<> Paper to the Skeptics Society – 26 September, 2009 <> <>Keywords: History of Ideas, Methodology & Philosophy; <> <> <>Today I want to reflect on the extent to which economics is a science and the extent to which it is not. In doing this I come from the approach of someone who was trained a scientist, who continues to think of himself as one, and who is heavily influenced by the philosophy of Karl Popper. I suppose that makes me a sceptic. <> <> <>The point about a sceptic is that they are continually testing the theories they hold against the facts, and trying to improve them. As such, they are what Thomas Kuhn called revolutionaries, challenging and replacing the conventional wisdom. I take it that the Skeptics Society consists of fellow iconoclasts. Today I am going to address some of these false gods directly. Perhaps you hold some dear. Please understand I am just applying the standards of scientific scepticism to them as you expect to be applied elsewhere. <> <> <>Popper points out that even though you know your theories will be replaced by better ones, hold on to the best you have until a better one comes along. Towards the end of this presentation I will talk of some examples where scientific economics has held – even still holds – theories knowing their weaknesses, and where we may make progress in the not too distant future – one hopes. <> <> <>Popper said the most important Platonic dialogue is The Apology in which Socrates reflects on the Delphic Oracle’s utterance that he is the wisest of men. He concludes that he is only wise because he knows how ignorant he is. As another of my heroes, Isaac Newton described himself, he was ‘only a child playing on the beach, while vast oceans of truth lie undiscovered before me.’ <> <> <>Newton also said ‘If I have seen further than others, it is by standing upon the shoulders of giants.’ That is one of my themes today. Science is the accumulation of wisdom. We would do well to recall and understand the giants of our science before we claim some particular insight. Some of the greatest minds of the last two hundred years were economists – some were scientists. <> <> <>I want to begin however, talking a bit about the contrast between the subtlety of economics and the crudity of its critics. A couple of examples will illustrate my point. <> <> <>I am frequently told that economists believe that per capita Gross Domestic Product is the measure of welfare of a nation. That is a strange claim since every economist knows that the more relevant measure is Net National Income because GDP includes depreciation and it measures the income of a region not of the people who belong to the region. They differ because of, among other things, some of the profits of the region go to investors outside it. <> <> <>Such things are overlooked by the critics, but even more extraordinarily, they only rehash what economists have always known. I do mean ‘always’. The creator of the statistical base out of which GDP comes was Simon Kuznets who wrote in his original report in 1934 ‘the welfare of a nation can scarcely be inferred from a measurement of national income’. But you wont find him quoted in the standard critiques of GDP, nor John Kenneth Galbraith who wrote an elegant chapter decrying its use as a measure of welfare in his Affluent Society some fifty years ago. <> <> <>I am not denying that some people use GDP as the measure of welfare, or that GDP is an economists’ measure. My point is that properly trained economists use it for other purposes – the purposes for which it was designed. Politicians, journalists and business people like to talk about GDP as if it is a measure of welfare and bolster their ignorant use by claims that economists agree with them, even when they dont. <> <> <>You might say, why in the last 75 years have economists not constructed a better measure of welfare? The short answer is that we have tried, and we have not been able to develop a satisfactory one. <> <> <>Today there is another attempt going on by a committee led by Joseph Stiglitz and Amartya Sen, two other giants of the profession – I shall name only giants today. Their preliminary report was released about a week or so ago. What I found interesting is that they have concluded there is no single measure of economic welfare, and are looking for a number of indicators. <> <> <>Which rather undermines all the critics who have their own single measure which they claim is better than GDP. There is no unique single measure of a nation’s welfare. Had there been economists would have developed it – around 74 years ago. One must never assume that the best economists are as stupid as their critics. <> <> <>Now I am going to use the concept of GDP later today. I will use the measure as an indicator of market activity, which is what economists designed it for. Couple of caveats – I shall be referring to annual market activity, and when I make comparisons through time I shall be referring to volume GDP, that is production adjusted for the change in prices. Sorry to be tedious – but I am an economist and have to understand such things. Incidentally, GDP was originally derived for tracking unemployment. Today we know that it is not a very good short run indicator for this purpose, that economic activity and unemployment track differently. So even if the activity contraction has ended we may expect rising unemployment for a while yet. <> <> <>My second illustration is that I am often told, by those who have not studied economics, that economics depends upon unlimited economic growth. That cannot be true since many giants of the economics profession – Thomas Malthus, David Ricardo, Karl Marx, John Maynard Keynes and Joseph Schumpeter, for instance – were stagnationists who expected economic growth to come to an end; Keynes wrote of the ‘euthanasia of the rentier’. What he meant, and others thought too, was that as capital was accumulated, the return on capital would fall, until there would be no incentive to invest, and economic growth would stop. This is a consequence of the laws of thermodynamics. As Paul Samuelson has pointed out, economics is grounded in those laws – without them there would be no trade-offs, a fundamental notion of economics. <> <> <>The difficulty with this stagnationist approach was that per capita incomes in the rich world quadrupled in the 180 years between Ricardo and Schumpeter. You can set up auxiliary hypotheses to explain the inconsistency but in the 1950s, as the data became available, it became evident that a theory of economic growth dominated by pure capital accumulation was inconsistent with the facts. <> <> <>We now know, following a famous 1956 paper by Bob Solow, that what he called ‘technical change’ adds to economic growth. By technical change he meant ‘a shorthand expression for any kind of shift in the production function. Thus slowdowns, speedups, improvements in the education of the labour force, and all sorts of things will appear as “technical change”.’ <> <> <>The story of how the scientific community has misinterpreted this economic research for its own political purposes belongs to another occasion. The point to be made here is that it is simply not true that economics says that economic growth is necessary. When there is no more technical change, the growth may stop but there will still be a role for economics. <> <> <>Were the critics a little sharper, a little more subtle, they could instead argue that the current economic system is dependent upon economic growth. The technical mechanism is that the true profit rate is close to the growth rate; so no growth, no profits. When growth exhausts itself the nature of the economic system would change. If you want to pursue the implications of that you might read – well, er – Malthus, Ricardo, Marx, Keynes and Schumpeter. <> <> <>So there are two kinds of economics. One is what competent economists do, and the other is articulated by the politicians, journalists and business people who have misunderstood professional economics, often for self-serving ends. This self-serving is the key reason why this misrepresentation dominates the public discourse. Why bother to get it right if ignorance supports one’s ends? It is the scientist who pursues getting it right as an end in itself. <> <> <>I was taken by a history of Lysenko whose pseudo-science, which confused phenotype with genotype, was imposed for political ends to the detriment of Soviet Agriculture. What struck me was that a large proportion – perhaps 95 percent – of the Soviet biological profession simply accepted the faulty paradigm. Of the remainder, about half got on with doing proper science and the other half ended up in Siberian concentration camps – or worse. But that so many Soviet biologists got it desperately wrong does not prove that biology is not a science. <> <> <>I’d like to think that there would be a higher proportion of the economics profession who could see the fallacies in an imposed economics paradigm, and certainly fewer of us end up in concentration camps. One day there will be a very interesting analysis of how so many economists were misled into thinking the macroeconomics which has led to the current crisis had so much validity. But not all did, and economics can claim that it is being corrected by the facts. <> <> <>Notice that I am distinguishing between what economics is and what economists – and others such as business people, journalists and politicians – think. If you use a definition that economics is what economists do, then deciding whether economics is a science becomes a question of whether economists are scientists, an empirical question. <> <> <>Probably all the giants of economics were scientists in the sense that they practised a scientific method which Popper would recognise. When we look at shorter members of the profession – even those who were followers of the giants – we observe another way of pursuing economics. <> <>To make the division clear, I shall contrast sceptics with the believers. Sceptics are the scientists who are continually testing the hypotheses they hold against alternative hypotheses. For them knowledge is tentative but it also progresses as it replaces existing hypotheses with better ones – typically as a result of an encounter with facts. <> <> <>On the other side there are the believers, who hold a known truth which is invulnerable to challenge. Facts do not challenge their truths, or cause them to be replaced with a better ones. Rather the task is to explain the facts within the framework of belief; if necessary they will ignore inconvenient facts. <> <> <>Let me give some examples. Suppose the belief is in the literal veracity of the bible. The biblical account of the development of the world is inconsistent with the theory of evolution. Therefore the theory of evolution is wrong and the challenge becomes to explain why it is wrong thereby keeping the integrity of the literal veracity of the bible. <> <> <>Or consider the right wing economic philosophy which rejects taxes and other forms of economic intervention. Economics has a well established and rigorous theory that if pollution generates costs to others, then an effective way of improving economic welfare is to use taxes and such like. Global warming appears to be a straight forward example of pollution generating costs to others. So the extreme right challenges the premise that global warming is caused by human actions. Thus they see no need to impose taxes and other economic interventions to deal with this problem. That seems to be the position of the New Zealand Act Party. <> <> <>A third example is the belief in the policies which we call Rogernomics, and which are more widely known as ‘neo-conservative economics’. They were applied in New Zealand between 1985 and 1993, and so the Rogernomics believers conclude they worked because their theory says so. As it happens the economic growth rate for New Zealand did not speed up under Rogernomics. Indeed per capita GDP stagnated from 1985 to 1993, so it was the same in 1995 as it been eight years earlier. It was in that period that we got badly behind Australia. <> <> <>I should like to tell you how Rogernomes explain this stagnation since they said their theory promised economic growth. I’d really like to know, since I have a theory which explains why the stagnation happened and I would like to test it against alternative theories. Unfortunately the Rogernomes simply ignore the fact of stagnation. I know of no case of any of them mentioning it, let alone gives any account of why it happened contrary to their theory and promises. <> <> <>You will detect here the frustration of a scientist. I get better theories by comparing mine with others using the facts that test them. But how can I do that if they ignore the facts? <> <> <>There is also a policy issue here. It is hard not to conclude that Rogernomics and its Ruthanasia successor failed. There is currently a committee to consider how we might speed up economic growth and catch up with Australia in GDP per capita terms. At least three of its five members were Rogernomes. It will be interesting to see to what extent they address the failure of the policies they advocated in the 1980s and 1990s. <> <> <>Another group you need to be wary of is those who are paid by their employers to represent their business interest. While they they do a good job, sometimes they reflect the firm’s or sector’s interests. <> <> <>More fundamentally, as Galbraith pointed out, we are the slaves of the conventional wisdom which is a mix of what Keynes called the thinkings of ‘defunct economists’, our aspirations which are not always based on reality, and the theories which support the hegemony of the dominant interest groups of a society. <> <> <>While I was meditating on such things – indeed while I was writing this paper – journalists announced the ‘recession was officially over’ because GDP increased 0.1 percent between the March 09 and the June 09 quarter. <> <> <>What gave the journalists the authority to claim that the recession was officially over? There is no official definition of a recession in New Zealand; there is not even a standard one. The journalists probably did not have the foggiest idea of what economists mean by a ‘recession’, other than they knew it was a bad thing. <> <> <> <>The number which led to these pronouncements was a minuscule plus 0.1 percent of GDP, but equally it could have been presented as minus 0.2 percent of GDP per capita, Moreover, there is a margin of error for any figure the Government Statistician reports, and the quarter by quarter GDP change is subject to a large one. They are also subject to revision – five of the eight quarters of the last two years were revised with the new announcement. Or had you realised that the average growth rate in the last decades boom was about 0.9 percent a quarter,. So the June quarter outcome was not only that output per head was falling, but since economic capacity is continuing to grow, the underutilised capacity in the economy was growing too? Bad news for the unemployed and putative unemployed. <> <> <>You can infer that I am a little irritated by the way the media handled the story. Nobody likes a recession, but the subtlety of the economist’s analysis is lost in the crudity of the journalists’ anxiety that the recession – whatever they mean by it – is over. We sceptics cannot be sure of course, but do not be surprised if this week’s hoopla seems silly in a year’s time. As the Minister of Finance said ‘Tough times are still ahead’. Probably. My assessment is that there are very tough times still ahead of us. <> <> <>Mechanical measures and definitions do not properly reflect the evolution of the economy. If someone said that a eutrophied lake was saved because the oxygen level was no longer diminishing, a limnologist would think them as uninformed (at the kindest). This is equivalent to the announcement the recession is over, Economies are just as complex as ecologies. <> <> <>(The commentary on the following day was more informed, including my talking to Katherine Ryan on Radio New Zealand’s Nine to Noon program at a level – I hope – intelligible to the public but which most economists would appreciate. If I dont they soon tell me.) <> <> <>My irritation arises, not only because of the poor quality of so much of the commentary, but because it sets the tone for the public. I am likely to be deluged in the next few weeks by sentiments of ‘hooray the recession is over and things are getting better’, followed up a little later by ‘you economists misled us, things have not improved that much’. <> <> <>We did not mislead you. You chose to listen to people who were commenting beyond their competence. That’s not the economists’ fault. Nor is it our fault if the public relies on the same people to initiate them into the mysteries of GDP and economic growth. If one listens to dwarves the stories are going to be a bit short of genuine content. <> <> <>So we face a confusing stories. Much of economics may be scientific but many economists are not, and in any case most of the public learn their economics from those who could not possibly be considered professional economists. <> <> <>As one last attempt to convince you that economics is a science – and like all sciences complex and subtle – let me look at three areas where economics is progressing. Note how in each case the evolution is due to a dialogue between theory and fact, and how like all scientists I make no apology if the current theory is to be replaced by a better one, albeit one which stands on the shoulder of the old one. <> <> <>I promised to finish off with some examples of well held economic theories which are under pressure at the moment. I’ll give three. In the nature of things, some of the people I am going to mention are not quite the giants I have been mentioning, but I need to give you some pointers. They are all pretty tall. <> <> <>Economic Behaviour <> <> <>First there is the theory of individual economic behaviour. For a long time economists have held, in an increasingly rigorous form, the notion of rational economic man – homo economicus. He – he is always male – takes all that is known into consideration .and pursues his own self-interest by maximising his utility which reflects only his welfare and does not vary through time. A little introspection suggests that we dont actually do this; the theory held on for the simple scientific reason that there was not a better one to replace it. When we use it for policy purposes, many of us make ad hoc adjustments to bring homo economicus closer to actual behaviour. <> <> <>Recently some economists have been looking at the psychological literature to obtain insights into human behaviour. Among my heroes are Richard Thaler, Matthew Rabin and Daniel Kahneman the psychologist who received the so-called Nobel prize in economics in 2002 (the Prize awarded by the Bank of Sweden in honour of Alfred Nobel). <> <> <>While economics has not yet got a rigorous theory, it is certainly making progress. I tell you this example to illustrate that economics evolves. I admit there is a lot of resistance to behavioural economics. It includes those who are comfortable with the old paradigm and dont want to learn anything new. (Keynes remarked we rarely learn anything fundamental after the age of 30.) It also includes those with a political agenda who think that behavioural economics justifies the state over-ruling individual preferences (it doesnt). So, Lysenko like, their politics overrules science. Meanwhile you will find increasing application of the theory; the Kiwi saver scheme was influenced by Thalerian principles, although hardly anyone mentioned it. <> <> <>Happiness and Material Consumption <> <> <>My second example illustrates that economics, like other sciences, can have an anomaly which has yet to be resolved. Two hundred years ago, Jeremy Bentham said the more you consumed the happier you were. That has been a central assumption in economics ever since. But is it true? <> <>We have only had the data to test the proposition in recent years. The most important involves asking whether people are happy and comparing their responses with their incomes, after controlling for other variables. There is some research which indicates that the subjective responses are consistent with objective data, but of course the area is treacherous. <> <> <>When we pull together the available evidence we find that a rise in average material consumption in poorer societies seems to be associated with rising average happiness. However that does not seem to apply to affluent societies. The best example from the longest data series is that levels of consumption have doubled in the United States over the last 60 years, but there has been no rise in average happiness there. <> <> <>Even so, while rising average incomes do not increase happiness over time, those with higher incomes at any point in time are happier than those with lower incomes. But not that much happier. Some work Ryan You and I have done (you’ll have to go to the original paper to get the details) shows that the happiness score goes up from 8.1 to 8.3 when annual income rises from $20,000 to $120,000 – by 0.2 points on the 0 to 10 scale. In contrast happiness falls by 0.5 points if an employed person becomes unemployed, which suggests that a job is far more important for happiness than the income it generates. Even more dramatically, the happiness of a married woman who becomes separated falls 0.6 points on average and the man who moves from married to separated falls 1.2 points. <> <> <>So income is not as important in determining happiness as a range of other – not economic – things. Insofar as income is important, it seems to be because it demonstrates one is higher up the pecking order, rather than the additional material consumption it generates. What this all means is unclear. Its an anomaly. Probably the best source if you are interested in the subject is Richard Layard’s book Happiness although I dont agree with everything he says. (I’m a sceptic.) <> <>The Global Financial Crisis <> <> <>My third example is a major row going on in economics which has been precipitated by the Global Financial Crisis. The disagreement has long been there but new facts and new events have exposed it. It would take me a whole of the afternoon to explain the dispute, but I have to be brief. <> <>Following the Great Depression of the 1930s, Keynes wrote his General Theory of Employment, Interest and Money. (no mention of GDP, you’ll notice) which became the basis for what we know as the Keynesian paradigm of how the macro-economy works. By the 1960s it was challenged by monetarism (the expression was not invented until 1968) which evolved to a point where it is said the founders such as Milton Friedman would no longer recognise it. This alternative paradigm (there is quite a lot of the Keynesian apparatus in monetarism) became dominant for policy purposes at the US Federal Reserve and in the popular press and business community, but not in the academy which divided between – in the jargon – ‘saltwater economists’ who were Keynesians (generally) working in American universities on the east and west coasts and ‘fresh water’ ones who were anti-Keynesians usually working in inland American universities. <> <> <>In the academy this was all good competitive fun, with lashings of rhetoric – and some (I’m afraid) personal abuse. In the policy domain there was an uneasy truce. The arrival of the Global Financial Crisis has now turned the truce into open public war. Think of the disagreement whether light was a wave or a particle – but shift it to the twenty-first century with its greater and instantaneous public communication and of a more immediate policy concern. <> <> <>I’ve tried to put the argument fairly, but I dont want to seem to be sitting on the fence. Briefly my position is I am with the Keynesians, although I have doubts about American Keynesianism which is too influenced by the peculiarities of the US government arrangements. Moreover I dont think the Americans have thought enough about the particularities of their economy whose currency is also the international means of exchange. I warned you that economics can be complex and subtle. <> <> <>You may be surprised that I should be Keynesian given that Keynes published his book almost three-quarters of a century ago, about the same time as Bohr’s complementarity, Heisenberg’s uncertainty, and Pauli’s exclusion principles and Schrodinger’s equation They all remain in the foundations of quantum mechanics but the subject has evolved. So has economics. <> <> <>An even better example might be that this year we celebrate the 150th anniversary of Darwin’s On the Origin of Species. The book still speaks to us, even if the theory has had to be enriched by a host of subsequent research. Keynes’ General Theory has a similar status. <> <> <>So let me finish this brief discussion with the cryptic remark that I reckon that progress will not just happen with the Global Financial Crisis testing the two paradigms. There will have to be a new theoretical innovation based upon some previously unavailable empirical data. I speculate that it will be the incorporation of balance sheets into Keynesianism. Keynes knew about them, but there was not enough material to incorporate them into his account – except crudely. <> <>However there is a bigger lesson here. Paradigmatic battles are not resolved as easily in the social sciences as they are in the natural sciences – although none of them has lasted as long as the one about the nature of light. It is worth recalling Plank’s law: “A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents eventually die, and a new generation grows up that is familiar with it.” <> <> <>That may be true in physics. It is even more so in the social sciences. <> <> <>Conclusion <> <> <>What I have tried to do today is answer the question of whether economics is a science. My conclusion is that there is a strongly scientific element in much of economics and many economists are scientists. Regrettably though, many of those who use economics do not do so in a scientific way, which is why it is right to be sceptical about what you are told are economic truths. But that does not mean that none exist. <> <> <>Go to top
They Say It’s All Your Fault
<>Spending on health care is rising rapidly – but there’s one thing we could do. <> <>Listener: 26 September, 2009. <> <>Keywords: Health; <> <>We are told that the health-care sector is a drag on the economy. It is growing faster than the economy as a whole and is chewing up a fifth of core Crown spending. A couple of decades out it may be taking as much as 40% of a larger public budget. <> <>The trouble is that you (yes, I mean you, dear reader) want the health care. The evidence suggests you do not benefit much from rising material standards of living. Instead you want to live longer and more healthily. And that’s what’s been happening. Life expectancy for newborns has been rising – it now averages over 80 years – and my impression is that today’s unwell experience a better quality of life. <> <>That spending on health care is rising faster than total spending may seem a perfectly sensible development to ordinary people. If the demand for chocolate chippies doubled over 20 years because people wanted to consume them, we would have no qualms. But we have two reports – from the Ministerial Health Review Group and a private consultancy – that blame the difficulties the health system faces on your increasing desire for health care. Shame on you! <> <>The failure might better be attributed to the inability of the market – or any system – to deliver good health care efficiently and fairly. It is the largest single industry in the US, the world’s greatest capitalist economy. Yet America’s health care is extremely expensive and inefficiently delivered. Despite having some of the most impressive medical centres in the world, the average American gets a much poorer deal than people in all other rich countries with which comparisons are usually made. <> <>There is no ideal system. Every country has its own institutional quirks, which make reform very difficult. You are not to blame for the mess. Our desires to have more spending on health at the cost of less other material consumption seem quite reasonable. It’s just that no one can work out how to effectively deliver the reasonable demands. <> <>There’s not a lot of difference between a public funding system and a comprehensive private insurance one. I would caution against insurance or health-care provider systems based on competition between suppliers. It is easy to promote their strengths or identify their weaknesses, but providing a balanced account of both aspects is messy. In the rhetoric of vigorous political debate, who wants to acknowledge a mess? <> <>The ministerial review, Meeting the Challenge, is a great disappointment. You can’t have 170 recommendations that are all bad, but few seem to tackle the real issues. Some seem to have a hidden agenda, especially the one about resurrecting the health funding agency of the 1990s, with its funder-provider split. The 1990s reforms promised 20-30% productivity improvements, but there were none. This time the promised gains – if any – are not quantified. <> <>On the other hand, the review does not have the 1990s’ passion for “competition”, which works – if at all – in only very narrow parts of the health system. The focus seems to be more on co-%ordination. <> <>The review’s top-down approach is a major limitation. How can we tackle any real health problem unless the clinicians own it? The bureaucrats want a rationalisation of their safety committees. Far more important than having committees hidden in the bowels of hospital bureaucracies, or in Wellington, is that those who deal directly with patients work in and promote a safe environment. <> <>I trust our clinicians to supply good health care far more than I trust bureaucrats and managers. Some humility from the latter would be welcome. But clinicians are not particularly sensitive to cost-effectiveness. Obviously we have to restrain what can be offered. Leaving non-clinicians to do that doesn’t work. Our clinicians have to own the restraint, too. At the moment they don’t do that very well. <> <>As for you, dear reader, if you expect better health care without higher taxes and/or increasing insurance payments, then it really is your fault.
New Zealand Catching Up with Australia
<>Notes for Seminar 22 September, 2009.
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<>Keywords: Globalisation & Trade; Growth & Innovation;
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<>While there is much talk about New Zealand catching up with Australia in per capita GDP terms there is not a lot of careful economic analysis. The accompanying graph shows the record over the last forty odd years. In 1967 Australian and New Zealand per capita GDP was roughly the same. After that Australia grew faster than New Zealand. Initially the growth difference arose because Australia had a mining boom, while New Zealand had a collapse in the price of its main export of the day – crossbred wools.
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<>The New Zealand diversification from the dependence on wool was largely over by the mid 1970s, and there was some recovery in the Muldoon years. However from the mid 1980s there was a long decline which started with those policies we call Rogernomics. The decline bottomed out at the end of the 1990s, and through most of the last decade New Zealand grew at the same rate as Australia – perhaps a fraction faster. Last year the New Zealand economy contracted while the Australian economy grew. I have not incorporated the 2009 figures but the same thing is happening this year.
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<>Had I time I could detail the various ups and downs but the pattern is clear enough. New Zealand has experienced a long term decline relative to Australia. Note that the peaks and troughs reflect phases of the business cycle. It is the trend which is important.
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<>I’ve added in blue the trend if we are to attain the 2025 goal of per capita GDP parity with Australia. It is a big challenge. Given the likely Australian growth rate, we shall need a volume GDP annual growth rate near 5 percent allowing for population growth. (Instead of declining relatively about 0.85 percent p.a. we need to improve, relative to Australia, by 1.85 percent p.a. That means a per capita growth of about 4 percent p.a., a volume GDP growth rate near 5 percent p.a.)
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<>Attaining the goal is not a matter of arithmetic. It requires a change in real economic behaviour. When proper economists do the calculations we find that the target is probably impossible. One study recalled the aspiration of the magic bus. ‘I want it I want it; but you cant have it’. The fastest 17 years growth New Zealand experienced relative to Australia was to 1906 following the refrigeration boom. That was 2.3 percent p.a. Since then the best we have done was 1.3 percent p.a to 1959.That is about two thirds of the aspirational growth target of being 1.9 percent p.a. faster than Australia.
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<>How can those in the external sector of the public service contribute to accelerating the growth rate? Increases in volume GDP are critical, but your most important contribution could be lifting the price we get for our exports – improving our terms of trade. While I dont want to deny that bilateral and plurilateral free trade agreements have a role, the big one for New Zealand is the multilateral Doha round. On behalf of all New Zealanders I wish you the best in your endeavours.
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Reliving the 70s Horrors
<> <>If nothing is done, our credit rating will be downgraded and interest rates will rise. <> <>Listener: 12 September, 2009. <> <>Keywords: Macroeconomics & Money; <> <>When the economy plunged in 1975 as a result of the first international oil shock, the Labour Government increased public borrowing. But when the world economy recovered, the New Zealand fiscal deficit remained large, with the incoming National Government increasing spending by making (what is now) New Zealand Superannuation universal for everyone over 60. <> <>Prime Minister and Finance Minister Robert Muldoon took some fiscally prudent measures after his election in 1975 – although we are still recovering from his cutback on infrastructural spending. But these measures were insufficient, and he became timid after his party won fewer votes than Labour in the 1978 election (but more seats under the quirky winner-takes-all electoral system). <> <>So in the late 1970s, every Treasury official was faced with trying to haul back government spending and raise government revenue. What they managed to do was not enough, so Treasury scouted around the world to borrow the funds to cover the internal deficit and the external one (on the current account of the balance of payments). Big spenders and tax cutters loathed the officials, who wanted to spend small and hike taxes. In the end it was inflation, rather than political leadership, that solved the shortage of tax revenue over spending, devaluing the incomes and assets of fixed-income savers. <> <>Although committed to a career of research and teaching, rather than giving policy advice, I had a deep empathy for those Treasury economists. Like them, I knew political procrastination simply compounded the problem for the future. I – and most of them – had a deeply moral objection to piling up the costs of one’s failures onto children and the unborn. Much of the pain of the 1980s occurred as we dealt with the legacy of the Muldoon debt – although we worsened it by adopting some silly policies. <> <>Fast-forward 30 years and we find today’s economy in a similar situation – and possibly worse, for households are also not saving. Again the country has a large fiscal deficit that can be resolved only by political leadership. <> <> <>A month ago I thought gloomily that we might repeat the experiences of the late 1970s. The Government would tinker with spending cuts and revenue raising, but nowhere near enough to address the size of the deficit. Perhaps the Government – Micawber-like – would hope something turned up, or that it could at least hide the problem sufficiently to get re-elected in 2011. That would make being a Treasury official very miserable. <> <>Instead, coming to the rescue is – of all things – a credit-rating agency. The smallest of the big three, Fitch, has put us on credit watch. In time, Nos 1 and 2, Standard & Poor’s and Moody’s, may join them. We have very high overseas debt, which we are not addressing, and the ongoing fiscal deficit is making it worse. If nothing is done, our credit rating will be downgraded and interest rates will rise. <> <>The Government has already responded. In an unprecedented speech to the National Party conference, Finance Minister Bill English said there was no possibilities of tax cuts for at least five years. (He thought there might be a place for a change in the tax mix, but that’s another column.) He suggested there may be opportunities to increase revenue “without actually raising the tax burden”. We shall see. <> <>Even so, to avoid a credit downgrading we are also going to have to cut government spending. I don’t know what, and I don’t know when. But I do know that even if it is phased in, it will create difficulties for ordinary New Zealanders – which is why I favour raising taxes as part of the adjustment. <> <>Drastic measures are necessary if we are to avoid a repeat of the Muldoon years. My job here is to explain the reasons for the measures and evaluate their impact. I will be arguing for a coherent macroeconomic strategy, something we have not had for ages, and a fair sharing of the burden of adjustment. <> <>I should not be surprised if some of today’s Treasury economists agree with much of this column. The ones of 30 years ago certainly would.
Weighing Human Costs Critical
<>Letter to National Business Review, 11 September, 2009 <> <>Keywords: Health; <> <>Dear Editor, <> <>In his profile of me (4 September 2009), John Bishop compares my estimate of the cost of alcohol misuse ($16.1b) with that of the BERL estimate ($5.3b). Aside that they are for different years, and in different prices, they are not comparable because the BERL figure covers only tangible losses (that is lost of effective production) whereas mine also includes intangible losses, that is the shortening of life and the reduction of the quality of the life of the living as a result of alcohol misuse. <> <>Because of the widespread morbidity and mortality that alcohol misuse generates, and because we greatly value human life, the loss of the intangibles are far greater than the loss of the tangibles. Hence the substantive difference between my and the BERL estimate. <> <>It would be foolish to ignore these intangible losses when we undertake social cost exercises. For instance the tangible costs of gambling abuse are small; the effect is mainly redistributive, rather than loss of effective production. But the human costs are substantial. To ignore them would be to conclude there is no problem gambling. <> <>Brian Easton <>Wellington
Drinking and Self Assessed Welfare: a Statistical Analysis
This is the draft of a paper for 2009 Conference of the New Zealand Statistical Association, 3 September 2009. The presentation was a PowerPoint based on it. It is part of a study of the impact of drinking by associates undertaken by the Centre for Social and Health Outcomes, Research and Evaluation (SHORE), Massey University.
Authors: Brian Easton and Ru Quan (Ryan) You (with Sally Casswell and Taisia Huckle)
Keywords: Health; Statistics;
Introduction
An earlier paper described the 3068 respondent sample survey on which this is based.
This report focuses on drinking behaviour. Respondents were asked about their own drinking and also whether they had associates who were heavy drinkers, as well as their personal characteristics and self-assessments of their personal well being.
The statistical method is to use the various responses to predict the personal well being variables. Insofar as the equation is valid, the impact of each of the independent variables can be assessed. This enables the consequences of drinking or of associating with drink to be evaluated.
The primary purpose of the survey was to assess the effects of drinking associates on aggregate welfare. It also gave some useful insights into the effects of self drinking behaviour.
The Variables
Each respondent was asked on 12 dimensions of life including satisfaction with life as a whole (sometimes abbreviated to ‘happiness’). The responses were on a 0 to 10 scale. (Casswell, Huckle &You 2009) Note that the personal wellbeing responses are subjective, although there is some evidence that they correspond reasonably well to an objective assessment (where one exists)..
We asked whether the respondent had drunk alcohol in the last year. (We asked also of those non-drinkers were they ex- drinkers. but their responses have not been evaluated yet.) Drinkers were then asked a series of questions which in this report are summarised as
The frequency of drinking occasions (reported here as occasions per week);
The typical number of drinks on each occasion (reported here as 15ml of absolute alcohol drinks).
While there are problems with individual’s recall of their drinking behaviour although because of the way respondents are asked, SHORE surveys elicit far greater aggregate coverage than many other surveys.
Additionally respondents were asked about associates who were heavy drinkers. Their responses were categorised as:
Level 0: no heavy drinkers among associates (71.6%)
Level 1: associated with heavy drinkers not living or occasionally lived in the same household (15.4%)
Level 2: heavy drinkers sometimes living in the same household (7.5%)
Level 3: heavy drinkers living in the same household for more than half of the time (5.5%)
There is also an adjustment for multiple heavy drinking associates.
(For details see Casswell et al 2009)
Additionally they were asked for various (largely objective) personal characteristics. These are described in You & Easton (2009).
The Impact of Self Drinking
The approach is similar to Ryan & Easton (2009) with the following adaptions.
– we need to avoid the situation of a drinker who drinks nothing.
– the amount and occasions variables are cardinal;
– the occasions and amounts variables are related, at least through having a common intercept.
We found the following equation from worked well, where
Y is the normal logit of the dimension of life variable;
Z the other demographic variables;
A is the amount drunk on a typical occasion
F is the frequency of occasions
u is a random variable with the usual properties.
Y = a0 + b*Z + a1A + a2A2 + a3A3 + f1F + f2F2 + f3F3 + u,
and where the as and fs are constants to be estimated – we estimated them differently for men and women.
We found a cubic polynomial satisfactory. In some cases a shorter one would have worked, but for consistency we maintained them all at order three.
Interpreting the data the following should be kept in mind.
– it would be very rare for someone to have been surveyed while they were drinking; this is about responses to drinking when one is not drinking;
– this probably does not measure long term welfare effects of drinking, and certainly does
not measure any long term effects on health (such as cirrhosis of the liver).
We found that as a rule regularity of dinking did not greatly affect personal well being after we controlled for other characteristics) . For instance, consider the impact on the life satisfaction of a woman who imbibes 15ml of absolute alcohol each occasion by the number of days a week she drinks. It rises slightly, suggesting the regular drinker – of one glass – is likely to be happier than the infrequent drinker. Given that the zero is the never drinker, you can see the modest drinker is slightly better off. This low gradient was generally true for men, and for other life dimensions. However it is not always so that drinkers – even moderate drinkers – are better off than never drinkers.
(Note that this assessment does not include any effect of long term physical health nor the impacts of the drinking on others.)
The male response was also largely unaffected by the frequency of drinking, but they reported that they were less satisfied with life than non-drinkers.
A stronger effect comes from looking at the number of drinks per occasion. While moderate drinkers were sometimes higher on the dimension of life measure than non-drinkers, sometimes lower, those that drunk more were always lower than those that drank less except that the functions tended to flatten out for very large drinking, perhaps because we did not have a lot of observations.
When we looked at women assessed by the quantity of their drinking. we found those who frank more were increasingly less satisfied with life. Those who drank a single drink once a week or two drinks on a daily basis were happier than a non-drinker with the same characteristics. Bigger drinkers were less happy.
Men also show as strong a decline although unlike the women all drinkers report a lower satisfaction of life than for never drinkers (on average). This strong downward slope is universal across all dimensions of personal. However, there is not the time/space to present the individual results – in any case this is a statistics conference concerned with general principles of method, rather than detailed results.
Care needs to be taken in interpreting these graphs. It would be easy to misinterpret them as indicating that a person can raise their personal wellbeing by reducing the quantity they drink each occasion, moving back up the graph line.
However seductive as such a conclusion may seem, the graph lines are not causal relationships. They may be thought more of as sophisticated correlations. We cannot tell whether they are saying that the unhappy drink, and the unhappier they are the more they drink, or whether those who drink make themselves unhappy. Probably both effects are then in the curves.
Unfortunately, this is survey data, and it is never easy to identify causal relationships from cross-sectional data.
However, if this research strengthens anyone’s resolve to reduce their daily alcohol consumption to a modest (or even zero quantity) , the decision would be beneficial even if the conclusion cannot be statistically validated.
The Impact of Drinking Associates
Again the procedure is similar to Ryan and Easton (2009) where each person has a set of personal characteristics (vector) Z, with their drinking associates status indicated by (H1, H2, H3) which has Hx either 1 (associates have the characteristic) or 0.
If each’s person level of welfare on some dimension is given by Y as before, and using the same notation. then we estimate assume that
Y = a + b*Z + h1H1 + h2H2 + h3H3 + u,
Once the coefficients have been estimated the impact of heavy drinkers on the personal wellbeing of New Zealanders can be calculated. Here is an example for Satisfaction with Life.
The mean for satisfaction with life was 7.5 out of 10. (logit(.75) = 1.098).
The coefficients in the equation for H1, H2, H3 were – 0.048, -0.111, -0.353, and they apply to 15.4%, 7.5%, 5.5% of the population, giving a weighted average change of -.035.
It follows that were there no heavy drinking associates the mean of the scored satisfaction with life would 1.098 + 0.035 = 1.133 in logit form, or 0.756 (Since Probit(.756) = 1.133), or 0.85 percent higher.
This gives some credibility to Easton’s guestimate that associates reduced the quality of life by about 1 percent (or it shows that he was very lucky). Easton (1995) too that not all the dimensions of life experience a similar reduction and religious and spiritual values actual rise. ‘God our help in ages in past’?
Conclusion
The SHORE Survey has provided a rich data base. While its primary purpose is to evaluate the impact on the associates of heavy drinkers, it can also be used to investigate the impact of self-drinking and demographic characteristics on personal wellbeing. In two of the cases – the impact of heavy drinkers on others and impact of demographic characteristics on personal welfare, the conditions are probably such that we can say with some confidence that we are observing causal relationships. However in the case of the self-drinking the causality is likely to be in both directions and we are left with intriguing speculations we cannot verify.
Characteristics Associated with Happiness
This is the draft of a paper for 2009 Conference of the New Zealand Statistical Association, 3 September 2009. The presentation was a PowerPoint based on it. It is part of a study of the impact of drinking by associates undertaken by the Centre for Social and Health Outcomes, Research and Evaluation (SHORE), Massey University.
Authors: Ru Quan (Ryan) You and Brian Easton (with Sally Casswell and Taisia Huckle)
Keywords: Health; Statistics;
Introduction
This paper reports results from a survey whose primary concern was the impact of drinking on personal welfare. In order to investigate the impact of drinking, we have to control for demographics variables since they influence both drinking behaviour and general behaviour. In this paper we report on how those characteristics influence one particular indicator of welfare – satisfaction with life which, following economics practice, we sometimes abbreviate to ‘happiness’ (although psychologists warn they are not quite the same thing). In particular we control for other characteristics (and drinking) so that the interaction between variables is allowed for (for instance widows tend to be older than married, so the happiness of widows may reflect their age rather than their marital status).
The Survey
The general population survey was conducted using the SHORE/Whariki in-house Computer Assisted Telephone Interviewing System during 2008/9. The primary survey population included people aged 12 to 80 years living in private residential dwellings with a connected landline telephone in New Zealand, although a feasibility survey of a secondary random sample of residents with cell phone only access is currently being conducted.
The survey instrument, which was developed in collaboration with our Australian colleagues who are doing a parallel survey included measures of quality of life using the Personal Wellbeing Index and the EQ5-D. Respondents were asked about their drinking behaviour and the heavy drinkers in their lives. Questions on demographic variables were also included
Altogether there were 3068 responses with a 64 percent response rate.
The Focus of this Paper
While the primary purpose of the research project is to evaluate the impact of drinking of associates, it was necessary to control for demographic variables. The drinking behaviour is reported in a subsequent paper. This paper focuses on the relationship between the various personal characteristics and their responses to the satisfaction with life question. Time precludes reporting similar results for the other dimensions of personal well-being.
The satisfaction with life question was:
I am now going to ask you how satisfied you feel on a scale of Zero to 10.
Zero means you feel completely dissatisfied. 10 means you feel completely satisfied and the middle of the scale is 5 which means you feel neutral (i.e neither satisfied nor dissatisfied).
Thinking about your own life and personal circumstances, how satisfied are you with your life as a whole?
0 = Completely dissatisfied , 1, 2, 3, 4, 5= Neither satisfied nor dissatisfied, 6, 7, 8, 9, 10 = Completely satisfied.
(also scored Refused Don’t Read & Don’t know or Don’t Read)
Respondents generally scored a 7, 8 or 9.
Notice that this scale is over a finite interval. Consequently the reported variable was scaled to unity and transformed into a normal logit (say Y = LN(x/10/(1-x/10)) where x is the reported score.
The impact of the demographic variables (Z) was estimated with the equation
Y = a + b*Z + u,
Where u was a random variable with the usual properties of being normally distributed.
Results
All the results reported here are relative to a person who is a 50 year old female of Pakeha ethnicity, who is employed as a professional with a university degree, on an income of $60,000 p.a. and who does not drink. On average she would report a satisfaction with life score of 8.2. In the tables bold marks the base category.
An asterisk (*) indicates that the other status is significantly different from this at a 5 percent significance level. Note that two estimates may both be significantly different from the base, but not from each other.
Gender
If the base female is 8.2, the male with otherwise similar characteristics is 8.4. This is not statistically significantly different. It is common to find on average males are less happy than females, but this is because they have more unhappiness prone characteristics rather just their gender.
Life Satisfaction by Gender
Age
A quadratic fitted age against life dimension was statistically significantly with a minimum at 48 years old. Thus a person is happier when they are young, their happiness declines progressively as they get older, until they are about 50, and then increases again. Note that sample consists of those in their own homes (which may be important in interpreting older people’s life satisfaction, and who are not dead (which almost certainly is).
Life Satisfaction by Age
Ethnicity
The only ethnic group which is statistically different from the base (is Pakeha) was Asian. This is a cultural response; Asians always tend to score in the middle of survey scales, whereas in the case of happiness non-Asians tend to score more at the top. This is a reminder that there are cultural elements to the responses.
Note that the estimate does not tell us that, in actuality, Maori are as happy as Pakeha, only Maori with the same demographic characteristics are the same.
Life Satisfaction and Ethnicity
Marital Status
Marital status matters. The married are more satisfied with life on average. and this is statistically different from other the states. Women who are separated (or widowed or divorced) are statistically less happy than married women but much the same level of happiness applies to single women. Separated men are even less happy than women, but single men are about half way between married men and separated men in life satisfaction terms.
Life Satisfaction and Marital Status
Employment Status
It turns out that the only two employment situations which are statistically different from being employed full time are being sick or being a full time male parent.
Life Satisfaction and Employment Status
Education and Training
Other than men with a trade certificate, educational and vocational training has little direct effect on one’s satisfaction with life. It may have an indirect effect since marital status, employment status, occupation and income are all affected by qualifications.
Life Satisfaction and Education and Training
Occupation
Occupations divide into two categories. Occupations higher in the hierarchy – professions and their allies and skilled workers – are more satisfied with life than those lower in the occupational hierarchy — trades workers and labourers
Life Satisfaction and Occupation
Incomes
A statistically significant quadratic on log income gives the patters shown in the following table. Certainly one’s happiness rises with increased income, but the increase is surprisingly small. For instance quintupling income form $20,000 p.a. to $100,000 per year, increases happied by .2 units, whereas being sick relative to being employed reduces it by six times that and being single relative to married three times that. One might conclude it is happier to be married healthy and poor than living alone sick and ric – on average of course. .
Life Satisfaction and Income
Conclusions
1. The results are not markedly different from similar overseas studies.
2. There are New Zealand studies but they tend to ignore the interaction effects.
3. For small changes the impacts are additive so that other combinations of characteristics can be calculated providing the total change is not to large (where the log-normal effects become non-linear).
4. A similar analysis can be done for other dimensions of personal welfare.
5. This is preparation for the main purpose of the survey which is the impact of drinking on personal welfare.
Response by Recipient Of 2009 Economist Of the Year Award
3 September, 2009 at the NZIER AGM
Keywords: Miscellaneous;
I am deeply touched and honoured to be awarded this generous prize, and embarrassed by the even greater generosity of the accompanying citation.
Normally it would be a time to mention all those who have mentored and supported me over the years. It is a very long list and includes people in this room. Thankyou for being here. However I thought it appropriate on this occasion to mention but one mentor, without whom I would have never got here tonight. It is the NZ Institute of Economic Research.
The Institute was conceived by Professor Horace Belshaw as a source of independent public good research, recommended by the 1956 Royal Commission on Money and Banking, and established some 51 years ago. Initially it pursued its public good objectives by publishing research and by training recent graduates. I was one of the beneficiaries of this program and I thank Jim Andrews and Gert Lau – the first chairman and deputy-chairman of the Board of Trustees – and Conrad Blyth and Alan Catt – the first director and deputy-director – for giving me that opportunity and that training in applied economics. Perhaps I can also mention John Mowbray, who was later to give me the opportunity to direct the Institute. This evening shows, I hope, that their faith in me was justified.
And as an ex-director, may I, with the three other ex-directors in the room, wish the best to the new director Jean-Pierre de Raad and his team in the pursuit of the Institute’s objectives? I hope they have as much fun as I did – but less stress.
The Institute has extended beyond its initial activities of publishing research relevant to the public debate and training young economists including nowadays taking on summer interns, while its education activities now extend to information on its website. It tells a lot about person as to where he or she first looks in an annual report. I went to page seven where the Institute lists it Public Good Work. Even those who focus on the accounts will observe that they include a line item of Public Good Costs, in effect the part of the Institute surplus which is devoted to public good activities
The award I have just received is a further contribution by the Institute to promoting the public good in economics. I know how hard it is to find resources to promote it. And yet we must – my current program is writing a history of New Zealand from an economist’s perspective and analysing the macroeconomics of the crisis we face. I promise that as respect for the award and for the objectives on the Institute I shall invest the prize in further research for the public good. I thank the Institute for the contribution.
I shall cherish the citation forever.
2009 Nzier Economics Award
Citation of Award made on 3 September, 2009 at the NZIER AGM
Keywords: Miscellaneous;
The NZIER Economic Award’s Operating Guidelines enjoin the Awarding Panel to “look for outstanding contributions to the advancement of economics and its applications in New Zealand”. To qualify for the Award, a contribution “must advance economic matters of direct relevance to New Zealand”, and must be “likely to be of long term lasting importance to New Zealand”.
The recipient of the 2009 Award has made outstanding contributions, amply meeting these requirements, in the fields of the economic history of New Zealand, the collection and evaluation of long-run economic statistics relating to New Zealand, and the stimulation and informing of debate about economic questions affecting New Zealand among the interested public.
Our knowledge of the economic history of New Zealand would have been considerably poorer without the recipient’s work on social policy and the welfare state in New Zealand, and on the impacts of world economic events on New Zealand’s economy, international trade and capital flows. His written works, under such attention-demanding titles as The Commercialisation of New Zealand, In Stormy Seas: The Post-war New Zealand Economy, The Whimpering of the State: Policy after MMP, The Nationbuilders, and Globalisation and the Wealth of Nations have kept the lessons of economic history for New Zealand in the minds of decision-makers and policy-crafters. His focus on those lessons has no doubt been of value in his work as a member of influential economic policy review panels, including the New Zealand Growth and Innovation Advisory Board.
Reliable conclusions cannot be drawn from history, at least in economics, without a deep and accurate understanding of the statistics available from the periods under study, and of the quirks and unpredictable figures which they sometimes contain. The Award’s recipient is a Chartered Statistician, and a Fellow of the Royal Statistical Society. His knowledge of significant economic statistics concerning the New Zealand economy is exceptional, and is widely admired by other researchers, not least because of his unfailing willingness to explore those statistics and discuss them.
The “advancement of economics and its applications in New Zealand” requires decisions to be made, often in a political context. If politics is indeed the art of the possible, then the boundaries of what is politically possible, let alone desirable, will be widened if the interested and influential public has an adequate understanding of the reasons why certain actions might be considered by policymakers, and of what the consequences of those actions might be, or might be hoped to be. The Award’s recipient has been an outstanding economic journalist, and a participant in public economic debates, bringing unusually broad perspectives to issues of lasting importance, for over 30 years. The public of New Zealand has benefited greatly from his tireless work, and from the exceptional clarity of his writing. He has indeed “advanced the study and understanding of economic matters directly or indirectly affecting New Zealand”, as the Award seeks to recognise and promote.
The NZIER Economics Award for 2009 is accordingly given to Dr Brian Easton
Less Equal Than Others
When I was working on the problems of inequality and poverty in the 1970s, my colleagues joked I was a social economist, even if they spent more time in bars, for social economics was seen as peripheral to the centre of economics. Never mind that it covers about three-quarters of Government spending.
But my colleagues’ jesting also reflected a discomfort with the issues that social economics raises. Homo economicus is an isolated being, whereas humans (including even economists who don’t go to bars) are intensely social. As economics spread its interests, it needed to broaden its account of how humans behave.
Recent research on inequality has increasingly confirmed this challenge. Richard Wilkinson’s book The Impact of Inequality notes that societies with great inequality are more prone to poor health, social hostility and crime. The cause seems to be stress, because those lower in social rankings suffer from the comparisons (the stress of keeping up with the Joneses) whereas those at the top are keen to show off. In a more equal society, the rankings are not as clear, conspicuous consumption is less effective at driving spending, and there is less stress, better health, less crime, less hostility and more social cohesion.
My initial research into recent trends in New Zealand society suggested economic inequality diminished after World War II, probably because we had full employment and as a society we cared about fairness.
However, from the mid-1980s economic inequality increased sharply, caused mainly by a tax regime more favourable to the rich and by lower real (inflation-adjusted) welfare benefits. More recently, the inequality has increased slowly. The more-market economy seems to be favouring skilled workers and senior managers, while we do little to even up their gains. (Not maintaining the wage relativity for benefits has not helped.)
Some evidence suggests the turmoil of the late 1980s increased the mortality rates of the poor. A scientist might hypothesise that recent increases in violent crimes were a result of the rising inequality, but would do so cautiously.
A second source of discomfort arises because the issue of equity gives policy advocates some tricky issues to grapple with. The giant of distributional economics, University of Oxford’s Tony Atkinson (I’ll break a column rule and mention he was knighted; social economics has a higher status elsewhere), reminds us that economics is a moral science. “Many of the ambiguities and disagreements about economic policy stem not from differing views about how the economy works but from differing values.”
The mantra “cut taxes for the rich” looks less attractive if one has to say “cut taxes for the rich and increase inequality”. Better to avoid it, especially in the form “cut taxes for the rich, increase inequality and imprison the criminals”.
So assessing social inequality involves deep philosophical issues that add to many of today’s economists’ discomfort because, with a few exceptions, they are not conversant with philosophy, despite some of the profession’s greats, such as John Stuart Mill and Amartya Sen, having contributed to it.
Which makes Dunedin student Sophie Elliott’s essay “Why Measure Inequality? A Discussion of the Concept of Inequality” all the more remarkable. It was published on the Oxonomics website (oxonomics.typepad.com) shortly before her murderer was convicted. Written as an University of Otago term essay when she was only 21 – a baby in economic terms – it was described by her teachers as “easily the best essay on equity and equality either of us had ever read”. Atkinson wrote: “Sophie’s essay is a testament to the way in which clear thinking and hard analysis can contribute to advancing our understanding of these crucial issues.”
We cannot measure the loss to Elliott’s family and friends, and to those she would have made had she the future she deserved. She is also a great loss to the economics profession.
Another Think Coming
Unfortunately, there’s no magic bus to accelerate us to Australian levels of income.
Listener: 15 August, 2009.
Keywords: Growth & Innovation;
Sometime in the 1960s, New Zealand economic growth went through a “climacteric”, a point when the growth rate started slowing down. Think of it like driving your car up a hill. Once it starts running out of momentum from the run-up, it decelerates.
The climacteric probably occurred when the sheep-based economy that had driven New Zealand for a hundred years ran out of puff as synthetics took over from wool. But more research needs to be done to help us understand the details.
Now National and Act have agreed to set a “concrete goal of closing the income gap with Australia by 2025”, 16 years away. The historical record shows the divergence from Australia began in 1966, 43 years ago. So they expect we will catch up two-and-a-half times faster than we got behind. Yeah, right.
Some people think they have the answers, but only because they don’t bother with research. The facts present them with too much of a challenge.
When politicians claim their policies will accelerate economic growth, how do they know and, more important, by how much? Take some contentious public policy issue – say changing the Resource Management Act (RMA). Advocates of the change say this will enhance New Zealand’s economic growth prospects. It would be helpful if they were to specify the amount.
I cannot think of any rigorous scientific means of calculating how much. Proponents and opponents of such reforms typically depend on a handful of anecdotes linked by faith. One approach is the Delphic technique whereby a panel is asked to guess.
Recall the political advertisement that listed a number of policies with a claim of how much each would accelerate the economic growth rate? There is no way the numbers could have come from a scientific forecast; perhaps a group of advertising executives made them up to suit the client.
So, yes, the composition of the panel counts. One consisting of businesspeople guessing the impact of the RMA changes will have quite a different forecast to one consisting of, say, greenies.
This shows how critical the Government’s proposed “2025 Commission” (or whatever it to be called) will be. It’s purpose will be to tell the Government how to attain income parity with Australia by that year. By choosing the right members, the Government should be able to get the answer it wants.
However, the commission faces a number of sobering reports that have tried to work out how much productivity could be accelerated. One of my favourites – I was not involved – is nicknamed the “magic bus”, referring to the song by the Who, which goes: “I want it, I want it – you can’t have it!”
One of its many merits is that it goes as far back in time as the official data allows – before the climacteric of the 1960s. Far too many other productivity studies use too short a time frame, leaving out or ignoring the periods of poor performance that contradict the efficacy of the policies being explicitly or implicitly advocated.
It is going to be a real challenge for the 2025 Commission to meet the Government’s requirements and maintain high standards of analytic rigour.
Finance Minister Bill English has given the commission an out by saying he wants more “freethinking”. No, he was not saying the country is so broke it can’t afford to pay Treasury officials. Rather he wants independent, creative and – may I surmise – rigorous thinking.
That means any member of the commission – indeed the entire commission – is being invited to say there is little we can do to attain income parity with Australia by 2025. That is the research evidence, and is almost certainly what any freethinker will conclude.
New Zealand and the European Union Edited by Matthew Gibbons.
Pearson Education New Zealand. 163pp. $53. ISBN 978-0-7339-9383-1.
Review for New Zealand Journal of History, 43, 2. (2009) p.226-227.
Keywords: Globalisation & Trade; Political Economy & History;
New Zealanders have difficulties with the notion of Europe, despite the vast majority being of some European descent and the culture primarily deriving from Europe albeit with Pacific and, latterly, Asian modifications. (A further substantial contribution is from North American, itself largely European derived.) It is partly the problem of a fish coming to terms with water, but it is also because the locus of New Zealand’s Europe is the British Isles which is perhaps the least European part of Europe. So rather than see the European Union as a cultural, economic, political and social idea – a grand conception to resolve a millennium and more of warfare and cultural conflict – New Zealanders tend to see it as an economic entity only, rather as the British do.
As it happens, a crucial element of the mechanism for the resolution of aeons of conflict has been economic integration. The first institution in the development of the EU was the European Coal and Steel Community which aimed to so integrate France and Germany’s industries so that they could never go to war again – a view consistent with the notion that markets resolves certain sorts of conflicts and trading partners dont (or cant) war. Then there was the European Economic Community; many New Zealanders continued to use the term long after it became obsolete over a quarter of century ago. It would be difficult to justify the EU’s anthem – Beethoven’s Ode to Joy – in terms of a customs union.
It is perhaps, then, not surprising that the ambitious title New Zealand and the European Union should be of a book largely about New Zealand’s economic relations with the EU. Five of the six contributions on that topic and only one – the fifth chapter – is on ‘people to people and political links’. That chapter is superficial and disappointing, drifting into a discussion on marketing of tourism, but neglecting many cultural aspects. It does not even mention that New Zealanders can speak more European languages (other than English) in total than they can speak Maori.
After an introduction by Matthew Gibbons, Carol Neill provides a detailed statistical account of New Zealand’s pastoral exports to the EU-15 (the membership before the enlargements since 2005) followed by Gibbons’ overall review of the pattern of merchandise trade in the second chapter. Chapter three and four, also by Gibbons, cover expert opinions and exporting to the new EU countries. To one’s amusement, Gibbons finds that the forecasts of ‘experts’ reported in the earlier Frank Holmes and Clive Pearson Meeting the European Challenge, proved to be not very successful. (The new book is much more satisfactory than its 1991 predecessor, which was widely greeted with disappointment.)
The final chapter by Caroline Saunders is about New Zealand’s access to European markets for its agricultural products. This is a matter of very great importance, but it is not only the access to European markets. Europe has been a major dumper into third markets of the surpluses arising from its agricultural protection and subsidisation. In the 1950s Europe was a net importer of dairy products; today its dairy exports are at a similar order of magnitude to New Zealand’s, thereby driving down our returns. Saunders reports that the EU promises to eliminate subsidised exports by 2013.
Neither individually nor collectively do the chapters address what seems to me to be the central problem of trade relations between the two entities. It is true that the book points out the fall in overall share from about 80 percent of all merchandise exports going to the current members of the EU in 1960 to about 20 percent today. Of course there is pride in the diversification to new markets and new products which the falling share implies and it is easy to explain it in terms of British decline and protectionism. But it is generally accepted that New Zealand’s exports have not grown fast enough, so we could have had the diversification together with more success in European markets. Why did we not? It is even more surprising that this decline has not been a matter of national angst. After all, the EU is a slightly bigger economy than the US by output (though its larger population means it has a lower per capital income).
Any systematic analysis needs to look at shares by export product for all the world’s economies. There is a methodological issue here. Today no bilateral trading arrangement (or indeed a cultural or diplomatic one) is so strong that it can be evaluated without reference to other parties – to the rest of the world. I am not even sure that was true when New Zealand was a colony of Britain.
There are of course, particularities which explain some of the decline (Neill nicely sets out the pressure on wool from synthetics), but what must be feared is that New Zealand lost the huge European market because it could not produce the sophisticated products that Europe wanted, nor cope with its complex and heterogeneous markets. Such a gloomy conclusion would suggest that the previous government’s Economic Transformation Strategy would have fallen foul of our lack of the necessary skills (and even energy and innovation). More cheerfully Gibbons reports European growth in the share of tourists, our single biggest exchange earner. It is also possible we do well in other ‘invisibles’ to Europe; unfortunately the incompleteness of the data makes it difficult to be sure.
The failure to pursue – not just in this book, but generally – the big economic question of why we have not been more successful exporting to Europe is all the more surprising, given New Zealand’s obsession with the EU as an economic entity. Because of our affections for our cultural roots and the commonalities of our visions in the world order (in addition to the need to have an international counterbalance to the US) a New Zealander might hope for an ongoing and constructive relation with the EU. But it has to be multidimensional and, hopefully, it wont be based on the single (and declining) dimension of trade (and investment which hardly comes into the study).
This, then, is a monograph rather than a book. It contains much useful (some original) material on economic relations which will contribute to a comprehensive study of New Zealand and the European Union. But it is a long way from the promise in its title.
New Insights into the Experienced Generations
<>Speech to Launch the Report “New Insights into the Experienced Generation” for the Hope Foundation, 30 July 2009 <> <>Keywords: Social Policy; Statistics; <> <>This report represents a further step to our understanding of ourselves as a society. Only a few decades ago we treated all New Zealanders as the same, with the implicit assumption that they were moderately affluent white men, whose age did not matter because they all followed the All Blacks. Slowly and increasingly we have come to realise that ours is a community of diversity. It is no longer unnoticed that half the population lacks a Y chromosome, that brown skin does not only mean a good sun tan nor does yellow necessarily mean jaundice, that different generations differ in a variety of ways, and that there were rich and poor as well as the moderately affluent. <> <>This report shows that so complex is New Zealand society, even those categories are not fine enough. Once we treated the half a million seniors as a single entity. The report shows there are groupings within them. To a lesser or greater degree an individual may belong to more than one group – any statistical technique has to draw lines to categorise – but the report underlines that not all the elderly are the same. <> <>Our more subtle political commentators knew this. There are those who claim to speak for all the elderly. On certain matters – say the level of New Zealand Superannuation – the vast majority of the over 65s have a common interest. But the political polls show, and the political parties know, that on many issues the older generations are as divided as the rest of us; there can be no one spokesperson who represents them all. <> <>What the Nielsen survey has done is identify five subgroups of roughly equal size. These categories reflect attitudinal differences rather than the standard demographic and financial differences which an economist uses. <> <>Four of the five groups have much the same age profile – although Kiwi Battlers tend to be a little older. <> <>Four of the five groups have much the same income – the exception is Affluent Investors, whose income tend to be about 50 percent higher than those in the other four groups. Even the groups’ average investments – excluding pension entitlements and housing – are more together than one might expect. Home ownership is clustered too: 83 percent of the Kiwi Battlers live in their own homes and so do 93 percent of the Affluent Investors. <> <>Again, excepting the Affluent Investors, the seniors experience similar financial pressures, Typically just over about 40 percent of each of the four groups are finding their current financial situation a struggle, either having no spare money and feeling like they are going backwards, or they typically manage to meet expenses but have nothing over. Under 10 percent – again the affluent investors excepted – have few financial concerns. The figures are probably not very different for the rest of the population. <> <>I am not surprised at this clustering of the financial variables of four-fifth of the elderly. A few years ago I was working on health and the financial characteristics of the population, and we trialed our statistical analysis on the over 65s. We, unexpectedly, found no relationship between health and income for those in the bottom four quintiles, although those with top incomes were healthier. We concluded that the incomes of the majority of the majority of the elderly were so clustered together on the income dimension that it was not good predictors of their behaviour. <> <>Affluent investors aside – as in our study, they are almost exactly a fifth – this study separates the remainder mainly by non-economic variables. At which point an economist should perhaps go silent, except I am also a social statistician. So what does the survey tell us? <> <>To my surprise, the four groups are not divided by two dimensions, but by three. <> <>The first dimension on which they are all divided into two groups is health. The behaviour of Active and Awares and the Paradoxical Pensioners conform more to the recommendations of health professionals than do Traditionalists and Kiwi Battlers. <> <>It is the environment which distinguishes the Actives from the Paradoxical. The Actives and Aware are pro-Green while the Paradoxical Pensioners think the threats to the environment are exaggerated. <> <>The other two groups are both less concerned with environmental pressures. What seems to separate them is that the Traditionalists are more likely to have an active social life, while the Kiwi Battlers appear more isolated – which may not be surprising given that they are more likely to be living alone, are older and are poorer. Even so they, and all the other groups, are likely to make charitable donations or do voluntary work. It is possible that Traditionalists evolve into Kiwi Battlers as they get older. <> <>Affluent Investors fit into this pattern as follows. Their health activities are similar to the Actives and Paradoxical and they seem socially integrated, but the report does not tell us about their environmental concerns. <> <>In summary, the divisions reported here are those you might expect if you looked at most age groups in our society. Just as New Zealanders are diverse as a whole, so are the seniors. They have particular concerns, of course – the level of New Zealand Superannuation, aging and perhaps becoming isolated. But on many dimensions they are much like their children and grand children. <> <>If there is any evident social problem this survey points to (other than like many New Zealanders not all seniors have good health practices) it is the Battlers – an eighth of a million of them. As well as being isolated and lonely, nearly two thirds of them say they are not sure who they can trust and over half think things are changing too fast. They are not poor by the standards of New Zealand’s families with children, but they may well be poorer in spirit. <> <>It may be a little comfort to the Minister of Finance that money is unlikely to be the solution to their social isolation. All New Zealanders may need to make an effort to interact with the elderly a bit more, although I cant help thinking that the more convivial retired elderly may also have a major role here. <> <>Like all good research, the survey answers a few questions and raises more. We know a lot more about the over 65s – in a particular they are a diverse lot. The Hope Foundation may want to do more investigation on those who are socially isolated and lonely.
Hollow Auckland
There are at least three good reasons that the restructuring of our largest city will fail.
Listener: 25 July, 2009.
Keywords: Governance; Growth & Innovation;
Author Bruce Jesson once said New Zealand was a “hollow society”. He meant that although we had a central government and individuals, the social institutions between them lacked independence. The government preceded most settlers, so their social organisations were not able to evolve organically but depended on central government.
There are some exceptions. Iwi were here before Governor Hobson, and have survived as organic institutions, despite having had their resource base stripped away by the settlers. Treaty settlements have recapitalised them, leaving them increasingly strong players in New Zealand social and political life.
Business was dependent on the central government up to the 1980s. The Rogernomics revolution removed state protection and intervention, leaving business largely to fend for itself. Its success has given it a robust independence, which it uses in the political arena to further its objectives.
Apart from a few exceptions, most of our social institutions are still very dependent on central government, not least because they have few independent sources of funding. As a consequence, the political structure of New Zealand is immature, without the checks and balances that come with comprehensive independent social organisations.
This is well illustrated by local government. Central government often treats local authorities with contempt – or at least doesn’t bother with the niceties of consultation. It needs local bodies to do the mundane roading and drains, while you want them to reflect your community, provide wider services and protect you from the excesses of Wellington.
Earlier this year the Government withdrew a local authority petrol tax without consultation; shortly after that it suspended democracy in Auckland overnight. It is now imposing its will on the governance of Auckland without significant consultation. It does not even have the fig-leaf of the royal commission’s soundings to cover it, since its proposals barely connect with the commission’s. Whatever happens, Super-Auckland will not be an organic body of its citizens. (And it will be underfunded, which, no doubt, will result in public assets being privatised.)
One can understand the Auckland business community’s impatience with the existing governance of the city. Take roading. Although the main moan is that the local bodies have been unable to come up with a decent transport network for commuters, central government is also to blame, given the funding problems. Auckland business needs a road network for its trucking – public transport is no solution here – and is fed up with the ongoing failure of the governance to meet its reasonable demands.
With business now one of the powerful organisations in the hollow society, it is no surprise that the structure of Super-Auckland reflects business preferences, especially its strong centre and the weak role of citizens. I don’t recognise any known robust political form in the proposed structure. The closest may be a business, but frankly that is not a very good fit, either. The proposal is an ill-thought-through compromise.
My guess is that ultimately the proposed governance structure will fail for at least three reasons. First, its implementation is too hurried, and there will be unnecessary – and even catastrophic – mistakes. Second, without a proper local mandate, the citizens of Auckland will find the new arrangement alien and will eventually revolt, especially as the mistakes become evident.
Third, central government is setting up a powerful political entity that will ultimate challenge it. Compared with the central government, there appears to be no comparable local body in size and scope anywhere else in the world – capital cities excluded – and the Mayor of Super-Auckland may be said to be elected by more people than the Prime Minister. Central government will limit Auckland’s independence by controlling its funding, and – as Jesson would say – then what?
I am reminded of the health sector re-dis-organisation of the early 1990s. Badly designed, too hurried and imposed without any popular mandate, it damaged the provision of healthcare for the rest of the decade, not to mention prospects of the National Government that tried to implement it. Yet this Government seems determined to ignore the lesson.
It has been said those who don’t learn from history are condemned to repeat their mistakes; the first time is tragedy, the second time farce. And it will be a melancholy one in the case of Super-Auckland.
Was Paul Right?
<>Sea of Faith Conference: 18 July, 2009. Auckland <> <>Paul, Timothy Money and the Economy discusses the same biblical text, but in terms as to what it reveals about Paul’s views of the economy. <> <>Keywords: History of Ideas, Methodology & Philosophy; <> <>I thought good context for today’s paper would be a biblical text – verses 6 to 10 of chapter 6 of the first pastoral epistle from Paul to Timothy <> <>6: But godliness with contentment is great gain. <>7: For we brought nothing into this world, and it is certain we can carry nothing out.
8: And having food and raiment let us be therewith content.
9: But they that will be rich fall into temptation and a snare, and into many foolish and hurtful lusts, which drown men in destruction and perdition.
10: For the love of money is the root of all evil: which while some coveted after, they have erred from the faith, and pierced themselves through with many sorrows. <> <>The last verse is often misquoted as ‘money is the root of all evil’. The difference is important. Paul is not ruling out that money may be a useful part of an economy and society, a means to an end. The evil arises when it becomes an end in itself. <> <>Today’s seminar is about responding to the recession. I want to do so in the spirit of the Pauline epistle by suggesting that it is a good time for us to ask, what is the purpose of the economy? We are going to have a lot of people telling you what we should or should not do but they will fudge as to what is the point of it all, ignoring the purpose and focusing on the technical. Instead let’s call upon your expertise – the informed reflection of those concerned with spiritual values – to try to provide some guidance on where we should be going. <> <>You will appreciate that as an economist I am operating outside the normal competence of my profession. What I hope to do is give you some background to build a better understanding than we currently have. <> <>Although there have been numerous modifications to the initial idea, most of economics is built around the notion that individuals maximise something called ‘utility’, which is the response to the various things the individuals consume. A simple summary of the underlying philosophy might be ‘more means better’; for utility assumes that the greater the consumption the better off one is. <> <>(In most of this paper I shall refer to income more often than consumption, although it is consumption that gives utility. There is a technical reason for this; what is not consumed is saved, and generally economists treat savings as deferred consumption, and that generates utility too. So it turns out that income is a better measure of utility than consumption.) <> <>I dont have time to go through the caveats of this analysis – economists have many caveats – but ultimately they conclude that an approximate indicator of the total utility in a community is measured by aggregate total output, such as GDP (perhaps with modifications like for environmental degradation) and that a market economy (with modifications) is the best way to produce the maximum GDP – that is, maximum utility <> <>Utility was thought to measure happiness. Jeremy Bentham, the founder of utilitarianism, said ‘happiness is the greatest good’. He is even better known for ‘the greatest happiness of the greatest number is the foundation of morals and legislation’. Two hundred years ago it was assumed the more one had the happier one was. But is this true? <> <>Today we directly measure happiness by asking people how happy they are. I am going to report on some New Zealand research from Massey University’s Centre for Social and Health Outcomes Research and Evaluation. The 3000 plus person survey was not directly concerned with the issues I am about to discuss. Its pioneering focus was on the impact of alcohol consumption on the welfare of the associates of drinkers. But we needed to ask whether the associates have less satisfaction with their life – are unhappier – than those who do not have drinkers among their family, friends and colleagues after we allow for the individual’s economic and social characteristics (so that we can ensure that they do not contaminate our conclusions). It is these effects which I shall now report. <> <>First consider gender. It turns out that women say they are happier than men, all other things we can measure being equal. (As it happens there is not a statistical difference but the finding is consistent with international surveys.) <> <>Second, we found the internationally characteristic pattern by age. The young are happier, but as they grow older, they are less happy, hitting the bottom at the age of about 50. After that life satisfaction starts improving again – for the over 65s their life satisfaction is about the same as late teenage levels. <> <>On the whole of ethnicity does not matter. Our Pasifika people are about as happy as Pakeha, Maori are slightly less happy, but not statistically so. (That is, after the differences in the social characteristics are controlled for – and of course these differences are large.) However, Asians report themselves as less happy. The Asians in our research team tell us this is a cultural response; apparently Asians always tend to score in the middle of survey scales, whereas in the case of happiness non-Asians tend to score more at the top. <> <>This is a reminder that there are cultural elements to the responses. As far as we know this does not undermine the findings I am reporting since we are controlling for ethnic differences. However it not impossible that the male-female difference, say, is also ‘cultural’, although it not clear how one would test this objectively. <> <>Marital status matters. One of the strongest effects from our survey and from the international literature is that the divorced and single are less satisfied with their lives than the married are. Do remember these are averages; of course there are some married couples who are deeply unhappy, and there are singles and divorced who are on top of the world. But as a general rule, the married are happier. <> <>There appear to be few differences in satisfaction with life by educational attainment. Perhaps the sample is not large enough to capture with statistical certainty the slightly higher happiness of the better educated. It is also possible that education opens up opportunities for other things – marriage, employment and income – which do enhance happiness (but whose effect is measured directly). But we also need to recall the conclusion of John Stuart Mill, Bentham’s godson and intellectual successor, who said that ‘it is better to be a human dissatisfied than a pig satisfied; better to be Socrates dissatisfied than a fool satisfied’. <> <>There are two economic variables in the data set. As far as employment status is concerned, the sick and unemployed are markedly unhappier that those working, whether part or full time. Those studying or parenting are much the same as those working; the retired are likely to be slightly happier. <> <>Utilitarian analysis would predict that the higher the income the happier one is. The survey broadly confirms that pattern but the gains in happiness are surprisingly small compared to the variables I have just described. For instance a person on $15,000 a year with a job is likely to be happier than an unemployed person on $30,000; a person on $50,000 a year who is married is likely to be happier than a single person on $100,000 a year. <> <>The small benefit in life satisfaction from additional income is even more paradoxical if we look at happiness and income through time. The data I have been describing is cross-sectional; a snapshot of what individuals reported to us last year. As it happens the American government – mindful that their declaration of independence says a fundamental right is to pursue happiness – have been surveying Americans for the last sixty odd years. In that time their real incomes have tripled on average. But the average level of happiness has hardly changed (albeit it fluctuates a little from year to year, and the relative happiness of some subgroups has changed). <> <>We get a similar picture of average level of happiness by country. We might expect countries with higher average incomes (say measured by National Income per capita) to have higher average happiness. Among rich countries – New Zealand and those like us – that is not true. There are inter-country differences in average happiness but they are not explained by differences in average real incomes. The rule seems to be rich countries are all about equally happy, with particularities which cause differences which are nothing to do with income <> <>This is a bit of a setback for economics. For two hundred years it has assumed that ‘more is better’, but the evidence is that higher incomes does not seem to mean greater happiness, whether we are looking through time or between countries. That higher incomes within a country generate a little more happiness at a point in time, suggests there is a relativity effect which I shall try to explain. <> <>But whatever that explanation, it is humbling for an economist to realise that phenomena other than income ones, such as marital status and employment are far more important than income is when it comes to determining life satisfaction. <> <>Inevitably economists dispute what this means. This is not a central debate within the profession, although more that a handful of economists observe there is an anomaly and think it should be addressed. (Many scientific disciplines have such anomalies for long periods.) Rather than go through the debate, let me give you my explanation. <> <>While, as I mentioned earlier, average happiness in rich economies does not rise as the economy gets richer, that is not true for those economies which are poorer – say below two-thirds of the New Zealander’s average income. Below that threshold there is a strong correlation between happiness and income. As income and consumption rise, people in economies below the threshold say they are happier on average. <> <>What this suggests is that Bentham may have been right in his time, when ‘more’ did mean better. Increased production meant people ate better, were better clothed and lived more comfortably. However at a certain point one reaches a threshold and more spending does not increase happiness because the material requirements of life are already met. America seems to have been at that stage for about sixty years. We dont have the same longitudinal data for other rich countries, but New Zealand seems to be among those that are now comfortably above the threshold. <> <>Once a country is above the threshold what is the purpose of the extra production? To try to answer this (albeit only in part given the time I have) I am going to use the notion of a ‘hierarchy of needs’ as first proposed by the American (Jewish) psychologist Abraham Maslow. <> <>It is a framework widely used by other social-science disciplines, although it is a little too timeless, ignoring longevity, perhaps assuming it does not change much. In fact there appears to be a correlation between income and health and life expectation. I leave that for another venue. There is a story about employment, but that too will have to be left for another day. Today I am going to just explore the implications of the hierarchy of needs for income. <> <>Maslow’s hierarchy of needs involves five steps. At the bottom are physiological needs such as food, water, and shelter. A central role of an economy is to provide these basic needs. What seems to have happened is that in the rich world the economy now does that pretty successfully. They are above the first step of the hierarchy of needs, although we should never forget that most of the world’s population live in countries which are not so rich, where their basic needs are not met, and where they are, on the whole, not so happy. <> <>The second step up involves safety needs although perhaps we dont think a lot about them until, say, there is a crime or accident in our neighbourhood. While responding to these needs usually takes resources – jails and safety equipment for instance – economics is not at the centre of these issues. Criminology is quite a separate discipline. <> <>Having said that, I should mention a recent development, which I am cautious about; it is plausible but it does not have the same rich data base that the happiness research depends upon. What, Richard Wilkinson in his The Impact of Inequality, among others, argues is that the degree of social inequality in a society affects the health and welfare of the society. <> <>Using data bases from country comparisons, from the states of America, and from comparisons of cities it appears that the higher the social inequality, the worse is average health (which is where the research area is most worked through). But the murder rate is also likely to be higher when there is greater social inequality, while there is also likely to be greater social hostility and lower social trust. In a different venue we might ask whether the rise in income equality in the late 1980s and early 1990s triggered the phenomenon increasing demand for law and order. <> <>Apparently the higher the degree of social inequality the harder it is to secure the second step on the hierarchy of safety needs. I shall return to this finding shortly. <> <>The next step up – it’s the middle step of the hierarchy – is love, affection and belonging. Perhaps economics has little to say about this need for people to seek to overcome feelings of loneliness and alienation. The Beatles tell us that ‘Money Cant Buy Me Love’; perhaps I should leave it there, except to note that money may enable the time and reduce the stress which makes effective love, affection and belonging possible. <> <>The second to top step in the hierarchy is esteem, which covers both self-esteem and the esteem a person gets from others. Humans have a need for a stable, firmly based, high level of self-respect and public respect. Until they are fulfilled, the person feels inferior, weak, helpless and worthless. When their esteem needs are satisfied, the person feels self-confident and valuable as a person in the world. <> <>At this stage economics comes back. Recall that while over time average incomes do not increase happiness, that any point in time those with higher incomes are happier. This suggests that one component of happiness is your income relative to others, and that perhaps once some threshold is past – the threshold implied by Maslow’s first step of meeting physiological needs – the value of income and wealth is that it helps enhance one’s self esteem. <> <>We often rank people by their wealth, so that it appears that an individual can obtain greater public esteem by earning and owning more. In response we attribute to them a wisdom, which was not evident before they became famous. As Tevye noted that 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/ … And it won’t make one bit of difference if I answer right or wrong./ when you’re rich, they think you really know’. Money may not be able to buy you love, but it seems to be able to buy public respect – or at least many people operate as if it can. <> <>There are a couple of points here. If the only dimension of self esteem is income and wealth, then we have a striving to increase the inequality in order to obtain a higher ranking of public esteem. But recall that greater inequality increases crime, thereby undermining the second step of the hierarchy of safety needs. <> <>Second, in order that income and wealth justify public esteem we have to believe that in some way that those with high incomes (which may accumulate into great wealth) represent some general benefit to the public. Economists have spent much time trying to establish whether this is generally true. There is Hume’s problem that an is cannot convert ‘is’ into an ‘ought’ – how the economy works does not tell us about what is ethical or good and bad. Economists partly get around this by the notion of utility as a measure of worth, yet it may be an increasingly flawed theory. Even were it not, the economist’s argument that one’s income reflects one’s value to society proves circular. It says high incomes reflect contribution to society because we say so. That teachers are paid less than bankers does not mean they are less socially valuable. <> <>Obviously in some cases the income is associated with the social contribution. Let me hazard that Peter Jackson has made a greater contribution to the world welfare than most of us, although it is not clear that his contribution is in proportion to his income. However that is certainly not true for many others. For instance it hardly explains the bonuses of those in financial institutions whose actions have contributed to the Global Financial Crisis. Nor can one easily say of those who have inherited wealth that their holdings in some way represent their personal merit. <> <>In summary, we should be very cautious about assuming that high income or great wealth reflect social merit, and be unwise to assume that such people are automatically worthy of public esteem. <> <>Those who desire public esteem from their wealth have two not incompatible strategies which I shall call demonstration and contribution. After all how can one obtain the public esteem from one’s wealth unless it is demonstrated? Hence the importance of ‘Rich Lists’ – showing off. <> <>Another means is possessing what economists call ‘positional goods’ whose purpose is to demonstrate the wealth of the owner or consumer – to flaunt it. (Thorstein Veblin, called the phenomenon conspicuous consumption.) So the rich get bigger cars, not because they need bigger ones, but the owner needs to publicly display that they are higher in the social ranking than the mass of car owners. Some people seem to have more houses than they can possibly use. But jewellery, designer clothes, expensive parties and so on are all positional goods – perhaps even that my mobile phone is cleverer, or at least more expensive, than yours. <> <>The difficulty with this positional goods strategy is that higher incomes and technological innovation undermine them. Soon everyone can have a bigger car. You observe this in the evolution of holiday homes. As they have become more common, the very rich have found their territories invaded by those they judge of lesser standing, so they move on, and on. Perhaps it is to home at a more remote location, or to a third home, or a yacht. <> <>Positional goods are not confined to the very rich. I was recently looking at housing at a more middling part of the market. I was struck by how those homes have been constructed to be larger in recent years, but usually the additional space is not particularly functional. One can only live in a certain area – the rest is for display;’ look at my house, it shows how well off I am. Dont you think more highly of me?’ <> <>We are beginning to get here modern day version of Paul’s love of money. It may not be able to purchase love, but it seems to be able to purchase social esteem. This seeking of public esteem by way of display – of positional goods – is one of the drivers of economic growth. It gives temporary additional happiness – only a little – but it is continually undermined by economic growth raising all incomes and so enabling those who are lower ranked to acquire the positional goods too. Thus once the basic needs are met, there is no general rise in happiness over time. <> <>Just to complete the story, another way of adding to one’s self esteem is by using the income and wealth to contribute to society. I certainly dont want to play down the genuine charitable aims of the rich, especially by those who are a little embarrassed by their wealth. But charity was once more circumspect. Is it my memory, or is conspicuous consumption more common today than, say, before 1984? <> <>Earning public esteem by conspicuous consumption (even if it is on borrowed money) drives increasing consumption without increasing average happiness, because the public rankings remain the same on average. Thus the desire for economic growth does little to raise actual welfare (while depleting fixed resources and degrading the environment). <> <>Perhaps the most obscene example of this ranking by wealth/income was the way that the money markets were organised to give bonuses to those in the financial sector which involved sums out of line with any realistic assessment of what the recipients were contributing. Hardly any of those in the scramble for the vast sums asked whether they were worth it in absolute terms. What was important was their ranking in the hierarchy together with the certainty that they ranked well above the ordinary public. <> <>So money became the ultimate positional good, with the love of it as the root of the evil. It led to the financial boom and now the bust of the Global Financial Crisis. <> <>We can go all to manner of controls to try to prevent this happening again, but it as long as individuals think they can purchase self-esteem then the system is vulnerable to repeating the evil. No law can prevent this. Instead we need a society whose thinking is not dominated by wealth, in which we award public esteem for other attributes. going back to the traditional virtues. Accepting this means abandoning public ranking based only on crude economic values. It requires more subtle understanding of the human condition, and one in which there is not single dimension on which each of us could be ranked. Recall that the sweetest thing of all to Tevye was to discuss the holy books. That may not be your ultimate objective, but you can still respect others for whom it was. <> <>We are increasingly moving outside my professions competence; perhaps it is the time to pass these matters to the floor. Except that I have yet to explain the top of Maslow’s hierarchy of needs He argued that it was self-actualisation, the realisation of one’s potentialities with the implication that each of us has a different potential to realise. <> <>The psychologists’ debate on self-actualisation is fraught with complications. This audience is far more competent than I to discuss such issue. So perhaps I shall leave the last word to Paul. Verse 11, which follows that condemning the love of money as the root of all evil, says: <>But thou, O man of God, flee these things; and follow after righteousness, godliness, faith, love, patience, meekness. <> <>Footnote: I was asked whether there was a resolution in terms a better measure of output than GDP. All the proposed measures assume more means better, and miss the conclusion of the end of a variety of ways one should be given self respect, and can attain self-actualisation. . <> <>Go to top
Equity and the Tax System
Tax, Saving Welfare and Retirement: Have We Lost our Way? Symposium, Retirement Policy and Research Centre, University of Auckland, 16 July, 2009
<> <>Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Maynard Keynes <> <>Keywords: Distributional Economics; History of Ideas, Methodology & Philosophy; Regulation & Taxation; Social Policy; <> <>I was invited to give this paper because a few months ago I wrote a Listener column (4 April 2009) in which I pointed that a recent Wellington tax symposium had hardly discussed equity. Contributors advocated tax reform – as they have done for some 25 years – and their apparently sensible proposals have been ignored. When one has been advocating change for a quarter of a century and made little progress, it is time to step back and wonder why. I suggested it was because the reformers were not paying attention to equity, but their political masters had to. <> <>The Wellington Seminar is not alone. In May the government announced a tax working group to advise them. It would be fair to say that not a single one of the group (perhaps aside from its officials) has any expertise in equity issues. The IRD recently put a list of six factors contributing to a good tax system. The last was ‘A good tax system is characterised by high levels of voluntary compliance and is thus perceived as broadly fair’, a grudging acknowledgement that equity (albeit an odd notion of and justification for equity) might be taken into consideration but it was not a high priority. <> <>Yet, equity – or at least self interest – is never far from any discussion on taxation. Politicians do not over-rule reformers out of cussedness, but because equity is an important component of the tax system. So how did economics get into a muddle of ignoring equity considerations? (I leave how politics did, to another venue.) <> <>It is useful to go back to Arthur Pigou’s magisterial Economics of Welfare published in 1920, which derived many welfare rules, from the assumption that an additional dollar was less valuable to a rich man than a poor man. But, said those who came after him, how do we know that to be true; what is the scientific basis for comparing the standard of living of different people? And if we have no scientific basis to make comparisons, surely economists are no better placed than others, to make comparisons of well being. <> <>Instead economists tried to build welfare economics around another objective which seemed to be much less contentious. Pareto Efficiency, named after the Italian economist Vilfredo Pareto, says that economic situation One is superior to economic situation Two if somebody is better off, and nobody is worse off in situation One compared to situation Two. <> <>It is a strong requirement, because it is hard to think of practical policies that do not make someone worse of. There is even an economist’s principle which states this. Rabin’s Law is that all existing policies are Pareto Efficient, that is if you change the policy it will make someone worse off. Perhaps there are a few exceptions, following the introduction of a new technology or a new situation, but they are very rare. If we taught equity properly in economics we would not only teach Rabin’s Law, but as a matter of course we would assess who were better off and who were worse off when policy changed. <> <> <>An extension of the Pareto criteria is that the winners in a policy change from situation Two to situation One could compensate the losers so they were no worse off. When they applied the compensated criteria economists found that many – but not all – of the Pigou welfare rules gave Pareto optimal with compensation. <> <>However there were many other areas of policy where this new approach did not work. Yet economists wanted to give, or were asked for policy advice. So they sought to relax the rigorous requirement of Pareto Efficiency with compensation. One option was that after the policy shift from situation Two to situation One there was still a sort of gain, even though those worse off were not compensated. I think what the proponents had in mind was that it was someone else’s job to make the interpersonal comparisons and decide whether the improvements in the better-offs more than compensated for the losses of the worse-offs <> <>Where compensation need not happen, the notion is sometimes called ‘efficiency’, although I should warn that there are so many meanings of ‘efficiency’ floating around in economics that it is a very treacherous term. The basic idea of the various notions is getting more output for a given set of inputs (or resources). Is so increasing efficiency seems to be a reasonable objective. Few would advocate waste as a social objective. <> <>This narrow definition of efficiency is the underlying notion of those who advocate tax changes to increase GDP. The evidence is equivocal as to whether, within practical ranges, the average level of a tax system affects the level of output. That is a (very heated) debate for another day. To do it today would be to avoid facing up to equity, which might be an explanation as to why the debate is so heated. (It is evident from the studies that the winners will gain much more than the GDP increase, so others will be worse off. Even if there was a gain it would not be a Pareto efficient one.) <> <>(I also need to warn you that while we treat GDP as a simple measure of output, its level depends upon the relative prices in the system, and they can alter the level of GDP. This is a bit technical – those of you who puzzled over the Scitovsky criteria, in which welfare loci crossed, were struggling with this problem. I mention it as a warning; often underpinning simple economics are some very complex and subtle goings-on.) <> <>I have seen the GDP efficiency criteria – summarised as ‘a dollar is a dollar’ – called ‘Hume’s Law’. This is not a general term. David Hume is more famous for the insight that ‘is’ and ‘ought’ are conceptually different and should not be interchanged; a lesson lost on many economists, especially those who are advocating policies which they pretend to be pure value-free economics. <> <>The ‘dollar is a dollar’ formulation illustrates the problem of this GDP efficiency notion. Suppose a dollar was taken from each of the hundred poorest people in the land as was given to the richest man in with a gain of one dollar (say from administrative savings), so he was $101 better off. GDP would be a dollar higher too, and there would be an ‘efficiency’ gain – that is an increase in GDP. The explicit notion is a dollar is just as valuable to the rich as to the poor. Is it not extraordinary how step by step one set of principles which favoured the poor were reversed into a set which favoured the rich; how in the name of being ‘ value free’ the opposite set of values were introduced? <> <>So would the society be no worse off if we took a dollar from one hundred poor people, and gave it to a rich man? Pigou would not think so. Is the marginal value of a dollar to the rich exactly the same as the value to the poor? That seems unlikely given the universally accepted principle in economics that marginal utility diminishes for each individual as they consume more. Pigou has been upside-downed, and interpersonal comparisons have been sneaked back in. <> <>Earlier I warned that efficiency is a treacherous term. For instance, is there an efficiency-equity trade-off, the notion that if the economy pursues equity there will be a reduction in efficiency? But surely the advocates of equity want to pursue their ends in a way which is efficient. So what could efficiency-equity trade-off mean? <> <>The paradox may be resolved by observing that the term ‘efficiency’ is used here in two ways. <> <>The claim of an efficiency-equity trade-off is actually a belief that an economy which pursues equity will have a lower GDP than if it ignored equity – GDP is reduced if one pursues fairness. As I have said, a comprehensive review of the research literature does not support this conclusion. But suppose the volume of output would fall is the income distribution was made a mite less unequal. Then there would be a efficiency-equity trade-off with ‘efficiency’ meaning GDP. <> <>The second use of efficiency in the expression that the advocates want to pursue equity as efficiently as possible. That simply means they want to do it in an effective way as possible. Of course. But the meaning of efficiency here is not the same as GDP efficiency. (A diagrammatic representation off the argument. <> <>There is an even greater paradox. Consider a change which is Pareto efficient when there is compensation. For instance, suppose a tariff reduction gives an increase in output, but workers in the previously protected industries have to shift to lower wage ones. A way to compensate them would be to tax the winners on part of their increment, and recycle the takings to those who are worse off. But so we are told, taxation reduces efficiency. Which means that even though the proposed policy change is Pareto efficient, it cannot be implemented in a Pareto effective way because there could be no compensation. <> <>The fact is that policy proponents have economic values which underpin their recommendations. They need admit to the values they hold. (Hume would remind them that such values do not come out of any empirical knowledge but out of an ethical belief.) That would involve a radical change to the existing policy debates. Admitting one has values which underpinned the policy recommendations means that someone with different values might recommend different policies. Better to pretend to be value free while pursuing values which are in one’s self interest or the interest of one’s client or patron. <> <>This conclusion should be no surprise. In 1971, economist James Mirrlees, a Nobel laureate, wrote ‘An Exploration in the Theory of Optimum Income Taxation’ which shows the optimal tax structure depends on the nature of the social welfare function – there are very few general results. <> <>Where there are general results, they are often uncomfortable for those who want to reform the tax system, and tend to get ignored. Here is a simple principle I learned about thirty years ago, but which is still ignored. I present it at the simplest level. <> <>Suppose one wants to give everyone a guaranteed income which is a certain proportion of the average after-tax income of the population; suppose it is funded by a proportional income tax. I shall assume that there are no government services, only transfers. (Other government spending can be added with little extra cost with no increase in insight.) <> <>Suppose we identify everyone in the population with a number i, there are n people and their market income is Yi. The total income to be allocated will be ΣYi, summed across all n observations. <> <>The average income is therefore ΣYi,/n Let’s call it Y*. <> <>We set the minimum income as mY*, where m is the target proportion of the minimum income as a proportion of the average income. <> <>Then each person’s after tax income is the sum of their guaranteed income polus their market income after tax, or <> mY* + (1-t)Yi,. <> <>Summed across all people we get the total income is Σ(mY* + (1-t)Yi,) which can be arranged to <> nmY* + (1-t) ΣYi, <>or <> (1 + m – t) ΣYi, (since nY* = ΣYi,). <> <>Since we have no government spending, the total after tax income equals the total before tax income so <> <> (1 + m – t) ΣYi,= ΣYi,, <> <> or <> m = t. <> <>That is the average tax rate equals the ratio of the minimum to average income. That is an important enough conclusion to put in capitals. <> <>THE AVERAGE TAX RATE <>EQUALS <>THE RATIO OF THE MINIMUM TO AVERAGE INCOME. <> <>When I have asked people, they have typically said they think a minimum to average income ratio of about 60 percent seems reasonable, so their logic is that the flat tax rate has to be 60 percent. <> <>This is a very high rate. across the board, but it is an underestimate. <> – it ignores that government services also have to be funded from taxation, <> – it ignores the cost of administrating the tax system <>AND (a very big ‘and’ you notice) <> – it assumes there will be no behavioural response so that individuals faced by high marginal tax rates will not reduce their effort to make market incomes (however some may have an income target and may increase their effort). <>Collectively, then, we have to conclude that a flat tax has to be at least the ratio between the minimum and average incomes. <> <>Is the problem the flat tax? Could a cunningly designed variable tax avoid the high rates? It turns out that for any income distribution with some people with low market incomes, somewhere in the tax system there has to be a marginal tax rate which is at least that of the ratio of minimum to average incomes. <> <>I have tried various ways of lowering marginal taxes for a minimum guaranteed income. One solution is that each person should be taxed with a lump sum based on their particular earning ability, a result which will be no surprise to tax afficionados. Unfortunately it is impractical since in order to be equitable we have to know what each individual’s income earning capacity. <> <>One can,. of course, reduce the ratio so the minimum income is lower thereby reducing the required flat tax rate. That may be unacceptable in social terms – although one cannot help thinking that was a major driver when the real value of social security benefits were slashed in 1991. It was thought that increasing the wage-to-benefit gap would encourage people to move off the benefit in order to increase their income. However they were not able to reduce the gap sufficiently (in any case it is impractical to expect all beneficiaries to go to work), so to the pull effect of the higher income has to be supplemented by the push factor of the system trying to get individuals off the benefit. <> <>A way to get the average tax rate down would be to divide the population into those we expect not to work those we expect to work. Only the first group get a guaranteed income, the second get a guaranteed job. That is how we ran the social welfare system when there was full employment. The unemployed who turned up to the Department of Social Security were told to get a job, and they usually did. Alas that option is not so possible in today’s economy with its more dynamic labour market, and with greater difficulty maintaining full employment. Even so, I have wondered whether, in more benign times, this distinction might be useful in a redesign of the welfare state. <> <>In the interim we are stuck with high effective marginal tax rates, somewhere in the income redistributional system. It is to cry crocodile tears to argue that we should reduce top tax rates and to worry about the high EMTRs on those on low incomes. Those high rates can only be ultimately reduced by reducing the minimum accessible income or by increasing tax rates further up the income. <> <>My intention here has not been to advocate a minimum guaranteed income but to explore its implications for the tax system. Those who do advocate a minimum income are probably ‘Rawlesians’, that is followers of John Rawles’ principle that one should organise society by paying attention to the needs of the poorest. (I happen to be a Rawlesian for distributional objectives; I only mention this because I dont want to pretend I am entirely value free, even if the above analysis is.) <> <>What distributional principle is followed by those who pursue efficiency and a dollar is a dollar is harder to discern, especially as they are not forthcoming about the ideology and values which underpin their policies. Some seem to me to be so pro-rich they might be called anti-Rawlesian; the rest might just need to be more explicit. <> <>This is not a trivial matter. The tax reforms in the late 1980s and early 1990s gave a measurable boost to the after-tax incomes of the highest decile. In fact their incomes continued to rise in real terms at about the same rate as they had previously, for the effect of those tax reforms was to transfer income from the bottom 80 percent of the distribution to those on top incomes. Since the economy as a whole was contracting – GDP per capita fell every year for six years in a row – those at the bottom experienced even greater real income falls. One consequence is those on high incomes have quite a different memory of the period to the rest of the community. They were shielded from the fact that average after-tax and benefit incomes fell. For the rich the reforms were a triumph, for the rest they were an economic disaster. <> <>Another lesson from this period is that the lowering of the tax rates on higher incomes led to no discernable improvement in the economy as a whole contradicting the claim that tax cuts improve economic performance. The memory the rich have of the period shields them form this reality too, making it easier for them to claim tax cuts improve efficiency. they did not on any measure in the late 1980s and early 1990s. <> <>The last two paragraphs are based on well established estimates of the income distribution. But we dont discuss them – even though they are revealing about the political economy of the times as well as the impact of tax changes – because we are unwilling to discuss equity. <> <>That is the theme I finish on. It is time that advocates of policies were more explicit about their values and how their value-based policy proposals impact on the welfare of the various groups in the community – on the economic distributions. Recalling Rabin’s Law they need to be more explicit on who is going to benefit from their policies and who is going to be made worse off. This outing would be a big challenge to the profession since we lack many of the tools to carry out this evaluation, and where we have tools the policy advocates usually lack the skills to apply them. But we can develop them. <> <>It is a terrible criticism of the policy community to say this, but it has been lazy, unwilling to use the tools available to better understand the policies that are being advocated let alone develop better ones, or incompetent unable to use the tools. <> <>This paper began quoting Keynes’ remark that practical men and women are but slaves to some defunct economist (or other intellectual). One of the reasons I have gone through, in more detail than usual, the development of welfare criteria is because I wanted to bring to light some of the defunct economist which today’s practical policy advocates call upon. <> <>So how are we to get equity back into the tax reform discussion? One is from these kinds of presentations – but that is water dripping on a stone. There is another way. Suppose every time a policy was advocated, someone of goodwill but without a policy agenda asked the advocate – in public – that since Rabin’s Law said someone was going to be worse off from the policy change, would they list who would be worse off from their proposals? <> <>After a stunned silence (or lots of ‘ers’ and ‘ums’) the advocate may well nominate a few – an inadequate few, but it is a beginning. Persistence will eventually draw more out, and slowly and reluctantly a higher standard of identification of the winners and losers will be attained. Equity considerations would once more be included in the tax reform debate. <> <>Go to topUnderstanding the Fiscal Imperatives
<> Paper for Towards a Value Driven Public Sector Summit, 15 July, 2009. <> <>Keywords: Macroeconomics & Money; Regulation & Taxation; Social Policy; <> <>Before talking about the fiscal imperatives in the narrow sense, I want to make a couple of general remarks about the rhetoric of policy. . <> <>The first is that the need for a value driven public sector is quite independent of the state of the economy. It would be very easy to say that we are facing the consequences of a Global Financial Crisis, and therefore a certain set of policies towards the public sector should be pursued. In fact those policies, if they are valid, should be pursued whether we are in boom or bust. I understand the argument that a crisis creates the political opportunity to implement certain sorts of policies, but the policy itself should independent of the situation. I mention this because crisis mentality often generates poor quality policy responses which are expensive, ineffective and have to be reversed. The classic in my lifetime was the health sector re-dis-organisation of the early 1990s. <> <>The second remark is the relevance of Rabin’s law, which is an example of there being no such thing as a free lunch. Technically, Rabin’s law says that all policies are Pareto optimal, by which an economist means that any policy change will make at least one person worse off. Policies are frequently promoted without any reference to the fact that there will be some people who will be worse off as a result. The policy critics focus only on those that will be worse off, and the proponents and critics talk past one another. <> <>When you are advocating a policy change, always assess who will be worse off. Perhaps list them; you may see some tweaks which will reduce the damage. Sometimes the damaged are such a large proportion of the polity, that the policy will not be implemented or the implementation will involve modifications which distort its desired effect. Sometimes a politician will drive a damaging policy through, at enormous cost to her or his party, with the likelihood that at the loss of power – earlier than necessary – the policy will be reconstructed beyond recognition. Again the classic example was the health sector re-dis-organisation which expended a lot of the previous National government’s political capital and yet within about five years even its ministers were saying that the health system was being moved back to the track it was on before the re-dis-organisation. <> <>These preliminary remarks are about the management of policy change. They are not intended to say ‘dont do it’, but to place the core of this paper – the fiscal imperatives of public policy – in a political context. <> <>Economists start of with a preference for the market provision and purchase of the goods and services of the economy. The preference is not really an ideological one, but a respect for how the private market works. I want to focus on three key notions. In a market: <> – individuals only acquire a product if they value it at a greater (resource) cost than to the economy as a whole. <> – the total production for the whole world is equal to the total purchases so there is a kind of balance between supply and demand. <> – where there is sufficient competition there is pressure on producers to seek the most efficient (that is resource minimising) means of provision. <>There are of course a lot of caveats to these notions. An important one is that there is no guarantee that all resources will be fully utilised so there will be a need for a macroeconomic policy. Additionally, there is also no guarantee the resulting distribution of consumption will be fair or acceptable, so there may be a need to ensure the income distribution is socially acceptable. But subject to such caveats, and some others (not least about the impact on non-market activities such as society and the environment) , the account I have just given is broadly true for most market transactions. <> <>However, there are a set of activities for which the market does not deliver as well as the nation wants and which might be better provided by another means – such as the public sector. But public provision has not those advantages of the market I have just outlined. <> <>First, consumers may want a state provided service even though they value it at less than the cost of providing it. Public sector services are generally provided free, so each of us wants them to the point where they become valueless to the individual. Thus the state needs a different rationing system to the market, which depends upon income to ration access. <> <>Second, there is no automatic mechanism which will balance total supply with total demand. The actual mechanism we use is the cumbersome process of taxation to generate the revenue to purchase the resources. However there is no direct connection between the taxation the individual pays Instead the resources the state supplies. Were there such a mechanism, the service could probably be provided by the private market, and there would be no need for public provision.. Instead politicians – especially cabinet ministers – judge how much tax there should be and where the proceeds should be outlaid. <> <>Third, public provision is usually by a single supplier, so there is not the direct pressure on the (public) supplier to seek maximum efficiency of the use of the resources, something which the competitive market does automatically. <> <>Each on of these is a serious problem. However sometimes private provision is a disaster too, so that some sort of public provision is to be required despite its defects. <> <>It is difficult to generalise so each case has to be separately evaluated Instead I shall give some illustrations. Take the provision of health care, a matter which is under review in New Zealand and is a major public policy issue in the US. <> <>The basic problem with purely market provision of health care is that people will die, unnecessarily and unacceptably, while others will find themselves as equally unsatisfactorily disabled and life limited. An example of this gloomy situation is in the US where those not covered by the state or by private insurance typically have short, poor quality lives. <> <>As a result the US has various schemes to cover the population who cannot depend solely upon personal financing of health care. Sometimes these involve private health insurance, which may attract a public subsidy, sometimes there is direct government funding as for medicare and medicaid; sometimes it is charity. President Obama sees the implementation of a comprehensive, coherent health system as his most important domestic reform. In the interim we observe that while private healthcare meets the three market features I have just described, it fails to deliver. <> <>First, the connection between the payment by the individual for private insurance and the services that he or she gets is just as tenuous as if it were a publically provided. So in a private system individuals will demand health care past the point where it is efficient too. <> <>Second, there being no other mechanism to balance supply and demand, the price of the health services tends to be pushed up, which is why the US health system is so expensive. Ironically, while the insured get the care with little or no payment they are paying very high rates for the insurance scheme which funds the care. No wonder many cannot afford health insurance. <> <>Third, competition between health insurance schemes is based on providing additional services rather than the cost to the insured. The US health system is notoriously inefficient – that is wasteful for the services it delivers. <> <>Deeper within this failure is the ignorance of the consumer and the power of the provider Usually when a consumer acquires a service they have market incentives to purchase the product. In health care they have neither the competence to make the decision, nor the incentive when they are not paying for the service. So the insurance companies have found it easier to compete by offering additional services, even when they are not needed. <> <>It is the provider, typically a physician, who advises what is appropriate treatment and typically the patient takes the advice. This generates the possibility of supplier induced demand, that is the physician has the incentive to over treat. The over-treatment may be because the provider is paid for the unnecessary treatment, thus inflating their income, but there may be other reasons such as vanity and power – or, in the case of the US, fear of litigation. Supplier induced demand is a real enough phenomenon for President Obama to hope that he can reduce the costs of providing comprehensive coverage to all Americans, by restraining it. <> <>It is no wonder that the US private heath system fails on so many measures despite it also having some of the best medical care in the world. It is the world’s most expensive system and is also the rich world’s most inefficient – that is it gives low health returns despite enormous the resources it uses. It is curious fact that the single largest industry in the US, its health care industry, performs so poorly despite the US economy being cited as the one the rest of the world should imitate. <> <>We learn from this that once the market fails to deliver what is required, ad hoc modifications to it may make it function even worse. So while a publicly provided service – such as the New Zealand public health service – may not be perfect, we need to judge it against the practical alternatives, not some ideal. It is true that New Zealand’s health system is dominated by a monopoly funder and provider. But in comparison to the more decentralised competitive US system, it gives near universal coverage with greater efficiency and better cost control. Monopoly is not always bad; competitive markets are not always good. (And it turns out that public provider systems with a single funder and provider also tend to have lower administrative costs too.) <> <>Sometimes the public sector works because the private sector objectives are distorted. Currently there is a fashion for increasing competitive pressure on schools. But competition among schools may distort educational goals. That was brilliantly demonstrated by When Schools Compete by Edward Fiskeand Helen Ladd, but I want to add to their story Gillings law, which states ‘how you score the game determines the way the game is played’. This means is that if the scoring scheme does not align with the objectives of the system, the system will be distorted towards the scoring system. <>There are many opinions about the fundamentals that schools should be aiming for our children. However I doubt that ‘passing exams’ would be high on the list, even if the higher objectives are difficult to assess and measure. So the government is demanding a measure of the school’s record of how their students perform on standardised tests. <> <>Since schools will be assessed and given rankings, on this measure – it being the only school-wide measure there is – Gilling’s law warns us that the schools will adapt their behaviour away from the higher educational goals and focus on maximising their ranking on this test performance measure. <> <>Its worse than that. You might think that the ranking measures the efficiency of teachers in attaining the test performances, However, schools which recruit well-prepared students with high ability will do better than those that cannot, irrespective of who are the have better teachers. <> <>In economic terms the rankings will reflect gross output rather than net output. We know that is a disastrous strategy. There are dairy farmers throughout the Northern Hemisphere who stuff their cows full of grain to produce more milk per cow than New Zealand ones, because that is how their market incentives are rigged. New Zealand’s supremacy in dairying is based on market signals which have farmers seeking higher efficiency, measured in valued added terms, not gross output. So why are we doing just the opposite in education? <> <>The result is that school behaviour will be very distorted, for each school will not just be aiming for the wrong objective – not among our highest educational priorities; it will pursue it by recruiting students rather than by focussing on teaching them. Getting the incentives to align with what is desired is a major design problem in public sector management – Gillings law poses the severity of the challenge. <> <>I have deliberately used education and health as illustrations because these two spending areas represent almost three-fifths of government spending (excluding transfers which involve quite different administration principles). Even so, while we need to get these two areas ‘right’, the other two fifths face the same challenge and need to learn from the same lessons: <> – be clear about each program’s objectives; <> – be clear about why a particular program has to be in the public sector; being neither ideologically inclined towards using the market nor not using the market. <> <>We should not portray taxpayers as necessarily victims of public sector activity. I may believe in education, and be willing to sacrifice some private consumption to enable others to be educated; I may be happy to contribute to funding the public health system, as a kind of social insurance, hoping that I shall never have to avail myself of it. And perhaps I know that in order to obtain state support for classical music, I have to help support others less interested in that, but keen on the Rugby World Cup. <> <>We over-emphasise the alleged inefficiencies of the tax system. It is true there are studies which demonstrate that high taxes reduce economic output. But there are also studies that demonstrate the opposite. The evidence shows that there may be an effect – or there may not – but the effect is small, so small that we cannot easily measure it. <> <>It is certainly true that a badly designed tax system can create distortions and inefficiencies The fact we do not fully tax investment housing intensified the current recession as investors over-invested in rental housing for capital gains. But that argues for a better designed tax system not lower taxes overall. <> <>However, there is an important political element in the tax debate. There are those who think they are paying too much tax. True, they probably received a publicly funded education and expect assistance from the health system if anything goes seriously wrong; they may well go to both the NZSO and the Rugby World Cup; they certainly expect a considerable effort to protect their property and person by the forces of law and order. and they use public infrastructure like the rest of us. To admit they just wanted to pay less tax would seem selfish, so better find spurious economic arguments for lower taxes. <> <>Even so, each of us have to tradeoff between public and private goods, between the amount we pay in taxes and the amount we keep to spend for ourselves. There does not appear to be any perfect technical way of evaluating the tradeoff. It requires political decisions. Most people’s unreflective answer to whether to have more public goods and services or more private goods and services is ‘both’. It a miracle that our politicians so often manage some degree of restraint. <> <>But the truism touches on an important issue. Resources used in the public sector are not available for use in the private sector. Resources used in one part of the public sector are not available for another part of the public sector. Inefficient use of resources compound that truism. Every sector – public or private – needs to use resources as efficiently as possible. Recall that the public sector does not have the natural pressure from market competition which much – but not all – of the private sector has. <> <>Because there is not natural brake on the demand for public services, and given the difficulties in raising taxation, I have a bit of a bias towards using the market, unless the non-market decision is clearly superior. Market failure is not the reason something should be dumped into the public sector. Severe market failure is the criterion. This is not an ideological conclusion but arises from a recognition that the public sector is so over-whelmed by the difficult tasks, that there is merit in focussing it on only those tasks which are of the utmost priority. . <> <>And yes, managing the public sector is difficult; often a far more difficult task than managing the equivalent in the private sector. Ironically public sector management is far more subject to public scrutiny than an equivalent private venture. Think, for instance, of the giant failures of private enterprise Telecom and Air New Zealand in Australian ventures, both of which has cost the public considerably in higher prices or bailouts. Criticisms of Jet Star are modest compared what they would have been had the same venture been a new public one. One of the reasons the public likes nationalised industries, is because they can be held to account in the way no private enterprise will allow. It is no accident there is not a parallel ‘Towards a Value Driven Private Sector’ summit. <> <>In public sectors throughout the world we see tensions between spending more because of public demand, and spending less to keep taxes down because of the same public’s private demands. Ensuring any public spending is effective is not a total solution, but it vital to ease the tension. That is the fiscal imperative which drives public sector management. <> <>Before finishing – I shall repeat my themes at the end – I need to say a couple of things about the fiscal situation. There are two fiscal crises: <> <>One is that we are limited in our ability borrow offshore, even temporarily to tide us through the world recession, because that would increase the possibility of a credit downgrade and higher interest rates. Dealing with this is too large a matter for this conference with its longer horizons, so I shall talk more about the second, medium term, crisis. <> <>Normally a government borrows during a recession, but as the economy recovers tax revenue also recover and some spending (such as on unemployment benefits) abates, while some of the public infrastructural spending gets wound down. The fiscal position thereby returns to the situation before the recession. Since the New Zealand government was running a fiscal surplus before the recession we might have expected a return to fiscal surplus in, say, 2011. <> <>However, it turns out that the fiscal position does not return to a surplus. We seem to be suffering not only a cyclical deficit but a medium term (or structural) fiscal deficit. What that means is that government debt rises – and eventually becomes unsustainable. At the very least interest rates will rise. <> <>The structural deficit appears to have arisen from two problems. One is that the permanent income tax cuts have reduced revenue in the long run. But there is also the problem of public expenditure. <> <>The aggregate public spending track set out in the 2009 budget is similar to that in the 2008 budget track (although there are changes within the aggregate, including more debt servicing). So if the track was OK in 2008 what has gone wrong a year later? <> <>What seems to have happened is that the long run GDP track is lower. While it is expected that the post-recovery economy will grow at about the same rate as it did over the last decade, the future track appears to be about 3 percent lower. In effect, during the last decade the economy was running hotter than was sustainable, fuelled by offshore borrowing. The forecasters seem to think there not only has to be a recession to stabilise the borrowing, but the economy will not run as hot thereafter. <> <>If the economy moves onto a track 3 percent lower than the recent past, it follows that there is a case for saying that government spending projected on the old track is 3 percentage points of GDP too high. Meanwhile there is a loss of tax revenue relative to the old track of about 1 percentage point because of the fiscal drag in the tax system. These are on top of tax cuts to tide us through the recession which will not be reversed after it. Combined the various effects and the past structural fiscal surplus becomes the future structural deficit. <> <>The data seems to suggest a deficit which is too high by about 10 percent of total government spending, although that percentage may reduce if economic growth accelerates faster than expected, or increase if the recovery is slower than is expected. <> <>Getting back to a structural surplus is going to preoccupy the government for at least the next three years. The prudent options are either to cut spending or increase taxation, or both. The imprudent option is to do as little as possible in the hope that something will turn up – or perhaps it will be dealt with after the next election. <> <>Cutting public spending by 10 percent is such a big political ask, that I think there will have to be tax increases. But that is speculative. What public sector managers are confronted with is additional pressures on their performance, although one could easily argue that the fiscal crisis is irrelevant; that you should be doing your best anyway – boom or bust. <> <>While public sector managers must constantly seek improving the efficiency of the delivery (while ensuring that the delivery is on target to the intended goal), whatever measures they take will not generate the required expenditure savings. I do not believe there is some 10 percent inefficiency to be magically reaped.. Of course there is waste in the public sector just as there is in the private sector. But the fat is not that of rump steak, thick and easily cut out. Rather it is stippled through a prime porterhouse; if you try to remove it, you will destroy quality meat. <> <>Insofar as taxes are not to be raised, there will have to be cuts in programs. No matter how efficiently public sector managers manage their resources, it is a matter of law and practice – and indeed democratic theory – that it is politicians who have to make the decisions about programs. In effect they will raise the margin by which public provision has to better than private provision. Any resulting user-pays is a form of taxation, for the public have to pay more for their consumption; what they got free from the public sector now has to be paid for. Some activities will simply not be purchased – adult community education is an early example. <> <>This is not a happy scenario, but it is a realistic one. It is not an ideological scenario. Were the government of a more reddish tinge, it would be faced with the same challenges. Perhaps its solution might be more tax in the medium term, but it would still want public sector managers to seek the maximum value for the resources applied to them. <> <>In summary then, while the rest of this conference treats these public sector issues as managerial ones, there lurk behind them major fiscal ones which arise out of the economic perspective of <> – should the activity be in the public sector or the private sector? and <> – what is the precise goal that the public sector provision is trying to achieve? <> <>These questions are always difficult to answer, but today they have to be answered in the context of as severe a fiscal crisis as we have faced for some years. <> <>Go to top <> <>I was asked after the presentation what was the relevance to this paper for local government. The term ‘fiscal’ is not usually applied to anything other than central government; but the general principles of public sector management for central government also apply to local government, which has even more limited revenue raising powers, and greater limitations on its ability to borrow. <>
Rocky Horror Show
Could New Zealand become a “Southern Rock”?
Listener: 11 July, 2009.
Keywords: Macroeconomics & Money;
Northern Rock, a British bank specialising in mortgages, nearly went bust a couple of years ago. It was getting a quarter of its funds from depositors, with the remaining three-quarters coming from the international money market – that is, from other financial institutions.
When the markets jammed up in September 2007, Northern Rock could not roll over its short-term borrowings and it went to the Bank of England for support. Its depositors rushed to withdraw their cash, fearing it could be locked up until the mortgages were paid off, the first “run” on a British bank since 1866.
In February 2008, the UK Government nationalised Northern Rock. Our trading banks also borrow from the international money markets. There were three main reasons a similar thing did not happen to them.
First, they rely on the money markets for only a third of their funds; two-thirds come from depositors. Second, they are better managed than Northern Rock, with “vanilla” rather than fancy borrowing. Third, the Reserve Bank handled the potential crisis effectively.
Today a run on a New Zealand bank is neither likely nor necessary. The retail deposit guarantee scheme means depositors will get their cash back even if something goes desperately wrong. The risk is borne by the New Zealand Government – that is, by us taxpayers.
Nevertheless, Northern Rock is a lesson. Could New Zealand, with its dependence on international borrowing, become a “Southern Rock” if the money markets jam again? Certainly, another jam could happen, and it might even happen during this financial crisis if things go wrong in the Northern Hemisphere.
You may be confident that the Reserve Bank and the Treasury have thought about this problem, and have backup reserves and lines of credit. But although using these could prevent a total meltdown, it would be costly. Better to take preventative measures – and that means “us”, since it is our over-borrowing that is causing the threat.
New Zealand trading banks have borrowed over $90 billion offshore, and foreign investments help fund New Zealand businesses. In total, our net international investment position (the difference between our external financial assets and liabilities) amounts to nearly our annual GDP. It is falling because we are continuing to borrow offshore – that is what a current account deficit means. Exports and other earnings are less than imports and other current payments; we borrow to cover the difference.
What’s more, we have been doing this for a long time. I estimate almost a quarter of our onshore assets are either owned offshore or have an offshore debt attached to them (like a third of your mortgage – probably). The chunk that is borrowed direct from the international money markets is the potentially most dangerous if there is another global financial crisis, or if this one prolongs and deepens.
There would be other benefits in having lower overseas borrowing, according to research by economist Dennis Rose*. The more we borrow, the higher our interest rate. Were we to have only half the net foreign liabilities we currently have, our annual interest rates could be 0.75 percentage points lower (more than $40 a week on a $300,000 mortgage).
The exchange rate might be 8% lower, resulting in a stronger export performance and more economic growth.
We cannot halve our liabilities overnight, but this is a target we might aim for. That means increasing the national savings rate, and ultimately that means households and the Government saving more.
Mind you, this may not seem the right time or place to start, although it never is. New Zealand needs more spending in the short term to prevent unemployment rising too far. It will not be easy to reconcile the contradictory policies. My advice is to behave prudently, which probably means cutting back your spending, leaving the Government to increase its spending to cover the gap. However, you must expect the Government to ease back its own spending – and/or raise taxation – as the New Zealand and international economies recover. The Southern Rock has to be based on a solid foundation of the nation saving to own itself.
* D. Rose (2009) ‘Overseas indebtedness country risk and interest rates’, Policy Quarterly, February 2009.
Economic Growth Research in New Zealand: the Fathers That Begat Us
Paper to the 50th Anniversary Conference of the New Zealand Association of Economists: 1 July, 2009: Wellington.
Keywords: Growth & Innovation; History of Ideas, Methodology & Philosophy; Statistics;
Keywords: Growth & Innovation; History of Ideas, Methodology & Philosophy; Statistics;
This paper looks only at the first 25 years of the New Zealand research program on economic growth. It focuses on the empirical analysis but refers to the one significant contribution to theory. The paper does not pay much attention to the policy issues, except as they impacted on, or illustrate, the scientific issues. I have included the principal lessons I learned from the research, as a way of illustrating its novelty; much which was original then has been incorporated into the conventional wisdom, some has been forgotten. [1] As George Satayana said ‘those who cannot learn from history are doomed to repeat it.’ [2]
It is the pioneers who should not be forgotten. The subtitle of this paper is ‘the fathers that begat us’. Thus the paper is a contribution to the 50th Anniversary Conference of the New Zealand Association of Economists, for the key players in the research program were involved with the Association all those years ago. [3]
That the research program on growth commenced only about fifty years ago may seen surprising, but that is because the theory was then fundamentally different because there was not much data, and in any case it focussed only on the role of capital. Given the central role of diminishing returns in economics – Paul Samuelson reminds us it is a consequence of the laws of thermodynamics – economic growth based entirely on capital intensification must ultimately stagnate, a view that was common through most of the history of economics.
Among the stagnationists were Thomas Malthus, David Ricardo, Karl Marx, Maynard Keynes and Joseph Schumpeter. Initially, reflecting the economy of the times, Malthus and Ricardo had economic progress choked off by diminishing returns on land. The economy evolved and Marx’s stagnation arose from diminishing returns from capital; Keynes talked about the ‘euthanasia of the rentier’; Schumpeter thought that capitalism would be replaced by socialism. Each’s theory allowed there would be some lift in economic standards from various effects – such as trade and specialisation (Adam Smith’s contribution) – but eventually the economy would reach a point where additional capital would not produce significant additional output, and there would be stagnation – except Malthus expected population growth to exhaust those gains earlier.
Fifty years ago little attention was given. to the classical account of economic growth in the economics taught at New Zealand universities. A few years later I attended two. Our introductory text, Samuelson’s Principles (4th edition), did not have a section on economic growth, while the only growth economist I can recall was Evsey Domar. There were a number of courses on development economics, about how the poorer countries of the world could raise their living standards to that of the rich world. There were also related topics such as industrial economics.
The omission reflected the state of the subject. In 1952 in a survey of the economics of growth commissioned by the American Economics Association, Moses Abramovitz, contrasted growth theory with the other parts of economics, arguing that, unlike them, ‘the problem of economic growth lacks any organised and generally known body of doctrine whose recent the subject … In spite of a continuing interest which began very early, the question has remained on the periphery of economics.’ [4]
Yet between Malthus’s Essay on the Principle of Population and Schumpeter’s Capitalism Socialism and Democracy the per capita GDP – material output per person – of Western Europe grew about 1.1 percent per annum or about 5 times in 150 years. [5]
There are a couple of lessons here. The first is that there is much criticism of economists that their theories say that economic growth is inevitable. For over three-quarters of the profession’s life that is simply not true. The second lesson is that. despite a host of eminent economists being stagnationists. economies nonetheless grew, a humbling reminder that perhaps economists dont have much influence on economic growth.
The phase of a ‘lack of doctrine’ came to an end in 1957 with the publication of Robert Solow’s seminal ‘Technical Change and the Aggregate Production Function’. [6] Like most great scientific revolutions it depends on newly developed data – in this case long run data sets of GDP, capital and labour and so on.
The essence of Solow’s finding was that while capital per man-hour had increased 31 percent in non-farm America between 1909 and 1949, non-farm GNP per man-hour had increased 105 percent. This is not what one would expect if there was a diminishing marginal efficiency of capital (which Solow sneaked in via an aggregate Cobb-Douglas production function). So there had to be something else which was driving economic growth. Solow famously attributed to technical change , but saying
‘I am using the phrase ‘technical change’ as a shorthand expression for any kind of shift in the production function. Thus slowdowns, speedups, improvements in the education of the labour force, and all sorts of things will appear as ‘technical change’. (original’s italics)
Thus his ‘technical change’ was just a label for what today we call ‘multi-factoral productivity’ and which Tommy Balogh and Paul Streeten called ‘the coefficient of ignorance’. [7] In the fifty years since the classic paper, there has been no convincing comprehensive measurement of the impact of the effects which contribute to this residual – say in contrast to the conclusion that around 20 percent of the growth of output per worker was due to increasing capital intensity.
The consequence has been that policy analysts have been left with little that they can be sure contributes to economic growth above that which capital formation does. Over the years a host of policies on what might explain the residual have been proposed and pursued.
A particular weakness has been that the subtlety of Solow’s analysis has been lost on many who would seize upon it to promote their special interest – the best known example being the claim it is all due to ‘technology’, used with a far more specific meaning than Solow defined, and which leads to demands to increase spending on the special interests. Much of this approach seems to be to aimed at increasing the coefficient of ignorance, and the advocates certainly seem to have the necessary prerequisite.
One cannot but observe that economic growth seems to happen largely independent of the policies which are pursued. That does not mean that the growth path cannot be damaged ; one instances the Xhosa people who, following prophecies, slaughtered their cattle and destroyed their crops in the belief that there would be a millennium of abundance rejuvenation, the return of the dead and the dispersion of the Whites, thus leading to the destruction of their economic base, poverty and servitude. [8] However it is sobering that for half a decade after Solow, there have been prophets disguised as economists who have promised to accelerate the rate of economic growth, but there is no evidence that any of their nostrums have worked.
Horace Belshaw (1898-1962)
Of course, there are rarely decisive breaks in intellectual development, something which Horace Belshaw’s last book Population Growth and Levels of Consumption, with Special Reference to Countries in Asia (1956). reminds us. Belshaw, whom I never met, was a generation older than the economists we are about to consider, dying in 1962 at the age of 64 having been a leading New Zealand economist for the preceding thirty years, including chairing the inaugural meeting of the NZAE.
As the book title indicates, Belshaw was primarily, but not exclusively, concerned with underdeveloped countries, and his chief concern was population control. His development mechanism is capital intensity but he devotes an entire chapter to ‘innovation and growth some requirements’, largely influenced by Schumpeter. However innovation is not treated as important as, say, improving the quality of the labour force (as well as capital and social organisation).
I think it would be fair to say that Belshaw’s instincts were that innovation had a role to play but he was not certain of their importance and, in any case in an underdeveloped country the issue was getting better technology rather than new technology.
John (Jack) Victor Tuwhakahewa Baker (1913 -2009)
Given that Solow was dependent upon the data base for his insights, it is appropriate to begin the New Zealand story with Jack Baker who became one of the great Government Statisticians (1958-1969). He was a founding member of the Association and subsequently a president. Because he was a public servant, some of his contributions are anonymous, while it is possible to attribute to him some work which was done by others, for statistics development is often a team effort.. [9] So it was John Kominik who developed the National Accounts and Jim Rowe (probably) who developed the first input-output tables.
Jack was not the first official New Zealand statistician involved in the estimation of aggregate economic production. There are nominal estimates in the New Zealand Official Year Book for the 1930s, when he was not in the Department of Statistics. Colin Clark probably had some influence on them.
The first official set of national accounts were derived by Dudley Seers who was working in the Prime Ministers Department during the war, before he returned to Britain. He once told me (with a gleam in his eye) that since social security taxes were levied on incomes consistent with those used in national accounts he simply grossed up the receipts to get the income side [10] The expenditure side was estimated conventionally by spending, except that private consumption was the residual to balance incomes with expenditure. [11]
Subsequently, the Department of Statistics took over the estimating National Accounts. It also produced Input-Output Tables for 1952/3 and 1954/5 (and later), which were also to play an important role in the economic growth research program.
Initially, as for the Seers estimates, the accounts were nominal [12] However the Economic Surveys for 1960 and 1961 tabulated volume estimates of GNP back to 1949/50, estimated on the expenditure side [13] It is not evident who did them – the Economic Survey was issued in the name of the Minister of Finance, and presumably prepared by the Treasury. The statistics may have been calculated by the Department of Statistics, although they dont appear in its Yearbook.
Shortly after, a volume series for GNP, GDP, and GDE estimated from production side beginning in 1954/5. began appearing in the Monthly Abstract of Statistics, although it did not get the official imprimatur of the Yearbook until 1968. [14], [15]
While it is a truism that National Income equals National Expenditure equals National Product if a consistent set of prices are used, the various prices relate differently over time so that the aggregates do not equal one other when they are measured in constant prices. This is particularly troubling when the terms of trade change, because the value of an export in the production account is different from its value in the expenditure account, since a rise (say) in export prices relative to import prices enables the purchase of more imports for a given volume of exports, and hence greater expenditure.
Because the terms of trade suffered from substantial volatility, this was a prominent concern to the New Zealand economists of the day. [16] The issue became especially important in the Arbitration Court during general wage order hearings, for wages were set in relation not to productivity bu effective productivity, that is adjusted for the change in purchasing power as a result of the terms of trade. So the Government Statisticians appeared before the Court, and the Department of Statistics, published tables in the Monthly Abstract to explain this.
More generally, the consequences of terms of trade change on the measurement of aggregate output was one of a number of alerts I experienced as a student and researcher in the early 1960s, which told me that sectoral prices were important, and therefore sectors were important. It is perhaps not an accident that many years later, it was a New Zealand economist who drew the OECD’s attention to the fact that they were measuring income and not production in their international purchasing power comparisons.
Another alert was Jack Baker’s half year course in economic statistics at Victoria University. in which covering the construction of price indexes, he showed that prices increases were all over place and the index was a weighted average. That meant, of course, a different weighting including for a sub-aggregate, could give a different price index path.
Much of what Jack Baker taught us is now a part of the canon. Alas some has been forgotten.
Conrad Alexander Blyth (1928-)
Solow provided a theory based on the data. The major conduit of that theory to New Zealand was Conrad Blyth, who returned in 1960, after a PhD in capital theory at Cambridge University. to become the first director of the NZ. Institute of Economic Research.
The NZIER’s first research paper was Conrad’s Economic Growth: 1950-1960 (1960), prepared shortly after he arrived. It uses the Economic Survey data to evaluate economic growth in the decade, observing that national output had grown 3% p.a. and labour productivity 1.2% p.a. in the decade. It also estimates growth by sector concentrating on manufacturing and farming, the balance between them being a major policy issue at the time. [17]
The paper is pre-Solow, concerned only with the capital contribution to growth. [18] It paid particular attention to the balance between the agriculture and manufacturing sectors, which was a focus of much of the public policy debate at the time; protection – in particular the degree of protection to be applied to domestic manufacturing.
The paper’s focus on capital was not alone. The following year the recently established Monetary and Economic Council published Economic Growth in New Zealand (1962) – the first substantive report after a current economy situation one in 1961 Its Appendix C on ‘Causes of Slow Growth in New Zealand’ lists ‘growth as a neglected objective’, instability and inflation, imports and growth, capital problems (four are identified), industrial structure and stage of development, transport incentives, taxation, and restrictive practices and regulations – almost all today’s usual suspects. Those missing are those which Solow would have labelled ‘technology’. (While it is difficult to identify exactly, the climacteric, the point at which New Zealand’s growth rate began decelerating, seems to have been about the same time as the Council deliberated, another example of how little impact economic growth policy pronouncements have on actual outcomes.)
The same pre-Solow is evident in the Budget statements of the time which concentrate on the role of capital in growth. It may be wrong to attribute this entirely to the Minister of Finance, Harry Lake; it presumably reflected Treasury advice. [19]
Conrad wrote that his first paper was an agenda for research. in his valedictory research paper Strategic Factors in New Zealand’s Economic Growth: 1965 to 1975 (1965) before leaving the NZIER (to go to Australia and Britain). It reflects Solow’s insights including an Appendix ‘Technical Progress and Economic Growth.
As a research assistant at the Institute from 1963 to 1966, I do not recall ever thinking about a production function with labour and capital which omitted technical progress. I wonder too, whether that was where the importance of sectoral differences first came to my attention, although input-output tables and Chenery and Clark’s Industry Economics (1959) – prescribed for development economics courses – would also have been influential, as would also relative prices.
Between his first and valedictory papers Conrad ran a research program on growth including involving Colin Gillion, Paul Hamer and Kerry McDonald, as well as directing the Institute. [20] However one project which led to the Blyth-Crothall linear programming model was particularly important. As Conrad records
‘I think the development of my LP model went something like this: In Cambridge I was thinking about the incorporation of the terms of trade into a GE model suitable for NZ. I read Chenery and Clark and the penny dropped. Sometime in 1959 … I turned to [RGD] Allen’s Mathematical Economics to bone up on LP, so when I arrived in Wellington in August 1960 I had an idea of what I wanted to do. But it took a year or two before I got really under way. Robin Williams, of the Applied Maths Lab of the DSIR … and Colin Simkin were supportive. But I soon realized I needed a mathematical assistant and that is where Graham [Crothall] came in. As they say, the rest is history.’ [21]
Graham came to the Institute, after completing a mathematics Masters at the University of Canterbury in 1961 with a thesis on linear programming. The combination of Graham’s mathematical skills with Conrad’s economic ones created New Zealand’s first Computable General Equilibrium Model. [22] Indeed it was one of the first in the world, as indicated by publication in Econometrica [23]
By today’s standards the pioneering model was crude. Based on the 1954/5 Input Output table, it had twelve sectors – manufacturing was either primary product processing or other – and applied a single point in time, with an investment constraint to ensure there was sufficient capital for tomorrow. Nevertheless there were at least three important elements to the model.
First, for a young economist who had done a little reading in general equilibrium theory (it was not taught, except indirectly by two dimensional models), here was a real live one. What was more, it illustrated the practical importance of shadow (or even market) prices. I knew the theory of LP but here it was connecting to economic issues of the day.
Second, the model had a lower return on exports after a threshold was crossed reflecting a non-zero price elasticity for exports. Here was the caution that the standard international trade theory does not give maximum output for zero tariffs when the demand for exports is price elastic and so sensitive to the amount supplied, since a tariff on a domestic good could reduce the export good on world markets, thereby raising its price.
Third, there was a seminar at the Institute which Jim Stewart attended [24] At that time Jim was a senior lecture in farm management, but he went onto the chair, and eventually principal of Lincoln University. I assume he was there, because he was applying linear programming to farms.
As it happened Jim had already worked with the third pioneer in New Zealand economic growth, although initially the focus was the farm sector [25] I assume Jim returned to Lincoln and discussed the Blyth-Crothall model with Bryan Philpott. The LP version did not appear for some years, but shortly after Bryan began using input-out put tables to study the economy from an inter-sectoral perspective necessary, as he would explain, to put the farm sector in an overall context.
Bryan Passmore Philpott (1921-2000):
Bryan went to Victoria University College as a returned service man, having worked in a stock and station agency before the war. His post-graduate work was under Arthur Brown at Leeds University on the wool economy. Returning to New Zealand he worked first for the Meat and Wool Economic Service before taking up the foundation chair in economics at Lincoln College in 1958 and establishing the Agricultural Economics Research Unit in 1964.
His first (economics) love which, as we shall see, had important implications for his subsequent work, was the economics of wool. As his research program developed it extended to the whole of the farm sector, then the farm sector in the economy, and eventually, when he took up the McCarthy Chair in Economics at Victoria University of Wellington in 1970, the economy as a whole. (He maintained an interest in wool; he would say in the latter years of his life, he could still class wool.)
One of Bryan’s many eminent students was Bruce Ross who filled his vacated chair, later becoming Vice Chancellor of Lincoln University, and eventually Director General of the Ministry of Agriculture and (sometimes Fisheries, sometimes Forestry). Following his masters thesis – Bryan and Bruce published the first report in his ‘Studies in the Structural Development of the New Zealand Economy’ series.
The practical need for the model came to a head in 1968 in the National Development Conference. A key element was the setting of indicative targets for economic growth. Two models were used to provide them [26]
The first, due to the NZIER (supervised by the then director, Jim Rowe), involved projecting GNP from the expenditure side, with some attention to the ensure such ratios as investment to production and imports to production were plausible.
The second, more elaborate, model was the Lincoln Model (involving Bryan Philpott, and presumably, Bruce Ross) which focused on production side with a 15 sector disaggregation. The five and ten year projections for the two models were similar.
I was not in New Zealand at the time. Reading the reports of the conference some years later, I was struck how the modellers struggled with the problem of projection when there had been a change in the terms of trade and hence a divergence in the expenditure and production side volume estimates. Their base year, 1967/68, was the first full year following the dramatic fall in the price of wool in December 1966. It was not just a matter of projecting the future price path, but how to interpret the volume changes when the expenditure and production aggregates did not readily reconcile.
There has always been a major problem with these forecasts. Performance depends on incentives – most particularly, in a capitalist economy, on the profit rate. Implicit in these volume forecasts there are profit rates, but they were never derived, not assessed to see whether they were realistic enough to induce the behaviour required to meet the volume projections. It is hard not to conclude that the New Zealand approach was too influenced by the material balances approach of planning in the Soviet Union, with little understanding – as Leonid Kantorovich, among others, was to draw attention to – that there were implicit market prices related to the shadow prices of the optimal planning. (That lacuna remains today. One might say for those who cannot count, that profit is a four letter word, not to be mentioned in polite company.)
One of the sector committees was ‘Education, Training Research’. The following extract from the report of the Chairman (Geoff Schmidt, then professor of management accountancy at Victoria University of Wellington) has a particular relevance to this paper:
The various forces that contribute to the part of economic growth that cannot be explained by reference only to the size of the labour force and the stock of capital are in some cases known collectively as the residual factor. … The residual factor can be confidently claimed to be at least as important as capital investment in achieving economic growth. For example, a study published by the New Zealand Institute of Economic Research in 1965 estimated that over 60 percent of the increase in output per head of the labour force in both farming and manufacturing in New Zealand between 1955 and 1962 was due to this factor.
Now, of course, the residual factor is composed of many elements which, like the whole residual itself, are none the less really valuable, if difficult to measure. Mr Rowe gave us a list of the items … improvements in the field of industrial and commercial policy, economies of survey, better marketing and distribution systems, market research, improvements in determining the priority to be accorded the various agricultural industries and Government and commercial projects, technological innovations, managerial innovations, labour skills, and last but not least, the general content of the labour forces. [27]
Three years later, Blyth’s 1965 paper continued to resonate. Note that the exposition does not give the significance to research, science and technology that a similar conference might give today.
Moreover, insofar as the NDC did not really know what was in the residual, and had little idea about the profit implications of the projections, most of its recommendations were related to commonsense and private interest, rather than to the quantitative targets.
The Lincoln Model, driven by Bryan and refined over the years, continued to be used by the National Development Conference after 1968 until it was closed down in 1973. By them Bryan had moved onto the McCarthy Chair in economics at Victoria University of Wellington.
<>Colin Gillion <> <>Rather than go direct from Bryan at Lincoln to Bryan at Victoria, it is useful to deviate to discuss his VUW colleague Colin Gillion. Colin was at the NZIER between 1962 and 1972, with a break working at the NIESR in London. He then moved onto VUW and went to the OECD in the late 1970s. From the late 1960s he worked on the Golden Kiwi program which evolved into his PhD Structural Change in the New Zealand Economy: Data, Model and Strategy (1977) which described a thirteen sector Computable General Equilibrium model. The model is considerably more sophisticated than the either Blyth-Crothall or Lincoln-Victoria. but it still had standard neo-classical assumptions. Various scenarios were tested with an overall conclusion that: <> <>Provided full employment and external balance can be maintained and provided also that the elasticity of export prices is negligible, the thrust of the argument is towards increasing specialisation in production. Mainly because of its neo-classical structure the model places great emphasis on the principle of comparative advantage, going beyond the free-trade position in its attempts to concentrate employment in those industries where it is most productive. The optimum economic structure is pictured as a large primary sector exporting nearly 40% of GDP and employing a fifth of the labour force. Secondary industry on the other hand. has a gross import content of 20% and produces only 18% of total net output. Such a structure would yield a GDP some 4% higher than the benchmark estimate. <> <>So despite favourable assumptions, the ‘gains-from-trade’ were small, a conclusion that was to be repeated in the Victoria suite model runs, illustrating an oft overlooked proposition that while the theory says that ‘free-trade’ may give an optimum output, in practice the actual increase in output may be trivial. <> <>I think I first picked up this conclusion from the related model in Gillion and Michael O’Neil A Statistical Basis for Medium-term Projections (1978), which paramatises the degree of openness (under the standard neo-classical assumptions) to show there is an optimum but the economy can settle a long way from the optimum without a great loss of output. However there are considerable changes to factor prices (the returns to labour and capital) and sectoral size. This suggested to me that the protection debate may be more about the redistributional wins and losses than about output gains and losses. <> <>After Colin left New Zealand the Gillion model disappeared into the bound copy of a PhD thesis. It seems likely, though, its lessons were absorbed into the Philpott research program. Colin was to write ‘I owe particular thanks to Professor B. P. Philpott, whose support has run through all aspects of the study’; it seems likely that Bryan had as much reason to be grateful to Colin Gillion.
Modelling at Victoria University of Wellington.
At the university Bryan assembled a suite of CGE models usually with women’s names – Emily, Joanna, Joany, Julienne and Victoria (which was a LP model) are among the better known – typically again assembled by another galaxy of students including PhDs for Gareth Morgan, Ganesh Nana and Adolph Stroombergen. [28] In doing so he built up a deserved reputation among international CGE modellers for outstanding modelling and innovation. I can attest this, not only by the respect for him shown in the conversations I had with them in the 1980s, but I attended overseas seminars on issues which Bryan and his team had already solved.
One of the puzzles is why, after he retired, Bryan’s economics department let (perhaps) their only international competitive advantage in economics lapse. (He continued to work in the department, but it took no measures to continue his program once he moved on.)
One reason may have been the expense. By comparison with much economic research (or doing no research at all) economic modelling is expensive. As well as drawing on university resources, the modelling was funded by small grants from the public sector (notoriously they were cut off in the 1980s under the Rogernomics regimes), from consultancy work (via the BERL economic consultants – Bryan was a founding director in 1958), and the New Zealand Planning Council, established in 1977. As a result of the resource shortages, many developments, such as of a skills differentiated labour force, were delayed, while others, such a the fiscal and distributional implications of the economic path, were never explored.
A feature of the Victoria suite of models was that they are usually better at analysing inter-sectoral relations than projecting a growth path. In the case of the Planing Council projections, a simple econometric model known as ‘Haywood’ was used, although in my view it gave few insights and in some respects was less economically sophisticated than the NZIER model used by the 1968 National Development Council [29]
Many of the runs of the Victoria suite of models are uninteresting, giving much the same conclusions as under a single sector model. But when the model runs are not trivial, they provide useful insights.
First, the runs are most revealing (relative to a single sector model) where their sectors grow at different rates. This occurs in the medium term in all economies – but as important as it is, it has to be ignored when an single commodity model is being used.
This ‘twisting’ during the expansion can be caused by output restrictions arising from resource limitations (e.g. energy and fishing) or from biological limitations (livestock growth is subject to a maximum biological rate). Conversely, a new resource can twist a sector in the opposite direction (e.g. the Taranaki hydro-carbon fields).
Differential productivity growth can also cause twisting. If the export sector is treated as an earner of foreign exchange for the purpose of imports, then a change in the terms of trade is equivalent to a productivity change. Change them and the economy twists in the medium term.
Although they are rarely decisive, different income elasticities of domestic or international demand will also cause sector to expand at different rates. Another cause of twisting can be the objective of the model changes, as explained in the next paragraph.
Second, it matters how a computable general equilibrium model is closed. It will be recalled that the standard totally self-contained general equilibrium model contains one more (commodity) variable than there are (independent) equations. The lacuna is resolved by setting the price of one commodity as the numéraire, so that the prices of other commodities are measured relative to it. In the Victoria suite, there are closure options other than a numéraire (equivalent to an inflation path), including a constraint on the size of the current account deficit, a maximum acceptable level of employment and a given real wage. The resulting configuration of the economy depends upon the choice of constraint, with the simple lesson that the choice of economic objective will affect the outcome (so that choosing an acceptable inflation track will result in a different track for the economy from choosing full employment or an acceptable international debt target).
The third lesson was that given the demand for New Zealand exports were price elastic, a positive tariff gives greater economic output than a zero tariff (a conclusion earlier demonstrated by the Blyth-Crothall model.) It was said that Bryan’s moving from Lincoln to Wellington led him to abandon the farm sector for the manufacturing sector. In fact at Lincoln he had favoured abandoning of import controls and the introduction of a uniform tariff – variations of which he supported in Wellington. The irony of the criticism of Bryan was that any policy shift was founded on his earlier work on measuring the price elasticity for wool. As the models began to seek optimal output (as when the Lincoln model morphed into the Victoria LP model), he found that he could not gain maximum output without a tariff, because increased agricultural output lowered the terms of trade.
Brian cherished his economic models as if they were daughters. To startle us he would say they could be disposed of like a woman. Following my telling him that some women objected to the metaphor, he apologised, and I never heard him use the image again. Ironically, when I argued that the Victoria model was obsolete, he defended the old girl basically because of his great affection for her.
Measuring Growth
Underpinning the model suite was the measuring economic growth. Bryan’s interests go back to the 1950s since he was already measuring farm sector when he was at the Meat and Wool Economic Service (with Jim Stewart). My guess he got the passion – his greatest research passion – while as a post-graduate student at Leeds. Almost certainly his interest arose in a pre-Solow framework although he soon adapted to measuring the residual. .
At first he pursued this measurement of growth in the agricultural sector back to the First World War (his AERU colleague Robin Johnson took over the updating). Subsequently he investigated all the sectors of the economy. His output series goes back to 1954/5, but because he used the perpetual inventory method to measure capital stock, some of those series go back to the nineteenth century.
As far as I know there is no inventory of all the series which Bryan constructed. Today there are official estimates of his sectoral output, labour force and capital series, but they start much more recently. If one wanted to push them back to start at an earlier date, one would go to the Philpott data base. One always needs to push them back, there is a kind of sod’s law which states that no matter what period one is looking at, there is always a need to have a data base that starts at least a decade earlier. A recent instance is studies of economic growth which start in 1970, whereas the climacteric seems to have started in the 1960s. [30]
Bryan was using the data series to calculate the Solow residual by sector. Since sectors expand at different rates, and have different Solow residuals, the aggregate Solow residual changes over time (say the last 50 years), even if the sectoral ones do not. A further complication is that the growth of sectoral and aggregate output is affected by the business cycle which makes it difficult to changes breaks in the residua track. Long series help.
Peter G. Elkan (?- 2008)
The one original and significant contribution to growth theory came from Peter Elkan. His biographical details are regrettably vague. He grew up in Hungary, was trained as a classical European economist, and then in 1948 was retrained as a Marxist economist. Escaping in 1956, he was trained for a third time at the University of Cambridge, which added to his considerable intellectual talents an extremely wide perspective of economics. He was one of Conrad’s earliest recruits to the NZIER where he stayed to 1970, before moving on to UNCTAD and the ECE at Geneva, eventually retiring ito Cambridge.
His interest was international economics, where he proposed a number of inventive policies ingeniously underpinned by empirical research. He was (probably) the first New Zealand economist to estimate effective rates of protection, and he went onto a two-sector growth model of the economy which he published in The Meaning of Protection (1977) and the New Model Economy (1982).
The model’s agricultural sector experienced diminishing returns because of the limited lands, but the manufacturing sector had increasing returns so that average productivity was higher the bigger the sector. As a result output was maximised by protection. [31]
Peter’s model assumed that the terms of trade were constant. Years later, and unaware of Elkans’ pioneering work, Mashita Fujita, Paul Krugman and Tony Venables linked two economies which had exactly the same endowments, at which point the outcome becomes almost bizarre (and mathematically intractable, in that there is no known general solution). [32] Both economies cannot produce high productivity manufactures, while the state where they have the same pattern of output is unbalanced. So one becomes a poor specialist producer of agricultural products and the other a rich specialist producer of manufactures. [33]
The Treasury Research Program
In the 1970s the Treasury began a growth research program led by one of Bryan’s students, Jas McKenzie who subsequently became a deputy-secretary of the Treasury and Secretary of Department of Labour. It was, understandably, more policy oriented than the work I have just described, but as best I can gather, it did not start with policy preconceptions but tried to identify the causes of the slow growth at the time, in order to set a foundation for a policy framework. There are only fragmentary public publications, but in 1984 a paper was prepared for the Economic Summit Conference which was intended to be a Treasury summary of the program’s finding, albeit it with a policy twist. A Briefing on the New Zealand Economy (1984) observed that New Zealand seemed to get a very poor growth return on its investment and concluded
First, the relative performance of the New Zealand economy has been poor for a long period (including periods, like 1965-72, when the terms of trade were relatively favourable). Second, although the deterioration in our terms of trade combined with a slowing of world trade in the mid-1970s and again during the 1980-83 recession would have had a negative impact on New Zealand’s growth rate, these factors cannot be said to have been solely responsible for the steadily increasing level of unemployment and the continually high inflation rates of the last decade. These problems reflect our inability to adjust to those shocks as much as the shocks themselves. Thirdly, there were a number of countries who suffered either the same, or substantially greater, degree of external shock as New Zealand during the 1970s and whose economies performed considerably better than New Zealand’s. Finally, although some fluctuations in real output coincided with similar fluctuations in external conditions, there are a number of instances during the last ten years when this was clearly not the case. Taken together these factors suggest that our experience over the last decade cannot be laid solely at the door of the world outside. The last decade has been particularly difficult for all countries. Some have fared better than others. We find ourselves amongst those who have fared worst despite the fact that many better performing economies have had to cope with external shocks as great or greater than those we have faced. (p.54)
The key lesson is that it recognises the role of the external economic environment on growth performance but argues that the internal responses were also important. So the research program began to integrate growth performance with macroeconomic management.
The notion that external conditions affect economic performance (albeit as the briefing says, are not the sole determinant, is not yet universally accepted. Growth studies which ignore it are common. It is true that today comparisons are frequently made with other economies, but they are mechanical rather than analytic failing to focus on differences in the experience of other countries relative to New Zealand.
In Conclusion
By 1984 we were moving into the next phase of the economic growth program, Jack Baker retired in 1969 after 40 years of service in the public service; he was to live in retirement for another 40 years. Conrad Blyth came back to New Zealand to the senior chair in economics at the University of Auckland in 1971, but his research interests moved on; Bryan Philpott retired in 1986, and while he continued to research until a few months before his death in 2000, there was little new innovation although there was a stedy progression of his work.
The new phase of the research program, borne largely by Bryan’s students and colleagues proceeded outside the academy. That is another story, and a complicated one, because funding and public debate became dominated by a policy vision which was not greatly interested in empirical research nor the world outside the theory.
Much of what has been reported here is now a part of today’s conventional wisdom. Economic growth is not seen to be primarily a matter of capital formation, although investment may be more important than the pure neoclassical model suggests, if what Solow called ‘technology’ is probably partly embedded in the capital.
If the effects of embedding can be ignored, we can measure with some precision the contribution of capital increases to economic growth using neo-classical theory. The conclusion is that, by itself, increased capital intensity makes only a small contribution to economic growth.
In recent years there has been the post-Solow theoretical development of ‘endogenous growth’. [34] However, while it offers useful (indeed innovative) theoretical insights, it contributes little to our measurement of the causes of growth and therefore the relative contribution of the various effects.
More generally, while there is quantification of the Solow residue, usually now called ‘Multi-Factor Productivity’, there is little systematic disaggregation into its various alleged constituents – no Dennison-like attempt to estimate components of the residual. This is true even for ‘human capital’ – that is the upgrading work-skills – which is one of the easiest components to measure. [35]
Instead the policy debate has attached to the residual all manner of nostrums. Undoubtedly the quality of economic governance is important (although it may lift the level of output rather than affect the growth rate); undoubtedly new technology in the narrow sense of ‘blueprints’ is important but the quantitative connection between research and development is not explored (while the issue of the importance of offshore origins of the blueprints and the effective conduits to New Zealand production is hardly mentioned). Innovation is said to be important – how important? There has been discussion on the role of distance (plus the role of the economies of scale), but this contributor has found it impossible to quantify it, and hence measure its impact). [36]
Even so, differences between sectors (and therefore prices and profits) are largely forgotten. Much of recent work has been on the aggregate production side with little attention to the demand side of the economy.
This paper has been largely a recording of a research program in the past. If there are any lessons they are that, with the exception of the one big idea that economic growth was not dominated by the quantity of capital, the research did not have a great impact on policy. (Conversely, policy does not seem to have had much of an impact on economic growth.) As a result of Bryan Philpott’s diligence, we have the possibility to measure the Solow residual by sector back to 1954/55 – before the New Zealand Economic Association was founded. While business cycles and measurement errors add a lot of noise around the trends, it is surely interesting to investigate whether there have been any acceleration or deceleration in the Solow residuals in the period which cannot be explained by composition effects.[37]
I opened with Satayana’s ‘those who cannot learn from history are doomed to repeat it.’ About a hundred years earlier, Marx had gazumped him with ‘the first time it is tragedy; the second time farce’.
Endnotes
[1] This paper might be thought of as the prequel to a memoir of my own contribution.
[2] Conrad Blyth Frank Holmes, Dennis Rose and John Yeabsley have contributed to this paper; thankyou.
[3] Conrad Blyth did not arrive back in New Zealand until 1960; Jack Baker and Bryan Philpott were at the founding meeting.
[4] M. Ambramovits (1952) ‘Economics of Growth’ in B. F. Haley (ed) A Survey of Contemporary Economics: Vol II, p.132.
[5] http://www.ggdc.net/maddison/
[6] R. Solow (1957) ‘Technical Change and the Aggregate Production Function’, The Review of Economic Statistics, vol 39 (August 1957) pp. 312-320.
[7] T. Balogh, T. & P. P. Streeten (1963) ‘The Coefficient of Ignorance’, Bulletin of the Oxford University Institute of Economic and Statistics, May 1963, pp.97-109.
[8] B. A. Pauw (1975) Christianity and the Xhosa Tradition.
[9] See http://www.stuff.co.nz/dominion-post/news/features/obituaries/1999243/John-Baker-Public-service-mandarins-long-run for an obituary.
[10] I think it was he who told me that margins were added for under-reporting: 25% for farm incomes, 10% for the incomes of the other self employed.
[11] This meant that Private Consumption included all the errors in the other components. Sometimes it was quite wrong. B. H. Easton (1966) Consumption in New Zealand; 1955/6 to 1965/6. A major problem was that the estimate for stock change aggregate included the effect of the price appreciation of the inventory items, as well as the volume change.
[12] I recall as a part of the Quarterly Predictions team in 1964 to 1966, that they were nominal was not considered a problem since inflation was low.
[13] And therefore subject to the errors mentioned in endnote [11].
[14] The Real National Product series of the 1961 Economic Survey maps reasonably closely to GNP and GDP series in the 1968 Yearbook.
[15] J. V. T. Baker (1965) The War Economy, uses only nominal economic aggregates and thus does not address volume of aggregate production changes, which is a pity. One might have the volume estimates could have been pushed back.
[16] In 1982 I met the eminent American business cycle researcher Geoffrey H. Moore at Columbia. He was struggling with the problem, and surprised when I readily understood it and at the elegance of the New Zealand solution.
[17] A minor point is that Blyth’s sectoral table does not sum up, a matter I checked in a minute or so with a spreadsheet. I mention this not to show off, but to remind current generations of the extraordinary computing power it has available to it, and how the fathers that begat us struggled without it. An obituary of Jack Baker praises him for introducing the first computer into the Department of Statistics in 1961.
[18] Blyth says that the paper ‘did not say much about the residual because I thought the contribution of the residual in NZ was relatively smaller than in the US and I was emphasizing the “fact” that it took a relatively large amount of capital to produce an increase GDP.’ email to author, 22 June 2009.
[19] Two Economic Lieutenants’
[20] I reported to Alan Catt, who was in charge of macroeconomics.
[21] Email to author, 22 June 2009.
[22] General equilibrium theory and linear programming are based upon much the same mathematics, and a linear program of an economy can be interpreted as a computable general equilibrium account of the economy. I illustrated this by constructing a parallel CGE model to Philpott’s Victoria LP model which had the same inputs and the same outputs. I called it Albert after Bert Brownlie, Professor of Economic at the University of Canterbury who was one of New Zealand’s most active general equilibrium theorists. Regrettably the paper on Victoria and Albert (in the antipodes) has been lost.
[23] C. A. Blyth and G A Crothall (1965), ‘A Pilot Programming Model of New Zealand Economic Development’, Econometrica, 33, No 2.
[24] By coincidence I was at the seminar in 1963. I had been interviewed in the morning for a job at the Institute.
[25] B. P. Philpott and J. D. Stewart (1958) Income and Productivity in New Zealand Farming, 1921-1956
[26] National Development Conference (1968) Report of the Proceedings of the National Development Conference:: Plenary Session 27-29 August 1968
[27] NDC (1968) op. cit. p. 122-3.
[28] For a detailed account of many the models, see G. Wells and B. Easton (1986) Economy Wide Models of New Zealand, especially pp.73-94; 169-275. .
[29] See Wells and Easton op cit. pp.135-148
[30] As a footnote, my estimates of the date of the climacteric are based on a series which begins in 1862. I wish I knew quantitatively more about what was happening in the 1850s and 1840s.
[31] I did the initial computing for Peter’s model.
[32] M. Fujita, P. R. Krugman and A. J. Venables (1999) The Spatial Economy: Cities, Regions and International Trade.
[33] B. H. Easton (2007) Globalisation and the Wealth of Nation is based upon the model.
[34] P. Romer (1990) ‘Endogenous Technological Change,’ Journal of Political Economy, Vol. 98, No. 5, “Part 2: The Problem of Development: A Conference on the Institute for the Study of Free Enterprise Systems.” (Oct. 1990), pp.71-102.
[35] I am pleased to report that there were papers at the 150th anniversary conference which were beginning to address this.
[36] Easton (2007) op cit..
[37] My current work is based on GDP series that go back almost 150 years. But there is no capital series, and the labour series behaves oddly (for the explainable reason that it is not possible to separate out full-time and part-time employment over the entire period). Nor is there any sectoral breakdown before 1920.
Reviewing the Sale Of Liquor Act: Tax and Pricing Consequences
Report prepared for the New Zealand Law Commission. Filed 30 June, 2009. Executive Summary Keywords: Health; : Health;1. The Policy Framework It is assumed that any review of the Sale of Liquor Act 1989 will continue the policy framework on which it was based. Previously, the implicit assumption was that almost all alcohol consumption was harmful, but there were some exceptions. Thus it was necessary to control all aspects of liquor supply as far as was practical. The Sale of Liquor Act was based on a quite different premise. It took the view that most consumption of liquor was benign or even beneficial. However some was harmful – even extremely harmful in comparison to most products. Its approach was that rather than control everything to do with liquor production, supply and consumption, the aim was to target consumption which was markedly harmful. It involved a marked liberalisation of the supply of liquor, moving from ‘quantity licensing’ (the number of outlets) to quality licencing (anyone could set up an outlet, providing they met certain quality standards). At the same time there were associated measures to reduce certain kinds of harm, including more vigorous pursuit of drink-driving. In my opinion, the Sale of Liquor Act was perhaps the most successful social reform of its times. It vastly improved access to liquor for moderate drinkers, transforming and enlivening inner cities with a plethora of small bars and restaurants (with a resulting lift in the standards of cuisine). At the same time there is no evidence that harm rose – indeed the downward trend of absolute consumption per adult continued across the reform period. A minimalist assumption is that the reform (which included other measures such as tougher drink-driver enforcement) had no effect on the level of harm from alcohol consumption. In recent years there has been some evidence of rising harm in some areas including – increasing teenage drinking. This is an international phenomenon, so it cannot be attributed to the New Zealand Sale of Liquor Act; – increased evidence of binge drinking, especially in the 17 to 27 age range (although it is less clear whether this is a rising phenomenon or whether it is just being better identified); – new forms of alcohol (including light spirits and ready-to drinks) which may, or may not, require specific policies; – evidence of the magnitude of the social harm from alcohol – discussed below – which is substantial. These are social problems which need to be addressed. The assumption in this paper is they should be addressed by targeted interventions in a spirit similar to the 1989 regime reform, rather than a return to the pre-1989 regime of widespread control of supply and consumption. Even so, there needs to be a review of the 1989 Sale of Liquor Act and subsequent amendments to see whether its performance can be improved. The concern here would be to ensure that the supply system is working with the maximum efficiency (the minimum of use of resources) while contributing – as far as it is able –to reducing harm. Because the Sale of Liquor Act is a part of the totality of harm-addressing programs a review of the act necessarily involves looking at the efficacy of those other programs. 2. The Harm From Alcohol Since the 1989 Sale of Liquor Act there have been two major attempts to provide estimates of the social costs of alcohol misuse (Easton 1995, BERL 2009). Their exact estimates may be challenged but they each bring together the existing available data on social harm and value them. While the valuations may be challenged, the underlying data has not thus far been criticised by the challengers. What it shows – whatever the valuations – is that there is substantial harm caused by the misuse of alcohol. This harm is so large relative to the overall consumption that it makes policy sense to address it by specific measures. (It is acknowledged that ordinary goods and services can cause also harm. Except in particular cases, there is generic legislation – perhaps with accompanying specific regulation – to minimise this harm. In the case of alcohol consumption – and a few other products – the unit harm can be so large that a specific policy framework is thought necessary.) The harm can be divided into three components. First, there is the additional costs to the public purse. Notable elements are costs to the public health system, to the police and justice system, and to the regulatory system. Second, there are the material (or ‘tangible’) costs which are borne by the private sector. For instance, car insurance costs are higher as the result of accidents from drunken driving. Third, there are the human (or ‘intangible’) costs covering the loss of quality of life (not only from poorer health but from the violence to others) and early mortality. (Note that the resources used to produce the beverage are not a ‘harm’, in this formal sense, since they are netted off against the benefit to the imbiber.) A major issue is the degree to which these costs are ‘internalised’, that is, taken into account by the person who purchases or imbibes. The government costs are certainly not taken into account, and it seems likely that neither are the tangible and intangible costs which fall upon others (including to the insurance industry). These external costs are a major justification for excise duty on alcohol, since insofar as the drinker fails to take them directly into account when they make the consumption decision. If they do not, the benefit of the consumption to the drinker is greater than the benefit to society as a whole; indeed the benefit to society as a whole may be negative if the ignored costs exceed the benefits to the drinker. 3. Rational and Irrational Drinkers What costs are included in a drinker’s decision is an empirical matter. For instance, the drinker may think of others as when a man choses to limit his intake because his wife does not like him drunk. At another extreme the drinker may not take into consideration all the costs which fall on her or himself. What is taken into consideration is a heavily disputed issue in economics (although other disciplines seem to accept as a matter of common sense that drinkers do not take into consideration all social costs). The default position of economists is to assume ‘rational economic man’ (Homo economicus) who takes into consideration all the costs of a consumption which impact on him (invariably he is treated as a man), but none of the costs which impact on others. A variation is that the man may not have full information (or the required computational power) and is ‘boundedly rational’. (Most economists would have little difficultly accepting that certain groups of people – say the young – may be so information limited, that the concept does not usefully apply to them.) Some economists treat the notion of rational economic man as a useful analytic device for want of a better hypothesis; others treat the notion as a fundamental economic assumption which may not be challenged (at least in its bounded form). The second group would argue that, say, drinkers take into consideration all the effects of the drinking on them (but usually not on others) including assigning a probability of serious damage or death, but with diminishing significance because future events are discounted. The first group of economists might accept that an inebriated person may miscalculate the probabilities, underestimate the harm and too heavily discount the future (even ignoring it). The difference between economics leads to a major disagreement as to what is or is not included in social costs. This is not a dispute about the facts but one of which harm is or is not to be included. It hinges on how rigorously we should take the notion of rational economic man. There is hardly any direct evidence, other than from introspection, that rational economic man is a realistic account of how humans make decisions. (Drunks are hardly notorious for this sort of introspection.) It does, however, make some predictions which are consistent with observation (such as about how people make normal purchases). That is why many economists treat the notion as a working hypothesis, acknowledging that other hypotheses about economic behaviour may give similar predictions in the same circumstances, but different ones in less standard ones (or which drinking might be a prime example). That a theory predicts well in some circumstances does not mean it will predict well in all circumstances; inebriation seems to be a circumstance where it does not (and one with potentially substantial differences in outcomes.) In recent years an alternative framework has begun to evolve around ‘behavioural economics’. It would be misleading to argue that it has been adopted by all the economics profession, but it was important in justifying to some economists the ‘Kiwi saver’ scheme. Depending on the definition of the subject it has already received two prizes in economics in honour of Alfred Nobel (Daniel Kahneman: 2002, Vernon Smith: 2003) and another leading innovator, Matthew Rabin, is expected to win one in due course following being awarded the 2001 John Bates Clark Medal – the second most prestigious prize in economics. (Another key thinker is University of Chicago professor, Richard Thaler.) Behavioural economics is characterised by close attention to psychology’s research and theories (Kahneman is a psychologist). It takes much less an a priori approach than that upon which rational economic man is based. The particular element of the approach relevant to this report is ‘time inconsistent’ decision making, which occurs when without any new information a person may regret a decision which earlier had been made rationally. A simple example is when someone plans to have a couple of drinks in a bar but, in the event, over imbibes and yet the following day regrets the decision. Each decision is taken rationally and yet collectively there is an inconsistency between the three ‘rational decisions’. The time inconsistency arises because the discounting of decisions through time differs from that which is assumed for rational economic man. It turns out that time inconsistent drinkers will welcome a tax on their consumption since it limits the excessive drinking which subsequently they will regret (see Rabin and Ted O’Donoghue on Optimal Sin Taxes). That means some consumption is not (subsequently) valued by the consumer, and therefore is an externality and a contributor to social costs. 4. The Case For Taxing Alcohol It is clear from the evidence that alcohol consumption causes considerable harm which is not always taken into consideration when individuals make decisions to imbibe. As a consequence public policy has introduced a range of interventions which aim, one way or another, to internalise the decision, so that the drinker takes into consideration more of the harm which the drinking causes. In practice it has not been possible to eliminate all the social harm by education, private arrangements and statutory and regulatory interventions. Drinking behaviour is too complicated; even heavy interventions, which impact onerously on moderate drinkers, are likely to be circumvented to some extent – as the prohibition era illustrates. It has therefore been a standard practice to use specific taxes on alcohol to attempt to deal with the remaining social harm. There are two channels by which this may work – modification of drinking patterns and compensation for social harm; one leads to an efficiency gain, the other to an equity gain. They are mediated by the distributional impact of taxes. Modification of Drinking Patterns It is generally assumed that the demand for alcohol is largely price inelastic, that is a hike in the price arising from, say, higher taxation on alcohol does not reduce the demand for alcohol greatly. However careful econometric studies shows higher prices do reduce some consumption. It is believed (on the basis of fragmentary empirical evidence – it being hard to obtain systematic evidence on individual price responsiveness to price changes – and on a priori grounds) that the main groups whose consumption is sensitive to changes in prices are – the young; – binge drinkers (insofar it will reduce the number of purchases during a bing); – heavy drinkers. Since each of these represent a known source of social harm, any reduction in the quantities they drink will reduce social harm to some extent. Thus the tax will increase the efficiency of the system. It is to be noted that the Rabin-O’Donoghue paper suggests that where there is time inconsistent decision-making the tax will make such drinkers judge themselves retrospectively better off in the long run, and that they will welcome it from this perspective. However, strictly the Rabin-O’Donoghue paper assumes that the additional tax revenue from the drinker is recycled back to the drinker (say in a lump sum income grant). In practice this does not happen; the recycling is not that neutral. This analysis also assumes that the impact on the quantities drunk by moderate (time consistent) drinkers is zero. Yet they pay more tax. Insofar as it is not recycled back to them, they may be worse off in real income terms (although they may be better off from lower social harm). The Distributional Impact of Taxes on Alcohol The previous two paragraphs show that a second role of specific taxation on alcohol is that it raises revenue. What exactly happens to this revenue depends upon fiscal policy, but since it is on the margin of fiscal revenue, we can simplify analysis with little loss of generality by assuming that the additional revenue is used to reduce income tax and/or to increase social transfers. (This assumes that the degree of other interventions, and hence the resources required for them, are set independently of available tax revenues.) It is unlikely that the income increases can be targeted on drinkers or on those who suffer social harm from drinking, and in any case the government has considerable discretion as to whom it recycles the additional tax revenue. Thus it is not possible to state with any precision the exact winners and losers of a specific tax on alcohol, except non-drinkers will be beneficiaries since irrespective of whether they receive any of the recycled tax revenue, they will pay none of it, and they will (probably) benefit from reductions in personal harm. By extension, low alcohol consumers will also benefit, but the threshold below which they benefit cannot be predicted a priori. It is also likely that despite some gains from reductions in social harm heavy drinkers may be worse off after they pay the higher alcohol specific taxes. More generally, since there will be overall reductions in social costs from higher specific taxes, the aggregate gains (including the reductions in social costs) of the winners will be greater than the losses of the losers. That is, there will be a net social gain from this efficiency gain. However it will not be distributed evenly through the community. Compensating for Harm The previous subsection on the distributional impacts of a specific tax (or an increase in the specific tax) on alcohol treats the status quo as the reference point. That perspective ignores that the situation is one where there is social harm from the drinking, some of which is impacting on non-drinkers (and socially responsible drinkers). This includes the fiscal costs of the interventions and the private costs which cannot be prevented by the interventions. It is surely unjust when non-drinkers and moderate drinkers pay for the harm of other drinkers. It follows that it could be argued there is justice in specific alcohol tax transferring some of the burden of these costs from the non-drinkers and moderate drinkers to the drinkers who are generating harm. Such compensation improves the equity of the system. 5. The Taxation Implications for New Zealand There is a tendency to argue that a hike in taxation is necessarily a good thing – perhaps using arguments analogous to those in the previous section to justify the policy. Practically policy needs to be more refined in order to determine the way alcohol is to be taxed, and the level at which it is taxed. But first the price elasticity analysis of the previous section needs to be extended. Each alcohol-containing drink involves at least two characteristics. One is the amount of absolute alcohol in the drink, the other – which actually summarises a whole lot of characteristics – we shall call ‘quality’. Absolute alcohol can be measured directly while the quality characteristic(s) is usually evaluated by the price a consumer is willing to pay. Thus two bottles of wine may have the same quantity of absolute alcohol but the higher priced one is judged to be of better quality. (More subtly we pay more for the same bottle of wine in a restaurant than a supermarket because we are purchasing ‘quality’ as a superior venue.) Now suppose the price of all alcohol goes up (proportionally to avoid the complexities of measuring the quality, as distinct from ranking it as applied in the previous paragraph). The purchaser-consumer is likely to adjust their consumption in response to that price increase. At the extremes they may reduce the consumption of absolute alcohol and maintain the quality, or they may maintain the quality and reduce the consumption of absolute alcohol. Only the second reduces harm. One of the reasons why the demand for alcohol is price inelastic (insensitive to a rise in price). Is that when the price goes up many people have the option of maintaining their absolute alcohol for the same cost, by reducing the quality of what they drink. (Because beverages come in fixed volume containers it is likely that in many situations – especially moderate – drinkers cannot easily adjust their absolute alcohol consumption and the adjustment is entirely via quality. This suggests more attention should be paid to container size in alcohol control policy.) There is however one group of drinkers who do not have the option of reducing the quality of their consumption when there is a price hike. There may be no cheaper form of absolute alcohol. In effect they are drinking entirely for the characteristic of absolute alcohol disregarding the quality characteristic. This group includes alcoholics but it also includes many immature drinkers, binge drinkers and heavy drinkers. (This is the reason why these groups are likely to be more price sensitive.) Some of the most harmful drinking occurs in these circumstances. The conclusion which follows from this analysis is that insofar as the aim is to use taxation to regulate absolute alcohol consumption with the objective of reducing harm, most attention should be paid to the price of absolute alcohol levels, particularly where they are cheapest. The New Zealand alcohol taxation regime is particularly suitable for this purpose since it is levied on the basis of absolute alcohol content (details are below). Thus it raises the price on the cheapest alcohol (measured in absolute alcohol terms), where drinkers cannot avoid the price increase, relative to the more expensive forms where drinkers can avoid the increase by reducing the quality of their purchases. Apparently the regime was introduce in the 1980s, because it was thought that absolute alcohol was the best indicator of social harm and so taxing it was the most appropriate way of implementing the compensation principle. It seems unlikely that the efficiency gain from targeting the cheapest drinks was fully appreciated. Although one can think of more complicated regimes which might have some advantages (such as a duty which is reduced for higher quality drinks so that for the same overall revenue the impact on the cheapest was even greater) they would not be easy to implement. It seems likely that in current circumstances the best duty is in proportion to the absolute alcohol content. What should be the level of the duty? There is a general acceptance that the aggregate revenue from the excise duty should at least cover the fiscal costs addressing alcohol harm. The compensation principle suggests it might also cover the social cost to the non-drinkers. However recall that some measures of social cost include the costs to themselves which drinkers do not take into consideration when making the purchase decision. Thus it could be inappropriate to equate the full revenue recovery to the total social costs of alcohol, even if there were an universally agreed measure. In practice it is likely that full cost recovery would not be complete and that some harm would not be compensated – even crudely – through the tax system. An alternative approach arises from the focus on modifying drinking patterns. In this case the excise duty level would be chosen to target some minimum price of absolute alcohol. This was discussed in Taxing Harm (Easton 2002) and it and subsequent developments illustrate the principle. At that time, seven years ago, there was a product, light spirits, a bottle of which contained 21 standard drinks which could be purchased for a price equivalent to the minimum hourly wage. The contents were enough to kill a person – as a couple of coroners found. The cheapness of the bottle was partly because the absolute alcohol came from very cheap industrial sources, but it also reflected anomalies in the tax system. When the anomalies were eliminated in May 2003, the price of a bottle of light spirits doubled and the product disappeared from the shelves. Taxing Harm recommended that the excise duty on alcohol should be set to target some minimum price of absolute alcohol. This would mean that while competition would cause producers to seek to minimise price by minimising the resources they use, any efficiency gains at the bottom end would accrue to the public revenue. An alternative proposal is to set a minimum price for absolute alcohol but how that would be implemented is not explained, nor how it would avoid generating substantial profits for the alcohol production industry. They might be used for, among other things, promoting alcohol consumption. recommended that the excise duty on alcohol should be set to target some minimum price of absolute alcohol. This would mean that while competition would cause producers to seek to minimise price by minimising the resources they use, any efficiency gains at the bottom end would accrue to the public revenue. An alternative proposal is to set a minimum price for absolute alcohol but how that would be implemented is not explained, nor how it would avoid generating substantial profits for the alcohol production industry. They might be used for, among other things, promoting alcohol consumption.In summary the two gains from a specific tax on alcohol – the efficiency gain from moderating harmful drinking, and the equity gain from compensating for the harm – give slightly different recommendations for the level of an excise duty on absolute alcohol. It seems likely however that, whether the purpose is to ensure the minimum price of absolute alcohol discourages harmful drinking or whether the purpose is to adequately compensate for the harm, that the current excise duty is too low. One complication is that the excise duty on absolute alcohol where the beverage is above 14 percent proof is 82 percent higher than the duty for alcohol below 14 percent. (Wine, typically does not exceed 14 percent, so the higher rate is on fortified wines, liqueurs and spirits.) It should also be noted that in practice wine is levied as if its proof is 10 percent, although it is more typically near 14 percent which represents a 30 percent discount relative to the levy on the absolute alcohol in beer. The reasons for these differences seem to arise from history and political compromise. It is sometimes argued that some forms of alcohol are less harmful than others. While that may be true, the differences are not quantified and it seems unlikely that they are as great as the excise differentials. The harm difference case for excise duty differentials needs to be quantified before it can be incorporated systematically into policy. The only other justification I can think of (other than the fortunes of history and political compromise) is that the excise duty differentials may result in a rough equality in the minimum purchase price of absolute alcohol. Some evidence to this effect was found when collecting data for Taxing Harm. (If there is little substitution between types of beverages, there is little efficiency loss from this approach. But if drinkers switch between drinks according to price. They might, for instance, choose wine because of lower prices due to lower excise duty when they could get the same value from spirits for a cheaper resource cost to the economy.) There is a case for a zero excise duty rate on alcoholic drinks of very low strength, which do not cause harm. Tax rates need always to be set with the possibility of avoidance. This includes home brewing and similar activities for other beverage forms. It also includes duty-frees. Any review of the tax regime on alcohol must take account that New Zealand has various international obligations which affect its policy freedom. (Many would argue that it should vigorously pursue international reform to minimise the harm to which duty-frees contribute.) Another consideration is that much alcohol consumption is not paid for by the consumer – as when the employer pays for it. This is not only another reason for the price inelasticity of absolute alcohol, but indicates the need for other policies to reduce harm. The host responsibility program is an example. 6. Conclusion In summary – on the whole much alcohol consumption is benign or even socially beneficial, but some generates very great social harm; – this harm may be reduced by various interventions, but their effectiveness is limited because of the need to allow consumption which is benign and socially beneficial; – a specific tax on alcohol is a means of reducing the harm through internalisation of an external cost ( (the efficiency gain), and compensating those who suffer harm from others’ drinking (the equity gain). However neither objective can be precisely attained. – the New Zealand system on an excise duty on absolute alcohol has much to commend it. However more attention could be given to the minimum purchase price of absolute alcohol. Go to top