Thinking about senior central bank appointments

The Bank of England lost a Deputy Governor the other day.  The Hon. Charlotte Hogg had been chief operating officer of the Bank of England for the last few years, and was recently appointed by the Chancellor of the Exchequer as Deputy Governor (with responsibility for banking and markets).    She was apparently quite highly-regarded, as well as being a scion of the British establishment (both her father and mother are peers in their own right, her mother was head of John Major’s Downing St policy unit, and her father, grandfather, and great-grandfather were all viscounts and Cabinet ministers).

Senior appointees to Bank of England roles (both top executive positions and the non-executive appointees to the decisionmaking committees on monetary policy and regulatory matters) are subject to confirmation hearings before a parliamentary select committee.     The select committee doesn’t get to decide whether the appointees get the job –  so it isn’t like the US system –  but they can ask hard questions, and can write and publish reports on the suitability of a candidate.  The House of Commons is large enough that there are plenty of MPs who either never will be ministers, or have already had a term as a minister,  That seems to make them  –  even those from the governing party – more willing to ask hard questions than one might expect.

In the course of her confirmation hearings, it became apparent that Hogg had not declared and disclosed to the Bank of England that her brother was head of group strategy for Barclays –  holding a senior position (including involvement in regulatory matters) in one of the largest UK banks, and one for which the Bank of England has supervisory responsibility.    Worse still, earlier in the hearings she suggested to MPs that she had in fact done so.

It is a strange story.  At one point in this episode, Hogg had declared that she was totally confident she had complied with all the Bank’s codes of conduct because “I wrote them”.   Even if so, how it never occurred to her to ensure she disclosed her brother’s position –  erring on the safe side if nothing else –  is a bit of a puzzle.  I’m also quite surprised that it wasn’t known and recognised within the Bank anyway –  they are hands-on supervisors, Barclays is a big and important bank, and the brother’s name would be familiar to anyone with a modicum of knowledge of modern British political history.

The Treasury select committee published a fairly forthrightly critical report, and shortly before it was published Hogg announced that she will resign.  The Guardian has is a nice summary of the story.

There is no suggestion of any substantive inappropriate conduct (whether information being passed, or behaviour influenced) beyond the non-disclosure itself.  But the resignation is the sort of standard we should expect from holders of high, and powerful, public offices.  As Hogg herself put it

“We as public servants should not merely meet but exceed the standards we expect of others.”

Regulatory agencies require punctilious adherence to the rules by those they regulate.  They weaken their own moral position if their own people aren’t held to at least those sorts of standards.

But as I read and thought about the Hogg story, it got me thinking again about our own Reserve Bank, and holders of senior positions there.

The Governor of the Reserve Bank exercises an enormous amount of power –  far more, personally, albeit in a smaller economy and financial system –  than the Governor of the Bank of England.  In that institution, most of the policymaking powers are spread across committees in which the Governor has only a single vote, and where most of the members are either executives not appointed by him or are non-executives.  And yet there is nothing like the confirmation hearings process here.  Most of the appointment power doesn’t even rest with the Minister of Finance –  who can be grilled in Parliament – but with the barely-visible Board members, who themselves face no parliamentary scrutiny.  Like the Bank of England, our Reserve Bank has a couple of deputy governors –  statutory positions.   Holders of those roles don’t have formal voting power –  unlike at the Bank of England –  but there is also no parliamentary scrutiny.  (There were suggestions that a former Deputy Governor was allowed to keep share options in an institution whose New Zealand subsidiary he was responsible for regulating.  If so,  external scrutiny at the time of appointment might have challenged that.)

Compared to the British system, in particular, our system is riddled with democratic deficits:  too much power in one person’s hands, the appointment of that person largely in the hands of non-elected appointees, and no parliamentary scrutiny on appointment of any of these statutory positions (Governor, Board, deputy governors).

In the aftermath of the Charlotte Hogg affair there were curious suggestions of unequal treatment.  Former Chancellor of the Exchequer, George Osborne, is quoted as saying

“Would she have gone if she had been an older man whose sister worked at a bank? I wonder,”

One can only respond “well, I certainly hope so”.

But again, contrast the position at the Bank of England with that at the Reserve Bank of New Zealand.  Hogg was the third female Deputy Governor of the Bank of England.    On the Bank’s statutory decision-making committees, two of the nine members of the Monetary Policy Committee are women, as are two of the members of the Prudential Regulatory Committe, and one member of the Financial Stability Committee. (Hogg serves on all three.)

The Reserve Bank of New Zealand has never had a female Governor or Deputy Governor.  Looking at the current organisation chart, two senior management roles are held by women, but they are both third tier internal corporate positions.    There has never been a more senior woman in the Bank, and thus none of the core statutory policy areas (monetary policy, financial regulation and stability, financial markets) has ever been headed by a woman.  There is no woman on the Governing Committee, and unless things have changed markedly in the last two years, there aren’t (m)any women managers in those core areas either. In fact, it is only about five or six years since the most senior woman in the core policy areas was made redundant.  There are plenty of able women further down the organisation, and I still recall –  35 years on –  the fearsome grilling I got from one smart woman in an interview when I applied to join the Bank, but none in the core senior positions.    (There are women on the Bank’s Board, but it of course has no role in policymaking.)

Quite why this is so is a bit of a mystery.  I doubt it is a result of direct or conscious discrimination –  although decades ago, women had to retire from the career staff if they got married.   And while macroeconomics and markets tend to be areas more men gravitate to than women, Janet Yellen chairs the Fed, and the Bank of England has managed three female deputy governors in the last 15 years.   And even across the Tasman, two of three Assistant Governors in the core policy areas  of the Reserve Bank of Australia are female.

But, whatever explains the patterns up till now, it must surely become a bit of an issue sometimes soon; perhaps one for the Minister and the Board in considering future appointments, and perhaps too for MPs and lobby groups wondering quite how the Reserve Bank appears to have remained so male-dominated for so long.

If one runs through the standard sorts of list of people who might be possibilities to become Governor next March, there are no female names  (Bascand, Orr, Carr, Sherwin, Archer and so on).  And if one restricts the field to that sort of background, I don’t think it is just because people have inadvertently overlooked the female names.   There are no women I’m aware of in New Zealand who hold, or have held, senior-level macro or banking regulatory roles –  eg one could look around the Reserve Bank or the Treasury, or the more prominent of the market economists and commentators and find none.

But perhaps it is time to cast the net wider?  That might be sensible anyway.  It seems likely that the next Governor will lead and preside over some potentially quite significant governance changes, and in many ways the organisation needs revitalising and opening up.  One could make a pretty compelling case for the appointment of a person with strong change management capabilities, rather than a more traditional economist.  Character and judgement would still always be vitally important, but they might be less important than the specific technical expertise.  In this case, after all, we know that there will be not just a new Governor but also at least one, and possibly two, new deputy governors –  and in any top team, there is a need for a complementary set of skills, not just clones of each other.    I’m not that familiar with many senior business figures but, for example, one of our major commercial banks is already, apparently very ably, led by a woman.

I could add that, to the extent that this surprising under-representation of women does concern those in power, my proposal to reform Reserve Bank governance to establish a couple of statutory decisionmaking committees (a Monetary Policy Committee and a Prudential Policy Committee) would also more quickly up more roles to which the Minister of Finance could appoint able women.  There shouldn’t be any real shortage of suitable candidates to be considered.

On the topic of gubernatorial appointments, readers might recall that when the Minister of Finance last month deferred the appointment of a new Governor until well after the election, giving deputy governor, Grant Spencer, a six month term as acting Governor, I raised questions as to whether this appointment was strictly lawfully permissible.  As I stressed then, I had no particular concerns about Grant himself, and had actually been suggesting for some time a variant of the same solution –  giving Graeme Wheeler a short extension, if he had been willing to accept it.  But the Act doesn’t seem to be written in a way that allows a new person to be appointed, with no Policy Targets Agreement, for such a short period.

Because there were no clear answers from the government, and no pro-active release of the relevant papers, I asked for copies of the relevant papers from (a) the Minister, (b) the Treasury, and (c) the Reserve Bank Board.  I didn’t really envisage it as a burdensome request, and although I was sure they would withhold any formal legal advice they had, I was interested in the advice the various agencies had provided to the Minister and Cabinet on the point.

So far, it looks a lot like typical bureaucratic delay and obstruction.  The Minister of Finance didn’t respond until well after the 20 working days (and was thus in breach of the Act).  When he finally did respond it was to say that he was giving himself another month to respond

“the extension is required because your request necessitates a search through a large quantity of information and consultations are needed before a decision can be made on your request”

Frankly, it would be surprising if the Minister of Finance held very many documents at all on this issue, but time will tell.   A week earlier I had had the same postponement, and same justification, from the Treasury – and again it would be a little surprising (especially as when they asked, I made clear that I wasn’t after working level email exchanges on the issue).  Curiously, the Reserve Bank Board itself –  the people primarily responsible for appointing a Governor –  didn’t claim to have lots of documents they needed to search, only that delay was needed

because consultations necessary to make a decision on the request are such that a proper response to the request cannot reasonably be made within the original time limit.

It isn’t an urgent issue, and in substance I don’t really have much of a problem with the Spencer appointment, but it is hardly the sort of open government, or commitment to the spirit of the Official Information  Act one might wistfully, foolishly, hope for.

Still no better than middling

The Minister of Finance greeted yesterday’s GDP numbers with the claim that

“While growth has softened in this latest quarter, the continuing trend is [with] consistent ongoing growth ahead of most other developed countries.

In the case of total GDP, that is no doubt true.  It is what happens when your country has had population growth of 2.1  per cent in the previous year.

But where do we sit in terms of growth in real GDP per capita?

The OECD doesn’t have data yet for all member countries, but here is how our GDP per capita growth compares, focusing on the December 2016 quarter over the December 2015 quarter, for the countries there are data for.

real GDP pc 12 mths to dec 16

And here is the same data for the full year to December 2016 over the full year to December 2015.

real gdp pc ann ave to Dec 16

Neither comparison is intrinsically better than the other.  Between them, really the best one can say is that New Zealand has been no better than the median country over the last year or so.  That’s nothing to write home about…….especially as our data suggest we’ve had negative productivity growth over the last year (whether one uses the point to point or annual average measure).   That means all our pretty modest per capita GDP growth over the last year has resulted from throwing more labour and more capital at the economy, and (less than) none at all by using resources smarter and better.

But according to the Minister

“This week’s statistics on economic growth and our external accounts show the benefit of the Government’s sensible, consistent economic management,” Mr Joyce says.

Productivity growth: still missing in action

We get some annual multi-factor productivity data from Statistics New Zealand next week, but for more a more timely read on productivity what we have is data on real GDP per hour worked.   This chart compares New Zealand and Australian real GDP per hour worked since just prior to the recession of 2008/09.   As previously, for New Zealand, I’ve average the two GDP series, and used the HLFS hours worked series.  There is a break in the series in June last year, on account of changes in the HLFS methodology.  That lifted hours worked (as measured) by about 2 per cent, and in this chart I’ve silently adjusted for that (while still hankering for an offical SNZ series that corrected for the break).

real gdp phw dec 16 release

Still going nowhere – perhaps even backwards – after five years.     Diverging ever further below Australia over that five years.  And for the full nine years, less than 5 per cent productivity growth in total.

You’d like to think this sort of gross underperformance would be getting some attention in the run-up to the election.  But there isn’t much sign of that.

Perhaps we are just supposed to think of it as some sort of “quality problem”, or a “problem of success”?  Mark me down as unconvinced.

 

 

 

 

 

Defenders of the NZSF

After the flurry of coverage a couple of weeks ago over the remuneration of Adrian Orr, chief executive of the New Zealand Superannuation Fund, debate seems to have turned towards the more substantive issues around the role of the Fund.   The chief executive has been out, in his usual feisty and rather opportunistic style, defending the Fund, advocating for it to be given more money to invest and so on.   One could reasonably question whether the latter in particular is the role of a public servant.  His job, surely, is to invest the money the government has chosen, under the terms of the legislation, to place with NZSF.    Wisely, in my view, no more money has been placed with Fund since 2009 (although even then I thought it was shame the government didn’t simply wind up the Fund).  But this is now an election campaign issue, with the Labour Party vocally calling for an immediate restart of contributions.   That is perhaps understandable from a party which now, once again, favours keeping the NZS age at 65 indefinitely –  which was pretty much their position back when the Fund was first set up.   But it is a debate senior public servants shouldn’t be participating in in public.  Whatever one’s view of the NZSF itself, there are simply fewer grounds for it if one thinks the age of NZS eligibility should be increased over time, as life expectancy improves.

What has also interested me is the vocal support Orr has had from various journalists. In the Orr interview I listened to, on Radio New Zealand’s Nine to Noon on Monday, Kathryn Ryan seemed to see her role as being to help Orr get “the truth” across, cheering him on as he went, rather than asking any searching or challenging questions.  And this morning, in the Dominion-Post, Vernon Small is channelling the Orr lines, but in even more strident tones.  He concludes that we’d be “barking mad” not to be putting more money into the NZSF each and every year.

Well, perhaps. But Orr in particular was guilty of downplaying quite a lot of important considerations.

First, for all the breathless excitement about the NZSF’s investment returns (around 10 per cent per annum, pre-tax, over the life of the Fund), there has been no hint from chief executive, or his media supporters, of the rather more disciplined approach official NZSF documents, presumably adopted by the Board, take:

It is our expectation, given our long-term mandate and risk appetite, that we will return at least the Treasury Bill return + 2.7% p.a. over any 20-year moving average period.

By design, it is a highly risky Fund (“high octane” was Orr’s description) and performance can only seriously evaluated over quite long periods of time –  20 year periods in the organisation’s own telling.  But Orr (or Ryan or Small) didn’t make that point.

Kathryn Ryan’s breathless praise of the investment performance included, a couple of times, “even over the global financial crisis”.     That period was certainly pretty dramatic, but for equity markets it just doesn’t look that unusual in the longer sweep of history.  Here is a chart of the S&P500, in real terms and on a log scale.

sp-500-historical-chart-data-2017-03-15-macrotrends (1)

The fall in equity prices over 2008/09 looks like the sort of fall one might expect every 15 or 20 years –  and that one was shorter-lived than most.  If you take lots of risk in equity and bond markets, the last 15 years haven’t been a hard time to make money.  As far as I can see, the NZSF has more or less been compensated for those risks (it has forced us citizens to bear) but no more than that.  (I was however amused by the shameless attempt of the Fund’s head of asset allocation, in response to a recent OIA request, to suggest that returns from January 2009 –  near the trough of global markets –  was a meaningful number to use in evaluating the Fund’s performance.)

So the problem with the Fund isn’t that its investment management choices (both those they would loosely classify as “passive” and those equally loosely classified as “active” –  the distinction is pretty arbitrary) have been particularly bad, or good.  They’ve probably been about what one might reasonably expect over that period.  And if we closed the Fund now, or shifted all the money back to low-risk assets, we could crystallise the gains and be thankful that, despite all the risk run, we made money rather than lost money.     But nothing in the Fund’s investment strategy will protect taxpayers if, and when, markets turn bad again.

Orr continues to misrepresents the NZSF as a “sovereign wealth fund”.  It simply isn’t.  We aren’t Norway or Abu Dhabi, managing for an intergenerational perspective, oil wealth that has been turned into cash.   All the money put into the NZSF has either been raised from taxes or borrowed.     There isn’t a pool of money that naturally needs investing.  Rather, the government has established a high-risk investment management subsidiary to punt on world markets.     That simply isn’t –  and never has been –  a natural business of government.

The Fund itself doesn’t have to worry where its money comes from.  But citizens do.   Who knows what governments would have done with the money if the NZSF had never been established.  I suspect much of it would have been wasted on increased government spending.  But it would have been possible to have cut the most distortionary taxes –  those on business income –  quite heavily, which would probably have given risen to a lot more business investment in New Zealand.  None of the analyses of the returns of the Fund ever seem to take into account, for example, the deadweight costs of taxes.  On mightn’t expect NZSF to do so –  they are just investment managers –  but if they don’t they aren’t really in a legitimate position to be calling for more public money to be steered their way.

Orr cites a number of other advantages for the Fund.   He argues that it has contributed to developing New Zealand capital markets.  I’d be interested to see the evidence for that claim.  Most of the Fund’s assets are invested abroad, by intentional design.   What would New Zealanders have done with money if they’d had it as individuals?   And I don’t quite see how sweetheart inside deals, whereby ACC and NZSF  – neither with any particular expertise in retail banking –  take chunks of Kiwibank from NZ Post, enhance New Zealand capital markets.  No doubt having a hulking behemoth (by New Zealand standards) like NZSF generates more activity –  NZDMO got to issue more bonds than otherwise, and then NZSF buys more (mostly overseas) assets –  but are the capital markets really better –  and by what standards – for the presence of the Fund?

I also heard him argue that the NZSF somehow reduces risk and improves certainty. I wasn’t quite sure what he was referring to, but it seemed to be about the future of NZS itself.    But again, he is really talking beyond his pay grade.  The future of NZS is a political issue that really has little or nothing to do with the NZSF size/performance.   It isn’t like a contractural funded defined benefit pension scheme.  Presumably the overall state of government finances, overall tax burdens, and a community consensus on what is fair and reasonable are more likely to shape the future of NZS than the presence (and investment returns) of NZSF.    And in thinking about the overall government balance sheet –  something Orr doesn’t seem to, and isn’t paid to, think much about –  NZSF is currently only about 10 per cent of total assets.

He is on similarly shaky ground when he talks about save as you go approaches beating out pay as you go approaches.  I’m sure we can all agree that saving for the future typically makes sense –  the power of compound interest and all that  –  but that insight doesn’t help at all in deciding what, if any, role NZSF should have.   After all, we could wind NZSF up today, use the proceeds to repay government debt, and nothing would change about accumulated public sector savings.  Higher public sector savings is mostly a choice between taxing more and spending less.   As it is, I’d probably be happier if overall government net debt (including NZSF assets) was quite a bit lower than it is (ie build up government savings a bit more), but at least until all the gross government debt is repaid the government simply doesn’t have to be in the financial investment management business –  it is a pure discretionary choice.    We haven’t been there so far in the 14 year life of the Fund, and it doesn’t look likely that we will be in the next few decades either.  And Orr gives no weight at all to the failures of government, which often see additional Crown revenues wasted rather than saved.

Orr, and his defenders, have also been keen to scoff at any analogies with how a household might approach decisions.  I heard him say something along the lines of “if governments could act like households, we wouldn’t need governments”, which is true, but irrelevant in this context.  One role governments play, on behalf of households collectively, is to absorb collectively some of residual risks that individuals aren’t well-placed to handle.  That might tell you that often governments can’t, or won’t or shouldn’t cut spending in severe downturns, because some of their obligations increase then (and they are willing to let automatic stabilisers work).  For that reason, governments should be wary of revenue sources, or investment returns, that are very highly positively correlated with the economic cycle.  For example, one reason to be wary of capital gains taxes is that they tend to flatter government finances in good times, only for the revenue to dry up just when governments need it most (see Ireland last decade for a classic case study).    The same might well be said of highly risky asset portfolios –  even if they do quite well over the very long haul, they will look particularly poorly at just the times when government finances are under most pressure for other reasons.  In fact, if the pressures get serious enough, governments might come under pressure to liquidate those risky holdings right at the bottom of the cycle.  Those aren’t issues Orr has worry about –  he is simply paid to maximise returns on his little chunk of government resources, subject to acceptable risk –  but citizens, and people worry about overall government finances through time should do.

After all, it is not as if governments don’t already have other income and investment returns that are quite tied to the economic cycle.  Even on the investment front, for good or ill the government has quite large commercial holdings (those SOE stakes), and on the revenue front the tax system effectively makes the government an equity stakeholder in every business in New Zealand.

Orr and his defenders also scoff at household comparisons because, so they note, the government can borrow more cheaply than households.  More flamboyantly, here is Vernon Small’s take

As a comparison it may be politically effective but it is about as useful as a chocolate teapot.

Show me the household that can tax, has a central bank to set interest rates and biff around the exchange rate paid at the corner dairy, can borrow more cheaply than any business at rates below any mortgage offered by banks – and can live on for decades past the final days of its family members – and I’ll show you the household that has much to learn from a central government or vice versa.

Actually, the typical government (as distinct from the idealised one no one has ever seen) has operated with a horizon considerably shorter than that of most households.  And that is understandable:  I care about my kids and potential future grandchildren, who will still be there in decades to come.  Politicians –  who run governments –  face elections quite frequently, and in the course of a single lifetime successions of them run policy all over the show.

And quite how do people think that governments borrow so cheaply?  Because they have the power to tax, and that power is mostly exercised not over random stateless aliens, but over New Zealand households.  Every debt the New Zealand government takes on involves risks for New Zealand households – risks that at times of stress, governments will disrupt household and business plans by unexpectedly making a grab for a larger share of our incomes/wealth.  That risk limits the other risks households can afford to take, and is why I keep stressing that an accountable government can’t think of the cost of funds as simply the government bond rate; it has to price the implicit equity, bearing in mind that the coercion involved in the power to tax is more costly and distortionary than (say) a large company having to issue new debt if times get tough.    People like to say that governments can’t (usually) go bust, and so are subject to fewer “bankruptcy constraints” in thinking about undertaking possible long-term activities –  but that is typically true only to the extent that they ignore the perspectives and finances or their citizens, who ultimately bear the risks.  Ignoring citizens isn’t what governments are supposed to do.

My bottom line remains that NZSF hasn’t done badly what it has been asked to do (if you want a high risk fund that is).  Equally, it hasn’t really been put to the test.  They probably made some quite good calls at times, but the risks they assume for the taxpayer are very considerable.  In that OIA response I referred to earlier, they attempt to rebut some of my arguments, by suggesting that the appropriate hurdle rate of return should depend on the riskiness of the project.  I read that and thought: “yes, and that is really to concede my point”.    Over the life of the Fund, the standard deviation of annual returns has been almost 13 per cent.  Those are really large fluctuations –  by design –  and in considering establishing (or retaining) a government leveraged investment fund –  effectively a business subsidiary of the government – taxpayers need a lot of compensation for that risk.    Especially as that risk –  in the extremes, which are what matter –  is pretty correlated with other risks to government finances directly, and those of household sector finances indirectly, so there isn’t much –  if any –  overall risk reduction taking place.   When typical Australian companies uses hurdle rates in excess of 10 per cent, we shouldn’t be that comfortable  in our government running such a risky investment management operation for returns that, over a good 14 years, have only just matched 10 per cent.  I’m not suggesting anyone could have done much better than NZSF managers have, just that it wasn’t worth doing at all, evaluated by the sort of standards firms and households apply to their own finances.     And all that on a Fund that at present is only around 13 per cent of GDP.   The risk dimensions of the Fund become even more important if contributions are resumed and we envisage a Fund that could become a much larger component in the overall Crown balance sheet.

There is a political debate that should be had about NZSF.  There is a debate to be had about the future parameters of NZS.  But the two aren’t really very logically connected –  despite the words in the legislation.  If speculative investment management is a natural function of government, it is so regardless of baby boomers ageing, life expectancy or the parameters of any element of the welfare system.  Short of New Zealand discovering Norwegian quantities of oil and gas, I suspect it is no appropriate business of government.

 

 

 

 

 

New Zealand Initiative on immigration: Part 8 Labour market

The New Zealand Initiative’s chapter four, on economic issues, includes most of their treatment of the labour market.   This isn’t going to be a long post, and in a number of key areas we agree.

In particular, they are quite right to push back against the suggestion that immigration “takes jobs” from natives: there is no fixed pool of jobs, and if anything in the short-run immigration has tended to boost demand more than supply, so that in the shorter-term, it acts as a boost to (net) demand, and something that lowers the unemployment rate a bit.  That is why, typically, the Reserve Bank is raising interest rates –  or lowering them less than otherwise – when immigration surprises on the upside.  In the medium-term, there is likely to be little or no impact on the unemployment rate, one way or the other.    Labour market and welfare system regulatory rules play a key role in influencing the normal, sustainable, rate of unemployment.

And the Initiative doesn’t seem to have signed on to the silly nonsense that we need lots of immigrants to ease “skill shortages” – a line touted by Business New Zealand and their affiliates, and by their predecessor organisations for many decades.   I’ve dealt with this issue in various posts (including here and here).  You have to wonder how other countries manage –  including the many richer and more productive countries than New Zealand that haven’t had anywhere near as much immigration over the years.  Here is some of how I responded to that argument in one of those earlier posts

Business sector advocates often try to have us believe that key sectors just couldn’t survive without reliance on large scale immigration.  Set aside the inherent implausibility of the argument –  how do firms in the rest of the world manage –  and think about some specifics.  Sure, it is probably hard to get New Zealanders with alternative options to work in rest homes at present.  So, absent the immigration channel, wage rates in that sector would have to rise.  Were they to do so, I can see no reason why in time plenty of New Zealanders would not gravitate to the sector.  It was New Zealanders who staffed the old people’s home my grandparents and great aunts were in 30 years ago.  Same goes for the dairy sector, or the tourism sector.

…..

Of course, none of this is obvious to an individual employer.  They probably can’t raise their wages to attract New Zealand workers instead, even if they wanted to.  To do so would undermine that particular firm’s competitive position.  But again, this is the difference between an individual firm’s perspective, and a whole of economy perspective –  and the latter should be what shapes national policy.  Cut back the immigration target, along the lines I’ve suggested, and we’d see materially fewer resources needing to be spent on simply building to keep up with the infrastructure needs of a rising population.   We’d see materially low real interest rates, and with them a materially lower exchange rate.  The lower exchange rate would enable New Zealand dairy farmers, and tourism operators, to pay the higher wages that might be needed to recruit New Zealanders into their industries, and probably still be more competitive than they are now.  And plenty of New Zealanders now working in sectors totally reliant on an ever-growing population would, in any case, be looking for opportunities in other sectors.

The Initiative mostly stays away from this line of argument, and they are right to do so.  Markets take care of incipient “shortages”, whether of labour, tomatoes or whatever –  prices adjust and, if necessary, over time production and/or structures and patterns adjust.  The Initiative are generally supportive of letting markets work.

A lot of the empirical literature focuses on wages, and in particular on wages for those relatively more lowly-skilled natives who are, to some extent or other, in competition with relatively lowly-skilled migrants.  As even the Initiative notes, a big influx of migrants looking for work in one particular sector will probably lower wages in that sector in New Zealand.  They use “fruit pickers” as an example in their report.  But one could probably use aged-care workers as another concrete example.

The Initiative’s reaction to this, reasonably self-evident, proposition is to be (perhaps unconsciously) in two minds.  On the one hand, they like to cite what is probably the consensus of the international literature, that if there are adverse effects of immigration on lower-skilled natives they are, in aggregate, relatively small.  Perhaps that is true, although it probably isn’t much comfort to someone at the bottom end for whom every dollar in the weekly pay packet really counts.  And recall that survey of US academic economists I mentioned the other day.  Quite a few respondents were uncertain, but there wasn’t much dissent from the proposition that in the US context (one of the strongest and most productive economies around).

Question B: Unless they were compensated by others, many low-skilled American workers would be substantially worse off if a larger number of low-skilled foreign workers were legally allowed to enter the US each year.

But on the other hand, the Initiative seems to want to celebrate how helpful even low-skilled immigration can be, even though almost the only way –  even in theory – it can be helpful is by lowering domestic wages, at least for those who are near-substitutes for the migrants.

Here is what they say

Arguing for immigration restrictions to protect the incomes of New Zealand fruit pickers is as misguided as arguing for tariffs on fruit to serve the same purpose.

We cannot manipulate wages by distorting the market in the long run. Virtually anything can be imported today if there’s the will. Cheap foreign labour already competes with New Zealand labour even if workers don’t land on our shores. If wages in New Zealand for similar output rise much higher than foreign wages, we can only expect more outsourcing and exit of New Zealand firms.

Ultimately, wages are determined by the value of a worker’s production at the margin and the willingness of the worker to forgo leisure for consumption. Bringing in productive migrants more willing to work than New Zealanders may lower wages for some in the short run, but it also means New Zealand can produce more goods and services cheaper.

For a start, it is simply incorrect that “virtually anything can be imported today” –  try it for a hair cut, a cafe meal or coffee, aged care for your mother, or the bus trip home tonight.  The boundaries between tradables and non-tradables are fuzzy, but it doesn’t make the distinction economically irrelevant.

But what really staggered me was the starkness of the way they put it –  we should be competing internationally on the basis of lots of migrants lowering wage costs.     They really can’t have it both ways: lower-skilled immigration might be largely harmless (if it doesn’t have any obvious effects on wages for natives), or there might be gains from trade from bringing lots of these people in, but if so only through a mechanism that involves lower wages (than otherwise) for the natives they are competing with.  It surely has to be one or the other?  No one pretends these people are where all the ideas and productivity spillovers are coming from.

Despite the literature they cite, the Initiative seems to be in the latter camp.  Here was another comment on lower-skilled migrants, and why we shouldn’t just focus on highly-skilled migrants.

Hiring migrant workers in the service industry, especially home production (childcare, cleaning, gardening), can free up time for workers in other sectors of the economy. This way, they can be an important complement to highly skilled workers.

It does that by lowering the relative cost of that type of work.

Earlier in the year, I wrote about an op-ed by a British economics academic that had run in the local papers, where she argued that low-skilled immigrants had been a great boon for professional women and their husbands.  I summed up my reaction to that this way

Perhaps this wouldn’t be (as) morally offensive if there was an entirely separable class of temporary guest workers, who didn’t substitute at all for low-skilled domestic workers.   The temporary workers would gain from the trade, and so would those employing them. But that (separability) isn’t how labour markets operate.  What Bateman is in fact arguing for is a policy designed to explicitly help people like her, at the expense of poorer less highly-skilled Britons (in fact, in the roles she talks of typically poorer relatively unskilled British women).  No one person is ever an exact substitute for another, but there is a great deal of overlap.    Even though she never says it, what Bateman is arguing for is a policy designed to increase the differences in incomes between the highly-skilled and the less-skilled –  for the comfort of the highly-skilled (women and their spouses).

I don’t see any gap between Bateman’s stance and that of the Initiative.

In their conclusion to their economics chapter, the Initiative try to sum up.  They begin

The overall impact of immigration on the labour market is small, but with a multitude of individual effects. Some individuals may experience wage reduction, some wage growth, and some may remain unaffected. The effect for each individual will depend on their own skills, the skills of the migrants, and the demands from the migrants.

I suspect that isn’t too far wrong, especially when we recognise that much of the immigration to New Zealand isn’t very skilled at all, and that those at the lower end of skill spectrum are those mostly likely to be losing.

But here’s the thing.  That summary really gives the game away.  If even the key advocates of large-scale immigration can only end up arguing that the impact on the labour market is small, what happened to those large gains they were citing a few pages earlier in their report.  Recall the recent IMF study they cited

The study finds that a 1 percentage point increase in the share of migrants in the adult population can raise GDP per capita by up to 2% in the longer run

If that was even remotely true, we’d have seen a massive increase in productivity, GDP per capita, and almost certainly wages as a result of the scale of immigration New Zealand has had over the last 25 years.    Perhaps the lower-skilled would still have done relatively less well, but  pretty much everyone’s incomes should have lifted, and by quite a lot.  The differences really should be quite easily discernible.  As it is, even the advocates haven’t been able to show those sorts of gains.  In New Zealand’s case –  and recall that that is my focus –  they just don’t seem to be there, and there is a plausible case –  weak productivity growth, high interest and exchange rates, weak business investment, weak exports, and a remote island location as personal connections have become more important –  that we might mostly be worse off.   Some people  –  some natives –  are better off (anyone, for example, holding regulatorily-restricted land in Auckland 25 years ago), but a best guess –  a best read of the New Zealand experience –  is that the country as a whole isn’t better off, and quite probably is worse off.

The economics chapter of the report ends with a line I quoted in one of the earlier of this series of posts

Free movement of labour is a fundamental driver of the creative destruction
process, just like free movement of goods and capital. It can be painful for some but it improves outcomes for many. And if managed well, the pain can be short-lived and the benefits perpetual.

It is a statement of faith at best.    We haven’t had “free movement of labour” but we’ve had a lot more of an inflow of non-citizens –  all policy controlled –  than almost any other advanced country.   And the perpetual benefits still seem, to put it mildly, very hard to spot.  Perhaps they are there in theory, in particular specifications (models), of how economies work generally, but the challenge for the Initiative should surely to have been to demonstrate that those gains are actually there for New Zealanders, amid the specifics  of how this economy has actually worked in recent decades.

 

 

 

Reforming the Reserve Bank

A couple of weeks ago I wrote a post on where the Labour Party seemed to be going on monetary policy, informed by Alex Tarrant’s interest.co.nz article on his conversations with Grant Robertson.  It all seemed to amount to not very much –  wording changes to make explicit an interest in the labour market (employment/unemployment), but without much reason to think it would make much difference to anything of substance.  My suggestion was that there was a distinct whiff of virtue-signalling about it.   And the sort of change Robertson seemed interested in on the governance front  –  legislating the position of in-house technocrats –  seemed unlikely to be much of a step forward at all.

Last week, interest.co.nz had a piece on the same issues by former Herald economics editor Brian Fallow, also benefiting from an interview with Robertson.   Fallow pushes a bit harder.  His summary is that

The changes Labour proposes to make to the monetary policy framework sit somewhere between cosmetic and perilous, but closer to the former.

Cosmetic for the sorts of reasons I’ve outlined.  On the one hand, the Bank has always taken the labour market into account as one indicator of excess capacity.  And on the other hand, plenty of pieces of overseas central banking legislation refer to employment/unemployment somewhere, but there is little evidence that the central banks in those countries have run monetary policy much differently, on average over time, than the Reserve Bank of New Zealand has.

Robertson’s response is pretty underwhelming.

Asked how much difference the regime he advocates would have made, had it been in place in the past, he said, “In the very immediate past, not that much, truthfully. But there have been other times in our history, and there have been other examples around the world, when lower interest rates could have helped to reduce unemployment.”

If he was serious about this making a difference, he’d surely be able to quote chapter and verse.  When, where and how does he think it would have made a difference?

He is, however, clearly tantalised by the current situation

Even now, “Are we satisfied as a country that with 3.5% growth 5.2% unemployment is okay?”

Given that the Treasury thinks our NAIRU is nearer 4 per cent, I don’t think we should be content.  But Robertson has spent so long over the last few years defending Graeme Wheeler that he can’t quite bring himself, even now, to suggest that monetary policy could have been conducted better in the last five years, whether on the current mandate or something a little different.

If the proposed change isn’t cosmetic, Fallow worries that it could be perilous.  Why?  Because when he pushes Robertson he gets a more explicit –  and more concerning –  answer than the one Alex Tarrant got.

He has told interest.co.nz’s Alex Tarrant that he was not going to tell the Reserve Bank whether one objective is more important than the other.

Talking to me, however, he said that ultimately the bank would remain independent. “But if unemployment starts to get out of control I would expect in that environment it says ‘At this time we are preferencing that and we are going to lower rates by a greater percentage than we might have’.”

In the event of a stagflation scenario he would expect it to focus more on the falling output and employment side of the dilemma and to ease.

“I think the setting of a clear direction here is what is important.”

In short Robertson seems to be saying that if Parliament were to change the statute, the message to the bank would be when in doubt err on the side of stimulus.

If unemployment is prioritised by the Reserve Bank in such circumstances, it is a recipe for inflation getting away.  In the medium-term, monetary policy can really only affect nominal variables (inflation, price level, nominal GDP or whatever), it simply can’t affect real variables.  Using monetary policy to pursue such goals directly is a risky prescription.  I wouldn’t want to overstate the issue –  New Zealand isn’t heading for hyperinflation – but part of reason we and other countries ended up with persistently high inflation in the 1970s is that too much weight was placed on unemployment in setting monetary policy.  Getting inflation back down again was costly –  including in terms of increased unemployment.  On a smaller scale, as Fallow highlights, the desire to “give growth a chance” was part of what was behind the monetary policy misjudgements of 2003 to 2006, when monetary policy wasn’t tight enough.

Robertson’s words suggest he still hasn’t thought the issues through very deeply or carefully.  For now, I’m sticking with the “cosmetic” or virtue-signalling interpretation of what Labour is on about.   And I’m still uncomfortable at the lack of command of the issues and experience in someone who aspires to be Minister of Finance later this year.

But yesterday, a mainstream economist came out in support of more or less the direction Robertson is proposing.  In his youth Peter Redward spent a few years at the Reserve Bank, and then spent time in various roles, including at Barclays and Deutsche Bank, before returning to New Zealand and establishing his own economic and financial markets advisory firm.  He focuses on emerging Asian foreign exchange markets, but keeps a keen eye on monetary policy developments in New Zealand.

In his short piece at Newsroom, Peter Redward says It’s time for a Reserve Bank change.  He notes of the last few years that

Whether Governor Wheeler consciously aimed for a hawkish interpretation of the Act, or not, we may never know. But hawkish he’s been, leading to tighter monetary conditions than were necessary, boosting the New Zealand dollar and confining thousands of New Zealanders to needless unemployment.

And argues that

…maybe it’s time to adopt a dual mandate in the Act. One possibility is the dual mandate of the U.S. Federal Reserve. The Federal Reserve has a two percent inflation target but it also targets ‘maximum employment’. Economists have differing interpretations of ‘maximum employment’ so it acts as a constraint, and that’s the point.

While no one knows exactly where ‘maximum employment’ in New Zealand is, I believe most economists would agree that it’s likely to be consistent with an unemployment rate somewhere around 4.5 percent (give or take 0.25 percent). If the Reserve Bank had a dual mandate, its elevated level would have acted to constrain the bank’s aborted tightening of policy in 2009 and 2014.

I’m very sympathetic to his critique of Graeme Wheeler’s stewardship of monetary policy, and highlighted in numerous of my own commentaries, after it became apparent that the 2014 OCR increases had been an unnecessary mistake, the Governor’s apparent indifference to an unemployment rate that remained well above any estimates of a NAIRU.

But I remain a bit more sceptical than Peter appears to be about how much difference a re-specified mandate might have made.  As I’ve argued before, past Reserve Bank research suggests that faced with the sorts of shocks New Zealand experienced, policymakers at the Fed, the RBA and the Bank of Canada would have responded much the same way as the Reserve Bank of New Zealand did.  That work was done for periods prior to 2008/09 –  for most of the time since then the Fed was at or very near the lower bound on interest rates, so the game was a bit different –  but it isn’t clear that the specification of the target has been the problem in New Zealand in the last few years.  After all, simply on inflation grounds alone the Reserve Bank hasn’t done well.

Here is a chart of the Reserve Bank’s unemployment rate projections from the March 2014 MPS, the occasion when they started raising the OCR.

2014 U projections.png

The second observation is the last actual data they had –  the unemployment rate for the December 2013 quarter.  So when they started the tightening cycle they thought the unemployment would be falling quite considerably that year, before levelling out around what they thought of as something near what they must have thought of as the practical NAIRU  (this was before last year’s revisions to the HLFS which lowered unemployment rates, and NAIRU estimates, for the last few years).    The problem then wasn’t that they didn’t care about unemployment, it is that they got their forecasts –  particular as regards inflation –  badly wrong.  It isn’t clear why a different target specification would have altered the policy judgement at the time.

Perhaps it would have done so once it became apparent that the OCR increases hadn’t really been necessary, but a stubborn refusal by the Governor to concede mistakes, even with hindsight, plus a mindset firmly focused on how “extraordinarily stimulatory” monetary policy allegedly was –  when no one had any real idea what a neutral interest rate might be in the current environment, and when inflation stubbornly didn’t rise much if at all –  seem more likely explanations.    The Bank kept forecasting that inflation would rise and unemployment would fall –  the jointly desired outcomes.

(And if one looks at the Bank’s forecasts in mid 2010, when they made the previous unnecessary start on tightening, one gets much the same picture –  forecasts of falling unemployment and rising inflation, that simply didn’t happen.)

So why should we supposed that a different specification of the target would have made much difference to how policy was set?  We had an institution that was misreading things, in a political climate where no one seemed much bothered by the unemployment rate holding up, and where for a long time financial markets endorsed the approach taken by the Reserve Bank (often more enthusiastic for future tightenings than even the Governor and his advisers were).   Getting something closer to the right model of the world (for the times), and quickly learning from one’s mis-steps, seem likely to matter more than the words of the Act in this area.

As I’ve said repeatedly here, I’m not firmly opposed to amending the relevant clauses of the Reserve Bank Act to mention the desirability of things like a low unemployment rate.  But even the Federal Reserve Act makes clear that good monetary policy focused on a nominal target creates a climate consistent with high employment.  High employment isn’t a goal for the Federal Reserve is supposed to pursue directly, even if –  all else equal –  a high unemployment rate relative to an (uncertain) NAIRU is a useful indicator that something might be wrong with monetary policy settings. It isn’t clear there is anything much to gain from such amendments –  or that they are where the real issues regarding the Reserve Bank are – but sometimes perhaps virtue needs to be signalled?    My own concrete suggestion in this area would be to require the Reserve Bank to publish, every six months, its own estimates of the NAIRU and to explain the reasons for the deviations of actual unemployment from the NAIRU, how quickly that gap could be expected to close, and the contribution of monetary policy to the evolution of the gap.

Brian Fallow’s article suggested that Labour still hasn’t settled on how to reform the governance of the Reserve Bank.

Robertson is non-committal at this stage on the composition of a monetary policy committee to take interest rate decisions, including to what extent it should include members from outside the bank.

Peter Redward has a more specific proposal for him.

What’s needed is a formal Monetary Board complete with published minutes and, released after a grace period, transcripts of the meeting and the voting record of members. In a recent speech, U.S. Federal Reserve Vice Chair, Stanley Fischer, argued that this arrangement is superior to the sole responsibility model in achieving outcomes and accountability. Changes to the role and responsibility of the Governor will necessitate changes to the structure of the Reserve Bank Board. Best practice would suggest that a Monetary Board should be created to set monetary policy with the Reserve Bank Board selecting candidates for the committee while maintaining oversight of the bank. To ensure that external board members are not simply captured by the bank it may be necessary to provide a secretariat similar to the Fonterra Shareholder’s Council, operated at arms-length from bank management.

It isn’t my favoured model, but it would be a considerable step in the right direction, and far superior – in terms of heightened accountability and good governance of a powerful government agency –  to Graeme Wheeler’s preference to legislate his own internal committee.  The biggest problem I see with the Redward proposal, is that it has too much of a democratic deficit.  Monetary policy decisionmakers shouldn’t be appointed by other unelected people –  the Reserve Bank Board –  but by people (the Minister of Finance and his Cabinet colleagues) whom we the voters can toss out. That is how it is pretty much everywhere else.

Peter’s proposal focuses on monetary policy.  But, of course, the Reserve Bank has much wider policy responsibilities, including a lot of discretionary power –  not constrained by anything like the PTA –  in the area of financial regulation.  I presume he would also favour committee decisionmaking for those functions.  I’ve proposed two committees –  a Monetary Policy Committee and a Prudential Policy Committee, each appointed by the Minister of Finance, with a majority of non-executive members, and with each member subject to parliamentary confirmation hearings (although not parliamentary veto).  It is a very similar model to that put in place in the United Kingdom in the last few years.  It puts much less reliance on one person –  who will sometimes be exceptional, and occasionally really bad, but on average will be about average –  and would be more in step with the way in which other countries govern these sorts of functions, and with the way we govern other New Zealand public sector agencies.  I hope the Labour Party is giving serious thought to these sorts of options, and while the headline interest is often in monetary policy, the governance of the financial regulatory powers is at least as important to get right.

And then of course, getting a good Governor will always matter a lot.  The Governor, as chief executive, will set the tone within the organisation, and determine what behaviours are rewarded and which are frowned on or penalised.  If the Reserve Bank failed over the last few years, it wasn’t just because Graeme Wheeler was the sole monetary policy decisionmaker –  his advisers mostly seemed to agree with him –  but because of the sort of organisation he fostered, where “getting with the agenda” seemed more important and more valued than dissent or challenge, in area where few people know anything much with a very high degree of confidence.    Character and judgement are probably, at the margin, more important than high level technical expertise.

And while people are thinking about reforms to the Reserve Bank Act don’t lose sight of how little accountability and control there is over the Reserve Bank’s use of public money, or about the provisions it has carved out for itself from the Official Information Act which allow it to keep secret submissions on major policy proposals even –  perhaps even especially –  when they come from parties who would be affected by those proposals.

Revising the Reserve Bank Act was the first legislative priority for the first Labour government that took office in 1935.    I’m not suggesting the same priority if there is a new Labour-led government later in the year, but there is a real and substantial agenda of reforms to address, which will take time to get right, and which take on some added urgency in view of the vacancy in the office of the Governor that needs to be filled by next March.   That appointment –  a key step in the reform and revitalisation of the Reserve Bank –  should be led by whoever is Minister of Finance, not by the faceless (and unaccountable) men and women of the Reserve Bank’s Board, the people who have presided complacently over the mis-steps of the last few years.

 

 

 

New Zealand Initiative on immigration: Part 7 Productivity and all that

Today I’m continuing on with the New Zealand Initiative’s chapter four, on the (claimed) economic benefits to New Zealanders of large scale non-citizen immigration. I don’t have the appetite to try to comment on every questionable claim in the report, so I start with a section headed “Agglomeration –  Bigger is Better?” in which (despite the question mark) the Initiative appears to position itself firmly behind not just the proposition that immigration is good for us, but also the proposition that a bigger population is good for us.

There is no good evidence I’m aware of for the latter proposition.  At a more informal level, I illustrated in this post that large countries (by population) haven’t grown faster (per capita income or productivity) than small countries.  And, of course, consistent with this impression, we have seen many more small countries emerge in the last few decades.

What there is little doubt about is that within countries people and economic activity tend to organise themselves in ways in which the higher productivity activities are increasingly more often found in larger cities.  Cities exist in substantial part because it was found economically advantageous for them to do so.  But it isn’t all that way, by any means.  Natural resource based production tends to occur where the natural resources are –  be it farming, oil and gas extraction, mining, or whatever.   And the observation that within countries an increasing share of high value economic activity is undertaken in cities, tells us little or nothing useful about comparative national economic performance, given the successful co-existence of highly productive large and small countries.

The Initiative seems keen to take the other view

Places, cities in particular, with large, dense populations face lower transport costs in goods, people and ideas. It is cheaper to supply capital or consumer goods and find good workers; there is a better network for knowledge exchange across people.  All vital components of economic growth. The existence of ‘agglomeration economies’ has been established in a number of studies. A meta-analysis of 34 studies found that the positive effects of spatial concentration on productivity remain even after controlling for reverse causality.  Another meta-analysis highlights the importance of considering the various mechanisms through which agglomeration can produce benefits.  New Zealand’s low economic productivity is partly explained by our small population, says Phillip McCann based on economic geography and urban economics.

But, as they acknowledge, I’ve pointed out what appears to be a pitfall in the argument in the New Zealand context, at least when it is used to back encouraging large numbers of new people into Auckland –  what I’ve termed, the 21st century Think Big strategy.

Reddell contends that Auckland’s failure to produce significantly higher growth
compared to the rest of the country contradicts this explanation.

Recall that Auckland’s GDP per capita has been falling relative to that of the rest of the country for the last 15 years, and is quite low relative to that in the rest of the country when compared with other main cities in other advanced countries.  Not only hasn’t Auckland outperformed, it appears to have quite badly underperformed.  One could throw into the mix another point I’ve made previously: there is no major outward-oriented industry (exporting or import-competing) based in Auckland.  It has the feel of a disproportionately non-tradables economy, servicing (a) the rest of the country, and (b) the physical needs of its own policy-driven growth.

How does the Initiative respond to this point?

However, a recent report highlights how standard measures can understate urban productivity differentials and estimates that Auckland’s firms have labour productivity 13.5% higher than firms in other urban areas.

This is, frankly, rather naughty.  The Motu study in question produces revised estimates of labour productivity in Auckland relative to the rest of the country that are not dissimilar to the estimates of the ratio of nominal GDP per capita in Auckland relative to the rest of the country.  No one has questioned that GDP per capita in Auckland is higher than that, on average, in the rest of New Zealand.  But, by international standards, the margin is quite small.  And, more importantly for this debate, the margin has been shrinking, even though the theoretical literature the Initiative seeks to rely on suggests it should have been widening.  More people, from increasingly diverse places, generating more ideas, and as a result selling more stuff here and abroad, and investing to support those sales prospects.  But it just hasn’t been happening.  Instead, immigration policy has been putting more and more people in a place that doesn’t seem to have been producing the expected returns.  And we know that New Zealanders, who presumably are best-placed to assess opportunities and prospects here, have (net) been leaving Auckland.

Frankly I was a bit surprised the Initiative didn’t have a more effective response to these indicators of Auckland’s underperformance and the troubling questions they appear to raise about the economics of New Zealand’s immigration programme.

The next section in the chapter is headed “Macro impact and how we measure it”.  As they note

As a measure of living standards, GDP is not without its faults, but it does indicate how much a nation can produce and, ultimately, consume.  The effect of immigration on GDP can be difficult to disentangle. There is little contention GDP increases with more immigration – that countries produce more with more people is a no-brainer.
Of more interest to economists is GDP per capita – how much the pie is growing relative to the number of people taking slices.

I’d add that the impact on the GDP per capita of natives is, or should be, of particular interest when it comes to considering immigration policy.

There is a surprisingly limited empirical literature on this point.  There is a variety of papers which set up (calibrate) models for how the authors think the economy works, add an immigration shock, and then  –  surprise surprise –  find that the model produces much the answer one expects.    Papers in this class cover the range of results.  Some are set up in ways that produce gains to natives of recipient countries, through some of the sorts of channels Initiative authors cite.  But others, allowing for say fixed natural resources or sluggishly adjusting capital stocks, find that emigration tends to benefit the natives left behind, and slightly dampen the prospects of those in the recipient countries (the modelling the Australian and New Zealand Productivity Commissions used a few years ago in their review of the trans-Tasman relationship worked that way).  In the recent Australian Productivity Commission report on immigration, the modelling work assumed that productivity growth in Australia would be mildly adversely affected by continuing relatively large immigration inflows (there is a somewhat jaundiced, but not inaccurate, summary here).

But in terms of straightforward empirical analysis of effects on GDP per capita or productivity, there isn’t a large pool of relevant papers (and none at all focused on New Zealand, even though we’ve had one of the largest planned immigration programmes anywhere, over a long period of time).

The Initiative authors refers to two papers.   The first they summarise thus

A study of 22 OECD countries from 1987 to 2009 found migrants are not just attracted to countries with higher prosperity, they also help bring it about.

That sounds promising.    The actual results don’t quite match the promise.

The authors estimates four different version of their model. In each case, they show results for how GDP per capita respond to net migration, net migration responds to GDP per capita, and how the unemployment rate and net migration respond to each other.

Here is the impulse response function chart from the first version of the model

boubtane etc model 1

The solid line is the central estimate, and the dotted lines are the confidence bands.

There is a statistically significant response of GDP per capita to a change in the migration rate in the first year after the shock, but everything beyond that is (a) statistically insignificant, and (b) slightly negative –  ie below the zero line.   No one would be surprised by a positive effect in the first period, since in the short-term demand effects from unexpected immigration inflows will typically exceed the supply effects.  But over the medium-term, there is no evidence here of a sustained boost to per capita income.  The pictures from the other three versions of the model all look much the same.

Before moving on, I should briefly highlight two other points about this paper:

  • it uses net migration, whereas most of the theoretical arguments for possible gains from immigration relate to inflows of non-natives (new ideas, new skills etc).  For most countries, the difference isn’t that important, but for New Zealand it is very important.
  • one of the key things the paper sets out to show is that immigration does not materially affect the unemployment rate.  This is a point that the Initiative and I are at one on, and  –  for what it is worth –  the results of the paper suggest, as we would expect, no statistically significant effect.

The Initiative then moves on to some recent empirical work (Number 8, October 2016) by several IMF staff researchers, which built on another recent paper, by Ortega and Peri, but focused only on advanced countries.

The study finds that a 1 percentage point increase in the share of migrants
in the adult population can raise GDP per capita by up to 2% in the longer run and that the benefits from immigration are broadly shared across the income distribution.

As it happens, I wrote about this paper , somewhat sceptically, when it was first released, in conjunction with the IMF’s World Economic Outlook, late last year.

Here is the summary version of why the results simply don’t ring true.

This chart is from the paper (here “migrants” is the foreign-born share of the adult population)
stock-of-migrants

And this was my comment last year.

Think about France and Britain for a moment.  Both of them in 2010 had migrant populations of just over 10 per cent of the (over 25) population.  If this model was truly well-specified and catching something structural it seems to be saying that if 20 per cent of France’s population moved to Britain and 20 per cent of Britain’s population moved to France (which would give both countries migrant population shares similar to Australia’s), real GDP per capita in both countries would rise by around 40 per cent in the long term.  Denmark and Finland could close most of the GDP per capita gap to oil-rich Norway simply by making the same sort of swap.    It simply doesn’t ring true –  and these for hypothetical migrations involving populations that are more educated, and more attuned to market economies and their institutions, than the typical migrant to advanced countries.

Or, we could turn it around, and think about New Zealand’s actual experience.  Let’s say that the foreign-born share of New Zealand’s adult population increased by 10 percentage points since 1990 –  I can’t quickly find the exact numbers, but it is likely to have been in that order of magnitude.  If this model is correctly specificied – and recall that New Zealand is included in its sample –  that should have given us a huge lift in productivity and GDP per capita, say by around 20 percentage points.  In fact, of course, despite having had probably the largest non-citizen immigration programme of any of these countries in that period (Israel, for example, isn’t in their sample), our productivity (GDP per hour worked –  the metric the IMF authors use) has slipped further behind that of other advanced countries.   Yes, perhaps there were lots of other particularly bad offsetting policies undermining New Zealand’s prospects –  but over this period international agencies, including both the IMF and OECD, repeatedly stated that they thought we had pretty good policies in place.

Of course, as I noted on Friday, my main interest is New Zealand.  If immigration to and among other countries has been productivity-positive, that is something to celebrate, but there is little evidence that it has been so for New Zealand.

One could take the critique and questions a bit broader.  For example, note how the gains arise in this study.  It is from having a large (increased) share of foreign-born people in one’s population.  But immigrants age, have children etc.  Without a continuing inflow of non-citizen migrants, any initial boost to the foreign-born share will erode quite steadily over time.

The US offers an interesting case study.  Around the time of World War One, about 15 per cent of the US population was foreign-born.  Immigration restrictions imposed in the 1920s, and in place for the following forty years, saw the foreign-born share of the US population fall to around 5 per cent by around 1970.  There was nothing comparable in other large migrant recipient countries (eg Australia, New Zealand, Canada).  All else equal, if the IMF model was correctly-specificied, this huge reduction in the foreign-born share should have resulted in a substantial deterioration in the absolute and relative producitivity position of the United States.  There is simply no evidence I’m aware of to support such a proposition (and, in fact, historical estimates suggest that the US had some of its strongest productivity growth in history during these decades).

In my earlier write-up of the IMF paper I noted that

There are other reasons to be skeptical of the results in this IMF paper.  Among them is  that there is a fairly strong relationship between the economic performance of countries today and the performance of those countries a long time ago.  GDP per capita in 1910 was a pretty good predictor of a country’s relative GDP per capita ranking in 2010, suggesting reason to doubt that the current migrant share of population can be a big part of explaining the current level of GDP per capita (and some of the bigger outliers over the last 100 years have been low immigration Korea and Japan and high immigration New Zealand).    In fact, I’ve pointed readers previously to robust papers suggesting that much about a country’s economic performance today can be explained by its relative performance 3000 year ago.  How plausible is it that so much of today’s differences in level of GDP per capita among advanced countries can be explained simply by the current migrant share of the population?

If this is the strongest empirical support advocates of New Zealand’s approach to immigration can adduce, those who have been inclined simply to go along should surely be rethinking their unquestioning support for the policy approach –  whatever merits it may or may not have for some other countries.  I’m aware of a tendency for New Zealand Initiative people to think that the onus of proof isn’t, or shouldn’t, be on them, so obvious and “morally right” is the case for immigration.  Quite where the burden of proof lies is probably more a political one than an economic one, but one might hope that the advocates could produce more evidence, or sustained analysis of the New Zealand case, than is evident in the New Zealand Initiative’s economics chapter.  Especially when the policy approach they support has been tried for more than 25 years, and when even they concede some puzzles about New Zealand’s economic performance in that time.

The authors of the IMF paper, and the earlier Ortega and Peri, paper, hypothesise that the gains from immigration come largely through a total factor productivity (TFP) channel.  Although they never explicitly say so, The Initiative seem to share this perspective, with all their talk of ideas, innovation, alternative perspectives etc.  The IMF researchers didn’t test the connection between immigration and TFP.     But in my earlier post I included this chart, using the same foreign-born population share data the IMF did.

imf-mfp

If anything, over the period they looked at, the relationship was negative –  a larger increase in the foreign-born population share was associated with weaker TFP/MFP growth.  New Zealand is the red dot in the chart.  The outlier –  in the top right hand corner –  was Ireland, which looks more positive for the IMF/Initiative story, except that as I also showed in that earlier post, it is quite clear that the surge of migrants into Ireland came several years after the surge in TFP growth.

And, on the topic of TFP growth, in a post last week I illustrated again just how weak New Zealand’s TFP growth has been relative to that in other advanced economies.    Surely, serious think-tank advocates of New Zealand’s large scale non-citizen immigration policy would want to engage with this sort of record, and the apparent inconsistency with the connections they have hypothesised?

Sadly, simply ignoring the actual record in New Zealand seems to be par for course in the economic chapter of the Initiative’s report.

To their credit, they devote a couple of pages of the report to my hypothesis around the contribution of immigration policy to New Zealand’s longer-term economic underperformance (pp 39 and 40 for anyone interested).  As they note, I have argued that

  • “given New Zealand’s continued heavy dependence on natural resource based exports, New Zealand might not be a natural place to locate many more people, while still generating really high incomes for them all”, and that
  • high levels of non-citizen immigration have helpd explain persistently high real interest and exchange rates, in turn deterring business investment, especially that in the tradables sector, and thus tending to undermine productivity growth.

But they don’t really know what to do with these ideas, and so end up largely ignoring them.  There is simply nothing more, in this section or in the rest of the report, on the issues around a natural resource based economy, that is very distant for major markets/suppliers/networks etc.   New Zealand may have many things in common with other advanced economies, but this is one probably very important difference.

And when it comes to New Zealand’s dismal long-term productivity record, the limit of their comment is this

New Zealand productivity has been less than stellar for a long time – a concern to many economists and policymakers.

And that’s it.  There is no attempt at all to engage with the data, or to tell some alternative story of economic management and prospects over the last 25 years or so, in which for example, non-citizen immigration has played a more favourable role.

There is a little bit more on real interest rates –  why they’ve been so persistently high relative to the rest of the world.

The hypothesis also cannot fully explain why the real interest rate has not converged to the rest of the world. Reddell says competing theories explaining the high real interest rate, such as a risk premium associated with New Zealand investment, do not fit with the evidence either, in particular with the persistent strength of the real exchange rate. He contends that the only explanation currently on offer is that the repeated shocks to domestic demand – not fully recognised in advance by market participants – must have been a big part of the story.

Clearly, the Initiative don’t find my story persuasive, but there is simply no attempt to explain why, or to pose a credible alternative hypothesis for one of the most striking features of New Zealand macro data in recent decades.

The best they seem able to come up with is to point out that any sustained demand pressures will tend to put upward pressure on real interest rates.  And that is quite correct of course.  An economy with very strong productivity growth, and the associated investment in support of it and consumption in anticipation of the future income gains, will tend to have high real interest rates (relative to those abroad).    And no one much will regard that as problematic –  rather it is a mark of the success of the economy.

But that hasn’t been the New Zealand story. Business investment has been quite low as a share of GDP (especially given our population growth) and productivity growth (labour or total factor) has been low.  There is little, or nothing, to suggest that the high relative interest rates we’ve experienced in New Zealand over the last 25 years have been a desirable market-led phenomenon.  They look anomalous not just relative to other countries, but also relative to our own underwhelming economic performance.

Here is the Initiative’s attempt to fend off my analysis

The concerns raised by Reddell would apply more broadly than just on immigration. For example, tourists are foreigners who come to New Zealand, purchase our currency and goods, and use infrastructure (they require accommodation, drive on the roads, may require police assistance, add waste to landfills. etc.). Hence, tourism also puts pressure on the real interest rate and real exchange rate.

As I’ve already noted, any persistent demand pressure –  whether from exports or the domestic economy – will, all else equal, tend to put upward pressure on local interest rates.

But except for population-driven pressures (in a country with a modest savings rate) we just haven’t had such pressures.  As I noted just before, business investment has been lower than we might have hoped, exports as a share of GDP have been sideways or backwards, and the consumption share of GDP has been flat for decades.  What hasn’t been flat has been the population, and particularly the foreign-born population, the direct consequence of government immigration policy.    Take their tourism example.  SNZ has data on the average daily stock of foreign travellers in New Zealand(boosting domestic demand) and the average stock of New Zealand travellers abroad (easing domestic demand), going back to 1999.     There are more foreign travellers here than New Zealanders abroad, on average, but the numbers aren’t large.  In 1999, there were on  the average day  16000 more foreign travellers here than New Zealanders abroad.  Last year, that number was 54000.    38000 (net) more travellers here is a helpful addition to net exports, and some pressure on demand.   But

  • the overall export share of GDP is less now than it was in 1999
  • from 1999 to 2016, there was a net inflow of 759000 non-citizen migrants to New Zealand.

That is both a very large number, and a direct government economic policy choice.  It has had consequences, and there seems a reasonable prima facie case, which the New Zealand Initiative has not attempted to seriously rebut, that that government-controlled influx has not been economically beneficial to New Zealanders as a whole.

This post has already got rather long, so just two final thoughts.

First, it is striking how little attention the Initiative gives to the large sustained outflow of New Zealanders over recent decades.  That outflow is certainly at a low ebb at the moment, but there seems little reason to assume that the exodus has come to any sort of permanent end –  as even the Initiative recognises, our productivity performance languishes.   Whatever one thinks of immigration policy in the abstract, surely it is a somewhat relevant consideration to look at what New Zealanders themselves are doing –  people best placed to assess opportunities and prospects here?   There is, among some policymakers, a weird approach to this issue, in which immigration policy is substantially about replacing those who leave.  I don’t think the Initiative subscribes to that silliness, but neither does it call it out.  When individuals are making rational choices to move – to leave New Zealand –  the burden of proof should really be on those who want the government to try to second-guess those judgements and choices.  When people left Ireland, Italy, Sweden or wherever for the US in the 19th century, it benefited those who left and those who stayed.  It would have daft for the authorities in those places to have responded “woe is me, we need to find some poorer people from other places to bring in to replace those who’ve left”.  A quite different approach would be to respect and respond to the market signals – movements of their own people –  and try to fix up their own economies in ways that might make it no longer attractive for  their own people to leave.  It would have been a much better lesson for the New Zealand authorities to take.  Residents of Taihape and Invercargill should be grateful governments didn’t/couldn’t respond to outflows of people from those towns by suggesting a presssing need to get other people from elsewhere in the world to move to Taihape and Invercargill, even though the economic opportunities had moved on from those places.

And second, in the IMF paper that the Initiative cite there are references to a new paper by various Harvard researchers on the economic effects of diversity (so recent that the references have been added since the version of the IMF piece that I commented on last year).  The authors note that typically in studies to date “the negative effects of diversity seem to dominate empirically”.  In this paper, they find more positive results, but they also look at what sort of diversity might produce benefits (p 26)

 we extend our index of birthplace diversity and account for cultural and economic distance between immigrants and natives. The productive effects of birthplace diversity appear to be largest for immigrants originating from richer countries and from countries at intermediate levels of cultural proximity.

and

This suggests that a combination of culturally closer immigrants and richer origins (potentially a proxy for higher skills) can be particularly valuable.

If this model is robust, then it is perhaps unfortunate for the economic case for the immigration programme that very little of New Zealand’s immigration is from countries richer than our own, and most of it isn’t from countries with close or intermediate levels of “cultural proximity”.  By contrast –  and uncomfortable as it is to point it out again –  all New Zealand’s immigration in the mid 19th century was from countries richer than us.  As such, there is little doubt that if lifted economic performance and productivity for all New Zealanders.    Whether the results are robust is something for others to look at, but it is the sort of specific results, that recognise that some immigration can be beneficial, but not all needs to be –  it depends on various things, including time, place, and people –  that the New Zealand Initiative should be engaging with rather than merrily asserting, with no New Zealand specific evidence –  that the gains to natives are there simply because people have come among us from another country, any country.