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

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

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

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

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

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

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

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

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

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

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

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

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

Anyway, for anyone interested here are the concluding paragraphs.

Conclusion

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

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

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

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

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

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

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

The OECD Survey process

The OECD’s biennial report on the New Zealand economy was out yesterday.

I noticed that Treasury has put out a blog post on the late phases of the process, in which New Zealand officials go to Paris to engage with other countries’ representatives on the analysis and recommendations, and to haggle over the numerous differences the authorities and staff will have.

I participated in this phase of the process on perhaps half a dozen occasions over almost 25 years.  In anticipation of the 2015 survey, I wrote a post along similar lines.

Being public servants, who have to keeping dealing with the OECD, the Treasury piece errs occasionally on the side of gush.

Every two years the Treasury assists some of the world’s best economists and policy analysts from the OECD with their study of New Zealand.

I, being of a more sceptical, perhaps contrarian disposition, and not any longer being a public servant, emphasised some questions.

It is, in other words, quite a political process. And that, of course, is also how these OECD Surveys are used.  Opposition parties have liked calls for, say, capital gains taxes.  The Reserve Bank likes references to overvalued exchange rates.  The government likes positive comments on fiscal consolidation.  And so on.  The Reserve Bank doesn’t much like references to leverage ratios, or the Treasury references to fiscal councils, but then no one much cares either.

What is the quality of the Surveys like?  I’m somewhat sceptical.  The OECD does have some fairly unparalleled databases, and quite a knack for compiling and presenting interesting charts.  I’m a data junkie, and I find those cross-country data comparisons fascinating, and labour-saving.  But the quality of the policy analysis and recommendations is rather more questionable.  I’ve looked at draft reports for New Zealand and for other countries over the years, and often found the argumentation quite unpersuasive, even in areas where I lay no claim to being a specialist or an expert.  These days there is a strong tendency to favour what I’d call “smart active government” solutions, and a disinclination to put much weight on markets and market processes.  That isn’t the image the OECD has often had in New Zealand – the late Roger Kerr often used to cite “OECD orthodoxy” to back his own arguments about what should be done in New Zealand.  But a few years back, I pointed out to the head of the Country Studies Division that the OECD could probably be best characterised as the technocratic wing of the more market-oriented strands of European social democratic movement.   He looked askance, and then somewhat reluctantly acknowledged my point.    Reasonable people will differ on how to read the evidence on the appropriate role of government, but OECD papers aren’t inclined to put much weight on questions of why governments fail so often and how policy should be shaped in the light of that.

All of which is by way of saying that no one should put too much weight on anything in any particular OECD survey.  Sometimes they will be right on the mark –  out of interest I went back last night and read the 1983 Survey and thought that they had done a very good job of highlighting the microeconomic and macroeconomic challenges then facing New Zealand, without any sense of imminent crisis.  At other times, they will be missing the mark, or adopting a particular recommendation based on not much more than institutional priors and the preferences of a few staffers.  As the OECD acknowledges, they have consistently failed to come to grips with why the New Zealand economy has not performed better over the last 25 years.  Without a good story about that it is hard to nest their individual recommendations in an overall narrative of what needs to be done.

Read together they’ll probably give you a reasonable sense of how these things come together.   I do hope the New Zealand Ambassador still offers as fine a lunch as ever.

A true believer from the OECD

The OECD released today its biennial Economic Survey of New Zealand.  I will write about it in due course, but there are 170 pages to read.

Usually these reports are just released on the website from Paris.  But today the OECD’s Chief Economist, Catherine Mann was in town, to help promote the OECD’s view of the world.  There was a press do this morning apparently, and then a Treasury guest lecture presentation, attended by all manner of past and present bureaucrats, and some others with an interest in what Catherine Mann had to say.

She gave us some brief observations on the state of the world economy, before turning to present the New Zealand survey –  the OECD’s story about what is going on here, and what should be done to make things better.  To their credit, the OECD is quite open about the ongoing severe underperformance of the New Zealand economy –  as they note, the productivity gaps to the richer OECD countries are large and, if anything, are getting larger.  Here was my variant (from a post last week) of the sort of chart she showed.

douglas 3

But the point of this post is about the bit where she took my breath away.  I couldn’t quite believe what I was hearing.  I don’t think even the Minister of Finance or the Prime Minister would have made such bold –  but unsupportable –  claims.

She presented a chart showing growth in real GDP per capita in the OECD as a whole in the US, the euro area, and in New Zealand.  As she noted, growth in all regions is still lower than it was in the 20 years or so prior to the 2008/09 recession.     In the other three regions, the OECD is picking that per capita GDP growth will pick up in 2017 and 2018, but in New Zealand they are picking it to slow a bit.  I looked at the chart and didn’t make much of it –  there is plenty of year-to-year volality, and I wouldn’t put much weight on just two years’ data.

But Mann couldn’t help herself.  She was here to tell a good news story, and proceeded to try to do so.     You might, she said, look at that chart and think it wasn’t a very good story for New Zealand –  real per capita growth was picked to slow after all –  but, no, in fact it was really a good thing.  Perhaps, I thought, she was going to say that the economy was overheating and needed to level out.    But it was a bigger bolder claim even than that.

Her argument was that per capita growth was just slowing “mechanically” because we’d acquired so many more people, and were forecast to keep on doing so.  Of course, she said –  advancing no story for why – this would weaken per capita GDP “arithmetically” in the short-term.  But –  and here I scurried to write down as much as possible her actual words –  because we were taking in so many more people to work and study, who would add value, bring fresh ideas, and create new businesses we were creating the underpinnings of a longer-term stronger economy.

Apparently, high levels of immigration were now bad for per capita income in the short-term, but would be good in the long run.  It was pretty much the opposite of the conventional New Zealand evidence –  that demand effects exceed supply effects in the short-term.  But set even that to one side for the moment.

[UPDATE:  On reflection, perhaps she had in mind some of the European countries with waves of refugees crossing borders, adding to population and probably not doing much for economic activity in the very short run.  But that is nothing like New Zealand’s immigration system –  most people arriving either have a job to go to, or are paying for a course of study about to begin.]

Because, in fact, she reckoned she had evidence that we were already seeing significant benefits.  And what form did these benefits take, in the assessment of the chief economist of one of the world’s premier international economic agencies?   Why, it was wage increases.

She had another chart, showing real wage growth for the US, the euro area, and New Zealand.   On this measure, real wages had been rising strongly in New Zealand in the last two years –  more strongly than the average for the 20 years prior to the recession.  (And over the same earlier 20 years New Zealand had had the lowest average real wage increases of any of the regions she showed).  And what was her story to explain this?  Why, it was the immigrants.  We were bringing in highly skilled immigrants, who will be earning higher wages, and –  look at the chart –  we see it in the data already.

Many of you will no doubt be wondering about this alternative universe.  But it is real data.    And, in fairness, comparing wage increases across countries is quite difficult, because countries measure things different ways.  In this case, she used a measure of “labour compensation per employee, adjusted for the GDP deflator”.   Ideally, one would want to use wages per hour worked, rather than per employee, but set that to one side for now.   More importantly,  in commodity exporting countries –  where the GDP deflator (value of the stuff produced here) inflation rate goes all over the place, no one but no one thinks that the GDP deflator is a meaningful statistic to use to deflate anything year to year.    When dairy prices plummet, on that measure real wage inflation rises, and vice versa.  From year to year, it tells one nothing meaningful.  And this, recall, was a presentation specifically focused on New Zealand.

Here’s an alternative –  much better –  measure of real wage inflation for New Zealand.  It uses the private sector LCI (analytical unadjusted measure) adjusted for the Reserve Bank’s preferred measure of core inflation, the sectoral factor model.  There is some short-term variability, so I’ve used annual average increases.

wages OECD

Not much sign of the recent high rates of wage inflation the OECD’s chief economist was touting.   The QES –  an actual compensation measure – is even weaker.

Of course, there isn’t much sign of the really highly-skilled migrants either.  Mann seemed to have forgotten that the OECD skills data –  which they use quite a bit in this report –  shows that while New Zealand’s immigrants are relatively highly-skilled compared to migrants to other countries, they  are on average less highly-skilled than the natives.  There hasn’t been a sudden change in immigration policy in the last couple of years that has generated some step-change increase in the skill level of migrants.

A sceptic sitting near me whispered, “just drink the Kool-Aid Mike”……

I was puzzled by all this, and waited for the question time at the end of her presentation.  I asked Mann quite what her optimistic take was based on  –  that while immigration would apparently be denting per capita GDP now, it would soon lead to an acceleration.  After all, I noted, we’d had large immigration inflows for decades, and on the numbers she had presented we’d had the lowest productivity growth and lowest real per capita GDP of the countries she had shown.    I wondered if she could explain her optimism in terms that took account of New Zealand’s experience over the previous 30 years or so  (not my chosen period, but the one she was using in her own presentation).

It was a pretty astonishing response.   She argued that this was an “immigration-driven economy”, and asserted that the skill characteristics of the immigrants were high, repeating that the evidence for this was the high real wage increases we’d seen in the last couple of years.  Moreover, she asserted, the pre-recession period wasn’t that relevant because we had so many more immigrants now (and presumably could therefore expect much larger future real economic gains).  She seemed not to be aware at all that the largest single component of the increase in the net PLT inflow had been the reduction in the number of New Zealanders leaving.  Or that the new analytical immigration data suggested there wasn’t anything very exceptional about the inflows of non-citizens we are seeing now (there was something similar 15 years ago).   Was she aware that there had been no increase in the residence approvals targets –  indeed a cut more recently  –  and that a significant chunk of the rest of the increase in the net inflow wasn’t more people chosen for their high skills, but (eg ) working holidaymakers and students mostly studying in relatively low-level courses.   It was a quite extraordinary degree of ignorance in someone holding forth so confidently on the undoubted gains New Zealand would see from the large immigration flows.   I don’t expect the chief economist of the OECD to be across all the details of New Zealand (a rather small and minor member of the OECD), but if she isn’t, she shouldn’t be holding forth with such breezy confidence on such a major issue of New Zealand economic policy and economic performance.  Instead, she seemed to have a doctrine, and patched together something that superficially appeared to make the data fit the doctrine.

It went on, because she attempted to explain away why our real wage inflation had been less than that of the US or the euro-area in the couple of decades prior to the recession.  It was, she claimed, because the historical US numbers were (somehow –  it wasn’t made clear how) biased upwards, and the New Zealand numbers were biased downwards.  Perhaps, but it was a new claim on me, and not one for which there was a shred of evidence produced.

It was an astonishing performance.  She then invited the OECD’s desk officer for New Zealand to add any comments.  I felt a little sorry for him – especially as he was an old friend of mine.    He noted that the actual slowdown in real per capita GDP growth the OECD was picking  for this year and next was mostly to do with them using the expenditure measure of GDP, and the gap that had opened up between the expenditure and production measures (ie just technical stuff).  He certainly wasn’t running an immigration story for that, as Mann had attempted to do.

He (who knows my story reasonably well) went bravely on attempting to address my question about how this optimism about the economic effects of immigration fitted against the backdrop of the last 30 years.  But it was clear that neither he, nor the institution, had any sort of narrative explanation that would even begin to fit the bill.  He seemed reduced to quoting the recent IMF cross-country empirical piece on immigration.  As he noted, in that sample (which included New Zealand as one of 14 countries), immigration did appear to have boosted per capita GDP.   But, as I pointed out in a post when the work was published even if that result was true on average for all the countries in the sample, there was no reason to be confident it had been so over this period for New Zealand (since these are average results).  More importantly, perhaps, the same study actually found negative effects (although not statistically significant) of immigration on both labour productivity and total factor productivity –  again, on average across this sample of countries.

I’ve seen quite a few leading international economic agency senior officials in my time.  This was one of the worst performances from such a senior person I’ve ever seen.   She may well have been quite good in her own area –  international economics –  and in fact I went along mostly because she had a very good academic reputation, and had performed well when I’d seen her previously.  But when she lapsed into advocacy and cheerleading for New Zealand’s immigration policy, without getting fully familiar with a credible story that fits the New Zealand data and experience, she probably did herself, and the cause, more harm than good.

[UPDATE: For anyone interested, her presentation slides –  including the charts I tried above to describe – are here. ]