ECONOMIC JOURNALISM GETS A FAIL MARK

Some of what passes for economic journalism in New Zealand is not impressive.

A case in point is this article in yesterday’s New Zealand Herald by Brian Fallow. Headlined ‘Ideology and tribalism behind questionable policy’, it poured cold water on the government’s partial privatisation announcement.

‘Ideology’?  Around the world governments of all political persuasions have been getting out of running commercial businesses for over 25 years.  Labor governments at federal and state levels in Australia, for example, have been to the fore. The only ‘ideological’ underpinning of policies in the world today seems to be the socialist attachment to ‘public ownership of the means of production, distribution and exchange’ in a few countries like Cuba – although even Cuba is changing – and North Korea, and in the policies of the last New Zealand government.

“There isn’t all that much family silver left in the cabinet.” Well, just a mere $18 billion, according to the December Investment statement, all or most of which belongs in the private sector. ‘Family silver’: is this economic analysis or politicised rhetoric?

“It does nothing to deal with the … perilously high reliance on foreign capital and credit.” This is a reference to New Zealand’s large current account deficits and increases in external liabilities under the last Labour government. These were due in part to a loss of international competitiveness as the government turned its back on efficiency-improving reforms such as privatisation.

Then the inevitable foreign ownership bogey: “once sold, it would be difficult … to prevent the new owners from selling them to foreign investors”.  No explanation is given as to why foreign investment would be a bad thing. A large part of the shareholding of companies like Telecom is inevitably and desirably in foreign hands: it would be unwise for New Zealand institutions to hold large parcels in their portfolios.

Then a real howler: “To the extent that these shares end up in foreign hands, they would increase the country’s net foreign liabilities …”  But a foreigner buying shares has to purchase them in New Zealand dollars, and the seller than acquires the same amount of foreign currency assets. The country’s net liability position is unchanged.

Fortunately, the Herald did better in an editorial the same day which supported the privatisation initiative.

Myths about privatisation abound, even though they have been debunked many times. For a rebuttal of some of them, see this report by Phil Barry.

FRIDAY GRAPH: WHAT A FLEXIBLE LABOUR MARKET LOOKS LIKE

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Hong Kong’s unemployment rate fell to 4 percent in December 2010 – its lowest level since November 2008. The rate spiked in 2009 from a low of less than 3 percent in 2008.

Hong Kong has been regarded as a place where everyone who wants a job can get one. It scores highly for labour market freedom, union density is low, and average wages are well above New Zealand levels.

The country has introduced a HK$28 (NZ$4.50) per hour minimum wage set to take effect on May 1 which economists say may restrain hiring.

But compare this rate with the $12.50 per hour minimum wage that even young workers now face in New Zealand: a far greater barrier to employment of low-skilled people and youth.

 

 

 

 

Tax-Free Threshold Awful Policy

The Labour Party’s proposal to introduce a zero rate of income tax on the first $5,000 of taxable income may have populist appeal but it is seriously bad policy.

New Zealand once had a tax-free threshold. Even the Great Populist Sir Robert Muldoon was sensible enough to abolish it.

All subsequent reviews of tax policy have rejected the idea. The best and most comprehensive, the 2001 (McLeod) Tax Review, had this to say in its Final Report:

… while poor people have low taxable incomes, low taxable income is not a good proxy for need.  Beneficiaries have their benefits set net of tax, so only their non-benefit income is affected by tax rates.  Low-income working families receive a variety of forms of assistance, which offset the impact of tax, depending on their income.  Many people with low taxable income are not needy.  These include second-income earners in middle- and high-income households, some self-employed, and people with income for only part of a tax year (for example, immigrants and emigrants).Given that income is a poor indicator of need, proposals for a tax-free zone poorly target those in need and have large fiscal costs.  These fiscal costs would raise marginal tax rates for most taxpayers.

Former finance minister Michael Cullen also rejected the idea, saying it would have “minimal benefit for a very small number of low income earners”.

Here are some ballpark numbers on Labour’s proposal:

According to Treasury, in 2010/11 total taxable income in the income band 0-$5,000 amounts to about $15,058 million.

At the current rate of tax of 10.5% (from 1 October 2010), a zero rate on the first $5,000 of taxable income would cost about $1,581 million in a full year. This assumes that the first step is split into two. The cost would be higher if all subsequent income thresholds were increased by $5,000.  It also assumes no change in the behaviour of taxpayers, and no change in other rates of tax. It is based on the 2010 budget forecasts.  Indirect tax and other flow-on effects are ignored.

Labour suggests that some of the lost revenue will be recouped by a higher top rate of personal tax and from a crackdown on tax avoidance. The rate has not been set “but it will only affect incomes comfortably into six figures, the top few percent of earners.”

Suppose the new top rate applies to incomes above $120,000.  Treasury estimates that $6,986 million of taxable income in 2010/11 is within that income bracket. To recoup all of the $1,581 million forgone from a new top rate, the additional rate of tax would need to be 22.6 percentage points, ie the rate on income over $120,000 would need to rise from 33 percent to up to 55.6 percent, an increase of 68 percent. With GST now at 15 percent, taxpayers in the top bracket would be paying combined income tax and GST of 61.4 percent of their earnings when spent.

What is happening to the company and trust rates? Labour has not said but it has alluded to the problem with trusts. If the company rate is retained at 28% (from 1 April 2011) and the trust rate at 33%, there would be strong incentives to divert income, so the cost would be higher than a static analysis suggests. Tax avoidance, which Labour says it wants to crack down on, could only increase.

Labour will find few tax professionals in support of this proposal. There is a strong consensus in favour of a broad-based, low-rate tax strategy.

FRIDAY GRAPH: SEEKING VALUE FOR MONEY IN EDUCATION

Last week UK Secretary of State for Education Michael Gove championed the release of data showing how spending extra on schools doesn’t necessarily lead to better education outcomes.

As a Department of Education paper Improving Efficiency in Schools states, there is:

… a large variation in expenditure between the schools; ranging from just over £4,000 per pupil to over £5,000. That’s more than a £1 million difference in spending for a school with 1,000 pupils. And there are significant savings to be made, even if a school moderately reduced its expenditure. If the higher spending school illustrated in the graph (at position 90) came down to the level of the lower spending school (at position 70), they’d save £331 per pupil, or £289,294 overall (they had 874 pupils last year). 

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If we look at these schools’ attainment, it is clear there is no direct link between higher spending and higher attainment. The following graph shows the same 100 schools, but also plots their exam performance (shown by the blue dots). If there was a direct link between the amount the schools spent per pupil and their performance, you would expect the blue dots to form a line following the red dots, but in fact there is no such pattern.

 

This research confirms the results of other studies and suggests the education debate should be refocused on making the system more efficient (eg through introducing greater parental choice and competition between schools, as Gove is promoting in the United kingdom), not on how much is spent.

PRIVATISATION DEBATE SHOULD BE RIGOROUS

It’s hardly a state secret that the government is considering some rearrangement of its portfolio of assets if it is re-elected this year.  Its Investment Statement reporting current asset holdings issued in December provides useful information on available choices.

There is much to consider on the why, how and when assets should be transferred from the public to the private sector.  This 2002 study by Phil Barry was commissioned by the Business Roundtable as a contribution to the debate.   It dealt with many of the myths concerning past privatisations.  (I discussed some in my blog of 9 December 2010.)

Another contribution was this article by commercial law academics Susan Watson and Chye-Ching Huang published in the New Zealand Herald of 15 January.  It made the case for partial privatisation, in line with the government’s assumed intentions.  However, it was not the sort of rigorous analysis that might be expected of academics.

Nowhere did it consider, for example, whether full privatisation would be superior to partial privatisation.  Academic studies clearly favour the former over the latter for commercial enterprises.

Nor did it expose the pitfalls of partial privatisations.  These involve continuing (majority or minority) government stakes in enterprises and the risk that political incentives will dominate commercial incentives (and limit the contribution of entities to wealth creation).  Conflicts between the government’s roles as owner and regulator are not resolved with partial privatisation.

We have seen partially privatised companies remain political playthings, a prime example being the former Auckland Regional Council’s nationalisation of Ports of Auckland.  Earlier experience with the partial privatisation of the Bank of New Zealand was also unhappy.

Watson and Huang note that the New Zealand sharemarket would benefit from partial listings, as did the Capital Market Development Taskforce.  But, other things equal, it would obviously benefit more from full privatisation.  Moreover, partial privatisation of the small entities they give as examples – Quotable Value, Learning Media and Asure New Zealand – would hardly be worth the candle.  Game-changing policy must involve major SOEs such as those in the electricity sector.

The article cites Air New Zealand as a model of partial privatisation but unaccountably fails to note that the company’s share price performance since the government resumed majority ownership has been poor.

They also commend the Singaporean Temasek holding company model.  This is also dubious.  The performance of the underlying businesses is not sharply reflected in such a model.

The authors mention the possibility of restricting privatised company shares to New Zealand nationals, and rightly note that this would depress the share price.  The arguments for such restrictions could only be political.  The idea that foreign ownership is a cost of privatisation is misplaced.  The level of foreign ownership in the economy is determined by the cumulative current account deficit or surplus in the balance of payments, not by which assets are for sale.  If foreign ownership of some assets is blocked, foreign stakes in other assets will be higher.  If this is an issue, a better approach would arguably be to simply give SOE shares to their true owners, New Zealand taxpayers.

The value of partial privatisation should not be over-stated (which is probably why the 2025 Taskforce recommended full sales for competitive enterprises).  Phil Barry concludes as follows:

… partial privatisation has significant disadvantages compared with full privatisation. Ownership of partially privatised companies is often widely held (outside the government’s stake) and control is not readily contestable; private investors have limited incentive to monitor the company, relying instead on the ‘deep pockets’ of the government to bail out the company if it gets into difficulty; and the company remains open to political interference. Further, governments, as owners, may be unable to agree for long as to why they own the company, thus making it difficult for the company to develop and implement a strategic direction.

The empirical evidence supports the view that partial privatisation is not a desirable long-run state. Most studies indicate that there is no lasting difference between the performance of fully state-owned and partially state-owned enterprises: that is, that full private control is necessary to achieve sustained performance gains. But as a stepping stone towards full privatisation, partial privatisation has merits.

A better article would have reflected these nuances.

FRIDAY GRAPH: JACINDA ARDERN OUT ON A LIMB ON YOUTH MINIMUM WAGE

Labour MP Jacinda Ardern is arguing that the last Labour government’s abolition of the youth minimum wage (a project of former Green MP Sue Bradford) did not contribute to the current appallingly high rate of youth unemployment.

This is a bold assertion. Elementary economics suggests that, other things being equal, the higher the price for a good or service (such as labour), the less is demanded.

If all wage rates in the economy were doubled by legislative fiat tomorrow, there would be wholesale layoffs and unemployment would skyrocket.

The ceteris paribus condition is important. Legislated minimum wage rates may have little impact if they are below market rates – wage rates that employers would have paid anyway.

Similarly, increases in minimum wage rates may be consistent with increasing numbers employed at those rates if the labour market is buoyant (as it was in the first half of the last decade).

Jacinda Ardern quotes research by Hyslop and Stillman which found no consistent evidence of an adverse impact on teenage employment when youth wage rates were increased in this period.

But this Hyslop and Stillman study was published in 2007. It is not relevant to the effects of the Bradford legislation.

One way to get a feel for those effects is to compare the unemployment rates of 15-19 year olds and 20-24 year olds today with the comparable rates in the early 1990s when unemployment was also high.

The following graph presents these unemployment rates for males.

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The rate of 15-19 year old male unemployment in 2009 was comparable to the peak rate in 1991, which is not the case for the 20-24 rate.

The following chart plots the difference between these two series – and puts a 5-quarter moving average through the difference for greater clarity.

This chart clearly demonstrates that the 2009 recession has hit 15-19 year-olds harder relative to 20-24 year-olds than was the case in the 1988-91 recession.

If Jacinda Ardern thinks that the abolition of youth minimum wage is not responsible for this sharply different outcome, she needs to give another plausible explanation for it.

Eric Crampton of the University of Canterbury has estimated conservatively that the Bradford legislation has cost young people around 9000 jobs. He has also responded to Jacinda Ardern’s statement here.

Ms Ardern also needs to engage with the analysis of the 2025 Taskforce, which said in its last report:

 New Zealand has a relatively flexible labour market by the standards of some OECD countries, but this flexibility was reduced substantially over the period 2000 – 2009. International indicators of labour market rigidity in New Zealand tend to highlight our minimum wage,….

…..In the last decade, New Zealand has introduced substantial real increases in the minimum wage. The minimum wage was increased sharply during the boom years of labour shortages, and in 2008 the separate lower youth minimum wage was abolished (putting all young employees on the same minimum wage as adults). In 2008, New Zealand had the second highest minimum wage in the OECD relative to the median wage at 59 percent of the median wage, up from 51 percent of the median wage, in 2002. Only France, whose minimum wage at 64 percent, was more generous, and the OECD average is for the minimum wage to be at 46 percent of the median wage (OECD 2010a).

These changes have had a particularly serious impact on youth unemployment (Figure 12.2). Making sure that young people are easily able to get into the workforce is important for them and for the wider economy.

High minimum wages are also likely to seriously impede any determined efforts to reduce long-term welfare dependency. The case for any minimum wage at all is questionable, and we believe it should be reduced in value, but as a minimum we believe the Government should move to lower the real value of the minimum wage by holding it constant in nominal terms. Further, and as a matter of urgency, the youth minimum wage should be reinstated to assist in addressing the chronic youth unemployment problem currently facing New Zealand.

 

Economic Wagers and the ‘Ultimate Resource’

A recent article in the New York Times by John Tierney about a current ‘energy cornucopia’ and his winning of a bet on energy resources has brought back to light the famous Simon-Ehrlich wager of 1980 – and sparked a mini-furore in the economic blogosphere and a possible third bet of a similar vein.

Bet 1

Convinced claims made by environmental doom-monger Paul Ehrlich that population growth would quickly outrun the supply of food and natural resources were false, Julian Simon had Ehrlich choose five commodity metals: Simon bet that their prices would go down in real terms, Ehrlich bet they would go up.

The chosen commodities, collectively costing $1,000 in 1980, fell in price by over 57% over the following decade. In October 1990 Ehrlich mailed Simon a cheque for $576.07.

Bet 2

Then in 2005, following in the footsteps of his friend and mentor Julian Simon, John Tierney accepted a bet for $5000 with Matthew Simmons (a former member of the US Council of Foreign Relations and author of Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy) that the average price of oil for the year 2010 would be less than $200 per barrel.

Tierney and Julian Simon’s widow Rita (who was so happy to see her husband’s tradition carried on that she shared half the bet) were sent their winnings on January 1 this year.

Bet 3?

Since Tierney’s article was published, economist Donald Boudreaux has been trying to organise terms for a third bet in a similar vein with Brad DeLong after DeLong foolishly nominated Tierney, Boudreaux and Mark Perry for the ‘stupidest man alive’ following Boudreaux and Perry’s support of the Tierney article.

No bet

In a comment on a blog I wrote titled Has the ‘Peak Oil’ Drama Peaked?, Steve W wrote that he had challenged Jeannette Fitzsimons to a bet along the Simon-Ehrlich lines during a debate… and that she refused.

The ‘ultimate resource’

Amusing and instructive as it may be, if you put all the gambling to one side it is the ‘ultimate resource’ principle that Julian Simon himself developed in his 1981 book of the same name that is the key to these arguments.

It is a principle that I subscribe to – that humans’ capacity to invent and adapt will overcome scarcity of natural resources.

One way of looking at the basic economics behind the principle is that as a resource becomes scarce, its price will rise. This creates an incentive for people to exercise intelligence and creativity to discover more of the resource, economise on its use and develop substitutes.

In a broader context, it is the ultimate resource because it is limitless – we are constantly discovering solutions to problems once thought insurmountable – and it will never run out.

Mark Perry puts it well:

…the “ultimate resource,” i.e. the human mind, human capital, human ingenuity, and human innovation, are infinitely abundant, and will meet, address and overcome any scarcity in natural resources. The bottom line as I understand Julian Simon is this: we’ll never run out of the ultimate resource. And that is why limited or finite supplies of natural resources have never, and will never, result in any significant binding constraints or limits on human progress, economic growth, or the continual increases in our standard of living, wealth and abundance.

It is also a positive way to think. We live in an age (or perhaps it has always been this way) where people lurch from one fearful impending doomsday scenario to another. If it’s not the ‘silent spring’ or the Y2K catastrophe, it’s ‘peak oil’, ‘acid rain’ or ‘global warming’.

It is reassuring that the historical record shows that humans can and do overcome the obstacles we face.

And of course the ‘ultimate resource’ has countless applications beyond oil and metals.

Consider the amazing work of the American genetic scientist and Nobel Laureate Dr Norman Borlaug who created a high-yield dwarf variety of disease-resistant wheat which, when coupled with modern agricultural techniques, solved the India-Pakistan food crisis of the mid-1960s; turned Mexico into a major wheat exporter; dramatically improved the lot of many other developing nations; and was eventually credited with saving over 1 billion people from dying of starvation.

This was a triumph of the ‘ultimate resource’.