No big improvements expected

This afternoon brings the release of the Monetary Policy Committee’s latest Monetary Policy Statement and OCR decision.  Most commentators expect the Bank to cut the OCR by another 25 points.  I’m more focused on what they should do than on what they will do – the two can diverge for quite a while at times –  and I’ve been consistently clear that the OCR should be cut further.  If the MPC was wavering though, you’d have to suppose that they would want to avoid a second successive big surprise for markets which would –  rightly –  renew the focus on how poor their communications have been this year.

The last piece of data relevant to the decision was finally released by the Bank yesterday afternoon: their survey of the macroeconomic expectations of a few dozen supposedly somewhat-expert observers (of whom I’m one).   As I’ve noted already, this release once again gives the lie to the repeated Bank claims of how open and transparent they are: survey responses were due on 22 October, the Bank could easily have had them a couple of days later at most, and yet they held the information to themselves –  to no public benefit at all – until 12 November.  As for private benefits/costs, having the information in public on a timely basis might have spared poor Westpac from going out on a limb calling no change in the OCR, only to reverse themselves yesterday.   Market whipsawing, in the absence of data the Bank already had, serves no public benefit.

The expectations survey has been running, in one form or another (changing questions, big reductions in numbers surveyed) for more than 30 years now and provides a fairly rich array of data (although there are some important gaps –  eg immigration, the terms of trade – the Bank refuses to remedy).    We know that the surveyed expectations (mostly a quarter ahead, a year ahead, or two years ahead) aren’t in any sense accurate predictions about what actually happens in future.  But neither are the Reserve Bank’s forecasts (and that isn’t a criticism of anyone: forecasting is hard, shocks happen).   What they do provide is a useful read on how the somewhat-expert observer community sees things, in a reasonably internally consistent manner –  eg answers about GDP or unemployment are presumably done simultaneously with (recognising two-way influences) views on the future OCR or the future exchange rate.

The headline news –  well, only media coverage –  in yesterday’s release was the further fall in (mean) inflation expectations.  Two-year ahead expectations had fallen quite a lot in the previous survey, and there was no bounceback, just a further fall from 1.86 per cent to 1.81 per cent.   You wouldn’t want to make much of it –  dig just a little deeper and the median expectation didn’t change at all – but the absence of any bounce, especially coming on the back of the 50 point cut, explicitly linked to inflation expectations and a desire to keep them close to 2 per cent –  should still have disconcerted MPC members.

And these weren’t inflation expectations conditional on the OCR remaining at the current 1 per cent.  Instead respondents expect a 25 basis point cut today (median OCR expectation for the end of the year is 0.75 per cent) and a further cut next year.    And they still expect no recovery in medium-term inflation (and in financial markets themselves, the implied 10 year average inflation expectations –  the breakeven rate between indexed and nominal bonds – are still pretty close to 1 per cent, when the Bank’s target is 2 per cent).

Consistent with this, there is no rebound expected in economic growth either, whether as a result of things already in train or of those further expected OCR cuts.

expecs 19.png

No respondents expected a recession, although the lowest individual expected 2 year ahead growth rate was as low as 0.6 per cent.

There wasn’t much sign of an expected strengthening in the labour market either (although those series have been volatile and the survey was taken before last week’s labour market data were published).

What about overall monetary conditions?  The survey asks about assessments –  on a seven step scale – as of now, and expectations for (on this occasion) the end of March and the end of September 2020 (the latter roughly a year ahead),   “Monetary conditions” isn’t defined –  it is up to each respondent to factor in things considered relevant.   What was striking this time was the sharp increase in the proportion of respondents expecting monetary conditions to become “very relaxed”

mon con nov 19.png

I was left wondering what weight respondents were giving to tightening credit conditions (this chart from the Bank’s credit conditions survey, also released after the expectations survey was done)

credit 2.png

But whatever went into those “monetary conditions” answers, they weren’t producing an expected rebound in either growth or inflation.

In a speech a couple of weeks ago the Bank’s Assistant Governor ran one of his boss’s frequent lines bemoaning the risks central banks face if they simply follow short-term market prices (since those prices themselves include market implicit expectations of what central banks will do).  It was  –  and is – a real but overstated point.   But it is also where surveys of macroeconomic expectations are relevant and useful, not subject to the same critique.   This pool of respondents –  with no better or worse information on average than the MPC – expressed not just expectations for the OCR but for overall monetary conditions, and for economic activity and inflation.  So they factored in what they expect the Reserve Bank to do, and are (in effect) feeding back a collective assessment that it really looks, at best, like barely enough.  Who knows why: perhaps expected adverse world developments, perhaps more initial weakness here, perhaps a weaker transmission mechanism, but the data (expectations) are there for all to see.

Against that backdrop the MPC would really have to produce a quite compelling alternative narrative to justify not cutting the OCR further now, perhaps especially when there isn’t another review until February.

(As I’ve noted before, there is a rich amount of data in this survey not open to the public.  For example, on the OCR expectations question at least one respondent expected the OCR to be zero by September and another for it to be 1.25 per cent. It would be fascinating to see the –  one hopes consistent –  forecasts of each of those respondents and the stories that underpin them.  Reminding ourselves of the sheer uncertainty of the future, and the possible stories that might underpin such alternative outcomes, can be a useful discipline.)

Falling population shares: a highly-productive big city

Writing about Wales the other day I included this chart

wales 1

The comparable chart for Scotland is even more stark (16 per cent of the Great Britain population in 1801 and just over 8 per cent now).

But what really caught my eye when pulling together the numbers was this chart.

london 19.png

I guess part of my brain knew that greater London’s population had fallen for several decades, but that bit never quite connected with the bits thinking about world cities, agglomeration and so on and so forth.  London is one of the great world cities, a key financial centre in an age when capital is more mobile than it was for decades after the war.  There is no other really great city in the UK, the UK’s population hasn’t increased that rapidly by New World standards, and yet the share of the UK population resident in greater London is less now than it was for decades prior to World War Two (true even using the orange dot –  for which there is no time series – the estimate of the population of the (defined by contiguity of population rather than local authority boundaries) of the greater London urban area.

(As it happens, on checking one finds that the New York metropolitan area population is also lower now, as a percentage of the total US population, than it was several decades ago – I could only see data back to 1950.  But the US is different  –  there are multiple very large cities and the spread of air-conditioning greatly affected the liveability of many of those places.)

As you may recall from Saturday’s post, estimated GDP per capita in London is 188 per cent of that of the EU as a whole (and about 180 per cent of the UK as a whole).  The only other (Eurostat-defined) region that comes even close to London is (close to London) “Berkshire, Buckinghamshire, and Oxfordshire” (at 151 per cent of EU as a whole).

These have the feel of places where if more people were able to live there more people would be better off.  The whole of the UK might even be better off on average (a larger proportion of the population able to do more highly-productive jobs), even if the London premium over the rest of the country narrowed somewhat.

And yet, of course, as everyone knows London house prices are really expensive –  price to income ratios similar to those in Auckland (with incomes higher), typically for small houses and small sections.  You can tell similar stories about San Francisco/San Jose or New York (where GDP per capita are well above those of the US as a whole).   Rigged housing and land markets really seem to have visible consequences in pricing people out of working in highly productive cities.

Where the story is much less compelling is in Auckland (or Sydney or Melbourne). I wish it were otherwise –  I’m a strong supporter of land use liberalisation –  but

(a) on the one hand, the populations of those cities (urban areas) have actually increased very substantially as a share of national population (especially Auckland: 8.5 per cent of the population in 1901, and about 33.5 per cent now), and

(b) in none of the Australasian cities do the estimates for GDP per capita show up with any very substantial margin over the rest of the country (see, by contrast, London above).  People who just don’t earn that much (or produce that much) have found a way to live in those cities anyway.

Fixing the New Zealand urban housing markets is, or should be, a matter of dealing to one of the grosser injustices in our economic system, but it is far from obvious that there is a compelling case in issues around productivity and wider economic performance.  If anything, there are probably already more people in Auckland – and perhaps Sydney/Melbourne –  that there really are highly-productive opportunities that are either waiting for them now or would spring up were housing once again as affordable as it should be.



My 12 year old daughter has been teaching herself Welsh –  a recent birthday present was a good Welsh-English dictionary – we’ve recently been watching a rather bleak Welsh detective series together, and this year she has also become (unlike her father) a bit of a rugby (“rygbi” in Welsh apparently) fanatic so I promised her that if Wales made the World Cup semi-finals I’d do a Welsh-themed post.  That’s economics rather than rugby though.

One of the themes of much modern economics literature is things about cities, location, agglomeration, distance and so on.  According to Eurostat data, London has the one of the very highest GDPs per capita of any region in the EU¹.  The two largest cities in Wales –  Cardiff and Swansea –  are each less than 200 miles from London.  And yet estimated GDP per capita in Wales is only about 40 per cent of that in London and 75 per cent of that in the EU as a whole (71 per cent of the UK as a whole).  Productivity in Wales (GDP per hour worked) might be about that of New Zealand.

And yet Wales has much the same policy regime as London.  Much the same regulatory environment, same income, consumption, and company tax rates, same currency (and interest rates and banks), same external trade regime, same national government (and as I understand it the Welsh regional administration doesn’t have control of very much), and the same immigration regime.  Most of the people are native English speakers (even many of those who also speak Welsh).

Huge populations are free to move to Wales.  There are 66 million people in the UK who face no regulatory obstacles to doing so.  They could set up firms in Wales.  So –  for the moment –  could people in most of the EU, and all legal migrants to the United Kingdom (with no particular ties to any other UK region) could move to Wales.  It isn’t open borders but in practical terms it is much closer to it than almost any sovereign state.

And yet……by and large they don’t.  The population of Wales today is only 50 per cent larger than it was in 1900 and only about 5 per cent of the population is born outside the British Isles.  Here is the share of Wales in the total population of the Great Britain.

wales 1

Wales used to have things going for it: plenty of room for sheep (wool and meat were two of our big exports to the urban population of the UK), the world’s largest slate industry,  and coal (lots of it) and the associated iron and steel (the latter booming from the start of the 20th century) industries.

But not, it appears, very much at all these days.   There is some tourism, some electricity exports (to the rest of Britain) and, of course, a variety of other industries.  It all generates tolerable living standards. albeit supported by significant inward fiscal transfers.  Unemployment is low, and (by New Zealand or London standards) house prices are fairly low –  Swansea (second biggest city) has median house prices around $350000.  But people in the rest of the UK, migrants to the UK, and –  importantly – actual/potential entrepreneurs don’t seem to find it terribly attractive.  Perhaps it would be different if it were an independent country –  the Irish company tax regime is apparently eyed up by some. But as it isn’t, one gets a cleaner read on the pure economic geography effects.

It is interesting to wonder what might have happened to Wales if it were an independent country and, all else equal, had had control of its own immigration policy.  What if they’d adopted a Canadian or New Zealand immigration policy –  or something even more liberal –  20 years ago?   Since there are plenty of places in the world much poorer than Wales (or New Zealand), and Wales itself is a small place, presumably they’d have had no trouble attracting people –  at least modestly qualified people from places poorer, or less safe, again: China, India, South Africa, the Philippines (to name just four significant source countries for New Zealand).   Even if many of the migrants initially saw Wales as backdoor entry to England, if New Zealand’s experience is anything to go by (become a citizen here and you can immediately move to much wealthier Australia) most wouldn’t.  Presumably the Welsh building sector would have been a lot bigger, but it isn’t obvious that many more outward-oriented businesses would have chosen Cardiff or Swansea over London or Paris or Amsterdam, even with the rest of Europe more or less on the doorstep.

Tasmania is another interesting example.  Like Wales, it shares essentially the same  policy regime (taxes, currency, external trade, most regulation) with the sovereign country it is a part of, in this case Australia.  There is unrestricted mobility for people within Australia, and external migrants –  including those from New Zealand –  can as readily settle in Tasmania as anywhere else in Australia. Hobart always looks like a really nice place.

Oh, and the population share of the total country is also small.  But the fall in the population share has been much sharper than for Wales.

wales 2

People –  and firms –  could choose to go to Tasmania but, by and large, they choose not to.  It is, after all, quite a way from Melbourne, and you can neither drive nor take a fairly-speedy train.   And unlike Wales, Tasmania is close to nothing else: Cardiff is much to closer to Dublin, Paris, Brussels, Amsterdam or even Frankfurt than Hobart is to Adelaide or Sydney.  Perhaps even more than Wales, the economic opportunities seem to be mostly in the natural resources (and no big new developments there in recent decades) and a few niche industries that might be there because the founder happens to like living there.   GDP per capita in Tasmania is just under 80 per cent of the whole of Australia average.

One could also do an interesting thought experiment as to what might have happened if Tasmania had been an independent country and had its own immigration policy.  Even had they just adopted the same policy as Australia did, almost certainly their population today would be materially larger than it now is (Tasmania now has three times the population it had in 1900, while Australia as a whole has more like seven times the 1900 population).  Being even smaller than Wales they’d have had no trouble attracting people.   But –  even more so than for Wales –  you are left wondering how many more outward-oriented businesses would have chosen to stay based in little Tasmania (few enough outward-oriented businesses are based in even the big Australian cities).

Are there lessons for New Zealand.  Our population has increased almost sixfold since 1900. In that time, we’ve fallen from (roughly) the highest GDP per capita anywhere to somewhere badly trailing the OECD field –  and maintaining even that standing only by work long hours per capita.

wales 3

It looks great to the strain of “big New Zealand” thought that has been around since Vogel at least.  But to what end, for New Zealanders?

Think of one last thought experiment.  What say we’d agreed a completely common immigration policy with Australia and held that in place for the last few decades?  More or less exactly the same number of people would probably have come to Australasia in total, but what do we supposed would have been the split between Australia and New Zealand.   It seems only reasonable to assume that a much larger proportion would have gone to Australia (than did).  After all, even those who went to Australia had a choice of Tasmania if they wanted cooler climes and a slightly slower pace –  but, to a very large extent they didn’t.  And we know what New Zealanders themselves –  who had ties to this physical places –  were choosing over the last 50 years, as hundreds of thousands left for the other side of Tasman.

And had that happened –  and perhaps New Zealand’s population was 3 million not almost 5 million –  is it likely that any fewer market-driven outward-oriented businesses would be based here than are today.   The land, the water, the minerals and the scenery would all still be there.  And how much else is there?

As a best guess, if by some exogenous policy intervention there had been another two million people –  of moderate skills etc – put in Wales, or another half million in Tasmania, it is difficult to have any confidence that average real incomes in either place would be any larger than they are now.  Most probably, they’d be worse off –  as say, the residents of Taihape probably would be if some exogenous intervention put another 5000 people there.  Having put an extra couple of million people in New Zealand – more remote than Tasmania, much more remote than Wales –  and not seen the outward-oriented industries, based on anything other than natural resources growing – we might reasonably assume we (New Zealanders) are poorer as a result.

Smart people are almost always a prerequisite to high incomes, but globally the top tier of incomes seems to focused on industries located in or near big cities, near big population concentrations, or on (finite) natural resources.   You can earn a very standard of living from finite natural resources –  it is the edge Norway has over the rest of Europe – but it looks pretty insane to confuse the two types of economies (when you have no realistic hope of transitioning from one to the other) and spread natural resource based wealth much more thinly by using policy to actively encourage rapid population growth.

From a narrow economic perspective –  and it isn’t of course, the only one the matters – the best thing for people from a lagging economic performance area is to leave.  It is what people did from Taihape or Invercargill, from Ireland for many decades, and (more recently and on a really large scale) what people did from New Zealand as a whole.   Governments can mess up that picture. In a way the Welsh are fortunate to have a rugby team but not an immigration policy, at least had they had the misfortune to have had policymakers like New Zealand’s.


  1.  Technically Luxembourg tops the table, but since a very large chunk of Luxembourg’s workforce doesn’t live there the numbers aren’t particularly meaningful (sensible comparisons need to take account of all the  – typical modest-earning –  support services populations need/use where they live).

Prime Ministerial whimsy

Whimsy more than anything else this morning.

I’m no great Boris Johnson fan –  except perhaps as newspaper columnist and (presumably) after-dinner speaker –  but I am a fan of Brexit, and really hope (against hope) that he is able to make it happen, in a way that really sets the UK free of the European Union.  Between his own inconstancy and the opposition of much of “elite” Britain, what actually happens is anyone’s guess.  One possibility –  not inconsistent with any of the possible Brexit outcomes –  is that Johnson isn’t Prime Minister for very long at all. A vote of no-confidence could be lost.  An election could happen (and at present UK polls have the vote split four relatively even ways, in an FPP system).

I was once a close student of interwar British politics (as a geeky teenager I knew the make-up of every interwar Cabinet) and knew that Johnson’s only predecessor as a foreign-born Prime Minister, Bonar Law, hadn’t lasted long –  only 211 days in 1922-23.    But although Law had the shortest tenure for a very long time (only one other British Prime Minister since 1900 has served less than a year), he didn’t have the shortest tenure.   In 1827, George Canning last only 119 days (and then died) and his successor Viscount Goderich lasted not much longer, only 130 days.

And it was here that the contrast with New Zealand struck me.   We’ve had Premiers and Prime Ministers since 1856, 40 of them in total.   Here is the list of shortest-serving Prime Ministers.

Henry Sewell 13 days
Francis Bell 20 days
William Hall-Jones 57 days
Mike Moore 59 days
Thomas McKenzie 104 days
George Waterhouse 143 days
Daniel Pollen 224 days

Some were in the very earliest days (Sewell was the first Premier), but four of them were in the 20th century, one as recent as 1990.  (There were other people who served very short terms who also served longer terms –  Keith Holyoake in 1957 is the most recent example – so these statistics are for total time as Premier/Prime Minister.)

Why the difference?   I’m not sure.  For most of our history, our political systems look pretty similar –  up to 1950 we even had two chambers –  although they’ve diverged more recently (MMP here, the Fixed Parliaments Act in the UK).   At least since 1890, as the party system crystallised, we haven’t changed governments particularly frequently.  Perhaps a three year term makes a difference –  Mike Moore and Keith Holyoake (and John Marshall and Bill English who served a bit longer, but less than a year) each took office on the brink of an election.  But I suspect most of the difference must be more idiosyncratic.   For example, Hall-Jones and Bell took office (effectively as acting Prime Ministers, but legally as PM) when Seddon and Massey died in office. But when Savage and Kirk died in office, there was simply an acting Prime Minister until the Labour Party confirmed a new permanent leader.

It turns out that deaths in office is one of the things that distinguishes the UK record from New Zealand’s.  Seven UK Prime Ministers have died in office –  one assassinated –  but the most recent of those was in 1865 (Palmerston).  Others  –  including Law –  died just a few days after leaving office.   But in New Zealand the following Prime Ministers have died in office, all after 1865 – Ballance, Seddon, Massey, Savage, and Kirk (and none of them particularly old).   Ward died fairly shortly after leaving office.   So much for the young and robust new country….

In a similar vein –  and I did say this post was whimsical – look at how long British and New Zealand Prime Ministers have lived for.   James Callaghan and Alec Douglas-Home lived to 92, Churchill to 90, Edward Heath to 89, and Margaret Thatcher to 87.    All of them lived longer than anyone who has ever served as Prime Minister of New Zealand.   George Grey remains our longest-lived Prime Minister, and he died (at 86) in the 19th century (1898).  He is closely followed by Walter Nash, also 86, who died more than 50 years ago.  The next three – Robert Stout and the short-serving Bell and Hall-Jones – were 85 and 84, but they were (at minimum) almost a century ago, and we (rightly) make a lot of improving life expectancies.   If Jim Bolger lives for another two years, he will overtake Grey, but even then the UK will still have had five second half of the 20th century Prime Ministers who will have lived longer than anyone who has held office as Prime Minister in New Zealand.

And finally, reflecting on increasing life expectancies, improved health care, and renewed expectations of people working later in life, I was struck by this mini-table (like almost everything in this post, thanks to Wikipedia)


Nash was the most recent of those and he left office almost 60 years ago now.  The Brits also beat us for the oldest person to leave office as PM (Gladstone).

Not much about US politics appeals to me, but it is interesting to note the contrast with the US where age doesn’t appear to be such a barrier to (much more demanding) office, be it Pelosi (79), Trump (73), Biden (76), Sanders (77), Reagan (69 when he became President), Warren (70) or whoever.

The US does look a bit idiosyncratic –  but should it, given life expectancy etc? Perhaps there is still time for Don Brash (78)?

Modern monetary theory, old-school fiscal practice

On various occasions previously, I’ve used here survey results from the IGM Economic Experts panel, run out of the University of Chicago Booth School.   They survey academic economists in the US and Europe and the results often shed some interesting light on consensus, and difference, within the academic economics discipline.  As ever of course, much depends on how the questions are framed.

Their latest effort was not one of their best.  There were two questions.



Glancing through the individual responses, if there are differences among these academic economists they seem to be mainly ones of temperament (some people are just very relucant to ever use either 1 or 5 on a five point scale).

But so what?  No serious observer has ever really argued otherwise.

So-called Modern Monetary Theory has been around for some time, but has had a fresh wave of attention in recent weeks in the context of the so-called “Green New Deal” that is being propounded by various more or less radical figures of the left of American politics.  Primary season is coming.  The brightest new star on that firmament, Alexandria Ocasio-Cortez, has associated herself with the MMT label.

One of the more substantial proponents of MMT thinking, Professor Bill Mitchell of the University of Newcastle, visited New Zealand a couple of years ago.  I wrote about his presentation and a subsequent roundtable discussion in a post here.    We had a bit of an email exchange after he stumbled on my post, and although we disagree on policy, I was encouraged that he thought my treatment had been “very fair and reasonable”.  I mention that only so that in the extracts that follow people realise that I’m not describing a straw man.   I don’t know how Professor Mitchell would have answered the IGM survey questions above, but what I heard that day in 2017 should logically have led him to join the consensus.  That’s a mark of how useless the survey questions were.

He seemed to regard his key insight as being that in an economy with a fiat currency, there is no technical limit to how much governments can spend.  They can simply print (or –  since he doesn’t like that word – create) the money, by spending funded from Reserve Bank credit.     But he isn’t as crazy as that might sound. He isn’t, for example, a Social Crediter.    First, he is obviously technically correct –  it is simply the flipside of the line you hear all the time from conventional economists, that a government with a fiat currency need never default on its domestic currency debt.     And he isn’t arguing for a world of no taxes and all money-creating spending.  In fact, with his political cards on the table, I’m pretty sure he’d be arguing for higher taxes than New Zealand or Australia currently have (but quite a lot more spending).  Taxes make space for the spending priorities (claims over real resources) of politicians.  And he isn ‘t even arguing for a much higher inflation rate –  although I doubt he ever have signed up for a 2 per cent inflation target in the first place.

In listening to him, and challenging him in the course of the roundtable discussion, it seemed that what his argument boiled down to was two things:

  • monetary policy isn’t a very effective tool, and fiscal policy should be favoured as a stabilisation policy lever,
  • that involuntary unemployment (or indeed underemployment) is a societal scandal, that can quite readily be fixed through some combination of the general (increased aggregate demand), and the specific (a government job guarantee programme).

Views about monetary policy come and go.   As he notes, in much academic thinking for much of the post-war period, a big role was seen for fiscal policy in cyclical stabilisation.  It was never anywhere near that dominant in practice –  check out the use of credit restrictions or (in New Zealand) playing around with exchange controls or import licenses –  but in the literature it was once very important, and then passed almost completely out of fashion.  For the last 30+ years, monetary policy has been seen as most appropriate, and effective, cyclical stabilisation tool.  And one could, and did, note that in the Great Depression it was monetary action –  devaluing or going off gold, often rather belatedly – that was critical to various countries’ economic revivals.

In many countries, the 2008/09 recession challenged the exclusive assignment of stabilisation responsibilities to monetary policy.  It did so for a simple reason –  conventional monetary policy largely ran out of room in most countries when policy interest rates got to around zero.   Some see a big role for quantitative easing in such a world.  Like Mitchell – although for different reasons –  I doubt that.    Standard theory allows for a possible, perhaps quite large, role for stimulatory fiscal policy when interest rates can’t be cut any further.

But, of course, in neither New Zealand nor Australia did interest rates get anywhere near zero in the 2008/09 period, and they haven’t done so since.    Monetary policy could have been  –  could be –  used more aggressively, but wasn’t.

As exhibit A in his argument for a much more aggresive use of fiscal policy was the Kevin Rudd stimulus packages put in place in Australia in 2008/09.   According to Mitchell, this was why New Zealand had a nasty damaging recession and Australia didn’t.  Perhaps he just didn’t have time to elaborate, but citing the Australian Treasury as evidence of the vital importance of fiscal policy –  when they were the key advocates of the policy –  isn’t very convincing.   And I’ve illustrated previously how, by chance more than anything else, New Zealand and Australian fiscal policies were remarkably similar during that period.   And although unemployment is one of his key concerns –  in many respects rightly I think –  he never mentioned that Australia’s unemployment rate rose quite considerably during the 2008/09 episode (in which Australian national income fell quite considerably, even if the volume of stuff produced –  GDP –  didn’t).

On the basis of what he presented on Friday, it is difficult to tell how different macro policy would look in either country if he was given charge.   He didn’t say so, but the logic of what he said would be to remove operational autonomy from the Reserve Bank, and have macroeconomic stabilisation policy conducted by the Minister of Finance, using whichever tools looked best at the time.  As a model it isn’t without precedent –  it is more or less how New Zealand, Australia, the UK (and various other countries) operated in the 1950s and 1960s.  It isn’t necessarily disastrous either.  But in many ways, it also isn’t terribly radical either.

Mitchell claimed to be committed to keeping inflation in check, and only wanting to use fiscal policy to boost demand where there are underemployed resources.    And he was quite explicit that the full employment he was talking about wasn’t necessarily a world of zero (private) unemployment  –  he said it might be 2 per cent unemployment, or even 4 per cent unemployment.     He sees a tight nexus between unemployment and inflation, at least under the current system  (at one point he argued that monetary policy had played little or no role in getting inflation down in the 1980s and 1990s, it was all down the unemployment.  I bit my tongue and forebore from asking “and who do you think it was that generated the unemployment?” –  sure some of it was about microeconomic resource reallocation and restructuring, but much it was about monetary policy).   But as I noted, in the both the 1990s growth phase and the 2000s growth phase, inflation had begun to pick up quite a bit, and by late in the 2000s boom, fiscal policy was being run in a quite expansionary way.

I came away from his presentation with a sense that he has a burning passion for people to have jobs when they want them, and a recognition that involuntary unemployment can be a searing and soul-destroying experience (as well as corroding human capital).  And, as he sees things, all too many of the political and elites don’t share  that view –  perhaps don’t even care much.

In that respect, I largely share his view.

Nonetheless, it was all a bit puzzling.  On the one hand, he stressed how important it was that people have the dignity of work, and that children grow up seeing parents getting up and going out to work.   But then, when he talked about New Zealand and Australia, he talked about labour underutilisation rates (unemployment rate plus people wanting more work, or people wanting a job but not quite meeting the narrow definition of actively seeking and available now to start work).   That rate for New Zealand at present is apparently 12.7 per cent –  Australia’s is higher again.     Those should be, constantly, sobering numbers: one in eight people.      But some of them are people who are already working –  part-time –  but would like more hours.  That isn’t a great situation, but it is very different from having no role, no job, at all.  And many of the unemployed haven’t been unemployed for very long.  As even Mitchell noted, in a market economy, some people will always be between jobs, and not too bothered by the fact.  Others will have been out of work for months, or even years.   But in New Zealand those numbers are relatively small: only around a quarter of the people captured as unemployed in the HLFS have been out of work for more than six months (that is around 1.5 per cent of the labour force).       We should never trivialise the difficulties of someone on a modest income being out of work for even a few months, but it is a very different thing from someone who has simply never had paid employment.  In our sort of country, if that was one’s worry one might look first to problems with the design of the welfare system.

Mitchell’s solution seemed to have two (related) strands:

  • more real purchases of good and services by government, increasing demand more generally.  He argues that fiscal policy offers a much more certain demand effect than monetary policy, and to the extent that is true it applies only when the government is purchasing directly (the effects of transfers or tax changes are no more certain than the effects of changing interest rates), and
  • a job guarantee.    Under the job guarantee, every working age adult would be entitled to full-time work, at a minimum wage (or sometimes, a living wage) doing “work of public benefit”.     I want to focus on this aspect of what he is talking about.

It might sound good, but the more one thinks about it the more deeply wrongheaded it seems.

One senior official present in the discussions attempted to argue that New Zealand was so close to full employment that there would be almost no takers for such an offer.   That seems simply seriously wrong.    Not only do we have 5 per cent of the labour force officially unemployed, but we have many others in the “underutilisation category”, all of whom would presumably welcome more money.     Perhaps there are a few malingerers among them, but the minimum wage –  let alone “the living wage” – is well above standard welfare benefit rates.   There would be plenty of takers.   (In fact, under some conceptions of the job guarantee, the guaranteed work would apparently replace income support from the current welfare system.)

But what was a bit puzzling was the nature of this work of public benefit.    It all risked sounding dangerously like the New Zealand approach to unemployment in the 1930s, in which support was available for people, but only if they would take up public works jobs.  Or the PEP schemes of the late 1970s.   Mitchell responded that it couldn’t just be “digging holes and filling them in again”.  But if it is to be “meaningful” work, it presumably also won’t all be able to involve picking up litter, or carving out roadways with nothing more advanced than shovels.  Modern jobs typically involve capital (machines, buildings, computers etc) –  it accompanies labour to enable us to earn reasonable incomes –  and putting in place the capital for all these workers will relatively quickly put pressure on real resources (ie boosting inflation).   If the work isn’t “meaningful”, where is the alleged “dignity of work”  –  people know artificial job creation schemes when they see them –  and if the work is meaningful, why would people want to come off these government jobs to take existing low wage jobs in the prviate market?

The motivation seems good, perhaps even noble.  I find quite deeply troubling the apparent indifference of policymakers to the inability of too many people to get work.   The idea of the dignity of work is real, and so too is the way in which people use starting jobs to establish a track record in the labour market, enabling them to move onto better jobs.

But do we really need all the infrastructure of a job guarantee scheme?  In countries where interest rates are still well above zero, give monetary policy more of a chance, and use it more aggressively.   For all his scepticism about monetary policy, it was noticeable that in Mitchell’s talks he gave very little (or no) weight to the expansionary possibilities of exchange rate.    But in a small open economy, a lower exchange rate is, over time, a significant source of boost to demand, activity, and employment.    And winding back high minimum wage rates for people starting out might also be a step in the right direction.

And curiously, when he was pushed Mitchell talked in terms of fiscal deficits averaging around 2 per cent of GDP.  I don’t see the case in New Zealand –  where monetary policy still has capacity –  but equally I couldn’t get too excited about average deficits at that level (in an economy with nominal GDP growth averaging perhaps 4 per cent).  Then again, it simply can’t be the answer either.    Most OECD countries –  including the UK, US and Australia –  have been running deficits at least that large for some time.

It is interesting to ponder why there has been such reluctance to use fiscal policy more aggressively in countries near the zero bound.   Some of it probably is the point Mitchell touches on –  a false belief that somehow countries were near to exhausting technical limits of what they could spend/borrow.      But much of it was probably also some mix of bad forecasts –  advisers who kept believing demand would rebound more strongly than it would –  and questionable assertions from central bankers about eg the potency of QE.

But I suspect it is rather more than that –  issues that Mitchell simply didn’t grapple with.  For example, even if there is a place for more government spending on goods and services in some severe recessions, how do we (citizens) rein in that enthusiasm once the tough times pass?  And perhaps I might support the government spending on my projects, but not on yours.  And perhaps confidence in Western governments has drifted so low that big fiscal programmes are just seen to open up avenues for corruption and incompetent execution, corporate welfare and more opportunities for politicians once they leave public life.  Perhaps too, publics just don’t believe the story, and would (a) vote to reverse such policies, and (b) would save themselves, in a way that might largely offset the effects of increased spending.      They are all real world considerations that reform advocates need to grapple with –  it isn’t enough to simply assert (correctly) that a government with its own currency can never run out of money.

I don’t have much doubt that in the right circumstances expansionary fiscal policy can make a real difference: see, for example, the experience of countries like ours during World War Two.    A shared enemy, a fight for survival, and a willingness to subsume differences for a time makes a great deal of difference –  even if, in many respects, it comes at longer term costs.

But unlike Mitchell, I still think monetary policy is, and should be, better placed to do the cyclical stabilisation role.    That makes it vital that policymakers finally take steps to deal with the near-zero lower bound soon, or we will be left in the next recession with (a) no real options but fiscal policy, and (b) lots of real world constraints on the use of fiscal policy.  Like Mitchell, I think involuntary unemployment (or underemployment for that matter) is something that gets too little attention –  commands too little empathy –  from those holding the commanding heights of our system.  But I suspect that some mix of a more aggressive use of monetary policy, and welfare and labour market reforms that make it easier for people to get into work in the private economy,  are the rather better way to start tackling the issue.   How we can, or why we would, be content with one in twenty of our fellow citizens being unable to get work, despite actively looking –  or why we are relaxed that so many more, not meeting those narrow definitions, can’t get the volume of work they’d like  –  is beyond me.   Work is the path to a whole bunch of better family and social outcomes –  one reason I’m so opposed to UBI schemes –  and against that backdrop the indifference to the plight of the unemployed (or underemployed), largely across the political spectrum, is pretty deeply troubling.

But, whatever the rightness of his passion, I’m pretty sure Mitchell’s prescription isn’t the answer.

I don’t think advocates of MMT really help their cause by using the label Modern Monetary Theory.   I understand the desire to make the point –  pushing back against those too ready to invoke “but the market will never buy it” argument –  that countries issuing their own currency never need to default.  As a technical matter they don’t.  Politically, some still choose to do so, and even if they never do there are very real (if not readily observable) limits well short of default, where the costs and risks no longer make any benefits worthwhile.  Only failed states actually lapse into hyperinflation.

But in substance, MMT isn’t primarily about monetary policy at all, and as I noted at the start of the earlier post.

He is a proponent of something calling itself Modern Monetary Theory, but which is perhaps better thought of as old-school fiscal practice, with rhetoric and work schemes thrown into the mix.

One can mount a case for a more active use of macro policy to counter unemployment running above inevitable frictional/structural minima (I’ve made itself for several years), one can also mount a case for a more joined-up approach to fiscal and monetary policy (I’m not persuaded by the case, but it was standard practice in much of the OECD for several decades), and any politicians who doesn’t have a burning passion about minimising involuntary unemployment isn’t really worthy of the office.  At present, in much of the world, that should be driving officials and politicians to (at very least) be better preparing to handle the next serious recession, in particular by doing something (there are various options) about the binding nature of the effective lower bound on nominal interest rates.  It might not be a cause that resonates in Democratic primary debates, but it could make a real difference to the prospects of many ordinary people caught up through no fault of their own when the next serious downturn happens.   Whatever one believes about the possibilities of fiscal policy –  and I tend towards the sceptical end in most circumstances –  you’d want to have as much help from monetary policy as one could get.

Perhaps next time, those who write the IGM questions could consider something a bit more nuanced, that might shed some light on the areas where there are real divergences of view around the light that economic theory and analysis can shed on such issues.

UPDATE: A post here, by a senior researcher at one of the regional Federal Reserve banks, also responds to this particular IGM survey.

Brexit and UK economic performance

Flicking around the web yesterday afternoon I noticed this tweet from Matt Ridley (more formally the 5th Viscount Ridley), the British journalist, businessman and author of various smart books including The Rational Optimist: How Prosperity Evolves.  (Ridley was also formerly  –  from 2004 to 2007 when it hit the rocks –  chairman of Northern Rock.)

Ridley is reportedly strongly pro-Brexit.  In my book, that is to his credit (had I been British, I’d almost certainly have voted Leave too.  Then again, the next recession is likely to shake the euro and the EU itself to its very foundations anyway).

But it was the quote from the paywalled Telegraph article that caught my eye.  Those look like pretty impressive numbers, at least for the first 10 seconds until one realises that they are almost certainly total GDP comparisons and British population growth had been faster than that of most of the other countries of Europe.  And, of course, polling data suggests that was one of the factors that led to the Leave vote in the first place –  in and of itself, higher population growth is hardly a mark of Britain’s economic success, let alone a clear welfare gain for the British.

But it left me wondering how the UK had done on other, more relevant, economic comparisons. For example, growth in real GDP per capita and growth in real GDP per hour worked.   The euro was launched on 1 January 1999, so here are a couple of comparisons (using annual OECD data) for growth from 1998 to 2017.  The comparators are  the 10 older western European countries that are in the euro (excluding Ireland whose GDP numbers are messed up by the tax system, and don’t –  to a substantial extent –  reflect gains to the Irish, and Luxembourg) plus Denmark, which isn’t in the euro but whose currency has been firmly pegged to the euro since its creation.  I deliberately didn’t include the former eastern-bloc countries, partly because they joined the euro at various different times over the last 20 years and because something else more important –  post-communist convergence –  is going on there.)

First, real GDP per capita.

UK 1

and then real GDP per hour worked.

UK 2

It isn’t an unimpressive performance over that period as a whole, especially considering (a) all the hoopla at the time the euro was created, including from some trade economists, about the new economic possibilities, and (b) the UK productivity performance since the period encompassing the 2008/09 recession has been really poor (growth in real GDP per hour worked of only 2 per cent in total).   And, I guess, it is now more than two years since the referendum, and the real naysayers would have predicted a further worsening in UK productivty growth since then.

Of course, on the other hand, it is fair to point out that the UK is in the bottom half of these countries for its level of productivity.    On the OECD estimates, in 2017 only Italy, Spain, Portugal and Greece had lower average labour productivity than the UK.   But over the 18 years in the chart those laggard countries underperformed, while the UK did actually manage some convergence.

I don’t think these numbers themselves shed any real light on how the UK will do, in economic terms, relative to the rest of western Europe over the next decade or two (whether or not there is the brief, but perhaps initially quite costly, disruption associated with a “no deal”).  And it is interesting just how widely performance has diverged even among countries in both the commmon currency and the single market.   People make choices about nationhood, and how they want their country run, for a whole variety of reasons, and in most cases a few percentage points of GDP either way doesn’t weigh that heavily –  as I’ve pointed out previously, many post-colonial countries (notably in Africa, but including Ireland) underperformed economically after independence, but probably few really regretted the choice of becoming independent.   Brexit won’t change the twi n facts that the UK is a moderately prosperous country, nor the fact that –  inside or outside the EU –  it has productivity challenges, if it wishes ever again to be in the very front rank of economic performance.

I attended a lecture a couple of weeks ago by the historian and “public intellectual” Niall Ferguson.  He noted that he had supported Remain, for what seemed to be not entirely serious reasons (he is/was friends with David Cameron and George Osborne and thought they were doing a good job, and was himself going through a messy divorce and thought breakups were very hard).  But he had become frustrated by what he described as “the bleating, whining, grumbling of the Remainers” and suggested that he now supported Brexit for two reasons.  The first was that, in his view, the EU could only survive if it became more like a federal state (good luck with that) and the UK could never have been a part of such an entity.  And the second was a hope that Brexit would help the UK confront the fact –  captured in the data above –  that its economic challenges are there whether or not it is in the EU.

I was reading last night an 1882 lecture by French philosopher and historian Ernest Renan, titled “What is a nation?”.   It seemed relevant at present, emphasising as he does that nationhood isn’t about race or language, but about two things

One is the past, the other is the present. One is the possession in common of a rich legacy of memories; the other is present consent, the desire to live together, the desire to continue to invest in the heritage that we have jointly received. Messieurs, man does not improvise. The nation, like the individual, is the outcome of a long past of efforts, sacrifices, and devotions. Of all cults, that of the ancestors is the most legitimate: our ancestors have made us what we are.

A nation is therefore a great solidarity constituted by the feeling of sacrifices made and those that one is still disposed to make.


Nations are not eternal. They have a beginning and they will have an end. …..At the present moment, the existence of nations is a good and even necessary thing. Their existence is the guarantee of liberty, a liberty that would be lost if the world had only one law and one master. By their diverse and often opposed faculties, nations serve the common work of civilization. Each carries a note in this great concert of humanity, the highest ideal reality to which we are capable of attaining.

That makes sense to me.  As does, through all its challenges and mismanagement, Brexit.



The costs of Brexit

That was the theme of a presentation in Wellington on Monday, organised by the research institute Motu, by visiting British economist Richard Harris.  Harris is a professor of economics at the Durham University business school, but had apparently spent some time at Waikato early in his career.

The presentation was promoted as an update on the Brexit negotiations, seven months into the two year Article 50 notice period.  Of course, it takes not much more than a cursory glance at your British media outlet of choice to know that things are not going that well, not helped by the tenuous hold on office the current government has.   Competing agendas all round don’t help either.  Plenty of people in the British government –  and the Opposition –  didn’t want to leave.  For them, minimal change from the status quo would be the best outcome. But for those who actually favoured Brexit that solution would, understandably be anathema –  the goal for many of them was to restore the UK’s freedom of action to that of a typical sovereign state.    And on the other side, some countries face pretty bad outcomes if there is a hard British exit.  For others it isn’t much of an issue. For some it might even be an opportunity, to attract multinationals –  including in the financial sector – that have operations currently based in Britain.    And although everyone knows that rising trade barriers comes at a (likely) cost to all countries, the EU doesn’t want any other countries –  or regions –  getting the idea that leaving the EU was a serious option.

Harris’s presentation helped me see more clearly where the EU “divorce bill” demands are coming from, and put the numbers in some sort of context.  At present the UK pays a net 14.6 billion pounds a year into the EU, and the sort of numbers observers like the FT think the EU might accept are only the equivalent of two or three years’ “membership fee”, in a club that apparently operates five year budgets.  At present though, as the FT observes, a number acceptable to Brussels would be “deadly” in Westminster.

It was also interesting to see some numbers on how restrictions on trade between the UK and the rest of the EU would rise if there is no trade deal and the two sides fall back to trading on WTO terms.   On goods, tariffs would rise from zero at present to around 4.4 per cent on average.   On services, where barriers are mostly non-tariff, the restrictions would rise from a tariff-equivalent of around 2 per cent to something nearer 8 per cent.   In principle, the UK could offset this to some extent by securing early trade agreements with other countries –  including countries that the EU does not have deals with –  but good deals, with significant countries, aren’t likely to be secured easily or quickly.  As various commentators have noted, the EU-Canada trade agreement took eight years. New Zealand is already among several countries objecting to early EU/UK proposals to divvy up agricultural import quotas.

Even though there is a lot of talk about smoothing the customs barriers between the UK and rest of the EU –  including on the Ireland/Northern Ireland border –  to faciliate, for example, the value-chains in manufacturing that rely on the seamless movement of goods, there doesn’t seem to be any great optimism as to whether any of these schemes can be made to work well.   That matters, even more than to the UK, for Ireland in particular, which has a very large share of its trade with the UK (and not just with Northern Ireland).  The Irish have been making opportunistic bids to try to semi-detach Northern Ireland from the rest of the UK.

It was pretty clear that Harris hadn’t voted for Brexit, and didn’t support it now.  But he had a pretty hard-headed assessment: the decision had been made and there was no imaginable way it was going to be reversed.   He couldn’t see how effective deals could be in place in March 2019, and even talk of transitional periods beyond that had all sorts of (technical and political) problems.  He envisages a pretty “hard Brexit”, and is very gloomy as to how the UK will cope.

In fact, that was one of the odder aspects of his talk.  He presented a (familiar) chart showing that in the 20 years to 2007. British productivity growth had been faster than that in most other major advanced economies.  But since 2007 there has been no productivity growth at all in the UK.  No one quite knows why, or even how much of what we see might be measurement and how much genuine.  Performance has been poor recently, but that has nothing apparent to do with Brexit.

And yet Harris used this record to claim that if Britain was to take advantage of Brexit, it needed to have a high productivity economy to benefit from comparative advantage.  He said it twice, so it presumably was an intentional statement.  But Stage 1 economics students learn that everyone has a comparative advantage: economy B might be better at producing all sorts of different goods that economy A (that’s absolute advantage), but comparative advantage just tells you that economy A will nonetheless be occupied producing the things it is relatively less bad at producing.     Misunderstanding that point didn’t fill me with confidence in the rest of the presentation, although I’m guessing he just meant that one might be more optimistic about British economic outcomes –  in or out of the EU –  if it was managing decent productivity growth now.

Harris did present the results of a couple of modelling exercises that have been done on how large the real economic costs of Brexit might be.  They usefully highlight that the costs won’t just fall on the United Kingdom –  indeed, one of them envisages job losses (transitional presumably) twice as large for the rest of the EU as for the UK (the EU is of course much larger).    There are losses in this scenario because, even with full free trade with the rest of the world (which won’t happen any time soon), there are typically fewer profitable trade opportunities with places further away than with places close to home (one of NZ’s problems).

In one paper (by Vandenbussche et al), it is estimated that the level of British GDP will fall by 4.5 per cent in a “hard Brexit”.   What I hadn’t realised –  or thought about before –  is that Britain might not be the biggest loser.  In this particular model, Irish GDP would fall by almost 6 per cent, and that of Malta –  with close historic ties to the UK –  would also fall by 5 per cent.    If a 5 per cent loss of GDP seems large, no one really knows the likely absolute magnitudes. Harris quoted estimates from another study by Dhingra et al: they in turn had bad and less-bad scenarios, but the central estimate of lost GDP for the UK was around 2 per cent.

There is a pretty widespread view among economists that these costs, whatever the precise number, are both large and avoidable.  Of course, they might be avoidable, if Brexit was to free up Britain to adopt far-reaching microeconomic reform and liberalisation.  Sadly, that doesn’t seem remotely likely at present –  and of course, many of the costly restrictions the UK imposes now (eg land use restrictions) are entirely home-grown.

Instead, economic elites lament the choice to exit the EU and wish, longingly, that it could be reversed.  That sentiment is perhaps particularly evident in places like the IMF and the OECD –  and Harris cited quite a bit of material from the latter organisation, which has an institutional bias away from the national in favour of the multinational.

I suspect, by the tone of the questions, and the sympathetic murmurs when Harris made particular points, that there weren’t many people in Monday’s seminar who were sympathetic to Brexit.  I am.  Were I a Brit, I’m pretty sure I’d have voted for it –  although, in truth, I’m not sure I’ve ever voted in New Zealand for a programme that might reduce GDP per capita by 4 per cent.  But Brexit has just never seemed primarily like an economic issue, and that seems to be the difference between the public –  polls suggest they are still pretty evenly divided as they were last June –  and most economists.

And so I stuck up my hand and suggested that if we’d been doing this sort of modelling 60 years ago, as territories pondered the possibility of independence from Britain, the results would surely have shown that, for almost all of them, they would be worse off economically than if they’d stayed with Britain.  (And that modelling would never have allowed for the gross mismanagement that followed in many of the newly independent African countries in particular).  And yet if they had been presented with estimates of a 5 per cent loss of GDP, how many would have turned down the chance to be independent – to be free?  Even now, decades on, few probably regret the independence choice –  Somalis might be an exception.   The essence of my point of course was along the lines of why shouldn’t Britons today make a similar choice about the EU.  (And, of course, a 4 per cent loss of productivity sounds big, but it is the loss of 2 or 3 years productivity growth in normal times, invisible over a 50 year horizon.  Adding another week’s annual leave probably reduces GDP per capita by a couple of per cent.)

I’ve made this point here previously, but I was interested in how Harris was going to respond to it.  His response was to acknowledge that many Scots had certainly favoured independence, even at an economic cost – although of course they, like the Quebecois in the 1990s – decided to stay part of the larger country.  But then he fell back on avoidance, arguing that the issues were different for India or Zambia, as their cultures had been squelched by the British etc, and no one could suggest that anything of the sort could be said of Britain and the EU.  Had I had the chance of a rejoinder, I’d have noted that my points would have applied to the choices New Zealand, Australia, and Canada (and Ireland –  although the cultural issues were a bit different) had made to progress towards full economic and political independence.  It may well have come at a cost, but few then –  and fewer now –  will have regretted the choice.  And in all three countries the predominant population was English.  Probably few Slovaks regret their divorce from the Czechs.

Harris’s fallback was that “the EU was always only an economic club, and it remains an economic club”.      That was the conceit of many in Britain.  It was never the vision of the founders of the EU, or of those driving it today.  The very treaties envisage an ‘ever-closer union”, and even today newspapers such as the FT are full of talk of plans for closer banking or fiscal unions, even talk of an EU finance minister.   New entrants to the EU – although not Britain, Sweden and Denmark –  are obliged to commit to enter the euro.  And –  as a matter of conscious and deliberate choice –  being part of the EU means individual nations surrender the right to legislate for themselves in many areas.  That is a (lost, or foregone) freedom that many Britons seemed (and seem) willing to pay some price to reclaim.  If you don’t value the nation state –  or you aspire to some mega European state –  you’ll think that choice irrational.  But most people do seem to value the nation state –  and not just in the UK.    And the British exit polls last year suggested that it was just those sorts of “chart one’s own destiny” considerations that counted with those voting to leave.

Nearly half (49%) of leave voters said the biggest single reason for wanting to leave the EU was “the principle that decisions about the UK should be taken in the UK”. One third (33%) said the main reason was that leaving “offered the best chance for the UK to regain control over immigration and its own borders.” Just over one in eight (13%) said remaining would mean having no choice “about how the EU expanded its membership or its powers in the years ahead.” Only just over one in twenty (6%) said their main reason was that “when it comes to trade and the economy, the UK would benefit more from being outside the EU than from being part of it.”

In the end, who knows whether it will matter much.  All the modelling assumes that the EU itself carries on much as it is.  A pessimist – perhaps an optimist –  might wonder whether the EU itself will last in its current form for much longer.  Public opinion in other EU countries seems to ebb and flow.   The next recession –  whenever it is –  is just going to accentuate the tensions already apparent in many countries, given that few EU countries have any material “fiscal space” and the ECB is likely to go into the recession with interest rates already at or below zero.  Perhaps in the end Britain will prove to be a pathbreaker –  something the eurocrats and EU-oriented elites must fear very deeply.

Harris concluded with a couple of slides making the point as to how little trade New Zealand firms/individuals and those in the UK now do.   He was inclined to the view that, therefore, what happens around Brexit doesn’t really matter to us.   I’m not sure he is right there –  even setting aside wishful thinking about full free trade between us, including in agriculture.    Even in the transition, a disruptive hard Brexit is the sort of event that could –  in the wrong circumstances –  matter for the world economy in 2019.  And for a small country, looking to materially increase its export orientation, we should certainly be hoping that a country of the size and sophistication of the UK can make it –  and prosper –  alone.  If they can’t, it wouldn’t bode well for us.

Brexit, Trump and all that

Last week, The Treasury hosted a guest lecture featuring two visiting academics under the heading Brexit, Trump & Economics: Where did we go wrongOne of the visitors –  Samuel Bowles, now a professor at the Santa Fe Insitute -had been around long enough that in his youth he had served as an economic adviser in Robert Kennedy’s presidential campaign,  and at other times as an economic adviser to the Castro government in Cuba.  The other –  Wendy Carlin –  is a professor of economics at University College, London.

When the invitation went out, I was rather puzzled by the title?  Who was this “we” that apparently “got things wrong”?    After all, I was –  and remain –  keen on Brexit, and will recall for a long time the thrill of that June Friday afternoon as the results rolled in.  And if I wasn’t a Trump supporter, I wasn’t a Clinton one either.  There is a fascinating question as to how Trump became the Republican nominee, but once that had happened one of two unattractive candidates was going to become president.

“We” turned out to be economists.  And by getting things wrong, Bowles and Carlin didn’t mean simply getting eve-of-polling-day forecasts wrong (after all, that late in the day even some pretty prominent Leave figures didn’t expect to win).  Instead, economists were held to blame for these otherwise unthinkable, apparently lamentable, events occurring in the first place.  If only economists had done a better job, the deplorable events would never have happened.  Or so the story went.  The tone was one that surely no right-thinking person could have wanted such outcomes (Brexit was even described as a “gloomy event”).    As this was the second Treasury guest lecture in recent months deploring Brexit, I start to wonder if the organisation now has a quasi-official view (or perhaps it is just the British CEO)?

I’m still not entirely persuaded that either event –  Brexit or Trump –  is quite as earthshattering as the liberal elite seem to make out, or even that they are very closely connected.  UK voters chose to leave the EU by a margin of 52:48.  That is a large enough margin not to require recounts, but hardly an overwhelming margin.  And the same voters only a year early had re-elected (this time with an absolute majority) David Cameron and Conservative Party, on a not-remotely-radical platform.  And today, Cameron and Osborne are gone, and Britain still has a not-remotely-radical (perhaps only slightly more reforming than John Key) Conservative government, with a massive lead in the polls – albeit, the latter is as much about the problems with the Labour Party as anything else.  The government is charged with implementing Brexit, and there seems to be not the slightest sign of some turn inwards, or reversion to protectionism, on goods and capital flows.

Of course, if your vision was one of ever-closer-union, and a mental model in which there was only a one-way door to the EU, perhaps it is a great shock.  After all, if Brexit works more less okay, it might suggest to other countries’ citizens that there are reasonable alternatives to being part of the EU.  And that simply isn’t so radical –  after all, most of the world’s people show no interest in becoming citizens of multi-national superstates.  And the tendency of the last 100 years has been towards more sovereign states not fewer.  Lower barriers to international trade help make that possibility more economically viable.

And it is not as if the public in the United Kingdom has ever been very enthusiastic about subsuming sovereignty into some quasi-democratic entity based in Brussels.  The technocratic elites may have been enthusiastic, but the public seem never to seen anything very wrong about being British.  When your country has been free, and on the right side of the major conflicts of the last 100 years, it is hardly a surprising stance.  Citizens of Spain or Austria might see things differently.

I wrote a post earlier in the year about the fascinating polling data from the early 1970s I stumbled across in a book reviewing UK entry to the EU in 1973.    For all the talk that it was poorer, unskilled, older people who voted to Leave –  as if somehow that changes the character of the decisions –  in the early 1970s, when overall opinion was pretty closely divided on entering the EU, it was those same groups who opposed joining.  And of course the same people who were young in 1972, are old in 2016.  As I noted in that earlier post, what was striking from the polling data (comparing the early 1970s and the 2016 exit polls), is the change in attitudes among the more highly educated groups.    Among the AB group (professional and managerial occupations), in the early 1970s there was a huge margin (50 percentage points) in favour of joining the EU. In the 2016 exit polls, there was a margin of only 14 percentage points  (57:43) in favour of remaining in the EU.   Poor and unskilled changed their minds (as a cohort) less than did the more highly educated groups –  and those more highly educated groups became much more opposed to staying in the EU.

But for Bowles and Carlin, economists had failed the world.  They presented familiar data showing that most economists thought that Brexit would come at some economic cost (and of course, the great and the good –  the OECD, the IMF, the Bank of England, and the UK Treasury shared that view).  And yet the voters had the temerity to ignore these experts.   When I pushed them on the point, they did –  somewhat reluctantly –  accept that it wasn’t necessarily unreasonable for voters to make decisions on grounds other than economic ones (as I noted, most colonial independence movements  –  even the Irish one – probably came at an economic cost).  But it was a reluctant concession –  these were people who could really only see one end in view, less national sovereignty, more global rulemaking, and they could only lament the choices of British voters –  blaming economists for championing policies which had “made the backlash inevitable”.

(The second half the guest lecture was a presentation about a new approach to teaching introductory economics.  It looked quite promising, but the connection between a possible better approach to teaching basic economics and voters in future “being more willing to take advice from economists” seemed tenuous at best.)

As for the Trump phenomenon, I’m also not sure quite how big an event that should be seen as.    The last count I saw gave Hillary Clinton 48.2 per cent of the popular vote, and Trump 46.3 per cent.    Four years ago, the Democratic candidate scored 51.1 per cent of the popular vote, and the Republican candidate 47.2 per cent.   Presidential elections aren’t decided by national popular vote totals (any more than, say, UK parliamentary elections are) but these aren’t big shifts in the overall vote share.  Yes, the presidency changes hands –  as it was going to do anyway –  but a few hundred thousand votes in a few key states and things could easily have been different.  Are economists really to blame for the fact that the Democratic Party chose such a weak candidate –  who largely ignored many of those tight rust-belt states, despite the advice of her own husband?  And whoever is to blame for Wikileaks I doubt it is the economics profession?

In 1984 Ronald Reagan took 58.8 per cent of the popular vote, in 1972, Richard Nixon took  60.7 per cent, in 1964 Lyndon Johnson took 61.0 per cent and in 1956 Dwight Eisenhower took 57.4 per cent.  Those were landslides (in a New Zealand context, electoral landslides –  1972, 1975, and 1990 involved perhaps seven percentage point gaps in overall vote shares).   This was a very tight election, fought between two deeply flawed candidates.  And if Trump’s success may have helped some Republicans in the House and Senate, very few were campaigning on some Trumpesque policy ticket –  whatever the specifics of such a ticket might actually have looked like.  Like them or not, the appointees to the Trump cabinet announced so far, don’t seem a million miles from many of the sort of people who might well have been appointed to serve in any Republican president’s cabinet.  And being a democracy, parties tend to alternate in office.

What was pretty clear as the Treasury guest lecture went on was that the speakers were mostly just pushing a social liberal ideological agenda (as they characterised their concern it was about a “a revolt against liberal tolerance”.  Things were wrong when their side didn’t win and somehow –  weirdly – economists were to blame.  That isn’t just my interpretation of the event –  it was a proposition put to them at the lecture by Professor Jonathan Boston, himself proudly socially liberal.  What wasn’t clear was why our Treasury was aiding and abetting their cause.   (Or for that matter, how  the ascendancy  –  voted in by US voters, well aware of most of his flaws – of such a symbol of the decadence of modern culture as Trump even represents a defeat for the social liberal project.)

In passing, there was one truly fascinating snippet in the lecture.  Bowles is adamant that a much higher level of economic equality is “not hard to create” –  and he treats such outcomes as highly desirable.  According to his research, the level of economic inequality in modern Denmark and Sweden is about the same as that found in ancient hunter-gatherer societies.  It was almost worth venturing into town for the afternoon just for that.

In the same vein, I came across an interesting report from a conference held in the UK last month under the title “Brexit and the economics of populism”.  The conference was attended by a cast of 50 or so academics, journalists, and some leading market economists from across Europe.    There were some very able participants and it looks to have been a fascinating day’s discussion.  The 12 page conference report is well worth reading for anyone with an interest in Brexit, Trump, modern macro and micro policymaking –  and in the attitudes of the (non-political in this case) elites.

What was perhaps striking –  and this is the real link to the Bowles/Carlin lecture here last week –  is that there is no sign in the entire report that anyone who spoke had themselves been a Brexit supporter (even though 43 per cent of the ABs had favoured Brexit). The report captures one questioner noting that it is not unreasonable for people to vote on non-economic grounds, and that is about it.  And the report is full of references to those ill-defined and pejorative phrases “populism”, “xenophobia”, “nativism” and –  heaven forbid –  “nationalism”.  I had to look up “nativism” –  it isn’t a term that pops up much in New Zealand debates.  According to Wikipedia

Nativism is the political position of supporting a favored status for certain established inhabitants of a nation (i.e. self-identified citizens) as compared to claims of newcomers or immigrants

One might play around at the margins with the precise wording, but it looks like a definition that probably describes the overwhelming bulk of voters.  And there will be few elected politicians  (ie people who have actually persuaded people to vote for them) who seriously think that the interests of foreigners rank equally with the interests of citizens.

Next thing people will be having a go at “familism” –  the belief that the interests of one’s own family might rank more highly in one’s own concerns than those of other people’s families, domestic or foreign.

The conference report suggests participants thought governments needed to do better.  And, of course, there are areas in which that is no doubt true.  Often enough, that might involve avoiding hubristic schemes –  like the euro, or the EU on current scale –  in the first place.  Or respecting the principle of subsidiarity –  pushing decisions back to national governments (and perhaps even lower levels of government) whenever possible.  And respecting public preferences and choices.  And acknowledging the sheer limitations of the knowledge of experts in so many areas –  including economics.

But that wasn’t the focus of the attendees at this conference.  Instead, it was a recipe that seemed to have three broad dimensions:

  • a more active role for government, in particular in discretionary fiscal policy (as if debt levels in many of these countries were not already uncomfortably high),
  • putting more decisions at an arms-length from elected politicians (whether delegating more fiscal policy to independent agencies, or promoting international regulatory alignment), and
  • convincing the public that there really were significant benefits from large scale immigration.

In fairness, there was some recognition that dysfunctional housing markets are a major problem, but no speaker or questioner is reported as having favoured extensive land use liberalisation.  Instead, more roles for active government were in view.

The immigration stance, of course, caught my eye.  As the report writer noted there is an “academic consensus that wealthy countries benefit from migration from developing to developed countries”, but most of the comment was devoted to trying to play down the potential costs to relatively unskilled native workers.  I’m sure these people are quite sincere in their beliefs that there are benefits to advanced countries (and their existing citizens?) but I can’t help thinking that if the gains were that real, and it were that important an issue, the advocates would find it much easier to demonstrate the benefits (to the rest of us) than they do.  Perhaps quite often large scale immigration doesn’t do much harm to natives, but there isn’t much sign that does much good either.  In fact, support for large scale immigration –  whether in Europe or Australasia – is often more of an ideological proposition than one grounded in robust evidence.  It seems as much about a desire to change a society –  in ways which natives often don’t want –  than to lift overall economic prosperity for citizens.    (But in defence of the Europeans, at least no one in this conference is reported as advocating for immigration on the specious grounds –  invoked often by our business leaders and the incoming Minister of Finance –  that immigration is needed to fill “skill shortages”.)

If you got this far, you might be wondering what the point of this post was.  I feel somewhat that way myself. But it was partly about getting a few things off my chest, partly about passing along the link to the interesting conference report, and partly about thinking through my reaction to those who ominously go “could it –  Trump, Brexit –  happen here?”       Could what?  A couple of close votes  –  one of which leaves in place a very moderate centre-right government, and the other of which installs a President who seems to have very few fixed views.  In the specific sense, clearly not. We aren’t part of some multi-national entity like the EU, and our electoral system is very different from that of the US.  Then again, perhaps there could be a revolt against decades of economic underperformance, decades of elite indifference to that underperformance, and an extraordinarily high target rate of immigration which changes the character of the country without doing anything apparent to improve its economic performance.  It could happen, but frankly it doesn’t seem very likely right now.  Easier just to keep on pretending everything is fine.



NZ and the UK: strongest performers in their blocs?

An article in yesterday’s Herald caught my eye. In a double-page feature on Brexit, it was headed “Options beyond the EU” and featured some comments from the former New Zealand Minister of Finance, Ruth Richardson.  I was a bit puzzled by the article, which didn’t really seen like a New Zealand article, but wasn’t attributed to any foreign newspaper or wire service.  When I checked it out, it turned out that it was a backgrounder that had run as part of a series in the Telegraph three months ago looking “at four non-EU economies to see if they could provide a model for Britain’s post-Brexit future”.  One was New Zealand.   (The Telegraph had gone so far as to described Richardson as  a”great economic reformer”, although the Herald quietly deleted the “great”.)

Several passages interested me:

Ruth Richardson, a former New Zealand finance minister and a great economic reformer, believes there is a clear parallel between the two nations, and the choice that each will face. “When Britain decided to become very closely connected [with the EU], Britain was regarded as the sick man of Europe,” she says, with the UK “almost on the brink of the International Monetary Fund dictating policy” to it. Similarly, “when New Zealand decided to explore closer economic relations with Australia, we were clearly the sick man of Australasia”.

However, Richardson says, “nations ought not to be trapped by historical perspective”. She believes that the arguments behind a once sensible decision may have shifted. As in business, decisions over a country’s political future should be made on the basis of what will work best in the here and now, Richardson says.

Both the UK and New Zealand have risen to become the strongest performer in each of their respective blocs, and the reasons to pivot towards emerging markets have become clear.


A pair of radical politicians helped New Zealand through this difficult period. Richardson was the finance minister in a Right-of-centre National party government from 1990 to 1993, and her efforts, combined with those of her predecessor, the Labour party’s Roger Douglas, transformed the economy from one at the bottom of the pile to something far more dynamic.

Shaun Goldfinch, a New Zealand-based academic, says that the country moved from being “one of the most hidebound economies outside the former communist bloc, to among the most liberal in the OECD”.

I wasn’t entirely sure that I recognize the pictures being drawn here.

In both cases, it is a picture of economies transformed –  the UK and New Zealand having ‘risen to become the strongest performer in each of their respective blocs’ (the EU and the CER respectively).

The UK entered the (then) EEC on 1 January 1973.  The initial six members of the EEC had been France, (West) Germany, Italy, Belgium, Netherlands, and Luxembourg.  I’m going to ignore Luxembourg in subsequent comparisons, and focus on the five reasonably large initial EEC economies.

For the UK the path to the EEC was pretty slow.  The first de Gaulle veto had occurred in 1963, and the second in 1967.    Over the 1960s, annual UK inflation  was around 1 percentage point above the median of the five EEC countries.  In 1972, just prior to joining the EEC, that gap was 1.4 percentage points.   Things got a lot worse in the following few years, but even then there was only one year –  1975 –  when the UK had the highest inflation rate of these six economies. Italy was typically worse.

And in the 1960s, real GDP per hour worked in the UK is estimated –  using the Conference Board data – to  have been almost exactly equal to that of the median country of the EEC-5.  Britain’s unemployment rate had been slightly below the median of the unemployment rates of those other European economies.

Of course, Britain had its challenges –  economic, and the psychological/political hurdles of the end of empire –  but it was hardly a basket case.

And nor has it, very obviously, gravitated to top of class since then

Here is real GDP per hour worked.

uk gdp phw

The decline in Britain’s GDP per hour worked, relative to those of the EEC-5, ended in around 1980.  And it has gone almost exactly sideways ever since.   Of these five European countries, Britain now only matches the real GDP per hour worked of Italy.  In the other four countries, labour productivity is around a quarter to a third higher than that in the UK.  Perhaps entering the EU staunched the decline, but there were probably a variety of other factors including financial liberalization (financial services being a huge chunk of British exports), the Thatcher reforms, and the end of the post-war catch-up phase.  But……Britain now has a lower level of labour productivity than all but one of these five European peers: it does no better than 80 per cent of the median of these other countries.  Not exactly a “top of class” performance.

One area where they have done better is unemployment.  The following chart shows the UK unemployment rate and the median rate for the same five European countries.  It combines official current OECD data (on harmonized definitions) since 1983, and several years of earlier OECD data from their Historical Statistics: 1960-1988 publication.

uk unemployment rates

Over the last 20 years or so, the UK has clearly done materially better than these five European countries.  Each of the other five is in the euro, but that shouldn’t explain any difference given that these five countries include four of the larger euro-area economies.  But even among those other five countries, the Netherlands has typically had a lower unemployment rate than the UK’s –  although that isn’t so right now.

And what about the New Zealand/Australia comparisons.  Negotiations on the CER agreement began in 1979, and the agreement was signed in early 1983.  Given that there are only two countries in Australasia, I won’t dispute the description of New Zealand by then as the “sick man of Australasia”.  Our economy had been very severely hit by the post-1973 fall in the terms of trade.   The large outflow of New Zealanders to Australia really gathered pace in the 1970s.  Neither country was running macro policy –  or micro policy –  that well, but New Zealand was generally accepted to be lagging somewhat behind Australia.  We compounded the problems with the Think Big energy projects programme in the early 1980s, which temporarily boosted demand, but simply threw away some of the nation’s wealth.

But the story wasn’t totally bleak.  Our unemployment rate, while rising, had been consistently below that of Australia. And over the years when CER was being negotiated, New Zealand’s real GDP per hour worked was about 79 per cent of that of Australia –  alert readers might notice that that is about the same ratio as that between UK GDP per hour worked today and that of the EEC-5 (see chart above).

I’m not about to dispute that lots of worthwhile reforms were done here during the subsequent years.  And I think it is likely –  although hardly certain –  that CER was helpful to both countries (although trade diversion effects were probably material in some sectors).  And there are whole sectors of the economy where I think policy  in New Zealand could reasonably be judged better, at least in terms of encouraging resource utilization, than that of Australia.  The labour market is one of them –  we don’t need elections called on the ostensible grounds of breaking the power of corrupt trade unions.  I know some readers disagree, but I think our approach to retirement income policy is superior to Australia’s.  And I often like to mention that taxi industry, where deregulation has given us a much better outcome than Australia has.

But has it made us the strongest performer in our little two country bloc?  Not really.

Take the real GDP per hour worked comparison, again from the Conference Board.

nz au real gdp phw

The late 1970s were a very bad period, as reflected in these data.  But on this measure things improved a bit of the 1980s –  partly no doubt the unsustainable boom that bust after 1987 –  before tailing off again.  Today, New Zealand’s GDP per hour worked is a little worse, relative to Australia’s, than it was when the CER negotiations got underway.  Perhaps the exam paper was upside down when that “best in class” grade was being awarded?  Of course, both countries are richer, and more open, than they were back then, but Australia has kept on doing a bit better than us.

And a significant part of the liberalization and reform process in both countries was the opening to external trade (not just bilaterally).  Here is the data for exports as a share of GDP.

exports nz and ausNew Zealand’s export share of GDP hasn’t changed in 35 years.

Of course, there are some area in which we do better –  and we have the distinct attractions (to New Zealanders at least) of no snakes or crocodiles.  As I noted earlier, the labour market tends to be one such area.  Here are the unemployment rates for the two countries back to the 1960s (prior to 1986 the New Zealand data are estimates, but good enough to be used by the OECD).  I have taken account of the revised data Statistics New Zealand published earlier this week.

u rates back to 60s

Our unemployment rate has been below that of Australia most years since 1967.  Only on two occasions was our unemployment rate higher – the first episode was in the wake of the post-1976 share and commercial property crash, and the second was in the couple of years after 2009 when Australian commodity prices –  and the associated business investment boom – were at their peak.  We should, of course, welcome the fact that our labour market typically generates less unemployment than Australia’s does, but it is worth mentioning that the gap in our favour is smaller than it was pre-liberalization.

No doubt our economy is rather more “dynamic” than it was –  although it is fair to wonder quite what that words mean specifically –  but it isn’t obviously much more successful., not even relative to Australia.  Compared with the late 70s, both countries now have low and stable inflation –  but their inflation rate is nearer target than ours.  Both countries have low levels of public debt, but in flow terms at present our government accounts are roughly balanced while theirs are still in deficit.    We have a slightly larger reliance on foreign capital (larger net IIP position as a share of GDP) than Australia does, but perhaps they have a slightly more compelling story about the new business investment (tradables sector) that capital has financed.  Both countries have seriously dysfunctional housing markets – it is hard to tell which of two bad performers is worse.  Oh, and New Zealanders are still (net) moving to Australia, not coming home again.

It is election day in Australia.  I was amused when Malcolm Turnbull became Prime Minister and talked about wanting to emulate New Zealand’s approach to economic reform.  In the intervening period, there hasn’t been much sign of reform in Australia –  any more than there had been in New Zealand –  but for all Australia’s challenges, it has still managed more productivity growth in recent years than New Zealand has.

real gdp phw nz and aus

As I noted earlier, the United Kingdom has hardly been a top-of-class performer in Europe in recent decades.  The sobering thing is that over the last few decades, Australia –  with all its newly developed mineral wealth –  has managed to do no better on the productivity front than just about keep pace with the UK.  New Zealand, of course, couldn’t even manage that.

real gdp phw nz aus uk

If Britain is searching for lessons and models in a post-referendum world, New Zealand might offer a model of good intentions.  As for outcomes, not so much.








The End of Alchemy?

I’ve been reading recently a couple of books by former officials, the common theme of which is probably “avoiding the next collapse”.

Mohammed El-Erian spent much of his career at the IMF, and at one stage was even touted as an outside possibility to become Managing Director of the Fund (being Egyptian when people were trying to break the European lock on the job).  These days he works for Allianz, the big German insurance and asset management company, and previously ran PIMCO, a major subsidiary of Allianz.   I’ve always been a bit skeptical of El-Erian but picked up his book The Only Game in Town –  which a reader had kindly passed on  – with interest.   His key idea is that there has been too much reliance on central banks in the last decade to stimulate activity, and that countries need a wider range of policy responses, better targeted at the underlying issues, to get us back on a more sustainable path.

Initially it sounded plausible, and there is some interesting material in the book, but I came away unconvinced that El-Erian really had much of significance to add to the current debate.   A key part of his argument rests on the not-uncommon line that global monetary policy is incredibly stimulatory (the same line Graeme Wheeler runs here), which gives little weight to the idea that the neutral or natural rate of interest might have changed (fallen) quite substantially.  The fact that advanced country inflation is so low, despite the low interest rates, suggests there isn’t very much stimulation going on.  And there are external reasons to think that neutral interest rates have fallen –  notably the falling rates of population growth (involving less need for new capital) and the declining rate of productivity growth (also likely to associated with a reduced demand for new capital).  If so, central banks haven’t been the heroes of the last few years (as El-Erian’s tale has it), but rather bureaucrats sluggishly recognizing and reluctantly adjusting to the changing external conditions –  often enough champing at the bit to take interest rates back up to levels that might have been appropriate a decade ago, but simply aren’t now.

And yet in the index to  El-Erian’s book there are no references to neutral or natural interest rates (let alone Wicksell), and no references to demography or population growth rates.  In the text there are many more references to PIMCO than to productivity.

Of course, markets have often also been slow to recognize what has been going on  –  and probably no one has a fully convincing answer –  but most central banks deserve little of the praise El-Erian bestows on them.

Of course, his praise of central banks is partly a rhetorical device – a stick with which to beat governments, most of whom have done little in the way of structural reform in recent years.  But he doesn’t actually have much specific to offer on boosting productivity growth. And I’m also more than a little sceptical because of El-Erian’s enthusiasm for multilateral solutions (“the world needs to return to the wisdom of strong multilateralism’) –  perhaps a not unexpected enthusiasm from a former senior IMF official and quintessential internationalist.  In a book published only a few months ago, El-Erian laments the seeming inability of the EU to deliver on their “ever closer political union”: perhaps he might lament it, but few citizens of European countries seem to.  He can’t seem to face the alternative –  that the process might actually be about to head in reverse.    Perhaps even less relevantly, he calls for reforms of the IMF as key part of his list of desirable changes.  Whatever the answers to the current problems ailing the world, I find it difficult to see that:

  • giving the IMF more money
  • giving China more say
  • removing the European lock on the MD job, and
  • strengthening the ability of the Fund “to name and shame countries”

is a material part of the answer.  What legitimacy, one might reasonably wonder, might the IMF have?  What interests does it pursue?  And even if it had legitimacy, none of those measures are ever likely to materially change economic outcomes for the better.

But the main point of this post was to write about The End of Alchemy, by Mervyn King, the former Governor of the Bank of England.  It is a book prompted by the financial crisis of 2008/09, but it isn’t directly about that crisis.  It isn’t a memoir. King suggests that such books are “usually partial and self-serving” –  no doubt, but surely readers can compare and contrast and reach their own judgements (for example, I found his former boss, Alistair Darling’s account of the crisis very useful) – and reckons that future historians can have his account “when the twenty-year rule permits their release”.  Of course, British taxpayers can’t force former Governors to write a memoir, but when a longstanding Governor (including through the biggest crisis in modern times) of considerable intellect and capacity with the pen retires laden with state honours (Knight of the Garter and peer of the realm –  Lord King of Lothbury)  perhaps it wouldn’t have been unreasonable to have hoped for a bit more accounting for the crisis and his role in it.  Ben Bernanke’s book won’t be the last word on the US crisis, but the debate is better for it having been written.

Following the end of his Bank of England term, King visited New Zealand a couple of years ago, and I had the opportunity to participate in a couple of roundtable discussions with him at the Reserve Bank.  I wasn’t the only person who came away from those sessions struck by his reluctance to acknowledge any mistakes whatsoever.  Even tactically, after such a costly banking crisis and disruptive few years, one might have expected some minor concessions, but there was nothing. Senior people tend to look better, more credible and authoritative, for being seen to recognise that all humans –  even them –  make mistakes, even if just small ones.  It was, for example, no secret that in the years prior to the crisis King had had little or no interest in the financial stability functions on the Bank of England.

In many ways King’s book is much more ambitious than any memoir, and it is a stimulating contribution to a different debate: how should we best organize banking systems and financial regulation to produce the best long-term outcomes for the countries of the world.  It is quite ambitious in its reach –  both in the material he covers, and in audience he aims at.  It is explicitly not a book aimed just at economists, but at “the reader with no formal training in economics but an interest in the issues”.  I suspect the book will stretch such readers, but mostly in a good way –  even if I disagree with him in a number of areas, I’d recommend it.  There is a lot of context and background material that is often taken for granted (as well as fascinating bits of obscure history such as the monetary arrangements of French overseas territories in WWII), and King writes fluently and authoritatively.  The downside, perhaps, is that there is so much background, that King devotes less space to fleshing out the case for his alternative perspective than might have been desirable.

There is a lot of stuff in the book that I like.  King is very skeptical of central banks’ forecasting capabilities –  which, of course, didn’t stop him presiding over the development of the current forecast-based system at the Bank of England –  and has long been recognized as a sceptic of the euro.  He is one of the few senior (establishment) people in Europe willing to openly discuss –  and not deplore – the possibility of a break-up of the euro.

And some of his practical policy suggestions seem very much along the right lines.  Higher capital ratios for banks, with an important role for a more constraining leverage ratio (a tool used by most bank regulators, but eschewed by our own Reserve Bank), are appropriate responses to the high (demonstrated) risk that governments will bail-out failing banks, and to the limited ability of apparently-sophisticated capital models to truly capture the changing nature of the risks around complex credit exposures.  Higher required capital ratios, especially for large banks, come at little or no efficiency cost, especially in jurisdictions where the tax system treats debt and equity reasonably neutrally.    And higher liquidity requirements are a prudent part of any system in which, come a crisis, a central bank will act as lender-of-last-resort in the face of intense liquidity pressures.  Requiring banks to hold a larger proportion of liquid assets, so that they can’t just “force” central banks to lend on assets that are highly illiquid even in good times (which is what happened, including in New Zealand, in 2008/09), is a step in the right direction.  Most central banks have moved this way since the 2008/09 crisis, and market pressures have (for now) worked in the same direction.  King suggests that what has been done already is not enough.

But I’m still left uneasy about some key aspects of his argument.

For example, he puts a lot emphasis on the point that credit to GDP ratios are a lot higher than they were a few decades ago (although in places like New Zealand and Australia data suggest they may still be lower than they were in the 1920s).  In this context he discusses the possible contributions of falling real interest rates and a liberalization of domestic and international financial systems.  But in many countries, the largest single component of domestic credit is lending for housing.  And in many countries –  the UK and New Zealand among them –  it is now widely recognized that planning restrictions have created artificial scarcity in urban land supply, bidding the prices of urban land and houses.  Younger generations purchasing houses need to borrow more to buy such houses (in effect, borrowing from the older generations, including –  indirectly –  the sellers),  That raises the level of gross credit in an economy, and perhaps even erodes the financial stability of the system, but it is best understood as an endogenous response to the binding planning restrictions (especially in combination with population growth pressures), not as something driven out of the banking system.  And yet in a book of almost 370 pages there is no mention of this factor at all.    Perhaps banks have aided and abetted the rigging of urban land markets by governments, but the fault surely largely rests with governments not banks.

His historical account of the evolution of central banks, and particualry of the Federal Reserve, is entirely conventional, in playing up the number and severity of  the crises the pre-Fed United States experienced. But he doesn’t seriously engage with either the argument that the crises were themselves partly the outcome of the extensive regulatory restrictions the US had in place in those pre-Fed decades, nor with the experience of some other countries –  notably Canada – which operated for decades with no central bank and no systemic crises.  This isn’t the opportunity to review all the arguments and evidence on those issues, but on my reading King comes down far too readily on the side of the instability of the system –  perhaps with some of the zeal of a convert.

In many ways, Britain itself is a good illustration of the point. Prior to 2008/09, the last really serious systemic financial crisis in the United Kingdom was that prompted by the outbreak of World War One (an episode King discusses, and which is more fully dealt with here).  That crisis wasn’t really the result of any systemic weaknesses in the financial system –  rather governments suddenly changed the rules of the game, having more pressing geopolitical concerns in mind.  Even the crisis in the United Kingdom in 2008/09 was primarily the result of the troubled banks’ exposure to offshore markets –  loan losses on UK domestic banking books never posed a systemic threat.  The key offshore market, the US, was one that was highly distorted by other regulations.

King concludes his book thus

A long-term programme for the reform of money and banking and the institutions of the global economy will be driven only by an intellectual revolution. Much of that will have to be the task of the next generation. But we must not use that as an excuse to postpone reform. It is the young of today who will suffer from the next crisis –  and without reform the costs of that crisis will be bigger than last time.

But I simply didn’t find persuasive the claim that the costs of the next crisis will inevitably be bigger than the last one.  After all, in most countries the experience of the 2008/09 recession was much less severe than that of the Great Depression –  the last really big common advanced country crisis.  Perhaps this points to one of the other issues that King didn’t really address.  If the extent to which GDP per capita and productivity measures are today so far below the pre-crisis trend level is all down to the financial crisis itself, and the associated failings of the financial system, then perhaps King’s case gets stronger.  But he doesn’t make the case for that claim, and since the productivity slowdown was already underway well before the financial crisis, it isn’t necessarily an easy case to make successfully.

Since I got to the end of the book, the title itself has been troubling me.  King is careful to define his “alchemy”

By alchemy I mean the belief that all paper money can be turned into an intrinsically valuable commodity, such as gold, on demand and that money kept in banks can be taken out whenever depositors ask for it.  The truth is that money, in all forms, depends on trust in its issuer…..For centuries, alchemy has been the basis of our system of money and banking.

No one, surely, disputes the importance of trust in a market economy. But if there are distinctive characteristics of  the issue as it affects money and banking, the issues around trust aren’t unique to money and banking.  I trust that the food on sale at the supermarket hasn’t been poisoned.  If ever widespread doubt arises about the validity of that assumption, there will be serious economic disruption.   Perhaps we could prosper with a different banking system –  most practical alternative suggestions seem to me unlikely to make very much difference –  but the West has done quite astonishingly well with the one it has (notwithstanding the current mediocre decade).

And King simply does not seriously engage with the question of how government, bureaucracies, and “government failure” have given risen to some of the distinctive challenges around the banking system.  If, for example, a tendency to bail-out failing banks is a feature of the political system, if regulators tend too easily to see things from the perspective of the regulated, and so on, how confident can we be in the robustness of alternative policy models, which depend on the active ongoing decisions of a new generation of policymakers and officials?  I think King is partly right to describe the last crisis as not primarily the fault of particular individuals –  many of whom were responding to the incentives they faced –  but have the political and bureaucratic and market incentives really changed that much?     Would, for example, Gordon Brown (keen on promoting the City of London as a global banking centre) have appointed Mervyn King as Governor in 2003 if Mervyn King had been known to be all over the issue of financial stability and actively making the case for much tighter controls on banks and the banking system?   What is it that means those same incentives and constraints won’t be at work again as the memory of the last crisis fades?

King devotes some space to the debate as to whether monetary policy should be used to lean against asset price booms and the build-up of credit (or just focus on the inflation target, in the upswing, and after any bust).  This was a major debate at the Bank of England –  including at the Monetary Policy Committee level –  as far back as the late 1990s.  King seems to hanker for the “do something” camp –  that perhaps “doing something” with monetary policy might have led people to reassess their future income prospects earlier, and limited the extent of the imbalances that built up. Of course, as he recognizes there were problems. In a world of national policymaking, a central bank that tried to lean against the boom would tend to see a higher exchange rate, and in some respects a more unbalanced economy.

I’ve always thought that the other problem was that –  thankfully –  central banks typically have a rather constrained form of independence.  Had the Fed or the Bank of England –  or the RBNZ for that matter – tightened monetary policy materially more aggressively during the boom, the pressures on policymakers to change the target –  or the powers of the central bank –  would have been great.  In Britain, the inflation target is set each year by the Chancellor –  I find it scarcely credible that Gordon Brown would have welcomed a years-long undershooting of the inflation target he himself had set, and not just as a result of “forecasting errors”, but as a matter of deliberate policy choice.  Perhaps there is something in the old line about the job of the central bank being to remove the punchbowl just as the party is getting into full swing, but the actually the waiter can really only remove the punchbowl with the consent of the partygoers.  In the last boom, there was simply no appetite anywhere for materially tougher policies –  and no one knew the future, and many credit booms (even those of 00s) haven’t ended badly.  King rightly stresses the importance of “radical uncertainty”, but central banks and financial regulators are no more gifted with insight or fine judgement than the rest of society.  And they face institutional incentives, for good and ill, as the rest of us do.

King is clearly uneasy about the current low level of world interest rates. And in one sense, he is right to be so –  we all want to better understand the underlying forces that have delivered such interest rates (not just policy rates, but the extraordinarily low bond yields).   And it is also, clearly, correct that monetary policy is not an instrument that can generate the sort of faster long-term productivity growth that most countries would now welcome.  But to suggest, even if only implicitly, that somehow things would have been materially  better if only policy rates had not been held so low for so long seems more like wishful thinking than hard-headed analysis.  If he has such analysis, it didn’t make it into the book.

It is an interesting and stimulating book, well worth reading.  In a way it is shame that he overreaches.  His mostly-sensible actual policy recommendations do not, to me, seem to represent anything like the sort of transformation his title implies.  But nor, I suspect, is such a transformation needed.