What was and what might have been

Yesterday’s short post –  which countries were rich or highly productive in 1900 and which are now –  wasn’t really about New Zealand at all (it was an article about the US and Argentina that prompted me to dig out the numbers).   But it prompted a question about New Zealand from a reader that sent me off playing around with the relevant spreadsheets again.

The question was along the lines of when were we at our economic peak (relative to other countries) and, given that we no longer are what it might have taken, in terms of different growth rates, for us to match the leading group now.

As a reminder, for historical periods the standard collection of reference data is that by the late Angus Maddison.  He collated estimates of real GDP per capita for a wide range of countries.  The numbers are only as good as the estimates made by the researchers Maddison drew from.  Perhaps they could be improved on  –  some researchers have tried for individual countries –  but for now they are still the standard starting point.   For more recent decades, I prefer to use real GDP per hour worked estimates (which will tell more about an economy’s productive performance, the wage rates it will support etc), either from the OECD or the Conference Board (the latter for a much wider range of countries).

My first chart yesterday was the top group as at 1900 – a date chosen just as a nice round number.

1900 GDP pc

The top five countries on this chart were the top five pretty much all the way from about 1890 to just prior to World War Two.   Here is how New Zealand did relative to (a) the median of those five countries, and (b) to the country that would emerge after World War Two as the clear leader, the United States.

NZ rel to others pre war.png

There is a bit of noise in the year-to-year estimates (particularly those for New Zealand), so I’m not putting any weight on that 1920 peak,  But abstracting from year to year noise the picture is reasonably clear.  Relative to this group of countries –  highest incomes anywhere at the time –  New Zealand did just fine in the quarter-century to the start of World War One.  We were, there or thereabouts, right up with the very richest. On these estimates, the number one slot moved around among the UK, the US, New Zealand and Australia.

Wars are dreadful things.  But they tend to be relatively less bad for countries producing food and wool, and not facing any physical destruction to their own country.  Even better perhaps for distant neutrals, as the US was until mid-1917.

New Zealand’s relative decline in the 1920s is notable (and not inconsistent with a story I’ve run for some years, about the lack of any really favourable idiosyncratic productivity shocks favouring New Zealand based industries, of the sort we’d had in the 30-40 years prior to World War One).

But perhaps what is interesting is the recovery –  especially relative to the United States – in the 1930s.  In 1939, for example, we were basically level-pegging again with this top group of countries –  a touch behind the US (No. 1), a touch ahead of Switzerland (No. 2).

Was everything then fine as late as the start of World War Two?  I’d argue not.   First, business cycles matters and don’t always run in phase across countries.  The United States, in particular, was very slow to recover from the Great Depression. Here is the unemployment rate

fredgraph U 30s

That is an unemployment rate in excess of 15 per cent at the end of the 1930s. In New Zealand, by contrast, the unemployment rate had been under 6 per cent as early as the 1936 census and the numbers registered as unemployed dropped away very sharply in the following few years, especially in 1938.

I was reading the other day an academic volume The Macroeconomics of Populism in Latin America, and was rather struck by the parallels between New Zealand in the late 1930s and some of the Latin American case studies (from the 70s and 80s).  Most of those experiences ended very badly.  New Zealand authorities were running very expansionary policies in the late 1930s which certainly boosted GDP and employment in the short-run, but culminated in the imposition of extensive foreign exchange controls at the end of 1938 and would almost certainly have ended in a highly public debt default in 1939 or 1940 if we hadn’t been –  as it were –  “saved by the war” (first, the British desire to avoid serious ructions in the run-up to the war, and then the intensified demand for our primary exports etc once the war began).

Consistent with that story is that after the war, when all three economies were pretty much fully employed –  and none had been directly physically affected by the conflict – New Zealand’s GDP per capita was well behind (10-20 per cent depending on the precise year and country) those of Switzerland and the United States.  Our heyday really had been the pre World War One period.

The second strand of my reader’s question really related to how far behind we now are.

Here was my second chart from yesterday, showing the top-20 real GDP per hour worked countries (from the Conference Board database) in 2018.

GDP phw 2018

I’m happy to set aside Norway (markedly boosted by oil/gas) and Luxembourg (city state with some material tax distortions) and focus on the next group of countries (Switzerland to Belgium) I’ve highlighted here in various posts.    On this measure, the median real GDP per hour worked exceeds that of New Zealand by 68 per cent.

New Zealand implemented a huge range of policy reforms in the late 1980s and early 1990s.  The aspiration was to make material inroads on closing the gaps that had opened between New Zealand and the OECD leaders.  Sadly, the gap has actually widened.  1990 is a common starting point for comparisons –  not only was it well into the reform period, but it was just prior to the New Zealand (and other advanced country) recession of 1991, so comparisons are not messed up but that particular cyclical issue.   In 1990, the median of that group of seven leading OECD countries was “only” 56 per cent ahead of New Zealand.

But what if things had been different?  How much more rapid productivity growth (than we actually experienced) would we have to have had since 1990 to have caught up with this leading bunch?   That is 28 years.  We”d have needed productivity growth that was 1.85 percentage points faster on average, each and every year.

Would that have been possible?   Who knows.   28 years seems a bit ambitious. But I did have a quick look at the data for some emerging OECD countries. Over the last 20 years or so, these countries have had productivity growth rates (on average over that long period) in excess of 1.85 percentage points above those of the median of that “leading bunch” of OECD countries:  South Korea, Lithuania, Poland, and Slovakia.

Would it have been possible for us? Who knows?  Would it be possible now, for the next 25 or 30 years?   I don’t know.  Personally, I’d be a bit surprised if we could close the gap that quickly, or fully.  But for now we are still going backwards (relatively)…..as we have, more or less, for 100 years.   And there seems no great sense of angst, unease or urgency among any of political parties, or the economic establishment.

What a diminished legacy for the next generation.

 

 

 

Revisiting some RB history

One of Stuff’s political correspondents, Henry Cooke, had a column in this morning’s  Dominion-Post about Adrian Orr and the power he wields, single-handedly, around banking regulation.

The column starts with some comparisons with some other senior public servants

Think Police Commissioner Mike Bush, former Treasury boss Gabriel Makhlouf​, or State Services Commissioner Peter Hughes. These three have had more influence over the way this country is run than all but the most powerful MPs.

Yet that trio can technically be called to heel by their ministers, even if doing so will probably result in a serious headache for the minister in question. Not so for Reserve Bank governor Adrian Orr, whose independence is enshrined in law.

Not probably company most would want to be numbered with.  A Police Commissioner who gave a eulogy at the funeral of a former policeman widely accepted as having planted evidence in a murder case, who seems to be counted on not to make trouble for whichever party is in power, and who is only too happy for the NZ Police to cosy up to, and assist, the PRC security forces.  A now-departed Treasury Secretary who presided over the decline of his own institution, and then flitted the country refusing to accept any serious responsbility for his own conduct over the “budget hack” affair.  And so on.     Whatever influence these people might have – not much I’d have thought in the case of the Police Commissioner – they have no policymaking powers themselves.

By contrast, when it comes to banking regulation, the Reserve Bank Governor enjoys a great deal of formal power, with little accountability and no rights of appeal against his policy decisions.   They are powers which should be reined in, by MPs and ministers, and which while they exist need to be used with the utmost judiciousness and care.  Under Orr, it is more like a bull in a china shop, pursuing personal whims, perhaps political agendas, all supported by not very much robust analysis at all.   I’ve written about all that previously and am not going to repeat it today.

Cooke notes the suggestion by Paul Goldsmith that the Governor should have fewer policymaking powers, with big policy calls in banking regulation being made by ministers and MPs, as big policy calls in most other areas of public life are.  But then follows a strange end to his article, which is the point of this post.

Goldsmith knows all about how the Reserve Bank can set off real political fires. He wrote the book about the last Reserve Bank governor to step so seriously into the fray: Don Brash. Way way back in 1990 the then-Labour government’s election-year Budget was utterly blunted when Brash decided to immediately hike interest rates in response. Brash was drawn into the bitter debate between David Lange and his own finance minister, and the whole thing was extremely public.

We are nowhere near that level of chaos yet. But things sure are starting to get interesting.

I guess it is what comes of middle age, but the events of 1990 still seem to me not much further back than yesterday (not “way way back”), but I suppose the typical journalist is young.  Even so, it isn’t hard to have checked that the Prime Minister in question was Geoffrey Palmer  (and, unless I’ve missed something, the Goldsmith book doesn’t seem to deal with the episode in question at all).

And there are a few things to bear in mind as institutional context to that episode:

  • the Reserve Bank had received statutory operational independence only a few months earlier, under legislation initiated by the government in question (4th Labour government,
  • under that legislation, the Bank was responsible for pursuing an inflation target, primarily set by the government but formalised in a Policy Targets Agreement between the Governor and the Minister.  That agreement had been signed as recently as March 1990 and required as to get to price stability (0 to 2 per cent annual inflation) by the end of 1992,
  • at the time, the Labour government was miles behind in the polls, in an FPP electorial system, and generally expected to be thrashed in the polls later that year (I see in my diary that in the week in question I observed that “the only question seems to be whether Labour will hold St Albans and Christchurch Central”, two of Labour’s safer seats, held by Minister and PM respectively,
  • while National had supported the Reserve Bank Act (a) it was promising to push the target date further out (to 1993) and (b) that was with the Richardson camp dominant, but there was a fear that a less “hardline” strand within the caucus might prove dominant (eg, as it was thought at the time, the popular Winston Peters and Bill Birch),
  • the reform programme had already ripped apart Labour, the economy was in the midst of a difficult adjustment, and privately even someone as mainstream as the Minister of Finance was saying privately (in a meeting with officials), “we all know that if we don’t get to 0 to 2 per cent, we’ll just change the target”.

All of which could be summed up in the idea that there was not yet a great deal of credibility attached to the notion that inflation was actually going to be securely lowered into a 0 to 2 per cent range.  People, including markets, were searching for signals and signs that might buttress or undermine confidence.  And yet it was the Bank’s job –  mandated by Parliament and the Minister – to deliver that price stability outcome, and to do so at least transitional economic cost.

So what happened?   On 24 July 1990 the government brought down a Budget that was treated by financial markets as something of an election giveaway.  Under the rules at the time, they posted a surplus, but only by including what was in effect a large expected asset sale proceeds as revenue, and significant deficits were again forecast in the out-years.  It was widely viewed as a reversal of direction after five years of sustained fiscal consolidation.  There were a number of measures in the Budget (reductions in government price/fees/excises) which would have the effect of lowering the headline inflation rate for one year, but those weren’t really the focus of either the Reserve Bank or the financial markets.

Bond yields rose in response, and as market participants reflected a bit further the exchange rate fell.    It was that move, rather than the Budget itself, that prompted a reaction from the Reserve Bank.  Until the exchange rate fell, we had planned only a mild passing comment –  about the importance of ongoing fiscal discipline –  in the next Monetary Policy Statement.

At that time, we did not set an official interest rate (the OCR wasn’t a thing until 1999).  And the conventional view, not just at the Bank, was that exchange rate changes had a big short-term effect on domestic prices (whereas these days the short-term effects are roughly a 1 per cent change in the CPI for a 10 per cent change in the exchange rate, in those days empiricial estimates suggested anything up to a 4.6 per cent change in the CPI for a 10 per cent change in the exchange rate).  And so, roughly speaking, we ran policy with (unpublished) ranges in which the TWI could fluctuate, which were reset each quarter in light of the inflation outlook and changes in economic data.  If the exchange rate looked to move through the bottom of the range, we made a statement (‘open mouth operations’) and usually the statement itself was sufficient for interest rates and the exchange rate to adjust (the latter back into the range).

On Tuesday 31 July – thus a week after the Budget –  the exchange rate had fallen throught the bottom of our indicative range, and the Governor agreed to tighten monetary policy (it was a decision made a bit more easily than usual because all three of the more dovish senior officials were all away that week, but it was entirely in line with our standard operating framework).  We knew it wasn’t going to be popular – I noted in my diary that evening the question of whether it would spark a confrontation with the government – but the point of an operationally independent central bank was to be willing to be unpopular, especially in the run-up to elections.  There was a bit of a sense that it would not look good for the case for operational autonomy if we did nothing when first market doubts arose.  (Some years later David Caygill confirmed to me that the government had not expected any adverse reaction.)

We made an initial statement the following morning, which pushed interest rates up but didn’t do much to the exchange rate.  The statement was well-received by market economists (“who seemed surprised that we had the backbone – an NBR article this morning openly suggested that we want to back away”) and the Opposition finance people “who are impressed with the explicitness and clarity of the statement” (they had been criticising us for oblique communications), and even the media coverage wasn’t bad.  The Minister of Finance was not terribly supportive, but the Prime Minister was overseas.

On the following day, we were pondering whether we needed to make another statement –  to get the exchange rate back within the range.    Those with a particularly good memory may recall that this was also the day (2 August) Iraq invaded Kuwait, which pushed oil prices sharply upwards.  At the time –  although we weren’t knee-jerk reacting to oil prices –  our stance would have been that first round oil price effects were to be looked through, but that much higher oil prices would create risks of higher inflation expectations and a spillover into holding underlying or core inflation above target.

And so we made another statement the following morning.  For a time that day we thought we’d completely botched things because there were wire service reports that Iraq had gone on to invade Saudi Arabia too, but of course that was soon proved false.  Interest rates rose quite a bit, and the exchange rate also edged higher.  Banks began raising mortgage rates prompting the Minister of Finance to come out with rather silly comments (“presumably under Palmer’s orders”) about the banks being mean and out to get the government.  With the Prime Minister’s return both he and the Minister were out with further critical comments –  recall that they were less than three months out from an election thrashing .  The comments were aimed especially at the banks, while noting that there was nothing the government could do (monetary policy operational decisions having been handed to the Bank).

It wasn’t as if the Bank itself was totally blinkered and doctrinaire during this period.  In the days following this episode we discussed ourselves at senior levels whether we should consider recommending pushing back the target date (to, say, 1993) but on balance decided not to do so just yet.

That specific controversy died down pretty quickly, and to my mind remains an example of the system working as it was supposed to.  We were doing our job, and the government was doing its (setting fiscal policy, having initially set the inflation target itself).   I haven’t checked with Don Brash but I’ve never heard a suggestion that the framework, the target, or Don’s position was then in jeopardy.  In fact, a month or so later, Don was upsetting the Opposition by making himself somewhat party to the “Growth Agreement” the government and the unions reached –  in our terms, what that amount to was simply restating that if inflation pressures (this time wages) were lower then all else equal monetary policy would be able to be easier and interest rates (and the exchange rate) lower.

With the benefit of hindsight one can argue about whether the Bank’s monetary policy tightening was really necessary. In some respects, the market reaction post-Budget was a confidence shock and demand might have been expected to weaken anyway.  Moreover, actual exchange rate passthroughs were to prove weaker in future than had been the case in the past.   With better analysis might we have realised that sooner? Perhaps.  But as I noted, the Bank’s reaction was wholly consistent with the Policy Targets Agreement, signed only a few months earlier, and with our best understanding then of how the economy worked, in the midst of a highly contentious and uncertain disinflation, and was supported by the bulk of private market economists.

I’m not sure where Henry Cooke got his story, but it just wasn’t “chaos” then, and to the extent there was any, it wasn’t Bank-initiated.

In fact, that episode wasn’t even close to the toughest political challenges for the Bank.   Only a few months later, National was in power and Jim Bolger in particular was very unhappy with some of the choices the Bank was making.  Goldsmith records Ruth Richardson warning Brash, as she was about to leave for an overseas trip, not to “make waves” as his “best friend at court” wouldn’t be around to provide cover.  That angst went on for months, and even culminated in pressure on the Bank from senior Treasury officials to ease monetary policy specifically to assist Richardson’s own political position.  (I am less confident that we handled 1991 that well, even on the sort of information we should have used at the time).

And then, of course, a decade later there was Don Brash’s infamous Knowledge Wave conference speech –  given rather against the advice of various of his closer advisers – which, whatever its substantive merits, did involve stepping well outside his statutory role, and greatly irritated the then Prime Minister, in turn poisoning the prospects for any internal candidate succeeding Brash when he left for politics in 2002.

The point of this post is really twofold.  I quite like delving into the monetary policy history, much of which isn’t that well or readily accessibly documented.  But I was also keen to differentiate that episode from the current controversy around Orr.  In 1990 the government set the mandate –  and was free to change it at any time –  and we were simply doing our best to implement that mandate, in a climate of huge political and economic uncertainty.

By contrast, when Adrian Orr is proposing banning people from serving on the boards of bank parents and subs or –  much more radically –  proposes that he should more or less double how much capital locally-incorporated banks would need, he isn’t following some clear and specific mandate set by Parliament or the Minister, against which he can readily be held to account.  He is pursuing a personal whim.  His stated goal –  reducing the risks to the soundness of the financial system –  is certainly an authorised statutory goal, but there is no professional consensus on what level of risk is appropriate, or what policy steps might deliver that level of risks, or what costs might be imposed in the transition or the steady-state.  And there are no effective rights of appeal, no override powers, to his one-man exercise of his personal preferences.     That simply isn’t appropriate.  With superlative supporting analysis, and a long and open period of real consultation –  before the Governor nailed his colours to the mast, as prosecutor in the case he himself will judge –  it might be one thing (still not ideal).  What we’ve actually had in the past year falls far short of that sort of standard.  It is a much more serious situation –  including because there are no self-correcting mechanisms (eg inflation falling below target, telling the Bank it has things a bit tight –  than a one-week flurry around a modest monetary policy adjustment implemented in pursuit of a goal the government itself had explicitly set.

The Minister of Finance and the Board do not have formal override powers.  But they could, and should, be using the leverage they have to insist on a much more compelling case being made for any actual policy adjustment (and not for that case to be published only after the decision itself has been made).  Cooke’s article quoted a submission suggesting annual GDP costs of up to $1.8 billion a year, but the Governor’s own deputy has quite openly suggested that the policy will cost the economy $750 million a year.  For gains –  in a sound and well-managed banking system – that are far from evident, in an economy where tightening credit conditions, even just in a transition, are about the last thing that is needed.

 

80 years today since we entered World War Two

It is eighty years today since New Zealand declared war on Germany, joining the United Kingdom in responding to the unprovoked aggression of the German invasion of Poland.  Until just now, glancing at one of the government historical websites, this statistic hadn’t occurred to me

New Zealand was involved for all but three of the 2179 days of the war — a commitment on a par only with Britain and Australia.

It is estimated that 11928 New Zealanders died in the course of that conflict, a death rate (per million population) higher than in any other Commonwealth country.  Dreadful as the war was, it still strikes me as something closer to a just war (for our side) than most other conflicts in modern history –  although, of course, the counterfactual is unknowable.

Back in the very early days of this blog, I wrote a short post on some aspects of the New Zealand economy in and around World War Two (while lamenting the absence of a modern analytical book-length treatment).  Here is the gist of a few of the paragraphs from that post

Two things from the period did stand out.

The first is that, while New Zealand devoted almost as much of its GDP to the war effort as any of the major combatants (at peak similar to that in the UK, although the UK held the peak for longer), material living standards for the civilian population seemed to remain relatively high –  notably the quality of the diet, access to petrol etc.  Perhaps that partly reflects just what a rich country New Zealand then was.  Using Angus Maddison’s data:

1939 GDP pc

New Zealand’s GDP per capita in 1939 was second highest of those countries shown (a year earlier –  the US in recession –  we’d been top of the table).  It may have been easier to devote a larger share of GDP to the war in a rich country like New Zealand than in a relatively poor one like the USSR, where a larger share of resources would have to have been devoted to subsistence.

And the second point is the dramatic transition: New Zealand went from being on the brink of default in 1939 to being, in effect, defaulted on just after the war.  In 1939, in the wake of the imposition of exchange controls, Walter Nash emerged from a humiliating mission to London, with a very onerous schedule of overseas debt repayments.  If the war had not been looming –  which made the British government keen on maintaining good relations with the Dominions –  it is quite possible that New Zealand would have been unable to rollover maturing debt at all, probably ending in a default to external creditors.  By just after the war, New Zealand  –  having markedly reduced its external debt ratios during the war – made a substantial gift to the UK (as did Australia): in reality, Britain was quite unable to meet all its obligations and needed some of them written down.

In a paper a couple of years ago, some IMF economists looked at examples of countries that had markedly reduced their overseas debt.  The New Zealand experience during WWII was as stark as any of those reversals, but is too little studied.  It seems to have mainly resulted from a determination to pay for as much of the war as possible from taxation, together with the controls and rationing that limited private sector consumption and investment.  But it was not because of any strength in New Zealand’s terms of trade:

WW2 TOT.png

New Zealand’s terms of trade fell during the war years –  our import costs rose as global inflation increased, but there was little adjustment in the prices of the agricultural/pastoral products New Zealand sold to Britain.

Notwithstanding the lives lost (and the constraints on consumption, free speech etc) New Zealand’s experience of World War Two was pretty mild.  No combat occurred on our shores –  nor was it ever credibly likely to –  and we didn’t even have anything akin to the bombing of Darwin or of Pearl Harbor.

Of all the countries involved, perhaps Poland’s experience was worst.  I wrote a post here late last year, at the time of the 100th anniversary of the end of World War One (in turn leading to the re-establishment of an independent Poland), in which I noted that

My own reflection on Poland is that it is hard to think of a place in the western world (say, present day EU, other bits of western Europe, and western European offshoots – eg New Zealand, Australia, Canada, US, Argentina, Chile, Uruguay) that wouldn’t have been preferable to live in over the last 100 years or so, at least as judged by material criteria.   Perhaps if you were German, you have to live with the guilt of World War Two, but most of Germany was free again pretty quickly.   Romanians and Bulgarians might have been poorer on average, but they largely escaped the worst horrors of the German occupation.  To its credit, Bulgaria managed to largely save its Jewish population, while the Polish record was patchy at best.  With borders pushed hither and yon, and not a few abuses of other peoples (notably ethnic German) post-war, sanctioned by the state, the place then settled into 40 years of Communist rule.   There is a lot to admire about Poland, but I wouldn’t have wanted to live there any time in the 20th century.

And never more so than during and just after World War Two.

But against that backdrop it leaves the story of the Poland in the last 30 years or so all the more impressive.    Some will be critical of various aspects of Polish governance etc, but they are now bringing up 30 years of democratic government –  and changes of government –  something that would have been hard to imagine when I was young, or –  in the late 30s –  when my parents were young.

And then there is the economic performance.  In 1938, it is estimated that Poland’s average real GDP per capita was just a third of New Zealand’s.    The most recent IMF estimates suggest that this year, Poland’s GDP per capita will be 82 per cent of New Zealand.  New Zealand has, of course, been a poor performer, but relative to Germany over the period Poland’s GDP per capita has improved from 40 per cent to 60 per cent.

And then, of course, there is productivity: real GDP per hour worked.   We don’t have very long runs of data for this variable, but here is the ratio of Poland to New Zealand for the 25 years for which there are data for both countries.

poland real GDP phw

Them doing better doesn’t make us worse off (of course).  Their success is great for them and their people.

But, as we ponder the deeper issues of loss, sacrifice, freedom, the threat of tyranny etc –  all exemplified in the story of World War Two –  it might still be worth reflecting on how extraordinary New Zealand’s relative economic decline  (relative to every single country on that first chart above) would have seemed to our leaders in 1939 if someone could have told them then how poorly New Zealand itself would do over the next 80 years.

 

A run on the bank (well, building society)

Being a bit early for an appointment yesterday, I ducked into a secondhand bookshop and emerged with a history of Countrywide Bank (by Tony Farrington, published in 1997), to add to my pile of histories of New Zealand financial institutions and major corporates.   For younger readers, perhaps unfamiliar with the name, Countrywide grew up from the building society movement, became a bank in the late 1980s after deregulation, and was taken over by the National Bank (itself later taken over by ANZ) in the late 1990s.

As I idly flicked through the book, I came across the account of one of those little episodes in financial history that (as far as I know) are not that well documented: the run on the building society, in April 1985.  Literal physical retail bank runs –  people queuing in bank branches and out onto the street – just aren’t that common.   When there was a run on Northern Rock in the UK at the start of what become the widespread financial crisis of 2008/09, the story was told that it was the first retail run in the UK for 140 years.  I am not sure if that is strictly true, but (fortunately) such runs are rare.   Deposit insurance supposedly contributes to that, but so do well-managed banks.

In April 1985, it was still the very early days of the comprehensive new wave of financial liberalisation that had begun when the Labour Party had taken office the previous July.  And it was only six weeks since the exchange rate had been floated, and five weeks or so since the extreme pressure on liquidity had seen overnight interest rates trade up towards 1000 per cent.  One-month bank bill rates peaked at about 70 per cent, and three-month rates peaked at around 35 per cent before the Reserve Bank intervened to stabilise the situation.  The overall level of interest rates had risen enormously (even post liquidity stabilisation) and anyone left sitting on (say) long-term government bonds faced very substantial mark-to-market losses.   There was a great deal of uncertainty about who might flourish, and who not, in the new environment.  And the newly-floated exchange rate was not exactly stable.

According to the Countrywide history’s account, in early April there had been rumours circulating for several days about the viability of Countrywide, which crystallised on Wednesday 10 April when an Auckland radio station ran a comment from one of their journalists that “there is no truth in the rumour that Countrywide is in financial difficulty”, which seems to have made the rumour much more widely known than it had been.

Countrywide protested to the radio station (perhaps reasonably so, but inevitably it was futile –  what was done was done), and they prepared a media release supposed to highlight their strength, but it took several days to get this in daily newspapers.  Reading the release now, with 34 years hindsight, I’m not sure that as a nervous depositor I’d have been reassured by it –  indeed when financial institutions boast about how rapidly they had been growing (in a climate of big changes in relative prices, and a great deal of uncertainty) it is probably reason for increased unease.

By this time, deposit withdrawals were already increasing significantly, and management was at pains to ensure that no branch was in danger of running out of cash even briefly.    And by this time, management had tracked down how the rumours seem to have started –  in the failure of a totally unrelated trucking company Countrywide Transport Systems Limited.  By then, the knowledge wasn’t much use to them.  They’d planned a press release explaining where the rumour had come from, but before it could run they had to deal with a development completely from left field: a Social Credit (monetary reformers) MP had issued a press statement referring to “widespread rumours about the impending collapse of a major building society” (by this time there were only two majors).

Countrywide called in the Reserve Bank and the then Governor, Spencer Russell, managed to get hold of the MP concerned –  at Wellington airport –  within 45 minutes of the statement being issued.  Morrison retracted the statement, but it was too late. As the history records “hundreds of depositors demanded their money”.

The run seems to have been focused in Wellington (and Hamilton), with queues outside several branches – 50 metres down the street outside the main Lambton Quay branch.   By the end of the day, customers had pulled out $10 million of deposits (Countrywide’s total assets then were about $445 million).  The next day, Thursday, they lost another $9 milliom in deposits (not just “mums and dads”, with withdrawals by solicitors being particularly evident.

The powers that be engaged in a significant (and successful) effort to staunch the run, with statements from the Associate Minister of Finance, the Governor of the Reserve Bank and the chief executive of the National Bank all reassured the public that Countrywide was sound.  By the Friday, it was estimated only $1 million of panic withdrawals occurred.

(These numbers don’t fully add up but) the history records that total deposit losses over the period of the run were around $30 million –  a far from insignificant share of total deposits.  Countrywide estimated that the run had involved a  direct P&L hit of around $1m, arising from the need to liquidate assets (government stock) in a rush, and additional staff, advertising, and communications costs.

And then the money flooded back –  it is recorded at times there were long queues to deposit the funds that had been withdrawn just a few days previously.   And the history mentions –  without comment –  that people were often depositing the same cheque they had taken from Countrywide only a few days previously.  I don’t really remember the run –  I was a junior Reserve Bank economist doing monetary policy stuff, and yet there is no mention of the run in my diary at all –  but that factoid was grist to the mill in debates about financial stability for years to come.  If you were so concerned about the health of your bank (building society) as to run on the bank, spend an hour in a queue, forfeit your place in the queue for mortgage eligibility (this was a thing still in 1985), why would you (a) take a cheque from the very bank you were concerned about (the danger of mugged on Lambton Quay had to be small, for example), and (b) why would you then not bank it straight away and pay for expedited clearing?  I still don’t claim to fully understand the answer to either question.

Eligibility for mortgage lending was still an issue in early-mid 1985.  Banks and building societies had been liability-constrained, and thus the practice grew up of having to have a suitable “savings record” with a specific lender to get a (first) mortgage (at least if you didn’t work for a bank, an insurance company, or the Reserve Bank).  The lender was doing you a favour not (as now to a great extent) the other way around.   Pulling your money out of the financial institution you might want to borrow from really was a big issue. Of course, better to lose your place in the mortgage queue than to lose your deposit (had it come to that), but it was a hurdle many depositors faced then that they would not face now.

As it happened, times were a changing, and the history records that Countrywide eventually “relented” (their words) and restored to their place in the mortgage queue those who had pulled their money out in the run.  Before very long, those depositors would have found other lenders competing to lend to them.

There are quite a number of unanswered questions in the Countrywide history (unsurprisingly –  geeky monetary economists weren’t the target market for the book), and I had a look at various other books on my shelves to see if I could find any other angles.  There was nothing in Roger Douglas’s book or in the biography of (then Deputy Governor) Roderick Deane, but there was a brief mention in the history of the Reserve Bank published in 2006.   Here is the relevant text.

countrywide.png

But, of course, that passage only raises further questions, including ones about how the Governor (or the Associate Minister) could be confident in their assertions about the soundness of Countrywide.  Whatever the substantive health of the institutions, were their statements well-founded in verified and verifiable data, or were the statements to some extent a confidence-trick: well-motivated, but actually based on little or no more information than the public had?    (There are readers of this blog who would pose similar questions about the style of bank supervision adopted by the Reserve Bank to this day.)   The Bank’s files may offer some answers (or maybe not).  And was the statement of support from the National Bank chief executive supported by offers on unsecured liquidity assistance (that would be a clear signal of confidence that might have encouraged the Reserve Bank).

Perhaps  the authorities made a relatively safe call –  after all, resurgent inflation meant that the value of Countrywide’s loan collateral was rising. On the other hand, like all regulated entities in those days, Countrywide had had to hold significant amounts of government securities, and government security interest rates had risen sharply.    Many institutions –  notably the trustee savings banks –  had taken big mark to market losses, and there was a strong sense that the viability of some of them would have been in jeopardy, especially if there had been timely and clear mark-to-market reporting.  Add in the high and very variable wholesale funding costs (probably only a small proportion of Countrywide’s funding) and one is left wondering how robust an analysis lay behind the official statements of support.  There was another building society run –  on competitor United –  a few years later, and the Reserve Bank history records that that time United took the view that official statements of support (Governor and Prime Minister) were tardy.    What sort of rethinking went on internally after the Countrywide episode?

I’m not playing any sort of gotcha here.  If anything, it is more a plaintive appeal for some economic and financial historian to undertake a systematic treatment of the New Zealand banking and financial sector through the liberalisation period.    There were all manner of small crises and near-crises during this period (PSIS, the devaluation “crisis”, Countrywide, United, RSL, the DFC, NZI Bank, the BNZ (twice) and probably others that don’t spring immediately to mind.  There are serious scholarly treatments of the experience in the Nordic countries with liberalisation at about the same time, but surprisingly little about New Zealand.

Not, I suppose, that historians will be able to help answer the question of why panicking depositors took their money in a cheque and then, it appears, in many cases didn’t even rush to get the cheque cleared, or to bank it at all.

I’m sure there are readers who were involved to some extent in these matters, whether at the Reserve Bank or elsewhere. I’d welcome any perspectives or insights in comments.

Economic failure: the reluctance to recognise the implications of extreme remoteness

As regular readers know, I tend not to be particular upbeat about the New Zealand economic story.  For anyone new, there should be a hint in the very title of the blog.  If, by chance, you are still attracted to an upbeat take, only last week in a post here I critiqued a recent book chapter taking that sort of view.

And so I was a bit surprised when, more than a year ago now, I was asked to write a chapter for a forthcoming book on aspects of policymaking, and associated outcomes, in a small state (this one).  In principle, the book sounded potentially interesting, and they were approaching a bunch of pretty serious and senior people to contribute.  But it wasn’t clear there was much in it for me, and since the plan was for the introduction or foreword to have been written by the head of the Department of Prime Minister and Cabinet, it seemed likely that the thrust the organisers were looking for was a positive take on the New Zealand story.   So as not to mess people about, I declined the invitation, only to have my arm twisted, with assurances that there was no such agenda.  In the end I agreed to write something, and although the organisers/editors still seem keen on a more positive spin, by the time I discovered that I was committed.

The latest draft of my chapter, attempting to be positive where I can, is here.

An underperforming economy; the insufficiently recognised implications of distance (draft chapter)

I’ve had useful comments from various people on an earlier draft (none of them bear any responsibility for the current version though), but if any readers have comments you’d like to add to the mix, you can earlier leave them as comments to this post or email me directly (address in the “About Michael Reddell’s blog” tab).

The potential market for the book, as I understand it, is people like students of public policy, perhaps in parts of Asia.  Many of these potential readers, I’m given to understand, see New Zealand as a sucesss story.   Within the (severe) limitations of length, I’ve set out to provide a more balanced take on the economic story.  In a way, I guess, New Zealand is a sort of success story.  200 years ago on these islands there was not much more than a subsistence economy, and only recently had overseas trade resumed after the inhabitants had been isolated for several hundred years.  From that to one of the richest countries in the world in a hundred years was remarkable.  And even now, after a century of relative decline,  there is only a handful of countries in east Asia and the southwest Pacific with material living standards matching or exceeding our own (Australia, Japan, Singapore, Taiwan, with South Korea coming close).   And from a macroeconomic policy perspective, we’ve now had low and stable inflation again for 25 years, have had low and stable public debt, and a considerable measure of financial stability.  That isn’t nothing by any means.

But it doesn’t exactly mark us out.  What does mark us out is that century of relative decline: of course, we are much richer than we were 100 years or so ago, but then we were among the top three countries in the world (GDP per capita), and now we languish a long way down the advanced country rankings (especially on productivity measures).    With productivity levels not quite 60 per cent of those in the leading bunch of advanced economies, we are getting closer to the point where New Zealand could really only be described as an upper middle income country.

My story, as a regular readers know, is that our physical remoteness –  in an era where, internet notwithstanding, distance appears to be not much less of a constraint than ever in many respects – is the key issue in our underperformance.  It isn’t that –  as some models and sets of estimated equations suggest –  distant countries are inevitably poorer, but that distant countries seem to thrive (to the extent they do) mostly on natural resources, and industries building directly on those resources.  And with a limited stock of natural resources, there are limits to the number of people that such places can support top tier incomes for (a very different proposition than for economies –  eg those of northwest Europe – where most of the most productive economies are found) where natural resources are simply no longer that important, and where the advantages of proximity can be realised more readily.    The story is much the same for Australia as for New Zealand –  and Australia has also been in (less severe) relative decline over the last 100 years – with the difference that Australia found itself able to utilise whole new sets of natural resources, either unknown or uneconomic previously.  New Zealand has had nothing – that material – similar, and no big asymmetric technology shocks in our favour for a long time either.   Against that backdrop, using policy to drive population growth (rapid by advanced country standards) simply did not make sense –  putting more people in a fairly unpropitious location, albeit one with some reasonable economic institutions (rule of law etc).  It didn’t make sense decades ago –  before people fully appreciated the nature of New Zealand’s relative economic decline –  and it doesn’t now.   There was a valuable signal, that policymakers and their advisers simply chose to ignore, when New Zealanders –  who know New Zealand best –  starting leaving in numbers that (while cyclical variable) are really large by international or historical standards (absent a civil war or the like).

Perhaps the new bit to my story in this draft chapter – which was prompted by the way the initial specification was framed –  was to think about why the stark economic underperformance has been allowed to go on, not just by our politicians and political parties, but with no compelling remedies offered by our major economic policy advisory institutions (The Treasury in particular) or by international agencies that offer advice (notably the OECD).  I suggest a story in which it is simply difficult to identify that right comparator countries when thinking about economywide productivity and economic performance issues.  For many areas of policy –  monetary policy is an example, but it is probably true of health and education and welfare –  pretty much any advanced market economies can offer useful benchmarking, but if remoteness really does matter (not just to, say, defence, but) to the viable options and business opportunities available here, then the experiences of –  say –  Belgium or Denmark just aren’t likely to be that useful, even if Denmark has a similar population and was once the major competitor for UK dairy markets.

We may be able to learn something from reflecting on the differences, but it is typically much more compelling if one can point to another similar country (or 2 or 10 of them) and learn from them.   And thus I note an important difference between New Zealand and many of the (now fast) emerging advanced economies of central and eastern Europe.  Not only are they physically proximate to various highly productive economies (easy and cheap to meet fellow policymakers and analysts regularly, including in EU fora), but have a lot of similarities across each other (similar location, similar communist past, and so on).     I don’t claim to know Hungary, Slovenia, the Czech Republic or Slovakia in great detail, but if I were a policymaker in any of them, I’d be (almost obsessively) benchmarking my economic policies against those of the others, and of nearby rich and productive countries (eg Austria and Switzerland).  There are never exact parallels, but in New Zealand’s case it is hard to find good parallels at all. I suggest that Israel might be in some respects the best for New Zealand –  but it is little studied here (and its productivity performance is about as bad as ours –  partly, I’ve suggested, for similar reasons).

The lack of easy examples to benchmark ourselves against isn’t really an acceptable excuse, but I suspect it is part of the explanation.  It is long been a problem for the OECD in their advice to New Zealand: they’ve repeatedly brought a northern European mindset to a remote corner of the world, after early on investing quite a lot in the idea that the New Zealand reforms were exemplary, and almost sure to reverse our underperformance.  Places like the OECD work a lot on illustrating cross-country comparisons, but they simply never found the right ones for New Zealand (on these economywide issues) and have not shown much sign of trying.  It is particularly problematic because the OECD are full-on committed to high immigration, regardless of the experience of an individual country (see my post about the then OECD Chief Economist extraordinary performance when she launched their 2017 New Zealand report – there is a new report due out in a few weeks, and I’m not holding my breath).

Of course, New Zealand politicians no longer seem to have any appetite for trying to reverse the staggering decline in New Zealand’s relative performance.    But just possibly they might if their advisers were offering a compelling diagnosis and set of prescriptions.  As it, The Treasury seems to have no more idea than the OECD, and seems to have abandoned much interest in the productivity issue, in favour of the feel-goodism and smorgasbord of random indicators that makes up the Living Standards Framework, supporting the “wellbeing Budget”.  I was exchanging notes the other day with someone about the mystery as to who the next Secretary to the Treasury will be (there is a vacancy a month from now, and applications closed three months ago).  It is hard to be optimistic that it will make much difference who gets the job –  given the hoops they will have to have jumped through to get it –  but sadly it is a story of a low-level equilibrium: no political demand for answers and options to reverse our decades of relative decline. and no bureaucratic supply of such answers or the supporting analysis either.

Anyway, for anyone interested here are the concluding paragraphs.

Conclusion

After the bold reforming period of the 1980s and early 1990s, official and political economic policymaking in New Zealand appears to have been at sea, without a tiller or compass, for at least a couple of decades.   Much that was positive was done during the reform era, and various good institutional reforms were put in place.  Much needed to be done, and in some respects it was to the credit of a small country that so much – initially attracting considerable international admiration –  could have been put in place so quickly.    Seared by the experience of the quasi-crisis of 1984, and rapid escalation of official debt in the previous decade, New Zealand has since enjoyed an enviable degree of macroeconomic stability: low and stable public debt, low and stable inflation, and domestic financial stability (even amid severe policy-induced upward pressures on house prices and household debt).  Unemployment rates that are fairly low on average are another successful element.   In those areas of policy, meaningful international benchmarks have provided a routine check of policy, and the external advice sometimes provided has typically been drawn from countries (small floating exchange rate countries), where the comparisons are apt and insightful.

But if stability has been successfully regained and maintained, on the wider counts of economic performance only a “fail” mark could possibly be assigned.  Among the failures, policymakers managed to preside over reforms that have created artificial scarcity of urban land and sky-high housing prices, in common with many of their Anglo peers.  But the productivity failure is more stark, because it is more specific to New Zealand.   Despite numerous (de)regulatory steps taken to open the economy to international competition –  and a considerable increase in the real volume of exports and imports –  foreign trade as a share of GDP has shrunk and with it the relative size of the tradables sector.  The export sector itself remains heavily dominated by industries reliant on domestic natural resources (a fixed asset) – services exports have been shrinking as a share of GDP – and, despite rapid population growth, business investment has been modest at best.

To an outsider, perhaps the surprising feature of such an underperforming advanced economy is that population growth has nonetheless been quite rapid. Birth rates have been below long-term replacement rates for several decades now. But defying the revealed preferences of New Zealanders, who have left the country in huge (but cyclically variable) numbers over the last 50 years for 25 years now policy has been set to bring in one of the largest migrant flows (per capita) of any advanced country.   Regularly presented as a skills-focused approach, it has remained difficult to attract many really talented people to a small remote country with lagging incomes and productivity[1] and there have been few (apparent or realised) outward-oriented economic opportunities in New Zealand for either natives or migrants.

Advocates and defenders of New Zealand immigration policy often attempt to invoke arguments and indicative evidence from other countries.  Even then, the value of insights appears more limited than the champions believe: not one of the high immigration advanced economies (Canada, Australia, New Zealand, Israel – or the United States) has been at the forefront of productivity growth over the last 50 years, and only the US is now near the frontier in levels terms.  But even if those arguments might have some validity in some other countries, there has been too little serious engagement with the specifics of the New Zealand situation: remoteness, lack of newly-exploitable natural resources,  and the actual experience (lack of demonstrable gains for New Zealanders) following 25 years with a high level of (notionally) skills-based immigration.    As by far the most remote of any advanced country, it is perhaps the last place one might naturally expect to see policy actively working (encouraged by local officials and international agencies) to support rapid population growth.

Looking ahead, if New Zealanders are once again to enjoy incomes and material living standards matching the best in the OECD, policy and academic analysts will have to focus afresh on the implications, and limitations, of New Zealand’s extreme remoteness and how best policy should be shaped in light the unchangeable nature of that constraint (at least on current technologies)   Past experience –  1890s, 1930s, and 1980s – shows that policies can change quickly and markedly in New Zealand.  But with no reason to expect any sort of dramatic crisis – macro-economic conditions are stable, unlike the situation in the early 1980s –  it is difficult to see what might now break policy out of the 21st century torpor or, indeed, whether the economics institutions would have the capacity to respond effectively if there was to be renewed political appetite for change.

[1] OECD (2016) adult skills data suggest that although the gap between skills of natives and migrants is small, migrants to New Zealand are, on average, less skilled than natives.

There won’t be any posts for a few days as we are heading off this morning to attend the funeral for my wife’s (extremely aged) grandmother.  Back blogging on Tuesday.

(Un)successful public policy

Yesterday afternoon I saw this in my Twitter feed

My first thought was along the lines of “well, I guess there is nothing about New Zealand economic policy”, (a) so poor has our long-term performance been, and (b) because surely outcomes matter?.   But I’m a policy geek sort of person, ANZSOG is chaired by our very own State Services Commissioner, and ANU is the top-ranked university in Australasia, so I clicked the link to see what examples of successful policymaking in New Zealand they’d found. To my surprise I found this

New Zealand’s economic turnaround: How public policy innovation catalysed economic growth (PDF, 0.2MB)Michael Mintrom and Madeline Thomas

(Downloads of all the individual chapters appear to be free, and there are pieces on ACC, early childhood education, Kiwisaver, nuclear-free New Zealand, and so on, some of which may interest some readers.)

But I was a bit flummoxed even by the title of this economic chapter.  I recognised the “public policy innovation” –  thirty years on I still support most of it –  but the idea of an “economic turnaround” or “catalysed economic growth” seemed, to say the least, at odds with the data.

Mintrom is a public policy academic, now at Monash University in Melbourne. He worked for The Treasury for a few years in the late 1980s before heading off to do his PhD.  But, from the look of his publications, he seems to know a lot about public policy processes, but not necessarily a great deal about economic growth or overall economic performance.  Thomas is his research assistant, with a psychology degree and some experience working on social policy with local governments.

When I got into the chapter itself it turned out the authors were focusing on a handful of specific initiatives undertaken in the late 1980s and early 1990s:

  • reduction of market interventions (controls, subsidies, import restrictions etc),
  • creation of SOEs and subsequent privatisations,
  • simplification of the tax system and introduction of GST, and
  • passing responsibility for monetary policy to an independent Reserve Bank.

And they lay out early on how they define success.  Their first criterion is endurance, and thus they argue that “these policy innovations have now remained in place for decades. Thus, judged by endurance, they have been highly successful.”

There, it would appear, speaks someone more interested in processes than outcomes.  After all, the broad range of policies the 1980s and 90s reforms replaced –  exchange controls, heavy import protection, monetary policy set by ministers – also lasted for decades, and were generally not accounted a success.   The Soviet Union managed 70 years.

But the authors offer three other perspectives from which to view the success of the policy programme.  There was something called the “programmatic perspective”, which seems to be encapsulated in these two sentences:

A highly coherent theory of change guided the development of these policy innovations.  After a relatively short time, it was clear the changes were producing beneficial outcomes.

Then there is the “process perspective”, where they claim (and I mostly wouldn’t disagree) that “the policy innovations were well designed and generally well managed”.

And, thirdly, there is the political perspective, which they describe as “more complicated”.  That, presumably, does duty not only for the deep divisions that opened up in the Labour Party, Jim Anderton’s breakaway, and the divisions that opened up in National, culminating in the founding of New Zealand First, to all of which one could add the public sense that politicians hadn’t been straight with them (many readers will be too young to recall that in 1987 Labour published its manifesto the week after the election) and the replacement of FPP by MMP (you may think that change good, but it simply wouldn’t have happened without the ructions of the previous few years).

Remarkably, in a chapter focused on economic policy and –  at least according to the title –  economic growth, the authors take as their “starting point” several very positive assessments of the reforms written from 1994 to 1996.    Some of those articles are valuable, but each was written with the benefit of almost no distance or perspective, and were written a quarter of a century ago.  I found it remarkable that in a chapter about New Zealand’s economic growth, there were no references at all to the literature over at least the last decade about New Zealand’s disappointing productivity performance (sometimes, but quite wrongly, characterised as the New Zealand “productivity paradox”).    Those concerns, from extremely orthodox sources, have been around much longer than that: I happened to be dipping into the OECD’s 2000 report on New Zealand yesterday and found explicit concerns there about the failure of the New Zealand economy to converge, highlighting in particular the disappointing productivity growth.

The first part of the chapter is devoted to rehearsing some of the political and economic context for the reforms –  with which I mostly have only relatively minor quibbles – before they move on to focus on the four areas of reform (listed above).  Again, as pure description, it isn’t too bad –  with the odd annoying mistake (eg the exchange rate was not pegged to the US dollar in 1984, the price freeze had been lifted before the 1984 election), but whenever there is any sort of evaluative tone it is almost always very upbeat.  And perhaps only a young Treasury official from those days could describe, with a straight face, the Treasury’s approach to other departments as “Treasury analysts showed a great desire to….seek insight from colleagues in other departments”.

There is a variety of odd claims.  Thus,

The move to a more independent Reserve Bank came after several years of a floating New Zealand dollar, which was also viewed as a key element of market liberalisation; it was therefore uncontroversial.

Where did they get that from?  The Reserve Bank Act was intensely controversial at the time, with considerable opposition (wrongheadly in my view, but it was there nonetheless) from most prominent academic economists in New Zealand and some vocal business lobby groups.  The authors talk up the legislation passing Parliament unanimously (perhaps so if Jim Anderton was away that day), but if they’d done even the slightest refreshing of memories, they’d have been aware that the legislation divided both major party caucuses.  National – in Opposition – voted for the legislation, but Ruth Richardson’s former economic adviser recorded later that the vote in favour at caucus secured a majority of only one: Sir Robert Muldoon (opposed) was away seriously ill, and Winston Peters (opposed) for some reason skipped the meeting.   And I’ve perhaps mentioned before that in every subsequent election –  down to and including 2017 – one or other political party was campaigning on a platform of changing the Policy Targets Agreement or the Reserve Bank Act.

There are other odd claims.   The authors are mildly circumspect about aspects of the privatisation programme (“some sales were poorly managed”), but then cite as evidence of the “policy success” of the Labour government’s privatisation programme, that the succeeding National government did more privatisations.

The authors begin their Analysis and Conclusions section suggesting that in the early 80s New Zealand was heading towards “economic collapse”, but that is simply overblown political rhetoric for a process of stagnation, fairly high and variable inflation, and rising debt.  The broad direction of policy was still towards liberalisation, but it was a halting, half-hearted, and inconsistent process.  A crisis it wasn’t –  even if forced devaluations make good headlines.  Thus, the authors note that “unemployment grew” and yet the historical backdating of the HLFS suggests that the unemployment rate in June 1984 was 4.4 per cent, almost identical to the current rate.

What else struck me?  There was the claim –  about the 80s period –  that “through listening and working with others – even those who might have strong objections to a proposals –  it is possible for advocates of change to improve policy design and build a strong colation to support change”.  No doubt that is true generally, but it bears very resemblance to anyone else’s impressions of 1980s/90s reform period –  it was. after all, Roger Douglas, who championed the approach of “crash through or crash”.

Our authors carry this lesson forward:

“subsequent New Zealand governments have achieved important reforms while moving more slowly and working to ensure implementation is well managed. For example, the National Party-led coalition of 2009-17 [wasn’t a coalition, and it was 2008-17, but I guess those are details] established a new program of privatisation of government assets. Important work was done that drew on lessons from hre past and met considerable success.”

You might –  as I did –  have supported those more recent partial privatisations, but lets remember how small they were.  One of the companies involved was already market-listed (Air New Zealand) and all are still majority state-owned.    And the list of “important reforms” undertaken by that more recent government was limited, to say the very least.

The very final (short) paragraph begins this way.

In sum,we judge New Zealand’s economic turnaround to have been a major public policy success. Innovative public policy changes catalysed economic growth.

And yet, remarkably, in the entire chapter there is not a single number or chart or even a discussion of the specifics of economic growth. Not one.  And despite (rightly) lauding the removal of protection and subsidies, no mention of the fact that foreign trade as a share of GDP is no higher now than it was in 1984.   Absent evidence of this “catalysed economic growth”, perhaps we are just supposed to imagine it, and somehow feel better for the thought?   But I hope this isn’t how ANZSOG helps train our public servants.

My own take on the reform and stabilisation effort of the 1980s/90s is roughly as follows:

  • stabilisation was a major success.  We have low and stable inflation, low and fairly stable government debt.  We also have a considerable measure of financial stability.  For all that, we should be truly grateful.  But we should also recognise that (a) low and stable became a pretty global phenomenon (especially in the advanced world) around that time, and (b) that various other well-managed countries (eg Australia, Canada, Sweden, Switzerland) have much the same sort of fiscal record we do.  That leaves me sceptical of stories which put too much emphasis on specific New Zealand events, circumstances, law, individuals, or policy processes.    Moreover –  and I don’t think this appears in the chapter at all – we have greatly benefited from a big increase in the terms of trade (reversing the couple of decade decline that policymakers from the late 60s to mid 80s had to cope with),
  • many of the specific reforms (including those Mintrom and Thomas deal with) served us well.   Lower import protection, a well-designed GST, injecting much greater efficiency into state trading operations and a bunch of others benefited most New Zealanders.
  • but that isn’t true of all the reforms.  One might focus in on the RMA and associated provisions which have given us among the most unaffordable house and urban land prices in the developed world, or one might look at the tax treatment of savings.  And then there are the immigration policy reforms.
  • and, as honest observers have known for 20 years, there has simply not been the productivity turnaround that champions of the reforms hoped for at the time (and there is also no reason to suppose that problem is just that we didn’t engage in radical enough reform.)

Here is a table I was working on the other day, comparing average productivity in New Zealand with that of a leading bunch of OECD countries.

prod 1

The book was an ANZSOG project.  Here is labour productivity for New Zealand relative to Australia, indexed to when the New Zealand domestic data start in 1989.

prod 2.png

I reckon there is a plausible argument that the whole reform programme taken together slowed the rate of decline in New Zealand’s relative fortunes (although even that isn’t clear-cut: the rate of decline slowed, but I’ve not seen any careful attempt to assess how much of that was policy and how much about, say, improvements in the terms of trade).

But that isn’t the case Mintrom and Thomas attempt to make.  Judged by economic growth outcomes –  the sort of criterion their title asks us to use –  the programme just cannot be judged a great success. Perhaps the processes were good in some respects, and there was certainly a lot of intellectual rigour behind some of the reforms. It remains a fascinating case study in concentrated far-reaching reform.  But the productivity results really suggest that the episode belongs in another book, about the disappointing results despite the very best of intentions.  Those are salutary lessons policy advisers need to be trained in too.

How we –  certainly anyone who supported, voted for, worked on the reforms –  wish the outcomes had been different –  much better.   But they weren’t.  That is a failure –   uncomfortable as it is, there is no other word for it –  politicians and policy advisers have to grapple with honestly.

 

 

 

 

 

An expert weighed in on Reserve Bank reform

I was exchanging notes last week with someone who is doing research on New Zealand economic policy, and the development of economic institutions, in the 1980s and 1990s.  In the course of that conversation he sent me a copy of interesting short paper –  presumably obtained from the national archives –  from the period when the thinking and debates that led to the Reserve Bank of New Zealand Act 1989 were underway.

Reform of the Reserve Bank had been in the wind for some time.  Loosely, the Reserve Bank tended to be keen on an independent central bank, and recognised that some accountability procedures would be part of the price of that.  On the other side of the street, the Treasury was keen on an accountable and efficient central bank.  Neither institution –  nor the key ministers at the time –  wanted the Minister of Finance to be determining day-to-day monetary policy. (Ministers determining policy adjustment had been the standard practice, by law, for decades – and it was the practice at the time in most western countries, the exceptions being Switzerland and West Germany and (more or less) the United States.)   Everyone involved wanted a much lower average inflation rate than New Zealand had had in the 1970s and 1980s.

The Treasury was heavily involved in work on reshaping the institutional form of much of what central government did.   Of particular relevance was the new state-owned enterprises (SOE) model, adopted for many/most government trading enterprises (NZ Post, for example, is still with us today).    The Reserve Bank, then as now, was a somewhat anomalous organisation and part of the – at times – acrimonious debate between the Reserve Bank and the Treasury over several years reflected the idiosyncratic nature of the institution, and differing views over what parallels or comparators were relevant.    For example, were banknotes or the retail government banking operations, or the sale of government bonds really just commercial activities really just commercial activities.  And might the (apparent) policy goals be achieved better in an organisation given more commercial incentives.

At one end of the spectrum was a proposal out of The Treasury in late 1986 to turn the Reserve Bank into an SOE (it was never quite a final Treasury proposal, but was written by a senior Treasury adviser and taken seriously as the highest levels of The Treasury.  For anyone interested, you can read more about it in Innovation and Independence, the 2006 history of the Bank (bearing in mind that that history was very much written from a Reserve Bank perspective, one of the authors not only having been an active protagonist in the late 1980s debates but at the time of writing serving as chair of the board of the Reserve Bank).

The proposals were stimulating, far-reaching (including allowing for the Reserve Bank to be declared bankrupt and statutory managers appointed) and –  in the views of probably all Reserve Bankers involved at the time (and in my view now) –  quite unrealistic, and failing to really grapple with the reasons for having a central bank at all.  I am one of those who believes that the economy and financial system could function adequately without a central bank –  although on balance I think a central bank can improve our ability to cope with severe shocks –  and in many respects the logic of the Treasury position might have been better developed into a proposal to explore whether we could do without a central bank altogether.  But they didn’t.  (Had the Bank been abolished, my position –  then and now –  is that New Zealand would fairly quickly have become a de facto part of the Australian dollar area, with monetary conditions influenced by the RBA with Australian perspectives in mind.  That is probably clearer now than it was then –  in 1986/87 only Westpac and ANZ of the larger banks were Australian owned.)

But the point of this post isn’t to rehearse all the old debates. I was overseas on secondment at the time, and only got involved in the debates (which lingered in various forms for several years, even after the Reserve Bank Act was passed) a bit later. But I was intrigued by this one particular paper I was sent last week.

The Reserve Bank has received the “Reserve Bank as SOE” proposal in November 1986.  At the time, the Reserve Bank Board was the decisionmaking body for the Bank itself (although not on monetary policy, which was in law set by the Minister).   The Board asked management to obtain independent expert analysis and advice on the Treasury ideas and for their March 1987 meeting the Board had in front of it a six page commentary from Professor Charles Goodhart.

Goodhart is one of the more significant figures in the last 50 years or so in thinking and writing about central banking.   At the time, he was Professor of Money and Banking at the London School of Economics and had previously served as Adviser to the Governor of the Bank of England.  He had relatively recently published an influential book The Evolution of Central Banks: A Natural Development? (and had been the star guest, and guest lecturer, at the Reserve Bank’s somewhat-extravagant 50th anniversary celebrations in 1984).  Goodhart was very smart and thoughtful, but well-disposed to a traditional (British) view of central banks.

A decade later, Goodhart served as one of the first members of the UK Monetary Policy Committee, after the newly-elected Labour government in 1997 gave the Bank of England operational independence in the conduct of monetary policy.  But in 1987, the Bank of England was, to a considerable extent, the executing agent for the policy choices of the Chancellor of the Exchequer –  the Chancellor being advised by both the Bank and the Treasury, and typically being closer to The Treasury (in the UK ministers have their offices in the department for which they are responsible, not something akin to the Beehive).  It is worth noting that by 1987 the UK had successfully lowered its inflation rate very substantially (the UK inflation record in the 1970s had been, if anything, worse than New Zealand’s).

It is perhaps also worth noting that when the Reserve Bank of New Zealand Bill was finally brought to Parliament in 1989, Goodhart played an important role in providing public support (including FEC testimony) for the chosen model.  Part of that involved providing an academic counterweight to the New Zealand academic (macro)economics community, most of which, at very least, sceptical of the legislation.

But that was 2.5 years later, long after the notes for the Reserve Bank Board had been written.  In those notes, Goodhart’s stance –  while useful to the Bank in countering Treasury – was very different to the legislation he later provided public endorsement to.

The first half of the paper (history and theory) is interesting, but not particularly controversial for these purposes. But the second half is about “policy conclusions”, drawing from an analysis that was generally in favour of (a) discretionary monetary policy, and (b) a central bank not influenced by profit-maximising considerations.

Here is his view on who should do what

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Get the Minister of Finance further away from the conduct of monetary policy and let the Reserve Bank itself decide what rate of inflation to target.  (This was more than year before “inflation targeting” itself became a thing, and was presumably just about setting a broad direction for policy –  in New Zealand at the time there was, for example, beginning to be talk about “low single figure inflation”).

I don’t suppose that idea went down overly well with his Treasury readers (including the Secretary to the Treasury who was then a member of the Board).

One of the later mythologies that developed around the Reserve Bank Act (over the years we spent a lot of time rebutting it) was that the Governor’s salary was tied to the inflation target.  It never was.    But until reading this paper I hadn’t realised where the possibility of making such a link had come from.  Here is Goodhart, talking about accountability.

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Wow.  At this stage, there was still no sense of making the Governor the single decision maker, but a leading academic writer on central banking was seriously proposing not just that the Reserve Bank should be able to set a target rate of inflation for itself, but that a range of key executives should be partly paid in the form of options that would pay off if the target was met.    He doesn’t seem to notice, for example, the distinction between a private business (operating in a market it can’t control) and a public agency able to do whatever it takes, at whatever short-run cost, to achieve a target rate of inflation.

At the time, there was still a presumption that decisionmaking at a reformed Reserve Bank would be made (ultimately) by the Board –  as, of course, responsibility in SOEs and many other Crown agencies rested with the respective boards.  The Board was largely non-executive (Governor, Deputy Governor, Secretary to the Treasury plus other members appointed by the Minister) and Goodhart moves on to discuss the issue of whether non-executives could be involved in monetary policy decisions.

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Reasonable points in some respects (how to manage potential and actual conflicts has been an issue even in the recent appointment of members of the new MPC), although note that in Australia the Reserve Bank of Australia Board –  which sets monetary policy –  is very similar in composition to the way the RBNZ Board was in the 1980s.

Perhaps more interesting is about the qualms Goodhart has –  in early 1987 –  about the case for an independent Reserve Bank, in particular around the case for a more active coordination (at least in some circumstances) of fiscal and monetary policy.

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Goodhart’s paper ends with this paragraph.

good8If you were generous, you could interpret the final Reserve Bank of New Zealand model as looking something like that paragraph.  Unlike the Bundesbank, the Reserve Bank of New Zealand never had the power to set any specific policy objective for itself, and there was explicit override provisions built into the legislation allowing the government to (temporarily) override the agreed (Governor and Minister) policy targets.  But this paragraph sounds a lot more like the Bank of England in the 1980s, than the case made in public for the Reserve Bank of New Zealand Act 1989 (much of which was about having as few residual powers for  Minister as was consistent with getting the legislation through the Labour Party caucus).

In fairness, the Bank asked for these comments from Professor Goodhart at relatively short notice. On the other hand, he was at the time a leading academic writer in the area, and a former senior practitioner.  And so I am still struck by the conflicting strands of thought that one finds in this short paper –  on the one hand, the idea of options to reward senior central bank staff for meeting a target they might specify themselves, and on the other a real concern about the potential disadvantages in separating fiscal policy too far from monetary policy, and thus some ambivalence about too much operational autonomy for the Reserve Bank at all.

Having said all that, in a way what struck me most about the Goodhart paper is what wasn’t there.    The UK’s disinflation experience in the 1980s had a wrenching one.  Economic historians will still debate the contribution of monetary policy to the peak of three million people unemployed, but no one seriously doubts it played a part.  At the time, there hadn’t been many economywide costs to the degree of disinflation New Zealand had so far managed –  the credit boom and stock market excesses were still in full swing-  and for a time that was to induce a degree of complacency among New Zealand advisers (I recall a meeting I was in perhaps a year or so later at which the then Deputy Secretary to the Treasury was telling the IMF about how modest he expected the costs of disinflation to be –  the head of the IMF mission politely begged to differ).

But in this paper there is no mention of output costs at all  – either those associated with getting inflation down to a much lower average level, or the short-term deviations of output from potential that would come to play such a large role in central bank thinking in subsequent decades.  Just none.  It is quite extraordinary  (and thus when Goodhart talked about tying staff pay to the inflation target, no sense of the political impossibility of giving central bankers financial bonuses for actions that would, at least temporarily, raise unemployment –  even if one could accurately and formally specify a binding target for the life of the options he proposed).

What of Reserve Bank staff ourselves?  From mid-1987 I was Manager of the Monetary Policy (analysis and advice) section at the Bank, and thus quite heavily involved in clarifying what it was we were going to target, how and when.   If memory serves, I think many of us were probably too complacent, perhaps a little blind, around the short-run issues, and tended to work on an over-simplified mental model in which once inflation was lowered to target all we really had to worry about were things like oil price shocks or GST adjustments (we didn’t explicitly – and probably not implicitly –  think much about significant positive or negative output gaps developing).

On the costs of disinflation itself, we were (on the whole) more realistic, but to some extent that depending on the individuals.  There were “battles” between what might loosely be called “the wets” and “the dries”, the former tending to emphasise the transitional costs and the latter the medium-term goal.   Some of the wets (I was mostly of the other persuasion) probably doubted that the 0 to 2 per cent inflation target, adopted in 1988, was really worth pursuing.  Perhaps what united us was a belief that a lot of other reform –  greater fiscal adjustment and more micro reform –  would reduce the costs of getting inflation sustainably down.

Some 20 years ago now I wrote a Bulletin article on the origins and early development of the inflation targeting regime.  In that article, I tried to capture some of competing models that influenced the legislative framework (a funny mix of independence –  not trusting politicians –  and accountability –  not trusting officials and having ministers hold them to account). I also reported some extracts from some of the papers we wrote (I often holding the pen) as the target came together.    From one early and somewhat ambivalent paper (and I can’t recall why shipping got so much attention that month)

Moreover, the Bank noted that “the potential improvements in living standards to be derived from more rapid and complete removal of import protection, and the deregulation of such grossly inefficient sectors as the waterfront (already under
way) and coastal shipping, far outweigh the real economic benefits of slightly faster [emphasis added] reductions in inflation”. In an early echo of what later became a dominant theme in subsequent years, the Bank argued that if price stability was to be pursued over a relatively short time horizon, everything possible needed to be done at least to try to influence expectations and wage and price-setting behaviour.

This post isn’t about having a go at Charles Goodhart, The Treasury, the Bank, or me and my colleagues who were working on some of this stuff at the time.   Mostly, it is just about history, and the sober perspective that history often provides –  things that seemed clear at the time seem less clear with the perspective of time, and some things –  that one later realises are really quite important –  that hardly get attention at all.  If it is an argument for anything, it is probably for more open and deliberative government and policy development processes, perhaps even for incremental and piecemeal (in Popper’s words) reform.   That probably never appeals to reformers –  perhaps especially not young ones  –  and perhaps there are occasions when it can’t be (practically) the chosen path, but blindspots are all too real.

As for the Reserve Bank Act 1989, if there were mistakes and weaknesses in its design (most especially the single decisionmaker model), it did probably serve New Zealand fairly well for several decades.  It was, almost certainly, superior to the Atkinson/Treasury scheme.   And yet one can also overstate the difference legislation really makes –  Australia having made a similar transition to low and stable inflation under legislation still much as it was first passed in 1959.