The Archbishop and the Economist

<>St Andrew’s Trust for the Study of Religion and Society  24 October, 2013

 

Keywords: History of Ideas, Methodology & Philosophy;

 

Those who founded this venerable church, more than 160 years ago, might be a little disturbed that the Archbishop of Canterbury should be introduced into it. However my intention is not so much to be ecumenical as to recall a debate in economics of a mere 60 years ago, in which the ethical dimension of an economic question was symbolised by the Archbishop. In a different context it could have been a Moderator, the Vicar of Rome or, for that matter, a Chief Rabbi, an Imam, a leader of any other religious faith or even the minister of your local church. The point is that such people have an ethical comparative advantage over economists.

 

The incident which precipitated the issue involved economist Dennis Robertson. Although not well known today – I used one of his textbooks as a student – he was an eminent professor of economics at the University of Cambridge in the 1930s, when it had the most important economics department in the world, and he was knighted for his services to economics. It may also be relevant to mention that Sir Dennis was the son of an Anglican clergyman.

 

Among his contributions to economics was an article Utility and all That in which he pondered on the issue of interpersonal relations in welfare economics. From early days economics has been based on the utilitarian assumption that greater consumption generated higher welfare. There are a number of caveats to this conclusion, which economics takes into account. But as a general rule we assume a person is better off with higher income. The justification for using per capita GDP arises from this assumption.

 

The problem which concerned Robertson was what if a rise in one person’s income made other people feel worse off. This is an example of what economists call interpersonal utilities. Your own feelings of wellbeing – of happiness – depend up the feelings of other. Envy is a particular example; your feeling of wellbeing goes down if others are happier.

 

Where envy was widespread, it was possible that, in a certain sense, a rise in one person’s income could reduce the welfare of the public at large. What were economists to do? In his 1954 paper Robertson argued that economists should

 

assert as a plain matter of fact that economic welfare undoubtedly will be increased [in the event of some receiving higher incomes], then … call in the Archbishop of Canterbury to smack people over the head if they are stupid enough to allow the increased happiness which might be derived from this plain fact to be eroded by the gnawings of the green-eyed monster.[1]

As an aside, if economists are to discount envy, are they not also to discount altruism? My theme is that interpersonal utilities – envy and altruism – generate the most profound problems for economic analysis. For instance, another eminent economist, James Tobin, has shown that the standard propositions about how the market works are not true where there is widespread envy or altruism. In particular, self-seeking does not necessarily lead to the public economic benefit.

 

If pressed, most economists would mutter that a rising tide lifts all boats, and if everyone had a higher income there would be no increase in envy but there would be a rise in general welfare. Robertson would have added some caveats but would not have been uncomfortable with that conclusion. In summary, economists are driven by a belief that ‘more means better’.

 

Observe that the issue here is one of the normative economics of welfare comparisons, of how we evaluate economic outcomes. It does not ask whether envy and/or altruism is a significant factor in economic behaviour – whether the Archbishop’s bouts of head smacking have had any effect.

 

Until recently economists would have been unsure even how to investigate the question. However in the postwar era, and especially in recent years, data has been collected which throws some light on the issue.

 

Suppose you ask people whether they are happy. The reply involves a subjective response and economists are uneasy about such subjectivity. But there are other measures of happiness, including biological ones, which show similar patterns to that which I am about to report, so I think we can proceed on the basis that self-rated subjectivity reflects some objective reality.

 

What do the replies to the question generally tell us? There are lots of fascinating results including:

– Happier countries tend to be richer countries.

– More important for happiness than income are social factors like the strength of social support, the absence of corruption and the degree of personal freedom.

– Unemployment causes as much unhappiness as bereavement or separation.

– At work, job security and good relationships do more for job satisfaction than high pay and convenient hours.

-Behaving well makes people happier.

– Mental health is the biggest single factor affecting happiness in any country.

– Stable family life and enduring marriages are important for the happiness of parents and children.

– In advanced countries, women are happier than men, while the position in poorer countries is mixed.

– Happiness is lowest in middle age. [2]

I’ll come back to these later. Initially I am only going to focus on two major findings.

 

The longest series we have on happiness is from the United States. Since 1946 they have been asking people whether they are happy. The survey is a consequence of Congress responding to the Declaration of Independence which states that ‘all men … are created equal [and] are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.’

 

So for 70 odd years Americans have been dutifully carrying out the surveys. In that time per capita GDP has risen more than three times. In contrast average responses to the happiness question are much the same today as they were in 1946. Although their data is over a shorter period you get much the same conclusion for other rich countries. Despite rises in real incomes over time, there is no corresponding rise in people’s self-assessed happiness. More does not seem necessarily better.

 

Yet, apparently paradoxically, if you ask a group of people at any point in time whether they are happy you find that those on higher incomes say they are happier and those on lower incomes are less happy. So if my income goes up I am happier, but if everyone’s goes up, I am not.

 

Such a conclusion is threatening to the conventional wisdom. Inevitably it has been challenged. Some of the challengers are simply deniers who say the finding cannot be true. The more sophisticated argument is that the question is misleading, but methodologically however, their argument is circular because they do not draw on independent evidence but implicitly assume its truth and then prove it.

 

One empirical argument is whether it is true that communities with higher incomes are, or are not, happier. It turns out that in poor countries rises in average incomes are associated with greater happiness. So as, say, Bangladeshis, who live in one of the poorest countries in the world, get richer they also get happier. That contrasts with the rich United States which has not had a rise in average happiness for as far back as we can measure, despite rising incomes.

 

We can resolve the paradox by concluding that if a community is really poor, its members do feel happier as their standard of living rises. If your food, clothing, shelter is inadequate you do feel genuinely better if you have more of them. But at a certain threshold when adequacy is reached, additional consumption does not add to your happiness. In mathematical terms the relationship between happiness and incomes is non-linear: rising when incomes are low and cesign to rise when incomes are high.

 

 

Note that, when the foundations of the economics discipline were laid in the nineteenth century, even in Britain – then the richest country in the world – many people’s consumption was far from adequate, and it is a reasonable hypothesis that more meant better for them. But British living standards have since well passed the threshold and they, like the US, dont get a boost in happiness from a boost in income. Nor do we.

 

How high is the threshold? It is difficult to measure exactly and it may change over time. But currently it appears to be about two thirds of average New Zealand incomes. So we join the US and Britain – and indeed most OECD countries – in that higher average incomes do not raise average subjective welfare.

 

Because some poor countries have moved up closer to the adequacy threshold the world seems to have become a little happier in the last 30 years. Economic progress seems to have done some good.

 

The remainder of what I have to say today is about these rich countries above that threshold. With one exception. There is nothing I am about to say which changes such obligations we have, or may think we have, to enable people in poor countries to have a standard of living above the threshold – to get them to the state that when their income increases they remain about as happy on average.

 

So I return to my main theme: in rich countries more for everyone does not seem better – certainly not happier. However, another paradox, to have more relative to others in your community does increase one’s happiness.

 

As a result people will strive to lift their incomes relative to their fellows. But not everybody can do that. Ironically if we all succeed in raising our income we are not all happier. It’s a bit like when we used to sit on benches at rugby matches. When the game got exciting we all stood up, to see better but, of course, if we all stood up we did not see any better. Similarly if we each stand up for a high income to make us happier, we do not seem to get any happier.

 

But, and this seems crucial, I have just described a mechanism which generates material economic growth raising the material standard of living. People strive to improve themselves and that raises material standards of living. The difference of the story I am telling from the economic orthodoxy, which goes back at least 250 years to Adam Smith, is that the rise in material standards no longer seems to increase general welfare. You now have a sense why many traditionally trained economists are so vehement in their dislike of the outcomes from the happiness research.

 

Why are people on higher relative incomes happier than those on lower relative incomes? Twenty years ago some of those then on relatively high incomes had a material standard of living comparable to the income of those who today are relatively poor. Twenty years ago the income made a person relatively happy, today exactly the same standard of living makes a person relatively unhappy.

One mechanism to explain this strange state of affairs is the Robertsonian one of envy. People on high incomes are happy, and people on low incomes would be as equally happy if they were not envious of those better off than they are. If this were true the Archbishop should smack them all on their heads, thereby curing them of envy – with the result that their happiness would rise (presumably as soon as their headaches were over).

 

But there exists another – not unrelated – explanation. Perhaps incomes are associated with social status. A high income has others looking up to the rich, giving them attributes which are not justified by any talent they have but by the high incomes they have. Remember Tevye, from Fiddler on the Roof singing about if he were a rich man:

 

The most important men in town would come to fawn on me!

They would ask me to advise them,

Like a Solomon the Wise.

‘If you please, Reb Tevye…’

‘Pardon me, Reb Tevye…’

Posing problems that would cross a rabbi’s eyes!

 

And it won’t make one bit of difference if I answer right or wrong.

When you’re rich, they think you really know!

 

Certainly many of our rich who are not loathe to impart their wisdom to us all– trite and self serving though it may be – apparently on the basis that wealth gives them special insights. (I must add, however, that celebrities of any hue make the same claim – not just those exceptionally well off).

 

Because ‘money’ enables one to exercise public power and to purchase acquiescence, those who possess more of it have a status in society. Given that higher status generates higher self esteem the rich are happier. But as Bob Dylan reminds us, money does not talk, it swears.

 

Of course the rich have to demonstrate their wealth. I can remember the time – say 30 years ago – when it was not polite to boast about it. There were still huge houses but they were then hidden behind modest fences and – as I understand it – such people made generous donations but they were anonymous.

The acceptable way of establishing in public that one was well-off was by grumbling that one paid an awful lot of income tax. When top income tax rates fell the grumbling ceased – after all, given the generosity of the tax cuts to the rich, it would be impolitic to draw attention to them, especially as the main argument today is that high income tax rates encourage the well-off to avoid their public responsibilities. New ways had to be used to display one’s wealth.

We do not know the exact mechanism which led to the change, but it is evident that about a quarter of a century ago, conspicuous consumption became more common. Houses became ostentatious – the most ostentatious had two of them; trophy wives in expensive fashionable clothes began to appear in our gossip magazines; Gatsby parties were thrown with much media attention. More honourably the rich continued to make large donations to worthy causes. Most notably this is supporting creative activities (although, unlike in other countries, little is given for the promotion of a high quality public debate – which may explain why the nation is doing better in the arts and literature than it is intellectually). But unlike the past practice the generosity was accompanied by prominent mention of the donors’ names.

 

More generally, my impression is that not only did the policy changes of that period make major changes to the way the economy operated but there was also a change in society. It had not been well explored. Economists can only go so far and sociologists have not really started to address it. We know there was a large step up in inequality but my impression is that there was also a change in the texture of society as well, although other phenomena, such as the rise of the earning mother and the consolidation of the urban Maori, also had a major impact.

 

The economist qua economist observes the rise of conspicuous consumption and allied changes as a fact about economic behaviour. Perhaps they may feel a little more inhibited about applying welfare economics – or even to assume that more means better – but ultimately it is a shrug of the shoulders and the laconic ‘that is the way things work’.

 

At which point the Archbishop or some other religious leader steps in. A good place for them to start is to ask how it is that we value some people’s economic effort more than others? Economists might respond by pointing out that there is a difference between value and price; the facts are that some people’s work effort is remunerated more by the market than others, they are paid a higher market price, but that is not the same thing as value.

 

But, says our Archbishop, why do we pay the head of the Ministry of Health more than those who look after our elderly in residential homes? Surely the carers are doing more valuable work than the administrator.

 

Economists have thought about this problem a lot, albeit with a different example. Even as an economic student I was confronted with the question of why we value diamonds more than water, whereas the water is obviously more valuable to wellbeing.

 

It is partly a consequence of playing on two meanings of the word ‘value’. I could rephrase the question: why is the price of diamonds higher than the price of water? To simplify, the answer is that diamonds are scarcer than water, just as senior administrators are scarcer than residential home workers. Their price reflects their scarcity, not their value.

 

I am just about to explain the alternative meaning of the word, when the Archbishop jumps in asking why then do we equate ‘price’ with ‘value’? The short answer is that 200 years ago, economists were confused by the two terms and lumped them together. Even today, in the jargon of the profession, what should be called ‘price theory’ is still called ‘value theory’. Everyone else was equally muddled. But while economists got the issue sorted out just over 100 years ago, the general public still has not.

 

Our Archbishop persists. Then why do we equate value with price? Does it mean that high-priced workers contribute more to society than low-priced workers – and so they are more valuable? A well-trained economist gets very embarrassed at this point. It turns out that there is a sense in which high-priced workers contribute more to the economy – which is, of course, not the whole of society, Your Grace, because that is more encompassing than just the economy. However the justification is circular; the theory slips in the assumption that workers are valued at their price.

 

Economists cannot properly equate value (in this sense) with price without adding an assumption which does not come from economic science. The point is, Your Grace, that economists can progress the analysis only so far, but they have reached the point where they can go no further.

 

The Archbishop looks puzzled. He says that this is not what he hears in the public debate. Well, many who pronounce on the economy are not trained economists. It’s a bit like in religion all sorts of untrained experts pronounce on eternal truths, quite unaware of the subtlety of theological discourse. Do I see the Archbishop smile? Many in the economic debate are self-seeking, or representing the interests of those who pay them. Sadly too, the issues I’ve been raising are so hard that they are put aside. My impression is that many of today’s economists are not taught them; certainly we do not teach methodology as we once did. It is a bit like getting a religious training without much theology.

 

So we just take it for granted than more means better, that the purpose in life is happiness from higher material standards of living. Your Grace may want to challenge that assumption.

 

Actually there was a major economist who did. But he was also a very important philosopher. It was in that role I first read John Stuart Mill. About 150 years ago he had been asked by the utilitarians, who included his father, to provide a rigorous foundation for the theory, which argues the aim should be greatest happiness for the greatest number of people. In the end Mill undermined the Utilitarian’s theory when he wrote:

 

It is better to be a human dissatisfied than a pig satisfied; better to be Socrates dissatisfied than a fool satisfied. And if the fool, or the pig, are of a different opinion, it is because they only know their own side of the question. The other party to the comparison knows both sides.

 

Economists found that Mill’s challenge so difficult that they have tended to keep to happiness as an objective. You could argue the Rogernomic changes twenty-five years ago were predicated on producing happy pigs. (Whether the pigs ended up any happier is a matter for another occasion.)

 

So allow me, Your Grace, to continue with the notion that the ultimate purpose is happiness, although when you come to lecture here in your own right, I shall be all ears as to what might be a better purpose and how economists might contribute to it.

 

Let me go back to the research which listed the correlates with happiness. There are certainly some others but we dont have the evidence to be sure of them. Here are those factors which affect happiness which we do know about, in a slightly different order.

 

First, we know that age and gender matter, but even Archbishops cannot do a great deal about them;

 

Second, there are factors like the strength of social support, the absence of corruption, the degree of personal freedom, stable family life and enduring marriages, behaving well and quality mental health. These are all factors to which archbishops may make a contribution but economists certainly do not.

 

Third, job security and good relationships at work do more for job satisfaction than high pay and convenient hours. Important issues which we can do something about, although modern economic theory may not be much help because it says that pay will compensate for poor job security and work relationships; there is not a lot of evidence that it does.

 

The final group of factors which affect wellbeing are unemployment and sufficient income to provide an adequate standard of living. These are economists’ concerns. But as I have explained, already in rich countries we have generally hit the threshold of an adequate income. So all that leaves economists to focus on is unemployment – except, of course, to tell the world what is going on (something we are very good at, providing you do not look at our past record).

 

Now you may think that the economic conclusion from all this is that rich countries should give up economic growth since it is not contributing to their people’s happiness. I’m afraid, it is more complex than that.

 

First, as I have already explained, economic expansion is driven by individuals striving to better themselves. Suppose New Zealand was to give up economic growth. Then some – many? – New Zealanders would go overseas to strive there. Humiliatingly they would come back and, to boost their self-esteem, they would lord it all over us as to how well they have done – as already happens.

 

So we cannot avoid the world outside. But suppose world economic growth stopped – let us not forget there are billions below that standard of living threshold, so we would be condemning them to eternal unhappiness. However science would continue to progress and the resulting technology – new scientific applications – would continue to raise productivity and perforce reduce employment. This could mean more leisure but almost certainly the impact would be uneven and unemployment would occur for some, reducing their happiness.

 

Now I am not saying that economic growth is inevitable. There have been alarms about the world running out of resources and stagnating – or worse – going back to Thomas Malthus. In the following two hundred plus years it has not happened, primarily because technological progress has found substitutes for the scarce resources. Obviously one day Malthus is going to be right, but we dont know when.

 

A more serious immediate possibility for the rich world is that while productivity continues to rise, real incomes do not because the relative prices for their products fall. The good news is the beneficiaries from the fall will be many of the poor countries.

 

Do I hear the Archbishop saying with exasperation, ‘once more you economists are going on about the next world, mainly because we cant know whether you are right or wrong and when we do find out you will be forgotten. What I have to deal with is the here and now.’

 

I think what the economics says about the present is that we have to be a lot more careful about evaluating progress. Some makes us better off and we need to give a greater focus on them than just promoting more material production. One example is improved health care, another is in creative activity.

 

More generally, another great economic philosopher, Amartya Sen, has argued that we should pay more attention to what he calls ‘capabilities’ – life choices. Certainly a society which stunts the future opportunities of so many of our children could be improved considerably. Because we are running out of time I have to leave that for another day.

 

So what is the role of an archbishop? The message is that the economy needs more moral leadership. I dont mean the technical discussions of what is happening. Rather economists need more help on how we are to evaluate the performance of the economy. And so does the public.

 

They, as well as economists, have trapped themselves into thinking what matters is material output – that more is better. However, whatever is the purpose of existence, economic growth in an affluent society is probably not closely related to it Even so economic growth will happen to some extent and it would be sensible to harness it for the higher purposes.

 

So, Your Grace, you might emphasise that the measure of man – or woman – is not their income. It may well be more important how they spend it, especially how much they give to others including through taxation to the public chest, for often that is the best way to raise public wellbeing.

 

An earlier religious leader – you will know Jesus’s teachings, Sir, but how little they impact on modern society – told the story of the widow’s mite.

 

Jesus sat over against the treasury, and saw how the people cast money into the treasury: and many that were rich cast in much.

There came a certain poor widow, and she threw in two mites.

He called to him his disciples, and said ‘truly this poor widow has cast more in, than all they which have cast into the treasury:

For all they did cast in of their abundance; but she of her want did cast in all that she had, even all her living. [3]

 

The Archbishop has a puzzled smile. ‘You are really arguing for interdependent utilities are you not, Brian’?

 

‘Yes, Your Grace, but the opposite way around to that which concerned Robertson. Against envy and for altruism.’

 

‘But you said, Brian, that would muck up economics.’

 

‘So be it. We should not run the world to suit economists. The purpose of life is not set by them. Our role is to understand the economy but also to help it meet society’s needs. Others have to determine what those needs are. We are servants not masters.’

 

‘Just like archbishops.’

 

‘Even more than archbishops, Your Grace.’

 

Endnotes

[1]  D. H. Robertson, “Utility and All That?” Economic Journal, December, 1954.

[2] The list is adapted from the First World Happiness Report:

http://earth.columbia.edu/articles/view/2960

[3]  Mark 12:41-44: adapted from the King James Version.

 

Labouring over Inequality

The big issue concerning Labour’s grass roots is a bit of a surprise.

 

Listener: 17 October, 2013

 

Keywords: Distributional Economics; Political Economy & History;

 

The popular party vote that elected David Cunliffe leader of the Labour Party reveals much about what the party grass roots think. They gave a lower significance to identity politics than the upper echelons of the party did. It is not that they care less about the “minorities” but rather that that concern is no longer particular to Labour. The gay marriage bill was passed on a cross-party vote.

 

Nor was the “spy state” prominent. I thought the left might use this to counter the “nanny state” accusation. But although clumsy government handling of surveillance issues is of great concern to some – who may well be far-seeing – it does not appear to have moved the public yet.

 

No, the message from the meetings was that the red roots remain concerned with economic issues. I am not referring to promises to accelerate economic growth. An opposition always promises that; in government, the party is grateful to maintain the past growth rate and its promises to attain higher targets are soon forgotten. Remember National’s in 2008 or Labour’s in 1999?

 

Other issues that concern economists are not uppermost in the public mind, such as the failure of light-handed regulation: the deaths in industrial accidents and earthquakes; price gouging in telecommunications and electricity; lost savings in the financial sector; and wasted investment from badly constructed buildings. The Government is addressing these failure by failure, but it has no comprehensive philosophy; there will be more failures.

 

Savings remain a problem. If we don’t save, we end up with the country being bought up by foreigners and a high real exchange rate stifling exports, production and jobs. But again it is a bit hard to enthuse the public about such a technical issue.

 

One might also worry about the quality of life. Today’s most vigorous concerns are the law and order campaign at one end of the political spectrum and the pressures on the natural environment at the other. But there are many in-between – for example, the alcohol limit for drivers. It would be an exceptional politician who could lead the public by advocating improving the quality of society.

 

What the Labour members emphasised was a concern about economic inequality. This is a bit surprising. Inequality in New Zealand increased sharply a quarter of a century ago. The result has been well known to researchers for two decades, but few took much notice. The degree of inequality has since remained at roughly the same level – in the OECD, we’re 15th out of 34 countries, compared with 10th out of 17 in 1985 – but suddenly it has become a matter for public concern.

 

Probably the increased interest reflects inequality having recently risen sharply in some countries we follow where there is now a vigorous debate that we colonials imitate. Recall that a (social science) prophet is without honour in his own community. Our conventional wisdom prefers the ephemeral.

 

Perhaps, too, many people are tired of their low incomes and think that reducing inequality will raise them. But you can’t raise everyone’s. Some of the voters Labour is after may suffer, making a sacrifice in the public good.

 

The inequality rhetoric places the Government at a disadvantage, because there is no easy response like the one to Labour’s housing package. It could say that this is a “gimme” policy, a bribe to potential voters. But National’s tax cuts have been, too, except it was the rich who benefited.

 

It is easier to raise concerns about inequality than to propose robust, effective policies. Much of what is put forward reminds us that every complex problem has a policy response that is short, simple, understandable – and doesn’t work.

 

Today we are paying the price for more than two decades of high inequality. As the Child Poverty Action Group has repeatedly said, too many children have grown up in deprived conditions that will mar their adult lives by low productivity, poor health and additional social costs. The consequential adult delinquency and poor social quality will be with us for a long time.

Commentary on Treasury’s Living Standards: a Short Guide to ‘Managing Risks”

<>This is a commentary of a Treasury document available at 

<>http://www.treasury.govt.nz/abouttreasury/higherlivingstandards/hls-ag-risks-jan13.pdf

            The living standards framework is at:

            http://www.treasury.govt.nz/abouttreasury/higherlivingstandards

I was asked to do this comment in a hurry. Some of the thinking is as superficial as that of a university professor (as we say in the trade).

 

Keywords: Governance; Statistics;

 

Introduction: The Pentagon

 

The context of this paper is ‘the pentagon’ which is a diagrammatic representation of the New Zealand Treasury‘s living standards framework. Each vertex summarises one of the outputs which Treasury uses to assess whether its policy recommendations contribute to improving New Zealand’s living standards. They are

– economic growth

– sustainability for the future

– increasing equity

– social infrastructure

– managing risks.

 

In my opinion the way to think of them is that they summarise the issues that the minister they are advising might want to raise, and hence the framework becomes a checklist for each Treasury analyst when evaluating policy. Of course each minister will give the objectives (the vertices) a different weighting/significance. But it is not for the Treasury to second guess the minister. Rather it needs to be prepared to respond to the minister’s preferences.

 

(There is a weakness in this interpretation however. Some ministers – all ministers to some extent – with be concerned about the quality of output. This includes

– externalities

– the impact of policy on the non-market sector

– and, as John Stuart Mill put it, ‘it is better to be a to be a human dissatisfied than a pig satisfied; better to be Socrates dissatisfied than a fool satisfied.’ (Since this is an issue which economists often overlook let me illustrate. The 1989 report on Post Compulsory Education and Training said that policy should not distinguish between education and training. In doing so it argued that educational policy should ignore the quality of the outputs of the educational sector. That approach has characterised most public policy since. Whether it has achieved that objective – that the pigs are happy – may be debated.

 

In my experience some ministers have been concerned about at least some aspects of the quality of life in New Zealand. Without that notion in its living standards framework, the Treasury is not well prepared to respond to this concern.)

 

This paper is about the managing risks component of the living standards framework – one of the vertices of the pentagon (or hexagon, if quality is added as a living standards objective).

 

The Treasury Risk Management Document

 

The need for a Treasury document on risk management was well illustrated by the following from the just released Financial Statements of the Government of New Zealand. ‘EQC expects to have the necessary financing to meet its liabilities as they fall due over the next twelve months’. It is a great comfort to those living near the Wellington Fault that there is no risk of a major earthquake this year.

 

But how is the government to take into consideration that some things are less certain than the impossibility of a major earthquake in Wellington? This Managing Risks document might be thought as a step towards addressing the issue. However, I am uneasy about its approach to managing risk as a vertex on the living standards pentagon (while accepting that it may be a useful document for Treasury officials to have for management purposes). The other four vertices are social outputs, each intended to be a valuable object in itself. Managing risk, as presented here, is much more of an input – a management process.

 

I shall explain later about how one might redefine the point as an output, trying to reduce certain sorts of risks that we all face – accident, aging, crime, food poisoning, ill health, unemployment and so on. But this is not what this document is about; it is a management document.

 

Describing the document as a ‘short guide’ implies that there is a long guide. I have not seen it, so necessarily these remarks are preliminary.

 

The Meaning of Risk

 

First, I need to tease out the meaning of ‘risk’. I am a bit old fashioned with a Knightian view. The good Chicago professor distinguished between risk and uncertainty: risk is what you can quantify, uncertainty is what you cant. As it happens, a particular case often locates itself ambiguously between the two. You may know something about the probability distribution of the event but not with a sufficient degree of precision. In which case it may not be possible to apply the standard risk management strategies. On the other hand, if there is some knowledge about the distribution, the standard response to uncertainty may not be the most efficient approach in the case.

 

People thought they found a way around this by the application of Bayesian probability theory. If the risk is not fully quantifiable then – to quote a past prime minister – you ‘make it up’, or rather the market makes it up. The danger of such an approach was well-illustrated in the Global Financial Crisis. Models – more highly strung than those that use a catwalk – were deficient in key parameters, so the users made them up. When the models were stressed by the world as it was – rather than as their managers hoped it would be – they collapsed and the financial structures on which they were based collapsed with them.

 

At least one conclusion from this rather calamitous farce is to be aware that there are ‘known unknowns’, and not to transform them into ‘known knowns’ by the use of fictitious parameters or untested theories.

 

The Knightian approach provides a slightly different framework to the ‘pokie machine’ on page 3 of the paper we are looking at. To simplify it says

– identify all the sources of uncertainty;

– select the ones which are important. Typically that means they have a high probability of happening, or the cost when they happen is high;

– try quantifying the distribution’s parameters of each case. Where that can be done adequately this is a case of risk, where it cant it is a case of uncertainty.

 

If it is an uncertain case there are fewer options to deal with it. The most obvious is to reduce the risk by mitigation – perhaps a mini-max strategy. This uncertainty may not be the same thing as resilience, which I discuss later.

 

If the case is risk there may be an additional option of insurance type responses. I add to my earlier warning not to make up parameters, the additional caution to be careful of thick-tailed distributions. The conventional approach is to estimate a mean and variance from a sample and apply it to a normal (or related) distribution. However the distribution in real life may have thicker tails than the normal distribution. As Benoit Mandelbrot observed

 

According to portfolio theory, the probability of these large [stock price] fluctuations would be a few millionths of a millionth of a millionth of a millionth. (The fluctuations are greater than 10 standard deviations.) But in fact, one observes spikes on a regular basis – as often as every month – and their probability amounts to a few hundredths. …The discrepancies between the pictures painted by modern portfolio theory and the actual movement of prices is obvious.

 

There are two warnings here. First, dont assume that the world is (near) normally distributed; second, portfolio theory does not work where it isnt. This seems to be a part of the failure of the financial models which contributed to the Global Financial Crisis. I mention this because where there is a thick-tailed distribution one tends to be forced back into treating the event as uncertain.

 

Risk Shifting

 

One option available for risk management – not mentioned in the paper – is risk shifting. That, of course, is what insurance is about, where the risk is shifted to others more willing to take it.

 

There is a more insidious form of risk shifting, where the risk or uncertainty is shifted surreptitiously (or compulsorily) onto others. That is what happened in the 1980s when a lot of risk was shifted from the public sector (that is the taxpayer) to the individual. For example, government superannuation was converted from a defined-benefit to a defined-contribution scheme so the risk of the level of payout is the retired civil servant’s rather than taxpayers’.

 

There are many other examples; today is not the place to list or analyse them. I mention the phenomena as a practical illustration of risk shifting,

 

The Importance of Applications

 

I have one other caution about the paper before finishing with it. It has few practical examples and applications. This is a short guide and I have not seen the long one which may contain them. So let me illustrate the issue by the Regulatory Institutions of the Productivity Commission. Despite being a long paper it too lacks examples and applications. As someone who is working, and has worked in, a number of regulatory areas, I found it of little value, irrelevant to the practical intricacies I am concerned with. One is reminded of the economist who had read the kama sutra a dozen times but had never been out with a woman.

 

This paper faces the same danger. Even in the day since I was asked to give this presentation I have been alerted to the risk dimension in a number of topics with which I was dealing. In no case did I find the paper of much help.

 

So I would urge that if it is decided to continue the focus on ‘managing risk’ as a managerial input rather than a living standards output, the redraft pays more attention to examples.

 

(At this point one recalls the wisdom of Alfred Marshall applying it to management principles rather than mathematics:

 

[I had] a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics: and I went more and more on the rules – (1) Use mathematics as a shorthand language, rather than an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) If you can’t succeed in (4), burn (3). This last I did often.

 

Risk Management as an Objective

 

But is there a kind of risk management as an output of living standards – or an objective of attaining them – rather than just risk management as an input for public sector management? Whatever its strengths for management purposes The Short Guide to Managing Risks does not sit happily with the other four vertices of the pentagon which are outputs, each, in their own way, contributing to higher living standards. Can we recover the notion of risk to make it an output?

 

In fact government interventions often involve risk management aimed at raising the living standards of its people. In New Zealand’s case a major example is the welfare state.

 

Now it is not obvious that the state should eliminate all risk and uncertainty in people’s lives even if it could. Moreover it cannot, even if it wanted to. Very often it only reduces the risk in one person’s life by shifting it onto others – typically taxpayers. Trying to get a better balance was one of the objects of the policy changes of the 1980s. We can argue whether a better balance was attained, but I am eschewing that today. My point is that this is a proper matter to be included in policy analysis, and that the consequential decisions will affect living standards. I suggest that is the proper approach to the ‘manage risk’ point on the pentagon.

 

Without such a vertex there is an incentive to risk shift away from the government, even in circumstances which would result in a general reduction in living standards. Indeed it is unclear how the welfare state, whatever its form, fits comprehensively into the pentagon framework. You might suggest that the ‘increasing equity’ point on the pentagon encompasses the welfare state. I am at a disadvantage because I have not seen the relevant paper. My guess is that the welfare state still needs a separate dimension – vertex on the pentagon – discussing risk and uncertainty.

 

(In thinking about these issues one piece of research is not unimportant. Under certain experimental conditions it can be shown that people (Americans actually) trade off the possibility of a $1 loss against a $2 gain on average. I have never seen the implications worked through for public policy; but it suggests that some policies can improve living standards.)

 

The Role of Resilience

 

An earlier draft of this paper confused the risk vertex with resilience. Resilience has recently become a popular term following the failure of some buildings during the Canterbury earthquakes (although the environmental movement was concerned with it long before). Its popularity means it tends to be used casually without a clear analysis.

I use ‘resilience’ here to mean the ability to cope with an external shock. From the perspective of an economist there is a host of such shocks, including natural ones like earthquakes, numerous external offshore shocks (much of my research as been studying these) and shocks from new technologies (which may, or may not, be beneficial economically but often put additional strains on other dimensions of society). How to handle self-induced shocks is unclear.

 

Such lists are not analysis, although necessary if one is going to do the analysis in the context of the real world. However, the point to be made here is that resilience is something which we should be concerned about – a proper matter for public policy. Indeed one might argue that much of what Rogernomics was about was increasing the resilience of the economy (with the hope that everything else was sufficiently robust/resilient to be able to cope with the substantial self-generated shock the changes induced).

 

This is straying outside the original remit of the paper. So I want to make but two further points. The first is to mention Murphy’s principle: ‘design the system on the assumption that what can go wrong will go wrong.’ (This is, incidentally, not the same thing as Murphy’s Law that ‘anything that can go wrong will go wrong’. It is a design principle for managing risk and uncertainty). It is a minimax strategy, which led me in an earlier version of the paper to confuse resilience with risk.

 

The second point is to make the distinction between the two. Resilience is not really about living standards. It is about an attractive (one might say necessary) characteristic of any system. As such it belongs to a group of design issues which the living standards pentagon assumes – human rights and the rule of law are companions. In my view they should be included at the centre of the pentagon (or hexagon if quality is included as a relvant output).

 

However, as I have already argued, we can manage risk directly to improve living standards. So it cannot be the same thing.

 

Conclusion

 

In all this I affirm that in the living standards approach there is a need for a vertex covering risk and uncertainty (and security) as an integral part of living standards. One cannot avoid them, but sometimes collective actions can reduce their impact for the benefit of everyone.

 

“Inequality: a New Zealand Crisis’, Max Rashbrooke (ed)

Max Rashbrooke and his contributors have begun a valuable discussion about wealth distribution in New Zealand – but it is no more than a starting point, and one with huge gaps.

 

Listener:10 October, 2013

 

Keywords: Distributional Economics;  Social Policy;

 

In recent years, debates about income inequality in rich countries have become prominent because of two new concerns. The “inefficiency” one, as argued in The Spirit Level: Why More Equal Societies Almost Always Do Better (2009) by Richard Wilkinson and Kate Pickett, is that high levels of inequality generate poor overall health and increased social delinquency. The “macroeconomic” one is that the spectacular increase in American income inequality was a major contributor to the global financial crisis.

 

These concerns add to the traditional “ethical” critique that a society with high inequality is socially immoral and that there is surprisingly little evidence inequality stimulates economic growth in rich countries. Perhaps they also illustrate the fourth, “political” argument: the rich in America and Britain have ignored inequality, instead corrupting the political process by subverting democracy into plutocracy.

 

Such overseas concerns have, at last, reached New Zealand. The facts are that income inequality rose significantly in New Zealand about 25 years ago. In 1985, we were in the bottom half of the Organisation for Economic Co-operation and Development (OECD) in terms of inequality; 10 years later, we were in the top half. Inequality has not changed much since then, but New Zealand is no longer an egalitarian society.

 

It has taken a long time for such well-established facts to come to public prominence. Inequality: A New Zealand Crisis is the first major popular work. It both oversells the issue – if we are in crisis, we have been in it for over two decades (although the impact may be cumulative) – and undersells it by not being up to date with the research.

 

After two introductory chapters by the editor, journalist Max Rashbrooke, a useful chapter by Robert Wade, of the London School of Economics, offering an international overview and a couple of a more philosophical disposition follow. Then there are five on some of the consequences – for housing, educational and ethnic inequality and crime.

 

However, critical issues such as child poverty, health outcomes, social mobility, women and the tax and benefit system don’t get separate chapters. The last omission is particularly unfortunate given almost all the increase in our economic inequality stems from the reductions in the effectiveness of the redistribution system as a result of the lower taxes on the rich introduced by Rogernomics and of the benefit cuts under Ruthanasia.

 

Consequently, the five final chapters, addressing what may be done, suffer from the lack of foundation in explaining why we are now among the more unequal of rich nations. Some are pious, although others falteringly discuss “predistribution” policies – that is, what can be done to reduce inequality in the market system so redistribution policies do not have to be so expensive.

By bringing the inequality issue to our attention – numerous two-page “viewpoints” may help the reader to appreciate the impact of inequality – the book offers a starting point for a more sophisticated discussion of what is to be done if we want to become an egalitarian society again.

Volting in a Vacuum

Wellington’s disdain for local councils makes the present elections almost meaningless.

 

Listener: 3 October, 2013.

 

Keywords: Governance;

 

The abolition of the provinces in 1876 made New Zealand one of the most centralised states in the world. Not completely, however – a second level of regional, city and district councils exists that we are voting for at present.

 

But local authorities have little power to act, except at the behest of central government, which frequently overrules them. It is as if they were courts. Any “litigant” who dislikes a local authority decision can appeal to the higher “court” of central government, which will overrule the decision if the appellant – often business interests – puts up a powerful enough case.

 

Overruling, which can come in the form of a law change, replacement of a council by a commissioner or arbitrary threats and directions, is frequently done with the excess and enthusiasm reminiscent of a bully. For instance, was it necessary to replace the dysfunctional Canterbury Regional Council with a commission that has lasted beyond two elections?

Sometimes the centralist argument is that “our” money is involved. They mean general taxpayers’ money. The money, and the need for urgent co-ordination, might have justified the imposition of the Canterbury Earthquake Recovery Authority to deal with the quake mess, but need Wellington dominate the rebuild? Should not the citizens of Christchurch have a greater say?

 

It is not only money. According to its citizens’ representatives, Auckland faces future transport needs at an infrastructural cost that cannot be afforded from rates. A committee recommended user-pays, including tolling and petrol taxation. Not only would those measures help meet the funding target but, properly applied, they would reduce demand – especially during peaks – and encourage commuters to use public transport.

 

That sounds right to me, especially as one of the 70% of New Zealanders who live outside Auckland, I am not happy with paying for its infrastructure unless I get to use it. But the Minister of Transport, Gerry Brownlee, vetoed Auckland’s proposals. Hopefully a future minister will show more common sense. But what is instructive, for this column’s purposes, was Brownlee’s instant reaction.

 

The minister could have said he was glad to see the Auckland Council working through its problems, especially its acceptance of the need for a local initiative with a corresponding willingness to bear the additional cost. He could have worked with it to pass enabling legislation. All Parliament would require would be that Auckland’s actions reflected local wishes and did not compromise the general principles of government, including the needs of other localities.

 

But oh no, the Wellington control freaks weren’t having any of this local democracy thing, any more than the citizens of Christchurch could be allowed to decide the shape of their own city. Local democracy is verboten unless it does what the centralists want.

I wonder why? The Government’s behaviour typifies the long tradition of bullying locals, for the other side has been no better. The minority parties haven’t shone, either. Libertarian Act was hardly pro-decentralisation when it held the local government portfolio. You might expect the Greens to be, but MMP has given them a direct route into Parliament instead of building a platform in local body politics. In any case they, like the rest, are all too keen to grab power at the top and use it to direct everyone else.

 

Is there any point voting in local body elections? I shall vote in order to demonstrate to the centralists that I believe in local democracy, even if they don’t. The more people who vote in local body elections, the stronger the message that we want a less-centralised system.

Perhaps one day we will get a central government that listens to, rather than bullies, us. But I vote this month knowing that my real local body election – the one that actually affects my local community – is in a year’s time.

Calculating Sen’s Real National Income for New Zealand

<>Keywords: Distributional Economics; Growth & Innovation; Statistics;

 

I have just realised that we can calculate Amartya Sen’s ‘real income’ measure  for New Zealand for a 30 year period, by combining our Statistics New Zealand estimates of national income with the Ministry of Social Development estimates of household gini coefficients. This note describes how this may be done and reports the results. It demonstrates the exercise is feasible and that the gains from improved terms of trade over the last decades seem to have gone only to the rich rather than across the community as a whole.

 

Sen’s Measure of Real Income

 

The conventional measure of GDP, when interpreted in welfare terms, ignores the distributional impact of any gains (or losses) of output. Thus it gives exactly the same outcome if the all gains go to the very rich as if the gains are shared equally among everybody.

 

To get an insight into the issue consider two people whose joint income is 100. Richard has 70 of it; Paul 30 (this is roughly the share between the richest and poorest halves of New Zealand). Now suppose they get between them an extra 10. The GDP approach is to assess this as a 10 percent increase. But suppose it all goes to Richard. His increase is 14.28 percent while Paul’s is zero. Perhaps a better measure might be to say the increase was the average of the two or 7.14 percent. A different sharing of the income increase – say Paul got it all, a 33.3 percent increase – would give a different increase to the joint incomes – 16.67 percent as it happens. The point of the illustration is that the distribution of any gains (or losses) matters and that the GDP measure ignores this.

 

Sen suggested an alternative measure which he called ‘real national income’, which takes into account the distributional impact of changes. (1976; 1979) Ultimately it deducts from national income the share, measured by the gini coefficient, to reflect the degree of inequality.

 

Practically the gini coefficient is the average difference (in income in this case) between any two people in a population scaled by the mean of the distribution (in effect it is calibrated to one unit). A gini coefficient of zero expresses perfect equality, where everyone has exactly the same income; a gini coefficient of one expresses perfect inequality, where one person has all the income. If there is perfect equality with each person receiving the same share, Sen’s real national income corresponds to the conventional measure of national income in the system of national accounts; if there is perfect inequality Sen’s real national income is zero.

 

Of course, Sen has a more complicated – and rigorous – analysis (including whiy it is the gini coefficient which is used for the adjustment rather than some other index). But the exposition thus far is sufficient for these purposes. (There are other distributionally sensitive measures of income. See Jenkins 2012 and Atkinson 1970.)

Constructing Sen’s Index of Real National Income

 

We begin with the official GDP series. (In all of the following the aggregate measure is valued in constant prices and per capita.) This is converted to National Income in Production Prices (NIPP) by deducting consumption of capital (depreciation) and net payments to foreign factors. (As it happens the proportional deduction is broadly constant over the period; the rise in foreign ownership of New Zealand production is roughly offset by a falling share of depreciation in GDP.)

 

Since NIPP is measured in production prices, for income assessments it is necessary to convert it to National Income in Spending Prices (NISP) which differs by changes in the terms of trade. Generally, the terms of trade were rising in the period, so the spending price aggregate was rising faster than the production price aggregate.

 

The final step to get to Sen’s Real National Income (SRNI) is to multiply NISP by one minus the gini coefficient. The gini coefficient is as derived by the MSD report on Household Incomes. (Perry 2013) Years for which there is no data have been interpolated. Because income inequality has been rising, the SRNI grows more slowly that NISP (but, as we shall see, at a similar rate to NIPP).

 

National Income: 1982-2012

 

Each of the three series is scaled to an average of 1000 over the 1982 to 2012 years. (The gini coefficient series begins in-1982.) The data is shown in the Appendix Table and the Graph of the table.

 

Much of the story they tell is familiar. There was economic growth in the early 1980s, but from the mid 1980s there was a downturn reaching its nadir in 1992 or 1993. The turnaround led to strong growth, although income did not return to its mid-1980s level until the mid-to-late-1990s. Growth continued steadily until the mid-2000s, slowed down (or flattened out) and went into a contraction following the Global Financial Crisis. All the income series show a rebound at the end of the period, but this is mainly a statistical consequence of the treatment of insurance inflows after the Canterbury earthquakes of 2010 and 2011. (The inflows precede the write-offs of capital destroyed by the earthquake.)

 

To what extent do the three series tell different stories?

 

Over the thirty years between 1982 and 2012 the terms of trade rose about 40 percent. There was a major lift (of about 20 percent) in the period from 1986 to 1994, and further lift (again of about 20 percent) from 2003 to 2012.

 

The shift is sufficiently long term to require a structural explanation. The most compelling account is that the current phase of globalisation, in which manufacturing jobs are shifting to East Asia, is raising the demand for food faster than it can be supplied and so the price of foodstuffs (and also other natural resources) is rising faster than that of manufactures, the reverse of the story of the first three-quarters of the twentieth century. (Easton 2006) The shift only affects the quarter or so of New Zealand output which is exported, so income in spending prices rose about 10 percent more than income in production prices over the three decades.

 

So while the annual growth in NIPP was 1.37 percent, that of NISP was 1.66 percent.  That means that the terms of trade gain added slightly more than a quarter to incomes relative to production. The graph shows them having slightly different tracks over the three decades, but the difference is small compared to their secular trends.

 

The gini coefficient which converts the NISP to Sen’s measure rose in the period (sharply in the first decade and subsequently level since), which means it will not have increased as much as NISP. Again the track is not too different from the NIPP and NISP. The trend annual increase is 1.31 percent, very similar to NIPP and 0.35 percentage points (or about a fifth) below the NISP.

 

The implication is that the gains from the improved terms of trade went to those on higher incomes rather than were shared across the whole community (as was the intention of the General Wage Order when Arbitration Court operated). However, it is not obvious that the two phenomena are directly connected.

 

New Zealand’s Ranking in the OECD

 

In 2009 the OECD ranked New Zealand 21st out of 34 (its 33 members plus Israel) in per capita Net National Income, based on current PPP (i.e common prices). This measure corresponds near enough to NISP (but in common prices so there is no need for a terms of trade adjustment). Converting the totals to Sen’s measure (by multiplying by the complement of the gini coefficient) New Zealand’s place on a SRNI ranking falls to 24th (out of 34) passed by Iceland, Slovenia, and Korea. Each has a lower NISP but their less unequal income distribution means they rate higher on Sen’s measure of SRNI.

 

(One may have doubts whether New Zealand NISP has such a low level or whether there is some statistical artefact depressing New Zealand’s aggregate. However the basic message – that New Zealand’s relatively high income inequality compared to those near it in rankings lowers its SRNI ranking – probably applies if the NISP is higher. It should also be noted that 2009 – the most recent year for which we have comprehensive gini coefficients for the OECD countries – is the year in which the Global Financial Crisis impacted on the world’s economies with the probability that there have been some major changes in the GDP and NISP relative levels.)

 

Conclusion

 

This note establishes that it is possible to construct Sen’s measure of Real National Income back to 1982 and that the resulting series are appear to be useful for interpreting some aspects of New Zealand’s economic performance.

 

 

References

 

Atkinson, A. B. (1970). ‘On the measurement of inequality’, Journal of Economic Theory, 2, 244–263.

Easton, B. H. (2006) The Globalisation of the Wealth of Nations (Auckland AUP)

Jenkins, S. J. (2012) Distributionally-sensitive Measures of National Income and Income Growth, paper to LSE Growth Commission (24 May 2012)

Perry, B. (2103) Household Incomes in New Zealand: Trends in Indicators of Inequality and Hardship 1982-2012 (Wellington, MSD)

Sen, A. (1976). ‘Real national income’, The Review of Economic Studies, 43 (1), 19–39.

Sen, A. (1979). ‘The welfare basis of real income comparisons’, Journal of Economic Literature, 17 (1), 1–45.

 

Appendix Table: Measures of National Income

Year toMarch

 NATIONAL INCOME

Production Prices

(NIPP)

Spending Prices

 (NISP)

Sen’s Real Index

 (SRNI)

1982

842

811

864

1983

844

809

862

1984

859

823

874

1985

889

849

905

1986

875

831

889

1987

977

841

901

1988

901

881

946

1989

907

902

944

1990

912

916

933

1991

889

883

892

1992

868

855

857

1993

831

824

822

1994

873

868

861

1995

904

897

886

1996

937

927

911

1997

966

953

935

1998

969

954

934

1999

990

973

949

2000

1051

1032

1005

2001

1047

1043

1010

2002

1066

1069

1038

2003

1116

1106

1077

2004

1145

1146

1119

2005

1176

1193

1165

2006

1187

1205

1177

2007

1175

1198

1171

2008

1183

1236

1205

2009

1151

1206

1173

2010

1126

1166

1156

2011

1165

1238

1184

2012

1277

1365

1356

Trend

1.37 % p.a.

1.66% p.a.

1.31% p.a.

 

 

 

 

 

University Rankings by PBRF Score [1]

 

 

Keywords: Education; Statistics;

 

The PBRF (Performance Based Research Fund) score card has modified university behaviour substantially. This is not a paper about how that internal behaviour has changed. Rather it suggests that the scores may be used in different ways to draw quite different conclusions. Gilling’s law states that the way you score the game shapes the way the game is played. The PBRF scores seem to be shaping the way the universities are playing their games.

 

The origin ogf the PBRF arose from an unfortunate policy arising from a conflation between education and training, recommended by the 1988 Report on Post Compulsory Education and Training in New Zealand (The Hawke Report). That meant, in principle, tertiary training institutions would be funded at the same level as universities. Inevitably means were sought to get around the absurdity of the equation of education with training. One such means was to financially reward tertiary institutions (predominantly universities) for the research they did. The PBRF exercise was to measure the amount of by staff’s publication records.

 

It involves each university submitting a list of academics and their research records, who are then graded and scored. The scores are aggregated to give a measure of average ‘quality’ which is reported by subject groups within reach universities and for each university.

 

The Tertiary Education Commission (TEC) then reports the scores by ranking the universities by their average quality score. There is no need to; they could report them by alphabetic order, for instance. Or they could rank them by some of the other measures we shall report below.

 

One observes that while the financial rewarding continues, the PBRF exercise has taken a life of its own by ranking the universities by their PBRF scores. The universities compete fiercely to have a high average quality score. There are numerous reports of the manipulation of the PBRF measurement system. This note is not about that, although an appendix describes some of the alleged manipulations; it assumes that the exercise is broadly honest (or at least the universities are equally dishonest). Its point is to show there are still various ways to rank the universities.

 

The TEC ranking is as follows:

 

Average Quality Research Score of Submitted Staff

Victoria University of Wellington      (VUW)            5.51

University of Auckland                      (AU)                5.12

University of Otago                            (OU)                4.96

University of Canterbury                    (CU)                4.79

University of Waikato                         (WU)               4.53

Massey University                              (MU)               4.31

Lincoln University                              (LU)                4.02

Auckland University of Technology  (AUT)             3.59

 

I’ve done a simple check on the ranking, comparing the proportion entered for the PBRF exercise score with the entire staff. I could find data only for the 2011 (a year earlier than the PBRF census). [2] Here are the resulting rankings. [3]

 

Proportion of All Staff (EFTS) submitted for PBRF Assessment

UC                  34.5%

AU                  32.5%

VUW              32.5%

OU                  31.1%

MU                  30.9%

WU                 28.6%

LU                   25.6%

AUT                21.9%

 

The differences in ratios are rather surprising.

 

FIREPOWER

 

For some purposes what matters is the economies of agglomeration, the total number of staff on the campus who are doing significant research. The total quality on campus may matter rather than the average quality. Here are the rankings for aggregate PBRF (here called ‘firepower’).

 

(Observe that the original purpose of the PBRF exercise – to reward universities for their research activities – was to calculate the firepower, not the so-called ‘research quality rankings’.)

 

Total Quality Score (Total PBRFs)

AU                  7964

OU                  5795

MU                  3959

VUW              3535

CU                  2956

WU                 1996

AUT                1542

LU                     700

 

There are a couple of problems with this measure. First, the university may be multi-campus and it may be that the amount of firepower on each campus matters more than the total across all campuses. However, it is not easy to calculate the numbers of campuses each university has. [4]

 

Moreover what may matter for economies of agglomeration is a cluster of subjects (such as agriculture, arts, medicine or science) rather than the firepower of the whole university.

 

In any case this measure favours large universities. What about student access to significant researchers?

 

FIREPOWER PER STUDENT

 

Do students benefit from the PBRF-rated staff? We cannot answer that (there are excellent teachers who are of great benefit to students even if their PBRF grading is negligible). But we can assume that it may be true and calculate firepower per student (actually per 100 EFTS based on 2011 numbers).

 

Total Quality Score per 100 EFTS

OU                  32.8

AU                  27.6

LU                   25.2

CU                  23.6

MU                  23.6

WU                 23.0

VUW              22.7

AUT                10.2

 

A rather different ranking from the previous ones.

 

FIREPOWER PER DOLLAR

 

How much does the government get for its spending in each university?

 

PBRFs per $million Total Government Payments 2011

VUW              23.0

OU                  21.8

MU                  21.7

AU                  21.6

WU                 20.5

CU                  19.4

LU                   17.0

AUT                10.9

 

The rankings change again.

 

How much does the country as a whole get for the total revenue of each university, which includes student fees, research grants, business contributions, donations, interest income and the like?

 

PBRFs per $million Total Revenue 2011

VUW              10.5

UC                  10.2

OU                  9.8

MU                  9.1

WU                 8.9

AU                  8.5

LU                   6.1

AUT                5.1

 

This table might be thought of as measuring gross productivity of the university, except that it ignores teaching as an output. To get a rough idea of net productivity we deduct the average cost of an EFTS in the Institutes of Technology and Polytechnics (ITP) sector for each university sector ($14,800 per EFTS) from their government and fee revenue and divide it by the EFTS.

 

In effect we are assuming that were the universities without other (research) responsibilities their production costa would average the same as ITPs. However they receive more cash because of those other responsibilities thereby producing non-teaching outputs which are proxied by the PBRFs.

 

This gives a kind of net productivity (above teaching) measure and ranking.

 

PBRFs per $million Non-Teaching Revenue 2011

AUT                58.6     (1)

VUW              40.6     (2)

CU                  32.7     (3)

WU                 27.9     (4)

MU                  27.0     (5)

OU                  21.3     (6)

AU                  17.4     (7)

LU                   12.1     (8)

 

Arguably the university courses are more expensive than the ITPs ones (e.g. more postgraduates courses and also exceptionally expensive courses such as medicine). The third column shows the ranking if each university courses are 10 percent more expensive that ITP ones. They prove to be the same.

 

Conclusion

 

No, am I not going to rant against the PBRF which seems to have been designed by those with no understanding of economists’ thinking about incentives in tertiary education. There is at least one 50-year-old paper about this, but it would be too much to expect the designers to be only half a century behind the frontier. (No doubt they were given As for their PBRFs.)

 

Nor am I going to say any more than is in the appendix about the manipulations that universities seem to have got up to in order to enhance their scores.

 

I am certainly not going to say which of the above measures is best. The point of this paper is that you can choose different but reasonable criteria and get quite different rankings. Anybody who clings to a particular (and no doubt favourable) ranking over any other is – well – deserving of a high, if dishonestly earned, PBRF score.

 

Endnotes

[1] Economic and Social Trust On New Zealand, www.eastonbh.ac.nz In research it is usual to declare potential conflicts of interest. The author holds honorary positions in six of the universities and degrees from a seventh. I mention that I was also on one of the minor PBRF assessment panels in 2012. I am grateful for a number of academics who commented on an earlier version.

[2] The main source of data is the Tertiary Education Performance Report 2011.

[3] Note that the total jobs does not include outsourced jobs; practices may differ from university to university.

[4] Two campuses may be close to one another in the same city or they may be sited in different of cities.

[5] It has not been possible to allow for differences in course mix by university.

 

Appendix

 

The following ‘manipulations’ of the PBRF assessment system have been mentioned. The examples come from different universities.

– refusing to accept a resignation from a high research performing academic until after the census date, instead classifying them as on unpaid leave;

– accelerating the appointment of a high research performing academic, so they squeak in before the census date;

– laying off low research performing staff even though they are excellent teachers;

– temporarily laying off low research performing staff so they are not on the books at the census date but performing teaching duties before and after it;

– coaching staff to increase their apparent research performance.

– omitting very low scoring staff to boost the average of the remainder. [A1]

 

One might argue that in some cases parallel behaviour by a student would be judged ‘cheating’.

 

[A1] There are a number of discussions on the net about the ‘rorting’ including:

http://www.kiwiblog.co.nz/tag/pbrf

http://offsettingbehaviour.blogspot.co.nz/2012/04/pbrf-games.html?utm_source=twitterfeed&utm_medium=twitter

 

PS The 2013 World University Rankings from Quacquarelli Symonds gave the following ranking of New Zealand universities (In brackets is each’s world rankings.).

AU (94)

OU (155)

CU (238)

VUW (265=)

MU (343=)

UW (401-410)

AUT (471-480)

LU (418-490)

The survey ranks over 800 institutions (and looks at over 2000) So New Zealand universities generally appear to be in the top half.

On Capital Gains Tax

It’s time to stop subsidising speculation on housing.

 

Listener: 19 September, 2013.

 

Keywords: Regulation & Taxation; Social Policy;

 

Scared by finance company failure, you decide to invest some of your savings in a rental property. You borrow just enough so the tenant’s payments cover the interest, rates and other outgoings. The return you get is not from those payments but from the capital gains, on which you pay no tax and which are high because the price of housing is rising.

 

Why do housing prices rise? There are numerous reasons but a major one is that housing is not simply something people live in. It can also be an investment with a good return. Sure, there may be some supply shortages – especially in Christchurch – which contribute to rising house prices, but even a major building programme will not increase the amount of accommodation sufficiently to head off price rises. Regrettably, much of this price-raising demand comes from the lack of a capital gains tax, with the borrowing – or leveraging – giving you an even greater return.

 

A capital gains tax is one of those things that never quite get onto the public policy agenda, perhaps because too many influential people avoid paying taxes by investing in capital gains. That does not include ordinary homeowners. Sure, they make a profit when they sell their houses but they promptly make a loss when they buy the next one. A capital gains tax needs be levied only on investment homes, the houses owned in addition to the one you live in.

I see no need for an onerous capital gains tax designed to expropriate private wealth. It would not be retrospective but use as the base the rateable value at the time of implementation. Only increases above the rate of consumer inflation need be treated as the capital gains to be taxed.

Taking the demand pressure off housing as an investment, even on the margin, will slow down housing inflation. And yes, people will have to start investing in real production, not bubbling paper.

 

Special interests will object with a host of arguments to the effect that – well, er – they will be worse off. Of course they will be. The absence of a capital gains tax is a subsidy; withdraw the subsidy and they are worse off.

 

Because they are not as well-organised, there is not the same outcry from those being squeezed out of owning a home by the inflating price of housing stimulated by the government subsidy to speculators. The family renting your investment may well have been outbid for their home by a better-capitalised investor simply after the best return.

 

Won’t the proposed restrictions on mortgage advances to those with small deposits help? Although it is popularly presented in terms of its effect on prices, this is but one of various Reserve Bank initiatives aiming at improving the robustness of the financial system. This one is about a possible bursting of the housing bubble. Banks with borrowers with too little equity relative to debt are less robust than those with better margins. You can now have even more confidence in the strength of your bank.

 

This restriction probably will reduce the demand for housing a little, especially from first-home buyers. In any case, people will find ways around the restriction. That will increase the vulnerability of those who deposit their savings with second-mortgage lenders: be warned.

What is going on here is a common problem: the Government fails to act. In this case, it continues to subsidise investment in housing, but more commonly the problem is a weak fiscal stance. So, we all hope someone else, often the Reserve Bank, will offset its cowardice. But in this case – and usually – the Reserve Bank does not have effective policy instruments to address the Government failure. Those are in the hands of the Government.

 

As long as policy confuses housing as a home with housing as an investment, we are going to get wasteful speculative investment in houses, a weaker performance of the economy, rising house prices and families without their own homes.

State Leadership in New Zealand’s Economic Development

<>Public Sector Conference: 5-6 September, 2013

<>Published in Foreign Control Watchdog 134, January 2014: p.46-50

 

Keywords: Business & Finance; Globalisation & Trade; Governance;  Political Economy & History;

 

If you look at the top ten companies on the New Zealand share market, you will find that half were once owned by the government or once bought a major business from the government, one is dependent on government for a large proportion of its revenue, two depend upon government licences, and only two – Fisher & Paykel and Trade Me – are relatively free of government involvement.

 

The stock exchange list does not include businesses that are owned offshore and do not trade on our sharemarket, some of which are or have been as equally dependent upon New Zealand government. Three of our biggest factories – at Bluff, Glenbrook and Kawarau – are like this.

 

Or to cut the story a different way, recently political journalist Colin James wrote in his Otago Daily Times column that in the last month or so the government has deemed three businesses ‘too big to fail’ and has gone about assisting their survival. The three were Fonterra, Meridian, and Chorus. Allow Chorus is not even in the top ten of the sharemarket. Add those which are not on it and there must be at least thirty odd businesses which are in the ‘Too Big to Fail’ category.

 

This paper is not a rant against private enterprise. Rather it is to point out that the history of New Zealand economic development has been about a close relationship between the private sector and the public sector which has been far more intricate and nuanced that the political rhetoric of ‘private enterprise good, public enterprise bad’. As Colin James was pointing out, the complicated relationship between the two is likely to continue into the distant future.

 

It was not always like this. Before the arrival of the market, Maori had no national government while their economic activity was integrated into their life activity in a way foreign to us today. Early European contact involved business largely without government although even sealing and whaling were affected by British maritime law designed to exclude Americans. The sealers, whalers, gold miners and many other of the first Europeans worked in what we call quarries; their resources depleted and they moved on.

 

Adventurer Baron de Thierry presaged the future. Acquiring, he thought in a large chunk of land in the Hokianga with the intention of establishing his authority as sovereign chief. In 1823, he asked the British government to provide him with an armed vessel to defend his holdings.

 

The imposition of sovereignty was the prime interest of the early governments of New Zealand. While they were not greatly concerned with the economy, the provinces – wanting to attract migrants and mop up unemployment – offered bounties to stimulate economic activity; the most famous is the one which Gabriel Reed got for finding gold.

 

However, once the sovereignty problems in the North Island were resolved by the ending of the New Zealand Wars and with the gold boom exhausting itself in the South Island, the state turned its attention to promoting economic activity. We call this state-led economic development, called ‘Vogelism’, after its first great advocate, Julius Vogel.

 

There were two legs to Vogel’s strategy. The first had the state borrowing in London, hoping to service and repay the borrowings from the proceeds generated from the economic prosperity. The second leg was to spend the borrowings on improving the productivity of the economy. That included building the transport infrastructure and bringing in migrants to bulk the population.

 

The strategy of stimulating of economic development had a precursor in the provinces’ activities, but not to the extent which Vogel envisaged. Their borrowing was often more reckless than Vogel envisaged, which is why the provinces were abolished in 1876, making New Zealand one of the most politically centralised states in the OECD.

 

As much as we honour Vogel, his strategy was deeply flawed and could well have gone badly awry. The export quarries were replaced by wool, whose falling price was not fully offset by improved productivity on the farm and after the farm gate to which state. Involvement made a considerable contribution. When the foreign borrowing became restricted as the world economy entered the Long Depression of the late nineteenth century, the New Zealand economy stagnated too.

 

Ultimately we were saved by the arrival of refrigeration in 1882 which made it possible for meat and dairy products to be sold north of the equator. Vogel’s 1889 book, Anno Domini 2000, missed the new economy; it thought our salvation was in canned fruit. Without the benefits of refrigeration we probably would have had a similar destiny to Newfoundland. Overwhelmed by its debt and without a sound economy, the Dominion collapsed in 1933, becoming a province of Canada. Without refrigeration we would be a poor state of Australia today.

 

The New Zealand government responded to the opportunities of the export of processed grass by (you’ve guessed it) borrowing, although the deepening of the economy meant it was borrowing more from New Zealanders than from London. Less was spent on immigration but infrastructure still loomed large in government spending.

 

Now more of the borrowed funds were used for land settlement. The opportunities based on crossbred sheep and dairying were not suited to the great sheep-for-wool stations of the South Island, which were bought up by the government and ‘burst’ up into smaller farms, to be broken in by the sweat of a family. In the North Island much suitable land was still owned by Maori in the late nineteenth century and was similarly acquired by the government for farm development.

 

When we talk about infrastructure we usually think of roads, rails, ports and the post and telegraph, adding – in the twentieth century – energy, airports, airlines, telecommunications. But there had to be an institutional infrastructure to go with it. In 1876 Vogel founded the Public Works Department to supervise the building of the physical infrastructure while what became the Department of Lands and Survey was intimately involved in land development.

 

The government also established a number of businesses either because the private sector would not invest (or its investment collapsed) or because it was a means of regulating what was considered an over-rapacious private sector. That includes the Public Trust Office, the Government Life Office and the State Insurance Office. The State Advances Corporation was established to channel government borrowing to farms and, later, housing. The Bank of New Zealand partially fell into the government’s hands in 1894 when it had to be rescued from incompetent – some would say fraudulent – private governance. The similarly placed Colonial Bank was merged into it the following year. (Business ethics in the nineteenth century were not a high as today, and politicians more often failed to recognise a conflict of interest between their public duties and their private activities.)

 

Other organisational forms – neither public nor private business models – also sprung up, especially farming cooperatives. These might provide farm insurance and the like, but best known is the organisation of dairy processing. The first cooperative dairy factories might involve only six farms but over time they merged into Fonterra and smaller competitors. You will not be surprised to learn that even in the nineteenth century the government skewed the taxation system to favour cooperatives – in response to farmer lobbying of course. (Not-for-profit economic organisations still have an important role in some parts of the economy today.)

 

Another example of private sector failure occurred in the early twentieth century when, recognising that the native forests were being quarried to extinction, the government began planting exotic forests. This was not the last time that the government had to lead the private sector. Two recent examples are the establishment with Crown Fibre Holdings to head the ultra-fast broadband roll-out and the concessions to Sky City to establish an international convention centre in Auckland. The order in the expression ‘Public Private Partnership’ is a reminder of public leadership.

 

I shall not extend this brief history into the twentieth century, although I shall give further examples as I develop my main theme of the central role of the state in New Zealand’s economic development. Rather I want to make a couple of key points.

 

The first was that the state involvement was largely pragmatic and practical rather than politically inspired. Which is why it worked.

 

There were exceptions; perhaps the full nationalisation of the Bank of New Zealand in 1945 was the greatest. Moreover a government of the right was more likely to select a pro-private enterprise organisational structure than one on the left. When the Reserve Bank of New Zealand was established by the Coalition Government in 1934 it had private shareholders; but they were bought out by the Labour Government; today it is wholly government owned.

 

There is an important issue here. New Zealand history is sometimes presented as if the leftish governments were the promoters of state development and the rightish ones were not interested. In fact for most of its history the New Zealand right has supported and promoted state economic leadership although they organise it differently from the left.

 

State leadership need not mean state ownership although there have been two important drivers – other than politics. One was that until recently only the New Zealand government could borrow offshore in any quantity. There is a sense that remains true today for all the overseas borrowing of the banks is implicitly carried out under the umbrella of the state. That is why the Reserve Bank has to impose some restrictions on the trading banks’ overseas funding. If things go belly up, it will be the state which rescues them.

 

But not only the banks. For instance, under a National government the state has put nearly a billion dollars into Chorus as a part of its broadband roll-out. (Half of the taxpayer investment is in non-voting shares, half interest-free loans; my guess is that a Labour government would have done much the same, but had a stronger element of state ownership.)

 

The other driver for state ownership was monopoly (sometime compounded, in the case of some infrastructure by the absence of any practical way to price it properly). State ownership is a means of regulating monopoly, especially important in New Zealand given the size of the national economy and the isolation of many regions. Although our first competition-promoting legislation was passed in 1908 we did not really take pro-competition law seriously until the mid-1970s and it is still settling in. I’ll describe how we got telecommunications dramatically wrong a bit later, but I mention as an aside that in my opinion we have not got the electricity market properly organised yet. Instructively the current alternative regime, promoted by the Opposition but not the Government, involves a state-owned enterprise.

 

If the state involvement in the leadership of the economy was largely pragmatic and more bipartisan than the political rhetoric proclaims, my second key point is that it was sometimes inefficient. I am not using ‘profitability’ here as the measure of efficiency, although the Rogernomes who I am about to talk about equated the two. I mean that the state interventions did not always effectively attain the (multiple) targets set for them. The targets might be profit but could be such things as employment generation, regional development, technological innovation or simply state leadership.

 

But if state involvement is not always efficient, sometimes private enterprise is not very efficient either. Again I am not going to detail its failures – telecommunications is still to come – but recall that we privatised both New Zealand Rail and Air New Zealand with the promise that they would be more efficient (whatever that meant) as private enterprises. In each case the private sector management was so lamentable that they had to be renationalised.

 

Yes, while we need to keep inefficiency to a minimum – providing the means do not stifle innovation and progress – the real test is overall economic performance, the standard used when economists are evaluating capitalism.

If you do not get over-sentimental about what a wonderful country we are in, you will be struck by all the economic disadvantages it faces. It is small and isolated from the rest of the world. It has few valuable minerals (water excepted); even our soils are not particularly fertile. Our comparative advantage has been in foodstuffs and natural resources whose price relative to the price of imports fell through most of the twentieth century. And yet, despite all these handicaps and despite the inefficiencies of the public and private sectors, we have one of the highest standards of living in the world. Surely we are not saying that had there been no state leadership in economic development we would be even better off. As likely as not, without it, we would be more like Argentina, Chile or the Falklands (or Newfoundland).

 

New Zealand has had five great stagnations in the last 150 years. (We are probably in the sixth.)

1. The Long Depression: 1878-1895 (caused by a world depression)

2. The Interwar Stagnation:  1908-1935 (caused by stagnations in the British market stagnation, the Great Depression and soil fertility depletion)

3. The Post-War Adjustment: 1944-1950

4. The Wool Price Collapse: 1967-1978

5. The Rogernomics Recession 1986-1995

6?  The Long Recession: 2007-? (caused by the Global Financial Crisis)

 

Four of the five were largely caused by events outside our control. Only one can be readily attributed to poor economic management by the New Zealand government. Between 1986 and 1995 there was hardly any rise in per capita output – it fell horribly in the early 1990s. Ironically, the only stagnation that seems to be entirely our own fault was when we abandoned state leadership in development strategy.

 

Pretending inefficiency exists only in the public sector but not in the private sector is like awarding the prize in a singing competition to the second diva after having only heard the first. It is what the ‘public sector bad; private sector good’ rhetoric is about. Sadly that was the mode of political thinking in the 1980s and 1990s. It turned out the second diva by herself was a bit of a disaster, but together they can sing beautifully.

 

I do not have the time to detail how we got into such a muddle in the 1980s. In summary the world had moved on. It was no longer necessary to frame the issue of economic development as the social ownership of the means of production, distribution and exchange. Instead, the issue became the social control of the means of production, distribution and exchange.

 

Social control does not necessarily require ownership, which explains something which once greatly puzzled me. If public ownership was so good, why not nationalise all corner dairies? The answer is that subject to various laws, market competition means the dairies act in a way that society requires. We control corner dairies for social purposes by market regulation.

 

A step further was to recognise there was a need to separate political and commercial decision making. That does not mean that there should be never any political involvement, but it had to be a lot more restrained and transparent than it was in the Muldoon era.

 

The Fourth Labour government came to power wanting to accelerate the modernisation which Muldoon had delayed. However, for reasons that remain obscure, it chose to do so via the most extreme option of neo-liberalism – we call it ‘Rogernomics’. Antagonistic to the nation-building state, it is no coincidence that it dismantled historic institutions of the strategy, such as the Ministry of Works and Development.

 

The simplest explanation of this odd choice was set out by the French observer, Andre Siegfried, eighty years earlier. He thought that New Zealanders’ outlook was

 

not too carefully reasoned, and no doubt scornful of scientific thought, mak[ing] them incapable of self distrust. Like almost all men of action they have a contempt for theories: yet they are often captured by the first theory that turns up … In most cases they do not seem to see difficulties, and they propose simple solutions for the most complex problems with astonishing audacity.

 

Yes, for every complex problem there is a solution which is simple, obvious, easy to implement and which is bound to fail. Thus it was with Rogernomics. Not only did the economy stagnate, but many of its extremist polices – those opposed by the more sober modernisers – have been reversed, although it has taken two decades to do so. I give a couple of examples.

 

The first, as promised, was the privatisation of the state-owned Telecom. It was legislated – overnight as it happens – without putting into place a proper regulatory framework over its monopoly of the copper line between exchange and user. It was like putting a carrier in charge of the road; other carriers could use it, but they had to chug along behind the monopoly carrier. The result was an unregulated private monopoly which proved to be very profitable for its owners but which set back the development of telecommunications sector relative to other rich economies.

 

Eventually, after two decades, the business had its monopoly element was separated out into Chorus. Having lost its privileged position, Telecom appears to be struggling. (I hope it can overcome its difficulties for we need a competitor to offset Vodafone’s market power.) The lesson is that commercial profitability may not be a good measure of economic performance in an uncompetitive market.

 

My second example is the ‘so-called’ leaky buildings disaster (although there are also earthquake problems with some recently built buildings too). As in the case of Telecom the poor regulation of material use and design was the consequence of the penchant for ‘light-handed regulation’ which too often meant very little regulation industry at all. (Light-handed regulation is sometimes called ‘light-headed’ regulation; sometimes ‘light fingered’ regulation.)

 

There is no authoritative estimate of the size of the unfit-building disaster, but it seems likely to exceed the cost of the failed Think Big major energy projects – perhaps more than double – while additionally there is the misery of many of those personally involved. A significant proportion of New Zealand’s building industry activity is now devoted to replacing the inadequate buildings – often at very great cost to individuals, if not bankruptcy. Too much of today’s New Zealand investment is cleaning up the mess of failed regulation rather than adding to the economy’s productive capacity.

 

Did I say two examples? Briefly, a third. We have an unusually high rate of industrial accidents – about double the Australian one and well above comparable countries like Britain, Canada and Norway. The exemplar is the 29 fatalities at the Pike River coal mine (which occurred later than these statistics). It is hard to conclude light-handed regulation has been a success on the workplace floor either.

 

The conclusion has to be that the Rogernomes implemented the market reforms poorly and that we continue to suffer from that poor implementation. Even where we publicly reject neo-liberalism we still carry much of its baggage in our thinking and in our practices.

 

The solution is not to return to old ways. The socially and technologically transforming economy in a globalised world rules that out. Instead I want to finish by suggesting the policy framework that we should be using.

 

The most important lesson from the past – from our successes and from our failures – is that the state is going to be actively involved in the economic development of New Zealand. Its involvement is evolving. Here are five general principles.

 

1. The state will continue to play a major role in the provision of key infrastructure of New Zealand. Sometimes it will be necessary for the state to own the infrastructure, sometimes it will be a careful – but by no means light – regulator of private monopoly.

 

2. The state will remain involved in funding New Zealand economic development. Sometimes it will be by direct ownership financed by savings from its fiscal surplus or its borrowing. A new development is its sovereign funds such as those for New Zealand Superannuation, Accident Compensation, Government Superannuation and the National Provident Fund, and for quasi-sovereign funds, such as the Kiwi Savers. It is important that these funds have opportunities to invest in New Zealand – to reduce the proportion of New Zealand owned overseas.

 

3. The state needs to regulate actively but not onerously; where the market is not competitive, where there is an imbalance of marked power between the parties involved, where long-term considerations have to be taken into account. That covers such things as competition law, consumer law, workplace law and quality standards. It also needs to be involved where the failure substantially pushes back onto the taxpayer – as it would following a systemic financial failure.

 

4. The state needs to be careful not to be captured by a particular pressure group. For my taste, the current government is overly close to some business interests, although every government has to be sensitive to the needs of business. This must always be the understanding the purpose of business is to help to meet our social goals; never that business is the goal.

 

5. My fifth general principle is that the core public sector and the commercial sector operate in quite different ways. The Rogernomics revolution, which aimed to make the public sector like a business, was quite misconceived. It downgraded professionalism and responsibility, which is at the core of the public service ethic, and upgraded generic management and accountability, which more characterises business. While the public and private sectors should have the greatest respect for each other’s mode of operation, does not mean that one is always better than the other; each has a different purpose and functions in a different way.

 

The final point I want to make today – although there is much else I could add – is that while historically state economic development has been concerned with economic growth, in the future were are going to be less obsessed with economic growth as conventionally measured. Jobs and adequate minimum living standards will remain important, but environmental, political and social sustainability and the quality of life will become increasingly relevant. All in the context of the world we live in with the opportunities it creates and the limitations with which it constrains us.

Cleaning up Corruption

CLEANING UP CORRUPTION

Becoming a democratic country is not as simple as just holding free elections.

 

Listener: 5 September, 2013.

 

Keywords: Growth & Innovation; Political Economy & History;

 

Indonesians think of their country as a democracy following the introduction of relatively fair and free elections after the collapse of the Suharto dictatorship in 1998. This is certainly progress on the road to democracy, but an elected government is not the only requirement – the rule of law is vital.

 

Occasionally, Indonesian locals in some regions administer summary justice to an alleged criminal because the police have taken no action. The police are not well paid and sometimes focus on adding to their income rather than the routines of policing that we think normal.

 

Indonesia ranks 118th out of 174 countries in Transparency International’s 2012 Corruption Perception Index. Given that a central element of most corruption involves the acquisition of income, it permeates the economic system as well as the judicial and political systems.

 

You might ask, what is wrong with that? Isn’t it just a market system parallel to the conventional one?

 

New Zealand is least corrupt on the Transparency International index along with Denmark and Finland. The middleclass revolution, which began in the 19th century, has cleansed us of many forms of corruption. But they remain elsewhere.

 

Economic corruption is often associated with regulation and licensing (and tax avoidance). For example, quotas control how much beef Australia and New Zealand supply to Indonesia. We would sell a lot more if we were allowed to, so the licences are valuable. But who gets the rents – the income – from the licences?

 

When we had import licences, some of this income went to quota holders, making some of them very wealthy; other quota holders were squeezed out by price controls and some went to the alternative, New Zealand manufacturers. All of which distorted the efficiency of the economy and, arguably, its fairness. But it was extremely rare for any of the rents to go to the public servants and politicians who allocated them, such is the integrity of our system (in part due to the implementation of the Public Service Act, whose centenary we celebrate this year).

 

In Indonesia, those who allocate the licences can get some of the value. There are allegations that one of the political parties received funds from the beef licences. Its total slush fund, to which the meat quotas may have made a small contribution, is said to exceed NZ$250 million. (Parties need them, it is said, to fund their election campaigns.) The funds ultimately come from consumers paying higher prices and from producers (such as our farmers) getting lower returns. It might be better if the quotas were auctioned and the revenue used to lower taxes and increase public spending (including paying the police decent salaries).

 

Such reforms are difficult to implement. It’s not just a matter of setting up, as the Indonesians have, a Corruption Eradication Commission to investigate the kickbacks to the rich and  powerful. What matters is how economic relations are organised – even at the lowest levels.

 

So democracy is not just the electoral process. The rule of law matters perhaps even more. Political leadership is critical, yet we should never expect too much from a single politician. It is a long and intricate process to build the tools and systems required to deal comprehensively with corruption.

 

Indonesia is not unusual for corruption in developing economies – it is in the middle of them on the Transparency International list. Although we may be uncomfortable about corruption, the phenomenon is a part of the transition from the pre-market economy to an effective market one. In political and judicial processes, it reflects a parallel transition.

 

Today there is less in Indonesia than under Suharto. Hopefully, one day in this developing country and in many others, there will be even less as they make their way towards a fully modern economy and democracy.

 

This is the fifth column based on a study tour funded by the Asia New Zealand Foundation

Culture of Dependency

We must remember the lesson of the 1960s and ensure the diversity of our exports and markets.

 

Listener: 22 August, 2013.

 

Keywords: Globalisation & Trade; Growth & Innovation; Political Economy & History;

 

We learnt from the Great Depression of the 1930s that New Zealand was over-dependent on a few exports – wool, meat, dairy – being sent to very few markets. Economist and historian Bill Sutch called us a monoculture exporting processed grass to a single market, the UK.

 

Applying the lesson and diversifying proved much harder. We tried wood (Tasman at Kawerau), aluminium (the Bluff smelter) and hydrocarbons (Think Big); we tried import substitution but that shifted our dependency to imported components; and 50 years ago, we formed a free-trade arrangement – now called CER – with Australia.

 

We were alerted to our single-market vulnerability in 1961 when the UK applied to join the EEC (now the EU) with its protectionist agricultural policies. Conveniently, 12 years elapsed before it was admitted. Even so, when the wool price collapsed in 1966, we were still sending two-thirds of our exports to the UK. There followed the most rapid export diversification in the OECD. Once we were among the most dependent on a few products and markets; by 1981 we were in the middle.

 

The UK had long ceased to be our major market; today it is sixth behind Australia, China, the US, Japan and Korea, although collectively the European Union is our second-largest. Wool, which once constituted 40% of our exports, is now ranked 19th on the list of exported goods, and there are some big service exports as well, particularly tourism.

 

We have moved out of simple commodity exports to a complex array of products. Dairy exports are no longer dominated by butter and cheese; milk powder heads the list. Fonterra is also into “chaining” – supplying components of milk to other producers as inputs for their products.

 

Similarly, a meat plant’s disassembly line sends different parts of the same lamb carcass to China, the US, parts of Continental Europe and the Middle East as well as the UK; some byproducts, such as the pancreas, are converted into pharmaceuticals.

 

Worries remain that we are still excessively concentrated. There has been much pleasure at the growth of the Chinese market as a result of the free trade agreement, but we don’t want to become as dependent on it as we were on the UK. So we are trying to do deals with India, Japan, Korea, the US and the EU. But we are small and tend to get left waiting in the queue (in any case, each of those countries is very protective of its farmers). Hence the importance of multilateral (such as WTO) and plurilateral (such as Asean) deals. We seek opportunities in Asia, and have just done a deal with Taiwan, but the regional interdependence from

chaining means when China goes into a downturn, those economies will stagnate too; this has been Australia’s recent experience.

 

A new problem – obvious with hindsight – has arisen. Selling complex products requires sophisticated international marketing and distribution, which involve branding and reputation.

One of the strongest brands in the international dairy world is Fonterra. Its reputation is being damaged by some of its products, sold to other producers, being contaminated. Phytosanitary regulation has returned to the agenda following the melamine scare in China and the dicyandiamide one here – not just for Fonterra but for all our biologically based products.

 

My guess, based on some sophisticated economic models, is that the future of the New Zealand economy is centred on the export of advanced products and services based on our natural resources. We are not going to replicate the growth of the larger rich economies in other areas – we do not have the size to reap their economies of agglomeration.

 

By their nature, biological processes – in the production of meat, fish, forestry, horticulture and wine as well as dairy – are more subject to contamination than physical ones.

 

Brand and reputation require a high standard of quality assurance. It is not a matter of pretending we are clean and green. We have to earn it. That involves every worker. Relying on inspectors and regulation is not enough; it hasn’t been in the current case.

Where My History Research Is At: A Business Background

<>These are some notes I prepared for a session on 15 August 2013 to students doing a Bachelor of Applied Management (Business Heritage, Culture and Sustainability section) of the Christchurch, Northland, Otago and Waikato Polytechs.  

 

Keywords: Business & Finance; Political Economy & History;

 

To begin provocatively. Last week the government announced a $30m subsidy to the Tiwai aluminum smelter. Old hands will recognise that is exactly the sort of intervention which Muldoon used to do. Before we have a political reaction – indignation or support – we need to think about why the repeat of this behaviour.

 

While I have been writing a history of New Zealand from an economic perspective I have become focussed on Muldoon’s economic management as not an aberration but as an extreme form of the intimate relation between the state and business which has characterised the whole of post-European arrival economic development. (There is a lot in the book on Maori development too.) For instance, when in 1823 Charles de Thierry acquired, he thought, 40,000 acres in Northland he requested British protection. (The Colonial Office rebuffed him.)

 

Business functions nowhere in the world without some state involvement. The issue is how to get the right balance, something which has preoccupied me throughout my professional life.

 

For preparation I am going to list a number of Listener economic columns I have written over the last two years on this theme. If you do not have access to The Listener website or a hard copy, I describe an alternative below.

 

http://www.listener.co.nz/current-affairs/economy/the-fine-line-between-gambling-and-investment/ (6 August 2012)

http://www.listener.co.nz/current-affairs/economy/do-we-deserve-to-host-the-rwc/ (3 September 2012)

http://www.listener.co.nz/current-affairs/economy/infrastructure-problems-in-new-zealand/ (17 September 2012)

http://www.listener.co.nz/current-affairs/economy/loose-regulations-sink-economies-and-buildings/ (14 October 2012)

http://www.listener.co.nz/current-affairs/economy/government-not-paying-attention-to/ (19 January 2012)

http://www.listener.co.nz/current-affairs/economy/the-future-of-the-south-island/ (18 February 2012)

http://www.listener.co.nz/current-affairs/economy/breaking-away-from-light-regulation-in-new-Zealand/ (23 March 2012)

http://www.listener.co.nz/current-affairs/economy/botching-privatisation-again/ (14 April 2012)

http://www.listener.co.nz/current-affairs/economy/nz-governments-influence-on-economic-growth/ (26 April 2012)

http://www.listener.co.nz/current-affairs/economy/convention-centres-and-public-subsidy/ (26 May 2012)

http://www.listener.co.nz/current-affairs/economy/water-rights-and-ownership/ (4 August 2012)

http://www.listener.co.nz/current-affairs/economy/economy-soe-bonus-scheme-the-pms-priority/ (18 August 2012)

http://www.listener.co.nz/current-affairs/economy/leaky-legislation/ (15 September 2013)

http://www.listener.co.nz/current-affairs/economy/son-of-think-big/ (7 March 2013)

http://www.listener.co.nz/current-affairs/economy/sky-lark/ (23 March 2013)

http://www.listener.co.nz/current-affairs/economy/partial-sale-of-the-century/ (4 April 2013)

http://www.listener.co.nz/current-affairs/economy/competitive-advantage/ (16 May 2013)

 

Each of these columns is on my website (www.eastonbh.ac.nz) – albeit in a less attractive form. Use the key words to find them. For more, look at the ‘Business & Finance’ and the ‘Political Economy & History’ categories.  The following might be of particular interest:

 

http://www.eastonbh.ac.nz/2012/12/the-politics-of-nz-inc/

http://www.teara.govt.nz/en/economic-history

http://www.eastonbh.ac.nz/2011/07/five-great-stagnations/

 

See you all Thursday,

 

Brian (Economic and Social Trust On New Zealand)

Future Pressures and Caring for the Elderly

How to live with the Treasury’s Long Term Financial Projections.

 

Listener: 11 August, 2013.

 

Keywords: Regulation & Taxation; Retirement Policy; Social Policy;

 

I was on the external panel advising the team from the Treasury that put together its Long Term Fiscal Projections, required every four years and looking half a century forward. A hopeless exercise? They are not predictions but offer a framework to think about the future further out than most politicians do. Their aim is to reduce political shorttermism – the failure to face a looming reality. This column is not about the advice I gave (or what the Treasury

thinks), but about what I learnt.

The Long Term Fiscal Projections incorporate population change more clearly into our economic thinking. Because demographics change slowly – migration aside – we tend to be a bit casual about them in short-term forecasting. But because they change slowly, we can predict the population much further into the future. We know about the prospect of the population ageing, although in recent years it has been more than offset by changes in younger age  groups. This “demographic dividend” of the past is ending as baby boomers retire. The big pressure is over the next decade, after which the proportion of aged will still rise but not so severely.

 

This means increased fiscal pressures. I have long argued we should raise the age of ntitlement to New Zealand Superannuation in line with our increasing longevity. It would be stupid if we all got Super from 65 but lived to be 100 on average. The reversing of the demographic dividend adds a fiscal reason for raising the age.

 

Before an explanation of the related problem of costs of healthcare for the elderly, something about the general problem. Government expenditure has tended to rise as a share of the total from as far back as there is data. There are a few exceptional items – spending on defence has been coming down; let’s leave social transfers for a later column.

 

There is nothing wicked about this rising share. Society wants things that cannot be efficiently delivered by the market. Many – state expenditures on conservation, heritage, culture and recreation – are relatively small at present but they are growing. After decades of increases, education spending may flatten out relative to GDP, reflecting the diminishing proportion of the young in the population. The law and order vote is rising.

 

The biggest problem is government spending on healthcare, which according to the projections may double as a proportion of GDP in the next half century. That is no more than has happened in the past, together with demographic change, and is similar to what is happening elsewhere.

 

It is perfectly reasonable to want to spend more on effective healthcare as we become more affluent and technological innovation creates new opportunities for treatment. Public funding is the most efficient way of doing so. If there was an equally effective form of private funding, I would favour it. Private insurance is hopeless (ask President Obama); compulsory social insurance is just another (clumsy) form of public taxation. We are stuck with a large part of health spending being paid for out of the public purse. (Not all; we buy our own aspirins.)

 

That means rising tax levels for those things that cannot be privately funded, effectively putting upward pressure on the tax take. (Sure, we can introduce new taxes; my list of possibles includes carbon taxes, a capital gains tax, a financial transactions tax and GST on online overseas purchases.)

 

Consequently, there will be severe pressure to spend less. In response, we could easily undercut the very high-cost services to the very elderly by neglect; they can’t complain as much because of their infirmities

 

If we do, some of you may find yourselves having to provide extra care for your parents; of course you should, but in companionship not finance. Moreover, not all the very old have children, so they will be neglected. Aside from the common sense of raising the age for New Zealand Super in line with our living longer, reducing fiscal pressure from doing so means we will have more for public spending where it is needed, like when we are really old.

The Business of Inequality

<>Nelson Spirited Conversations; 24 July, 2013. (Revised)

 

Keywords: Distributional Economics; Political Economy & History;

 

On a recent television program New Zealander Robert Wade, Professor of Development Studies at the London School of Economics, suggested that New Zealand might be ruled by 1 percent of the population, say 35,000 adults. The Deputy Prime Minister, Bill English, rejected the claim, adding to Wade ‘Dont you dare say that again’.

 

Wade was referring to an argument that a small minority of rich people in America and Britain – ‘the 1 percent’ – have influence on government decision-making out of proportion to their numbers, for a purpose which is quite different from what the rest of the community desires. This literature argues that the 1 percent are not only rich but come mainly from the finance sector, which the government supports it to the detriment of the rest of the economy. New Zealand has no financial sector comparable with the American and British ones, so one cannot simply transfer their experience. Even so, Wade was right to raise the question – to dare to raise the question – whether there was a group who had disproportionate influence on the governing of New Zealand.

 

I am going to take up this challenge by looking at a particular example of a political decision. Working through it one can, I think, make some progress about how New Zealand is governed today and where those who govern want to go. There are many possible examples; tonight I am going to focus on the decision to give the Sky City Casino a number of concessions in order that it will build an international convention centre in Auckland.

 

The background to the project arises because New Zealand has no facility to host big international conventions. Many cities have convention centres, but they do not have the large conference hall, the breakout rooms and the associated catering and hotel facilities to attract very large ones. The result, it is argued, is that New Zealand is missing out on a growing international industry, which instead goes to Melbourne and Sydney in this part of the world.

 

However, when the calculations were done, it was concluded that such an Auckland centre would not be commercially viable, that is, generate sufficient profit for the private sector to invest in it. Other businesses would benefit, and it is possible that they may make sufficient profit to justify the project on a national basis. There is much dispute whether this will happen, with allegations that some of the evaluations are biased.

 

Because the convention centre is not commercially viable, there is no private consortium willing to risk its funds in the investment. Instead the potential beneficiaries – they are mainly the hotels and the providers of other auxiliary services and the building contractors – expect the government to stump up with the investment funds, thereby exposing the government to the risk of the downside despite not getting a return on its investment, even if the private sector interests do.

 

Additionally a major worry is that any international convention centre may not be adequately utilised – that it may be a great white elephant. So there is a downside risk; we could be left with an investment which gives insufficient return.

 

You will recognise the parallels with the Think Big investment strategy. The government is being asked to invest its funds to the benefit of the private sector. In the case of the Major Projects it was the government – the tax payer – which was left carrying the cost when the projects failed commercially.

 

We learned from the Think Big experience, and over the years the government has introduced a number of measures which, while they do not rule out engaging in another investment disaster, they do make it transparent when the government offers a large subsidy to a sectional interest.

 

Faced with this, and the overall fiscal constraint, the government invited proposals for the convention centre from the private sector. All of them required some government support. Apparently there was no careful evaluation of the merits of each proposal, but the Prime Minister, as Minister of Tourism, chose the proposal from the Sky City Casino, apparently on a hunch.

 

(As an aside: the PM has been accused of cronyism in his choice. I do not know whether he is particularly close to Sky City. New Zealand is such a small society that any PM would almost certainly know the principals of all the proposals. What I am struck by is the casualness of the decision making. That he did not get a proper evaluation suggests that he is insensitive to the possibility of claims of cronyism, a conclusion reinforced by his forgetting meetings with Ian Fletcher before he was appointed to head the GCSB. It is well to remember that these sort of informal relations and decisions are considered a curse in the public sector but are a norm in business.)

 

Sky City said it would go ahead with an international convention centre if it were given a number of concessions which would increase the profitability of the casino activities. In the end the government agreed to:

a 27-year extension of Sky City’s licence;

230 extra pokie machines;

12 automated multi-player gambling tables;

the introduction of cashless pokie machines and ones that can take $100 notes.

 

While such concessions are extremely valuable to the casino but there is no suggestion that they would increase its international clientele; the financial gains will be from greater use by New Zealanders. Therefore some other New Zealand enterprises – smaller ones – will suffer.

 

The existence of restrictions on gambling arises because some gambling – especially involving pokies – is socially damaging and requires controls. Accepting this, an economist would argue that the restrictions were of value and the enterprise which obtained a licence should pay the Crown for the privilege. The effect of the proposed deal is that the Crown receives the payment and uses it to subsidise the convention centre.

 

We dont know how much social damage these extensions to the opportunity for gambling will generate, nor the financial cost to the government in additional corrections staff, court personnel, health clinicians, policemen and social workers, nor on extra social security spending. It may be a little, it may be a lot. Research I was involved in suggested the biggest damage from gambling was psychological – damaging to the gamblers and their families. Clearly there is a tradeoff between the establishment of an international convention centre and other things New Zealanders’ want or dont want.

 

There are many other examples which could be used to illustrate the general point. Time and again the government has proved it is particularly responsive to the desires of the business community, especially the Auckland one. Examples include those which impact on the environment, the sale of Mighty River Power, the backdown over restrictions on alcohol sales and reducing harm from gambling, favourable tax policy to the rich and the rigorous reductions of government spending and the privatisation of supply.

 

Now Mr English might agree that this is true, and yet offer a different perspective. He might say that if the decisions do favour the business sector in the first instance, that is because they also favour all – or most – New Zealanders. His argument is that the private sector produces the incomes and jobs which enable New Zealanders to have a higher standard of living.

 

It is broadly true that businesses pursuing profit will increase GDP and jobs. (I have to add a caveat here that this may not be true in the medium term when the businesses are in the hyper-financial sector.) But is aggregate market output necessarily what we want, since it may include spending and jobs on economic bads like the social damage from gambling and environmental depletion? Are all jobs are equally valuable? Let me give a simple example which shows they may not be.

 

The Canterbury Earthquakes have done enormous damage, including people dying, lives messed up, and the destruction of heritage, residential, public and commercial buildings. Shortly after the shaking had settled down there was a view that the rebuild was beneficial to the New Zealand economy because it would create economic activities, profits and jobs. Let’s get real before we get enthusiastic. The gainsayers are not saying we need more earthquakes are they? Would it not be better if there had been no earthquakes and the workers were, say, out surfing on the same pay? Isnt the logic that we would benefit from more earthquakes of the Canterbury magnitude? What nonsense!

 

Or to go back to my casino gambling example, are we really better off from all the additional corrections staff, court personnel, health clinicians, policemen and social workers dealing with the social damage from gambling? Would not it be better if their jobs were unnecessary and they went surfing? It is not always true that increased output from increased profits is a good thing.

 

At this point I can go down a number of paths. For instance, there is a need for a rigorous economic assessment of what the government is doing about the environment. However, I was asked to talk tonight about inequality which is also the context of Robert Wade’s comments. In brief, his thesis was that inequality has been growing in America and Britain especially with the very extreme end – the 1 percent – receiving an increasing share of income.

 

So what has been happening to the incomes of our top 1 percent of taxpayers? Currently their share of reported taxable income amounts to about 9 percent of the total; that means the top one percent’s average before-tax income is about nine times that of the average taxpayer. They pay about 14 percent of all income tax and their share of after-tax income is about 7 percent, or seven times the disposable income of the average taxpayer.

 

There is a caveat here, because there is considerable tax avoidance among those in the higher income brackets. A common means is that if one lives only for a limited number of days each year in New Zealand, then one does not have to pay income tax. This is true for some of our most prominent rich. There is an irony here. Taxation may be the price of citizenship, but while rich tax avoiders not paying the price, they are still treated as eligible for knighthoods.

 

How does our one percent compare with those in other jurisdictions? In the United States the top one percent get 22 percent of all income if capital gains are included (and 18 percent if capital gains are excluded, as they are in the New Zealand data). So our rich are not nearly as rich as the American rich, nor as those in Britain.

 

One of the important features of the American and British rich is that they had much lower shares of income in the past. Twenty years ago the share of the rich Americans was 15 percent; it has gone up dramatically since then – by half to 22 percent. Twenty years ago though, the share of the New Zealand top one percent was still about today’s 9 percent of taxable income. Their share has not changed much over the two decades, although of course it is possible that tax avoidance has increased. So it is hard to conclude that New Zealand’s rich have been benefiting relative to the rest of the community in the way which has happened in America and Britain.

 

This has been using tax data. There is a second standard source to measure income inequality in New Zealand – the Household Survey. It gives a better indicator of the standard of living because it is based on total household incomes, rather than the individual’s personal incomes, because it includes dependants, so comparisons can allow for household composition and size, and because it can be measured after-tax and benefits. The latest results, updated to the March 2012 year have just been released.

 

Because the data is based upon a sample of up to only 5000 households, the analysis cannot be as fine grained as the tax data which covers all taxpayers, so it is usual to report the results only in deciles. So we have data on the top ten percent but not the top one percent on this basis.

 

The basic finding is that the top ten percent of households have about a quarter of all household income. – that’s about two and half times the average level of incomes. It goes up and down a bit. In the year to March 2010 it was 26.7 percent while in the year to March 2012 it was 24.3 percent, reflecting fluctuations in the business cycle. (Additionally it is quite difficult to interpret the figures in recent years because of the impact of the Christchurch earthquakes with some households receiving insurance payouts; I proceed with caution.)

 

Allowing for this noise, the basic conclusion is that the quarter share of the top ten percent has been fairly constant for almost two decades. On this indicator there has been no increase in inequality since 1993, a conclusion similar to that we derived from the top one percent of those who reported taxable income.

 

Before discussing what happened before 1993, I should point out that there are a number of indicators of inequality, and they may tell different stories. So let us look at two more.

 

Consider the share of income of the bottom fifth of households. Most estimates suggest that around about a fifth of the population is in poverty, so what is being reported closely corresponds to the poor’s income share.

 

The income share of this poorest fifth of New Zealand has hovered near 8 percent of total income for the last two decades. That means that on average their income is about 40 percent of the disposable income of New Zealanders and a sixth of the level of the top ten percent. Because of time I am not going to say much about the difficulties the poor have of living on such a low incomes. To summarise all the research, it is bloody difficult, they probably have unnecessary physical and psychological health and it handicaps the life opportunities of their children.

 

Earlier I said that the share of the poorest fifth hovered near 8 percent over the last two decades. It is a bit more complicated than that. From 1993 to 1999 their income share was 8.1 percent but it drifted down to 7.5 percent in 2004. That is quite a big shift.

 

But their real incomes did not fall – on the whole – even if their share did. In the period of the Labour Government it rose by about 22.0 percent in real terms – relative to inflation. However overall incomes rose even faster – by 23.6 percent – so the bottom fifth got further behind.

 

(Compare 2.4 percent annual income growth per annum during Labour’s administration with 0.1 percent a year during the first three years of the current National government. The stagnation is in part a consequence of the shock from the Global Financial Crisis.)

 

You may be surprised that under a Labour Government the poor did not do very well. There were three reasons. First, benefits were increased in line with prices rather than wages, so they did not share in the rising real wages. Second, beneficiaries were not entitled to the working-for-families tax credit, which benefited those in higher deciles. Third, many beneficiaries were unable to take advantage of the booming labour market to find jobs. (It is, however, possible that beneficiaries were greater recipients of some of the concessions Labour introduced, like reduced rents for state rental housing – any accommodation supplements are included in the calculations – and increased primary health care subsidies.)

 

So we have now two indicators of inequality over the same period, one – the income of those at the top – says there was negligible change in inequality, the other – the incomes of those at the bottom – says there was a small increase in inequality. Let’s look at a third.

 

The Gini coefficient looks at the whole distribution – at all households. I wont go into the details of its construction and meaning, but essentially it measures the average difference between the incomes of all the households (scaled by the average income).

 

One of the advantages of the Gini coefficient it is that it is available for international comparisons. New Zealand is in the most unequal half of the 35 OECD countries. In about 2010 we were 14th in terms of inequality, near Canada, Ireland and Australia – below the United States and Britain and much more unequal than most of the non-Mediterranean European OECD members.

 

However, small countries are likely to have lower inequality than large ones. I shant go through the details of the arguments, but observe that there is no inequality in a country of one person. When we adjust the Gini coefficient for population size, we find New Zealand is eighth to most unequal. So it would be stretching it to say we were in the middle of the OECD in terms of the income inequality dimension, and we are certainly not among the bottom of those with low inequality.

 

Looking at New Zealand by itself through time, it turns out that our Gini coefficient has been falling slightly since about 1993, whether you measure it by household incomes, as I have been doing earlier, or just by market incomes, ignoring the impact of income taxation and benefits. By this Gini measure the income distribution is getting slightly less unequal. The shift is perceptible – perhaps it amounts to a five percent reduction in the width of the income distribution.

Wait a moment! Some measures seem to suggest that in the last two decades income inequality has increased, some that it has remained much the same, others that it has decreased. What has been going on?

 

We can readily resolve the paradox once we understand there is no rigorous measure of inequality. You may have been told that the Gini coefficient was such a one, but it is about as useful a measure of inequality as GDP is of welfare – helpful but certainly not authoritative. There is no authoritative measure. What the conflicting measures are telling us is that any change in the income distribution over the last two decades has been small – very small – and possibly in either direction.

 

But if we go back before 1993 – we have data back only a decade to 1982 – the same indicators are consistent in what they say. There was a huge change in inequality, so large as that it does not matter which measure we use. I’ll use the Gini coefficient.

 

According to the OECD, New Zealand’s Gini coefficient increased from 0.27 in 1985 to 0.32 to 2009. That is roughly equivalent to the income distribution getting about 40 percent wider.

 

However, over the same period there was a general increase in income inequality equivalent to about a 25 percent increase in the standard deviation. New Zealand had one of the biggest increases in inequality. So much so, that whereas New Zealand was in the bottom half of the OECD countries in 1985, it had joined the top half by 1993.

 

What this means is that all the big increase in income inequality which has occurred in New Zealand occurred before 1993. We know precisely why it happened. First in the late 1980s, the Rogernomic Labour government slashed top income tax rates; that was a spectacular benefit to the rich. Whereas the top 10 percent had about a 20 percent share of household disposable income in the early 1980s, by the mid-1990s they had a 25 percent share. The tax cuts boosted their income by a quarter. Consequently the rest of the community – the other 90 percent – had a reduction in their income share, and also their incomes since this was a period of economic stagnation.

 

Second, in the early 1990s, the Ruthanasia National Government savagely cut the income share of beneficiaries by another ten percent. There have been no corresponding changes of such magnitudes since, which is why income inequality has been largely stable since 1993.

 

So it is true that income inequality has increased in New Zealand, but it happened between 1985 and 1993, two decades ago. Observe that the increased inequality can be readily explained by conscious actions of the governments at that time – by changes in tax and benefit policies (not, as in America and Britain, the result of market forces from the financial sectors). The consequence of this increasing inequality by the actions of our government was that before 1985 we were among the more egalitarian of rich nations; since 1993 we have been among the most unequal.

 

While there is no evidence there has been a significant increase in income inequality in the last two decades, the critical fact is that by international standards New Zealand has been at the high income inequality end among rich countries for about two decades. Does that matter?

 

There are three classes of reasons why it might. The first group is that there is accumulating evidence that communities with high economic inequality suffer from various forms of social distress. The best demonstrated correlation – those of you who have read The Spirit Level will have seen it – is that unequal societies are more likely to have poorer health, but there is also evidence of higher social delinquency including criminality. Thus far, the research provides but a correlation and every scientist knows that correlation is not causation – that two events are associated does not prove that one causes the other. There are various hypotheses about the mechanisms which might cause the social distress, but none are yet proven in a scientific court. Even so, in my view, there is enough evidence to suggest that we should be concerned about increasing economic inequality.

 

It also seems likely that the greater the economic inequality, the lower the intergenerational mobility. There is a view that economic inequality at a point in time doesnt matter, what matters is equality of life chances. The reality is that a child who comes from a deprived background is likely to have poor health throughout the rest of their life, and to have less access to educational and vocational opportunities and more likely to experience social delinquency. That is the central issue about child poverty – it is not just that a quarter and more of our children do not have an adequate standard of living through no fault of their own. Those children are our future adults; if we under-invest in them, we are under-investing in our future.

 

I have just described a set of arguments which centre on the inefficiency of economic inequality. The second group of arguments is about the equity of economic inequality. That is a political judgement; how fair do we want New Zealand to be? Are we happy that New Zealand is among the most unequal societies in the rich world?

 

Undoubtedly some inequality is necessary for economic success. But how much? We know that many successful economies function on significantly lower levels of inequality than New Zealand, including France, Germany Japan, the Netherlands and the Scandinavians. It seems unlikely that we need current levels of inequality to improve our economic performance. That, by the way is an efficiency argument; let’s return to equity.

 

While we have some choice about how much inequality we are willing to tolerate, we do not have unlimited discretion. If our tax rates are too high, we will drive capital and enterprise away from New Zealand. But I would think there is some room for clever increases in tax rates and benefit payments, which would contribute to a reduction in economic inequality.

 

And while redistribution through the tax and benefit system remains an important component of any war on excessive inequality – and on poverty – we need to think more about what is called ‘predistribution’ policies which try to prevent inequalities occurring in the first place rather than ameliorating them later through redistribution.

 

It is perhaps ironic that this National government is far more concerned with predistribution policies than are its critics. Their policies – aiming to get welfare beneficiaries back into the labour force with decent skills – are clumsy and often cruel. Moreover the more economically unequal a society is, the more expensive are effective predistribution policies – as Mr English will find out. His may well be ineffective.

 

Even so that it is exploring such policies puts the government ahead of its critics. It would be disappointing if the government inching into predistribution meant advocates of reducing inequality were to ignore the strategy, especially – and regrettably – since some of the policies they put forward to ameliorate inequality are very clumsy and relatively ineffective.

 

Do we want to pursue a lower inequality strategy, or are we happy to remain among the most unequal of the rich? That is a political decision. I imagine Mr English would say that the National government has got it about right, perhaps pointing out that it was reelected on this judgement. But you could hardly say that the electorate was offered an alternative vision. The advocates for less inequality have had little impact on our political parties. What they are exploring is whether there is a public demand for a reduction in inequality.

 

My guess is that there probably is a demand for a kinder gentler society – a more egalatarian one – than the one we have, one which is socially more like we were before 1985, when we were in the bottom half of OECD inequality. Whether there is a will to make the sacrifices to move back towards there is another matter.

 

One major issue is that we seem to be socially fragmenting. In the kinder gentler society which people yearn for, just about everybody was a neighbour. Today each of us is a lot less knowledgeable about swathes of New Zealanders, and there is a lot less empathy – compassion – for those who are worse off than we are.

 

This results in ill-informed accounts in the public debate about beneficiaries. Many commentators have no knowledge of the minimal living standards which beneficiaries experience. I do observe a willingness to impose sanctions on beneficiaries with no reflection that those who will suffer most will be their children – innocent children.

 

This leads to the third group of arguments for avoiding great inequality. It was presented by Robert Wade in terms of America and Britain where the issue is starker. There, he argues, the power of the rich means they are able to have considerably greater influence over government than those with less income. Because of their greater influence, the American and British government’s responses to the Global Financial Crisis have been pro-rich at the expense of the general populace – all the more ironic because the rich got the world into the crisis by their greedy actions.

 

Is this as true in New Zealand? We have not got the powerful financial sector that those two economies have, so we cannot simply transfer their experience to ours – unless we have a colonial mentality. But as my opening example on the convention centre decision may suggest – as do many other examples – that business is more influential on policy than the country wants.

 

Now Bill English would say ‘dont you dare say that again, Easton’. I remind him that I have explained better than has his government why it might be deferential to business – because it often delivers economic output and jobs.

 

However, I have a sense that New Zealand business is increasingly out of touch with the rest of society other than in its role as consumers. It is a consequence of that social fragmentation I have just been describing. It may well be that big business does not connect with its workers and locals as well as did the small businesses which were the traditional foundations of the New Zealand economy. But it is probably also a symptom of the declining empathy and neighbourliness that I was just describing.

 

I first became aware of the phenomenon during the Rogernomics era, when the advocates of the policies were so obviously out of touch with typical New Zealanders. When they said they were running ‘crash-through’ policies, they ignored that the victims of the crash were in social groups they did not know.

 

This is perhaps best illustrated by the consequence of the tax changes which meant that the rich’s incomes continued to grow in real terms while the majority of the community’s real incomes actually declined. Thus the rich have no personal sense of the economic stress which dominated the Rogernomics era; many still think of it as economic success despite the clear evidence of stagnation. Another example of the change is that while there were rich before Rogernomics, they did not show their wealth off and most of their public donations were anonymous. Today the rule is ‘flaunt it’, as conspicuous consumption rules.

 

This fragmentation leads me to my final conclusion. I wonder if public sentiment is not placing as much importance on economic growth that business wants and can deliver. The public does want jobs but it also wants environmental sustainability, a better quality of output and less inequality. I should not be surprised if it desires a kinder gentler society – and an egalitarian one.

New Zealand’s Trade Dilemma

 

In the new partnerships New Zealand is joining, we need to maintain strong bottom lines.

 

Listener: 25 July, 2013

 

Keywords: Globalisation & Trade;

 

Southeast Asia was not a stable region in the 1960s, not least because of the conflict in Vietnam. In 1967, Indonesia, Malaysia, the Philippines, Singapore and Thailand came together to form the Association of Southeast Asian Nations (Asean). Subsequently, Brunei, Burma, Cambodia, Laos and Vietnam joined.

 

Progress was slow, and there was much distrust. After all, only the previous year the “Confrontation” between Indonesia and Malaysia ended; it cost over 700 lives, including those of seven New Zealand soldiers. Once, some militaries would not talk directly to each other but relied on intermediaries such as Australia and New Zealand. Today, the navies of Indonesia, Malaysia, Singapore and Thailand (assisted by India’s) jointly patrol against piracy in the heavy shipping lanes of the Straits of Malacca.

 

Although regional peace and stability may have been the initial driver, Asean has adopted a wider agenda of accelerating economic growth, social progress and cultural development among its members. Economic integration is not just a matter of abolishing such trade restrictions as tariffs and import licences; it includes facilitating trade in services, eliminating or easing other border controls, simplifying restrictions on investment, business movements and intellectual property rights. They plan to be the Asean Economic Community by 2015.

 

Were it a single economy, Asean would be the sixth largest in the world, behind the EU, the US, China, India and Japan. But because its individual states are jealous of their sovereignty, it is a much looser association. Inevitably, it has looked outwards, engaging with other trading nations in a number of free trade agreements (including one with us and Australia). It wanted a more ambitious extension known as “Asean plus three” (China, Japan and Korea) but because there was a danger of it turning into an uncomfortable China versus Japan conflict, Asean eventually settled on “Asean plus six”, inviting India, Australia and New Zealand to join the Regional Comprehensive Economic Partnership (RCEP). The group produces almost a third of the world’s GDP; its other members take 58% of our goods exports.

 

It is not as ambitious a trade deal – not addressing as many issues – as the Trans-Pacific Partnership (TPP) proposal led by the US. Since the TPP does not include China, some see it in conflict with RCEP, although there is considerable overlap of membership – four of the Asean members are involved in TPP negotiations, as are three of RCEP’s extra six.

 

New Zealand, involved in both, does not see it necessary to favour one over the other. Undoubtedly, though, each set of negotiators will be looking to the other, not wanting – if they can help it – to offer an inferior deal.

 

New Zealand, like other smaller Asean nations, has the challenge of being heard in the hubbub of international affairs. Although we have a number of trade agreements, some proposed ones are languishing while our partners attend to more important deals. Agreements that are multilateral (such as the Doha Round) and plurilateral (such as these) increase our effectiveness and reduce the chances of our being bullied, although they certainly don’t eliminate it.

 

The danger is that we may end up with an unfavourable deal. Of course we can walk out; the Prime Minister has stated that, in effect, we will from the TPP if there is not significant improvement of access for our food exports and if the effectiveness of our pharmaceutical purchasing arrangements is undermined.

 

He is right; we need firm bottom lines in all trade negotiations, but with a realistic acceptance that a country does not get wins for its exports without making some concessions – although the bigger bullies sometimes behave as if they think they can.

 

Such decisions involve careful judgment. The terrible dilemma we face is that New Zealand’s economic prosperity depends on specialisation and international trade. We can hardly hope to be a significant agenda-setter ourselves, but by working with other groups such as Asean we can, hopefully, advance our economic and national ends.

 

Brian Easton studied Asean on a trip sponsored by the Asia New Zealand Foundation.

Uh! Oh! Something for Nothing

Published in <>New Zealand Herald, 13 July, 2013.

 

Keywords: Miscellaneous;

 

In June, a brochure arrived in the letterbox advertising a Malaysian travel agent, ‘Embrace Holiday’ celebrating, it said, their tenth birthday. It looked professional enough, and announced a ‘Complimentary Lottery’. I idly scratched the card – it was a very boring meeting – and discovered I had won a second prize of $US170,000 (About $NZ 220,000). Uh! Oh! Something for nothing.

 

I contacted them. Justin of the Claims & Events Department – an affable fellow; we later discussed his wife’s Chinese cooking – verified I was a winner and said he would contact the company’s sponsors Marcus and Nicole Ltd, a Hong Kong financial services firm. It transpired that things had gone a little wrong. The intention had been that while the brochure would go out to a wide range of people the winning scratchies were only to go out to clients of MN. Apparently one had been put in my envelope by mistake. Uh! Oh! A rigged lottery.

 

Even so, the ever eager Justin Skyped MN and they agreed, reluctantly they said, that legally I had won a prize, and in any case both firms’ reputations mattered so I should get the payout. However MN was anxious that its clients should not hear of my luck and asked me to sign a confidentiality agreement. Uh! Oh?

 

I said that I never signed agreements without consulting a lawyer. Justin, the epitome of naivety, asked why that was necessary. Uh! Oh!

 

My lawyer friend said it would do no harm if I signed; I emailed the image. They have never returned it countersigned. Uh! Oh!

 

The next step involved contacting Lee Dickson, the operations manager of MN, but he proved to be too busy (and has never been in contact). Only the assistant operations manager, a Vince Lin, contacted me. Uh! Oh!

 

The news was that it was necessary, as a part of the money laundering surveillance system of Hong Kong, to obtain a letter of authorisation from the court, which could be used for authentication in New Zealand too. The process required a deposit of 4.3% of the amount of the transaction. $US7310. Uh! Oh! Hong Kong is a major Asian (nay, world) financial centre. It would not be if every financial transaction that could be money laundering required a 4.3% deposit – which of the billions of dollars of external transfers might not?

 

MN went on that the requirement was that each party to the transaction would have to put up half the deposit. That would mean a contribution from me of $US3655. UH! OH!

I wrote explaining the letter of authorisation had no standing in a New Zealand court unless I was independently represented in the Hong Kong court. Might I contact a New Zealand lawyer in Hong Kong to represent me? Vince responded that if I did I would break the confidentiality agreement, quite missing my point that under it MN could give permission. He finished with warm regards but, with underlying menace, giving a deadline for a response without a lawyer. Uh!! Oh!!

 

Neither Vince nor Justin knew, but may have guessed, I checked on the web. Embrace Holiday’s displayed itself as a conventional travel agent; I failed to notice, until I looked again, not a single person was mentioned. Same thing when I checked the brochure. http://embraceholiday.com/index.html

 

I immediately observed, though, the omission of personnel in the Marcus and Nicole website. For a financial services firm, which claimed to provide advice on complex operations such as mergers and acquisitions, this is very unusual. Such firms thrive on reputation, listing their top staff (and their board) and some of their successes. In fact most of the website was platitudes. http://www.mnlimited-hk.com/eng/about.html.

 

I Googled ‘letters of authorisation’ in Hong Kong. The web is strangely silent except for a British lawyer advising in 2010 that they were part of a scam.

 

A site at http://www.scamadviser.com reported that embraceholiday.com was established in May 2013 (not 2003). It said it had no online reputation and gave it a score of 39 percent for trust. Scam Adviser’s assessment for Marcus and Nicole was similar. MN’s owner is, it thinks, based in Malaysia. There is nary a hint of any connection with Hong Kong. Despite claiming to be a company established in 2005, the website was set up in May 2013 too.

 

Like everyone else on the net I get all sorts of offers which are too good to be true. I dont usually follow them up; what intrigued me about this one was the posted brochure. The whole operation was more elaborate and expensive than most which have passed me by.

 

I do not expect my $US170,000, even if I am ‘legally’ entitled to it. I had a lot of fun not getting it, and even more spending it in my mind.

 

Footnote: All they required for identification was my driver’s licence number. I have since learned that a friend involved in an intra-family domestic transfer was required by the bank to show his driver’s licence, his passport and a bill to establish he lived at the address he claimed, a far higher standard for money laundering protection than the ‘prize’ required.

How Good is our Schooling?

Presentation at Launch of ‘Ethnicity, Gender, Socioeconomic Status and Educational Achievement: An Exploration”, 9 July, 2013. The full report is here.

Keywords: Education; Maori

While there is much grumbling about our education system, the evidence suggests it is doing very well. Every three years the OECD surveys a sample of 15 year old students. The exercise, known as PISA (Program for International Student Assessment), looks at three dimensions: reading, mathematics and science knowledge. That is not everything we want from our young – decency would rank high on my list – but they are easier to measure, and they are important.

Our educational specialists celebrate the results. In a sentence, on these measures, and subject to caveats, New Zealand students up to the age of 15 experience a world class education system. Better than ‘world class’ actually. The superiority of the New Zealand education system is demonstrated by an average 15 year old New Zealander being about a year ahead of the average OECD student. That’s right, our system is more effective than most of the OECD including some of those colonials look up to – such as the American and British ones. Measured properly our system is of higher productivity.

First caveat, the achievement may not simply be the schools’ (including early childhood education). What happens in the home is also important, as are wider social institutions such as the media. But the schools do matter and, in any case, the informal education system is partly a consequence of what schools did for earlier generations.

A second caveat is that we do not know how well the education system functions for post-15-year-olds, as there are no comparable international measures.

Some of our social groups do not do as well as average (but let’s avoid the fallacy of the politician who complained that half our children are below average). Among those are the Maori. However, Maori students tend to come from a more deprived background; it is well established, throughout the OECD, that students from lower socioeconomic status households do not do as well educationally, illustrating the powerful way that the informal education system affects achievement.

But suppose Maori students had the same social class background as the population as a whole; how well would they do? The answer is that their educational achievement would be about a year behind our population as a whole. That is they  only do about as well as what American and British students achieve.

Not good enough you say? I agree! But let’s stop pretending we know why – that is an empirical question which deserves scientific investigation, not jumping to (often racist) conclusions. If you think that the Maori achievement is not good enough then you need to be equally critical of the American and British education systems.

Caveat: the students classified themselves whether they were Maori; they could also say they were Pakeha, or Pasifika or Asian or whatever and they could nominate themselves as belonging to more than one ethnic groups. This self-classification may bias outcomes. There are differences between the numbers of Maori boys and girls in the random sample, suggesting that some students of Maori descent with high educational achievement may not classify themselves as ‘Maori’. Social investigators face the reality that because Maori ethnicity is very often a subjective characterisation; we know that individuals may even change their classification depending on the circumstances.

While Maori achievement is more cheerful than it is usually portrayed (it is OECD average even if it is not good enough), the achievement of Pasifika students is well below the OECD average, even when adjusted for their social background. That is definitely not good enough.

Nor should we be complacent about our Pakeha and Asian students. On these measures they have a better than world class education system. But to avoid other countries catching up we have to keep working at improving our education system. But let’s first recognise its success, and stop introducing untested and outlandish changes based on anecdote, and often derived from education systems which are failing compared to ours.

This column summarises my just released report “Ethnicity, Gender, Socioeconomic Status and Educational Achievement: an Exploration”. The research was funded by the PPTA.

**********************

Rereading this column a couple of years later I remain puzzled why it was rejected. The Editor said that it reflected a conflict of interest. I did not have to mention who funded the research but I am scrupulous about such things. If funded research was a source of a conflict of interest, then little could be published and public commentary would be even more dependent on uninformed opinion than it is.

Even more puzzling is that there were at least two serious conflicts of interest in the Listener hierarchy which, as far as I know, were never addressed.

To compound the calumny the Editor said there was a feature about to come out on the same topic. It didn’t, and when many months later a feature on education came out it did not address this issue.

Possibly what was going on was that I had touched a raw nerve in the politics of education. Perhaps the funding of the research by a teachers’ union made the column unacceptable. I am not an expert on educational politics (nor on the economics of education; once I gave an address ‘Why Economists Don’t Understand Education … but Still Try to Run It’). But I know enough to know that there was subversion in the column (but should not every column have an element of subversion in it?).

The conventional wisdom decried our educational achievement It was never clear to me whether it was just whining, or perhaps settling personal grievances from their or their children’s experiences (which enables us to be well placed to have opinions on education). Undoubtedly all of us have had bad experiences – we tend to forget the successes. It was simply not politically correct to report that New Zealand had one of the most successful pre-tertiary education systems in the world.

There have been at least two ‘remedies’. One, which from my reading of the literature seems plausible, is to improve the quality of the teachers. Perhaps the reference to the PPTA was the red flag to the Editor. Unions stand up for their members and, not incidentally, get in conflict with head teachers and other administrators and politicians. Arguably they slowed the improvement of teacher quality by protecting inept teachers. On the other, hand they may well speed it up by pressing for programs to upgrade quality.

The other remedy, alluded to in the column, is to adopt American solutions uncritically. The American educational system has its problems. It is not at all obvious they are the same as ours – as I pointed out, its average achievement is about a year behind New Zealand’s. When they introduce ‘charter schools’ (or whatever) they are dealing with their own particular issues. Were their charter schools, say, to progress average educational achievements by a year, they would only just catch up to New Zealand.

One factor may be the right wing dislike of a public education system. In my view there is a danger of it being monolithic, but I am moved by the American and other debates that argue for its values and achievement. I can see why neoliberals may be antagonistic to them.

Our tendency to grab others’ solutions without doing any hard thinking about how to adapt them (and where inappropriate reject them) for the particularities of New Zealand is an example of the colonial cringe which besets so much of our conventional wisdom – on the right and the left. It happens in many fields – not just in education. I have thought, on occasions, that my unwillingness to do this has not improved my reputation among those who wield power.

The column was, nevertheless, published elsewhere. News of its rejection caused a minor storm in educational circles. Apparently some teachers did not renew their Listener subscription; others said they would no longer encourage their students to read the Listener.

One venue was the Pundit blog. This was my first post and has had one of the highest hit rates, indicative, I take it, of the literacy of the educational establishment – hardly people one would want to put off reading the Listener.

I should have realised this was a signal my time as Listener economics columnist was coming to an end.

Banking Religiously

 

The new wave of “sharia-compliant” banks go to a lot of trouble to neither charge nor pay interest.

 

Listener: 27 June, 2013

 

Keywords: Macroeconomics & Money;

 

‘No risk, no return” is a summary of Islamic financial principles. So their system has to work without interest.

 

Muslims are not opposed to business – Muhammad was a merchant before he began teaching Islam – but the Koran prohibits gambling.

 

By conventional standards, Islamic financiers go to considerable trouble to avoid paying interest. Instead, depositors in their banks get a share of the profits. Banks do not charge interest, either; they charge borrowers in other ways. This allows Islamic banks to carry out the conventional banking role of collecting and pooling others’ savings and advancing them for productive purposes.

 

Sophisticated Islamic “sharia-compliant” banking is a relatively recent phenomenon (sharia is Islamic law derived from the Koran and the teachings of Muhammad). Once, many Muslims kept their financial savings “under their beds” because suitable banks did not exist. One Islamic scholar I spoke with, on my Asia New Zealand Foundation-sponsored study tour, said hiding one’s savings this way was un-Islamic because they were not being utilised. (It is also risky and unrewarding.) So, Islamic financial institutions were developed; some of the earliest were conventional banks with sharia “windows” offering sharia-compliant services.

 

However, there was a concern that ordinary banks would mix their depositors’ funds together, lending them at interest, and that they might invest them in Islamic-prohibited areas, such as gambling and alcohol. Islam also imposes charity obligations and encourages people to settle their debts to those having real difficulties.

 

What is a permissible investment for a proper Islamic bank? Consider the routine trading problem in which goods are paid for some time after they are sold. The conventional arrangement involves providing the future cash at a discount – in effect an interest payment. Instead, an Islamic bank buys the goods and sells them at a higher price later, so the seller gets the cash immediately and the bank manages the risk associated with the ownership of the asset and credit-worthiness of the end buyer.

 

As an alternative to bonds, Islamic financiers issue “sukuk” financial certificates in which the holder owns a share of the physical investment. In a case explained to me, the sukuk holder ended up owning a share of the plane that the cash was financing. Importantly, there are increasingly secondary markets for sukuks, so investors can sell them if they need the cash, just as they can with bonds.

 

As the transactions get increasingly complicated, each Islamic bank has to establish the appropriate mechanism to consult sharia advisers to ensure its innovative transactions are compliant. In Malaysia, ultimate decisions reside within the Shariah Advisory Council of the Bank Negara Malaysia. (The central bank’s feisty governor, Zeti Akhtar Aziz, is proof that Islam need not oppress women.) Malaysia aims to position itself as the international centre of Islamic finance, which amounts to only 1% of the world’s financial system.

 

Sharia-compliant finance has to be much closer than much conventional finance to real economic transactions and productive activities. Islamic finance prohibits the higher “derivatives of derivatives” that collapsed the world into the global financial crisis, leading one to ponder whether sharia-compliance has some relevance to our search for a banking system whose collapse does not undermine the payments system.

 

That does not mean sharia-compliant banks are totally safe. Like our trading banks, which also avoid higher derivatives, they can make bad investments and can hire fraudulent employees. Risk is a reality of any financial system.

 

Sharia-compliance is unlikely to be a handicap when the Reserve Bank is faced with registering an Islamic bank in New Zealand. Rather, our 40,000-odd Muslim population is not big enough to attract one. If we do get one, some non-Muslims might like to entrust it with their savings, attracted to its style of financial arrangements and its more ethical investing.

 

For an earlier column on Islamic finance:

http://www.eastonbh.ac.nz/2004/09/for_fear_of_allah/(September 11, 2004)

The Austerian Economists’ Error

The Austerian Economists’ Error

In the battle of opinions for managing sluggish economies, rhetoric often misrepresents the research.

 

Listener: 13 June, 2013

 

Keywords: History of Ideas, Methodology & Philosophy; Macroeconomics & Money;

 

The right response to high unemployment and lethargic economic activity is to cut back government spending, according to “Austerians”, whose name is a pun on “austerity” and “Austrians”, a rightish version of economics. Some fiscal conservatives, including me, argue that many governments in debt have to be restrained because their creditors are reluctant to lend them more. But Austerians go a step further, holding that the adjustment should be only on the spending side and that there is no place for tax increases.

 

They claim their policies work by reducing interest rates, thereby stimulating private-sector investment. So far this has not really happened. Their position often seems ideological. You hear austerity advocacy most in the public comment of politicians, ideologists and rhetoricians who take it that somewhere there is a theory that justifies their prejudices, even if they do not know where.

 

Some reputable economists take an Austerian line, but generally they don’t join in the rhetoric. Their greatest contribution has been to critique anti-Austerians – sometimes called “modern Keynesians” – the most prominent of whom is Paul Krugman (who sometimes descends into rhetoric, too, obscuring what a fine economist he is).

 

There is a science that underpins economics. The discipline is in three parts: research, policy and rhetoric (which typically misrepresents the research). The division is nicely illustrated by a recent kerfuffle.

 

Carmen Reinhart and Ken Rogoff are also fine economists, whose book, This Time Is Different, is a monumental and respected historical study of financial and banking crises. More recently they published a paper that said that when the ratio of government debt to GDP exceeds a 90% threshold, the economic growth rate markedly falls. Austerians seized the research as evidence for their policies.

 

Research needs to be capable of reproduction in some manner. Economics has few experiments, but then it’s the same with astronomy, evolutionary biology and geology. As a rule, I require a large number of confirming studies before accepting an economic finding as “verified”. But the first test is whether the result can be repeated.

 

When economists tried to reproduce the Reinhart-Rogoff findings, they found them flawed to the extent that the two have apologised and withdrawn them.

 

Yet, as has happened with earlier research, a collapse in evidence that Austerians had claimed proved their case has done nothing to dissuade them. One is left with the impression of drunks using a lamp post for support rather than to shed light. When the post falls over they wander on looking for another one.

 

One critical flaw centred on New Zealand; without it the results look decidedly shaky. It turned out that the two misinterpreted what was going on here. I’ve been involved with a handful of economists in New Zealand, France, the Netherlands and the US trying to sort out the mess. The work has been detailed; describing it would be time-consuming, but it does illustrate that much scientific research is tediously boring.

 

More generally, research economists have concluded there is no debt threshold that, once crossed, collapses economic growth. They recognise a connection between high debt and poor economic performance, but don’t know which causes which.

 

This finding is so feeble that it has had little impact on most economists’ policy thinking. In contrast, the Reinhart-Rogoff book had considerable impact.

 

My view remains that countries in weak debt positions need to be fiscally cautious, but that a number of key countries in a better position – particularly the US, Germany and China – should be more fiscally expansionary. That would benefit the weak.

 

I remain fiscally cautious for New Zealand, but unlike the Government, I do not think all the adjustment should be from cutting government spending.

 

I argued for funding the Canterbury earthquake recovery by a small income-tax surcharge and borrowing to spread the burden over a generation. Regrettably, the Government blew that one. We are going to pay a high price in the future as the public sector malfunctions from the emphasis on spending cuts.

 

Unlike the Government, I do not think all the adjustment should be from cutting government spending.