A radical alternative to macro policy?

Last Friday, an outfit called Strategy2040 New Zealand, together with Victoria University’s School of Government, hosted a lunchtime address by an Australian academic, Professor Bill Mitchell of the University of Newcastle.   He is a proponent of something calling itself Modern Monetary Theory, but which is perhaps better thought of as old-school fiscal practice, with rhetoric and work schemes thrown into the mix.

Mitchell attracted some interest on his trip to New Zealand.  He apparently did two substantial interviews on Radio New Zealand and attracted perhaps 150 people to the lunchtime address –  a pretty left-liberal crowd mostly, to judge from the murmurs of approval each time he inveighed against the “neo-liberals”.    In fact, the presence of former Prime Minister Jim Bolger was noted –  he who, without apparently recanting any specific reforms his government had put in place, now believes that “neo-liberalism has failed New Zealand”.     Following the open lecture, 20 or so invitees (academics, journalists and economists –  mostly of a fairly leftish persuasion) joined Mitchell for a roundtable discussion of his ideas.   Perhaps a little surprisingly, I didn’t recognise anyone from The Treasury or the Reserve Bank at either event.

Mitchell has it in for mainstream academic economics.   Quite probably there is something in what he says about that.  Between the sort of internal incentives (“groupthink”) that shape any discipline, and the inevitable simplifications that teaching and textbooks require, it seems highly likely there is room for improvement.   If textbooks are, for example, really still teaching the money multiplier as the dominant approach to money, so much the worse for them.   But as I pointed out to him, that was his problem (as an academic working among academics): I wasn’t aware of any floating exchange rate central banks that worked on any basis other than that, for the banking system as a whole, credit and deposits are created simultaneously.  He quoted the Bank of England to that effect: I matched him with the Reserve Bank of New Zealand.    And if very few people correctly diagnosed what was going on just prior to the financial crises in some countries in 2008/09, that should be a little troubling.  But it doesn’t shed much (any, I would argue) light on the best regular approach to macroeconomic management and cyclical stabilisation.  Perhaps especially so as (to us) he was talking about policy in Australia and New Zealand, and neither country had a US-style financial crisis.

He seemed to regard his key insight as being that in an economy with a fiat currency, there is no technical limit to how much governments can spend.  They can simply print (or –  since he doesn’t like that word – create) the money, by spending funded from Reserve Bank credit.     But he isn’t as crazy as that might sound. He isn’t, for example, a Social Crediter.    First, he is obviously technically correct –  it is simply the flipside of the line you hear all the time from conventional economists, that a government with a fiat currency need never default on its domestic currency debt.     And he isn’t arguing for a world of no taxes and all money-creating spending.  In fact, with his political cards on the table, I’m pretty sure he’d be arguing for higher taxes than New Zealand or Australia currently have (but quite a lot more spending).  Taxes make space for the spending priorities (claims over real resources) of politicians.  And he isn ‘t even arguing for a much higher inflation rate –  although I doubt he ever have signed up for a 2 per cent inflation target in the first place.

In listening to him, and challenging him in the course of the roundtable discussion, it seemed that what his argument boiled down to was two things:

  • monetary policy isn’t a very effective tool, and fiscal policy should be favoured as a stabilisation policy lever,
  • that involuntary unemployment (or indeed underemployment) is a societal scandal, that can quite readily be fixed through some combination of the general (increased aggregate demand), and the specific (a government job guarantee programme).

Views about monetary policy come and go.   As he notes, in much academic thinking for much of the post-war period, a big role was seen for fiscal policy in cyclical stabilisation.  It was never anywhere near that dominant in practice –  check out the use of credit restrictions or (in New Zealand) playing around with exchange controls or import licenses –  but in the literature it was once very important, and then passed almost completely out of fashion.  For the last 30+ years, monetary policy has been seen as most appropriate, and effective, cyclical stabilisation tool.  And one could, and did, note that in the Great Depression it was monetary action –  devaluing or going off gold, often rather belatedly – that was critical to various countries’ economic revivals.

In many countries, the 2008/09 recession challenged the exclusive assignment of stabilisation responsibilities to monetary policy.  It did so for a simple reason –  conventional monetary policy largely ran out of room in most countries when policy interest rates got to around zero.   Some see a big role for quantitative easing in such a world.  Like Mitchell – although for different reasons –  I doubt that.    Standard theory allows for a possible, perhaps quite large, role for stimulatory fiscal policy when interest rates can’t be cut any further.

But, of course, in neither New Zealand nor Australia did interest rates get anywhere near zero in the 2008/09 period, and they haven’t done so since.    Monetary policy could have been  –  could be –  used more aggressively, but wasn’t.

As exhibit A in his argument for a much more aggresive use of fiscal policy was the Kevin Rudd stimulus packages put in place in Australia in 2008/09.   According to Mitchell, this was why New Zealand had a nasty damaging recession and Australia didn’t.  Perhaps he just didn’t have time to elaborate, but citing the Australian Treasury as evidence of the vital importance of fiscal policy –  when they were the key advocates of the policy –  isn’t very convincing.   And I’ve illustrated previously how, by chance more than anything else, New Zealand and Australian fiscal policies were reamrkably similar during that period.   And although unemployment is one of his key concerns –  in many respects rightly I think –  he never mentioned that Australia’s unemployment rate rose quite considerably during the 2008/09 episode (in which Australian national income fell quite considerably, even if the volume of stuff produced –  GDP –  didn’t).

On the basis of what he presented on Friday, it is difficult to tell how different macro policy would look in either country if he was given charge.   He didn’t say so, but the logic of what he said would be to remove operational autonomy from the Reserve Bank, and have macroeconomic stabilisation policy conducted by the Minister of Finance, using whichever tools looked best at the time.  As a model it isn’t without precedent –  it is more or less how New Zealand, Australia, the UK (and various other countries) operated in the 1950s and 1960s.  It isn’t necessarily disastrous either.  But in many ways, it also isn’t terribly radical either.

Mitchell claimed to be committed to keeping inflation in check, and only wanting to use fiscal policy to boost demand where there are underemployed resources.    And he was quite explicit that the full employment he was talking about wasn’t necessarily a world of zero (private) unemployment  –  he said it might be 2 per cent unemployment, or even 4 per cent unemployment.     He sees a tight nexus between unemployment and inflation, at least under the current system  (at one point he argued that monetary policy had played little or no role in getting inflation down in the 1980s and 1990s, it was all down the unemployment.  I bit my tongue and forebore from asking “and who do you think it was that generated the unemployment?” –  sure some of it was about microeconomic resource reallocation and restructuring, but much it was about monetary policy).   But as I noted, in the both the 1990s growth phase and the 2000s growth phase, inflation had begun to pick up quite a bit, and by late in the 2000s boom, fiscal policy was being run in a quite expansionary way.

I came away from his presentation with a sense that he has a burning passion for people to have jobs when they want them, and a recognition that involuntary unemployment can be a searing and soul-destroying experience (as well as corroding human capital).  And, as he sees things, all too many of the political and elites don’t share  that view –  perhaps don’t even care much.

In that respect, I largely share his view.

Nonetheless, it was all a bit puzzling.  On the one hand, he stressed how important it was that people have the dignity of work, and that children grow up seeing parents getting up and going out to work.   But then, when he talked about New Zealand and Australia, he talked about labour underutilisation rates (unemployment rate plus people wanting more work, or people wanting a job but not quite meeting the narrow definition of actively seeking and available now to start work).   That rate for New Zealand at present is apparently 12.7 per cent –  Australia’s is higher again.     Those should be, constantly, sobering numbers: one in eight people.      But some of them are people who are already working –  part-time –  but would like more hours.  That isn’t a great situation, but it is very different from having no role, no job, at all.  And many of the unemployed haven’t been unemployed for very long.  As even Mitchell noted, in a market economy, some people will always be between jobs, and not too bothered by the fact.  Others will have been out of work for months, or even years.   But in New Zealand those numbers are relatively small: only around a quarter of the people captured as unemployed in the HLFS have been out of work for more than six months (that is around 1.5 per cent of the labour force).       We should never trivialise the difficulties of someone on a modest income being out of work for even a few months, but it is a very different thing from someone who has simply never had paid employment.  In our sort of country, if that was one’s worry one might look first to problems with the design of the welfare system.

Mitchell’s solution seemed to have two (related) strands:

  • more real purchases of good and services by government, increasing demand more generally.  He argues that fiscal policy offers a much more certain demand effect than monetary policy, and to the extent that is true it applies only when the government is purchasing directly (the effects of transfers or tax changes are no more certain than the effects of changing interest rates), and
  • a job guarantee.    Under the job guarantee, every working age adult would be entitled to full-time work, at a minimum wage (or sometimes, a living wage) doing “work of public benefit”.     I want to focus on this aspect of what he is talking about.

It might sound good, but the more one thinks about it the more deeply wrongheaded it seems.

One senior official present in the discussions attempted to argue that New Zealand was so close to full employment that there would be almost no takers for such an offer.   That seems simply seriously wrong.    Not only do we have 5 per cent of the labour force officially unemployed, but we have many others in the “underutilisation category”, all of whom would presumably welcome more money.     Perhaps there are a few malingerers among them, but the minimum wage –  let alone “the living wage” – is well above standard welfare benefit rates.   There would be plenty of takers.   (In fact, under some conceptions of the job guarantee, the guaranteed work would apparently replace income support from the current welfare system.)

But what was a bit puzzling was the nature of this work of public benefit.    It all risked sounding dangerously like the New Zealand approach to unemployment in the 1930s, in which support was available for people, but only if they would take up public works jobs.  Or the PEP schemes of the late 1970s.   Mitchell responded that it couldn’t just be “digging holes and filling them in again”.  But if it is to be “meaningful” work, it presumably also won’t all be able to involve picking up litter, or carving out roadways with nothing more advanced than shovels.  Modern jobs typically involve capital (machines, buildings, computers etc) –  it accompanies labour to enable us to earn reasonable incomes –  and putting in place the capital for all these workers will relatively quickly put pressure on real resources (ie boosting inflation).   If the work isn’t “meaningful”, where is the alleged “dignity of work”  –  people know artificial job creation schemes when they see them –  and if the work is meaningful, why would people want to come off these government jobs to take existing low wage jobs in the prviate market?

The motivation seems good, perhaps even noble.  I find quite deeply troubling the apparent indifference of policymakers to the inability of too many people to get work.   The idea of the dignity of work is real, and so too is the way in which people use starting jobs to establish a track record in the labour market, enabling them to move onto better jobs.

But do we really need all the infrastructure of a job guarantee scheme?  In countries where interest rates are still well above zero, give monetary policy more of a chance, and use it more aggressively.   For all his scepticism about monetary policy, it was noticeable that in Mitchell’s talks he gave very little (or no) weight to the expansionary possibilities of exchange rate.    But in a small open economy, a lower exchange rate is, over time, a significant source of boost to demand, activity, and employment.    And winding back high minimum wage rates for people starting out might also be a step in the right direction.

And curiously, when he was pushed Mitchell talked in terms of fiscal deficits averaging around 2 per cent of GDP.  I don’t see the case in New Zealand –  where monetary policy still has capacity –  but equally I couldn’t get too excited about average deficits at that level (in an economy with nominal GDP growth averaging perhaps 4 per cent).  Then again, it simply can’t be the answer either.    Most OECD countries –  including the UK, US and Australia –  have been running deficits at least that large for some time.

It is interesting to ponder why there has been such reluctance to use fiscal policy more aggressively in countries near the zero bound.   Some of it probably is the point Mitchell touches on –  a false belief that somehow countries were near to exhausting technical limits of what they could spend/borrow.      But much of it was probably also some mix of bad forecasts –  advisers who kept believing demand would rebound more strongly than it would –  and questionable assertions from central bankers about eg the potency of QE.

But I suspect it is rather more than that –  issues that Mitchell simply didn’t grapple with.  For example, even if there is a place for more government spending on goods and services in some severe recessions, how do we (citizens) rein in that enthusiasm once the tough times pass?  And perhaps I might support the government spending on my projects, but not on yours.  And perhaps confidence in Western governments has drifted so low that big fiscal programmes are just seen to open up avenues for corruption and incompetent execution, corporate welfare and more opportunities for politicians once they leave public life.  Perhaps too, publics just don’t believe the story, and would (a) vote to reverse such policies, and (b) would save themselves, in a way that might largely offset the effects of increased spending.      They are all real world considerations that reform advocates need to grapple with –  it isn’t enough to simply assert (correctly) that a government with its own currency can never run out of money.

I don’t have much doubt that in the right circumstances expansionary fiscal policy can make a real difference: see, for example, the experience of countries like ours during World War Two.    A shared enemy, a fight for survival, and a willingness to subsume differences for a time makes a great deal of difference –  even if, in many respects, it comes at longer term costs.

But unlike Mitchell, I still think monetary policy is, and should be, better placed to do the cyclical stabilisation role.    That makes it vital that policymakers finally take steps to deal with the near-zero lower bound soon, or we will be left in the next recession with (a) no real options but fiscal policy, and (b) lots of real world constraints on the use of fiscal policy.  Like Mitchell, I think involuntary unemployment (or underemployment for that matter) is something that gets too little attention –  commands too little empathy –  from those holding the commanding heights of our system.  But I suspect that some mix of a more aggressive use of monetary policy, and welfare and labour market reforms that make it easier for people to get into work in the private economy,  are the rather better way to start tackling the issue.   How we can, or why we would, be content with one in twenty of our fellow citizens being unable to get work, despite actively looking –  or why we are relaxed that so many more, not meeting those narrow definitions, can’t get the volume of work they’d like  –  is beyond me.   Work is the path to a whole bunch of better family and social outcomes –  one reason I’m so opposed to UBI schemes –  and against that backdrop the indifference to the plight of the unemployed (or underemployed), largely across the political spectrum, is pretty deeply troubling.

But, whatever the rightness of his passion, I’m pretty sure Mitchell’s prescription isn’t the answer.

 

 

 

Another Budget in an underwhelming economy

If people had wanted a centre-left government, one might suppose that they would have voted for the real thing.  Despite the additional redistribution announced in yesterday’s Budget, perhaps they still will.

Still, for all the headlines about money being put (back) in people’s pockets, it is worth keeping the overall numbers in perspective.  Core Crown tax revenue as a share of GDP was 27.8 per cent last year, is estimated at 27.7 per cent of GDP this year, is forecast at 27.5 per cent in 2017/18, and in the final forecast period it is predicted to be 27.7 per cent.  The government isn’t yet shrinking its pre-emptive claim on overall economic resources.  Expenditure as a share of GDP is forecast is gradually shrink, and if that was sustained –  which will be a challenge, including because of the reluctance to act soon on NZS –  it could open the way to future real reductions in the tax burden.

It is sad to reflect that much of the increased spending announced yesterday was simply a palliative for the failures of the government.   The cost of housing is, pure and simple, the fault of successive governments’ land-use regulation.  In a country with plenty of land, and the lowest real interest rates for decades, housing should be more affordable than ever.  That it isn’t, should be something governments are held accountable for (and although governments of both parties have had much the same flawed policies, the current government has now been in power for almost nine years).    And the lack of productivity  growth –  recall that we have had none at all for five years now –  is the biggest single thing that holds back the income growth of working people.    With a well-functioning housing market, and an economy with robust productivity growth, many of the pressures that led to increased spending yesterday would simply have been unnecessary.

As for tax, how many more decades will we have wait before a simple reform like inflation-indexing the income tax brackets is enacted?  Even the United States, with its enormously complex and distorted tax code, manages that one.

Perhaps more importantly, for all the rhetoric about encouraging enterprise –  and more subsidies for favoured uneconomic industries (film, rail and so on), there was no sign at all of action to lower what is probably the most costly and distortionary major item in our tax system –  the company tax rate.   It is curious to reflect that the previous Labour government cut the company tax rate more than the current government has.

I ran this chart a few weeks ago
company tax rates

New Zealand’s company tax rate is in the upper third of OECD member country rates.   For a country that talks a good game about welcoming foreign investment, and supposedly aspires to reverse the decades of productivity underperformance,  it simply isn’t good enough.    Politicians seem afraid of making the well-established economic point that taxes on businesses are typically borne substantially by wage-earners, not by owners of capital.   Less investment than otherwise means fewer high productivity and, thus, high wage jobs.  And if our company tax rates are high, it makes it harder for overseas investors to justify locating an operation here rather than in a lower tax country.   For a country with a pretty disadvantageous location to start with, it is the sort of additional burden we shouldn’t be putting on enterprise.    (I’ve focused this paragraph on foreign investors.  Taxes also discourage domestic-owned business investment, but for owners of those businesses, the maximum personal tax rate is ultimately the important consideration, rather than the company tax rate itself).

Anyone who listened to, or read, the Budget speech itself was clearly supposed to come away with a message about how well the New Zealand economy was doing.  There on the very first page was the Minister’s claim

“Our economy is 14 per cent larger than it was just five years ago”.

Yes, but the population is about 8 per cent larger.  That would leave an annual average growth in per capita terms of 1.1 per cent.  Better than nothing, to be sure, but not the sort of stuff most finance ministers would want to boast about.

And Treasury’s own numbers –  done at arms-length from the Minister –  don’t really back up the Minister’s story, whether cyclically or structurally.

Take the cyclical position first.  Here is Treasury’s estimate of the output gap (positive numbers suggest activity and demand are running a bit ahead of what is sustainable –  “potential GDP” – and negative numbers suggest there is still slack in the economy).

treasury output gaps

On these estimates, New Zealand will have had a negative output gap –  resources being underutilised –  for 10 consecutive years, including the whole of this government’s term to date, and the next year as well.    One can argue all one likes about what governments should or shouldn’t have done to lift potential productivity growth, but these estimates just take for granted what actually happened with structural policy and look at the cyclical position.  And there is really no excuse for putting the economy through such sustained period of resource underutilisation.  I can’t think of any time in modern New Zealand history, when the output gap would have been negative for so long.

Output gap estimates are pretty bloodless things, that don’t necessarily resonate with a wider audience.  They also can’t be observed directly.   But here are the unemployment rate numbers (actual and Treasury forecasts).

Tsy U

Last year, Treasury told us that they thought the

Treasury takes the view that the unemployment rate consistent with full employment (the nonaccelerating inflation rate of unemployment or NAIRU) has also fallen over time, so that…. it would be closer to 4.0%

I’m not sure precisely what number they had in mind, although in a chart included in that 2016 paper, the unemployment rate levelled out at around 4.1 per cent, so I included an indicative NAIRU line in my chart at 4.1 per cent.   But whatever the precise estimate, on official numbers and Treasury estimates we are looking at 10 years (or perhaps 11) with an unemployment rate higher than necessary to keep inflation in check.  The government has consistently presided over less than full employment.  That is simply poor economic management, and since we know that having a job is one of the best ways to secure better life outcomes, it is pretty poor management more generally.

Perhaps such unfortunate results might be excusable in a country that had no discretionary monetary policy leeway left (interest rates were already at or just below zero), or which was in fiscal crisis and had no borrowing capacity left.   Places like Portugal spring to mind.    But not New Zealand.   We have a floating exchange rate and our OCR has never got below 1.75 per cent (and even if that capacity had been exhausted, our public debt has been relatively modest).

It is also easy –  and right at one level – to blame the Reserve Bank.  They do short-term macroeconomic management.  But only as agent for the government and the Minister of Finance.  The Minister sets the targets and is ultimately responsible to citizens for their performance.  I do hope that Treasury, in offering advice to the Minister of Finance (whoever he or she may be after the election) on the appointment of a new Governor, and the design of the PTA, will take seriously the record of underperformance over the last decade.  This isn’t some trivial inside-the-Beltway governance issues.  These are real lives and opportunites that are unnecessarily blighted.

The government also likes to pretend that New Zealand’s economy is doing very well by international standards.   Thus, we are told by the Minister that

“we are at the moment growing faster than the United States, the UK, Australia, the EU, Japan and Canada”

One would certainly hope so.  Our population is growing materially faster than the population in any of those countries/regions.

But what about per capita growth?

I noticed various commentators yesterday suggesting that Treasury’s growth forecasts looked a bit optimistic.  I had some sympathy for that view, but here I’ll just take them at face value.   And I wondered how their forecasts for real per capita GDP growth compared to those the IMF has recently published for each advanced economy.

Treasury forecasts on a June year basis, and the IMF numbers are for calendar years. Over a forecast horizon of four years (Treasury’s horizon), it shouldn’t make much difference.    In the chart below I used Treasury’s forecasts of real per capita growth for the four years to June 2021, and compared them to the average of the IMF’s forecasts for the four years to December 2020 and the four years to December 2021.

IMF forecasts of real GDP pc

If the Treasury numbers are right for New Zealand, our growth in real GDP per capita would be just slightly below that of the median advanced country over the next four years.   I guess that isn’t that bad, but it isn’t much to boast about either.

After all, our per capita incomes are a long way down this list of countries.  On the IMF’s numbers

IMF real GDP pc.png

The aim –  supposedly –  for a very long time has been to catch up again with those top tier countries, almost of whom we were richer than not that long ago.    And catch-up or convergence certainly isn’t unknown, or unexpected, for other countries.   Here is how those Treasury forecasts for New Zealand’s real per capita GDP growth compare to the IMF’s for the 12 countries poorer than us.

IMF and the poor advanced countries

We only manage to beat two of those countries.    In fairness, of course, some of those poor advanced countries are recovering from savage recessions.    But even if one just focuses on the six former eastern-bloc countries, all but one is forecast to not only manage faster per capita growth over the next few years, but also to have achieved faster growth than New Zealand for the whole period from 2007 (just before the global recession) to 2021.  They are catching up. We aren’t.

(Compared with the richest 12 advanced countries, we are forecast to match the median per capita growth rate of those countries over the next four years, but the eastern Europeans are actually catching up.)

In wrapping up his Budget speech, the Minister of Finance claimed that

“we have a strong and growing economy built on a strong economic plan.  We must maintain our focus on growing the economy and sticking to the plan”

Earlier he had claimed that

Under the Government’s strong economic leadership, New Zealand is shaping globalisation to its advantage.  We’ve embraced increased trade, new technologies, innovation and investment.

All this in a country where exports as a share of GDP have been shrinking.  And productivity growth has been all-but-non-existent for years.

The bare-faced cheek of these assertions should be breath-taking.  Sadly, it seems like just another episode in a long succession in which the government simply makes stuff up.

 

Budgets, journalists, Switzerland and all that

Last week I wrote about the New Zealand Initiative’s study tour to Switzerland, where (so we were told) a large and high-powered group of CEOs and chairs were seeking to learn from Switzerland’s success.  As I noted, it seemed odd to look for inspiration from the one OECD country that has managed to achieve less productivity growth than New Zealand since 1970.   Even since 1990, Swiss productivity growth has underperformed New Zealand’s own poor record.

I learned about this tour in an article in the Herald, written by veteran journalist (and apparently “Head of Business at NZME”) Fran O’Sullivan.  It was presented as a straight news story, with no suggestion of any Herald involvement with the trip.

But in today’s Herald O’Sullivan devotes her column to Five elements of a good first Budget.  I’ll come back to the substance of the column in a moment.  But in the middle of the column was this

From a distance (in Switzerland travelling with the NZ Initiative to look at how New Zealand can once again become a “rich country”) it is easy to overlook that for some nations – like the Swiss – posting surpluses is mandatory.

So a leading journalist writes about a business lobby-group’s study tour to Switzerland without disclosing that she herself is participating in the tour?   One presumes NZME is paying for her to undertake the tour, but even so.   Wouldn’t it normally be elementary to let readers know of your involvement when you write up the story?  Isn’t it just possible that, in what looked like a straight news story, the fact that the author herself was participating in the tour might colour the angles put on trip, and reports of what it might reasonably hope to achieve?      It will be interesting to hear, in due course, what O’Sullivan makes of the Swiss experience, but how likely is that we will get a balanced and rigorous account when she has gone in with the New Zealand Initiative to do this trip, running their advance lines about “lessons to be learned” etc  (and presumably NZI organised everything, arranged the programme of meetings etc)?      Presumably at a distance, she still hadn’t noticed that while Switzerland is pretty rich, its productivity performance has been shocking, and it has slowly but steadily been dropping down the league tables.

That quote come from item 2 in O’Sullivan’s list of five elements she wants to see in Steven Joyce’s Budget tomorrow.     And yes, the Swiss have changed their constitutional rules to require budget surpluses, but as the chart in my post this morning showed, on net government debt (as a share of GDP), they are virtually identical to New Zealand, and both of us have a bit more debt than Australia.     Perhaps a formal binding surplus rule might make some sense –  although when you don’t have a formal constitution it would be hard – but the case doesn’t seem that compelling in a country that successfully maintains low public debt itself, and yet is exposed to very nasty (and very costly) natural disasters.

What are the five items O’Sullivan looks for?

First –  for G*d’s sake, be bold

Second: Post a surplus?

Third: Budget is the plan

Fourth:  Get economic growth up on a per capita income level

Fifth:  Strip out the smoke and mirrors

Item 1 is the sort of item that helps reinforce conservatives in their conservatism.  Being bold might sound good, but her lead proposal is simultaneously bold and daft.

A bold Budget would unveil a significant long-term investment in the country’s infrastructure. For example, a high-speed railway network to service Auckland from elsewhere in the Golden Triangle (Hamilton, Whangarei, Tauranga).

This generation’s Think Big, if I hadn’t already applied that label to our immigration policy.

The British government is envisaging spending 55 billion pounds –  stop and take in the number –  on their HS2 high speed rail route.   There is plenty of scepticism about that proposal –  and this is country with many many more people, at either end of the proposed routes, than anything we are ever (or even just in our lifetimes) likely to have in northern New Zealand.    If the costs in New Zealand were similar, that would be $100 billion (or around 40 per cent of current GDP).     We do lots of government capital spending badly in this country –  check out the Transmission Gully project –  but an HS2 equivalent would surely take the cake?

Urging boldness on politicians is fine, if there is a strong and well-grounded agreement on what they should be bold about.  Otherwise, it feels a lot like random action because “something must be done” and anything is something.

She poses a question mark around the second item –  post a surplus.  This seems to be because she is tantalised by the idea of using surpluses to fund “major infrastructure to support growth”.  As I noted this morning, government infrastructure may involve ongoing maintenance and depreciation costs, but straight government capital expenditure doesn’t show up in the operating balance.

What of the third item –  the plan.

Does the Government have a plan? New Zealand is at a choke point. There needs to be a credible five-year plan to capitalise on the major influx of immigrants. Ensure New Zealanders can be housed; clean up our waterways … the list goes on.

Joyce has had a lengthy eight-year period as English’s understudy.

That’s more than enough time to come up with a plan.

Hard to disagree that a credible plan would be nice.  After eight years it doesn’t seem likely that one will suddenly be granted us.   And, given the Minister’s penchant for interventions all over the place (universities, student visas, tech schemes etc), it isn’t likely that any such plan now would offer us a credible way forward.  He was, after all, the Minister primarily responsible for the exports target.    Over recent years, we’ve been moving away from that target rather than towards it.

The fourth item –  lifting per capita growth –  is really the same as the third.  It would be nice –  rather more than that actually.    But there isn’t much sign of doing differently things that have given us such weak per capita GDP and productivity growth for the last eight years.

On the fifth item –  smoke and mirrors –  one can only agree.

Joyce – like previous Finance Ministers – will be a fail on this score. He is unlikely to strip out the “smoke and mirrors” which politicians use to overstate government expenditure; particularly on social programmes such as housing.

He’s already been caught out by Labour’s Grant Robertson when it comes to massaging the numbers on an $11 billion investment in infrastructure.

Robertson labelled the $11b figure as “just playing with numbers”.

“When you peel it all back, what you have is National only promising to spend an extra $300 million a year from the promise made in the half-year Budget update.”

Finance Ministers really shouldn’t play this game and Treasury should issue tables which keep a running track of “re-announcements” of spending promises.

It is the sort of reason why Treasury forecasts and fiscal reporting are supposed to be done at arms-length from the Minister of Finance.  Each time ministers do this stuff it erodes, just a little further, what remaining confidence the public might have in our elected leaders.  A cheap (brief) win, and a long-term cost.

In the end, it is a pretty bleak column.  Plenty of stuff to wish for –  much of it quite sensible, provided you forget about the high speed train –  and little prospect of any of it happening.

But I still can’t help thinking that we deserve a lot better from a leading journalist in the country’s largest circulation newspaper than a story writing up and promoting the activities of a lobby group, only to find out 10 days later that the journalist in question is herself a participant in that same (apparently rather misguided) study tour.

 

 

 

New Zealand and Australian public finances

It is the time of year when both New Zealand and Australian governments hand down their budgets.  And these days it seems it is an opportunity for an annual comparison, in which New Zealanders feel rather virtuous about fiscal management here, and many Australians –  perhaps especially people on the right – take a turn breast-beating, regretting that they are not, in this regard, as well-governed as New Zealand.    Particularly florid Australian commentators are prone to invoking comparisons with Greece and other fiscal disasters.

I don’t find the story particularly persuasive.  Both countries had their fiscal blowouts late last decade –  in Australia, much of it was initially intended as active counter-cyclical use of fiscal policy under Kevin Rudd, while here it was discretionary choices to increase spending in the late years of the last boom.  In different ways, both the Australian Federal Treasury and the New Zealand Treasury were culpable to some extent; the former for enthusiastically embracing fiscal stimulus, when there was still plenty of monetary policy capacity left, and the latter for getting the forecasts wrong (they had told the government that big increases in spending would still leave the budget roughly balanced).    In some ways, New Zealand had a rougher time of it: the Canterbury earthquakes were a much bigger adverse hit to New Zealand government finances (a few years back) than anything in Australia.  Then again, Australia had to deal with much bigger volatility in –  and uncertainty about –  the terms of trade.

But what do the numbers show?  For history, I turned to the OECD’s database, where they have lots of fiscal series going back typically to around 1989.   While much of the attention focuses on the Australian federal government finances, it is important for New Zealanders to recognise that state governments are a large part of the overall government mix in Australia.  The OECD numbers are for “general government”, encompassing federal, state, and local government (or, specifically, national and local government in New Zealand).

It is also worth remembering that the size of government is smaller in Australia than it is in New Zealand.  That is so whether we look at revenue.

aus nz receipts

Or expenditure

aus nz disbursements

And government spending as a share of GDP has also been more stable in Australian than in New Zealand.  In fact, last time I checked government spending as a share of GDP had been more stable in Australia, over decades, than in almost any other OECD country.

What about fiscal balances, adjusted for the state of the respective economic cycles.  Here is the OECD’s measure.

aus nz deficits

A remarkably similar pattern really.    Our surpluses have averaged a little larger (and our deficits a little smaller) than those of Australia in the last 15 years, but there really isn’t much in it.  And do note that on this cyclically-adjusted measure, New Zealand is estimated to have been in slight deficit in 2016.

And what of debt?  This chart shows gross general government financial liabilities as a per cent of GDP.

aus nz gross debt

That is certainly a less favourable picture for Australia –  gross debt as a per cent of GDP higher than at any time for decades.   But here is the  –  superior for most purposes –  net debt picture.

aus nz net debt

Australian governments have had less debt than New Zealand through the whole period, and if the gap has closed just a little in the last decade, the change is pretty slight.    From a public debt perspective, Australia doesn’t seem to have much to worry about, with net financial assets (across all tiers of government) of around 10 per cent of GDP.

We won’t see the New Zealand government’s projections for the next few years until the Budget is released tomorrow.  But plenty of commentary focuses on the prospect of rising surpluses for years to come in New Zealand (as if this is somehow a good thing, when debt is already low), in contrast to the projections of deficits in the federal government books in Australia.

But one problem with those comparisons is that they aren’t apples for apples comparisons.  Thus, our government accounts for a long time have focused on the operating balance.  Relative to more traditional fiscal measures –  of the sort typically given prominence in Australia –  our deficit/surplus measure excludes capital expenditure but includes depreciation.  In a country with (a) a positive inflation rate, and (b) a rising population and rising living standards, government capital expenditure will typically exceed depreciation.   That isn’t a problem in itself, but it can make cross-country comparisons harder (the OECD historical numbers in the earlier charts are done consistently).

But here –  taken from the Australian official documents – are the federal government deficit measures done the Australian way (“underlying cash balance”) and something very like the New Zealand way (“net operating balance”).

Underlying cash balance Net operating balance
Per cent of GDP
2015/16      -2.4 -2.0
2016/17      -2.1 -2.2
2017/18      -1.6 -1.1
2018/19      -1.1 -0.6
2019/20      -0.1 0.4
2020/21       0.4 0.8

As they note in the Australian Budget documents

The net operating balance has been adopted for some time by the States and Territories (the States) and some key international counterparts as the principal focus for budget reporting. All the States report against the net operating balance as the primary fiscal aggregate. New Zealand and Canada also focus on similar measures.

One might feel slightly queasy about how the Australian government is raising additional revenue –  that populist bank tax seems to have more to do with utu (the Australian Bankers’ Association appointed a former Labor premier as their Executive Director, much to the annoyance of the Treasurer), and undermining Opposition calls for a Royal Commission into banking, as with principles of sound taxation –  but operating deficits of 1 per cent of GDP simply shouldn’t be a matter of concern, in a growing economy with low levels of public debt and relatively modest (by international standards) overall tax burdens.

But wait, as they say in the TV ads, there’s more.     The Australian Federal Treasury’s background Budget papers point out that

the Commonwealth provides grants to others (primarily the States) for capital purposes (that is, to acquire their own assets). This spending appears as a grant and detracts from the underlying cash balance and the net operating balance.

In 2017/18, the amounts involved are around 3.5 per cent of federal government spending.

Make that adjustment, and this is what the federal government’s operating balance would look like.

Underlying cash balance Net operating balance Adjusted net operating balance
                           Per cent of GDP
2015/16 -2.4 -2.0 -1.5
2016/17 -2.1 -2.2 -1.5
2017/18 -1.6 -1.1 -0.4
2018/19 -1.1 -0.6 0.0
2019/20 -0.1 0.4 0.8
2020/21 0.4 0.4 1.2

The adjustment doesn’t change anything about overall public sector finance in Australia.  The states will, presumably, in future have to account for the depreciation on these federally-funded capital projects.   But if one is looking just at the federal level, it seems like a reasonable adjustment.  On that adjusted measure, the federal operating budget in 2017/18 is projected to be very close to balance.  Of course, unlike the situation in New Zealand, Australian governments can’t count on getting all their budget measures through Parliament, but on the face of it, the endless angst in some quarters about Australian government finances does seem rather overdone.

The other thing that muddies the water in short-term comparisons is differences in rates of population growth.  A few years ago, Australia’s population was growing faster than New Zealand’s –  helped by all the New Zealanders going to Australia.  For now, New Zealand’s population is growing quite a lot faster than Australia’s –  not so many New Zealanders are going to Australia (and we have slightly larger controlled immigration programme per capita than Australia does).   In the short-term, unexpected population growth tends to boost demand more than supply, and specifically tends to flatter the government operating balance measures.   Consumption tax and income tax revenue both rise quite quickly, and operating expenditure tends to lag behind.   Even government capital expenditure tends to lag –  notice the recent announcement of more infrastructure spending here, much of which is to catch up with the unexpectedly fast population growth –  and you don’t have to maintain, and can’t depreciate (depreciation is in the operating balance), an asset that doesn’t yet exist.  That spending pressure will come.

This post isn’t intended as a criticism of New Zealand governments (there are plenty of other grounds for that), or as praise for Australian governments.  It is mostly just about making the point that, when considering overall fiscal management, if one stands back a little the similarities are much more apparent than the differences.  And that is to the credit of a succession of governments on both sides of the Tasman.

Standing back, here is how the OECD countries ranked last year on net general government liabilities as a per cent of GDP.

NZ and Aus net debt

O to be Norway one might reasonably conclude.  But given the choice, I’d take New Zealand or Australia’s cumulative (and current) fiscal management over those of almost every other country in the OECD.  And unlike many of these countries, neither country has huge off-balance sheet (ie not in these numbers) public pension liabilities either.

Productivity (or lack of it) is another story of course.

 

 

 

Fiscal policy: in defence of the last Labour government

Bryce Wilkinson of the New Zealand Initiative was out yesterday with a comment, in the Initiative’s weekly newsletter, on the Labour/Greens proposal to establish a fiscal council.  I wrote about –  and welcomed – that proposal a week or so back.

Until I saw Bryce’s note, I had forgotten that the New Zealand Initiative had proposed the establishment of a fiscal council.   So add their names to the list of supporters:  the OECD (the technocratic wing of the European centre-left) favours a fiscal council, the Treasury’s independent reviewer of fiscal policy (a long-time senior IMF official) recommended a fiscal council, the New Zealand Initiative favoured a fiscal council, and even the (fairly right wing) 2025 Taskforce (of which Bryce was a member) favoured looking at something like a fiscal council.  And now our Labour Party and Green Party also do.   As many other OECD countries now have something of the sort, it all seems to amount to a reasonably strong case.

Of course, doing it well would be a challenge –  getting a succession of the right people would really matter.  But that is true of many of our public watch-dog and monitoring roles.

As Bryce notes, the current National-led government hasn’t adopted the recommendation.

Why not? Probably, it sees little need given its proven commitment to restoring fiscal surpluses. True virtue is its own witness. Establishing a superfluous agency to attest to its virtue would undermine it. To which our churlish response is that fiscal virtue is as ephemeral as the political winds and John Key’s promise to steer clear of New Zealand Superannuation was less than fiscally virtuous.

And he then asks

So why are Labour and the Greens on the virtuous side of this issue? After all, the last Labour government left National facing fiscal deficits for as far as the average geriatric eye could see.

That observation likely answers the question. Newly found virtue lacks credibility. Governments that can’t make credible commitments are weak governments. However, we hasten to add that this does not make it less of a virtue. A commitment to fiscal virtue is a fine thing.

I’ve already pointed out privately to Bryce that that seemed more than a little unfair to the previous government.   Let me explain why.

It is certainly true that when the current government took office in November 2008, official fiscal forecasts showed large deficits for many years into the future.  But the last fiscal initiatives of the outgoing Labour government had been the 2008 Budget, the parameters for which were set out in the Budget Policy Statement released at the end of 2007.

Throughout much of the previous Labour government’s term of office, a key theme of fiscal policy developments had been the surprising strength in revenue.  It was, in many respects, why the fiscal surpluses were so large during those years –   Treasury and the government kept being taken by surprise, and Treasury was (prudently) cautious about treating the surprises as permanent.  If it was just a series of one-offs, or something cyclical, it wouldn’t have made sense to increase spending or cut taxes in response.

The Treasury gradually revised upwards their assessment of the underlying fiscal position.  Unfortunately, they took a particularly optimistic stance by the end of 2007.  I can recall the then Prime Minister making much of the fact that Treasury was now assuming that most of the revenue gains would prove permanent (and thus could support some mix of increased spending and lower tax rates) without the risk of dropping back into deficits.  I joined Treasury on secondment in mid-2008 and I have seen documents written to the Minister of Finance during early 2008 stating that reassessment.  I was under the impression that some had been released, perhaps as part of the pro-active release of 2008 Budget papers, but on checking that link on the Treasury website, I couldn’t see the paper in question.

But the facts of the reassessment aren’t in dispute.  Several Treasury staff produced a paper last year on the process of getting back to surplus, including the background to the deficits.  Here is what they had to say

Over the period 2005-2008, the Treasury increased its estimates of structural revenues by around 1 percentage point of GDP each year, and by 2008 the Treasury considered most of the operating surplus was “structural”

and

When the tax reductions [along with further spending increases] were announced in Budget 2008, the Treasury was still predicting the operating balance to remain in surplus through the forecast period, albeit at a lower level.

With the benefit of hindsight, the degree to which the surpluses were structural was overestimated. Although the tax reductions announced in 2008 turned out to be well-timed from the perspective of stabilising the economy following the GFC, their permanent nature added to the subsequent structural deficits.

Here is the chart from the 2008 Budget Economic and Fiscal Update.

Figure 2.6 – Total Crown OBEGAL

Figure 2.6	- Total Crown OBEGAL.

Source: The Treasury

That document was signed off  by the Secretary to the Treasury as representing his best professional assessment of the economic and fiscal outlook, incorporating the effects of announced government policy.  In New Zealand –  unlike many countries – the forecasts are those of the professional advisers, not those of the Minister of Finance.

On the basis of the economic and fiscal information available to it, the Treasury has used its best professional judgement in supplying the Minister of Finance with this Economic and Fiscal Update. The Update incorporates the fiscal and economic implications both of Government decisions and circumstances as at 9 May 2008 that were communicated to me, and of other economic and fiscal information available to the Treasury in accordance with the provisions of the Public Finance Act 1989.

John Whitehead
Secretary to the Treasury

14 May 2008

The projected surpluses by the end of the forecast period were tiny –  essentially the budget was projected to be in balance by then.  The economic and revenue outlook had worsened over the first few months of 2008, after the broad parameters of the Budget had already been sketched out in the BPS.   As we now know, New Zealand was already in recession by May 2008.   But on best Treasury advice, the then Labour government thoiught they were leaving an essentially balanced budget, on top of an already very low debt level, not deficits.

Of course, the government was wrong in that assumption.  But, specifically, Treasury was wrong in its best professional advice.    Perhaps the government would have run quite expansionary discretionary fiscal policy anyway, even if Treasury had been less optimistic about how permanent the revenue was.  They were, after all, behind in the polls, and the PM’s office –  didn’t Grant Robertson work there? –  would no doubt have been putting a lot of pressure on the Minister of Finance.  But that hypothetical didn’t arise.    They didn’t have to make such awkward political choices –  their own professional advisers told them they could have tax cuts and spending increases, and still keep the budget in (modest) surplus.  The Opposition National Party shaped its, more generous, tax cutting promises on much the same sort of Treasury forecasts and estimates.  (And a few years earlier, the 2005 election had partly been a bidding war as to how best to spend the surplus –  not whether there really was a structural surplus).

It wasn’t Treasury at its finest.  It is, perhaps, a reason to be cautious about just how much a fiscal council might add.   Would such a body, faced with similar circumstances –  a long succession of revisions upwards in revenue –  have really reached materially different judgements about the outlook then?  Perhaps.  We can’t know, but back in 2008 Treasury was using its best professional judgement, and the mistakes were still made.

There is a bit of a tendency afoot to suggest that the current National-led government has done a better job of fiscal management than the previous Labour government did.  I’m not really convinced by that story.   I’d accept that the previous government might have had an easier job than the current government has –  since one inherited modest but growing surpluses, while the other inherited deficits.  The current government had some nasty shocks (earthquakes) but also some of the best terms of trade in decades and the weakest wage pressures.      But if we expect our politicians to be guided by professional advice in areas like this, the previous government did what most orthodox opinion advised them to, keeping on delivering surpluses and reducing outstanding debt.  Probably they should have emphasised tax cuts more than spending increases, but this particular debate is about overall fiscal balances.

By the end of Labour’s term, government spending as a share of GDP was rising a lot –  but then Treasury was telling the government the money was there to spend.  And for all the talk of how the new Labour/Greens rules commit a new left-wing government to keep spending at around current National government levels, that level is around the average level that prevailed under the previous Labour government.

core crown expenses

There are things I’d criticise about the previous government’s policy. Allowing big structural surpluses to build up, as happened in the first half of the term, set the scene for a big spend-up later (which would have been big tax cuts if National had won in 2005). It is probably better to recognise the limitations of knowledge and typically keep both surpluses and deficits small. But it is easier to say in hindsight than it might have been at the time.  And in 1999, the severe fiscal stresses of 1990/91 were pretty fresh in everyone’s memory.

Of course, this note has been a defence of the previous Labour government.  The Greens don’t have experience in government, and don’t have the same degree of historical credibility.    So in that sense, no doubt Bryce Wilkinson is right to argue that part of the motivation for the recently announced package is the desire to use commitments like this to help establish some credibility (even at the expense of burning off some of their own loyalists).

And I can only endorse Bryce’s final observation on the fiscal council proposal.

So three cheers to Labour and the Greens for this initiative. May they stick to it.

Labour/Green Budget Responsibility Rules

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

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

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

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

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

The first two points are

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

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

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

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

On which I would make just two points:

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

The third of the rules is

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

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

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

The fourth rule is interesting and somewhat surprising

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

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

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

core crown expenses

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

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

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

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

I’ll pass over the tax commitment quickly

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

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

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

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

Measuring our success in government

  • The credibility of our Budget Responsibility Rules requires a mechanism that makes the government accountable. Independent oversight will provide the public with confidence that the government is sticking to the rules.
  • We will establish a body independent of Ministers of the Crown who will be responsible for determining if these rules are being met. The body will also have oversight of government economic and fiscal forecasts, shall provide an independent assessment of government forecasts to the public, and will cost policies of opposition parties.

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

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

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

I noted at the time that

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

On the overall proposal, I noted

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

Before concluding

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

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

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

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

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

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

New Zealand Initiative on immigration: Part 4 Fiscal implications

The next couple of chapters of the New Zealand Initiative’s immigration advocacy report cover material closer to the core expertise of the Initiative and its staff –  economics.  Chapter 3 is headed “Population Pressures” and looks at the impact of New Zealand immigration on three areas:

  • government finances more broadly,
  • house prices, and
  • the impact of an ageing population (ie improving life expectancy).

I want to focus today on the first two, but first some brief remarks about the ageing population issue.

The New Zealand Initiative tend to mischaracterise this issue.  There are some specific fiscal pressures that arise from changing birth rates through time.  Low birth rates in the 1930s, for example, gave us a considerable fiscal dividend for quite a while in the 1990s and 2000s –  there just weren’t that many people becoming eligible for NZS.  On the other hand, high birth rates from after World War Two to the early 1960s mean that since around 2011 there has been quite a big increase in the numbers claiming NZS.   But those effects tend to wash through over time.   The much bigger issue –  a cause for celebration mostly, even if it should prompt reassessment of some government spending choices –  is the strong trend increase in life expectancy (I had some thoughts on this issue here).  The issue isn’t about baby-boomers, selfish or otherwise, but about the fact that we can expect to live much  longer than our grandparents did (at a rate of improvement of towards two years a decade), and we might reasonably expect our grandchildren to live much longer than we do.    There are technically simple appropriate policy responses to those trends –  notably, it simply doesn’t make sense now to be paying universal retirement benefits to people at 65, and the age of entitlement should probably be indexed to further trend improvements in life expectancy, as various other countries have started to do.      When they aren’t trying to defend immigration policy, the able people at the New Zealand Initiative know all this, and make these sorts of points themselves.  And they (rightly) celebrate things like the gains in life expectancy.    So what are they doing making over the top claims like this

policymakers need it [immigration] as the fiscal implications of baby boomer retirement become more acute

Not even a nice-to-have, but a need.

As it happens,  in their more reflective moments even they are more hesitant

Although replacing the exiting workforce with migrants has merit, the idea should be treated with caution. International competition for skilled workers will increase as
the world becomes more interconnected and the ageing problem worsens in developed countries. New Zealand, while an attractive destination in its own right, will struggle to compete with markets offering higher financial and lifestyle rewards.

If we take lots of migrants we should do so because they increase the productivity and living standards of existing New Zealanders, not because they might temporarily help us avoid taking overdue sensible decisions on what proportion of the human lifespan we pay universal benefits to people for.   We should bring in ever more people (since this isn’t just a one-off issue) from elsewhere simply to ease pressures to change internal policy that almost everyone now knows are overdue for change?  I think not.  And nor, generally, would the Initiative.  They are usually much better than that.

What of government finances more generally?

Here the Initiative is very confident.   In the section headed “Fiscal Discipline”, while acknowledging that in other countries immigration does seem to lead to net fiscal pressures, in writing about New Zealand they begin

Migrants tend to have a positive impact on the fiscal side of the government ledger.

They base this claim on MBIE-funded work carried out by BERL.  In that exercise, BERL take some aspects of government review and spending,  and allocate them –  quite carefully –  across New Zealand-born and foreign born residents of New Zealand.  On this snapshot basis, and on these components of government finances, they estimate that in 2013 the average foreign-born person contributed $2653 to government finances in 2013, and the average New Zealand born person contributed $172 to government finances.  Overall, of course, in 2013 the New Zealand government was running quite a substantial fiscal deficit.

It is quite surprising that an economics-based think tank like the Initiative simply accepts and presents these results at face value.    The BERL report –  one of a series done over the last 15 years –  has its own value (comparable data through time).  But it isn’t state-of-the-art in estimating fiscal impacts of immigration (as the authors note, they weren’t paid for a literature review, but simply to slot new numbers into the existing methodology).  It doesn’t even cover quite a few major areas of government revenue and spending.  And in a technical appendix to the report (obtained from BERL –  it doesn’t appear to be online), the authors explicitly note that

In addition, the estimates do not allow for life-cycle impacts of migrant characteristics. That is, the calculations are of a ‘snap-shot’ single year. Issues such as migrants’ varying contributions and expenditure claims over their lifetime are not captured. Dynamic micro simulation might be used to establish the lifetime contribution of a particular type of migrant, but such a technique is beyond the scope of this project.

Bring in a whole bunch of 25 year olds, and of course they won’t involve much government health, welfare or education spending.  But over time, they’ll have children, and age.  Bring in 50 year olds, and they’ll (soon) be eligible for health and NZS spending, but won’t typically have paid that much New Zealand tax over their lifetimes

I’m not criticising the New Zealand Initiative for not producing state-of-the-art estimates themselves (that is a very substantial project) but for not at least acknowledging some of the limitations of the estimates they choose to rely on.

I’ve commented previously on the BERL estimates, when Nigel Latta made great play of them in his TV documentary last year on immigration.  Here are some of the points I made then.

But even in what it does look at, there are some quite severe limitations:

  • recall that the report estimates that both NZ born and immigrants made a net positive fiscal contribution to the government’s accounts.  Perhaps, but recall that in 2013 (the year studied) the government was still running quite a large fiscal deficit.  In other words, even if the study is roughly accurately capturing the relative contributions of immigrants and the native-born, it isn’t remotely accurately capturing the absolute contribution.
  • The BERL exercise does not appear to recognize at all that much of the demand for increased government capital spending now arises from the immigration programme itself (as it notes, between 2001 and 2013, the New Zealand born population aged 25 to 64 actually fell slightly while the foreign born population of that age increased by 222000 people).  Over those 12 years, 80 per cent of the total population growth has been among the foreign-born.   Assign much of the (above-depreciation) government capex to the immigration programme and suddenly even the fiscal numbers will look quite different.
  • These are snapshot effects rather than inter-generational ones.  It is hardly surprising that an immigration programme that brings in relatively young people involves less government operating spending (per capita) than for natives –  people that age are typically young and fit –  but if we want to think about even the fiscal impact of the immigration programme as a whole it would be important to look at the impact not just of the immigrants in the couple of decades post-arrival, but (for example) at the impact as those people age, and the impact of their own children (many of whom will be New Zealand citizens, but still a consequence of the immigration programme).
  • perhaps most importantly, any sort of exercise like this is only meaningful if it deals with very small changes (when one can keep the rest of the economy held constant).  By contrast, the potential for a large scale immigration programme to affect real interest rates, the real exchange rate, and the underlying structure of the economy, means these fiscal exercises offer no insight at all on the overall impact of immigration even on the fiscal accounts, let alone the wider economy.

In addition, I think there are at least two other points worth making.

First, company tax revenue (and, I think, trust income) isn’t included in the calculations at all.  On the sort of snapshot basis used here, this is likely to skew the results against the native-born, because it is likely that the capital stock is disproportionately owned by natives rather than immigrants.  (This is, in a sense, simply the flipside to the fact that the average migrant is younger than the average native).  Perhaps as importantly, there is a reasonable argument that revenue that results from New Zealand’s natural resources should be assigned to natives, rather than (implicitly spread across both natives and migrants).  Those revenues  –  from farming or fishing or gas extraction etc –  would have arisen regardless of whether we had any material level of immigration in the last few decades, and are unlikely to have been enhanced by the much-increased population (indeed, if my concerns about the real exchange rate are correct, they may have been reduced).

And second, it is important to remember that BERL is comparing the NZ born and foreign born populations in total.  Although they do undertake some decompositions, it isn’t really an attempt at a marginal analysis –  looking at (ideally) the lifetime impact of the next 1 per cent of the population that comes in as migrants.  The foreign-born of New Zealand today includes old people who came in the 1950s, the small numbers who came in the 1980s, as well as the huge numbers who have come in the last couple of decades.  Research evidence –  summarised in Julie Fry’s 2014 Treasury working paper – shows that, for example, migrants for the Pacific and Asia take much longer than, say, migrants from the UK to reach native-born levels of income (and presumably tax contribution) for any given set of qualifications etc.  Moreover, even with the pool of migrants we take each year, there is wide range of skills and capabilities –  some will end up making a big positive (economic and) fiscal contribution, and others –  especially, say, the parent approvals –  will be a substantial fiscal drain.   Since the policy argument now isn’t about the stock of people already here, but about who, and how many, we should let in going forward, a more appropriate analysis –  for current policy purposes – would focus on trying to better understand what level of immigration, of what sort of people, would maximise any fiscal gains, or minimise any fiscal costs.  The BERL report doesn’t attempt that sort of thing, and the New Zealand Initiative don’t even note the relevance of the perspective.

For all these specific points, I’ve never made much of the fiscal issues around immigration in New Zealand.  The comment I made a few months ago still reflects my position.

I’ve never made much of the fiscal issues around immigration.  By international standards our residence programme , if large, isn’t bad  –  if it doesn’t attract many very skilled people, at least it does successfully focus on getting people quickly into the labour market.  But precisely because in the end we are largely bringing lots of people quite like us –  who can readily get jobs –  it is very unlikely that in the long-run there will be much net difference in the fiscal effects between the contributions of those whose ancestors have been here for generations and more recent arrivals.

With an immigration programme like ours, the fiscal impact probably isn’t much of an argument one way or the other.  Although if there are fiscal gains on offer, we could probably maximise them with more demanding entry criteria than those we currently use.

On reflection, this post has got long enough.  I’ll tackle the housing issues in a separate post later in the day.