Debt and deficits

The OECD’s latest Economic Outlook came out a few days ago. As always with the OECD, the value is rarely in the analysis or policy prescriptions, but mostly in the vast collection of more-or-less comparable tables, collating data for a wide range of advanced economies (and a few diversity hires).

Take public debt as an example. Next week our Treasury will be out with their HYEFU and more-detailed New Zealand numbers for central government. But there is no easy way of comparing Treasury’s New Zealand numbers with those for other countries. And so I tend to focus most often on the OECD series of “net general government financial liabilities”, which includes all layers of government, and doesn’t exclude things that particular national governments find it convenient to exclude (in New Zealand’s case, all the assets in the Crown’s hedge fund, the NZSF).

The OECD’s forecasts only a couple of years ahead, but that is probably about the most that is useful anyway, Here are their recent forecasts for net general government liabilities as a per cent of GDP (for the 30 countries they do these numbers for).

debt 2023

For New Zealand, the 2023 number is 14.82 per cent of GDP and on these forecasts we’d be 7th lowest of (these) OECD countries. There isn’t a forecast for Norway for 2023, but they have net financial assets of about 350 per cent of GDP, so call it 8th.

Going into the pandemic, our net general government liabilities as a per cent of GDP in 2019 was 0.8 per cent. (Including Norway) we were 8th lowest of these OECD countries.

That is a not-insignificant increase in net debt as a per cent of GDP. Between 2007 and 2012 – serious recession and the earthquakes – net general government financial liabilities were increased by about 12 percentage points of GDP. But, and on the other hand, in five good-times years (from 2002 to 2007) net general government liabilities as a share of GDP dropped by 23 percentage points of GDP.

Here is the cross-country comparison over time

gen govt liabs

I’m not suggesting we should be totally comfortable about that picture, but our net public debt is forecast to remain (a) low, and (b) much lower than the typical advanced country.

What if we break out the countries. Some argue (I’m not really convinced) that big countries, at least those with a history of reasonable government etc, can comfortably ran higher ratios of public debt than smaller countries. And, on the other hand, perhaps the countries most like New Zealand are the fairly-small places with their own central bank and floating exchange rate. Here are the relevant comparisions over time (medians in both cases).

gen govt small and big

The big countries – Germany excepted – really have been on a rising debt path. I’m not one who believes crisis and/or default is looming (generally – Italy remains a wild card) but were I a voter in one of those countries I’d be seriously uneasy. Were I involved in an opposition political party, I hope the high and rising debt would be made a salient political issue.

But – and generally – the small advanced countries have done pretty well (true on this sample of countries, or if one uses all the small countries – including those in the euro – in the database), and there has been (and is) nothing startling or particularly impressive about the New Zealand performance. If anything, one might note the widening gap at the end of the period.

Of course, none of this includes the fiscal challenges imposed by the rising NZS fiscal burden from maintaining the age of eligibility at 65 (although it is now a decade since baby boomers started turning 65) and the expected trend increase in public health expenditure….but I really can’t see public debt itself being a particularly salient issue in 2023.

But what about deficits? No one argues the government should have been running a balanced budget last year, and perhaps not even this year (given the renewed lockdowns and big output losses the government left itself open to), but why not 2023? These are the OECD’s projections – the primary balance excludes financing costs, and a common rule of thumb is that even a small primary surplus is consistent with keeping debt in check. “Underlying” captures cyclical-adjustment.

primary defs

In 2023, with the economy projected to be fully-employed (a reasonably significantly positive output gap), with a strong terms of trade, and (as ever) with some of the highest real interest rates anywhere in the advanced world, the OECD estimates that the government’s fiscal policy will see us in 2023 with a large primary deficit, a bit worse than the median OECD country. (Norway’s primary deficit is much larger, but remember that they have big net earnings (finance receipts) on the government’s huge net asset position.

Were one confident that spending initiatives were being ruthlessly scrutinised to keep waste to an absolute minimum, perhaps one might be a little less worried – although small structural surpluses, where spending is funded by taxes remains a good rule of thumb – but does anyone suppose that describes current New Zealand approaches to public spending.

I don’t suppose Ardern and Robertson are likely to let things get really out of hand. They seem oriented enough towards broad macro stability – in the traditions of all New Zealand governments of recent decades – even as they too watch our real economic performance decline, but at present the structural deficit picture (as the OECD interprets our data and policies) isn’t looking that good.

primary def nz

There should be considerable scrutiny on the government’s plans in the forthcoming Budget Policy Statement, and the Treasury’s HYEFU projections.

Reserve Bank people

There is a lot of personnel change going on at the upper levels of the Reserve Bank. It has been an ongoing process since Adrian Orr took office as Governor only just over 3.5 years ago. It seems to be the way with new public sector CEOs – clear out the previous lot, and then churn until you get the tolerable set of loyalists – perhaps compounded in Orr’s case by a reputation over the years for not tolerating dissent and really only welcoming true believers (or those who can simulate the appearance and live by the lies/rhetoric/spin). He seems to be in the midst of a second clear out….in under four years. Compare, for example, the senior management group in the first Orr Annual Report (2018) with the group Orr will have gathered around him by early next year (when recently announced departures take effect). There isn’t much overlap, and not one of the changes – I’ve seen – has involved people moving on to bigger and better jobs.

A couple of months ago it was announced that the Deputy Governor, Geoff Bascand, was leaving. Bascand is probably in his early 60s but there was no hint that he was retiring. I guess he was old enough that, if Orr gets a second term, he was never going to be Governor, and perhaps some mix of a bit more golf, some consulting, some directorships (and no more involvement in the trying Reserve Bank superannuation scheme) had its appeal, but on paper it looks like quite a loss to the Bank. Of the internal people on the Monetary Policy Committee (and it is an internals-dominated committee) he seems to be the most capable – thoughtful, fluent, and with the intellectual capability to churn out, say, a somewhat-respectable speech. Did he come to find working for Orr all a bit too much?

Who knows. But then yesterday there was a second curious departure from the upper ranks of the Bank, and the Monetary Policy Committee. And that brought to mind the Oscar Wilde line from The Importance of Being Earnest”, in whic Lady Bracknell remarks, “‘To lose one parent, Mr Worthing, may be regarded as a misfortune; to lose both looks like carelessness.”

The unexplained departure of one senior monetary policymaker might not be very interesting, but when two (of four) leave in quick succession, it looks like more of a story, and probably not one reflecting entirely well on the Governor.

The latest departure is Yuong Ha, the Bank’s Chief Economist, who has been in the role for less than three years (an Orr appointee) and is only about 45. The Bank’s press release gives no hint of what he will be doing next, suggesting that he does not know.

It was a curious appointment in the first place. Ha may have been a competent section manager, but had never been seen as one of the Bank’s thinkers or intellectual leaders (and surely the Chief Economist should normally have been where the MPC looked for such leadership). It was always possible that he could have surprised and stepped up in the role, but sadly it wasn’t to be. There were a succession of (often individually small) mis-speaks – my favourite was when he suggested in public that things like the LSAP couldn’t offer much, about 10 days before the Governor/MPC went all-in on their new and very expensive toy, claiming a great deal of effect. And in almost three years, he had not been allowed to do a single on-the-record speech, through some of the most difficult and turbulent times for monetary policy in quite some time. If Orr has now engineered his departure, it is probably for the good of the institution. But it doesn’t speak well of Orr’s judgement in having appointed him in the first place – especially as the vacancy arose only after Orr engineered the departure (by demotion, and then resignation) of Ha’s predecessor, John McDermott.

Of course, in the public sector one can’t just buy-out people you no longer want around, suggesting that some further restructuring has been used to achieve the outcome. McDermott was got rid of by creating a new rank between McDermott and the Governor, and (presumably) telling McDermott he wasn’t going to get the more senior one (the one that carried the title he already had). The Assistant Governor role is soon to be vacant – Christian Hawkesby having been appointed as Deputy Governor – so perhaps Orr is going to collapse the two jobs into one again, with Ha being given to understand he wouldn’t get the more elevated (direct report) position. We’ll see soon enough I guess (more adverts to follow after the raft of Assistant Governor positions advertised a month or two back).

But whichever way Orr goes, there are now two vacancies on the Monetary Policy Committee (and, which we’ll come to shortly, two of the three external members have terms which expire early next year). This is, supposedly, a very powerful and important statutory body, and you might hope for a bit more media and parliamentary scrutiny (there almost certainly would be if more than half the committee was potentially changing in the US or the UK). It isn’t as if there are outstanding candidates for the two internal positions – whether outside economists or internal people who buy their research or other intellectual leadership cry out to be appointed. And of course, anyone appointed has to be willing to work with and for Orr, independent thought discouraged. One possibility is that Orr (and the Minister) appoint the head of the financial markets department and the new chief economist, but who (really capable) will want the chief economist job is an open question.

For a serious, open, and accountable central bank, the first wave of external members of the MPC have been something of an embarrassment (for a Governor who wanted to keep control, and a Minister happy to go along, all has probably been fine). Not one of the three has given even a single on-the-record speech, and I’m pretty sure that among the three of them there has been only a single media interview. There is no transparency, no accountability, and little reason to suppose these three have added any value. One (probably the least qualifed for the role) was, so the papers revealed, appointed primarily for diversity reasons. The other two – Bob Buckle and Peter Harris – have terms that expire early next year. Buckle is the only one of the three with a focus on macroeconomics, but recall that Orr, Robertson and the Board chair got together to ban from the Committee anyone likely (now or in future) to be doing any active work or research on macro/monetary issue – one of the more ludicrous (if revealing) aspects of the entire RB reform process. Unless, the Minister – perhaps encouraged by Treasury – has had a rethink, presumably the incumbents will be reappointed. The title looks good on the CV, and the fees make reasonable retirement pocket money. But taxpayers and citizens deserve more and better. At present, not one of the remaining members of the MPC commands – and demands – respect as a key thought leader in a powerful independent government agency.

But it isn’t just the MPC and management where change is afoot. Parliament has recently passed amending legislation that means that from the middle of next year the current Bank board – a largely toothless beast, notionally charged with monitoring and holding management to account – will be replaced by a real Board, in which will be vested all the powers given to the Bank, other than those explicitly assigned to the Monetary Policy Committee. On paper, it is a step forward, and will finally put in end to the 30 years in which the Governor alone held huge discretionary policymaking powers. And the Bank wields huge powers, as policymaking agency in many areas of financial regulation (as well as implementing agency). The new Board – despite its primary focus being organisational and financial regulatory – will also be charged with the appointment of the Governor and the MPC members (subject only to ministerial veto).

Even the government and Parliament recognised that – on paper at least – they were handing a lot of power to these people, and in the new law there is explicit provision that the Minister of Finance can’t just appoint his mates, but must consult with other political parties in Parliament before making an appointment. They don’t get a veto, but the consultation requirement is presumably supposed to act as something of a dragging anchor.

Some weeks ago, with no fanfare, the first appointments were announced (or appeared well down a Bank web page). The Governor and these first three appointees are acting as a “transitional board” to oversee preparations for the new regime, but all three have been apparently appointed by the Governor-General, and presumably have been consulted on. Unfortunately, the three appointees are at least as underwhelming as the government’s MPC appointments.

The current Board chair, Neil Quigley (Vice-Chancellor of Waikato University) is staying on as chair of the new Board and the two other appointees are both professional director types, each with a long list of (present and past) directorships but no obvious expertise in the matters they are to be responsible for. There are, we are told, five more appointments to be made, but it is hardly confidence-inspiring (unless your model is one in which everything changes but everything stays the same, with all power in Orr’s hands). It doesn’t seem like good practice – and must be quite unusual now – to keep on a chair who has already done almost a decade on the Board, especially when that Board had a reputation for doing little but providing cover for the Governor.

But the bigger issue is that no one involved – management or Board – has any reputation for excellence as practitioner or thinker on these important areas of policy the Board will be responsible for. Take management. Orr and his new deputy (and head of financial stability) are both economists by trade. Nothing wrong with that of course, but to the extent they have wider experience it is solely in funds management (Orr as head of NZSF, Hawkesby a few years at a local funds manager). Neither has any real background in the core business of banking, or in regulation. And neither have any of the new Board members announced to date. Those with long memories might think of Quigley as something of an exception, in that earlier in his career he did some interesting (mostly historical) work on banking regulation, but…..that was probably 25 years ago, and in recent decades he has largely been an enterprising university manager, skilled at playing the PBRF game etc. It could have been a good opportunity to have found some really good people, including perhaps one from overseas, who could have added gravitas and standing to the new institution. A former top banker perhaps? A leading thinker on financial regulation? Instead, so far, we have a typical group of the sort of people who end up on all manner of government boards, supposedly playing a key role in setting an important area of policy, of appointing future key monetary policy makers, all with a management team that is underwhelming at best, and evidently subject to frequent churn. One can only wonder if any of the other political parties pushed back at all.

I write more about the Reserve Bank because it is the organisation (and policy areas) I know best. I don’t suppose the Bank is much worse than most other New Zealand government agencies, and perhaps it is unrealistic to expect it to for long ever be much better than the rest, but what a lost opportunity the expensive and longrunning reform process of recent years has been. The government could have laid the foundations for an excellent and highly-regarded institution. Instead, it seems only interested in the appearance of change, the shadow not the substance.

House and land prices

The local Wellington magazine, Capital, which seems to be a curious mix of the serious and the lifestyle, earlier in the year asked if I would write a piece on house prices. That article outlined the story I’ve run here repeatedly, that durable and very large reductions in house and land prices are quite possible – we see everyday examples in perfectly pleasant urban areas in the United States – but are only likely to happen if there is genuine aggressive competition among owners of land beyond existing urban areas. It is that sort of competition, from land whose best other use is probably for something agricultural in nature, that would durably lower land (and house) prices in existing urban areas.

That article ran in April. In late September the editor got in touch and asked if I was interested in doing another piece. Since there had been numerous policy announcements around housing this year – from the government, from the Reserve Bank, sometimes from the government to the Reserve Bank – I suggested that a piece along the lines of “sound and fury, signifying not much at all other than some new inefficiencies and distortions” might be in order. That article is in the issue on sale in Wellington now, and the text is here. I will include the full text at the bottom of this post.

I wrote the article four weeks ago. It isn’t quite the article I would write today because since then we’ve had the joint Labour-National announcement on new legislation that is being rushed through which will allow more intensive (but still relatively low-rise) development in existing urban areas of our larger cities, but appears to do nothing of substance to free up land-use beyond existing urban areas (and, as I noted in both articles, there is lots of undeveloped land in greater Wellington, much of it with little economic value in alternative uses). But if I’d write a slightly different article today, the bottom line does not change: there is no sign (from ministers, Opposition spokespeople, city councillors or whoever) that those who hold power have any interest at all in delivering much lower house prices on a durable basis. They refuse to express any such interest, and nothing they have done or are now doing seems likely to bring about such an outcome. Urban density may be all very well and good, for those who like that sort of lifestyle (and good luck to them), but the international evidence offers no example I’m aware of in which allowing much-greater density in cities has been followed by move towards house/land prices dropping back towards what we see in (typically quite low-density) cities in much of the US.

In the article I suggested that much of what had been announced this year was little more than “performative display” – doing stuff for the sake of being seen to act, seen to care. That seems right for most of the initiatives, since typically the supporting advice that has been published doesn’t suggest any likelihood of a sustained impact on prices. It is possible that the parties to the latest deal actually believe that this initiative might actually make a difference – partly because they have been cheered on by some people from the genuinely pro-liberalisation side of things. But even if they do believe that – and refuse to openly say so for fear of scaring some heavily-indebted voters – they are almost certainly wrong.

The second reason for scepticism I included in the article was this

The second clue is that prices have kept on rising, and at best are perhaps expected to fall back just a few percentage points over the period ahead (despite the huge increases we’ve seen). If people – smart people with lots of money at stake – really thought that the policy changes already made (tax rules, access to finance) or those in the works (such as the replacement for the RMA, or the National Policy Statement on urban development) were going to make an enduring difference, we’d see to
see it in the prices of the assets already. That is how asset markets work, whether stock markets, foreign exchange markets, or (a little more murkily) land markets. But there are no signs or reports of substantial falls, whether for existing properties or potentially-developable land

I still reckon that is basically right, but were I writing today I might put more emphasis on the possibility of quite a shakeout over the next year or two, even while the structural problems are unchanged. In a way, this is just the sort of point the Reserve Bank has been making in its discussion around “sustainable” house prices. “Sustainable” in their terms does not mean affordable, or US-style normal. It really just means where a market might be expected to settle given all the policy-settings and distortions in the system (that underpin land prices well above best alternative use price). One can see material, even significant, falls in house prices in such markets without the longer-term structural fundamentals being fixed at all. Such falls aren’t likely to last (and in New Zealand aren’t likely to pose a financial stability threat) but they could get the headlines for a time. Many of the falls in house prices that happened around 2008/09 were of that sort – whether those in San Francisco (now incredibly expensive), New Zealand (now incredibly expensive), or even Dublin.

Building activity in and of itself does not solve the underlying problem – land prices – but it can still lead to shorter-term overhangs in the market. There has been quite a lot of housebuilding going on.

Interest rates have risen and seem likely to rise further. A return to rapid population growth, from immigration, still seems some way off. The fiscal stimulus which has helped boost economic activity will be fading, and there are all those tax and access-to-credit restrictions. None of these address the longer-term problem of a rigged market that renders peripheral (developable) land incredibly expensive in a land-abundant country, but in combination they could be a recipe for a non-trivial fall at some point soon. Of course, prices ran up so much in the last year or so that even such a fall is unlikely to take prices back to real levels even two years ago, but…..falls of that sort would grab the headlines, and would probably lead some politicians to want to claim credit for having solved a problem they haven’t really even begun to address.

Without further indenting or block-quoting here is the full text of that article.

Lots of action, but none that will fix the housing market

Michael Reddell

(Published in Capital magazine, November 2021)

October 2021

Even before Covid, house prices in much of New Zealand were very high.  Over the last year or so they’ve again risen sharply almost everywhere, putting home ownership further beyond the reach of most, and underpinning rising rents.  This dreadful situation, transferring resources (wealth) from the relatively poor and young to the relatively rich and the risk-takers, is utterly unnecessary and deeply unjust. 

In a well-functioning market, times like these should be a renter’s dream.  Purchasing a house should never have been cheaper, and rents should be lower (in real terms) than ever.

That’s because interest rates are at record lows.  The New Zealand government’s 20-year inflation-indexed bond currently trades at about 0.8 per cent.  25 years ago the comparable rate was about 5 per cent.  Basic finance theory suggests that when rates of returns on one long-term asset fall so will those on other long-term assets. And in a well-functioning market, rents are the main source of return to the owner of the rental property.

But a well-functioning market is one in which it is easy to bring to market and develop new land and new houses. In that sort of market, developing the new land (building the new houses) would now be easier and cheaper than ever.   It takes time to develop a subdivision and build houses, and finance costs are one of the major costs those in that business face.   New Zealand has abundant land, that could readily be converted to urban uses. So, of course, does Wellington, and much of the land surrounding Wellington isn’t worth much in alternative uses.   But if regulations make land artificially scarce, then lower interest rates (or other sources of higher demand) can translate quite quickly into higher house/land prices.

The alternative isn’t just some theoretician’s dream.  When I wrote here six months ago, I highlighted Little Rock, Arkansas, as one example of the many growing, pleasant and highly-affordable US cities.  Real house prices in Little Rock hadn’t changed much in 40 years and median house prices appeared to be about NZ$300000.  Interest rates are at least as low as those here.  Check any website and you’ll easily find modern townhouses to rent in Little Rock for no more than NZ$1000 per month.   Try that in Wellington.

In a well-functioning market, when interest rates fall and prices look like beginning to rise, owners of land (whether existing sites in the city or new areas at the periphery) should be falling over themselves to get new land, and then new houses, to market, and owners of rental properties should be competing aggressively to get and keep tenants.  The alternatives would be a vacant property (earning nothing) or money in the bank (earning little more).

But this is New Zealand where, absent a well-functioning market, house/land prices have surged again, where rents have been rising, and where price to income ratios –  which should be less than 4 in well-functioning markets –  are now more like 10.

There has been all manner of policy announcements this year, some substantive and others little more than rhetorical.   The government has extended the “bright-line test”, so that investors selling properties within 10 years will pay a sort of capital gains tax, and – in one of the more bizarre moves – is legislating to stop businesses owning investment properties deducting their interest costs against taxable income.  A select committee is looked into new resource management legislation.    And, of course, some councils – including Wellington’s – are moving to allow some more intense development in some parts of the city.     Bureaucrats have got in on the act too, with renewed loan-to-value (LVR) restrictions from the Reserve Bank and the threat of more restrictions to come.  And the government has insisted that the Reserve Bank should talk more about house prices.

But there are two pointers that none of this amounts to much more than performative display. The first is that government ministers – from the Prime Minister down – refuse to express any interest in lower house prices.  Instead, they talk repeatedly about just lowering the rate of increase. Councillors, and Opposition parties, are rarely much better.

The second clue is that prices have kept on rising, and at best are perhaps expected to fall back just a few percentage points over the period ahead (despite the huge increases we’ve seen).   If people – smart people with lots of money at stake – really thought that the policy changes already made (tax rules, access to finance) or those in the works (such as the replacement for the RMA, or the National Policy Statement on urban development) were going to make an enduring difference, we’d see it in the prices of the assets already.  That is how asset markets work, whether stock markets, foreign exchange markets, or (a little more murkily) land markets.  But there are no signs or reports of substantial falls, whether for existing properties or potentially-developable land.

This year’s measures aren’t designed to fix the broken housing market, just to throw some sand in the wheels, be seen to be doing something, and perhaps to buy a bit of temporary relief.  Nothing done or promised is likely to make very much sustained difference at all, because none of it gets to the source of the problem.

Some put a lot of hope in provisions allowing for greater urban density – even as our cities are already quite densely populated by New World standards.  They are probably wrong to do so.   Increasing density has already been a feature of the last few decades – think of all the infill housing a decade or two back – and, of course, the physical footprint of our cities has also expanded.  But in the face of rapid population growth – likely to resume once Covid passes – these grudging changes have only been enough to avoid house prices rising sooner to even more outrageous levels.  

Without a radical freeing-up of land use at the periphery, creating aggressive competition between development options in cities and those at the margins, simply allowing a bit more densification will not bring land prices down. It may even bid up the prices of some sections, now able to be developed more intensively.  A lot of houses are being built right now, but there is no prospect of enduringly much lower prices unless or until owners of vacant land, on the peripheries of our city, are free to bring that land into housing and other urban uses.

New Zealanders should be able to count on a well-functioning housing/land market and ready access to finance.  Increasingly we have neither; just more complexity, more inefficiency, and more-unaffordable house/land prices.


USSR, Russia, and China

I’ve been reading a couple of books in the last week or so about the decline and fall of the Soviet Union (USSR). The first is Armageddon Averted: The Soviet Collapse 1970-2000, by Stephen Kotkin a Princeton historian who has since gone on to write an (as yet unfinished) three-volume life of Stalin, and the second The Struggle to Save the Soviet Economy: Mikhail Gorbachev and the Collapse of the USSR, by Chris Miller, another US academic historian.

Both are quite short, but for anyone interested in the era they are well worth reading. Kotkin’s book was first published in 2000 so really rather close to the events he was trying to make sense of (the revised edition I read dates from 2008), while Miller’s book is much more recent, published in 2016. Kotkin attempts to synthesise and offer an overall interpretation, while the Miller book draws deeply on Soviet-era archives, up to and including minutes of Politburo meetings. I found Kotkin interesting for a number of points, including the (obvious once you think about it) way in which this heavily armed behemoth, heir to hundreds of years of Russian imperial expansionism, dissolved so peacefully. He highlights the contrast, not far away and at much the same time, with the wars of the Yugoslav succession, but also with the unwinding of European empires a few decades earlier. Another point he emphasises is that the dissolution of the empire was, at least in part, a consequence of way the Soviets had set up their system. The tie that bound the individual republics (set up after the Revolution) together was not, so he argues, the central state itself (republics were not legally subservient to the central state) but rather the Communist Party, and once the Party’s monopoly on power was reduced/eliminated by Gorbachev there was little left to hold the Union together – other perhaps than brute force which by 1991 no one was willing to consistently use (not even those who staged the feeble coup of August 1991).

The Miller book was much closer to the usual concerns of this blog. It was a fascinating discussion of economic policy in the last years of the Soviet Union, with a particular emphasis on what the Soviets were learning from China. I hadn’t known how closely and carefully Soviet officials and scholars were studying the Chinese experiments with economic liberalisation after the late 1970s, or the extent to which (a) they were recognised as successful and (b) especially after 1985 were imitated. Miller also highlights how Soviet officialdom already knew what gains could be on offer from reform, from previous (abortive, short-circuited) experiments, including under Brezhnev in the 1960s. The macroeconomics was also enlightening – both the extent to which the Soviet Union had maintained macroeconomic stability and fiscal discipline up to the early 1980, but then the extent to which budget discipline was thrown to the wind in the Gorbachev years. That was partly bad luck – falling oil prices, partly the consequences of ill-thought-through initiatives (eg loss of tax revenue from the assault on heavy vodka drinking) – but much of it was in an attempt to buy off reluctance to reform from the powerful interests and patronage networks which – so Miller argues – by this time dominated the Soviet system (be it the agriculture sector, oil and gas, the military and the associated industrial complex or whatever. Miller argues that those around Gorbachev thought of this partly as a reasonable gamble – if they could materially accelerate growth, as in China, they could grow their way through the deterioriating fiscal (and hence monetary) position. It was not, of course, a gamble that worked, and the first few years after 1991 saw widespread economic chaos.

Miller argues that the strategy was never likely to have worked, and contrasts that with the experience in China. Why couldn’t it have worked? In the end, his claim reduces to the proposition that those who really favoured reform simply did not have the political clout to make it happen, even if one of those was the General Secretary himself. For decades after Stalin – under whose reign of terror many were shot, senior people were moved around frequently – the patronage networks (within which people often spent an entire career) were able to grow to become a force they simply weren’t in China (just after the further upheaval of the Cultural Revolution). Add to that things like the fact that life in the USSR was relatively comfortable in 1985, in a way that it hadn’t been in China in the late 70s. The imperative for change was much weaker, whether near the top, or at the grassroots (he contrasts the attitude to agricultural reforms of Chinese peasants and Russian farm workers). And there was the military, consuming a huge proportion of GDP in the USSR and reluctant to adjust, in contrast to the reduced military expenditure in China in the first years of economic reform.

There is one contrast between the USSR and the PRC that emphasises that in China the Communist Party kept hold on power and Russia it gave up power. For the CCP that is a clear victory (whatever it means for the Chinese people). But the other often attempts to tell a story about relative economic performance, with an emphasis on those first few severely disrupted years after 1991 in the (former Soviet Union) and, of course, the high growth rates the PRC continued to report for a long time. In this part of the world, New Zealand politicians and business people are nauseatingly prone to praising what they see as the economic success of the PRC (as if somehow this covers for the innumerable abuses of the regime).

China was, of course, richer than Russia for a long time. For not inconsiderable periods of history China was at least as rich – or richer – than anywhere on the planet. Russia never was. But here is the (rough) picture of GDP per capita comparisons for various years, drawn from the (widely-used) Maddison database.

russian and china

By 1913 – the eve of World War One – estimated GDP per capita for the “former USSR” (of which Russia is the largest chunk) was almost three times that of China. The “former USSR” in turn enjoyed real GDP per capita less than a third that of the leading bunch of countries (including New Zealand), and less than a third that of (say) France and Germany

By 1980 – several decades each of Communist Party rule – real GDP per capita was about six times that in China (as noted above, the starting points for reform were very different). China really was an utter basket case.

But where do things stand now, after decades of fairly rapid growth in China, and decades on from the chaos of the immediate post USSR period?

Here are the IMF’s estimates for real GDP per capita for the former Soviet Union countries and China.

former USSR

Even using these official numbers – and people like Michael Pettis will argue compellingly that GDP in China does not mean what it does elsewhere – China currently has real GDP per capita a bit less than Belarus, a bit more than Turkmenistan. The Baltic states are stellar performers but even authoritarian Russia, heir to all that 1990s dislocation, has real per capita incomes 55 per cent higher than those in China.

And what about labour productivity? The IMF doesn’t produce estimates for that, but the Conference Board does. Here are their latest estimates for the whole former Soviet bloc, and China.

former eastern bloc

China makes Belarus look really rather good, and on these estimates China is still lagging behind Moldova. The gap between China and Russia is huge and – as best as can be told from these estimates – Chinese productivity growth has slowed sufficiently it is no longer obvious they are even closing the gap.

Russia, of course, is hardly a stellar performer. You can see it even on these charts, and in GDP per capita terms it is still only about half the incomes earned per capita in France and Germany/

And then one last set of comparisons.

prod comparisons russia

China pales by comparison with all of these economies, even grossly-underperforming New Zealand.

There were things the USSR was able to learn from the PRC 40 years ago. But how to generate a high income country, that might match the material living standards in the West – a constant aspiration – was not then, and is not now, one of them.

Rising house prices do not make New Zealanders better off

I didn’t really read the housing section of last week’s Reserve Bank MPS – housing isn’t their responsibility and their analysis of it has rarely been up to much, often lurching unpredictably from one story to another. And their new material on house prices in each MPS only stems from the Remit change Grant Robertson foisted on them early in the year, knowing it would make no substantive difference to anything, but designed to look as though the government cared.

So it was only when the Herald’s Thomas Coughlan tweeted this chart yesterday that I noticed it.

RB house prices

The chart is prefaced with this text

The MPC sets monetary policy to achieve its inflation and employment objectives in the Remit. It considers the outlook for the housing market because house prices can influence broader economic activity, employment, and consumer price inflation (figure A5).

So we are presumably supposed to take this as the best professional view of the seven members of the Monetary Policy Committee. After all, it isn’t a throwaway line from a single member in an ill-considered press conference or interview comment. There is a bunch of different channels identified (and no obvious space constraints – they could easily have added more if they thought others were important), and nothing of substance gets into a Monetary Policy Statement without a fair degree of senior management scrutiny and review.

There are so many problems with this graphic it is difficult to know where to start. But perhaps first with the clear impression a casual reader would take away from this that the seven Robertson-appointed members of the MPC think that higher house prices are “a good thing”. After all, for most of the last decade inflation undershot the Bank’s target (unemployment lingered disconcertingly high for a disconcerting period of time too). More would have been better on both counts. Perhaps a charitable reader might wonder if the MPC really only had some short-term effects in view, but there is nothing in the substance of the chart or its title to suggest that.

And then there is the problem of the left-hand box: they start from “house prices” and “housing market activity” but these things never occur in a vacuum (as, for example, they would no doubt – and rightly – point out if they were talking about any other price (say, the exchange rate). Most often, surges in house prices (at least in New Zealand) have been associated in time with surges in economic activity driven by a range of different (policy and non-policy) factors.

But perhaps the biggest problem is with the claim – almost explicit in the top box of the second column – that higher house prices leave New Zealanders as a whole (remember, this is a whole-economy macroeconomic agency) better off. They don’t.

That they don’t, in principle, is easy enough to see. Everyone in the country needs a roof over his or her head. If I need a roof over my head for the rest of my life, ownership of one house meets my housing consumption needs. What matters is the shelter services the house priovides not the notional value the house might be sold at. Whether my house is valued today as $0.5m (roughly what I paid for it years ago), $1.75m (roughly what an e-valuer site tells me it is worth today) or $3.5m makes not the slightest difference to me. I still want to consume the bundle of services (location, size, sun etc) that this particular house provides.

Now, I might feel differently if I had a large mortgage: after all, negative equity gives the bank the right to foreclose (which can be both expensive and inconvenient), and even if the bank didn’t foreclose (mostly they don’t) it might also make it impossible for me to buy a similar house elsewhere if job opportunities suggested a move.

But this is where one needs to step back and think about the population as a whole. To a first approximation, for every apparent winner from higher (national) house prices there is a loser and for most – perhaps especially middle-aged owner occupiers – it makes no difference at all. There is no more economywide purchasing power created. And real gains that accrue to some people are offset by real losses to others. Owners of rental properties really are better off when real house prices go up. After all, they don’t own houses to live in them, but mostly for the profit they expect to make and the future consumption opportunities for themselves and their families. They can realise their gains and move on, or simply borrow against them.

But on the other hand, there are a lot of people made materially worse off by higher house prices – the people who don’t own a house now who either want to buy one in future or who are, and expect to, keep on renting. Consider someone just graduating from university who, a few decades ago, might have expected to buy a house after a couple of years working. But with real house prices in New Zealand as they are now not only does the deposit requirement push back any feasible purchase date, but the total amount of the lifetime income of the young graduate will have to devote to house purchase costs is so much greater. (Of course, real interest rates are lower than they were decades ago but recall that in the Bank’s scenario we are just thinking about house prices.) Earnings that are (eventually) used for the acquisition of a house can’t be used for other things. Earnings saved now to accumulate a deposit are not spent.

The story isn’t so different for long-term renters since in the medium-term (the adjustment isn’t instantaneous) if house prices are higher one can expect rents to be higher (than otherwise). In latter day New Zealand that has taken the form of rents holding up, or rising a bit, even as real interest rates have fallen a lot, which would otherwise have been expected to lower rents. Earnings spent (and expected to be spent) on rents can’t be spent on other things.

What (mostly) happens when house prices rise is that purchasing power is redistributed – usually towards those who have (houses) and away from those who have not (houses). Of course, it is further muddled by things like the Accommodation Supplement which shifts some of the losses onto the Crown……but that only means that taxes will be higher than otherwise in future. There is no net new purchasing power for society as a whole. (Were one inclined to an inequality story one might note that wealthier people tend to have lower marginal propensities to consume than poorer people.)

Are there possible caveats to this in-principle story? The story I used to tell was that, in principle, we might be better off from higher house prices if we all sold our houses to foreigners (at over the odds prices) and rented for the rest of our lives. But it was a story to illustrate the absurdity (and marginal relevance) of the point, and that was before the current government made such foreign house-buying illegal.

I’ve told you an in-principle story. The Bank likes to claim that the data don’t back this sort of story, And it is certainly true that there will often be a correlation between increases in house prices and increases in consumer spending. But that is mostly because – as I noted earlier – in the real world something triggers house price increases, and that something is often strong lift in economic activity and employment (in turn with triggers behind those developments). When the economy is running hot – and especially when land supply is restricted – buoyant demand, buoyant employment, rising wage inflation, increased turnover of the housing stock, and surges in house inflation are often happening at the same time. And in recessions vice versa. It isn’t easy to unpick chains of causation in the data.

Since higher house prices do not add to the lifetime purchasing power of New Zealanders as a whole, the Bank’s wealth effect story has to rest largely on some sort of view that households are systematically fooled by the house price changes. It is possible I suppose, at least the first time prices surge, but it doesn’t seem very likely. It isn’t as if surges in house prices – nominal and/or real have been uncommon in modern New Zealand.

The Bank also sometimes likes to highlight a story (it is there in that graphic) that even if the population doesn’t feel any wealthier, rising house prices might also boost consumption – at least bring it forward, without boosting lifetime consumption – by easing collateral constraints. In principle, a bank would lend even more to me secured on the value of my house than they might have done a couple of years ago. But again my ability to borrow a bit more has to be set against the reduced ability to borrow of the young graduate who now has to save even more in a deposit to get on the (residential mortgage) borrowing ladder at all. Sadly, in today’s bizarrely distorted housing market, we often find parents with freehold or lightly-indebted houses gifting or lending money to children, net effect on consumption probably roughly zero. With real house prices surging to fresh highs each cycle for decades now, it doesn’t seem that likely that many people are very collateral constrained.

For years I’ve been running a commonsense test over the Bank’s claims. This chart is of New Zealand real house prices

house prices aug 21

This series ends in December last year, so as of now we can probably think of real New Zealand house prices being four times what they were in December 1990 (I chose the starting point because that quarter was just prior to the 1991 recession getting underway, but you can see that real house prices hadn’t moved much for several years).

These are huge increases in real house prices, some of the very largest (for a whole country) seen anywhere over a comparable period (notably a period in which productivity growth was underwhelming). Were there to be much to the Reserve Bank’s wealth effects story (or its collateral constraints story) at the whole economy level mightn’t one have expected to see consumption as a share of national income rising, savings as a share of national income falling?

Of course there is all sorts of other stuff going on, but this is a really big – unprecedented in New Zealand – change in real (and nominal) house prices. But here is consumption as a share of national disposable income, back to the late 80s, just before house prices began to surge. The data are for March years.

consumption and NDI

The orange line is private sector (households and non-profits) consumption, while the blue line adds in public (government) consumption spending.

Of course, there are cycles in the series. There are two peaks, during the two big recessions (1991/92 and 2008/09): consumption tends (quite rationally) to be smoother than income. There is quite a dip in the early-mid 2000s, which can readily be shown to line up with the really big surpluses the government was running at the time – the country was earning a lot of income, but the Crown was temporarily sitting on a disproportionate share of that income.

And what of the house price booms. There were three during the period in the data (so not including the last year) – the few years running up to 1996, the period from 2003 to 2007 (particularly the early part of that period), and the period from about 2013 to about 2016. There is nothing in the consumption/savings data over those periods that would surprise someone who didn’t know about the house price surges.

And across the period as a whole, at best consumption has been flat as a share of income over 30 years of unprecedented house price increases. Looked at in the right light perhaps it has even been trending down a bit (private consumption as a share of income was as low in the March 2020 year as it was 16-17 years early when not only was the Crown running huge surpluses but real house prices were much lower.

I’m not suggesting any of this is definitive but when there is (a) no reason to think that New Zealanders as a whole are any wealthier when real house prices rise, and (b) no sign over decades in the macroeconomic data of the sort of effect the Bank likes to talk up, it might be safer to conclude that the effect just isn’t there to any meaningful macroeconomically significant effect.

Of course, as noted earlier there are all sorts of short-term correlations, typically resulting from common third factors at work, but the story the Bank seemed to be trying to tell in that graphic was neither representative of the economy as a whole, nor helpful.

The line I’ve run in this post is not new. In fact, 10 years ago now the Reserve Bank itself published an article in its then Bulletin discussing many of the same issues, and suggesting very similar sorts of conclusions (with, of course, 10 years less data). I was one of the authors of the article but – as was the norm – Bulletin articles carried the imprimatur of the Bank, and were not just disclaimed as the views of the authors.

Perspectives on New Zealand immigration policy

Several years ago the Law and Economics Association hosted an event in Wellington in which the New Zealand Initiative’s Eric Crampton and I each told our stories about New Zealand immigration policy. My account is here, and a link to the talk I gave is here.

A few months ago a couple of Victoria University of Wellington academics responsible for a Masters class (in a programme I didn’t even know existed (Masters in Philosophy, Politics and Economics)) invited us to do something similar for their class. We did that today.

My text (a bit fuller than what I actually used) is here (if Eric chooses to link to his slides on his blog I will include a link) (UPDATE: link here). My focus was solely on the economic dimensions of immigration policy, and in particular on the implications for economywide productivity (as the best proxy for whether large-scale policy-led non-citizen immigration has been beneficial for New Zealanders). My focus was primarily on the long-term programme, and entirely on the situation in normal times (ie I was not addressing the current Covid mess, which reflects poorly on the government but has no necessary connection to the appropriate medium-term approach).

My approach tends to start from a series of stylised facts about New Zealand’s economics performance in recent decades. This was the list I used this time.

But first, the gist of my story, which starts from a set of stylised facts about our economy.  Most of them are not in contention, even if the meaning and implications are debated:

  • New Zealand’s productivity growth has continued to languish, and even after the reforms of the 80s and early 90s (including a return to large-scale immigration) there has been no narrowing of the gaps. We’ve fallen further behind Australia, and increasingly behind central and eastern European OECD countries.  It would now take a two-thirds lift in the level of productivity to catch the OECD leading bunch,
  • Foreign trade as a share of GDP has stagnated, and this century has gone backwards. This in the new great age of globalisation,
  • New Zealand’s exports have remained overwhelmingly reliant on natural resources (whether agriculture, tourism or whatever).
  • Consistent with this, the rapid growth areas in our economy have been the non-tradable, not internationally competitive, sectors,
  • Also consistent with this, our real exchange rate has remained high, even as productivity has declined relative to other countries over decades,
  • Even as real interest rates have fallen, they have remained persistently higher than those in other advanced economies,
  • Business investment as a share of GDP has been weak (OECD lower quartile),
  • Indications are, globally, that if anything distance has become more important not less, with high value economic activity increasingly clustered in big cities near the major markets of the world,
  • Unlike what we see in the US and Europe, GDP per capita in by far our biggest city isn’t much better than that for the country as whole – if anything the gap has been narrowing.
  • Over the last few decades, no country has aimed to bring more migrants (% of population) than New Zealand did – although Canada and Australia have come close to matching us, and Israel too.   
  • OECD data show the NZ migrants also have the highest average skills levels (but still a bit behind natives) of migrants to any OECD countries.

Not one of the expected economywide benefits of a large-scale immigration promotion policy has shown up. Not one.   And we aren’t five years into this experiment, by 25 to 30.

I stepped through my standard arguments for why large scale immigration here may have been damaging to our medium-term economic performance. I noted that of the handful of OECD countries that have tried anything on the scale of New Zealand’s experiment (Canada and Australia and – in a slightly different context – Israel) none stands out as a productivity leader, and yet very little of the literature on the economics of immigration looks specifically at this group of countries. What isn’t always appreciated is that New Zealand has much more experience of large scale immigration and emigration (the latter, of nationals) than almost any other country – the sustained outflow of natives has been a thing since at least the mid 1970s, while our governments have actively promoted large-scale non-citizen immigration for all but about 15 years since World War Two.

When we’ve considered the economic performance over recent decades of the active immigration-promoting countries, and the countries experiencing outflows of their own people, the ball should really be in the court of the pro-immigration economists to show us, concretely, where and how large-scale immigration is lifting the productivity and incomes of the natives.   That is particularly so in New Zealand, given the disadvantages we can enumerate in advance – distance and continued natural resource reliance – and the signal implicit in the decades-long outflow of natives.

I talked about a number of other problems, and (in particular) gaps, in the existing literature before ending with this conclusion.

There might be all sorts of reasons for favouring high immigration – better ethnic restaurants[1], defence, a liking of big cities, or trains. If your country has prospered greatly, you might be happy to share the gains widely.  But the economic case for large scale immigration, as a way of boosting the productivity outcomes for natives in already advanced economies[2], looks thin at best.  Not many countries have run the experiment in modern times, notwithstanding the models that are claimed to support such an approach.  New Zealand has been at the forefront – actively promoting large scale immigration for all but 15 years since World War Two.  Unfortunately, New Zealand has had the worst relative economic performance of any advanced economy over those decades – we haven’t just come back to the pack, but now languish well down the rankings, have led the GDP per capita tables just 100 years ago (when abundant land, small population, and asymmetrically favourable technology shocks combined in our favour).

As I review the experience of advanced countries, if one wanted to take a punt on policy promoting large scale immigration (and few have) the best places to try look to be countries:

  • Close to the centres of global economic activity (whether Europe, North America, or East Asia),
  • Having experienced an asymmetric productivity shock – whether from the market or other policy reforms – favouring longer-term economic prospects in your country,
  • With economies with substantial reliance primarily on sophisticated manufactured products and high-tech services,
  • With their own people coming back home

And it looks like a highly risky strategy if your country is

  • Very far from anywhere,
  • Heavily dependent on (fixed) natural resources,
  • And has seen little sign of asymmetric favourable productivity shocks for your industries in a quite a long time,
  • Somewhere your own people have been leaving in large numbers

These look to be quite general insights.  And yet few if any of the countries that have three or four of the first characteristics have gone in heavily for policy-led immigration (perhaps Ireland or the UK might have been the closest- but UK immigration per capita was also about a third of New Zealand’s (per capita), and the UK is no productivity star).   Of the countries that went heavily for policy-led immigration, even Canada and Israel each meet only one of the three criteria – and neither can readily show the economic gains from large-scale migration. Australia and New Zealand meet none.

As for New Zealand, we can (sadly) tick all four items in that second class of conditions.  This was – and is – perhaps the least propitious advanced economy on earth to experiment with a large-scale immigration strategy.  And yet we did. If it was perhaps defensible in 1946, and optimistic in 1990, persisting now it just stubbornly wrongheaded, defying experience and evidence.    It isn’t quite as wrongheaded as a strategy to promote mass migration – however able the people – to Kerguelen, the Chathams or the Falklands, but not far short of it.  Australia has coped better with its experiment only because they were able to bring to market lots of natural resources previously lying idle.

It isn’t that people are any different here – locals or migrants.  And water still flows downhill.   But the opportunities just aren’t very good at all.  It is an old line but no less true for that: a definition of insanity is doing the same thing again and again and expecting a different result.  We’ve tried this one far too many times for our own good.

[1] I recall Eric Crampton once suggesting an Ethiopian quota

[2] The contrast, say, to the economic gains New Zealand Maori may have received from 19th C immigration.

Colonial constructs

A couple of weeks ago the Sunday Star Times had a full page article – in a Money supplement, self-described as offering “Intelligent Money News, Tips and Insight – by Jade Kake headed Debt as we know it is a colonial construct (the online version runs under the title “Maori have colonisers to blame for concept of individual debt”.) The column ends even more starkly: “Debt is a colonial construct”, observing that “the implications of which continue to be felt in the colonies”.

As it happens, Ms Kake herself could probably be described – without animus – as something of a “colonial construct”. When I looked her up it turned out she was Australian (born, bred, and educated), of parents who themselves had been born in New Zealand and the Netherlands respectively. Lots to celebrate there one might have thought, and certainly it would have been inconceivable – impossible really – prior to, say, 1769. These islands and the descendants of their first settlers had been almost entirely cut off from the rest of the world- whether people-to-people movements, trade or technologies. And one of those missing “technologies” was credit – or debt.

There doesn’t seem to be any real debate about that. Ms Kake states it herself, and when I looked up some books on the pre-contact Maori economy they all made more or less the same point. There was some gift-exchange elements, but nothing at all resembling credit/debt as it had been known for some time – rather a long time in some places – in much of the rest of the world. A few years ago there was a book by the American sociologist David Graeber called Debt: The First 5000 Years. and I’ve written here about debt jubilees from thousands of years ago But that innovation, and evolution, had completely passed this part of the world by. Consistent with the absence of so many technologies and trade here, material living standards were very low.

“Colonial” is one those ill-defined words. Sometimes it means lots of permanent settlers from abroad, and sometimes just a period of control and government by a foreign power. In New Zealand, of course, it involved both, although the control by the foreign power was very short-lived. But, as people sometimes point out, even if these islands had never fallen to any foreign power, or if there had been little or no foreign settlement, many of the technologies would still have found their way here. Credit/debt is surely one of those sets of technologies. And that is a good thing.

Ms Kake is, of course, less sure (to put it mildly). But even she doesn’t really seem able to make up her mind. On the one hand she laments the arrival of the first bank in New Zealand (an ANZ forerunner) – but interestingly doesn’t mention our first very early quasi central bank, the Colonial Bank of Issue – but by the end of her column she is lamenting what she sees as evidence that it can be a bit harder to get credit if you are “visibly Maori”. If the latter is true it is, of course, unfortunate, but then we are left thinking that really credit/debt isn’t so bad after all. It depends – on what is used for, the reasons it is taken on, the conditions applied etc etc. Hitler’s regime borrowed in World War Two, but so did our side to defeat him. But when private parties take on debt, and do so not under duress, it is generally enabling and empowering.

Could one envisage a modern technologically-advanced world without debt? One could (and I briefly did here, in a debate a couple of decades ago with a visiting monetary reformer), but they’ve tended to go hand in hand. And no doubt Ms Kake would tar arms-length equity investment – also unknown here in centuries gone by – as another “colonial construct”. One might – as I do – wish there was much less household debt (because governments fixed the land supply regulatory disaster and got house/land prices a long way down), without having any particular qualms at all about young couples being able to borrow to buy a first house (rather than, say, generally wait until they were 50+ to buy a house outright). Much the same goes for business credit. Credit/debt is a sophisticated device enabling risk-taking, enabling smoothing of consumption, and so on. Financial development tends to go hand in hand with more intensive economic development and much higher material standards of living – not necessarily causally, although there are probably causal aspects (long-distance trade tends to rely on credit, on trust).

It is simply silly to say the debt is a “colonial construct” – it was simply one of the many things (institutions, cultures, technologies) that residents of these islands got access to when these remote islands finally opened, so late, to the wider world. There was – and is – nothing particular British – or even Dutch or northern European – about debt, technology itself transferred to, refined in etc, those parts of the world from elsewhere well before anyone settled here.

There has been a bit of debate over the weekend about the legacy of colonisation in New Zealand, prompted by some remarks by National’s education spokesman suggesting that in his view colonisation had, “on balance” been beneficial for Maori. One might debate aspects of his framing, and I don’t want to launch into an extensive debate here (a couple of pieces of mine that might be relevant are here and here). But, equally, the state of economic development and material living standards tend to speak for themselves about at least some aspects of such a question.

There is a big academic literature on the influence on imperial government, colonial settlement etc on the level of (say) real GDP per capita of different countries, and I’m not going to attempt to summarise it here. My own take is that the effects of imperial rule are not that large, but those associated with colonial settlement often have been. British settlers to (say) New Zealand and Australia in the 19th century brought with them many of the aspects – legal systems, culture, education or whatever – that had then made Britain the country with the most advanced economy and highest incomes.

Here is the IMF’s estimates of real GDP per capita this year for a variety of Pacific countries.

IMF real GDP

All of these lands were governed for a time in the 19th or 20th centuries by countries from outside. Two had large scale settlement – complete with the attendant, often embodied, “institutions” broadly defined – from places that were among the very richest and most productive on earth. It shouldn’t really be a surprise that the inhabitants of those two countries now – and not just the descendants of the settlers but the descendants of the earlier inhabitants (categories now often quite mixed) – have by far the highest material living standards of any of the countries in this region (all of which had previously been largely cut-off from the technologies of the rest of the world). Of the other countries on the chart it probably isn’t a coincidence that Palau and Fiji had the largest degree of settlement of peoples from outside the region. (As far as I can see the French territories – French Polynesia and New Caledonia – would come between Palau and New Zealand on the chart, but their stories are complicated by the ongoing ties to – and subsidies from – France.)

My best guess is that if, somehow, these islands had not been settled by outsiders but had simply been governed from outside for 100 years or so – as with most of these other Pacific states – real GDP per capita here might be similar to that in Samoa. They have computers, they have phones, they have credit. But they do not have an advanced economy offering high material living standards for their people (many of whom prefer to migrate to New Zealand). There might be reasons to debate this view, but even if these islands somehow generated per capita incomes twice those of Samoa they’d still be very low by advanced country (or modern New Zealand/Australia) standards.

Material living standards aren’t everything by any means. But they do seem to count for quite a lot.

Lacking in serious analysis, not well-grounded in law

Yesterday was the Reserve Bank’s six-monthly Financial Stability Report. It might these days almost be almost better labelled the “Make the financial system ever less efficient report”, and with little real challenge or scrutiny from the assembled media.

With the Governor off sick it was left to the Deputy Governor Geoff Bascand to front the press conference. He seemed ill-at-ease and a bit uncomfortable in the spotlight – surprising in one who has held senior positions for so long – and often offered answers that were longwinded without actually saying much.

One of the questions he was asked on several occasions was about the reforms announced last week, and whether they reduced or increased the powers of the Minister of Finance and/or the Bank when it came to imposing direct controls on lending. Bascand never once answered the questions directly, delivering lines about how the new law would provide “greater clarity” but in what he said, and in what he didn’t say, he more or less confirmed the interpretation I ran in a post last week that the de facto powers of the Minister will be reduced – since the Minister will have no say on which tools the Bank can use, whereas under the ad hoc convention of the last decade the macroprudential Memorandum of Understanding between the Bank and the Minister governed that. Under the planned new legislation the Minister will be able to stop the Bank putting in place controls on broad classes of lending (eg residential mortgages) but at least under this government that will be an empty power, since the government is already content with the Bank having LVR restrictions, and the Bank will be free to apply any other controls it likes, whenever it likes. You might think that is a good thing. The Bank probably does. But it hands over much too much power to an unelected unaccountable Board.

But what I really wanted to focus on in this post was the area the Bank itself (and much of the media coverage) focused on: housing. 

You would barely get the idea from any of the material that the Bank has no responsibility for housing at all.  Its financial regulatory powers over banks have to be exercised to promote the maintenance of a sound and efficient the financial system.   And that is pretty much it.     The government is in the process of reforming the law to downplay the efficiency dimension, but (a) the law today is as it is, and (b) even under their new law the focus is supposed to be on the soundness of the financial system.   A couple of months ago, as is his right, the Minister of Finance issued a direction to the Bank requiring them to “have regard to” this government policy:

But this direction alters neither the statutory purposes the Bank must exercise its powers for, nor alters the Bank’s statutory powers.   The Governor promised that the Bank would explain quite what import this section 68b direction actually had, but it appears that that would have been embarrassing or awkward, because no such explanation is offered or attempted in the FSR.  In fact, they both misrepresent the substance of the direction, and then do more than suggest that it “aligns well with the Reserve Bank’s objective to promote the maintenance of a sound and efficient financial system”.   But bear in mind that not even the Cabinet paper that discussed this direction (and the equally empty change to the monetary policy Remit) envisaged much effect on anything much.

So we are simply left with those twin goals of maintaining a sound and efficient financial system.    But amid all their talk of housing financing restrictions, old, new, and foreshadowed, there is barely a mention of the efficiency of the financial system.   Which is probably just as well (for them) as there is no conceivable way that there most recent restrictions, described here, do anything but seriously impede the efficiency of the financial system.

The Bank hasn’t even attempted to make an efficiency case for almost completely banning any loans to residential rental property providers in excess of 60 per cent of the value of the property (all the while allowing much easier access to credit for owner-occupiers). If there are any real differences in the riskiness of such loans, not already factored into pricing and capital requirements, they are small relative to these differences in rules. So what we have isn’t a set of rules that is about either soundness (which capital requirements already manage) or efficiency – in a banking system that has proved itself robust over many years – but purely political interventions, resting on no sound statutory foundations, to attempt to skew the playing field in the housing market, consistent with Labour Party wishes and political preferences. Thanks to the Reserve Bank the market in houses will function less well, and the market in housing finance will be much less efficient and effective (and that without even addressing the “new homes” carve-outs, which again are all about politics and not at all about risk – new developments tend to be riskier – or efficiency).

Now, on a good day there are still some shreds of economic rationality and logic buried somewhere in the Bank. Deep in the FSR we find this good paragraph

I especially liked that slightly desperate footnote “see it isn’t only us”.

Now the Reserve Bank can’t fix any of that stuff – it is all about central and and local government failure – but they are nonetheless quite happy to operate beyond their legitimate sphere and powers to feed a government narrative and paper over symptoms. providing aid and comfort to the government doing little to get to the heart of the issue (the government that disavows any suggestion that perhaps house/land prices should fall). But that’s Orr for you.

Now perhaps you are thinking “but isn’t the financial system imperilled by these higher house/land prices?” Well, the Bank itself doesn’t think so and in the rest of the report they are at pains to stress how resilient the system is, how sound the banks are – even while being just about to resume their never-well-justified drive to push further up capital ratios that are, in effect, already among the very highest in the world. At the press conference, the Bank was at pains to note that the system could cope quite well with even a large fall in house prices. The Deputy Governor rightly highlighted that if prices fell recent borrowers might be in a difficult position, especially if for some reason the unemployment rate was to rise a lot at the same time but…….that simply isn’t a financial system soundness issue.

Much of the discussion in the document and in the press conference etc was about what fresh horrors – housing finance interventions – the Reserve Bank might be cooking up, in league with the government. Unsurprisingly perhaps – since they’ve wanted this tool for years – their preference seems to a debt to income limit (or a series of them, perhaps further impairing the efficiency of the system by picking favourites). Even the Bank seems to recognise that LVR limits are already so tight, especially on residential rental providers, that it might be embarrassingly inconsistent with their mandate to go further, and (sensibly) they don’t seem at all keen on banning interest-only mortgages. It is all a bit hypothetical at present – since as they note the latest LVR controls only came into effect last week – but there is no stopping a bureaucrat with an agenda (Bascand used to be regarded as a fairly pro-market economist), so we heard lots of talk about what they’d be prepared to do “if needed”. There were no criteria outlined for what might warrant further interventions, let alone criteria grounded in the Bank’s act. It really was handwaving stuff, of the sort we might once have been familiar with under people like Walter Nash or the later Muldoon.

You will note that the Minister’s direction referred to the government’s desire to support “more sustainable house prices”. The Bank has picked up that line and has clearly been toying with how to give it substance – but appeared to have made little or not progress, one of their staff even suggesting it was a new phrase and there wasn’t much research around about it. All the FSR itself says is this

FSR 21 2

And that’s it. And it didn’t seem to have taken them far. Bascand claimed to be optimistic that in time the Bank would be in a position to opine regularly on whether house/land prices were above, below, or close to sustainable levels, but he offered no real hint of what he thought sustainability might mean in this context, let alone attempting to tie it back to the Bank’s actual role, around the soundness of the system. For now – clearly keen not to get out of step with his political masters – he couldn’t even bring himself to suggest that lower house prices would be a good thing, although for some reason he did claim (on RNZ this morning) that a gradual fall would be better than a sharp one (offering no clue on why the death from a thousand cuts might be preferable, and for whom).

And, from the few hints he offered, his concept of sustainability seemed idiosyncratic to say the least. Apparently if the population was trending up it was okay for house prices to rise and stay up – quite why was never stated (and he ran this population line several times). We heard a lot about interest rates, but no real suggestion as to why low long-term global neutral interest rates supposedly mean higher house prices (they don’t seem to in much of the US, places where it is easy to bring land into development). It was just a muddle. I guess he couldn’t bring himself to say that no sustained fall in house/land prices was likely unless/until the government sorted out the regulatory dysfunction around land use, nor could he easily own up to the fact that if such laws seemed set to remain problematic then, with well-capitalised banks, what was any of this to do with the Reserve Bank.

It really was all over the place, not well-grounded in any of the Bank’s statutory roles, and yet…….these are the people the government wants to hand more discretionary power to, to further mess up access to finance. It was all too characteristic of the pervasive decline in the quality of policymakers (political and official) and policy advisory institutions in this country.

The sprawling burble continued with questions about whether banks should lend more to things other than housing – one veteran journalist apparently being exercised that a large private bank had freely made choices that meant 69 per cent of its loan were for houses. Instead of simply pushing back and noting that how banks ran their businesses and which borrowers they lend to, for what purposes, was really a matter for them and their shareholders – subject, of course, to overall Reserve Bank capital requirements – we got handwringing about New Zealand savings choices etc etc, none of which – even if there were any analytical foundation to it – has anything to do with the Bank. (He did, in fairness, note that there wasn’t much sign of strong business credit demand.) But I guess once you start down the path of the highly regulatory and intrusive state, it is hard to get free of the tar baby – in fact, bureaucratic life then selects for the sort of people who relish this stuff.

On a quite different topic, there was a box in the FSR on what was described as “Maori access to capital”. The Bank has apparently decided that, with no evidence whatever that there are distinctive Maori issues around either monetary policy or financial stability, to spend scarce public resources promoting this sort of stuff. Again, it is all highly non-analytical – no sense, for example, of why these ill-identified so-called Maori issues (in the ambit of the Bank’s functions) might be different than those of (say) ethnic Indians or Chinese, Catholics or atheists, left-handers, ethnic Samoans, women, men or whoever. It is all just a political whim, pursuing the personal ideological agendas of the Governor and at least some of his senior management (one of his offsiders has an extraordinarily political speech out this morning).

Anyway, we are told that

This work aims to use the Te Ao Māori strategy to incorporate a long-term, intergenerational view of wellbeing into the Reserve Bank’s core functions. It will also inform the Reserve Bank’s financial inclusion work and the allocative efficiency elements of its monetary policy and financial stability mandates. The Reserve Bank is treating this work as a high priority within its strategic work programme.

So with no serious problem identification, no serious grounding in the Bank’s statutory functions (which incidentally have no “intergenerational” character at all) all this is – in the Governor’s view – a high priority use of scarce public resources.

One can’t help feel that the Bank’s core functions might be in need of any spare resources they happen to have.

Holding senior officials to high standards

I’ve been bothered for some time by how lightly the Director-General of Health, Ashley Bloomfield, was excused over his lapse of judgement in accepting hospitality from New Zealand Cricket at a time when preferential access to the Covid vaccine for the New Zealand cricket team was a matter of some concern to New Zealand Cricket, and when Bloomfield himself exercises considerable clout in such matters (having both formal statutory powers assigned to him ex officio, but also being (one of) the Covid minister’s chief advisers). It wasn’t even as if this was a single lapse, since Bloomfield acknowledged that he had last year several times accepted tickets to rugby games, and yet the Rugby Union had been negotiating with the government re the ability to host foreign teams in New Zealand.

New Zealand has tended to pride itself over many years about the incorruptibility of public life. Unfortunately, we have seen too many cases over the last few decades that suggest this is more folk myth than reality, although clearly there are many places worse than us. But “many places worse than us” is simply not an acceptable standard; rather it expresses a degree of complacency that allows standards to keep slipping a little more each time, with excuses being made (“not really that big a deal”), especially for those who happen to be in favour at the time. But those sorts of cases, those sorts of people, are precisely where a fuss should be made, where mistakes or rule breaches should not be treated lightly. Integrity – and perceived integrity and incorruptibility – really matter at the top, and if there is one set of accommodations for those at the top, and another (more demanding) standard for those at the bottom it simply feeds cynicism about the political system and about our society.

What I worry about was captured quite well in a recent article in the Financial Times headed “British politics is morphing from delusion into sleaze”. Britain used to be highly regarded on this score too, but (sadly) no longer. Things seems worse there than here, but “many places worse than us” isn’t the standard we should tolerate.

I really don’t understand the near-deification of Ashley Bloomfield in some circles. Perhaps it is because I have not watched a single one of those 1pm press conferences. The man is a highly-paid very powerful senior public servant who, in the course of his stewardship at the Ministry of Health. seems to have done some things well and quite a few things not that well. But my indifference to the “cult of St Ashley” is really neither here nor there. A senior public servant could have, so to speak, walked on water, and it would still have been a staggering misjudgement to have been accepting hospitality from an organisation that wanted to lobby him/her. Even more so, when it was not just a single lapse.

When the story first broke, I lodged OIA requests with both the Ministry of Health and the Public Service Commission (former SSC) asking for copies of their policies on acceptance of gifts and hospitality. The Ministry of Health responded quite quickly and I wrote about their response in a thread of Twitter. Rather than go through all the material again, here is a copy of the thread I posted.

bloomfield 4

bloomfield 5

bloomfield 6

Good policy, simply ignored by the chief executive (Bloomfield). It wasn’t as if this was the sort of decision he’d had to make under extreme pressure or on the spur of the moment. If he wasn’t aware of his own agency’s policy – which would be pretty extraordinary – no doubt he has not just an EA but a whole office, any one of whom could have been asked to check the policy and get back to Bloomfield. He could have checked with his senior colleagues whether taking this hospitality was likely to pass the smell test. If he was still in doubt, he could have checked with his employer, Peter Hughes, the Public Service Commissioner. It appears he did none of this things, until after the story broke. From someone who has huge powers vested in them, it is not just a lapse of propriety but a stunning lack of judgement. If this is how things we come to hear about are dealt with, how much confidence can we have re other matters the Director-General is responsible for.

One hears suggestions that, Bloomfield having eventually realised it hadn’t been appropriate, all was made good by the fact that Bloomfield wrote a cheque for the equivalent of the cost of the tickets and donated it to the City Mission or some other worthy charity. In fact, that is almost pure distraction, since the money was never the main issue – on his salary he’d not have had any problems going to the cricket or rugby at his own expense if he’d wanted it (as many thousands of others did). Writing a small cheque simply doesn’t adequately deal with the inappropriate behaviour in the first place – any more than it likely would have were it to have been someone well down the public sector food chain.

Anyway, that was the Ministry of Health response. Yesterday, the Public Service Commission finally responded to my request. They provided me with the PSC’s own policies, for their staff and management, and a link to the guidance the PSC provides to public sector chief executives on such matters. I thought they were both pretty good documents.

The guidance to chief executives (of whom Bloomfield is one) is most relevant. This from the first page was just the sort of thing one would hope to see.

hughes 1

And this was pretty good to.

hughes 2

Did Bloomfield never read it?

And, slightly off topic, I was quite impressed with the austerity of this section of the guidance.

hughes 3

In some respects, the PSC’s own policies for their staff – not binding on Bloomfield – are even better.

hughes 4

hughes 5

Good stuff. The SSC policy even extends to immediate family.

hughes 6

Stringent rules, and aptly so.

So the Ministry of Health has stringent policies, the SSC has stringent policies, and the SSC guidance to chief executives is also stringent. Not one of those sets of policies should have led any employee – no matter how junior, or senior – to think that accepting sporting hospitality from entities trying to influence (“persuade, convince, explain”) the public servant would be anything close to appropriate. Such offers should have been declined immediately and repeatedly. And not necessarily because Bloomfield’s advice or decisions would have been influenced by hospitality – though as he is human too, who (including himself) can really know – but because it is simply a dreadful look, that corrodes reasonable public expectations around the integrity of the public service, all the more so in this time of Covid when the state has been wielding more extensive than usual powers, and then (somewhat inevitably) exercising discretion around exceptions to the rules.

But what actually happened? We might deduce from Bloomfield’s later comments that the Public Service Commissioner had told him his conduct in these matters had not been acceptable. But we are left to guess even at that. Perhaps defenders of Bloomfield might cite personal privacy, but when you are a very high official and you overstep the bounds in public, any rebuke also needs to be clearly visible to the public. Otherwise, we might reasonably think one of the public sector elite was looking after another of that same elite, perhaps even playing politics.

Because the political “leadership” was far worse. We – the public can’t do anything about Peter Hughes or Bloomfield – but we rely on the politicians we elect to demand high standards from the public service. And what happened in this case? Both the Prime Minister and the Covid minister did little more than laugh off these breaches, suggesting that no one begrudged Bloomfield an afternoon at the cricket after all his work. Pure distraction, pure minimisation, when the issue was never about him having a Sunday afternoon off at the cricket, but about who hosted him, and what interests his host had in influencing him.

I don’t think accepting one invitation to a sports event should be a firing offence – even for someone as powerful and prominent as the Director-General of Health. Repeat offences, as we saw in this case, do raise the ante somewhat, because they create doubts about the man’s judgement, and even about a possible sense of entitlement. David Clark lost his position as Minister of Health for offences that, in the scheme of things, were less serious, albeit embarrassing to the government.

But we should have been able to expect the Public Service Commissioner, the Prime Minister, and the Covid minister (for that matter the Minister of Health) to all have made it crystal clear, in public, that Bloomfield’s behaviour represented a serious and repeated lapse of judgement, a breach of the clear standards expected of MoH staff and public service chief executives, and that any repetition of this sort of lapse would be utterly unacceptable.

Or are the rules only for (a) show, and (b) little people?

Messing around with housing

And so yesterday we got the long-awaited government package in response to the latest surge in house prices. As a reminder, it is just the latest surge in the more than trebling in real New Zealand house prices over the last 30 years.

BIS real house prices

We know it wasn’t really a serious policy designed to fix the housing market, not just because it didn’t even address the core issue (land use regulation etc) but because the Prime Minister still can’t bring herself to say that she would like to see lower house prices – not even just reversing the rise of the last few months – and the Treasury’s Regulatory Impact Statement is headed “Tax measures to moderate house-price growth”. Add to that I’ve seen reported that Treasury expects the extension of the so-called “brightline test” to boost government revenue, when a package that actually did something about fixing the market would see that specific revenue line almost evaporate for many years to come.

There is a lot that is odd about yesterday’s announcement, including the Treasury claim (in the RIS they published) that they opposed the deductibility rule change because they hadn’t had time to properly analyse it. Even if this was a last minute idea dreamed up by someone in the Beehive – and Richard Harman’s newsletter this morning suggests not, that the idea had been under consideration at least since November – what does it say about the loss of accumulated expertise in The Treasury that they could not offer robust analysis at short notice on almost any of the myriad possible housing tax changes that have been proposed and analysed at various times over the last 20 years? Surely (a) this is core capability (especially in a New Zealand with longrunning housing policy dysfunction), and (b) the analysis involved would have been qualitatively similar to whatever advice and analysis Treasury provided on ring-fencing rental income losses only a couple of years ago?

There are two tax components to the package; the extension of the brightline test to 10 years, and the removal of the deductibility of interest expenses for residential rental landlords. The latter is the more significant measure, but I’ll come back to that.

The only good case, ever, for the brightline test was what the name implied. Using time rather than intent (hard to prove) to determine which sales of investment property were subject to tax was easier, clear and simple. If, instead, you want to tax investment asset appreciation more generally, you’d introduce a capital gains tax. Such a tax would capture all investment assets (not just a particular class the government of the day doesn’t like), and it would provide for loss-offsetting arrangements. A proper CGT is somewhat akin to the government becoming an equity partner in your assets; ups and downs (although not generally in a fully symmetrical way). You might or might not agree with a CGT, but (a) no serious person/government ever thought one was the answer to house prices (and if any did experience should have long since disillusioned them), and (b) there is no sign in New Zealand house prices (and unsurprisingly) that the initial introduction of the brightline test, or its more recent extension, made any material difference to New Zealand house prices. So there is little reason to suppose this change will either (contrary to Treasury who claim to believe it will make a difference even in the “medium term”, albeit perhaps not the long term). It will, of course, change some transactional behaviour, reinforcing a lock-in effect for some investors (and thus reducing the efficiency of the housing market), but that is a different matter than any sustained impact on prices.

One aspect of the brightline test extension I haven’t seen referred to – and is not mentioned at all in the RIS – is the interaction with inflation. Over a 10 year horizon – let alone the 20 years Treasury favoured – a significant chunk of any house price increases will be general CPI inflation (if the Reserve Bank met its target the CPI would rise by 22 per cent over 10 years). There is little serious case anywhere for taxing general inflationary gains (as distinct from increases in real asset prices/values), and the issue is reinforced by the increases in the maximum marginal tax rate to 39 per cent. Suppose the government’s policies finally got on top of growth in real house prices and the only increase in house prices was from general CPI inflation. Someone selling just before the 10 years would be paying 8.5 per cent of the value of their asset in tax even though they had had no increase in real purchasing power at all. That would be a straight confiscatory tax, even more so at the horizons Treasury favoured (where it is harder to avoid by delaying sale). And yet Treasury regards a longer brightline test horizon, with full nominal gains taxed at a higher rate as both fairer and more efficient! A capital gains tax should tax either real gains or, much less desirably, tax nominal gains at a reduced rate. For the scapegoated sector we now have nominal gains taxed at a high (and rising) rate.

What of the deductibility policy? This is, as announced, a simply bizarre policy, not helped by the egregious spin – really bordering on lies – from the government suggesting that the ability to deduct interest from gross income in calculating the owner’s tax liability is a “loophole”. It is simply standard practice, a deduction open to any business. Except, very soon, operators of residential rental businesses. In many firms, in a wide variety of sectors, interest is a cost of doing business.

I can think of three bases on which a policy change around deductibility might have made sense. There is a decent argument that, for tax purposes, no interest paid should be deductible and no interest earned should be assessible. But that would involve universal application. There was an argument that some (from memory including Don Brash) used to advance that with no tax on capital gains, perhaps interest on investment property should not be deductible. But extending the brightline test to 10 years substantially undermines that argument for houses…..leaving it more potent for other assets (eg farm land) to which deductibility has not been limited. And that argument that I find most appealing – and which from memory the Reserve Bank used to favour – was that some proportion of interest deductions were really just inflation compensation, and didn’t really amount to a real expense (just maintaining the real value of capital). But that would argue for a symmetrical treatment of interest income and interest outgoings, and for a comprehensive approach, not just one picking on a current government scapegoat. Had the government been serious about rigorous reform that improved, not worsened, the tax system they could have foreshadowed that sort of change. At present, with interest rates so low, it probably would have reduced by about half the extent of interest that could be deducted.

(The “loophole” argument appears to be based on the fact that owner-occupiers cannot deduct interest. It should barely need saying that owner-occupiers are also not assessed for tax on the imputed rental value of living in their home – nor, of course, (generally) are they subject to the “brightline test”. Whenever there have been serious suggestions of taxing imputed rentals it has been recognised that interest deductibility would need to be introduced as part of any such mix. )

There seems to be a range of views around about what impact the deductibility change will have, especially on house prices. Westpac appears to mark out one end of the range, suggesting in a bulletin yesterday that house prices could settle 10 per cent lower over the longer-term with the potential for “much greater effects” in the shorter-term.

As they note, the Westpac economics team – their chief economist is currently on secondment to The Treasury – have long been advocating a model of house prices in New Zealand that emphasises the power of tax policy and tax policy changes to affect house prices. I’ve long been sceptical of that sort of story (and to refresh my memory dug out notes I’d written on the specific role of tax while at both the Reserve Bank and the Treasury). A paper with a very similar approach to the Westpac one was published as a Reserve Bank discussion paper some years ago, and it has a useful table (page 14) looking at the way in which various variables, including tax ones, affect the price various classes of potential purchasers (leveraged, unleveraged, investors, owner-occupiers) will be willing to pay for a house.

I’m no more convinced this time that tax (or regulatory) changes will have a large effect on prices (and a 10 per cent longer-term effect is quite large) than on previous occasions. One might expect some difference in what type of entity owns the property, but even then it is as well to be cautious. Just a couple of years ago, the ability to offset rental losses against other income was removed, and I’ve seen little in the way of analysis or argument suggesting that had very much effect at all, in prospect or in realisation. But if we go back further, there was little sign that the increase in the maximum marginal tax rate in 2000, foreshadowed with certainty for at least a year, gave a big boost to house prices (as the model predicts, because interest deduction is more valuable) or that the reversal of that increase a decade later cut house prices. The arbitrary removal in 2005 of the ability to deduct depreciation – on houses (as distinct from land) – didn’t seem to have a discernible sustained effect. The PIE regime, which worked against individual landlords, had little obvious effect. And going back further there is even less sign of such effects as decades earlier maximum marginal tax rates rose to 66 per cent, and then fell again, when inflation raised nominal interest rates (increasing the value of the interest deduction) or when ring-fencing was abolished in the early 80s and reinstated in the early 1990s. I’m also sceptical because we can see the huge divergence in house price outcomes in US cities, with fairly similar tax codes and banking practices across them, in ways that point to land use restrictions – and the long-run supply price of new houses – as the more important explanatory factor.

Perhaps this time will be different (although, almost inevitably, we will struggle to know, trying to unpick all the competing influences. Presumably some holders of investment properties will take the opportunity to sell now. Quite probably yesterday’s changes will help bring forward the temporary pause, or perhaps even pullback, that was always likely before too long (with no population growth, much tighter LVRs, perhaps a (irrational) ban on interest-only lending, perhaps even some lift in term mortgage rates etc). We’ve seen such pauses before and will no doubt see them again. But the supply/land issues have not been tackled.

It is worth noting that under the sort of model Westpac (and the Reserve Bank, see above) used, the purchaser willing to pay the highest price for a house was………..not the highly-leveraged investor but the unleveraged owner-occupier. That was so back in 2008 (when the RB analysis was done), reflecting the fact the imputed rental income is not taxed (and such purchasers have no interest payments). The difference is greater now – even prior to yesterday’s announcement – because owner-occupiers don’t have to worry about the brightline tax, while any investor – even if iniitally intending to hold for more than five years, rationally has to factor in a probability of seeling earlier.

Perhaps a little surprisingly (my notes record that it was so to me) is that the group next most willing to pay is the unleveraged investors. They do pay tax on their rental income, but – like the owner-occupiers – they have to think about the opportunity cost of their money, which has to be invested somewhere. Deposit rates are typically a lot lower than mortgage rates, and one will pay a price to avoid being stuck in deposits. Heavily-geared landlords (and remember, they can now borrow only 60 per cent from banks) come in only third. Of course, there may be times when highly-leveraged landlords are key marginal players – quite plausibly the last few months, especially when dealing with a temporary lifting of financial repression targeted at such people – but it wasn’t the general case, even pre-brightline.

One of the uncertainties, of course, is to what extent rents rise in the wake of this change. There is a lot of headline coverage of that, but the honest answer is that we don’t really know (although, again, the nature of the effect should be similar to that for ringfencing, albeit potentially on a larger scale). I’m a little sceptical as to how large the effect will be – notwithstanding the buffering the Accommodation Supplement provides – because if leveraged landlords were able to recoup all/most of their increased costs, that would leave excess expected returns on offer for unleveraged landlords (who are not directly affected by the loss of deductibility). Owner-occupation certainly hasn’t got easer – relative to six months ago LVR controls are back and prices/deposit requirements are higher (or even on Westpac’s take no lower) so I’d expect the biggest difference to be a shift over time from more heavily leveraged landlords to less-leveraged or unleveraged landlords, perhaps with a relatively modest (sustained) rise in rents.

This is, of course, then a policy that skews opportunities away from those needing debt finance (it explicitly no longer treats debt and equity similarly, previously one of the strengths of the NZ tax system) and they tend to be….the new entrants and more-marginal players. In favour of old money, institutional investors etc – who have pools of money that need investing. Now if you are a central banker you might think less leverage was “a good thing” (although that is what capital requirements are for) but it isn’t obvious that is so more generally, given the rigged land market. As Adrian Orr used to say – back when we were analysing housing options at the Bank 15 years ago – many of the leveraged investors are people like (his example) firemen, with a modest salary and using leverage – where it is available with good collateral – to get into an investment property, doing maintenance etc on their days off, getting a foot on the ladder (and some “forced savings” too). It was like that for a long time, whether or not real house prices were rising strongly.

Officials and ministers – especially Labour ministers – really don’t seem to like those sorts of people, and the sort of housing supply that results. Over a couple of decades now policy seems to have been set increasingly in ways that will have the effect of driving these small, initially quite leveraged, players from the housing field. In some cases that has seemed deliberate – including from some who really think home ownership isn’t something people should reasonably aspire to, and that long-term renting is some sort of Germanic ideal – in others just a side effect, but the direction is pretty clear: they favour institutional savings, not individual, and institutional (or large scale) rental providers not individual ones. And so the policy system – which 30 years ago treated these groups neutrally – no longer does. PIEs are taxed less heavily than individuals. Increased regulatory burdens (as ever) favour large players not small. Taxes based on realisations favour large unleveraged players, since they are less likely to be forced to sell, and have future gains to carry forward losses against). And now this egregious new distortion favouring equity over debt in rental housing. I don’t have any problem with institutional and corporate providers of rentals, but it should be an outcome of choice , enterprise, opportunity etc, not regulatory and tax distortions secured in their favour. Worse still, of course, is that if this latest package really does impair the availability of private rentals it will just strengthen the argument on the left that the state should be a much larger rental provider. There is a role for state rental dwellings, for a very small minority of troubled people, but in a functioning land and housing market there would simply be no market failure justifying such an intervention.

And a functioning land market – where there is aggressive competition among land providers/owners and genuine choice for potential purchasers between options on the periphery and options at greater density – is how unimproved outer-urban land prices should once again be somewhere near the price at the best alterative use (mostly farming presumably), not driven higher by artificial regulatorily-supported interventions. But such a market is what the government seems utterly uninterested in providing. The alternative – increasingly messy interventionist version of the status quo – appeals to the Greens and the statists, but it shouldn’t appeal to New Zealanders who care about their children becoming self-sufficient and able to meet the simple aspiration – readily achievable in a land-abundant country – of being able to purchase a basic house in their 20s.

Sadly, whatever was going to happen to house prices over the next three to five years anyway, it is hard to think that after some initial disruption, yesterday’s package will make very much sustained difference to prices at all. But I guess it will buy some political time and ease the headlines; today’s substitute for serious courageous leadership. Fixing the land market (and indexing the tax system) is still an option for some real leader, some day. If only.