranted within the terms of the agreement?

Which brings us to (h) above Not avoiding “necessary” macroeconomic adjustment might sound uncontroversial, but…..any such controls substitute, almost by construction, for other forms of macroeconomic adjustment. One could always let the exchange rate go lower (shifting more resources into exporting), or default (reducing the amount of resources that need to be shifted into exporting). Is it really appropriate to have such judgements – about the best mix of policy tools in a crisis – reviewed by courts – let alone private foreign tribunals?

(g) has long puzzled me, (even though it sounds reasonable) because it has never been entirely clear what it means.

And if 5 has ended up in a reasonable place, it still seems to have a stronger preference for price-based measures (fees and taxes) rather than quantitative restrictions than may really be warranted. I’m all in favour of price-based measures as a general principle, and think that many of the quantitative restrictions countries put in place are quite costly (think quotas rather than tariffs). But the track record is that many of the authorities with a strong rhetorical commitment to price-based interventions actually themselves use quantitative restrictions when under pressure. I’ve frequently pointed out to people that during the 2008 crisis, short-sales prohibitions were common interventions in many countries (including the US). Personally I thought they were wrongheaded, but smart people – and, more germanely, people with a political mandate, disagreed. I’m not sure I noticed price-based measures in FATCA, for example. “Temporary safeguard measures” shouldn’t be used very often at all, but if they are used only in extremis it is quite likely that quantitative restrictions will be the most effective, and perhaps even efficient, remedy at times. As a simple example, when the exchange rate is collapsing, or expected to collapse, almost no credible fee or tax will discourage someone who just wants his or her money out.

But my biggest single concern around the temporary safeguards provisions relates to 4. This clause prohibits any current or capital account restrictions applying “to payments or transfers relating to foreign direct investment”. I think that is a bad policy to pre-commit to for several reasons:

There is no good reason to preference foreign direct investment over other flows, capital or current
The agreement contains no definition of foreign direct investment
This exception opens potentially large enforcement problems.

If anything, one could probably mount an argument for putting the restriction in the reverse. After all, as the footnote to this article points out “FDI”, as envisaged here, tends to be undertaken to establish a “lasting relationship” – unlike (say) as foreign investor buying a 90 day bank bill – and this agreement allows controls for only 30 months at maximum. If you establish a lasting relationship, isn’t it reasonable to share the opportunities and restrictions of the residents of the country? In bank crisis resolution for example (eg the OBR), the focus is on quickly re-establishing the liquidity of transactions balance accounts, with much less immediate interest in the liquidity of longer-term claims. Why reverse things here? And why are countries agreeing to preference flows that relate to a foreigner’s investment in New Zealand over those of an identical asset (say, another sawmill) held by a New Zealander. And note that the prohibition here is not just on the capital proceeds of the sale of an FDI asset, but on the earnings of that asset. Under TPP, it appears that a country could put in place restrictions on a foreign owner remitting interest receipts (from, say, a government bond) abroad, but not on a foreign owner (of, say, a factory or a bank) remitting interest on a related party loan, or on remitting a dividend. What is the ground for such a differential treatment? I can’t see it.

The clause has a footnote

For the purposes of this Article, “foreign direct investment” means a type of investment by an investor of a Party in the territory of another Party, through which the investor exercises ownership or control over, or a significant degree of influence on the management of, an enterprise or other direct investment, and tends to be undertaken in order to establish a lasting relationship. For example, ownership of at least 10 per cent of the voting power of an enterprise over a period of at least 12 months generally would be considered foreign direct investment.

But what, if any, legal force does that have? It is descriptive rather than prescriptive. That might be fine for statistical classification purposes, at a time when there are no controls. But it looks to provide no effective buffer against the numerous attempts that will come, if controls are ever put in place, against attempts to get round the law. If, for example, a foreigner’s government bond matures and they invest the proceeds as 100% of the shares of “XYZ Asset Management Company”, the only asset of which is the proceeds of the bond, is that foreign direct investment (for the purposes of this agreement)? If it is held in that form for at least 12 months? People more skilled in financial engineering than I am could surely quite easily invent countless more clever ways of bringing their funds within this ill-defined ambit of “foreign direct investment”.

And all these matters appear to be resolved, when disputes are taken, not openly by domestic courts under domestic law, or even through state to state dispute resolution mechanisms such as those under the WTO, but by offshore administrative tribunals litigated by individual aggrieved private companies.

For some people on the libertarian side of things, all these objections will be moot. Who cares, they might argue. Controls such as these are always and everywhere a bad idea, and anything that makes them harder to enforce is a good thing. If we must have such provisions in international agreements to fend off the antediluvians, this is the second-best way of rendering them meaningless.

And I can see the logic of their argument. But it doesn’t appeal. Strong and successful countries make their own laws, and set their own constraints. Democracy and national sovereignty are probably never absolute principles, but I think New Zealand governments should have the option of imposing these sorts of controls, and trying to make them work, especially in crisis circumstances – which one could readily envisage lasting longer than 30 months. The longstanding multilateral framework, reflected in the IMF Articles, agrees. If New Zealanders really want to rule out the crisis controls options, that’s fine too. But write and debate a constitution and establish these economic freedoms in such a national, domestically justiciable, document.

As it is, even our own Treasury and Reserve Bank signed up to a non-binding international declaration the other day which said that “we further recognize that excessive volatility in capital flows can create policy challenges that may require a policy response”. Personally I’m sceptical, but they signed it. Are they really saying that in no conceivable circumstances can those “serious difficulties for macroeconomic management” ever last for more than 30 months? I’d be interested to see their analysis/evidence for that proposition.

Uneconomic school fairs

November 7, 2015 Michael Reddell Uncategorized

(This is something of a rant….but it is Saturday, and it doesn’t involve the Reserve Bank.)

Today was the annual fair at the school my daughters attend. As I understand it, the Island Bay school fairs tend to raise around $25000. I used to be quite impressed, until I thought about it and realised that it is a school of around 500 kids. So the net proceeds are perhaps $55 a child. We have two children there, so our “share” of the fundraising is perhaps $110.

We don’t usually get very involved in the fair. But I’d donated perhaps $25 of ingredients a while ago for people making preserves, sweets etc. And yesterday I made them a plate of chocolate marshmallow slice – a slightly fiddly recipe and, between ingredients and time, that probably cost at least $15. My nine year old is on the School Council and was “coerced” into manning a stall. She spent two and half hours doing that. I’m not sure how to value her time, but it isn’t zero.

And because she was on the stall and they needed parent volunteers as well, we weakened and put in half an hour or so each (getting to and fro etc made that perhaps 45 minutes each in total). How to value our time? Well, the marginal cost has to be above the average cost, and one needs to think in after-tax terms. $50 per hour seems very much towards the low end, but if we run with that, it was a donation of $75 between the two of us.

Oh, and then there was the money “wasted” at the fair – a rare concession to “pester power”, such that the kids were allowed to buy their lunches at the fair. Granting that there might have been some consumer surplus – fair lunch beats Dad’s lunch – but across three kids, there is another “donation” of $10-15.

That adds up to a contribution of $125 from our family – costed at the low end of a possible range of estimates. Had we just written a cheque for $110 to the school as an additional donation, we’d have been able to claim back a tax refund (as it would be a charitable donation) for a third of the amount. So we spent $125 to provide the school $110, even though we could have provided the same benefit to the school for perhaps $73. This can’t be an uncommon story. I might have costed our time a bit higher than the average parents would have, but this is a decile 10 school. Parental time is scarce and valuable.

And plenty of people will have put in much more time and effort than we did – the extensive advance organisation (emails at 11.11pm on Thursday night), and some people will have been there for three or four hours today alone. Oh, and the distraction from education seems quite real too – my daughter apparently spent a large chunk of yesterday at school making (very pretty) signs for her stall.

And, of course, quite a lot of the profit to the school didn’t come from parental input at all, but as donations from local businesses, which will have treated them as part of the respective business’s marketing budget.

Were there any offsetting gains to compensate for the wasted $52? Well, it was nice to see the nine year old responsibly helping run the activity (but she has other involvements outside the home). Perhaps some people get a warm fuzzy feeling from “doing something together for the community”. But this is a school. We don’t apply this funding model to the local GP or, say, the supermarket We write a cheque. As a pro-defence conservative, the old liberal line about holding cake stalls to fund the air force once annoyed me a little, but…….they make a fair point. Cake stalls to fund our education system?

Now I know that high decile schools are somewhat caught. They are funded much less well than lower decile schools, and they are not allowed to charge fees. They can ask for “donations”, and most parents pay them, but even at lower-end decile 10 areas (which is how I’d characterise Island Bay), the resistance will start to rise if the requested donation is raised too far. But the economics of the current model just don’t seem to add up. And while there are deadweight losses from taxes, from the less inefficient taxes they are not as large as the waste implied by my cost calculations above.

And that was going to be the end of the rant, until I actually went and helped out on the “catch a flamingo” game stall. I came away feeling quite uncomfortable about it. Children were being encouraged to pay $2 to toss three quoits, trying to get at least one of them over the necks of one of the several plastic flamingos pegged in the ground a couple of metres away. And the prize? A lollipop.

The Principal had been running the stall before I came on, and had made a unilateral decision to lower the price to $1. And we’d both decided that for the littler kids who missed we’d give them a lollipop anyway. But I reckon no more than one in eight of the children managed to get a quoit over a flamingo, so that in principle they were paying $8 for a lollipop. When I got home I priced lollipops – one could buy a big bag at 5 cents per lollipop and rather smaller bags at 10 cents a lollipop.

Of course, one can’t ignore the pleasure the children got from tossing a plastic ring at a plastic flamingo, but frankly it felt like a rip-off. Oh, and not to mention the sugar. I’m not a fanatic, but we never willingly allow our own children to have lollipops. But if lollipops still sell at $8, those sugar taxes the zealots argue for will have to be quite high.

I’m sure there are plenty of stalls that offer a quite reasonable deal – good baking at half or less the price one might pay in the local café, let alone Wishbone. But this wasn’t one of them. It felt a lot like exploitation frankly. Willing buyers certainly, but…..

I’ve never been convinced of the case for financial literacy education in schools. This might almost have been enough to change my mind, except that it was the school itself that was engaging the kids in such a shockingly bad deal. No teacher like experience I suppose…..

Next year, we’ll have only one child at this school. I think I’ll just write a cheque.

I’m sure this is the sort of issue Eric Crampton could find a clever academic paper about. A quick Google this morning showed up nothing, but just now I did find this old rant along similar lines from Deborah Russell.

The Joint Macroeconomic Declaration

November 6, 2015November 6, 2015 Michael Reddell TPP

I’m a bit puzzled about the new Joint Declaration of the Macroeconomic Policy Authorities of the Trans-Pacific Partnership Countries, that dropped into my inbox just after midday, courtesy of the RBNZ and the RBA. This was, apparently (and according to the RBNZ/Treasury press release)

“one of a number of issues that the US Congress has required the US Executive to demonstrate progress on, before it will consider passing the legislation necessary to implement TPP”.

The Declaration itself does not state who these “macroeconomic policy authorities” actually are, but I presume that the Reserve Bank of New Zealand and the Reserve Bank of Australia are directly parties to the declaration, even though both have operational independence in respect of monetary policy. In the New Zealand case, the Minister of Finance has extensive powers to direct exchange rate policy, implemented by the Reserve Bank, but I’m not aware that there are comparable provisions in the RBA Act.

I’m partly curious about who is party to this declaration because I went to the Federal Reserve website, and found no press release or mention of the declaration (while the US Treasury Secretary – a politician – has put out a release).

The joint Wheeler/Makhlouf statement is an odd affair. The RBA’s statement is terse, and really just provides a link to the Declaration text. But the New Zealand statement is substantial (longer than an OCR announcement release) and rather defensive – perhaps reflecting an awareness of the public unease around TPP itself. They are at pains to point out that it is all non-binding. But non-binding statements can still come back to create difficulties in future.

From the Declaration itself, I was struck by the opening sentence:

We, the macroeconomic policy authorities for countries that are party to the Trans-Pacific Partnership…welcome the ambitious, comprehensive, and high-standard agreement reached by our respective governments in Atlanta.

Is that really the sort of political puffery that the Governor of an independent central bank should be signing up to about highly-contentious policies? One might even ask whether the non-political head of the New Zealand Treasury should be making such statements, rather than (perhaps) leaving them to the Minister – who could, quite reasonably, congratulate his colleagues. I was curious what analysis either agency had undertaken to enable them to conclude that the 6000 page agreement was “comprehensive and high-standard”, and have lodged an OIA request with both agencies.

I also noticed the observation that “we further recognize that excessive volatility in capital flows can create policy challenges that may require a policy response”. But perhaps there are enough qualifiers in that statement to render it meaningless (“excessive” volatility is like “unnecessary” variability – different in the eye of each beholder).

The heart of the statement is a paragraph on exchange rate policies.

Each Authority confirms that its country is bound under the Articles of Agreement of the International Monetary Fund (IMF) to avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage. Each Authority is to take policy actions to foster an exchange rate system that reflects underlying economic fundamentals, and avoid persistent exchange rate misalignments. Each Authority will refrain from competitive devaluation and will not target its country’s exchange rate for competitive purposes.

Authorities commit to “not target its country’s exchange rate for competitive purposes”. Perhaps this thought might discourage Graeme Wheeler from quite so many references to overvalued exchange rates in his monetary policy pronouncements. But perhaps more importantly, transforming New Zealand’s economic prospects probably does require a strategy that focuses on a sustained lowering of the real exchange rate, to put New Zealand’s competitive position on a much stronger and more sustainable footing. Sure, that doesn’t involve using monetary or fiscal policy directly to bring it about, but it really needs to be a key focus of economic policy taken together. This declaration risks de-emphasising the real exchange rate as an adjustment mechanism. As for “competitive devaluation”, it is worth remembering that the countries that devalued first came out of the Great Depression fastest – oftten described as the “beggar thy neighbour” period. “Competitive devaluation” is mostly an empty phrase in substance, but that won’t stop it being used – cited – by critics (in the US Congress or other places) if some large TPP country or other (think Japan) actively seeks to depreciate its real exchange rate in ways that might help the country concerned and the wider world economy.

The Declaration also sets some provisions for (at least) annual Macroeconomic Policy Consultations, which will involve yet more travel for some unlucky Deputy Secretary/Deputy Governors. I was amused at the line that “The Group is to conduct its meetings in a mutually respectful manner” – the presence of which phrasing probably tells us a lot about the enthusiasm of some authorities to be part of this process.

The sort of talk that will take place at these meetings is surely largely harmless, but not necessarily cheap. At its annual meetings this Group is to consider the macro and exchange rate policies of each TPP country, including “the policy responses which address imbalances”. Perhaps we will finally get the long looked-for answers to New Zealand’s persistent macroeconomic imbalances? Even if the meeting is, say, tacked on in or around the IMF Annual or Spring Meetings, how much time is going to go into preparing background papers, reviewing them, as well the travel etc. How much does the Reserve Bank of New Zealand really want to know (or do we want to spend on it knowing) about macro policy and imbalances in Vietnam, Brunei or Peru? At the time of the Funding Agreement earlier in the year the Reserve Bank was keen to stress its austerity, and I had understood that the Treasury was also under funding pressure. What will be sacrificed so that yet another pointless international meeting can become a regular part of the international schedule?

And what of the defensive RB/Treasury statement?

A few lines caught my eye.

More broadly these commitments could help support stronger trade between TPP countries and seek to avoid practices that are harmful to economic growth and financial stability.

I’m not sure how. As the agencies keep noting, it is all non-binding, and if (as in the NZ case) it is the Treasury and the Reserve Bank who are the parties, they don’t even the power to commit governments as to how they will use, eg foreign exchange intervention powers. But this really comes down to the point above: “competitive devaluation” is a meaningless phrase, but the ability to depreciate one’s currency, perhaps sharply, in the event of significant economic weakness is not a power that should be lightly traduced. What behaviours do Gabs and Graeme have in mind, undertaken by the TPP member countries, that have previously been “harmful to economic growth and financial stability”? This, after all, is their own commentary, not some international lowest-common-denominator text.

Would the Reserve Bank’s policy on currency intervention breach the Declaration?

No. The framework does not restrict the ability of the RBNZ to intervene.

The framework setting out the operating of currency intervention policy under Section 16 of the Reserve Bank of New Zealand Act provides for interventions when the exchange rate is exceptionally high or low and clearly unjustified by economic fundamentals. This is consistent with the text of the Declaration.

Will this restrict New Zealand’s ability to change its exchange rate regime or approach to monetary policy?

No. The text on exchange rates largely echoes New Zealand existing commitments under Article IV of the IM Articles of Agreement.

The exchange rate elements of the Declaration – for example the avoidance of exchange rate manipulation – are helpful in supporting stronger trade.

It would be helpful to hear how the Reserve Bank and Treasury regard this document as it affects not just the section 16 activities of the Reserve Bank, but those that could be initiated, at any time, by a Minister of Finance under sections 17 and 18. Those clauses are much more far-reaching. I presume this press release was very carefully drafted, and carefully avoided reference to those powers. Personally, I hope those powers are never used, but they are the powers that would allow for much tighter management of the exchange rate should some future government choose to. Would such a government be advised by the Reserve Bank and Treasury that such a choice was inconsistent with this declaration? I hope not.

I also noted that “largely” in the response to the final question. It would be helpful to have spelt out where this (non-binding) agreement goes beyond the IMF Articles.

And, to repeat the point, the final sentence involves a pretty strong assertion, that there are gains in the form of larger international trade, to be had from non-binding declarations to discourage behaviours that the signatories have not pointed to examples of. If TPP countries have not been doing this stuff, pledging (in a non-binding way) to go on not doing so can offer no trade gains. If they have been doing this bad stuff, we should be made aware of the examples that the Governor and Secretary have in mind. Which exchange rate management practices of TPP countries in the last 20 years raise concerns for the Governor and the Secretary?

One does wonder how much this Declaration is aimed at the US Congress (no doubt to a fairly large extent) and how much it is aimed as a pre-emptive shot at China? Would the parties, for example, consider that a Chinese choice to devalue the yuan in the current environment would breach the provisions of this agreement if China were a party to it. And would the words strengthen the hands of mercantilist critics, even if the high-minded macroeconomists were unbothered by such choices.?

In the end declarations of this sort are about politics, including the price of getting TPP across the line (if it manages to). If the agreement really is (quite) good as our government claims – or as gung-ho as the US Trade Representative would have one believe, extending more regulation further across the world – then perhaps it is worthwhile. Of course, without a proper independent assessement – eg by the Productivity Commission – it will be hard to know. But if it is mainly about politics, it would be been much preferable for gushy statements and commitments (non-binding) to have come from Ministers of Finance – the true “macroeconomic authority” at least in New Zealand – and not from non-political and/or independent officials like the Secretary and the Governor.

Thinking further about employment and unemployment

November 6, 2015November 6, 2015 Michael Reddell Monetary policy, unemployment

Just when I’d been writing yesterday that I was puzzled that so many of New Zealand’s elite seem to think that New Zealand has done quite well in recent years, and seemed quite indifferent to the number of people unemployed, along comes another example.

In his column (not apparently online) in this morning’s Dominion-Post, Pattrick Smellie leads with this line

“On any rational analysis, New Zealand’s employment statistics are among the strongest in the developed world”

How could one “rationally” disagree? Well, it is certainly true that the ratio of employment to population in New Zealand is quite high by international standards (though any table in which, as with Smellie’s, New Zealand is bracketed between Colombia and Russia should probably be a bit of a warning), but by what criteria is Smellie judging this to be “a good thing? There is no real hint in the article, except perhaps a Stakhanovite sense that more paid labour must somehow be a good thing, for someone. For“the national interest” perhaps?

But labour is a costly input – costly not just to the employer who has to write the cheque to pay for it, but for the employee who gives up the time and opportunities he or she would otherwise have. Some people have a real passion for the paid employment they do, but for most they work because they have to, to provide the basics for themselves and their families, and because the value to them of the things they get to consume (or risks they get to allay) as a result of working outweighs the cost of giving up free time.

I’m disgruntled that our governments have continued to run policies that mean that 10 per cent of working age adults are on welfare benefits (and did I really hear that, despite this, the ACT Party last night voted to raise real welfare benefits?). I’d prefer that most of those people were providing for themselves – which for many/most would involve paid employment A move in that direction would tend to raise our labour force participation and employment rates.

But equally I’m glad that my elderly mother does not (have to) work A larger share of the population in much older age groups will, quite reasonably, tend to lower labour force participation and employment rates, even if we could get the NZS eligibility age raised somewhat. And polling data shows that many parents would prefer that one of them was able (financially) to stay home full-time at least when they had young children – but our scandalously expensive house prices, especially in Auckland, make that very difficult for most. Reforming land and housing markets to make housing more affordable might lower participation and employment rates – and that would seem likely to be a good thing, (given private preferences).

There are reasons to be concerned if public policy measures are unreasonably discouraging people from participating in the labour force. But a measure of a country’s success is not the proportion of its adult population that is in the paid labour force (or the hours they work – see, eg, Korea). Personally, I counted it as a measure of our family’s modest success that I’m not in the labour force any longer, and have no intention of being regularly in it again. I get to do for my kids what my mother did for me. That is gain not a loss.

And that is, of course, why most attention in the labour market data goes on the unemployment rate, because it is a measure of the people who want to work, are actively looking for work, are available for work now, but don’t have a job[1]. As a general proposition, the lower that number is the better. These people would prefer to be working – not necessarily in just any job, but in a job – and are taking active steps to find one.

One can take the economist’s tack and (somewhat queasily) compare people unemployed to goods on the shelf of a supermarket. I can always buy butter when I want it only because the supermarket stock enough to cope with fluctuations in demand. Those stocks serve a valuable purpose (which is why the supermarket owners willingly pays the cost). The unemployment story is a bit different; a pound of butter is a fairly homogeneous commodity, and people are not. The search and matching process – matchng the “right” job to the “right” worker – takes time and effort. Mostly, workers would probably prefer to do that matching while they are still in another job (whereas a pound of butter can’t be in my fridge and simultaneously available for another casual customer wandering into the supermarket), but sometimes unemployment actually allows the time for a more intensive search (or search in a different city). At the margin, unemployment benefits make that a more feasible option than it would otherwise be (as, of course, do private savings, and the pooling of multiple incomes within a household).

But unemployment is not something we can, or should, be complacent about. I think there was something profoundly right about the post-war emphasis on achieving full employment, even if it was carried too far, and pursued in ways that were probably detrimental to the longer-term economic performance of the country. “Full employment” barely even figures in modern discussion, except perhaps when macroeconomists are tempted to treat a NAIRU as something akin.

New Zealand has had a mixed historical record on unemployment. Here is how our unemployment rate has compared with the median OECD country’s unemployment rate, and that for the median of the other Anglo countries (Australia, Canada, Ireland, US and UK) since the HLFS was set up.

Mostly, we haven’t done too badly – the big exception being, of course, the late 1980s and early 1990s, when inflation was being brought down and a good deal of structural reform was going on. Things are not terribly bad compared to these other countries right now, but they aren’t that good either. The United States and the United Kingdom, both of which went through nasty financial crises, have lower unemployment rates now than we do. And both had long since more or less exhausted the room for conventional monetary and fiscal policy to do much about helping to deal with any cyclical components of unemployment. We haven’t.

Even the US unemployment rate of 5.1 per cent is still, as I noted yesterday, consistent with every person spending two years, in a forty year working life, officially unemployed. Markets look as though they should be able to work better than that.

That should disquiet our political leaders, but it is not clear that it does.. A local political blog the other day highlighted this exchange from the House on Wednesday:

Andrew Little: What responsibility, if any, does he take for unemployment rising to 6 percent?

Hon BILL ENGLISH: Of course, if unemployment was a direct choice of the Prime Minister of New Zealand, there would be none of it. You would just decide to have none. But, of course, it is not.

The flippancy is perhaps par for the course in the House (question time is partly about “gotcha”), but I looked at Hansard and nothing in the answers to the supplementaries gave me any greater confidence that the issue was being taken very seriously.

The question wasn’t about the absolute rate of unemployment, although there must be plenty of structural stuff governments could do to lower that over time, it was about the increase in unemployment that has now gone on for several quarters, and is apparently forecast to go further.

As I’ve noted previously, it is fair for the Minister of Finance to respond that he doesn’t directly control the principal lever of stabilisation policy, which is monetary policy. But he hires, sets the goals for, and fires the person who does – the Governor of the Reserve Bank. We depend on the Minister of Finance to hold the Governor to account, both directly and through the sort of people he appoints to the Reserve Bank Board. Judging by the Minister’s public silence, by the absence of any concern about the issue in his annual letter of expectation to the Governor, and by the “we look after the Governor’s back” approach taken by the Board in their Annual Reports, unfortunately he associates himself with the errors the Bank has made, and keeps on making. The Governor’s errors are those of commission and the Minister’s might be those of passivity or omission, but they are choices nonetheless. The increasingly large number of people unemployed suffer the consequence.

In closing, a final observation on the Smellie article. He claims that our participation rate/employment rate are remarkable because they are coinciding with “unprecedented” [not actually, but rapid certainly] population growth, reflecting strong net inward migration. I reckon he has that story the wrong way round. For decades, every economic forecaster in New Zealand has worked on the basis that the short-term effects of immigration are such that the boost to demand that results exceeds the boost to supply. Immigrants have to live somewhere, and need roads, schools, shops etc – so they need day-to-day consumption, and a material addition to the physical capital stock. That is why the Reserve Bank tends to tighten monetary policy, all else equal, when immigration picks up. There is lots of debate about the long-term effects of immigration, but there has never been much doubt about the short-term effects. Immigration to New Zealand doesn’t boost unemployment; all else equal it lowers it. If we’d not had the impetus from immigration over the last couple of years, we’d be grappling with even weaker inflation pressures and more of a need for the Reserve Bank to have cut interest rates further.

[1] Simply noting here, but skipping over, the wider measures of unemployment and underemployment.

Unemployment – a pretty poor record

November 5, 2015November 5, 2015 Michael Reddell unemployment

The HLFS data came out yesterday, and once again they made sobering reading [1].

The unemployment rate was up a bit further to 6 per cent.

I don’t usually pay much attention to the table at the back of the HLFS release, which compares New Zealand’s unemployment rate with those in other OECD countries. Since New Zealand’s labour market is generally regarded as more flexible than those of most OECD countries, our unemployment rate has typically been quite low by OECD standards. But we aren’t looking so good now. There are 34 OECD countries, and 14 of them now have lower unemployment rates than New Zealand does.

And what about the increase in the unemployment rate? I downloaded the OECD data since 2000. I’ve previously done the comparison between the current unemployment rate and the low prior to the 2008/09 recession. Only fixed exchange rate (euro area) countries have had more of an increase than us. But people could (reasonably) object to that comparison, as perhaps we just had a bigger boom at peak than most other countries. Other indicators, such as output gap estimates don’t suggest so, but as a cross-check I compared the current unemployment rate with a somewhat longer-term average. This chart shows the current unemployment rate for each OECD country less the average for the 9 years 2000 to 2008.

A depressingly large number of countries have higher unemployment rates than they averaged through those years. But the New Zealand experience is particularly bad. Only countries that have no domestic monetary policy (either in the euro or pegged to the euro) have done less well than us. And, of course, the euro area itself has largely exhausted conventional monetary or fiscal capacity.

It is well-known that fixed exchange rate regimes tend to handle adjustment less well than floating exchange rates. Our exchange rate fluctuates quite considerably, and yet we now have an unemployment rate near that of the median OECD country, and materially above what we managed over 2000 to 2008. It continues to baffle me that so many of the New Zealand elite seem to want to believe that New Zealand has done quite well over the last few years. We’ve had very little productivity growth, not much income growth, and haven’t even been able to get the unemployment rate back down again.

Too often, unemployment rate numbers roll glibly off the tongues of economists. But it is worth remembering what a 6 per cent rate means. If everyone spent 40 years in the labour force, and spent one year of that time unemployed, that would still only generate an unemployment rate of around 2.5 per cent. A 6 per cent unemployment is, in effect, every person in the labour force spending more than two years officially unemployed (not on a welfare benefit, but officially unemployed). These are really large numbers. And recall that these are HLFS definitions – to be unemployed, you have to be actively looking for a job and available to start work straightaway. There will always be some frictional unemployment, but most people leave jobs to move into another one: not many voluntarily leave to become what the HLFS would define as unemployed.

And bear in mind the possibility that the normal, non-inflationary rate of unemployment may itself have been falling. Among other considerations, bear in mind that people aged over 55 made up barely 10 per cent of the labour force when the HLFS began in 1986. That share is now 23 per cent of the labour force, and still rising. And people aged over 55 have only around half the unemployment rate of the labour force as a whole (3.5 per cent at present)

A 6 per cent unemployment rate should be treated as something much more serious – as a failure of some mix of stabilisation and structural policy – than it currently seems to be.

[1] Kudos to Statistics NZ for avoiding an “accentuate the positive” headline.

The Government is doing everything it can?

November 4, 2015November 4, 2015 Michael Reddell Housing

Tempting as it is to follow up yesterday’s post with some thoughts about how one might assess the Reserve Bank’s performance over recent years, I’m totally tied up today dealing with some rather older Reserve Bank issues. I’m preparing for a meeting tomorrow surrounded by various old documents, a number of legal opinions, and numerous rulings from the Court of Appeal, the House of Lords etc all bearing on some important, but complex, questions about events from 25 years ago. The investigative process has, unfortunately, already thrown up one explicit breach of the law – responsibility for which falls ultimately on the then Governor.

But before plunging back into that, I wanted to comment very briefly on a story Bernard Hickey ran yesterday on Auckland house prices. The headline says “PM says government doing everything it can on Auckland prices”, and from the quotes in the body of the article it doesn’t seem to be an unrepresentative headline. The quote that really caught my eye was this one

Asked if NZ$918,000 was too high, he said: “Well clearly it’s a lot but, there’s a big range and you can go on TradeMe and look at homes under $400,000 in Auckland and there are some.”

The blithe indifference was almost breathtaking. Median house prices in Auckland are closing in on 10 times median income, and the Prime Minister can’t even say prices are too high. He is reduced to suggesting that if you look hard enough you can find a few under $400000.

Those absolute bottom-end houses would still be more than five times median household income in Auckland. A reasonable benchmark for median house prices is around three times income – about a third of the current ratio in Auckland. I’ve never been one of those to criticise the Prime Minister for his wealth, but when he makes comments like this it does come across as someone who has got rather out of touch with the plight of ordinary New Zealanders (especially the younger, poorer, browner ones), perhaps reinforced by two weeks swanning round Europe attending rugby games at the taxpayer’s expense.

The Prime Minister is also reported as claiming that “There is an unprecedented level of construction and consenting now taking place in Auckland”.

I’m not sure quite what he has in mind. His claim took me by surprise, so I went to Infoshare and dig out the quarterly data on the number of residential building consents in Auckland. The latest consents numbers are barely at the peak of the 1990s boom, let alone the 2000s one. Auckland’s population is much larger than it was back then.

Different experts in planning and parliamentary vote-counting might differ on whether the government could do more now, if it really wanted to, on freeing up land use restrictions, and allowing land owners to use their own land as they see fit, and as the market encourages them to.

But what is quite clear is that the government is doing nothing at all about cutting back the immigration target. The number of residence approvals that is granted is wholly at the discretion of ministers, and could be changed tomorrow, requiring not a single vote in the House or any support from minor parties. Cutting back the target from the current 40000 to 45000 per annum to, say, 10000 to 15000 would make a great deal of difference to population pressures on the housing market, especially in Auckland. Cutting back immigration isn’t a direct solution to the longer-term issues about dysfunctional over-regulated markets in land use, but it would make a great deal of difference now. And it is not as if the government, or its official advisers, have been able to show any convincing evidence that New Zealand’s large scale inward permanent migration programme is producing any other net economic benefits to New Zealanders.

croaking cassandra

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

Author: Michael Reddell