Product market regulation

February 11, 2020February 12, 2020 Michael Reddell New Zealand economic performance, Regulation

Writing yesterday about the Productivity Commission’s draft report on why firms don’t invest more (in “technology”), prompted me to take a look at the OECD’s Product Market Regulation (PMR) indicators. In the OECD’s own words

The economy-wide PMR indicators measure the regulatory barriers to firm entry and competition in a broad range of key policy areas, ranging from licensing and public procurement, to governance of SOEs, price controls, evaluation of new and existing regulations, and foreign trade.

There is both a summary economywide indicator (the focus here) and a range of detailed component indicators and sectoral indicators. As always with cross-country attempts to assess policy, the indicator(s) won’t be perfect, but such indicators can still shed some light on differences across advanced economies and across time – the OECD has published the data every five years starting in 1998.

Here are rankings for 1998. (On this measure, the lower the score the less burdensome -or whatever your descriptor – the product market regulation is.)

PMR 1998

In the wake of those numbers, when people talked about the productivity performance in New Zealand you’d often here something like “well, our business regulation is less burdensome than almost anywhere in the OECD” so (among the optimists) gains will follow or (among those less sanguine) whatever the big issues are they seem unlikely to be those relating to product market regulation. A few years on we were still 2nd (in 2003) or 3rd (in 2008).

But by 2013 we were only ranked fifth. Perhaps not disastrous, but some slippage evident. And here are the 2018 numbers, fairly newly released (data for two countries still not there) assessing things as they stood on 1 January 2018.

pmr 2018

That is now a pretty unambiguous drop back in the rankings. And three former Communist countries now beat us, with another two just slightly behind.

And it isn’t as if New Zealand has just been improving a bit more slowly than the rest of the OECD. Here is the absolute score for New Zealand and for the median OECD country (no material differences if I used just the subset of countries for which there is a score on all five dates).

PMR 3

We’ve gone backwards, in absolute terms, since 2008.

I get quite a few comments whenever I write about productivity, suggesting that the web of regulation has been more constraining and all-encompassing over the years. I have a fair amount of sympathy with many of those comments, even while doubting that such regulations will explain much of our poor productivity performance. But in the PMR indicator we score poorly in a quite different area of government involvement.

The OECD publishes the data broken out into two “high-level indicators”. One is “Barriers to domestic and foreign entry” and the other is “Distortions induced by [direct] state involvement. Here is how we did in 2018 on the first of those.

PMR 4

Not too bad I suppose – 5th equal, and very close to the couple of countries just above us.

But here is the other high-level indicator

PMR 5

In turn, there are four sub-components to public ownership bit of this high-level series, and on each of them we score less well than the median OECD country.

PMR 6

On the “involvement in business operations” sub-components of the “distortions induced by [direct] state involvement high-level indicator we are the OECD median on one, and do a little than the median on the other two.

Of the other sub-components in the overall indicator, there were six where New Zealand scored materially differently than the median OECD country: three better, three worse. Of the “worse” ones, only six countries score worse than New Zealand, and on the FDI one (and I know the interpretation is contentious) we score worst of all: none look like the sorts of areas a small economy, with persistent current deficits, should aim to score poorly.

New Zealand Worse

Assessment of impact of regulations on competition

Complexity of regulatory procedures

Barriers to FDI

New Zealand Better

Admin requirements on new companies

Barriers in service sectors

Treatment of foreign suppliers

One could go playing around in the relevant spreadsheets (economywide, and the additional sectoral ones) at great length. Perhaps I will come to them in another post next week.

One can also debate just how much regulatory and state intervention poor scores really matter in terms of overall economic performance. It is no doubt easy to point to any of the sub-components and find some highly successful country scoring poorly. But when you are starting as far behind the leaders as New Zealand now is, then even if regulation and state control issues – of the sort captured here – aren’t the key factors, if we are serious about improving productivity we should be doing whatever we can wherever we can to provide a more facilitative climate for firms to prosper on their merits.

UPDATE: An OECD economist, in comments below, has helpfully drawn my attention to some methodological changes in the 2018 PMR which mean that scores cannot be compared (reliably) across time (the 1998 to 2013 ones should work, but there is a discontinuity to 2018). I think her comments leave most of this post looking okay (the relative rankings should still be meaningful, and the identification of where we now do poorly) but one should be a little cautious about the time series chart (noting, however, that the trends I was highlighting were already apparent by 2013).

Contemplating trade restrictions and industry protection

July 23, 2019July 24, 2019 Michael Reddell Australia, Regulation, Trade

I’m just back from a family holiday in sunny south-east Queensland. Being a New Zealander, I have a visceral fear of snakes, but as we saw them only in the zoo, one could concentrate on the upsides of Australia. Seriously good newspapers for example. Daily surf swims in the middle of July. Plastic bags in plenty of shops (Queensland seems to have outlawed – the very useful – thin supermarket bags but not others). And, of course, one could look around, and read the papers, and contemplate what productivity and higher material living standards really mean. It was a while since I’d been in Brisbane, and the central city certainly had a look and feel more prosperous than what one finds in Auckland (or Wellington).

At the turn of the century, GDP per hour worked (PPP terms) was about 31 per cent higher in Australia than in New Zealand, and on the latest OECD estimates than gap is now 41 per cent. And it isn’t as if Australia itself is some stellar productivity performer. (Those with longish memories may recall a time barely 10 years ago when there was serious political talk of closing the economic gaps with Australia, but – as a result of policy choices of both National and Labour governments – the gaps have just widened.)

I couldn’t see state-level GDP per hour worked data for Australia, but there is GDP per capita data. The gaps between New Zealand and Australia aren’t as large for per capita income as for labour productivity, simply reflecting the longer hours the typical New Zealanders engages in paid work over their lifetime. For Australia as a whole, GDP per capita (PPP) terms is “only” 34 per cent higher than in New Zealand. In Queensland – with below average state GDP per capita – that gap is “only” about 25 per cent. Even a 25 per cent difference purchases a lot of (say) cancer drugs, new cars of whatever other public or private goods and services people aspire to. I’m sure the Australian health system has its problems, but I was struck reading three papers a day over 10 days not to see stories about health underfunding. And yet the (various levels of ) Australian governments spend a smaller share of GDP (35 per cent) than New Zealand governments do (38 per cent).

So there was sun, surf, papers, productivity in Queensland. And there was another thing I always look out for abroad.

trout 2

I prefer fresh but the little supermarket near where we were staying “only” had smoked. Not, in this case, the Australian product but (so I was surprised to notice when opening the packet) Norwegian.

trout 3.jpeg

The wonders of a global market and all that. But just not in New Zealand.

There are, of course, plenty of trout in New Zealand – all descendants of trout introduced in the 19th century (it isn’t exactly a native species). In fact, some of the trout species in Australia was introduced from New Zealand.

But if there are lots of trout in New Zealand, the only way you can consume any is to go and catch one yourself, or make friends with someone who fishes for them and who will gift a trout to you. It is as if I could only consume milk if I owned a cow or had someone close by who would give me milk. Perhaps the first half of that sentence did describe much of the world prior to the 20th century, but even then the sale of milk wasn’t banned. But the New Zealand government has for decades now banned the sale of wild trout.

When I went looking, I discovered that the sale of other trout isn’t outlawed in New Zealand, but as a recent regulatory impact statement prepared by the Department of Conservation put it.

The sale of trout (except for wild trout) is allowed in New Zealand. The reason it is not available for sale is because there is no way to obtain trout to sell – trout farming, selling wild trout, and importing trout are all prevented by legislation or the CIPO.

(that’s a customs import prohibition order). The prohibition extends to smoked trout. Here is the latest version of the restriction, just renewed a few months ago.

Read literally, clause 4(1)(b) appears to suggest that the imports for sale are only prohibited if they are for amounts of less than 10 kgs.

trout 4.png

That can’t have been what was intended, but it appears to be what the law says. [UPDATE: I misread it.]

There was a policy process undertaken last year that led up to the government’s decision to renew the import ban. It was weird policy process, described thus

There has been no public consultation on the options covered by this paper. The views of the various interest groups are well known to officials, but there may be Treaty implications if a firm decision was taken without formal consultation with iwi. The nature of the issues mean that a decision has to be made as to which set of interests should be given precedence.

Officials – of course – consider they know all that needs to be known. And quite Treaty issues arise in respect of foreign trade in a species itself introduced to New Zealand is beyond me – but fortunately I’m no longer a public servant.

Of the official agencies that were consulted, MFAT actually favoured allowing the import restriction to lapse. I’m not usually a fan of MFAT – and had Beijing objected for some reason, no doubt they’d have taken the other side – but well done them on this one. It isn’t a good look when New Zealand prattles on about open trade, rules-based orders, when it maintains in place a near-absolute prohibition of the importation of an innocuous, but tasty, food product.

I guess no one looks to the Department of Conservation for high quality and rigorous policy analysis, especially on economic issues. Their RIS on the trout CIPO did nothing but reinforce those doubts.

The entire official case for the prohibition of imports of trout (and, by implication, for continuing restrictions on domestic trout farming – although that isn’t the focus of this particular policy process) appears to rest on supporting the recreational trout fishing industry.

22. The import prohibition and the prohibition on the farming of trout are aimed at protecting the New Zealand wild trout fishery.

Like, for example, banning deer farming to protect hunting of deer in the bush? Or pig farming? Or salmon farming?

The officials even acknowledge that (for example) allowing the sale of salmon has not led to widespread salmon poaching, and that other countries successfully manage to have wild trout fishing and trout sales. But, they plaintively suggest, New Zealand is somehow different. For example

If imported trout could be sold, the illegal sale of wild trout would be much more difficult and costly to detect.

Which is, of course, not an argument for maintaining the existing restrictions but for removing both import and domestic sales (and farming) restrictions, not continuing to run industry assistance to a small tourism sector – somewhat akin to the protection that used to be offered to the New Zealand car assembly industry or the New Zealand television assembly industry. You get the impression reading the document that the DOC officials have simply got all too close to their mates in Taupo, and are subject to regulatory capture.

The documents contains this paragraph

42. The Government’s objectives in regard to the issues examined in this paper can be summarised as follows:
• Maximise recreational and tourism values of wild trout fishery
• Maximise employment and economic values of wild trout fishery
• Maximise economic growth and employment opportunities in the wider economy
• Provide for maximum consumer choice in purchasing decisions
• Minimise risk of friction in negotiations with trading partners.

These objectives are not referenced to any fuller document in which “the government” makes its case, and they have the feel of being made up on the fly with little or no supporting analysis. They go on to state

43. The interactions between these issues mean that it is not always possible to progress all of these objectives simultaneously. Actions that could advance some of the objectives may restrict progress on other objectives. Decisions on which objectives should be given precedence therefore need to be made by elected Ministers.

In a way, of course, that is true. If your goal is to maximise the size of the protected sub-industry, whether buttressed by direct subsidies (think film), import bans (trout), domestic production of a related product (trout farming ban) it will conflict with overarching goals about consumer choices and economic efficiency (as well as that lesser goal about living the words about a free and open economy with respect to trading partners). But, as in so many industries in the past, that tension should be resolved in favour of the consumer and of economic efficiency. In this case, it isn’t even clear that there really is much of a tension. DOC’s RIS offers not the slightest evidence that allowing imports of trout meat (smoked or otherwise), or even allowing domestic farming of trout, would make any difference whatever to the number of North American anglers who come to Taupo. Perhaps on the domestic side there might be a smaller number of trout fisherman…….in the same way that a much smaller proportion of us milk house cows, collect our own eggs, or whatever than we once used to. The only “value” really being protected here is that people who don’t go fishing shouldn’t be able to eat trout in New Zealand. If that is a values-based policy framework, it is a pretty weird one. Logically, one might apply the same daft policy to native fish too.

It is really quite shoddy advice, in support of shoddy policy. As one gets to the end of the RIS one gets the impression a reasonable number of government departments are beginning to conclude that the policy around trout is a nonsense and should eventually be revisited. But it isn’t clear that DoC is among them – then again, they are probably brought up to dislike all introduced species (may not even be too keen on people, disturbing that natural environment), and they simply aren’t the agency that should be responsible for an issue of industry protection policy and interfering with the ability of New Zealanders to easily consume a safe and lawful product.

There was petition last year seeking to introduce trout farming in New Zealand. Whether it gets anywhere, only time will tell, but it is hard to be optimistic when the current government extended the existing import ban again only last year. Perhaps New Zealand consumers will have to hope that foreign governments will take up the issue more seriously, and put more sustained pressure on the New Zealand government to remove the barriers between consumers and trout (more cheaply and efficiently than holidaying abroad).

Disclosing regulatory actions

July 9, 2019 Michael Reddell insurance, Regulation, Reserve Bank

I haven’t followed the CBL saga very closely at all. (Disclosure: until the end of 2014 I was a member of the Reserve Bank’s Financial System Oversight Committee, which advised the Governor on prudential policy matters, including insurance prudential supervision. That Committee rarely dealt with individual institution issues, but nonetheless was part of the overall atmosphere around the Bank’s approach to regulatory and supervisory issues.)

But the one aspect of the CBL story I had paid attention to was the decision by the Reserve Bank in 2017 to ban CBL from telling shareholders, policyholders (actual or prospective), or other creditors of the Bank’s regulatory actions and interventions (specific directions). It seems extraordinary to say that managers and directors of a company cannot tell their owners – the people they actually work for – about important developments affecting their (the owners’) company. It runs against most canons of what we understand about the importance of trust, or disclosure, and of the relationship between principals (owners) and agents (managers and directors).

I also haven’t yet read the full report the Reserve Bank commissioned on its handling of the CBL affair (and remain sceptical that a report commissioned by Bank management – and which apparently sought no outside perspectives – was likely to be even close to a definitive assessment). But I did turn to the short chapter 15 (from p136) on “Confidentiality and Disclosure”.

In that section, the reviewers outline the relevant parts of the legislation that the Reserve Bank was using, and was constrained by. They refer first to Section 135 of the Insurance (Prudential Supervision) Act covers the protection of data supplied to the Reserve Bank for prudential purposes. This provision is not actually very relevant here: it is mainly designed to ensure that the Bank – and Bank staff – can’t, by accident or intent, treat confidential information lightly. And even then, the Bank itself can choose to release material in a number of circumstances, including these two

(c) the publication or disclosure of the information, data, document, or forecast is for the purposes of, or in connection with, the performance or exercise of any function or power conferred by this Act or any other enactment; or

(e) the publication or disclosure of the information, data, document, or forecast is to any person that the Bank is satisfied has a proper interest in receiving the information, data, document, or forecast; or

Section 136 also allows the Bank to approve publication. And so stories that suggest that the Reserve Bank was not free to publish information about its concerns or its actions, under pain of potential heavy fines, are just not correct. The reviewers themselves run this quite misleading line.

The confidentiality obligation on the Bank is an onerous one. Officers and employees of the Bank, and investigators, are liable on conviction to up to three months’ imprisonment and/or a fine up to $200,000 if they do not comply with this provision.

Rogue or cavalier employees are (rightly) at risk. The Bank itself has considerable protections and freedom of action (again, largely rightly so).

The reviewers then turn to the (much more relevant) provisions around the disclosure of the giving of directives. In July 2017, the Bank issued to CBL Insurance a direction covering a variety of matters, operating under section 143 of the Act. Section 150 of the Act makes it an offence for anyone to disclose (other than to directors and advisers of the directed entity) that a direction has been given. Again, there are substantial fines for breaches. But, again, this provision of the Act did not constrain the Reserve Bank, because the Bank itself is free to disclose the existence of the direction, or to allow others to disclose the fact of the direction.

The Bank itself has subsequently sometimes sought to imply that really the confidentiality of the directions was CBL’s choice, arguing (factually correctly) that when in February 2018 CBL requested that the confidentiality restriction be lifted, the Bank agreed. But that looks a lot like distraction. It is clear that, whatever the views of CBL managers and directors, in July 2017 the Reserve Bank was insistent on keeping the fact and content of the direction confidential. It acknowledged as much in a response to an OIA request from NBR in April 2018.

The Reserve Bank’s self-chosen reviewers (the one with some expertise in the field being a former Australian insurance regulator) backed the Reserve Bank’s call on this point.

It was appropriate to maintain confidentiality over these steps. Matters were at a fact-finding stage. The Bank had serious concerns that warranted action, but it had not yet gathered the relevant information, tested it with CBL, and arrived at a sufficiently informed position. Obviously public disclosure of the fact of an investigation or initial concerns that have not yet been tested would be highly damaging to the reputation of CBL and to the value of its parent.

Except that by this time matters don’t seem to have been just at the fact-finding stage. Rather, the direction imposed specific restrictions on CBL Insurance’s business – the sort of action the Reserve Bank never engages in lightly (and, as the rest of the report apparently elaborates, coming after several years of concerns and fact-finding).

The reviewers go on to defend the Reserve Bank, arguing

The primary reason for confidentiality is that the Bank, quite correctly, is cautious about releasing information on any licensed insurer (or licensed bank) that may affect public confidence in the licensed company until the Bank is sure of its position. The confidentiality requirement, however, creates a quandary for the boards of listed companies who have a continuous disclosure obligations under NZX rules/Corporations Act 2001 (AU) rules.

In the CBL case, the position is also confounded to some extent by the fact that CBL Insurance is a subsidiary of the listed entity, CBL Corporation, which itself is not licensed.

Given the risks to public confidence in a licensed insurer if the Bank is carrying out an investigation or otherwise querying the credentials of an insurer before anything is proven, it is entirely appropriate for the Bank to maintain confidentiality by not making any public disclosures itself and also exerting control over any potential disclosures by the insurer.

Expressed another way, it is important that the Bank retain the power to intervene at any time in the affairs of an insurer. The Bank has to be able to recognise and choose to act early on any potential risk issue that it identifies and it also has to be able to stand back, without adversely affecting public confidence in the insurer, if the potential risk is not realised.

Before concluding

The Bank’s actions in relation to confidentiality and disclosure in 2017–2018 were appropriate.

We do not consider there was any earlier occasion when it would have been appropriate for the Bank to make public disclosures.

The lack of disclosure at the time of interim liquidation can be said to have been awkward for shareholders because, with no prior disclosure by the Bank or CBL, they were deprived of information that they may well have judged to be relevant to their position as investors. Arguably it was also awkward for policyholders, but that is a secondary matter in the eyes of investors.

On that point we note that CBL Corporation issued two relevant press releases in August 2017. In the first, on 18 August 2017, it disclosed concerns by the Gibraltar FSC over Elite’s claims reserves, the Gibraltar FSC’s reference to possible inadequacy of CBL’s claims reserves, and announced a reserve adjustment. The CBL Corporation share price reacted at the time, falling some 30%, but a week later there was a second press release that promoted the company’s prospects and gave a purported explanation for the claims reserving adjustment. The share price recovered by around 10% and then remained more or less static until suspension of trading in February 2018.

It is the policyholders, however, to whom the Bank owes its responsibility, not the investors. The Bank’s essential prudential concern always must be that policyholder promises can be honoured, irrespective of the fate or views or fortunes of shareholders.

I’m not entirely persuaded, on a number of counts. And I say that even though it is quite plausible that the way the Reserve Bank handled this specific aspect of the affair (non-disclosure) might have been in accord with common supervisory practice.

Here it is worth having a look at some of the specifics of the New Zealand act. For example, the purpose provisions in the legislation

IPSA 1

When this legislation was being planned I argued that only the first strand should be included, and recall arguing explicitly that having “promote public confidence in the insurance sector” could, at some future date, be used to defend keeping real problems secret, in ways that might support short-term confidence, but would risk undermining long-term confidence in the sector and in the regulation/supervision of the sector. That seems like a valid concern. But even with that provision in the legislation, it provides no clear guidance on whether specific regulatory interventions should be kept secret, since the goal is not to protect individual firms, but with a sectoral focus. And if one believes in the efficacy of supervision – I tend to be sceptical – knowing that the regulator is (a) on the ball, and (b) not hiding stuff, is most likely to support a sound and efficient sector over time, and support public confidence in the bits of the sector where such confidence is warranted.

The Act next has a long laundry list of “principles” – no hierarchy, no weighting, no nothing (the sort of list Paul Tucker, in his book on delegated power, including to central banks, frowned on).

IPSA 2.png

But they are still worth mentioning because, contrary to what the reviewers imply, the New Zealand framework is not exclusively built around policyholder protection; indeed, even the one bullet that explicitly mentions policyholders puts the “public interest” as of equal importance. As importantly, look down a couple of rows and you find another principle: “the desirability of providing to the public adequate information to enable members of the public to make those decisions” (ie regarding insurance), which might argue for as much transparency as possible. In short, you could pick any approach you like out of these purposes and principles (which makes it bad legislation from a citizen perspective – albeit beloved by officials), and none of these specific considerations are discussed by the reviewers in considering the disclosure/confidentiality issues around CBL. At least from the wider public perspective, that was a missed opportunity.

It is worth bearing in mind that as a society we have generally come to favour the continuous disclosure approach various stock exchanges have now adopted. Inside information is supposed to be kept to an absolute minimum, with owners being presumed to be entitled to know of any material developments affecting their companies. Shareholders provide the capital than underpins the provision of services and markets, including those in insurance. Continuous disclosure provisions typically have a carve-out where disclosure is prevented by law, and that is what the parent of CBL Insurance relied on in this case (that NBR OIA I linked to earlier has the text of email exchanges with CBL’s lawyers on non-disclosure to the market). In this case, there was no automatic protection for information about the Reserve Bank’s direction – which was highly relevant to shareholders, and others dealing with the company and its associates – since the Reserve Bank had full discretion to allow the fact of the direction to be disclosed (an option it explicitly rejected in an email dated 22 August 2018).

In this case, it may well have suited both the Reserve Bank and CBL managers/directors to keep the directions confidential, but their interests are not necessarily representative of either the public interest, or of the specific interests of the owners of CBL, or those dealing with the company. It isn’t even clear that their preferences aligned with the interests of policyholders, here or abroad: rather it is a paternalistic approach that says that the supervisor is better placed to look out for the interests of policyholders than are (actual or potential) policyholders themselves. The evidence for that proposition seems slim – including, in this particular case, based on what we read of the Bank’s handling of CBL over several years.

There are no easy or straightforward answers to these issues, which is why it would be valuable to have a fuller, and more open, exploration of the issues. In principle, I believe it would be better – including reducing the risk of the supervisory being morally liable for any later losses in a failure event – for the default presumption to be that any use of formal direction (or similar) powers by a prudential regulator should be disclosed by that regulator, and should be subject to usual continuous disclosure provisions in the case of listed entities. The alternative both corrodes public trust in regulatory agencies – what are they up to that we don’t know about? – and corrodes the trust that needs to exist, and be robustly nurtured, between managers/directors and owners and creditors of private business entities

But there are risks to adopting this approach. The ones I’m concerned about – at least in the insurance sector – aren’t some sort of market panic (runs on insurance companies don’t have the meaning they do for banks). The share price of a listed entity might fall sharply – but that seems an appropriate possibility – and people might become more reluctant to deal with the firm (ditto, at least until after hard questions have been adequately answered). My concern is more that disclosure might make the supervisory entity more reluctant to act when it should, and more reliant on moving into the non-legal shadows, relying on pressure and threats of direction. Perhaps too we would risk seeing courts more actively involved as the regulated entity sought injunctions to stop a supervisor using directive powers? Those are real risks that need debating, but they should not be conclusive arguments, especially when the alternative involves the regulator and managers/directors getting together to keep highly valuable information from shareholders (whose money is mostly at stake), policyholders, prospective policyholders, and other creditors.

My interests are really less on the specific CBL case – although specific cases help focus attention – than on thinking about potential problems with banks at some future date. There are very similar powers in the Reserve Bank Act re the confidentiality of directions to banks, and the issues get even more complicated because (a) bank runs are a real issue, (b) our bank supervision legislation does not have a depositor protection focus, (c) the disclosure regime has been designed to encourage creditors to take responsibility for themselves, (d) the proposed deposit insurance regime is very limited in scale, and (e) most of our banks are subsidiaries of foreign listed entities (can the Reserve Bank enforce directions on Australian parents?). My own prior is that the world’s banking regulators do not have such a stellar record that we should be entrusting them with such powers of coerced silence, preventing companies telling their shareholders and creditors etc that they are subject to directions from the regulatory authority. Perhaps the best thing might be more directions, made public at the time they are given as a matter of routine, so that markets, media, and the public can learn to weigh and evaluate the significance or otherwise of the issues and risks the regulator is highlighting.

I’m sure mine is a minority position, and I’m putting the issue out there as much as anything to try to encourage some reflection and debate on the issues. In reality, perhaps the issues are not be black and white (in general – although each specific involves final decisions), but regulators need to demonstrate that they have earned the trust, and extensive powers, reposed in them. And our laws, and the applications of them, should be framed against principles of open government, accountability for regulatory agencies, and a belief that – within government and within firms – sunlight is typically the best disinfectant.

On which note, it is now the school holidays and we are heading off to find some sunshine and warmth. Most likely there won’t be another post here until 23 July.

Fit and proper?

February 27, 2019March 6, 2019 Michael Reddell Banking, China, Regulation

Should Jenny Shipley be on the board (actually chairing it) of the local arm of China Construction Bank? A question primarily, you might have thought, for the owners (CCB in China), perhaps taking account of the views and behaviour of the bank’s customers and investors. I’d be pretty hesitant about putting my money in a bank (or any other company) that had as the Board chair someone against whom there was the sort of civil judgement that was delivered yesterday by the High Court in the Mainzeal case. But I’m not, so I don’t really have a strong view on the matter. And I might be as worried about having a former primary school teacher with no particular expertise in banking, and no reputation for being willing to ask awkward questions and follow through, as chair of the Board of any bank I had money in.

The Reserve Bank doesn’t have the luxury.

And here I’m going to rerun much of an old post on the matter of “fit and proper” rules.

Under Reserve Bank rules (outlined here):

no appointment of any director, chief executive officer, or executive who reports to, or is accountable directly to, the chief executive officer, may be made in respect of the registered bank, and no person may be appointed as chairperson of the board of the bank, unless the Reserve Bank has been supplied with a copy of the curriculum vitae of the proposed appointee and has advised that it has no objection to that appointment.

“Fit and proper” requirements are pretty common internationally. But citizens should reasonably ask “to what end, and with what evidence that the requirements make a useful difference?”

The Reserve Bank’s prudential regulatory powers have to be used to promote the soundness and efficiency of the financial system (sec 68 of the Act). The focus of the suitability (“fit and proper”) tests is presumably on the soundness limb of that provision. Prior Reserve Bank “non-approval” must be expected to reduce the threat to the soundness of the financial system (not just the individual institution, but the system itself). How might it do that? The Reserve Bank says it focuses on integrity, skills and experience.

At the (deliberately absurd) extreme, if the Reserve Bank were blessed with the divine quality of omniscience, they could see into the soul of each potential appointee, and discern accurately how those individuals would respond to the sorts of threats, risks, shocks ,and opportunities they would face while serving with a New Zealand registered bank. No one prone to deceive under stress, to breach internal risk limits, or to take “excessive” risk would get appointed. That sort of insight would be very helpful. But it isn’t on offer.

Instead, the Reserve Bank’s document suggests a backward-looking focus – checking out past appointments, past criminal convictions, and the like. All of which is fine, but all of that information is known (or knowable) to those at registered bank concerned who are making the appointment. And most of the stuff that is really interesting, and telling, is likely to be about character. That isn’t knowable in advance, and certainly not by Reserve Bank officials. What expertise do Bank economists and lawyers – many very able people – have in second-guessing the judgement of the banks themselves in making such appointments? And what incentive do they have to get it right? The model looks like one that favours the appointment of grey colourless accountants and lawyers, who have not yet blotted their copybooks – perhaps never having taken any risk – with a bias against anyone who has learned banking, and what it is to lose shareholders’ money, the hard way.

Banking regulators worry about the risks to depositors and taxpayers if widespread or large banking failures occur. But the first people to lose money as a result of mistakes, misjudgements, or worse are usually the shareholders in the bank concerned. They might reasonably be assumed to have more at stake from bad appointments of directors or senior managers than central bank regulatory officials do. New Zealand has in place pretty demanding bank capital requirements.

No doubt there will be people (and perhaps there already have been) who were employed by failed finance companies coming up for Reserve Bank approval in the next few years. In some cases, those people will have had no responsibility for the failure, and in others there may have been some culpability. But business failures happen, and they aren’t always a bad thing (indeed, unlike some systems, our banking regulatory system is explicitly designed not to avoid all failures). Why is the Reserve Bank better placed than the registered bank concerned to reach a judgement on whether any previous involvement with a failed finance company should disqualify someone from a future senior position in a bank (or other regulated financial institution)?

In a similar vein, I wonder if the Reserve Bank has done a retrospective exercise and asked itself how likely it is that, with the information available at the time, it would have rejected any (or any reasonable number) of those responsible for the 1980s failures of the DFC and the BNZ. Done in a suitably sceptical way, it would be an interesting exercise

I’m not suggesting there be no rules at all. Perhaps conviction for an offence involving dishonesty in the previous [10] years should be an automatic basis for disqualification from such senior positions? It wouldn’t be a perfect test, but it is certain and predictable, and probably better than a “we don’t like the cut of your jib” sort of discretionary judgement exercised by regulatory officials. It doesn’t hold the false promise of regulators being able to sift out in advance people who might, in the wrong circumstances, later be partly responsible for a bank failure.

Perhaps too there might be a requirement that a summary CV for each director and key officer be shown on the registered bank’s website. Those summary CVs might be required to list all previous employers or directorships.

But the current fit and proper tests seem to be an additional compliance cost, for no obvious public policy benefit. It has the feel of something they feel the need to be seen to be doing, to be a “proper supervisor”, and get ticks in the right boxes when the next IMF FSAP comes through, rather than something where there is evidence that the rules have advanced financial system soundness in New Zealand.

Provisions of this sort cost money, both to banks to comply with and to taxpayers to administer the provisions, and impede business flexibility. Individually, the amounts involved and the degrees of inconvenience, are probably not large, but the old line remains true “take care of the pennies and the pounds will take care of themselves”. There should be a general presumption against regulatory burdens – particularly where they impinge directly on the lives and professional careers of individuals – and an onus on the regulators to show that their provisions are making a material net difference to worthwhile public policy objectives.

2019 here again:

I can’t see that the Reserve Bank will have any choice but to indicate to CCB that they would object to the contined presence of Jenny Shipley on the Board. The Mainzeal case involved the failure of a substantial institution while Shipley was chair of that Board, and not because of some unforeseeable shocks out of the blue, but because of actions and choices that the Board had control over. The record suggests, apparently, that Shipley had expressed some unease on the Board. That’s good, but of little or no value to anyone if it changed nothing, and she then did nothing further.

Of course, there is almost no chance the local CCB is going to collapse – any problems are much more likely to be group ones, over which the local board will have no control. But rules are rules, and how could the Bank’s fit and proper regime have any residual credibility if Shipley remains chair of the New Zealand registered, Reserve Bank supervised, bank’s board? And this isn’t a time for pleasantries. Whether or not she stands aside voluntarily, or the owners remove her, the Reserve Bank should make clear that her continued presence on the Board (let alone chairing it) would not be acceptable to the Reserve Bank.

One could, of course, argue that no CCB New Zealand problems have become apparent on Shipley’s watch. I presume that is true, but it is also irrelevant. Since (see above) the regime has no way of knowing who will turn out to be a dud as a director, it can really only exercise condign discipline after the event. And I don’t think there is really a case for waiting for any appeals either. The judgement has been delivered. Perhaps a higher court will interpret the law differently, but there seems to be less dispute about the facts than about the legal implications, and frankly whether or not the directors are finally held financially liable, if a fit and proper regime is to mean anything it has to mean holding people to a higher standard, as bank directors, than is evident in the record at Mainzeal.

As I say, it shouldn’t be a matter for the Reserve Bank. There is so much high profile coverage of this case that no one can seriously claim to be unaware, and if Shipley’s presence bothered them, they can bank elsewhere. If enough people are bothered enough, the self-interest of the owners will resolve the situation. It shouldn’t be the Reserve Bank’s business, but it is. They need to be seen to act pretty quickly.

As for Shipley’s membership of the executive board of the China Council……surely that tawdry taxpayer-funded body that sticks up for Beijing at every turn, has Jian Yang on its advisory board, defends Huawei, and won’t stick up for Anne-Marie Brady is just the place for her? Then again, if the government doesn’t want the last vestiges of any credibility its propaganda body still has to be in shreds, they should probably remove her too. But that was probably so anyway after all those pro-Beijing words she gave to the People’s Daily in December. Effective propaganda can’t be too overt.

The tree god again

December 19, 2018December 20, 2018 Michael Reddell Adrian Orr, Banking, Financial stabilty, Regulation, Uncategorized

Some months ago the Governor of the Reserve Bank inaugurated his audacious bid to have his institution – seen by most as a official agency created by, and accountable to, Parliament – seen as some sort of local pagan tree god, with him (I assume) as the high priest in the cult of Tane Mahuta. We’ve been told, by the Governor, that a people – New Zealanders – walked in economic darkness until finally the light dawned with the creation of the Reserve Bank. It is pretty absurd stuff, not even backed by decent history or analysis, and one might be inclined just to ignore it, but the Governor seems serious. In particular, he keeps returning to his claim. In fact, he was at it again – claiming the mantle of Tane Mahuta – yesterday with another little release that poses more questions than it offers answers (and which presumably means we’ll end the year still with no substantive speech from the Governor on anything he actually has statutory responsibility for).

Readers might recall that there was a damning report on the Reserve Bank as financial regulator, drawing on survey results of regulated institutions, released in April by the New Zealand Initiative. This chart summed it up quite well

partridge 1

It has, presumably, been a priority for the Governor to improve the situation. After all, even the Bank’s Board – always reluctant to ever suggest any weaknesses at the Bank, even though their sole role is monitoring and accountability – was moved to comment on this report, and the issues it raises, in their Annual Report this year.

And thus the Governor begins

In a step toward achieving the best “regulator-regulated” relationships possible, the Reserve Bank (Te Pūtea Matua) has established a Relationship Charter for working effectively with banks. The Charter will also be discussed with insurers and non-bank deposit takers in the near future.

One might question just how “best” is to be defined here – after all, the public interest is not the same as that of either the Reserve Bank or of the banks, and there have been many examples globally of all too-comfortable relationships between regulators and the regulated.

But it was the next paragraph that started to get interesting.

Reserve Bank Governor Adrian Orr said the Relationship Charter commits the Bank and the financial sector to a mutual understanding of appropriate conduct and culture. “This is underpinned by the principle ‘te hunga tiaki’, the combined stewardship of an efficient system for the benefit of all,” Mr Orr said.

I’m not sure that understanding is necesssarily advanced when an institution operating in English introduces little-known phrases from another language to their press releases. Here is how Te Ara explains “te hunga tiaki”

Te hunga tiaki

The Te Arawa tribes use the term ‘te hunga tiaki’ instead of kaitiaki, explains Huhana Mihinui.

The prefix ‘hunga’ is more common than ‘kai’ amongst Te Arawa, hence te hunga tiaki rather than kaitiaki. The essence of hunga is a group with common purpose. Hunga may also link with the sense of communal responsibilities. The same meaning is not conveyed with ‘kai’ … te hunga tiaki likewise invokes ideas of obligations to offer hospitality, but also to manage and protect, with the implicit recognition of the group’s mana whenua [customary authority over a traditional territory] role in this respect. ¹

Which sounds pretty problematic frankly. Banks and the Reserve Bank do not have a common purpose or a common set of responsibilities. The Reserve Bank has legal responsibilities to the people of New Zealand, and the banks have legal responsibilities to their shareholders. The two won’t always be inconsistent, but at times they will and there is little gained (and some things risked) from trying to pretend otherwise. In both cases – but particularly in that of the Reserve Bank – there are limits on the ability of the principals (citizens and shareholders) to ensure that the boards and/or managers are actually operating according to those responsibilities. Shareholders can sell. Citizens are stuck with the Governor.

The statement goes on

“Writing it was the easy part. Operating consistently with the conduct principles is the challenge. We will regularly mutually review behaviours with the industry. Appropriate conduct is critical to the trust and wellbeing of New Zealand’s financial system, and the Reserve Bank – the ‘Tane Mahuta’ of the financial garden,” Mr Orr said.

It is the tree god again – a tree god that has some considerable way to go in improving its own conduct, be it around attempting to silence critics or whatever.

But this is also where I started to get puzzled. In both those last two paragraphs from the statement, there is a suggestion that this document is some sort of agreed position between the banks and the Reserve Bank. It is there in the charter document itself – a one pager, complete with cartoonish tree god characters.

RBNZ-Relationships-Charter

(What I didn’t see was, for example, “we will avoid abusing our office and putting pressure on regulated bank CEOs to silence their economists when those economists write things we don’t like”.)

The word “mutual” is there twice, clearly suggesting that the banks have signed on to this.

But, if so, isn’t it a little strange that there are no quotes from any bankers, or the Bankers’ Association, in the press release, just the Governor’s own spin? And when I checked the Bankers’ Association website, there was no statement from them. In fact, I checked the websites of all the big four banks and there was not a comment or statement from any of them. Frankly, it doesn’t seem very “mutual”. It looks a lot like gubernatorial spin.

And, to be frank, I don’t really see any good reason why there should be such mutual commitments. Regulated entities don’t owe anything to the regulators. They may often be intimidated by them, (privately) derisive of them, or even respect them. But the regulated entities are just private bodies trying to go about their business in a competitive market. By contrast, the Reserve Bank – the Governor personally – carries a great deal of power over those entities, and they have few formal remedies against the abuse of that power. What might reasonably be expected is unilateral commitments by the Governor as to how his organisations will operate in its dealings with regulated entities, standards (ideally measurable ones) that they and we can use to hold the regulator to account. But that is different from what purports to be on offer in yesterday’s statement.

Of the brief specifics in the list of commitments, I don’t have too much to say. There is a big element of “motherhood and apple pie” to them, and a few notable elements missing. There is nothing about analytical rigour, nothing about transparency, nothing about remembering that the Bank’s responsibility is primarily to the New Zealand public, nothing about maintaining appropriate distance between the regulator and the regulated. But I guess those would have been inconsistent with the fallacious claims about all being in it together and working for common goals.

It is at about this point that the Bank’s press release changes tone quite noticeably (not quite sure what happened to “one organisation, one message, one tone”). Deputy Governor Geoff Bascand takes over and claims

Deputy Governor Geoff Bascand said the Reserve Bank’s recent announcement of a consultation with banks about the appropriate level of bank capital highlights the usefulness of the Relationship Charter.

And even in that one sentence he captures some of the mindset risks. As I read the announcement the other day, it was a public consultation about the appropriate level of bank capital, and yet the Deputy Governor presents it as a “consultation with banks”. If the Bank is going to run with this “Relationship Charter” notion, perhaps they could consider one for their relationship with the only people who give them legitimacy, Parliament and the public (having said that, perhaps I should be careful what I wish for).

And then weirdly – in a press release supposed to highlight a new era of comity, open-mindedness etc – the Deputy Governor launches into an argumentative spiel about the proposed new capital requirements.

“There is a natural conflict of interest. Banks will want to hold lower levels of capital to maximise returns for their shareholders. However, customers and society wear the full economic and social cost of a bank failure. We represent society’s interests and will naturally insist on higher capital holdings than any one individual shareholder,” Mr Bascand said.

Strange use of the phrase “conflict of interest”, which usually relates to a person or an organisation having two competing loyalties (perhaps personal and institutional), but even if one sets that point to one side for now, the rest is all rather one-dimensional and not terribly compelling. He seems unaware, for example, that banks often hold capital well above regulatory minima – creditors and rating agencies have perspectives too – or that in most industries firms happily determine their own levels of capital, and somehow society manages (and prospers). And, of course, there is not an iota of recognition of the way in which bureaucrats all too often serve bureaucratic interests (rather than societal ones), of the distinction between loan losses and bank failures, or of how the interventions of official and ministers often create the problems in the first place.

And then there is the final paragraph

“Following our Relationship Charter, we long signalled the purpose of our work and shared our analysis and consultation timetable. We have also committed significant time to engage with banks and provide a sensible transition period to make any changes we decide on. The Charter means what we are looking to achieve can be discussed professionally, while we continue to build appropriate working relationships. Outcomes will be superior and better understood and owned by society,” Mr Bascand said.

Of course, for example, whether the proposed transition period is “sensible” is itself a matter for consultation (one would hope – and not just with banks). Given the high probability of a recession in the next five years – and the limited firepower here and abroad to deal with a severe recession – some might reasonably wonder at just how wise it would be to compel big increases in capital ratios over that five year period, at a time when the Bank’s own analysis repeatedly suggests the banks are sound with current capital levels. Credit availability might well be more than usually constrained.

One might go on to note that the level of disclosure in the consultative document is seriously inadequate for such a substantial intervention – one that would take New Zealand further away from the international mainstream not closer to it. As I noted in a post a few days ago, back in 2012 the Bank published a fuller cost-benefit analysis of the sorts of capital requirements that were then in place. There is nothing similar in the consultative document issued last week, not even (I gather) any engagement with the previous cost-benefit analysis. Given the amounts of money involved, that is simply unacceptable. I’ve lodged an Official Information Act request for the (any) modelling and analysis they’ve done, but I (and others) shouldn’t have needed to; it should have been released as a matter of course. In fact, even better they should have published a series of technical background papers over the year, held discussions with a range of interested parties (not just banks) before coming to the decisions they chose to formally consult on. That is what good regulatory process might have looked like.

And then there is that bold final claim

Outcomes will be superior and better understood and owned by society

I’m all for effective and professional relationships between the Reserve Bank and the banks it regulates. Perhaps that may even lead to better policy outcomes, but there is no guaranteee of that (after all, at the end of it all the law allows the Governor to make policy pretty much on a personal whim – which is a lot like what the proposed higher capital ratios feel like). But quite how a better relationship between the Reserve Bank and the banks will make outcomes “better understood and owned by society” is a complete mystery to me. There are plenty of examples of regulators and the regulated ganging up against the public interest, and others of the regulators ramming through changes that might – or might not – be in society’s interest. There is simply no easy mapping from a better relationship between the Bank and the banks, and good outcomes for society, let alone ones that – whatever it means – are “owned by society”. Good outcomes rely heavily on very good and searching analysis. And nothing in the Charter commits the Bank to that.

When one reads the argumentative second half of the press release it is little wonder the banks themselves wanted nothing to do with the statement. I guess there isn’t much chance of the banks and the Reserve Bank getting too close to each other in the coming months as they (and the bank parents and APRA no doubt too) fight over the billions of additional capital Adrian Orr thinks they should have.

Meanwhile, the Governor can play at tree gods. But it would be much better for everyone, including most notably citizens, if he were to engage openly and (in particular) more substantively on the issues he has legal responsibility for. Cartoons and glib statements don’t build confidence where it counts.

The Reserve Bank and financial regulation

January 17, 2018January 17, 2018 Michael Reddell Financial stability, Regulation, Reserve Bank Act reforms

Still working my way through the various articles and documents that turned up just before Christmas, I got to a lengthy issue of the Reserve Bank Bulletin, headed “Independence with acccountability: financial system regulation and the Reserve Bank”. It is, I suspect, designed to fend off calls for any significant reform.

The Bulletin speaks for the Bank, and although as I read through the article I noticed distinct authorial touches and tendencies, when all is boiled down the author was sent into the lists to make the case for how things are done now: powers, governance, and accountability. He does a pretty good job of presenting the party-line, against significant odds in many areas. Even where one disagrees with the Bank’s case, it is a useful and accessible addition, in part because the Bank’s powers and responsibilities in regulatory areas have grown like topsy over the years and are scattered across various pieces of legislation.

Much of the first half of the article is designed to make a case for an independent prudential regulator, by reference to the theory and to the writings of the Productivity Commission. But, for my tastes, it was far too broad-brush to add much value. Probably no one disputes that we want the rules applied fairly and impartially, with politicians largely kept out of the process. In the same way, we don’t want politicians deciding which person gets arrested and which not – we want an operationally independent Police for that – or who gets convicted – independent courts – or which airline passes safety standards and which not, and so on, so we don’t want politicians deciding to look favourably on one bank’s risk models and not on another’s. There are many independent regulatory agencies – or even government departments where the chief executive exercises responsibility in independently applying the rules – but to a very substantial extent they apply and administer the rules, while other people make the policy/rules.

The Reserve Bank wants to make the case that in its area the rules/policy shouldn’t be set by elected people (whether Parliament itself, or ministers by regulation), but by an independent agency, and that the same agency should both make and apply the rules (without any possibility of substantive appeal). It is the “administrative state” at its most ambitious – unelected officials (a single one at present, not even directly appointed by a Minister) are lawmakers, prosecutor, judge and jury (and quite possibly the equivalent of the Department of Corrections as well).

The Bank seeks to rest a lot on the notion of time-inconsistency, a notion from the academic literature that is sometimes used to try to explain the high inflation of the 60s and 70s, and to make the case for an independent central bank to make monetary policy. The idea is that even though one knows what is good in the long-run, the short-term benefits of departing from that strategy (and endless repeats of the short-term) mean that the long-term gains are never realised. The solution, so it was argued, was to remove the short-term management of the business cycle from politicians. I’m not particularly persuaded by the model as it applies to monetary policy (a topic for another day), and it is curious to see a central bank putting so much weight on that model after year upon year of inflation below target. But today’s topic is financial regulation and financial stability, where the Bank would have us believe it is desirable/important to have the rules themselves – the policy – set by someone other than politicians.

No doubt it is true that there can be some tension between the short and the long-term around financial stability. But that is surely so in almost every area of government life and public policy? Underspending on defence now frees up more resources for other things now, but one might severely regret doing so if an unexpected war happens later. Skimping on educational spending now won’t make much difference (adversely) to economic performance or the earnings of anyone (teachers aside I suppose) for a decade or two. Running big fiscal deficits now can offer some short-term benefits, but at the risk of heightened vulnerability etc a decade or two down the track. But in none of these areas do we outsource policymaking: they are political choices, and we then employ officials and public agencies to administer and deliver those choices. The Reserve Bank has, as far as I’m aware, never offered any explanation as to what makes their specific area of policy different. Sometimes they draw on academic authors writing about financial regulation, but many of those specialists fall into the same trap – they see their own field, but never stand back and think about how democratic societies organise themselves across a wide range of policy.

As it happens, the current system around the Reserve Bank and financial regulation is a bit ad hoc and inconsistent to say the least, a point that the article more or less acknowledges. Thus, for banks the Reserve Bank can vary the “conditions of registration” to change all sorts of big policy parameters, without any formal involvement from elected politicians at all (all the variants of LVR policy, from the first Wheeler whim were done this way). But even for banks rules around disclosure have to be done by Order-in-Council, and thus require ministerial approval. No one would write the law that way – such different regimes for two different aspects of bank regulation – if starting from scratch (the actual legislation has evolved since 1986).

For insurance companies, the Reserve Bank itself can issues solvency standards (effectively, capital requirements for insurers), but for non-bank deposit-takers capital rules (and other main prudential controls) can only be set by regulation, again requiring the involvement and approval of the Minister of Finance. (Incidentally, this is why LVR rules apply to banks but not non-bank deposit-takers: Wheeler could regulated banks directly, but couldn’t do the same for non-bank deposit-takers.

(And, as the Bank notes, it has “no direct role in developing rules associated with AMLCFT”, even though it administers and applies those rules for banks.)

At very least, there would appear to be a case for streamlining and standardising the procedures for setting the rules. It isn’t clear why the Reserve Bank Governor should have almost a free hand when it comes to banks, but such limited scope to set policy when it comes to non-bank deposit-takers. And, if anything, the case for ministerial involvement in settting the rules for banks is greater than that for the other types of institutions because (as the Bank acknowledges) bailouts and recessions associated with financial crises etc have major fiscal implications, and one might reasonably expect elected ministers to have a key role in setting parameters that influence the risk of systemic bank failures. And, again as the Bank acknowledges, it isn’t easy to pre-specifiy a charter – akin to say the Policy Targets Agreement – for financial stability policy.

The Bank attempts to cover itself against suggestions that it might be, in some sense and in some areas, a law unto itself, by highlighting various ways in which the Minister of Finance might have some say. There are, for example, the (non-binding) letters of expectation, the need to consult on Statements of Intent, and the potential for the Minister to issue directions requiring the Bank to “have regard” for or other area of government policy. These aren’t nothing, but they aren’t much either – and as the Rennie report noted, the power to issue “have regard” directions has never been used. Even budgetary discipline is so weak as to be almost non-existent: there is a five-yearly funding agreement, but it isn’t mandatory (something that needs fixing in the current review), isn’t particularly binding, and doesn’t control the allocation of spending across the Bank’s various functions. The Minister of Finance doesn’t even get to make his own choice of Governor – and all Bank powers still rest with the Governor personally.

The contrast with the other main New Zealand financial regulatory agency, the FMA, is pretty striking. Policy is mostly set by the Minister (by regulation), advised by MBIE (to whom the FMA is accountable), and the powers of the organisation itself rest with the FMA’s Board, all the members of which are appointed directly by a Minister, and all of whom – under standard Crown entity rules – can be removed, for cause, by the Minister. Employees, including the chief executive, only have powers as delegated by the Board. The FMA model is now a pretty standard New Zealand regulatory model, and an obvious point of comparison with the Reserve Bank.

Somewhat cheekily, the Reserve Bank attempts to present their own model as providing more scope for ministerial input than for the FMA (see footnote 16, in which they note that for the FMA there is no power of government direction). As regards policy, it isn’t necessary, since the government sets policy and appoints (or dismisses) the Board. As regards the application of rules, one wouldn’t want – and doesn’t have – powers of government direction in either case. As regards the banking system, mostly ministers can’t set policy, can’t hire their own Governor, and can’t fire him (re financial system policy) either. The Governor and the Bank have far more policy power than is typical – across other regulatory agencies – appropriate, or safe.

The second half of the article is about accountability. As they reasonably note, when considerable power is delegated to unelected agencies, effective accountability needs to provided for. In their words “accountability therefore generates legitimacy and legitimacy in turn supports independence”.

It is, therefore, unfortunate that the Bank’s very considerable powers are matched, in this area in particular, by such weak accountability. After pages of attempting to explain themselves and what they see as the various aspects of accountability, even they end up largely conceding the point. These sentences are from the last page of the article

the BIS (2011) argues that financial sector accountability mechanisms should be focussed more on the decision making process rather than outcomes per se. This is because of the more intrusive nature of financial sector policy, and the issues associated with observing outcomes (lack of quantification and very long lags). Put another way, there should be less reliance on ex post accountability mechanisms and more obligations placed on ensuring decision-makers are transparent about the basis for their actions.

I’m not sure I entirely agree – although there is certainly the well-recognised point that absence of crisis is evidence of nothing – but at very least a focus on strong process might argue for:

a more effective separation between policymaking and policy administration (as is customary for many regulatory entities, but largely not for New Zealand bank supervision),
a decisionmaking structure in which power did not rest simply with a single individual, who is himself not directly appointed by an elected person,
decisionmaking structures that involve real power with non-executive decisionmakers,
effective and binding budgetary accountability,
a high degree of commitment to transparency and to ongoing external engagement,
a culture that is self-critical and open to debate,
perhaps some more effective scope for judicical review (including on the merits, rather than just process),
monitors with the expertise, mandate, and resources to ask hard questions and to critically review and challenge choices being made around policy and its application.

At present, as far as I can see, we have none of these for the Reserve Bank of New Zealand as financial regulator.

Take the formal monitors for example. Parliament’s Finance and Expenditure Committee has little time, no resources, and little expertise. The Treasury has no formal role, no routine access to Bank materials (or eg Board papers) and is probably quite resource-constrained in developing the expertise.

And what of the Bank’s Board? By law, they play a key role, as agent for the Minister of Finance in monitoring the Governor, and (now) obliged to report publically each year on the Bank’s performance. The Bank often likes to talk up the role of the Board – doing so provides them cover, suggesting the presence of robust accountability – but the latest article is surprisingly honest. The Board gets a single paragraph, which simply describes the legislative provisions. There is no suggestion of the Board have actually played a key role in holding the Bank (Governor) to account – not surprisingly, since in the 15 years they have been publishing Annual Reports, there has never been so much as a critical or sceptical word uttered. Of course, it isn’t surprising that the Board doesn’t do a good job: it has no independent resources at all (even its Secretary is a senior Bank staffer), the Governor himself sits on a Board (whose main role, notionally, is to hold the Governor to account) and the Board members themselves typically have little expertise in the areas (quite diverse) around which they are expected to hold the Governor to account for. (Their job is, of course, made harder by the rather non-specific mandate the Bank has in regulatory areas – there is nothing akin to the Policy Targets Agreement (which has its own challenges in monitoring).)

What of some of the other claims about accountability? The Bank points out that it is required to do regulatory impact assessments – but these are typically done by the same people proposing the policies, and there is (or was when I was there) nothing akin to the sort of process some government departments have for independent panels vetting the quality of the regulatory impact assessments.

They are also required to consult on regulatory initiatives, and must “have regard” to the submissions. But, except perhaps on the most technical points, there is little evidence that they actually do pay any real heed to submissions. For a long time, they also kept the submissions themselves secret – even attempting to claim that they were required by law to do so. They’d publish a “summary of submissions”, which highlighted only the issues they themselves chose to identify. As they note, and in a small win for a campaign by this blog, they have now started publishing individual submissions, belatedly bringing them into line with, say, Select Committees of Parliament or most other regulatory bodies. But there is no sign of much change in the overall attitude, or of any greater openness to ongoing debate and critical scrutiny.

Then, of course, there is the Official Information Act. The Bank is subject to the Act, but chafes under the bit, is very reluctant to release much, threatens to charge requesters, and generally seems to see the Act as a nuisance, rather than an integral part of an open and accountable government.

We had a good example just a couple of months ago as to how unaccountable the Bank is in its prudential regulatory areas. It emerged that Westpac had not had appropriate regulatory approval for some model changes used in its risk-modelling and capital calculations. But, as I noted at the time, the short Bank statement left many more questions than it answered, and no one – including journalists asking directly – has been able to get straight answers from them, even though capital modelling is at the heart of the regulatory system.

And, of course, if the formal monitors are lightly (or not at all) resourced, there isn’t much other sustained scrutiny. Banks are scared – and more – to speak out: this is where culture matters a great deal, as banks will always have a lot of balls in the air with the regulator, and in an open society should feel free to openly challenge the regulator, without fair of undue repercussions. Academics with much expertise in the area are thin on the ground, as are journalists with the time or expertise.

Mostly, in its exercise of its extensive financial regulatory powers, our Reserve Bank isn’t very accountable at all. Providing it jumps through the right, minimal, process hoops it can do pretty much what it likes in many areas of policy, and the public is left just having to take the Bank’s word (or not) that things are okay. That needs to change – and thus phase 2 of the current review of the Bank’s Act needs to be taken seriously. Making the changes isn’t about one single measure, and there are plenty of details that will take a lot of work, and thought, to get right. Part of it is about building a better internal culture, one that (from the top) really wants to engage, and which welcomes challenge and critical review.

After yesterday’s post I had an email from a reader with considerable senior-level experience in the banking sector noting just how weak much of the formal scrutiny of the Bank is in these areas.

From my perspective the Bank would benefit from independent challenge about their prudential responsibilities, and cost-benefit analysis. I am unsure if they have reviewed this post the Westpac capital model issues.

I am unsure how the Board discharges the independent prudential review role effectively given their experience – two Directors have insurance experience and no directors have Banking, payments system or other non-bank financial experience. Likewise experience of Insurance/Banking/Payments technology systems and risks. While there are some very good RBNZ executives they are not particularly strong in banking risk experience – funding, liquidity, credit etc.

…. I think it would be useful for the RBNZ at a governance level to have experience of how financial balance sheets, and liquidity operate under stress, they will have some very important decisions to make when the next financial crisis occurs.

Much of that rings true to me. We have typically had Governors with more experience of macro policy, and perhaps financial markets, than of banking – and yet financial regulation is a hugely important role in what the Bank does – and now have a new Head of Financial Stability with no background in banking or finance at all. We have a Board responsible for monitoring the Bank across monetary and regulatory responsibilities, and with little specialist expertise. The contrast with, say, the FMA is quite stark.

Quite what the right balance of a solution is, I’m not quite sure. I favour moving to a committee-based decision-making structure, and moving more of the policy back to the Minister (with the Bank as a key adviser), but even a Financial Policy Committee might only have three or four externals on it, and no such group is going to encompass all the right bits of expertise. As often, I guess it is partly about the willingness to ask the hard questions, and to be willing to commission independent expertise (whether from New Zealand or abroad, from academics or people with industry background) and to engage. If the Board remains as a monitoring agency – as Rennie recommends, but I’m sceptical of – it needs to be provided with resources. And the Minister needs to be willing to use his statutory powers to commission independent reviews of aspects of the Bank’s stewardship, to enable us (and the Bank) to learn from experience by critically evaluating performance (and process). Personally, I’m still tantalised by the idea of a small independent agency resourced to pose questions, and commission research, on the stewardship of fiscal, monetary and financial regulatory policy.

If not all the answers are clear, what is clear is that New Zealand is a long way from having got the model right: the right allocation of powers, the right accumulations of expertise in the right places, the right cultures, and the appropriate mix of formal and informal accountability that can really give New Zealanders confidence in the regulation of the financial system.

Food, culture, regulation….and a walk with the kids

April 29, 2016April 30, 2016 Michael Reddell Regulation

Spurred by a Herald article yesterday, my kids and I went for a walk (well, we do most days but this one had a specific purpose). The newspaper was reporting new Auckland university research showing – shock, horror – that.

“Sixty-nine per cent of urban schools have a convenience store within 800m and 62 per cent have a fast-food or takeaway shop in that distance”

Frankly, I was surprised the number was that low, but then in Wellington one finds small schools in all sorts of odd nooks and crannies. My three kids now go to three different schools, and each of the schools has shops nearby. But, as it was nearest, we walked around the area that encircles my youngest child’s decile 10 primary school. And what did we find?

On the first corner:

a dairy
a specialist pie shop

On the next corner:

two dairies
a Chinese takeaway
the Empire Cinema, with its neighbourhood café and gelato outlet

And then in the main shopping area

the supermarket, (as the kids pointed out, it was chock full of all sorts of stuff, “good” and perhaps “not so good”)
a Hell Pizza outlet
two fairly casual daytime cafes with plenty of take-out options
a combination fish and chip shop/Chinese takeaway
the video (and Post) shop, with lots of sweet and savoury nibbles
an Indian takeaway
another dairy
a lunch-bar/bakery
the butcher – bacon and cheerios don’t score well on the “disapproval” lists, and that is before getting onto the question of red meat.

And that was without including the:

bottle store and bar, and
three other evening-focused restaurants, two offering take-out
and a couple of arty galleries/shops selling quite good chocolate.

But so what? If 70 per cent of urban schools are close to at least one convenience or takeaway outlet, isn’t that simply telling us that our schools are typically in the heart of our neighbourhoods. Which is probably where they should be. And I’d be surprised if the number of dairies and takeaway places has changed much in the almost 40 years since I was getting off the school bus at one of these corners (although there was no gelato back then, even in this Italian-influenced suburb).

Buried in the Herald article, well past the calls for governments to “do something”, was this comment from the lead researcher

But she acknowledged that no link between obesity and access to unhealthy food shops had been clearly established by research.

‘The evidence is quite mixed…You don’t have to wait for the evidence to take action. It’s the same with the sugar tax – there’s no definite evidence. It’s hard to get definite evidence in science. The fact is, unhealthy food is so available, accessible, affordable, we should protect children from potentially harmful products. ‘

At one level one can sympathise. Definitive evidence is certainly hard to come by in lots of areas (including the ones I’ve been closer to, in macroeconomics). But it is also a good reason for governments to be particularly wary of optional regulatory interventions, that directly impinge on ordinary citizens’ choices and options.

And that is even if one granted that obesity was somehow the government’s problem. The common argument is that the public health system makes it so, because the government bears the medical costs of the choices people make. There is something to that of course – although we all die of something, and the longer-lived cost more in New Zealand Superannuation, rest-home subsidies etc) – but as an argument it has chilling implications: we should give the government the right to coercively regulate all manner of behavior, simply because the government bears one lot of the costs if things go wrong? I support a public health system, but taken very far this argument will eventually risk undermining support for such a system, and that would be unfortunate.

In fact, most of the costs of obesity fall on the individuals concerned, and perhaps their families. A shortened life expectancy, or more sick days, has a cost to the person concerned. The benefits from the food consumption, or choice to do things other than exercise, also accrue to the individual.

Do people always make wise choices? Of course not. Do children and young people always do so? Even more so, of course not. Part of growing up is taking risks, and pushing the boundaries. But a big part of good parenting is to constrain the choices, and to educate kids in a way that means they are less likely to push the boundaries too far. It is about the ability to say no. It is about the ability to offer treats, in sensible sizes and sensible frequencies. And to balance that with a good basic balanced diet, with all sorts of foods mostly in moderation. And for adults to model eating sensibly – both within the family, and within whatever other groups the family might be part of (church, marae, sports club, or whatever). That is a big part of what culture is – memorizing, practising and reinforcing a sense of the way we do things, ways that support getting through life reasonably successfully.

Do governments have a role in all this? I don’t see one (and was unnerved to read that the Health Minister is apparently proud of the fact that the government has “22 initiatives targeting child obesity”). Which Ministers (or their Opposition peers) would I regard as good role models, or qualified to provide guidance on shaping the next generation? A few perhaps, but not many. Speaking personally, I’ve never found the presence of dairies, takeaway, or even the layout of supermarket shelves, makes my parenting more difficult. Perhaps others have a different experience but – to loop back to the Auckland University researcher’s acknowledgement – some robust evidence would be nice before governments rush in, trying to tell people where they can locate their businesses, who they can sell to, and so on.

But my inclinations are more austere Puritan than New Zealand Initiative libertarian, and so although I don’t see a role for government controls in this area, I was quite shocked last night when my elder daughter told me that her intermediate school sells potato chips and a variety of other foods of dubious nutritional value at the morning break. I’m running for the Board of Trustees – just to make some points in my campaign statement, rather than expecting the Green voters of South Wellington to prefer someone like me – and if elected would want to encourage the school to look again at quite what products it was offering for sale.

Speaking of the New Zealand Initiative, Geoff Simmons of the Morgan Foundation had an op-ed in this morning’s Dominion-Post attacking the Initiative for its new report The Health of the State and its skeptical take on specific taxes on disapproved classes of food (and alcohol and tobacco). Simmons leads with the point that the Initiative is “corporate-funded”, as if somehow that matters It is not as if there is any secret as to where the Initiative gets its money from – its members are listed in the Annual Report, and if anything I was rather disconcerted to learn that the Wellington City Council (always happy to intervene in anything) was a member (and Auckland University in fact). There are lots of things I disagree with the Initiative on, but the issue should surely be the quality of the argumentation, analysis, and evidence. That goes for the Morgan Foundation surely just as much as for the New Zealand Initiative – both privately-funded research and advocacy bodies, whose presence lifts the generally weak level of public debate in New Zealand.

Simmons suggests that it is really all about “ideology”. I don’t think that is right – there is plenty of debate, or should be, about evidence (partial as it inevitably often is). But he ends his column this way:

“Instead of a facile debate over whether a sugar tax would work or not, we should be discussing which we value more – living in a free society where you can eat what you like and burden the state, or whether we value having a healthy productive society”

Surely there is room for both? A serious ongoing debate about the impact and efficacy of proposed interventions, using insights from overseas experience, from other similar interventions, and so on. But also a debate about what sort of society we want. Personally, I like the idea of a free society, in which people can eat whatever they like – but typically choose to restrain themselves, in food as in all other areas of life. We don’t exist as servants of the state – if anything, it is the other way round. Civilisation and prosperity have always required restraint and self-discipline in a whole variety of areas of life. But the track record of governments in creating such cultures doesn’t look good: governments more often corrode cultures than foster successful ones.

School choice and the ACT Party

August 31, 2015August 31, 2015 Michael Reddell Education, Regulation

Reading the Herald over lunch, I found an article about potential future heightened pressures on the rolls of Auckland Grammar and Epsom Girls’ Grammar.

But what struck me was the stance of the local MP, and leader of the ACT Party, David Seymour. In addition to these roles, Seymour is also

Parliamentary Under-Secretary to the Minister of Education
Parliamentary Under-Secretary to the Minister of Regulatory Reform

The ACT website says of ACT’s policy on schools and pre-schools

ACT believes that education at this level is an investment in human capital that the government rightly makes. However, the delivery of the service has been captured, at the primary, intermediate, and secondary levels at least, by a providing bureaucracy that limits choice and innovation for the purpose of self-preservation.

ACT believes that state education funding should be seen primarily as an asset of the parent and child, to be used at a school, public or private, of their choice. ACT would diminish the role of the Ministry of Education in allocating resources, separate the property ownership role of the Ministry from the operations role, make Boards of Trustees more autonomous in their governorship of schools, introduce better mechanisms for State and Integrated schools to expand and contract according to demand, and increase the subsidy to private schools to the extent that it is expenditure neutral.

To be sure, ACT has only a single seat, in effect gifted to it by the National Party, but where is the evidence of this sort of approach in the stance adopted by Mr Seymour? ACT has pursued the cause of so-called Partnership Schools, but these are not really a vehicle for parental choice, since the only people who can set up these schools are those targeting “underachieving children”. That is one worthy goal, but it is quite different from a framework that facilitates widespread parental choice on schooling. Reasonable academic achievement isn’t the only thing parents value.

What does Seymour have to say about the pressures in the Grammar zones? Is he suggesting abolishing the zones? Is he suggesting establishing new excellent state schools? Is he suggesting allowing new integrated schools to be established easily? Is he suggesting practical ways to treat “state education funding…primarily as an asset of the parent and child”. The answer, of course, is none of the above. And it gets worse, as he is reported as toying with an idea that students in new houses would not be included in the zone? And this from a party allegedly favouring more responsive housing supply.

Seymour’s response seems to be primarily about protecting the choice, and the property values, of one small group of among the highest income New Zealanders, in Mount Eden, Parnell, Newmarket, Remuera, and Epsom. And it is not as if this stance is new. As the Herald reports, he has previously come out opposed to intensification in his own area, and opposed efforts of neighbouring schools to extend their zones in ways that overlap with the Grammar zones. ACT rightly criticises corporate welfare, and has also been fairly critical of the growth of the welfare benefit system, but there is gaping inconsistency right at the heart of their home territory. It looks a lot like protecting elite privilege. Many people would like to send their kids to one of the Grammars – or schools like them. But a rapidly decreasing number can afford the house prices in those suburbs and the dominant state provider doesn’t build any more. Why would one take Seymour seriously on any proposed policy when he is not willing for his policies to start at home?

I think he is right about the education bureaucracy, but it isn’t only the provider bureaucracy that seems driven by self-preservation. The Under-Secretary for Education and MP for Epsom seems to have gone the same way. ACT is likely to be at its best when it is attacking, not defending, established advantage, and when it is campaigning to democratise access to excellence and strongly advocating competition, even if it means some transitional costs fall on some of their own supporters. Thank goodness that governments that abolished import licensing – which had provided many very comfortable livings – did not take the ACT approach. I’m sure Seymour (and his party colleagues), knows that his position is untenable when put up alongside party policy. And so I wonder what he really stands for? Allowing bars to open more easily on the mornings of a few rugby games is all well and good, but beginning to make progress on allowing real school choice for the mass of middle New Zealand is a rather more important, and more enduring, issue for the longer-term.

These issues don’t just arise in Auckland. In the weird world on education bureaucracy, my son is zoned out of the closest state boys’ school (which we don’t particularly want him to attend) because for decades the Ministry of Education has failed to build even a single state school in what is generally regarded as New Zealand’s largest suburb.

New Zealand already has a limited quasi-voucher system in the integrated schools system. For some parents, there is an effective choice, between a neighbourhood state school and a (slightly more expensive) integrated school. But in practice the choice is limited: most of the schools are Catholic, and Catholics are supposed to attend Catholic schools and (reasonably enough) there aren’t many places for those from other traditions. And rolls are capped. The integrated schools model was a far-reaching reform of the Third Labour Government in the 1970s, in response to a funding crisis in the Catholic system. More than 10 per cent of New Zealand children are educated at such schools, and (unlike the so-called Partnership Schools) there seems to be little debate around their performance – it is just recognised that some parents will prefer one sort of school, and others will prefer different types. But why not use the integrated schools model as a basis for a real extension of choice? Allow proprietors – existing, new, for-profit, and non-profit – to set up new schools, as they like, and provide per capita funding accordingly if they can attracts parents and students. For most parents – especially with more than one child – private schools aren’t a real choice – the financial burden is just too heavy. And perhaps there will never be much effective choice in most small towns. But most of our population lives in our larger cities – half in Auckland, Wellington and Christchurch alone – and in those places (and no doubt most of our larger provincial centres) effective and genuine affordable choice could be made to work.

Yes, no doubt there would be some duds set up. There are some disastrous schools now. No doubt there would be some excess capacity built. But that is akin to an argument that we’d be better off with one supermarket in a suburb than two, to avoid the wasted extra physical capital, or the old days of licensing when a new entrant might have to prove there was insufficient capacity, rather than simply being allowed to take a risk and open up.

Yes, there are lots of other details to work out The state has some legitimate interest in ensuring a minimum standard of schools, but it has much less interest in that than parents have. The state, its bureaucrats and ministers, gets to make mistakes over and over again. But each child only goes through school once: the stakes are that much higher for parents and kids than they are for the education bureaucrats and politicians.

None of that necessarily helps with what should happen in Auckland right now. Someone is going to miss out, and political choices will (openly or not) decide who. That is a problem for Mr Seymour, and perhaps one he should have thought harder about before campaigning for school choice and reduced land use restrictions in suburbs like Epsom. Real choice rarely comes from the elites – they aren’t, generally, the ones with most to gain from it.

“Larry Summers on TPP makes perfect sense”?

June 16, 2015July 31, 2015 Michael Reddell FTAs, Productivity, Regulation

Tyler Cowen wrote last night “Larry Summers on TPP makes perfect sense. I haven’t seen anything on the anti- side coming close to this level of analysis, and in a short column at that.”

I’ve been a bit ambivalent about TPP, so thought that I’d better read the Summers piece. My problem was that I came away more skeptical than I went in.

My own priors are pretty clear. Free trade is good – as a matter of liberty and as a means to greater prosperity. I’m sure one can find exceptions, but the rule is a pretty good one to live, and make policy, by.

But then Summers tells us that:

First, the era of agreements that achieve freer trade in the classic sense is essentially over. The world’s remaining tariff and quota barriers are small and, where present, less reflections of the triumph of protectionist interests and more a result of deep cultural values such as the Japanese attachment to rice farming. What we call trade agreements are in fact agreements on the protection of investments and the achievement of regulatory harmonization and establishment of standards in areas such as intellectual property. There may well be substantial gains to be had from such agreements, but this needs to be considered on the merits area by area. A reflexive presumption in favor of free trade should not be used to justify further agreements. Concerns that trade agreements may be a means to circumvent traditional procedures for taking up issues ranging from immigration to financial regulation must be taken seriously.

But if free trade is good, the same case can’t be made for “regulatory harmonisation”. We just don’t know enough about what regulation is sensible, and worthwhile, and we live in democracies where the case for regulation in specific areas should be fought out through domestic political processes. A diversity of regulatory approaches is often the way we learn. And protections for intellectual property are typically far too high anyway – in other words, agreements on such matters risk being (or are by design) generally anti-competitive, anti-market, measures.

In fact, the strongest argument for TPP I could find in the article was one grounded in domestic US politics ( recalling that Summers had been a senior official in both the current and previous Democratic administrations).

The repudiation of the TPP would neuter the U.S. presidency for the next 19 months. It would reinforce global concerns that the vicissitudes of domestic politics are increasingly rendering the United States a less reliable ally.

Really? We all know that second-term US Presidents, especially those whose Vice-President is not heir presumptive, quite quickly become lame ducks. Is this presidency really any different? And where is the pressing demand for TPP? No doubt there are elites in each of the negotiating countries with a great deal at stake, but where is the popular demand for this agreement? As Summers puts it, it doesn’t seem to be a free trade agreement anyway. Which population centre will think worse of the US if negotiations stall? No doubt some US business groups will be aggrieved, but that is domestic politics, not international relations. Failure of TPP would be embarrassing for Barack Obama, but that seems less like a national interest issue than a partisan one?

I’ve long been a bit puzzled by what was supposed to be in any deal that would make it economically worthwhile for New Zealand (as distinct from being “inside the club”). I recall the IMF doing some modelling a decade or more ago on the US-Australia FTA, which had concluded that that agreement had been modestly welfare-diminishing for Australia – as if a desire for a deal, any deal, and perhaps the momentum that any process takes on over time had overridden a hard-headed assessment of the economic interests of Australia. If there were genuine large-scale liberalisation of the global dairy trade, then we might reasonably think New Zealand would be better off from a deal. But has that ever seemed very likely? And if only small (or no) trade gains are on offer, how should we weigh that against the losses from strengthened intellectual property protections?

And how should be think about the incentives on our key political participants? Having pursued an agreement for so long, what sort of threshold would have to be crossed before they would be willing to walk away from negotiations? It is not clear that the personal and national interests are necessarily tightly aligned. Perhaps the US Congress will vote in ways that mean they never have to make that decision.

To repeat, I’m a free trader. I think New Zealand should have removed its remaining tariffs, and wound back its anti-dumping regime, long ago. I’m in favour of a materially more liberal approach to foreign investment. And I generally favour less regulation rather than more. But all these are causes that should be fought out openly, and in the domestic political process. So, I hope there is a better case for TPP than that put forward by Larry Summers, who actually seems somewhat ambivalent if it weren’t for the impact on Obama’s political position, but so far I haven’t found it.

And that before I saw Keith Woodford’s recent column on interest.co.nz. Woodford knows a great deal about the global dairy industry, and he makes what seem like pretty persuasive arguments that there might not be much in it for New Zealand even if the US and Canada were to move towards an unsubsidised and less heavily regulated dairy industry.

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