Age discrimination and the next Governor

Michael Reddell Governance, Reserve Bank

It is now June, which means it is only 15 months or so until Graeme Wheeler’s ill-starred term as Governor of the Reserve Bank ends.  Conversations begin to turn to the question of what happens next.

I’ve probably left many people unconvinced, but I still reckon there is a plausible case that the Governor of the Reserve Bank is the most powerful individual in New Zealand.  He exercises a lot of discretion with few checks and balances (perhaps especially in areas other than monetary policy) and there are no established appeal or review rights.  Many Cabinet ministers have lots of power, but they can be dismissed whenever the Prime Minister chooses.  The Prime Minister can be toppled by his or her own caucus with no notice or appeal (see Kevin Rudd, Julia Gillard and Tony Abbott –  or Jim Bolger and Geoffrey Palmer for that matter).  Judges make crucial, life-changing, decisions, but all lower court decisions are subject to appeal, and all higher courts sit as a panel of judges.  Of course, the Governor has power in only a specific range of areas, but as those areas include monetary policy and financial regulation, the effects of the Governor’s choices can be felt very widely.

A month or so ago, I wrote a couple of posts (here and here) about the curious democratic-deficit in the way in which the position of Governor is filled.  It is a choice Parliament made, but it is a very unusual one, whether considered against the models used for central banks/financial regulators abroad, or for other senior positions in the New Zealand government.  Even though the Governor wields so much power, the choice of who serves as Governor is not made by an (elected) Minister of Finance, but by the faceless, largely unaccountable, group of people who constitute the Board of the Reserve Bank.  The Minister technically makes the appointment, but he can only appoint someone recommended by the Board.  That makes the Board members the key players in the process.  Perhaps equally weirdly, the Minister gets to determine the Governor’s terms and conditions (he only has to consult the Board).  In a more reasonable assignment of roles and responsibilities, one might have thought the Minister should be able to appoint an appropriate person as Governor (as happens in most countries, including Australia), perhaps consulting the Board, and perhaps leave the Board to set the terms and conditions, perhaps in consultation with the Minister.

There are no confirmation hearings for either people appointed to the Board, or for a Governor-designate, even though between them these people will have considerable influence on the economy and financial system for years to come.  One might reasonably ask what expertise, let alone public mandate, Rod Carr, Keith Taylor, and the rest of them, have to make those sorts of selections, or why they are better placed to do so than an elected Minister.  Recall that appointing a Governor is not just akin to appointing a CEO of a government department –  who typically has little or no effective policy discretion – or the CEO of a private company.  It is about appointing a key policy (one might almost say “political”, albeit not in a partisan sense) player whose discretionary choices –  and they involve real and substantial discretion – are probably at least as significant as those of most Cabinet ministers, with the associated need to be at least as open and accountable as Cabinet ministers.   It seems like the sort of role that senior elected ministers, not faceless former finance sector executives and academic administrators, should be filling.

But unsatisfactory as the law is, it seems almost certain that it will be the law governing the next appointment of a Governor.

Someone who has paid closer attention to some of the details of those provisions than I have pointed out to me recently clause 46(1)(c) of the Reserve Bank Act.    Under the provision, no one can serve as Governor, or Deputy Governor, once they are aged 70 or over.

This provision is quite old.  The legislation was passed in 1989, and life expectancy has increased by perhaps five years since then.  In addition, New Zealand legislation passed since then has prohibited compulsory retirement ages, unless they are specifically provided for in statute (as this one is).  There is a similar statutory age limit for judges.

In a year when the race of the job of President of the United States seems set to be fought between one candidate who will turn 70 this month, and another who will turn 70 next year (who is in turn still being challenged by a sitting senator who is 74) it is a surprisingly low age limit.  Life expectancy has increased, but in fact it is almost 60 years since Walter Nash became our Prime Minister at age 75, and then left office at 78.

I’m not opposed on principle to having an age limit for the Governor.  If anything, as our law is currently written, the case might be stronger than  that for judges.  In respect of judges, the contrast is striking between our situation and that of the US Supreme Court, where judges often seem to hang on until death (as much as anything to manage succession risk), and where three of the current sitting judges are aged 77 and over.

It is, rightly, difficult to remove a sitting higher court judge even if that person’s physical and mental capabilities are evidently in serious decline.  In our system, it takes a vote of Parliament, in an address to the Governor-General.  Age limits help to protect against the indignity and awkwardness of such difficult and very public removals.   Then again, between the assignment of cases, appeal provisions, and the fact that appellate courts sit with a bench of judges, the damage a declining individual judge can do can be mitigated.

It is technically easier to remove a Governor of the Reserve Bank whose capacities were failing.  It requires only an Order-in-Council.  But in practice it would be no easier, and potentially much harder to manage in the interim.  A Governor in office has full powers to set monetary policy as he judges appropriate, and to make and vary a wide range of financial regulatory policy measures.  There is no one who can temporarily assign some of those powers to other officials, and there are no appeal rights.   And the Reserve Bank operates in the full glare of scrutiny by domestic and international markets.

But an age limit of 70 simply doesn’t seem to strike quite the right balance.  Ideally, the entire governance structure of the Reserve Bank will be revised, and if the Governor had just one vote (among say 5 or 7) on each of a Monetary Policy Committee and Financial Regulatory Committee then no age limit might be needed at all (there is none in Australia, or the United States –  Greenspan was 79 when he left office).  For now, serious consideration should be given to raising the age limit to at least 75.

As it happens, the age limit is unlikely to have been a binding consideration since the Act was passed. Don Brash left office at 61, and Alan Bollard was a similar age when he finished as Governor.  But Graeme Wheeler will, apparently, be 66 late next year.  That means he could not serve another five year term, even if he wanted one, or if the Board wanted to reappoint him.  He could, however, serve –  say –  a four year term, which might parallel the typical arrangements for government department chief executives (who typically get an initial five year appointment, and then often get a three year extension).

I hear on the grapevine that the Governor has already indicated to staff that he will not be seeking a second term.  If so, the issue is moot as it affects him.

But with more people staying longer in the workforce it might still be relevant to some of the people the Board could consider to fill the office of Governor.

For example, although it has now been 35 years since the position was filled by someone with a Reserve Bank background –  an extraordinary statistic that the Board might want to reflect on – former senior officials would no doubt be among those who might be thought of as candidates for Governor.  The Act not only requires that no one can be Governor or Deputy Governor once they turn 70, but it also requires that first terms as Governor must be for five years.

There are, for example, two current and four former Deputy Governors who are still professionally active.

Peter Nicholl was Deputy Governor in the 1990s, before going on to serve as Governor of the central bank of Bosnia.  He is still apparently professionally active on the international central banking consulting circuit. But he is 72, and so barred from serving as Governor here.

Murray Sherwin succeeded Nicholl as Deputy Governor.  He is now chair of the Productivity Commission, and in many ways could be a very good Governor if he was interested.  But it appears that he is turning 65, probably next year, and so the age-70 limit could be a constraint.

Grant Spencer is a current Deputy Governor, and will have served in that role for a decade by the time Wheeler’s term expires.  Spencer has considerable experience inside the Bank, as well as decade in relatively senior roles at ANZ, but also appears to turn 65 shortly (the first academic publication I could find dated back to 1974).

Three other current or former Deputy Governors don’t face the same issue.  Rod Carr, Adrian Orr, and Geoff Bascand are all in their 50s, and each has chief executive experience.

Where else might the Board look?  There are other senior ex Reserve Bankers, such as David Archer, former Assistant Governor and Chief Economist now in a senior role at the BIS, or Arthur Grimes.  Or if they were interested in plucking someone from an international agency, my first boss Andrew Tweedie is now the Director of Finance (not just a bean-counting job) at the International Monetary Fund.

There isn’t a strong tradition of academics moving directly into policy roles in New Zealand, and nor are there many academics working in policy-oriented research on monetary policy or financial regulation.  Then again, there are two academic administrators on the Board, either of whom might themselves be interested.

The Reserve Bank now has a major and active role as regulator and supervisor of financial institutions, and so some banking background might be a consideration the Board looks for.   There are few senior New Zealand bankers, and especially not ones with the capability to be, and to credibly front as, the single decision-maker on monetary policy.  Some of us used to worry that Mark Weldon’s friendship with the Prime Minister might have seen him succeed Alan Bollard, but perhaps the OCR leak debacle further reduces that risk.

What of public servants?  Iain Rennie, the outgoing State Services Commissioner, has a strong background in macro, and was for a time the Deputy Secretary of that part of Treasury.

Finding the right person should be quite challenging.  It is a big job, and also an unusual one.  The Bank itself isn’t a large organization, but it has quite a range of functions, where the Governor personally has a great deal of discretionary policy power.  And the Bank operates in an area where there is a huge amount of uncertainty.  Filling the role well needs management capability, it needs intellectual capacity, it needs good judgement, and it needs the self-confidence on the one hand, and the humility on the other, to recognize the uncertainties, to be willing and able to engage openly with alternative perspectives, and to acknowledge that –  being human –  from time to time the Governor will make mistakes.  Precisely because the power is so concentrated in one individual, inevitably the questioning and challenging will often focus on that individual.  The ability to embrace sustained scrutiny and work effectively in that spotlight isn’t a talent everyone has –  and nor is it needed for most roles.

From time to time, people talk about the possibility of appointing a non New Zealander as Governor.  I don’t think it is a viable or sensible option.  Think of how much political mileage there still is in New Zealand from bashing Australian banks.  How would people take to having an Australian setting our interest rates, and regulating those Australian (and other banks)?  I don’t think it is politically tenable, and neither –  given the extent of the discretion the Governor wields –  would it be desirable.  I wrote about this issue a while ago and concluded:

I think it would still be a mistake to go global.  Some aspects of the role could be done by any able person –  revitalising, for example, the Bank’s research and analysis across the range of its policy functions.  That is partly just about good second and third tier appointments, and partly about being a voracious customer for the insights that analysis throws up .  But the role also needs someone who understand the New Zealand economy, the New Zealand system of governance, and someone who understands the New Zealand financial system.  And it needs someone who is comfortable, and credible, in telling the Bank’s story – and sometimes it will be a controversial or difficult story –  to New Zealand audiences.  Plenty of people criticized Don Brash over the years, but few doubted that his heart was in this country, and that its best interests were his priority.  In a small country, with a foreign-dominated financial sector, a very powerful central bank, and ongoing controversy about the role of monetary policy and New Zealand’s economic performance, it is hard to imagine any foreign appointee successfully filling the bill.

Of course, it might be a little easier if the governance of the Bank was reformed.  For example, in a system in which the Governor was chief executive, but had no more voting rights on monetary policy or financial regulation policy matters than others members of the respective committees, the stakes are a little lower.  But even then, I think such governance reform more appropriately opens the way to the appointment, from time to time, of a foreign expert as a member of one or other of the voting committees.  Since the Bank of England’s nine-person Monetary Policy Committee was established by legislation almost 20 years ago it has not been uncommon to have a foreigner sitting on that committee. In a New Zealand context, supplementing local expertise with outside perspectives in that way could have some appeal – if New Zealand government board fees were sufficient to attract quality candidates –  but we are still likely to be best, in all but the most exceptional circumstances, to look for a Governor from home –  as we do when we choose ministers, judges, (and these days Governors-General), military chiefs and so on.

The appointment of the next Governor is further complicated by the timing.  The Governor’s term expires almost three years to the day since the last election.  In times past it wouldn’t have been a great problem –  there was a broad bipartisan consensus around the Reserve Bank.  Similarly, when the appointment of Phil Lowe was announced just a few days prior to the Australian election being called it wasn’t a problem: Labor and the Coalition don’t seem to have any material differences on the RBA.   But here all the Opposition parties are campaigning on a different approach to monetary policy.  We don’t know quite how different –  in 2014, Labour’s policy was marketed as quite different, but on closer examination it appeared pretty similar to the status quo –  and part of that would depend on the respective vote shares in a coalition that made up an alternative government.   If the government were to change, it would seem pretty unsatisfactory that an incoming government could find themselves lumbered with a Governor taking office on virtually the same day they did, for a term of five years, appointed by a Board appointed entirely by the outgoing government.  It shouldn’t matter that much, but such is the extent of the policy discretion the Governor has under current legislation, that it does.  Frankly, it should probably bother someone taking the job –  appointed, but not knowing what framework he or she will operate under.

People push back against this argument, noting that changes of government can happen in the middle of a Governor’s term.  And that is, of course, true.  But it is particularly stark when the new term would begin at virtually the same time a new government would be taking office, and when there are –  it appears –  more differences between major parties on the Reserve Bank Act than would have been the case in earlier decades.  There are no easy or comfortable ways to resolve this issue.  An early appointment keeps any announcement clear of the election campaign, but that isn’t really the issue.  Any new Governor has to be appointed for an initial term of five years.  The Acting Governor provisions of the Act can be used only to complete a Governor’s unfinished term.   I noted a while ago that one option might be to offer Graeme Wheeler a brief extension, allowing the longer-term appointment to be resolved once the make-up of the next government was clear.  Perhaps if there were a self-evidently outstanding single candidate for Governor, commanding respect on all sides of politics, it might also be less of an issue.

Under our current legislation these issues are inescapable from time to time.  A five year term will expire in an election year every 15 years, on normal cycles.  One could give the Governor a six year term, which would reduce the chance of the coincidence, but even then a snap election could bring the two dates into synch again.  Much better would be to move to a system that put much less weight on any one individual.  No other advanced country central bank/regulatory agency gives so much discretionary power to a single unelected individual.  We shouldn’t.

How has our population grown?

Michael Reddell Immigration

New Zealand’s population is estimated to have risen by 11.8 per cent in the last decade (much of it in the last three years). The starting point for that estimate is reasonably well-anchored: I used the population numbers for the March quarter of 2006, and the 2006 Census happened in that month. The end-point (March 2016) is only an SNZ estimate, which will be recalibrated after the next census.  But for now it is what we have.

Here is the high-level breakdown of where the population growth came from.

population decomposition

Net migration accounts for about 35 per cent of the total increase.

But even at very high level, this chart somewhat misrepresents the picture.  Many migrants are of child-bearing age, and some of the natural increase will itself have resulted from the net migration flows of New Zealanders and foreigners (both those during this period, and those from earlier periods).

I’ve found it useful to think about the contribution of immigration policy to New Zealand’s population.  At the extreme, almost the entire non-Maori population of New Zealand ultimately exists as a result of  post-1840 immigration policy.

But even over more recent periods, one can distinguish –  at least conceptually – between the choices of New Zealand citizens to come and go (mostly go), and those of foreign citizens.  The choices of New Zealanders aren’t a matter of immigration policy at all.  We shouldn’t, and don’t, try to impede those flows.    By contrast, any foreign citizen living here requires the explicit permission of the New Zealand government.  Some will be permanent residents, others will have work visas, and some will be students.

Statistics New Zealand has data on permanent and long-term migration flows by citizenship.  But, as I’ve noted before, it is only indicative.  People change their minds and their plans.  New Zealanders planning to leave for a few months end up staying away for decades, and vice versa.  And the same happens for foreigners coming here –  some came intending to stay forever, but it just doesn’t work out and they leave.  Others come thinking it might just be something short-term, and they end up getting permission to stay longer.

Over the last decade, these statistics show a net 233000 New Zealand citizens leaving, and a net 440000 foreign citizens arriving.   That inflow of foreign citizens is equal to 89 per cent of the increase in the total population over that decade.

Actually, the contribution of non-citizen migration (the policy-controlled bit) might not be quite that large.  The net migration inflow in the chart above is 177000 people over the decade, and the gap between the citizen and non-citizen net PLT data over the same period is 207000 people.  We know the natural increase, and we have a reasonable fix on the population.  So maybe somewhat fewer New Zealanders actually stayed away than said they were intending too, and perhaps some of the non-citizens who intended to stay went home.    My hunch –  no more –  is that over this period more of the mismeasurement is around the NZ citizen flow (the Australian labour market has been tougher than most expected).   But if the mismeasurement is split evenly between the NZ citizen and foreign citizen data, the direct contribution of immigration policy to population growth over this period would still be around 85 per cent.  And the contribution to the birth rate of those non-citizen migrants is on top of that.

Then again, according to the arrival and departure cards, a net 228000 more people arrived in New Zealand in total than left between March 2006 and March 2016.  That is rather more than the 177000 net migrants implicit in the SNZ population estimates.  So perhaps we’ll find that the population has been growing even faster than SNZ thinks.  If so, the contribution of immigration policy might drop back to around 80 per cent over the decade.

There is plenty of imprecision in all of this. But what is fairly clear is that (a) New Zealand’s population has been growing much faster than the population of most OECD countries, and (b) that the overwhelming bulk of that growth is resulting from immigration policy choices (the scale of the influx of non-citizens).  Reasonable people can differ on the economic implications of those high rates of non-citizen immigration, but that the population would not have been growing rapidly at all without our unusually large non-citizen immigration programme shouldn’t really be in question.

Internationally, there is a variety of experiences of course.  Among advanced countries, one has relatively successful countries with sharply falling populations (Latvia and Lithuania are down more than 20 per cent in the last 25 years) and sharply rising populations (Singapore’s population is up over 80 per cent in that period), and both good and mediocre performers with quite rapid population growth (New Zealand and Australian population growth rates have been similar over 25 years, and Israel has also had about 80 per cent population growth and a productivity performance about as disappointing as New Zealand’s.  Population changes, even those directly associated with immigration, can be a response to domestic opportunities or available foreign ones. In some circumstances they might help strengthen per capita growth, and in other cases they might impede.  One needs to take a country by country approach.

Taking a longer view, this chart is one I’ve used before.  It compares New Zealand’s population growth rate with those of advanced countries and the world as a whole (using UN data).

world population growth

Typically, our population growth rate has far-outstripped those of the advanced countries as a whole.  The exception was the period I referred to in my post on Saturday, between the mid 1970s and the late 1980s, when the large net outflow of New Zealanders was already well-established, but immigration policy was not aggressively pursuing a large inflow of foreign citizens, unlike the situation in the decades before and since.

Convergence…and not

Michael Reddell New Zealand economic performance

I’ve been under the weather with a bad cold and wasn’t going to write anything today.  But pottering around various websites, I discovered that the Conference Board had last week released its annual update of labour productivity estimates, in PPP terms, for a wide range of countries.

Since my involvement with the 2025 Report some years ago I’ve been intrigued by developments in the eastern European countries, which laboured under Communist rule for decades until around 1990.  By 2009  when we wrote that report, the first ex-communist country had almost caught up to New Zealand’s real GDP per capita.

Older readers will recall the line Bob Jones made much of in the 1984 election campaign, in which he compared New Zealand’s economy in 1984 to a Polish shipyard.  The implication, of course, was that it was the heavy burden of protection and controls that were accounting for New Zealand’s disappointing economic performance.

Of course, for all that was wrong with economic policy in New Zealand in the decades from the 1930s to 1980s, our economy was not remotely as distorted as those of the east European countries.    But in a sense the narratives were similar in the two countries: open up the economies to more international competition, and liberalise domestic markets in a context of secure property rights, and stabilize macro policy imbalances, and one should expect to see a lot of convergence, catching-up with the more successful market economies.  Here is an illustration of the sort of thing that was expected in New Zealand –  a 1989 photo (reproduced in the Herald a few years ago) of then Finance Minister David Caygill’s expectations/aspirations.

caygill 1989 expectations

How have the eastern European countries got on?  The Conference Board has GDP per hour worked data for 11 eastern European countries back to 1990.  Here is how each of them has done relative to New Zealand in the 25 years from 1990 to 2015.

east europe convergence to NZ

The median eastern European country had GDP per hour worked 55 per cent of New Zealand’s in 1990, and that had increased to 77 per cent last year.  All except Russia gained material ground on New Zealand.

That might look unsurprising.  After all, these were very  badly distorted economies during the Communist era.

But, in fact, this chart materially flatters the extent of eastern European catch-up.  Here is the same chart showing these eastern European countries and New Zealand relative to US productivity levels.

east europe cf USA

In 25 years since the fall of Communist rule in eastern Europe, the median country of those 11 had increased labour productivity from only 38 per cent to 48 per cent of US levels.  Russia had lost ground relative to the US.  And so –  less dramatically –  has New Zealand.   (And the picture is much the same if one uses France and Germany as a benchmark, rather than the US.)

They were daft and damaging protectionist/statist policies we had in place during those decades – 20 TV factories indeed –  but they don’t look to have been a big part of the story in our relative decline.

 

 

Scattered thoughts on the Budget documents

Michael Reddell Fiscal policy, New Zealand economic performance

A Budget from a government that seems to have no real sense of how strong sustained growth in productivity and living standards arises was perhaps never likely to produce anything of great interest.  The cheerleading for the, demonstrably failing, “ever bigger New Zealand” approach –  failing, that is, to generate any sign of better productivity growth, perhaps especially in Auckland –  and the questionable rhetoric about a more diversified New Zealand economy, was accompanied by yet more claims that somehow New Zealand’s economic performance is better than those of almost all our advanced country peers.  Meanwhile, oppressive taxes are raised on some of the poorest people in the country, to fund pouring more money into things like KiwiRail, regional research institutes, apprenticeships, and high-performance sport.

I heard some comments on Radio New Zealand this morning about “ideological” approaches to spending, and in particular about the share of GDP devoted to core Crown operating spending.  Since politics is about conflicting values and ideologies, I wasn’t sure what the problem was.  But in any case, the tables in the BEFU (Budget Economic and Fiscal Update) suggest that the government plans that its operating spending in the coming year will be 29.9 per cent of GDP.  As it happens, that is also the average share for the three June years 2015 to 2017.  The average share in the last three years of the previous government was 30.2 per cent.

In the last three years of the previous government, taxes were probably too high.  The core Crown residual cash surplus –  which some of smarter people at Treasury encouraged me to focus on when I worked there – averaged 1.5 per cent of GDP over those years, 2006 to 2008.  By contrast, even on yesterday’s numbers there is no sign of a residual cash surplus until the June 2019 year, and over the three years to June 2017, the average residual cash deficit is expected to be 1.1 per cent of GDP.

Through some combination of fiscal drag and continuing savage tax increases on tobacco, and perhaps some cyclical effects as well,  tax as a share of GDP which had fallen as low as 25 per cent in the year to June 2011 is now just under 28 per cent.

International comparisons of spending and tax levels are largely impossible just using Budget numbers.  Countries calculate things differently, and I recall a painful few days once when I was inside Treasury trying to get from the OECD how they translated our numbers into their numbers.

But here are the latest OECD numbers, which use “total outlays” (not just operating spending) and are not done on an accruals basis.  I’ve shown spending as a share of GDP for the median OECD country and for New Zealand.  There is nothing very unusual about the path in New Zealand.  In levels terms, spending as a share of GDP is a bit below the OECD median, but it is also a bit above the median for the other Anglo countries (only the UK is higher).

gen govt outlays 2016

And here is the same chart for revenue.  Again, nothing stands out about New Zealand’s path.

gen govt receipts 2016

Of course, a notable difference is in the deficit/debt position.  We were better-positioned than most going into the recession, and eight years on we are also better-positioned than most.  In one sense that is a legacy of successive governments going back 30 years, but then legacies are only preserved if each successive government makes sensible decisions.

That is fiscal policy.  But in many ways it was the Treasury economic forecasts that accompanied, and underpinned, the fiscal numbers that got me most interested.  Several other economists have noted that they seem to err on the optimistic side.  That is my fear too.

But I was also interested in the starting point.  According to Treasury, we currently have a negative output gap of 0.9 per cent of GDP. That is a little larger than the estimated gap a year ago, and the gap is expected to just as large in a year’s time as it is now.  And that on the back of negative output gaps every year since the 2008/09 recession.

There is a lot of imprecision in these estimates.  But the idea that there is still excess capacity in the economy –  7 years on from the recession  – seems quite plausible.  After all, the unemployment rate is 5.7 per cent, and Treasury (quite plausibly) thinks a “natural” rate of unemployment (given the structural features of the labour market, the welfare system etc) is around 4.5 per cent.  That used to be the Reserve Bank’s long-term NAIRU estimate too.    And as we know, inflation has been very low, persistently undershooting the midpoint of the inflation target (after persistently overshooting the target for most of the previous two decades).  If Treasury is right, it is a pretty sorry commentary on the conduct of short-term macro policy in New Zealand.  And that, not to put too fine a point on it, has been Graeme Wheeler’s responsibility for the past four years.  I continue to be a bit surprised that the Opposition doesn’t point these things out.  People have been unnecessarily unemployed because of the choices/judgements of the Governor.

But in terms of the Budget, it is probably the projections from here that matter more.  Treasury expects real GDP growth rates to average 2.9 per cent over the next four years.  But it isn’t really clear how or why.

It doesn’t seem to be from the effects of macro policy. The fiscal impulse over the forecast period is estimated to be slightly contractionary.  And they seem to have allowed only one more cut in the OCR, but they recognize that inflation expectations have been falling, so real interest rates are going to be no lower than they were a couple of years ago before the ill-fated tightening cycle.  The exchange rate has come down quite a bit, and perhaps they are assuming some quite powerful lagged effects from that fall.  They assume some recovery in the terms of trade, but nothing as dramatic as the increase in dairy prices a few years ago.  And, on the other hand, the level of repair and rebuild activity in Christchurch –  a major impulse to demand for several years –  will be fading.

And then there is immigration. As everyone recognises, the unexpectedly large net immigration flows over the last few years have been a significant boost to total economic activity.    Treasury assumes –  fairly conventionally –  a sharp fall in met migration inflows, from 71000 in the June 2016 year, to only 19000 in the June 2018 year.  But there is no assumed change in immigration policy, and so the assumed change in net arrivals must all be endogenous to relative economic performance and opportunities.  And yet, they aren’t forecasting much of a pick-up in Australia.  To me, something doesn’t quite add up.  How are we going to get a sustained growth acceleration here –  producing per capita real GDP growth almost as fast as in the period from 1991 to 2007/08 (ie after the reforms and through the massive credit expansion) –  with a pretty sluggish world economy, and all with a substantial negative impulse coming from a sharp cut in the population growth rate?

There is so much uncertainty about medium-term forecasts, that any of these numbers could turn out right.  But they don’t look like the most plausible story to me –  and seem too reliant on just assuming that things finally come right.  If so, they don’t represent the most plausible basis for thinking about future fiscal policy options.  Frankly, I’d be a bit surprised if we ended up with incipient surpluses in the next few years any larger than the modest positive balances the government has right now.   I remain very skeptical of the case for keeping the New Zealand Superannuation Fund in existence, let alone putting more money into it at this late date.  But if my doubts about the macro outlook prove well-founded, then the date for resuming contributions –  already almost a decade on from the NZS eligibility age for the first baby-boomers –  will fortuitously be pushed further into the future.

Among the spin yesterday was the continuing claim from ministers and the Prime Minister that New Zealand’s economic performance is better  –  and will be better, on these Budget economic numbers – than that of most of our advanced country peers.  As I’ve pointed out numerous times before, our growth rate for total real GDP isn’t bad by international standards (while remaining weak by historical standards), but that almost entirely reflects the very rapid population growth.  Per capita growth has been very weak by international standards in the last 12 months or so.

How about the outlook?  I downloaded the latest IMF WEO forecasts for advanced countries. Here is a chart showing forecast growth in real GDP per capita for the next four years (calendar 2019 over calender 2015). For New Zealand, I’ve used the Treasury BEFU forecasts for the four years to June 2020 – ie four years from now –  although as it happens the IMF forecasts for New Zealand aren’t much different.

imf weo gdp growth

On these numbers, New Zealand is doing not too badly.  Our forecast growth rates are very close to those of the median country, very similar to the US and UK (among G7 countries) and Sweden and Denmark (among countries nearer our size).  Which is fine in its way but (a) as I’ve noted, the New Zealand forecasts look rather optimistic, and (b) given our starting point, so much poorer than most of these countries, a successful economic strategy would have involved rather faster growth rates.

Slovakia, for example, might be an achievement to aspire to.  On these IMF numbers, between 2007 and 2021 Slovakia will have recorded almost 43 per cent growth in real per capita GDP, while we’ll have managed 15 per cent.   After decades of Communist rule, Slovakia started a long way behind New Zealand.  It has already matched our real GDP per hour worked, and looks likely to be moving past us.

We don’t have very much positive to write home about.

 

 

 

 

Nationbuilding in Nelson

Michael Reddell New Zealand economic history

Today is Budget day in New Zealand and so no one is probably much interested in reading about other economic stuff.  And after the ickiness and dysfunction of some of the stuff I dealt with in yesterday’s post, I wanted a change too.  After my post the other day about nationbuilding, a reader sent me a few links to pieces about the planned Nelson railway and cotton-mill, the economic case for which might, as he put it, be considered ‘thread-bare’.

For younger readers, this all happened a very long time ago.  In fact, I first recall reading about it in 1974 or 75.  I was a budding (very young) political junkie, and my grandfather  – a denizen of the “elite Glandovey Road” (Brian Easton’s term in The Nationbuilders)  – had been given a (distinctly unwanted) copy of Robert Muldoon’s first book, The Rise and Fall of a Young Turk, which he had passed on to me.   In that book, Muldoon recounts his role in a backbench rebellion that helped overturn this nationbuilding, or blatant electioneering, project.

In the 1950s Nelson appears to have been something of a backwater –  a rather pleasant one, no doubt, to judge from Geoffrey Palmer’s account of growing up there then, as the son of the local newspaper editor.  There had long been a hankering for a rail connection from Nelson to the main trunk line.  But the National government of the 1950s had actually been bold enough to close down the local railway line that had operated, wildly economically, for a long time.  As the 1957 election approached, Labour promised to build a railway line from Nelson to Blenheim, thus connecting with the main trunk line.  Labour took the seat in that election, and became government on a rather slim majority.

In March 1960, the Prime Minister went to Nelson to start the earthmoving machines on the new station.  As Muldoon puts it

The railway, of course, should normally have been commenced from the Blenheim end, which was the railhead, but the votes were in Nelson

Sir John Marshall’s memoirs –  he was the minister who had to deal with all after the 1960 change of government  – record of Nash

At the same time he announced –  rather prematurely, since no agreement had been signed –  that Nelson would also have a new cotton mill to provide freight for the railway and jobs for Nelsonians.

This announcement apparently went into quite some detail. Nash’s biographer, Keith Sinclair, records

The boards of the companies had not yet approved the project. Neither they nor the Department nor the Minister wanted the project announced. But Nash liked giving away presents.  At the railway ceremony he said that Nelson was to have a 4 million pound cotton spinning, weaving, and processing mill. Initially it would produce meat wraps, denim, drills, sheetings and the like.

The 1957-60 government had devoted a lot of effort to attracting foreign companies to manufacture here, to take advantage of the high protective barriers –  raised further by that government –  which made local production cheaper than importing finished product, if one could even get a licence to import the finished product.

The next election was approaching and initial negotiations for the cotton mill fell through, which left the government in something of a bind.  The government had to secure a deal, and did so “after talks between the company and the Department which lasted only a few days”.  Perhaps unsurprisingly, the deal proved to have a lot of loose drafting.

A British company would import cotton from Britain (in turn presumably imported from India or the US), and would be guaranteed 80 per cent of the New Zealand market for the first few years.  There was even talk of export markets developing.

As Sinclair records, “there was a public outcry”.  Most newspapers opposed it, as did many business groups.  Even the Manufacturers’ Federation couldn’t support the deal, as it had many clothing and textile manufacturers among its members.    As Sinclair records

“The cotton project was criticized on many grounds. For instance, it hindered the expansion of trade with Asia. To many conservatives and economists the whole concept of a state-guaranteed monopoly was anathema.  But probably more important was a feeling that there was something ludicrous about starting a cotton industry, based on imported cotton in New Zealand.”

Labour lost the 1960 election – doomed by the 1958 “Black Budget” rather than by industrial policy.  Labour’s share of the total vote dropped by 5.87 percentage points.  As Sinclair records, however

Labour’s biggest gain was in Nelson, were the vote rose 2.76 per cent. Apparently the cotton mill had pleased some people.

Shortly after the December election, even the feisty head of the union movement –  F P Walsh –  attacked the deal as the “best racket ever”.

The British company, Smith and Nephew, had moved fast once the deal was signed and within months had, in Marshall’s terms “lost no time in purchasing land, planning the mill, and letting contracts for plant and machinery”. [Could anyone move that fast with today’s planning and resource management laws?] so that things were well underway by the time the government changed.      Approached by the British company, the new government agreed that the contract the previous government had signed was binding and must be honoured.   They had badly misread public and business sentiment.

In Marshall’s words

Throughout the year 1961 these pressure groups grew in strength and vehemence.  As time went on others joined the fray: the Meat Board, the Constitutional Society, the Chambers of Commerce, the Plunket Society, the Social Credit Political League, and some branches of the National Party

We had the unusual spectacle of the Labour Opposition, which had signed the deal, and the National Government, who had confirmed it, standing side by side, with their backs to the wall, trying to defend it. No one else came to their aid.

Muldoon records that he first got involved when, as a first year backbencher out mowing his lawns one Saturday, he was accosted by a neighbour who owned a clothing factory.

“He asked me why we were permitting the Nelson cotton mill project to go ahead when it would cost New Zealand so much in dearer goods and lack of variety.”

He and some backbench colleagues started asking awkward parliamentary questions of ministers of their own government.  Not content with being fobbed off (including being told “importers should now deal with the Nelson mill”), Muldoon pursued the matter in a general debate, noting explicitly that responses from the Minister (Marshall, the Deputy Prime Minister) had not been satisfactory and highlighting a wide range of concerns about the project.  The backbench group concluded that the cotton mill deal was the worst of the “ten new monopolistic industries” set up by the previous government, and became determined to stop it before it went into production.

The controversy heightened further, with the British company seeking reassurances, officials arguing that the mill should proceed, but with Cabinet increasingly rankled by the backbench discontent.  Long caucus and Cabinet meetings ensued in early January 1962, with the Prime Minister telling caucus his personal view was that “For my part, I’d close it tomorrow”.  Some months earlier Smith and Nephew has indicated that they would be will to withdraw, subject to receiving reasonable compensation.   Cabinet finally accepted that proposal on the evening of 12 January 1962. Company representatives were summoned to the PM’s office and a deal was agreed in the early hours of the following morning.  Smith and Nephew was reimbursed for its actual costs, and the Crown took over the assets.  The planned Nelson-Blenheim railway project had by then already been abandoned.

Muldoon notes that he and his colleagues

had saved the right of choice for the consumer and scuppered a proposal that should never have been started. The final cost of buying out the contract was money well spent and has already been repaid many times over in economic terms.

Marshall notes

from this time on, the policies, plans and projects for industrial development became matters of much wider public interest and more critical community assessment. Secondly, we set in motion, through the new Tariff and Development Board, a complete review of the criteria for approving new industries.

The citizens of Nelson were rather less impressed. Geoffrey Palmer notes that

my father wrote strong editorials condemning the decision to stop the mill….The decision caused outrage in Nelson.

This piece from a contemporary publication captures some of the local mood, in words and pictures.  Labour retained the Nelson seat for many years.

All in all it seem like a fairly good outcome for the country.  Public and business opinion combine to resist a particularly egregious example of manufacturing protectionism and the advance of the Labour Party “manufacturing in depth” strategy.  And for all the later concerns some had about the FPP electoral system, stroppy backbenchers acting behind the scenes and in public made a real difference.

Then again, when the cotton mill building was completed it was sold to another protected business –  becoming an assembly plant for British Leyland for the next few decades.

It was a signal victory for its time –  marked in part by the space key figures give it in their later books.   The cotton mill was closed before it became a long-term drag on the economy.   But it isn’t that obvious that the quality of decision-making is much higher, and more rigorous, than it was in 1960 when Walter Nash kicked off this project.  These days perhaps it isn’t import protection that is at stake, but sports stadia, convention centres, “roads of national significance”, and –  perennially –  railway lines. I guess Project Palace isn’t quite at the level of the cotton mill but it isn’t clear why we need taxpayers’ money spent trying to identify how many hotels might, or might not, be needed, and marketing the opportunities to foreign investors.  Fortunately, we got rid of the Tourist Hotel Corporation some decades ago. It isn’t obvious what any market failure might be in the market for the provision of accommodation for overseas visitors.

Oh well, I guess one has to take wins where one finds them.

Nationbuilding?

Michael Reddell Fiscal policy, New Zealand economic performance

Whenever I hear the term “nationbuilding”, and particularly when calls come for this or that programme in the name of “nationbuilding” I shudder somewhat. I spent some time working in southern Africa in the 1990s, and after-effects of the disastrous “nationbuilding” programmes of people like Kenneth Kaunda and Julius Nyerere were already apparent.  Since then, the sheer awfulness of Hastings Banda and Robert Mugabe have also become increasingly obvious.   “Nationbuilding” has a ring of something post-colonial, whether in Africa or Latin America, and (to me) a ring of persistent failure.

New Zealand has had its share (perhaps more than its share) of “nationbuilders”, people who seek to use the power of the state and its (our) resources to pursue one or another vision of what the country could become. There was Julius Vogel with the massive debt-fuelled expansion.  And Sutch/Savage/Nash, financially fairly austere perhaps, but with a vision of an insulated New Zealand with a large manufacturing sector (those 22 TV factories). We’ve had NZ Steel and Tasman Pulp and Paper –  and the Raspberry Marketing Council.   We’ve had those who actively encouraged (and even subsidized) large-scale immigration.  We’ve had the Think Big strategy of Muldoon and Birch.  And latterly another wave (of decades-length) of large scale (supposedly) skills-based immigration, supposedly as a “critical economic enabler” –  as if somehow the people we have aren’t really “good enough” for those holding the levers of power.   And there are all sorts of other programmes that fly a bit further under the radar –  film subsidies for example, or grants to those who capture the imagination of bureaucrats –  or which simply never managed to command enough public support in time (the slightly younger Roger Douglas’s call for sixteen state-funded carpet factories).  Each of these programmes that has been implemented made a difference, but how many of them were for the good is, at very least, an open question (my provisional answer is none of them).   And if they weren’t good, there was almost no effective accountability for any of the designers.

I pulled off my bookshelf this morning Brian Easton’s 2001 book The Nationbuilders, 15 profiles of people Easton saw as having “shaped the New Zealand nation in the middle years of the twentieth century”.  They are mostly political and bureaucratic figures, or people whose contribution was around politics and policy.  None was particularly market-oriented (Coates and Muldoon appear, both from the activist ends of their respective centre-right parties).  One major business figure was profiled –  James Fletcher – but even his success was in no small measure down to the huge government construction projects.  Oh, and there was Dennis Glover, who founded Caxton Press.

Which is a somewhat longwinded introduction to an article in the Dominion-Post a few days ago in which Shamubeel Eaqub called for this week’s Budget to be a nation-building one.  It wasn’t simply a line in passing –  the phrase appears three times in a not-overly-long column.  In this case, “more public debt” is the call –  in this case to build houses (30s revisited), public transport, and “rail in critical infrastructure corridors” (1870s revisited).

He continues

The reality is that the current expenses or lost revenue could be easily redirected into debt repayment to fund some serious amounts of new investment.

If we raised a 100 year bond, as Ireland has done recently, we could probably borrow about $30b for every $1b in debt repayment. Incidentally we spend about $1b a year on accommodation assistance. Redirected to borrowings, we could perhaps build about 82,000 houses on existing Housing New Zealand land in Auckland.

Set aside for the moment the long track record of poor quality government capital investment –  not just here but abroad – and then consider a key difference between Ireland (and Belgium which also recently issued a 100 year government bond) and New Zealand.

First, both have very high levels of government debt (general government gross debt in excess of 100 per cent of GDP) and so the idea of locking in some of that debt for a very long time must seem quite attractive to the respective debt managers.  Neither country seems to be launching an expansionary fiscal policy with the proceeds.

And second, there is quite a difference between the price of Irish or Belgian debt, and that issued by the New Zealand government.   Belgium issued its 100 year bond at a nominal yield of 2.3 per cent.  Ireland issued its at 2.35 per cent.  The ECB has an inflation target of just under 2 per cent, and inflation in last 25 years has averaged 2.2 per cent in Ireland and 2.0 per cent in Belgium.   At most, a reasonable estimate of the expected real interest rate over 100 years is perhaps 0.5 per cent.   That should represent quite cheap borrowing (although whether it is really cheaper than a succession of 10 year bonds only time will tell).

What of New Zealand?  We don’t have a 100 year bond.  But the New Zealand government does issue quite long-term inflation indexed bonds. A bond with 14 years to maturity has a yield of around 1.82 per cent, and one with 19 years to maturity yields around 1.93 per cent.  The implied 5 year rate in 14 years time (ie the last 5 years of the 19 year bond) is around 2.2 per cent.  Who knows at what yield the New Zealand government could issue 100 year bonds (having taken all the inflation risk back on itself) but it seems unlikely that it would be less than 2.5 per cent.   That is a huge difference in likely real borrowing costs from those European sovereign issuers.  And yet Eaqub proposes we borrow to spend (“invest”) at those high yields, even though the real productivity performance of the New Zealand economy over decades has been far inferior to that of either Belgium or Ireland.   In our case, a 2.5 per cent real interest rate not only materially exceeds past and likely future productivity growth rates, it may even exceed the likely future rate of real GDP growth.

For the government to borrowing at 2.5 per cent real might look reasonably attractive if the benchmark is New Zealand interest rates over, say, the last 25 years.  But being in debt at all, as a government, should have been extremely unattractive during that period given how high New Zealand’s interest rates have been (and, laudably, successive governments markedly lowered our public indebtedness).  Perhaps a long-term real borrowing rate of around 2.5 per cent real might be borderline attractive if we could count on excellent governance and disciplines and an assurance that projects would be subject to rigorous cost-benefit analyses.  The track record on that score isn’t promising.

On a perhaps-related issue, Treasury last week released a series of blog posts on the financial return to the Crown from its investment in Air New Zealand, from the time of the Crown bailout in 2001.    As a purchaser of last resort (in late 2001, post 9/11, no one was keen on airline shares), the Crown should have got quite good entry levels.  And Air New Zealand remained listed on the stock exchange, with minority private interests throughout the subsequent 15 years, ensuring some level of ownership-based market discipline.  Air New Zealand is widely regarded as a very well-managed successful airline, and for now is riding the back of relatively low oil prices and an upsurge in inbound tourism.

Over the period since 2001, the nominal 10 year government bond rate has averaged 5.3 per cent.  And yet the internal rate of return the Treasury analyst calculated on the Crown’s investment has been 8.4 per cent per annum –  and much of that is unrealized, and dependent on the current, still relatively high, Air New Zealand share price.    Buy the entire equity index and I suspect few investors would regard a 3 percentage point equity risk premium as reasonable (from memory, historic market estimates are typically in a 4- 7 percentage point range).  But Air New Zealand is not as risky as the index as a whole –  it is far far more risky.  Government debt financed that Air New Zealand investment, and taxpayers don’t seem to have gotten a remotely adequate compensation for the risk they assumed, even in an industry with lots of competition and market disciplines.  It isn’t clear why advocates of large scale borrowing now – in a country with still quite high real long-term interest rates –  think they would do better in generating economic returns.

So-called “nationbuilding” projects have usually been a way of wasting (with a fairly high degree of confidence) the nation’s resources in pursuit of some politician’s or economist’s pet vision.  Government don’t –  or perhaps rather shouldn’t –  make nations, and in particular they certainly don’t make the wealth of nations.  That is down to individuals, firms, and the networks of society.  There is an important role for government –  and whatever government does needs to be done as well (or least badly) as possible – but “nationbuilding” as a call seems no more likely today to result in a good, high-yielding, projects, than it did in 1870 or 1980 or 1935 or……

Alternative narratives

Michael Reddell New Zealand economic performance

From time to time people who are persuaded by my story about New Zealand’s economic underperformance ask why it hasn’t been more widely accepted, and the policy implications adopted.

And, of course, there is a variety of good reasons.  They include:

  • my own story/analysis is quite recent and is continuing to evolve.  I’ve spent over 30 years as an economist, but central bankers mostly focus on the short-term.  It was really only two years spent at Treasury from 2008, and my involvement there in helping the 2025 Taskforce, that energized me to start thinking hard, and reading widely, on the issues around New Zealand’s long-term economic underperformance.   The first time I wrote anything down on any of this was 2010, and it hasn’t exactly been a fulltime occupation since then.   The presentation I gave last Friday has quite different emphases in some important aspects than the first public presentation  of related ideas that I gave in 2011.
  • it is a competitive market in ideas, and there is a variety of competing narratives around to help explain our underperformance, and what (if anything) might be done to remedy it.   Some have had considerable resources put into them, and others are less formal.  Some are produced under important and influential ‘brands”.
  • it is not as if the problems are new.  It is now more than 50 years since the first major reports were published on New Zealand’s relative economic deterioration (eg the Monetary and Economic Council in 1962).   Many stories have been told, and explanations attempted, in the subsequent decades.  Various strategies have been tried since then –  some well-founded, and others daft –  and the decline has not been fully arrested, let alone reversed. In some ways, I think that experience leaves people a little jaded, disillusioned, and perhaps rather wary.

What are some of the alternative narratives?

Treasury is probably the organization that has put the most resources into exercises of this sort (and, of course, it is the New Zealand organization with the most resources).  Prior to the last election they put a lot of effort into a disciplined process reviewing the arguments and evidence in a range of areas, including getting contributions from people elsewhere in the public sector in particular.  The public face of what they produced was Holding On and Letting Go, part of their post-election advice to the Minister of Finance.  There was also a substantial (60 pages) and more specific paper for the Minister of Finance done in late 2013, (which has been released to me under the OIA but does not appear to have been put on the Treasury website with their other OIA releases), which grouped policy recommendations under nine headings.   Treasury has come and gone a bit on what it emphasizes but savings, public pensions, and problems with macro policy loomed large back then.

One could also think of the 2025 Taskforce’s reports in a similar vein.  With a lot fewer resources, those reports represent a story about what could, and should, be done to reverse New Zealand’s economic decline.  The Taskforce itself summed up the essence of its approach

 The key elements of the Taskforce’s approach are:

  • Significantly cutting government spending and tax rates.
  • Finding better, more effective, ways of ensuring the delivery of services the government does fund. „
  • Substantially improving the rigour with which government spending proposals are evaluated.
  • Substantially improving, across the board, the quality of economic regulation. „
  • Getting government out of the ownership of business assets

It was a “smaller and better government” prescription.  When I read through the specifics again this morning, I don’t find many I disagree with, and there is much I would strongly endorse.  But when the work of the Taskforce was over, I was left with a sense of “important as some of these issues may be, it doesn’t seem quite enough”.  Whatever one’s judgement on the appropriate size of the state, for example, that in New Zealand doesn’t seem unusual.

The Productivity Commission, mostly focused on specific inquiries assigned to them by Ministers, has also been turning its attention to trying to answer the question of how to lift New Zealand’s productivity growth.  Paul Conway, the Commission’s director of research, gave an oral presentation to last year’s NZAE conference, and it will be interesting, in time, to see where the Commission as a whole lands, in both diagnosis and prescription.

And no doubt there are others.  Roger Procter, the thoughtful  former (recently-retired) Chief Economist at MBIE had some interesting analysis and views on appropriate policy to reverse New Zealand’s underperformance.  Philip McCann’s analysis created significant interest a few years ago (and my own views are probably less far from his than I realized at the time), and the New Zealand Initiative –  while not, that I’m aware, having a fully worked-out framework for thinking about our underperformance –  would also probably emphasise smaller government and more open markets (people and capital).

And there are also the overseas prescriptions, notably the biennial advice of the OECD.  The OECD has long been somewhat puzzled by the underperformance of New Zealand –  we were somewhat embarrassing because in some respects by the early 1990s we were almost their best pupil.  Their analysis and prescription tends to be a modern social democratic one (open markets and lots of smart active government), and in my judgement hasn’t really got beyond treating New Zealand as if it were another small northern European country.

I’m not going to go through each of these diagnoses or prescriptions here  today (let alone ones from decades past, like the major World Bank report on New Zealand in 1968), Having said that, I always used to stress to staff that it was no use beating a caricatured straw man version of an opponent’s argument –  one had to engage with the strongest and best arguments that people could mount on the other side.  So perhaps I will spend some time as the year goes on working through some of these other documents and explaining why I haven’t yet been persuaded by their (often quite different from each other) stories.  I might also highlight the aspects of my own story that I’m relatively less comfortable with.

All of which is a long-winded way of saying that it is not as if my ideas, or those of any new contributor, are coming into a vacuum.  Able people have been trying for a long time to develop stories, and prescriptions, that best fit the collection of New Zealand economic stylized facts.  Different people emphasise different subsets of those stylized facts, which can often mean that it feels like quite different, unrelated, conversations are going on.  Each perspective probably has some useful policy presciptions to offer, but most probably won’t make a difference on the scale that is required.  Will mine?  I think so, but advocates of some of the other approaches no doubt think that is true of their models as well.

And it is also worth recognizing that any set of existing policies in place gathers vested interests in support.  That will be quite a mix: in some cases it might just be people who benefit financially (as those with import licenses in earlier decades were reluctant to see that policy changed), but more often it will probably be about the emotional and intellectual investment in a way of seeing the problems, and remedies.  We are all prone to those sorts of biases, and they are hard to overcome –  I wrote, with some conviction, the section of the first 2025 Report on why size and distance were cop-out explanations and I wince a little now when rereading that.  In respect of my own analysis, a “bigger New Zealand” mentality has pervaded political and economic life in New Zealand for a very long time. If it is misguided, as I think, it is not likely to be a sentiment that is abandoned readily, at least absent some sort of crisis.

On a slightly different note, I’d recommend people read (economist and economic historian) Deirdre McCloskey’s piece from the Wall Street Journal the weekend, ‘How the West (and the Rest) Gor Rich’, drawn from her new book Bourgeois Equality, the final in her massive trilogy of works in this area.  I rather liked the last few paragraphs, which remind us that politicians –  and policy analysts –  don’t generate our prosperity.  But they can –  and too often have –  got in the way of such prosperity.

What public policy to further this revolution? As little as is prudent. As Adam Smith said, “it is the highest impertinence…in kings and ministers to pretend to watch over the economy of private people.” We certainly can tax ourselves to give a hand up to the poor. Smith himself gave to the poor with a liberal hand. The liberalism of a Christian, or for that matter of a Jew, Muslim or Hindu, recommends it. But note, too, that 95% of the enrichment of the poor since 1800 has come not from charity but from a more productive economy.

Rep. Thomas Massie, a Republican from Kentucky, had the right idea in what he said to Reason magazine last year: “When people ask, ‘Will our children be better off than we are?’ I reply, ‘Yes, but it’s not going to be due to the politicians, but the engineers.’ ”

I would supplement his remark. It will also come from the businessperson who buys low to sell high, the hairdresser who spots an opportunity for a new shop, the oil roughneck who moves to and from North Dakota with alacrity and all the other commoners who agree to the basic bourgeois deal: Let me seize an opportunity for economic betterment, tested in trade, and I’ll make us all rich.

 

Location matters

Michael Reddell Immigration, New Zealand economic history, New Zealand economic performance

That was, more or less, the theme of my talk to the Fabian Society in Wellington last night.

I outlined some of things that seem to matter in explaining which countries prosper and which ones don’t.  The people and the “institutions” they develop, or adopt, matter most of all.  But natural resources also do –  note, for example, the contrast between the GDP per capita in Sweden (high) and Norway (materially higher).  But location, or geography also seem to matter. Once, much of that was about access to navigable waterways, and perhaps some climatic issues.  These days it seems to be more about proximity.  Whether in the past or present, one just doesn’t find many really prosperous places, or many people living in those places, at the peripheries.  As I noted

the total population of Kerguelen, the Azores, Hawaii, Seychelles, Fiji, Iceland, Tasmania, Reunion, St Helena and the Falklands is just a bit less than New Zealand’s.

If anything, proximity and personal connections seem to have become more important, not less.  Quite why this should be so, despite the rise of communications technology, isn’t entirely clear to me (it must be something about the nature of the products/services), but that it is so seems evident in the continued economic outperformance of big cities, even in already-advanced countries.  That puts New Zealand at a big disadvantage –  we have able people, a moderate level of natural resources, but are a very long way from anywhere.  And the stock of natural resources is largely fixed, and doesn’t need lots more people to make the most of (indeed, often fewer people –  think of how many more cows an average farmer can run now, compared with the situation a century ago).   New Zealand just isn’t a very natural place for many global businesses to develop successfully, or to stay.

The Treasury was the first organization really to capture my attention on the significance of distance.  About 15 years ago they drew a useful comparison:  if one drew a circle with a radius of 1000 kms around Wellington one would capture (now) 4.5 million people and a lot of seagulls, but the same circles drawn around northern European or Asian capital would encompass hundreds of millions of people.  But it is puzzling that Treasury doesn’t seem to have taken that point and applied it in thinking about the appropriate immigration policy for New Zealand.  They tend to ignore the market signal (the hundreds of thousands of New Zealanders (net) who have left), and also ignore the logic that if distance is, in effect, a tax on economic prosperity here, it isn’t obvious why one would set out, as a matter of policy, to expose even more people to that tax.    Nothing of these ideas was in the recently-released Treasury material that I wrote about the other day.    Implicitly, Treasury and MBIE immigration policy advice- and the advice of bodies like the OECD (perhaps more pardonably, located in the heart of Paris) –  is being formed as if New Zealand were moored just off the coast of western Europe or North America, or perhaps even in the South China sea.  They need to take more seriously the fact that these islands are in the middle of nowhere.  High value economic activity takes places on such islands, but mostly only stuff that is location specific –  the iron ore is in the heart of Australia, the fish stocks are off the coast of New Zealand etc.  But it is really hard for modern, non-location specific businesses, to develop, and be the best they can be, in such a remote location.  It isn’t specific to New Zealand –  check out those other remote islands too.

But we make it all the harder for anyone with the drive and ideas to develop such firms.  Having persistently the highest real interest rates in the advanced world, and a real exchange rate that never sustainably adjusted down following our decades of relative decline, just further skews things against the prospects of the tradables sector.  Business investment has been consistently modest.  And the Think Big mentality, of bringing in enough –  modestly skilled –  migrants each year to have given us one of the faster population growth rates in the OECD, both reinforces those pressures on real interest and exchange rate –  resources have to be used to accommodate a growing population rather than enriching the existing population –  but also ensures that the fruits of the largely fixed stock of natural resources is spread over ever more people.  In effect, we trade away one of our few advantages.

I argued that we need our politicians and their advisers to both take more seriously the constraints of our location, and abandon the sense –  embedded in the New Zealand psyche almost ever since first European settlement –  that we need more, and more, people.  There is simply nothing wrong with a country of around 4 million people.   There are plenty of successful small countries.  For many of them perhaps it is more of a discretionary choice. At such distance from world markets, mostly trading on our ability to apply smart ideas to natural resources, it is much more of an imperative –  at least if we are serious about trying to give our people material living standards that match those of the better-performing OECD countries.

Anyway, here is the text I spoke from. It was delivered to the Fabian Society –  where we had a good discussion and lots of questions.  But for readers skeptical of the left-wing audience, it is almost identical to what I would say on these issues to an audience anywhere else on the political spectrum.

Fabian Society speech 20 May 2016

As ever, comments (and questions) are most welcome.

 

Expectations measures still warrant further OCR cuts

Michael Reddell OCR

The Reserve Bank’s Survey of Expectations (of some reasonably “informed” respondents) came out the other day.  It was one of the last significant pieces of New Zealand macro data likely to emerge before the Bank finalizes the forecasts for next month’s Monetary Policy Statement and the Governor makes his OCR decision.

As ever, there wasn’t that much media attention on these numbers, and arguably not much changed in this survey from the previous one.    But in a sense that in itself should be newsworthy.

For a year now, the Reserve Bank has been reluctantly cutting the OCR, more or less reversing the ill-judged aggressive tightening phase the Governor undertook in 2014.  I say only ‘more or less’, because although the current OCR is lower than the 2.5 per cent that prevailed for several years until the start of 2014, inflation expectations have also fallen.  Using the two-year ahead survey measure, the real OCR was about zero at the start of 2014, but it is around 0.6 per cent now.  And, as the Bank reminded us in the FSR last week, the margins banks face, over the OCR, in tapping wholesale funding markets have also increased.

But the Bank has been cutting nominal rates for a year now, and still respondents to the survey don’t take very seriously the chances of the Bank getting inflation back to the 2 per cent midpoint of the target range, an explicit target that Governor himself had added to the PTA.  The last year or so is the first time ever that two-year ahead expectations have been below the target midpoint.  But despite 125 basis points of OCR cuts, there is no sign of medium-term expectations picking up again.

infl expecs and target midpoint

Some reporters noted that one year ahead inflation expectations had increased but (a) that shouldn’t have surprised anyone given the rise in world oil prices, and (b) there is no sign of the lift in expectations for the next couple of quarters flowing beyond that.  The survey provides expectations for each of the next two quarters, and for the year ahead, which enables us to derive and implied expectation for the second six months of the year ahead (which shouldn’t be much influenced by eg changes in oil prices).  Here is that chart.

implied 6mths ahead

I wouldn’t want to make much of a single observation, but the latest fall just continues a trend that has been underway ever since the 2008/09 recession.  There is no sign of growing confidence that inflation will soon be getting back to target (note that the annualized rate of inflation for the second six months is only 1 per cent, at the very bottom end of the target range).

And these inflation expectations are based on expectations that monetary conditions will be eased further.  In the history of this survey, respondents typically only expect monetary conditions to ease over the coming year when they are already judged to be quite tight.

monetary conditions

For example, over the period from 2004 to 2008 respondents thought conditions were tight (the red line) and expected that they would ease over the year ahead (the blue line).  At present, they think conditions are quite easy, but they still think conditions will (have to) ease further over the coming year.  The size of the expected future easing isn’t large; it is the fact that they still expect further easings at all that is striking.  Even with that expected easing, inflation expectations remain subdued.

If the Reserve Bank is keen to get these medium-term inflation expectations back up to around the target midpoint –  as a marker of how much confidence people have in the seriousness with which the target is being pursued –  there are broadly two ways to do that.

The first is through credibility/confidence effects.  In other words, a substantial programme of interest rate cuts could, of itself, be enough to raise expectations of future inflation.  People think along the lines of “gee, inflation has badly undershot the target, but I see the Bank is moving decisively now, and accordingly I’ll adjust my responses in the survey”.  As already illustrated, there is no sign –  a year into the easing cycle –  of that sort of behavior at work.

If not, then they need to rely on the second channel: actually boosting economic activity, putting more pressure on scarce resources, and raising actual core inflation, leading people to revise up their forecasts of future medium-term inflation.  This is probably usually the more important channel –  people more often revise their forecasts/expectations in the light of actual experience with inflation.

The survey enables us to see whether respondents expect additional pressure on resources.     Take the question about GDP growth, for example.  In this survey expectations of GDP growth for the next one and two years actually fell.  In the case of the two year ahead expectations, this fall reversed a rise in the previous quarter, but left expectations as low as they’ve been since the end of the 2008/09 recession.   The survey doesn’t ask respondents for their population growth estimates, but at present the population is growing by almost 2 per cent annum, and if that continued then the expected 2.33 per cent GDP growth wouldn’t put much pressure on resources, or give much reason to expect inflation to rise.   Perhaps respondents to the survey are just wrong, and will be surprised by how much growth actually happens.  But at present there isn’t much evidence of a growth acceleration that might lift the core inflation rate.

The survey also asks about unemployment rate expectations.  Respondents are asked what they expect the unemployment rate to be in a year’s time and in two years’ time.

expec rise in U.png

The chart shows the expected increase in the unemployment rate between one and two years ahead.  When the unemployment rate is very low, and monetary conditions are tight (see chart above), as in the pre-recession period respondents typically expect that the unemployment rate will rise in future.  After the 2008/09 recession, for several years respondents expected material falls in the unemployment rate.  But now. with the actual unemployment rate at 5.7 per cent, they still expect it to be 5.53 per cent two years from now.  There is simply no sign that these respondents expect capacity pressures to intensify from where they are.  And, thus, they see no reason to expect underlying inflation (abstracting oil and tax changes etc) to head back to 2 per cent any time soon.

Who knows what the Reserve Bank will make of the recent data, including the Survey of Expectations.  On their past track record, the expectations survey might provide them cover to not cut the OCR in June (“look, two year ahead expectations stabilized”).   Given the Governor’s apparently strong bias to focus on the housing market whenever possible –  for which he has no mandate –  and avoid cutting unless the other data overwhelm him, it might make a plausible story for some.

But it would be the wrong message to take.  The Governor’s mandate for monetary policy is to keep inflation near the 2 per cent target midpoint.  Almost four years into his term, he has consistently failed to do that.  Reasonable people might differ on quite how much responsibility he bears for that failure –  what was forecastable and what wasn’t  –  but right now there is almost nothing suggesting (a) that informed observers have any confidence that inflation will settle at 2 per cent, or (b) that growth will accelerate and capacity pressures will intensify, in a way that might raise actual inflation and lead survey respondents to reassess the outlook for inflation itself.   The succession of grudging OCR cuts over the last year has probably eased the disinflationary pressures a little, but the evidence suggests they have been nowhere near enough to address the problem of inflation persistently undershooting the target the Minister of Finance (on behalf of the public) has given the Governor.

If we look back over the last five years, there were various factors that have, and should have, supported demand/activity at any given interest rate.  The terms of trade rose strongly on the back on high dairy prices, boosting domestic incomes.  The Christchurch repair and rebuild process was a big boost to demand  –  didn’t boost productivity, but it sucked up real resources that couldn’t be used for other things.  And at least on some readings, the world economy was providing some support to domestic activity –  both the sluggish recovery in the West (about as sluggish as New Zealand’s) and the buoyant demand in many emerging economies.

None of those things is supporting any sort of intensified pressure on resources now.  The terms of trade have fallen quite a lot, and while world dairy prices might be stabilizing (a) we can’t just assume that they will soon rise very much, and (b) the full effects on domestic spending etc of current weak payouts probably haven’t yet been seen.  The Christchurch process has a long way to go, but there is no sign of the level of repair/rebuild activity rising from here (and the recent cement sales data actually showed a large fall in Canterbury sales).  And there are very few bright spots in the world economy at present.

Perhaps the hope rests on a domestic (non-Canterbury) construction boom?  Given the population pressures that might be welcome, but it remains much more of an aspiration than a forecast –  respondents to the RB survey, expecting only very subdued GDP growth, seem to think so too.

Much better now for the Reserve Bank to move decisively to finally get on top of the downward drift in people’s expectation of future inflation, and the persistent undershooting of the target midpoint.  At present, I reckon the Governor’s reaction function is one in which (changes in) house price inflation dominate, unless other data suggest to his forecasters a material risk of inflation staying below 1 per cent.  That isn’t the target he has been given, but if that is something like the way he is operating, it is no wonder respondents to this survey see no reason to expect inflation to head back towards 2 per cent any time soon.  The Governor has only 16 months left in office –  just enough time, if he really took the issue seriously, to get underlying inflation settling back to around 2 per cent.

 

Non-resident purchases of houses: the data

Michael Reddell Housing

Last week, LINZ released the first batch of data from the new attempt to measure non-resident purchases of property in New Zealand.

As they note, at this stage the data have considerable limitations (including around the exclusion of purchases by trusts and companies).  In addition, it is unlikely that the few months these data cover will prove to have been representative.  On the one hand, there may have been some permanent behavioural changes as a result of the introduction of the “brightline test” and the tax number requirement introduced on 1 October.  For those concerned about non-resident purchases of houses in New Zealand, if those legislative changes reduce the extent of purchases that would no doubt be welcomed, but it will also mean we will never know with any certainty what the extent of non-resident purchases was in the couple of years before the law was changed.

So our law changes may have permanently reduced offshore purchases.  But they will almost certainly have temporarily disrupted the flow of such purchases.  Some people will have rushed to get in ahead of the law changes, and others will simply have been unsettled by them, or a little confused by them.  Many regulatory changes have that sort of effect –  a (potentially material) short-term disruption, which gradually abates.  In the housing market, we’ve seen it with the succession of new LVR restrictions.

All of which means that whatever the non-resident share of house purchases over the first three months of the year, it is likely to be a low-end estimate of the number of non-resident purchases (at least until China more effectively cracks down on capital outflows, and/or runs a regime that makes people more comfortable with holding their wealth in China. As I’ve pointed out before, in normal successful countries citizens don’t rush to buy houses in other countries as some sort of safe-haven store of value.

The focus of the discussion of this issue has been on the Auckland market.  The LINZ data tell us that in the January to March period, 4 per cent of transfers involved non-resident purchasers.  In most other localities, that share appears to have been smaller, but in the Queenstown-Lakes TLA, the share was a little higher still (for the entire October to March period).

What has surprised me somewhat is that 4 per cent has been treated by most people as a small number.  In writing about this almost a year ago, I noted that –  with no data whatever to back the supposition –  it wouldn’t surprise me if 5 per cent of Auckland housing demand was from non-residents, and that in a market with fairly tightly constrained new supply, even quite small percentages could make a material difference to house prices.

And much of the discussion of this issue seems to ignore the fact that most turnover in the housing market is not as a result of people entering the market for the first time or leaving it for the last time.    Most turnover involves New Zealanders buying and selling from one another –   people changing city or suburb, or just changing their stage of life (wanting a bigger house as the kids grow, or a smaller house later in life).  The same goes for residential rental properties: the stock turns over as individual owners’ circumstances and interests change.  A well-functioning housing market will have a lot of turnover (facilitating those changes in life circumstances etc) and little persistent pressure one way or the other on real prices.    In these data, New Zealanders bought sold from each other around 40000 houses in a six-month period.

Pressure on prices arises from net new demand to the market (or –  the Christchurch story post-earthquake – net reductions in supply) not from routine turnover.  It is a bit like immigration influences on the housing market.  In a year in which there are big swings in net migration, those fluctuations might amount to only around 1 per cent of the population.  Even if migrants typically eventually purchase their own home, probably most don’t purchase in their first year or two here (especially as many initially come on temporary –  work or student – visas), so newly-arrived immigrants themselves might still only account for a quite small percentage of house sales in any year.  But previous formal empirical studies have  suggested that a 1 per cent shock to the population from a change in immigration can still produce up to a 10 per cent change in house prices.  Markets operate at the margin –  it is changes in the net new demand/supply that really should be the focus of attention.

If the average New Zealand house was turned over five or six times in the course of an adult life (eg turning over roughly every 10 years), then perhaps 80 per cent of all turnover would just represent “churn” –  a term that sometimes has pejorative connotations, but here I just mean New Zealanders moving through different phases of their lives.  If, on the other hand, most of the non-resident purchases were net new demand to the market, then 4 per cent of total turnover might be more like 20 per cent of net new demand to the market.  I’m not staking anything on that number; it is purely to illustrate that data suggesting non-resident purchases are 4 per cent of turnover may tell one very little about what role those purchases are playing in the overall balance of pressures on the Auckland market.

The issues around immigration are a bit different from those around non-resident purchases.  Immigrants need to live somewhere, regardless of whether or not they own a house themselves.  Non-resident purchasers, almost (but not quite on the LINZ measure) by definition don’t need somewhere to live here.  On the other hand, the suggestion has been  – although we don’t have the data to know the extent of it –  that many non-resident purchasers have been buying properties and leaving them empty (recall the store of value motive).  If that is happening to any material extent, the impact on the housing market is much as if they were a new migrant. If, on the other hand, houses purchased by non-residents are placed on the rental market, non-resident demand might still raise house prices materially (in a supply constrained city) but shouldn’t materially affect the affordability of accommodation itself –  ie rents.

One other limitation of the residency data is that it doesn’t give a sense of transitions from one residency to another.  For example, the data show quite a large number of purchases, and a large number of sales, by Australian tax residents.  One possibility is that most of these people are actually New Zealand citizens.  A New Zealander might have gone to Australia a few years ago, and left a house behind, unsure how long they would stay in Australia.  Finding that life has worked out well in Australia, and having become an Australian tax resident, they might now be selling the house here.  Or a New Zealander who has lived in Australia for some time, and become an Australian tax resident, might be looking at coming home, and purchases  a house here in anticipation of the move.  Given the easy migration flows between New Zealand and Australia, there is likely to be a different interpretation on transactions by these non-residents than there might be in respect of most purchasers with Chinese tax residence (a country where there is a well-known high level of capital outflows to a variety of countries, often manifest in residential real estate purchases).  Of course, if that Australian story is correct, there is a considerable element of “churn” in those transactions too, rather than net new demand to the market.

It is going to take time, and more refinements by LINZ, to really get a good sense of the situation, particularly after the first disruptive effects of last year’s regulatory changes pass.   But, for now, it is best to keep in mind that even if the offshore non-resident purchases (from people not having lived here previously or likely to live here in the near future) are only equivalent to a few per cent of total housing turnover in Auckland, that probably isn’t a small number in terms of its economic effect.  In a well-functioning house supply market it might be different –  increased demand boosts supply, in effect providing a new export industry.  When supply doesn’t work well, quite small changes in the net balance of demand can have uncomfortably large implications for prices.