Fiscal Policy Should Focus More on Net Worth

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


We should follow the Golden Rule of Fiscal Management and not borrow for consumption in the medium run.

Asymmetry is a crucial, but often ignored, feature of credit transactions. You would normally be surprised if a shopkeeper said they would sell you 1kg of apples but not 2kg, even if you offered to pay a higher price. Yet such a response is routine if you ask for credit. As past Minister of Finance Downie Stewart recalled, Keynes advised that New Zealand should borrow as much as it could to offset the Great Depression, but if Keynes were the lender he would probably not be prepared to advance New Zealand any more. That asymmetry is at the heart of the political power of the finance sector over the real economy.

It is not an unreasonable stance. The cost to the lender of a failure to repay a loan can be substantial. Sovereign borrowers prove especially troublesome because it is difficult to enforce debt repayment against a country. Lenders go to considerable trouble to assess the likelihood of such a failure. While they do their own assessments, they are often advised by credit rating agencies (CRAs) who, helpfully for us, offer a window into lenders’ thinking.

Those who have faced CRAs in their regular visits to give New Zealand a credit rating, report they look at the whole economy in an informed, firm but understanding way. Sure, they may be ideologically to your right, but they are not stupid. While they look at a spectrum of indicators, they do not fix on any one. More important, they have to convince themselves that the New Zealand Government has a credible commitment towards its debt obligations as well as an ability to service them including to manage its investments. In the end the lender gets its profit from lending (providing the debt is honoured), so they want to do deals.

That commitment need not be as crude as adhering to a debt-to-GDP ratio target, although that is the way it is currently signalled. However, that target does not make rational economic sense insofar as it results in poor investment decisions.

For example, the government is outsourcing public medical procedures to the private healthcare sector. That avoids the government having to borrow to invest in adequate public sector facilities – such as buildings and equipment. (Other resources – such as staff – are fluid between the public and private healthcare sectors.) Rather than borrowing and investing itself, the government is getting the private sector to do the task and then paying it for the debt servicing. It is keeping its debt-to-GDP ratio down but still paying for the investment. I am more relaxed about such outsourcing than many involved in the healthcare sector, but it makes no sense that the main driver of any decision should be an arbitrary debt target.

This is but one example of the absurdity of the debt-ratio target. Another is the tangle we are getting in over the need to invest in the water infrastructure. Very substantial public funding is required unless we privatise. (Overseas experience suggests that option is not very attractive, except to ideologists.) However, the government has been trying to keep any resulting debt off the books. No doubt the CRAs will see through the muddle because any public funding will be ultimately underwritten by the government, even if it does not appear in the public accounts as a legal contingent liability.

Nowadays, CRAs must be worrying because we are currently borrowing for consumption. (It does not matter whether the funds are spent on public items rather than private ones; a social security benefit is a transfer to household spending, while public expenditure could be paid for by higher taxation and less household spending.)

We can trace this via the Crown’s net worth, the total assets of the Crown less its debt (analogous to the amount you would bequeath to a subsequent generation). When you buy a house with a mortgage, your debt goes up because that measure does not include your current ownership of the house. Your net worth remains the same. It is far better indicator of your financial position. Similarly for the government. (Your bank will remain concerned about your net debt and you will keep an eye on it because you have to service it.)

The Treasury Investment Statement reports that government’s Total Net Worth was $192m (48% of GDP), falling to $183m (42% of GDP) this year (2025) and continuing to fall throughout the next decade. It projects net worth to be $158m (or 24% of GDP) in 2034 although that does not allow for changes due to inflation.

This means the government is consuming its capital, not adding to it. There are various ways of running down net worth including directly borrowing (or selling assets) to fund consumption or running down the stock of capital. (The latter is the reason why our water infrastructure is in a mess.) The New Zealand Government is not saving but over a six-year period it is consuming more than its revenue. It may be a legitimate decision for a retired person to do this but hardly appropriate for a government which expects to live forever.

The hard truth of our current fiscal stance is that additional borrowing is being used for consumption not investment. We overlook this when we focus on the level of debt rather than what we are doing with the borrowing.

How can we make the notion of net worth, with its focus on the distinction between public consumption and investment, more prominent in public discussions? The Treasury is doing its bit in its recent Investment Statement. *

A step forward would be for the government to adopt the ‘Golden Rule’ of fiscal management which focuses on net worth. (It is already implicit in the Public Finance Act even if it seems to be ignored.) Put simply, over the economic cycle the Government would borrow only to invest and not fund current spending. (The principle allows raiding a ‘rainy day account’ to prop up consumption in the short run after a shock but the fund needs to be topped up shortly after, ready for the next shock. It certainly does not envisage six and more years of raiding.)

The Golden Rule only covers the trend in net worth; there is still a need to discuss what level it should be. That should be welcomed.

This is the approach of a fiscal conservative. It would not disturb the CRAs and the lenders they represent. The explicit adoption of a Golden Rule would increase the credibility of the government’s fiscal management. The concern of the debt-to-GDP ratio would continue but it would be seen as a constraint under which the management operates, not the purpose of the fiscal management as too often it appears to today.

* Treasury’s Investment Statement 2025 was published as this column was going to press. It raises some important issues and approaches. Time and space means that I must leave them to a later column.

The Next Crash

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

Queen Elizabeth II famously asked about the 2008 Global Financial Crisis, ‘Why did no one see it coming?’

In fact, many economists (including yours truly) had pointed out that the financial system probably would crash. But we failed to predict what would precipitate the collapse, how severe it would be and when it would happen.

This is partly a logical problem. If we knew when the crash would occur – say 30 February 2026 – then everyone would take action the day before – 29 February 2026 – which would bring the collapse-day forward, invalidating the prediction. Similarly, for the ‘how’ issue.

Consider a building which engineers think is prone to collapse. They cannot tell what the shock will be that does the damage nor when it will hit. It could be an earthquake, a fire, heavy wind gusts, a truck smashing into it …

These remarks are preliminary to the increasing references by reputable observers that various key financial markets seem shaky, including the American share market, the cryptocurrency market and the venture capital market for AI. (Currently, there is little attention being given to the Chinese financial system, but who knows?) There have been recent collapses by smaller firms, such as car-parts provider First Brands, which seem to be tied up with financing. Small collapses are integral to capitalist evolution – ‘creative destruction’ – but too many can be an indication of an impending financial crisis. There is the rule of thumb that the world has a good financial shakedown every decade or so. The last one was 17 years ago, which suggests the next might be a whopper.

Please read a lot of caution into the last paragraph. It is a time for prudence rather than hysteria.

The technical problems arise because market prices reflect subjective value – what people think assets are worth – not some objective value. Contrast the value of the house you live in with its market price. If the price were to change, your dwelling would provide exactly the same comforts as it did earlier. But you may also treat your house as a financial investment, hoping that an increase in its price will add to your wealth.

That is fine, until you start borrowing, speculating that the rise in house price will add to your wealth faster. True, but if the house price falls the opposite happens and your wealth falls faster. However, the value to you of living in the house remains the same.

It is this ‘leveraged’ borrowing which is key to understanding why financial crashes are so dramatic. Typically, the source of the loan is a financial institution which has borrowed to fund the loan. Depositing amounts to the institution borrowing from you.

The depositor does not usually know where their money is being on-lent, trusting the institution to make good decisions. Of course, it will make mistakes but the expectation is that they will be few and any losses are covered by the margin between the interest from your deposit and what they charge the lender.

It is not so simple. As we saw during the GFC, many financial institutions go into complex financing arrangements which no single person understands (including an economist), while the activities of the borrower may not be as transparent as they appear. As the Guardian article cited earlier remarks, ‘as ever in finance, it’s what investors don’t know that scares them most, and with First Brands, there appears to be plenty’.

Moreover, investors may borrow for investments with prices more volatile that their financial returns – if any. Examples are share markets where there may be dividends and cryptocurrencies where there are not.

The earlier shaky building parallel does not capture the way that financial markets develop over time. Suppose the building is continually being renovated and added to. It may not change the engineer’s basic assessment of its instability – strengthening is discussed below – but it becomes even more difficult to understand the details.

Hyman Mynsky described, in very top-down terms, the evolution of the financial system, with three phases.

During the Hedge Phase, financial institutions and borrowers are cautious. Loans are minimal so that borrowers can afford to repay both the initial principal and the interest.

The Speculative Phase emerges as confidence in the financial system recovers during the Hedge Phase. Borrowers no longer invest on the basis that they can pay both principal and interest. Instead, loans are issued for which borrowers can afford to pay only the interest. As the loan principal comes up for payment, they rely on being able to refinance (‘roll over’) their debt, borrowing the principal again.

As confidence continues to grow, investors move into the Ponzi Phase, in which they neither pay the interest on the loans nor repay the principal, relying on the capital appreciation from what they have invested to finance their investing. The asset-price appreciation that the Ponzi investors rely upon cannot go on forever, especially as it needs to accelerate. Eventually, Stein’s law takes its toll; if something cannot go on forever, it will stop. (Just before is known as the ‘Wile E Coyote moment’, when the cartoon character has run off a cliff but not yet realis

ed that there is no ground beneath him.)

Many reputable commentators think the current financial system is in its Ponzi phase, with the expectation that at some stage the bubble will pop at the ‘Minsky Moment’ after which everyone tries to get out of their investment commitments, turning them back into cash. Ponzi borrowers are forced to, because they have no cash; speculative borrowers can no longer refinance the principal even if they are able to cover interest payments. The prices of assets fall, with innocent lenders suffering as well as guilty borrowers.

We cannot predict when the Minsky Moment will occur. Nor can we prevent it, although there are some who try to prolong it – promising a bigger crash.

What we can do – in this small corner of the earth – is to take measures to mitigate what happens, just like making a building more robust to a shock. Much has done been since the GFC. The government tries to keep its debt down to give it freedom to manoeuvre. The housing market has been dampened down (although some are still trying to beat it up). The RBNZ has increased its supervision of the financial system (which may reduce your return on financial investments today, but mitigate your loss after the crash). There is the deposit compensation scheme, which shifts risk from small depositors to the public purse in return for an insurance premium. Regulation has reduced the amount of self-interested financial advice.

Much of this is like fighting the last war, adding protections we needed during the GFC. The next war will be different – who predicted the role of drones when the Ukrainian invasion started? The GFC was different from the 1928 Wall Street crash and the 1987 Stock Market (Black Monday) debacle, not only because the financial system evolved but because mitigating protections had been put in place.

As for you, the advice is surely to reduce your leveraged borrowing and your exposure to others’ leveraged borrowing. Even so, while the impact of a financial crash may differ for the prudent from the imprudent, it is not too fussy about whether one is guilty or innocent. The building comes down on everyone.

Underlying Economic Growth

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

What have the 2025 Nobel awards in economics to say to us?

One of the economic puzzles of human existence is that for most of it, going back to its beginnings, the material standard of living did not change much. Then, about 200 years ago, it began increasing; in some places more than others but material living standards in even the poorest regions are today markedly higher than in 1800, and higher than they possibly could have conceived of then.

Economic historians have struggled with what triggered this economic growth. There is no consensus but this year’s Nobel Prize in economics was half-awarded to Dutch-Israeli economist and economic historian Joel Mokyr for his seminal contribution to understanding it. (I deal with the other half below.)

There was a lot of ill-informed comment about the award. It was not the first Nobel in economic history; in 1993 Robert Fogel and Douglas North were so recognised. Nor was it the first award about the role of technology in economic growth; Robert Solow was recognised in 1987. However, neither they, nor their successors, tackled the question of the trigger.

The answers are outside narrow economics. Solow, who first studied sociology under Talcott Parsons, dismissed sociological theories as too fuzzy by economic standards. Mokyr was not as nervous.

First, he defined culture as ‘a set of beliefs, values, and preferences, capable of affecting behavior, that are socially (not genetically) transmitted and that are shared by some subset of society’, distinguishing culture from institutions by regarding culture ‘as something entirely of the mind’ which is ‘to an extent, a matter of individual choice’. By contrast, institutions are ‘socially determined conditional incentives and consequences to actions. These incentives are parametrically given to every individual and are beyond their control.’ (Economists have thought a lot about the role of institutions; its first Nobel economics award was to Ronald Coase in 1991.)

Mokyr focuses on the cultural shift which precipitated economic growth. Between the 16th and 18th centuries, a group of European intellectuals groped their way towards a new view of nature and knowledge in which by disinterested and open inquiry, nature’s secrets could be understood and then used to the benefit of humankind, nurturing the Scientific Revolution and the Enlightenment. The approach percolated throughout society, influencing individual behaviour. Once the notion became widespread that objective knowledge was possible and could be used to improve people’s lives, the emergence of self-sustaining economic growth became possible.

Scroll back to the period before. Have you noticed how its histories are dominated by warfare – as economically destructive an activity as humanity has invented? True for Māori oral histories, but also for written ones from other cultures. You get a sense that the point of human existence was seen to be in the honour which came from fighting (women hardly appear). Economists have tended to explain this by the lack of investment opportunities (although there was often a lot of conspicuous consumption of constructing large buildings – cathedrals and palaces – which may have stimulated economic activity but did not stimulate economic growth).

There was nothing particularly ‘European’ in this cultural shift – it just happened there first. Similarly, I don’t think there is anything particularly European in quantum mechanics even though it was pioneered by Europeans and Americans; today we acknowledge the contributions of Asians with Nobels too. (Perhaps as an aside, the first Nobel to a non-European economist was in 1979 to West Indian Arthur Lewis; I still draw on his insights.)

Mokyr then went onto to trace how this cultural shift transmitted into economic growth. Of course industrialisation happened in particular places which had the resources (such as coal in the English Midlands) and institutions (typically stable ones dominated by the rule of law).

As Solow saw, although initially only vaguely, this change in attitudes kept identifying new production possibilities – technologies – which meant that the same combination of labour and capital could produce more output (and new kinds of output). The new technologies lifted the material standard of living, much more than capital accumulation by itself.

Hence the second half of the 2025 economics Nobel award. Philippe Aghion and Peter Howitt describe a process whereby the new technology is introduced. It involves creative destruction – first identified by Joseph Schumpeter who would have received a Nobel had they existed when he was alive – in which firms die and new ones grow.

Crucial may be the willingness of society to allow this to happen. It may not be so critical when there is that accelerated growth phase through which many countries go. (New Zealand’s was in the late 1930s and 1940s; China’s may be coming to an end.) But during the period of sedate growth which follows, it is politically tempting to shore up industries and businesses (and regions) from the past. Their winding down and closure is socially painfully, especially to the workers involved.

In my view we need to recognise this pain and evolve a system of redeployment and upskilling – like the social unemployment insurance scheme the Ardern-Robertson Government was developing. That will only soften the disruption but it will not be eliminated. I am reminded of a unionist who was vociferous in opposition to the closure of his freezing works but some years later told me that it ‘was the best thing that happened’ to him.

Aside from the scholarly interest, is there a contemporary relevance in Mokyr’s findings? Didn’t the Scientific Revolution and the Enlightenment happen sometime ago? But is there not some reaction against it going on? I am not talking here of the rise of Romanticism which occurred shortly after the Enlightenment and pointed out that it did not cover the entirety of the human experience. As John Stuart Mill’s autobiography illustrates, both approaches are needed.

Rather the forces of the counter-Enlightenment appear to be rising especially in the US with its MAGA right but also in the woke left (except that is not as well-organised or powerful). Those tendencies exist here too.

They amount to a reversion to approaches which dominated a quarter of a millennium ago. Very often the holders of these archaic ideas do not understand what has happened since. Just because we (including me) do not understand quantum mechanics does not mean it is wrong. Indeed, applications of quantum mechanics are riddled through our everyday life. If you want to reject quantum mechanics, you should abandon your mobile. If you want to reject the Scientific Revolution and the Enlightenment, you should opt for the material standard of living which was normal for our ancestors for thousands and thousands of years.

So the second leg recognised by the 2025 Nobel in economics, creative destruction, is at the heart of modern-day living. Hence the resistance to change. But as Catherine Booth, cofounder of the Salvation Army, said, ‘if we are to better the future, we must disturb the present’.

I don’t think New Zealand is particularly prone to social inertia except that our small size makes it easier for the conservative leadership to resist change and to promote platitudes in place of insight and wisdom while excluding those with whom they disagree – and may be ahead of them – from their conversations.

That is why we have to maintain an open stance to new ideas and to the world. Mokyr argues the enlightenment transformation occurred because its participants were in a ‘republic of letters’ in which they corresponded across distances and time. MAGA seems to be turning its back on the openness, even repressing it. Let’s not join it.

Avoiding the Horrendous Fiscal Crisis.

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

Our current fiscal settings promise that we will eventually face a public debt explosion. A major cause would arise from the aging population. Is there anything we can do?

It has long been known that the ageing population would create future fiscal pressure. It was quantified in the first (2006) Treasury long-term fiscal projection and has been confirmed in every subsequent one. It is not simply that with relatively more elderly, the cost of New Zealand Superannuation rises markedly faster than GDP. The elderly also require more public healthcare and related social support much of which is today funded by others.

For the record, the just released 2025 Treasury Long-Term Projection calculates that given the current expenditure and revenue settings net debt would amount to two years of GDP in 2065.* Of course, the true figure is not that precise, but the order of magnitude is probably right. Whatever the ratio is, it will be acceptable to those expected to lend the debt to the government. Fundamentally, the current fiscal settings are not sustainable. A major contribution to the blowout is the aging population.

Despite the 2006 warning, very little has been done to address the challenge. Michael Cullen introduced Kiwisaver, a semi-compulsory earnings-related second-tier top-up on NZS but it will do little to reduce the fiscal pressure.

He also instigated the New Zealand (aka Cullen) SuperFund, in which the government invests financially now with the intention to draw down the fund as a bulge in the proportion of elderly comes through. Subsequent National Governments have not always paid into the fund in the way that Cullen intended.**

Meanwhile, the public remains impervious to the danger of a fiscal crisis. They seem to dismiss the challenge because they think it will not happen in their lifetimes. A consequence of Dornbusch’s law? Since the crisis takes longer to arrive than you think, you ignore it; when it  happens it will be faster than you thought and you will be very angry at no one taking preventive measures (but not angry with yourself). Today’s young-uns may wake up one day to find we are (or the world is) in an economic and financial crisis which requires their retirement prospects to be ‘unexpectedly’ and severely curtailed.

What to do? The first option is to do nothing and hope that action will have to be taken after we are dead, with the cost of our sloth falling on younger generations – that has been the approach of recent decades.

The second option would be to Americanise the pension system – to abandon NZS as it was originally conceived and is understood today, replacing it with an income- or means-tested minimal income support for the poorest and leaving everyone else to fend for themselves. The Treasury tried to do this with its proposal in the 1997 referendum. Although fronted by Winston Peters, the scheme was neoliberal as set out by Roger Douglas in Unfinished Business. It was rejected by a huge majority (92.4%) of voters. I suppose it could be imposed without popular consent but that seems unlikely so I won’t critique it.

Treasury has also proposed that the level of NZS be indexed to prices rather than wages with the effect that the elderly would not share in any rise in material prosperity. (It was a part of the 1997 scheme.) Such price-indexation was imposed on benefits in 1991. The outcome was increased hardship. Whether it would be politically acceptable is for others to decide. (The Treasury is not unknown to advocate policies which it knows are politically unacceptable.) The change would give a little short-term relief to fiscal pressures, but would not resolve the longer-term pressure.

The indexation shift is likely to be a part of the resolution response to any Horrendous Fiscal Crisis (HFC). There would also be endings of various concessions (e.g. health, social support and transport), and the introduction of incomes- and/or means-testing. (Means-testing involves an assets test.) The winter energy supplement would be high on the abolition list. This is an ugly scenario – essentially an Americanisation – over which we would have little control.

That leaves two options (or both). One (the fourth in this list) would be to raise the age of entitlement. I have long been an advocate of this policy although I originally arrived at it from an equity rather than fiscal perspective. It seemed to me that as longevity increased and as those in later working age groups – the pre-elderly – became more robust, it did not make sense to give them the same state support as when the New Zealand pension system was first formulated in 1898.

I was impressed by the raising of the age of eligibility from 60 to 65 which Ruth Richardson (then Minister of Finance) and Cullen (then Opposition Spokesperson on Finance) agreed to in 1992. Well-signalled, small, incremental steps, with a provision to cover those unable to work and in hardship. Why stop at 65? Why not continue the process until some reasonable age of eligibility is reached? I suggested that might be where expected longevity would be 17 years. In 1898 that the expectation of a 65-year-old was 13 years; today it is 20 years. We do not expect to reach an expected longevity until age of about 72. Were we to adopt immediately the Richardson-Cullen process raising age of eligibility 3 months every year, we would not reach 72 until 2041. (For further detail see here and here.)

I am not arguing here for reducing the scope of the modern welfare state. Rather, I favour adapting it to changing circumstances. (Once, a single woman was eligible for the pension at the age of 55; I leave you to list the changing circumstances which made that archaic even if originally it was a humane policy.)

The National Party proposes raising the age of eligibility to 67 some years away. (I leave you to judge whether that is politically courageous or timid.) It was ruled out in the coalition agreement with NZF. It leaves the danger that one morning during an HFC, those who are 64 will wake up to find they will have to wait another two or more years before they become eligible for NZS.

The fifth option would be to claw back the incomes of the well-off elderly more than the current income-tax system (with its low top rate) does. There are potentially big gains here. On the two occasions a government tried to impose a clawback (it was called a ‘surcharge’), the public outcry was such that it backed down.

Which seems to leave us with the first option, to do nothing and wait for the HFC to do it to us.

Let me make a small suggestion which would give some flexibility for future change. Set up a special tax code for NZ superannuants. Let’s call it ‘G’ for golden oldies. (I suggested a parallel code for families with children here.)

Initially, it would have exactly the same tax regime as the existing one. Only those joining the scheme would be required to use the G code – current superannuants would not. An important reason for leaving them alone is that one cannot trust those designing the G-code to make transferring to it simple. But also it provides more certainty to the existing superannuants that their entitlements will not be undermined. Both reasons would reduce the initial antagonism to the new G-scheme.

In the long run though, the G-scheme could be changed with tax rates on upper incomes increased relative to ordinary tax rates – a clawback. (I could give a lot more detail if there was any interest.) Thus we would have an arrangement which could be used to progressively, flexibly and incrementally address the challenge of the aging population, rather than wait for the HFC to do it for us.***

* Note for Geeks. The public debt-to-GDP ratio will not be 200% as was widely reported. It may be 200% years. What separated out the good mathematicians in my class from the rest, was that the former knew they had to keep their units consistent. If you didn’t, you made egregious mistakes. Debt is a stock measured in dollars (say), GDP is a flow measured in dollars per year (say). In which case the Debt-to-GDP ratio is dollars divided by dollars per year, so its unit of measurement is ‘years’. You may think this does not matter but I have seen discussions in considerable confusion because the participants were not distinguishing stocks from flows. Part of our clumsy response to the Asian Financial Crisis of 1997 arose from the Reserve Bank not understanding this elementary mathematics.

** The economics of the Cullen fund is complicated. It requires distinguishing between the situation for a person from the situation for the economy as a whole where feedback loops are so much stronger. Do not make the ‘fallacy of composition’, which ignores these feedbacks. It led to a lot of faulty analysis during the Great Depression and probably intensified it. The critical assumption is that the Fund can make a higher return on its investments than the costs of government borrowing.

*** I shall write about the role of immigration in a later column.

Political Bullying

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


It even happens in New Zealand. Local autonomy suffers.

While Donald Trump may be democracy’s greatest political bully, he is not alone. It happens in New Zealand, not only in the offices of politicians and whips dealing with caucus. Cabinet ministers practise it in public, not least towards local government.

L ocal governments are legally required to forecast investment over at least ten years including the infrastructure necessary to meet additional demand, to improve service levels and replace existing assets. You probably think that is a good thing (although meeting the requirement almost destroyed my local council). Central government agencies do not have any such legal requirement;  the vast majority do not do it. The bully says, ‘you do what I say, not what I do’.

The contempt for local government is deeply embedded in the way we run the country. They are treated as handmaidens rather than independent agencies of government. The attitude is deep in our political culture with Parliament commonly overruling local preferences. It is not just the current government; the drive to centralise operates throughout the political spectrum. Among the centralising actions of the Ardern-Hipkins Government were to disempower localities in the management of their healthcare, polytechnic education and water as well as imposing Māori wards even where locals had already rejected them.

When in opposition, this government promised to reverse these actions – one of its few coherent policy approaches was to promise to reverse whatever the incumbent Ardern-Hipkins Government had introduced. While it has made some reversals, they have typically been partial and painfully slow.

Meanwhile, this central government has been willing to get into other stoushes with local governments. Take, for instance, the quarrel between the Minister for Housing and Infrastructure and the Auckland Council over local housing policy. A feature of Auckland Council is that it is getting big enough and politically strong enough to fight back, although because it is less united than a minister-sole backed by cabinet, it is not so even a fight.

The people’s Republic of Canterbury used to be bolshie, but the Canterbury earthquakes left it dependent on central government, which had all the funding. It will return to that more independent view.

The central government has two powerful weapons in any fight. It can change the law, ignoring whomever it wishes, and it has the funding, which it doles out to local government in return for acquiescence. The Minister for Local Government wants to take a proposal for capping local council rates to Cabinet before Christmas. The effect would be to further restrict what local governments can do, except where they can go to Scrooge central government and wheedle further funds out of them, giving central government even more control.

I don’t particularly like my rates rising, but I also want locally responsive cultural, environmental and social services. Those activities will be the first to be restricted if there is a rates cap, and my locality will be the nastier for it. Such matters are not easy trade-offs. But they are ones the locals should make, not bullies in Wellington.

Getting a new deal for funding localities is not easy, but central government is not even interested in trying. (Hence the grim joke that there is a ministry against local government in Wellington.) It would reduce its power to bully and we cannot have that, can we?

We are currently about to elect our local councils for a three-year term. There does not seem much enthusiasm for the exercise, in part because councils have so little power relative to central government. What happens locally over the next three years is likely to be far more influenced by central government decisions. I don’t know about yours, but my local candidates seem little interested in standing up to central government.

The issue of political bullying is wider than just local autonomy. There is increasing diversity on many dimensions – age, culture, gender, ethnicity, region, religion, sexual expression, taste … The traditional approach of ignoring the diversity and assuming we are all the same (and you will better bloody conform) is increasingly not working. To give the Rogernomics Revolution credit, it recognised the diversity pressures by handing over more decisions to individuals – to the market (although neoliberalism has little recognition that for the market to work well requires fair income and wealth distributions). However, it never recognised that there remains a need for lower-level collective institutions like local authorities and unions.

Once the paths of many MPs to Parliament were through local councils (or other collective mid-level institutions like Federated Farmers and unions). The apprenticeship gave them a connection with ordinary people. The Fabian roots of the Labour Party evolved from (English) local body activity. National once prided itself on its grassroots foundations – giving priority to selecting those candidates the electorate knew. Overseas, the evolution of Greens was founded on local activity, but New Zealand’s show little interest in local politics. (ACT is putting up a handful of candidates in these council elections.) Perhaps the lack of local input explains a number of eccentric – but not long-lasting – MPs.

Today the ambitious politician skips such formative experiences; they are more likely to have entered from having worked as political advisers in Parliament and then onto an MMP list. The traditional Saturday morning clinics have been delegated to paid underlings so that on this dimension also, the humble task of engaging with ordinary people is diminished.

Getting into power seems to make one a natural bully, forgetting that once the role of politicians in a democracy was to serve the people – all people, not just the ones who elected them (typically only a minority of the population – often a small minority). Nor was it to serve only the interests of the pressure groups which funded their election. Imposing one’s personal beliefs on the majority of the population was not a part of a modern democracy. Getting into power often involves the bully politician claiming to know things better than experts (although they rarely have the time to master the subjects). It can be an ignorance compounded by arrogance.

Trump is an extreme example of political bullying. American legal, political and social institutions seem unable to restrain him in the short term; whether they will be able to restrain his authoritarianism in the longer term is yet to be seen. In the interim, his attacks on localities, diversity, and knowledge and expertise are damaging the future of the United States – perhaps irretrievably. (He is certainly accelerating the decline of American global power.)

He is not unique – although his personality may be. There are other bullies, even here. Our bullying is usually not as vigorous, but it could evolve that way, especially if someone with a Trump-like personality got into power. New Zealanders need to stand up to any bullying but also to create and strengthen institutions which play their part in resisting it.

Around the Corner?

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

What the latest Statistics New Zealand GDP figures might be telling us.

Statistics New Zealand’s publication of GDP for the June Quarter got a lot of media coverage, some of which bordered on the hysterical. To say the figures demonstrated the country was ‘bankrupt’ is a nonsense. Bankruptcy is about debt. Not a single one of the 28 tables SNZ published measured the debt of the nation, so they cannot tell you anything about the nation’s solvency, even metaphorically.

Why the focus on the single GDP number, given that SNZ provided literally thousands of them (although they are all interconnected)? The data is largely irrelevant for those who already know what the problem is: say Nicola Willis or Grant Robertson – or perhaps, as in the case some years back when a Rogernome argued the economy does well when the All Blacks do, we should blame it all on Razor Robertson.

It is never simple to know what is going on. First, how reliable is the estimated decline? There will be revisions. (The released tables are littered with ‘R’s indicating that estimates released in the past have been revised – but not by much. They have to be, unless either new information is ignored or we wait until all of it is in – we’d have to wait over a year.) I doubt that future revisions will be sufficient to reverse the conclusion that the economy contracted in the June 2025 quarter.

Why did the economy contract? Not that long ago the expectation was that the economy would turn the corner by June. If it has, the turn has been downward.

One answer is that it has been in contraction since September quarter 2022. That shifts the question to why we are in a long-term recession. (Here is my most recent discussion.)

Focusing on the last year, SNZ offers a breakdown of production by industrial sector and by types of expenditure which allows us to more than express hysterical shock.

SNZ reports 16 industrial sectors. It would be tedious to go through each, even if we stuck to comparing just two time periods. With three exceptions, all the industrial sectors have been struggling (contracting or growing less than the population) recently. Primary industries have  been growing but not booming – as has healthcare and social assistance. The only sector with strong growth has been rental, hiring, and real estate services. The big takeaway has to be that the construction industry is down substantially.

The expenditure sectors tell us something about who businesses are selling their reduced output to. Per capita private consumption expenditure fell 0.3 percent in 2025 June on a year earlier, while general government consumption fell 0.2 per cent. (Local government expenditure has grown strongly, hence higher local body rates.)

It is not possible from the published accounts to explain why household expenditure was weak because the tabulations don’t give the transfers (direct taxes and benefits) between households and government. We know that unemployment is up and real market incomes are falling, but without knowing those transfers we cannot assess to what extent households are raiding their savings and going into debt.

We know that the falling government expenditure is from a deliberate decision by the government to cut its spending (major exceptions are on education and healthcare). Thus the falling production of the professional, scientific and technical, public administration and arts and recreation sectors where government funding is important. The expenditure of nonprofit organisations serving households fell dramatically, probably because the government has been more successful at cutting its funding to them than cutting back on its own activities.

The rest of the world purchases of New Zealand output are reported as exports of goods and services. Exports and the associated sectors have been strong in recent times. There was a falloff in the June 2025 quarter that some attribute to Trump’s tariff policies. His first increases were only implemented in early April; it will take time for their effects to work through. The worst may yet be to come.

Firms are cutting back on their investment, so gross fixed capital formation is down. We saw that in the construction sector, and it will be a source of the manufacturing sector decline since it supplies building materials. The record is that residential building has been falling since 2021 and business investment since 2023, both before uncertainty from Trump’s erratic policy became evident.

The Reserve Bank began hiking nominal interest rates in 2021 and by 2022 they were back to the levels of the 2010s, after having been kept low during the Covid crisis. Interest rates have since been coming down. Even so, they are still higher than the late 2010 levels.

You may have expected from government announcements that capital formation should be lifting rather than falling. However, none of the ‘think big’ projects have got under way and many of the announcements seem to be repackaging older commitments rather than initiating new ones. The government’s freedom to increase public investment is limited by its ambition to get its borrowing and debt levels down.

Business closures seem unusually high. It is possible that we are going through a structural change. That certainly seems to apply to Auckland’s and Wellington’s hospitality industries, although reporting may be exaggerating by focusing on closures and giving less attention to new openings. It may be that our CBDs are contracting, as you would expect in Wellington with the government reducing its public sector – but thus far not by much. If so, why also Auckland? The post-Covid increase of working from home may be a factor. If there is a CBD structural change, landlords may be reluctant to reduce their rents, which would increase the number of empty shops.

More puzzling are the closures of large businesses in the regions – especially those processing local resources such as fish, foodstuffs and trees. Some changes amount to consolidation, relocating the operation elsewhere (which is little consolation to the locals). But there has to be a concern that something more fundamental is going on. One might hope the Minister of Economic Development and two Ministers of Regional Development would commission a report on what is happening – one which focused on the facts rather than sought superficial policy responses.

The focus of this column has been grappling with the facts rather than seizing one and attaching to it some unrelated political demand – like the country was bankrupt and ministers should resign. However, interpretation of facts is always in a framework of a theory; the one used here is the conventional wisdom. And yet the previous two paragraphs leave one uneasy; perhaps there is a more serious problem.

One of the SNZ tabulations compared New Zealand’s GDP change in the year to June 2025 with a selection of other (affluent) economies. It showed that New Zealand’s contracted in the last year while all the others expanded; typically, New Zealand was at least 1.5 percentage points behind. Hence the unease. Perhaps our structural economic policies are quite wrong, or perhaps the future of the New Zealand economy is bleak, irrespective of the quality of the policies.

Is the Capital in Capitalism Coming to an End?

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

Big Corporations Are Not What We Think They Are

John Kay has been widely described as ‘one of the greatest economists of our time’. He is well grounded in economic theory and has taught it. He is rich with practical experience, both as a consultant and a corporate director, which he melds shrewdly with the theory. He writes precisely and charmingly. And he is not constrained by the inertia of the conventional wisdom. I particularly liked his books on Obliquity, Other People’s Money and Radical Uncertainty (the latter he wrote with Mervyn King) where he pushes economists’ thinking forward– the conventional wisdom will eventually follow.

His latest book, The Corporation in the 21st Century, is even more challenging. A warning though. The publishers subtitle, ‘Why (Almost) Everything We Are Told About Business Is Wrong’, is misleading. Kay is explicit that he is writing about mega-corporations rather than conventional businesses. The standard paradigm still applies for most of those we know, work for and purchase from. The book, however, makes a compelling case that there is evolving a quite different sort of business, typically associated with products we may love, but whose producers we hate.

That is almost the title of the book’s first chapter which, initially, I found had a strange theme. Kay cites a recent legal case in which an investor sued Goldman Sachs for not following its ethics and values statement which begins ‘our client interests always come first’. The investment bank defended its case in court by arguing that the code was puffery and that no reasonable person would regard it as a statement of fact on which they might rely. The argument was supported by the US Chamber of Commerce and various other business peak associations. The US Supreme Court sided with the argument. Apparently, you should not trust what businesses tell you. Kay cites other instances with similar conclusions. 

(Kay does not explore the common notion that a successful economy depends on trust, although he has an acerbic ‘the 2024 meeting at Davos adopted its theme “Rebuilding Trust”. Well it might.’ Perhaps that will be in his next (fourteenth) book.)

The purpose of the opening chapter seems not only to express moral outrage, but also to frame the book: don’t believe what business tells you. What then are you to believe? Who then are you to believe?

Kay’s book is so rich in insights and examples that it is difficult to summarise. Basically, his message is that the features of corporations we are familiar with are no longer dominant. The archetypal business of the Industrial Revolution was a steelworks or a textile mill. Subsequently, the model was extended to embrace new technologies such as automobile production.

However, business went beyond that, nicely illustrated by the evolution of General Motors, which transformed from a company which made cars to a finance corporation which used its cars to secure its lending to consumers.

This rising role of finance in the modern economy is one of the major transformations of the modern era. Kay cites the case of the Halifax Building Society, once the largest mortgage lender in the world, whose board he was on – he left before it collapsed. For more than a hundred years it was a mutually owned organisation. It was converted to a shareholders’ company, became merged with the Bank of Scotland and crashed with it in 2008 under the impact of bad loans and inept money market trading. (One employee was fined £500,000 for reckless conduct.) Kay thinks the rot set in before the demutualisation saying:

‘I trace the beginning of the decline to an earlier board decision to establish Treasury, which managed day-to-day cash balances as a profit centre in its own right. … Trading in short-term money market instruments is essentially a zero-sum game – one party’s gain is another’s loss. So what was the source of the trading profits that not just our company, but every company in this business, claimed to make? The experienced bankers would shake their heads at this naivety. If they deigned to answer the question at all, it was to say that our traders were uniquely perceptive and prescient, although it was difficult to remain convinced of that once you had met them. The fantasy that sustainable earnings could be achieved through a sleight of hand was dispelled by the 2008 crisis – and was a principal cause of it.’

So the financial gains were a kind of Ponzi scheme in which the traders used a valuation of their assets unconnected with tangible assets or the actual future flow of income to give the impression that they were all making money. It came crashing down in 2008. But we never learn and, no doubt, the same thing is happening today. Mind you, those involved in the dealing make a mint during the boom, which is ultimately paid by the losses suffered by depositors, shareholders and taxpayers when the crash occurs.

When will the next crash happen? I can’t tell you. Dornbusch’s Law states that crises ‘take longer to arrive than you think, but then happen faster than you thought’.

Yet we are only halfway through the book (and have already skipped a lot of interesting ideas). Its second half moves on to explore another of Kay’s central themes. ‘The value of production today lies in the ideas rather than the stuff – think of pharmaceuticals or smartphones.’

A startling illustration is Amazon, a two-trillion-dollar company, which reports holding assets which are less than a quarter of that. Most of its buildings and the like are leased property which it does not own. ‘The key point is that Amazon has virtually no [tangible] assets akin to the Carron ironworks, the rail line from London to Bristol or Henry Ford’s River Rouge complex.’ Most of the limited assets its owns are financial. Trillion-dollar Apple has a similar story. It does not make computers, distribute them or sell them. It coordinates these activities.

Kay argues these companies are more typical of the modern mega-corporation. The core ideas in his book – collective intelligence, radical uncertainty, disciplined pluralism, relation contracts and the mediating hierarchy – lead to a quite different account of the organisation of the firm from how the standard economic theories and the law characterise it.

That discussion is for another venue. In fact, this book is a work-in-progress. It will take us a long time to work out its implications. Sometimes he gives the impression he may not fully understand himself. That is the nature of revolutionary tracts.

The concluding chapter, ‘After Capitalism’, is an indication of just how revolutionary Kay’s thinking is. I am not sure that is the right way to think about this era. Capitalism has transmuted greatly in the two centuries since the Industrial Revolution.

Observe that ‘capital’ has two different meanings. Kay is pointing out that in the evolving era, physical capital appears to be less significant. But financial capital remains significant, as this book and some of his earlier ones argue. Symbolically, Trump’s cabinet is stacked with billionaires.

And if financial capital remains politically powerful – the golden rule of those who have the gold make the rules – what if it is all a Ponzi system? Gee willikers.

The Fashion for Merging

This entry was posted in Governance, Pundit on by .

Do we need bigger multipurpose government mega-departments?

Restructuring seems to be the fashionable management practice whenever faced with a challenge. (Eminent health economist Alan Maynard’s caaled it ‘redisorganising’ citing Petronius Arbiter in Satyricon: ‘we tend to meet any new situation by reorganising, and what a wonderful method it can be for creating the illusion of progress while actually producing confusion, inefficiency, and demoralisation.’

Yet the restructurings continue (until the demoralisation ends?). They are reminiscent of a cargo culture, with the expectation that eventually a magic spell will succeed. It every new senior generic manager commences with a restructuring it surely implies that the structure which the outgoing chief executive left behind was inadequate. In turn, their structure will suffer an upheaval, presumably with the same implication.

Currently the Public Service Commission is considering reducing the number of government departments by merging them. But what is the evidence of the effectiveness of the mega-departments which bring a diversity of activities under the same chief executive?

Anecdote there is. The Lambton Quay view – the term for the discussions by Wellington insiders – rarely has a generous word to say about the Ministry of Business, Innovation and Employment – a department of diverse miscellaneous affairs (it has twenty ministers). Promised synergies have not appeared. For instance, the various divisions of what was once the Department of Labour have not articulated a coherent approach to labour market policy.

The other great example of a miscellaneous affairs agency is the Department of Internal Affairs (DIA). It also gets few plaudits from Lambton Quay. We have one study, which I report in chapter 17 of In Open Seas, of what happened when Archives New Zealand and the National Library were forced to rejoin the DIA in 2010.

No justification was given for the mergers. The most likely one was that the State Services Commissioner thought he had too many chief executives reporting to him – about forty. There may be a similar reason for the current proposals to reduce the number of government agencies.

The DIA’s subsequent stewardship of Archives New Zealand has been far from impressive. (Nor has it treated the National Library well.) Following the amalgamation, Don Gilling, a retired professor of accounting with considerable public sector accounting experience, found that the DIA was raiding the funds allocated by Parliament to the two to prop up its other activities. One understands the challenges faced by an underfunded department but this was thwarting Parliament’s intentions. How did the department respond to Gilling? It rejigged its accounts, making them less transparent so it is no longer possible to do a Gilling analysis.

You may think that the public record is a trivial part of overall government, but it is central to accountability. Without protecting it, the Official Information Act (OIA) would be neutered. A requested document which the executive did not want to be revealed could be legally destroyed.

That accountability of government is but also true for past ones. When legislation was first passed to provide for investigating Treaty of Waitangi grievances, it applied only to contemporary issues. Later it was extended back to 1840 and has worked well because of what is available in the public record, even though the record is not perfect as the tattered remnant of the document of what was agreed at Waitangi reminds us.

The executive loathes accountability and, as we saw with the DIA accounts, will do its best to neuter attempts to apply it. A nice illustration, reported in In Open Seas, was that in 2019 the DIA deliberately manipulated the official information process to prevent the public obtaining a document before their policy decision was made so the public assessment could be ignored. (pp.214-8)

(The DIA manipulations enabled it to overrule the three ministers directly involved – the Minister of Internal Affairs, and the associate ministers, the Prime Minister and the Minister of Finance – a reminder on how powerful a department can be against weak ministers.)

So how to downgrade the use of the public record for accountability purposes? The DIA is increasingly merging management of Archives New Zealand with the National Library’s, claiming that they are both heritage institutions. (I leave you to explain why they are not in the Ministry of Culture and Heritage.)

The consequence is that the constitutional role of the public record is downplayed. We should not undervalue the significance of the state’s heritage responsibilities but accountability must be the priority in a democracy. After all, dictatorships are jealous of their heritage too; they distort them to reinforce their authority.

Whatever the intrinsic constitutional interest in this example – for democrats it must be high – the illustration shows that mergers do not always work. As mega-departments become multipurpose it becomes easier for managers to avoid a purpose they don’t like or find too difficult. If they don’t like accountability, they redirect the activity towards heritage; if labour market policy is too difficult then fragment those who ought to be dealing with it.

One of the major reasons we have separate departments despite their appearing to be in the same area is that they have different roles and purposes. Merge them and the roles and purposes get fudged. It was right to separate out the Ministry of the Environment, which is a policy agency, from the Department of Conservation, which manages the state’s environmental assets. Fuse them and both jobs will be done badly.

MPs have often been supine when their ability to maintain accountabilty is threatened. Recall how they happily passed the 2020 Public Service Act even though it reduced their ability to hold government agencies accountable. Will they be as complacent this time?

Reducing the number of the chief executives is not the only option. Before the 1989 State Sector Act, there was a panel of commissioners each of whom were responsible for a set of departments.

Without evidence to demonstrate that mega-departments work. It’s all unthinking reaction. Almost certainty the proposed mergers will further reduce the executive’s accountability to the public. The confusion, inefficiency, and demoralisation will continue.

Restraining Dictator-inclined Politicians.

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

With his ‘I have the right to do anything I wanna do. I’m the president of the United States.’ Donald Trump is echoing Louis XIV who may have said ‘L’état, ce’est moi’ – ‘I am the state.’*

The founding fathers of the American constitution were mindful of the authoritarian streak in English royalty; some had even claimed a ‘divine right of kings’ with unconstrained power. Charles I had made such a claim and had been beheaded. That led, several decades later, to the 1688 Bill of Rights which constrained the sovereign (it is now a part of New Zealand law) and the political writings of John Locke which were influential in the founders’ thinking when they were designing the constitution.

So they designed the American constitution with the fear of a Trump-like president (their equivalent of the sovereign) in mind. They assumed that the counterbalances from Congress and the Supreme Court would mean that a president would never try to abrogate the rule of law to the extent that Trump has. (Test it where it is ambiguous – yes.) What they perhaps did not appreciate was that the checks and balances would respond slowly and a determined president could do many things before they became binding.

I do not think it is likely that we could end up with a Prime Minister who would overrule our laws when it suited her or him. Even so, we should be concerned about the executive having unrestrained power.

From our perspective, Robert Kennedy Jnr, Trump’s secretary of Health and Human Services, may be more relevant. Thus far he has not broken the law. (One restraint may be that he is a registered attorney with law degrees from two respected universities. He has even less background in the discipline of healthcare than I have.) But he has had a surprising amount of discretion within the law.

It would be easy to dismiss Kennedy as unique to America, where he is both rich and has a high public profile from his family. (His father, also Robert Kennedy, was assassinated while running for president.) When Kennedy was running for president in 2023, Trump considered him such a threat that he was offered the health secretaryship in return for his support. So he is a kind of coalition partner in the Cabinet with only a little public support. Sound familiar?

Kennedy is an acknowledged vaccine sceptic. I avoid a discussion on this view here (but read David Isaacs’ Defeating the Ministers of Death, although it finishes before the Covid pandemic, alas). Even so, during his Senate confirmation hearings he said, ‘I’m going to empower the scientists at HHS to do their job and make sure that we have good science that is evidence based … I’m not going to substitute my judgment for science.’ (my italics)

Yeah right. Since coming to power Kennedy has cut back funding of medical research, discouraged vaccination programs and either directly, or indirectly by his behaviour, laid off administrators with acknowledged expertise in the area. Illustrative of his approach, he is cutting $US500m of research funding for mRNA vaccines, claiming that they ‘fail to protect effectively against upper respiratory infections like Covid and flu’. Had he fulfilled his promise to the Senate he would have directed the research to pay more attention to investigating this alleged failure. (My understanding is that vaccines rarely fully protect, but their enhancement of the overall quality of life more than offsets any failures. Settling the balance is an evidence-based research exercise.)

Kennedy has similarly intervened in other medical areas. Further detail would only reinforce the central issue: to what degree can a cabinet minister pursue some policy very distant from conventional understandings, when the politician has no mandate for the pursuit? That Trump is tacitly supporting Kennedy’s policies by not sacking him or reining him in, is not a satisfactory answer. It is not simply that Trump has only a limited mandate (about a third of registered voters); even that majority of that minority probably did not vote for these particular policies.

Do we observe some New Zealand Cabinet Ministers pushing personal policies with a Kennedy-like lack of attention to the evidence? Would they do so further, were they not restrained by checks and balances? As a British Lord Chancellor said, a parliamentary system is an ‘elected dictatorship’. Our dictatorship is restrained by the requirement of having an election every three years. In those thirty-six months the dictator-politicians are also subject to formal and informal checks and balances. Without them, as Trump’s ignoring of them in his first eight months well illustrates, a politician can do a lot of damage. On the other hand we expect our political leaders to lead and object to eunuchs who do nothing. It is a delicate balance.

The Coalition Government is currently putting to a referendum the proposal that New Zealand extends its three-year electoral cycle to a four-year one, thereby extending the dictatorship and weakening a key mechanism which holds our politicians accountable.

The ACT party has reservations about this power increase and suggested that we should support the four-year term if there are more checks and balances. Theirs was a grudging concession along the lines that if electoral accountability is reduced, parliament would make minor changes to strengthen the checks and balances. It has since withdrawn it; ACT has offered no alternative.

Surely the change should be the other way round. Politicians would acknowledge that the checks and balances on the executive are weak and need strengthening. They would make changes to increase their accountability. Having done this, they would then ask for a four-year electoral term.

As Trump and Kennedy demonstrate, the likelihood of politicians reducing their power belongs to the ‘yeah right’ basket.

* Another parallel with the Sun King is that Trump appears to have similar golden tastes redecorating the White House.

Appendix: Some Ways to Strengthen Accountability

1.‘Officers of Parliament’ – the Auditor General, the Commissioner for the Environment and the Ombudsman (who is also Official Information Officer) – have accountability roles similar to MPs but with more resources and expertise. There are others with similar roles – a list is here – but because they are based in government agencies and subject to them, they are less able to hold the executive to account. They should be made officers of parliament.

2. Properly fund the Ombudsman’s office so that challenges to the executive’s Official Information restrictive decisions can be dealt with more quickly.

3. Strengthen the ability of select committees to challenge the executive. (The ACT proposal attempted to do this.)

4. Make the public accounts more transparent so they make using them for accountability easier.

5. Reduce the power of parties relative to voters by having list MPs appointed to Parliament on the basis of those who obtained the most electorate votes but did not win their seats, thereby increasing the independence of MPs. (Like the way Samoa tops up the number of women MPs.)

6. Further limit the power of those with finance to fund parties.

7. Make political lobbying more transparent.

8. Give local authorities more independence (which also means more financial independence).

Luxon and a Long Recession

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

What are the economic and political implications if the New Zealand economy stagnates for five and more years?

Prime Minister Christopher Luxon told Morning Report that ‘We’ve got the worst recession* we have had in 30 years’. (Observe, he could have said ‘since the Rogernomics Stagnation which finished 30 years ago’, but some things may not be mentioned in public.)

One takes it that he is referring to assessments like Treasury’s 2025 Budget Economic and Fiscal Update which reports a three-year downturn from September Quarter 2022 ; although my impression is that everyone has become even gloomier since May. Treasury then did not expect the economy to reach the September 2022 per capita level again until September 2027 (a year after the next election). Treasury expected the decline to bottom out about now. But the return to growth is slow and if the Treasury is right, the economy will grow at about its earlier rate, with a track about 8 percent lower than in the past. That would mean it has lost about five years of economic growth in this ‘recession’. We are not having a business cycle fluctuation.

One can fiddle around with these figures, but the basic story would remain unchanged. Luxon is talking about a long recession; although he does not give an explanation as to why it is happening. (He mentions ‘the Covid hangover with all the extra spending’ but that simply brings the ‘recession’ forward; it changes neither its shape nor existence.) His promise to ‘fix the economy’ is without much explanation either. As my In Open Seas observed, trying to fix something without understanding what went wrong is a common approach in New Zealand.

There have been five great stagnations in the last 160-odd years. Excluding the Rogernomics one, which was unique to New Zealand and probably reflected policy incompetence, the other four were all associated with global stagnations, although excessive borrowing may have intensified the experience here. It turns out that currently most of the countries whose macroeconomics I monitor closely – America, Britain, China, the European Union, France, Germany, Japan, Russia – are struggling (as are many others). Germany, for instance, is beset with a recession and a not very robust governing coalition. (Holger Schmieding, chief economist of Berenberg, a German bank, said that the German premier, Friedrich Merz ‘is not an experienced politician, he acts more like a CEO’.)

Their difficulties could be – like New Zealand’s – attributed to the post-Covid unwinding compounded by the chaos that Trump’s tariff warfare is adding to the world economy, perhaps most by adding to decision-making uncertainty.

(A caution. We are only three years into this ‘recession’. While that makes it longer than a conventional business cycle. Treasury does not think it will last as long as our great stagnations.)

Observe that some economies currently in ‘recession’ were struggling before the Covid pandemic (in a way that New Zealand was not), tempting one to dismiss Covid as the underlying cause of the current difficulties but compounding them. What are those underlying processes?

First, leave aside China, whose astonishing growth phase seems to have come to an end. I am reminded of what happened to Japan, which also had an impressive growth burst which flattened out, leaving its economy struggling for decades. Warring Russia is also obviously a special case. The remainder are affluent economies.

I have discussed whether they are suffering secular stagnation. I shan’t go through the details; you can see them here and here. What is critical is that while affluent economies and their societies continue to evolve, it may be a different evolution from that with which we are familiar in the last two centuries.

So different that we are struggling to explain exactly what is happening. We need much more experience and data to be confident in our analysis. On the other hand, uncomprehending nostalgia tends to invoke the unthinking inertia of using a paradigm of the past. I am afraid that is what I hear from Luxon. I do not have a lot of respect for the policy thinking (if any) of the Ardern-Hipkins Government – and I have yet to be convinced that Labour in opposition is any better – but I credit them with trying to cope with evolving New Zealand even if they could not explain this to themselves.

Luxon campaigned on ‘back on track’ which was a return to the policies of the past with little recognition that things were changing. – not only in the economy. Morning Report headlined that he claimed that his government’s ‘policies were working to fix economy, raise living standards’, although how he was proposing to do so either does not appear to have been covered in the interview.

Obviously improving infrastructure, making regulation more effective and increasing trade opportunities are worthwhile, but they are not particularly related to the ‘recession’. (We may argue over increasing exploitation of depletables, as is Shane Jones’, ambition, but again the approach is not particularly about the ‘recession’.)  None explain why the ‘recession’ began in the early 2020s.

Luxon appears to be assessing the issue as being one of growth of GDP – the measure of market output – rather than wellbeing. Increased GDP is a goal welcomed by business because it increases profits – a lot of businesses are struggling at the moment. Moreover, increased GDP is associated with increased tax revenue, although it will also increase the need for additional public spending because of its downsides. Whether there is a net gain depends upon the degree to which the government responds to these expenditure pressures.

Indeed, the Coalition Government has reduced its commitment to the arts and culture, the environment (including reducing carbon emissions) and to public health, matters which the public will judge them on.

That political judgment occurs in just over a year’s time in the 2026 General Election. The indications are that the state of the economy – say, measured by the unemployment rate – will be a little bit worse than it was at the 2023 election but prospects may be improving, whereas in 2023 they were looking dimmer (and were made even dimmer by some of the actions the Coalition Government undertook).

However, the role of the economy in the election campaign may depend on the Labour Opposition – I doubt that a capital gains tax will be decisive either way, except perhaps to stiffen loyalists in either camp. Events over the next 12 months are likely to be more important. Key ones may be unpredictable. Ability to manage coalitions may be critical.

Even so, trying to understand and respond to our long recession will almost certainly involve our adapting overseas analysis for New Zealand’s unique circumstances. The affluent world may be entering on ‘secular stagnation’ as assessed by GDP. If so, we probably cannot avoid that fate either.

* Recession has various economic meanings. Traditionally, it referred to a particular stage in the business cycle but when the cyclical downturn is stretched out beyond the normal length it becomes something else, often called a ‘long recession’ (as occurred after the GFC) which may morph into a long stagnation (it did not in the case of the GFC). I have put recession in quotation marks to emphasis that Luxon and all are talking about a long recession where traditional business cycle analysis may not apply.

How Should We Organise Research?

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

A physician’s memoir describing a successful research program leads to pondering about research funding strategies.

A few years back, I was, in effect, commissioned to review the development possibilities of a local biotech industry, especially one for creating new pharmaceuticals. At the time, it was fashionable in every regional plan – anywhere in the world – to claim that local prospects of developing an innovating biotech industry were high.

From my reading I concluded that the United States did not have a biotech industry. Rather, a dozen of its large urban centres had one and everywhere else hardly mattered. That was because the industry had to function in a deep, skilled-labour market with numerous medical centres and tertiary educational institutions, and a variety of specialist ancillary services such as precision assaying (measurement) and patent lawyers. Smaller centres would not have enough work to support the specialisation. (The technical term is ‘economies of agglomeration’; they are central to economic development as my Globalisation and the Wealth of Nations explains.)

The population of the smallest of the US biotech centres was larger than Auckland, although if Hamilton was added it just exceeded the threshold (especially given the expertise in Ruakura). That led me to argue that good linkages between the two centres were vital – we are getting there – and it seemed likely we could further enhance the potential ‘size’ of greater Auckland by improving its connections with the rest of New Zealand. (At the time, the expertise for maintaining high air quality was in Wellington, a short air trip or overnight shipping away; broadband was to come.)

Even so, the biotech industry has not thrived as much as was hoped. My guess is that there has not been enough private venture capital to fund the development of a biotech industry which has a high rate of failure, while the government was unwilling to fill the gap. I moved on to other issues.

Reading Eric Espiner’s A Physician’s Journey: Chasing Hormones You Never Knew You Had, and Why You Need Them prompted a return. (A warning. The book is not an easy read; its target audience is those very familiar with general medicine. This layman struggled to keep up.)

Hormones (their study is called ‘endocrinology’) are one of a body’s signalling devices in which molecules flow between glands and organs which react to their signals. The known number is 75, but more will be discovered. Most people know of a handful – adrenalin, cortisol, dopamine, growth hormone, insulin, melatonin, oxytocin, oestrogen, testosterone … – and a handful of the glands which produce them – ovaries, pancreas, pituitary, testes, thyroid …

To my surprise, even the heart secretes hormones. (On reflection, I shouldn’t be surprised at anything in endocrinology.) In between his clinical duties as a hospital physician, Espiner (and his team) was a pioneer in the study of one of three hormones the heart secretes: the C-type natriuretic peptide (CNP), which plays a crucial role in regulating various bodily functions, including cardiovascular homeostasis, bone growth, and neuronal function. (I am afraid you’ll have to look up elsewhere if you want more detail; I don’t trust myself.)

This internationally pioneering research was based in Christchurch. It occurred, serendipitously perhaps, because, like Espiner, Don Beaven was a Christchurch boy, who established what is now known as the Don Beaven Medical Unit. His interest was diabetes, where he developed a world class reputation and he recruited to his medical unit endocrinologists in training such as Espiner. The unit was not just an isolated part of the University of Otago. It drew on other local institutions: the Canterbury hospital system, the Canterbury Research Foundation (which Beaven helped found), Lincoln University (a lot of the experimental work was done on sheep) and the University of Canterbury science faculty. It had good connections with other international centres of excellence; as well as the professional interchange, they used the Christchurch team to do some of their assaying.

Such a centre of excellence does not make Christchurch a biotech centre comparable to the American dozen. It is a reminder that centres of excellence can exist in just about any city. It is also a reminder that public policy has to be flexible. Who would have guessed that such pioneering medical research would arise in Christchurch? (There is other excellent research being done outside Auckland. The Dunedin Multidisciplinary Health and Development Study has recently celebrated its fiftieth anniversary to international accolades.)

I am not convinced that our approach to public research has been responsive enough. Espiner grumbles about the time he wasted making abortive research grant applications. (The Canterbury Medical Research Foundation could only make a small contribution but what it did was invaluable.)

I know of a lot of other quality researchers with similar grumbles. It’s partly the funding shortage, but also – in my experience – the way the research funding selection boards tend to favour the fashionable and the conventional; moreover they tend to support projects rather than programs in centres of excellence. The failure applies to the social sciences as well as the natural sciences. You would have to be Trumpish brain-dead to support the Ministry of Culture and Heritage’s abandoning Te Ara, Aotearoa New Zealand’s world-leading electronic encyclopaedia.

What about commercialising the research by a patent which produces something which could be sold, thereby paying a royalty? That was the background to my original investigation. Create a new medical drug and one can end up with zillions; the fashion did not notice that only a trivial number of chemicals investigated got as far as commercial use (which was why venture capital is so important). Espiner describes the difficulties patenting their findings – patent lawyers were hard to find in New Zealand – but ultimately there was no commercial firm that could see how it could make a profit from them; eventually the patents were dropped because of the expense of maintaining them. The intellectual property is available free to all endocrinologists and their patients.

That is characteristic of a lot of research. The findings may be immensely valuable but they cannot be commercialised. Einstein was working in the Swiss patent office during his 1905 annus mirabilis when he published four groundbreaking papers, including one which was foundational in quantum mechanics while another was his special theory of relativity. He could not take patents out on any of them.

Focusing public funding on commercialisable research – that which contributes directly to GDP rather than wellbeing – is very short term and, probably, not very rewarding. Some might conclude that we should abandon public research funding altogether (aside from some obvious exceptions such as into potential geological disasters). But that is thinking around the wrong way.

The work of Espiner, Beaven and their colleagues was vital for importing frontier endocrinology into New Zealand. Because they were doing quality research this transfer of international knowledge was more effective. That some research was pioneering increased the effectiveness of their interactions with overseas colleagues and the transferring of their findings here. The learnings from Christchurch flowed into endocrinology practice throughout New Zealand. We all benefited.

Tariffs Are Taxes

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

What can Econ101 tell us about Trump’s tariffs?

Before reviewing the economics of tariffs as indirect taxes, here is a brief account of their constitutional role. In particular, in some jurisdictions, including New Zealand, taxes and therefore tariffs are the preserve of Parliament, not that of the executive or kings. England’s civil war is complicated – wars always are – but one factor was that King Charles I was raising taxes without the approval of Parliament. The issue was eventually settled in the 1689 Bill of Rights – now a part of New Zealand law – which clearly states that only Parliament can raise taxes. One factor in the American colonists’ revolt against Britain a century later was ‘no taxation without representation’, which is enshrined in their constitution in its first article.

It is true that sometimes Parliament or the US Congress gives the executive the power to raises some taxes in an emergency but that power is usually for circumscribed situations. President Trump has claimed that such situations give him the power to raise tariffs. One American court has ruled that the increases are not legal, although reverting tariffs back to the pre-Trump levels has been suspended until the US Supreme Court makes a ruling. There is a view that the Court will back down on the constitutional principle as fast as Taco Trump always chickens out.

It is necessary to go through this because it is not certain that the Trump-imposed tariffs are firmly in place, adding to the uncertainty that the world economy faces. This column is going to assume that the Trump tariffs are permanent – until the times do alter.

It is a routine Econ101 exercise to distinguish between the apparent incidence of an indirect tax – who pays it – and the actual incidence – who ultimately pays it. Excise duty on beer is paid by the brewery to the government, but they then pass the tax on in higher prices to the drinker who bears (most of) the burden of the excise hike. I have said ‘most of’ because consumers may reduce their consumption and that will affect the brewers’ profit. As the Econ101 student learns, this balance between the suppliers’ burden and consumer’s burden depends upon the elasticities (responsiveness) of supply and demand.

Trump wants to have it both ways. Part of his rhetoric is that the burden of his tariffs will be borne by the exporters, as a punishment for their country running a trade surplus with the US or for its (alleged) political misdemeanours. In which case, US consumers will not face price rises. Another part of his rhetoric is that it will stimulate competing US production, but that requires US consumers to face higher prices so that the US producers find it more profitable to increase supply.

Both will happen to some degree. The conventional wisdom is that most of the burden of Trump’s tariffs will be pushed onto consumers. The expected price hikes are only dribbling through because exporters and those purchasing from them are uncertain as to how long the tariffs will apply.

Given the complexity of Trump’s tariff changes it is difficult to assess their quantitative impact, especially over time. Among the educated guesses is that the impact on output in the long run may be small – a reduction in output of much less than 1 percent. It will be even smaller in the short run. There is a view that the distributional changes will be larger than the aggregate output changes. In particular, it is argued that the working class – who tended to vote for Trump – will be hit most heavily. The tariffs will contribute to government revenue (although not sufficiently to cover the deficit from the ‘Big beautiful bill’).

Trump’s tariffs may contract the world economy. The uncertainty of it all is probably its greatest difficulty the world currently faces. If you export to the US, do you start looking for alternative markets? If you are a US producer do you invest to expand production? The additional output will take time to come on stream and by then the tariffs may be wound back. Better at the moment to tai hoa. Thus, we may see extra US inflation which will affect US – and hence the world’s – monetary policy with some fall-off in demand. Trump prides himself on his ‘weaving’; his negotiating strategy is based on the uncertainty it generates. What this ignores is that businesses (generally) want as much political certainty as possible; it’s hard enough dealing with market uncertainty.

(The analysis is further complicated by what happens to the US dollar; it has fallen relative to the US’s trading partners since Trump became president – but no further than the level it was during the last two Biden years.)

The analysis of tariffs compared to other indirect taxes is complicated by only some suppliers being taxed. Think what would happen if only North Island brewers, say, were levied excise duties. It would be even more complicated if North Islanders north of the Bombay Hills were levied differently from those to their south. That is why every country wants to get the tariffs it pays to the US down. They are put at a competitive disadvantage relative to those countries where Trump has imposed lower rates.

Moreover, unlike in much of Econ101, external suppliers can look for alternative markets. After all, across the board the US only absorbs about 10 percent of the world’s exports even if it produces about 18 percent of the world’s output. (Large ‘generalist’ economies tend to export relatively less than small specialist ones; we don’t classify a sale of a New York-made product to California as an export.) The likelihood is that proportion will be even smaller in the future.

As an economist, I am enthralled by Trump’s tariff experiments; it allows us to test theories and measure magnitudes. As a citizen of the world, I am appalled.

Aspiration Without Content

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

The Government’s Growth Strategy Seems to Have Little Analytic Content.

In 1990, the Prime Minister, Geoffrey Palmer, announced that he would halve unemployment – its rate was then more than 7 percent of the labour force. An OIA request turned up no technical papers. Apparently, the PM’s political advisers – jock wankers/politicos – thought the aspiration would go down well with the public.

More recently, the Minister of Workplace Relations, Brooke van Velden, presented a ‘Health and Safety Reform Construction announcement’ which proved to be, according to one exasperated journalist, ‘an announcement of an announcement you hope to make later in the year once you know what it is you’re announcing’. As the minister explained, her non-announcement (about the regulation of scaffolding) was ‘because people are really excited about this stuff. You should put it up on your website and see what response you get.’ Aspiration without content.

As Jonathan Milne in a Newsroom newsletter commented:

Banning cellphones in schools when schools already had their own policies restricting cellphone use. Setting up a road cone tip line, inviting people to dob in excessive cone use. Banning gang patches. Banning voters from enrolling in the last 13 days before polling day. They’re striking initiatives, guaranteed headlines and social media clicks. But what they have in common is the dearth of actual evidence behind them. They’re dreamed up in party-political strategy brainstorming sessions. There’s little reference to the subject specialists in the public service; there’s no prior consultation with the wider public and those who are affected.

An earlier, and perhaps more portentous, initiative was Christopher Luxon’s announcement that he was leading an ‘economic growth’ government.

Presumably he and his political advisers saw that the public thought the Luxon-led Government was drifting. (This is January 2025.) How could they seize the initiative? Economic growth was their suggestion, which Luxon adopted. But how to add content to the narrative? Cough, cough. ‘We’ll make Nicola Willis the minister for economic growth.’ As far as the politicos were concerned, the problem was solved. What was the analytic content?

Appointing Willis as Minister of Economic Development placed her in charge of the large amorphous department, Ministry of Business, Innovation and Employment, which had been created by Stephen Joyce in what was seen as a power grab. (It appears to have been partly to demote the previous minister, Melissa Lee, out of cabinet; I leave the politics to others.)

MBIE is really a ministry of miscellaneous economic affairs, with (over half the cabinet ministers holding or sharing its portfolios). It is not thought to function well and needs to get its various divisions to work better together. Handing it over to the Minister of Finance, who usually has enough on their plate, is odd. (Willis is also Minister of Social Investment.) In principle she is more powerful than Joyce ever was. I am surprised that there was no one else in cabinet to take the job.

Willis has not made much of a mark. She is in the public eye for trying to increase competition in the supermarket sector and reduce the price of butter, hardly matters central to the finance or development portfolios. David Cunliffe, when a junior minister in the Clark-Cullen Labour Government, was charged with increasing competition in the telecommunications industry (and got it right). Minister of Finance Michael Cullen told me he was right behind him, but the leg work was by the more junior minister. Willis is out front.

It is hard to see that the announcement has had much effect other than the ministerial reshuffle. The key ministers driving the government’s economic growth agenda are Chris Bishop, Shane Jones and David Seymour. The first two ministers are doing much as you would expect – improving infrastructure and exploiting resources. (Perhaps add Todd McLay, minister of trade negotiations, since thrust from the external sector is vital.)

Seymour’s involvement reflects a changing perception, here and overseas, of the determinants of economic growth. Economic theory has tended to downplay transaction costs – they are so difficult analytically. There are some Nobel laureates for transaction costs – notably Ronald Coase and Oliver Williamson – but there is little connecting their work to economic growth.

There has been recently an increasing focus on how transaction costs from public sector procedures are limiting economic growth. (Not a lot of attention is given to private sector transaction costs, which might suggest there is a whiff of neoliberal economics in the thinking.) There are a number of other ministers and ministries – over half a dozen on my count – who are also addressing regulatory standards. The most prominent, which does not mean the most effective, is Seymour’s Ministry of Regulation. In principle, its concern is improving the quality of public regulation. Sometimes the impression is that it is adding to the regulatory burden, as in the case of the Regulatory Standards Bill.

Of course, reducing the regulatory process may be a good thing if the resources it releases get usefully deployed elsewhere. But the gains are likely to be small in terms of GDP and not affect the growth rate. On the other hand, too little regulation can be a disaster. The reductions of building regulation led to the tragedy of leaky buildings, estimated to cost the housing sector alone between $11b and $33b plus a lot of heartache and some deaths.

I am not unsympathetic to the argument that some of our regulatory processes are unnecessarily burdensome and could be simplified. (I’ll address their impact on economic growth shortly.) But regulations serve other – often valid – purposes.

The most common justification is ‘market failure’ when unregulated market transactions damage GDP (as in the case of leaky buildings). Two others are often overlooked.

One is that where economic output is not the same as wellbeing, an intervention may shift economic activity towards higher wellbeing, albeit at the cost of depressing GDP. For instance, most healthcare interventions cannot be justified in terms of enhancing GDP but they add to longevity and the quality of life. Cut them back and since people will experience poorer health and die earlier, GDP per capita will go up.

Second, regulation usually has a distributional impact. In simple terms there are winners and losers. Changing regulation changes the balance between them. Abolishing them can abolish some people’s implicit property rights. For instance, some of the environmental regulations give the public, collectively, entitlements to environmental resources which they do not privately own. The effect of the Regulatory Standards Bill is to prioritise explicit private property rights over implicit ones. (The bill would be a better if it made this trade-off more explicit by requiring the reviewing process to identify them.)

I have long been looking at whether regulatory changes affect New Zealand’s economic growth rate. There have been constant promises to improve the growth rate, but there is not the slightest evidence that anyone has succeeded. (By ‘slightest’, I mean within the known margins of measurement error – say plus/minus 0.2 percent p.a..) I concluded that good economic policies keep the boat moving forward but no faster.

That was especially true with the major changes to regulation implemented by the Rogernomes. I had expected there would be gains and tried so hard to find them; I could find none. (I found some improvements in the ‘quality’ of output which are not incorporated in the measurement of GDP.)

Given the way the economy is tracking, I shan’t be surprised if per capita GDP is much the same at the time of the next election as it was when Luxon announced that economic growth was the government strategy (the level will be lower than it was in late 2022). Probably output will be moving up in late 2026 after stagnating this year. No doubt there will be confusion between a cyclical recovery and sustainable growth; a common mistake which politicians in charge like to encourage.

The Luxon-led Government’s political advisers may well be looking for a new slogan. At the National Party conference, he announced that the New Zealand economy was ‘turning the corner’. One is reminded of Muldoon’s announcement of there being a ‘light at the end of the tunnel’. It proved to be a train coming the other way. We don’t know what is around the corner.

How Important is Distributional Economics?

This entry was posted in Distributional Economics, Political Economy & History, Portraits, Pundit on by .

Angus Deaton’s Economics in America challenges the direction that economics has taken.

In 2015 Angus Deaton was the sole awardee of the Bank of Sweden’s Prize in Honour of Alfred Nobel, for his contributions in the study of ‘consumption, poverty and welfare’. (It has been relatively rare for this Nobel to recognise poverty or welfare; nowadays the award covers a slightly wider remit than just economics.) The Royal Swedish Academy of Sciences, which makes the award, said that ‘more than anyone else, Angus Deaton has enhanced this [understanding of economic policy intended to reduce poverty]. By linking detailed individual choices and aggregate outcomes, his research has helped transform the fields of microeconomics, macroeconomics, and development economics’.

Deaton described himself as ‘someone who’s concerned with the poor of the world and how people behave, and what gives them a good life’. His Deaths of Disease and the Future of Capitalism, which he coauthored with his wife Anne Case, illustrates both his concerns and how innovative he (they) can be.

He grew up in Scotland, going to Cambridge University where he graduated with a doctorate. Forty years ago he took up a chair at Princeton University near New York. Thus he is both an immigrant and well embedded in American life, which is a good place from which to provide an insight into the state of economics and US, as his memoir Economics in America: An Immigrant Economist Explores the Land of Inequality well illustrates. (If you think ‘civilised economist’ is an oxymoron, you have not read this book.)

Of course, American economics is not the whole of economics, but some 71 of the 93 Nobel laureates were born in the US, and a goodly number of the remainder spent most of their working lives at American universities; American economics dominates the economics profession.

Deaton reports that when he shifted to the United States from England, he was struck by how little attention was paid by American economists to distributional economics, which perforce means by the economics profession as a whole. I won’t say he has trod a lonely path, but certainly it has been the path less trodden.

For example, some years ago, I was looking at some New Zealand research which was trying to estimate the gains from reducing border protection. The assumptions in the model ensured there would be gains; at issue was how much? The research concluded that they would amount to an increase of about 0.3% of output. What the research did not notice was that the changing shape of the economy had real wages falling by about 5% and profits correspondingly rising, which meant that the distributional impact of the proposed policy change was far greater than the gain in efficiency. The winners gains from the redistribution far exceeded the gains from greater allocative efficiency. 

I am not arguing these figures were correct. The point here is that the researcher did not notice the distributional implications of the research. Had I raised it with him, I would have been dismissed by the argument that workers could be compensated for their loss of income, but there would have been no consequent discussion of how the compensation would be implemented – that would involve raising taxes.

That is the story of much public discussion about the economy since. Lots of attention to efficiency gains – which are often quite small (and promised rather than measured) – and no attention to distributional impacts, which can be quite large. I often observe advocacy based upon efficiency gains – promised but not measured – without any attention to the effects on equity. Surprise, surprise; the advocate would be one of the beneficiaries from the gain. Even less surprising, the change is resisted – to the incomprehension of advocates – by those who will be made worse off; advocates attribute it to ‘politics’ (which they pretend to be above). Distributional economics is one of the most complex and difficult parts of economics, but that is no excuse for ignoring it, especially if the analysis is about policy.

Take, as but one example, the Regulatory Standards Bill and let us assume the charitable interpretation that its purpose is to provide a more systematic review of a regulation when it is being introduced. I would have thought that any systematic review would identify winners and losers but there is hardly any reference to that in the proposal. The exception is that a review is required to identify the losses (but not the gains) of those with property rights – commercial capital. One might have expected a similar provision for losses for those with human capital – their earnings. On that the bill is silent. (Even that addition would not cover wider distributional issues such as the degree of income and social inequality and poverty.)

Such criticisms are not peculiar to New Zealand; much of our economic debate echoes that in the US and elsewhere. That is what Deaton is challenging in public policy, area after public area, including health economics, which combines distributional issues with challenging technical ones. Deaton points out that while the healthcare sector consumes about 15 percent of US output (less in New Zealand), there are comparatively few health economists, and they generally have lower status (also true in New Zealand).

Deaton is not a minor economist. Among his recognitions are that he holds a prestigious economics chair at Princeton University, which is globally ranked among ten universities for economics and econometrics (most of them are American). He has been elected president of the American Economic Association. Deaton is an insider writing from the inside.

A great autobiographical memoir describes a journey through life, its vistas changing. Last year, Deaton wrote that he had changed his mind on large parts of the mainstream economics he had previously supported. While acknowledging that economics had achieved much, he concluded, that economists’ mistakes showed how ‘economists could benefit by greater engagement with the ideas of philosophers, historians, and sociologists, just as Adam Smith once did.’

The final chapter of his memoir, entitled ‘Is Economic Failure a Failure of Economics?’ is as an impassioned and informed essay on the state of economics as I have come across for some time – Keynes would have been proud to have written it. It is so dense, balanced and thoughtful that any paraphrase would be inadequate. I suggest you sneak into your local (good) bookshop and begin reading it. I bet you buy the book.

Politicos vs Wonks

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

Winning office is not the same as achieving change.

A recent Economist columnist divided politicians and their political advisers into either ‘jock wankers’ or ‘nerd wankers’. It’s a distinction which I use here, but with the less pejorative ‘politicos’ and ‘policy wonks’.

In opposition, the politicos are primarily concerned with getting their party elected; in government their concern is maintaining party support to get the government reelected. The Economist recalls ‘a period of swaggering jocks, charming or bollocking journalists until they wrote something nice about Sir Tony Blair’.

The policy wonks are concerned about the development of effective policy. Of course there is overlap between the two but it is characteristic of the politicos to be concerned about articulating (often poorly defined) policy goals which sound plausible but are not implementable. Think of boot camps for which there is no evidence of their effectiveness – let alone cost effectiveness – but resonate with the public and so win votes. How many policy proposals of this government – indeed of every incoming government – are on the list of such examples?

Very often the politicos have studied politics at university and pop up in advisory positions to incumbent politicians. There are lots of good reasons for studying political processes but, alas, understanding how policy is made is not one of them in New Zealand. In principle, one can take policy studies courses, but my impression is they don’t contain enough gritty case studies – the devil is in the detail.

A salient example of the approach of ‘politicos’ is Elon Musk who having helped Trump get elected, wanted to downsize the US government. Even if we ignore his exaggerated promises typical of the Trump administration, his attempts were a failure because he had no understanding of how the bureaucracy worked; the outcome has been damage followed by (often ineffective) damage control.

The distinction is useful to understand the ‘paradox of Jacinda’. Ardern with a degree in communications and politics and an adult life spent in politics, was a prime minister who was superb in her first term to the extent that her party won a majority of seats in the election at its end. But in the second term, it lost support to the point that she retired early and her party was electorally demolished.

A common trope is that her loss of popularity was because she was a woman, but that has not applied to the same degree to Jenny Shipley, Helen Clark or Judith Collins. The Economist dichotomy provides useful insights, although it is not a perfect fit.

As signalled by the title of her memoir, A Different Kind of Leadership, Ardern saw herself as a leader, skills greatly required in her first term during a number of crises, notably the Covid pandemic and the mosque massacres. (I just marvelled at her handling of the latter, although it is likely that Bill English, say, would have done as well leading during the brunt of the pandemic.)

Her Labour Government could excuse itself for not having much policy during its first term because it was generally quite unprepared for winning the 2017 election. A few – very few – ministers were prepared but their achievements did not amount to an overall direction. Ardern promised ‘transformation’ but that was aspiration without content.

Fortunately for her, and for her Labour Government, the first term was riddled with issues where leadership was vital; Ardern handled them well. Hence the election of a majority Labour Government in 2020. Now was the time for policy which would lead to the promised transformation.

It did not happen. It was not so much that the government was unprepared for policy changes but there was no coherence in the overall direction and some, especially the penchant for centralisation, were in the wrong direction. I have detailed this in my book In Open Seas.

Ultimate responsibility rests with Ardern and her Minister of Finance, Grant Robertson. They may be contrasted with their predecessors, Helen Clark and Michael Cullen, both of whom were policy wonks. (That I give them this attribute does not mean I support all their directions. I have various hesitations with Clark; Cullen I am more comfortable with. Bill English was a policy wonk too; Key was not, as his abortive attempt to change the flag demonstrates – his role was political leadership.)

It is instructive that Ardern’s policy achievement with the greatest transformational potential was the 2018 Child Poverty Reduction Act which gets little mention in her memoir (see my Chapter 22). Arden was not the policy wonk to implement its strategy; she largely employed advisers like her. They were rich with goodwill towards the ambition, but they did not understand the technical issues – the devil is in the detail. The act became aspirational and has achieved little.

I puzzle over Robertson. He too was a politics graduate but had more experience outside the political system. (I am not judging his macroeconomic management here.) In the end I conclude he was not a policy wonk like Cullen or English. He too proposed a transformational policy, probably driven by work which began in Treasury even before English. But the promise to pursue wellbeing rather than output was never bedded in, despite it being, in my view, the economic approach of the future. (See my Chapter 2.) Instructively, it was hardly mentioned in Labour’s 2023 campaign (poverty reduction couldn’t be because there was hardly any). There was not the sort of dual leadership which characterised the Key-English Government.

Instructively, the current Luxon-led Government has wound back most of the Ardern-Hipkins legacies. It was partly because some were misconceived, but also because the current government has a quite different account of the economy and its future. They have yet to convince us it is forward looking.

Neither Christopher Luxon nor Nicola Willis are policy wonks, although some ministers are dealing with their portfolios more than competently. Luxon’s ‘going for growth’ strategy seems to have come from the politicos among his advisers. They are all sizzle and no sausage. Thus the increasing dismay of the public towards the government. Same happened to the recent Labour Government in its second term.

If there are any policy wonks near the current government, they may be advising ACT although they show little of the political judgement of politicos. 

It is too early to judge the efforts of the Opposition – whether Labour has learned from its failure in government. (It should read my book; even if I have it wrong it may stimulate them to get it less so.) Aotearoa New Zealand is going through a rapid social and economic transition but most of the public discussion is backward looking.

The choice between politicos and wonks is that the politicos are better at attaining and maintaining office, but their policy achievements are aspirational and rarely effective; policy wonks find it harder to get elected but when they are, they have the power to change. The Economist article is about getting the balance right.

The Reality of Fiscal Constraints

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

Why is the British Labour Government penalising its poor?

We have the spectacle of the Starmer-led British Labour Government taking measures which are making some of the most struggling Brits worse off. It has got to the point where Labour’s parliamentary backbench is revolting and the government has had to make partial concessions – the latest is a backdown over cutting disability and sickness benefits. It’s hard not to see Keir Starmer and Chancellor of the Exchequer, Rachel Reeves, practising fiscal austerity.

The underlying reason is that the British economy is stagnating. Since the 2008 Global Financial Crisis there has been no real growth in British per capita GDP. The economy is producing a quarter less than it would have if the pre-GFC trend had continued. (There are other affluent economies which are similar, so it is not just Brexit.)

You may think that if per capita GDP is flat, then things are not getting any worse, and ask why some people have to be made worse off. Leave aside that when there is an average of zero economic growth there are many people whose income is decreasing (offset by those whose incomes are increasing); averages can be misleading.

As this column has had occasion to point out, when focusing on the average, output (income) is not the same as wellbeing, nor does an increase in output necessarily mean progress. Indeed some rise in output may be associated with making things worse.

The most recent example was how smartphones – which have added to GDP – seem to have made adolescents worse off. Once young adults reported themselves happier than mid-age adults and about the same as the elderly. It was described as the ‘U Curve’ of wellbeing by age but today’s generation say that on average they are more miserable than all those older – happiness increases with age. The youth’s state may not be economically induced – we do not have the research evidence although one can think of causal processes – but it illustrates how ‘progress’ may not be progress. This is but an example. Do be cautious about equating GDP growth with social progress.

Additionally in Britain, and for much of the West, there are plans to increase military spending – mainly as a result of Russian aggression but not helped by Trump or Netanyahu. The output may increase national security but I doubt that people think it adds to their personal wellbeing. However, it diverts public spending from activities that they think will do so.

A further ongoing issue is that during a period of fiscal austerity some measures are delayed – in New Zealand we have held back on building public infrastructure – and the consequences of the failure eventfully catch up, adding to the fiscal pressures.

The British fiscal position is gloomy. Currently the budget deficit is about 5 percent of GDP while the public debt-to-annual GDP ratio is near 100 percent. While these figures may be defined slightly differently from New Zealand’s, they are certainly higher than ours. So the economy has little room for a boost in private and public spending. What to do?

The easy option is to talk about boosting sustainable economic growth, but despite the clamour of (conflicting) policy proposals, few are based on evidence or even explain the current long-term stagnation (and, to be honest, I am puzzled too). Even those policies which might boost growth will do so sometime in the future (when the current proponents are no longer in power).

Why not borrow more? This would amount to future generations paying for current consumption (and might explain why young adults are so melancholy). But most countries are nearing their public borrowing limits, in that lenders are becoming increasingly reluctant to hold more government debt. In a curious way (and presumably unintentionally), lenders are guarding the interests of future generations (although not out of benevolence). *

Britain’s independent Office for Budget Responsibility has warned that British public finances are in a relatively vulnerable position, with pension costs, climate change and volatile bond markets all posing significant risks. It observed that the UK has ‘the sixth-highest debt, fifth-highest deficit and third-highest borrowing costs among 36 advanced economies’. There is not a lot of room for fiscal manoeuvre, so Reeves has had to restrain or cut national expenditure.

That need not be public expenditure. Private expenditure could bear the burden by raising tax levels. Thus far, Reeves has been unwilling to do so in a major way, although she introduces increases where she thinks she can get away with it. (Jacinda Ardern ruled out her government raising tax rates, thereby drastically limiting Labour’s ability to implement the policies its supporters wanted including reducing inequality and child poverty. Nevertheless, desperate for revenue, her Minister of Finance, Grant Robertson, inched in new taxes whenever he could get away with it.)

I am not sure why Reeves and Starmer are so loath to raise tax levels other than the usual one that taxpayers don’t like them (but they don’t like the alternative policies of inadequate public services either). In New Zealand there are also vociferous neo-liberal lobbies which are opposed to any increases in taxation and therefore, being good fiscal conservatives, support cutting government spending. (Some of their work identifying shoddy government spending is to be applauded. They should be on select committees.)

So a Cabinet has to make choices. Think of it having a list ranging from the unavoidable (say, in the British case, increased military spending) to the nice-to-have, each accurately costed. (Actually they don’t; this is a simplification.) The list will include possible public spending cuts with financial gains. Tot up how much money there is to spend, go down the list until it is all spent, and cut off all those below it. It is not as simple as that but it illustrates the spirit of the exercise.

There will be divisions within cabinet. The amount of consultation outside will vary both directly with caucus and indirectly by budget leaks. The 1958 Black Budget was notorious for there being little consultation; the following Holyoake Government had very full consultation with its caucus. That would be difficult given the British Labour caucus totals more than 400 MPs.

Whatever the extent of the consultation, over 100 members of the caucus threatened to vote against some of the recent measures. The Starmer-Reeves Government made concessions. (There had been earlier upwellings but the Labour Government did not pay them enough attention.)

I’ve laboured through this process – even then it has been simplified – because the nature of the resistance is similar to what commonly happens here. The criticism was about a particular policy but there was no attention given to the underlying cause of fiscal restraint and no mention of how any alternative policy was to be funded. It was likely that the Labour cabinet was not enthusiastic about the cuts. They just had higher priorities on their list – healthcare would have been one (and the dissenters would have been just as unhappy had some healthcare programs been cut).

The economist who sees tradeoffs – there is no such thing as a free lunch – finds such public debates uncomfortable. There are almost overwhelming demands for the government to spend more (or to cut taxes so the private sector can spend more) but the constraints it faces are typically ignored or vague. Curiously, the ‘left’ tends to be more precise, with more specific proposals to raise taxes to fund their spending demands; the right tends to be vaguer about what public spending should be reduced to pay for their demanded tax cuts. Both drift towards taxing future generations – that is, borrowing.

The Starmer-Reeves Government plans to fund the concessions they made to their revolting caucus have been deferred to the end of the year. The hints are that there may be a tax increase. It is not easy governing in times of stagnation – being in Opposition is almost better and certainly easier.

* There is a crude Keynesianism that governments are borrowing from their public and have almost unlimited borrowing power. It would be tiresome to detail all it faults – Keynes would have been appalled; he spent a lot of effort negotiating US loans for Britain – but a key one is that countries are open to the world and are borrowing directly or indirectly offshore.

Is Progress Progressive?

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

We should not assume that all adopted innovations are progressive. Jonathon Haidt’s ‘The Anxious Generation’ illustrates that sometimes they require social measures to enhance well being.

The Anxious Generation is a book which probably everyone engaging with adolescents should read. Haidt’s thesis is that smartphones replacing flip phones led to a marked deterioration in the wellbeing of American adolescents, causing an epidemic of mental illness. He is a social psychologist so I am not qualified to judge how right Haidt is but he certainly appears convincing. (I also greatly admired his The Righteous Mind, where he is acting as a public intellectual.)

The thesis reminded me of the wider problem of how to deal with technological innovation. Smart phones are an impressive technology, but do they improve wellbeing? Are they progress?

Progress is a relatively recent notion in the history of humankind. Plato described how once there had been a golden age, and how things have gone downhill since. When Copernicus proposed that the earth went around the sun, the conventional wisdom comforted itself that Pythagoras had already thought of that; it couldn’t be new knowledge, could it?

About five hundred years ago, the view developed that not all valid knowledge was imbedded in the past – in books – but that it would evolve out of empirical investigation. An early proponent was Francis Bacon in his Novum Organum (written a decade after the King James Bible, but in Latin). That approach has since driven science. In a meaningful sense science is progressive because it builds on past results modifying and discarding old theories.

This is nicely illustrated by the suggestion that were Plato to be reincarnated there would be a bidding war for him – no doubt won by Harvard, the world’s richest university. (This is not to say that there have been no great philosophers since but I would go to a lecture by Plato – providing it was in English and not Greek.) However a reincarnated Archimedes, the greatest Greek scientist, would be relegated to a 14-year-old’s maths class. Science progresses.

Science creates technologies – ‘blueprints’ for doing things which get applied to human endeavour, most notable with the economy. Before science, per capita economic output had been constant for millennia. Had economies stagnated at that level, today’s per capita output would be a fifteenth of its current level. (That does not mean we are fifteen times happier, or even any happier. But we have undreamed of choice and opportunity, and live longer and healthier lives.)

Thus we think of technology as progressive too. But is it? The answer has to be cautious. Just because someone is promoting the new, it is not necessarily beneficial. Very often the real benefit comes after we have provided a social framework for its use.

That’s what Haidt is saying about smartphones. He is not against them but thinks that there should be rules for their use:

            1. No smartphones before high schools;

            2. No social media before 16;

            3. Phone-free schools;

            4. Far more unsupervised play and childhood independence.

I am not in a position to assess these policies, but an economist notes that the first two cannot be implemented by the state and yet are not simply a matter for individual parents since they won’t want their child to be left out if everyone else has them. The third could be state-imposed, but in my view it’s a direction to be implemented by individual schools to allow for local particularities (and to work with parents to effect the first two recommendations). The fourth is very much parental – read the book about how it fits in.

Sometimes greater state intervention is necessary. Laissez faire does not always work especially when a new technology arises. But a caution: we don’t usually know when a significant new technology appears how to regulate it. Smoking is a good instance.

Legislation was passed in 1907 to ban tobacco sales to persons under the age of 16, as it was feared that tobacco would ‘stunt’ a minor’s growth. It was a response to the introduction of cheap cigarettes. A feature of the parliamentary debate was that MPs said that smoking was appropriate for adults (i.e. themselves) but they were concerned for adolescents. They had no evidence.

It took half a century for scientists to be sure that smoking was harmful to the smokers. By then, there were powerful tobacco companies which not only opposed control, but deliberately suppressed their evidence that smoking was damaging to health. Given that tobacco is also addictive, it has taken till now to reduce tobacco usage substantially.

The new development is vaping. We don’t know how damaging it is – it will take a generation of vapers to assess its impact on their health with confidence; the 1907 debate indicates that initial assessments can be very wrong. The current advice is that it is better to vape than smoke but who knows? Best give up both.

Vaping is but one recent innovation with puzzling impacts. Make your own list of concerns: AI, social media, microplastics, smartphones … it goes on.

This column appears to make conflicting recommendations. One is that almost every significant technological change will need a public policy response which the longer we leave, the harder it will be to overcome entrenched interests. But second, identifying appropriate policy responses early is difficult and we may get them very wrong.

It must be a concern that we do not have much capacity to introduce early responses. The changes that this government has made to science funding have virtually closed down serious social science research except what can be funded under the medical science remit. (Much of what was previously funded was so woke it hardly counted as serious research, but that should have been addressed by tightening up criteria and appointing more credible selection panels.) We are left very exposed to failing to use many new technologies in a socially effectively way.

Importing findings from other countries is hardly the whole answer. We need local research capacity to channel overseas research into New Zealand for responses to the innovations may be affected by cultural circumstances. This is nicely illustrated when Haidt describes quite different responses by boys and girls to smartphones (although both end up with higher rates of mental illness). Readers will not be surprised by the differences; Haidt does not tease out why. If there is this difference within America – Haidt mainly focuses on American Whites implying that things may be further different for Blacks and Latinos – then how much of his analysis is relevant here in Aotearoa New Zealand? (The answer must be some – but which?)

The government’s focus on economic growth means it is concerned with technological innovation. Given there is no certainty that the innovation will enhance wellbeing and that some will be detrimental, it is unwise not to strengthen relevant social science, instead of relying on the laissez faire of low government involvement. Haidt’s The Anxious Generation illustrates its dangers, while the book’s drawing on a wide range of American social science research illustrates that neglecting it here will compound those dangers.

Investing in the Public Health System

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

What can you do when you have hit your borrowing limit and still want to spend?

One option is to cut back on maintenance of your capital – say, to delay repainting the house or keeping the car in tip-top condition. The government does the same. Hence our three water systems leaking, polluting and flooding; hence the deteriorating quality of the state housing and other buildings such as schools and hospitals ….

Another option is not to add to your capital assets – the car is still outside because you can’t afford to build a garage. Government does the same. Roads, schools and hospitals are crowded when they should be extended …

Or you can borrow sneakily on a credit card or by hire purchase. This is much more limited in the case of the government. The standards set by the 1989 Public Finance Act require reporting all borrowing including that in Public Private Partnerships (PPPs). Part of the reason for the 1989 change was that previous governments – especially Robert Muldoon’s – had been de facto borrowing by giving guarantees to private borrowers which were not reported to Parliament. That failure screwed up the debate of the ‘Think Big’ major projects; had the public known, the resulting decisions would have been different and less costly to the public purse.

But there is a more cunning form of de facto sneaky borrowing which is even more expensive. You can only afford to buy a house an inconvenient distance from the job, so you pay through the nose in the costs of travelling to and from work; you cannot afford to buy a house, so you rent from a landlord who in effect buys it for you and charges you a rent, the total cost of which is higher than if you had purchased the house yourself. The current government seems to be reduced to pursuing such strategies.

For that is the consequence of the Minister of Health’s announcement that he expects Health New Zealand (HNZ) to take out ten-year contracts with private health providers to deliver surgery. This is structural outsourcing, a form of privatisation (although the minister would deny the claim). Since a public hospital could hire the labour inputs directly, the essence of such HNZ ten-year contracts is the government hiring buildings and equipment it cannot supply itself (while giving the private hospital the security of cash flow to be able to borrow to acquire the buildings and equipment).

The minister could have given a direction to HNZ that it install the buildings and equipment for itself. But that would have involved funding public investment and the government judges that it has reached its borrowing limit. It is behaving like a credit-limited person.

At this point I have to deviate from the economics column and discuss whether the outsourcing will compromise the public health system. There are many with far more expertise in the area than this columnist who think that it will. (For instance, Ian Powell argues that ‘increasing the use of private hospitals for elective surgeries will normalise a two-tier system and enable the Government to perpetuate the continuing neglect of public health and further running down public hospitals’.) *

Only an ideologue thinks the private sector will necessarily be more efficient that the public sector (and sufficiently so to pay its higher cost of capital) without evidence. I have not seen many studies and those I have compared delivery where the treatment has been routine rather than complex. Moreover, it is rare for them to allow for the costs of professional training, which public hospitals (mainly) do.

Complexity would appear to be critical. I’ve just read Ivor Popovich’s A Dim Prognosis: Our Health System in Crisis — and a Doctor’s View on How to Fix It, which is salutary for somebody who has never worked in a hospital (and also a bloody good read). Admittedly, as he says, he highlights the medical crises and not the more boring bits. Popovich works in intensive care and there are currently no proposals to outsource that sort of care. But any operation can go wrong and as its complexity goes up, most of us would prefer to be near an ICU.

There are two issues an economist might raise. First is that these ten-year contracts amount to PPPs. I leave it to the accountants to decide whether they should appear as a liability in government accounts, but in economic terms they are an indirect borrowing for capital investment as a consequence of the government’s borrowing being restricted. We should consider costs when making outsourcing healthcare decisions, but it is ridiculous that the primary determinant should be some arbitrary borrowing rule.

(At this point it might be useful to reread last week’s column which explains how lenders function and why the government faces a borrowing constraint.)

So I want to suggest a way around the rule acceptable to the lenders, which means it will have to be transparent and sensible.

During the attempt to commercialise the public health system in the early 1990s – one could argue that the minister’s new directive is related to the notions driving that commercialisation – I argued there was a case for separating out the management of hospital buildings from the management of healthcare services. This corporatisation – for they would still be public-owned entities – would have involved the (then) AHBs renting the buildings from the hospital building owners, who would be managing them as commercial properties. The separation was to get AHBs to focus on healthcare delivery, which is quite a different exercise from managing buildings. As a general rule, ask an agency to do two such different tasks and it will do both badly.

This is not as extreme a proposal as it might at first seem. That is already how private hospitals function. The doctors using them lease facilities from the hospitals; they don’t own them. Moreover, it is not too different from the debt proposals of the previous Labour Government’s three waters scheme – that had other weaknesses.

The State Owned Enterprise would borrow for extensions. The resulting debt would appear on the government books. Lenders would be more relaxed about this addition, not only because it would be transparent also because it was set off against tangible development. In effect lenders would accept a higher public debt-to-GDP ratio because in the end it is not the number which matters but whether the debt is well managed.

To be clear, I am not trying to get the government to borrow sneakily. That is inefficient, it distorts decisions and is anti-democratic. But we need a regime which treats the provision of quality healthcare on its merits, undistorted by the need to get around accounting and banking rules.

* I am not ideologically opposed to outsourcing. Almost everyone agrees that the public healthcare system should be outsourcing to primary care. Too often patients are turning up at hospital emergency departments because they have not seen their general practitioners or went to see their GP far too late. That is both inefficient and also compromises the public’s health.

Constraining Fiscal Management

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

Why Government borrowing is limited

This column started out to explain how the proposed structural outsourcing of public surgery was partly a consequence of the peculiarities of our fiscal borrowing practices. In summary, the restriction on the government’s debt level means seeking indirect ways to provide the required capital. One way of doing this is ‘leasing’ the capital from the private sector. Next week I’ll explain how that is done in the healthcare sector; this week is to explain where the debt constraint comes from.

The consequence is that we either make some hard decisions or we undermine the future of the New Zealand economy by having too much debt and not enough capital. Wilkins Micawber reminds us it is not much fun being a debtor.

New Zealand’s Debt Strategy

The asymmetry between borrower and lender is well illustrated by Keynes telling the New Zealand Minister of Finance, William Downie Stewart, that New Zealand should borrow as much as it could to offset the Great Depression, but if he (Keynes) were a lender he would probably not be prepared to advance New Zealand any more.

Each lender has to make an assessment of the borrower’s ability to service and repay the loan in the future. The lender is likely to be more cautious about that prospect than the borrower. Arguably, the financial cost to the lender of failure is greater than the cost to the borrower. (However, the human cost may be less, although this is not usually a major consideration in such financial decisions.)

This superior position of lenders frames New Zealand’s debt policy. The government judges that its net-debt-to-annual-GDP ratio should not exceed 50 percent (based on its chosen debt measure). Because there is a need for a margin for emergencies – like the Great Depression – the government targets 30 percent. Currently the ratio is about 40 percent as a result of measures taken during the Covid pandemic.

In my view a 20 percent margin for emergencies is reasonable, so I focus on the 50 percent ratio. It largely comes from discussions with credit rating agencies (CRAs) and larger lenders. A credit rating saves every potential lender going through the same process of assessing the risk of default. The awarded grade help sets an industrywide benchmark – the higher the grade, the lower the risk and the lower the interest rate charged, not only for the government but for private borrowers too. As Keynes indicated, their judgement is decisive even if it is irrational (which it need not be).

I have never been at an assessment meeting with representatives of a CRA but I have had discussions with a number of those that have. I was told that the raters are sophisticated and knowledgeable; their questioning can put the New Zealand team under considerable pressure (which, those who have told me to their chagrin, is usually justified). CRAs do not just look at the government-defined debt ratio (which has varied under different regimes) and they include the NZ Super Fund assets in their assessments. They also look at private foreign debt, especially the offshore debt of the private banking system, because it can affect the ability of the government to service its debt.

This was well illustrated during the GFC, because a deterioration in the liquidity of foreign exchange markets meant the banks might not have been able to roll over their maturing offshore debt and could have turned to the Reserve Bank, forcing it to do the international borrowing instead.

I am certain that the CRAs are tetchy about borrowing for consumption. I’d like to think they accept that such borrowing can be temporarily justified during an emergency, as occurred with the GFC and the Covid pandemic, just as you would do during a household crisis. But, as I reported in an earlier column, the government’s relative net worth is projected to decline from about 40 percent of GDP this year to under 36 percent in 2029. That suggests we are borrowing for consumption and running down the public assets.

Borrowing for Development

Credit rating agencies are more benign towards funding investment for development (providing politicians are not syphoning off funds for personal use). Even so, there are caveats which mean that there will still be limits to how much lenders are willing to advance. Vogel’s publicity, aimed at lenders to fund his ‘think big’ development, insisted that New Zealand’s total debt was not high. Attitudes have not changed much since.

Consider the Ardern-Hipkins Government’s three-waters proposal which involved $10b and more of funding for future investment on fresh, waste and storm water systems. It would have made no sense to load onto this generation the cost of the infrastructure which provides for four and more generations. It seems that the Treasury was keen to keep the debt off their books and potential lenders were asked to advise which of the various funding options was most acceptable to them. This was one of the sources of the contorted policy; politics was another. The lesson is that funding arrangements affect the ability of New Zealand to develop.

Can we do better? First, because it is generally considered last, the private sector has a role. The more it borrows overseas, the more it compromises our credit rating, making it more expensive for the government to borrow. The more we save, the less we borrow overseas. There are some fine-tuning options. For instance, foreign direct investment in businesses is considered less compromising than bank borrowing. (Since the GFC, the Reserve Bank has reduced the exposure of the banking system to short-term international crises.)

Second, the CRAs probably think the government accounts remained exposed. (The government goes on and on about reducing borrowing but it is the debt and net worth levels which really matter; perhaps they don’t want the public to notice that net worth is deteriorating.)

Third, it seems likely that lenders would be more willing to make advances where it is transparent that the funds are being invested competently in real infrastructure. That suggests that separate entities may be relevant. I illustrate this in regard to hospitals next column.

The measures outlined require sacrifices to implement. But there is no easy alternative unless compromising the future of New Zealand is easy.

Footnote: I would not expect my readers to make this mistake, but they may have to remind friends that the government issuing cash is borrowing. In effect a banknote is an anonymous deposit in the Reserve Bank. (Issue too much cash and people try to dispose of it for goods which can contribute to inflationary pressures.)

Will and Resources

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

Trump may be accelerating the decline of US power.

In the 2004 film Downfall (Der Untergang), which portrays Hitler’s last days in a Berlin bunker, he says that if the German people are weak they deserve death. It is a view from philosopher Friedrich Nietzsche who argued that conflicts are won by those with the strongest will. The particular situation shows the flaw in the argument. Whatever the will, there is not always a way; there has to be the resources. The film has Hitler ordering his non-existent armies to resist the allies, but they had already been overwhelmed by Russian boots and American weaponry.

I was reminded of Downfall by Fintan O’Toole’s description of Trump’s version of history that the default condition of American capitalism is global capitalism; if it has been lost, it can be restored by sheer political will. I do not equate Hitler and Trump – there are parallels and there are perpendiculars. I am drawing attention to the parallel of the importance each ascribes to political will and the danger of not having the resources to back it.

Therein sits the inherent failure of the Trump strategy to make America great again. He is correct that America is not as relatively powerful as it was once – say after the Second World War, when the US share of world GDP was 27 percent while next down were the Soviet Union and Britain at about 7 percent each, and only the US had nuclear weapons. Currently, China’s GDP is about 19 percent of the world total, with the US at 15 percent, fractionally ahead of the EU. Russia and Britain are in the 2-3 percent group with Indonesia, Brazil and Turkey, while India (8%) and Japan at (4%) sit above. (GDP is measured in common prices.)

This column is about economics but there is an endnote about military strength; in the long run it also depends upon the economic base. A second endnote reviews the international monetary world order; this column focuses on trade.

Economists have a reasonably coherent account to explain America’s falling share of world output. To simplify, it is hard to progress the technological frontier which drives economic growth at the top of the affluent economy hierarchy; it is easier to import existing technologies and apply them once local governance is favourable. (There are lots of complications and caveats, many of which I wrote about in Globalisation and the Wealth of Nations.) But basically, we should not be surprised that the US share has decreased as other economies have grown faster. It happened to Britain in an earlier era, as America and the European continent with their larger populations overtook it. I shall not be surprised if eventually the world returns to the pattern of 1750, when the relative size of economies roughly corresponded to the relative size of their populations; of course there are complications and caveats.

Trump and many Americans have an entirely different explanation for America’s relative decline. They think politicians (of both parties) and the Washington bureaucracy have not had the will to maintain the US hegemony, making concessions to other countries at the expense of America. A leader with strength of character and purpose will not just stay the decline but reverse it, making America great again.

An economist finds this a difficult proposition; here I focus on the policy responses. The logic of this success-by-strength approach is for the strong to operate bilaterally. In a bilateral negotiation the stronger party can win by bullying the weaker one. Trump repeatedly tries this approach, hence his abandoning the multilateral trading system. The US is usually stronger than the other party, but in the case of China the two contestants are more equal. (This is also true for the European Union but its clumsy political structure, which gives many of its countries a near veto, has led to Trumpian America interfering in domestic politics to create regimes more favourable to MAGA.)

Other economies are much smaller and offer the possibility of successfully divide and conquer. Thus far the strategy has hardly worked because the smaller have sat tight rather than settle. Some have concluded that by working together they can resist the bullying. ASEAN, a loose federation of 10 South East Asian economies which collectively make up about 6 percent of the world’s GDP, is aiming to increase cooperation – including that none will make concessions to the US which harm the other nine – and to diversify which means working more closely with China, the EU and Japan. China is particularly keen because it would welcome a greater leadership role in the international economy, although it faces a number of limitations. (Who wants to replace one bully with another?)

Regrettably, much of our public discussion on international relations ignores its economic dimension (it’s a bit like Hitler and his armies) Meanwhile, the government has long been pursuing international cooperation and diversification, which will be vital in these troubled times. But Australia aside, we have few natural allies and Australia at about 1 percent of world’s GDP is only a larger tiddler – we are a sixth of Australia. (Sure, we may have special responsibilities towards nations in the South Pacific but they have even less economic leverage.) Our preference is for a multilateral world order based on the rule of law. That is not Trump’s, nor have recent US presidents – and, especially, the US Senate – seen it as a priority.

That is the irony of MAGA. It will not reverse the long-term diversification of the world economy but it may speed it up. The US will increasingly need friends too, but ‘America First’ is alienating them. It is certainly not going to make the country great again. Trump’s policies are undermining the arts and literature, science and technology, universities and its moral leadership, which is what has really made America ‘great’. While he may be trying to make America dominant again, the logic of the world’s economic development is that the dominance objective will fail whatever the strength of will of its leadership.

Endnote on Military Spending. The military story is slightly different but as revealing. The US totals about 22 percent of the world’s military spending at common prices, compared with 12 percent for China and 9 percent for Russia, together almost equalling the US total. But NATO, excluding the US, pitches in another16 percent. What is unusual about the US spend is that it is worldwide, whereas most other countries’ military are focused on their backyards. Ukraine uses just over 5 percent (including that supplied by NATO countries) so there are other factors which affect the effectiveness of the spend, but only by so much. That the US is insisting its NATO allies spend more suggests that it judges there are severe limitations to its ability to police the whole world.

Endnote on the International Monetary Order. The US dollar dominates the world monetary system more than the US dominates the world economy. The issue is not that the US dollar is internationally the common unit and means of exchange. Critical is its share in international currency reserves. That is steadily diminishing as central banks reserves increase the share of other currencies (especially the euro). Nothing Trump has done will reverse the trend. His ‘big beautiful’ budget measures may accelerate the decline since it not easy to see how a reserve currency can be backed by a government with trillions of dollars of debt. However, in the immediate future the world will still depend upon the US Fed (Federal Reserve) in an international financial crisis, as it did in the 2008 GFC. In turn, the Fed has to be backed by the US Government which may this time be less reliable, especially if a cabinet of billionaires is more concerned with its personal fortunes rather than the world’s. The central banks governing the euro, renminbi and yen have been strengthening their abilities to play a greater role than in 2008, but they are not there yet.