The Secretary to the Treasury on productivity

June 20, 2017June 20, 2017 Michael Reddell New Zealand economic performance, Productivity, Treasury

A speech appeared on The Treasury’s website the other day. It was, we were told, by Gabs Makhlouf, Secretary to the Treasury, and given as the closing address at a Productivity Hub Workshop last Friday. The Productivity Hub is a grouping of government agencies, hosted at the Productivity Commission

which aims to improve how policy can contribute to the productivity performance of the New Zealand economy and the wellbeing of New Zealanders

It is a laudable aim. I’ve been to a few of their events, and at times they’ve had some interesting and stimulating speakers. Whatever the event was that Makhlouf was speaking at, it has a very low profile – there is nothing about it on the Hub’s homepage, or anywhere else I can see. I’ve lodged a request for the papers and presentations.

I’m all in favour of pro-active release of material by government agencies, but I was a little curious why The Treasury chose to make this speech something on-the-record. Closing addresses usually seek to summarise and draw lessons from what has been heard at the conference/workshop. But in Makhlouf’s speech there is no reference to any of the papers that had been presented, or any of the material discussed at the workshop. Perhaps he just wanted to signal that he, Secretary to the Treasury, treats productivity as something important (on checking, I found that Treasury had also published his brief remarks to a couple of previous Productivity Hub events)?

Whatever the reason, when the Secretary to the Treasury – head of the government’s main economic advisory agency – talks about productivity, it should be worth taking note of. After all, presumably even now Treasury is in the process of pulling together the analysis and advice that will form the basis for their Briefing to the Incoming Minister (BIM) after the election. We might hope they will be (a) pointing out to the Minister of Finance that New Zealand’s productivity performance is woeful, and (b) offering a compelling narrative and set of recommendations for what might reverse that performance and enable New Zealand to deliver for its citizens the sort of standard of living they should reasonably expect. But on the basis of the Secretary’s latest speech, I wouldn’t be holding your breath.

Of course, one can’t expect any sort of fully-developed story in a few pages closing a workshop. But if there is (a) a sense of urgency, and (b) a well-developed set of policy proposals being worked-up, that should be clear in a speech of this sort. Neither is there.

Makhouf recognises that our productivity performance leaves something to be desired, but how is this for minimising the issue?

We are middle of the OECD pack at best in the amount of income we derive per hour worked, and we have made little or no headway on lifting our productivity performance rankings over the past 15 years.

There are 35 OECD countries now, and only 13 had real GDP per hour worked less than New Zealand’s in 2015 (most recent comprehensive data). And the only reason we are even near the middle of the OECD pack is because so many poorer countries have been allowed into the OECD. Every single one of the 11 new members in recent decades was poorer, and less productive than us, when they joined.

When we joined the OECD in 1973, it was a club of 24 countries. OECD data go back to 1970. And in 1970, our real GDP per hour worked was similar to that in France and Germany. These days, they have productivity 60 per cent higher than ours, and of those 24 countries only Portugal, Turkey, and Greece now have lower real GDP per hour worked than we do. In 1970, Turkey had GDP per hour worked less than half ours, while on the latest estimates it is now almost equal to us.

And while it is certainly true that “we have made little or no headway on lifting our productivity performance rankings over the past 15 years”, the story is much worse than that, as even the OECD highlighted last week. Here is their chart

OECD productivity

And this is mine, from a post a couple of weeks ago

douglas 3

In 47 years now there has never been a time when New Zealand has succeeded in narrowing the productivity gaps that have opened up between us and other advanced countries. At best, we’ve gone sideways in some periods.

And if Makhouf understates the severity of the problem, he overstates any signs of progress

Our understanding of New Zealand’s productivity performance is improving, thanks to a wealth of information that has recently been released including as a result of the Productivity Commission’s report Achieving New Zealand’s Productivity Potential, the OECD’s New Zealand Country Study and Going for Growth, and the Treasury’s He Tirohanga Mokopuna. (That last one is a cracking read, by the way.)

Really? The Treasury report he refers to was their long-term fiscal report, and I’m genuinely puzzled as to how he thinks that (useful) report advances our understanding of the productivity underperformance. The Productivity Commission piece, which I wrote about here, was an interesting effort, and did represent a step forward in some areas (including the treatment of immigration policy) but it has hardly galvanised the nation – or even, as far as I can tell, official Wellington. As for the OECD’s report, surely Makhlouf was just being diplomatic – the OECD chief economist was at the workshop – rather than seriously suggesting that they have a compelling narrative to explain New Zealand’s underperformance and, thus, a solid model to use in proposing remedies?

Makhlouf goes on

Our challenge now is to keep building the momentum of progress and turning our growing understanding into action that lifts our productivity performance.

But where is the progress at all? Where, specifically, is the evidence that Treasury – or other government agencies – are any closer to credible answers?

Makhlouf set out what might have been an interesting marker

As I mentioned, we have seen little improvement on where we rank among OECD countries for productivity, yet we have been told that we have world-leading settings.
This raises a few questions for me. ….. Or could it in fact be that New Zealand’s world leading economic and policy settings aren’t so world-leading anymore?

I’m not sure who really thinks of New Zealand policies are being “world-leading” these days. In some areas, perhaps they are. In other areas, we score quite badly. But I’d have thought a fair overall description would probably be ‘no worse than the typical OECD country’.

Sadly, Makhouf doesn’t really do much to develop his tantalising question.

‘World-leading’ is always evolving. Looking back through history, Rome, China, India and the United Kingdom have all at times been world leading economies, just as the United States is today. So while some things will continue to hold for productivity and incomes, we need to make sure we are not working towards something that used to be world-leading, but is no longer so. It’s also likely that what’s world-leading will vary by country so it’s not a recipe that we can simply copy.

Surely all this confuses great power status – not unrelated to economic strength typically – with world-leading (economic) policy settings? After all, he could have noted that 100 years ago, New Zealand looked pretty world-leading – not as a “great power” but as one of the very richest and most productive nations on earth. Nor am I really quite sure how “what’s world-leading will vary by country” makes much sense, unless he is saying – in which case I agree – that in thinking about diagnosing New Zealand’s problems and offering remedies to policymakers we need to think hard about the specifics of New Zealand’s situation. It isn’t clear that the OECD (at least) has really done that.

But it isn’t clear that Treasury is really doing so either. Because Makhlouf devotes the rest of his remarks to

five factors that the Treasury believes always matter: skills, connections, markets, resources and rules.

Any micro-focused policy agency almost anywhere in world could trot out that list

Of skills

The Treasury believes that opportunities remain to lift skills and resilience in the workforce, and it’s important that those opportunities are pursued.

No doubt, but it doesn’t seem particularly persuasive that gaps here are big part of the 45 year story of underperformance, when the OECD adult skills data suggests New Zealand workers already have among the highest skills of any in the OECD.

Of connections

Connections matter, in particular people-to-people connections. And as Asia continues to dominate economic activity, perhaps those types of connections – ie, relationships – matter more than ever. Improving connections can help to improve the flow of people, capital, trade and ideas that contribute to productivity. Strong people-to-people relationships build confidence and understanding and promote learning. They help our businesses to identify capabilities that will help them improve their productivity and ultimately compete and succeed in both domestic and global markets.

I suspect this is some sort of code for “keep on having lots of immigration”, but it isn’t terribly specific. And as a reminder, with rare exceptions, Asia isn’t the home to the richest or most productive economies. But again, with hugely high (by international standards) rates of non-citizen immigration, did Makhlouf and Treasury have anything remotely specific in mind?

He gets a little more specific on “markets”

In the Treasury’s view we need to continue to lift the competitive intensity of the New Zealand economy. The pressure of competition pushes firms to be more productive, for example by innovation to improve quality or cut costs. We need to ensure our markets are as competitive as possible by reducing the barriers to entry, including for imports (whether in goods or services), or by regulating the price and quality of goods and services in markets where there is little or no competition, such as in our telecommunications and electricity markets. And we need to maintain the effectiveness of competition laws and institutions. If we want competitive markets and the productivity gains they bring, we have to ask ourselves: what are the regulatory barriers preventing competition and what can we do about them? How bold do we want to be to invite competition?

It isn’t really my area, but if there is useful stuff to be done in this area how plausible is it that it can materially explain 45 years of relative economic decline? Say what you like about competition in New Zealand now, but in almost all areas there is a great deal more than there used to be.

Then he moves onto natural and physical resources. Here he includes housing.

Our natural and physical resources are next. One of the most high profile issues we’re examining in New Zealand – housing – illustrates how these resources are a significant factor in productivity. We are all aware of issues in house price growth in Auckland and the inefficiencies in our use of land which are proving to be a bottleneck in New Zealand’s growth and productivity.

I’m not sure there is really any evidence for this proposition. If there is, in a New Zealand context, perhaps The Treasury could publish it. Dreadful as our housing policies are, when the city that is worst affected by them has (a) had very rapid population growth, and (b) has a very small margin by which productivity exceeds that in the rest of country, it suggests that overseas studies – on places like San Francisco and New York (which have had little population growth, and very high productivity margins) – may not be of much direct relevance here.

Still on housing

the degree of its affordability or unaffordability is a product of our entire urban development chain and of multiple interacting areas of policy. We’re considering these issues holistically, as well as particularly how land owners capture the economic rents and potentially magnify the problems. We see the concept of competitive land markets as an important part of the way forward.

Surely if there is something there, it could have been written a great deal more simply? And portentous words about “the concept of competitive land markets as an important part of the way forward” almost make a mockery of people priced out of home ownership right now.

In some areas, I’m not sure Makhlouf really knows what he is saying

At the moment, it can be argued that too much of our natural resource use is determined by incumbency rather than most efficient use.

Does inumbency here mean “the person who owns it”? But, surely, land is our greatest natural resource. Mostly, it is pretty freely tradable. Anyone with a better, more profitable use, in mind can surely make an offer? Or (but surely not) is the Secretary perhaps a bit worried about private land ownership?

Actually, despite what he said, he seemed to be mostly talking about water rights and pollution. What he says on water sounds sensible

To use water as an example, the ‘first-in first-served’ approach to water allocation means it may not always be allocated to the highest value use, and the current system lacks sufficient incentives for use to move to a higher value one. The Freshwater Allocation Work Programme is considering options that could be more appropriate to ensure that we are getting the best use of our water resources.

And I’m sure there are some real issues around pollution too. But when he says

Better rules around use and around pricing externalities such as pollution are critical to making best use of resources and are likely to be key to promoting significant diversification of the economy and contributing to an improvement in productivity.

I think he makes it sound all too easy. For example, it is all very well to talk of water pollution arising from more intensive dairying, or indeed of the implications for carbon emissions, but without a great supporting analysis it sounds a lot like feel-good rhetoric to suggest that restricting such industries is likely to be significant in lifting overall productivity in the economy. What channels, one wonders, does the Secretary have in mind?

His final category was rules

The making of rules and regulations – whether by central or local government or even by self-regulated occupational groups – has an impact on productivity. All rule-makers help shape the environment in which investment, enterprise, and job creation is either promoted or limited. Rule-makers in the public sphere have a double responsibility: to ensure effectiveness in public spending and decision-making, and to provide the best possible regulatory and policy settings.

Hard to disagree really. But is this really the best the Secretary to the Treasury – an agency with key responsibility for regulatory review policy – can do on the contribution of New Zealand regulation to productivity? There isn’t even an attempt to draw some of his points together, and note that (for example) well-intentioned but flawed rules help explain the absence of a well-functioning market in urban and peripheral land.

Overall, there is no sense of urgency, and no hint of any fresh insights either.

Makhlouf ended his speech this way

We need to continue to test our assumptions about what does and doesn’t work, and to apply new things where they make sense. I know there’s a lot of willpower and brain power here to ask questions, find solutions and take actions to raise New Zealand’s productivity.

Of course, it is elected politicians, not officials, who would get to “take actions to raise New Zealand’s productivity”. Sadly, despite the approaching election, there is little sign among any of them – or those competing to take their place – of much will to change, or much interest in attempts at serious answers to decades of decline.

Should there be more urgency? I’d have thought so. There has been plenty of talk in the last few years of New Zealand and Australia relative economic performance. Australia is our biggest trade and investment partner, and of course historically an outlet for New Zealanders pursuing the far higher incomes typically on offer there. It is certainly true that the Australian labour market has been cyclically weak in recent years, even more so than ours. But here is the latest update of labour productivity in the two countries (in NZ, using an average of the two GDP measures, and an adjustment to hours worked for the break in the series last June). The chart is indexed to 2007q4, just prior to the recession, but remember that even then we were well behind Australia (incomes and productivity levels)

GDP phw NZ vs Aus June 17

As it happens, Makhlouf’s appointment as Secretary to the Treasury was announced on 28 June 2011. We’ve had barely any productivity growth since then (none for the last five years). That, of course, isn’t directly his fault, but one does have to ask whether The Treasury under his stewardship has even once put forward a compelling set of policy proposals to end even this multi-year drought, let alone to reverse the 45 years and more or relative decline. On the basis of this latest speech, we shouldn’t be very hopeful of what they might have to offer a government formed later this year.

“Considerable public interest”?

June 8, 2017 Michael Reddell PTAs, Treasury

As I noted yesterday, the Minister of Finance and Grant Spencer have signed a document purporting to be a Policy Targets Agreement, to cover the management of monetary policy between the end of Graeme Wheeler’s term and 26 March 2018. I also noted that I had lodged OIA requests with the Bank and Treasury for the documents relevant to the pseudo-PTA.

As it happens, Treasury had already beaten me to it, and they rang this morning to point me to the obscure corner of their website where they had yesterday pro-actively released the one substantive relevant document. Pro-active release of papers by minister and public servants is to be strongly encouraged, and welcomed when it occurs. Not only is it consistent with the principles that underpin the Official Information Act, but it is also cheaper and easier for the agency concerned. I probably wouldn’t have bothered with this post if I hadn’t wanted to commend Treasury.

Just occasionally one gets a sense of having made a very slight difference. In recommending pro-active release Treasury noted

There is considerable public interest in Mr Spencer’s appointment, and a proactive release would pre-empt an expected OIA request.

It (more or less) did that, but to be honest I’ve not seen any one much other than me writing about the Spencer appointment. Treasury went on

We also consider the proactive release of this report desirable as it would help to ensure that future public commentary on Mr Spencer’s appointment is well-informed. This is because some commentary about Mr Spencer’s appointment has questioned whether the appointment is legal, based on an inappropriate interpretation of the Act and an erroneous assumption that you would not be signing a PTA with Mr Spencer.

I had certainly misunderstood the implication of earlier statements from the Minister about the PTA. I remain convinced that both the appointment is illegal, and that there is no statutory provision for a PTA with an acting Governor. My interpretation of the Act may well be erroneous, but the best way to clear that up would be for the Minister, the Treasury, or the Bank’s Board to explain – or provide – their own legal advice and interpretation of the relevant provisions. They continue to refuse to do that (although I will refer this paper to the Ombudsman’s office, for consideration in reviewing whether it would be in the public interest for the relevant legal advice, or a summary of it, to be released).

What else do we learn from the Treasury’s advice to the Minister?

First,

A PTA is required for the appointment of both a permanent and an interim Governor.

It is clearly Treasury’s interpretation, but they provide no justification for that interpretation. There is, after all, no mention of an interim or acting Governor in any of the provisions of the Act dealing with PTAs. Again, a summary of the legal advice would help clarify the matter.

Second,

The Board recommends that Mr Spencer be appointed on the same terms and conditions as the current Governor. This is also the basis upon which Mr Spencer has accepted the appointment.

I don’t have any real problem with that, but…..an acting appointee doesn’t really have the same responsibilities as a substantive Governor (medium-term planning and positioning of the institution etc), and has no effective accountability (monetary policy, for example, works with a lag of more than six months, and Spencer will be long gone before the impact of any of his choices are apparent. But I guess Spencer was doing them a favour in taking the job.

The Treasury appears to be relying on a creative interpretation of the Act in which every reference to the Governor is somehow construed to also mean an acting Governor. But they aren’t even consistent about that. They note that

The process of agreeing the conditions of employment is complicated by the Act requiring you to agree the conditions of employment, including remuneration, with the Governor. As Mr Spencer will not be the Governor until after assuming the office of Governor, the conditions of employment should not be formally signed until Mr Spencer’s appointment takes effect.

In fact, of course, Mr Spencer will never be Governor, only acting Governor. But it seems a rather literal interpretation of the relevant section of the Act to suppose that the terms and conditions can’t be agreed until a person (acting or substantive) has actually taken office. I wonder if the same approach was applied when Messrs Bollard and Wheeler were appointed? If it really is a correct interpretation, it looks like a case for a minor amendment to the Act (joining a long list of necessary reforms).

To repeat, kudos to Treasury for the pro-active release. I do hope they will adopt the same approach next year when a new longer-term PTA is signed with the new permanent Governor, and would encourage the Reserve Bank to consider following Treasury’s lead. In the meantime, as they are no doubt aware, Treasury is still to respond to a request for the papers relevant to the 2012 PTA. Pro-active release at the time would have been much simpler.

Treasury on immigration, productivity and real wages

May 30, 2017May 30, 2017 Michael Reddell Immigration, Treasury

I’m still under the weather with the after effects of a bad cold, so this won’t be a long post.

Treausry has long been a champion of New Zealand’s large scale non-citizen immigration programme, going all the way back to when the system was opened up in the earlier 1990s. But more recently, there have signs of some differences of view even within the organisation. in 2014, they published (consultant) Julie Fry’s working paper on migration and macroeconomic performance in New Zealand, which was a pretty sceptical, but careful, assessment of whether there had been any material gains to New Zealanders. Fry’s conclusion was that any gains had been “modest”. There was, I gather, quite a difference of view within the organisation as to whether the paper should even be published.

Treasury has also been on record as having some concerns about possible adverse labour market outcomes for lower-skilled New Zealanders from, for example, the big increase in the number of working holiday schemes New Zealand has signed up to. They noted, in a presentation released last year,

Our key judgment is that migrant labour is increasingly likely to be a substitute for local low -skill labour, and this is an impact that we should try and mitigate.

But they have remain upbeat about the potential contribution from genuinely highly-skilled immigrants.

And at the top of the organisation, the public view on New Zealand’s immigration from the Secretary to the Treasury, in a succession of speeches and interviews, has been relentlessly positive – and equally relentlessly devoid of evidence.

In the Treasury’s Long-Term Fiscal Statement released late last year they were apparently torn between creedal statements, and a grudging engagement with the evidence, notably a recognition that “we are not seeing the agglomeration effects we would expect from Auckland’s size and scale”.

So I was interested to see that in the Budget Economic and Fiscal Update last week, Treasury looked at a scenario in which the overall net migration inflows stay even larger for longer than Treasury’s central projection. As it is, their central projection numbers are already high: after growth in working age population of 2.4 per cent in the year to June 2016, they expect to have seen growth of 2.7 per cent in the year to this June, and 2.4 and 2.1 per cent increases for the next two years.

The scenario is as follows

This scenario illustrates the impact of higher migration on the economic and fiscal outlook when capacity constraints arise. In this scenario, net migration is assumed to remain around its current level of 70,000 per annum through to the end of the forecast period.

The results include

In this scenario, stronger population growth drives faster growth in household consumption, residential investment and business investment. Stronger domestic demand is reflected in faster employment growth. However, in the construction sector, it becomes increasingly difficult to access labour and materials. As a consequence, there is additional upward price pressure on construction costs, which leads to higher headline inflation. The policy interest rate rises earlier and the exchange rate is higher as monetary policy seeks to stabilise inflation.

So far, so conventional in many ways. This is the standard experience in New Zealand when there are large migration inflows. There is nothing here of the lines the Reserve Bank has been running for the last year or so, in which increased net migration somehow eases overall inflation pressures.

But what really caught my eye was the next sentence

Reflecting these conditions, growth in labour productivity, real wages and real GDP per capita is more moderate than in the main forecast.

They didn’t need to include that observation at all. The scenario would have made perfect sense without it. But here is the government’s premier economic advisory telling them – and us – that if net migration remains at current levels it would be expected to have detrimental effects on productivity (and wages). I wonder what the Secretary to the Treasury makes of that?

After all, it is not as if there has been much productivity growth for the last few years. Treasury uses a measure of GDP per hour worked that simply uses production GDP (I usually use an average of the two GDP measures in charts here). Here is what their measure looks like.

tsy productivity measure

No growth in labour productivity at all for the last five years (the last year’s drop is largely just a series break in the HLFS hours worked, consequent on survey question changes).

Perhaps coincidentally, that happens to have been the period over which we’ve had big increases in, and persistent very high levels of, net PLT migration (much of it a reduction in the annual outflow of New Zealanders). And, as I noted, the other day, on Treasury’s own estimates, there have been no economywide capacity constraints at play in that period – the output gap is estimated to have been (and still to be) negative. For enthusiasts for large scale migration, it should have been a good time for seeing lots of productivity growth.

For some reason, in their central forecasts Treasury expects quite an increase in productivity growth from about now. They never explain what (about the economy or policy) is changing that will end now the run of five years of zero productivity growth. These are their central forecasts (on page 6 here) for labour productivity growth.

Forecast annual growth in labour productivity, June years
2018	1.3
2019	1.9
2020	1.1
2021	1.1

Perhaps as puzzling, are their real wage forecasts. Even though Treasury expects the unemployment rate to fall, and the rate of productivity growth to accelerate, these are the real wage growth forecasts.

Forecast annual growth in real wages, June years
2017 (est)	0.0
2018	0.7
2019	0.6
2020	0.0
2021	0.0

Five years and a forecast growth in total real wages of only 1.3 per cent. It is enough to make one glad not to be in the paid workforce. Workers will surely be hoping that Treasury’s alternative immigration scenario – with those adverse productivity and real wage effects they talked about – don’t come to pass. (And I am a little surprised that no Opposition party seems to have pointed out how bleak the outlook for workers’ incomes is under the central Treasury forecasts.)

It would be interesting to have an updated honest and considered assessment from Treasury as to what our immigration policy is doing for New Zealanders. I suspect there is still a tension between the textbooks and the “ideology”, and the growing accumulation of reasons to doubt that, in these remote islands, in an age when personal connections matter more than ever, simply piling up more people here – many of the newcomers not even being that highly-skilled – is making us better off, not worse off. It is a strategy that is great for owners of business in the non-tradables sectors – more people means more demand – but not for the economy as a whole. Our living standards depend heavily on the ability of firms here to find ever more ways of successfully selling stuff to the rest of the world. That simply hasn’t been happening on anything like the necessary scale, and the absence of aggregate productivity growth is just one reflection of that.

I’ve written previously, and quite critically, about various speeches given by Gabs Maklouf, Secretary to the Treasury (including here, here, here, and here) . I continue to be surprised that we have someone that poor as head of the government’s premier economic advisory body – for that I guess we should blame Iain Rennie and the State Services Commission. It was perhaps even more disappointing that Makhlouf was reappointed for a further term earlier this year – for that both SSC and the Minister of Finance must surely be held responsible. And, since I assume he does have some strengths even if economic and policy analysis is not among them, I remain surprised that he does (is allowed to do?) so many on-the-record speeches. This year, for example, he has done many more public speeches than the Governor of the Reserve Bank, even though the Treasury’s prime role is to advise the government, while the Reserve Bank Governor has extensively discretionary policymaking powers affecting directly or indirectly a large proportion of New Zealanders. In some other countries – Makhlouf’s native United Kingdom for example – the Secretary to the Treasury is generally not seen or heard by the public.

There was another Makhlouf speech a couple of weeks ago, headed Growing our Economic Capital: Investing in Sustainable Improvement in our Wellbeing.

There is a lot in the speech I could comment on. There is the notion that “we are in a new era of policy frameworks and I’m proud to say the Treasury’s Living Standards Framework is at the forefront of economic thinking” – which would be laughable, if it were not that Makhlouf, head of the government’s principal economic advisory agency, appears to take this claim seriously. Bryce Wilkinson of the New Zealand Initiative wrote an excellent critique of the Living Standards Framework here (pages 6 and 7) , and I’m not going to try to improve on that piece.

And there is the rank cheerleading – that probably went over okay in the Beehive – in Makhlouf’s opening description of the economy

The New Zealand economy has been performing well over the past 4 years, relative to both the potential growth rate of the economy (of around 2.7%), and to most advanced economies. Over this period, our economic growth rate has averaged 2.8% while the average growth rate of OECD economies has been around 1.7%.

in which he goes on to suggest that the results are commendable, to be celebrated, and something to “feel good” about. And yet there is not even a hint of the fact that:

our population has been growing incredibly rapidly over that period, and so
per capita real GDP growth has been no better than the (disappointing) median of other advanced countries, and
our official data suggests there has been no growth at all in labour productivity for the last four years,

And all this on the back of 15 years of no growth at all in per capita real output of the tradables sector.

Sure, things could have been worse, but there isn’t much to celebrate. Makhouf included the unemployment rate is that list of good things, and yet his own department estimates that the NAIRU is now around 4 per cent, and the unemployment rate hasn’t been that low this decade.

Of course, I largely agree with Makhlouf that

We need to look as much to lifting the economy’s long-run average growth rate, one of the main sources of a sustainable increase in our collective wellbeing, as we do on worrying about whether the economy is operating at or close to its short term potential growth rate.

Indeed, one might think that the Treasury should put a lot more emphasis on how to lift long-term productivity growth. The short-term stuff is mostly the Reserve Bank’s job. And yet there is nothing at all in the speech, and nothing in anything else the Treasury has published, to suggest that the organisation has any real idea what it might take to reverse the staggering decades of relative economic decline in New Zealand. Instead, the Living Standards Framework seems to function in part to distract attention from that failure: providing robust advice to governments on how to reverse long-term relative economic decline has become all too hard, so we’ll burble on instead about bureaucrats’ personal agendas for how society and government should be organised. Hiding under that broad heading of “economic capital” that Makhlouf wants to build, for example, is “social capital (including culture)”. It is far from clear that the Treasury has anything useful to say on building culture, or that the views of its staff have any greater merit than those of the first 1000 voters in the Auckland telephone directory. That is what we have political processes for: Midwest evangelicals and New York liberals (and their New Zealand counterparts) have quite different and conflicting visions of culture and society.

There is also the staggering hubris and faith in governments (officials I suspect more than the elected ones) that pervades the speech. And, on the other hand, signs of an agency that (at least at its head) has totally lost sight of how prosperous stable societies develop and maintain themselves. I searched through the speech and the word “markets”, for example, appears only in reference to financial markets – nothing at all about competitive processes, private sector innovations (products and institutions) and so on. And, on the other hand, almost nothing on the limitations of knowledge that all of us face – perhaps governments most of all. Surely only a bureaucrat – and a not very introspective one at that – could say this

Government strives to take a system view. A system approach underpins the direction the public service has been moving in following the Better Public Services report in 2011. It reflects the fact that central government is well-positioned to observe and monitor the system dimensions that influence our collective wellbeing. It also has system-level instruments that can help make a difference, some of which are about devolving power and using the energy of communities.

At the centre, technology enables us to collect and share information on what various communities are doing to improve their lives. We also have the analytical capabilities to assess what works and does not, but we need to do the hard work of converting that potential into practical initiatives through appropriate investments in economic, environmental and social infrastructures.

The frightening thing is that he doesn’t seem chastened at all by the repeated failures, here and abroad, of well-intentioned government interventions in so many areas. In a week when attention focuses on the inability of central government to effectively operate something as relatively basic (and close to a public good) as a tsunami warning system, it is a reminder that we are really owed much more humility from our senior public servants. Rather than imperial visions of reshaping society, or even just championing yet more “smart active” interventions that all too often prove to be anything but, in part because too rarely do the advisers take into account that humans design and run these systems, not angels, we’d be better with a Treasury constantly focused on what governments can’t do well. Plenty of people criticise the 1980s and 1990s Treasury, but one thing the institution certainly knew then was that government failure was as pervasive as market failure, and that institutions had to be built on and around the limitations of flawed human beings. At least at the top of the organisation, that conception now seems long lost.

I could go on – I quite enjoy the occasional rant – but I wanted to focus specifically on some of Makhlouf’s comments about macroeconomic policy and financial regulation. Bear in mind that he has no known background in either subject.

He starts with the 2008/09 international financial crisis.

For example, one of the main events of the last ten years has been the global financial crisis. This was system failure par excellence. It showed us that a combination of placing too much weight on the wrong indicators, guided by mis-specified models, could lead to disastrous policy decisions being made in many countries and outcomes affecting millions of lives. These models ignored the critical role of financial markets and networks. The policy prescriptions they led to misjudged how complex systems work. They resulted in coordination and communication failures, among other things.

Which might sound impressive, but in fact there is much less there than meets the eye. No one seriously thinks that the limitations of formal macroeconomic models – typical models didn’t have an explicit financial sector – explain the crisis that hit several countries in 2008/09. Among other things, government agencies in countries that didn’t have domestic crises – New Zealand, Australia, and Canada among them – used exactly the same sorts of models. Having said that, you might have thought this paragraph would give Makhlouf pause for thought – if really smart people in governments around the world could get things so wrong (the British bureaucracy included, where Makhlouf held quite senior positions) what gives him confidence that things will turn out better next time? Limitations of knowledge are frustrating, but profound.

Makhlouf looks to the future

People are still trying to understand the lessons from the GFC. One area of learning which has had international attention is the critical role of better coordination of fiscal, monetary, financial and broader macroeconomic policies in order for those policies – whether fiscal, monetary, financial and broader macroeconomic – to be implemented effectively when one of them faces constraints. It can be the difference between a well-conducted orchestra playing a symphony and ninety disorganised musicians creating a cacophony. This area has been a focus of the G20 and IMF since 2008.

Maybe, but it is difficult to spot much visible change in how macroeconomic policy is conducted, or in how macroeconomic policy institutions are designed and organised.

What of New Zealand?

I should emphasise that New Zealand was one of the countries that coordinated fiscal and monetary policy effectively over the course of the GFC. Fiscal policy supported monetary policy through the crisis by being stimulatory when needed and then contractionary once the economy was recovering. But that doesn’t give us an excuse to cut class when experience delivers useful lessons and poses questions, including on policy coordination. And we should also make sure we learn the lessons of putting too much weight on simplified economic models.

Makhlouf wasn’t in New Zealand during that 2008/09 period. Perhaps that explains what is simply a mistaken description of how things worked here. In fact, New Zealand was one of the few advanced economies where there was no discretionary fiscal stimulus undertaken during the recession. On the assumption that the good times would last, and on explicit Treasury advice to that effect, the previous Labour government had been putting in place quite expansionary fiscal policies anyway, and by chance some of those measures were still taking effect when the recession hit, but there was no coordination on those matters across The Terrace. In my observation, the two agencies (the Reserve Bank on the one hand, and Treasury/Minister) got on well enough – and worked closely together on specific interventions like the guarantee schemes – but there was no fiscal/monetary policy coordination. Rather fiscal policy had set its medium-term course, and monetary policy took that into account in setting and adjusting the OCR with the aim of meeting thre inflation target. The system worked as it should – and it helped that New Zealand interest rates didn’t get to zero – but that isn’t the sort of thing people have in mind when they talk about policy coordination.

And – minor cosmetic changes aside – the legislation fiscal and monetary policy operate under today is the same as it was in 2008/09. If Makhlouf thinks something different is needed, he should tell us – and advise the Minister accordingly.

Makhlouf seems to favour change or – perhaps – just wants to sound as though things are different now.

Building on what I said earlier, my first example relates to the coordination of monetary, financial (including prudential) and fiscal policies towards not only keeping the economy operating close to its current growth potential, but doing so in a way that does not cause harm to the growth potential of the economy. Indeed it can enhance it.

International experience over the past 10 years and maybe more casts increasing doubts about the effectiveness and efficiency of monetary policy alone in managing the economy’s performance relative to its current growth potential when it is adjusting to a large structural shock. In fact, relying on monetary policy alone to do that job risks the longer term growth potential of the economy as well, by leading to the misallocation of resources towards investments such as residential investment that are comparatively less productive in terms of generating wealth and well-paid jobs.

It is certainly true that to the extent that some hubristic economists came to believe (consciously or otherwise) that serious recessions were now a thing of the past, they were simply wrong. And, of course, plenty of people are asking questions about whether there are better ways of running policy in relevant areas – although doing that well surely depends on a clear and compelling explanation for the 2008/09 recession and aftermath (without it, policy change risks being as unrelated to the causes of the problem as many of the post-Depression policy changes in the 1930s, here and abroad, were).

But if people are asking questions, what is surely striking is how little institutional change there has been in the years since that severe recession. As the Governor of the Reserve Bank often, and rightly, points out, no country has even switched from inflation targeting to some other nominal anchor. No country I’m aware of has made any material changes to institutionalise the coordination of fiscal and monetary policy. And although various countries – including New Zealand – have been making a bit more use of direct controls of bits of the financial system, it is hardly some integrated coordinated approach to policy – if anything, it looks a lot more like assigning a new tool to a new target. Some argue at present for tighter monetary policy in various countries even though inflation is low, in the belief that doing so would assist longer-term financial stability and growth prospects. But it doesn’t seem to be an approach that governments (or central banks) are signing on to. Of course people are dissastisfied with the economic outcomes globally over the last decade, but there isn’t any sign yet that greater macro policy coordination within countries is a material part of the answer.

I’m not sure what Makhlouf really thinks about inflation targeting. He has been on record suggesting that he doesn’t think major change in the PTA is warranted next year. But then it seems strange for the Secretary to the Treasury to be undermining a macroeconomic policy framework that has worked quite well for New Zealand – macro policy can’t solve long-term productivity problems, but we’ve avoided serious economic and financial crises for the 25 years of the current fiscal and monetary regime. That is something to appreciate.

And before I leave that section of Makhlouf’s speech, he talks about the risk that inflation targeting (in isolation?) can lead to “the misallocation of resources towards investments such as residential investment that are comparatively less productive in terms of generating wealth and well-paid jobs”. Just two points in response: the first is that houses are to live in, not to generate “wealth and well-paid jobs”, and second, surely everyone now accepts that one of the biggest issues – policy failures, but not macro policy – in New Zealand (and Australia, the UK, Canada, and large chunks of the US) is that far too few houses were built, on land made artificially scarce by regulation. We simply do not have a problem of over-investment in housing, however that concept is defined. Surely the Secretary to the Treasury knows this?

I could go on but won’t – tempting as his central planners’ approach to tourism is, for example. The overall quality is just depressingly poor. Lots of virtue-signalling, and little sign of really hard-headed analysis and engagement with the specifics of New Zealand, or the limitations of government.

In conclusion, Makhlouf observed

It’s about being prepared for the unknown unknowns. And I should add that part of this preparation is making sure our institutions are fit for at least the next 25, 30 or 40 years.

That sort of timeframe is probably unrealistic – elections come by every three years after all – and the deeper-seated institutions of our society and culture shouldn’t be lightly tampered with anyway. But it is hard not to be concerned that our Treasury is not now fit for even the next decade. Even a centre-left government – to whom things like the Living Standards Framework might be appealing – should expect (and will probably need) something more rigorous than seems to be on offer at present. Perhaps even more unsettling is that the weakness at the top of the Treasury don’t seem counterbalanced by strengths in any of the main economic policy or advisory agencies.