Literacy and Development

This entry was posted in Education on 20th June 1999 by Brian Easton.

Speech to the 1998 Planning Hui of the Adult Reading and Learning Assistance (ARLA) Federation of Aotearoa New Zealand: Waipapa Marae, University of Auckland, Saturday 20 June. Published in Nga Kete Koreo, the Journal of Literacy Aotearoa, July, 1999.

Keywords: Education;

During his second voyage of discovery, James Cook had two boats which arranged to meet in Queen Charlotte Sound. They did not. After waiting around, the Resolution had left a week or so before the Adventure arrived in late 1773. The arriving crew found a tree stump, which told them there was a message below. They dug it up, to be told – in a rather curt note – that Cook had sailed on. The Polynesians were amazed, for here were two men communicating, without being in each other’s presence, and without a human intermediary.

There is a sense in which that was the day, 225 years ago, when writing came to New Zealand. Despite being an oral culture, the Maori seized reading and writing with alacrity. At first it was to read the bible, which is a communication from men hundreds of years before, and so long dead. Later they used writing for numerous purposes including petitioning the nineteenth century government about wrongs, letters which are important today in the identification and settlement of Tiriti grievances.

I recall this history not because it shows that the European introduced writing into New Zealand. In fact they had learned it from the Middle Eastern Phoenicians, who in turn had been influenced by African Egyptians. Independently, the Chinese – the ancestors of the Maori are thought to have come from China – had their own writing. Thus the ability to read and write does not seem to be an inherently cultural one, but programmed deep inside all humans, perhaps as an extension of the universal ability to speak. Some came to writing early, some late. By the middle of the nineteenth century many Maori were more literate than many Europeans.

That still applies today. The International Adult Literacy Survey, which – alas – is still not fully published, reports that there are almost one and a quarter million New Zealand adults are not competently literate in that they are unable to cope with a varied range of material found in daily life and work. Most of those would be Pakeha/European. However the rates were much higher in the Maori, the Pacific Islanders, and those of other minority ethnicities. About 40 percent of Pakeha are not functionally literate on this measure, but for the other groups the figure is more than 60 percent.

The Survey splits those who are not functionally literate into two groups. The lowest group were those with very poor skills, who experience considerable difficulty using the printed materials that they encounter in daily life. There appears to be about half a million adults in this group. Another three quarters of a million are able to use some printed material, but this would generally be relatively simple.

Most of those with the poorest literacy are Pakeha/European, but the problem is proportionally higher other ethnic groups. The highest reported proportion is the 70 percent of Pacific Islanders born outside New Zealand are at this bottom level.

Other social variables are also related to the poorest literacy level. Women are slightly more functionally literate than men are, although the report mentions that Polynesians men are better at being able to read a document or material using numbers, than the women who are nevertheless better at reading prose.

The least literate are also least likely to be employed, and more likely to have low incomes. The correlation does not tell us that a lack of literacy destines a person to unemployment and poverty, but that seems probable for many. But it would be misleading to concentrate on the unemployed. About 38 percent of the employed are not functionally literate; around 10 percent are in the very lowest group of poor literacy.

The longer at school, the higher the level of literacy although – astonishingly – even 7 percent of those with a tertiary education are among those with the poorest level of literacy. Low schooling is one of the reasons for poorer literacy among the eldest. Even more astonishing it would seem that more 40 percent of those who complete their formal education in recent years are still not attaining functional literacy. That means each year over 20,000 students leave school who are not functionally literate.

In pointing out that we have a half a million New Zealand adults with very poor literacy, and another three quarter of a million adults whose literacy is at best limited, it is not my intention to bash the education system. It has insufficient resources as it is. I suspect, though, much of the system may suffer from what might be called the “English disease”.

A British friend, Professor Sig Prais was intrigued why the German economy was doing so much better than the British one. So he compared the educational attainment of German and English workers. He found that the top of each labour force attained impressively high standards. The difference was that when the bottom half were compared, the German students preformed much better than the British ones. Thus the Germans did not just concentrate on their top students. They made sure that their bottom students also gained good skills. The English education is very successful with elite students too, but it puts much less emphasis on the rest. (It shows in other international comparisons. The International Literacy Survey gets the same conclusion. Germans attain higher literacy standards than the British. I’ll come back to the international comparisons.) In summary it seems that the performance of a country’s top scholars may be less important than the whole team effort.

Does New Zealand have a German or an English approach to education? Many schools are committed to their educationally weaker students. Nevertheless I cannot help noticing that the educational debate is often in terms of the successes at the top of a school. Each year our newspapers publish schools ranked by school certificate or scholarship passes: terribly English really. What we really want to know is about achievement, not attainment: the extent the school takes students with a particular background and improves their performance. A school which takes in students from a diversity of ethnic backgrounds, including immigrants, where many come from poor and social difficult circumstances, where many are – and have been – poor academic achievers, may be very successful in upgrading the skills of its students. But it may not do well in the School Cert stakes.

Do we allocate the resources fairly among the schools with their different mixtures of students? Or do those with easy students get more relative to the task asked to them? All those to whom I have spoken, acknowledge there is some so-called compensatory funding in grants to schools, but it is nowhere near enough.

Let me express a prejudice. There is a dispute between the Ministry of Education and the educational unions over whether some funds should be spent on bulk funding or funding more teachers. Me, this lay person, thinks we should be hiring more teachers. This is not to argue bulk funding is wrong, I am arguing that more teachers at the book face are a priority. Now I am aware of the research which says that smaller classes do not increase educational attainment. But it can still be efficient to use adjunct teachers, to upgrade particular skills of students. Recall that there are over 20,000 students leaving school who are not functionally literate. The argument is about an extra 1200 teachers. That is about 17 students per full time teacher. Those teachers could be used to get literacy standards up among the weakest students, who would leave school better able to function. It would also mean they would get more out of school. They might even stay on longer.

It is no good saying that there are students who will never be literate. It is a much smaller proportion than you might think. For instance 75 percent of adult Swedes are functionally literate, and only 5 percent are at the lowest level. (New Zealand’s figures are just over 50 percent, and almost 20 percent.) If the age effect of those with a poorer education is allowed for, and if recent immigrants are taken out, Sweden must be getting very high rates of effective adult literacy over 90 percent among its young adults. That is the sort of goal we should be setting ourselves.

Putting more resources into raising literacy at school still leaves between half a million and one and a quarter million adults who have left school in a poor state of literacy. That is the place for organizations such the ARLA Federation. But as valiant and noble are your effort – in 1997 you dealt with 8935 students, up 31 percent on your 1996 effort – the 1997 achievement is still less than half the number of not functionally literate students leaving the formal education system in 1997. The numbers of functionally non-literate are probably increasing. There is a sense, you know, that the nation has a literacy crisis, which it does not even know about it, let alone do something about it. This crisis is not self-correcting.

Admittedly the available report of the International Literacy Survey suggests that New Zealand is in the middle of the eleven countries survey surveyed, or perhaps just a little below the average. The report warns that international comparisons are difficult. For the record Sweden, the Netherlands, and (probably) Germany are definitely better than we are; Poland definitely worse. We do worse on document literacy and quantitative literacy than on prose literacy. But to settle for average is hardly a commitment to excellence. Moreover it mat be our place in the ranking is deteriorating. Does such a literacy crisis matter? For instance does poor national literacy affect economic performance? There is some evidence it does.

I have already mentioned the correlation between poor literacy and unemployment and low incomes. The research of Sig Prais supports the conclusion of the importance of everyone doing well in literacy and other school attainments. We also know that poorer countries have lower average literacy. Insofar as other factors – such as technology and sound business systems – drive economic growth, one of the main means of access to them is via reading and writing.

Moreover this week’s visitor, American economist Robert Reich, reminds us at the heart of successful economic development is the quality of the labour supply. Quality labour is high productivity labour; international investors seek it out. Quality labour can read, read better than 38 percent of the New Zealand labour force. Being unable to read instructions is a handicap: for instance being unable read safety instructions leads to accidents. And what about the most famous New Zealand advice of all “when all else fails, read the instructions.” That advice is no use to almost two fifths of the labour force.

Nor must we think about this in static terms. The level of literacy which was sufficient for our grandfather’s workplace is hopelessly inadequate for the workplace of our grandchildren. We talk about the microchip revolution, but what relevance does the revolution have to a person who cannot easily read a screen. While it may liberate the literate, enabling them to attain higher and higher standards of living, the relevance of the computer to those who stumble over reading and writing is surely long term unemployment and poverty.

So economic imperatives require a higher standard of literacy than we are currently producing. But the economy and material production are but means to an end of higher human welfare, and literacy also contributes to other human purposes as well. In the nineteenth century the Maori did not want literacy for the purposes of economic development although, of course, it helped. They learned to read because they wanted access to the bible, to a new way of thinking. And they wrote to pursue their democratic rights. The material output of the economy is important, but culture, spirituality, knowledge, and liberty are all important too. Without literacy the individual loses those opportunities which makes us so inherently human.

That lack of literacy leads to shame, nicely illustrated in a couple of recent important novels: Primary Colours (now a film) and a German novel Die Vorleser, or The Reader. Note I can get in contact their world through books, but they cant use the medium to contact my world.

From that fundamental human rights perspective, as well as the needs of economic development, we – I dont mean the schools, I mean we, the whole of society – have failed to give New Zealanders some of the most fundamental human rights there are, the right to be able to participate fully in the life of their society. There are at least half a million, even one and a quarter million adult New Zealanders who are denied that right.

The Adult Reading and Learning Assistance Federation is committed to giving those rights to New Zealanders, as many as it can organize. In doing so it belongs to a long and honourable tradition, going back to the first missionaries who knew the Maori wanted to be able to read and write, to obtain the benefits of access that literacy provides. In commending your effort, I also say it is not enough. But that is not a criticism of your effort, or of you. It is a condemnation of a nation that has failed to recognize a major internal crisis of so many people who are not functionally literate.

The Green Tiger: The Irish Can Joke About New Zealand

This entry was posted in Globalisation & Trade, Listener, Macroeconomics & Money on 19th June 1999 by Brian Easton.

Listener 19 June, 1999

Keywords: Globalisation & Trade; Macroeconomics & Money;

The OECD report on the Irish economy, released this month, is unusually fulsome about their economy, describing its performance as “stunning” and “the envy of countries around the world.” They were referring to the last three years, but they could have been referring to the last fifteen. The accompanying table shows an annual GDP growth rate of 6 percent, high employment and productivity growth, low inflation, a balance of payments surplus, and the almost halving of unemployment.The feat is all the more extraordinary because their economic performance before 1985 was worse than New Zealand’s. Between 1978 and 1985 Irish employment actually fell, consumer inflation was marginally higher than ours, and at 8 percent of GDP the current account deficit was even larger than New Zealand’s is today.

Admittedly the Irish have had some advantages. They are the first stop from the US to the European Union, and English speaking at that, making Ireland attractive to the American business that wanted to produce and distribute in Europe. As a poor member of the EU with a largish agricultural sector it has received substantial subsidies from Brussels, probably amounting to around 5 percent of GDP. But even without these subsidies the current account deficit would still be smaller than New Zealand’s. Their strong growth of imports has been more than covered by stronger export growth.

At the heart of the success has been an open economy strategy. There has been little import protection (being in the EU gave no choice); their growth strategy emphasises exports: and the economy is be open to foreign investment. The Irish have also maintained a firm fiscal and monetary policy, reducing government debt (without depending on privatisation).

This may appear to be the New Zealand strategy also, but there are some important differences. A social consensus covering wages, taxation, and government spending between the social partners (including the unions) and the government has buttressed macroeconomic policy. Monetary policy does not have to be too tight, since the wage path assists the anti-inflation strategy. To help stabilise house prices, the Irish government builds more houses, rather than drives up interest rates. They ran a realistic (and undervalued) real exchange rate.
A second major difference is that Irish microeconomic interventions actively support industry. Direct support includes grants to new business, tax breaks, and industry incentives. Indirect support includes active labour market interventions, and a strong educational system. (The OECD appears to commend the introduction of free third-level education.)

The third major difference is that while New Zealand concentrated upon opening up its economy financially, including selling off New Zealand firms, the Irish focus has been on foreign direct investment building new businesses. (That New Zealand produces relatively more commerce graduates, whereas the Irish produce relatively more science and engineering degrees, reflects this difference.)

Compared to the New Zealand policy stance, the Irish spend more on active labour market policies, and have higher social security rates, higher direct tax rates, and more on government spending. In other words the Irish just about reverse all the rules we are told are necessary for New Zealand to improve its economic performance. Humiliatingly for those who promised us an economic miracle by following the policies opposite to the Irish ones, the New Zealand economic performance has been dismal compared to their’s. In the last 15 years Irish GDP has grown 80 percent more than New Zealand, and it now has an average level of production above the European Union per capita average.

The New Zealand Race Relations Commissioner discourages jokes against the Irish. Look at the table and wonder if his Dublin equivalent prohibits jokes about the New Zealand economy.

ECONOMIC PERFORMANCE: 1985-1998
Average % p.a 1985-1998 change unless otherwise stated.

Performance Indicator	New Zealand	Ireland	OECD
GDP Volume	1.7	6.0	2.7
Employment	0.8	2.2	1.2
Labour Productivity	0.9	3.8	1.5
Consumer Prices	4.6	2.6	5.5
Export Volume	3.9	11.7	6.9
Import Volume	5.3	9.8	7.2
Current Account* Deficit	3.9	-0.8+	0.2
Unemployment 1986**	4.0	16.8	7.1
Unemployment 1998**	8.2	8.9	6.5

* percent of GDP (average for 1985-1998)
** percent of labour force
+ surplus

Who Should Be Treated? Interferon-β for Multiple Sclerosis

This entry was posted in Health on 17th June 1999 by Brian Easton.

Presentation to Information Workshop on Disease Moderating Agents, sponsored by the Multiple Sclerosis Society of New Zealand: Thursday 17 June 1999.

Keywords Health

The Public Policy Context

Public policy is about problem solving. The specific problem I shall look at today is who with multiple sclerosis should be able to obtain access to Interferon-beta therapy? But public policy answers to such questions have to take place from a wider perspective. Resolving the public spending problem on multiple sclerosis has to take place mindful of the tradeoffs with other public spending (including on other diseases) and the raising of the revenue (typically via taxation) to fund them. There has to be a consistency between the specific answers, for otherwise the various decisions – the resolutions to the problems – becomes a matter of arbitrariness, creating ongoing tensions (and further problems) because of inconsistencies.

Each democracy solves its public policy questions differently in terms of the institutions it uses, and technologies it uses for evaluation. There is however, considerable convergence between different countries’ practices. The New Zealand arrangements I am going to describe today would be recognized as similar to those in most western democracies – the US, with its emphasis on commercial principles excepted although they may be at different stages of implementing the systematic practices.

At this point, I should state that I am neither a neurologist nor a pharmacologist, so I know very little about these aspects of the treatments considered here. My contribution is to say something about the resource consequences of the use. I shall be using published papers, each typically by a team which includes a neurologist, a pharmacologist and an economist. If my task were to do an original evaluation, I would work with such a team too.

The registration of pharmaceuticals, is medical-pharmacological matter, which among other matters considers safety aspects of the drug. Once a drug is registered, it is available for a treatment. Registration provides no guarantees of universal accessibility if the drug is expensive. Those who can afford the drug may purchase it. Aspirin is available from a chemist. However many drugs – especially new drugs – may be far too expensive for the typical sufferer to afford. At which point arises the public policy problem of whether it should be funded in whole, or part, by the public purse.

The Funding of Public Health Care

A simplified version of the public policy towards the funding of health care goes like this. At the top of the system the government decides how much it is willing to spend on all its activities. That decision depends largely on the amount of taxation revenue it raises, and on a judgement of the effects of various tax rates and the willingness of the community to pay those taxes.

There is no value-free formulae which tells a government how much it should tax or spend. In a democracy that decision is made by the political judgements of the government in power. Once every three years we have the opportunity to vote for a parliament to select a government. One of the factors which influences our voting is our personal preference for more or less government spending and less or more taxation. Within the period between elections, the government is continually judging the extent to which the public in general, and its supporters and potential supporters in particular, want to spend and tax more or less.

Having decided on total spending, the government allocates it between the various general areas, including health. For instance, in last month’s budget the government announced total spending of about $36.4 billion for this fiscal year, of which $6.8 billion it allocated to health spending. Again there is no rigorous formula which says how much the government should allocate to health or any other spending. That is a matter of political judgement.

I have stressed these political judgements at upper levels, because as the money moves down through the system, technical considerations become increasingly important, and politicians become increasingly less involved. That is how it should be in a democracy. We do not want politicians making the decisions in the clinic or surgery. Even so, technical decisions almost always value judgements lurking near them.

Reflecting the changing balance of political and technical, parliament decides the amount of the health vote which goes to the Health Funding Authority which funds (in the jargon “purchases”) the various health and disability services the public health sector provides. This year the amount is about $6.2 billion. The HFA allocates about $700 million to Pharmac or the Pharmaceutical Management Agency, which is charged with administering the public subsidies on about 3000 pharmaceuticals.

Pharmac’s Problem

The policy problem which Pharmac faces is how to use its funds effectively. Some of its actions are fairly obvious. It buys drugs as cheaply as possible. It tries to make sure the drugs it pays for actually work. It tries to make sure they are not wasted. Even when such sensible things are done, the demand for medication far exceeds the funds that Pharmac has available.

I am now going to try to explain the policy framework which Pharmac is increasingly using to decide which drugs to fund, given the budget constraint it faces. The underlying theory is complex, although I have done my best to keep the exposition as simple as I dare. Some readers may find it convenient to jump three pages, accepting that there is a criteria, and the ratio of the Net Cost to Quality Adjusted Life Year (or QALY) is a rational way of making the decision whether to fund a drug or not. However others will value the opportunity to obtain some idea as to the underlying analysis behind the theory.

The (over) simple example is set out in the Table 1. It assumes there are just 10 drugs (Column 1) to be funded, which in total cost $55m (Column 2). But suppose there is only a total of $20m available for funding. How is the $20m to be spent given that the demand for funds far exceeds those funds available?

There are many possible rules, some of which have developed in an ad hoc way over the years. For instance, the “grandfather rule” is that if the treatment had applied in the past it should continue into the future. Whatever its merits – much of today’s treatments are grandfathered rather than using any systematic approach – the rule does not tell us how to decide between new therapies.

Another approach might be called the “shout principle”: those who make the most noise get the treatment. There are a number of dangers: given all the shouting, no-one may be heard, however justified their need; it is an encouragement for political interference in technical decisions; and it can be very wasteful of resources.

To illustrate, suppose that therapies are chosen in order to have the maximum number of people treated – since loudness is in numbers. That is equivalent to allocating the funds by cost per patient (or shout). Column 3 shows the cost per patient for each therapy. Table 2 ranks the drugs by cost per patient. Drug A costs $10 a patient, cheaper than any other, so the rule would fund the 1,000,000. Drugs E and G are the next to lowest in cost per patient terms, so they are funded. The three cost $20m, and exhaust all the available funds. On the shout criteria, the drugs A, E, and G would be funded.

There is absolutely no allowance in this assessment for the benefits of the treatment. For instance, drug A may be something like an aspirin, which is of small benefit to a lot of people. In contrast drug H might be a matter of life and death – if the patient does not get it the patient dies. Intuitively one feels that drug H should be given more significance than drug A, but the cost per patient criteria does not take that into consideration.

QALYS and Decision Making

In order to get around the problem of treatments having different benefits, economists have evolved the QALY, or “quality adjusted life year”. QALYs work like this. A person living a normal life, in normal health, has a QALY of 1. A person who is dead has a QALY of zero. People whose health is between have a QALY level between 1 and 0. If a person’s health changes, then the QALY level also changes. For instance a person who is saved from certain death has a QALY level of 1 rather than 0, and a treatment that saves is treated as adding one QALY a year to the person’s life. Calculating QALYs is complicated and riddled with problems. Let us take it here that they are a reasonable way of resolving the impossible problem of comparing everybody’s health. We know no better one.(1)

Historically, a common means of measuring the effects of Multiple Sclerosis has been by the Kurtzke expanded disability status scale (EDSS) of neurological impairment on a 0 (normal) to 10 (dead) scale, based on responses to 20 questions. The EDSS scale can be mapped onto a QALY one, which applies to all health statuses.(2)

Column 4 of Table 1 shows the QALY gained from the treatment for each patient. The aspirin of drug A gives only a small gain of .0001 QALY per patient, but the life saving drug H treatment gives a gain of 1 QALY. The gains for the other drugs are in the range from .1 to .4 QALYs. Column 5 gives the total QALYs gained from each treatment, and Column 6 gives the cost of each QALY gained. They range from $6000 for drug H to $500,000 for Drug I. If we want to maximize the QALYs to be gained from treatment, we will choose those which are cheapest in terms of the cost per QALY. This is summarised in Table 3, where you see that drugs D,E,G and H are the cheapest and there total cost is $20m. So if we choose our therapies by the criteria of QALY gained, we replace the low return drug A (the aspirin) with drugs D and life saving H which seems to be a more sensible outcome.

There is one further major modification to the Pharmac evaluation method. Some therapies save resources elsewhere in the health system. For instance, a course of Interferon-β may mean fewer relapses, and less use of medical and hospital resources. Column 8 of Table 1 lists the cost savings to the health system for the various therapies, Column 9 shows the net total cost to the health system when the savings per patient are deducted. It makes sense to include these cost savings in the calculations. For instance, without them the method could rule out a better and cheaper drug therapy for a particular condition, because it would ignore the savings from abandoning the old therapy. So instead of using gross cost per QALY, we would use net cost per QALY, which is shown in Column 10.

Table 4 shows the rankings. Now drug J is the cheapest, and that with drugs H, D, G, and F would be the recommended ones. However, while their gross cost is $20m, their net cost (after we have deducted the savings to the health sector) comes to only $12.2m. We can now also afford drug E, and still have a bit over for some spending on drug C.(3)

Table 5 summarises the outcomes of different choice of drugs within the budget constraint. By changing the selection criteria we change the set of drugs which the agency would provide free. As the criteria moves from gross medical cost per patient to cost per QALY, drug A gets dropped in favour of D and H. Shifting to net medical cost enables drugs F, G, and part C to be added.

What is unavoidable however, is that given the budget constraint a selection has to be made, and that some selections are better than others.

Some Problems with the Method

I have simplified the method for expository purposes. However there are some issues which are still being debated and need to be briefly mentioned:

– Should other net gains to government revenue (such as savings in social security benefits and additional tax payments from working) be included? But we need to be careful about the implications. For instance, incorporating the gains from employment could mean that the potentially employed were given preference to the unemployable.

– Should non-government gains (such as the extra earnings of a well person) be include? We have to be careful here not to double count, since the quality of life includes the consumption which goes with it. Moreover, too wide an approach can lead to ethical issues: if some illnesses cause marital breakups, which treatment prevents, does that mean the treatment should preferentially be given to the married?

– Are all QALYs are the same? Some surveys suggest that people think some lives have characteristics (such as age) which are more worthy.

– How are the effects of the treatment on the quality of life of others to be included? For instance there is a case for a higher QALY score of parents with young children, because it improves the young’s quality of life too (or adding in a QALY for the better life of a child without a sick parent).

– Should low probability health events (such as MS) be treated differently from high probability ones (headaches)? Part of the issue here is what costs can be reasonably attributed to the person. We dont give higher social security benefits to people who need to more to eat.

– What about moral hazard, the technical term for situations which affect one’s health or entitlement to treatment? Most people would be more reluctant to provide aspirins for a headache precipitated by a hangover, which the patient’s drinking brought it on.

– How events that take place over time to be treated?. The technical notion is “discounting”: there is some dispute over what is the correct discount factor. Different ones may affect the relative ranking of wasting diseases such as multiple sclerosis compared to one-off gains from surgery.

These are proper matters for debate. Very often they will reduce the cost per treatment but not change the rankings. Whatever the outcome of these debates, I doubt they will have much influence of the question of the funding of Interferon-β therapy. And they certainly do not invalidate the need for an approach which involves a systematic decision rule.

In Defence of Pharmac

After presentations such as this, economists are often accused of being calculating and hard hearted. Calculating we are, just like engineers who design bridges you can trust. In the economists’ jargon the calculations are to get “as big a bang for the buck as possible.” Without them there will be a waste of resources, and less people would be effectively treated.

But economists are not necessarily hard-hearted. What we are aware is that where there is a budget constraint, being warm hearted to one means being cold hearted to others. It is a sad truism that people allege cold heartedness when they are turned down, but dont mention a warm heart if they are given a “yes”. Economists dont push into health policy because they are intelligent, beautiful, witty, wise, or power hungry. They may (or may not) be some (or all) of these. The reason economists get involved because of the funding constraint. Were there no economists, the government’s health agencies would still face the problem of what to do with limited funds. Eventually someone would recommend a prioritisation not unlike that which economists recommend.

My impression of the economists and others who work for Pharmac is that they would love to be able to say “yes” to everyone. They, too, have friends and family who suffer illness but are unable to get the maximum treatment for conditions they suffer, because of the budget constraint. Of course they are tough. They have to be, when they say “no” to one treatment because the funds could be better spent on another. And they have to be tough when the front up to a pharmaceutical company to get the best possible price, knowing the money saved can be spent on other drugs.

The Threshold

In practice, Pharmac does not do the elaborate exercise I have just described, for that would mean evaluating every drug therapy every time a new drug appears. Rather they calculate the net cost to QALY ratio of each new drug, and compare the ratio with that for other drugs. This is equivalent to a “threshold” approach where if the cost per QALY of a new drug is below the base threshold it is subsidised. Usually there is a grey area, where drugs with ratios above the base threshold up to a second higher threshold, where other factors not included in the Cost per QALY consideration are taken into account.

Looking at Table 4, the lower threshold might be $10,000. If the ratio comes below that, and Pharmac has the money, they are likely to recommend to the provision of the drug without charge to the patient. In the grey area, say up to $20,000, they are likely to say no, unless there are some other relevant considerations.

Pharmac has not said what its thresholds are. Essentially they are the consequence of the amount that parliament provides for health care. The more money voted, the higher the thresholds, and the more drugs and other treatments that can be funded by the public. However, we can guess the Pharmac thresholds must be near $20,000 a QALY. That is about the average (public and private) consumption per New Zealander. If, for instance, the threshold was $200,000 a year, then ten people in the community would have to give up all their consumption in order to gain one QALY. It seems unlikely that New Zealanders would be willing to accept the taxation consequences (and their personal consumption loss) of such a high threshold. Thus the technical threshold for evaluating the drug ratio reflects a political judgement at a higher level.

(Even so, I am of the view that there is a case for spending about an extra $500m a year on the health sector, in terms of what New Zealanders are willing to sacrifice, and the substantial health improvements which would arise as a result.)

The Net Cost to QALY Ratio for Interferon-β

Although there has been no New Zealand specific evaluation of the costs per QALY for Interferon-β treatment for multiple sclerosis, there are four foreign reports in the public domain, which give us a strong indication of what a New Zealand analysis would look like. They identify two key benefits from the treatment, where it is applicable (noting that there is no evidence those with primary MS benefit from the drug). Among those with its relapse-remission from it appears that as a result of using Interferon-β:
– there are (perhaps a third) fewer relapses, which saves medical costs and gives a better quality of life;
– the progression of the disease is retarded. However, not a lot is know about the long run retardation, mainly because the systematic evaluation of the treatment is recent, so there has not been enough time to observe its effects in the long run. Trials have been at most three years, and there may never be long term trials because of the ethical issues involved.

Here is a brief summary of each, focusing on the key efficiency finding:

A Therapeutic and Economic Assessment of Betaseron@ in Multiple Sclerosis. (Dalhousie MS Research Unit, Halifax, Nova Scotia, Canada: July 1996)
The net cost/QALY of the Betaseron® therapy amounts to around $CAN160,000 (say $NZ200,000) for women and $CAN136,000 ($NZ170,000) for men.

Interferon Beta-1a in Relapsing-Remitting Multiple Sclerosis. (The Wessex Institute for Health Research and Development: December 1997)
The net cost/QALY of the Interferon Beta-1a therapy amounts to between £740,000 and £5.5m ($NZ2.1m and $NZ16.5m). The report concludes “not proven”, the lowest level of its five recommendations.

Comparison of Drug Treatment for Multiple Sclerosis. (Canadian Coordinating Office for Health Technology Assessment: November 1998)
The net cost/QALY of the Rebfin® therapy amounts to at least $CAN406,400 ($NZ.500,000).

A Cost-Utility Analysis of Interferon Beta for Multiple Sclerosis. (University of Newcastle: December 1997)
The net cost/QALY of the Interferon Beta therapy amounts to between £228,300 and £809.900 ($NZ680,000 to $NZ2.4m). This study, the most comprehensive, looks at various retardation rates and reports “[t]he most optimistic estimate from the ten year model, incorporating some extreme assumptions about natural history and the impact of therapy was £74.500 [$NZ220,000] per QALY gained.”

These are all very high figures – the lowest is around $200,000 per QALY, well beyond any likely threshold that Pharmac (that means “us”) can afford. I was asked to look at doing a New Zealand study, which would have applied New Zealand parameters to these studies. My advice to the MS Society was that they would be wasting their money, because whatever changes were made, the ratio would remain well out of line with any Pharmac threshold.

Why is Interferon-β so cost ineffective? An examination of the studies suggests that:
1. Interferon is expensive – treatment costs about $20,000 a year;
2. It is ongoing treatment (rather that a one-off therapy – like surgery);
3. The average reductions in other medical costs are relatively small. For instance, while there are medical savings from fewer relapses, one study estimated that the saving was only 31 percent of the cost of the drug.
4. The therapy is ineffective for many people, and it does not eliminate all relapses. The studies assume that it is not possible to discriminate between those who will benefit and those who wont, and so – as it were – much of the expensive shot is wasted.
5. The health (quality of life) gains are on average relatively small per dollar spent.

It appears that in our current state of knowledge, the gains from reducing relapses are insufficient to justify Pharmac subsidizing the medication. Ultimately the justification is likely to be from better targeting on those with a high relapse rate (because that may reduce high hospitalisation and other medical costs), but the big gains arise if the progressivity is greatly retarded, especially with better targeting. Only further trials will tell if we have been too pessimistic.

In the longer run, we can expect neurologists and pharmacologists to refine their administration of the therapy to get improved patient benefits, while the drugs themselves will improve, and their costs reduce. The net cost to QALY ratio is likely to lower steadily overtime. Unless someone finds an better drug, Interferon-β may eventually be made widely available without charge by Pharmac or its successor. But that date is some time away.

A Strategy for Accessing Interferon-β for Multiple Sclerosis

What is clear is that Pharmac is not going to be funding the drug to all potential beneficiaries (no matter how small the benefit) in the near future. What is to be done in the interim? I am assuming that the MS Society will not want to do nothing, nor would it waste it time by trying to bust the policy framework.

It appears that in most countries where there is MS, make Interferon-β available for some patients without charge. But given the greatly varying utilisation rates, they must have quite different rules about its use. This suggests that New Zealand will also settle on a selective rather than universal entitlement.

The criteria for selection needs to be designed primarily by neurological and pharmacological specialists, but with a clear view of the implications of the policy framework analysis which I have outlined above. Pharmac will be most responsive to a criteria which targets those:
– who are most likely to respond to the treatment; and
– who have highest relapse rates or otherwise incur relatively high health sector expenditure; and
– who are likely to experience high retardation of the progressive deterioration; and
– where there are rigorous and effective criteria for identify those who are not responding to treatment, and should have the treatment withdrawn. (Alternatively a trial followed by selection as to those who are successful may be an option.)
Basically we should be searching for practices which cut therapeutic costs (of both the drug and of other therapies), and/or which increase the efficacy of the therapy in terms of some concept as the EDSS or QALYs.

There may also be personal factors which may affect eligibility for treatment (as occurs for the surgical waiting lists). One which may be especially relevant to a MS, with its high initial incidence among young women, is that parenthood should be taken into account, since success will also benefit the quality of life of young children.

Ultimately the criteria could even end up with a points system, like in surgery eligibility.

However, I would not wish to raise the expectations of the MS Society and its members that there will be a lot of people eligible under this criteria. Because funds are so scarce, Pharmac is more likely to look favourably on a proposition involving 25 people than 450.

If I may end on a personal note. I usually enjoy my consultancy work. This case is an exception. It gives me no pleasure to have to be so pessimistic about the short term opportunities for moderating the condition of people suffering a debilitating disease like multiple sclerosis. But that is how the material available to me appears. I would have even less enjoyment if I had used my expertise to tell the sufferers an untruth.

Endnotes
1. There are alternative proposals, such as Disability Adjusted Life Years (or DALYs), but they are not as nearly convincing as QALYs. They would not change the story greatly. Pharmac, rightly in my opinion, uses QALYs.
2. One contribution at the seminar argued that QALYs are not yet well defined for neurological problems.
3. I am not sure whether the HFA directly gives over to Pharmac the savings to the rest of the health sector from the use of pharmaceuticals. However, what we can be sure is that insofar as Pharmac increases its contribution to the rest of the health sectors savings, the HFA will increase Pharmac’s budget in due course.

When Things Go Bump: Is Monetary Union a Help or a Hindrance?

This entry was posted in Listener, Macroeconomics & Money on 5th June 1999 by Brian Easton.

Listener 5 June 1999

Keywords: Macroeconomics & Money;

The Cook Islands lost 13 percent of its population in the last two years, about the same as New Zealand losing Christchurch. The economy suffered some severe external shocks – mainly from New Zealand – which contracted the economy. The government tried to spend its way out of the crisis, ran out of foreign currency, and the consequential cuts plunged the economy into depression and unemployment.

Given the severity of the shocks, the Cooks were bound to face economic difficulties. But different policy responses can moderate the impact to different degrees. Because they were in a kind of monetary union with New Zealand – the Cook Island dollar is at parity and freely exchangeable with the New Zealand one – they were unable to change their exchange rate. Instead there was a reduction in national spending and a rise in unemployment was one. Because the Cooks are in a labour market union with New Zealand – the Islanders may readily come here – a major adjustment was through emigration.

New Zealand regions experience similar external shocks to the Cooks. But the local government in, say, Christchurch, in monetary union with the rest of New Zealand, knows it cannot spend its way out of a contraction. However the region is also in a nation wide fiscal union, paying taxes and receiving government spending. When its businesses close, the workers go onto the unemployment benefit and the tax drain lessens. The Christchurch contraction would not be as severe for the same shock as the Cook Islands’.

The recent rhetoric advocating monetary union has paid little attention to external shocks or how to adjust to them. Over the last thirty years New Zealand has had major ones (good and bad) in 1971-2, 1973-4, 1979, 1981, 1984, 1986, 1987, 1991, 1993, and 1997-8, including export price collapses, oil price shocks, the international world business cycle, and world financial chaos. I have probably overlooked some, but the record is an average of one every three years or less. If New Zealand’s economy is a ship buffeted by stormy seas, many of the arguments for monetary union assume that the sea is calm. As Keynes said “economists set themselves too easy a task if in tempestuous seasons they can only tell us when the storm is long past the ocean is flat again.”

Forming a monetary union with Australia or the US (or Pantagonia, for the advocates seem not to care with whom), would mean give up the ability to use monetary and exchange rate policies to assist the adjustment with the external shocks. But there would be no fiscal union, and there is no labour market union with the US. We would be better off by being a state of either country. It is true there is not full fiscal union in the European Union (there is labour market union) but there is a supranational political system and there are central funds. If, for instance, there was a disease which destroyed the olive crop of its Mediterranean members (equivalent to foot and mouth disease here), the European Union would switch its funding to help the devastated regions adjust.

If there can be no emigration and no fiscal inflow, monetary union forces a region to adjust by reducing its domestic price level. We simply do not know how to induce deflation on top of an already contracting economy without causing a depression. I am not saying that with independent monetary and exchange rate policies, a country can avoid the pain from a large detrimental external shock. The Cook Island’s are bound to suffer a major and painful adjustment. But not having available the full range of policy instruments is like turning up to fight a big fire with a fireman or two short.

Whatever the nationalist reasons for monetary independence – for having one’s own currency – if there were significant gains to be made from monetary union, the task would be to redefine our nationhood in terms of a country without its own money. Its a challenge many European nations and sub-nations are facing. But monetary union without full economic union makes the ship easier to manage in calm waters. The concern is its seaworthiness in storms. That probably means sailing under its own flag.

View from Abroad: What Do We Know About Economic Growth?

This entry was posted in Growth & Innovation, Listener on 22nd May 1999 by Brian Easton.

Listener 22 May, 1999

Keywords: Growth & Innovation;

Even a good scientific theory experiences anomalies which it cannot explain. Resolving those aberrations eventually leads to a better theory. However ideologists prefer certainty to complexity and ignore inconsistencies. An article in the April 10 London Economist – the world’s top economics weekly and prominent upholder of “more market” – nicely illustrates the phenomenon.

Although it is not as extreme as our commercialisers, The Economist regularly praises the US economy for being more market driven and more flexible. But when it looked at actual outcomes, comparing the US with the other two big economies of Germany and Japan, to its (suppressed) horror, it found that the US performance was not superior. I have shown their figures for the last decade below. (I added New Zealand’s.) US production per head has grown more slowly than Germany despite the German’s difficulties of absorbing the shambolic East German economy, and about the same as Japan, despite everyone muttering that Japan is in permanent recession. Its labour market performance is better, with more job growth (US unemployment is down to a miraculously low 4.5 percent of the labour force), but that is because its productivity performance is miserable. (New Zealand shows the same pattern of relatively high employment growth which is offset by poor productivity and miserable per capita growth.)

does not defend the US by arguing that the most technologically advanced and highest income economy in the world suffers because others have a catchup effect, as they cheaply imitate the US. Nor does it argue that economies with large service sectors find productivity growth difficult, because the expanding service sector tends to have low productivity (the so called McJobs effect). Both are relevant, although they do not seem to explain all – or even the large part – of the inconsistency.

One answer may be that the flexibility of the market is not as crucial as is claimed. (This is a different argument from that the market outcomes are inferior: that belongs to another column.) Arguably, economic actors need some stability in their economic decision making, and an un-intervened market is too volatile. One might illustrate this on the shop floor, where the Employment Contracts Act gave managers a high degree of labour force flexibility, but the insecurity means the workers lose their commitment to the employer, which may reduce their productivity. Microeconomic policy becomes a matter of finding the right balance to allow sufficient flexibility to enable firms to seize opportunities and deal with crises, but not so much that normal performance suffers.

The article dismisses some anecdotal explanations where a special factor favours one economy over the other. Indeed The Economist – like this columnist – thinks some of recent US economic growth is based on a speculative bubble, so perhaps their US figures are misleadingly high. Instead, it argues that macroeconomic policy – monetary, fiscal (and in a small economy like New Zealand) exchange rate policy – are as important. Or even more so: the article is a vague at this point. It is not arguing that microeconomic policy is irrelevant. It would probably agree with my view that macroeconomic policy works better if there is some flexibility in the economy.

But below The Economist’s concerns of the poor productivity performance of the US economy is an unspoken question: what do we actually know about the process of economic growth? One theory says that by reducing government interventions, abolishing protection, reducing taxation, an economy will grow faster. (It is the theory that the reforms from 1984 was based on.) The supporting empirical evidence is not very compelling: much begins by assuming the theory works (the ideologists’ approach), rather than testing it (the scientists’). The more I look at the evidence the more I am struck with how little we know, especially in contrast to how confidently ideologists present their conclusions. This is not to back down from the central theme of my book, In Stormy Seas: the Postwar New Zealand Economy, which argues that the economic growth of a small open multi-sectoral economy is intimately related to the effectiveness of its export and import substituting sector. What it does not explain is the economic growth of the world economy. But neither can The Economist.

What The Economist said about New Zealand

New Zealand is only referred to twice:

“Even New Zealand’s mode, of which The Economist has been a big fan, has been looking somewhat sickly: it was the only rich country besides Japan that suffered from recession last year.”

“Radical reforms in the 1980s transformed the rich world’s most regulated and closed economy into one of the most free-market, with [one of] the lowest tax, lowest trade barriers and widespread privatisation. Bad point: a big increase in inequality.”

Most will agree an increase in inequality is bad. But The Economist overlooks that we have not done too well in the economic growth, productivity, or employment stakes either.

THE GROWTH STATISTICS (1989-1998)
(percent annual growth rates)

Country	GDP/head	Productivity	Employment
Germany	1.8	2.5	0.0
Japan	1.7	1.1	0.8
US	1.5	1.2	1.3
New Zealand	0.6	0.5	1.3

Means to an End: Social Radicals Who Are Fiscal Conservatives

This entry was posted in Listener, Macroeconomics & Money on 8th May 1999 by Brian Easton.

Listener 8 May 1999

Keywords: Macroeconomics & Money;

Michael Cullen and Helen Clark are fiscal conservatives. They think there is a practical constraint to the size of the government’s budget deficit: they may well prefer it to be in a surplus. While they may think, as sophisticate Keynesians, the size of the deficit should vary over the business cycle as a part of demand management, in the long run they see the internal deficit as constrained. However much of their Labour Party are not fiscal conservatives. In government, already evidently in opposition, Labour will face tensions because much of their caucus – even the cabinet – are not so committed to fiscal austerity.

Understandably, for Labour sees a run down public sector under severe expenditure restraints and observes the resulting harm to New Zealanders that results. Spending more on culture, education, the environment, health, housing, industry assistance, law and order, public infrastructure, science research, social security, and so on would relieve the pressures. Moreover, there is a crude Keynesianism which seems to suggest there is no limit on the size of the government deficit or, if there is, it is substantially larger than the current level. If so the policy prescription seems to be to spend more and run a larger deficit.

The argument for fiscal conservative requires greater sophistication. How is a larger deficit to be financed? Pure credit creation (increasing the money supply or zero interest loans from the Reserve Bank), either blows out through spending on imports (and a balance of payments crisis) or through inflationary pressures (or both). (The Cook Islands is an illustration of that path) Borrowing leads to higher interest rates and an increasing public debt burden. Either path ultimately leads to severe fiscal austerity.

The reason I have focused on Cullen and Clark – other fiscal conservatives include Bill Birch and Bill English – is they are confronting the dilemma. Both believe, like the rest of the Labour Party, that there are substantial benefits from additional government spending. To fund it fiscal conservatives have to raise taxes. Labour has announced that if in government it will raise taxes on high income individuals (over $60,000 a year) to raise an extra $400m a year. They have also stated their spending priorities for this extra funding. (They can tell you which.) It is disappointing that the resulting public debate focused almost exclusively upon the higher taxes, ignoring government spending.

It is easy to argue that taxation is a bad thing, and if it were only a matter of raising taxes – which is much the way the public discussion is presented – that would be true. But if there is a purpose to the additional taxation, the argument is transformed. Now the debate is about the adequacy of public provision, and the amount of private consumption we are willing to sacrifice to have that public consumption
.
For example, Jenny Shipley, as Minister of Health gave a direction that 90 percent of New Zealanders were to be within an hour of an emergency treatment at a hospital. The Alliance Party’s hospital plan adopts that target (actually 91 percent will be within 80kms of the service). I spend most of my time within an hour existing emergency services. Probably I would average not more than week a year away from them. Other New Zealanders are not so well off. So the choice posed is whether I am prepared to pay an extra 50 cents a week in taxation for the extra coverage I’d get, plus the benefits to others worse off than me. (Private health insurance cannot provide it so cheaply.)

What is the response of the average New Zealander to this choice? Do they prefer the current hospital configuration and tax levels, or do they prefer a more comprehensive one and are willing to pay for it with higher taxes? The choice we are being offered is about the balance between public and private consumption, not more or less taxation. All New Zealanders will have an opportunity to express their choices in the next general election, providing the politicians are principled enough to present the alternatives before us honestly.

Possibilities: Could New Zealand Have a Financial Crisis?

This entry was posted in Listener, Macroeconomics & Money on 24th April 1999 by Brian Easton.

Listener 24 April 1999.

Keywords: Macroeconomics & Money;

If it were possible to predict the precise timing of a financial crisis, everyone would take precautions, and precipitate an earlier one. However the footnote has three lists of indicators. My scorecard for New Zealand gives 5 out 8 for macroeconomic performance factors and 5 out of 7 for macroeconomic policy factors (although some of our policy changes were more than a decade ago). But for microeconomic conditions (which the conventional wisdom says is the more important), I reckon it is 0 out of 8 (assuming reasonably competent bank management – who can tell until after the event?). Moreover, with one small exception all New Zealand banks are owned overseas. Megabank International will quickly and quietly bail out Megabank New Zealand if gets it into trouble, to protect its reputation elsewhere.

Non-banking financial institutions which take deposits have a higher (although still usually low) likelihood of difficulties. The rules of capitalism are that, under a liberalized financial system, the odd financial institution will occasionally go bust. That is why some pay higher interest rates – a premium for risk – and why prudent investors never put all their eggs in a single institution.

Other factors could damage the New Zealand financial system. Because the New Zealand dollar floats we wont get into the difficulties like those with a fixed currency regime. A currency collapse is unlikely to hit our banks directly, since they limit their foreign exchange exposure. But they lend to importers and non-bank financial institutions which may be more exposed. The same broadly applies if there was a sharemarket collapse. If a disruption is sufficiently great, who can be sure what will happen?

The New Zealand financial system cannot isolate itself from a systemic international financial collapse. The world has evolved a variety of institutions (such as the IMF, the Bank of International Settlements, and the G7) to prevent a repeat of the 1930s, but the international financial system has also got more complex. The recent performance of the IMF and others suggests they may not be able to cope with a full blow out.

Between the local and the global possibilities is that of “contagion” where financial disruption in one country spills over into others as investors “reassess risks” (i.e. panic). New Zealand seems to have benefited from the contagion effect of the East Asian crisis as some international investors treated us as a safe haven. (We are, of course, suffering from a loss of export markets.) But were Australia to get into financial trouble, so would New Zealand, despite the protestations (and fact) that we are different.

What to do? Many consider the Reserve Bank’s system of prudential supervision is the best available. Even so, it cannot guarantee every depositor’s dollar in every financial institution. Moreover until it is tested by a rip-roaring financial disturbance we cannot be sure how it will work. Improvements would be to limit speculative capital flows, without disrupting long term capital flows. But no one knows how to do so effectively. (Better macroeconomic performance would also help.)

What is the individual depositor to do? Putting money into an overseas bank exposes it to similar risks. You could invest in the sharemarket, but a sharemarket crash is much more likely than a financial one. Put the money under your bed? There is the danger of burglary, fire, or nuclear war.

It would be irresponsible of this column to conclude there was no chance of a financial meltdown in New Zealand. Life is about risk: true for one’s savings too. Even during the secure 1970s they were being systematically undermined by inflation. In today’s world there is a non-zero probability of one’s savings being slashed by a financial crash, instead of being eroded by creeping price rises.

FACTORS COMMONLY ASSOCIATED WITH BANKING CRISES

1. Macroeconomic Performance
Low GDP growth
High real interest rates
High inflation
High stock of money relative to international currency reserves
High private credit relative to GDP
High credit growth
An external (current account of the balance of payments) deficit
Low GDP per capita

2. MACROECONOMIC POLICY
Financial opening (domestic financial market liberalisation)
Opening to external capital (freeing up international capital flows)
Currency appreciation
Disinflation
Trade liberalisation
Fiscal expansion (increase in internal, or government, deficit)
Domestic credit expansion

3. MICROECONOMIC CONDITIONS
Deficient bank management: poor credit assessment & monitoring, poor internal risk management & risk controls, strained credit assessment skills
Connected lending: loans extended to banks’ owners, managers, and related businesses. (sometimes called “cronyism”)
Poor supervision or regulation (by the financial authorities)
Deficient market oversight
Political interference (which often involves cronyism)
Weak judiciary
Fraud
Deposit insurance (which encourages poor bank management, and cronyism)

What Happened to the Nation Building State in New Zealand?

This entry was posted in History of Ideas, Methodology, Philosophy, Political Economy & History on 21st April 1999 by Brian Easton.

Paper for the New Zealand & Australian Studies section of the Conference of the Western Social Sciences Association, April 21-24 1999, Fort Worth, Texas.

Keywords: History of Ideas, Methodology & Philosophy;

Brent McClintock’s “Gordon Coates and the Nation-Building State: 1920-1935”, which precedes this paper, also sets its stage. [1] In the interwar period there arose a group of New Zealanders who were committed to use the instruments of the state to build a New Zealand nation distinctive and independent (as much as it could be). Coates may have been the earliest, but numerous other New Zealanders in politics, the public service, corporations, and cultural life also participated. Most are recognized in The Dictionary of New Zealand Biography and many have full biographies published or in the process of being written: politicians Peter Fraser, Apirana Ngata, and Walter Nash (as well as Coates); public servants Clarence Beeby, Joe Heenan, Alistair McIntosh, Douglas Robb, and Bill Sutch; businessmen James Fletcher and James Wattie; writer Rex Fairburn and Frank Sargeson (with prominent artists coming a little later). Even so, acknowledging such great totara trees but locates the bush over which they towered: that bush below was dense with others equally committed to the nation building state. Curiously, there are no obvious women for the list. The tallest was Te Puea, but her vision was to build the Tainui nation.

The influence of most of these men continued through the war, and well into the post-war era. They had successors, some of whom grew to totara of comparable height. Nation building was a central part of the political agenda through to the early 1980s. There is not the place to detail the story, but the strength of nation building might be illustrated by Robert Muldoon’s “Think Big” energy industrialisation strategy which was intended to use the energy surplus that developed in the late 1970s to make New Zealand a significant player in the world energy: an ambition which failed, but here is a useful illustration of the persistence of the nation building vision.

This papers focus is on economic policy, and in particular the dramatic collapse of the nation building vision in the 1980s. This collapse did not necessarily occur in other fields. New Zealand’s commitment to a nuclear free territory was a continuation of a theme of an independent foreign policy which goes back to the 1930s nation builders who challenged the Italian invasion of Abyssinia in 1938 and made significant contributions to the development of the United Nations immediately after the war. The arts flourish, and while their practitioners take a vigorous interest in overseas developments, none of the greatest trees could be said to suffer a cultural cringe, even though they win international recognition.

The decisive change in economic direction – of the conception of what constitutes a national economy – could be demonstrated by listing various policies which had the effect of reducing New Zealand’s national economic autonomy – the effective abolition of foreign investment controls, border protection, and preferences for New Zealand businesses, and the selling of state owned businesses to foreign companies. There is not a comprehensive study of the degree of foreign economic protection but two statistics will illustrate the transformation. In the 1984 March year the difference between GDP and GNP, which is the part of total production which goes to foreigners was 3.7 percent of GDP. By the March 1997 year this proportion had risen to 8.0 percent, or more than double. [2] Secondly, the New Zealand Business Roundtable, the peak powerful organization for big business and the most vociferous exponent of the new economic policies, shifted from a group of chief executives of mainly New Zealand owned businesses (which were producing enterprises) in the late 1970s when it was founded, to members who are mainly CEOs of foreign owned companies today (and which are mainly financial enterprises).

The turn around is all the more puzzling because it was made by the fourth Labour government (1984-1990) whose predecessor first Labour government (1935-1949) bedded in the economic nation building which Coates was an exponent. Not that nation building was a solely left wing activity. While there is dispute where Coates is located on the political spectrum, the first great secretary of the modern Treasury, Bernard Ashwin, was undoubtedly a political conservative. Yet as Secretary, he was actively involved in the founding of the Tasman Pulp and Paper Company in the 1950s, which might be thought of as a (successful) precursor to “Think Big”, retiring from the Treasury secretaryship (he served from 1939 to 1955) to play a major role in the company. After retirement he objected strongly to the National Government’s sale of its interest in British Petroleum (NZ) in 1955 for essentially nation building reasons. [3,4]

Instructively too, while the Australian Labour Government (1983-1995) was pursuing similar policies if more moderately, one gets no sense of their betraying their commitment to Australian nation building to the same extent. (A more extensive version of this parer would illustrate the vision was widespread in the post-war era, especially among ex-colonies. What appears is unusual is that few – perhaps no other – retreated from the nation building vision as much as New Zealand did.)

It could be argued that the Labour leadership of the 1980s was as committed to nation building as its predecessors, but it ventured unknowingly down an economic policy strategy, which had the unforeseen consequence of undermining nation building. It is true that some of the Labour leaders maintained the rhetoric of nationalism, but it was largely in non-economic contexts. Rarely was national interest invoked in economic policy, other than in the platitudinous rhetoric that the changes would benefit all New Zealanders. (They did not.) That may be the key in economic policy terms. The intellectual foundations of the economic liberalisation which Labour adopted, largely on the advice of its public servants, was based on the (right wing version of the) standard economic model which had been primarily developed by US based economists. [5,6] While purporting to be a general model of all economies, it is riddled with assumptions which are peculiarly American, and which do not readily apply to New Zealand. It assumes that individual markets are generally large enough so economies of scale are unimportant and there are sufficient actual and potential firms to make each market competitive for practical purposes. It assumes that the national economy is a significant proportion of the international economy, and so is not subject to the external financial, price and political shocks that a small open economy such as New Zealand regularly experiences. It ignores that public choice theory, while purporting to be general, reflects the institutional political arrangements of the United States with its large population, its federal structure, its separation of powers although, ironically, the political strategy the New Zealand reformers used to implement their policies would be have been impossible in the US because of the very different political arrangements.

It would be easy to explain the use of the inappropriate model as intellectual laziness, grabbing the most readily available from the shelf, without considering its relevance to the local situation. Phillida Bunkle, currently an Alliance MP, has a more fundamental explanation.

… I met a large number of them [the future reformers] in the United States. They’re baby boomers, and they returned to this country with a vision that was very much gained from graduate school in the United States. They came home with a cosmopolitan[‘s] view of New Zealand. They were going to transform this society. Now they thought they had 1960’s student values, but they actually were very impressed by North America and its consumerism and its choice and civil rights and all that. They came back with that liberalized kind of vision. But it was also I think that they had a kind of sense of embarrassment about what a hick little place they had come from. They were in Chicago, they were in New York, they were in Harvard, and they were very aware that they came from `Hicksville’. And part of it was their awareness that they were products of the welfare state because what the welfare state does in New Zealand is bring in social uniformity. It is deeply egalitarian. People end up having the same social services. They were not very sophisticated. and what they were going to do – they were going to bring us into the global village. They were going to bring MacDonalds and all these wonderful slick things and transform `Hicksville’ into a sort of social paradise of the sort you would dream of in Cambridge, Massachusetts in 1968. [7]

Before discussing where this inferiority complex (the Australians call it a “cultural cringe”) it is worth taking the story of the reforms a little further. In terms of their overt objectives – better economic performance – the reforms failed miserably (other than in the squeezing out of inflation). [8] Table 1, which compares the performance of the New Zealand economy between 1985 and 1998 to Australia and Ireland, and to the OECD average demonstrates the unimpressive performance of New Zealand (other than in price stability) in the post-liberalisation period. Any shorter period, providing it is cyclically adjusted, gives the same picture, as do all the authoritative projections/predictions of future performance. The optimistic ones suggest the New Zealand economy will grow at the same rate as the OECD (but from a base lowered by the reforms) while continuing to depend upon an unsustainable current account deficit, financed by a private capital inflow. Advocates of the reforms, who only a few years ago were enthusiasts (typically after confusing a strong cyclical upswing following an exceptionally long contraction with a new secular growth trend) are today either bewildered or, at best, promising significant benefits some time into the future.

There are still a few who think the reforms succeeded, but typically their criteria is that the reforms were implemented, rather than the economic outcomes are better. Overseas, there are those who advocate liberalisation policies and use New Zealand as an example of the success of the policies they advocate. But they do not evaluate the outcomes either. (There is an odd symbiosis between them and the New Zealand reformers. Because of their inferiority complex, the latter require the plaudits of overseas commentators – I have seen them respond to praise from good, or even mediocre, “overseas experts” like puppies having their tummies tickled. So each group has an incentive to misrepresent the true situation to the other, and neither has an incentive to carry out a proper scientific examination.)

In one unspoken sense the reforms succeeded for they put a new elite in charge of the economy. In a just published, and very important, book Only their Purpose is Mad, Bruce Jesson calls this the “financial transformation” because the elite is now characterized by being business people primarily interested in financing rather than production. [9] We observed this earlier in the transformation of membership of the Business Roundtable. The transformation occurred partly because the reforms implicitly assumed that finance was at the core of economic decision making. But perhaps even more important, the resulting economic failure, coupled with the globalisation of the world financial system that was occurring at the same time, meant that there has been substantial capital inflows into the New Zealand since the liberalisation of the external capital account at end December 1984. Much of this has involved the purchase of equity in New Zealand businesses, including those sold by the government of New Zealand. Thus the financial community’s main function is to manage the finances of overseas investors.

Jesson is critical of the competence of many of the financiers. But in addition, and more fundamentally, he argues that they lack a sense of the history and culture of the land in which they live. This cannot have arisen simply from a failure of New Zealand to articulate such matters to its people. The vitality of the local artistic community is evidence enough that they have absorbed that culture, and used it powerfully in their creative activity. But the confidence of the New Zealand arts community to be able to do their own thing, and yet be of international standing, did not carry over to the modern policy community and the business community which benefited from the policies. Perhaps the failure begins with the dominance in New Zealand business schools of overseas staff, most of whom are not good enough to get comparable positions in their home countries. New Zealand business, economic, or financial graduates are thus poorly educated in the basics of their own history, culture and economy. From the beginning New Zealand is treated as something inferior, not conforming to the overseas model which is being taught as some ultimate truth. Thus the New Zealanders end up with the inferiority complex that Bunkle identified. Nation building policies got abandoned because they had no commitment to the nation in which they lived, and which nurtured them. Instead, they clung to some idealised model of very different economy, of which the United States economy is the closest living example.

Today the New Zealand business elite – the financial community – are but subordinates of overseas interests. The abandonment of nation building has strengthened the neocolonial status of New Zealand, exactly as Coates and his generation of nation builders feared. Recovering a significant nation building element in New Zealand economic policy, will not be easy, given the burden of foreign liabilities which dominate the nation’s balance sheet, and a continuing cultural cringe among the elite.

Go to top

Notes
[1] B. McClintock, “Gordon Coates and the Nation-Building State: 1920-1935” (Economic Department, Carthage College, 1999).
[2] This excludes retained profits of foreign owned firms. The SNA treats their profits as domestic income (since foreign owned corporations are legally local entities) until the profits are remitted. Thus the true proportions (i.e. are even higher, and probably the increase over the period is even greater.
[3] B.H. Easton, “Bernard Ashwin: Secretary to the Nation Building State”, New Zealand Studies, November 1997, p.13-21.
[4] B.H. Easton, “Ashwin, Bernard Carl 1896-1975,” Dictionary of New Zealand Biography: Vol 4, (AUP, 1998) p.21-22.
[5] B.H. Easton, “From Reaganomics to Rogernomics”, in A.E.Bollard (ed) The Influence of American Economics on New Zealand Thinking and Policy (NZ-US Educational Foundation & NZ Institute of Economic Research Monograph 42, Wellington, 1989) p.69-95.
[6] B.H. Easton, The Commercialisation of New Zealand (Auckland University Press. 1997)

[7] CBC Ideas program, “The Remaking of New Zealand” (first broadcast on October 1994).
[8] B.H. Easton, In Stormy Seas: The Post-War New Zealand Economy (Otago University Press, 1997).
[9] B. Jesson, Only Their Purpose is Mad (Dunmore Press, 1999).

Table 1 ECONOMIC PERFORMANCE: 1985-1998

	NZ	Aust	Ireland	OECD
Inflation	Private	Consumption	Deflator	(%p.a.)
1985	17.3	6.7	5.0	6.9
1998	1.3	1.9	2.7	3.3
Average 85-98	4.6	4.1	2.6	5.5
Inflation	GDP	Deflator	(%p.a.)
Average 85-98	4.5	3.9	2.7	5.4
Unemployment	(% of	Labour	Force)
1986	4.0	8.1	16.8	7.1
1998	8.2	8.1	8.9	6.5
Average 86-98	7.2	8.6	12.9	6.6
Employment	Growth	(%p.a.)
Average 85-98	0.8	1.9	2.2	1.2
GDP	Volume	Growth	(%p.a.)
Average 85-98	1.7	3.1	6.0	2.7
Labour	Productivity	Growth	(%p.a.)
Average 85-98	0.9	1.2	3.8	1.5
Export	Price	Change	(%p.a.)
Average 85-98	1.4	0.2	0.5	1.0
Import	Price	Change	(%p.a.)
Average 85-98	0.5	2.3	0.7	0.5
Terms	of	Trade	Change	%p.a.
Average 85-98	0.9	-2.1	-0.3	0.5
Export	Volume	Growth	(%p.a.)
Average 85-98	3.9	7.1	11.7	6.9
Import	Volume	Growth	(%p.a.)
Average 85-98	5.3	6.6	9.8	7.2
Current	Account	Deficit	(% GDP)
Average 85-98	3.7	4.8	-0.8	0.2

OECD Economic Outlook (December 1998). The New Zealand figures do not always correspond to the official figures, but are used here for consistency. The OECD consists of 28 economies. The 1998 data is estimated.
* G7 for unemployment.

Go to top

Constant Crises: It Is True – There Are More Of Them

This entry was posted in Listener, Macroeconomics & Money on 10th April 1999 by Brian Easton.

Listener: 10 April, 1999.

Keywords: Macroeconomics & Money;

The worldwide trend of financial liberalisation since the early 1980s seems to have resulted in more financial crises. These include currency crises, where the foreign exchange market is disrupted, forcing the government to change its exchange rate regime (frequently either changing the peg of the fixed exchange rate, or shifting to some sort of floating regime). New Zealand had a currency crisis in July 1984 when there was a fixed exchange rate, and so much conversion of New Zealand into foreign denominated financial assets that the Reserve Bank (which funded the conversion) became short of foreign currency.

There are banking crises, where the banking system is under stress, typically when the balance sheets of assets and liabilities of a number of banks are awry. It may be they are illiquid and are short of the cash to pay their immediate bills (but have enough assets in the long run to do so), or they are insolvent and their liabilities exceed their assets, so they could never pay all their bills. There has been no banking crisis here, unless one so treats the upheaval beginning with the collapse of the overseas Bank of Glasgow in 1878 (before the Reserve Bank was established in 1934). The resulting credit contraction led to our long depression of the 1880s.

There are bank crisis, where a single bank is illiquid or insolvent (There is a danger one could undermine public confidence in the entire banking system precipitating a systemic banking crisis). The illiquidity of the Bank of New Zealand at the end of 1990 was a bank crisis. There have been other bank crises, most famously in the nineteenth century.

Even if some politicians panicked, the BNZ bank crisis was a tiddler, costing less than 1 percent of GDP. The banking crisis in Mexico (1994-7) cost about 15 percent, in Israel (1981-84) 30 percent, and in Chile (1981-84) 41 percent, while the Argentinean crisis of 1980-82 cost a whopping 55 percent of GDP. Most countries have had a bank or banking crisis in the last twenty years. (Note the list does not include sharemarket or property collapses. Such a collapse can cause a banking crisis, when banks have too many of their assets in devalued shares or property.)

Currency crises can cause banking crises. Banks usually have some liabilities denominated in overseas currencies (they borrow overseas). If the value of the currency falls, the value of the banks’ liabilities rise, and the equity on the assets side may be wiped out, so the banks becomes insolvent. Prudent banks do not greatly expose themselves to foreign currency risk. However, when a government has been successfully maintaining a fixed exchange rate, the temptation is to assume that it will always be successful. That is what happened in East Asia, so when the various currencies devalued, the banks found themselves in difficulties. Worried investors subjected them to greater scrutiny, and there was a growing realisation that many of their assets were overvalued too.

The Thai baht collapsed in mid 1997 (see below). Currency ructions followed in other East Asian countries later in the year. The Russian rouble collapsed in August 1998, and the Brazilian real joined in a couple of months ago. None of these economies have yet really recovered, although some may have bottomed out. We are told that the current world financial crisis is over. Perhaps. I would wait at least a year after the last collapse before I was confident.

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

MEXICO 1994

Between 1988 and 1993 economic stabilization and reform in Mexico led to a sharp reduction in the rate of inflation, although it depended on a real appreciation of the exchange rate so import prices rose more slowly that domestic production prices. Not surprisingly, the current account deficit widened as exporters found the going more difficult and importers found it easier. There were huge inflows of speculative capital attracted by favourable interest rates. In early 1994 the flows reversed. Accounts mention the First Chiapas uprising and the assassination of presidential candidate Luis Colosio. Various economic and financial indicators looked weak before then, so the political events may have drawn attention to problematic fundamentals. International reserves fell rapidly. Interest rates rose. But the external deficit expanded to over 7 percent of GDP. Reserves continued to fall. By late December the authorities’ ingenuity defending the currency peg was exhausted, capital flight was severe, and the exchange rate collapsed from around 3.5 pesos to the US Dollar to 5.5 pesos. Banks depending on foreign loans were in trouble.

THAILAND 1997

Again there was a fixed exchange rate, and a real appreciation as Thailand inflated faster than its trading partners in the mid 1990s, in this case complicated by the baht being primarily fixed to the US dollar, which appreciated relative to the Japanese yen in whose area Thailand had important markets. The current account deficit widened – to about 8 percent of GDP in 1996. Speculative pressures built up from December 1996. Foreign reserves began to run down. Defensive measures proved ineffective, the baht was floated, and fell 42 percent against the dollar (after being stable since 1984). At which point Thai banks found they had too many liabilities denominated in US dollars.

Michael Bassett’s Review Of in Stormy Seas

This entry was posted in Political Economy & History on 31st March 1999 by Brian Easton.

Letter in New Zealand Journal of History@ 33, 1 (1999), p.134-135.

Keywords: Political Economy & History;

Michael Bassett’s review of my In Stormy Seas: The Post-War New Zealand Economy, opens with “[t]his book has had a bad press from economists and a business newspaper.” (NZJH Vol 32, No 2:222). I do not know whether he is referring to Joe Wallis in New Zealand Books, Keith Rankin in Political Review, or to David Mayes in The Economic Journal. If they are “bad” reviews, Bassett’s could only be described as “rotten”. Admittedly not all reviews have been as favourable, but with the exception of the business newspaper and Bassett’s they have not been ill tempered and unscholarly.

Bassett does not seem to understand the discipline of economic history. He says, “the nearest Easton gets to a primary source is a published departmental document. National Archives has splendid Treasury and Industry and Commerce files. With persistence one can access documents as late as 1986. … One would have thought that an economic historian would find such files meat and drink. Not so. Nowhere in Easton’s writings [sic] can I find more than an exiguous use of archival sources.” I mention in passing that I do use archival sources as those with familiarity of my writings on the Tiriti o Waitangi and on Bernard Ashwin demonstrates. Moreover, although Bassett seems unaware of the procedure, one can get archives well after 1986 by the use of the Official Information Act.

Bassett states that I believe that the “Rogernomes … dropped enough hints about a pending devaluation to create a foreign exchange crisis.” Not only would Bassett be completely unable to offer a single citation to support that I hold that view, for I do not, but in a work cited in the book I used official papers to show it is wrong. Even so, such archives are not the “meat and drink” of economic history, as any review of earlier New Zealand studies would demonstrate. John Condliffe, Gary Hawke, John Gould, and Colin Simkin use the standard economic models, to describe and evaluate the path of the economy and its consequences. To confine the discipline of economic history to official archives would not only redefine and limit the subject, but miss the point of what it is trying to do – to offer an account of how the economy evolves, not how a group of officials and politicians thought it was evolving at the time.

Relying only on archives has its limitations. Consider Bassett’s biography of Joseph Ward. Despite assiduous reading of the available archives, he made little sense of the economic context. Ward is portrayed as being a successful Colonial Treasurer and a less successful Prime Minister. Those familiar with New Zealand’s economic history know the economy went through a climacteric about the time that Ward changed roles, with an evident slowdown of the secular growth rate. The possibility, not addressed by the Bassett biography, is that the apparent deterioration in Ward’s political performance reflected the economic environment in which he was working.

Bassett’s makes no reference to the 120 odd tables and figures in the book, which might be useful to a numerate historian. His analytical understanding is extraordinary. One may but chortle at his coinage of “unreal exchange rates” (even if the book explicitly mentions the dangers of using the “real” in this way on page 17). He says he found the diagram on page 37 “unintelligible”. I have used the diagram in a number of learned papers, in Listener columns, and in numerous teaching situations, and that is the first time that adjective has been used. Bassett complains that “terms like `purchasing power parity’ .. are suddenly introduced.” The term is first used on page 11, with a brief description and an explicit reference to the main exposition on pages 19 to 21. I am not sure how one avoids introducing any new concept “suddenly”, but the import of Bassett’s comments is that concepts unfamiliar to him may not be used, reducing any exposition to a lowest common denominator of the New Zealand history profession. Even so, I dont understand how a LCD can so confidently state “there is a great deal of hocus pocus masquerading as economics.”

Finally, I must defend my publisher, the University of Otago Press. For the record the manuscript was read for them by two scholars. (In addition, it was earlier read in entirety by four other economists, parts were read by others, plus, of course, much of the material has been published in learned venues.) Bassett concludes “[h]ave we reached a stage in academia where anything goes? If so, it just might be the most serious outcome of the last 14 years”. I will not judge whether the worst thing to happen since 1984 has been my book, but merely suggest that MPs, and apparently some ex-MPs, do not always realise how pathetic the rhetoric of the parliamentary debating chamber sounds to those outside.

Weighing It Up: a Case for Government Intervention

This entry was posted in Business & Finance, Listener, Regulation & Taxation on 27th March 1999 by Brian Easton.

Listener 27 March 1999.

Keywords Business & Finance; Regulation & Taxation

Just suppose there was no government agency concerned with accurate weights and measures. How would you know that the `kilogram’ of the bananas you were buying weighed a thousand true grams? You could carry you own scales. Not trusting the draper when you want to buy two metres of cloth, better carry your own ruler. A few percent difference – the butcher’s thumb on the scales – may be the difference between profit and loss, between whether the customer gets a fair deal or is ripped off.

It is no surprise, then, that the first New Zealand statute was as early as 1846, based on existing British standards. The classical Maori had, of course, mathematical concepts of measurement, but they do not seem to have had standard measures. This was possible because their trading involved one-off (and often complex) deals. It would be like haggling at the supermarket counter over a bunch of bananas (moderated, in the Maori case, by the transaction usually being between relatives). As we moved to routine transactions, between people who do not know one another, and a seller who may not even own the product (a shop assistant for instance), trading standards became necessary. Many readers will be familiar with the fast food outlet caught selling underweight mashed spuds and coleslaw. It has been estimated that consumers were at least $4m a year out of pocket, from all the known instances of underweight. On the other hand a baker was unsuccessfully prosecuted in 1968 for his loaves being overweight. And while I have written thus far in terms of consumers, exporters also need precise international standards. (The International Metric Convention established an international bureau in France in 1875.) As technology becomes more sophisticated those standards have to be increasingly accurate.

“Metrology” is the name for the science of weights and measures. A witty book on the subject is The Sizesaurus, by Stephen Strauss, rich with idiosyncratic information. (What is the pressure of a shark’s bite? What is the air pressure required to burst a condom?) But the humour facilitates the serious purpose of explaining measurement. In an ideal world, every science student would have mastered the book before leaving school.

Systematic standards are a sort of oil which ensures the market transactions run smoothly. Without it we would have to carry our own standards when shopping, if we wanted to be sure of purchases because we did not trust the retailer. We have an example of reducing `transactions costs’, the friction in the market machine. Typically we leave competition to minimize transaction costs, just as we do for production and distribution costs. However, the private sector cannot always do so alone, and sometimes a public initiative (in this example the Trading Standards Service of the Ministry of Consumer Affairs) lowers the costs for the entire economy.

Another effective public facilitator of transactions are the courts. A good legal service means that contracts can be enforced, so there is the confidence to enter into them. This is starkly illustrated in those countries where it takes years to get a disputed credit contract into the courts. Hire purchase is limited, because traders cannot recover the goods if the customer refuses to pay. The way the law is structured is also important. A clumsy or ambiguous law may add to the costs of the transaction. On the other hand the law may provide cheap ways to resolve disputes – a small claims tribunal for instance. Even if you never have to use one, they are of advantage because you know you can enter into an honest transaction, and if anything goes wrong there is a redress mechanism. Similarly when the courts process credit failures efficiently, sellers can advance hire-purchase, confident that on the rare occasions when action is necessary, the matter can be resolved. We all benefit, including those who never fail on their debt commitments.

The Trading Standards Service is an example of those government agencies modestly operating away, yet vital for an effective economy. As with the courts and good law it provides a practical illustration that some sorts of intervention work.

*************
A New Microeconomic Policy Approach?

Such musings have led to a the argument that microeconomic policy should be based on the “Coase Normative Principle” (CNP – Ronald Coase was the economist who started us thinking about transaction costs). It states “organise the government’s interventions in order to minimize transaction costs.”

There are, of course, other reasons for intervening, such as distributional fairness, promoting social goods, limiting social bads, and seeking non-material social objectives, but the CNP especially applies to industry and consumer regulation. A strength is that it is not extremist for it neither supports commercialising everything, nor heavy public involvement. Since public intervention can add to transaction costs instead of reducing them, the CNP provides a rule which limits government involvement, as well as guiding where it may be appropriate. The CNP is not at the heart of today’s economic policy. Not yet, but one day it may well be.

Questions, Questions, Questions … for Macroeconomic Forecasters

This entry was posted in Listener, Macroeconomics & Money on 13th March 1999 by Brian Easton.

Listener 13 March, 1999

Keywords: Macroeconomics & Money;

Sometimes public comment on forecasts focuses on the statistics, and ignores that there ought to be an underlying account of the state of the economy. With the March quarter round of forecasts underway, it may be useful to set down the some of the questions that top forecasters are pondering.

We know the economy is an expansionary phase of the business cycle, but what sort of expansion? The main options are the expansion is driven by exports or it may be a domestic one. If the latter, with a big increase imports and insufficient exports, the current account deficit will look even worse.

What are components of the expansion? It might occur by the stock cycle (retailers and manufacturers replenishing their stocks); by an increase in public spending (a big one seems to be on at the moment; but it partly reflects oddities of statistical definitions); from an expansion in private consumption (perhaps induced by the July tax cuts); by an increase investment (additional productive capacity and/or extra housing); by additional exports (a lot of the value data we are seeing reflects higher prices from a fall in the exchange rate, rather than additional production). Forecasts with similar overall expansions may have different patterns for the components. So despite the apparent unanimity, they have quite different accounts of what is happening in the economy.

Why have we low inflation, despite a fall in the exchange rate? A lower exchange rate (around ten percent in the last year on some measures) means higher prices for imports (and for domestic products which are also being exported). That should appear in higher consumer prices. But consumer inflation remains low. Part of the explanation seems to be that the world price of exports and imports are falling too. Export prices have fallen further than import prices, which is bad news for exporters, for some of their exchange rate gains are only compensating for the parlous state of their world prices. But is the external price path all of the explanation? Are New Zealand firms squeezing their margins? Is it because of productivity gains, or are they cutting into profits? What would be the implications of lower profitability.

What are the sustainable growth prospects? Forecasting is about considering the fluctuations about a long term trend growth rate. Without one you cannot tell whether the upswing is rapid or slow, and whether the economy is overheating into a burst of inflation, or will struggle weakly along. The general view seems to be the growth rate of volume (or real) New Zealand GDP in the long run is about 3 percent p.a., much the same as the rest of the OECD. How did the forecasters come to this conclusion? Is there enough capacity and ongoing investment to enable the economy to grow at this rate? Will it be able to earn enough foreign exchange from exporting to fund the imports a sustainable expansion requires?

How are we paying for the expansion? While there is much comment on the low household savings levels, the big New Zealand savers are the corporations and unincorporated businesses. While a lot of big corporations are part or fully owned by foreigners, the rest of the businesses are mainly owned by the households, so their savings are a part of the nation’s private savings. But they are insufficient, given the large current account of the balance of payments deficit the economy faces.

Can we rely upon foreign investors to cover the gap between our foreign earnings and foreign spending? New Zealand is seen to be a safe haven for investors, so they put here some of the funds they withdrew from more risky East Asia, South America, and Eastern Europe. We have been lucky in the world financial crisis. Will that continue? If it does not, we could be a basket case to join the other areas.

How are we to interpret the latest pronouncements of the Reserve Bank?

Reforms, Risks, and Rogernomics

This entry was posted in Political Economy & History, Statistics on 5th March 1999 by Brian Easton.

Invited Presentation to the Jubilee Conference of the New Zealand Statistical Society, 5-7 March, 1999, Wellington.

Keywords Political Economy & History; Statistics;

Fabian ‘… unless you do redeem it by some laudable attempt either of valour or policy.’
Sir Andrew Auguecheek ‘An’t be any way, it must be with valour; for policy I hate; …”
Twelfth Night

Introduction

Thankyou for the honour of being invited to speak to the Jubilee Conference of the New Zealand Statistical Association. My associations go back only two-thirds of its history, but they are experiences and friendships I greatly value. Indeed, had there been an academic career path in social statistics, I may well have ended up pri

Invited today to talk on the relevance of risk in economics, one faces an overwhelming task because of its central role in so much of economics, I must be selective. Economics divides itself between the positive and the normative. The “positive” is essentially about the realm of the scientist, studying the world as it is. It includes the standard statistician’s activities of measuring, estimation, and hypothesis testing, together with forecasting where the purpose is to predict the world. The “normative” is essentially about the world of the policy-maker, of the world as it should be – of what could be done to improve it. Normative economics involves statistics insofar as policy makes use of positive economics. In addition, policy-making is about managing risk. That includes private policy decisions such as financial investment, as well as public policy, on which I shall focus.

My approach today is positive, and yet I shall talk about policy-making, for it is a part of human endeavour, and therefore susceptible to positive analysis by the standard tools of a social scientist. As it happens the average policy-maker’s grasp of statistical methods is limited, and much of what I have to say would normally go over their head. Even so, I am going to try to keep the presentation as accessible as I dare. In doing so I may tread on a few statistical prejudices. In particular, my approach will be primarily frequentist, although there will be a guest appearance from bayesian analysis.

The positive analysis of policy-making – what I have called “policy as process” – is not a popular activity in this country. Practical New Zealanders want to talk about what policy should be, rather than how it happens. A number of reviewers of my The Commercialisation of New Zealand complained that analysis of the recent reforms was all very well, but they wanted really to hear about the alternatives. As it happened, many chapters discussed policy options, because scientific method necessarily thinks about alternatives, about competing theories or, in the case of statistics, we need a null hypothesis to evaluate an alternative. In the book’s successor The Whimpering of the State: Policy After MMP I have been more explicit, both describing what I am trying to do, and by including a couple of chapters which discuss alternatives. Today, I am going to describe the statistical decision analysis which underpins both books, but is not presented in them because of the audience. Thankyou for giving me an opportunity to do so.

I am going to make some gross simplifications. The first is that I am going to ignore the rhetoric and the theatre – what Fabian and Sir Andrew might have called the “valour” – although it is never very far away from any policy story.

Second, I shall assume that the goal of policy is agreed. Divergences in goals are more common than are usually admitted, or are a clothed in a rhetoric of the “national interest”. For instance, the current case for lowering tax rates is really about increasing the share of disposable income of those on highest incomes, of altering the pattern of output by reducing further the share of public supplied goods and services and, even more fundamentally, of changing the balance in the national culture towards less community and more individuality. These are proper matters of political debate. Sadly, they are obscured in tax policy by rhetoric and theatre. (There, I told you we cannot easily leave the valour out of the story.)

The third assumption is that the underlying model is not contested. Typically it is, but I want to look at a situation where, say, a government agency has some agreed empirical and theoretical model underpinning its advice. In fact often there is no attempt to think through a systematic model.

Even suppressing valour, goal disagreement, and contestation, there remains serious issues. The discipline of statistical decision analysis is one of the best ways to explore it.

Risks in Policy Advice

Suppose, to keep it simple, there are two policy options, the “no change” policy – keeping the existing policy – and the one being advocated. I will label no-change as “N” (statisticians will automatically think of “Null”) and the advocated one as “A” (as in “Alternative”).

Following tradition, we represent the objective by a parameter, called θ. In summary the advice favours option A over N because, because the policy-advocates believe:

θA > θN. … (1).

Now suppose the minister receiving the advice was well trained in inferential statistics. He or she would begin by noticing that the θ were forecasts consequential on the policy option chosen, and observe that the typical policy document only implies Equation 1, without giving specific estimates. The minister might ask for the actual estimates of θA and θN, or just θA-θN. This is likely to cause a bit of a flurry in the advice agency because it often has no estimate, merely claiming things will get better under A compared to N. But supposing there was. The minister would then ask whether the forecast difference applied for every situation. Probably the officials would say something like: “the actual outturn depends on the circumstances. The provided figures are an estimate of the average improvement as a result of the adoption of the alternate policy.” So they are not saying Equation 1 at all, but

E(θA) > E(θN). … (2).

The Minister, no doubt smiling to her or himself, would then point out that the forecast of the effects of the advice was a probability distribution, and they were simply reporting the mean of this distribution. Why the mean?

Now I happen to have a client who is debating whether they should forecast the mode, median, or mean. The usual justification for the mean, especially if the underlying distribution is asymmetric, is that the loss function is quadratic. I doubt most politicians have a quadratic loss function – its is probably not even symmetrical. If θA-θN is negative, the government will suffer much more grievously than if it is positive. That is the nature of the rhetoric, although it is partly the politicians’ own fault, because they sell their policies as though there will always be a positive gain. When was the last time you heard a policy advocate admitting their policy could go wrong?

Our statistically trained Minister might accept that elaborating the entire distribution of θN-θA was an excessive challenge, but still ask what was the probability that it could be less than zero, which is important given the penalties politicians carry if they are wrong.(1) In practice such questions are rare, although even the most bumbling minister might ask the likelihood that the proposed policy will result in deterioration from the status quo. That is:

“What is P(θA-θN < 0)”?

There are various responses to such a question. Often theory is used to claim there will be always be a positive increase. I wont go through the general analysis but briefly illustrate the claim with the free trade debate. It is a well established economic theory that under certain production and consumption assumptions – and providing full employment is maintained – the introduction of free trade increases total welfare compared to if there had been barriers to trade. The theory does not predict how large the increase is. When New Zealand economists tried to measure the benefits of free trade in the 1970s they found increases in GDP of less than 1 percent.(2) While the mean increases may be small, the theory seems to say the gains from trade are never negative.(3) Advisers relying on this theory often conclude there are never net losses. But even in the case of the trade policy debate, the assumptions of the theory do not always apply. To be certain there will always be gains, may require ignoring the possibility that reality does not match the theory.

Risks and the Tight Prior

This ignoring of reality became exceptionally exaggerated in the reforms of the 1980s. The key paper here is by Melvin Reder, a Chicago professor of economics writing about the methodology of the Chicago School of Economics which underpinned much of the thinking of New Zealand policy advisers in the 1980s.

As befits some of Reder’s scientific contributions, I shift from classical to bayesian inference. Recall that bayesian inference begins with a prior distribution which melds with new information to give a posterior distribution. It is not hard to see this happening in policy advice. The advisers start off with some previous view of the situation (a theory in the Popperian sense), which they combine with new information to get the distribution of θA-θN, on which they base their policy advice. Thus the advice is a mixture of prior theory and evidence, and the prior distribution influences the posterior distribution. A parameter of the prior distribution which markedly influences the posterior is its standard deviation.

Let me illustrate this by supposing we are trying to estimate the mean of the distribution. Suppose the mean of the prior distribution is 10 say, and the new observation is 1. From this information we cannot tell what will be the mean of the posterior distribution. Suppose the variance of the prior distribution is such that 95 percent of the distribution lies between -10 and +30. Then the posterior distribution mean may well be close to the 1 observed from the new evidence. On the other hand, if the 95 percent range for the prior distribution is between 9 and 11, the posterior distribution has a mean much nearer 9.

Reder argues that Chicago School method involves a “tight prior”, that is the prior distribution has a narrow standard deviation.. That means the posterior distribution will be close to the prior distribution, and the theory will dominate the evidence. Transferring the methodology to policy advice, as occurred in the 1980s, a tight prior means the theory rather than evidence will dominate that advice. If, the theory assumes that θA-θN will always be positive, then so will the posterior. Even a shrewd minister, asking for the probability of the downside, could be misled and, presumably, astonished later when the policy outcome proves negative. Despite being told

P(θA-θN < 0) = 0,

very often the outturn is

θA < θN.

We may also that the estimate of E(θA) – E(θN), the mean differences between the policies, is almost certainly biased upwards, a revelation of little comfort to the minister.

We can now understand two features of the post 1980s period. The first is there was a collapse in the quality of empirical work in economics. Certainly there were some who continued to work away, often maintaining high quality, but their role in economics was downgraded. Instead, extraordinarily thin pieces of statistical work were promoted, because they were consistent with the tight prior. The point is that under a tight prior methodology, empirical work does not change the advisers’ minds much: like the drunk with a lamppost it gives support rather than sheds light. Indeed evidence that contradicts the theory is best ignored, it has no effect on the posterior distribution.

Second, we can see why so many of the policies failed. It was not just the theory was wrong, because normally a bad theory gets improved by the facts. But under the tight prior, the theory would not be modified by evidence which contradicted it.

This is well illustrated by the health reforms, based on the proposition that commercialisation would be beneficial. Evidence and expertise to the contrary was ruthlessly ignored. As late as the 1996 Treasury Post Election Briefing showed the graph in the appendix and stated “there does not appear to be a close relationship internationally between total spending per capita and … life expectancy …”(4) In fact, with one exception, the graph shows a plausible positive relationship. Countries which spend more on health tend to have higher life expectancy (although one may not cause the other). The outlier is the United States, well known to be peculiar, for its extensive use of commercial health care delivery, which has proved extremely expensive and inefficient. Americans appear to get little extra benefit from higher health spending. The 1996 Treasury PEB overlooked the obvious, because it was inconsistent with its theory.

So there are two weaknesses of a policy based on a tight prior methodology. It leads to badly designed policy advice, while policy failure does not lead to the revision of the policy. Basically, as argued in detail in my two policy books, Rogernomics with its lack of attention to reality and its suppression of dissent was a high risk strategy. If it succeeded the gains would be great. But when it failed the losses are painful.

Risk and Uncertainty and Safety Margins

Not only was the commercialisation policy methodology flawed, its underlying probability assumptions were problematic. To begin with the economists’ distinction between uncertainty and risk. For an economist, risk involves a knowledge of the probability distribution of the event under consideration, uncertainty does not. A strict bayesian may deny that such a distinction exists, but allow me to avoid this dispute by suggesting that uncertainty is where the knowledge of the relevant probability distribution is so meagre it is, in effect, unusable.

An important implication of uncertainty is to that the relevant decision rules are from game theory. Sometimes, the policy framework designs a system where certain possibilities are totally ruled out. For instance, for reason of child safety, the size of the parts of very young children’s toys have to be larger than that which they could swallow. Perhaps the decision analysis could be put into a probabilistic framework, but it is not.

There is an intermediate stage between risk and uncertainty. Normally we think of the tails of the distributions are “thin”, converging at the same rate, or less, than the normal distribution. That means one can use standard probabilistic decision analysis. Major deviations from the centre of the distribution are unlikely and the expected costs are small. However Benoit Mandelbrot has pointed to distributions which are thick tailed, converging slower than the tails of the normal distribution. In a recent Scientific American he discusses “10 sigma” storms in financial markets.(5)

“According to portfolio theory, the probability of these large fluctuations would be a few millionths of a millionth of a millionth of a millionth. (The fluctuations are greater than 10 standard deviations.) But in fact, one observes spikes on a regular basis – as often as every month – and their probability amounts to a few hundredths.”

He goes on:

“The discrepancies between the pictures painted by modern portfolio theory and the actual movement of prices is obvious. Prices do not vary continuously, and they oscillate wildly at all time scales. Volatility – far from a static entity to be ignored or easily compensated for – is at the very heart of what goes on in financial markets.”

Modern portfolio theory underpins much economic analysis outside financial markets and thereby much policy thinking. For instance the recent electricity market reforms should handle adequately two sigmoid disturbances, but they may not handle higher one. If Mandelbrot is correct we may see more systems breakdown than the minister and advisers might expect. Throughout the economic system is built in surplus capacity. Mandelbrot’s analysis raises the raises the possibility there is insufficient when we shift from the traditional rules of thumb to analyses based on portfolio theory. I shall to be less ambitious than Mandelbrot and look only at four and five sigma crises. For daily fluctuations which are independently normally distributed, they occur between once a decade and once a lifetime.

Consider an accident and emergency service in a hospital. The number of arrivals in any period cannot be exactly predicted, but it conforms to a statistical distribution which can be analyzed. Because most observations are around the median, rather than in the upper tail, that has to be estimated under somewhat stronger assumptions than the middle of the distribution. Under financial pressure, the hospital reviewing its A&E service, might conclude that the on-duty team can be reduced, say, by one doctor (and associated nurses). There will be a bitter dispute between the staff and management. Suppose management prevails. Most of the time the on-duty team will function adequately, although under greater stress than in the past. However, the safety margin has been reduced, and when the fourth or fifth sigma disturbance occurs – perhaps more often than once in a decade or a lifetime – there will be no capacity to cope with every emergency. The possibility is that, literally, someone will bleed to death, because the doctors are so busy with other patients they cannot attend her or him. That may have actually happened at the Christchurch Hospital A&E service. Certainly the Stent report leaves the impression that safety margins were cut back excessively, which may have contributed to unnecessary deaths.

Excessive waiting lists are riddled through the hospital system. The fire safety reforms would have had the effect of reducing the fire brigade’s service to the private dwellings. There are parallels in physical infrastructure such as for energy, transport, water and waste water disposal. Here again the safety margins have been cut back. Generally, capacity is not actively reduced. But as demand rises there is a need to augment capacity. That can be expensive (especially if interest real rates are high) and the margins are squeezed. Under commercialisation we would expect four and five sigma crises to happen more often, especially where demand is growing fastest, for there safety margins are undermined fastest. So we should not be surprised at the energy and water shortages that Auckland city faces. Slower growing urban areas may eventually follow suit, and similar crises may occur in transport, waste-water and other parts of the infrastructure.

The Public Attitude to Risk

What is going on here is the commercialisers promised higher economic growth, but they were doing so, in part, by trading off the safety margins. They failed on the economic growth front, but the safety margins were cut anyway. It is not clear that the public wanted this tradeoff – they were certainly not consulted. The jargon talks of “public sector risk management”, but in practice it is a risk shifting from the public to the private sector. To compensate for the expected public sector failure, the individual has to pay for extra capacity in various ways – additional supplies, insurance, willingness to tolerate queues. Often it is not even clear what the individual can do privately to ensure an adequate safety margin. Health insurance does not in general purchase A&E capacity, while the dwellers of downtown Auckland were not in a position to put in an extra power cable.

In the past the government covered New Zealanders for uncertainty – for the thick tail. It did so by providing a safety margin, or by taking action when a four or five sigma event occurred. That increasingly no longer applies. Yet most New Zealanders still expect such actions from their government. A recent example of failure was the sluggish response of central authorities to the tropical cyclone which struck the Hokianga earlier this year.

There is a realism behind the public’s assessment: if you are out the back you do not expect as good A&E care as in the middle of Auckland, although the closure of the Taumaranui hospital service left many people dismayed. This weekend’s high country snow in the South did not have those affected saying the government ought to have stopped the outages. But they did expect some improvement in response since the last big snow fall, thirty years ago.

Abraham Maslow constructed a well known “hierarchy of needs”:

– Top
– need for cognitive understanding;
– need for self actualization;
– esteem needs;
– needs for belongingness and love;
– safety needs;
– physiological needs.
– Bottom (6)

The bottom need is the material one that economics policy is primarily about. It is a foundation for, but not the ultimate end of, human existence. As it is adequately satisfied the higher needs in the hierarchy become increasingly important. The Whimpering of the State argues that government has limited contributions to the higher needs, but in the case of New Zealand, commercialisation often undermined them. A good example is the one I have just demonstrated: the undermining of safety needs.(7)

Conclusion

Where does that leave us? I have not wasted your time today by arguing that the reforms have largely failed. With a few minor exceptions – inflation and the way the rich have benefited – that failure is now widely recognised. At issue is why they failed. Today I have not argued the commercialisation theories of rogernomics were wrong – I have done that elsewhere. Rather, I have argued that the policy process which instituted them was fundamentally flawed, a point elaborated in my two policy books. Today, I have used the statistical decision analysis paradigm to show some ways in which the policy-making was flawed. But in truth, as the books argue, the fundamental problem was an antagonism to the scientific approach.

I hope this paper has perhaps reaffirmed, perhaps extended, your belief in the usefulness of the statistician’s craft in the policy process. Most of us will not be attending the centennial conference in 2049. But one hopes there will be papers at it which will demonstrate a strong input by the statistics profession into the overall public policy process in the next fifty years, just as it has contributed so successfully in the detailed practical level in the last.

Notes

1. It is interesting to speculate what probability of failure would be acceptable to the average politician, not to mention what the public would think if they knew the critical level of this analogue of a Type I error.
2.Easton (1980).

3. You may ask why then is there such a fierce debate over protection. Despite the rhetoric of increasing output, it is actually about the distribution of output between factors such as labour, capital and land. Factor shares are much more variable under different protections regimes than is aggregate output.

4. p.98

5. See cover feature of February 1999, and letters in June 1999.

6. Maslow (1954:147-150)

7. It is intriguing that there is considerable concern across the political spectrum for the safety needs of law and order and of defence – which must be about a five plus sigma disturbance, while the economic health and related safety needs that are being undermined.

Hands Together

This entry was posted in Growth & Innovation, Listener on 27th February 1999 by Brian Easton.

How to Get Manufacturing and the Rest of the Tradeable Sector to Grow
Listener 27 February, 1999

Keywords: Growth & Innovation;

“Deindustrialization” describes the process whereby the manufacturing sector grows more slowly than the rest of the economy. Almost all rich OECD countries have experienced deindustrialization in the last three decades. Including New Zealand, whose manufacturing sector’s contribution to production decreased from 24 percent of GDP in 1974 to 18 percent in 1993. (The employment share fell from 27 percent of the labour force in the 1960s to 17 percent in 1993. The sharper employment fall, here and in rest of the OECD, reflects the faster rise in manufacturing productivity.)

Perhaps surprisingly for a country that thinks itself rural, the relative size of New Zealand’s manufacturing has been similar to the OECD average. It is true that we lack some of the most prestigious industries – jet aircraft, computers and specialised steels – while our factories are often smaller than their international equivalents. However we have had a large food processing sector – dairy factories and freezing works – which, competing against protected overseas equivalents, is usually larger and more efficient.

Deindustrialization is relatively new to New Zealand. Manufacturing’s has provided a fairly constant quarter of GDP since the 1920s (our earliest data), through to the early 1980s. although its composition changed. But since 1984 New Zealand has been deindustrializing faster than the rest of the OECD (despite the “Think Big” expansion of the petrochemical industry based upon processing Maui gas). This is partly a result of the major reduction in tariffs, and import licensing, export subsidies, and other interventions which supported the sector. But probably more important, the high real exchange rate made exporting more difficult and importing easier, so the sector has found it difficult to invest and expand.

Does this relative decline matter? In most OECD countries other industries have expanding to create the production and jobs to offset the diminution of the manufacturing sector. The big expansion is in the lower productivity service industry, which ranges from fast foods to medical care to leisure activities. Another big expansion has been the finance business sector, although I find this a little puzzling since once upon a time each worker in that industry serviced fourteen workers in other industries. Now they only service six. Other evidence suggests financial sector productivity is decreasing.

But unlike most of the service sector (the big exception is tourism) the manufacturing sector earns foreign exchange (or saves it by displacing imports). It is not, for primary industries are also a part of the tradeable sector. But as the foot note shows, the agriculture sector has also been diminishing in relative size. The other primary foreign exchange earners (including fishing and forestry) are not filling the gap. Not surprisingly then, New Zealand is finding it increasingly difficult to earn the foreign exchange it desires to pay for its imports, evident in the large current account deficit the economy faces (of about 7 percent of GDP).

The macroeconomics is more complicated than just requiring manufacturing and the other tradeable industries to grow to in order to fill that gap. However, unless these industries grow faster than the economy as a whole, any other measures will fail, or do so only by a major contraction of the domestic economy, which would mean lower living standards and rising unemployment. Conversely a larger manufacturing sector means more jobs. If manufacturing was as relatively large today as it was in the mid 1980s, it would employ about another 100,000 workers, reducing the unemployment queue. In addition their purchasers would generate jobs elsewhere in the economy.

So how to get manufacturing (and the rest of the tradeable sector) to grow faster. The Irish experience shows that a shrewd industry policy can assist. On a recent visit here, the feisty Mary Harney, Irish Deputy Prime Minister and Minister of Trade, Enterprise, and Employment, described the extraordinary success of the Irish economy. In part there is the advantage of being close to the European Union. But they have also pursued policies quite different from ours: a sound open-economy macroeconomic policy, a wages accord, a venture capital fund, strong regulation of competition, an emphasis on technical education, research, and responding positively to industry problems. It was a hands-together rather than hands-off approach to industry policy. In contrast we abandoned our car tariffs, without anything to replace the production, other than financiers to borrow to cover the increased external deficit.

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

LOOSE CHANGE … The Farming Sector Too.

Just after the First World War, the farm sector contributed 30 percent of GDP. Today it contributes about 5 percent. While its share steadily declined between 1920 and 1985, like the manufacturing sector, the decline has been sharper thereafter.

It is harder to trace trends in farming production, because its production gets so affected by the weather, but the impression is that farming has suffered proportionally more than manufacturing. (Like the “Think Big” boost that manufacturing got from the pre-1984 policies, farm output is higher because of the horticultural sector subsidies.) This suggests the manufacturing sector decline is mainly the result of macroeconomic policy, rather than the loss of its interventions.

Whatever, the farm based New Zealand economy has disappeared, into one which is more diversified, but at the cost, apparently, of wastelands and unemployment.

His Purpose Is Clear: Reflecting a Life Of Thought and Experience

This entry was posted in History of Ideas, Methodology, Philosophy, Listener, Political Economy & History on 13th February 1999 by Brian Easton.

Listener: 13 February 1999.

Keywords: Political Economy & History;

It was perhaps inevitable that Bruce Jesson, growing up in the Canterbury of the 1950s with a freezing worker father, would study Marx. Christchurch is often said to be our most class conscious city. Actually, all our big cities have acute class differences. In Wellington it matters whether you are a political insider or an outsider; in Auckland the measure is money. Because Christchurch does not have the politics or the easy money, its differences are more evidently social status.

Marxism is often applied as an unthinking ideology, generating slick answers. (The New Zealand Right is guilty of the same laziness.) However it can be used as a powerful framework to analyze social, political, and economic phenomena, providing a different penetrating perspective from the conventional wisdom. (The best short summary of marxism is “it’s the economy, stupid,” that is economic behaviour explains many political and social phenomena too.)

Bruce is New Zealand’s best marxist intellectual. Not for him the colonial cringe which has dominated policy for two decades. Recognizing the dependency status of New Zealand made Bruce an early proponent of republicanism. This was not simply replacing the Queen with a president. That is symbolic of a wider issue. In any case an independent New Zealand is only part of the prescription. True republicanism involves a society in which no man or woman is socially superior – a society in which there are no classes, which is an egalitarian democracy.

Graduating in law, but never practising as a solicitor, for that involved an oath of allegiance to the Queen, Bruce shifted to Auckland, as a part of a companionate and affectionate marriage with Jocelyn. For most of the 1970s he was a househusband caring for their two daughters, while Joce taught. But he also produced an extraordinary periodical “The Republican” (recently amalgamated with the “Political Review”). Originally gestetnered and consequently difficult to read, Bruce’s articles and editorials were insightful, well researched (he would spend weeks down at the companies office, sifting through files), and thought provoking. In the early 1980s, Warwick Roger snapped him up as the “Metro” political commentator. Although Bruce today describes his profession as journalist, he is really an intellectual without an institutional base, one of New Zealand’s few – and most important – independent scholars.

He began to investigate the Kerridge-Odeon cinema chain, moving on to Fletchers. This lead to a small book The Fletcher Challenge, which developed into the highly successful, and seminal, Behind the Mirror Glass, a shrewd investigation of the financial boom of the times. Bruce was not surprised by the 1987 share-market collapse. There has been no better observer of the Auckland business scene.

In 1989 he turned from Auckland to Wellington with his timely Fragments of Labour, which came out just as Prebble was sacked from the Labour cabinet. The study is not just an account of the collapse of the Labour governments, for there is an underpinning notion of the `historic compromise’ in which business gave up some of its freedom in return for labour moderating its demands for socialism. The compromise’s breakdown in the 1980s, and the increasing colonialization of New Zealand, led to Bruce taking the unusual course, for a New Zealand intellectual, of joining a political party: first NewLabour, subsequently the Alliance. With hindsight he may have regretted that decision, for it limited his independence as a commentator. But when as Alliance candidate he was elected to chair the Auckland Regional Services Trust (ARST), he gained crucial experience by observing a financial corporation from the inside.

(ARST were instructed that the Yellow Bus Company be privatised. Bruce delayed, arguing there was conflict in the law. His letter to the minister hit the too hard basket. So the ARST did not sell the asset for the $35m expected. Over the following years ARST received dividends about equal to the expected capital sum. This year the Company was sold for $111.6m. Auckland’s infrastructure will benefit from Bruce’s delaying tactics. The Second Harbour Bridge should be named after him.)

His latest book, to be published shortly by Dunmore Press, Only Their Purpose is Mad, brings together his reading, observing, legwork, and insider experiences. It is a vigorous indictment of the financial sector, arguing that although it is competent, the outcome of that financial competence is detrimental to the interests of New Zealanders. As it currently functions, the finance sector does not benefit the economy, but damages economic growth and social welfare, and increases dependency. The thesis is closely and lucidly argued. The book is one of the major analytical studies of rogernomics and the finance sector. Being doubtful about the financial sector is common today. The book provide facts and analysis which can convert gut reactions into a coherent understanding.

Despite his being one of our few genuinely original thinkers, there may be no successor to this book, for his next book on contemporary New Zealand politics may not get finished. He has terminal cancer. Even so his ideas – his spirit – will reach out to us long after his body is gone.

Tales Of Soes: a Review Of Books About Corporatisation

This entry was posted in Business & Finance, Listener on 30th January 1999 by Brian Easton.

Listener 30 January, 1999.

Keywords: Business & Finance; Governance;

One of the great upheavals of the 1980s was the `corporatisation’ of the state owned enterprises (SOEs). Following widespread concerns in the late 1970s, the 1984 Labour Government reorganized the government’s businesses into private corporations in every aspect except that the shareholders were a couple of government ministers. As many as seven major studies have been published on corporatisation. What can we learn from them?

Two books are about Forestcorp. Out of the Woods (Reg Birchfield & Ian Grant), commissioned by the company, seems to have been a `get-Treasury’ exercise. It fails because while citing official papers, there is no referencing, so there is no way of checking them. (In my experience many people have difficulty interpreting official documents, especially if they come with a particular predisposition.) A Century of State-Honed Enterprise is a celebration of state plantation forestry. Written by Andy Kirkland and Peter Berg who were closely involved in Forestcorp’s corporatisation and privatisation, it combines pride with sadness the era has ended.

This book, with Vivienne Smith’s Post Office story, Reigning in the Dinosaur, are the two best (and well illustrated) reads. Yet for all its interest, anecdotes and achievements, Smith spoils the book with her last sentence, which skites that the Post Office had been awarded a AA+ credit rating. Such things are a means to an end. What is really pleasing is that we still getting good service at a remarkably low cost.

The Power to Manage (Barry Spicer, Robert Bowman, David Emanuel and Alister Hunt) is one of three books from the Auckland University School of Business and Economics. It arises from a Treasury funded study to assess the creation of Electricorp. The approach is based on accounting, management theory, and historical anecdote (some of which is revealing, although not necessarily in the way the authors intended). Like most of these studies it is greatly enamoured with the outstanding competence of the men who ran the new enterprises (there were hardly any women). And it provides detailed financial performance indicators which show significant performance gains.

The theme of The Remaking of Television New Zealand 1984-1992 (Spicer, Michael Powell and Emanuel) is nicely illustrated by the book’s cover which looks like a corporate annual report. Again there is considerable detail about the changes. All the reviews I saw of this book were unfavourable, typically written by media experts who were furious that so little regard was paid to the impact of the corporatisation on the quality of the TV programs. This is nicely illustrated by the conclusion which lists achievements such as improved profits, market share, and share of local programming. But the critical issue for the average TV viewer, whether programming content is any good. One recalls a 1960 satirical group called `The Rubbishers’ who when evaluating children’s books, looked at every aspect – wearability, tearability, affordability, washability – except the content of the book, against which the matters investigated were trivial. It takes more than double entry bookkeepers to run a TV station, but the reviewers should surely have found the book enlightening as to what happens when they try.

The three authors makes a parallel mistake in their Transforming Government Enterprises, which looks at Electricorp, TVNZ, Coalcorp, Workscorp and the Government Computing Centre. in the same manner but with less detail as the previous two books. They conclude that there was an improvement in the SOE’s `economic and financial performance.’ However economics is not the same as accounting, and they markedly fail to evaluate the economic issues.

This was probably a consequence of the three studies’ commissioning agent, the Treasury. The same problem applies to economists Ian Duncan and Alan Bollard’s Treasury commissioned study on nine SOEs, published as Corporatization and Privatization. Restricted to looking at the individual firms they could not assess at the overall economic impact. For instance, the corporatised industries seem to have dumped around 40,000 workers (according to some data prepared by Bryan Philpott). It matters a whole lot whether those workers were reabsorbed into employment, or whether they remained unemployed (or displaced other workers who became unemployed).

We may not be able to answer that question. But as the TVNZ case illustrates, an enterprise’s purpose is important. It may not be captured by accounting measures. A retired Secretary of the Treasury said the studies they commissioned misled in regard to the likely success of corporatisation of public hospitals, where the concern is health care not profits. In summary there is a lot of evidence that the corporatisation of SOEs gave some benefits, especially in financial productivity, but there is very little that there was an overall benefit to the economy.

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

None of these studies really address privatisation, although the Auckland academics keep leaping to the conclusion that privatisation is warranted, without any evidence except a thin theory (which is often contradicted by fat facts).

One is reminded of a story told by MP Rodney Hide’s friends. Apparently Hide’s lectures could be as riotous as parliament, and the students were having trouble throwing their various missiles into the wastepaper basket. Asked what he would do about, Hide is said to have avoided the obvious solutions such as stop throwing missiles or get a bigger bin. His solution was to privatise the university. If privatisation is the answer, very often one has misunderstood the question.

***************
KERR’S RETREAT

Note Roger Kerr commented on the article in a letter to The Listener (22May 199). My reply in the column of 19 June 1999, was as follows.

Roger Kerr, executive director of the Business Roundtable, seems to be backing down from the extremism of his rogernomics. Once it was insisted that all government businesses should be privatised because all would perform better in private ownership. We are now told that this was true only on average. That means some businesses perform better if they were retained in public ownership. An able government would retain those that operated better in the public domain. However, Kerr still claims that a range of studies demonstrate that on average and over time privatisation is better. Another range of studies comes to the opposite conclusion.

Kerr and I would probably agree there are no studies which show a national benefit from underpricing state assets which are privatised, as the New Zealand government has done (including, by the Minister’s own admission, Contact Energy), nor using the proceeds to pay for temporary tax cuts as occurred in the past, and as some still advocate.

The Soros Manifesto

This entry was posted in Globalisation & Trade, History of Ideas, Methodology, Philosophy, Listener on 16th January 1999 by Brian Easton.

The Endangered Open Society Propels an Urgent Plea For World Financial Reform
Listener 16 January, 1999.

Keywords: Globalisation & Trade; History of Ideas, Methodology & Philosophy;

One of the more bizarre events of the late 1980s was the right wing think tank, the Mont Pelerin Society, holding a conference in Christchurch in honour of philosopher Karl Popper. The approach – one would hardly call it a philosophy – of the majority of attenders was an anathema to Popper. Especially Roger Douglas, whose paper reported his infamous blitzkrieg policy implementation principles, in which democracy is over-ridden, in the total certainty that his policies were correct. Popper would have been interested in the extent that the policies worked – they have not – but Douglas’s unwavering certainty in the truth of his vision would be totally unacceptable. For Popper knowledge is fallible. One constantly reviewed one’s hypotheses to judge their truth. Scepticism is at the heart of his approach, not ideological belief. Douglas’s paper was the equivalent of devil worship in the Popperian church.

Fortunately Popper has genuine followers. Alan Musgrave, professor of philosophy at the University of Otago, was Popper’s research assistant for many years. I strongly recommend his post-popperian Common Sense, Science and Scepticism as the best introduction to the theory of knowledge (epistemology) I have read. Popper’s best known supporter is financier George Soros whose has just published The Crisis of Global Capitalism. He was writing the book at leisure, but the financial turbulence of the last eighteen months converted it into an urgent plea for world financial reform. This thriving speculator argues that financial speculation needs to be controlled. He seems to be saying “stop me from being so successful.”

Despite being an important philosophical issue, I skip past the book’s initial focus on the puzzle of the problem of social knowledge. Soros goes on to argue his financial decisions are influenced by Popper’s philosophy. He reports his mistakes, which makes a welcome difference from our politicians and businesspeople. (It is easier to make such admissions, when one’s successes outweigh them. Soros’s Quantum Fund took on the British pound in 1992, and won. Recent successes include against the Hong Kong dollar and the Malaysian ringgit. The book has a rivetting account of the Russian crisis of August 1998, based on Soros’s diary.) He also uses a popperian approach as a part of the investment strategy. The greater the divergence between his hypothesis and the conventional wisdom, the greater the risk but also the greater the potential profit.

Soros especially dislikes “market fundamentalists”. We would call them “rogernomes” or “economic rationalists” – or true believers. Leaving aside his epistemological concerns, he worries that their focus on monetary values and transactional markets do not provide an adequate basis for social cohesion. Ultimately they are hollow men. Moreover the fundamentalists are opposed to interference in their cowboy ways (except when they foul up, and anxiously demand a government bail out). Soros believes that there is a need for regulation of the world financial system, to prevent global financial capitalism destroying itself. While the opposition to such reforms is usually attributed to nation states unwilling to reduce their sovereignty, the reality is that the financiers use states as a front to resist interference. The logic of the Soros position is that we will have to have a thumping world crisis to get the required reforms. The financiers appear to be doing their best to induce one.

Soros, a refugee from Hungary and thence the closed British establishment, celebrates the open society which accepts human fallibility which it seeks to improve. (The Soros Foundation contributes almost as much as the European Union for the transformation of Russia to an open society.) It is a long way from that proposed by the market fundamentalists with their unique insight to the truth, which they impose on the rest of us, in a manner not too different from the authoritarian regimes which Popper opposed when in Christchurch, as he wrote The Open Society and its Enemies.

Richard Thaler’s Savings Principles

This entry was posted in History of Ideas, Methodology, Philosophy, Retirement & Savings on 7th January 1999 by Brian Easton.

From The Whimpering of the State: Policy after MMP p.75

Keywords History of Ideas, Methodology & Philosophy

People do not behave with the rationalism of the economic theory on which commercialisation was based, especially over their savings. The standard economic theory of individual behaviour is contradicted by the evidence of irrationality (or ‘quasi-rationality’).(1) In practice, as has been attested by numerous studies, the major predictions of economic rationalism fail.(2)

Richard Thaler’s summary of observed human savings behaviour gives the following rules:

1 Live within your means. Do not borrow to increase consumption except during well-defined emergencies (such as unemployment).
2 During emergencies cut consumption as much as possible.
3 Keep a rainy day account equal to some fraction of income. Do not raid the account except in emergencies.
4 Save for retirement in ways that require little self-control.
5 Borrow only on the security of a real asset.

Each rule, widely practised and generally thought prudent, infringes the economic rationalists’ theory. The fourth point has significant implications for retirement policy. We are not very good at saving unless there is a contractual element. We save by paying off the house mortgage or contributing to an occupational pension or life-assurance scheme. Berating us, as economists and government officials are wont to do, will not markedly raise savings, unless it induces us to contract into a compulsory long-term savings scheme (even though the contracting may be voluntary). Despite our best intentions, putting a little something aside each week for our old age will not generally succeed in providing a decent retirement income, unless we are forced to do so. On current policies it would appear that many New Zealanders are going to have a miserable old age.

The behavioural logic suggests that there is some merit in a compulsory second-tier retirement provision. Such proposals outrage economic rationalists. They have imposed their ideology’s narrow conception of the human condition on the public. Those who do not share it should be punished with an impoverished old age. Despite their claims to be liberals, the economic rationalists are fascists about personal behaviour, demanding ‘behave according to our rules, or our policies will punish you.’

Endnotes
1. Thaler, R.H. The Winner’s Curse: Paradoxes and Anomolies of Economic Life, Princeton University Press, 1992; Quasi Rational Economics, Russell Sage Group, New York, 1994.
2. If two people have identical lifetime earnings profiles, and one has $100,000 of pension wealth and the other has none, then economic rationalism predicts that the latter will have other wealth (such as shares and bank deposits) to offset the pension deficit. Even allowing for personality differences, the empirical evidence is that this prediction fails.

Economics for Children

This entry was posted in Listener, Literature and Culture on 2nd January 1999 by Brian Easton.

C.S. Lewis’s The Voyage of the ‘Dawn Treader’ is a parable about the economy.
.Listener 2 January 1999.

Keywords: Literature and Culture;

A hundred years ago, scholar, critic, novelist, C.S. (Clive Stapleton) Lewis was born. Like his close Oxford friend, J.R.R. Tolkien (of The Hobbit and The Lord of the Rings), Lewis was an Oxford professor. He is best known for his religious writings (notably The Screwtape Letters and The Four Loves), a science-fiction trilogy, his autobiography A Grief Observed, which became a film Shadowlands, and his Chronicles of Narnia for children, especially The Lion, the Witch, and the Wardrobe, which was turned into a film. Lewis’s greatest work of scholarship was The Allegory of Love, about the courtly love tradition of medieval times.

The tradition of allegory in a religious context, so fundamental to medieval writing, was carried into the Narnian fables I enjoyed as a child. Years later, reading them to my nine year old, I realised that each was concerned with a theological problem. Some are trivial, but The Silver Chair, with that marvellous marsh-wiggle, Puddleglum, explores the existentialist basis of religious belief. My favourite Narnia story is A Horse and His Boy, for the sheer pleasure of the narrative, but I found the first and last of the seven books (The Magician’s Nephew and The Last Battle) quite pedestrian.

This economics column is about The Voyage of the Dawn Treader, in which the earth children, Lucy and Edmund Pevensey, and the dreadful Eustace Scrubbs, sail with Narnians such as Prince Caspian (who gives the title of the previous book) and a metre high talking mouse, Reepicheep, to the ends of the world. To a nine year old it is a picaresque tale of adventures in a series of islands. To the economist it is a series of parables about the economy.

Thus they arrive at the Lone Islands, where slavery is rampant, and are temporarily captured. Escaping, Caspian demands that the slaves be freed, and is told by governor Gumpas that the slaves are “necessary, an essential part of the economic development of the islands. Our present burst of prosperity depends upon it.” The slaves are needed for export. “We are a great centre of trade.” Challenged, Gumpas explains that it is not “possible that you should understand the economic problem involved. I have statistics, I have graphs.” To liberate the slaves would be “putting the clock back. Have you no idea of progress, of development?” Caspian tartly answers “I have seen both in an egg, We call it `going bad’. This trade must stop.” It does.

Greedy Eustace becomes a dragon in the next island, to be saved by the grace of Aslan, the mystical lion, who is Lewis’s Narnian symbol for Jesus. Later a lake, which turns everything into gold, causes the companions to quarrel. Again Aslan saves them. On the other hand, when a sea serpent threatens to crush the ship near the Burnt Island, it is the collective effort of the crew which saves the ship.

The loveable duffers (or monopods) of the Island of Voices speak in unison, agreeing with the last speaker even if it contradicted what they had said just before. Perhaps Lewis is warning that collective action, evident in the Burnt Island episode, can also be dangerous. Meanwhile Lucy learns the dangers of various kinds of power in an encounter with a magic book.

The last island, the one at the beginning of the end of the world, provides Lewis’s answer to the economic question. Sadly it is a disappointment, for there is a table covered with food which is magically replenished every day. Lewis seems to be saying “the good lord will provide.” I take it that he does not literally mean that material needs will regularly appear magically. Perhaps he is referring to non-material needs.

Children will read the story for the fantasy narrative. Adults who are not of a religious persuasion may find some of Lewis’s religiosity a bit heavy going. So may some of the more religious. But it is unusual to have a quality children’s writer addressing so explicitly economic issues, albeit at a simple level. Lewis deserves acknowledgement in his centenary year.

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

AULD LANG SYNE

Lewis’s most cited quotation may be “friendship is unnecessary, like philosophy, like art … It has no survival value; rather it is one of those things which gives value to survival” (from The Four Loves). An economist might now plunge into Oscar Wilde’s retort about knowing “the price of everything and the value of nothing.” Certainly economists puzzled over the distinction between “value” and “price”, and have some understanding of the difference.

Or consider King Lear’s “Oh reason not the need. Our basic beggars are in the poorest things superfluous,” echoed by Bobby Dylan’s she “knows just what you need, but I know what you want.”

So let us, as the year closes, remember friends past, friends present, and friends future. For all the materialist concerns that an economics column inevitably addresses, friendship – and art and philosophy – give a meaning to our life beyond that of economic value.

The Casino Economy: Using Other People’s Money to Become a Millionaire

This entry was posted in Business & Finance, Listener on 5th December 1998 by Brian Easton.

Listener 5 December, 1998.

Keywords: Business & Finance

Use $20,000 to deposit on a $100,000 house, borrowing $80,000 from the bank. Get a friendly valuer to say the house is worth $200,000. Get the bank to lend you another $80,000 against the value of the house (so you have a mortgage of $160,000). With the $80,000 of cash the bank has just given you, buy another four $100,000 houses, borrowing another $80,000 on each house. Get your pet valuer to double the price of the four new houses, so your houses are now worth a $1,000,000. You can borrow an extra $320,000. Repeat.

After the third round of this magic you will own $10.6m of buildings, have debt of $8.48m, and equity of $2.12m. You are a millionaire, and you only started with $20,000! If the reader is a little lost trying to follow the sums, dont worry. Some who worked the system, candidly admit that they lost track of their finances too.

It is not quite that simple. You will have to pay your helpful valuer, various bank fees, interest charges, and so on. But it illustrates how by revaluing assets, and raising debt on the new value, the business can obtain cash for repeating the miracle.

Hire a public relations specialist, who will convince the financial journalists that you are a terribly clever fellow, with a knack for spotting commercial opportunities. The lenders will be impressed and come beating at your door. Do another round. (You will have to diversify into property and shares.)

Now you have $42.6m of assets, $34.08m of debt, and $8.52m of equity. Your picture is on the financial pages. You are asked for advice on things which you know nothing about, like the economy. (Your PR adviser says “praise free enterprise”.)

People clamour to have a share of your wizardry, so reluctantly (of course) you agree to float on the sharemarket a portion of your private company. Suppose you sell off half the shares at a 50 percent premium. (And again for simplicity ignore the costs of PR, merchant bank, share broker, and financial journalists. The journalists get free trips to your meetings, dinner and wine, but usually not cash like the others.)

Immediately after the float you have $6.39m in cash and shares worth $6.39m which retain a controlling interest in your company. The day after the float the share price leaps another 50 percent, The stags who bought the shares, sell them at a tidy profit, and happy share punters find themselves owning shares in a company at more than twice the net (already grossly inflated) value of its assets.

The story keeps going but eventually it comes out your business is a fraud, the share price dives, and the company becomes worthless. The banks foreclose. The assets are still there but their true value is about half of what was in the company books, there is no equity left. Just a lot of debt. Still you have the $6.39m of cash from the float. Invest it wisely.

Grimy details aside, the point is the $6.39m cash return from the original $20,000 comes from other people’s savings. (The banks have made a loss too, which does not affect their depositors, but the shareholders in the banks also take a lost.)

I tell this fable, because I continually meet people who expect to make fabulous returns on their investments, but who never ask what is the underlying process which generates the return. Where does the cash come from? During an asset (property or equity) boom revaluation gives fictitious profits, which only become real when the asset is sold and turned into cash. Now the overvalued asset is owned by some other investor who has given up the cash, but hopes to do the same. It can be like passing a parcel which contains a bomb.

Of course there are some genuinely high returning investments, but they are few in number. The typical investment gives a return of 3 percent above the rate of inflation. By a bit tweaking you might get it a little higher, or avoid paying tax. Promises of easy 20 percent annual returns, say, in the current low inflation climate are – well – problematic. You may be cleverer than the average investor, or luckier. Then again you are more likely to be below average (because the return is skewed). High investment returns are often at the expense of ordinary investors, who find their savings consumed by other investors. Keynes once described the sharemarket as a casino. Casinos randomly redistribute people’s savings, less a margin for the dealer.

The Following Books Fill in the Details
The Ariadne Story: The Rise and Fall of a Business Empire by Bruce Ross.
Bond by Terence Maher.
Crash! Corporate Australia and New Zealand Fight for Their Lives by John McManamy.
The Hawk: Alan Hawkins Tells his Story to Gordon McLauchlan by Alan Hawkins.
Lost Property: The Crash of ’87 … and the Aftershock by Ollie Newland.
Report of a Special Investigation into the Affairs of Ariadne by R.W. Gotterson.
The Rise and Fall of Alan Bond by Paul Barry.
The Rise and Fall of JBL by Reg Birchfield.
Too Good to be True: Inside the Corrupt World of Christopher Skase by Lawrence van der Platt.