Really?

Michael Reddell Fiscal policy, Treasury

A few weeks ago an invitation dropped into my email inbox to attend a joint Treasury/Motu seminar on recent, rather major, changes that had apparently been made to the discount rates used by The Treasury to evaluate proposals from government agencies.

It was all news to me, but when I went over to The Treasury’s website I found that the new policy had come into effect on 1 October last year (relevant Treasury circular here) and that the work on this major policy change had apparently going on for a long time, dating back to the days of the previous government (the two consultant reports are both dated June 2023). All the papers Treasury has released are here (I have also now lodged an OIA request for other relevant papers, including advice etc to current or former Ministers of Finance).

The new discount rates are shown here

This is a dramatically different model than what had been used until now, when all projects were required, as a starting point, to be evaluated using a 5 per cent real discount rate.

I have read all the papers The Treasury released and went along to the seminar on Monday, and came away even more troubled – about both the public policy and analytical dimensions – than I had been initially. Why, you might ask, should commercial projects be evaluated at dramatically different rates than non-commercial projects? Who is going to decide what counts as “commercial” and what as “non-commercial” (and should so much hang on what must, at the margin at least, be something of a line call)? And why would a change of this magnitude, which will materially affect advice going to ministers across the whole of government have been done with no public consultation whatever (and Treasury confirmed to me that this had indeed been the case, and that such consultation as there had been had only been with other government entities)?

But, first, those acronyms: SOC (social opportunity cost) and SRTP (social rate of time preference). Under certain restrictive conditions these two things should be the same, but estimates of them are rarely even close. There is a vast literature on this stuff, going back many decades.

Here is how The Treasury describes the two approaches

There is quite a bit of (questionable) editorial in these descriptions, but the gist is fine: SOC is designed to capture the cost to “society” of funding some public sector proposal (funds could be used for other purposes and projects by firms or individuals), while SRTP attempts to capture how much current consumption “society” (however represented) is willing to give up in exchange for more future consumption.

For decades, Treasury has used a SOC-based approach here, and in my view were right to do so. Of the other countries shown in the various reports, it seems that a majority also use the SOC approach while a small group of European countries used a SRTP approach.

Treasury and their consultants all seem to agree that on straightforward commercial projects, the SOC approach is the only sensible one to take. To do anything else – to use a materially lower discount rate – would be to skew the playing field in favour of the government investing in commercial projects that the private sector could do just as well. In that sense, moving to an 8 per cent real discount rate for unquestionably commercial projects is a step in the right direction (although I suspect that even at 8 per cent, the discount rate is likely to be lower than the hurdle rates of return required by many/most private sector companies in deciding on investment proposals).

A common argument that claims this is okay is based on the fact that government bond yields are typically lower than those for corporate bonds. I’ve long thought (and written about here) that that is a deeply flawed argument, because a key reason government bond yields are lower than those of private sector securities (no matter how large the corporate) is that government’s ability to pay is secured on the coercive power to tax, and that risk (to us, as taxpayers) needs to be priced in evaluating proposals to spend public money. All the more so when one realises that the likelihood of draconian tax increases to meet government obligations is probably pretty strongly correlated with adverse economic circumstances in the wider economy (and thus for the ability of taxpayers to comfortably pay). I’ve also long been uneasy about the idea that public sector proposals should be evaluated at rates that are probably below private sector hurdle rates because of the utter absence of market disciplines government agencies and politicians as decisionmakers face. When people who face no market disciplines want to take our money – tax now, or via debt – and use it on long-term projects, it seems not unreasonable that their schemes should be evaluated on at least as demanding a basis (but ideally more demanding) as private commercial entities do. After all, it is a pretty widely-accepted stylised fact that cost over-runs and execution failures are more the norm than the exception in major public projects in New Zealand (not only New Zealand of course). Remarkably, in none of the Treasury papers nor in the seminar on Monday was there any mention of incentives and disciplines: government failure was all but unknown in a land of benevolent and wise social planners.

But commercial projects (ones that are clearly so) are the easy bit of all this. The latest change was at least a step in the right direction. And the Treasury circular is clear that

The real problem arises in respect of the “non-commercial proposals”. You will look in vain in the Treasury Circular for any official justification for using such wildly different discount rates for the two types of proposals, with the far lower discount rates for those proposals that – almost by assumption – are subject to fewer market-type tests and greater uncertainty (including about specifying benefits and objectives). It will be interesting to see how The Treasury framed advice on this issue to the Minister of Finance. One hopes they mentioned that even so-called non-commercial projects have an opportunity cost – a real burden on taxpayers whose money could be used for other things.

Now, in fairness, the background papers briefly mentioned some arguments (including suggestions that future generations are not represented in today’s market prices, but may be represented by a benevolent government decisionmaker – although it is never clear why (eg) families are less likely to internalise interests of future generations than governments, the latter being individuals facing re-election every three years, and no effort is made to evaluate the actual demonstrated interest in or ability of past or present governments to effectively represent those interests). However, the main paper Treasury cites, that by academic economist Arthur Grimes, has just three recommendations at the end, and not one of them is for anything like this stark (although he notes that “long-term payoffs to projects for which the populace is likely to have a lower rate of pure time discount compared to that for generalised consumption could have a lower [social discount rate] than the default rate….This proposal…is one which warrants further investigation). Grimes was a little sharper in his slides on Monday, but even then his proposal was only for lower discount rates for “some non-market activities” (and quite whose preferences were to guide the choice of “some” wasn’t clear).

What that 2 per cent discount rate for non-commercial proposal does is to ignore the actual opportunity cost of funds (that 8 per cent, or more) and preference – in ranking possible proposals for using scarce societal resources – non-commercial proposals (that generally won’t cover the social cost of capital) over commercial ones. And that is quite regardless of the character of the individual non-commercial proposal, a category that even in concept covers a vast array of possibilities. It is really quite extraordinary, and perhaps all the more so to see it adopted by this government, which came into office focused (at least rhetorically) on low quality government spending, the rapid run-up in debt under the previous government. (I had been unsure until Monday whether these policies had simply been adopted by Treasury, but I was assured by Treasury officials that they had in fact been signed off by the current Minister of Finance).

Now, to be clear, there are some caveats. First, discount rates aren’t everything. All too often cost-benefit analyses have simply been ignored, even when done. And if one looked at the table of discount rates used in other countries that was presented on Monday, the only country using a lower discount rate than the New Zealand 2 per cent is Germany – a country that many of the great and good think does far too little government capital spending (their debt brake – a very sensible initiative in my view – acts as a constraint presumably). In a New Zealand context, simply changing discount rates won’t of itself get more projects off the ground.

But both operating and capital allowances are fluid over time – they are no sort of anchor – and there is no real debt constraint at all. What the change to discount rates will do is make many more non-commercial projects look to pass a cost-benefit assessment, creating pressure from interested parties on governments to raise taxes or take on more debt “because, you can see, so many good projects just aren’t being funded”. And going by the mood of the room on Monday – most attendees seemed to be public service affiliated – many officials will think that just a fine thing indeed (there were people getting up and thanking Treasury for making this change, which would make such a difference to their preferred types of schemes). What was the Minister of Finance thinking when she signed this off?

Especially as the entire thing seems like an indeterminate muddle.

First, there is this table from the Treasury circular, designed to assist agency CEs and CFOs in doing their cost-benefit analyses.

So things that politicians or officials happen to think are good for people (“merit goods”) – whether we value them or not – get evaluated at a much more favourable (lower) discount rate than other stuff. But even setting points like that aside, one is left with more questions than answers. Take schools for instance. Most are provided directly by the state with no charge at point of use, but not all are, and there is no technical reason why a quite different operating model couldn’t be chosen. Same goes for health and hospitals. Are they “commercial” or “non-commercial”? How will Dunedin hospital – a long-lived capital project – be evaluated (if at all)? Does a different discount rate get used if a PPP is involved (see final item in the “commercial” column), than if the government provides the finance directly? And if so, why? And “social housing” is in the right hand column, even though housebuilding and rental operations are directly amenable to commercial models (perhaps with income subsidies to poor users). One could go on.

I asked about some of these specifics at the seminar on Monday, and got no better than handwaving answers, along the lines of “well, we don’t really know, but time and experience will tell”. It was pretty breathtaking really, but then I came home and reread the official circular and that was more or less exactly what they’d told agencies too. It was there in the text above that table, and also in this “The Treasury may publish further guidance as we gain experience with the new PSDRs.”. May…..how helpful.

Now again, to be fair, the circular notes that agencies will be required to stress test proposals by presenting evaluations done at both high and low discount rates. And there will be plenty of public sector proposals where it may not make much difference (where the costs and benefits are both substantially spread through time), but for anything with a major long-lasting capital commitment (think infrastructure) the difference will be enormous. And there is just no guidance, either to agencies, or to enable the public to have a sense of how proposals are likely to be evaluated by officials.

But in case you were thinking that surely not too much would be done at 2 per cent, there was this final guidance to agencies

That is pretty much everything central government actually does.

The whole thing is rendered even more unsatisfactory by this note at the end of the Treasury Circular

If the social cost of capital estimate is 8 per cent real – per this new guidance – it is hard to see any decent basis for keeping the capital charge rate, which incentivises agencies to use scarce capital prudently, at 5 per cent. And whatever the capital charge rate is set at – 5 or 8 per cent, or something higher still – our Minister of Finance and Treasury are happy to evaluate almost all central government department proposals at a discount rate of 2 per cent, far below our cost of capital to enable and fund such activities. I’m happy to agree that there are probably a handful of things that might appropriately be evaluated at below the cost of capital, but….they are few indeed (and probably contentious across different groups in society). And the approach Treasury and the Minister have taken just increases the risk of more uneconomic proposals being adopted over time, with more of a bias towards proposals where there are fewer solid external benchmarks. That seems less than ideal, especially in a government that touts its commitment to “turbocharging” economic growth and productivity.

(I’m also not really persuaded by the case for generally declining discount rates on all non-commercial projects, especially beginning at such a short horizon (30 years, which seems to be shorter than those other countries that adopt this approach), but it would be largely irrelevant if these projects were being evaluated at discount rates nearer the cost of capital.)

Finally, in a country where so much is subject to public consultation, what possible grounds were there for moving ahead on a change of such (potential) magnitude with no wider consultation whatever?

Willis and Rennie speaking

Michael Reddell New Zealand economic performance, Treasury

Last week various of the great and good of New Zealand economics and public policy trooped off to Hamilton (of all places) for the annual Waikato Economics Forum, one of the successful marketing drives of university’s Vice-Chancellor.

My interest was in the speeches delivered by the Minister of Finance and by Iain Rennie, the newly appointed (by this government) Secretary to the Treasury. The Minister also used her speech to announce the launch of a Going for Growth website complete with a 44 page document (15 of which are photos and covers, and another 9 are lists of things (being) done) titled “Going for Growth: Unlocking New Zealand’s Potential” – in the Minister’s words, “Going For Growth outlines the approach the Government is taking to turbo-charge our economy”.

Yeah right.

Now, to be clear, there are some (mostly small) useful things the government has done in the area of economic policy. There are also some (fewer in number) overtly backward steps (eg increasing effective company tax rates by eliminating tax depreciation on buildings, free liquidity insurance for big end of town property developers, debt to income limits imposed by the Reserve Bank), and some important areas where the government has so far failed to act at all (eg last year’s Budget didn’t reduce, and actually marginally increased, the estimated structural fiscal deficit). There is just nothing in what the Minister said, or in what the government has done (or has concretely indicated it will shortly do), that comes even close to being likely to “turbo charge” the economy. It isn’t even clear that either the Minister or her Treasury advisers has anything close to a compelling model and narrative about how we got into the longer-term productivity mess, let alone how we might successfully get out of it (if any politicians really cared enough to want to do so).

Take the Minister’s speech first. I read it against her speech to the same forum last February, given just a couple of months after she had taken office. In that speech we got quite a lot of good stuff about things the incoming government had quickly undone. It made a reasonably impressive list for a first couple of months. By contrast, it is thin pickings in this year’s speech.

We are told, for example, that

Leaders around the world are being compelled to act more boldly than they have for several decades

But there isn’t much sign of it – with the growth focus she talked of – in either what the government is doing, or in what is discussed in the speech.

It isn’t a long speech (just under 8 pages of text) but two full pages are devoted to supermarkets. It is the centrepiece of the speech, to an economics forum just a couple of weeks after the Prime Minister’s big push on emphasising growth-focused policies. Now, I’m as much in favour as the next person of removing regulatory restrictions that might impede the entry of new supermarket competitors – and of cutting company tax rates when possible (which bear particularly heavily on overseas investors’ calculations) – but as the focus of the Minister’s speech it seems like not much more than populist rhetoric. One could eliminate every cent of supermarket profits in New Zealand – which presumably no one wants to do, because unprofitable businesses tend not to keep operating – and it might lower grocery prices by 5 per cent of so (half that for some more realistic scenario based on claims around “excess profits”). Nice to have of course, but not exactly transformative even for households, let alone for the productivity and performance of the economy as a whole. And yet the Minister touts there as being “massive gains for Kiwi shoppers”. And as for suggestions that the government might help hold the hands of potential entrants, how about just getting the regulatory roadblocks out of the way for everyone, rather than rewarding lobbying with special treatment for those who have a taste for and knack of bending the ear of governments for favourable treatment for their particular firms?

Following on from those two pages, the Minister lists four other areas of potential policy overhauls:

  • Government procurement rules. There is talk of a review underway.  It sounds sensible enough (but nothing specific), but it is a little hard to believe that what might eventually be delivered will be any sort of game-changer
  • Tax settings.  Here the Minister tells us that “I am considering a range of proposals to make out tax settings more competitive over time”.  Which is fine, but….there is barely any mention in the speech of the fiscal constraints (the structural deficit the government has so far done nothing about), or of course of the fact that the government increased taxes on business just last year.
  • Affordable energy sounds like a good thing of course.  But there is nothing specific in the speech, and in fact there is a potentially troubling reference to potential steps “the Government may need to take to incentivise new generation”.   Other than removing regulatory roadblocks and, perhaps one day, tax imposts?
  • Savings.  Here there is disconcerting talk of changes to KiwiSaver rules, although probably in the end with marginal effects at best (or worst).  There is talk of enabling more investment in private unlisted assets, even though KiwiSaver fund managers may have little expertise in those sectors, and liquidity and valuation challenges will be very real.  There is the suggestion that more KiwiSaver balances should be invested in New Zealand, which makes little sense for individual New Zealand savers’ whose assets these are and who diversification imperatives should be driving a heavy weighting on international assets.  The Minister tells us she is looking at taking options to Cabinet, but since there is little evidence that difficulty of raising wholesale funding has been a major obstacle to growth in New Zealand it is difficult to see that whatever she comes up with is likely to make much useful change.

And so, almost half way through the government’s term, supermarket reform seems to be what the Minister is holding out as the big prospect (and of course there is Kiwibank, another much-touted cause likely to deliver little useful). 

What of the Secretary to the Treasury’s speech?  You may recall last year that it was reported on several occasions that the Minister of Finance was wanting bold, fresh, innovative thinking from whoever got the job (and since she sets out the search requirements and Cabinet makes the appointment, it really is a government appointment, one in which PSC simply acts on their behalf).

I’m fairly ambivalent about heads of Treasury giving public speeches.  On the one hand, it should be an opportunity to advertise the analytical chops of the Secretary and his/her team, and thus to be welcomed.  On the other hand, the Secretary and the Treasury are the government’s principal economic advisers and those internal relationships are much more substantively important than Treasury public speeches.  There are distinct limits –  quite severe limits in practice –  on what the Secretary can really say, since he or she can’t really be out of step with the Minister in public.  Which means it is never quite clear whether what we are hearing is their best professional analysis, or just what they more or less have to say.

I was pretty underwhelmed by Rennie’s speech, and perhaps the more so as it was I think his first on-the-record speech, and was being delivered not to a provincial Rotary club but to a significant professional economics and policy forum.  No one forced him to accept the speaking invitation, and so we might reasonably have expected the best Treasury had to offer.

Instead, we got a fairly once-over-lightly treatment of both the productivity and fiscal challenges, and the highly dubious claim –  but perhaps it went over well in the Beehive –  that “the Government already has a significant economic reforms programme underway”.   Really?  Do tell.  Interestingly, on the productivity side of things Rennie stated (of Treasury) “we are confident that we understand the basic problems”.  But there was little in the speech to suggest that they really do.  Instead, we get the same rather mechanical growth-accounting stuff that The Treasury has been trotting out for 20 years, and that has found its way into speeches by ministers too.

Thus, we are told that “New Zealand’s low capital intensity is a key driver [note the choice of words] of our poor productivity performance”.   No one disputes that business investment as a share of GDP has been low in New Zealand for a long time, more particularly when considered in the light of rapid population growth.  So the capital stock per worker is, in some mechanical sense, quite low.  But what this approach invites –  and has for the 15-20 years Treasury has been running this line –  is some of “lump of capital” fallacy, that if only more capital was thrown at the economy things would be much better.  It is also captured in comments from both the Secretary and the Minister that are reasonably read as suggesting that somehow individual firms are making bad choices and not putting enough capital into their production processes.

The mentality is all wrong.   Low levels of capital intensity are at best seen as symptom not as any sort of cause or “driver” of productivity growth failures economywide.    New Zealand has never had a particularly problem attracting finance – for example, for decades we’ve financed largish current account deficits even as on average the real exchange rate has stayed high.  And we should assume that, on average, firms and potential investors are responding rationally, and even optimally on average, to the opportunities they face.     So the issue is not that firms are failing to use enough capital in their production processes –  they are most likely doing what is best for them – but that, having regard to all the other constraints (taxes, FDI rules, RMA regimes, other bits of regulation, real exchange rates) there just aren’t that many attractive projects here in New Zealand.  A highly successful New Zealand economy would be likely to be more capital intensive (and generate higher wages),but focusing on the capital intensity or otherwise is the wrong lens with which to look at the problem.    Firms and investors respond to opportunities, and sometimes (often) governments get in the road and make investment (particularly that in the tradables sector) unattractive.

The emphasis on “capital intensity” also drives a focus –  and it is there is the Secretary’s speech –  on something labelled “savings policy”.   I suspect there is a more sophisticated analysis behind some of this stuff, but again the way it comes across is to feed a mentality that if only more “savings” were available more productivity would flow.  As already noted, we’ve had no problem attracting generic foreign savings, but government policies do make business investment proposals often rather unattractive, whether the potential finance is from domestic or foreign sources.

Rennie also addressed (or largely avoided addressing) the fiscal challenges.   “Avoided addressing” because he was more or less stuck with his Minister’s choice to go very slowly and to keep postponing the date for a return to structural fiscal balance.   Instead we get lines like “the current Government has committed to concrete steps to address structural deficits” –  which is generous at best, since they have taken few actual concrete steps, and have only “committed” to the variable vapourware of future (changeable) operating allowances – and suggestions that somehow adjusting over a long period of time is just fine, when there was never a robust economic case for the current structural deficits at all.

And then of course there was the heartwarming, somewhat detached from reality, ending

Governments need to make progress in the here and now. Our job is to advise them on
which pathways are the best to start walking down. We do think hard about a coherent
programme, drawing on evidence and judgment but also remain mindful of the uncertain
connections between policy changes and policy outcomes when you look out over the
horizon. Over time governments will choose to stride faster or slower down those paths.
The important thing is to keep taking those steps and maintain momentum across a broad
front of economic and fiscal policy frameworks.

First, it has an implicit assumption that Treasury knows what is best to do, whether around fiscal or productivity issues.  This is the same Treasury that was advising Grant Robertson only a couple of years ago that higher spending was just fine, the Treasury that seems keen on more active use of fiscal policy (notwithstanding where that mentality got us in the last few years), and the same Treasury that does not have and has not had a compelling narrative around productivity failures or solutions.  And then there is the rather delusional suggestion that, Treasury having identified the right paths, different governments might just walk them at different paces.  The real world is one in which different governments will, at times, be walking in almost exactly the opposite direction to what either fiscal prudence or better productivity performance might call for.    One might think of raising corporate taxes last year, or film and gaming subsidies, or…..or……or……. (all parties, all governments).

Perhaps it really is the case that all the answers to New Zealand’s economic woes rest with failure to adopt the old-time religion.  I rather doubt it, but whatever the case the sad reality of the Secretary’s first public speech is that there was no sign even of fresh or interesting ways of articulating the old-time religion or any interesting or bold new angles.

But that probably suited his political masters.

Going for growth…..perhaps

Michael Reddell New Zealand economic performance, Productivity

The Prime Minister’s speech 10 days or so ago kicked off a flurry of commentary. No one much anywhere near the mainstream (ie excluding Greens supporters) questioned the rhetoric. New Zealand has done woefully poorly on productivity for a long time and we really need better outcomes, and the sorts of policy frameworks that would supports firms and markets delivering better material living standards for New Zealanders.

The Prime Minister asserted that “2025 will bring a relentless focus on unleashing the growth we need to lift incomes, strengthen local businesses and create opportunity”. Assuming that these are shorthands for measures intended to durably and substantially lift economywide productivity growth (I saw a nice quote the other day from the Canadian Leader of the Opposition to the effect that no one talks about productivity per se except economists and friends of economists), one could only respond “good if true”.

We have been promised a “rolling maul” of new policy measures as the year unfolds. And the Minister of Finance (now rejoicing in the rather absurdly named additional title of Minister for Economic Growth -albeit perhaps no more absurd that the Economic Development title it replaced) went further in her press release announcing the Budget date and promising

It is a distinctly different emphasis than in her Budget-date announcement press release last year.

Nothing like building up expectations….and one hopes journalists will keep an eye on this set of promises.

I’d give this government credit for a number of steps that, at the margin, may help boost growth, productivity, and efficiency of the New Zealand economy. But it is hardly a case of everything working in the same direction: last year, for example, we had increased business tax rates (re building depreciation), increased taxes on inbound tourists, more restrictions of bank mortgage lending, passing up chances to overhaul key personnel at the Reserve Bank, and of course a Budget that, taken together, slightly widened the structural fiscal deficit. And it wasn’t as if the growth rhetoric wasn’t around last year (eg this quite respectable, as far as these things go, speech from March 2024).

Perhaps this time they really will deliver “bold steps” in May. I’m open to being convinced – and in this case would love to be wrong- but count me sceptical.

For various reasons:

  • For all the rhetoric from the PM and Minister of Finance there is no specific goal which they are willing to use as a stake in the ground (even John Key for a short time would run the line that “our vision is to close the gap with Australian by 2025”),
  • There was nothing in the National Party’s campaign material in 2023 that suggested either a deep understanding of the issues or a policy agenda equal to the sort of challenge New Zealand faces (and that was so even when there were some specifics I thought made sense),
  • We are now 14-15 months into the government’s term –  the election is next year –  and not much has been done so far, no compelling narrative has been developed, no key government agencies have been overhauled and made fit for the challenge etc,
  • Where are the advisers? It isn’t obvious that there are first-rate productivity-focused political advisers in ministers’ (or the PM’s) offices, and what about MBIE and Treasury?  MBIE is a bureaucratic behemoth run by a former Air New Zealand HR senior manager (no, before Luxon’s time) and in appointing a new Secretary to the Treasury, and despite more fine words from Willis last year, the government ended settling for a recycled former Deputy Secretary, who is certainly skilled at managing upwards but would never have been mistaken for a bold and innovative policy reformer (or leader of such people/processes).  Oh, and the Ministry for Regulation is headed by a non-policy recycled public sector chief executive, who didn’t seem to be particularly well-regarded in her previous chief executive role.
  • The Budget is now a mere 3.5 months away.  Based on standard timings Treasury will be finishing their economic forecasts by the end of next month and the Budget is unlikely to incorporate anything not decided by the end of April.  Without excusing bureaucratic sludge, good policy processes take time, perhaps especially in a coalition government.
  • And, of course, none of the three measures announced in the last 10 days look to add up to very much (Invest NZ – one wonders why this spin-out from NZTE is needed at all, and what private sector advisers can’t provide –  the re-organisation of the CRIs, and the digital nomad visa)

There is, of course, some stuff in train that should in time prove helpful (for example, the RMA overhaul, although with the best of intentions it is likely to be years until we can be confident just how helpful – the original RMA having been understood at the time as a liberalising reform).

One can only assume that the word has gone out from the offices of Luxon and Willis to all ministers, and then all public service agencies, to pull together whatever they now can – and perhaps hold off on other announcements for a while – to enable a set of Budget announcements that can be dressed up as passably resembling “bold steps”. No doubt there is stuff in the works – there almost always is – so perhaps the net effect will even be positive (though with enough confidence to lift Treasury’s assumptions about real per capita potential GDP growth?) but I wouldn’t be holding my breath that it will be the real thing, or even begin to get to grips with the magnitude of the challenge. But – Trump ructions permitting – quite probably there will be some cyclical rebound in GDP growth in time for next October (for which the government will deserve no more credit than it deserves blame for the monetary policy induced recession last year),

On that note, the Sunday Star-Times yesterday ran an op-ed from Don Brash and me, prompted by some combination of memories of that goal of catching Australia by 2025 (Don chaired the taskforce and I provided analytical and drafting support) and the PM’s speech, trying not be to be particularly partisan (the failure – and the rhetoric, in varying volumes – has been common to all governments for decades). We ended the column this way.

For anyone interested, the full text follows:

When Don was young and Michael’s parents were young, New Zealand had among the very highest material standards of living in the world.  It really was, in the old line, one of the very best places to bring up children.  But no longer.

For 75 years now, with no more than brief interruptions, New Zealand has been losing ground relative to other countries.   Australia and the UK pulled ahead of us, previously poor places like Singapore and Taiwan caught up and overtook us, and increasingly now the former eastern bloc countries (Slovenia, Estonia, Poland, and so on) are catching and overtaking us. 

Don’t get us wrong: material living standards here are still well ahead of where they were in the 1950s, but if we were once a leader we are now a laggard.  All too many of our people have seen better opportunities across the Tasman for themselves and their kids and have made the move.  That’s good for them, of course, but a poor reflection on economic performance and policy back here.

For 40 years, successive governments have talked a good game about reversing that relative decline and closing the gaps that were opening up.    In the earlier part of the period there were far-reaching policy reforms, which probably helped slow the rate of relative decline.  In more recent decades, the ratio of talk to action has very much favoured talk.  And that is so whichever of our main political parties has led the government.

In late 2008, nearly 17 years ago now, as part of a post-election agreement with ACT, the then government led by John Key announced a goal of catching up with Australia by 2025.  A Taskforce was set up to advise the government on policy options that might enable aspiration to be turned into solid economic achievement.  Don chaired that 2025 Taskforce and Michael wrote much of the Taskforce’s first report.   

The report wasn’t well-received by the then government –  in fact, the then Prime Minister openly dismissed it even before it was released publicly – but that didn’t alter the facts:  New Zealand was lagging far behind Australia (and Australia itself wasn’t, and isn’t, a stellar economic performer).

It is now 2025 and over the intervening years –  under successive governments, led by both main parties – no progress at all has been made in closing the gaps to Australia.  If anything, and as measured by labour productivity (output per hour worked), the gaps have widened a bit further.  Recently the Australian government has made it easier, and more secure, for New Zealanders – any of us, skilled or unskilled, young or old –  to cross the Tasman.   It isn’t that Australia has done particularly well economically in recent years –  rather the contrary –  it is just that New Zealand hasn’t even managed to match their underperformance consistently.    Productivity growth – the only secure foundation for material prosperity – here dropped away further from about 2012.

This month we’ve heard a lot from the Prime Minister about the importance of economic growth.   It is fine rhetoric and we entirely endorse his argument.   Material prosperity – whether it is private consumption or better and more public services – rests on restarting sustained economic growth, which in turn rests on accelerated sustained growth in productivity. 

This isn’t just about the ups and downs of the business cycle. Economic activity has been particularly weak in the last 12-18 months as the Reserve Bank has been getting on top of the inflation it inadvertently generated with too easy monetary policy during the Covid period. Now that inflation is falling and interest rates are dropping, we should expect a cyclical recovery.    But a near-term bounce isn’t anything like enough; what we need is, say, 20 years of 2-3 per cent per annum productivity growth.  Over the last decade, actual productivity growth has averaged not much more than 0.5 per cent per annum.

The Prime Minister announced a couple of small reforms in his speech this week.  They may well be individually helpful, but small changes aren’t what will produce really big differences in outcomes. 

We’ll watch with interest the promised “rolling maul” of reforms but aren’t confident that this government, any more than its National and Labour predecessors this century, is likely to respond on the scale equal to the challenge.  

Sadly, it isn’t obvious either that the government has a public service with the energy, intellectual ferment, and concrete ideas that a willing government could pick up and run with.   But some of the options that should be considered are pretty obvious:  economics literature suggests that most of the burden of heavy taxes on business is actually borne by labour (in the form of lower wages than otherwise), and yet New Zealand –  plagued by decades of low levels of business investment – has one of the highest company tax rates in the OECD, and takes a higher percentage of GDP in corporate income tax than almost any OECD country.   Foreign investment in New Zealand remains harder than it should be, and is taxed more heavily than it should be.

We can choose to continue to drift, with just incremental reforms, as successive governments have done for 30 years even amid the fine talk.  But if we do, more and more New Zealanders are likely to conclude rationally that there are better opportunities abroad, and for those who stay aspirations to first world living standards and public services will increasingly become a pipe dream.  

It is a multi-decade challenge under successive future governments, but as the old line has it the longest journey start with the first step.  We hope the Prime Minister’s bold rhetoric signals the beginning of a willingness to lay things on the line, to lead the debate on serious options, to spend political capital, for the serious prospect of a much better tomorrow for our children and grandchildren.

ENDS

NB: Since I saw a BusinessDesk column this morning claiming that 1950-type cross-country comparisons are unfair (much of continental Europe was still recovering from the war), it is worth pointing out that exactly the same could have been said of 1939. New Zealand had among the very highest material living standards among advanced economies throughout the first half of the 20th century.

Reviewing Covid experiences and policies

Michael Reddell pandemic

I’ve spent the last week writing a fairly substantial review of a recent book (“Australia’s Pandemic Exceptionalism: How we crushed the curve but lost the race”) by a couple of Australian academic economists on Australia’s pandemic policies and experiences. For all its limitations, there isn’t anything similar in New Zealand.

What we do have is the Phase 1 report of the Covid Royal Commission which was released by the government at the end of November. You can find the full 700+ page report here. I haven’t read the full report but did read Chapter 6 on “Economic and social impacts and responses” (which starts on page 242 of the Report itself, or page 285 of the pdf). It was, frankly, a pretty disappointing read. If the overall Royal Commission report itself got surprisingly little coverage, I don’t think I’ve seen any mention at all (certainly no serious or sustained reporting or analysis) on the economic dimensions of that exceptional period.

It is disappointing on a number of counts. First, and perhaps least important to me at this point, we were told (and the terms of reference make clear) that the focus on the Royal Commission was supposed to be on lessons learned with a view to being better equipped/prepared to handle future pandemics. But in the economics section of chapter 6 there is almost none of that, and the focus seems to be almost entirely on describing and evaluating policy responses and the impact of them. Which would be fine, except that the chapter is very much an establishment perspective, with little or no sign of any critical scrutiny before reaching the generally rather complacent conclusions.

I went and had a look at the list of engagements and people the Royal Commission had met with had over the course of their inquiry. I was looking to see which economists, academic or otherwise, the Royal Commission might have met with. They had, of course, met with The Treasury and the Reserve Bank, they’d met with three [named] former Secretaries to the Treasury (another former Secretary to the Treasury was one of the commissioners), they note a meeting with one economist described as a “public policy expert” on aspects of the wage subsidy scheme. And other than that all we got was, in November 2023, a mention that they had met with “various [unnamed] independent economic commentators”. Which was more than a little surprising when, for example, leading New Zealand economist John Gibson had been producing work on related issues since early days of the pandemic (discussed first on this blog here), as had former academic Martin Lally. I worked my way through the 12 pages of end notes to Chapter 6, and not only was there no reference to anything by Gibson or Lally, but there was no reference to any commentary or critique etc by any outside economists, academic or otherwise (although there is a quote from a Bernard Hickey Substack). There is a one sentence reference to “considerable concern” they heard from “some expert stakeholders” about the LSAP, only to dismiss this on the grounds that “these policies are now well accepted by international organisations” and going on to channel the Reserve Bank’s own lines in its defence. Fiscal losses of “in the order of $11 billion” are noted. but there is no attempt to evaluate the strategy or to think about how support might better (and more cheaply) be provided in future. That isn’t scrutiny and evaluation; it is reporting.

The chapter is weak right from the start, when the Commissioners simply assert (there is no supporting analysis) that “the strict public health measures introduced in March 2020, especially the border closure and national lockdowns, were essential [emphasis added] to protect the economy and society from the immediate and devastating effects of the pandemic had the virus been allowed to spread unchecked”. There is no analysis as to what extent of restrictions was required (it is a very all or nothing assertion), there is no reference to the fact that significant reductions in movement were occurring prior to any legal restrictions (or, for example, to the work of Goolsbee and Syverson from the US, using mobile phone data, and suggesting that almost 90 per cent of reductions in movement pre-dated legal restrictions). There is no suggestion of any cost-benefit approach at the margins (as there was no sign of it in the official advice, and we recall the trouble the Productivity Commission got into when they did one brief illustrative exercise), and no comparison looking at how the economic costs and benefits of the New Zealand approach stacked up. Of course, no country let the virus “spread unchecked” but the US is often used as a foil and counterpoint to New Zealand and Australia, and for all the differences in approach it is striking how similar the respective paths of real GDP per capita proved to be (for quite different health outcomes of course).

I don’t have a strong view on what, if anything, in this area should have been done differently, but we should have expected more challenge and scrutiny from the Royal Commissioners.

There is no attempt anywhere in the chapter to consider whether the things fiscal policy was used for could have been done (materially) more cheaply – either in evaluating 2020 and 2021 or thinking about the future. The fiscal costs were staggeringly high. It also isn’t clear that the Royal Commission really understands the point of the initial fiscal approach. They talk about the aim being to support economic activity, when in fact it was quite the contrary: the point of the lockdowns (and private risk-averse behaviour) was to largely shut down the economy for a time. What the wage subsidy approach was designed to do was (a) tide individuals over (the government compelling many not to work, and b) facilitate a quicker rebound than otherwise by maintaining established firm-specific arrangements and human capital. It certainly did the former, but to what extent it really did the latter (see chart above) deserves more serious scrutiny. Headline unemployment rates in the US went far higher than in New Zealand (and Australia) reflecting different intervention approaches, but (see chart) it isn’t immediately obvious that overall US economic performance suffered.

The Royal Commission also runs a line one sees too often, taking the very gloomy economic forecasts that were around in the second quarter of 2020, contrasting them with actual outcomes, and concluding that credit belonged to the policymakers (the Royal Commission hedges a little but is in the same camp with its “No doubt, these better-than-scenario outcomes reflected, at least in part, the speed and generosity of the Government responses”. But that simply has to be wrong. Treasury and Reserve Bank forecasters in the second quarter of 2020 knew all about the scale and nature of all those responses (economic and public health): the effects they expected were already embedded in their forecasts/scenarios. What actually happened was a massive forecasting failure, misunderstanding the nature of the shock and the way the balance of supply and demand pressures was likely to play out. Of course, plenty of private sector commentators and forecasters made the same mistake, but official failures had rather more consequences.

The Royal Commission is keen on the Reserve Bank’s self-described “least regrets” strategy (which, incidentally, has just a single mention in the RB May 2020 MPS), by which they thought – sensibly enough – that faced with a big adverse shock you wanted to act early rather than late. The problem was never with that as applied to RB actions in March 2020, but that they failed to apply anything like the same logic when it started to be apparent that inflation was becoming a problem. They were slow to recognise the speed of the economic rebound or the emerging capacity and core inflation pressures, and were slow to act, and acting rather slowly (Orr to this day attempts distraction, around things like Ukraine that didn’t happen until after the economy was already well-overheated and core inflation had risen strongly). That series of mistakes – in common with many other central banks – added hugely to the overall cost to New Zealanders of the Covid experience, and we are still dealing with the aftermath now. The Royal Commission seemed much more inclined to channel Reserve Bank stories, down to and including repeating a cross-country chart from the Bank’s own self-defence publication designed to make New Zealand look good by using headline inflation in 2022 (much of Europe affected by a gas price shock) rather than core, and the level of unemployment (rather than either the change, the NAIRU gap or the output gap) when – quite unrelated to anything around Covid economic policy – New Zealand has one of the lower NAIRUs in the OECD. Most extraordinarily, and with no supporting analysis at all, the Royal Commissioners conclude that the severe inflation outbreak was an “unavoidable price” of good policies. If so, we’d really better change the Reserve Bank’s mandate, and perhaps whitewash from history their own very weak forecasts for inflation from late 2020 and early-mid 2021. They certainly didn’t think inflation was inevitable; they (paid to get these things roughly right) got their forecasts, and thus policy, badly wrong.

Now to be fair to the Commissioners they do note the obvious, that both fiscal and monetary policy were too loose for too long, but it is all very subdued, and with no insight on what went wrong and why, or what might be better in future. There are complacent comments that if there were some gaps in Reserve Bank/Treasury coordination “it was good by international standards”, even as though offer no evidence for such claims. They don’t even mention – a point the Reserve Bank acknowledged in early 2020 – that the Bank had failed to ensure that negative interest rates were a technical possibility: had it been otherwise they might never have gone so big and so long on the LSAP, at such vast risk and (as it turned out) fiscal costs (the Bank, to be fair to them, had not historically been keen on LSAP types of instruments).

I could go on with many smaller points, but that would mostly be to bore readers. I’ll end with just two: there is no attempt to evaluate whether the exporter freight subsidies really made sense, and for so long, nor is there any attempt to evaluate whether it made sense – as was done at the start of the pandemic response – to permanently increase welfare benefit levels going into a pandemic that was (a) likely to have large economic and fiscal costs, making us poorer on average, and b) wasn’t going to affect the real incomes of those on benefits.

Overall, I thought this bit of the report was a serious lost opportunity. Perhaps the economic establishment (RB, Treasury, Grant Robertson) like it because there is no serious challenge or scrutiny, but just the appearance of it (a 700 page report don’t you know) but what use is that to New Zealanders, either in holding powerful officeholders to account (and yes time were tough but you take these jobs for the tough times) or in being better prepared for the inevitable future adverse shocks.

Inflation (but not that sort)

Michael Reddell NZ politics

The CPI will be out later this morning and I’m sure all eyes will be on that.

But the Prime Minister’s reshuffle on Sunday prompted thoughts about inflation of another sort – the number of ministerial portfolios/titles in our executive government. When the reshuffle comes into effect on Friday there will (still) be 30 members of the executive (Cabinet ministers, ministers outside Cabinet, and parliamentary under-secretaries), 79 portfolios, and 6 distinct “other responsibilities” (and of course lots – 25 in fact – of “Associate Minister of” titles, but I’ll ignore those).

This is how the official ministerial list is laid out these days.

In this reshuffle, the Prime Minister didn’t add any new ministers (net), but he did add to the very long list of job titles: Tertiary Education and Skills was split into Universities (Reti) and Vocational Education (Simmonds) – as if (eg) law, accounting, or medical degrees weren’t primarily vocational – and a new “other responsibility” was created in the form of Minister for the South Island (like Minister for Auckland it isn’t a warranted portfolio). The new Minister for Economic Growth title was simply a relabelling of the old, and latterly unimportant (announcing handouts to various “major events” – check Melissa Lee’s press releases) Economic Development portfolio.

Numbers of portfolios (and ministers etc) do fluctuate from time to time. Re portfolios, government re-organisations/reforms matter – eg the Minister of SOEs now has responsibility for a whole bunch of government trading entities that once each had their own minister (and others were sold). But the long-term trend has been solidly upwards.

I went back to the New Zealand Official Yearbooks to get some snapshots each quarter century since 1900. (Here I simply followed the lists and counted “Deputy Prime Minister” and “Minister without Portfolio” as portfolios, a description here which does not distinguish (as NZOYB did not) between warranted and other distinct responsibilities. There were very few associate or deputy positions until the 2000 list)

The current Ministerial List structure seems to be available online back to about 2005. So for more recent years I used those lists. For what follows I’ve used Helen Clark’s final list (the numbers from her first list are in the table above), John Key’s first one, Bill English’s last one, Jacinda Ardern’s post-election 2017 and 2020 lists, a late one from Chris Hipkins, and Christopher Luxon’s first and most recent lists. I’ve shown both the number of warranted portfolios and the number of (distinct) “other responsibilities”, partly because over time some roles have gravitated from one column to the other with legislative change (eg responsibility for the SIS and GCSB), and partly because the older lists summarised above didn’t make the distinction).

So that is two new records – 81 job titles in his first list a mere 14 months ago and 85 now – set by Luxon, leading the government that had won office on talk of government bloat etc. And if the number of members of the executive isn’t a new record, it is certainly right up there (we’ve had 120 MPs since MMP was introduced in 1996, and as recently as 1999/2000 had “only” 25 members of the executive).

By contrast, in 1949/50 and 1975 – when the government had its hand in so much of the economy – National Party Prime Ministers Holland and Muldoon had governments with many fewer members of the executive and many fewer job titles (In 1991, Bolger had 25 people in the executive and about 70 distinct job titles).

Do these job titles come at vast expense? No doubt, not (a few changes to ministerial letterheads). Most of the “grace and favour” ones seem empty or unnecessary or just a piece of cheap political rhetoric: “we care” about group or sector, x, y, or z. A cynic who I mentioned these numbers to wondered if perhaps Luxon might have a growth target of getting to 100 ministerial titles: Minister for Wellington, Minister for Regional North Island perhaps, or Minister for Catholics, Minister for Protestants, Minister for Other Religions, and Minister for Atheists? Given how much money we throw at the industry it is perhaps a little surprising that no PM has yet set up a “Minister for Film” or Minister for Gaming”. And in a few countries (including in our region) they do split Treasury and Finance into separate portfolios.

It is insubstantial bloat – fault of successive Prime Ministers, although on this one Luxon appears to be the worst – made worse because every new portfolio titles attracts interested parties and pressure to “do something” under the aegis of that portfolio. Cynics suggest, for example, that the Minister for the South Island title was created mainly because there is no capable South Island minister actually in Cabinet, but presumably now the pressure will be on for James Meager to have some announceables (perhaps even some distinct bureaucrats). It just sends all the wrong signals from a government that talks about restraint, fiscal discipline, focusing on essentials etc. Much better to have slimmed the list of titles – and perhaps the list of people. Without more than two minutes effort I found it really easy to eliminate 21 of the job titles (and that is before starting on the associates – Associate Minister for Sport and Recreation anyone (that’s Chris Bishop by the way), and we once had an Associate Minister for the Rugby World Cup).

Not only would ending the title inflation be quite possible here, it can be and is done elsewhere. In the UK, for example, (a much bigger country and Parliament) there are lots of junior ministers but only around 30 distinct portfolio areas/titles. Australia’s federal government appears to have about 50.

Where might one start? Well, consider James Meager (who seems a perfectly able person, so this is not intended as a reflection on him). He has been given 3 distinct portfolios/responsibilities – Minister for Hunting and Fishing, Minister for Youth, and Minister for the South Island – not one of which is actually needed (at least for anything other than political show).

2025 and what might have been

Michael Reddell Australia, New Zealand economic performance

Okay, so the weather in Wellington is even less conducive to either being at the beach or in the garden than it was on Friday.

Tomorrow it will be 2025. Once upon a time there was a government that adopted a goal of catching up economically with Australia by 2025. I don’t suppose the Prime Minister of the day – John Key – really cared that much for the goal, although for a while he articulated the rhetoric well enough, and he’d campaigned in 2008 on the continuing exodus of New Zealanders to greener pastures – well, higher incomes anyway, on a dry continent – across the Tasman. The goal, and the associated taskforce set up to advice the government on how it might get there, was more of an ACT win.

Treasury provided the secretariat to the 2025 Taskforce, and since I was working at Treasury at the time, and as the chair was my old boss Don Brash, I ended up working extensively with the taskforce and holding the pen on most of the first report (after I went back to the Reserve Bank, Neil Quigley was contracted to write the second report, and I had less to do with that report). The first report was (very publically) binned by John Key the day before we released it. I later came to conclude that while I agreed with most of the long list of policy recommendations in the first report, they weren’t sufficient and overlooked one important issue in particular, but even if one disagreed with the specific policy recommendations – and Key clearly had no stomach for them – one might have hoped that his government (and those that followed) might be serious about the goal itself and looking for effective policy solutions. After all, as the 2025 Report pointed out in 2009 there had been a long history of politicians talking about catching up again with the best performing countries abroad (just no sustained success in bringing it about). (There is a link to both 2025 Taskforce reports here.)

Here it is worth noting that even in 2008 Australia wasn’t one of the stellar advanced economies, with average real labour productivity (in PPP terms) not much above the median OECD country. Much better than New Zealand of course, and Australia mattered for us both as a natural point of reference in our part of the world (similar disadvantages of distance, similar cultures) and as the place where almost all New Zealanders could readily move if they chose (and hundreds of thousands already had).

In this chart I’ve shown how things have actually unfolded

Over the full period we haven’t caught up with Australia, we haven’t even begun to close the gap, and instead the gap has widened a bit further again. Both series are noisy and subject to revisions (in New Zealand alone there are levels differences between the income and expenditure real GDP measures), but overall things have gone in the wrong direction. If one wanted to look on the less gloomy side, I guess one could note that whereas Australia has had no productivity growth at all since 2016, we have had a bit, but I wouldn’t put much weight on that myself (including with declining foreign trade shares, weak terms of trade). And although one could generate a bunch of other comparative graphs, it is productivity that ultimately underpins a country’s longer-run average prosperity.

What I find most depressing – and why I have, somewhat gloomily, been anticipating for some years writing this post – is the lack of any apparent sense of urgency in New Zealand about turning things round or actually finally beginning to sustainably close the gaps. And that has been true really regardless of which parties have held office – if Key binned the advice on the 2025 goal and did little or nothing useful instead, Ardern/Robertson refocused the Productivity Commission on distributing the economic pie rather than growing it, and Luxon/Willis show no better than occasional conventional rhetoric on the topic. And all this against a backdrop where Australia has again made it easier and safer for New Zealanders to move across the Tasman.

As it happens – and what reminded me to write the post – in the New Years’s Honours list released this morning, the government chose to honour one of the members of the 2025 Taskforce, the economist Bryce Wilkinson. That’s nice, but if I know Bryce I’m pretty sure he’d much prefer that governments – including this one – had gotten serious about finally reversing 70+ years of relative economic decline. That would have benefits for all of us, and for our children and grandchildren, who might be more interested in staying to build a better New Zealand.

The Secretary to the Treasury defending govt fiscal policy

Michael Reddell Fiscal policy, Treasury

I wasn’t envisaging writing anything more for a while, but….Welllington’s weather certainly isn’t conducive to either the beach or the garden, and the Herald managed to get an interview with Iain Rennie, the new Secretary to the Treasury (not usually the sort of stuff for 27 December either).

I’ve always been rather uneasy about heads of government departments doing interviews, on anything other than operational/internal matters for which they have specific personal responsibility. When they get onto policy it is never quite clear whether they are expressing their own views or championing those of the minister, and even if the former they are inevitably somewhat constrained by the views and tolerances of the minister. The primary responsibility, after all, of heads of policy agencies is provision of free and frank policy advice to the minister.

Rennie does a bit of self-promotion, claiming that he is the sort of “change agent” the Minister of Finance has asserted that she wanted, and that he is at his best reforming things. I guess time will tell on the former claim – although count me sceptical – but his previous years in senior positions (Deputy Secretary at Treasury, State Services Commissioner) weren’t exactly known for being a reforming era, and it wasn’t obvious that he was an exception to that. And he was responsible for the appointment and reappointment of Gabs Makhlouf, who took Treasury in more of self-indulgent direction than one driving forward hardnosed and rigorous policy advice.

He claims to be keen on The Treasury being more upfront and public about its view on possible reforms. I’m not sure that’s wise – hardly likely to strengthen effectiveness with the Minister when, as is inevitable at times, those views are very much at odds with those of the government – but I guess that is their call. Lets see, for example, what they come up with in the Long-term Insights Briefing they are required to produce next year. In any case, Rennie – creature of the 80s/90s Treasury – claims to be keen on more means-testing. Views will differ of course, but it has its own problems (especially once done across multiple programmes) and the last attempt to apply it to retirement income provisions did not end well.

He also touched on tax. There is some ambiguity about that second para, but I take it that he is advocating taxing capital income at a lower rate than labour income. If so, he’d have my full support, but championing it in public is going to buy quite a fight – even with a notionally centre-right government that has just increased business taxation and shows no inclination at all to do anything about one of the highest company tax rates in the OECD.

But the real reason for this post – and the reason why I phrased the title of this post as I did – is Rennie’s apparent complacency on fiscal policy: it could have been channelling Willis. There is, we are told, no hurry to close the structural fiscal deficit

“That’s why I’ve been very clear that fiscal consolidation will need to happen over a number of years.”

We didn’t get into a structural deficit “over a number of years” (but quickly), we’ve now been running one for more than a few years, nothing done this year reduced the deficit, and on the government’s own projections any return to fiscal balance is still several years away. And this is in a country that was running surpluses less than five years ago (the first – and mostly necessary – Covid splurge was March 2020). Core Crown operational spending this year (24/25) is almost six percentage points of GDP higher than it was in the last full pre-Covid year (18/19).

Now, it is certainly true that not all reforms can be done overnight, but that doesn’t mean that fiscal adjustment couldn’t – and shouldn’t – be done a great deal faster than either Robertson or Willis have been willing to contemplate. And there is not a sign of recognition from Rennie that the date for the return to fiscal balance has been pushed out again and again – it isn’t as if successive governments are making steady progress on a well-understood and stable forward track.

There seems to much the same sort of elite resignation around productivity issues and failures. He seems willing to acknowledge that it is a significant issue, but with no sense of urgency, and no sense of just how deep-rooted the problems have become – weak productivity growth isn’t just some phenomenon of the last few years, but something that now dates back 70+ years in New Zealand, with no sustained period since when New Zealand has made any progress in closing the gaps.

Rennie’s final comments are about comparisons with 1990/91

Again, it feels more as though he is channelling his Minister, who desperately does not want to be compared with Ruth Richardson.

A fair amount of the debate around 1990/91 is more about mythology than hard facts. Reasonable people might differ about the pros and cons of welfare benefit cuts then (as they might about the ill-judged increases in real benefit rates under the last Labour government), but….

Here is total Crown primary (ie ex interest) spending in the fiscal years through that period

Government spending was not slashed and burned.

And what of that story of 15 years of failed fiscal adjustment. Here, from Treasury’s own data, is the primary balance from that era

Very considerable progress had in fact been made in the previous few years, with large primary surpluses having been achieved (nominal interest rates at the time were very high, but much of those interest rates were simply compensation for inflation, not an additional real burden). Now, it is certainly true that in the dying days of the 1984-90 government fiscal discipline weakened – primary surpluses were smaller – but there were primary surpluses throughout.

It is also true that at the end of 1990, there had been the second (and more severe) BNZ failure/bailout, unemployment was rising, and another recession was almost upon us. There were genuine fiscal surprises for the incoming government – and the ratings agencies – but the basic position, while well short of ideal, was not dire. And if net debt – at about 50 per cent of GDP – was higher than it should have been (and higher than today), it was pretty moderate by the standards of indebted OECD countries today. And, since Rennie rightly notes ageing population pressures on spending now and in the years to come, back in 1990, not only had the outgoing Labour government already put in place a plan to raise (very gradually) the eligibility age for the state pension, but the demographics going into the next 10-15 years were particularly favourable, since the birth rates 60 or so years earlier had been so temporarily low.

Instead now we have deficits well into the future, no serious evidence (yet) of a government with a willingness to make hard adjustments, and demographic pressures that are already on us and will only intensify. It is, therefore, more than a bit disconcerting to hear such complacent noises from the Secretary to the Treasury, as if to pat us all on the head and say “don’t worry, we’ll get things sorted out eventually”. No doubt it will make for holiday reading for the public that the Minister of Finance will smile favourably upon. But one can only hope that when Rennie is alone with the Minister he is rather more urgent in his advice. If not, perhaps he really is the Secretary Willis wanted…..but the only sense in which he might then be a “change agent” is in somehow acting to help accustom us to a new grim reality in which neither main party is any longer that worried about returning to fiscal balance.

Rennie’s final line was that one about there allegedly being “confidence” our “fiscal institutions” will respond and consolidate successfully. I’m not sure who has this confidence – perhaps a few members of the government party caucuses – or what foundation any such confidence might rest on. It feels more like wishful thinking, or just spin.

Fiscal failure and indifference

Michael Reddell Fiscal policy

I was away in Papua New Guinea last week when the HYEFU came out, and have only just gotten round to looking at the numbers. Quite possibly, what is in this post will be repeating ground others have covered, and if so the post will end up being mostly for my records (good to be able to look back and see what one said at the time).

It was this tweet from a non-partisan analyst that really caught my eye

Three sets of spending forecasts: those for Labour’s final Budget last year, those from last year’s PREFU (and available to political parties finalising their fiscal promises), and those from last week’s HYEFU. They run out only to the year to June 2027, because that is as far as the forecasts done in 2023 went.

Spending on core Crown expenses is as higher or a little higher than in Labour’s last Budget.

It isn’t because interest rates are higher (out of the government’s control); in fact, primary spending is also a touch higher over four years than was planned in last year’s Budget.

It isn’t because of the state of the business cycle: the output gap forecast now for 26/27 is almost identical to that forecast for 26/27 in last year’s Budget.

Overall, core Crown expenses are forecast to be 32.2 per cent of GDP in 26/27, up from 31.5% for 26/27 in last year’s Budget.

And net debt (excluding the – quite variable – NZSF assets) is forecast to be $42 billion higher in 26/27 than was forecast just 18 months ago.

Of course, defenders of the government will note that revenue forecasts are a lot lower. That is partly a matter of pure political choice – tax cuts – and partly a changed view on the potential rate of growth of GDP (not about the business cycle). But when the family’s income estimate are revised quite a bit lower over the medium term it would be usual to adjust future spending plans. But not, it appears, this government.

For all the pre-election rhetoric, the current coalition government seems to be keeping right on with the path adopted by the previous Labour government, which had more or less abandoned (for practical purposes) any serious interest in running budgets in which the revenue raised paid for the groceries. National wasn’t very ambitious in its election campaign fiscal plans, but its numbers now represent deep underperformance even relative to those modest electoral ambitions. Will we see a balanced budget ever under Luxon/Willis. Unless something positive just happens to turn up it seems very unlikely – and with each passing year the ageing population fiscal pressures just keep mounting. If the failure is first and foremost the responsibility of the Minister of Finance, no Prime Minister can ever escape shared responsibility for this kick-the-can down the road approach to fiscal management.

As a reminder of the broader fiscal position, here is Treasury’s chart showing the estimated cyclically-adjusted and structural deficits.

Not only is no progress at all being made at present, but the imbalances are a bit larger than those Treasury was estimating at the time of the 2023 Budget. People rightly criticised Labour’s fiscal excess, and the structural deficits they chose to incur. The coalition’s structural deficits are also pure choice – bad ones. And we can’t have much confidence in the eventual sluggish return towards balance after the next election – as for any government, forward operating allowances are no more than lines on a graph at this point, and the government has shown little inclination or ability to make and sell sustained hard fiscal choices consistent with those operating allowances.

Orr on Q&A – Part II

Michael Reddell Adrian Orr, Monetary policy

My post this morning was based on Adrian Orr’s Q&A interview as found on TVNZ+. However, it turns out that that wasn’t the full interview which (thanks to the kind people at Q&A for pointing me to it) is now available on Q&A’s Youtube account here. The full interview is almost half an hour, and is probably worth watching if you haven’t already watched the selections on TVNZ+ – it is a more rounded presentation and chance for Orr to tell his story.

As in the previous post, there was something in this bit of the interview where I welcomed the Governor’s comments. He lamented the underinvestment in official economic statistics, that has gone on for decades now, and suggested governments really should do better. And while he noted (fairly) that there is a lot more other data than there used to be, it remains something of an open question (would be interesting to see RB analysis of it) as to whether the Bank and other forecasters have gotten any better at recognising early quite what is going on in the economy and inflation. Perhaps 2020/21 was an unfair test, but we’ve seen a lot of lurches even this year from the MPC. But if the Governor is championing full monthly CPI and HLFS data and more timely GDP data, I can only agree with him.

But if that was the positive, there were plenty of things to lament in the Governor’s comments in the extended interview.

There were, for example, outright falsehoods. Thus, he talked of his European peers having struggled with inflation in excess of 20 per cent per annum. As far I can see, the only OECD European central bank that faced an inflation rate that high was Hungary (briefly) although a couple of others were in the high teens for a while. Gas prices severely affected headline – but not core – inflation, and New Zealand (and Australia) weren’t exposed to that post-Ukraine shock. In the euro-area (most of Europe) headline inflation peaked – gas shock – at 10.6 per cent. The Governor then claimed that the UK had had 15 per cent inflation. That didn’t sound right either.

11.1 per cent isn’t even close to 15 per cent. Why does he just make these things up?

(And a reminder of the graph in this morning’s post: on core inflation (the bit central banks do much about) we were simply middle of the pack in the OECD.

I noted this morning that the LSAP hadn’t come up in that bit of the interview. It did in the fuller interview, and sure enough we get the repeated Orr make-believe blustery arguments. Not only had the Bank’s interventions saved the economy from a “deep recession” (quite how when as the Governor correctly notes the lags in monetary policy are long, and GDP here quickly rebounded after the first lockdown), but the costs (the $11bn or so of losses to the taxpayer) were “more than overwhelmed” by the “net benefits”. The net benefits have never been successfully identified, and the absurd claim needs to be read against the fact that overall Reserve Bank monetary policy calls led to the economy massively overheating, a severe outbreak of core inflation, big redistributions, and then a protracted – if not overly deep – recession to get things back to balance. Whatever the good intentions, there simply were no “net benefits” (probably few gross ones either) and large losses to the taxpayer. But Orr never engages straightforwardly on such issues. (For anyone who listens he cited some IMF work – I picked apart an earlier piece from the IMF on this issue here : the IMF had simply imagined a world (and economy) quite different from what New Zealand actually experienced.)

There were two other interesting lines from Orr.

The first was a bold statement that banks had been making “excessive profits”. Not high, but “excessive”. Quite what basis he as prudential regulator had for that claim isn’t clear, but he has long had it in for the Australian banks. He seems to consider it somehow unfair that the Australian banks are efficient low-cost operators.

And the second was the claim that we are seeing unusual (greater than previously) changes in relative prices globally. Since oil prices were one of those he mentioned, here is a long-term chart

The alleged greater volatility isn’t apparent there. Perhaps there is something to the claim more generally (would be interesting to see the analysis and data), but it seems unlikely, and perhaps particularly in the New Zealand context, where one of our most important relative prices is the exchange rate, which has displayed remarkably greater stability in the last decade or more than in the first 25 years after it was floated.

Orr also claimed that inflation itself was going to be more variable, but again it isn’t obvious. There has been a bad outbreak of inflation a few years ago, now brought back under control, but is there really any evidence (beyond the Governor’s desperate desire to talk about climate change) for the proposition, or that it would matter if it were true (headline vs core considerations again)?

Towards the end, Orr was talking up the strength of the Bank, notably the Board (signally underskilled in fact, with a chair reappointed who did/said nothing about the mistakes of recent years) and the MPC (most of whom we never or very rarely hear from, at least one of whom has no relevant qualifications at all). As for the rest of the senior management, those I have anything to do with (several) simply aren’t very impressive (in two cases “not very impressive” is to flatter). Perhaps when standards are that low Orr gets away with the sort of loose language, bluster, and Trumpian-style false claims internally (as well as the intolerance of dissent etc that he is known for). But it shouldn’t be acceptable in such a powerful figure, and if central bank Governors are never going to be some sort of single source of truth, at very least they should (a) prompt one to think, and b) not prompt one to worry that yet another claim just bore little or no relation to reality.

But this is latter day New Zealand.

More outright dishonesty from Orr

Michael Reddell Adrian Orr, Monetary policy

The Reserve Bank Governor has given an interview to TVNZ’s Katie Bradford, apparently done under the aegis of the Q&A show but too late in the year to actually be broadcast on Q&A itself or to be done by Jack Tame, Q&A’s regular and most demanding interviewer.

There is a TVNZ article reporting the interview here, and you can find the full thing (only about 13 minutes) somewhere on TVNZ+ (my son found it for me). [UPDATE: Apparently that was only half the interview and the full 26 minutes is on the Q&A Youtube account.]

What is reported in the article is pretty breathtaking, with Orr reported as standing by his (or, presumably, the MPC’s) decisions during and since Covid with no apparent regrets, and then moving on to attack the public and the media for being focused on housing and house prices. We – and he – might regret the fact that we do not have a well-functioning land supply/use policy regime, but we don’t, and haven’t done so for decades, so it should hardly be a surprise (or a cause for attack/lament) that when interest rates are cut in what proves to be an overheating economy house prices go up.

But it got a whole lot worse when I listened to the full interview itself, where Orr seemed to just play on the fact that his interviewer wasn’t a specialist (with all the facts at her finger tips) to simply run claims that he knows not to be true. It was a reprise of his form earlier in this cycle when he repeatedly and deliberately misled Parliament’s FEC (but so supine are our democratic institutions that there were no consequences for what Parliament’s website solemnly assures us is a serious offence).

Orr was asked whether the Bank had been too slow to raise rates (of course it was, as the Bank has even grudgingly acknowledged in the past). His response was to claim that the Reserve Bank of New Zealand was the 2nd or 3rd central bank to raise rates in 2021. It simply wasn’t so. Even among OECD economies – and there are only about 20 separate monetary policy areas in it (much of the OECD having just the euro) – the Reserve Bank was the 8th (equal) to move (those moving ahead of us were Iceland, Norway, South Korea, Mexico, Chile, Czech Republic, Hungary). Perhaps as importantly, the issue should never be about who went first or second, but whether a particular national authority moved sufficiently early and aggressively for the circumstances their own economy faced. On IMF estimates, New Zealand had the most overheated economy of any of the advanced country monetary areas it does the numbers for (a group which doesn’t include all those in the list above, but does include the US, UK, Canada, Australia, Japan).

Orr then went to the claim that the Bank had been “lauded internationally – although not domestically” for being one of the most responsive central banks. It is certainly true that some market commentators have run such a line, but almost all of them seem to have had in mind the big countries and the Anglo countries, not the wider group of OECD economies. The Reserve Bank certainly wasn’t the slowest to move, but then it was dealing with a really badly overheated economy and should have moved a lot earlier. Their mistakes weren’t unique – misreading economies and pandemic macroeconomics was a common mistake, among central banks and private commentators – but they voluntarily took on the power and responsibility in New Zealand, and they actually made the bad policy calls, including increasing rates too late and initially far too sluggishly. Other people can hold their central banks to account.

(And, of course, the MPC also lost $11 billion or so or taxpayers’ money punting in the bond market. TVNZ didn’t ask about that particular bad call so we were spared a repeat of Orr’s blustering attempts to defend that. Puts the cost of running an RNZN vessel straight onto a reef not realising the autopilot was still on in some perspective….)

And then Orr claimed that the Reserve Bank was one of the few central banks confidently reducing policy rates. Which was a bit odd when most advanced country central banks have been reducing policy rates in recent months (obvious exceptions being Australia and Japan). But don’t let the facts get in the way of the Governor’s spin.

He had the gall to round off that section of the interview by suggesting, rather patronisingly, to Bradford that “your potted history is kind of incorrect”. Dear, oh dear. This from a very senior and powerful public official. Is this the sort of thing the Minister of Finance expects/tolerates? (Well, on the evidence so far anything goes.)

Bradford moved on. As was accepted, had it not been for the Covid outbreak in Auckland, the Bank would have started tightening at the August 2021 MPS (they actually started at the next review). So Bradford took a look at the projections in that Monetary Policy Statement. She pointed out (correctly) that in those projections, annual inflation was expected to be back down to 2.2 per cent by the year to September 2022 (with, as it happens, very little monetary policy help at all: as everyone agrees, there are long lags, and by the end of 2021 the OCR was expected to be only 0.75 per cent). I guess her point (obviously correct) is that the Bank was still badly misreading things by that point (and of course even now annual core inflation is still somewhere between 2.5 and 3 per cent, having required an OCR at 5.5 per cent to bring that about).

But Orr wasn’t going to be bothered engaging with facts. Instead, we got the same old outrageous claims he used to try to fob Parliament off with. “Do you know what happened after that [August 2021]”, he asked. “We had the Ukraine invasion, rising food prices”, going on to add in cyclone effects and so on. He even had the gall to suggest that we had among the lowest inflation rate peaks in the OECD and that European countries had been dealing with 20 per cent inflation. It is an outrageous attempt to mislead and distract, simply breathtakingly dishonest, and especially so when set against any discussion of core inflation or the economic overheating. Take the New Zealand labour market for example: the unemployment reached its lowest level (extremely overheated) in the December quarter of 2021 (ie before the invasion), oil price pressures from the invasion never lasted long, and…..as importantly….both food and energy prices are typically “looked through” by central bank policymakers focusing on core inflation. On CPI ex food and energy measures, New Zealand’s peak was about middle of the pack among OECD countries (and the extreme headline numbers in a few countries were largely the result of the gas price shock to which New Zealand – no pipeline or LNG trade – was not exposed).

As for cyclone effects on inflation, one of his own managers contradicted Orr in front of FEC last year, to confirm that any effect was actually very small.

Orr then moved on to an interesting claim (that I have not heard him make before, and which has not been documented in any published papers or material in MPSs) claiming a) that to have kept core inflation in the 1-3 per cent range the OCR would have to have been raised to 7 per cent on the first day of the pandemic, and b) that even if that had been done we’d still have had 6 per cent headline inflation. Neither result seems very likely, and given Orr’s record of just making stuff up should be heavily discounted unless/until they produce some robust formal estimates. On Orr’s telling it would have taken more monetary restraint to stop inflation getting away than it actually took to bring it down again once it had gotten away. That doesn’t seem very likely, and perhaps a useful counterpoint is the experience of Japan and Switzerland which didn’t cut policy rates into the pandemic, and didn’t see a particularly severe later inflation experience. As for the 6 per cent claim, that seems simply preposterous, since there has been no time in the last few years when the gap between headline and core inflation has been anything like as large as 3 percentage points.

Later in the interview, questioning moved on to fiscal policy. Here I will give Orr credit on one point: he explicitly corrected the journalist to note that the current goverment had certainly cut spending, but that it had also cut taxes, and that the two effects were roughly even. This is exactly consistent with the estimates in Treasury’s cyclically-adjusted balance series (chart in Monday’s post), in which this year’s deficit is just a touch larger than last year’s. Of course, it would have been nice had the Bank made this point in its MPSs, instead of spending the last 18 months – both governments – avoiding the issue and focusing on largely irrelevant series of government consumption and investment spending (rather than the cylically-relevant) fiscal balance and fiscal impulse measures.

For the rest of it, Orr was back in his preferred space, playing politician and advancing personal political and ideological agendas that are simply out his bailiwick. It was, we were told, critical for governments around the world to close infrastructure deficits and New Zealand’s was “one of the worst”. He appeared to attack a focus on reducing deficits and keep government debt in check, suggesting that the government needed to spend “a lot more” on infrastructure, suggesting that New Zealand had been failing in this area since World War Two (a claim that of course went unexamined – in fairness no time – but presumably includes overbuilt hydro power capacity, sealed roads in the middle of nowhere etc). Now, in fairness, he did also talk about enabling private capital – this the same Governor who only a few months ago was bagging foreign investment – but the overwhelming tone was to welcome more public debt. Waxing eloquent he launched into Labour Party and left wing themes about how great it would be if governments were investing and delivering more “social cohesion” (around whose values Governor?), an “inclusive economy” and so on.

In any sane environment it would have been to have significantly overstepped the mark, but Orr has done that so often – and worse, with all the misrepresentations and denials – with no consequences (no rebuke from the Board or minister(s), reappointment for a final term comfortably secured, tame board chair reappointed etc) that no doubt it will again pass with little notice.

It really was a pretty disgraceful, if again revealing, performance. But then the fact that Orr still holds office, and the incoming government – that used to rail against him and his style and the corporate bloat – has been content to see things just run on as usual, is just another sad reflection of the debased state of New Zealand public life and standards. One of many to be sure, but no less acceptable for that.