Looking back to the deposit guarantee

12 October 2008 was a frantic day.  It was a Sunday, and I never work Sundays (well, two financial crises, one in Zambia, one in New Zealand, in 30+ years).  There was a call in the middle of our church service summoning all hands to the pump, to put in place a retail deposit guarantee scheme that day.   We did it.  My diary later that night records that we’d “delivered a brand spanking new not very good deposit guarantee scheme”, announced a few hours earlier.   It was a joint effort of the Reserve Bank and The Treasury.

I had recently taken up a secondment at The Treasury.  I’d been becoming increasingly uneasy about the New Zealand financial situation for some months (flicking through my copy of Alan Bollard’s book on the crisis I found wedged inside a copy of an email exchange he and I had had a month or so earlier about Lender of Last Resort options for sound finance companies, potentially caught up in contagious runs) but I hadn’t had any material involvement in the unfolding sequence of finance company failures.   But it was the escalating international financial crisis – this was four weeks after Lehmans, 3.5 weeks after the AIG bailout, two weeks after the US House of Representatives initially voted down TARP, and two weeks after the Irish government surprised everyone by announcing comprehensive deposit guarantees –  that really accelerated interest in the question of what, if anything, New Zealand should do, or might eventually be more or less compelled to do.    The initiative for some more pro-active planning came from The Treasury, but with some parallel impetus  –  including around guarantees – from the then Minister of Finance, Michael Cullen (who, a few days out from Labour’s campaign launch, was also looking for pre-election fiscal stimulus measures).

On Tuesday 7 October, there was a long meeting at the Reserve Bank, attended by both the Secretary to the Treasury, John Whitehead, and the Governor of the Reserve Bank.  My memory – and my contemporary diary impression – is that the Governor was considerably more focused on the managing the Minister’s political concerns than on any sort of first-best response.    But the outcome of that meeting was agreement to quickly work up a joint paper for the Minister which would not, at that stage, recommend introducing a deposit guarantee scheme, but which would outline the relevant issues and operational parameters, giving us something to work from if the situation worsened.

Which it quickly did, both on international markets, and with the political pressure, with the Prime Minister signalling that she wanted to be able to announce something about guarantees in her campaign launch that coming Sunday afternoon.

I and a handful of others on both sides of The Terrace scurried round for the next few days.  I see that in my diary I wondered what the best approach was: do nothing, allow some risk of the crisis engulfing us, and then pick up the pieces afterwards, or be more pro-active and take the guarantee route.  My conclusion –  and even today I wince at the parallel (but this was a late-at-night comment) – “I suspect that if the pressures really come on, the Irish approach is best”.   As relevant context, although much of the finance company sector was in solvency trouble (many had already failed) there were no serious concerns about the solvency of the banking system.   (Liquidity was, potentially, another issue.)

At Treasury we had recognised the importance of the Australian connection –  most of our banks being Australian-owned.     I’m not sure of the date, but we had taken the initiative –  at Deputy Secretary level –  of approaching the Australian Treasury to see if they were interested in doing some joint contigency planning around deposit guarantees, and had been told that the Treasurer had no interest in such guarantees and so our suggestion/offer was declined.

But even Australian authorities could look out the window and see that the global situation was deteriorating rapidly, and by late in the week that recognition was being passed back to authorities on this side of the Tasman.  Alan Bollard always kept in close contact with his RBA counterpart Glenn Stevens, and on the Friday my diary records (presumably told by some RBNZ person I was working with) “apparently Glenn S[tevens[ told Alan this afternoon that the RBA/authorities might fairly soon have to consider a blanket guarantee”.     In the flurry and uncertainty, one other senior RBNZ person –  still holding a senior position there –  told me that in his view nothing should be done here unless there were queues outside New Zealand banks.

Between a handful of people on the two sides of the street, we got a paper on deposit guarantee scheme possibilities out to the Minister of Finance on the Friday afternoon.  It was a mad rush, with some uneasy negotiated compromises (and everyone’s particular hobbyhorse concern got its own mention). I was probably too close to it to tell, and noted I wasn’t that comfortable with it, but when I got Alan Bollard’s signature he indicated he was happy with it.  I noted “lots of small details to sort out next week –  we hope only that, not implementation”.     To this point, we were focused mostly  on retail deposits, but I see in my diary that in The Australian on the Saturday there was talk from bank CEOs of a possible need for a wholesale guarantee scheme.

The full, unredacted, paper we wrote is available on The Treasury’s website.   The thrust of the advice was that (a) action was not necessary immediately, but (b) that should conditions worsen a scheme could be put in place at quite short notice.  The rest of the paper outlined the relevant issues, and the recommended features of any such scheme, and we advised against announcing a scheme until the remaining operational details had been sorted out, something we suggested could be done in the folllowing week.

These were the key features we suggested, largely accepted by the Minister.

dgs 1

One thing that puzzles me looking back now is why we were focused on guarantee options, rather than lender of last resort options.  The latter would have involved lending on acceptable collateral to institutions that we judged to be solvent, perhaps at a penal rate.  It was the classic response to the idea of a contagious run –  troubles elsewhere in the financial system spark concerns about other institutions, and people “run” –  cashing in deposits, retail or wholesale –  just in case.  A sound institution could, in principle, be brought down very quickly by such a run (empirically there are few such examples –  most actual runs end up being on institutions that prove to be at-best borderline solvent).

In the paper we sent to the Minister on 10 October we don’t seem to address that option at all.  I presume the reason we didn’t was twofold.  First, guarantees were beginning to proliferate globally.  And second, there probably is a pretty strong argument that if (a) you are convinced your banking system is sound, and (b) there are nonetheless doubts in the wider environment (in this case, a full scale global crisis, and a domestic recession), a guarantee is likely to be considerably more effective in underpinning confidence.  Not so much depositor confidence, as the confidence of bankers (and their boards).    Even if lender of last resort funding, on decent collateral, had been available without question, few bankers would have been happy to rely on that, and many would have been very keen to cut exposures, pull in loans, and reduce their dependence on the good nature of the Reserve Bank Governor.   A guarantee –  where the Crown’s money is at stake –  is a much stronger signal than a loan secured on the institution’s very best assets.   On the other hand, as the paper does note, once given a guarantee may not leave one with much leverage over the guaranteed institution.

Almost all of the subsequent controversy around the deposit guarantee scheme related in one form or another to one key choice.

All the systemically significant financial institutions in New Zealand were banks (not that all banks were systemically significant).  But they were not, by any means, the only deposit-taking institutions, and we were in the midst at the time of a finance company in which many companies were proving to be insolvent and failing.  Other finance companies appeared –  not just to the Reserve Bank, but to the market, and to ratings agencies – just fine.

Treasury and the Reserve Bank jointly recommended to the Minister that any deposit guarantee scheme include finance companies.  Why did we do that?

The simple reason was one of both fairness and efficiency.  Had we proposed to offer a guarantee only to banks (let alone only the big banks) then in a climate of uncertainty and heightened risk, there would have been an extremely high risk that such an action would have been a near-immediate death sentence for the other deposit-taking institutions, including ones with investment grade ratings, and in full compliance with their trust deeds.    We knew that finance companies (while small in aggregate) were riskier than our banks, but that was no good reason to recommend to the government a model that would have killed off apparently viable private businesses.  It still seeems, with the information we had at the time, an unimpeachable argument.  Classic lender of last resort models, for example, don’t differentiate by the size of the borrowing institution.

We weren’t naive about the risks –  including that there was still no prudential supervision of finance companies and the like –  and we explicitly recommended that risk-based fees (tied to ratings) be adopted, and the maximum coverage per depositor be much lower for unrated entities.   We included in the table an indicative fee scale, based credit default swap pricing for AA-rated banks in normal times, scaling up (quite dramatically) based on the much higher default probabilities of lower-rated entities.

We even included a indicative, totally back of the envelope, guess as to potential fiscal losses –  drawing on the experience of the US S&L crisis.  As it happens, actual losses were to be less than that number, even though the scheme as adopted by the Minister of Finance was less good than the one we recommended.  (Treasury provided some other –  but lower – loss estimates a few days after the actual announcement, but I can’t see those on the Treasury website and can’t now recall the approximate numbers.)

But all that was just warm up.   We’d been under the impression that the Prime Minister was going to announce, in her campaign launch speech, that preparatory work was underway on a deposit guarantee scheme.  That was probably her intention.  But that didn’t allow for the Rudd effect.  The Australian Prime Minister decided that he was going to announce an actual retail guarantee scheme for Australia that day –  the Sunday.  And so it was concluded that New Zealand had little choice but to follow suit.   As a matter of economics, there probably was little real choice but to follow the Australian lead.  But the timing was all about politics.  Neither economic nor financial stability would have been jeopardised if we hadn’t had a deposit guarantee scheme announced before the banks opened on Monday morning.  We’d have been much better to have taken a bit more time and hashed out some of the details with the Minister in his office in Wellington, not at campaign launches and then, as the day went on, airport lounges (at one point late that afternoon I –  who’d talked to the Minister perhaps twice in my life previously –  was deputed to ring Dr Cullen and get his approval or some detail or other of the scheme).   But I guess it might have left open a brief window in which critics might have suggested that New Zealand politicians were doing less for their citizens and their economy than their Australian counterparts.

The main, and important, area in which Dr Cullen departed from official advice was around the matter of fees.   We’d recommended that the risk-based fees would apply from the first dollar of covered deposits (as in any other sort of insurance).     The Minister’s approach was transparently political –  he was happy to charge fees to big Australian banks (who represented the lowest risks) but not to New Zealand institutions (including Kiwibank).  And so an arbitrary line was drawn that fees would be charged only on deposits in excess of $5 billion.   Apart from any other considerations, that gave up a lot of the potential revenue that would have partly offset expected losses.  The initial decision was insane, and a few days later we got him to agree to a regime where really lowly-rated (or unrated) institutions would have to pay a (too low) fee on any material increases in their deposits. A few days later again an attenuated pricing schedule was applied to deposit-growth in all covered entities.   But the seeds of the subsequent problems were sown in that initial set of decisions.

The weeks after the initial announcement were intense.  We rushed to get appropriate deed documents drawn up, dealt with endless request from institutional vehicles not covered who sought inclusion (property trust, money market funds etc), and set up a monitoring regime.  In parallel, we quickly realised that the way wholesale funding markets were freezing up suggested that a wholesale guarantee scheme was appropriate, and got something announced in a matter of weeks –  a much more tightly-designed, better priced scheme, operating only on new borrowing (but I’m biased as that scheme was mostly my baby).  As it happens, that scheme provided the leverage to actually get the big banks into the deposit guarantee scheme.  Once the government had announced the retail scheme the big banks had little incentive to get in –  they probably thought of themselves (no doubt rightly) as sound and as too big to fail –  and the scheme was an opt-in one (we couldn’t just by decree compel banks to pay large fees).   But the Minister of Finance –  probably reasonably enough –  insisted that if banks wanted a wholesale scheme (which they really did) it would be a condition that they first sign up to (and pay for) the retail scheme.  Perhaps less defensible was the Minister’s insistence that any bank signing up to the guarantee scheme indicate that it would avoid mortgagee sales of home owners in negative equity but still servicing their debt (the ability of banks to do so is a standard provision of mortgage documentation).

After the first few weeks of the retail scheme I had only relatively limited ongoing involvement, and so I’m not going to get into litigating or relitigating the South Canterbury Finance failure, and whether –  even the constraints the Minister put on –  and how that could by then have been avoided (the Auditor-General report some years ago looked at some of those issues).   The outcome was highly unfortunate, and expensive.  Nonetheless, it is worth remembering that the total cost of all the guarantee schemes – retail and wholesale – was considerably less than officials had warned was possible.  And it is simply not possible to know the counterfactual –  how things might have unfolded here had either no guarantees been offered, or if the finance companies and building societies had been excluded from day one.  Personally, I think neither would have provided politically tenable, but we’ll never know that, or how that alternative world played out.

But with the information we had at the time –  including, for example, the investment grade credit rating for SCF (which had outstanding wholesale debt issues abroad –  and actually my only meeting with SCF was about their interest, eventually not pursued, to try to use the wholesale guarantee scheme) –  the recommendation made on 10 October seem more or less right. Given the same information I’m not sure I’d advise something different now.  And once Australia had made the decision to guarantee retail deposits, there was little effective economic or political choice for New Zealand.   Had they not done so –  and there was real data, regarding increasing demand for physical cash in Australia, supporting Rudd’s action (rushed as timing was) – perhaps we could have got away with a well-designed wholesale guarantee only.   That would have been a first-best preferable world, but it wasn’t the set of facts we actually had to work with.

 

Electioneering 1954 style

A few weekends ago I was fossicking in a charity book sale when I stumbled on The National Government 1949-1954: FIve Years of Progress and Prosperity, published by the National Party.   It was, it appears, published as part of National’s 1954 election campaign: 150 pages of (often quite detailed) text and tables, complete with a detailed chronology of measures, and an index.

I’ve always been interested in that first National government.  Apart from anything else, the Prime Minister (and Minister of Finance) was my grandfather’s cousin –  they’d been close, and in our family Sid Holland was always “Uncle Sid”.  It was a government with a fairly mixed record.  Through my career at the Reserve Bank I was always quietly proud that a relative had legislated to establish the primacy of price stability in what we expected from monetary policy and to put monetary policymaking at a further remove from direct ministerial control (even if, in practice, it didn’t make much difference).

There was some genuine liberalisation –  including of those banes of New Zealand economic management for too many decades, import licensing and exchange control.  And there was the ANZUS Treaty –  which I hadn’t previously known came into effect on ANZAC Day, a nice touch –  and the interesting episode of New Zealand’s approach to the Suez crisis.  It was the time of the wildly popular first ever visit by a reigning sovereign.  And the sort of short-term austerity that led to the Auckland Harbour Bridge being built too narrow from the start, or central planning that meant that for years the Reserve Bank wasn’t allowed to start building its own building.

In the territory of serious black marks, it is hard to defend the way the 1951 waterfront strike was handled –  not so much the confrontation with the watersiders itself, but the brutal undermining of civil liberties and the freedom of the press during that period –  often using powers introduced by the previous Labour government.

Perhaps only in New Zealand  –  where good histories and biographies are few – could a government that was in power for eight years, with a leader who spent 17 years in the role, not have either a decent scholarly treatment of that government or a biography of its leader.

But what of the book?

It has a foreword by the Prime Minister which, I imagine, captures quite well the way National saw things in those years

It is a proud thing to belong to a Government which is able to say that the people have never been better off, that there is a new spirit of vigour and enterprise abroad in the land, that there was never a time when so much progress was being made in the development of the resources of the country.

Once again, New Zealanders feel that the future belongs to them…….

Freedom, which is at the heart of the National Government’s philosophy, is perhaps an intangible thing – until you have lost it.  But it yields tangible results. The Government’s recrod, which this book outlines, is the answer to those who stand to the creed of Socialism.

But having lauded freedom, the Prime Minister goes on to laud the apparently growing role of the state.

A vast programme of development works is in progress –  imaginative and progressive schemes like the new pulp and paper and timber industry in the Rotorua-Bay of Plenty area, the utilisation of geothermal steam, the huge hydro-electric project at Roxburgh.  More hospitals, more schools, more houses –  there is no neglect of everyday necessities because of the scale of the development programme.  The Government has liberalised and extended social services, more is provided for other social services, trade is booming, the needy are cared for, the workers are prosperous, savings are greater.  On all fronts New Zealand has gone ahead, as a young country should…..

I lived in Kawerau as a child, but it is only over the last decade as I’ve come to read a lot more New Zealand history that I’ve come to realise how big a deal –  in some way, the decade’s Think Big, complete with outside capital and protected markets –  the Kawera/Murupara development really was in the 1950s.  The state was at the leading edge of promoting economic development, as it saw it (in this book, the Kawerua scheme is described –  perhaps with a little exaggeration, depending on how one classifies Vogel’s interventions –  as “the greatest single enterprise ever attempted in New Zealand”.

On the one hand, in the early 1950s, New Zealand still had some of the very highest material living standards in the world.  On the other, only a few years later people started writing serious reports (eg the new Monetary and Economic Council and the new NZIER) observing that New Zealand’s productivity growth was lagging behind.  Sadly, it was to be the story every decade from then to now.

But this post isn’t really intended to be an abbreviated political or economic history of the decade.  It was more that I was fascinated by things the National Party chose to highlight, and the accounts of interventions I’d just never been aware of.

Take rest homes for example.  When I was young, almost all of them were run and provided by church groups. I had never given much thought to why –  caring for the vulnerable was one of those things the church had done since Roman times.   But this little book tells how the government skewed the playing field:

Soon after taking office the Government introduced a policy of helping charitable or religious organisation to establish homes for aged people. Generous subsidies, up to 50 per cent, are offered, together with loans finance on favourable terms in respect of housing schemes.

The next sub-section recounts the introduction of a similar subsidy for such groups to establish youth hostels.

There are reminder of times past: anti-tuberculosis campaigns get two-thirds of a page to themselves.

There were 506000 radio licences in New Zealand in 1954, and not a single television.

And in a country of two million people, there were still only 334580 telephone subscribers (and a little subsection on “Mobile telephone services” –  some 2000 people had telephones in vehicles, up from only 192 when the government had taken office five years earlier).

The forerunner to Air New Zealand –  Tasman Empire Airways Ltd –  flew 30888 people trans-Tasman in the entire year to March 1954: fewer than 100 a day.  Domestic air services, so the party (fairly) boasted, has increased substantially during its term in government, but total passenger numbers were still less than 1000 per day.

And if economists are (largely rightly) inclined to be censorious about the excess demand policies of the period (inflation nonethless kept in check) there is still something to hanker after in these numbers:

In spite of the large increases in the labour force, ample work is still available.  At 15/1053 the number of vacancies for men was 13500 and for women 6500. Unemployment in 1953 averaged only 85 persons throughout the year.

(These were people registered as unemployed.  Five-yearly census numbers were higher, but still very low by modern standards.)

These were the days when, in New Zealand almost uniquely, cars held their value, the numbers imported being rationed.  There was an exception for people with overseas funds themselves (the “no-remittance” scheme) –  which made an English OE additionally attractive.  My grandfather was not infrequently heard to jest that my father proposed to his daughter only because she had a car, (having done her OE).

What of monetary policy?

The declared policy of the Government is to divorce currency and credit from political control, to avoid the issue of credit unbalanced by goods and services, and to stabilise internal prices by establishing a proper balance between money and goods.

From an economist’s perspective, two out of three isn’t bad, but that middle phrase is disconcertingly reminiscent of the real bills doctrine.  In fairness, the same government liberalised what were then known as “capital issues controls” restricting the ability of firms to raise funds on market.

And if there were elements of liberalisation, (eg the “state monopoly of coal seams” was abolished  on 10 October 1950) there was also this

The Potato Board was established in 1950 to control the production and marketing of main crop potatoes.

Why, one has to wonder?

In the some things don’t seem to change category, there was the boast that

Maori land claims.  Removal of grievances over land claims is being vigorously pursued, Claims settled include: [and a list follows]

Perhaps in the same category, pages and pages are devoted to housing and housing finance, including this curious observation under the heading “Encouraging local authorities to buy land and develop it for housing”

A retarding influence in many cases has been the desire on the part of local bodies to avoid placing a further burden on ratepayers by raising loans for housing activities, but the loan procedure has been simplified to open the way for local authorities to engage in housing activities without recourse to long-term finance.  They can now finance these projects on bank overdraft.

I’m clearly missing something in understanding the greater appeal of a bank overdraft.

Meanwhile large scale immigration has restarted (I wrote about it here), including subsidised (“assisted”) migration.  Being a skilled building trade worker was enough to get assisted passage for married people (at the time, policy explicitly favoured single people because of the housing shortages).  But there is no hint of the politicians realising –  what economists knew even then –  that new arrivals added more to housing demand, and overall resource pressure, than any feasible increase in supply (even in the building sector specifically).

For an economic history junkie, it is a fascinating read.  There is the line from L P Hartley’s novel The Go-Between that “the past is another country, they do things differently there”, and it comes to mind strongly reading this book  And, it won’t surprise regular readers to know that the other thought that comes to mind is one along the lines of “if only” we’d done things differently then and since, and could still today boast of being one of the richest countries in the world.  How much more we could offer our people –  on market, and off.  Of course, in material terms, people are better off today than they were in 1954.  That is an important benchmark, too easily lost sight of –  only a few years prior to 1954 my mother had done her masters’ thesis on the incidence of basic home appliances in Dunedin (far from universal) –  and yet, and yet, the failures and lost opportunities since then, which mean we now languish so far down the international league tables, matter too.  Both National and Labour must take responsibility for that failure.  Not that one would know it from either party’s campaigns last year.

 

World War One and the New Zealand economy

Earlier this week, in the lead up to ANZAC Day today, The Treasury drew attention to an interesting conference paper written a few years ago by Brian Easton on “The impact of the Great War on the New Zealand economy”.   From the opposite end of the political spectrum, Eric Crampton described it as “really great”.  I’m not sure I’d go that far, but for anyone interested in aspects of New Zealand’s economic history –  especially bits on which there are few systematic treatments (and often only patchy data) – it is certainly worth reading.

Easton’s focus is less on the details of how the economy did during the war than on supporting

my contention that the war experience fundamentally affected the way we governed New Zealand.  I shan’t be surprised if economic historians from other countries come to similar conclusions about their economies.

As Easton notes, the war itself took up a lot of resource.

How much diversion of resources? We dont know with any precision. During the war the troops overseas at any time, plus those in domestic training – amounting to at least 65,000 and even 100,000 men, over a fifth of the labour force – were not available for civilian production, but they were still consuming. Similarly there were workers diverted to producing war goods. There are no annual labour force figures at this time, so we don’t know the precise impact of having so many workers unavailable for domestic production. Some of the labour deficit would have been made up by running down the unemployed (although that was not a huge reserve), by drawing women into the labour force (although we dont know how many) and by working longer hours.

Other authors note that the number of women drawn into the labour force actually wasn’t that large.   In the 1916 Census, for example, there were 100000 women in paid employment, up from 90000 in the 1911 Census –  an increase as a proportion of the total female population, but not much of one (given the underlying rate of population growth). But it does appear that those people (male and female) in employment were  working a lot of overtime –  although data were only collected on female and youth overtime.

Easton surmises that resources equal to perhaps a third of GDP were diverted to the war –  similar to estimates of the resources devoted to World War Two.   Rich countries –  and New Zealand was then one of the very richest –  could afford to devote a large share to the war (since pre-war living standards were so much further above subsistence than in poorer countries).   One thing that made the New Zealand experience of World War One very different from that of World War Two, is that in the first war we had nothing like the massive influx of American troops seen after 1941 (our war was entirely overseas).

The war was financed by a mix of taxes and debt.

One of the most radical changes in our tax system occurred over the six years to 1919/20. Income tax made up just 9 percent of total tax receipts in 1913/14, behind customs duties (58%), land tax (13%) and death duties (10%). Six years later income tax was the single largest source of tax revenue at 39%, with the other three behind: customs 30%, land tax 9% and death duties 6%.

As for debt, here is a chart of the estimated public debt as a share of GDP.

ww1 debt

The level of debt – mostly domestic debt – roughly doubled, but there was so much inflation (despite, as Easton notes, resort to price controls) that the debt ratios themselves didn’t increase that much (nothing like the extent experienced in, say, the UK).  That didn’t stop our government claiming –  and securing –  a small portion of German reparation obligations after the war.

And that the demand impetus was led from the public sector rather than the private sector is evident in the ratio of trading bank advances to deposits.  There was plenty of deposit growth but pretty subdued growth in private credit.

adv to dep ratio

One aspect not touched on by Easton is that such rapid inflation was made possible by one of the very first New Zealand policy initiatives  –  the suspension of the Gold Standard.  In a very early post I wrote about that here, including the fact that gold convertibility was never resumed in New Zealand, and for the next 20 years (until the Reserve Bank was established) our monetary arrangements were idiosyncratic, and not really anchored at all.

But as I noted, Easton’s main concern in his paper is with the legacy of World War One for our economic management.    He argues, of the rehabilitation polices for returned servicemen

There is rarely a single event which initiates what proves to be a major policy, although there can be steps which accelerate its development. The rehab policies after the Great War might be thought of as starting the practice of widespread home ownership. Similarly the war’s broadening of the role of income tax was on the way to today’s dominant role of income tax in the revenue system. It seems likely that the administration of veterans’ pensions was part of the basis for the social security one set up in 1939.

And of the state control of exports during the war

….. by 1917 New Zealand had an agreement with the British Government that all the supplies available for exports would be requisitioned for the British market.

At the end of the war there was a considerable quantity of meat and wool in store. As shipping became available it, plus the normal annual production, was unloaded on the British market, as were South American supplies. Prices collapsed. Private enterprise seemed to have fail again, and the farmers turned to the public sector. In February 1922 the government, with dirigiste (‘Farmer Bill’) Massey at the forefront, passed legislation which established the Meat Producers Board with very wide powers. Although interrupted by the 1922 election, the Dairy Board was created almost as quickly.

We may ponder whether these producer boards would have been established as early – or at all – had there been no commandeer, had there been no Great War.

Perhaps more dubiously Easton argues for other longlasting legacies

This was most evident in the draconian wage and price freeze which the government of Robert Muldoon introduced in May 1982. The earlier war administrations would have been admiring. Of course, in ways that Muldoon never fully appreciated, New Zealand had moved on. The unwinding of centralised economic control that the successor government – the Rogernomes – undertook might be said to represent the end of the centralised Second World War approach to economic management of forty years earlier, itself a response to the Great War approach to economic management a further twenty-five years back.

Frankly, all of that seems a stretch in a New Zealand specific sense.   As he notes “I’m not sure that New Zealand was particularly more centralised than many of the other war economies”, and cross-country comparisons are often enlightening.  Ireland, for example, was long even more inward-looking than New Zealand.

Which isn’t to suggest that wars don’t have longlasting consequences –  economic, as well as political, social and personal.  Many scholars would ascribe the severity of the Great Depression in significant part to the conduct of policy (perhaps inevitable –  inflation, build-up of debt etc) around World War One.  Perhaps more locally, we wouldn’t have had a central bank as early as 1934 without the earlier war, and then the Depression.  Taxes and government spending seem permanently higher –  but who is say that that wasn’t an almost inescapable outcome of the worldwide lift in prosperity (and there is little sign that taxes are lower, or regulation less pervasive, in countries that stayed out of both wars).

On which note, perhaps I can end with the famous quote from John Maynard Keynes from The Economic Consequences of the Peace about the way in which global markets worked in the years prior to World War One.

The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages; or he could decide to couple the security of his fortunes with the good faith of the townspeople of any substantial municipality in any continent that fancy or information might recommend.

He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality, could despatch his servant to the neighbouring office of a bank for such supply of the precious metals as might seem convenient, and could then proceed abroad to foreign quarters, without knowledge of their religion, language, or customs, bearing coined wealth upon his person, and would consider himself greatly aggrieved and much surprised at the least interference. 

But, most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable.

And not a preferential trade agreement, attempting to reach behind borders and control this, that or the other aspects of other countries’ policies, in sight.

If anyone is interested, here is an early (surprisingly frequently read) post on New Zealand’s economy in World War Two.    There certainly seems to be a gap in the market for a good modern treatment of New Zealand economic history, and the history of economic policy, from say 1914 to 1945, encompassing the two wars.

For various other countries’ economic experience in World War One, I recommend Broadberry and Harrison’s The Economics of World War 1.

 

Len Bayliss RIP

I wasn’t planning to write anything today, but in the death notices of the Dominion-Post I noticed this morning the passing of Len Bayliss, one of the most prominent New Zealand economists of a previous generation (late 1960s to, say, the late 1980s).

I only met Len once, but when I first came to Wellington in the late 1970s he was a prominent public figure, and I was enough of a political/economic junkie to get a bit of a buzz from the fact that one of his sons was in my class at Rongotai College and that, for a year or two while I was at university, Len often caught the same bus into town each weekday morning as I did.

Len was born and educated in Britain, but wanted to get out of the United Kingdom after finishing his degree at Cambridge.  Eschewing South Africa for laudable reasons, he wrote to various banks and government agencies in Australia and New Zealand, and after an interview that seemed to be not much more than a cup of tea with a visiting Deputy Governor passing through London he was hired by the Reserve Bank of New Zealand in 1951, where he spent quite a few years in a vibrant economics department.

He moved on to the Monetary and Economic Council, and played a key role in that agency’s 1966 report calling for liberalisation of the financial sector –  which wasn’t particularly popular with the bureaucratic establishment.  But his most prominent perch was as the long-serving Chief Economist of the (state-owned) Bank of New Zealand, where he openly championed sound economic management and liberalisation.  In the early years of Muldoon’s Prime Ministership he served on the Prime Minister’s Policy Advisory Group and appears to have played an instrumental role in the financial liberalisation that government undertook in 1976/77.   Of Muldoon in this role he wrote

Excellent. He was the best boss I’ve ever had. Absolutely decisive. I wrote his speech for the Mansion House dinner, the most important speech he’d made after becoming PM. I gave it to him. He said send it to Treasury and see if it’s all right with them. They wrote back wanting something changed and wrote a little memo and he just put ‘No’. And he always was very proper. He may have been tough to his political opponents but as Bernard Galvin used to say, certainly in the time I was there, it was a very happy group. He never tried to force you to do anything. In a sense, he treated you just like a public servant, as a politician should treat them. He was decisive. He would argue very intelligently. Watching him at the Cabinet Economic Committee, he really tore strips off ministers who hadn’t done their homework. And I saw him several times in debates with Noel Lough [Deputy Secretary to the Treasury]. Noel Lough was a lovely bloke but Muldoon really won the debates.

After his secondment ended, Bayliss returned to the BNZ, from where a few years later, having become increasingly critical of the economic management of the New Zealand economy, he was put in a position where –  under fire from Muldoon, and with no support from the supine BNZ Board and management –  he felt he had no choice but to resign (at considerable financial cost to himself).

In the post-liberalisation year, Bayliss served on the Board of the BNZ, and he recounted in his published works the frustrations of trying to constrain a management gorging on bad credit, and eventually driving the bank to the point of failure.

At a macroeconomic level he had long-favoured liberalisation and stabilisation (cutting inflation, balancing the budget) but in the post-liberalisation decade he was increasingly uneasy about the persistently high real exchange rate –  a concern that he (rightly in my view) never lost.

As I said, I only met Len once –  although we had corresponded a bit since –  when the New Zealand Association of Economists asked me to record, and edit, a long interview with him (as part of a series on the life and work of prominent New Zealand economists).  The text of that interview has quite bit that might interest those concerned with the history of New Zealand economic and financial policy.

In preparing for that interview, I had been focused on the earlier decades and didn’t give the attention it warranted to his departure from the BNZ or his later time on the Board.   But

…as he records it, that interview and some follow-up questions from me prompted him to put together a volume of documents and recollections  –  Recollections: Bank of New Zealand 1981-1992  – dealing with his ouster from the BNZ and his later term as a government-appointed director of the BNZ as it descended into crisis and near-failure in the late 1980s and early 1990s.

And I used that material last year for a post on his ouster from the BNZ, having finally got under the skin of the Prime Minister once too often.

When some academic finally writes the definitive history of the financial debacle/crisis in New Zealand in the late 80s and early 90s, I hope they take time to draw on the perspectives and papers Bayliss has apparently lodged at Massey University.

His was a courageous voice, unusual for its day.  In an environment in which few could speak –  there weren’t many economists outside government –  it was a valuable contribution in articulating the increasing unease about New Zealand’s economic underperformance and poor economic management.

UPDATE (Oct 18)):  I was asked by the New Zealand Association of Economists to write an obituary.   It is on page 6 of the April 2018 issue of their newsletter Asymmetric Information.

 

Reflecting on Jim Anderton

I have a pleasant memory of the only time I met Jim Anderton. One of his daughters was in the same class as me at Remuera Intermediate, and at the end of the year the Andertons hosted a class barbecue at their home just up the street from the school.   I was a youthful political junkie and Jim Anderton was running for Mayor of Auckland.  It was a pleasant evening and he seemed to be a lively and engaged parent (later struck by the awfulness of the suicide of another daughter).

Accounts suggest that Anderton did a good job of helping to revitalise the Labour Party organisation in the late 1970s and early 1980s.  He was, for the time, a moderniser, instrumental in helping reduce the direct influence of the trade unions in the party, and promoting the selection of some able candidates who hadn’t served time in the party (eg Geoffrey Palmer).  Various tributes talk of a personal, and practical, generosity.

I don’t suppose either that there was any doubt that he pursued causes he believed in, and that those causes were, more or less, what he regarded as being in the best interests of New Zealanders (perhaps especially “ordinary working New Zealanders”).   Probably most politicians do.  Sometimes they are mostly right about the merits of the causes they pursue, and sometimes not.    In Anderton’s case, even if one agreeed with the sort of outcomes he might have hoped for, his views on the best means seem –  perhaps even more so with hindsight than at the time –  to have been pretty consistently wrong.   And for all the public talk in the last few days about Anderton’s contribution to New Zealand, few (if any) of the things he opposed in the 1980s have been unwound/reversed, and few of the things he championed when he served later as an effective senior minister have done much for New Zealanders.

Take the 1980s when, upon entering Parliament in 1984, Anderton quickly isolated himself in caucus.  Even before that election, he’d opposed the CER agreement with Australia, and opposed Roger Douglas’s talk of a need for a devaluation and a reduction in the real exchange rate.  Even after the 1984 election, in circumstances of quasi-crisis, Anderton still opposed the by-then inevitable devaluation –  and in league with Sir Robert Muldoon sought to use a select committee to run a kangaroo-court inquiry, to undermine the choices his own government had made.   He was opposed to GST, and he was opposed to creating SOEs for state-trading operations.   He opposed privatisations, whether small or large.   Of the large, there was vocal opposition to the sale of the BNZ and of Telecom.  I suspect the list of reform measures, not subsequently unwound, that Anderton did enthusiastically support would be considerably shorter –  perhaps vanishingly so –  than the list of those he opposed.

As a pure political achievement, to have survived resigning from the Labour Party – in a pre MMP period –  was worthy of note.  But then Winston Peters did much the same thing –  and he’d had the courage to resign his seat and win a by-election to return to Parliament.  And the distinctive Jim Anderton party has long since disappeared, as Anderton returned to the Labour fold.

And what causes did he champion as a senior minister (for a time, deputy prime minister, in the fifth Labour government).   Probably the institution that will be always associated with Anderton’s name is Kiwibank: it certainly wouldn’t have existed without him.  But to what end?   Has Kiwibank changed the shape of New Zealand banking?  Not in ways I can see.  It remains a pretty small player, operating in segments of the market where there has always been plenty of competition.  It hasn’t come to a sticky end –  as many state-owned banks have here and abroad –  but we’ve never had the data to know whether, even on strictly commercial grounds, the establishment of the bank was a good deal for taxpayers (but the fact that no private new entrant has tried something similar suggests probably not).   If simply promoting competition in banking had been the goal, perhaps it would have been preferable to have prevented the takeover of The National Bank by the ANZ?

There has been talk in the last few days of Anderton’s contribution to “revitalising the regions”.  I’m not sure what this can possibly mean –  even allowing for a few government offices being decentralised (at some cost) around regional centres.   Generally, the real exchange rate mattters much more for the economic health of the regions than direct stuff governments do.   Anderton was Minister of Economic Development.  In that role, he was keen on using taxpayer money to subsidise yacht-building (which didn’t end well), and a champion of film industry subsidies.   In tributes this week, there has also been the suggestion that Anderton was one of those responsible for the creation of the New Zealand Superannuation Fund, something I hadn’t heard before.   If so, I guess he deserves some partial credit for the fiscal restraint the then Labour government exercised in its first few years.  Beyond that, what was created was a leveraged speculative investment fund –  not a model followed, as far as I can tell, in other advanced economy –   with returns that over almost 15 years now really only seem to approximately compensate for the high risks the taxpayer is being exposed to.  No doubt Anderton opposed the decision in 1989 or 1990 to start raising the NZS eligibility age from 60 to 65, and the same opposition to any further increase in the age beyond 65 –  even though it is a step many other advanced countries have taken, as life expectancies improved –  was presumably behind any involvement he had in the creation of the NZSF.  In so doing, once again his hand was involved in holding back sensible gradual reforms, and keeping New Zealand a bit poorer than it need be.

I suspect many of the tributes of the last few days are mostly a reflection of Anderton’s part in the Labour reconcilation.  The prodigal son returned –  having been one of the leading figures in fomenting the civil wars in the first place, before walking out of the party.   They were tumultuous years, and few things are nastier than civil wars.  Anderton doesn’t ever seem to have been a team player, but by the end of his career he seem to have found his place back alongside the team he started with.

But from a whole-of-nation perspective, what did Anderton accomplish?     If the reforms of the 1980s and 1990s haven’t produced the results the advocates hoped for –  we still drift, more slowly, further behind other advanced countries – that wasn’t for the sorts of reasons Anderton advanced.  Had we followed his advice, we’d most likely now be poorer still –  and many of the issues around equality and social cohesion that he worried about might have been no more effectively addressed.     In the end, Anderton is perhaps best seen as a belated figure from the New Zealand of the 1950s and 60s.  There was a lot to like about the New Zealand of those years –  some of the best living standards in the world then – for all the increasingly costly distortions to our economy.   There are parallels to Muldoon –  who famously told a TV interviewer of his goal to leave New Zealand no worse than he found it –  both in the genuineness of their concerns, and the wrongness of too many of their policy stances.  Both seemed to back very reluctantly into the future, with all too much willingness to trust our fortunes to the state, and the possible winners identified by politicians and officials, rather than to the market.

The 1987 crash: experience and reflection

The upside of a decent memory and a pretty comprehensive diary is that one is reminded of how many things one misjudged, or at least sees differently now, over the course of decades.  In my case, the stock market crash of 1987 was one of those events.

There were excuses I suppose.  I was young –  just 25 –  and had only just come back from two years at the (central) Bank of Papua New Guinea – a place where I’d learned a great deal about economics, politics, regulation, statistics and so on but where, from memory, there were about five, rarely-traded, public companies.  In late August 1987, I’d taken up the role of Manager, Monetary Policy at the Reserve Bank, working for (current “acting Governor”) Grant Spencer.  The Reserve Bank wasn’t (formally) operationally independent at the time, and my section was responsible for our monetary policy analysis and advice, including that to the then Minister of Finance.    It was a very different world.  The Bank produced macroeconomic forecasts, but they weren’t that important in how policy was run.  We didn’t set an official interest rate, and to the extent we were guided by any financial market indicators, the “yield gap” –  between 90 day bill rates and five year government bond rates –  was the most important indicator.  My diary suggests my team spent a considerable portion of late 1987 working on a paper on the yield gap and the making sense of the slope of the yield curve, for a new Associate Minister who had trained as an economist and was intrigued.

Official doctrine was that it was very hard to interpret the level of interest rates.  It was only three years since we’d liberalised, so didn’t have much sense of an appropriate interest rate in normal circumstances, and these circumstances were anything but normal (hence the focus on the yield gap –  if short-term rates were well above long-term rates then, in a climate where we were trying to drive down inflation, we couldn’t be too far wrong).  Much the same line applied to interpreting the exchange rate.   Both interest rates and the exchange rate were extraordinary volatile.

wholesale int rate 85 to 97

We didn’t really have a good model for forecasting, or making sense of, inflation either.   Again, that wasn’t really surprising.  So much had been liberalised quite quickly and a lot of economic relationships that had once held up no longer did.   Our basic approach was that inflation was a monetary phenomenon, but it wasn’t as if the monetary or credit aggregates could then give us much useful guidance either.

The focus was on bringing inflation down.  It was the one thing we knew the Reserve Bank could do, especially once the exchange rate had been floated, and I don’t suppose there was anyone who opposed that broad goal.   There wasn’t a very specific goal, but for some time the talk had been of “low single figure inflation” which was, at least at times, seen as emulating the success of the UK and the US earlier in the 1990s in bringing inflation down.

But inflation itself was all over the place.

CPI inflation 83 to 87

Annual headline inflation was 18.9 per cent in the year to June 1987.  Much of that reflected the introduction of GST in October 1986, but even abstracting from that quarterly inflation was volatile, and disconcertingly high.    There had been a sense that by early 1986 things were coming under control –  hence the sharp fall in interest rates in mid 1986 (see earlier chart) –  but that proved illusory.   Just before I came back to the Bank in August I recall seeing Grant Spencer interviewed on TV after the June quarter 1987 CPI numbers came out: quarterly inflation of 3.3 per cent (I think the Bank had been expecting something nearer 2 per cent) left the Chief Economist “flabbergasted”.   Low single figure inflation seemed a long way away, as the commercial construction boom, and the debt-fuelled sharemarket boom and associated strength in consumption raged on.    The (volatile) exchange rate offered some solace –  at the time, the pass-through from the exchange rate into domestic prices was still quite strong (we assumed something like a 46 per cent pass through) –  although I’m sure we all remembered that after the devaluation of 1984, a key policy priority had been cementing-in a  much lower real exchange rate.  (As a young graduate analyst, I’d been the minute-taker in various meetings on that theme involving the great and the good of the Reserve Bank and The Treasury).

twi 87

And so in September 1987, the biggest concern in the Economics Department of the Reserve Bank was that we were making little or no progress in getting inflation back down again.  Perhaps we weren’t going back to the 15 per cent inflation we’d often seen before the wage and price freezes of 1982 to 1984, but there didn’t seem much reason for confidence that once the GST effects dropped out we’d settle at much below 10 per cent annual inflation.  That wasn’t good enough for the government –  newly re-elected, and just about to launch the next wave of reforms  –  or for us.

Other parts of the Reserve Bank may have had different perspectives.  We didn’t do much banking regulation or supervision in those days, but a new function was just getting going, and I didn’t have much to do with them.  Our Financial Markets Department was probably a little more focused on the excesses in the markets –  including the big speculative plays on the NZD –  but the Bank wasn’t responsible for equity markets, and we didn’t have a “macro-financial stability” type of analytical function there or in Economics.   At the time we didn’t pay very much close attention to what was going on in other countries, but had we done so, we’d probably have seen a bunch of smallish economies undergoing similar post-liberalisation experiences (Australia and the Nordics), while congratulating ourselves that at least we’d floated our exchange rate (which the Nordics hadn’t).

But our focus in September/October 1987 was on tightening monetary policy if at all possible.  And on 7 October 1987, we’d actually announced a discrete monetary policy tightening (implemented by an increase in the margin above market rates at which we would buy back short-dated government securities from the market).   We’d tried to buttress the case for a tightening by arguing that the strength of the stock market was an indicator of demand and inflation pressures, but an older and (with hindsight) wiser senior manager insisted we remove that line.  My diary records that I thought the tightening was “pretty feeble” and that at a market function immediately after the announcement at least one of the market economists I talked to agreed (Grant Spencer, to his credit, disagreed).    Actual interest rates didn’t rise very much at all –  at least in the way we thought about things then – but by 16 October 90 day bank bill rates were 20.56 per cent.  There was no unease from the Beehive –  my diary for 15 October records of a meeting with Roger Douglas and his associate only “the latter almost gleeful at having closed almost 450 Post Offices”.

In many ways, our stance to this point was quite justifiable.  A key element of the macroeconomic management agenda ever since the 1984 election had been to end New Zealand’s really bad record of inflation.  And that was the Reserve Bank’s job.  Moreover, even if we had properly recognised the ever-growing fragility of the financial system etc, neither we –  nor anyone else –  had any way of knowing when those risks would crystallise.   Persistent strong domestic demand, even if built on foundations of sand, represented a serious threat to any sort of success in lowering inflation to what were, by then, becoming more internationally conventional levels.  So it probably wasn’t wrong to have tightened on 7 October, and may not even have been wrong for people like me to think that more tightening might yet be required.   Annual money and credit growth rates were, after all, still running at around 20 per cent –  indeed, a couple of days after the crash began we got new numbers that I called “presentationally (and factually) very embarrassing when [our chief critics] get hold of it”.  If there was a real squeeze on the tradables sector –  and there was –  the unemployment rate in mid 1987 was stable at around 4.2 per cent (lower than it is today).   At the time we didn’t really believe that seriously high unemployment would, for a time, be required to get inflation down –  I recall an IMF mission chief at the time reproaching us for this view – probably partly because after three years, unemployment hadn’t risen.  But whatever the truth of the matter, 4.2 per cent unemployment, amid a major economic restructuring, wasn’t exactly the 3 million unemployed of Thatcher’s Britain earlier in the decade.

So if there was a criticism to be made –  and I think it is probably fair that one should –  it was that we simply weren’t prepared for what followed.   There may have been people at the Bank –  older and wiser than me – who saw things differently then, and if so all credit to them.  But I was pretty closely involved on the monetary policy side throughout the following five years and I don’t think my blindspots were particularly unusual (I wrote many of the major papers, including the first ever Monetary Policy Statement, which has little or no sense of a post credit-boom bust to it_.  Again, it is possible that our banking supervision people saw things differently, but banking supervision –  such as it was – didn’t impinge on monetary policy or our macroeconomic forecasting and analysis.   We never really worked through what an asset bust and financial crisis meant for economic developments and prospects, and mostly treated them as peripheral issues.

On 20 October itself –  the first day of the crash in New Zealand –  I recorded in my diary “Bank not at all twitchy yet, which is good, and Douglas put on a brave face tonight”.   I saw the risk of economic contractions and real wealth effects, but for some reason seemed to see the risks as mainly those from abroad (commercial property busts overseas associated with potential credit contractions, recessions, falls in commodity prices etc) and thus potentially helpful in our own disinflation efforts.  For some – now unaccountable –  reason I noted that I didn’t see the New Zealand fundamentals as particularly problematic.   As I say, records of the past can make one wince.

A week or so later –  in one of those events I’ve never needed a diary to recall –  Paul Frater and Kel Sanderson, then the leading figures at BERL –  pretty vocal critics of our approach to monetary policy – came in to see Grant Spencer and me.  Sitting in Grant’s office

“among other topics, they gave us their gloomy assessment of the impact of the share price falls –  very pessimistic about comm. property and about the future size of many broking firms and merchant banks”.

They foreshadowed a financial crisis, and a lot of stress on bank balance sheets.  We were pretty dismissive of their concerns.

Within a day or two, concerns were mounting even within the Bank, focused on the fate of some of the investment companies (“Judge, Rada and Renouf”) and those they might drag down with them.   There was, I recorded, no panic over financial institutions themselves, but we’d had internal discussion of a possible liquidity response, agreeing in principle to raise the target level of settlement cash and perhaps cap the level of the discount rate (which normally moved with market rates) –  I think, from context, this hypothetical response was envisaged if interest rates rose (as, say, they did in the 2008 crisis).

A week later we acted.  It was never represented as a monetary policy easing –  although it was –  and so even today there is a mythology abroad (I saw it in a recent Liam Dann article on the crash) that the Reserve Bank did nothing in response.  On the day, 90 day bill rates –  which hadn’t risen since the crash, despite increase risk concerns and limit cuts –  fell 1.5 percentage points on the day.    (By August the following year, 90 day bill rates were down to 14 per cent –  a similar-sized fall to the active cut in policy rates the Reserve Bank implemented in 2008/09.)

My diary entry that day is sufficiently long, and embarrassingly wrong, that I won’t quote from it at any length: suffice to say that I called it a “precipitate panicky move”.  To be sure, the issue in the market at the time wasn’t the interest rate (which hadn’t risen) –  it was blind fear and an often-quite-rational newfound reluctance to lend –  and we had no evidence that inflation or inflation expectations would fall, and the Bank had over the years been too receptive to pressure from banks.  But, such were the genuine fears and rising risk aversion, that the response was only prudent.   Immediate responses can always be revisited once the immediate panic passes and, frankly, there wasn’t much, if any, moral hazard risk in the sort of action we took.   We weren’t lending more to anyone, let alone to bad credits.

But it wasn’t the way I saw it.  A few days later, apparently, I circulated a discussion note “provocatively titled ‘Is it time to lower the cash target’, (ie tighten up again) arguing strongly in the affirmative”.  The same day I recorded that Grant Spencer had deleted a description in a draft Board paper of the 6 November easing as “temporary”, observing to me “nice try”.  My approach wasn’t totally hawkish –  I also toyed with the idea of a cap on our discount rate, in case renewed crisis pressures spilled back into higher interest rates.  As the month went on and interest rates fell further, my arguments (in another “longer and more reasoned note”) starting commanding more sympathy among my colleagues, and some hawkish market economists.    The Deputy Governor even did the courtesy of ringing to discuss it.  But this was one of those times when –  at least with hindsight – the more senior were better judges of the situation than those of us further down the food chain.  In mid-November, I recorded a conversation with Iain Rennie –  then an analyst at Treasury –  in which he told me that the distribution of views was much the same at Treasury.

The (apparent) tensions betwen the financial stability and inflation control perspective must have been very real.  When my latest note was discussed at (the equivalent of) the Monetary Policy Committee, I recorded that there was plenty of agreement with the analysis and none with the recommendation (to reverse some of the easing) – “terrified of the possibility of collapses corporate and financial” , with rumours rife.

Of course, there were plenty of collapses to come, of corporates and fringe financial institutions.   Of the things that were feared, most come true.  In fact, reality was worse, because the crisis eventually engulfed mainstream large institutions on both sides of the Tasman.  Really bad lending –  whether to investment companies, or on a massive commercial propety boom –  eventually does that –  enabling a really big misallocation of real resources, and then eventually being found out.  Most of the waste isn’t in the crisis-aftermath; rather the bad seed is sown –  the waste actually happens – when all feels exuberant and the new investment is being recorded as an addition to GDP.

If I look back on my views during that frantic couple of months after the crash began, I was clearly wrong.  Even if monetary policy wasn’t going to do anything to save Judge, Renouf, the listed goat companies or whatever –  and nor should it –  it was quite clearly, even on the facts available at the time, a shock to the system which meant that lower interest rates were warranted.  Credit demand and associated activity would be weaker.  Interest rate falls would have happened anyway, even without our intervention (that was how the system worked then), but the nudge downwards, and the willingness to accommodate lower interest rates was clearly the right thing to do.

But it is also worth wondering what we might have done if we had correctly understood financial crises, asset busts etc, if we had envisaged several years of little or no growth, and two near-failures of our largest bank.  (That we didn’t, even later, is evident in a major article written by Grant Spencer and one his colleagues in late 1988 –  published the following year in a book on the liberalisation process, and which I reread last week –  in which the crash appears as not much more than a corrective to the excess enthusiasm for consumption up to 1987.)   The doves –  of whom there were plenty including Spencer and then Assistant Governor Peter Nicholl –  would, almost certainly have argued for further easings, allowing interest rates to fall materially further.       And yet it is far from clear that that would have been the right approach to have taken.

Inflation edged downwards only relatively slowly over 1989 and 1990, and it wasn’t until the big fiscal consolidation after the 1990 election, and as the 1991 recession unfolded, that we felt comfortable letting bank bill rates fall below the 14 per cent they got to in the months after the crash.  We, and other forecasters, misread the 1991 recession, but until that hit us we didn’t appear to be on track to getting inflation to target any sooner than the government had (by then) asked us to.  Inflation at the end of 1990 was still 5 per cent, and the target –  by then agreed by both main parties –  was 0 to 2 per cent inflation.  Getting inflation down isn’t technically difficult, but when real people and real institutions (with all their biases, incentives etc) are involved it can, and usually has been, costly and difficult.  Sometimes, a little learning can be a dangerous thing.  Perhaps a proper appreciation of the looming crisis, and the wasted real resources, at the end of 1988 would have made it even harder, perhaps even eventually more costly, to have secured something like price stability here.  I wouldn’t like to be seen as suggesting that we should welcome blind spots, or even ignorance, but sometimes perhaps they end up being less costly than idle theorising might suggest.

Finally, a week or so ago the Herald ran an interesting series of articles on the New Zealand experience in 1987.  The thing that most surprised me about those articles –  and in a way what prompted the thinking that led to this post –  was the almost complete omission of the role of banks in making it all possible.   Every over-optimistic borrower needs an over-optimistic lender if the loan is to happen.  There were plenty of the former, but all too many of the latter too –  whether state-owned lenders like the BNZ or the DFC or private sector ones, new entrants (NZI Bank anyone) or old, New Zealand owned or foreign-owned.  And the few institutions, on either side of the Tasman, who didn’t participate boots and all often weren’t particularly virtuous and far-seeing, but just slow.  Given another year or two, they’d probably have got into the mix too, and if existing management wouldn’t do so, well other managers could soon be found.

In many ways it was a classic financial crisis –  the definitive history of which has still to be written.  There was the displacement of genuine new opportunities, enough of a narrative for even the cautious to believe that the future would be quite a bit different and better than the past, official backing (indeed, at times, cheer-leading), extraneous feel-good factors like the America’s Cup, relatively weak market disciplines (especially in the financial sector), little experience in lending or borrowing in such a different world.  There were probably even some real success stories (I’m struggling to think of them, but readers can nominate some).   And it didn’t, to any material extent, involved lending to households.

It all happened surprisingly quickly.  14 July 1984 was the election day that brought the fourth Labour government to office, and 20 October 1987 began the crash –  just over three years.  It took far longer to unwind the mess than it did to create it.  It is the deterioriation in lending standards that happened so quickly that market monitors, and central banks, really need to be watching out for.    When they start sliding, a bank can be destroyed remarkably quickly.    Such marked deteriorations in standards aren’t every day events –  we, after all, have seen no bank failure since 1990 –  and they rarely arise out of the blue.  They usually take some shock –  some innovation –  that is likely to leave regulators just as uncertain what to make of it as the lenders are. That’s inescapable, but is a reason to be cautious about just how much useful difference even the best regulators can make.   Seeing no harm for 98 years earns you no real credit (and should not either) if you aren’t much better than the lenders in the other two years each century.

The little engine that could…and other fairy tales

“I think I can.  I …..think ….I…. can, I………… think……… I…………… can” said the little blue engine”

It was almost to the top.

“I——-think”

It was at the top.

“I ———can.”

It passed over the top of the hill and began crawling down the opposite slope.

‘I ——think——- I—— can——I—– thought——I——-could I—– thought—– I—– could. I thought I could. I thought I could.¨ I thought I could.”

And singing its triumph, it rushed on down toward the valley.

“The Little Engine That Could” is a heartwarming childhood tale, about hard work and a willingness to give anything a go.    Perhaps the Prime Minister once read the story to his kids.  But…….it is a story.   Technical capacity, not willpower, determines whether engines can pull loads, get over hills etc.   However, the Prime Minister now appears to have adopted the storybook as the basis for his latest, rather desperate, defence of his government’s immigration policy.

At his post-Cabinet press conference on Monday, the Prime Minister appeared to be –  as NBR put it –  practising his election lines.

Answering questions about New Zealand’s capacity to handle current levels of population growth caused, in part, by very high net migration, English appeared to practice attack lines for the forthcoming election campaign, saying he believed the ability to cope with these challenges was “going to be a key issue in the campaign”.

“We believe New Zealand can adjust to be a growing economy with a growing population,” he said. “Our political opponents think New Zealand isn’t up to it, it’s too hard and the solution is to shut down the growth by closing off international investment, getting out of international trade, closing down migration and settling for a kind of grey, low-growth mediocrity where the best thinking of the early (19)80s sets our political direction.”

and, from another account (which I will draw on but can’t link to)

English said that National unashamedly believes in New Zealand’s capacity to be a growing economy and that its political opponents unashamedly think New Zealand is not up to it.

Belief is one thing.  Evidence is (much) better.    Winning elections might be a different matter, but whether, and to what extent, large-scale immigration is providing long-term economic benefits to New Zealanders isn’t something to be determined by whose swagger is most convincing; who can put on the most macho stance, or who is most ready to kick sand in the face of the weedy doubters.  Wishing for benefits won’t make them happen.   Instead, it is a matter of calm balanced analysis and an assessment of the evidence of New Zealand’s experience.  We’ve had plenty of experience.   And that must be a point of some difficulty for defenders of the current large-scale non-citizen immigration policy, presumably including the Prime Minister.

After all, 100 years ago, on the best available measures, New Zealand had among the very highest material living standards anywhere.   Some combination of abundant land, a temperate climate, dramatic reductions in transport costs, and refrigerated shipping had required more people to take advantage of the new opportunities, and enabled just over 1 million people to flourish in what was, by international standards, a highly-productive economy.  There were new opportunities here, and it took new people to take earliest and greatest advantage of them.

On some measures, even as late as around 1950 we still had some of the highest material living standards around.  There hadn’t been many more new opportunities specific to New Zealand in the previous few decades.  But, on the other hand, we’d avoided wars and revolutions at home.  It wasn’t much of a surprise that we were still wealthier than almost anywhere in continental Europe.

But mostly since then we’ve been slipping down the rankings, whether measured by productivity (the better measures) or average per capita income (which can always be boosted by working ever more hours).   After World War Two, large scale immigration, actively promoted by successive governments resumed.  Even then, leading New Zealand economists were sceptical.   All manner of arguments were run for actively pursuing increased population.  There were defence arguments, there were arguments about redistributing Britain’s excess population to the land-rich Dominions, there was the apparently-reasonable argument that opportunities and incomes were just better here.

But whatever the arguments, any economic gains just seemed to keep failing to show up.  Of course, we did lots of daft things during the post-war decades.  Trade protection meant that, for example, in the early 1960s we had twenty television factories in New Zealand, and we made or assembled here all sorts of stuff that would never have passed a market test.  In the late 70s and early 80s we poured money down the drain in the absurdly expensive energy Think Big projects (while being spared Roger Douglas’s ambition for 16 state-promoted carpet factories).   But strip all that stuff away –  as we did –  and we’ve still done badly.

Productivity growth lagged that in other advanced economies in the 1950s and 60s.  Since 1970, data suggest that among advanced economies only Switzerland and, perhaps Mexico, have done worse than us.  And even since all the reforms of the late 80s and early 90s, we’ve still brought up the rear when it comes to productivity growth.  On average, we just keep slipping further behind those other advanced countries we were once so much better off than.

My friends on the right will emphasise how high taxes are, how much wasteful government spending there is, and how pervasive poor-quality regulation is.  And I have a great deal of sympathy with many of their individual points.   But the median OECD country isn’t really any better or worse than us on those scores (on some we do rather better than the median, on others quite a lot worse).   We could all do better, but the explanation for New Zealand’s continuing disappointing performance simply can’t rest in those traditional pro-market verities.

A much more plausible story is one that recognises that New Zealand’s wealth was largely built on able people, and good institutions, making the most of our natural resources.    It shouldn’t really be controversial; you can see it in our trade data.    As it always was, so it is today – the overwhelming bulk of our exports are the fruits of the land or sea (and I’ll count tourism in those numbers, since that it mostly what tourists come for).   Of course, there is small number of successful outward-oriented firms in quite different industries, but strip away the subsidised ones (export education and the film industry) and the numbers are really pretty small.

And not only are no new natural resources being made, but in New Zealand for many decades there hasn’t even been any really large new discoveries of usable natural resources that were hitherto unrecognised (or idiosyncratic shocks that strongly favoured New Zealand production from natural resources).  It is, surely, the big difference between the post World War Two experiences of New Zealand on the one hand, and Australia and Norway on the other.  The prosperity of all three countries rests largely on the natural resource products their able people, with good institutions, can sell to the rest of the world.  Norway and Australia were able to bring to market whole new resources that, while always there, were previously unknown or uneconomic to tap.  New Zealand has had nothing similar.  No new land, no new sea and –  so far –  oil/gas and mining activities that are of fairly peripheral scale.    If we’d known that difference 50 or 60 years ago, few people (if anyone) would have thought it would make a lot of sense to import lots more people to New Zealand.   Combining many more people with a key fixed factor (“land”) is simply a recipe for making it much more difficult than necessary to support top-notch living standards for the people who were already there.    And that is so even if one can get lots of productivity growth in the land-based sectors.

Of course, the standard pushback is along the lines of “but that is all old economy stuff; ideas and new technologies are the way of the future, and one can develop those industries anywhere –  all that matters is the people, the people, the people”.  Which would be fine, but the evidence seems to be against it.  When it comes making physical stuff, global value chains have become ever more important, and it is really hard for many firms located at the end of the earth to be part of such value-chains (whereas it is quite easy if you are in Slovakia or Korea).  And when it comes to ideas-based industries, counter-intuitive as it might seem, personal connections and proximity (to suppliers, markets, specialist resources, clusters of knowledge) seems to have become more important than ever.    All sorts of firms can be set up by people in New Zealand –  or in Patagonia, Port Stanley, or Windhoek.  But those firms, and those people, will usually command more value relocated nearer those global centres –  be they in Europe, North America or East Asia.   Wishing it was otherwise –  like believing I can fly –  simply doesn’t make it so.

New Zealand’s strength is its people, among the most skilled in the world, its institutions (absence of much corruption, rule of law etc) and its natural resources.    The latter are crucial –  that isn’t something of ideology, or old-school thinking, but of hard numbers –  and are, for practical purposes largely fixed.  (Add in our (self-chosen) climate change objectives and those natural resource opportunities could almost be argued to be shrinking.) But our disadvantage, and it is a severe one, is distance/location, and at least before teleportation is mastered, that disadvantage isn’t changing –  it is a land so remote that until perhaps 200 years ago, there simply was no foreign trade.

Against that backdrop, it is simply crazy to keep letting the central planners (politicians and bureaucrats) try to drive up the population.   New Zealanders know it in their own choices.   There is nothing shameful about a fairly flat population, whether in a country – plenty of rich European countries have had them for decades –  or a city.  But it seems almost heretical in New Zealand.  It makes sense that cities, or countries, grow when new opportunities abound.  The evidence to date strongly suggests they aren’t abundant here.   Some might think that a shame –  in some ways I do too –  but believing otherwise doesn’t make it happen.

Is there 100 per cent conclusive evidence?  No, in this life there hardly ever is.  But lets look at some of the straws in the wind:

  • among the very worst productivity growth in the OECD throughout the post World War Two period,
  • an export share of GDP that has stagnated and even gone backwards (in a country that once had among the very largest per capita exports anywhere),
  • a major city that has incredibly rapid population growth over decades, and yet of which even Treasury now observes “we are not seeing the agglomeration effects we would expect from Auckland’s size and scale.”

I’m for evidence-based policy.  If we’d seen more and more New Zealand firms successfully establishing themselves in international markets, and the export share of New Zealand’s GDP rising (as it typically does in successful catch-up economies), if we’d seen a decade of productivity growth materially outstripping that of the other OECD countries so that we were finally catching up, if we are seeing evidence that GDP per growth in Auckland was consistently far-outstripping that in the rest of the country (as we find in many other countries centred on knowledge-based industries) then (a) we could all celebrate, and (b) it might make sense to think about whether we should open our doors to lots of migrants.   As it is, we see none of those things.  And that with one of the largest (per capita) legal immigration programmes anywhere in the world.   It is madness; ideology (“big New Zealand” more than theoretical arguments typically) over experience.

But the Prime Minister and the National Party still “believe” apparently.  Perhaps they could show us their evidence?

I don’t like to make too much of the last few years’ experience.  Apart from anything else, data revisions could mean that stories that look good today eventually disappear like the morning mist.     But, for what it is worth, the last few years don’t do much to instill confidence.

There is the dysfunctional housing and land supply market for example.  Sure, you can argue that it really has nothing to do with immigration policy, but if you can’t or won’t fix up the land supply market –  and neither this government nor its predecessors have –  don’t give us the nonsense that New Zealand can cope with his immigration policy.   Even if there aren’t large productivity costs from those land-use restrictions (I’m open-minded on that in New Zealand) the distortion to real house prices, that makes purchasing a home more and more difficult in our cities is a standing reproach to our leaders.

And then there is productivity.  I’ve repeatedly showed charts of real GDP per hour worked in New Zealand, where the data suggest we’ve had no growth at all in the last five years (even though the dogma suggests large immigration should be generating positive productivity spillovers).  It is often hard to get timely cross-country comparisons, but earlier this month the Conference Board released their latest annual estimates of real GDP per hour worked.    Here is how New Zealand has compared over the last five years (2011 to 2016) with a sample of 40 or so other advanced countries (the group I often use –  EU members, OECD members, plus Singapore and Taiwan).

2011 to 2016 growth in real gdp phw

And it isn’t just because those other countries were recovering from deeper recessions.  Our labour productivity growth also lags behind the median of these countries for the whole period since 2007 (just before the recession).  It is just the same old story of underperformance.   Are there mitigating factors?  Probably always to some extent.   The Canterbury rebuild inevitably dragged resources away from other uses.  On the other hand, relative to our worst decade of economic underperformance –  the 1970s –  the terms of trade have mostly been pretty good this decade.

With the export share of GDP drifting further backwards, it looks more and more like an economy that exists on building for each other.  Nothing wrong with that in one sense –  people need houses, offices, roads etc –  but it isn’t how economies successfully catch-up with those richer and more productive than them.  That typically involves finding more and better things to successfully take to world markets.

In his post-Cabinet news conference, the Prime Minister was also making much of the contribution to the net migration numbers of the decline in the outflow of New Zealanders to Australia.    That, he claimed. “was a vote of confidence in New Zealand”.   Perhaps it sounds good politically to say it, but lets face reality.  New Zealanders have gone to Australia is fewer numbers mostly because the Australian labour market is tough – the unemployment rate and underemployment rates linger high, and there is increasing awareness of how much on their own New Zealanders are in Australia if things don’t work out well.     And even though the labour market is tough, look at Australia’s productivity growth (from a much higher starting point) relative to ours in the previous chart.  It isn’t so much a vote of confidence, as an unexpected loss of an escape valve.   That makes things even tougher for New Zealand, especially when the government keeps on bringing in much the same number of non-New Zealanders as ever.   In the short-term it gives the economy a boost –  demand effects exceed supply effects in the short-term –  but in the longer-term it just keeps worsening New Zealand’s relative performance on the sorts of economic measures that matter.

The Prime Minister was also at pains to stress that he believed New Zealand –  government and private sector – could and would invest enough to handle the rapid growth in the population.  The evidence has long been against him on that one.  Despite having had one of the faster population growth rates in the OECD, we’ve long had one of the lower rates of business investment among OECD countries.   In a well-functioning economy with high productivity growth etc you’d expect it to be the other way round –  more people should need more investment, of all sorts.

My arguments are generally specifically focused on New Zealand –  opportunities in Ireland or Belgium may well be different than in, say, New Zealand, Tasmania or Nebraska.   But for what it is worth, here is a scatter plot, using IMF data, of population growth rates and investment as a share of GDP for the countries the IMF classifies as advanced.  I’ve used data since 1995, simply because that is the period for which the IMF has data for all countries.   Recall that one really should expect investment as a share of GDP to be higher in countries with faster population growth than in those with lower population growth, all else equal.

But

IMF scatter plot

There is almost no relationship at all – and certainly not the expected upward-sloping line.  If anything, the relationship is slightly negative.  And New Zealand –  the red dot above 30 on the horizontal axis –  doesn’t stand out from the pack.  Since people do have to live somewhere, it looks a lot like rapid increases in population tend to crowd out (rather more price sensitive) business investment.    Perhaps it isn’t surprising then that many of the advanced countries with the strongest growth rates in productivity also have flat, or even falling, populations?  But, whatever the wider story, there isn’t much reason in the international data to believe the Prime Minister’s wishful thinking that enough will be invested and all will be fine.  And when your country already has some of highest real interest rates, and a persistently overvalued exchange rate, it is probably safer to believe that all won’t be just fine.

I could go one, but I just wanted to make two final brief points:

  • in his comments quoted earlier the Prime Minister suggested that somehow the alternative to continuing very high immigration targets involved “settling for a kind of grey, low-growth mediocrity where the best thinking of the early (19)80s sets our political direction”.   Personally, I’d say the very best thinking from the early 80s –  that of reformers at Treasury and Reserve Bank for example –  was very much to the point.  But even setting that to one side, the Prime Minister’s attempted slur might well rebound.  I checked out productivity growth for the nine years to 2016, compared to the nine years to 1984.  In those 9 years of Sir Robert Muldoon’s stewardship, growth in real GDP per hour worked was (according to the OECD) 9.0 per cent.   Not great.  But on the Treasury’s preferred measure of real GDP per hour worked (and even correcting for the break in the series last year), productivity growth from 2007 to 2016, totalled about 5.5 per cent.    The Prime Minister was Minister of Finance for most of that period.   (Yes, sure there were plenty of other imbalances, bad choices etc then, as well as terrible terms of trade….but they still achieved faster productivity growth).
  • I could commend to the Prime Minister a column in The Australian yesterday from Australian labour economist Judith Sloan (there are extracts and commentary on it here).   Notwithstanding Australia’s stronger productivity growth, and overall higher incomes, she slams the Australian government’s substantial immigration target (just slightly smaller, in per capita terms, than New Zealand’s), noting in particular the ‘cynical charade’ in professing concern about house prices while doing nothing about immigration (land supply –  a major problem in Australia too –  isn’t under federal government law).  Sloan isn’t just any economist.  She led the Australian Productivity Commission 2006 inquiry into Australian immigration.  And in many respects, she is about as “right-wing” as they come (to the extent such slogans have meaning), so much so that she was nominated by ACT and the Business Roundtable, and then appointed by the government, to serve on our own 2025 Taskforce a few years ago, where she was instrumental in ensuring that that Taskforce did not champion New Zealand’s immigration policy.   She doesn’t write about New Zealand these days, but it would be surprising if her conclusions about our policy were les stridently expressed than those about Australia’s

The Prime Minister can “believe” all he wants. He can attack Opposition parties all he wants (and we have yet to see specifics of what either Labour or NZ First propose), he can diss a former leading figure of the business and economic establishment, Kerry McDonald, he can ignore the counsel of someone as able in this area as Judith Sloan.  But what he seems unable to do is offer any evidence that his immigration is, or ever will, work for the benefit of New Zealanders.