I Have a Little List

This entry was posted in Governance, Political Economy & History, Pundit on by .

With most parties having announced their lists for the next election, we need to think about how the system works.

As some day it may happen that an MP must be found

They’re put upon the list – I’ve got a little list

Of political offenders who are always safe and sound

And who never would be missed – so I put them on the list.

There’s opinionated graduates who always are around

Who’ve done absolutely nothing but are legislature bound

Who know absolutely nothing but think it’s so profound

Who don’t connect with anybody, staying underground

Who in any other job would be speedily dismissed

They’d none of ’em be missed – I’ve put them on the list.

There are those at all the meetings whose expertise is pissed,

With certainties of facts that never did exist

Who never help with anything but rush off to a tryst

They never would be missed – I’ve put them on the list

There’s the idiots who criticise with enthusiastic tone

While talking very loudly on the mobile telephone

Who speaks with sound and fury and dwells upon the past

Who enters a revolving door behind and exit unsurpassed

There’s a wireless jock, a salesman of tobacco, a proctologist,

I don’t think they’d be missed – I’m sure they’d not be missed!

There’s the political adviser and others of that race

The party loyalist – I’ve got them on the list!

Who stab you in the back while smiling to your face.

They’d none of ’em be missed – they’d none of ’em be missed

And there’s one who I have kissed, I’ve got HER on MY list.

There’s apologetic statesmen of a compromising kind

Such as – What d’ye call him – Thing’em-bob, and likewise – Never-mind

And What’s-her-name, and You-know-who, and some may not exist.

But it really doesn’t matter whom you put upon the list

For they’d none of ’em be missed – they’d none of ’em be missed!

I supported MMP. The previous electoral system – often called ‘First-Past-the-Post’ but better, I think, ‘Front Runner’ – exaggerated the mandate of the government which rarely won even half the votes but often ended up with a vast majority in parliament. Our parliamentary system has been described as an ‘elected dictatorship’. From 1975 to 1993 (and perhaps earlier) the government used that excessive mandate to pursue policies which ignored those who voted them in.

Since 1993 governments with much smaller majorities – a coalition of parties – have been much more sensitive to the public. Jim Bolger, Helen Clark and John Key all deserve praise for the way they have responded to the management challenge.

Even before it was introduced I, like many others, saw a weakness of MMP was how the party lists would be composed. A centralised party, such as Labour, could foist their party hacks on their voters; even the more decentralised party, such as National, ends up with a list on which there are people who hardly represent quality or the populace. (But then again under FR, there were some very unattractive electorate choices.)

I do not think we have really got our head around MMP. I shant discuss here the wrinkles which distort the proportionality and have directly benefited ACT, United Future and the Maori Party. However, they have indirectly benefited National; when the Electoral Commission recommended removing a key one (the way the threshold works) the government did nothing.

My interest here is how the system generates different outcomes for the two significant parties of the right (National and New Zealand First) from the two of the left (Labour and Greens); NZF would say it is a party of the centre but precise labels do not matter for these purposes.

First, observe the difference between National and Labour, using the 2014 election. National got 47.0% of the party list vote but only 46.1% of the electorate vote. In contrast Labour got 25.2% of the party list vote (not too different from the levels reported by recent polls) but 34.1% of the electorate vote.

This is because almost a third of voters split their vote between who they vote for in the electorate and who they vote for on the list. The proportions for National and Labour list voters who do so are considerably less (about a sixth of their list voters). But over half of list voters for NZF and the Greens (and ACT, UF and the Maori Party, just) give their electorate vote to another party.

Much of this is tactical voting. Suppose you were in the Nelson electorate, bitter about the National Government’s environmental policies. It might make sense to reserve your party vote for the Greens but to vote for the Labour candidate against National’s Minister for the Environment (Nick Smith) in the hope of toppling him.

The toppling did not happen in 2014 but suppose it did. Then Labour would have had one further electorate seat but would have lost one list seat (Andrew Little’s, as it would have happened) while National would have won one more list seat which, lo and behold, would have been given to their ousted Nelson candidate (who was high enough on the party list).

Thus the tactical voting which favours Labour electorate seats undermines its list seats. The example shows there is a sense in which Labour’s list seats are to be found in the Green Party’s seats.

The pattern is different on the right where a lot of supporters of the minor parties do not vote tactically to ensure the National candidate wins. Indeed many NZF party voters probably vote for Labour candidates in electorates. (Which is one piece of evidence that NZF may cite for their party being of the centre rather than the right; an alternative reading is that they are grumpy populists voting against the government).

Thus NZF wants to recruit voters from National and Labour, while the Greens mainly recruit additional voters only at the expense of Labour. This broadly explains why there is a different outcome between National and Labour in the balance between their electorate and list seats.

It may not be a good thing for the two largest parties to have this asymmetry. Others are likely to conclude there is a delicacy in the electoral outcomes for Labour and the Greens. How they handle – or mishandle – their electoral relations may be critical for each party’s survival.

Footnote. Suppose Labour had beaten the Māori Party in the Waiariki seat (Te Ururoa Flavell’s seat). That would have set the MP seats to zero and reduced the total of parliamentary seats to 120, since there would have been no overhang seat. Labour would have swapped a list seat (Andrew Little’s) for an electorate seat. The list seat would have gone to National who now with 61 seats, would have been able to govern alone. Huh?

(Help with the words of the song came from W. S. Gilbert and Elizabeth Caffin.)

Two Economists: W. J Baumol (1922-2017) and M. H. Cooper (1938-2017)

This entry was posted in History of Ideas, Methodology, Philosophy, Portraits, Pundit on by .

The lives of two outstanding economists who died recently illustrate just how diverse the profession is.

I first came across William Baumol when, as a student, I valued greatly his two textbooks: Economic Dynamics and Economic Theory and Operations Analysis, both lucid, intellectually challenging and with a gentle humour. (Rather than the conventional tradeoff of guns versus butter, he illustrated the principle with cummerbunds and zabaglione.)

I also read his Business Behavior, Value and Growth with its insightful notion that firms maximised revenue subject to a profit constraint. Neoliberal economists got very agitated and constructed elaborate explanations to show he was wrong – they were used in the 1980s to justify privatisation. They have been largely discredited since but the profit maximising firm is the standard assumption if not always evident in reality. (J.K. Galbraith used Baumol’s insight in his New Industrial State)

Baumol continued to do path-breaking work, not least in environmental economics and the economics of the arts. Later he contributed to the literature in which entrepreneurship has a central role in economic growth.

He (with some colleagues) almost made a major breakthrough with contestability theory, which showed that if there were no barriers to a firm entering or exiting a market, even a monopoly behaves as if it was in a competitive industry. It was very popular among Rogernomes who ignored the caveats. In particular, it is not a robust theory in which deviations from the rigorous assumptions left the conclusions intact. For instance, the theory of competitive markets assumes an infinite number of firms but in practice an industry with only a handful behaves as if it were competitive. In contrast, minor barriers to entering or exiting ruin the result that a monopoly behaves as if it is competitive and there are no monopoly profits.

A related issue was the Baumol-Willig pricing rule which suggested how prices might be set in a market dominated by a firm. It was used to protect Telecom’s monopoly for it locked in existing monopoly profits; I doubt Baumol would have been as enthusiastic as were Telecom’s defenders. Eventually the long (and expensive) legal dispute was resolved by the Telecommunications Act 2001, which specifically rules out the use of the Baumol-Willig rule. Apparently Baumol and his colleague, Robert Willig, are the only two economists mentioned in a New Zealand statute.

Baumol is best known for the ‘Baumol cost effect’ (a.k.a. ‘disease’ but that puts a judgmental dimension on an empirical phenomenon). It points out that the costs of many services will rise faster than the costs of goods because they do not experience the same productivity gains. The original illustration was that the same number of musicians is needed to play a Beethoven string quartet today as was needed in the nineteenth century so the productivity of classical music performance has not increased. On the other hand, the real wages of musicians have increased greatly since then, so the relative cost of concerts have gone up.

The Baumol effect particularly applies to government activities which are almost entirely services. I once mentioned this to a group of economists working on projecting government spending, pointing out that (with a few extra assumptions added) this meant that tax revenue would have to rise over time to cover the rising costs. There was a stunned silence and the meeting quickly moved onto other matters – raising tax levels, even to supply desired public services, is not high on our agenda.

Baumol’s innovative research covered an extraordinary range of economics and other issues (he had a minor career as a creative artist), illustrating Hayek’s ³nobody can be a great economist who is only an economist.’. Master all his writings and you would have a good training in economics. Yet, he never was awarded the Nobel prize in economics, illustrating the limitations of the prize and the eccentricities of the selection process.

Mike Cooper was one of a group of British economists who pioneered health economics in the 1960s. (There were American contributors, including Ken Arrow, whose seminal 1963 paper ‘Uncertainty and Welfare Economics’ appeared to be unknown to the Rogernomes who were redisorganising the health system three decades later. Had they known it, they would have seen how deeply flawed their approach was. Incidentally, Arrow’s paper cites an earlier work by Baumol as foundational.)

Mike first came to my attention in 1968 when he published, with Tony Culyer, The Price of Blood, arguing that blood-donors should be paid, thereby making it a market commodity in which supply balanced demand. (Yes the booklet had a blood red cover.) Richard Titmuss replied in 1970 with his brilliant The Gift Relationship: From Human Blood to Social Policy, one of the great social policy books of the twentieth century, pointing out that commodifying blood leads to a deterioration in the quality of its supply. (That is why we don’t pay blood donors). To Mike’s credit he recognised he was wrong – a humility which is not common enough in other professions either.

Mike wrote many other books including Rationing Health Care which some health economics teachers still use such is its ‘exemplary clarity’, as one reviewer said. In 1975 the notion was revolutionary, for the conventional wisdom assumed a public health system could meet all the demands on it. Today we accept that there have to be restrictions, although while waiting lists may be acceptable providing the wait time is not too long, the current practice of the not-on-the wait list – that is, having a need which the system does not recognise – is not, even if it is increasingly pervasive.

In 1976 Mike took up the senior chair in economics at the University of Otago which he held for two decades while actively working in a range of health areas; he was an applied economist. (He held many other positions but they are not relevant to this column except that he was at one time the chair of the Otago Area Health Board.) His tenure laid the foundation of the successful department we know today. For despite Mike’s international reputation in health economics, he worked in many other economic fields. (On retirement he took up cooking and producing award winning olive oil from trees on his and Joy’s estate in Martinborough.)

As befits a strong department led by a strong head, he inspired many graduates. Perhaps the jewel was Nancy Devlin who, I regret to report, holds senior positions in Britain Her tribute at the funeral service included ‘I would not have had the career I have enjoyed if it hadn’t been for Mike. …. [His] lectures were inspiring, challenging, and always thought-provoking. Theory was effortlessly mixed with examples, issues and applications to real life problems in health care. Mike gifted to me a life-long passion for health economics.’

Surprisingly Mike was never made a distinguished fellow of the New Zealand Association of Economists. I am not sure why. Perhaps the Baumol explanation will do: the limitations of the award and the eccentricities of the selection process. Such failures by selection committees are an inherent part of many of the awards in New Zealand.

House prices relative to inflation

This entry was posted in Macroeconomics & Money on by .


AUT Briefing Papers July 18, 2017

Historically housing prices in New Zealand have risen a little faster than consumer prices, but the increase has been sharper since 2001, except for the period when the Global Financial Crisis impacted.  I have graphed data from the Reserve Bank of New Zealand to see what the relationship is between house price rises and consumer price rises, or general inflation.

Graph I shows the Reserve Bank of New Zealand nominal housing price index (that is, prices not adjusted for inflation) for the 209 quarters from 1964Q2 to 2016Q2. Over the 52 years, the prices rose to over 80 times their initial level, an annual average increase of 8.6 percent per annum; this was faster than inflation.

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Graph I: The blue line is an index of actual house prices. The black line is the exponential trend line between 1964 and 2001. The growth rate for (nominal) houses prices averaged 9 percent a year.

Note, the linear vertical axis of Graph I does not show growth rates of prices.

Graph II shows the ratio of house prices to consumer prices, which presents a different picture of relative housing inflation.

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GRAPH II: The blue line shows house prices relative to consumer prices. Where it rises house price inflation is rising faster than consumer prices. The green line is the trend growth line from 1964 to 2001. It shows that while nominal house prices may not have been rising faster in the 21st century than they had earlier, they were rising faster than consumer prices because the later period was one of much lower consumer inflation.

Up to 2002 the average house price rise was 1.4% p.a. above the rate of inflation. By later standards this rise was small. Aside from measurement error, it might be the consequence of the supply of housing increasing more slowly than the underlying demand. We can speculate why, but any effect was not great.

After 2002 the average annual rise increases markedly to a rate of 8.2% p.a. The slow relative shifts in supply and demand described in the previous paragraph are surely insufficient to explain the quintupling of the relative rate of housing inflation. Moreover, as identified in the 2007 note, the change in the trend housing inflation rate is very abrupt.

Note that there was a five-year period between 2007 and 2012 when house price rises were checked by the Global Financial Crisis. Take this period out and the average increase across the country from 2002 was 12.4% p.a. – almost ten times as high as before 2002. The price increases will vary by region and Auckland’s are among the highest.

The acceleration in the relative premium after 2001 coincides with President George W. Bush increasing the United States’ fiscal deficit which flooded the world with financial liquidity. That made it easier for New Zealand banks to borrow offshore using the cash to fund housing purchases. While the housing price rise was not confined to New Zealand, The Economist reported in 2017 that New Zealand’s house price relative to inflation is the highest in the rich world.

Another source of funds from the international liquidity was investments by migrants or off-shore based investors. Some would have purchased the houses they would live in. But anecdote suggests that some purchasing was for speculation. Probably the source of the funds was capital flight especially from China; instructively Sydney, Melbourne and Vancouver have experienced similar price rises.

The funding inflow generated a speculative bubble, especially as the stock of housing cannot be easily increased. A speculative bubble is typically driven by expectations of strong asset price rises coupled with leveraged borrowing, giving a high return as long as the prices rise. But the price increases cannot sustain the spectators’ expectations forever and eventually the bubble pops or deflates with over-leveraged speculators stranded. Usually there are knock-on impacts which damage those who are innocently (that is, non-speculatively) involved. The lack of an effective capital gains tax in New Zealand has probably compounded the strength of any speculative bubble, especially when speculators could cover part of their purchase price by borrowing at fixed interest below the nominal house price increase.

The boom staggered around the time of the Global Financial Crisis, when international liquidity dried up. It returned when the central banks of the world began quantitative easing, which again injected liquidity into world financial markets. Confidence, expectations and the state of the labour market may also have contributed to this outcome, but may well have been a part of the transmission mechanism from the contraction in international liquidity to the housing market.

The way overseas borrowing works is not straightforward. Suppose I take out a mortgage of $1 million to purchase your house. You deposit the $1 million in the bank so the net position of the bank is unchanged and it can pay off the overseas loan it has used to fund my house purchase. The net position after the transaction appears to be zero.

If this was the entire story, any international borrowing only lubricates the sale and purchase transaction. But in the course of the sale there are transaction costs: real estate agents, banks, lawyers, valuers, surveyors, movers, and so on, while house buyers often go on to commission builders to alter the house and to purchase durables and furnishings. The total costs may be a considerable amount – in one modest case I know of they were in excess of $30,000 including the costs of selling the previous house (a downsizing too). In total this amounts to a considerable expenditure each year (100,000 houses at $30,000 per sales transaction is $3 billion) which is, in effect, borrowed offshore. Observe that it can hardly be argued that this offshore borrowing is funding ‘investment’ – although some is so classified in the official statistics.

If the long-run relativity that existed between 1962 and 2002 had persisted through the following 14 years, house prices today would be half the level they actually are. It could be argued that this is a measure of the degree by which housing is overpriced.

Are Markets Free?

This entry was posted in Pundit, Regulation & Taxation on by .

Effective markets are underpinned by the government. The interventions may be sophisticated and well-thought through or they may be clumsy and ineffective. The neoliberal rhetoric of ‘free markets’ leads to the latter.

In a recent Metro article, Matthew Hooten wrote ‘globalisation combined with free markets has been the most successful economic and social system of the world’. I do not propose to discuss whether we can describe as successful a social system which is riven with mental health and addiction problems or whether we can attribute them to globalisation and free markets. As a previous French prime minister, Lionel Jospin, said (in French) ‘Yes to market economy, no to market society.’

Nor am I going to spend much time discussing globalisation in this context. Adam Smith argued that specialisation (with its economies of scale and learning-by-doing) were crucial to economic development. Globalisation facilitates this, but never forget it has its downsides.

This column focuses on the pernicious rhetoric of ‘free markets’. Whatever the expression sounds like, markets are not typically ‘free’ but are regulated by a host of laws (imposed by governments) and other interventions.

It is unfortunate that the usual introductory economics course pays little attention to the government regulation of markets. Apparently neoliberals having struggled through Economics I (in a famous case obtaining a C pass) miss the point and end up using uncritically the idea of a ‘free market’.

The amount of government regulation varies. In the typical Economics I example, say apples, the transaction is repeated, you soon find out if you made a bad decision, and the loss from one mistake is small. Even so, you might contemplate when you next purchase some apples, how you are protected by the Fair Trading Act (among other interventions). You make the purchase with a degree of confidence in the quality of supply and that knowing there are remedies in the unlikely event that something goes wrong.

Compare that with purchasing a house. As the leaky buildings saga illustrates, you make the decision rarely and it may take considerable time – years – to find out if there is a defect, which may be very expensive and extraordinarily costly to remedy (but very profitable to lawyers). The failure arose in a period when belief in free markets was strong under the slogan of ‘light-handed regulation’. As a result, we have moved to much more heavy (local) government regulation; I am not sure we have got it right.

For once we move away from the naive neoliberal slogan, things get very tricky. I illustrate this with the ‘open bank resolution’ policy. It arises because it is possible – many would judge unlikely – that your bank may fail. There are a number of ways it can, but for these purposes consider the possibility that it has difficulties paying all its depositors either immediately or ever. You don’t think a lot about this when you place some of your savings in a bank but, golly, you would get angry if it were to happen.

Who covers any financial deficit? The easy response is ‘not me’; a slightly more sophisticated version is ‘the government’ which means the taxpayer – in effect someone else.

Why should the government worry? Aside from the political pressures, the banking system is key in the economy’s payments system so a bank failure could compromise the very basis of an effective market economy. (There are some splendid examples of responses. One of my favourites is that when one happened in Ireland, the local hostelries ran a credit system for their customers; it would not work here because most New Zealanders do not have such an intimate relationship with their pubs.)

The open bank resolution policy states how the government would deal with the situation. It reserves the right to suspend, for a period, depositors’ access to their funds during a temporary crisis and to haircut (that is reduce the value of individual deposits) if there is a permanent deficit. It is only a policy framework, because no one knows the details of an actual incident – the devil is always in the details.

At the same time the Reserve Bank has instituted a number of requirements for the banks which aim to reduce the likelihood of a bank collapsing and that, if it does, buffers – shareholders’ funds and other sorts of investment contributions – will be used first if there is a deficit. This gives greater protection (a lower likelihood of the haircut) to ordinary depositors.

New Zealand is not alone is such strategies. The Global Financial Crisis exposed the failure of the light-handed regulation that had existed throughout the world’s financial system. When things got strained it was the taxpayer who bailed it out, by literally billions of dollars.

Chief financial neoliberal in the era preceding the GFC was Alan Greenspan, Chairman of the American Federal Reserve (i.e. their central bank). Questioned afterwards by a congressional committee after the collapse, he said, referring to his free-market ideology, ‘I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.’

A congressman responded, ‘In other words, you found that your view of the world, your ideology, was not right, it was not working.’ Greenspan replied, ‘Absolutely, precisely.’

So much for the ‘free market’ in practice. This will be water off a neo-liberal duck’s back, but I want to draw another conclusion. It is one thing to criticise the shallowness of the free market ideology, it is a far greater challenge to design effective interventions.

I have illustrated this column with the open bank resolution policy and the other measures the Reserve Bank has instituted (and is instituting) because they seem very well-designed. (Of course there is grumbling from those who have to respond to the measures. Following the next financial crisis they will not apologise as Greenspan did; by then they will be retired on handsome incomes.) On the other hand, I see intervention frameworks in other markets which would be struggling to justify a C grade.

An unfortunate consequence of the free market and light-handed (I almost wrote ‘light-hearted’) regulation rhetoric has been to destroy our capacity to design quality interventions. A few exceptions aside, we may be drifting back to a Muldoon era regime of poor-quality market regulation.

When the Water Runs Out.

This entry was posted in Environment & Resources, Globalisation & Trade, Growth & Innovation, Pundit on by .

The growth of farm output may be slowing. Specialty cheeses show an alternative strategy of further post-farmgate processing.

Land for farming ran out in the 1950s. Farm production intensified. We shifted from more dollars of farm output by using more land to getting more dollars per unit of land. Among the challenges we had was to replace the nutrients we were depleting from the soil – notably phosphates. Fortunately the world’s reserves of cheap phosphates have not yet all gone.

Less fortunately, our water resources seem to have run out. Fresh water is limited and wastewater is polluting the sinks we use of our rivers and lakes. (Urban use is compounding the problem.) Perhaps we should replace the opening sentence with ‘water for farming ran out in the 2010s’. Unlike land and fertilisers, though, and despite the RMA’s system of resource consents, the water resource is not subject to a commercial property rights regime, so it is harder to follow exactly what is happening. Probably we are reaching the limits of total farm production although there may be some tweaking from using more water-conserving technologies and crops.

That bodes ill for the future of the New Zealand economy. Admittedly, farm production is no longer the dominant foreign-exchange earner it was in the 1960s when it supplied 95 percent of our external funds that were not borrowed. Today the ratio is less than half but it is not obvious that our other export industries can carry the deficit that a broadly stagnant farm sector would generate.

(Once upon a time we would make careful projections of our export potentials. Today we are much more casual; we borrow to make up any deficit – but that is not sustainable.)

So a challenge has to be how to earn more dollars per unit of farm land when farm output stagnates.

(One approach is to get better prices for our farm export products by reducing trade barriers. That is a major concern in our trade negotiation strategy but, except in farm newspapers, I see little reference to the gains. So, for instance, the public debate over the TPP focused on the downsides – the concessions we made – but rarely referred to the wins from better trade access for our primary products.)

One way of increasing dollars per unit of farm output is by value adding after the farm gate. Yes, we do further processing but often it is the minimum necessary to be able to export the stuff. Let me give an example with cheeses.

Historically we have exported cheddar cheese. In the early days of refrigeration we found that cheddar best survived the long sea voyages. In key markets today New Zealand cheddar has a reputation for good quality at reasonable prices. I’ll come back to the issue of market access shortly. However cheddar is an example of minimum necessary processing.

Apparently we make some world-class specialty cheeses and export a little of them. (I am concerned here with table cheeses similar to blue, brie, camembert, feta, gouda and the like; there are also local specialty cheeses such as Kahurangi. We also export specialist cheeses for industrial processing such as mozzarella for pizzas.) They involve more post-farm-gate processing. So why do we not do it more?

In contrast we have over the last sixty years switched our wine industry from producing plonk – they had the temerity to call it ‘sherry’ – to export wines with international reputations (despite some rather unfair tariffs against them). Why not the same for specialty cheeses?

Regrettably cheese is heavily discriminated against at many countries’ borders. (Often the definition of allowable cheese imports is very prescriptive, which limits opportunities for alternatives.) When we finally persuade another country to allow us to sell them more cheese (typically by increasing the tariff-free quota) we prioritise exporting cheddar. That is perhaps understandable if farm output is unlimited, but what happens in the new era we seem to be entering?

If the wine parallel is relevant we have to be able to export the specialty cheeses into highly discriminating markets such as France. Their connoisseurs then begin to admire our cheeses, as they did our sauvignon blancs; French tourists would taste it here and buy it back home. (It would help if our restaurants charged more reasonable prices for their cheese boards.) The international reputation would flow on to other markets and, for instance, we would have increased demand and prices in China, where we already sell a little specialty cheese. (It would also help if restaurants and the like identified the sources of their cheeses; imagine serving wine without mentioning the vintner.)

Of course it is more complex than that – trade deals always are — and it requires a lot of private initiative too. But the essential principle that we increase value adding of our exports of cheese is not. And the principle applies to other primary products, although each may differ in detail.

Otherwise with the water running out (or becoming insufferably polluted) farm production will stagnate and we will have greater difficulties generating sustainable foreign exchange. Borrowing is only a short-term measure – be it borrowing offshore or depleting the water resource.

PS. The EU and Japan have just announced a Free Trade Agreement (JEEPA), although the details are unclear. It is a strategic agreement intended to offer an alternative to Trump’s short-sightedness on trade. As well as the first mention of the Paris climate accord in an FTA, the deal includes Japan making major concessions on barriers to cheese, wine and other  agricultural products. Bother, we have been trying for a deal with Japan too (and with the EU). The TPP11 will give us better access.

Being a New Zealander.

This entry was posted in Macroeconomics & Money, Pundit on by .

By exploring the multiple worlds she grew up in in New Zealand, Helene Wong’s memoir ‘Being Chinese: A New Zealander’s Story’ tells us much about our worlds too.

Economists have a predilection for the open economy because, I think, openness to trade tends to be associated with openness to ideas, to technologies, to people, to opportunity, to the future. So the import controls on carpets in the 1960s meant New Zealand was unprepared for the rise of synthetics which decimated the market for coarse wools, crashing their prices in 1966. On the other hand, at about the same time it was agreed to relax the restrictions on imports of speciality cheeses to generate a public taste for them. The success of the strategy is not only evident in the domestically produced speciality cheeses displayed in our supermarkets but that we now export some.

I was reminded of this sentiment when I came across a scabrous letter reproduced in Helene Wong’s memoir Being Chinese: A New Zealander’s Story. But first some background. Helene was born in New Zealand, as was her Chinese mother, while her father came here from a Cantonese village when he was seven. Born in 1949, she is best known as an actress and film critic.

Much of her memoir will resonate with anyone who grew in New Zealand at about the time she did, for her public life was much like everyone else’s. (She suffered some nasty jeering over her ‘Ching Chong Chinaman’ status, although gangs of children tend to be cruel to anyone they deem outside their circle.) Her home life was particular – everyone’s is. Her parents were green-grocers and she spent a lot of time in the shop and helping Dad down at the wholesale markets. Her social life was enriched by many Chinese community celebrations.

She was not a banana – yellow outside, white within – as a white stepfather once described to me his adopted and assimilated Chinese son. For while outwardly she was like other Pakeha, inside there was a Chinese foundation. (She married a Māori, but that is a private story, which does not feature prominently in the book.)

Her integration proved to be a journey exploring the worlds to which she belonged. Ultimately the trip was about what it means to be a New Zealander and yet to have other cultural elements in one’s makeup. Since we all do, her challenge was not much out of the ordinary, although perhaps it is bigger for Asians; we are probably more tolerant of some backgrounds than others.

That is where the dreadful letter comes in. The New Zealand Chinese practice has been to take a low profile, but with growing confidence arising from her success in the New Zealand public world, she spoke out against the presentation of Chinese stereotypes, receiving in response an abusive letter, anonymous of course, which was, to use the mildest terms available, ignorant, intolerant and racist.

Sadly, there are some of us like that – Helene has the grace to suggest the writer may have had a bad Asian experience, perhaps in the military. My immediate reaction was to think what a closed mind the writer had, unable to engage with something different except with abuse – probably still only eats cheddar cheese.

That led to me to ponder on Trump supporters. People often say ‘isn’t it obvious he is a fake?’ Well not to a closed mind. Perhaps one day the accumulating evidence will change their minds, but a poll had 25 percent of the population supporting President Nixon on the day he resigned in disgrace.

There is an interesting row in Canada arising from Hal Niedzviecki, the editor of a literary journal, writing that everyone ‘should be encouraged to imagine other peoples, other cultures, other identities’; seems to me be a very appropriate sentiment. However Niedzviecki used it to defend ‘cultural appropriation’. I am not so politically correct as to reject all  cultural appropriation but it should be done with respect; it may be hard to do it well.

Recall Gordon Walters, who as an educator did much to promote Maori art. His elegant koru paintings were described by the politically correct as ‘cultural appropriation’. A better response was a retrospective of his Maori students at Porirua’s Pataka Gallery acknowledging their debt to him with works based on the koru.

Helene’s description of her Chinese background provided a perspective to engage with my being a New Zealander, something which has been greatly puzzling me as globalisation seems to compromise national identity.

You’ll have to read the book to find how Helene satisfactorily resolved to think about being a Chinese New Zealander but to give a hint, her family values (which an open-minded person would not grumble about) were anchored in Confucianism and Taoism which she only learned about while studying at Harvard in her thirties. Her family did not seem to know their ancestral culture’s great thinkers, but it practised their values.

Reading the book, you will also learn of a different perspective on the world and even a little Chinese history. For instance, Chinese resistance to the Japanese invasion in the 1930s delayed the fall of South East Asia. The book reinforces the unease I feel about interpreting the Chinese leadership using our values. There is also material on the history of the Chinese in New Zealand. I am embarrassed that some of it reflects attitudes as ugly as that letter.

You will enjoy the numerous anecdotes about being the New Zealander that Helene evidently is. My favourite is that in her thirties she had some public business in China and took a side trip with her parents to the village where her father was born. Because she was a member of the Prime Minister’s Advisory Group, Chinese officialdom provided an official car. I imagine that the villagers expected their visitor would be in a suit, probably a man. Instead the representative of the New Zealand premier stepped out of the car in a floral skirt and jandals – which any respectable New Zealand woman would have worn in the circumstances.

PS. I have just read David Galler’s Things That Matter. David is an intensive care physician and public health specialist. The book will be valued reading by anyone involved in the health system. He was the child of two immigrants – David’s mother survived the Auschwitz concentration camp, his paternal grandfather was Chief Rabbi of Poland. The memoir is another illustration of how migrants from ‘minority’ ethnic backgrounds can make extraordinary contributions to New Zealand.

Middle Class Welfare

This entry was posted in Political Economy & History, Pundit, Regulation & Taxation, Social Policy on by .

Jenny Shipley says the middle class has captured the welfare state. But did she understand what the welfare state actually meant before she began attacking it?

In her interview with Guy Espiner, Jenny Shipley regretted that the ‘middle class’ were still beneficiaries of the welfare state. Now the term ‘class’ is a summary of a lot of complex ideas useful in social discussions, but I cannot recall it being used by such a senior politician – at least not since Harry Holland. Indeed some commentators on the interview choked on the expression, quickly switching to ‘middle incomes’; which was both more precise and more in keeping with New Zealand’s political rhetoric.

The idea probably came from an English economist, Julian Le Grand, who passed through in the mid-1980s. I recall two takeouts from his presentation. One was that surveys reported that the public was willing to pay more than it cost for an iconic structure – double in the case of the vastly over-budget Sydney Opera House. (Reflect on the cost and the value of restoring ChristChurch Cathedral.) The message was promptly forgotten – presumably because of the fiscal implications.

The other message was that the middle class had ‘captured’ the welfare state. Julian was a student and, later, colleague of mine, but I do not think he then had it quite right. It is true that the modern welfare state provided some support for those on higher incomes. It was never intended solely to be vertically redistributive – that is, only transferring income from those on high incomes to those on low incomes. It was also horizontally distributive providing social insurance; the main source of funding of public healthcare for those on middle incomes is others on middle incomes; if you are unlucky in health (or whatever) others like you who are luckier would contribute to your treatment.

This illustrates another issue. Private market delivery is not always efficient. An even starker example – one of Julian’s examples – is the enormous subsidies to London public transport commuters. Remove them, as is Shipley’s apparent wish, and London traffic would come to a halt.

Geoff Bertram provided a good critique of the middle-class capture thesis in a report to the 1988 Royal Commission on Social Policy but it was ignored. Instead, the neo-liberals seized upon the notion to justify the stripping out of subsidies, and the minister – in this case Shipley – adopted it without apparently understanding the argument.

Indicative of this was her claim to Espiner that ‘[t]he middle class has had, and continues to capture, a welfare state that was never designed for them.’ Just who said it was not designed for them? While there were numerous threads in its design, I would have said that a key notion was that it was designed for all of us – that it was never intended to be only vertically redistributive.

Even more confusingly, Shipley promised in 1990 and 1991 to ‘redesign the welfare state’. Now she is talking about design as if that did not happen. Did she or didn’t she do it? Does she know what she is talking about? I would be surprised if she has ever read, for instance, the report of the 1972 Royal Commission on Social Security, and I expect her knowledge of the history of the welfare state is even thinner. (Happy to report a correction.)

Mind you, she was no more ignorant than her neoliberal advisers. They knew no history or only very recent, and not always accurate, versions of it. (A bit like Trump, really.)

David Seymour, who represents the neoliberals in parliament, claimed that the 2017 budget demonstrated that National was ‘abandoning its roots’. But the budget was in the tradition of National and its predecessor parties. The only time it has had a neoliberal prime minister was for the two years of Shipley’s term (December 1997 to December 1999). You will recall she started off shifting the government to the right, quickly found the move was thoroughly unpopular (and impractical) and trimmed back towards the centre.

Indeed after 1991, minister or prime minister, Shipley hardly pursued the policy she professes today. That was because it is undeliverable. Recall Welfare that Works. The booklet had lots of vague promises backed by impressive diagrams, but when the taskforce tried to implement them it quickly found they were but fantasies. You would have thought those with neoliberal inclinations might have learned from the exercise that you cannot target welfare without very high effective marginal tax rates. But they were too committed to targeting to learn from the failure.

Without effective targeting the promised redesign could not work and the actual package collapsed into vicious cuts of the incomes of the poor, used to pay for the tax cuts to those on upper incomes (or perhaps as Shipley would say, ‘the upper class’). Ironically, while Shipley seems to think the welfare state is essentially a vertically redistributive system, she contributed to markedly reducing the degree of vertical redistribution from the rich to the poor.

Were social policy in New Zealand an evidenced-based disciplined we would have concluded that the 1990s ‘redesign of the welfare state’ was a failure on virtually all its promised dimensions other than cutting the cost to the state. Instead we keep pretending it is a success while adding another patch to deal with yet another leak.

The patching of more and more increasingly targeted programs which are increasingly expensive to administer keeps generating demands for further patches because they do not work other than temporarily. Remind you of Muldoonism? So be it.

By the time the failed patches become evident, ministers and administrators have moved on, so no one is responsible or remembers and another patch is applied. The poor the patches are meant to be helping are left coping with a myriad of targeted programs which are confusing (the take-up rates are embarrassingly low) and which take an awful lot of the supplicants’ time (a short interview may involve them hanging around in a waiting room for hours – see here).

The redesign of the state may have increased the incomes of the rich but it has also created jobs for the middle class administering its complexities. The poor work hard to support them; perhaps they deserve a reward. Perhaps this is the middle-class welfare that Jenny Shipley should be really concerned with.

How Does Immigration Benefit the New Zealand Economy?

This entry was posted in Growth & Innovation, Labour Studies, Pundit on by .

Answering that question proves to be challenging. This preliminary assessment suggests the economic benefits to incumbent New Zealanders may not be great.

During the Vogel boom, say between 1871 and 1881, the population of New Zealand doubled, as did real GDP (as best as we can measure). That means per capita GDP was much the same at the end of the boom as it was at the beginning. Was it a boom then?

The reason is instructive. Vogel’s strategy had involved heavy overseas borrowing. Some of the proceeds had been used to ship migrants. That is why the population grew so quickly. Vogel, rightly, had encouraged young women to migrate here in order to get a better gender balance. Although he did not get to one for one (something not attained until the 1920s if we include soldiers away during the Great War) the number of women rose faster than the number of men. While the population doubled, the employed male workforce increased by only 60 percent. So their productivity measured by market output rose at about 1.4 percent p.a., much like it has done for most of our post-1860 history.

Despite the lack o0f GDP growth, the men were better off. They had companions (who were productive in their homes, if unpaid) and they had children. This is a useful reminder that GDP may not always be a good measure of living standards. More generally, it alerts us that assessing an economy with high migration can be complicated.

Thus it is today. The proud boast is that GDP is growing at about 2.9 percent p.a. but since the population is growing at 2.3 percent p.a., GDP per capita is growing at only 0.6 percent p.a. (This is about half the long-term growth rate, something I need to come back to in a later column.)

But whatever the average increase, the increase for those who are not immigrants is lower because the immigrants are more likely to be in paid employment; the opposite of the Vogel era. It is difficult to calculate the real production rise for incumbent New Zealanders, but my stab at the figure is that it is between 0.0 and 0.3 percent p.a.

There was another major difference between the Vogel boom and this one. Vogel also used the proceeds from the borrowing to build infrastructure: telegraph, roads, railways, ports … Current international research often suggests that the rates of return on today’s new infrastructure are above 10 percent p.a. That of 140 years ago was probably even higher.

Today, we are not borrowing for infrastructure. It is true that there are major programs in the broadband rollout and in some roading. We are getting hopelessly behind in housing, and a lot of effort is being put into recovering leaky and earthquake risky buildings which is not so much additional infrastructure as replacing poor investment in the past. The best I can estimate is that national capital per head is not really keeping up with economic growth. Sitting in your car in yet-another-bloody traffic jam, you may agree.

So some benefit from immigration, some do not. Presumably the former include the migrants themselves, but it also includes businesses which make profits from their additional employees while not having to trouble themselves in finding suitable New Zealanders or upskilling them. Those who may not have benefited include New Zealanders who do not get the upskilling and don’t get the jobs, those who miss out on decent housing or suffer from infrastructure failing to keeping up with population needs.

A complication is that the additional workers probably contribute more in taxes than they use social expenditure, so from these dimensions the young, the sick and the old are better off (assuming the government uses the extra revenue for spending rather than cutting taxes).

In summary then, immigration seems to be of little economic benefit to New Zealanders in terms of raising their standard of living, especially if it is used as an alternative to policies such as upskilling the labour force and if we do not build the infrastructure that the expanding population and economy needs. This conclusion obviously applies more severely the greater the level of immigration.

That leads to two policy conclusions. The first is that we need a comprehensive and detailed economic review of immigration instead of flying by the seat of our pants as this column has been forced to do. Second, it is likely to conclude that we need to be more restrained about levels of immigration in certain areas. (There is almost certainly a third policy conclusion. That we should have carried out the policy analysis earlier – but that concluion generally applies to most policies.)

Let me make it clear that this is not an anti-immigrant column. One of the few things I am sure of is that I will not vote for an anti-immigrant party (even if they indicate their position only with dog whistles). What the column is arguing is that we need to be more sensitive to the impact of immigration on the economy and that it need not necessarily be a good thing in narrow economic terms (as the women Vogel’s scheme imported were not). It is rejecting the neoliberal approach that immigration policy should not be coordinated into comprehensive macroeconomic policy. In particular, I should not be surprised if we need to restrain immigration a bit more, pay more attention to upskilling domestic labour and get a better balance of infrastructural expansion.

The Death of the Media?

This entry was posted in Business & Finance, Literature and Culture, Pundit on by .

If the Commercial Miracle of Newspapers is Over, What will Replace It?

Newspapers have been a commercial miracle. For a very small outlay one got access to a surprisingly wide range of news, opinion and information. Part of the explanation was economies of scale, but the trick was that much of the industry’s revenue came from advertising. The symbiosis was that advertisers attracted readers’ attention to their products by subsidising the paper’s news-gathering activities which attracted readers.

In recent years, much of the advertising – especially classified advertising – has collapsed or, more precisely, it has moved to other venues, most notably, locally, the TradeMe website. (Some newspapers once gained perhaps a third of their advertising revenue from small ads.) As it fell the cross-subsidy to journalism also fell and workers have had to be laid off. That means there is less news, or that it is more superficial and of poorer presentational quality – subediting has been especially heavily hit.

A poorer news service means the paper is less attractive to readers – especially as they can turn to news websites. So circulation has fallen, newspaper sales revenue has further fallen and they are less attractive to those advertisers who are left. It is not difficult to see newspapers, here and in much of the world, in a death spiral despite some innovative adaptations to reduce costs.

That means that their role as news collectors is diminishing too. Even those newspapers with paywalls on their websites generate insufficient revenue to employ a lot more journalists (or subeditors). The miracle is over.

If journalists, once our guardians and generators of verifiable facts, are diminishing, any gap is being filled by commercial and political interests, by opinions and by false news.

Recently the Northern Advocate of Whangarei published a story of a pseudo-historian who claimed that Celtic sailors reached New Zealand around 4000 years ago – circumnavigating the world before they could circumnavigate Britain. Once the stupidity of the article was pointed out, the paper dropped the article but it is there in cyberspace (if you must, here). What interested me, for this column’s purposes, was that the newsroom of the Advocate (circulation about 10,000) is so shallow that their journalists’ common sense did not stop the story before publication. How much bigger do you have to be to avoid being vulnerable to a more sophisticated hoax (including those sourced by commerce and politicians)?

 Broadcasting funded by advertising faces a similar challenge of alternative outlets and diminishing revenue. Meanwhile, what is loosely described as ‘social media’ (including Google) is proving to be extremely profitable from the advertising revenues diverted to it. They are natural monopolies, for their dominance is hardly threatened by competitors.

 People overuse the term ‘crisis’ – it is a word the media loves to use to grab your attention – but it seems to me that democratic society as we understand it is greatly challenged by the end of the media miracle. It was founded on the Enlightenment notion of rational debate leading to progress and improved wellbeing. I am not sure that has occurred during some recent political kerfuffles. For example, one of the requirements of a rational response to climate change is an understanding of the underlying science which deniers seem unaware of. (Reflecting, this economist has seen a similar phenomenon riddle through our economic discussions; he shares the bruising of climate scientist.)

 What can be done? It is no good hoping the trends will reverse themselves. Classified advertising is all but gone and there is not going to be a lot more display advertising. It still works in some areas because the web has not provided a viable alternative. Most of us use the property and travel supplements with a followup to a website. Community giveaways seem to work because they are focused on smaller communities (but their contribution to great journalism is likely to be limited). Many provincial papers are drifting towards community giveaways – they may prove viable. Sponsorship is a kind of advertising which may add a little to revenue.

 What about government funding? Yes, it can help but it should not dominate as authoritarian state-funding demonstrates. (The Soviet Union produced the state-owned Pravda (truth) and Izvestia (news). Its citizens knew there was no news in Pravda and no truth in Izvestia.) Yet we should not be completely dismissive. Both the BBC and RNZ (Radio New Zealand) provide great news services. (As an aside, plaudits to Minister of Culture Maggie Barrie, who managed to squeeze some extra money for RNZ out of her, no doubt grumpy, colleagues in the 2017 budget round.)

 There are also ‘angels’, people or trusts which subsidise the media. The Washington Post is owned by billionaire entrepreneur Jeff Bezos, the Amazon.com founder, who apparently sees this as a public commitment. The paper has recently changed its masthead slogan to ‘Democracy Dies in Darkness’. Even, so it needs revenue, including from a paywall on its news-site. The Guardian website has no paywall. It is owned by a trust which has been chewing through its financial reserves.

 The public is another source of funding. Subscriptions to hard copy help, but paywalls don’t seem to be big revenue generators. Yet the news-sites are becoming an increasing element of the media industry, either standalone or as a part of a hard-copy publication. I shan’t be surprised if they are becoming the preferred source for the younger generation rather than subscribing to papers. If the news-sites do not generate sufficient revenue there will be insufficient journalism.

 Many news-sites depend upon crowdfunding and donations. There is not the same tradition in New Zealand as in the US for such funding but my guess is that it will become more common. (I am not saying we are ungenerous; rather that we dont think about such things in the way many Americans do.)

 You will see at the top of this page an invitation to ‘become a supporter’ of Pundit. It would not be quite this column’s style to urge you to click on it, but unless sufficient people do the possibility is that the website will die. I am less reticent at encouraging readers to support financially all the free news-sites they value. Without that support there is a danger that our open democracy, such that it is, will descend into darkness.

Footnote: If you have doubts about the importance of good journalism look at this report on the collapse of the CTV building and the death of 115 people on 22 February 2011.Thankyou to the team of journalists and to the editors who thought it worth doing. One may wonder how many advertisements paid for it.

The Context of the 2017 Budget

This entry was posted in Macroeconomics & Money, Pundit on by .

Much of the commentary on the budget was shallow. What is really going on is that the changes are small but they reflect a particular political perspective. The financial threat was hardly discussed

Allow me to be irritated by the trivial discussion which surrounds the government’s annual budget. The budget is simply the government setting out its spending, revenue and borrowing plans for the year, as required by legislation and as has been a fundamental part of the constitution for three centuries. In most years – ones of benign growth without a crisis – any changes are incremental.

Over the long run, budget decisions can affect the quality of our life; in the short run they can have a large impact on particular, but typically small, interest groups who magnify any change (or lack of it) out of proportion to the overall significance. The government also has an interest in magnifying any favourable changes no matter how small, and it seduces commentators to do much the same thing. (Some commentators and the parliamentary opposition do the opposite, but they are playing the same game.) What is missing is the context.

Here I am going to use annual average changes from July 2015 to June 2019. I do this in order to smooth the fluctuations. The Treasury thinks that volume production (real GDP) will increase on average 3.5 percent p.a. over the four years. However, the population is expected to rise by 2.3 percent p.a., so per capita volume GDP rises 1.2 percent p.a.

The rapid population growth reflects high immigration. Because, given their ages, immigrants are more likely to work, the increase for the non-immigrant population will be less. I am afraid there are many such complicating details. I’ll concentrate on the big picture. I am not aware of any caveat that markedly changes the conclusions from the following analysis. (The calculations are in constant prices. Inflation (of about 1.5 percent p.a.) would add to the amount of data which has to be presented, but it does not affect the story.)

How much is a real rise of 1.2 percent in a year? The average annual household income is about $100,000. That is before tax (taxes will depend on household composition) and typically involves more than one earner in the family as well as social transfers (NZ Superannuation and social security benefits) and investment income. (The average wage is about $66,000 a year for men and $46,000 for women) So the average real increase for a household in a year is about $1200 or $24 a week. (This is before tax.)

Much of the annual increase comes from higher wages and social transfers. The Treasury expects real consumer wages to rise by about 0.6 percent annually. Thus much of the increase for an average household will come from a rise in market incomes.

At this point I could go into a confusing discussion of how households with different compositions of incomes and members are affected by ‘bracket creep’ (‘fiscal drag’), that is, as their nominal incomes rise the tax they pay rises more than proportionally. But I think you will have got the overall message by now: there is not a lot extra to go around.

When the government says its tax package is giving $10 or $20 a week additional to what the market will pay them, it is giving them a big share of the available additional income; the rest is public relations. When a household complains that there is not much in it for them, they are right; there isn’t. The economy isn’t growing enough to give a major increase in real incomes to a wide proportion of the community.

The government has been able to give a fraction more in tax cuts than the above calculations might suggest by restraining its own spending. Part of this restraint is that those on social security benefits will fall further behind average incomes. There is also restraint of wages in the public sector, cutting back services (mental health seems to be seriously underfunded) and cost-shifting so that users will be paying more for their education, healthcare and the like. (The tax and family incomes package is not implemented until April 2018. The government will explain it is an implementation lag, but because it is later, and represents more than one year’s growth, it can be bigger than if it was implemented this year.)

The budget projections have total government spending (adjusted for consumer inflation and population growth) at much the same level between 2009 and 2021 (as far out as projected). That means that spending is falling as a share of the GDP.

The flatness is a deliberate political choice. It was also broadly flat in the mid- to late-1990s under the previous National government (after falling sharply in the Richardson years). On the other hand the public spending share rose under the Clark-Cullen Labour government.

The balance between spending in the private sector and spending in the public sector is one of the few economic issues which is affected by electoral outcomes. Vote right and it is for lower taxes (on some) and fewer public services (for some), vote left and it is the other way around. I shall be surprised if that is the way it is presented to the electorate, but that is the reality.

The other big thing which needs mentioning is that the economic projections suggest that our prosperity continues to be funded by overseas borrowing. The Treasury forecasts say that not only will it be large but that it will increase. They think that the net international investment position is currently 59.8 percent of GDP and expect it to rise to 62.4 percent by June 2021. In the interim we would have borrowed $42.5 billion, almost $45 a week per person.

I would be more relaxed if the funds were being used to invest in activities which would generate earnings to service the debt. The reality is that much of the borrowing will leak into private consumption. (Households save hardly anything.) The cynic might think that foreign lenders are more generous than the domestic government, but in due course they will have to be repaid.

Such issues were hardly canvassed in the commentaries around the budget. They will be in the next financial crisis but few will link the two.

For an argument that the budget’s debt target is too austere, see here.

How Will Housing Prices Fall?

This entry was posted in Pundit, Social Policy on by .

Following up my ‘AUT Policy Observatory’ report on ‘Housing Prices Relative to Consumer Prices: An Analysis’.

Last week the Reserve Bank reported stress tests to assess the ability of borrowers to cope with higher mortgage interest rates. Assuming 7 percent p.a. – close to the average two-year mortgage rate over past decades – the RBNZ found that up to 5 percent of current borrowers would be put under severe stress and would not be able to meet day-to-day bills for food and power.

Stress test are an internationally used system of assessing what might happen under certain assumptions. Of course reality is more complicated, but like many measures it provides some insight into possible futures.

I guess one lesson is that the RBNZ will be cautious about raising its Official Cash Rate by the two or so percentage points which would push up mortgage interest rates to near 7 percent but it may have little option if world rates rise. It probably will increase them cautiously if it has to in, say, eight steps of a quarter of percentage point each, taking more than a couple of, or more, years. (In certain kinds of financial crises it may have to bump them up much faster.)

That means that those who are particularly vulnerable to financial stress from high interest rates may have time to adjust. (Whether they will is another matter.) In any case banks have had a signal that they should not increase advances to such potential vulnerables.

The stress-test report is yet another indicator that the housing price boom may be coming to an end (despite the ongoing optimism of some spokespeople for real estate agents). A report I prepared for the AUT Policy Observatory puts what may happen in a historical context. 

I used the longest housing price series available, starting over half a century ago in 1962, comparing it with consumer prices. For most of the period – the first 40 years – house prices rose a little faster than consumer prices, at about 1.4 percentage points a year. There is nothing special about this. You might expect them to rise a little more because land nearer city centres is limited.

However, since 2002 the rise has been much greater at 8.2 percentage points annually (12.4 percentage points if we omit the period when the Global Financial Crisis was at its most intense.) This is so much higher than the past trend that it is almost certainly due to a speculative bubble financed by offshore borrowing. (There are other lesser factors such as the failure to build enough houses and there has been housing pressure from immigration.)

The statistics suggest that our house prices are now about two-and-a-half times higher than they would have been had they risen at their pre-2002 rate. Alternately, housing prices would have to fall 60 percent to be back on track.

Typical home owners might feel poorer (speculative bubbles always make one feel wealthier than one really is – before they pop) but a lower price for their houses would not make much difference. They would still get the same value from living in them and outgoings would be much the same. Even if they have to move, on average the new house price would be proportionally lower.

There are two big groups who would be markedly affected. One are those without their own homes. They would now find it easier to find the deposit for a house and also to service the mortgage, so they might be able to buy their first house.

On the other hand, many who have been investing in housing would be worse off. For example, if housing prices were to stabilise or fall, the investor who has bought a house with as much debt as they could get away with, relying on the tenant’s payments to cover the mortgage while getting their return from the capital gain, would be faced with a zero or negative return. (They are especially vulnerable to rising interest rates.)

(A third potentially large badly-off group is home owners who lose their jobs.)

So how likely is a house price stabilisation or a price drop? The answer is ‘almost certain’, although we cannot be as certain when. Speculative bubbles are always like that. It is possible the market has already peaked; if not it will. (The sooner it peaks, the easier it is for the economy to adjust, but those exposed when it stabilises or falls hope that it wont be yet.)

It is difficult to predict the course of the adjustment. There are so many possibilities, for so many things are going on. I looked at history to make an assessment. It turns out that the typical price fall relative to inflation is about 2 percent a quarter – or 8 percent a year. So we have had not had the price crash some have predicted, presumably based on what has happened in America. My report argues that our institutional arrangements are different from those in the US and they cushion a rapid fall. (It acknowledges that sharp drops are possible in some regional markets.)  So it expects that the housing price falls will be sluggish. However the historical record is that the relative falls have never lasted for longer than five quarters. In fact it is going to take six or so years to get back to the long-run trend at the 2 percent a quarter rate fall. Who knows what might happen over that period – especially if interest rates also rise?

There will be a lot of distress among those who have over-borrowed and among investors who had not realised they were actually speculating. On the other hand, more will be able to buy their first homes.

There is another phenomenon which will add to the pain. During a speculative bubble the housing market is ‘liquid’, in the sense that there is a lot of buying and selling. Speculation adds to the ‘depth’ of a market so that people who have to change their housing – for family reasons, jobs, life style (the garden is too big) or aging (need better access) – have a big range of choices which dry up after the ‘downturn’. Those who service the buying and selling of real estate – including lawyers, valuers, and removal firms as well as realtors – will have less business.

So it will not be easy; speculative bursts never are. History reminds us they happen, especially in market economies when governments fail to take prudent measures early enough.

Housing Prices Relative to Consumer Prices: An Analysis

This entry was posted in Social Policy on by .

This report was published by the AUT Policy Observatory. It’s abstract is

This is an update of a note I wrote in April 2007. It uses a longer housing price series that starts in 1962 (instead of 1980) and finishes in 2016 (instead of 2007). It shows that while historically housing prices have risen a little faster than consumer prices, the increase has been sharper since 2001 (except for the period when the Global Financial Crisis impacted). It goes on to use the historical record to speculate on possible patterns of future prices. The focus is on house prices for the whole of New Zealand. There can be considerable divergences between regions.
The full report is here.

 

 

Is National Stealing Labour’s Social Policy Clothing?

This entry was posted in Pundit, Social Policy on by .

Or has Labour lost its clothes or forgotten how to put them on.

Some Labour supporters are disturbed that the government seems to be stealing their policies. Probably National is shifting a bit to the centre, perhaps for electoral reasons (although the party is almost certainly more concerned with New Zealand First than Labour) and because Bill English belongs more to a centre-right tradition than did his predecessor.

But are they stealing Labour’s clothes or is it naked anyway (at least in its economic areas)? In some policy areas Labour still has the initiative. I have been impressed by Phil Twyford, Labour’s spokesperson on housing since 2013, who has successfully led the opposition charge against the government’s lamentable housing record.

I puzzle why the government has made such a botch. Partly it is because housing policy is hard (some of the policy advice the government has been given has been pathetic); partly because there is no central agency in the government for housing policy – policy advisers are scattered all over the place with a plethora of ministers; partly because National seems to defer to developers whose interests do not align with good housing for the population.

Perhaps the housing situation has got out of hand, limiting effective policy responses. You can see the beginnings of it during the Clark-Cullen era. My guess is that had he been returned in 2008, Michael Cullen would have taken various effective initiatives which the following government took too late or has not taken at all. Some would have been an anathema to the right side of National. To be fair, dealing with earthquakes and leaky buildings has distracted attention, while high immigration puts pressure on the housing stock in the short term. Even so, the additional spending on housing in the 2017 budget, was  pathetically small, putting sticking plaster over a wound. After eight and bit years, the National government has still not got its head around the housing problem.

Whatever, Labour has certainly got the government on the run; witness their stuttering policy responses and hysterical reactions to anything Labour proposes. (One cannot help noticing that while in a recent package Labour said it would redeploy the revenue savings for housing purposes, the public dispute centred on the revenue gains with no attention to any expenditure offsets; thus has the New Zealand conversation become imbalanced.)

Labour has been much less successful over ‘social investment’, that is, policies designed to prevent (or ameliorate) social breakdowns before they occur. It is true that Labour has a long history of a ‘social investment’ approach, but I do not recall Labour making the case in the 2008-14 era, so they can hardly complain that National has gazumped them. (National only got the religion in 2014.)

I have a number of reservations about the government’s strategy, but this column focuses on the big one. Both parties have seen sound families as the basis of a sound society.

(There has been a bit of uncertainty as to what is meant by a family; the husband, wife and their three children living together is no longer a norm, except in certain ideological quarters. Forgive me if I skip definitions of what we mean by ‘family’ today, but practically it has to recognise many forms centring on a household living together with mutual commitments among its members.)

The foundation of the sound family was once seen to be a decent income, suitable housing and ready access to adequate health and education. Without these, families become dysfunctional and generate the sort of problems that the government’s social investment strategy is meant to be dealing with. This is not to argue that with adequate income, housing and so on there will be no dysfunctional families, but if these are inadequate there will be a lot more train-wrecks.

New Zealand abandoned the healthy families strategies in the early 1990s when incomes were cut, charges were increased for health and education and housing policy became fragmentedly neo-liberal. The train-wrecks did not start the following day but the conditions for them slowly built up. So we get the Ministry for Vulnerable Children with a big increase in their budget funding and the social investment strategy which is going to be spending a lot too.

We cannot really avoid this sort of expenditure. To reduce government spending and lower tax levels we have been undermining families for a quarter of a century and we are now paying the price for that additional stress.

But we can do something about future generations, reducing their proneness to train-wrecks. The policy is obvious enough. Ensure families with children have a decent income, do something about their housing, make sure they have appropriate access to health and education and other social support. Simple? Yes, but it may take a bit of time to get it in position.

Expensive? I’m afraid the answer is also ‘yes’. Yet doing it would boost the wellbeing of the poor (far more than any reduction of the wellbeing of the rich), reduce inequality, improve the efficiency of the education and health systems and lead to some early important gains as well as longer term ones. (Thankyou the Child Poverty Action Group and the NZ Psychological Society for a report on poverty and mental distress.)

If this sounds a bit like the strategy of the First Labour Government, so be it. For all I know it is the approach of the current Labour Opposition but if it is, I do not hear them articulating it; not the way Twyford has hammered housing, the Greens environmental degradation and Peters his agenda. And if they have not, it is nonsense to say that the National Government has stolen their policy.

Think of it this way using an image from the Maoriland Worker, which was a left-wing journal that began before the Labour Party. National is concerned about the ambulances at the bottom of the cliff. Social investment is an attempt to put some measures halfway up the cliff to prevent the catastrophes falling quite as far (so reducing the need for ambulances). Giving families a sound economic base is putting a fence at the top of the cliff.

Spend and Tax

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AUT Briefing Papers May 24, 2016

As a general rule, New Zealanders want more public spending. Surveys (such as the 2014 Election Survey) show consistent support for increases in spending, particularly in the areas of health, education, housing, law enforcement, public transport and the environment (in that descending order) as well as favouring reduced income inequality. However, it is not clear whether the public support higher taxation to fund the spending; one would like to think them realistic enough to accept this with such large public spending demands.

Government could borrow to increase spending temporarily but unless that spending was an investment which gave a direct return – very little of Core Crown Expenses are – then at a later stage the additional borrowing would have to be recouped through additional taxation. Basically a government spending more than its current revenue shifts the burden of taxation through time; it does not eliminate it. Note, however, that some government spending – most prominently on healthcare, education and child services – is a social investment any public return of which involves tax payments.

Assuming extra spending does not come from increasing debt, government income will have to rise. By international standards the burden of general government revenue in New Zealand relative to GDP among affluent economies is not high. The New Zealand rate of 39.7 percent of GDP is below the OECD country average (42.4 percent) in the 2013 year. If government spending were to increase by 1.6 percentage points of GDP ($4bn), New Zealand would still be below the OECD average and well below such luminaries as the Scandinavian economies, France and Germany.

Before considering the standard recipe of increasing income tax and/or GST rates, other possibilities should be considered. Obviously tax loopholes should be eliminated whatever. Here are some examples:

  • While trusts are an integral part of the management of property, they are also used for tax avoidance since their top tax rate (currently 30 percent) is below the top income tax rate on persons and corporations (33 percent). An obvious change would be to tax them in a manner similar to that for companies.
  • Tax all returns on capital to reduce distortions in investment decisions from the tax system. With some exceptions, capital gains are not currently taxed. Extend income tax to cover capital gains from share transactions and from all investment housing.
  • The failure to levy GST on low-valued imports of goods and services is partly an issue of compliance costs. Even so, the exemption threshold seems too high.

These changes might generate some useful revenue gains, in total they would be small in comparison to the size of the demands for additional government spending.

 Options for Raising Taxes: New Taxes

Excise duties on tobacco and alcohol demonstrate that properly targeted, low-compliance-cost duties can contribute to improving the nation’s health. That does not mean that all such levies will be equally effective.

In recent years the New Zealand government has outlaid an average of $215m a year to purchase carbon credits. The amount is likely to increase as the world takes global warming increasingly seriously. It is not obvious that this should be paid out of general taxation, when a carbon tax would both cover the outlay and encourage reductions in carbon emissions.

There is a strong case for a Financial Transactions Tax. However, it would be pointless for New Zealand to introduce it by itself since it could be easily evaded by shifting the transactions offshore. Some members of the European Unions are currently exploring the imposition of an FTT. If it proceeds, New Zealand should be a fast follower, perhaps within a consortium of non-EU countries which would implement a jointly compatible one.

Most members of the 2009 Tax Working Group (TWG) supported the introduction of a low-rate land tax. The supply of land cannot change and it is not globally mobile. Therefore, a well-designed land tax will have a negligible distortionary effect on use incentives. Unfortunately, the value of land is deeply imbedded in a regime in which there is no land tax, and owners have made decisions on that basis, especially borrowing to purchase it. The initial impact of a land tax where there is heavy debt on the land is difficult to evaluate. For instance, the TWG acknowledges that the price of land will fall if a tax is imposed; that would raise the debt-to-land value, in some or many cases, to dangerously high levels. Given the central role that the farm industry plays in the New Zealand economy it seems wise to proceed with a land tax with caution.

The New Zealand government is already in receipt of some revenue from resource levies but it does not seem to have a comprehensive approach to them. For instance, most water usage is not levied.

In summary, there are a number of prudent ways that New Zealand government revenue could be increased by extending the tax regime. But collectively they would not contribute the sort of sums the public seems to require for its public spending ambitions.

 Are There Spending Areas Which Can Be Cut Back?

It is easy, and therefore common, to propose cuts in existing government spending. Of course the government should seek to improve the efficiency of delivery of its services. It does; it has been doing so for as long as anyone can remember. There is no reason to believe it is less efficient than private sector equivalents.

But excessive downward pressure on some government spending programmes can compromise the quality of its delivery – especially in the long run. Additionally, it may raise transaction costs and/or increase effective inequality, especially when the effect is to shift costs onto households.

More relevant is cutting or greatly modifying spending programmes. This can be controversial for a programme valued by some may be resented by others. There may be a case for better targeting of some programmes. This will be easier if the overall system of redistribution is fairer, but there remains a danger of high effective marginal tax rates which will be a disincentive to people improving themselves. (They tend to be a burden especially on the poor.)

A widely held view is that the age of entitlement for New Zealand Superannuation should be raised above 65 years, reflecting the rising longevity of the elderly. Like the earlier increase from 60 to 65 the change should be well signalled and incremental. There would be some reduction in government spending from such a measure but because it would be phased in, the gains would not great in any immediate term.

 The Fundamental Conclusion

Major increases in government spending cannot be solely financed by the above measures. Instead it would be necessary to increase the rates of GST or income taxes. An increase in the GST rate would not do much towards reducing income inequality – one of the major public concerns. In order to reduce inequality much of the additional funding needs to be raised by higher income tax rates. Reducing income inequality requires that the tax system be more progressive, that the rate hikes should be higher at the higher income end than at the low income end. Even though the rich would pay relatively more if the redistribution system of taxation and transfers is more progressive, much of the burden of additional revenue raised would be paid by those in the middle of the income distribution. For many of the increases in spending they will be the main beneficiaries – especially over their life cycle in areas such as health.

Austerians vs Fiscal Conservatives

This entry was posted in History of Ideas, Methodology, Philosophy, Political Economy & History, Pundit on by .

Managing the government’s fiscal deficit need not mean cutting social expenditure.

An economic Austerian is someone who advocates cutting government spending, particularly social expenditures, in order to eliminate a government’s fiscal deficits. (The name is a portmanteau of ‘austerity’ and ‘Austrian’ from the neoliberal ‘Austrian School of Economics’.)

While Austerian policies are currently most evidently being applied in Mediterranean Europe, they are not new to New Zealand. In 1932 the National Expenditure Adjustment Commission made recommendations to cut government spending. Alan Fisher, professor of economics at the University of Otago, satirised the outcome as :

     ‘We object so strongly to having our own incomes further reduced by taxation that we think the incomes of pensioners should be reduced instead. … In times of depression it is necessary to curtail the community’s consumption of many goods and services. Already people with large or moderate incomes have diminished their expenditure on many of the pleasant but unnecessary things which formerly they enjoyed. Most of them are, however, still tolerably comfortable. A great deal of money is spent on motor cars and holidays, on racing and other amusements. But rather than curtail further expenditure of this kind, we think it will become necessary to reduce expenditure on education, in such a way as will definitely handicap the children of poor parents, and make it more difficult than it has been in the past for them to develop their natural capacities in the way which would be advantageous to the whole community.’

Again in the Rogernomics/Ruthanasia era, the government squeezed its spending while giving substantial tax cuts to those at the top which maintained their real incomes while the economy stagnated and everyone else suffered. (There was no similar response from any economics professor.)

Austerians are concerned about diminishing the role and the size of the state and seize upon a fiscal crisis to pursue their political ends, claiming that their ideologically based actions are the only possible response. They are not. You can be a fiscal conservative, as I am, without being an Austerian.

An alternative, as implied by Fisher, is a balanced reduction in public spending and an increase in taxation so that the burden of adjustment is shared in proportion to how comfortably off people are. (It must be acknowledged though, that the Mediterranean economies do not have as sound a tax system as New Zealand has, which inclines them towards cutting expenditure.)

A fiscal conservative remains wary of building up too much government debt. There are a number of reasons.

First, high debt limits the room for manoeuver in a financial crisis. This was well demonstrated in the response to the Global Fiscal Crisis when the prudence of earlier governments enabled the Key-English government to switch from a surplus to deficit (it did by tax cuts) without too much trouble borrowing (the challenge the Mediterraneans, with their high government debt, face).

But note that while our public debt is low, the private sector owes a lot offshore. There is a danger of private debt shifting onto the government books (as happened during the GFC with the finance company crashes and almost did with the trading banks) so we need low public debt. (It is not only financial crises we need to provide for but also major natural catastrophes such as earthquakes, volcanos, tsunamis, epidemics.)

Second, the debt arises from fiscal deficits contributes to a shortage of domestic savings. The savings deficit drives up the exchange rate, making it more difficult for exporting and import-competing businesses to produce profitably, so that in the long term we have less capacity to service the debt. Thus a fiscal surplus may be necessary to offset the private sector’s lack of savings, especially if the borrowing is being spent on consumption goods (which is broadly true during a speculative bubble such as the one we are having on housing).

Third, a fiscal deficit today is a charge on the future which has to service the debt; it enables us to increase our consumption at the expense of our grandchildren. You may think that is a damned good idea or you may have some moral qualms about burdening them.

The third reason provides some guidance to what the additional spending should be on when it is necessary to borrow (say for business cycle reasons). The obvious answer is infrastructure because the grandchildren will benefit from it while they are servicing the debt its funding incurred.

Not on health and education? Are they not social investments? I am very supportive of such social investment but the logic seems to be that it should be paid out of current taxation rather than by borrowing. Consider X for whom the state borrows to fund their health and education spending. If X subsequently leaves the country, the debt servicing is borne by those left behind. The difference with borrowing for infrastructure is that it cannot leave the country.

Curiously, the logic suggests that such borrowing applies to other spending which remains forever in the country. For instance, if we are serious about a predator-free New Zealand (are we?), then it might make sense to borrow for that rather than for another motorway.

What I have set out here is a general framework. There are lots of caveats, for the devil is always in the detail. The takeaway lessons are that you can be a fiscal conservative who supports more government spending without being an Austerian; that a fiscal conservative generally funds the spending from higher taxes; that a fiscal conservative does not favour increasing public debt in the long run (compared to the economy’s capacity to service the debt); that on those occasions when it is necessary to borrow, the additional spending should be directed to what benefits the later generations who will service the debt.

Is the government Austerian?

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AUT Briefing Papers May 16, 2018

The neologism ‘Austerian’ is a portmanteau of ‘austerity’ and ‘Austrian’ (School of Economics). It became extensively used after the Global Financial Crisis. It describes the policies of those countries which had to restrain public and private spending because lenders were unwilling to provide the funds for their budget deficits. Their debts were considered high and unsustainable.

When lenders have such a headlock on you, there is really not much choice other than taking some sort of austerity measures. Countries that  have some control over their exchange rate can issue domestic currency; to excess this will cause inflation, an exchange rate crisis, or both, which in due course will have to be addressed by austerity measures. Even in Zimbabwe.

However, while austerity measures may be necessary in certain circumstances, they have been overlaid with the philosophy of the Austrian School of Economics, a variant of the neoliberal small-state ideology. Thus the attainment of internal balance has involved cutting government spending but not raising taxes, especially not on the rich. Indeed, it is often accompanied by cuts to top tax rates. So the burden of the adjustment is borne by the poor and those on middle incomes; one consequence is greater income inequality. The pressures on the bottom have led to populist dissent, demonstrations and even violence, and to the support of populist parties and causes in the polls. Because of the deadlock from lenders and the refusal to include the rich in the burden of adjustment, the austerity measures usually continued, even when there was a change of government.

New Zealand has not experienced such extreme Austerianism. It had less difficulty adapting to the Global Financial Crisis because the Clark-Cullen Labour Government left its successor Key-English National Government a cushion which was used to ease the country through the trauma.

A particularly valuable part of the cushion was that the Clark-Cullen Government had reduced Core Government Net Debt  down from around 24 percent of annual GDP when it became government in 1999 to just above 5 percent when it left office – although it was projecting a rise to 13 percent in 2013. This ratio is exceptionally low by international standards, enabling the incoming National Government to sustain demand through major tax cuts financed by borrowing. Consequently, the Debt-to-GDP ratio rose to 25.5 percent of GDP in 2013, almost double that which Labour had projected. The ratio amounted to about 23 percent when National left office in 2018 and was projected to fall to slightly above 19 percent three years later.

That the Key-English Government has a much poorer record of fiscal prudence than the Clark-Cullen Government may seem surprising. In part this was due to different external economic conditions.

However, despite reputations to the contrary, New Zealand Labour governments have a better record than National ones on this indicator (as have United States’ Democrats over Republicans). This is probably because governments of the right are keen to cut income taxes, but one could write dissertations on other reasons which may be influential.

Despite the past record, last year in opposition Labour felt it necessary to correct the misperception of fiscal looseness, to comfort financial markets and the journalists with ‘you don’t need to be afraid of us’. The Greens joined them. Hence the Budget Responsibility Rules (especially Rule 1 and Rule 2). To many, the outcome of the rules will be Austerian.

The Key-English Government gave major income tax cuts in 2009 after it gained office in part in response to the Global Financial Crisis but also because that was its ideological bent. Arguably the reductions should have been reversed or eased-back when growth returned. Instead National did not return to the markedly downward net debt to GDP track of its predecessor. As a consequence there was a squeeze on government spending rather than effort to increase government revenue.

This is well illustrated by National’s response to the Canterbury earthquakes of 2010 and 2011. Such was their magnitude and so significant was the destruction that the government was going to be faced with a hefty bill for the reconstruction. It was argued that the rebuild should have been funded by a surtax on income tax. The government would then have explained that these were exceptional circumstances and they wanted to share the burden of reconstruction across the whole nation, with the assurance that if there was a similar regional disaster elsewhere – say a volcano in Auckland – its rebuild burden would also be shared. John Key would probably have been in a much better position to persuade the nation of this course than Helen Clark. (He did appeal to the spirit of nation-building when funding the 2012 World Rugby Cup although that was much less expensive.) But National chose not to pursue this strategy.

Instead, it funded the Canterbury rebuild within existing spending programmes. (Imagine doing this to fight in one of the great wars instead of the levying of special taxes which occurred.) One could argue that the Middlemore hospital debacle (or whatever one’s concerns about government spending failures) has arisen because of the need to fund the Canterbury rebuild within a tightly constrained overall budget.

National’s approach might be called ‘Austerian’. Indeed one could use that label for many of its other fiscal decisions where public expenditure demands were ignored or where, in order to maintain low levels of taxation, it was assumed they would be accommodated by productivity improvements (which never happened) or by cost shifting so that households privately purchased the required service (if they could afford it). The stance is not as Austerian as was seen in those European economies, even if we allow for the economy not being as stressed or as imbalanced. Let us call National’s stance ‘mild-Austerian’.

Mild-Austerianism was a significant reason for voters switching to the Labour-led Government. The myriad of complaints about the consequences of public underspending which have broken out since the new government came into office might reinforce this conclusion (although some may amount to political opportunism). Even so, there are those who argue that the Ardern-Peters-Robertson Government’s policy stance is, in effect, also mildly Austerian. Their claim goes something like this.

Under the Labour-led government elected last year a higher proportion of GDP will be attributed to government spending. It is promising 30 percent which amounts to about an extra $6.5b a year compared to National’s promises of about 28 percent of GDP. There are pessimists who think this will not be enough, arguing that there are not just current demands but an enormous backlog.

But Labour also says that it is going to maintain (broadly) National’s debt track, which means that it is not planning to borrow much more. The implication is that the government will have to raise extra revenue, which will be mainly extra taxation. What it is proposing will have only a marginal effect on revenue but it is promising no major new taxes. The proposed petrol levies might come under this heading but those proceeds are to be spent only upon transport.

There is a widespread view that Labour should borrow more (which would be out of character of four of the five past Labour governments – the exception was the 1984-90 Rogernomics one with its neoliberal preferences). There is a fear that if they do not, they will have to abandon addressing the public expenditure shortages with another three or more years of disastrous austerity in the public sector.

Should the Labour Government borrow more or should it run a higher debt track? New Zealand’s debt-to-GDP ratio is low compared to most other OECD countries and there are lenders who would like to hold more New Zealand government debt (at not too high an interest rate) given the quality of the country’s fiscal management and low debt levels.

Offsetting this is that were there another international financial crisis low debt would ease New Zealand through, as happened after the Global Financial Crisis when New Zealand borrowed almost an extra 20 percent of annual GDP. There also needs to be a protection for another great physical shock such as the Canterbury earthquakes. Prudence often appears Austerian, even by those who have more faith in the potential of the state to make a great difference to our lives.

One potential solution for the government – wanting to invest in infrastructure and social spending but also needing to convey fiscal responsibility – is to reform our system of financial accounting. I write more on this in my next paper. Meanwhile, we await budget 2018 to see how Austerian the current government is.

Housing Prices Relative to Consumer Prices

This entry was posted in Environment & Resources, Macroeconomics & Money, Social Policy, Statistics on by .

AUT Policy Observatory May 2017

About this report

This report is part of an ongoing series on urgent contemporary policy issues in Aotearoa New Zealand. This series has an objective of bringing academic research to bear on the economic, social and environmental challenges facing us today.

The Policy Observatory

Auckland University of Technology

Private Bag 92006 Auckland 1142

policyobservatory@aut.ac.nz +64 9 921 9999 extn. 7531 http://thepolicyobservatory.aut.ac.nz/

Recommended citation: Easton, B. H. (May 2017). Housing prices relative to consumer prices: An analysis.  Auckland: The Policy Observatory. Retrieved from https://

thepolicyobservatory.aut.ac.nz/

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This paper is covered by the

Creative Commons Attribution License 4.0 International

Foreword

Housing affordability has occupied news headlines in New Zealand for several years now. A range of measures – such as falling home ownership rates, the decreasing number of first home buyers, the prevalence of speculators purchasing housing, and median price to median income ratios – suggest that buying a home has become harder for those not already on the property ladder, especially in Auckland and Queenstown.

In this short report, economist Brian Easton explores some additional measures to establish whether housing is, indeed, less affordable than previously. Using Reserve Bank of New Zealand data from 1962 until 2016, he compares house price changes to changes in the Consumer Price Index, a measure of general inflation that does not include house sales. While we would expect house prices to rise over time as a function of general inflation, and for wage rises to (somewhat) compensate, this report reveals the extent to which housing inflation is out of step with general inflation, including some surprising periods of rapid change. Brian Easton also considers the prospect of house price deflation or stagnation, using historic trends as a guide. The report finishes with an exploration of other measures of housing afforability.

Housing Prices Relative To Consumer Prices

Brian Easton[1]

Abstract

This is an update of a note I wrote in April 2007. It uses a longer housing price series that starts in 1962 (instead of 1980) and finishes in 2016 (instead of 2007). It shows that while historically housing prices have risen a little faster than consumer prices, the increase has been sharper since 2001 (except for the period when the Global Financial Crisis impacted). It goes on to use the historical record to speculate on possible patterns of future prices. The focus is on house prices for the whole of New Zealand. There can be considerable divergences between regions.[2]

Nominal Housing Price Trends

Graph I shows the Reserve Bank of New Zealand nominal housing price index (that is, prices not adjusted for inflation) for the 209 quarters from 1964Q2 to 2016Q2. Over the 52 years, the prices rose to over 80 times their initial level, an annual average increase of 8.6 percent per annum; this was faster than inflation.

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Graph I: The blue line is an index of actual house prices. The black line is the exponential trend line between 1964 and 2001. The growth rate for (nominal) houses prices averaged 9 percent a year.

The linear vertical axis of Graph I does not show growth rates of prices. Graph IA does, so that the same slope reflects the same inflationary growth rate. Although there have been concerns about sharp rises in recent years, the big inflationary periods – where the graph line is steepest – are in the early 1970s and the early 1980s. Even the recent house price increases have not been as sharp as they were in 2002 to 2008.

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Graph IA: This graph is the same as Graph I except the vertical axis is a log-linear (or ratio) scale. Now the black trend line is straight – that is, it has a constant growth rate. Where the blue line of actual house prices rise faster than the black trend line, prices are rising faster.

House Prices Relative to Consumer Prices

Graph II shows the ratio of house prices to consumer prices, which presents a different picture of relative housing inflation. Historically there has been a tendency for house prices to rise faster than overall consumer prices. (The appendix discusses alternative deflators.)

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GRAPH II: The blue line shows house prices relative to consumer prices. Where it rises house price inflation is rising faster than consumer prices. The green line is the trend growth line from 1964 to 2001. It shows that while nominal house prices may not have been rising faster in the 21st century than they had earlier, they were rising faster than consumer prices because the later period was one of much lower consumer inflation.

Up to 2002 the average house price rise was 1.4% p.a. above the rate of inflation. By later standards this rise was small. Aside from measurement error, it might be the consequence of the supply of housing increasing more slowly than the underlying demand. We can speculate why, but any effect was not great.

After 2002 the average annual rise increases markedly to a rate of 8.2% p.a. The slow relative shifts in supply and demand described in the previous paragraph are surely insufficient to explain the quintupling of the relative rate of housing inflation. Moreover, as identified in the 2007 note, the change in the trend housing inflation rate is very abrupt.

Note that there was a five-year period between 2007 and 2012 when house price rises were checked by the Global Financial Crisis. Take this period out and the average increase across the country from 2002 was 12.4% p.a. – almost ten times as high as before 2002.

The price increases will vary by region. Auckland’s are among the highest. The increases reported here may seem less than the housing price rises headlined in the media. But those figures are often for sales only or for selected regions. The Reserve Bank of New Zealand index derived from Quotable Value applies to all housing. It is in the interest of those doing a beat-up during a speculative boom to give the impression that asset prices are rising faster than they actually are.

The acceleration in the relative premium after 2001 coincides with President George W. Bush increasing the United States’ fiscal deficit which flooded the world with financial liquidity. That made it easier for New Zealand banks to borrow offshore using the cash to fund housing purchases. While the housing price rise was not confined to New Zealand, The Economist reported in 2017 that New Zealand’s house price relative to inflation is the highest in the rich world.[3]

Another source of funds from the international liquidity was investments by migrants or off-shore based investors. Some would have purchased the houses they would live in. But anecdote suggests that some purchasing was for speculation. Probably the source of the funds was capital flight especially from China; instructively Sydney, Melbourne and Vancouver have experienced similar price rises.

The funding inflow generated a speculative bubble, especially as the stock of housing cannot be easily increased. A speculative bubble is typically driven by expectations of strong asset price rises coupled with leveraged borrowing, giving a high return as long as the prices rise.[4] But the price increases cannot sustain the spectators’ expectations forever and eventually the bubble pops or deflates with over-leveraged speculators stranded. Usually there are knock-on impacts which damage those who are innocently (that is, non-speculatively) involved. The lack of an effective capital gains tax in New Zealand has probably compounded the strength of any speculative bubble, especially when speculators could cover part of their purchase price by borrowing at fixed interest below the nominal house price increase.

The boom staggered around the time of the Global Financial Crisis, when international liquidity dried up. It returned when the central banks of the world began quantitative easing, which again injected liquidity into world financial markets. Confidence, expectations and the state of the labour market may also have contributed to this outcome, but may well have been a part of the transmission mechanism from the contraction in international liquidity to the housing market.

The way overseas borrowing works is not straightforward. Suppose I take out a mortgage of $1 million to purchase your house. You deposit the $1 million in the bank so the net position of the bank is unchanged and it can pay off the overseas loan it has used to fund my house purchase. The net position after the transaction appears to be zero.

If this was the entire story, any international borrowing only lubricates the sale and purchase transaction. But in the course of the sale there are transaction costs: real estate agents, banks, lawyers, valuers, surveyors, movers, and so on, while house buyers often go on to commission builders to alter the house and to purchase durables and furnishings. The total costs may be a considerable amount – in one modest case I know of they were in excess of $30,000 including the costs of selling the previous house (a downsizing too). In total this amounts to a considerable expenditure each year (100,000 houses at $30,000 per sales transaction is $3 billion) which is, in effect, borrowed offshore. Observe that it can hardly be argued that this offshore borrowing is funding ‘investment’ – although some is so classified in the official statistics.

If the long-run relativity that existed between 1962 and 2002 had persisted through the following 14 years, house prices today would be half the level they actually are. It could be argued that this is a measure of the degree by which housing is overpriced. We use this doubling up (or rather halving down) to illustrate the general proposition of the adjustment which follows a speculative boom.

Falling Nominal Housing Prices

There seems little doubt that in some sense today house prices are unusually high as the consequence of a speculative bubble. What will happen when the bubble pops or deflates? Usually this involves a fall in asset prices, in this case house prices, but how and by how much and with what consequences?

We cannot be sure. In particular, overseas experience may not always be relevant because of different circumstances. It is certainly true that the United States’ house prices collapsed in many parts of the country after the Global Financial Crisis – indeed their boom and bust was one of the causes of the crisis. But the obligations of mortgagors (typically banks) and mortgagees differ between the two countries. It is easier for mortgagees to walk away from a house in the United States than in New Zealand, leaving the banks holding the title and the expenses which go with it; that encourages fire sales.

Nor need history be a good guide. I hunted around for evidence of what happened in the 1930s but there is no data. In any case, mortgage arrangements differed because banks were not as heavily involved. There were mortgage and tenant relief measures but arguably they occurred because of general deflation and falling nominal interest rates.

The speculative housing boom in the early 1970s – evident in the graphs above – does not seem relevant because it was followed by a period of high consumer inflation during which house prices stagnated, returning to the relativity track between housing and consumer prices. There is no expectation of high consumer inflation in the immediate future.

Graph I shows that over the 52 years falls in nominal housing prices have been small and rare and, usually, for only a quarter or so; they are but market stutters. The one exception was the period from 2007Q4 (which precedes the usual date for the beginning of the Global Financial Crisis of August 2008) to 2009Q1. The fall across the five quarters was around 10 percent – 2 percent a quarter.

So New Zealand’s post-war experience is that significant falls in nominal house prices are unusual across all regions although sometime special factors affect a particular region. (This conclusion may not apply elsewhere – such as in the United States.) This probably arises from a ‘nominal house price rigidity’, paralleling the nominal wage rigidity which Keynes wrote about.

Suppose the speculation stops. There will be a steadying of house prices. Most home owners who traded up their houses during a boom – not unaware of the speculative gains – will now sit tight rather than sell their house below the peak price. There will be some distressed selling from those who cannot service their mortgages and some necessary selling from estates of the deceased, from those who have to move, or those who have had a dramatic change in their family size or circumstances such as ageing.

The bubble activity from speculation and trading-up will cease. It is understandable that speculators withdraw from a market when there is little expectation of price increases, when home owners stay tight and do not look for improved accommodation – forgetting that the house they would be buying will have fallen in price too. It can be compounded by the individual’s assessment that the quality of a house is partly a function of the perceived price, which is not an assumption in economists’ standard theory of demand.

Whatever the case, the indications are that – aside from traumatic economic and financial events such as a massive rise in unemployment – the nominal house price will be sticky downward because most homeowners will not want to move if prices fall. They will hang onto their home valuing it at its current (peak) price. (In behavioural economics this is related to the endowment effect, the theory that people place more value on the things that they own.) The price of housing is not going to fall by much in the short term.

Suppose the price slippage is at an annual rate of 8% (similar to the 2008 fall) and that consumer prices rise at 2% p.a (the current long-run assumption). After allowing for the rising pre-2002 relative trend (of 1.4% p.a.), it would take until 2022 for housing prices to return to the trend that existed before 2002. By that time, the average house would have lost about 40 percent of its nominal value. (My 2007 calculation was more optimistic because it assumed a higher rate of inflation while the over-valuation was not as great. It did, however, assume that house prices would stay the same, rather than drift downward.)

The previous paragraph is not a prediction, but an exploration based on a series of assumptions. It is to indicate that it is going to be difficult for housing prices to rebalance with consumer prices.

Turning to Graph II we see that the longest period of relative price stability was the six years following the wool price collapse of late 1966. The longest period of housing prices falling relative to inflation was also about six years – in the mid-1970s – but this was a period of stagnant nominal housing prices and high consumer inflation. The implication is that six years of even mildly falling nominal housing prices would be unusual.

Stagnation and Low Market Activity

What happens during periods of stagnation and low market activity?

First, the housing transactions industry is likely to contract; that will be most evident among real estate agents but others – financiers, solicitors, valuers and so on – will also experience a reduction in their activities.

Second, with the reduction in turnover it will be harder for people to find the houses they require. That they cannot move on will reduce the turnover further. In effect there will be substantial reduction in market ‘liquidity’. This term is usually used for more homogeneous financial markets but it can be applied, to some extent, to the very heterogeneous housing market.

The standard theory of financial markets observes that speculators contribute to markets’ liquidity by being willing to buy and sell the asset, matching market deficits or surpluses. Presumably the same thing happens in the housing market if we include speculation to cover buyers upgrading their housing, with nominal capital gains as a partial reason. The lack of this liquidity occurred to some extent in the immediate post-Global Financial Crisis housing markets and, arguably, may be occurring since late 2016, adding to the market stagnation.

The macroeconomic adjustment may be complicated but the size of the necessary discussion means that it cannot be fitted into this paper. There will be falling employment in the housing transactions industry. There may be less house building – but more house alterations since incumbents may adapt their houses rather than change to other ones. In principle a government concerned with housing a growing population (and/ or replacing poor quality housing) might increase housing construction from the public purse; the houses will be smaller though – and presumably more of them. Insofar as there is a fall in the exchange rate because offshore borrowing falls, there may be some surge in the tradeable sector, although New Zealand supply responses tend to be slow. In any case it is not obvious how to convert real estate agents into export salesmen and saleswomen.

Conclusion

At this point the reader may ask, what is to be done? However, this paper is about what has happened, what is happening and what may happen. Before deriving quality policy conclusions it is necessary to get those questions clear as well as to decide on priorities and options.

Moreover, there will be other things happening which will complicate the policy response. What happens to mortgage interest rates during a housing market downturn will likely depend heavily on the driver of the downturn and its macroeconomic consequences. If interest rates were to rise they would compound the difficulties of those who have over-borrowed in a stagnant market.

My view is that the government should not be concerned about those who have got into difficulties because they have over-borrowed, although there will be public pressure from them. I am not a fan for the coupling of privatisation of (especially speculative) profits with the socialisation of losses. The transfer of the losses of speculation – even those of owners of single homes – onto the public balance sheet is not a fiscal priority. It is accepted that the public – and hence the government – has an interest in ensuring the stability of the financial system. Recently published Reserve Bank of New Zealand stress test results suggest that the banks are not threatened by stagnant or gently falling house prices.[5]

In my view, the priority is to ensure that the population is adequately housed – which is not the same thing as being housed in mansions bigger than they need, the extra size being a part of their speculations. While rental housing, including public rental housing, will be a part of the solution, my impression is that the stock of housing is better looked after by owner-occupiers. Enabling families (including families yet to be formed) who currently do not own houses to purchase their own houses has to be a central part of the nation’s policy objectives.

Indeed, the housing market stagnation may create an opportunity for a programme of the building of modest-sized new housing and replacing dilapidated existing houses funded, in part, by offshore borrowing. This would more efficiently house the population while adding to the assets of the country rather than – unlike too much of the borrowing of recent years – disappear in transaction costs.

As recent and historical experiences show, the private market cannot be left to do this by itself. My earliest knowledge of public intervention is the workers’ cottages under the Seddon Government. (About the same time, owned housing was partially exempted in the asset testing for eligibility for the Old Aged Pension.) However, the measures undertaken by the Massey Government in the early 1920s were much more successful in achieving widespread housing and framed policy for the next half century.

Historically then, it was not just a matter of building public housing but also of facilitating the financing of private purchasing (some of which led to the private construction of housing). How to successfully house those with inadequate housing while getting a better relativity between house and consumer prices (that is, by avoiding further house price inflation) and without excessive fiscal exposure is a complicated policy issue. That will not stop fools rushing in where angels fear to tread, or tread only after much analysis. This note, one hopes, will be useful to some angels.

APPENDIX: Alternative Relativities

The main note deflates the housing price by the price of consumer goods. I understand the relativity concept – it is a conventional variable in the orthodox demand function.

Other deflators of house prices are sometimes used; I tried some of them out while preparing the statistical analysis. The more I worked on them the more I am puzzled as to the underlying concept.

The Ratio of House Prices to Rents

In principle the ratio of house prices to rents has some meaning although not all houses in the house price index are for rent and there are the complications of government interventions, like the switch to housing assistance in the early 1990s and the change in state rental pricing in the early 2000s.

Graph III shows the ratio of house prices to rents for the 1964–2016 period. The ratio is constant till the early 1970s – indicating that rents were moving in line with house prices – and then settles at a slightly higher level from the mid-1970s to the early 2000s. (The jump in the early 1980s is the effects of the price freeze which was more effective on rents.) Afterwards the ratio rises so that house prices have risen about two-and-a-half times relative to the pre-2001 level in the following 16 years – a pattern similar to what we saw with the ratio of house prices to overall consumer prices.

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Graph III: When the blue line is above 1000, house prices are rising at a faster rate than rents.

The similarity of the patterns in Graph III and Graph II (the ratio of house prices to consumer prices) arises because, excepting for the odd step, the two prices track one another as Graph IIIA (below) shows.

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Graph IIIA: Like Graph IA the vertical axis is a log-liner or ratio scale of Graph III.

Because a house rent has to cover insurance, local body rates, maintenance and administration, together with an allowance for vacancies, it does not simply reflect a return on the capital invested in the house; first those components need to be deducted. The landlord’s return is complicated by there probably being a mortgage, which involves servicing the debt and, insofar as house prices rise, a capital gain enhanced by leverage.

So the ratio of house prices to rents gives only an imperfect guide to the return on the investment. Given the degree of housing inflation there is no doubt that returns including capital gains have been high over the years, but the indications are that without the capital gains the investment returns seem to have been low and possibly even negative compared to bank deposits, even in a rising market. Until the rental property is sold, though, the return is not realised. Once the bubble pops or deflates it may prove difficult to realise the capital gains, while the landlord suffers from a weak cash flow after debt servicing and other costs.

On occasions, representatives of landlords have said that when house prices stagnate (and so there are no further capital gains), rents have to rise, implying that landlords are charging below market rates. Aside from inertia – especially for a good tenant – this seems unlikely.

Depending on the quantity of new building, a period of house price stagnation or slow decline could be a period of slow decline of rents (relative to consumer prices), compounding the difficulties that landlords face. If there are shortages – especially in niche markets or at particular times in the seasonal cycle – there may be a temporary sharp rise in rents in some localities.

The Ratio of House Prices to Wages

Consider the ratio of wages to house prices. There was a bankers’ rule, presumably developed from experience in times of relative stability, that the value of a house one should purchase was three times the annual earnings of the man. It depended on a series of assumptions about the deposit as a proportion of the house value, the income tax rate on wages, the interest rate and the payback period of the (table) mortgage. Presumably it involved some notion of how much the household should spend on its housing. Probably it also depended on a notion of future inflation trends. If any of the parameters were to change, the three times ratio would in principle change.

In the past, to cover the deposit, the bank’s mortgage was often supplemented with a short-term higher-interest second (flat) mortgage which was paid off quickly from the earnings of the wife. (I recall in the 1970s it was not unusual for the wife to become pregnant about the time the second mortgage was paid off.)

This three-times relativity was based upon the notion that there would be a single earner in the family. However in the 1970s there was a rise in the proportion of mothers earning in the labour force. This undermines any long-term affordability measure based on average wages since while many households have two earners (although it would be sensible to deduct childcare costs), others have one-and-a bit-earners and others only one.

Additionally other key parameters have changed: income tax rates, the deposit as a proportion of the house value, interest rates, the payback period and future inflation.

Such considerations mean that I did not calculate the ratio of house prices to wages. Until someone comes up with a rigorous theoretical underpinning, such a ratio is, at best, misleading.

The Ratio of House Prices to Household Disposable Incomes

To avoid some of the deficiencies of the house price to wage ratio, affordability is sometimes measured as a ratio of housing prices to disposable household income. Note that to be properly meaningful the other key parameters – the deposit as a proportion of the house value, interest rates, the payback period and future inflation – have to remain constant. For instance, as may be happening at the moment, suppose housing prices stabilise (or fall modestly) while incomes rise modestly. An affordability index based on the ratio of house prices to household incomes will fall. But it is not impossible that at the same time interest rates (and hence debt servicing) rise and that, practically, housing becomes less affordable to many.

Graph IV shows the ratio of house prices to household disposable incomes (per person). Unfortunately it was only possible to get a quarterly series back to 1998 which means we do not have a sense of the trend before 2002. Not surprisingly, the ratio begins to rise rapidly from 2002 to a level about 40 percent higher in 2007. It fell by 20 percent over the next five years, and then began rising again to about 75 percent above the 2002 level in late 2016.

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Graph IV: The blue line is the index of actual house prices, the black line is the trend.

Between 1998 and 2002 the ratio falls. We do not know whether this is a long-term trend. It could be the effect of rising incomes, which raises demand for houses, is being more than offset by the rising relative prices. Note however conventional supply and demand analysis assumes that there is not a speculative bubble.

I am not sure how to interpret this result precisely because I do not know the long-term past trend – and in any case it is not adjusted for the costs of debt servicing – but the broad conclusion is almost certainly consistent with every other ratio reported here: houses are overpriced today.

About The Author

Brian Easton is one of New Zealand’s leading economists with a unique profile as an economic development practitioner, consultant, journalist and commentator. A former director of the New Zealand Institute of Economic Research and a one-time member of the Prime Minister’s Growth and Innovation Advisory Board, Brian has numerous awards to his credit including being a distinguished Fellow of the New Zealand Association of Economists. Dr. Easton is an adjunct Professor of the Auckland University of Technology and is currently writing a history of New Zealand from an economic perspective.

Economic and Social Trust On New Zealand www.eastonbh.ac.nz

About The Policy Observatory

Based at Auckland University of Technology, The Policy Observatory provides a lens on public policy in Aotearoa New Zealand. We both conduct and commission research on economic, social and environmental policy issues, with the intention of publishing results in a form that is accessible to the general public. We work in a collaborative, networked way with researchers across institutions and in the private sector. Ultimately, we are concerned with how policy advances the common good.

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[1] I am grateful to Tama Easton, Julienne Molineaux, Bill Rosenberg and an anonymous economist for comments on an earlier draft.

[2] For a paper which pays particular attention to Auckland house prices, see Elizabeth Kendall (January 2016). ‘New Zealand House Prices: a Historical Perspective’ Reserve Bank Bulletin Vol. 79(1). It has less on the future course of prices.

[3] The Economist. (2017, March 9). Daily chart: Global house prices. http://www.economist.com/blogs/ graphicdetail/2017/03/daily-chart-6?fsrc=scn/tw/te/bl/ed/

[4] Ryan Greenaway-McGrevy. (2015, July 26). ‘Bubble trouble’. Briefing Papers. Auckland: The Policy Observatory. http://briefingpapers.co.nz/bubble-trouble/

[5] Reserve Bank of New Zealand. (November 2016). Financial Stability Report. http://www.rbnz.govt.nz/-/ media/ReserveBank/Files/Publications/Financial%20stability%20reports/2016/fsr-nov2016.pdf

The Price of Labour and the Value of Work

This entry was posted in History of Ideas, Methodology, Philosophy, Labour Studies, Pundit on by .

Do residential care workers deserve the big pay increase they are getting?

The recent historic pay equity deal for aged and residential care workers raises a tricky clash between quite different accounts of how the economy should work. Many people think that workers should be paid at a rate that reflects their social worth; others – mostly economists – think they are paid at their marginal product,  which I explain below.

It is easy to believe that your rate of remuneration measures your social worth – if you are on a high income. But is a person who earns $2m a year, say, a hundred times more valuable to a community than someone on $20,000? Are they even more valuable? Positive economics cannot answer that question; for it involves a value judgement which a scientist cannot make.

There is an economic argument which says that, under a particular set of assumptions, a person’s income equals their marginal product, that is the value their effort adds to the economy. While this can easily be explained in, say, a first year economics course, it turns out to be a circular argument. A wage may equal marginal product but how do we know what is the value of the marginal product? The answer is that it is measured by the wage the market pays.

It also ends up with paradoxes. We do not generally pay for parenting so is it valueless? Surely not. A couple of housewives take in each other’s washing and pay each other and suddenly their value to the economy increases. Again, surely not. Every time one gets a wage rise – as building workers are currently receiving because there is a shortage of them – does the same job becomes more valuable? Really?

Economics has a sophisticated theory of how prices and wages are set but it does not say anything about social value. (To confuse matters, when such things were more muddled in the nineteenth century the theory of price determination was called ‘value theory’ and it still is.) Hence the claim that ‘economists know the price of everything and the value of nothing’. To which they can justly retort that ‘we do know the difference’.

Despite the careful work of economists, the public continues to confuse the two. My guess is that were we to survey what people thought jobs were actually worth, the  sum total of their assessments would exceed the total market production of the economy (even though they may think some jobs are overpaid  – e.g. economists’, financiers’, journalists’, politicians’). They are talking about different things: value is not price.

You may be pleased that those residential care workers are getting a pay boost. It is, if I may say so, often a shit job and I am constantly surprised by the cheerfulness and commitment of those I meet doing it. But are they being paid at what they are socially worth? When I think about the question rigorously, my answer is that I do not know.

So is their pay hike, of between around 15 and 50 per cent depending on their qualifications and experience, justified? I am going to delve into another bit of economics to explain why I think it might be.

It involves the notion of monopsony, a kind of monopoly which is the sole purchaser of, in this case, labour. It can use their market power to depress the price (i.e. wage) of what is being purchased because the sellers have no alternative.

It happens that, for all intents and purposes, there is a monopsonist in the residential care industry. The bulk of the funds of residential care suppliers are provided by the government. Which is why the government has to legislate and fund the new system.

Frankly, I am embarrassed that my government uses its brute market power to suppress wages of those who are, in effect, it employees. Sure, as a taxpayer I have been a beneficiary – on average by $2 to $3 a week – but I have never got any pleasure by passing a false coin. (Okay, I have introduced a value judgement, but I have been open about it.)

Up to 1988 the government was scrupulous about not using its market power when setting the wages of its direct and indirect employees. There was a complicated system of benchmarking. For instance, the pay rates in New Zealand Railways were set by a comparison with comparable occupations in the private sector. (There was high inflation at the time and other public sector payrates – including those of university teachers – were indexed to the railway ones. But every five years or so they went through a separate benchmarking exercise.) The government then passed on to the relevant department (or whatever) the funds to enable the maintenance of the parity.

In 1988 the government switched to a system where it granted each department an annual sum and told them to set their own payrates. By squeezing the amount it provided, the monopsonist could squeeze the pay of those it employed. That was, in effect, the finding of the courts in the case of residential care workers.

Does this mean we are inching back to a benchmarking regime? I am not sure. There are, no doubt other occupations queuing for a similar treatment. (This issue really only applies to the public sector, not the private sector.)

There is one final bit of economics to add. A number of commentators have suggested that the new payrates for residential care workers will flow into other sectors. They may to some degree, but I would be cautious.

Equal pay for public servants was introduced in 1960. It was a response to a disgraceful case involving Jean Parker, an employee of the Inland Revenue Department, who having successfully appealed against a less qualified man being promoted ahead of her, had her salary cut. (Mrs Parker was then the sole earner for the household, her husband being a student.)

There is no evidence that the 1960 pay hike for women in the public sector flowed into the private sector. As a consequence an Equal Pay Act for the private sector had to be passed in 1972.

The economist’s explanation is called ‘balkanisation of the labour market’. which observes that labour markets are segmented and that people do not readily switch from one to another (thus there will not be too many railway workers – or university teachers – who are going to become residential care workers). That means that wage differentials between markets do not rapidly disappear by people moving between them.

Damn, there goes another neoliberal assumption. Actually the whole of this column is about labour markets being far more complex than we pretend. And that we certainly should not confuse a person’s value to society with how much they are paid.

The Productivity Commission tries to think about the Education and Training Sector

This entry was posted in Education, Growth & Innovation, Pundit on by .

The report of the Productivity Commission on the Tertiary Education Sector “New Models of Tertiary Education” is complacent.

The report observes that in the decade from 2001 to 2011, the ratio of non-academic and academic staff in the public tertiary educational system rose from about equal to six non-academics to five academics. In fact the number of academic staff has fallen slightly between 2005 and 2011 while non-academic numbers have risen. That probably means that the amount of teaching has fallen because the amount of research funding – and hence research time – has risen.

The report’s figures seem to suggest that the number of students has been falling over the period. (Unfortunately the report makes little effort to provide a comprehensive database, which is a signal that analytic rigour is not a priority.) So perhaps teaching numbers should fall. But why the rise of non-academic staff? Rather than investigate this question – an important issue if you are concerned about productivity – the report concludes lamely that ‘[t]he Commission has been unable to find more detailed information about the particular changes in composition that underlie these data.’

Or take its coverage of the system of Performance Based Research Funding. It reports the unease many academics have about the scheme. Let me remind you of just some of the PBRF’s weaknesses.
            – it has resulted in quality teachers, deemed to have poor research records, being laid off;
            – it distorts research in some subjects away from the deep and penetrating to the quick and superficial;
            – it is administratively clumsy, involving high transaction costs;
            – the measurement system is gamed (academics often use the term ‘corrupt’);
            – it is misused to portray to students the impression of the quality of the teaching and of their degrees (which is another form of corruption).

I would have thought this was an appropriate area for a productivity commission to investigate and suggest improvements. The report does not.

Or to go to the other end of the sector. It is clear that in a number of areas – most evidently for private institutions offering qualifications to foreign students – quality control is inadequate. It relies on students being able to make an assessment backed by the New Zealand Qualifications Authority (as an examination of websites portrays). Students starting a course are poorly placed to judge its quality, while the evidence suggests the NZQA has failed miserably to monitor standards, probably because its culture and focus is on secondary education. At the very least this suggests there is a need for a thorough investigation perhaps concluding that the tertiary sector needs a different agency for external quality assessment. There was no such consideration.

These are but some examples of how the Productivity Commission failed to do its job. To understand why, consider its remark that there is a need to avoid ‘false [and] outdated distinctions between “education” and “training” [and] between “academic” and “vocational” learning.’ Of course one should avoid falsehoods and outdated distinctions, but that does not mean there are no valid or universal ones. The report does not pursue this possibility.

One recalls the 1925 Reichel-Tate Royal Commission saying that New Zealand universities ‘offer[] unrivalled facilities for gaining university degrees but … [are] less successful in providing university education’, which is close to suggesting that they were good at providing certificates but not at teaching anything fundamental. You may think things have got better in the last ninety years but one wonders whether the tertiary education system is drifting back towards a focus on certification.

As far as I know, the lack of distinction between education and training was first proposed in the 1989 Hawke Report on post-compulsory education prepared in the Rogernomics era.

To understand what is going on, go back to Keynes’ ‘[p]ractical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.’

So what is the defunct economics? It is that the tertiary education sector should be run as a competitive industry, with the subtext that the highest performance occurs when businesses (here they are educational institutions) are privately owned and operated. The report quotes favourably a couple of academics who argue this, and is particularly revealing when it responds to the question ‘[i]s a university more like a workers’ collective than a hierarchy?’

For it dismisses the question without even discussing whether it is true. (Most academics would say that their institutions have become increasingly hierarchical and that today the so-called academic staff include increasing numbers of administrators who neither teach nor research which makes the evffective non-academic to academic staff ratio even higher and rising even faster.) The Productivity Commission favours a hierarchical model of governance, more like – as it says – that of a commercial business.

What strikes one is how unreflective the report is. Its writers were practical men and women enslaved to a defunct theory. (One might wonder, ironically, whether they had been educated to question the ideas they hold.)

Simple competitive models do not work well in the vocational training area and even less in educational ones. (This ‘even less’ generates the need to deny the distinction between education and training.) That is why the system has a plethora of government controls to try to make up for the defects in a competitive tertiary system. Given the imperfect underlying model, the government has to keep increasing its interventions. The Productivity Commission’s recommendations will breed further regulation which will require even more non-academic staff to manage them.

My view is that the report should be treated as a historic documen only. Such recommendations it makes should be treated with the greatest caution to avoid implicitly buying into support of the faulty ideology. Ideally, somewhere in the educational sector, a group of academics should propose alternative way of organising the system. They would, of course, risk their PBRF ratings and also of getting laid-off; we cannot have someone in a vocational training sector challenging the conventional wisdom.