Changing Expectations

This entry was posted in Environment & Resources, Governance, Listener, Retirement & Savings on by .

MMP has reduced policy extremism, but more consensus politics are needed to solve our big economic questions
 

Listener: 21 October, 2006.
 

Keywords: Environment & Resources; Governance; 

The rise in personality politics is an unexpected consequence of MMP. Certainly there are other factors, including a change in the US political debate (recall the attacks on the Clintons) and the blog commentaries, which have made public the ignorant vituperation that can occur in private conversations. But it is MMP that has intensified the role of personality in Parliament.
 

As intended, MMP has reduced policy extremism. As long as no party has an unassailable parliamentary majority – as happened under the Winner-Takes-All (WTA) past that gave us Muldoonism, Rogernomics and Ruthanasia – policy mainly will be steadily developed and thoroughly worked through. Mild biases reflecting the constituencies of the governing party will arise, but in the end there will be little real policy disagreement between the centre parties. The government will praise itself, the Opposition will whinge, while asking for more spending and  more tax cuts.
 

So the Opposition retreats to arguing that its people can better implement the existing policies. It is only a small shift from complaining “how awful” our political opponents are as public administrators to “how awful” they are generally.
 

There are personal cases, including some current ones, that should involve the closest scrutiny. But what about policy? We have an MMP Parliament, but it still suffers from the WTA culture of unremitting conflict. The parties and the politicians are only slowly learning how to work together.
 

A positive illustration is the proposed joint Tasman Therapeutics Products Agency agreed between the Australian and New Zealand governments. In WTA days the required legislation would have been rammed through with Parliament’s meek acquiescence. But the health select committee unanimously favoured mutual recognition (where each country accepts the other country’s registrations of products) ahead of a joint agency. Without a government majority, the bill has not been not passed. The point here is not whether the proposal is good or bad, but that the international negotiations were made without parliamentary consultation. We are seeing the executive and the legislature wrestling, which is what MMP intended.
 

But this instance is unusual. Parliament has still much to learn about consensus politics. That involves getting outside the WTA mindset and seeing that MMP involves a different approach to governance. As my political studies mentor, Professor Keith Jackson, said, “You can change institutions, but attitudes and expectations, whether of the public or MPs, are much more intransigent.”
 

Guy Salmon of Ecologic has been studying Nordic parliaments, which have such a commitment to consensus that only very occasionally is there failure. Because it was such a rare exception, he cites the Finnish Greens rejecting the otherwise parliamentary consensus on nuclear power strategy. But when it came to disposal of nuclear waste, the joint report was again unanimous. The Nordic countries have a longer history of proportional representation than we have, and their parliamentary culture reflects it. Ours doesn’t – not yet.
 

Can we speed up that evolution? Not by a cross-party committee on family violence, following the terrible deaths of the Kahui twins. It is too easy to descend into political point-scoring where there is a strong public outcry. Predictably, it occurred.
 

Instead, look for issues where consensus is needed, but the gains are long-term. Although the ageing of the population is not an immediate concern, the proportion of the elderly is going to start rising within a decade. Almost certainly there will be some policy changes (perhaps raising the age of eligibility for New Zealand Superannuation). Those expecting to retire need guidance now, so they can plan for retirement. They don’t want to wake up one morning in their retirement to find the government has changed the rules WTA-style. Why not get a select committee to work through the issue now?
 

Or consider “peak oil”, when world oil production reaches a maximum and starts tailing off. Though nobody knows when, we know that today we are building houses and transport infrastructure that will be there well after oil begins to decline. We should be planning for the post-peak now. Could Parliament take the initiative?
 

Such select committee inquiries require a different approach to policy-making, where the government does not propose to Parliament but listens while facilitating the inquiry. It involves a different attitude by MPs. One where their main interaction is co-operating, not slagging one another.

Should We Trade Emissions Rather Than Tax Them?

This entry was posted in Environment & Resources on by .

Guest Column for http://norightturn.blogspot.com/ 16 October, 2006.
 

Keywords: Environment & Resources; 
 

There appears to be a tendency to pose carbon taxes as the only economic way to address carbon emissions. But tradeable emission permits (TEPs) are a serviceable alternative which have both strengths and weaknesses over carbon taxes. Their greatest strength may be that they are politically more feasible.
 

TEPs, which permit emission of carbon (and without such permits no emissions are allowed), could be started off by grandfathering in recent levels of emissions so that current emitters got permits sufficient to allow them to emit their last year’s level, say. But each year the allowance attached to each TEP decreases so that at the end of the target period we got emissions down to our international target. This would force each emitter to reduce its level of carbon emissions unless it could acquire TEPs from others that had reduced their emissions more. Since the obdurate polluters are forced to purchase the TEPs from the reducing polluters, there would be a market incentive to seek technologies to reduce emissions, together with some demand side effects as the price of the products of carbon emitters would be forced up.
 

The scheme requires some development, particularly
            1. How to interface with the rest of the world, and
            2. How to deal with carbon sinks (one option is for the government to reward sinks with annual TEPs which they can sell to emitters, in effect offsetting the pollution with a sink).
            3. Administrative mechanisms.
 

Typically there would also be an annual resource levy to cover the cost of management, enforcement and R&D in the scheme.
 

This proposal essentially involves a market mechanism, but it does not involve a tax. (The levy is not a tax but user-pays. However, corporate gains from the market value of TEPs may well be treated as income and thereby taxed.) So the rents do not, on the whole, go to the public purse (which many would think a pity). It is easy to show that there would be some inequities (but a tax-based system would generate them too).
 

The advantage of TEPs over a tax (other than one can target aggregate emissions with precision) is that the scheme is relatively politically stable. Had it been in place last year, the coalition partners would not have asked for a repeal because they would have been destroying the property rights of the holders of TEPs who, despite any doubts about the scheme, would lobby against its abolition (since the alternative might be worse).
 

Of course the TEP scheme is clumsy. All impure market schemes are – which is why one only advocates them when the market is failing to deliver (big time in the case of carbon emissions). But a tax-based system is also clumsy. My guess is the TEP scheme is not as clumsy as a tax-based one, although it does not have the advantage of revenue raising.
 

The point of this note, is that sometimes having lost a policy battle, the losers want to fight again on the same battlefield, so sure are they of the justice of their cause. Thus those concerned with global warming seem to want to return to taxation as the mechanism. But sometimes it makes sense to look around for other policy options which give a reasonable chance of the advocates winning the next bout. As TEPs may do. At worse one learns about the strengths and weaknesses of the previous policy and its resolution.
 

For blog comments see
http://norightturn.blogspot.com/2006/10/guest-column-should-we-trade-emissions.html#comments


 

Get It Together

This entry was posted in Globalisation & Trade, Growth & Innovation, Listener on by .

The Rugby World Cup presents a challenge to Auckland’s governance. 

Listener: 7 October, 2006. 

Keywords: Globalisation & Trade; Growth & Innovation; 

The Auckland economy has been performing badly over the past few decades, partly because of the policies of the 1980s and 1990s, partly because of the failure to build adequate infrastructure. But the region’s fragmented governance (seven territorial councils and a regional council over them) has contributed to the failure, too. 

In the light of the recent failed attempt by the four Auckland mayors to reform this unsatisfactory structure, the distinction between government by federation and confederation may be useful here. 

In 1789 Americans adopted a constitution that merged their states into a “federation”, creating a powerful USA in which individual states had little power (while political power was centralised, economic power was decentralised through the market). Those who agreed to the new arrangement did not necessarily mean to undermine the individual states: after all, they did not vote for a “United State of America”. The nation-state is very much a 19th-century invention, so America’s founders had little idea of the political potential of their individual states. 

Almost 200 years later, nation-states were triumphant – too triumphant, since they had just fought two destructive world wars. So in 1958 the Europeans created what became the European Union as a “confederation” of states. Although the removal of commercial borders leaves economic decisions to the market, each nation-state retains considerable political autonomy. For instance, they have individual foreign policies: the states of the US do not. There is a European Parliament with elected members, but it is not nearly as influential as the EU Council of the heads of governments, nor the US Congress. The political power of the EU is organised around the nation-states. 

I became aware of the federation-confederation dichotomy when thinking about the future of world government for my Marsden Fund-aided project (which has led to the forthcoming book The Globalisation of Nations). As attractive as federal world government with elected representatives might be, the political reality is that nation-states will negotiate the outcome, and very few are likely to replace themselves with a federation. Like the EU – or the UN – they will favour a confederation. Nation-states are going to remain important, albeit with less discretion over commercial policy. 

Similarly for Auckland. Though one may or may not wish for a unitary government for Auckland, its local authorities are not going to commit suicide. Central government could try to pass yet another law reorganising the city, but if local commitment is not forthcoming there will be much resistance – while an MMP parliament limits the sort of unilateralism that drove through the 1990 mergers. Improvements in governance are more likely to depend upon a confederation, with the existing local authorities being (largely) retained but working together co-operatively. 

Co-operation will be vital to cope with the Rugby World Cup – the third largest sporting event in the world (behind the Olympics and the Football World Cup). In those few weeks in 2011 when the world will be looking at New Zealand, we need to be on our best display, for reputation and to entice future events and tourists. To do so we will have to build infrastructure for the cities – public transport, motorways, accommodation – and within five years. 

Consider the challenge of getting the airport-to-CBD rail link in time. Aucklanders are going to have to work together. The lasting legacy of that work is the real benefit of hosting such an event. 

Perhaps the best strategy would be to establish a special agency, with the purpose of getting the World Cup legacy infrastructure in place (and funded); it might consist of the mayors, the ARC and perhaps some special local interests and central government representatives. It would be organised as a confederation, with a super-majority of the local authorities – say, three-quarters – being required to make decisions. 

If the agency works, and other hosting centres are as successful, the 2011 World Cup will be a triumph for New Zealand (if not necessarily for the All Blacks, perish the thought). Hopefully the special agency would evolve into a more co-operative model of local governance and lead to the improved Auckland economic performance that all New Zealand needs. 

So You Don’t Get It?

This entry was posted in Business & Finance, Listener on by .

Being brilliant does not mean you are right. 

Listener: 23 September, 2006. 

Keywords: Business & Finance; 

Like most senior executives, Enron’s Jeffrey Skilling could be charming, creative, inspiring and playful; he could also be moody, arrogant and intolerant. Described by some as “incandescently brilliant”, and “the smartest person I ever met”, he saw intelligence as a supreme virtue, often hiring staff for only that talent and ending up with a bunch of clever misfits in a dysfunctional management team. 

They divided the world into those that “got it” and those that didn’t. 

Enron’s staff were tyrannised. There was no room for dissent. If you didn’t get it, it was common to pretend you had. After all, if your colleagues were “the smartest guys in the room” (the title of an excellent book on Enron by Bethany McLean and Peter Elkind, and that of a film based on it) you could convince yourself that it was true even if you did not quite understand. If you did not get it, you were out. 

But suppose the smarties were wrong. Suppose the outcast could see the fault in the theory, or perhaps only that the theory was not as robust as everyone said. The insiders would not know because they thought it not worth listening to any doubters. So Enron ended up a house of cards, tenuously glued together by an unquestioned belief in deeply faulty theories. The cards collapsed spectacularly, and Skilling is due to be sentenced for fraud and other convictions in October. 

I had the same problem with Rogernomics when it was being implemented in the 1980s. It was based on a theory that I just did not get. Not that it was propounded by world-class minds; but they were not fools, either. And they believed. So many people believed it (not all of whom can recall their enthusiasm 20 years later) that I thought they knew something I did not. I went over and over the theory trying to make sense of it. I waited for a year before criticising it publicly. But the economic logic was that it could not succeed or, if it did, it would involve an extraordinary combination of coincidences. 

Of course we should have liberalised our markets. That bit I got – even advocated it when it was politically unpopular. It was the extreme application of the liberalisation I did not get. 

Because the policies of the Rogernomes did not add up, it’s not surprising that they engendered our longest postwar recession. (Some Rogernomes still haven’t got that fact.) Similarly, because its theories were not rigorous, Enron bankrupted itself. (New Zealand was not bankrupt in 1984. I never got that one, either. Those who say it was don’t understand the concept and did not know the situation.) 

Certainly Enron experienced fraud, but the chicanery was forced on the company as it sought to deal with the failure of the theory. The favourable performance in the accounts simply did not reflect the underlying reality. Ultimately, a lack of cash flow, not fraud, brought the company down. 

McLean and Elkind say that Skilling had dangerous blind spots, also not brooking dissent, for he was “often too slow – even unwilling – to recognise the reality did not match the theory”. Skilling still thinks Enron was a success, undermined by those who did not get it. A harsher judgment is in the title of Kurt Eichenwald’s (also excellent) book Conspiracy of Fools. 

Eichenwald tells the story of Jim Bouillion, the executive in charge of purchasing Enron’s insurance. In the world of the smarties his job was seen as a routine activity – they said a monkey could handle insurance – and he was not considered worthy of annual bonuses. When the company collapsed, the high-flyers found themselves deep in civil litigation. Fortunately, Bouillion had done a superb job. Long after Enron’s financial structures and machinations had fallen over, the insurance he had organised was ironclad; it covered the executives for the hundreds of lawsuits they found themselves involved in. Whether they had been the smartest guys in the room or fools, they depended on craftsmen like the underpaid Bouillion. 

Notes Towards the Distributional Consequences Of Policy Changes

This entry was posted in Distributional Economics on by .

This is a simplified version of a paper to the Joint Conference between the Social Welfare Research Centre of the University of New South Wales and the New Zealand Planning Council, 10-11 November 1988, published in the Proceedings edited by Peter Saunders and Adam Jamrozik, as SWRC Report No 78, September 1989. This version was prepared in September 2006. Some remarks which were contemporary in 1988 have been omitted, as well as the more detailed analysis.
 

 A short note on the alleged Equity-Efficiency Tradeoff
 Keywords: Distributional Economics; History of Ideas, Methodology & Philosophy; Social Policy;
 

Introduction
 

The study of the distributional consequences of recent policy changes is a research program in its own right. Alas, the 1988  policy environment is antagonistic to serious research, perhaps more antagonistic than at any time since 1926 when the DSIR was founded. That means there is little useful research to use for such a paper as it risks the danger of being fragmentary rather than comprehensive, and open to misinterpretation.
 

In order to avoid the current fashion of opinion, servility, and superficiality as a substitute for serious independent analysis, this paper has set itself a limited task. Its main thrust is a review of the implicit objectives in much of the policy change and advocation, using the perspective of welfare economics. In particular it will become evident that much policy prescription which purports to be ‘value free’ is based upon values which may be self serving but are unlikely to reflect our traditional social objectives.
 

In addition the paper reports on some work which demonstrates that this issue is of considerable significance in the changing policy environment of recent years: It ends with a quick review of some research which indicates the limitations of the general framework which is used here, plus making the inevitable call for a sustained research effort.
 

The Objective of Efficiency
 

Here are some recent statements by a number .of New Zealand economists, all of whom have had some impact on policies and the implementation of policy in recent years. In each the policy objective which is referred to is ‘efficiency’, or some related production concept such as wealth maximisation. In each the objective is presented as though there is no question of its validity, that everyone would adopt the objective, and in this sense the implicit or explicit assumption of the objective is value free.
 

A system of incentives and sanctions is created through the market system to encourage efficient use of resources. It is generally argued that competition provides a set of incentives to promote good performance and a number of sanctions to penalise inadequate performance. The extent to which economic efficiency is maximised depends substantially on transaction costs. (Deane, 1988)
 

Economic efficiency should be the rationale underlying competition law. (Jennings and Begg, 1988)
 

Intervention in ‘market’ economies is inevitable because of the fundamental role of governments in establishing the institutional framework within which commercial activity is conducted. … These features of property rights underlie the system of incentives which operate in markets to ensure that resources are used more or less efficiently. (Jennings and Cameron, 1988)
 

It would perhaps reduce confusion if the term ‘competition policy’ were discarded in favour of ‘efficiency policy’ since economic efficiency should be the sole rationale for this type of intervention. (Kerr, 1988)
 

Proof of public benefit should not require applicants to prove the potential public benefit is distributed to any particular group. … The more emphasis that is placed upon the distribution of potential gains, as distinct from their realisation, the more political becomes the decision-making process. (Vautier, 1988)
 

Wealth optimising policy options. (Wilkinson, 1986)
 

It is harder to capture another feature of the articles from which the quotations are drawn. No other objectives are mentioned. It is not clear whether the writers think that the objective of efficiency is by itself sufficient, or whether they think in the particular circumstances they need only this objective.
 

Careful reading of these and other similar texts will indicate the concept of efficiency is not used rigorously, and is rarely defined. The concept is taken not only to be value free and important but almost primary without need for definition. This is particularly unfortunate, given that as we shall see the economic meaning is not the same as that in common usage.
 

We shall take it that the writers use the term with a common economic meaning, although interestingly that the third edition of The Macmillian Dictionary of Modern Economics (Pearce, 1986) does not define the term, emphasising its non-standard use. (It describes as Pareto optima what below is called Pareto efficiency.)
 

Greer (1988) writes
Economic efficiency is an archetypical teleological standard. By it we should incur total costs and gain total benefits in order to maximise net benefits. More precisely we can distinguish between allocation efficiency, production efficiency, and innovation efficiency.
            Allocation efficiency is achieved when existing stocks of resources and technical knowledge are allocated to produce the collection of goods and services that buyers value most highly as indicated by their willingness to pay for them. …
            Production efficiency requires that a given output be produced at the lowest possible cost in the light of known technologies and given resource prices. …
            Innovation efficiency allows for shifts in demands (due to product innovations) and shifts in costs (due to production innovations) over time. (p. 7)
 

The use of the term which most closely corresponds to the common notion of efficiency is that of ‘production efficiency’ and its idea of using as little input as possible to get the given output However the aggregation of a variety of inputs (capital, energy, labour, materials, etc.) according to their costs involves an uncommon notion and, for instance, green critics of economics rarely accept that market prices give the correct weighting for aggregation.
 

This dispute amounts to the correctness of the notion of ‘allocation efficiency’. It is not our intention to review all of the value theory which explains why economists come to such a conclusion, and the caveats they place upon it
 

But Greer captures the issue relevant to this paper, when he writes that the output is assessed by that which ‘buyers value most highly’ as indicated by their willingness to pay. Thus the valuation of output is dependent upon the market demand of purchasers, and thereby their purchasing power. At which point we may ask where the income distribution, and related equity issues, fit in with the notion of efficiency. Is the notion value independent?
 

The Treasury on Efficiency
 

It is also difficult to demonstrate briefly the dominance of the notion of efficiency in the Treasury 1987 post-election briefing. It is true that other objectives are mentioned, but the concept ‘efficiency’ appears to be given more prominence and used more frequently than other objectives and criteria. At one point five pages are devoted to it, compared to two for equity. and just over one for the rest (pp 26-34).
 

Illustrating the degree of ambiguity in the use of the term ‘efficiency’, without definition, is discussed as an objective on page 26, with what amounts to a definition appearing on page 97.
 

The general conditions required for efficient production of goods and services can be stated relatively simply. Allocative efficiency is achieved when t_e prices paid for a firm’s output cover the cost of the resources involved, thereby drawing resources into production of goods in demand. Productive efficiency is achieved by producing the firm’s output at least cost. Finally, production should be expanded up to the point where the increase in revenue obtained from the additional sales just covers the additional costs incurred. (1987, p. 97)  .
 

Many economists would dispute the Treasury definition, worrying about such ‘anomalies’ as unemployment and economies of scale, and noting that unlike Greer there is no recognition of dynamics. At issue for this paper though is that it is presented as value free, and the distributional assumptions implicit in the market demand are suppressed.
 

It is not necessary to pursue these points, but we note for later reference that the document talks of a ‘tradeoff’ between equity and efficiency (p. 33).
 

Utilitarian Welfare Economics
 

‘Efficiency’ is a word which has positive connotations. It would be strange to advocate inefficiency in a process unless one objects to the activity altogether. Yet as is evident from the discussion on Greer’s definition, the economist’s notion of efficiency is a special one, with a different meaning to and perhaps without all the positive connotations that the word has in normal usage. Moreover the way it is used in economics has implicit values underpinning it
 

This may seem strange to the non-economist, and it will be necessary to review part of the history of welfare economics to explain how economists arrived at this situation. The following illustration may be helpful.
 

Suppose we are at a point’ A’ and wish to reach ‘B’. Then we would want to get there as efficiently as possible. It might be more efficient, in some sense, to get from ‘A’ to point ‘C’. Do we take the more efficient option? Certainly not, for we want to get to ‘B’ not to ‘C’. Efficiency is about how to do something. By itself it does not tell us where we are going, or whether we want to go there. To put efficiency as a paramount objective, as the above quotations do, is to put the cart before the horse.
 

Traditionally neo-classical welfare economics centred around the notion that each individual’s behaviour could be characterised by a (mathematical) utility function in which the various commodities they consumed appears, and in which the more of each commodity the better (the higher the utility); The individual would select the commodities, paying for them subject to an income constraint, which would maximise the individual’s utility.
 

There are a number of objections to this characterisation of human behaviour, but these will be ignored here, although not in other contexts for such issues as social well-being, the environment, and the role of women.       .
 

The utilitarian description of human behaviour had both a positive and a normative component The normative economics which underpins policy advice culminated in Arthur Pigou’s classic text The Economics of Welfare (1925). The approach involves interpersonal comparisons of individual utilities. In summary, and I simplify, individuals with a higher income are taken as having higher utility than individuals with lower incomes.
 

Experience has shown most people prefer to be rich than poor, and we can take their judgement about themselves as authoritative, at least for such economic analysis. However assuming that two persons on the same income may be treated as being at the same level of welfare is far less obvious. It may be said to be ‘not scientific’ in that it is not possible to envisage an experiment which would accept or reject the validity of interpersonal comparisons, except by slipping in further equally problematic assumptions. But, once this assumption of the validity of interpersonal comparisons is made, a formidable set of policy prescriptions could be adduced, including support for a progressive taxation and other redistributional strategies.
 

It was appropriate and understandable that the economists who followed Pigou should ask whether it was possible to derive policy prescriptions which were not dependent upon interpersonal comparisons. but without adding some other equally unsatisfactory non-scientific assumption.
 

The New Welfare Economics
 

The abandonment of interpersonal comparisons might have seemed doomed to failure but the following simple example shows otherwise. Suppose there are two people, one of whom has a bag of apples and the other has a bag of oranges.
 

Suppose they are permitted to trade, the result of which is that they each end up with a mix of apples and oranges, and. each considers themself now better off. The almost trivial policy conclusion is that permission to trade has lea to an improvement in each’s welfare, and therefore it is a better policy than would have been prohibiting trade, in this instance.
 

Note that it is not necessary to make any interpersonal comparisons of the welfare level of the two people to form a judgement. The policy conclusion is possible without this assumption, because in both cases welfare increased.
 

This situation was systematised in the notion of ‘Pareto efficiency’ (or Pareto optimality), named after the Italian economist Vilfredo Pareto. This referred to the circumstance where it was only possible to increase the welfare of one person by reducing the welfare of others. Conversely, if there was not Pareto efficiency the possibility existed of increasing the welfare of some people without detriment to the rest. All other things being equal it is better for an economy to be Pareto efficient, for if it is not then it should be possible to improve the welfare of some people, without detriment to others.
 

From this notion were developed a wide range of policy prescriptions of the form that market trading would, under.. certain circumstances, lead to a pareto efficient outcome. The required circumstances may not exist in reality. For the purposes of this paper let us assume that they do.
 

Even then Pareto efficiency has some difficulties. For instance it turns out that there is rarely a unique Pareto efficient.. point of exchange and production in the economy. That depends upon the initial allocation of resources; that is, upon; the income distribution. We shall have to come back to this issue, but there is an even more fundamental problem.
 

The fact of the matter is that the policy prescriptions based upon Pareto efficient criteria cannot answer some very pertinent policy questions. For instance they give no guidance upon whether a tax system should be progressive or not. This is not the same as the paradigm of new welfare economics giving a wrong answer. Rather there are policy issues central to economics that the paradigm could not, in this form, cover.
 

Every scientific paradigm has limits to its scope. For instance while economists may claim that they can forecast the rate of inflation, and we do and sometimes we get it wrong, economists make no claim to forecast the weather. This is not critical to the survival of economics, weather forecasting being outside the scope of any reasonable definition of economics. However it would be most peculiar if economists were to say that their theory did not allow them to predict inflation. .
 

Yet that is what happened with the new welfare economics. The income distribution, and policies to influence it, were. outside the range of issues it could comment on. It could say that for a given income distribution certain polices would lead to a Pareto efficient optimum, but that was not much better than meteorologists saying that given it were raining they could predict the ground would get wet.
One result of this was that Pigouvian welfare economics. continues to have an active role in economic and policy analysis. The work I have done on household equivalence scales and poverty is very much in that Pigouvian tradition, with the conscious and explicit use of interpersonal comparisons (Easton, 1976; 1980). We shall use another development shortly.
 

The Rise of Efficiency
 

The second possibility was that the inadequate ‘new’ or ordinalist welfare economies would add additional assumptions which would enable it to cover a wider range of relevant issues. As it happens the crucial assumption had as little scientific validity as that of interpersonal comparison, and perhaps less. Not surprisingly it slipped into the paradigm almost by accident.
 

What happened was that economists became interested in ‘compensation criteria’. (Hicks and Kaldor are the names associated with this development.) In simple terms. suppose there is a policy change which makes some people worse off, but those who are better pay (i.e. compensate) the losers. If the compensation takes place, and the winners are still better off after the side payments, then there has been a Pareto efficient improvement.
 

Now suppose that the change occurs, but the losers are not compensated. It could be said that such a change represents a ‘potential Pareto improvement’. For instance one could imagine a policy adviser telling a minister that the proposed . change was a potential Pareto improvement, but that consideration would have to be given to compensating the losers, or whatever if the minister had a different income redistributional objective in mind
 

It turns’ out that the potential improvement is. under certain assumptions, equivalent to an increase in real National Income (which for many purposes is much the same as increase in real GDP). The policy adviser could say more briefly that the change would increase National Income, but the minister would still have to consider compensation measures, if any. By doing so the adviser would still be working within the new welfare economics paradigm.
 

However it is but a step to advocate the policy because it increases National Income, and not to mention the compensation issue. This is equivalent to increasing national wealth, because wealth may be thought of as the discounted flow of income.
 

An alternative formulation is that the policy increases ‘efficiency’ because, assuming there is full employment, there is more income or output for the same inputs. Note that the expression ‘efficiency’ used here is no longer referring to Pareto efficiency. Indeed. even the formal notion of (non-Pareto) efficiency developed here has been replaced by a looser one, as a reading of the literature associated with the above quotations will show. Among the changes is that the writers may seem to refer to increases in the potential national income, rather than actual national income, since the increase in their ‘efficiency’ may be associated with additional unemployment. Sometimes they may be referring to the notion of production efficiency only. although the cost weightings may have little validity if there is unemployment.
 

What for our purposes is crucial, in all this muddle over the efficiency approach is that there is no requirement to examine the distributional consequences of change, and whether some individuals are made worse off. as a result of the implementation of the policies being advocated.
 

What is sometimes called ‘Hume’s Law’ is
that a dollar is a dollar. Hume’s law means that if two persons are bidding at an auction for a sea-side cottage and a poor homeless family is outbid by a wealthy family wishing to own a seaside weekender, the result of the bidding is efficient. The house has been placed in the hands of the most dollar votes. The effect of Hume’s law is to divorce consideration of the allocation of resources from consideration of the distribution of wealth [or income]. (Williams, 1988)
 

There is an irony that the name of Home should be associated with a principle which is so manifestly not a natural law. The doyen himself would perhaps have described it as a principle of conduct, and subjected its standing to a far more rigorous analysis than its users do today.
 

The Lorenz Analysis
 

By abandoning the compensation caveat, the policy advice has subtly introduced a judgement about income distributional fairness. To see what this assumption is we need to go back to the Pigouvian framework, albeit in a 1970s version.
 

At this point the original paper used Lorenz curves to explain how to compare distributions. In order to avoid the geometrical presentation, this version id going to skip the details and go to the nub of the issue as a preparation for the next section.
 

Take a particular income distribution. Suppose that some of the income of the rich is transferred to the poor (those with less income). We can unequivocally say that the latter distribution is less un equal than the former distribution. That involves no value judgements, other than common sense.
 

Similarly if there is a transfer of income from the poor to the rich there is an increase in inequality.
 

Note that if some income is transferred from those on in middle incomes to the richer, and some is transferred from the middle incomes to the poor, we cannot say there is an unequivocal increase  or decrease in inequality without introducing a value judgement.
 

A more complicated situation occurs if the two income distributions also reflect different average incomes. Suppose that one with the higher average, also had lower incomes for the poor. How are we to compare the equity fo the two options.
 

John Rawls famously proposed a ‘veil of ignorance’, in which we do not know where we will be in the income distribution. So would we choose the one with the higher average income. If it was possible that we would be poorer. He argues we would not.
 

This implies we are totally risk adverse. Suppose but one person was worse off. Would we not gamble we were not that one person. Tony Atkinson has a different way of thinking about this – and a helpful one.
 

The Atkinson Analysis
 

Suppose we were to take a hundred dollars from one person and gave it to a second who was poorer. (The precise Atkinson measure is to someone who had exactly half income of the first). Using the previous analysis, that would be an unequivocal increase in equality.
 

But it might happen in this process of transferring some of the income was lost – through the deadweight loss of taxation. the disincentive effects, the costs of administration or whatever. The notion here is that a tax not only makes people worse off directly, but changes their behaviour. Consider someone who as a result of the higher income tax rate decides to work shorter hours, so there could be a loss of output to the economy as a whole. The measured loss would be even greater if she decided to cook and clean at home, now, rather than hire some on to do it. Much is made of this possibility, but it is also possible that the higher tax rate has her working longer hours in order to maintain her material standard of living – including the cleaner. (This possibility  is played down by those who are advocating lower taxes on themselves.)
 

Suppose that we took the $100 from the rich and were able to give only $X to the poor where X was less than 100. Many people would judge whether this was a good or bad thing only if they knew how much X was.
 

For instance if X equalled 99 so that costs of transferring the money were 1 per cent, many people, perhaps most people, might well think that the transfer was justified and that the outcome was a better income distribution. On the other hand if X equalled 1, so that the costs of transferring were 99 per cent, most people might well think the change was unjustified. For different X there would be different proportions of the population who would come to different assessments.
 

This notion of the willingness to accept a loss for an income transfer can be generalised into an overall measure of the income distribution (called the Atkinson ‘eta’ coefficient). To simplify, at one extreme X is 100, and society is willing to tolerate no loss of output for a change in the income distribution. The other extreme X is 0, where equality of distribution is such a priority that the consequence may be a loss of total output. (It corresponds to the Rawlsian approach of evaluating the total income distribution from the position of the lowest income group.)
 

Practically most people’s preferences lie somewhere between. We might predict that on average X is higher (that is a greater reluctance to lose average income) in some societies, say the United States, than in others such as New Zealand. Leaving aside the stark stylisation of a society by otherwise identical individuals except for their income, this coefficient might be treated as a useful measure of attitudes to egalitarianism in a society.
 

It should be evident by now that the efficiency criteria on its own has a covert X of 100, a total reluctance to lose any output as a consequence of an income transfer). Thus, far from being distributionally neutral, advocation of efficiency as a policy objective involves an extremist distributional objective, which is only obscure because the advocates of efficiency fail to mention it.
 

The Equity-Efficiency Analysis.
 

( A short note on the alleged Equity-Efficiency Tradeoff)
 This clarifies another puzzle. As mentioned earlier in the case of Treasury there are some who suggest there is a tradeoff between equity and efficiency. It appears to be a strange notion. Consider the announcement that the objective (of equity or whatever) was going to be pursued inefficiently. In normal parlance one pursues one’s objectives as efficiently as possible. But here the term ‘efficiency’ is not being used with a common meaning.
 

As far as one can judge, in this context the term efficiency can be replaced by national (or average) income or output, as follows from the above analysis. The essence of the alleged equity-efficiency trade off is that if there is any transfer there will be a loss of output (X will be less than 100) and average incomes will fall. That is true if the transfer is efficient’ in the nornmal meaning of the word.
 

In such circumstances, reference to an efficiency equity tradeoff is misleading. It is a sort of alliteration trick played by academics on undergraduates in exams to sort out the sheep from the goats.[6]
 

(However that fall may not always happen. Many would argue that over some ranges reducing inequality would increase average incomes, because of better human capital (from a better distribution of health, education, and like resources) and from improved performance from greater social solidarity (such as a higher degree of honesty and incorporation of externalities in individual behaviour).
 

In summary then, even a community which does not care about the degree of inequality may still practice some redistribution, because it may enhance average incomes.
 

It is also true that a community based upon the purest Rawlsian principles of evaluating only from the perspective of the poor, may allow income inequality if as a result of the inequlaity the income of the poor is higher.
 

There are at least two important caveats to this conclusion. First those who are rich may well have higher incomes under redistribution strategies. In such circumstances, without the veil of ignorance so they are aware of their income position, the rich may well advocate policies which reduce the national (average) income but are of benefit to them. This selfishness is not, of course, a peculiarity of the rich.
 

Second, the welfare analysis presented here is absolutest in material terms. If relativism was dominant, that is people cared only about the position in the income distribution, and not the income itself, the Utilitarian analysis would have to undergo substantial modification, as has been explored in recent years particularly by Amartya Sen.
 

The Trickle Down Effect
 

The ‘trickle down effect’ is a part of political rhetoric, but it deserves our consideration. The sort of policies which illustrate this phenomena might be that high taxation on the rich reduce incentives to work, invest, and save, which means less jobs and lower productivity for the poor. It may also mean less government revenue because of avoidance, and hence less social spending.
 

Thus despite the rhetoric, the trickle down effect may be important, and welfare enhancing. Presumably the objection to it is where the effect is small so that the poor are less well off relative to the rich. And sometimes it is used by opponents of redistribution in favour of the rich, as an ironic way of saying there will be no improvement in the lot of the poor.
 

Even so, I must report some bewilderment in an exchange in which I was tangentially involved. Accompanying a Listener article on the proposed December 1987 tax package which dramatically cut tax rates on high income recipients, was a cartoon by Trace Hodgson illustrating that in no uncertain terms the best the poor could expect was a trickle down from the tax cuts.I made no reference to this in the article (Easton, 1988).
 

In a far from considered response to the article, the Minister of Finance, wrote ‘I do not subscribe to the trickle down theory. That is to say, the idea that if you give massive benefits to the rich a bit will find its way down to the ordinary people’. (Douglas, 1988) Unfortunately there is no following sentence to tell us what the Minister does believe. Thus to what extent the clear government objective of ‘efficiency’, that is high real incomes, is moderated by equity is unclear.
 

Does Concentrating on Efficiency Matter?
 

All this would not matter if policies implemented on the basis of ‘national income efficiency’ were also Pareto. efficient, so that no-one was worse off as a result, and interpersonal comparisons were unnecessary. Unfortunately I know of no New Zealand research which examines the redistributive and output effects of changes on taxation, although there has been some work done overseas which could be applied here. However in at least two areas sufficient research has been done to indicate that often the income redistributive effects of a policy change are much larger than the gain in National Income.
 

One area is trade liberalisation. A 1979 review of the New Zealand literature found that while the models predicted, as might be expected given their assumptions, that wholesale trade liberalisation would increase national income these small changes, typically an increase of less than one per cent, were associated with dramatic changes in the profit to wage ratio, the regional pattern, and the size of individual sectors (Easton, 1980). . Further research has confirmed this finding (Philpott and Stroombergen, 1986).
 

These conclusions typically involve complex computational general equilibrium models. A similar conclusion, using a simpler more transparent model, is derived by Pickford (1986) when he examined the 1985 tariff cuts mainly on videos, motor vehicle parts and accessories, and microwave ovens, none of which were produced domestically. The effect of giving consumers a choice less distorted by erratic taxes was to increase national income by $11 million a year.
 

However the loss of tariff revenue to the general taxpayer was almost $72 million a year. That means the few purchasers of the tariff-cut items were $83 million a year better off and the general taxpayer $72 million a year worse off. Since the two groups do not coincide it follows that some people were worse off, although we cannot say who since we do not know how the revenue deficit was made up. The significance of the research for our purposes, is that it demonstrates the redistributive effects of the policy were far greater than the ‘efficiency’ effect.
 

The second research area where a similar conclusion is found comes from the general equilibrium modelling of labour market liberalisation (Easton, 1986). Suppose one occupational group in the community reduces its wages when some of its members are unemployed. That will generate additional demand for the workers and typically, more work and output generally. So there will bean increase in real National Income, and an increase in efficiency. However it is not evident as to whether the occupational group will share in this higher income. That will depend upon the increase in work relative to the cut in the pay rate, measured by the elasticity of demand for the occupation’s labour, the responses by other workers, the overall expansion in the economy, and the tax and social security arrangements.
 

This may appear to make generalisations possible, but the evidence points to the demand for most broad occupational groups being inelastic, and using this information in computational general equilibrium groups we find that while national income increases the income of the occupational group who takes the wage cut decreases.
 

For instance in March 1981 unemployment among professional people was 1.6 per cent. A 4.9 per cent drop in their salary rates would have eliminated this unemployment. Real national income would have risen .1 per cent, an increase in 1988 prices of $50 million a year. However the professionals would have had a drop in their real annual incomes equivalent to $132 million. Thus those who were not in the professional occupations would have been $182 million better off. Again the redistributional transfers are much larger than the output gain.
 

One piece of research on the microeconomics of liberalisation found effects which are not captured in the above studies. A study of five specific examples (Bollard and Easton, 1986) found little evidence for major gains in efficiency, measured by outputs relative to inputs. More important were a wider range of choice and better quality of service; It seems likely that these improvements are of most benefit to those on higher incomes, who have more discretionary spending. On the other hand liberalisation in the process of corporatisation, thus far not systematically studied, may indicate that the poor and those in peripheral regions got less choice and poorer quality as services were withdrawn.
 

There are hoped for ‘dynamic’ and entrepreneurial effects from liberalisation. If they do not appear, it may be the choice and quality effects will be ultimately the most important improvements from the policies. If so, they may well reinforce the distributive effects of the policies towards the rich.
The Politics of the Liberalisation
 

We are now beginning to see an insidious side to the advocation of the recent policies of liberalisation. They have been presented in terms of ‘value free’ efficiency, and of somehow being above politics. But the reality is that they have had an extremely value laden agenda. Policies are advocated providing they increase national income, irrespective of the distributional consequences.
 

Perhaps even that is not quite true. While the government has paid some attention to the needs of the poor, the main supporters and advocates of the policy thrust tend to support only those policies which promoted ‘efficiency’, and the interests of the rich. This is not difficult given that many of the policies of the past were probably willing to tradeoff national income maximisation for less inequality. But in some areas reform has been remarkably neglected.
 

Most evidently this applies to the financial sector, which has a number of advantages relative to the rest of the economy. These include the failure to institute a real capital gains tax, the continuation of taxation on the inflation premium of interest, the failure to impose GST upon financial services, the continuation of stamp duties which fall most heavily upon the small transactor, the failure to impose GST on foreign exchange purchases for consumption, and the financial market liberalisation without reform of commercial law. These have been of great advantage to the high fliers in the financial sector, but at the cost of the rest of the economy. It is surely no accident that the main advocates and supporters of recent reform have been in the financial sector, and who have notably failed to draw attention to these anomalies.
 

Indeed the situation where policies which promote ‘efficiency’ have a very small impact, while the redistributional gains are great, is likely to have the winners applauding the success of the policies out of proportion to the national gains – if any – because of the real benefits to them. In other words the economics of the liberalisation may be little more than the politics of rent seeking. Given the relative size of the redistribution of the national income gains, political analysts may find it more fruitful to describe recent events entirely in terms of rent seeking.
 

Complexity of People
 

Thus far we have treated all people as identical, except for having different income. However people have many differentiating characteristics, including sex, age, ethnicity, class, household situation and location. Suppose two societies had identical income distributions, but in males and females were evenly scattered through ti, while in the other all the males were at the bottom and the females at the top. Most would think the first society was fairer than the second (perhaps using a Rawlsian framework: under the veil of ignorance each would not know whether they were going to be a man or woman).
 

When I first wrote this paper there was some fragmentary evidence that the reforms were favouring the rich versus the poor. income distribution. Further research confirms this.  (Easton 1996)(Easton 1996).
 

The paper also discussed unemployment and the income distribution. Again we now know more about what happened. (Easton 1996)(Easton 1996)
 

Future Directions
 

The paper finished discussing further research directions. Sadly these were not pursued. Whatever the economic logic against it, the pro-rich politics dominated the public discourse.
 

Go to top
 

References
Atkinson, A. B. (1970) ‘On the Measurement of Economic Inequality’ , Journal of Economic Theory, Vol 2.
…. (1975) The Economics of Inequality, Oxford University Press, Oxford.
Bollard, A. E, and Buckle, R. A. (1988) Economic Liberalisation in New Zealand, AlIen and Unwin, Wellington.
Bollard, A. E. and Easton, B. H. (1986) Markets, Regulation, and Pricing, NZlER Research Paper No. 31, Wellington.
Deane, R. S. (1988) Privatisation and Beyond, address to the Annual Conference of the Electricity Supply Authorities, Wellington, 20 September.
Douglas, R. O. (1988) Response to Brian Easton’s Listener Article: ‘How Fair is the Flat Tax?’, Circulated Paper, 22 January.            .
Easton, B. H. (1976) ‘Poverty in New Zealand: Estimates and Reflections’, Political Science, Vol 28, No. 2, December 1976.
…. (1980) ‘Three New Zealand Household Equivalence Scales’, New Zealand Statistician.
…. (1983) Income Distribution in New Zealand, NZlER Research Paper No. 28, Wellington.
…. (1987) Labour Flexibility, Wages, and Free Lunches, University of Melbourne, Department
 of Economics Research Paper No. 180, Melbourne.
…. (1996) ‘Income Distribution’, A Study of Economic Reform: The Case of New Zealand, ed B. Silverstone, A. Bollard, and R. Lattimore, (North Holland Books: 1996) pp.101-138.
Greer, D. F. (1988) Efficiency And/Or/Versus/Equals Competition? paper presented to the AGM of the New Zealand Economists Association, September.
Jennings, S. and Begg, S. (1988) An Economic Review of Commerce Commission Decisions Under the Commerce Act 1986, paper presented for the Treasury, Jarden and Co. Ltd, Wellington.
Jennings, S. and Cameron, R. L, (1988) ‘State-Owned Enterprise Reform in New Zealand’, in Bollard and Buckle, op. cit., 121-152.
Kerr, R. L. (1988) ‘Time to Rethink Monopolies’, National Business Review, July, 8-9.
Pearce, D. W. (ed.) (1986) Macmillan Dictionary of Modern Economics, Macmillan, London, 3 ed.
Pigou, A. (1952) The Economics of Welfare, Macmillan and Co., 4th Edition.
Philpott, B. P. and Stroombergen, A. (1986) A General Equilibrium Analysis of Alternative Trade Regimes in New Zealand for 1990, RPEP Occasional Paper, Wellington.
Pickford, M. (1986) ‘Measuring the Effects of Tariff Cuts of 19 December 1985’, Massey Economic Papers, B8606.
Treasury (1987) Government Management, Post Election Briefing to the Incoming Government, Wellington.
Vautier, K. M. (1987) ‘Competition Policy and Competition Law in New Zealand’, in Buckle and Bollard (eds) op. cit., 46-66.
Wilkinson, B. (1986) Letter dated 31 January, to P. L. Read reported in Read The Treasury’s Fundamental Framework, Paper to the New Zealand Association of Economists, August 1986.
Williams, P. L. (1988) Why Regulate for Competition? Paper for N Z Centre for Independent Studies Conference, Regulating for Competition, Auckland, 7 March.
 

Go to top

To Celebrate the Jobs Letter Contribution to the Public Debate and Regret Its Demise

This entry was posted in Labour Studies on by .

Published in the last issues of The Jobs Letter 254, 9 September 2006 (http://www.jobsletter.org.nz)
 

Keywords: Labour Studies;
 

It seems a such long time since unemployment peaked in early 1992 in at 11.1 percent of the labour force, when over 181,000 New Zealanders were jobless and actively seeking work. Others had become so disheartened that they were not even bothering to seek work.
 

Even that figure is mislead as to the size of the trauma.  In the 57 months between October 1988 to June 1993, 754,312 had enrolled on the New Zealand Employment Service register. To give some idea of this magnitude, the average size of the labour force was about 1,612,000 people, so the enrolled unemployed represent about 47 percent of that total. Because people were entering the labour (from school leaving, returning to work, and immigration) this overestimates the proportion. But because not everyone who was unemployed registered the actual numbers involved were considerably higher. Whatever the true and meaningful figure there is no question that fifteen years ago New Zealand was going through its worse period of unemployment since the Great Depression.
 

The official rate of unemployment is now 3.6 percent which underestimates the change, since there has also been a reduction of those not-in-the-labour force. Why has this happened?
 

The first reason is that the economy has expanded, creating some 660,00 jobs, or around 45 percent more than 15 years ago. The second reason is that in the early 1990s the government introduced a more active labour market program, although many saw this as the stick of forcing people to look for work, to go with the carrot of pay and training.
 

We cannot rely on either trend in the future. First, past economic growth has involved low productivity growth and the taking aboard of additional labour. The labour reserves are running out – New Zealand now has high labour force participation by OECD standards, and it appears that the annual hours worked by New Zealanders are among the highest in the OECD (although the data may not be internationally comparable). Future economic growth is going to have to greater productivity growth, which means higher skills, more capital, changing workplace practices, and the abandoning low productivity jobs for high productivity ones.  Labour market programs need to be more pervasive.
 

A second difficulty occurs from the anti-inflation regime. The Reserve Bank has shown it has no  ‘target rate’ of unemployment, below which it will try to reduce demand in contrast to the 1990s when a 5 percent rate seemed to be the target.  But can unemployment get so low that it will take action? In fact the labour market inflationary pressures are not likely to come through a shortage of unskilled labour, which low unemployment indicates, but by a shortage of key skilled labour who push up their wages as employers compete for them. If other workers follow the wage rises then the labour market adds to other rising costs. Higher unemployment among the unskilled is just collateral damage –  but very damaging to those concerned.
 

Moreover, we cannot rule out that there will be an economic downturn which will slow down economic and jobs growth. Hopefully it will not be a self-induced one as occurred in the 1987-1993 period and, if it is an internationally induced one, it will short and not too deep – more like the Asian crisis of the late 1990s rather than that of the Great Depression..
 

So macroeconomic concerns wont go away, Even if they did there will still be ‘frictional unemployment’ – workers moving from low productivity to high productivity jobs passing through a transitional (and hopefully brief) period of unemployment. But there is likely to remain a core of those who will not easily return to employment. Some will have various limitations, others have got so embedded into the culture of welfare through a long – and often inter-generational – period of unemployment, that  it will be difficult to shift them into employment.
 

It was worth recalling the clumsiness of the jobs service when it first began using the stick. (More than one unemployed worker suffered an undeserved thwack.)The service will have lift its performance another step to deal with this rump of unemployed.
 

We also need to review the carrots. An important one was from first reducing the real value of the unemployment benefit in 1991 and then maintaining it since, even though wages have risen faster. Thus the gap between wages and benefits has risen, providing a greater income boost when someone finds work. But there is an absurdity here. The standard social security benefit has the same real value as it had fifty years ago, and is projected to remain there for another 50 years. Real wages will quadruple in the 100 years. Does that make sense?
 

Especially as it is punishing the unemployed by excluding then from belonging to and participating in society.  Surely the frictionally unemployed deserve better.
 

The current situation is even more vicious to families with children. In order to get as big an income boost on returning to work, a key element of income assistance (In Work Payment previously the Child Tax Credit) is given only to working families, this punishing the already poor children of the unemployed. Just as the unemployed can be a collateral sufferers of macroeconomic policy, children are collateral sufferers of the labour market policy. Is either deserved?
 

Implicit in this brief review is an agenda for further work. It is sad that the Jobs Letter wont be there to think about it, as it has been pursuing the earlier agenda set by the trauma of the 1987-1993 period. Who will?

Go to top

A Fate Worse Than Debt: We Owe Too Much. Go Figure.

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

Listener: 9 September, 2006. 

Keywords: Macroeconomics & Money; 

The external deficit (of the current account of New Zealand’s balance of payments) is currently around 10 percent of GDP. Once, a deficit of three percent of GDP was thought about right; we got edgy when it rose above five percent. Should we, then, be panicking now? 

Things are very different today. The value of exports of goods and services is still close to the value of the import of goods and services. What differs is the international investment income received by foreigners. Nowadays we owe so much overseas that the interest and profit on the debt and foreign investment amount to almost eight percent of GDP. That is more than is earned by our single largest exporter, the tourist industry. 

The economy is borrowing not so much to spend more on goods and services as to cover its debt servicing. It’s a bit like using a credit card to pay for the interest on your other debt. You avoid having to cut back on spending, but eventually the amount of debt servicing overwhelms you. 

Is that what New Zealand faces? In the old days, the gap was covered by government borrowing. Today the government’s spending roughly balances its revenue, and its net borrowing is negligible. New Zealand’s borrowing now is mainly private. 

Do private borrowers make good decisions? Many do not, and they don’t always get away with their bad decisions. (Nor do their lenders, a lesson learnt by those who invested in the finance companies that recently failed.) But it is not obvious who would make better decisions. 

Even so, in aggregate it’s hard not to conclude that we owe too much. I don’t know who are the more asinine: those who borrow for private consumption by mortgaging the house or those who say the borrowing is responsible because house prices are rising. Your house price is only meaningful if you are one of a handful selling. If everyone has to sell – during, say, a debt crisis – the price will fall and those capital gains you have borrowed against will become losses. 

You can’t juggle credit cards forever – and the same applies to the economy. Stein’s law says, “If it can’t last, it won’t.” Yet the immediate prospect is that debt servicing will continue to rise; and eventually spending will have to be cut to achieve a prudent level of debt. 

There are three broad ways in which the binge could be brought to an end: a voluntary reduction in spending; a shock peculiar to New Zealand, with overseas investors taking fright; or a major global financial shock. The second possibility is the least likely, so the outlook lies probably between the first and the third. 

Have we time to make the adjustment before that financial shock? Who knows? Any such shock – I can’t tell you the details, because it could happen in so many different ways – will impact heavily on those deep in debt. (Some creditors will also find their investments of little value.) Workers – even those with good credit records – will suffer, too, if they lose their jobs as spending and production shrink (though their savings will cushion them to some extent). 

The government, with a prudent balance sheet and low debt, will be able to ameliorate these impacts a little. But it won’t be able to do as much as the over-borrowed will expect. (Yes, despite the debt being the result of private decisions, we expect a public-sector bailout when we get into a private mess, as happened with the financial sector after the 1987 crash.) It would be very irresponsible for the government to increase its debt levels by, say, giving tax cuts (without public spending cuts) before the private debt mountain had been reduced. 

A cut in spending will cause a fall in imports relative to GDP. Provided export returns don’t fall, too – they could, under certain shock scenarios – the external deficit should fall. At which point an important lesson should become evident: a high external deficit is not in itself a bad thing but an indicator of severe internal imbalances. 

<>It is unusually high now.

Rough Trade

This entry was posted in Globalisation & Trade, Listener on by .
The Doha round is dead. But NZ’s bilateral trade deals are no substitute for global ones.  

Listener: 26 August, 2006. 

Keywords: Globalisation & Trade; 

The Doha round on trade liberalisation is suspended “indefinitely”. More colourfully, India’s Commerce Minister Kamal Nath said that the round, though not dead, “is between intensive care and the crematorium”. Trade Minister Phil Goff thinks “it is more cryogenics, actually. It’s on ice. There is a possibility of resurrection.” But a collapse of the negotiations does not mean the end of globalisation. 

Countries will continue to export, to import and to invest offshore. However, the forces of globalisation may take a different form. No one knows what. There is not even a common understanding of why the negotiations deadlocked. Many were quick to blame a veto by US farmers. Nath said he was looking after the interests of his 650 million farmers, while some of the subsequent responses by the EU have been maverick, to interpret them kindly. 

Whoever were the winners, New Zealand is a loser. We have long suffered from discrimination against our farm exports, which depresses the return to the farmers and the country. But the country also faces a major strategic issue: where do we fit in the world economy? 

The ideal is clear. In a multilateral world economy – the framework underpinning the WTO and the Doha round – we are one of many players. If that multilateralism fragments, the larger economies have more opportunities to manipulate trade in their interests. What significant market is going to give priority to a bilateral trade deal with an economy that is all of 0.2 percent of the world’s production? I don’t see the EU or the US (45 percent of the world economy between them) putting us high on their lists. China (10 percent) might have put us first so that they could practise for bigger deals. Some readers may dislike the WTO, but multilateralism is the foundation of a rules-based international trading system. The alternative is surely worse. 

A world fragmented into trading blocs is too horrible to contemplate. (The last time it happened was in the 1930s.) Whatever the blocs may be, we don’t fit naturally into any of them. Our best chance may be to hook into one we already belong to – APEC, ASEAN, the OECD. But, to be realistic, they are unlikely to do much for agricultural trade. And to be even more realistic, whatever collapsed the Doha round is likely to apply to such groupings, too. We could increase our leverage by going in tandem with Australia, although they went alone for their US trade agreement and have some very different trade concerns from us. In any case, Australia will be a relatively smaller market for us (and us for them) as Chinese exports become more pervasive. And together we are still only 1.3 percent of world production. 

An even gloomier prospect is the future role of the US. Over the past 50 years it has been the leader of a multilateral world economy. But the Doha round collapse in part reflects its increasing doubts over that role. The US Congress, beset by strong protectionist lobbies and much domestic indifference, seems more unilateralist. 

It is possible that Americans will elect a more outward-looking Congress in November. But one has a sense that the US is becoming more isolationist in response to its changing role in the world. It would be wrong to blame President Bush for the deadlock. He is a free trader, although he appears to have other priorities. President Clinton, at the peak of his powers, may have also found the domestic politics overwhelming. As may President Clinton at the peak of her powers. 

Americans are surely wrong to think they can go it alone. There are too many exporting US businesses, too many investors with holdings overseas and too many US consumers dependent on imports (not least, oil). Yet sometimes countries, like people, do damned stupid things against their long-run interests. Both the US and the EU may one day look back at last month’s Doha round deadlock and regret their obduracy. 

Coming Of Age: Can the Country Afford for Us to Retire?

This entry was posted in Listener, Retirement & Savings on by .

Listener: 12 August, 2006.
 

Keywords: Social Policy;
 

It may seem absurd to ask the Treasury to project the government’s fiscal position, that is, its tax and spending, out to 2050, but that is what Parliament requires of them in its 2004 Public Finance Act. Given rising longevity, some of the study’s authors may be around in 2050 to see how wrong they were – but they will be well retired. In the interim, the projections force the Treasury to think systematically about the long-term implications of government policies.
 

For instance, the Treasury had to think hard about future levels of social security benefits. Currently the real level of the basic benefit is much the same as it was 50 years ago. Are we to assume that the basic benefit will have a similar purchasing power in 2050 as it had in 1950? By posing such questions the long-term fiscal projection asks us how we are to set benefit levels. Is increasing them for inflation but not real wage growth acceptable? A worry has been that the income of a beneficiary relative to wages is too high, and discourages beneficiaries from looking for work. But does it make social sense for real wages to quadruple over a century and for the benefit level to remain constant? That’s what current policy assumes.
 

The projections also force us to think about momentous issues now only on the distant horizon, such as the ageing of the population and the increasing work capabilities of the elderly? We seem increasingly able to work productively into our late sixties if we want or need to. Even then we may expect a longer and more satisfactory retirement than many of our great-grandparents. Such a retirement will be expensive to the state – on current policies – because of New Zealand Super and the associated health and disability care, and the ageing of the population means there will be a higher proportion of us in receipt of this support. The projection thinks that the cost of public superannuation alone will more than double as a percentage of GDP. However, there is a window for almost a decade before the proportion begins to rise.
 

So who’s worrying, and why? Treasury officials are, and they are right to. Any substantial changes to New Zealand Super need to be clearly signalled well ahead, so that people have time to adjust to the new circumstances while they are working and saving. And the changes should be incremental so that those close to retirement have to make less adjustment. (Political common sense, distilled from the experience of the past 30 years, adds that the changes should not affect existing retirees and they should involve a broad multi-party political consensus.) So we should signal any changes that we expect implemented in the next decade now.
 

The projections provide two scenarios. One involves indexing the superannuation level to consumer prices rather than wages. That would give big long-run gains, but I don’t think it is politically practical, nor do I particularly favour its impact on inequality. My preference would be to increase the age of entitlement – incrementally, say three months every year from 2010 ,  until it reaches the age where the average life expectancy is 15 years. Currently that age is about 70 so the age of eligibility would be reached on this scenario in 2030. (It would probably continue to rise after that, as longevity goes up.) The long-term fiscal projections provide enough information to suggest that this would generate useful reductions in fiscal pressures (which will be further lessened by people working through their sixties). Raising the age of eligibility to even 67 would cut 20 percent off the projected public debt in 2050.
 

Although this proposal may not be very contentious, most politicians do not see it as urgent, for they will be out of office when the benefits accrue. It will take an uncommon political courage and perspicuity to take the initiative now. But it is the minimum we owe our young: to give them some confidence that the fiscal path is sustainable and that they will have adequate protection in their old age. Plus the clear signal that if they want to do better, they had better start saving.
 

What Does the 2004 Living Standards Report Tell Us?

This entry was posted in Distributional Economics, Education, Social Policy, Statistics on by .

This was submitted to http://norightturn.blogspot.com/, posted 3 August, 2006. 

Keywords: Distributional Economics; Social Policy; Statistics; 

The New Zealand Living Standards 2004 report depends entirely upon its “Economic Living Standards Index” (ELSI), first used in the previous (2000) report. At that time I expressed reservations about the index. Many have not been addressed. What I do here is set some down again, and then mindful of the ELSI’s problems, and try to draw some conclusions of what the latest survey may be telling us about what happened between 2000 and 2004. 

This may all seem a bit tedious. Who cares if the measure does not have any real meaning? Is it not better to use it for whatever (political) purpose we want without worrying about what the measure actually means? Don’t we do that all the time? Do we need to have a detailed understanding of the meaning of time or income or whatever? Cant we just trust those who constructed the measures? 

Well actually no. Typically scientists have spent much effort in constructing valid indexes. They are usually based on sophisticated theory, while each measure is verified by other scientists and is shown to have a practical significance related to things outside the narrow confines of the data which generates the measure. This is so routine for our authoritative measures that we assume it is true whenever someone proposes a new one. It may not be. Often indexes (i.e. measure of something or other) are not validated and amount little more than the opinions of the proponents. 

Validation usually involves two stages. First, there is the underlying theory. Is it rigorous? How does the index relate to it? (Its construction often has to make compromises, but if the theory is well understood one can evaluate the extent to which they matter.) Second is a empirical validation. Does the index relate to anything outside the data from which it was constructed? (Two examples of my trying to empirically validate indexes – sometimes called ‘calibration’ – are at http://www.eastonbh.ac.nz/?p=229 and http://www.eastonbh.ac.nz/?p=460.) 

Validating the ELSI Index 

The ELSI is based on asking households (strictly an “Economic Family Unit” – EFU) a set of questions about what items they have or have not got, what restrictions there are on their social activities, what economising behaviour they have had to practice, and how they rate themselves. The household responses are then combined to give the ELSI index. 

Note there are two stages. The first involves the questions asked. Are they the right questions? The second involves the aggregation of the responses. Has the right weighting (significance) been given to each response? How do we know the selection and weightings are not merely the opinions of those who construct the index, and that another set of “experts” would make different decisions? (For instance, the ELSI doubles the significance of some responses relative to others. Why not three times? Why not half?) 

As far as I know, there has been little attempt to validate the ELSI. There is no reference to a satisfactory validation in either the report nor its bibliography. That does not mean the index is necessarily invalid, but we need to be most cautious when using it. 

In my view the ELSI is a very poor measure of overall economic living standards (whatever that means). In particular, it is unlikely to be much use discriminating between those who are comfortably off. I should not be at all surprised if Bill Gates and myself would get much the same score, as might someone on the average wage and myself. That is because the questions are not designed to discriminate between the affluent. (There is not even a question on car ownership.) 

Thus one can give no significance to the average ELSI for the whole public. (If everyone got a(n extra) car it would have to have no effect on their ELSI score – other than perhaps through changes in self-rated satisfaction.) 

The difficulty arises because the researchers were focussing on the circumstances of the poor. So while we should dismiss the ELSI for the population as a whole we cannot be so dismissive of the index for those near its economic bottom. It is important if some people do not have a good pair of shoes (supposing that means “suitable for general purposes”, rather than “for dressing up”), which was one of the questions. 

So what I am going to focus on are those the authors describe as being in some or greater “hardship”. That category includes those in “severe hardship” and “significant hardship”. In my judgement their samples are too small and the measurement error too big for one to make comparisons involving them 

Comparing 2000 and 2004  

Famously, Moser’s Law says that if a statistic looks interesting, it is probably wrong. Despite the rise in real incomes between 2000 and 2004 (which the report acknowledges) the ELSI decreases slightly. Which is surely “interesting”, (I don’t have a feel of the significance of the fall in the ELSI from 40.6 to 39.7 – out of 60. That is one of the consequences of not validating the index.) But given that the index is probably meaningless for the majority – say top two-thirds – of the population measures based on the whole population (such as the mean) are of little value. 

What is more disturbing is the evidence that more of the population (that at the bottom) were in the hardship category. The rise in the proportion of the population in hardship rose from 23.6 percent in 2000 to 24.0 percent in 2004. 

A useful table (C10) in the report, which gives the proportions for the total and a huge range of sub-populations, shows this difference is not statistically significant – that is it could arise from the vagaries of sampling. 

There are a few cases among the sub-populations where there are increases and a handful where the difference is statistically significant (but remember that will happen by accident on occasions, given the way that statistical tests operate). You can pour over the table, and find some example that suits your assumptions. (For instance Labour-committed supporters will mention the decrease in hardship of the proportion of the Maori and two parent families. Those on the other side may draw attention to that there seems to be more employed and more of the elderly in hardship.) 

At this point we could drop the whole exercise, concluding the changes in the ELSI over the four years tell us nothing. But there is a really interesting problem – one where the “probability” in Moser’s Law warns us sometimes happen. Sometimes a statistic can be interesting and not wrong. 

The problem is this. The four years between the two surveys were ones of economic prosperity by almost all conventional welfare measures – higher real incomes and employment, lower unemployment … – as well as common sense. Yet there is no improvement in the ELSI. The inconsistency is sufficiently strong to suggest that the ELSI is generally not valid. I have already argued that is true, so I am not surprised. At which point we could end the story. 

What interests me though, is that where the ELSI might thought to better represent living standards – among those in “hardship” – there is no improvement either (indeed, a statistically insignificant deterioration). I find this much harder to understand. The ELSI cannot be that hopeless. 

I tried to think of some technical reasons. Perhaps household fragmentation has had an effect. When a poor couple splits up only is one is likely to have warm bedding (one of the questions asked) at best. Perhaps the drift north has had an effect too (they were asked about having a warm winter coat). But such effects are likely to be trivial in the four year period. 

The report acknowledges that beneficiaries had no real increase in their standard benefits over the four years, and some had reductions because some assistance (such as for families) was not adjusted for inflation. Would their lower real incomes be enough to increase their hardship and reduce the ELSI? Possibly. There is also a tricky problem that the sub-populations change over time. Suppose a better-off beneficiary in 2000 joined the workforce by 2004. That would lower the ELSI of the beneficiaries who are left. It may also lower the ELSI scores of the employed since they ex-beneficiaries are likely to be at the lower end of the standard living of the employed. Bother, bother, bother. 

There is another phenomenon which the ELSI does not deal with well. In each survey, respondents were asked whether they had a personal computer (for example). Now the options (to simplify a little) is “yes”, “no” (because I cant afford it), or “I don’t want one”. The “don’t want ones” are then netted out. Now it seems possible that some people who said “don’t want one” on 2000 said “no because I cannot afford one” in 2004. Their ownership has not changed one iota, but the standard of living of the household measured on the ELSI will have decreased. Are there enough of such items in the survey to actually depress the score? Possibly. 

What too about the family that has bought a computer because they now want (or think their children need) one and have made other sacrifices to fund the computer? The way the index works might depress the score. Indeed the additional purchase need not even appear in the survey. A household which bought a car (not in the survey) and sacrificed their annual holiday (in the survey) to do so. That would definitely depress the score. (And to complicate the story further, what if the car was necessary to go to work?) 

Trickling Down Prosperity? 

At this point one might become so uneasy about the ELSI, to judge of it of no value. However I think there is an interesting conclusion from the previous couple of paragraphs. To put it provocatively, during a time of prosperity, expectations may trickle down faster than income. 

This proposition brings together two issues. For more than thirty years I have been advocating that we should use a relative poverty measure. This expectation effect illustrates its relevance. 

Second, for some groups – the elderly and children – there is no automatic market trickle down effect, and that sharing prosperity requires some active intervention by the government. 

The elderly have a trickle down through the (imperfect) indexation of New Zealand Superannuation to wages. Beneficiaries don’t, because their benefit is indexed to consumer prices which rise slower than wages. 

Children have suffered even more because their public assistance is not indexed at all. (There is a big lift in the incomes of some of them via the Working for Families package.) 

I have argued that the benefit of the rising prosperity to those on social security has been to get an income increase from a job (not all of which disappears in the costs of employment and taxes and benefit abatement). Those on low earnings may also benefit from longer hours, higher pay and better working conditions, and upskilling. As pointed out, the ELSI can miss such improvements. 

But I have to modify that conclusion. What the ELSI for low income people seems to be saying is that those that have not got a job have not benefited. Even if their real incomes are maintained, they may experience falling “living standards” if prosperity raises expectations but not their incomes. 

The Real Issue 

We can go on in this sort of speculation, but the first real lesson is not to trust changes in the ELSI which contradict common sense. However the study affirms one old truth, and challenges a more recent one. 

We have long known there are some groups in hardship. According to the survey over 35 percent of our children are (compared to less than 25 percent of the population as a whole, including children). Interestingly, the hardship measure suggest proportions similar to those in the income poverty studies – the vast majority of the poor in income terms or in hardship in this study are children and their parents. (See various papers indexed in http://www.eastonbh.ac.nz/?p=152 for more details.) Perhaps this should be no great surprise, although it is satisfying to a researcher to have a rather different method coming up with similar conclusions. 

The degree to which the government’s recent measures to increase family assistance will markedly reduce hardship remains uncertain, because the support has been targeted on working families, rather than all families. 

Which leads to a challenge to a more recent “truth”. I think it was right in the early 1990s to place some emphasis on beneficiaries finding jobs. The conclusion, dimly seen through this report on living standards, is that after 15 years of doing so, plus a period of employment expansion and prosperity, there remains a rump who are still trapped into hardship. The policy strategy, which has succeeded for many, has failed them. If we are concerned about their hardship, and the often serious and longstanding (even inter-generational) deleterious consequences, we need to think about an alternative strategy which may be more income. It almost certainly is not to intensify a strategy which has failed them in the past. 

<>Go to top

Ozymandias By: Percy Bysshe Shelley

This entry was posted in Education, Literature and Culture on by .

I was invited to write about a favourite poem by students from Auckland Girls Grammar. It was to be part of a collection “Dear to Me” to be published in July 2007 by Random House, the royalties going to Amnesty International (New Zealand). I wrote two essays – to give the students a choice. They chose “Secular Litany” by M.K. Joseph. Here is the other one.
 

Keywords: Education; Literature and Culture;
 

I have many favourite poems. Because this is a collection sponsoredby students, I thought I’d choose one of the much loved poems I learned in my school days.
 

Not that the poetry loomed large then, for although an academically gifted class, our interests were scientific. When told to learn one poem for School Certificate, we went through the anthology and chose the shortest:still remembered though: ‘Three ducks on a pond …’
 

Nor, as others have told, did any teacher read poetry which stirred me. I dont even recall one reading a poem. The subject English was largely a task to be mastered rather than enjoyed. But somehow, some of it got through and years later I bought a copy of my upper-sixth anthology, Fifteen Poets. Its poets were a conservative choice – starting with Chaucer, its youngest was Matthew Arnold born in 1822. No modern poets (no one even mentioned that the writer of the essay on Byron was a poet in his own right: W. H. Auden). Certainly no New Zealand poets. (And no mention until university of my much loved John Donne.)
 

The poets I most enjoyed then were Keats and Tennyson, but I have chosen Percy Bysshe Shelley’s ‘Ozymandias’. A sonnet, 14 lines, 140 syllables, hardly a single one unnecessary to tell the tale. It is so minimalist you have to fill in the details. (It turns out that it is about the Egyptian Pharaoh Ramses II – the Great. What he actually said was ‘I am Ozymandias, King of kings. If anyone would know how great I am and where I lie, let him surpass any of my works.’)

One knew instinctively that it is a very good poem – anyway, it was in an approved anthology. But it was only years later that I came across the poem that Shelley’s friend Horace Smith wrote in response. What a pity we were not given both, and had a class discussion on why Smith’s poem was so pedestrian, so clumsy, so unsubtle, so crudely moralistic,while the other was – well – just brilliant. If you look at the rhyming schemes you’ll see Smith just manages to keep to the rules, but Shelley inventively breaks them. Yet his poem reads so well you dont notice. When an elderly friend recently asked me to read her some poems, it was natural to start with this one.
 

My youth added to its mystery. The long ago was unimaginable. (I did not do nearly enough history.) I revelled in the notion of a place so distant you could not visit yourself, but someone had to tell you about it. And I loved the irony. Here was the mighty of mighties telling all to despair, and his truth was that he too would despair.
Even then in my youth, or perhaps because I was young, I could see the poem was about the arrogance of the powerful and yet the transience of that power. I cant remember whether I knew, when I first read the poem, the term ‘hubris’ – ‘exaggerated pride or self-confidence, often resulting in fatal retribution’ – but the poem taught me the notion.
 

I often think of the Greek god Hubris, who is charged with dealing with those who show an impious disregard by thinking they are god-like. But I have never thought of him as vindictive. Those who do their best, succeed and take pride in their success need not be punished, providing they are humble. But those who are not, will be cut down, if only – as the poem says – by time. Hubris, and the poem, has haunted me all my life.
 

I once used ‘Ozymandias’ in a Listener column about the treatment of the environment in Saudi Arabia, where they still seem to think man can dominate the landscape without cost or consequence. While scrambling over the sand to a fourth century Christian church in sight of the giant Jubail gas-driven industrial complex on the Gulf Coast I was reminded of the final five lines.
 

Go to top
 

*******
OZYMANDIAS
by: Percy Bysshe Shelley
 

I met a traveller from an antique land
Who said: Two vast and trunkless legs of stone
Stand in the desert. Near them, on the sand,
Half sunk, a shattered visage lies, whose frown,
And wrinkled lip, and sneer of cold command,
Tell that its sculptor well those passions read
Which yet survive, stamped on these lifeless things,
The hand that mocked them and the heart that fed:
And on the pedestal these words appear:
‘My name is Ozymandias, king of kings:
Look on my works, ye Mighty, and despair!’
Nothing beside remains. Round the decay
Of that colossal wreck, boundless and bare,
The lone and level sands stretch far away.’
 

 

*******
ON A STUPENDOUS LEG OF GRANITE, DISCOVERED STANDING BY ITSELF IN THE DESERTS OF EGYPT, WITH THE INSCRIPTION INSERTED BELOW
by Horace Smith
 

In Egypt’s sandy silence, all alone,
Stands a gigantic Leg, which far off throws
The only shadow that the Desert knows: –
“I am great OZYMANDIAS,” saith the stone,
“The King of Kings; this mighty City shows
“The wonders of my hand.” – The City’s gone, –
Nought but the Leg remaining to disclose
The site of this forgotten Babylon.
 

We wonder, – and some Hunter may express
Wonder like ours, when thro’ the wilderness
Where London stood, holding the Wolf in chace,
He meets some fragments huge, and stops to guess
What powerful but unrecorded race
Once dwelt in that annihilated place.
 

Go to top

Coining It: Our Currency Is Worth Every Penny

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

Listener: 29 July, 2006. 

 

Keywords: Macroeconomics & Money; 

 

The change of coinage over the next few weeks will pay for itself. Not only will the new coins be more convenient to use, but also they are cheaper to make. The savings will pay for the administrative costs of the change. Today’s currencies cost less than their face value. The old 50-cent piece costs about 20 cents to make; its replacement will about cost about 3.5 cents. 

 

That is also true for our notes. The polymer ones, introduced in 1999, cost about 10 cents each, despite having face values between $5 and $100. Hence the attraction of counterfeiting. Yet, despite their low manufacturing costs, the notes have numerous features that make imitation very difficult. Probably only one in three million notes are duds – typically poor forgeries of the pre-polymer kind. When you are handed a note in New Zealand you don’t check its authenticity. You have to in some countries. 

 

The coins also have cunning features to discourage counterfeiting. They are not a single piece of metal, but contain a steel core surrounded by layers of carefully graded copper and nickel that have an electronic magnetic signature which coin-using machines can recognise. (That is why Australian and Fijian coins are rejected.) 

 

Once upon a time, the metal in coins was near the face value (it was a fraction below because of the cost of manufacture). A gold coin was made of gold. Today our one- and two-dollar “gold” coins are made of an aluminium-bronze alloy, and cost around 10 cents including manufacturing. 

 

Why do we accept coins or the notes whose cost of production is well below their face value? Because we know the next person will also accept them. Underpinning this is that the issuing authority, the Government of New Zealand through its reserve bank, will also accept them, especially for tax payments. 

 

Notes used to have the “promise to pay” on them. Nobody was sure what that meant, but we felt good about it. Nowadays we are so trusting that they say nothing. There is the signature of a Governor of the Reserve Bank. Many $20 bills are still signed by Donald T Brash, the previous Governor. We trust our currency so it does not matter. (It is not every country in which the Leader of the Opposition guarantees the value of its currency.) 

 

That our notes and coins are not fully backed to their face value is efficient because they are so cheap (and yet robust). A fully backed currency would cost more to make, and that would be a waste of – ahem – money. 

 

The profit from the issuing of the undervalued currency is called “seigniorage”. In the first instance it is a gain to the Reserve Bank that issues the currency. But the bank is required to pay the seigniorage to the Treasury, so it becomes a part of the government revenue. If the currency was produced at full face value, there would be no payment and we would be paying more taxes. Unfortunately, the seigniorage is small, amounting annually to about $10 per New Zealander. 

 

(There is also seigniorage on tokens such as those issued by the motor trade and the booksellers associations. The funds are used to fund their organisations. You don’t have to pay it: just don’t use the tokens. Since they are convenient, we do.) 

 

Not all “money” generates a seigniorage. The cheques you write are not money, but instructions to transfer the money in your bank account. The deposit may be “money”, but the costs of administration mean there is no seigniorage. Instead, you may pay bank fees for the service. Were there any additional benefits to the bank, the profits would be quickly wiped out as they competed by offering higher interest for your deposits. 

 

The government issues only so much currency. Partly that is because it is all we want to hold. But the government does not force more on us, to increase seigniorage and lower taxes. That would be inflationary and, as Milton Friedman famously pointed out, the tax of higher inflation would affect us all. 

 

<>The New Zealand currency system is thought to be one of the best in the world. Our notes and coins are worth every penny.

Prospects for Social Policy

This entry was posted in Political Economy & History, Social Policy on by .
In July 2006, I was approached by a team from the MSD involved in looking at past and future social issues to provide a context for social policy thinking. The following are revised notes from the 90 minute discussion. Contributors to the review are anonymous, but there was no objection to me publishing my thoughts. Which I have done so for the record. The interview (even followed by revised notes) is not the best way to set out one’s thoughts on such issues, but I am unlikely to get time to do a better job in the immediate future. Brian.
 

Keywords: Political Economy & History; Social Policy;
 

Looking back 50 years
 

Four significant changes have been:


1.                  Urbanisation
2.                  Change in the age structure, of both a rising proportion and significance of the elderly and of the new age group of teenagers/young adults.
3.                  Change in the role of women and consequent shift in gender balance
4.                  Rise in the acceptance of cultural diversity
 

Looking forward (up to 50 years)
 

Likely to see some intensification of these trends.
 

Ageing
We have a sort of aristocracy – a rentier class – of older people who live on the production of others via their investments, pensions and New Zealand Superannuation. The effective age of retirement from the work force will rise. He predicts the age of eligibility (for NZS) will slowly rise starting around 2010. The alternative of cutting the level of NZS seems politically unlikely. He discussed briefly the case for a lower retirement age for those with shorter life expectations, but argued that a universal entitlement not differentiated by gender or race was the only practical and fair option.
 

Global engagement and migration
This is likely to intensify with more people moving overseas.
            We tend to select migrants on skill. In future we may also need more less skilled workers – eg for care of elderly. Many may come from the Pacific, which provides cultural challenges and opportunities here, but also may leave major problems for those left in these small countries.
            With higher migration there will be consequences for how we view ourselves. Already 37.5% of Aucklanders were foreign born in 2001. We could look to Canada for models as they have found ways to get people to integrate – e.g. welcoming groups for new arrivals, major ethnic day ceremonies.
            There are implications for benefit eligibility. Residency requirement for NZS was once 20 years, now 8 of the last 10 years. The residential rules for entitlements may get stricter. There was a similar issue for health care. Traditionally residency has been the basis for entitlement to hospital services but how do we deal with the flux of people crossing the border, temporarily or illegally, as well as with recently arrived permanent residents.
            One issue is the impact of migration on political ideologies. Some Asian groups seem less committed to the welfare state, perhaps as a reflection their tradition of strong family-based welfare. However, it may be that as Asia modernises and its people relocates that tradition will breakdown (as it did for Europeans in the nineteenth century).
 

Economy
The loss of job security – the job for life – which became widespread in the 1980s will continue. That means more people will go through periods of unemployment. It also raises issues for industrial relations, with less employer-employee loyalty, the loss experience to the firm, and a lower incentive for firms to train workers (offset in the last case by increasing demands for skills as production processes becomes more sophisticated).
            Hourly productivity of NZ workers is low compared to other OECD countries (if we can trust the international data). That means New Zealanders work long hours. It is possible some future increases in productivity will be taken as more leisure.
            With broadband, more jobs could be done in rural areas – eg: the Hokianga. At the same time, more jobs involve global sourcing and collaboration – eg NZ Mercedes keeps spare parts in Stuttgart. (He observes that the range of the new planes to be introduced in about 2010 puts even Europe about 16 hours flying time away. Allow for the day-night switch that is about four hours – sort of as close as Australia today.) More services for NZ may be sourced from overseas, but there will also be opportunities for New Zealanders to supply services overseas by broadband too.
            Air transport is now very important – Auckland International  Airport is New Zealand’s second largest external port. To be provocative, he suggests broadband through Warkworth may become the biggest exporter and importer by the end of the century.
            There is an issue of the long run relationship between wage levels and benefit levels. Treasury’s Long Term Fiscal Projection, which uses current policies, has the real level of benefits in 2050 about the same as they were a hundred years earlier, while real wages are projected to quadruple. HE was uneasy about the social implications of this.
 

Urbanisation
It is likely that cities will become denser, because of higher transport costs. On current trends oil will be replaced by bio-fuels (e.g. from coppiced Swiss Willow grown around Taupo) at a price similar to current oil prices So we should be planning on the basis of $2 a litre for petrol. That would mean more urban transport. He recalled that while the cost/benefit studies do not currently stack up, it seemed sensible to develop urban transport infrastructures for the long term..
 

Wild cards
 

Given a list of wild cards events, he suggested that volcanic eruptions be added – both Rangitoto and Taupo had blown in the last 2000 years in a manner which would have been devastating for the current population. He recalled that it is said that the probability of a major volcano in Auckland is about the same as a major earthquake in Wellington.
            He noted the wildcard list did not include economic events. He could think off some which would be as structural and even more long lasting.
 

Focus for government over next 10-15 years
 

Health care
Expenditure is likely to rise to near 15% of GDP because of demands and new technologies and treatment (and population aging). Even so, rationing issues are likely to intensify. New Zealand is already has proportionally high private expenditure on health compared to the OECD average. A shift towards  a US in private health care is not a more viable option. Even so, there is – and will continue to be – debate about the relative responsibilities of the state and the individual for health care. The line is likely to be unstable and change with technological developments.
 

Living standards
There is an economic theory, which he finds plausible, that predicts the living standards of the affluent will stagnate or even fall over the next century as manufacturing becomes ‘commodified’, produced in low wage countries. (He adds hastily, in case this is read by professional economists, the model has orthodox assumptions, and the effect is the consequence of a fall in manufacturing terms of trade, something which Paul Samuelson has written on.)
 

Role of social agencies
He expects social agencies to have an increasingly important role, in part because broad economic measures (such as employment creation and income support) cannot meet the particular needs of everyone. He noted deinstitutionalisation as an example of how we are giving more attention to people’s individual needs and that requires social agencies for delivery.
            Although outside his specific competencies, he observed that rates of depression (and possibly other mental health conditions) have risen over his lifetime, and he regretted we did not know more about what was happening.
 

Other issues
Economic Transformation Agenda
He thought the way the economy would evolve would pressure social coherence, and suggested the objective of sustainability should include a sustainable social environment. The likely increase in the dispersion of market incomes had the potential to increased social incoherence.
            One problem is that the government’s three goals (economic transformation, families and national identity) may be siloed, and there is no strong mechanism to pull them together. It may be a bit early to expect one, but as yet there is no discussion of social implications of the proposed Economic Transformation.
 

Quality of Analysis
He talked about the intellectual limits of social scientists in New Zealand. Too many are hedgehogs, concerned with only one thing, lacking a broad perspective – a context in which that thing may be placed. He thought there were not enough acceptance of the role of foxes in the profession, who are concerned with many things. (‘The fox knows many things, but the hedgehog knows one big thing.’ Archilochus)
            Because he was working on the topics at the moment, he talked about the shortcomings of the ESLI and NZDep measures, neither of which were validated. His point was that we tend to accept such things without subjecting them to the robust critiquing which should be an integral part of the work of social scientists.
            One of his worries was that at the top of the scale ESLI which underplays the importance of choice. He argued that one of the central features of the last fifty years was how affluence had opened up choice for many. He thought Amartya Sen’s approach to welfare would have much more relevance for the next fifty years than the traditional utilitarian one.
            Another area he is working on was the future of Auckland (which may be the future of all New Zealand large urban centres) and lamented about the lack of data – even quality economic data.
            He thought there was no simple solution to the improving the quality of social science in New Zealand, but thought some gains would come if more academic institutions to set themselves standards of excellence rather than political correctness and what the conventional wisdom wanted to hear. He thought it sad that commissioners of research were not more discerning about whom they employ in what jobs and what standards they demanded. .
 

Go to top

Energy Futures: an Economic Framework and Some Policy Implications

This entry was posted in Environment & Resources on by .

Keywords: Environment & Resources; 
 

Introduction
 

This is a response to the IPS Bio-fuels seminar series of July-August 2006. It is is both a reflection of what I learned and an attempt to put it in an economic framework.
 

It may be useful to begin with a little of my view of economics. At its best it offers the opportunity to think systematically about some problems (typically involving resources). Most resource debates use an economics framework. What distinguish the useful from the unhelpful is the good or bad economics. The latter arises not just because the advocates dont understand the economics they are using, but often they are pushing economics beyond what it can say, perhaps to give a policy outcome they desire. In fact economics rarely gives decisive policy conclusions. It is at its best when it eliminates the bad arguments which often riddle policy debates.
 

This paper is about the likely long run energy use and some policy implications. While trying to set down the framework clearly, I have had to make a number of technological assumptions and forecasts outside my competence, and which have not been entirely resolved by the seminar. Hence the analysis is riddled with caveats. But the framework is robust, I think.
 

The World Energy Economy
 

Any analysis of New Zealand starts with the state of the world. So we begin here by observing that sometime in the future (there seems little agreement of when) the production of oil will peak.


As a consequence of the peaking, the price of oil will rise too. This will encourage production from more marginal oil reserves and lead to some reductions in the demand for oil. (That is while the demand schedule remains constant, the actual amount purchased will shift up the schedule – the curve – to a point of lower consumption.)
 

A third important response from the higher price is that alternative transport fuels will become commercially viable. The price at which they become viable sets a sort of cap on oil prices. (I say ‘sort of’ because oil is used for a number of purposes including diesel, petrol and avgas. That the alternatives may be better at producing some fractions than other complicates the analysis.)
 

Evidence was given to the seminar that bio-petrol should be available in the not too distant future at a price equivalent to oil in the range from $US70 to $US80 a barrel, say $US75. (At current world prices: it will rise with inflation.) Allowing for the above mentioned caveats in relation to the fractions of oil, this sets a long run limit on the normal price of oil. ( It would be great to have some firmer consensus on the figure.)
 

This $US75 price is similar to the current price of oil which, at first, may seem surprising. But at the moment $US75 is not thought to be the ‘normal’ price of oil but the abnormal. On occasions the price of oil will go above the ‘normal’ price because of short term events (such as a shortage of refining capacity, a cyclical surge in world demand, or a temporary disruption to world supply). Long term planning does not base its strategy on such transient abnormal prices, but it should have plans for dealing with such emergencies (such as reserves oil stocks).
 

The price of oil may also run for some time above the ‘normal’ long run price if the peak oil occurs before the alternative fuels can come on supply at their long run normal cost. In this case the price of oil would, for some time, rise above the long run normal price, and then fall back to it. The policy conclusion might be that countries which were adjusting to the $US75 price would deal much better with this difficult transition period than those which were not bothering.
 

There is a useful simplification from this price forecast. It summarises the state of the world energy economy, fractions aside. I wont say that it is all we need to know, but it is the single biggest thing. (Those unfamiliar with economics may be astonished that all economists appear to need for long run analysis, is the ‘normal’ price of energy. However, they are not ignoring the complexities of available resources, processing technologies and consumer demand. Instead the complexities are embodied in the price, and one has had to examine them to obtain its estimate.)
 

It also simplifies analysis. Suppose there is a major hydrocarbon find in New Zealand. It would not require a change of the framework described here. Of course there would be differences (and regional and income effects) but none of the policy points would be markedly affected.
 

(I wont go into details but the policies we use to tackle global warming wont much affect this analysis either – that is the relevant price is $US75 a barrel – assuming that bio-fuels are largely carbon-emission neutral. Of course there will be an impact on the return to the carbon emitters, and the mix of fuels which are used.)
 

Energy Prices in New Zealand
 

It appears that around $US75 a barrel New Zealand will be able to supply substantial quantities of bio-fuels. Coal-sourced fuels may also be possible. (This will be even more so – it appears – if hydrogen becomes a viable source of transport power. My impression is there is little consensus on hydrogen technology, except that its commercial viability is further into the future.)
 

As the price of transport fuels rises, it becomes economic to use standing energy for transport. This includes in public transport, the electrification of railways, and for hybrid and battery power cars. Standing energy becoming a major source of transport would have two major implications.
First, transport and standing energy uses currently hardly overlap in New Zealand. They may in the future. That is likely to raise the price of standing energy towards the equivalent of $US75 a barrel. (But how close?)
 

Second, New Zealand will be able to export standing energy (sort of) by substituting it for transport fuels and exporting (or not importing) the transport fuels. (On a per capita basis New Zealand seems well endowed in coal and solar energy (transformed by hydro, bio, wind and sea as well as directly) – even if there are no further hydrocarbon finds. One might therefore expect the economy to reduce its imports of oil, while shipping fuel overseas . It may be already export more energy than import it, if the energy embodied in our other exports are allowed for. While some energy exports may be raw energy, New Zealand should aim to value-add on the energy – embodied in other goods and services – as much as possible.)
 

How will energy-users respond to this higher normal price regime? There is plenty of anecdotal evidence that there has been a response to the current high prices of oil, with less car use, more use of public transport, and purchases of less fuel using new cars. To analyse the response systematically, we need to classify adjustments by different time horizons.
 

This is my list if there is a hike in the price of fuel (which is unanticipated).
Immediate
            Fewer car trips
            More use of public transport subject to the capacity limits
Medium Term (say about ten years)
            The majority of the stock of cars becomes more fuel efficient
            Increased capacity on existing public transport routes
            Some improvements in domestic energy use (assuming standing energy prices rise too)
                                                Adjustment of workplace-home relationship (to minimise commuting, including more homework based on broadband access)
                                                Fall in house (land) prices on outer city fringes relative those in CBDs and close to places of employment.
Long term (thirty and more years)
            New public transport routes
            The majority of houses becomes more energy efficient
                                                Intensification of city centre residences (although there may be an increase in holiday homes for weekend residence).
 

The list represents no more than an assessment of how long it takes to adjust capital stock. The list also broadly applies to small businesses, whose energy use in the totality of their decisions is similar to households. However, large businesses will adapt much more quickly.


What is important here is that I do not believe that people will at first react substantially to significantly higher energy prices, and then lapse back into their old energy intensive ways once they believe the energy price hike is permanent. What I do not know, however, is how big an adjustment they will make. And I also fear they may not think the energy price hike is permanent.
 

The market signals may not be strong in some activities until it is too late. There is little voluntary incentive for a builder to design a house for energy prices thirty years out, and the four or so owners in the interim will not have the expertise to know how well the builder has. When the price hike becomes painful, it may be too late for houses built years before: retrofitting is very expensive. The implication is, therefore, there is a case for some limited intervention in energy markets especially in regard to the long run capital stock.
 

(There have been too many energy experts crying wolf, especially extrapolating recent cyclical trends – as for instance, for the current surge – to quite unrealistic levels. This may scare the public today, but when tomorrow the bubble bursts, such projections turn in the other direction. The public rightly discounts the past hysteria, but then concludes that energy prices are not going to rise in the long run. The $US75 figure is not based on extrapolation of recent prices trends, but on technological trends: that should be stressed.)
 

Policy Directions
 

I have been working on the ‘Economic Transformation’ which is the Government’s core economic policy. Energy is a part of its infrastructural concerns, for it is an enabling sector which impacts on the costs of all other sectors. However, the above adds is that energy is also ‘transformational sector’, that is one that is going to experience major change over the next few decades. The following policy remarks are directed at that aspect of the sector.
 

1. We need to build into the nation’s thinking that the normal energy price, some years out, will be equivalent to $US75 a barrel of oil, say. Obviously there is a need to determine the price more systematically than I have been able to do, and it will also be necessary to turn it into more understandable level (say petrol at $2 a litre).
 

2. The Government should publish its assessment of the long run normal price, both as a guide to the public and to its own advisers.
 

3. The public should be made very aware of this assessment. But it would be an indicative price not an enforced one and that no one in the private sector would be required to use it in their own decision making.
 

4. There appears little consensus when oil production will peak, so it is not possible to forecast the ‘normal’ price path of oil, let alone the variations around it. However, I would be astonished if the $US75 was not normal (or below normal) in 25 years (i.e. 2030).
            Notice there is no policy recommendation for cars for most bought in the next ten years will be scrapped by then. It is up to individuals to make their decisions. The State need not do it for them. Rather than guessing the peak, or interpreting cycles, the State can best contribute by firmly emphasising the expectation of high energy prices.
 

5. The main policy intervention should be aimed to get the majority of the relevant capital stock largely adjusted to this higher long run price. This applies particularly to is housing (including its location) and the public transport infrastructure which take a long time to change.
 

6. At this stage I am not sure what policy instruments should use to improve the energy efficiency of housing. My guess it will be a mix of direction, subsidisation and certification. Government leadership can be important. Apparently the Canadian government embarked on a retrofit of its own building stock
            (I was struck by the remark that New Zealand tradesmen have not been properly trained in constructing energy efficient buildings. There will be no public commitment to energy conservation if skilled artisans are not involved, which suggests there is a role for a (voluntary) retraining and certification program.)
 

7. A standard evaluation of the infrastructure for public transport often concludes against proceeding with the investment. From the retrospection of 2030 that cannot always be true. We need to review the evaluation principles for strategic investments. (That includes the discount rate, the behavioural assumptions and the impact on location, as well as the price of fuel.)
            The aim should be a long term (say 25 year) program which leads to a more intensive public transport system in urban centres. Its application may have to be opportunistic. (For instance the 2011 World Cup may provider a justification for the acceleration of the public transport link between Auckland International Airport and the CBD.)
 

8. The government should avoid getting involved in determining the balance between energy sources, since that requires detailed assessments of future technological possibilities. That is something market risk-takers do best. Their average judgements may be no better than the government’s, but they are more dispersed, and those that get it wrong take the loss themselves. The additional complication is that the political pressures for assistance to each energy type is such is that the country will end up with a plethora of assistance to each, and nobody will have the foggiest idea what the net effect of the assistance is, or even whether it is positive (a situation familiar to those who have studied the pre-1984 economy, or the current US energy system).
            However, whatever the outcome of the current industrial assistance review, energy should have the same entitlements to that assistance. The argument here is against additional assistance for energy suppliers. (A corollary is that New Zealand’s global warming responsibilities should be pursued primarily by market means such as taxes and transferable quotas.)
 

9. Of course there will be research, science and technology funding. It should not reinvent the wheel. New Zealand cannot and should not compete against work being done overseas. The effort should be about transferring overseas research to New Zealand, including adapting their findings to the peculiarities of local circumstances.
 

10. I cannot see any logic to New Zealand aiming for self-sufficiency in energy (whatever that means). The earlier remarks about New Zealand becoming a net energy exporter are relevant here, although it may be an energy importer for certain fractions (bio-diesel and avgas).
            (If New Zealand is to become self-sufficient in this economic activity why not every activity, and why should not every country try to become self-sufficient in everything. Anyone can make a case for self-sufficiency in their particular interest. But that anyone can do it for any product tells us something about the strength of the argument.)
 

11. Certainly there should be measures to deal with major temporary disruptions (where a price mechanism adjustment would be punitive). The IEA arrangements and the oil stock reserve are intended to cover a breakdown in the world supply of oil.
            Other potential disruptions need also be considered: a breakdown in the electricity transmission grid – what happens if the Cook Strait cables go, the gas transmission system, the Whangarei to Auckland oil pipe line … ? The evolving energy configuration raises new issues. If New Zealand tallow is to be processed by the Australians into bio-diesel, a CER deal needs to be negotiated for when there is disruption in world diesel supplies.
 

12. The government’s energy policy advice structure seems fragmented, with a lead advice agency in the MED, numerous other public agencies, and another ring of private sector agencies and consultants. The result is a myriad of views and opinions (as evident in the seminar papers) with some massive gaps in our knowledge of key features (some of which were hi-lighted by resorting to overseas studies to fill them). Normally I am reluctant to advocate reorganisation (‘re-dis-organisation’ is the grumblers’ term), but in this case there may be a case for reviewing the advice strictures, particularly strengthening the Ministry of Energy within the MED, and paying more attention to getting a common data base and understandings and coordination.
 

Apology: I am acutely aware that I have made a number of assumptions about technology and related facts, and am likely to have made some errors while doing so. Sometimes it arises by the disagreement among energy experts. However, insofar as I have made errors – and am grateful for their correction – it is a humbling reminder of the limitations of the expertise of an economist. But it also a reminder that we all make errors when we move into a foreign territory – including energy experts when they apply economics to their areas of expertise.
 

Acknowledgements: There would have been even more errors had I not shown an early draft to Geoff Bertram who, however, may is not responsible for the ones left.
 

Go to top

Fit the Bill: Will National’s Policies Improve the Education System?

This entry was posted in Education, Listener on by .

Listener: 15 July, 2006. 

Keywords: Education; 

I thought the only really interesting manifesto policy in the 2005 election was National’s proposal to give parents more choice and schools more independence. National wants to relax rigid zoning restrictions, increase the number of places at integrated schools and restore the funding to independent schools to past levels so that more parents can afford to send their children to them. I was not convinced, so I invited National education spokesman Bill English to persuade me. 

Can parents make good choices? How can they tell what is a good school? The most quoted measures are misleading. The decile rating of a school describes only its students’ background, not how well it is performing, and the league tables of the students’ exam attainment do not tell us about each school’s teaching achievements since some students are easier to teach than others. 

English said many parents can and do choose schools now. National’s policy makes schools focus more on ensuring that their performance meets parents’ expectations. He also mentioned a Ministry of Education website, SchoolSmart, which offers a rich set of useful data that can be used to identify schools in trouble. But access is restricted to head teachers and ministry officials. He’s trying to open it up. 

Will parents be able to interpret it? After all, there is a rich set of useful data in the public accounts, but journalists (many of whom are parents) latch on to the “surplus”, which they interpret quite invalidly as justifying tax cuts. Won’t parents make a similar mistake, focusing on wrong criteria? If English is successful with his official information application, the ministry and the private sector had better get on with educating the public as how to interpret the data. 

Actually, English thinks that most schools are doing pretty well (as do I and the Ministry of Education), and that the differences shown in the data don’t matter a lot. He talks more about parent choice in terms of style – a school more suitable to the individual needs of the child – rather than educational achievements. 

Whatever parents choose, oversubscribed schools will have the real choice, cherry-picking the better (easier-to-teach, more prestigious) students. Enrolment schemes were introduced by National, but when I pressed him (eg, over balloting) English said more work had to be done on them. He also said National would help successful state schools to expand capacity, though with practical (and fiscal) limits. 

National wants state schools to take an ownership interest in their property should they wish. They will be “Trust Schools” similar to integrated schools but with state rather than religious origins, although whether the property will be sold, loaned or gifted is yet to be decided. 

The intention is that all schools would be bulk-funded, that is, receive a lump sum out of which they would pay teachers’ salaries and other expenses. (Universities are already bulk-funded.) But teachers seem happier to have the state as an employer rather than their school board, and they worry that there will be undercutting of pay rates, with a preference for two inexperienced teachers to one proven one. I worry that the boards may not be able to cope. Many head teachers already find their jobs excessively administrative. This would remove them even further from teaching. 

My views are greatly influenced by When Schools Compete, by Edward Fiske and Helen Ladd. (English had a copy of the book in his office.) They liked many aspects of the “Tomorrow’s Schools” reforms but were critical of others, thinking they relied too heavily on governance. Ultimately, education is about students and their parents, peers and teachers. 

I pointed out that the key to better educational performance might lie with teachers. Was he getting them on board? English said he got on well with teachers individually, and regularly attended their national conferences. But he is rarely asked to make a presentation. I said that was unwise. Too often we ignore the Opposition’s policies, meaning they are never adequately discussed, tested and improved. When the Opposition becomes government, the policies are put into operation and don’t work properly. Better the dialogue before the manifesto commitment. 

<>Will National’s policies improve educational performance? I remain uncertain. I do know I’d send my children to a school where Bill English was headmaster.

Unbungling: Can We Catch the World in Broadband?

This entry was posted in Business & Finance, Listener on by .

Listener: 1 July, 2006. 

Keywords: Business & Finance; 
It is not the first time that Telecom New Zealand has been “unbundled”. When it was a state-owned enterprise in the 1980s it was directed by its owner (the government) to provide the local-loop lines, which connect households and businesses to the telephone exchanges, separately from the service that goes down the lines. When the company was privatised in 1990, there was not a single Cabinet paper discussing its monopoly power – an astonishing oversight, perhaps justified by the government’s priority for a speedy sale, or perhaps an extreme ideological stance lurking beneath the privatisation advice. 
Whichever, as soon as Telecom was privatised, the two activities were snapped together. For the next 16 years, the regulatory framework was set by private litigation, which was always costly and frequently unresolved. The government imposed a telecommunications regulator in 2001, but eventually it lost patience, and announced that it will require Telecom to unbundle. By 2008, any other providers will have the same opportunities as Telecom to use those lines. 
Key to Telecom’s monopoly is that the local loop is a “common carrier”, a natural monopoly that is the only option to provide a service. It is true that a favoured few have an alternative line provided by TelstraClear, but it has stopped expanding its network. A relatively new technology, Digital Subscriber Line (DSL), means that Telecom’s traditional copper line can be used to deliver broadband (high-speed data transmission) more cheaply.   

Although cellphones are replacing fixed phones for voice calls – it may be that soon 70 percent of such calls will be on a mobile – the fixed-line system is increasingly carrying information in new forms: internet, music, TV, videos, other data. No one can be sure of the long-run potential uses of broadband, for innovations are turning up all the time. What we are sure of is that the future of world-class economies is dependent upon high-quality and quantity broadband delivery. 
Regrettably, New Zealand has been a laggard in the OECD broadband stakes. The easy explanation is that monopoly Telecom has not kept up with the pace. But the common carrier element of the monopoly may not be the problem. Rather, so it is argued by Telecom’s rivals, the combining (the bundling) of the common carrier with the services carried over the lines means that Tele-com has not been as innovative and service-oriented as it could have been in an environment of fair competition. They claim that given the same access to the lines they can provide better services to households and businesses by putting equipment in the exchanges to use the local loops. 
What may have been persuasive to government – recall it has been fumbling with this issue for over 16 years – is that the dominant and increasing pattern among rich countries is to unbundle line provision from services. Already 26 of the 30 OECD countries have unbundled loops, with New Zealand and Switzerland about to join them. 
Intriguingly, the sharemarket reduced its valuation of Telecom by over $2b, indicating it thought that the unbundled company would be less profitable than the bundled one. It must have been assuming that Telecom was making monopoly profits. Telecom has said it will co-operate with the unbundling directive, perhaps because it judges the political pressures are too great, but it certainly will have observed that British Telecom profits went up when it was unbundled, because the greater competition meant more use of its lines. 

If the unbundling is successful, we may even see Telecom split itself into two separate companies, one based on lines and the other on service provision. Because each activity has a different risk-to-profitability profile, shareholders would prefer them to be “unbundled” (to use the term in a different way) so that individual investors could chose their preferred mix of the two profiles.  But although that will be one indicator of the effectiveness of the unbundling of Telecom’s lines and services, it will not measure its success. That will be the extent to which New Zealand closes the gap between its broadband performance and that of the rest of the OECD. Australia did so spectacularly when it unbundled. We should, too, with a major boost to businesses’ productivity and the quality and interest of consumer life. 

 

The Wit and Wisdom Of J.k. Galbraith

This entry was posted in History of Ideas, Methodology, Philosophy, Listener on by .
<>Listener: June 17-23 2006 Vol 204 No 3449

<>

His different sort of economics is awash with insights.

I am often asked why John Kenneth Galbraith, who died recently at the age of 97, was never awarded a Bank of Sweden prize in honour of Alfred Nobel. The short answer might be that although he was probably the world’s best-known economist, writing with grace, flair, wit and insight, these are not attributes always greatly valued by his profession.     

For the prize is not given for such skills. Instead it is awarded for a narrow mathematical result that may progress the profession a little, but certainly does not challenge the conventional wisdom (a phrase Galbraith introduced). Innovators, who subvert the way we think, hardly get acknowledged.

So many of Galbraith’s ideas have been adopted today, yet we do not realise they had to be invented by someone. We worry about public squalor and private affluence every time we sit in a bad traffic jam. He raised the importance of “countervailing power” to offset monopoly. Generations before the view became popular, Galbraith drew attention to the inadequacies of GDP as a measure of a nation’s welfare.

Galbraith came from a different – not so popular today – approach to economics. “Institutional economics” dominated up to the 1950s, but got superseded by the more mathematical neoclassical economics beloved by those who award the Nobel Prize. Institutional economics’ trademarks are “empirical research, suspicion towards deductive theory, emphasis on the changing nature of economic institutions, habits, and norms, special attention to the divergence of market values (prices) from social values, and the belief in the reality of informed concerted action to improve human welfare”.

The (largely valid) implication of this definition is that neoclassical economics is less empirical and more deductive, assuming that institutions, habits and norms are irrelevant. (Often the implicit assumption derives from the norms of an idealised white middle-class US male.) It thinks market prices normally match social prices, and although collective actions rarely improve human welfare, individual ones usually do.

Galbraith was one of our great institutional economists. His New Industrial State, perhaps his most important book (although there are many of the 40 I cherish), argues that neither the market nor shareholders have control over the largest corporations. It is the management who determine how they run. This is an anathema to neo-liberals, who roundly abused Galbraith with deductive models to show he was wrong. Unfortunately, their deductions did not predict the Enron fiasco, where the management criminally rigged the accounts of one of America’s largest energy firms in their own self-interest, just as Galbraith predicted.

But even he said, “I hadn’t expected to see this problem on anything like the magnitude – the separation of ownership from management, the monopolisation of control by irresponsible personal money-makers. … Those of us who’ve concerned themselves with this matter cannot take satisfaction for discovering that we were at least partly right. That’s too much like seeing a Colorado forest fire and knowing there was inadequate protection.”

No, they never awarded Galbraith a Nobel Prize. But there are many great economists of the past who would not have received it, either. He joins that pantheon.

It Ain’t Easy Being Green: an Unfinished Conversation with Rod Donald

This entry was posted in Environment & Resources, Globalisation & Trade, Listener on by .

Listener 3 June 2006.

Keywords: Environment & Resources; Political Economy & History;

The last time I talked with Rod Donald was shortly after the 2005 election, walking along Lambton Quay. Rod was very disappointed with the election outcome, for his Green Party lost voter share, and hence seats. He thought that the scurrilous anti-Green election pamphlet did a lot of damage. I said that anyone who thought it valid was too ignorant to vote Green, although it damaged the Greens when the new government was being formed.

But I, too, was puzzled by the fall-off in Green support. I had taken the view that they had a core of six or so percent that would expand over time. But in 2005 they got only 5.3 percent, 20,000 fewer votes than in 2002.

I got on well with Rod, but I especially valued him as a member of the pragmatic wing of the Greens. Like the rest of them, he was passionate about sustainability and justice, but he saw the need to engage with the market. In contrast, the other wing (assuming there are only two) was anti-market (and usually anti-capitalist). Like Rod, I am a pragmatist attracted to using the market to solve certain economic problems not because of some compulsive ideological disorder, but because it often seems to be the best practical way of dealing with them. I know more than most about the market’s defects. But often a market-based solution seems to be the best way. If it is not, I advocate non-market solutions, but very often the solution retains a market element.

I am not saying that this was Rod’s position, but we could discuss these things. I valued the Just Trade newsletter from his electoral office as it provided a critical view of the “free trade” debate. Too many of the advocates of free trade ignore its downsides, which can include job loss, inequality, cultural destruction and the compromising of sustainability. But there are also upsides. I find myself making trade-offs between the two. Just Trade was helpful by reminding us of the downsides. I miss it.

In the end, I have concluded that the specialisation from international trade is broadly beneficial, that to get this benefit small countries, such as New Zealand, need a “rule of law” in the international system to protect themselves from the bullies. So I am cautiously supportive of the system that we call the “World Trade Organization”. Sure, there are parts of it that are defective – sometimes very defective – but I want to improve the WTO rather than reject it.

Rod would have had some sympathies with this view, without totally agreeing, and we would go hammer and tongs over which improvements and how urgent they were. But I’m not sure his views were widespread among the Greens. As for any Opposition party, they are much better at criticising than offering a constructive alternative. (Although, bless them, they have been less willing to leap into scandal mode.) But without one it is hard for the analyst to make sense of the party’s position. Wailing about the downside of an existing policy is not an alternative policy.

That does not solve the problem of the missing voters. The Green core must be smaller than I thought – or Rod hoped. In any election there are votes from those who are not as committed as the Greens might wish. (To contrast Rod’s despair at those turned off by the pamphlet, I cited Labour-sympathetic friends who voted Green, because they wanted a more left-wing government than they got.)

The Greens are torn between resisting change and being at its forefront. That generates their two wings. The nostalgic wing, where many of the core voters and party workers reside, claims to talk about the future but defends the past. The pragmatic wing faces the prospect of its good ideas being adopted by the major parties. But without their radicalism, the adoption would be much slower. Rod was a part of the policy and political management of that tension. Today the Greens look less balanced.

Rod reached Bowen House to veer off to his office. We said that we would continue the conversation. I never saw him again. This column is that continuation.

What Might New Zealand’s Economic Transformation Mean?

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

Speech to the Auckland University of Technology Residential Course on Regional Development, Tatum Park, Levin, May 30, 2006. The author is an adjunct professor of the Institute for Public Policy at AUT.

Keywords: Globalisation & Trade; Growth & Innovation;

Tonight I am going to talk about what New Zealand’s Economic Transformation might look like, and some of the things which need to happen in order to accomplish it. However, I need to begin with two caveats.

The first is that while ‘economic transformation’ is a phrase which the government is increasingly using, and was mentioned frequently in the 2006 Budget, the government has not published any authoritative account about what exactly it means. As far as I can judge, the policy development is still at an early stage in its thinking although there are some useful hints. So there is no sense that what you are hearing tonight is a gloss on the government’s thinking about the economic transformation. I am trying to preview it.

Second, I happen to be a member of the government’s Growth and Innovation Advisory Board, which is its most senior private sector advisers on its economic strategy. What I have to say tonight need not reflect the views of any other member of the Board, nor the Board as a whole. We simply have not yet discussed the Economic Transformation at a level at which we have a collective view.

So tonight’s paper is not the government’s view and is not GIAB’s view. It reflects my views. If in retrospect it provides guides to future thinking on the Economic Transformation, then so be it.

I begin with a brief historical overview. It is from a Labour-Left perspective, because that is where our current government comes from. That will take me up to the current state of thinking, including defining more systematically the notion of ‘Economic Transformation’. The paper then collects together as to what the government has said on the Economic Transformation, and extends it a little its Auckland and regional perspectives.

The Context

To begin with the Great Depression of the early 1930s, into which New Zealand was pitched by a dramatic decline in the price of our exports – in those days wool, meat, butter and cheese which went mainly to Britain. Its implications were not lost on economists: pastoral prices are volatile, and we should not over-specialise but instead diversify products and markets.

This conclusion was reinforced in later years, by the observation that the terms of trade for many primary products – what they would earn relative to the cost of imports – tended to fall in the long run. This phenomenon is not peculiar to New Zealand. My book The Globalisation of Nations illustrates the principle with Argentina, although I could have used Australia or Uruguay as well as New Zealand as the exemplar. Again the obvious strategy is to diversify.

A third strand in this thinking, arising out of the inter-war consolidation of our urban centres, was that cities offered opportunities that country life does not, thus enriching New Zealand life, for a sophisticated society requires strong and thriving cities. We’ll come back to the role of cities.

Sutch’s Vision

The logic of these themes was taken up by Dr Bill Sutch. What makes Sutch important is not only was he a senior public servant in the 1950s and early 1960s involved in implementing the policies, but that he was a prominent articulator of them. Thus, insofar as some of the policies became obsolete, he is blamed for them, although others long forgotten were just as involved. On the other hand where the policies he advocated have become the conventional wisdom, his contribution is forgotten.

In his historical context, Sutch was a progressive and subtle thinker. When he returned to New Zealand in the early 1950s a strategy known as ‘Import Substituting Industrialisation’ (ISI) was fashionable. It argued that a country should be less dependent upon earning foreign exchange by producing more at home. This requires domestic businesses to be protected from overseas competitors, at least initially (the so-called ‘infant industry’ argument).

New Zealand got involved in ISI from the late 1930s, before Sutch was involved. What was evident was that the export sector would not generate enough foreign exchange to employ all New Zealanders. To husband the scarce foreign exchange New Zealanders would have to be employed in production activities, mainly manufacturing, which would save foreign exchange. This typically requires protection and assistance.

Sutch came to a similar conclusion in the 1950s, albeit based on more detailed quantitative analysis than was available earlier. As time went on, he realised that such import substitution would not generate enough jobs by itself. So step by step he moved towards a more complex view that might be summarised as that as well as import substitution there should also be
(1) Exporting of primary products other than pastoral ones. Among those Sutch mentioned and promoted were fish, forestry, horticulture and tourism.
(2) Additionally, export of any primary products should be processed as much as possible in New Zealand. Thus he promoted exporting scoured wool, woollen tops and woollen carpets: that meat carcases be prepared in New Zealand for overseas shops instead of exporting them intact;
(3) He also saw opportunities for manufacturing and service exports not based on the primary sector. I shall have a lot more to say about them.

Sutch’s vision is now so routine a part of the conventional wisdom, that we overlook how extraordinary it was forty years ago. Unfortunately in 1965, Sutch was stood down from his position as Secretary of Industries and Commerce in charge of industrial policy. Away from the job’s pressures of industry strategy he turned to the role of education, health, social security, women, and national identity. So we cant be sure what he would have thought had he stayed on, or what he would think today – anyway he would be 99.

Had I to guess, I think he would be attracted to the approach of the South Korean economy which maintains a fortress home market protecting itself from international competition, and uses the protected domestic markets as a base for aggressive exporting. But if everyone has a fortress at home there is nowhere to export, so in a multilateral trading world the strategy is, alas, no longer generally available, and we missed the opportunity to avail ourselves of it when it was.

What one can report is that out of Sutch’s vision and the foundations it led to New Zealand seized the opportunity to diversify in the 1970s. According to economic historian John Gould, New Zealand went through the greatest diversification of any OECD country in that period, changing from being an extreme example of dependence on a few markets and commodities to a more typical one.

Sadly, the policies of the 1980s thwarted the diversification.. That story belongs to another paper. Here we note that for much of the 1980s and 1990s New Zealand economic development marked time. The ‘development strategy’, of which Sutch was a part, became unfashionable. But it remained in the political arena via Norman Kirk, who in turn passed it on to Mike Moore and thence Helen Clark, today under the term ‘global connectedness’.

I dont think Sutch would be that uncomfortable with the last major economic strategy document which the government has published Growing an Innovative New Zealand. This includes the ‘Growth and Innovation Framework’.
• A stable macroeconomic framework.
• An open and competitive microeconomy.
• A modern cohesive society.
• A healthy population.
• A highly skilled population.
• Sound environmental management.
• A globally connected economy.
• A solid research, development and innovation framework.

Good policy builds up on past successful policies. The key new idea here was ‘innovation’. The Economic Transformation will build on the growth and innovation strategy, further shifting us away from the import substituting strategy towards global connectedness.

Export Oriented Industrialisation (EOI)

Export Oriented Industrialisation (EOI has been the successor to Import Substituting Industrialisation. I doubt that anyone saw its logic immediately after the war. Merchandise exports were then around 5 percent of World GDP only a quarter of the 20 percent proportion of today. There were hardly any exports of services other than freighting and a trickle of tourism. Fifty years ago it was inconceivable that many products which are normally internationally traded today could be traded then. For the expansion of international trade has been one of the most spectacular changes over the last half century, in part the result of the falling costs of distance, and reinforced by reductions in protection and domestic assistance.

But is this exporting beneficial to the countries involved? There are two important reasons to think so. The first is that production in small economies lacks economies of scale if it is supplying only the domestic market. So they either abandon one of the most powerful forces for economic development, or they reap the economies of scale by specialisation in particular industries, exporting the surplus and importing what they do not specialise in.

There is second reason, which is more subtle, and also applies to large economies. Exporting is a highly competitive activity, which forces the successful exporter to innovate more efficient processes and new products. Protected domestic markets are not nearly as dynamic and do not have the same pressures to innovate. (Many of the protected industries which required assistance in their infant stage were soon asking for assistance in their senile stage, without ever having gone through a period of unassisted adulthood.)

That, in my judgement, was the major weakness of the Import Substituting Industrialisation strategy. There was not enough pressure to innovate and any such pressures were frequently thwarted by interventions protecting the domestic producers, which they promoted in their self interest and to which the politicians acquiesced. The same deal is not available in export markets because exporters dont own the foreign market’s politicians.

The need to specialise for economies of scale and the effect of competition driving innovation are at the heart of the EOI strategy. It is not a strategy without its risks. It is damned hard to export. Moreover the exporting country loses a degree of de facto sovereignty since, like any in mutually beneficial transaction, one has to make some concessions. And third, we should never forget that if the international order turns to custard the more one exports the bigger the mess.

The Structure of an Economy

The detail we have gone through, illustrates an important message. Economic development is not just about the economy as a whole. We need to think about the various sectors of an economy and businesses that operate in those sectors, and how they change.

Instead, much of the public debate focuses an account of the economy as a single commodity, in which there are no individual economic sectors. While there is much angst about New Zealand’s average productivity being below the OECD average, do we really believe that every sector of the economy is below the OECD average? Some might be above average – agriculture for instance.

Much of the productivity debate is incomplete. I have no problems with the workplace productivity campaign with its aim of improving workplace performance and upskilling the workforce. But productivity does not just come from more productive workplaces. It also comes from closing down low-productivity industries, shifting them offshore to low wage countries, and redeploying the released resources into high productivity activities. That was the problem with the Import Substitution Industrialisation strategy. It refused to close down low-productivity industries. There are always political reasons not to close them down.

Wouldn’t it be progress if we knew which industries were low-productivity compared to other rich countries? It need not be that they are inherently low productivity. We might be that we would find that all our manufacturing was above average, but the sector as a whole was below average because we had few manufacturing activities in those subsectors with inherently high productivity. It may be that our transport and distribution sector have low productivity by international standards because of our low population is over a large area. It happens that the way the figures are calculated, penalises producers of protected agricultural exports. And so on.

But it seems likely that the productivity of some of our industries is too low. We need to think about why: are the policy settings right? is the management up to it? should we not close it down and deploy the resources for a more productive purpose?

Sadly we dont have the data to enable us to think systematically about these questions. Because we think in terms of the aggregates, we know very little scientifically about the reasons for the poor performance of the New Zealand economy. That leaves plenty of room for ideologists. Sadly, ideology has been so dominant that there is a reluctance to acquire useful research about New Zealand’s growth problem.

Exporting

There are some exceptions. One of the most compelling conclusions is that the export sector is at the heart of the growth process. If the export sector does not fire, then the economy does not light up either. Over the last twenty odd years New Zealand has had a poor export performance. This is hardly noticed by those who look only at the economy in aggregate, but once you begin to look from a sectoral perspective, the conclusion is so obvious that you wonder why it has not been at the core of economic policy for the last two decades.

Let us not be too pessimistic. In recent years the government has been paying more attention to exports than any of its recent predecessors. But there is an enormous gap between where we are and where we should be. A New Zealand Institute report, Dancing with the Stars, gives a measure of the gap. It points out that the ratio of exports of goods and services to total output (GDP) is below 30 percent, but argues that for the typical rich country of New Zealand’s size, the ratio would normally be about 50 percent.

There are a number of problems with this 50 percent figure. It does not come from the sort of robust empirical investigation which I, and the NZI, really want. But were such a study be done, we may be sure that the optimal ratio of exports to GDP would be markedly higher than the current 28 percent for a country in New Zealand’s circumstances. That means that New Zealand is not specialised enough, that we are involved in too many low-productivity activities. Instead we should be importing their products, paying for them with the proceeds from the exports from high-productivity sectors.

Here is a crude calculation, to grab your attention about the implications of this export failure. Export industries have to have higher productivity than import-substituting industries, because they have to get over the hurdle of the trade costs – shipping and the like – of exporting. How much higher? A not unreasonable guess is that export business productivity would have to be about double that of a domestic supplier. If so, were New Zealand exporting an extra 20 percentage points of GDP, then the nation’s productivity would be 20 percent higher, and that would shift us from being below the OECD average to about the average.

This is a very heuristic calculation. But the general implication is true enough. A small economy which does not pay sufficient attention to the export sector will experience lower productivity and lower incomes.

What Kind of New Exports?

There is a second measure which underlines New Zealand’s poor export performance. So out of date is much of New Zealand’s economic thinking, it is not easy to explain. Two hundred years ago David Ricardo pioneered the theory of comparative advantage, in which a country specialises in what it can do well, exchanging it for the products which it is not as good at. We call this ‘inter-industry trade’. However there has evolved in the last fifty years a quite different form of trade, in which two countries trade the same product.

Why should two countries trade essentially the same product? Take cars, a common form of ‘intra-industry trade’. To our discriminating affluent perception we may think a Renault and a Volkswagen are different, and certainly their makers try to get us think that way. But there is not a great deal of difference between a four-door 1600cc sedan of the two marques. So Germans buy Renaults and the French buy Volkswagens, and the two countries trade the same product.

Intra-industry trade is an increasingly common phenomenon, thought to make up a quarter of all international merchandise trade, although the exact figure is dependent on statisticians’ definitions. It occurs where there are strong economies of scale and rapid technological innovation, with outputs subject to product differentiation, together with low costs of distance.

In contrast to the ‘comparative advantage’ of inter-industry trade – where having some natural advantages enable the industry to export – success in intra-industry trade involves ‘competitive advantage.’ Because existing technology and products are continually undermined by the innovations of other firm, the successful firm has to innovate too in order to keep its costs down and its products evolving. The business may not have any natural advantages, but makes up for them by the excellence of their competitive innovation.

New Zealand performs lamentably badly in the intra-industry trade stakes. We are at the bottom of the OECD (rich) countries, with Australia, a long way from the average. While the rich world has seized the opportunities presented by intra-industry trade, New Zealand has missed out..

It is easy to say that New Zealand is not good enough for competitive advantage, and we should stick to comparative advantage. But we produce pharmaceuticals from milk despite importing pharmaceuticals, we make films but also import them from Hollywood. We have firms committedly exporting by competitive advantage. We just dont have enough of them.

Intra-industry trade may seem to be antagonistic to the primary sector. It need not be. Since the totality of exports has to increase, there is room for more primary product exports as well as more manufacturing and service ones, although the share of primary product exports will fall in total exports. Moreover, some intra-industry trade exports, such as milk-based pharmaceuticals, will come from the primary sector.

The difference between them and, say, milk-based butter is that the butter has been exported for a hundred and more years. It is a commodity sold into markets where the supplier is a price-taker. In contrast you can be sure that the current milk-based pharmaceuticals, where the supplier is a price-maker, wont be around in a hundred years, or if they are they will be long out of patent and a commodity like aspirin. But by then the dairy industry should have created more pharmaceuticals. It will have to, in order to maintain its competitive advantage.

But what are these new industries and products going to be? In 2002 the government listed three which it wanted to pay greater attention to. They were

1. Biotechnology: Biotechnology is a bit of a catch all – it ranges from the production of new products such as pharmaceuticals to improving productivity in the biologically based traditional sectors. It could be argued that New Zealand has the potential for competitive advantage here arising from traditional scientific strengths, and primary sector experience.

2. Information Technology: Again this is a very wide-ranging activity. While we have some direct exports in IT goods and services, far more important is IT as an enabling technology which will be embodied in other exports.

3. Creative Industries: This again proved to be a very wide sector which divided into two. One group is activities like film, video, and sales of creative products to tourists, again direct exports. The other is industrial design, again an enabling technology which should be embodied in every product we sell overseas.

Were the government to review this list in today it would probably add:

4. Materials Science – Nano-technology: where we may have some potential competitive advantage in this area.

And perhaps even

5. Environmental Goods and Services if we are going to be world leaders in sustainability.

However, the government is unlikely to publish another list, because while it was intended to imply these were areas of special interest, the list was widely misinterpreted to imply that they were the only sectors of interest. The majority of export growth is going to come from sectors not on this list, albeit their performance may be enhanced by the enabling technologies.

There may be expansive growth of a single sector. Who twenty-five years ago would have predicted Nokia, the world class mobile telephone company which now contributes 5 percent of the Finnish GDP? But we cant predict a Nokia for New Zealand. What we have to do is make sure that an embryonic one is not aborted or goes offshore because it faces poor business conditions, poor infrastructure, skill shortages, and/or a lack of shrewd public support.

An increasingly higher proportion of our exports and imports will be shipped out by air or a telecommunications line, where the costs of distance have fallen sharply. Did you know that our second biggest international port by the value of exports and imports is Auckland International Airport (behind Ports of Auckland)? The comparison does not include the value of tourists.

But one day – perhaps a hundred years off – our biggest gateway for our products may be the satellite station at Warkworth, as we export services on line. My favourite example is translation services – despite languages not being a New Zealand forte – in which we turn around European documents over their night and our day. It is not a big industry, but it indicates there are new opportunities by using telecommunications to overcome the costs of distance. Royalties from intellectual property will come through Warkworth.

Ultimately the Economic Transformation is ending the butter mentality, shipping out bulk commodities over which we have little control over their conditions of sale, and more about innovative opportunities present by high value competitive advantage products.

What the Government Has Told Us About its Vision of Economic Transformation

About 40 percent of the 2006 budget speech was devoted to the Economic Transformation. It mainly covers topics such as higher education, infrastructure, business regulation and business taxation, all of which are very important but equally necessary if there is no transformation. They are necessary developments, they dont tell us where we are going,

There are two major clues in the budget to indicate what the government really means. First the government says it affirms its ‘commitment to transform New Zealand into a high value, innovative export-led economy that can compete effectively in global markets’, a notion clearly related to the economic analysis I have just been through.

The section then goes on to highlight a group of policies which contribute to this redirection. They include assistance for export market development, increased venture capital funding and more expenditure on research, science and technology. While some of the RST expenditure will be (rightly) used to seek productivity improvements in traditional industries, most of the new spending is about (new markets and) new products which if successful will be a part of New Zealand’s intra-industry trade.

The Future Role of Auckland

There is a further clue to the government’s thinking in its approach to Auckland. The traditional government attitude has been a smug ‘isnt it a good thing that Auckland’s politicians cant get their act together, because that means we dont have to address Auckland’s problems.’ Recently the attitude has switched to an impatient ‘for goodness sake, Auckland politicians need to get their act together, so that we can help them resolve Auckland’s problems.’ The cynic may think this is a political calculation based on the need for Auckland’s votes. While politicians do such calculations, Auckland is also a key part of the Economic Transformation.

Earlier I mentioned the importance of economies of scale, that is, how average costs fall as production increases. We normally think of them in the production process, but they also apply in a region. Congestion aside – it must be taken into account of course – large urban areas have lower costs of production in many of the industries critical to the Economic Transformation. We call these ‘agglomeration economies of scale’ They are very powerful, as the extraordinary growth of New York attests.

I was first impressed by their strength when I was studying the biotech industry. The US has no biotech industry. Rather, about a dozen American urban centres – the smallest slightly bigger than Auckland – are major biotech centres. That is because biotech is not a handful of stand-alone firms. They need firms supplying specialised services including in law, accounting and other business services, a sophisticated labour market for their workers, major knowledge bases, institutions of advance higher education, and so on. That requires a critical mass of the population. Only Auckland is near that critical mass in New Zealand.

The need for a critical mass also applies to other industries central to the Economic Transformation. They reinforce one another. An intellectual property lawyer fixing up a bio-tech patent may also be doing a software one.

The realisation of the importance of agglomeration effects has forced the government to think about Auckland in the Economic Transformation. We see it in its addressing Auckland’s roading deficit. The policy is more pervasive, including on health care, tertiary education, and cultural services. I have not the time to deal with it all, but I want to say something to the rest of New Zealand, which may be apprehensive about Auckland getting more than its fair share of the available resources.

Many industries will either be in Auckland, or not in New Zealand. That includes headquarter companies, biotech, and some specialised health care and education services. The choice may be having them in Auckland or them going offshore; of your children or grandchildren living in Auckland or instead living overseas because that is where the jobs are.

Yet as I began to think more about Auckland’s size I became gloomier. Auckland is about the 350th to largest urban area in the world by population, perhaps 150th in terms of total economic activity. While Auckland has some advantages, which might ameliorate its size disadvantage – it is New Zealand’s gate city – its agglomeration effects may not be as powerful as in many of the overseas urban centres it is competing with.

I mentioned that in biotech terms Auckland is at the smaller end of the successful US centres. That led me to wonder where Auckland’s boundaries are. Hamilton is going to be an important part of the Auckland biotech industry. Perhaps we should add it in our calculations – and Rotorua, Tauranga and Whangarei. Some of Auckland’s biotech companies get work done for them in Wellington, which by air is as close as Hamilton is by road. So are Christchurch and Dunedin (which is another important part of our biotech industry).

So perhaps to get the strongest possible agglomeration effects we have to treat the entire country as an urban area. I am not sure how to do this. But if we could be successful, New Zealand would be the around the 65th largest urban area by population, 45th by economic activity. And the downside of congestion need not be as extreme.

The implication that the whole of New Zealand needs to be involved in the promotion of the agglomeration effects for the Economic Transformation. Giving Auckland some priority is no more than when you want to do up your town you start with the main street. But that the redevelopment is paid for by the commercial centre. I am not arguing for the rest of the country providing unlimited subsidies for Auckland.

The Regional Implication

The short answer to the regional implications of the Economic Transformation is that as far as I know they are yet to be addressed. There is going to be a spectrum of regions. At one end there will be Auckland with its gateway role and as home of a high proportion of the new industries that transformation requires. At the other with be some regions which will almost solely be founded on resource-based industries and their processing.

The inter-regional communications network will be vital. We need to upgrade the national roading system, we need to get a high quality rail system for heavy goods transport, and quality broadband is essential. Some of Auckland’s key workers will be lifestyle living in distant Kaitaia and the Bluff, connected by telecommunications to Auckland.

But that is not the whole of a regional strategy. Articulating it with the Economic Transformation will be a major challenge.

A Knowledge Economy?

I have not mentioned the ‘Knowledge Economy’. The government uses ‘knowledge-based economy’. Its official website identifies but 78 uses of such phrases, which means minister refer to it but once a month. They hardly ever use the expression ‘knowledge economy’. (A Labour government may be reluctant to use the ‘knowledge economy’ phrase because it was the name of a 1998 economic package of the National government. Most users of the phrase are probably not aware they are referring to a policy of a previous government.)

The 2006 budget uses the phrase only once referring to ‘a high-wage, knowledge-based economy’. There is no mention of ‘knowledge’ in the Growth and Innovation Framework: closest is a ‘highly skilled population’ and a ‘solid research, development and innovation framework’.

In contrast to the careful use by the government, a New Zealand Google identifies almost 49,000 sites using the ‘knowledge economy’ and 10,000 site using ‘knowledge-based economy”, so it is much more popular with the public than with the government. The knowledge economy is such an evidently good thing, that one does not have to think about it. Instead the phrase is used rhetorically, commonly to justify unlimited government expenditure on education and research, particularly one’s own part of it. Thus a Sanskrit scholar may praise the ‘knowledge economy’ in order to advocate further funding of Sanskrit. But without a lot more thought – ironically enough the application of knowledge – the phrase does not amount to a policy.

The reason that the phrase is not so central in economic strategy is that it is so obvious – unless we hit oil we are not going to be rich without using knowledge – it does not tell us what has to be done, which bits of knowledge should be promoted and why. The Economic Transformation is an attempt to do this.

Conclusion

Nevertheless, the phrase ‘Economic Transformation’, is in danger of becoming a rhetorical expression with as little content. I hope it wont, that before the end of the year we would see a carefully thought out analysis of what it might mean.

At its heart has to be a change in a structure of the economy to one which is more globally connected, but a more diverse connectedness.

Michael Cullen, who was a historian before he was a politician, cautioned that Economic Transformations are not one-off. An economy’s structure is always changing. What this paper is about is a change which our grandfathers and mothers started in the 1930s, and has evolved since, except in the 1980s when it was slowed down when economic policy turned its back on the importance of economic structure. We are again on course, but we still have a long way to go.

Go to top

Is the New Zealand Health System Spending Enough on Pharmaceuticals?

This entry was posted in Health on by .

New Zealand Future Medicines Policy Summit, 29-30 May, 2006, Wellington

Keywords: Health;

My task is to set out briefly the issues that this panel of economists has been asked to address: whether the New Zealand health system is spending enough on pharmaceuticals. I’ll divide the answer into two. Is New Zealand spending enough on health care? Is New Zealand spending enough on pharmaceuticals in the health budget?

Is New Zealand Spending Enough on Health Care?

There is no scientific answer to the question of whether there is enough health care spending. That is a political judgement. One answer is that individuals can make their own decisions by paying for the health care. Once, however, there is a third party funder – be it the state or private insurance – the individual no longer has to pay, and will want all the care there is available. And their clinician will argue for that too.

The sum of all the care demanded if the cared-for and the carer do not pay for it will far exceed any reasonable share of the total resources available to the community, and far more than would be provided if it was paid for by the patient. Once health care is provided to patients without full charge, some other mechanism has to be introduced to restrain the resources used.

But by how much should the resources be restrained? That is a political decision. As in this month’s budget incumbent politicians have to make a judicious tradeoff between spending more on health and reductions in taxation. (Only Oppositions can clamour for both.)

A common test is to compare a country’s spending on health care with other countries. The usual indicator involves health care spending as share of GDP compared with per capita GDP (after adjusting for international price differences). International comparisons are treacherous, but the latest data for 2001 shows New Zealand is above the trend line. So on this test we are spending more than enough on health care.

That is not what the public seems to think. Politicians listen to them. Since the last international comparison, the government has continued to increase health spending faster than GDP. Providing the public accepts that reduces the room for tax cuts, so be it.

Is New Zealand Spending Enough on Pharmaceuticals in the Health Budget?

Once the overall public budget for health care is set, how much of it should be spent on pharmaceuticals? Note that demand for increased spending in a particular area – say drugs – has to be met by cuts somewhere else in order to stay within budget.

So that the question that faces the advocates of higher pharmaceutical spending is that given the budget constraint, should we spend more on pharmaceuticals and less on, say, primary care or surgery or mental health, or whatever.

In practice the system operates slightly differently. Let me set out how it works.

First the , that is that it provides some positive benefits in some circumstances. However, clinical effectiveness – which is a medical criteria – is not by itself sufficient. Consider a drug costing a million dollars that had some effect on a patient but not a significant one. Were you a billionaire and you thought the drug might improve your lot, you would be welcome to purchase it. But it would not be sensible for a public health system to fund such a drug. So it needs a systematic criterion to make sure the public are getting value for money – for their taxes.

The criterion that Pharmac uses – a standard economic one called cost utility analysis (CUA) – is to judge costs in terms of Quality Adjusted Life Years (QALYs) gained. Basically one QALY is a year of normal life, and the drug’s efficiency is assessed by how many years of normal life its treatment generates relative to its cost.

The criterion recognises that the patient may not have a full quality life after treatment, but that is better than death, or that they had a limited quality of life before treatment and an improved one after. That is what the word ‘adjusted’ in a QALY means. It is calculated by surveying people as to what they think the adjustment should be.

In the case of a pharmaceutical we calculate what improvement the drug makes to the patient’s length and quality of life and that is compared to the net cost outlay of the drug. The net costs include the costs of the pharmaceuticals from which are deducted any expenditure savings elsewhere in the health system. The net cost of a drug which avoids surgery, for instance, is the drug cost less the surgery cost.

A typical conclusion might be that for an outlay of a million dollars say 25 QALYs might be saved. Sometimes the conclusion is a no brainer. It was with statins, which prove to be very efficient means of reducing cholesterol, once their cost came down. Sometimes the calculation is much trickier. I was involved with the evaluation of beta-interferon for multiple sclerosis which required us to make assessments of gains twenty years ahead using very tenuous data.

Suppose there is a million dollars to spend. One drug gives a return of 40 QALYs and the other gives a return of 20 QALYs. It makes sense to use the drug which gives generates the highest number of QALYs for the same outlay, so an economist recommends the drug which gives the 40 QALY return. The QALY to cost criterion aims to get the best return for its spending.

In economic theory a new drug’s QALYs to cost ratio should be compared to a threshold. Pharmac does not use a threshold, but as I understand it drugs with a ratio above 25 QALYs a million dollars tend to be considered more favourably, those below that rate less favourably.

However, the implicit threshold is indicative, not definitive. It’s a bit like doing a blood test on a patient. If the indicator is well outside the range the physician knows what to do. But within a certain range, other factors will be taken into account. Pharmac uses expert panels to do this.. If the drug does better than that threshold, the drug is added to the list of those which are funded from the public purse (outside hospitals).

The parallel with the clinician’s decisions is a good one. The CUA criterion is based on a robust scientific theory although it is sometimes difficult to apply because of a lack of data. I have heard doctors criticising CUA in as ill-informed manner as some proponents of alternative medicine criticise conventional medicine. Of course the criterion should be subject to rigorous criticism – Pharmac invited me to do that last year. But the criticism should be informed.

Pharmaceuticals are unusual in the rigour of the assessment as to whether they should be used in the public sector. Surgery, for instance, is not subject to this scrutiny. This means that there are other treatments which are probably inefficient compared to with the use of pharmaceuticals. If so we should be spending more on drugs and less on such inefficient procedures, although it is a difficult to get their practitioners to give them up. One piece of good news, which I did not expect when I started my Pharmac review, is that the criterion means that more efficient drugs will replace inefficient procedures where practical.

Where does the implicit threshold come from? Each year Pharmac and the government (that is politicians) agree on what is called an ‘indicative budget’, which represents the amount that the pharmaceutical bill is meant to be kept below. The indicative budget implicitly sets the threshold. The government’s increasing of the indicative budget has been a factor in the fall in the implicit threshold from 40 to 25 QALYs per million dollars.

When one is sick, or one’s patient is sick, these complicated calculations may seem to be almost irrelevant. One just wants whatever, and every, drug or treatment which is available. And the patient willing to pay privately can have it. However, providing it via the public health system also involves a willingness to pay on the part of the public. The QALYs per million dollars of net outlay is the best we have. It deserves to be understood, respected, and – where possible – improved.

Go to top