Closing The Trans-Tasman Gap

It was good to see the New Zealand Herald editorialising today on the need for new policy to close the income gap with Australia.

The editorial made some good points:

Two years on, after a fall resulting from the global financial crisis, the move westward is growing again, up 16 per cent from 2009 to last year according to the statistics department. And National, too, is reduced to waving at the departees, our economy marooned in low growth and higher unemployment than across the Ditch. The number of New Zealanders returning from Australia is relatively static.

And again:

In government its answers have been limited: reducing company tax, shifting some direct income tax to indirect GST, tinkering with labour and planning laws, trying to hold the annual increase in state spending rather than cutting it, but ruling out big ticket changes such as to Working for Families, interest-free student loans and raising the entitlement age for superannuation.

But then it rather lost the plot:

The economic growth and prospects of a small, primary-produce-exporting nation are not directly comparable to those of a big, diverse, less indebted neighbour.

Hang on a bit!  New Zealand was once a wealthier country (in terms of income per capita) than Australia.  Its geographical position hasn’t changed.  Australia has always had those minerals in the ground.  Australia and New Zealand are both relatively small countries but small countries can do just as well as large ones (think Luxembourg, Switzerland, Hong Kong and Singapore) provided their markets are open and competitive.

Now consider this statement:

New Zealand’s options for revival are relatively limited by lower productivity, high private foreign debt and an almost cultural aversion by the state and individuals to cutting spending in favour of saving and productive investment.

Options limited?  But it is institutions (like electoral systems) and policies (spending, tax, regulatory, social) that mainly determine whether countries prosper or not in today’s world.  New Zealand’s productivity growth performance was slightly better than Australia’s in the 1990s but fell sharply in the last decade as economic reform stalled and reversed.  Decisions on institutions and policies are for us to make.  The question to ask is: If New Zealand moved in the direction of the policy settings of countries like Hong Kong or Singapore, why wouldn’t the income gap with Australia close quite rapidly?  (Think Ireland when it had its act together.)

Another argument:

Little is being achieved in catching up with Australia and it is possible that no policy setting, short of changes that would spark far more serious social upheaval than a brain drain will deliver parity in the foreseeable future.

 [The government’s] … 2025 productivity task force, headed by former leader Don Brash, twice predicted that major change was needed, and was given an almost unseemly short shrift. Dr Brash’s prescription suffered from a political tin ear, unaware or unpersuaded by the risks of a voter backlash to wholesale cuts to welfare programmes and taxes and sales of state assets.

This is hyperbole.  There is no need for wrenching economic change (unless we dither and it is forced upon us again).  The Brash prescription was orthodox, not radical.  It was entirely consistent with OECD prescriptions. It wasn’t the Taskforce’s job to play at being politicians; it was to deliver economic advice on how to close the gap.  And the government has on its agenda a number of possible initiatives which, if adopted, could make a difference, as I noted in this article.

Finally, somewhat contradictorily, the editorial concludes:

For its own sake, New Zealand needs bold economic initiatives that will position the country for sustained growth.

Sadly, the Herald put forward no suggestions at all for “bold economic initiatives”.  If it disagrees with the 2025 Taskforce, what is its alternative programme?  How can citizens and voters buy into the idea of “bold economic initiatives” if our leading newspaper does nothing to point the way?  And it doesn’t help if its op-ed pages are littered with articles like those of Bryan Gould (13 last year, two already this year) and Peter ­­­Lyons whose economic prescriptions would see us falling further and faster behind Australia.

What grade for the editorial?  Could do much better.

Advertisements

FRIDAY GRAPH: WHERE IS FACEBOOK NOT USED?

Today’s blog comes direct from LibertyScott.

Scott writes:

 Look at this map [click to enlarge], showing Facebook connections.

  

Well there are three reasons for big dark areas:

1.  Nobody lives there (vast tracts of the Amazon, Sahara, Arctic Circle, Siberia, majority of Australia but notice how Greenland is still connected despite a population of well under 1 million);

2.  Few can afford it (mountains of South America, central and west Africa, and the lower density in some areas);

But there is a third reason…

Look at China, no lack of people, no lack of people who can afford it, but it’s a blank.  In fact look at the Middle East, except the shining lights from Egypt through Israel, Jordan and Lebanon.  Beacons in the oil rich Qatar, Bahrain and UAE.  Not Syria, Saudi, Yemen, Libya and little Iran.  Yet Vietnam has some, and we can see free China in the form of Taiwan, Hong Kong and Macau against the near devoid lack of mainland connections.  South Korea vs North Korea is too obvious to point out.  Indonesia and Malaysia are wonderfully well connected.

Speaks far more of freedom than many indicators

THE TRUTH ABOUT PRIVATISATION: BLOG # 3

Last Sunday’s Sunday Star-Times editorialised against the government’s privatisation plans (‘Asset sales road littered with disasters and fiascos,’ 30 January).

Among other things, it said that government-owned companies “can be efficient as well as profitable. Kiwibank has been a brilliant success …”

The first part of this statement is certainly correct. Not all SOEs are poor performers and not all privately owned businesses perform well. But the unequivocal findings of economic research are that on average and over time, privately owned businesses outperform publicly owned ones (see here for relevant references). What matters for policy is this general result. Government should not bet against the odds with taxpayers’ money.

What about the claim that Kiwibank has been a “brilliant” financial success. I have never seen evidence to support this claim. Two points are relevant:

As I understand it, the original Cameron Partners advice to the government was that Kiwibank would ultimately earn profits but that these would not be sufficient on an NPV basis to warrant the investment, and

Many argue that Kiwibank has been cross-subsidised by the postal business of New Zealand Post.

Does the Sunday Star-Times have evidence on these points to justify the “brilliant success” claim?  I think we ought to be told.

THE TRUTH ABOUT PRIVATISATION: BLOG # 2

Veteran anti-market critic Frank Macskasy writes (Letters, Dominion Post, 31 January), “why should Kiwi mum and dad investors buy something that they already own?”

Taxpayers are indeed the true owners of SOEs (and other government assets).  A perfectly viable approach would be for the government to simply give shares in SOEs to them.  This is not necessarily the best approach but it would yield benefits because of the disciplines of private ownership.

A variant would be for the government to give shares to taxpayers but to set up a trust into which shareholders could gift their shares if they valued collective ownership.

Would Mr Macskasy be happy with either of these approaches, I wonder?

But if the government simply sold shares, Kiwi investors wouldn’t just be buying what they already own (or, rather, buying more shares than they currently indirectly own).  Those investors who bought shares would be paying fair value for them to all taxpayers (including themselves).  All that would be happening is that the asset portfolio of taxpayers would be rearranged (so that the government had less investment in risky commercial enterprises and more in, say, roads, hospitals, schools etc.  This is an argument prime minister John Key has been making.  Why would this be a bad thing?

THE TRUTH ABOUT PRIVATISATION: BLOG # 1

I am starting a blog series exposing myths in the privatisation debate.  It could become a lengthy exercise.

This one is on Air New Zealand.

Since Air New Zealand was effectively nationalised by the Labour government (I’ll leave aside here arguments about that controversial decision) it has often been regarded as a success story. Thus Finlay MacDonald in the Sunday Star-Times of 30 January described it as “a glamour product” and a letter in Friday’s Herald said “Air New Zealand is a classic example of a government/private partnership working well.” The government has also referred to Air New Zealand as a model of partial privatisation.

Under Ralph Norris and subsequently Rob Fyfe, I think it is fair to say that the airline has been innovative and performed well operationally. But the bottom line for any commercial business is just that: its bottom line. How has Air New Zealand performed for investors, the majority of whom are taxpayers?

The answer is, not well. 

One source of information is the Treasury’s Crown Ownership Monitoring Unit which published the 2010 Annual Portfolio Report in December last year. It tells us that for 2009 and 2010 Air New Zealand’s return on equity was 1.3% and 5.2% respectively.  While this period includes the recession, total shareholder returns in three of the last five years have been negative.  Air New Zealand’s total market capitalisation has more than halved since 2007 – from $2,776 million to $1,152 million in 2010.

Air New Zealand itself has reported in the past that it has not met its cost of capital. It appears that again in 2010 it failed to do so by at least 2%. Given the most favourable WACC of 8.4% and the operating return of 6.3%, the shortfall is 2.1% and equivalent to close to $100 million (NOPAT). 

A private firm that persistently under-achieves its cost of capital eventually gets restructured (like Fletcher Challenge in the late 1990s) or goes out of business.

What does a failure of a firm to meet its cost of capital mean?

First, it means that resources have been misallocated – scarce capital could have been employed where it yielded higher returns.

Second – which is saying the same thing – the poor profitability of a firm means that it contributes less to national value added or GDP (profits are a component of GDP). In other words, material living standards are lower than otherwise.

Third, a lack of profitability means that competition (with other airlines and transport modes in Air New Zealand’s case) may be distorted, reducing potential national income further.

Fourth, in the case of a taxpayer-owned business, taxes (or borrowing) will have to be higher, other things being equal, to make up the profit shortfall.

Some people may be happy to see governments owning unprofitable airlines, rail businesses or other enterprises out of nostalgia and for other reasons.

But they should recognise that investing in socially unprofitable activities (like Think Big) has been an important part of New Zealand’s economic problems and will hold back economic growth and increases in living standards.

The Spirit Level 2

The Sunday-Star Times and journalist Anthony Hubbard in particular appear to have embarked on a crusade against inequality in New Zealand, motivated by the 2009 book The Spirit Level by British academics Richard Wilkinson and Kate Pickett (neither of whom are statisticians or economists).

To read the Sunday Star-Times you would never know that the book has been subject to devastating criticisms.

I had a lengthy blog on the book on 22 December, citing several references.

I also wrote this article which appeared in the Sunday Star-Times of 30 January.

For a biting short summary of some of the criticisms, see this article titled ‘If you want something trashy to read on the beach, I’ve got a recommendation’ by Toby Young in The Spectator of 14 August 2010.

Young refers to a paper by Peter Saunders published by the London think tank Policy Exchange which can be found here.

Saunders writes that the message of The Spirit Level, that redistribution is the cure of most social ills:

… has received an enthusiastic reception from politicians and pundits on the left who believe The Spirit Level offers a rational, evidence-based justification for the radical egalitarianism to which they have long been emotionally committed. However, careful evaluation and analysis shows that very little of Wilkinson and Pickett’s statistical evidence actually stands up, and their causal argument is full of holes.

He goes on to say:

In this report, Wilkinson and Pickett’s empirical claims are critically re-examined using (a) their own data on 23 countries, (b) more up-to-date statistics on a larger sample of 44 countries, and (c) data on the US states. Very few of their empirical claims survive intact.

And Saunders sums up:

This report shows that The Spirit Level has little claim to validity. Its evidence is weak, the analysis is superficial and the theory is unsupported. The book’s growing influence threatens to contaminate an important area of political debate with wonky statistics and spurious correlations. The case for radical income redistribution is no more compelling now than it was before this book was published.

According to a chart in the Sunday Star-Times, Australia comes just under New Zealand on the measure of inequality used.  There seems to be little political support in that country for the kind of redistributive measures advocated by Wilkinson and Pickett: the emphasis is, correctly in my view, on economic reform to lift all incomes.

I agree with Toby Young that the book “belongs in the trash pile”. Others are free to disagree, but if they do it is dishonest not to acknowledge the criticisms and engage with them.

MORE ON ECONOMIC JOURNALISM

Brian Fallow isn’t the only journalist given to economic howlers (see the last point in my blog of 28 January).

Here is Tracy Watkins in the Dominion Post the next day making the same mistake:

There are no guarantees, meanwhile, that their sale won’t ultimately exacerbate New Zealand’s foreign debt position, given the possibility of shares ultimately being traded into foreign hands.

And here is Simon Collins in the Herald of 29 January:

Partial foreign ownership of our economy will increase” because “New Zealanders will be free to sell at least some of their shares to foreigners.

To spell out the point I made in my 28 January blog, here are the answers to Questions 4 and 5 of this report by Phil Barry:

4 Hasn’t privatisation led to more foreign control over New Zealand?

No. First, privatisation does not lead to a change in net claims by foreigners over New Zealanders. Rather, privatisation changes the mix of foreign liabilities, with the proceeds of any investment by foreigners being used effectively to repay foreign debt. Secondly, regardless of whom the shares are sold to, the assets stay in New Zealand, as do the jobs and the government’s sovereign powers to tax and regulate. Further, there are very good reasons for allowing foreigners to participate in the sale process. The number of (potential) bidders is increased, thus increasing the likely sale proceeds for the taxpayer. In addition, foreign ownership facilitates the transfer of international industry-specific expertise to the domestic firm. This transfer will in turn also increase the expected revenue raised from the sale (in a widely marketed sale, the purchase price will reflect fully the discounted expected cash flows)50 and the expected efficiency of the firm. Potential ownership by foreign companies also broadens the pool from which managers can be selected. Listing the firm in foreign share markets may also offer some advantages through increased monitoring, potentially extended information disclosure requirements and a ‘deeper’ market for the shares.  Finally, it is not the case that all the Crown assets have been sold to foreigners. Analysis of the residency of the buyers of assets (refer Annex 4) shows that around two-thirds of the assets (by number and value) were sold to combinations of foreign and domestic owners and around one-third to predominantly (that is, over 75 percent foreign-owned) or solely foreign-owned concerns. 50 As long as property rights are expected to be secure: refer to Maskin (1992).

5 Hasn’t New Zealand lost out from the huge sums of money sent overseas in dividends by the former SOEs? Hasn’t privatisation been a significant factor behind New Zealand’s large current account deficit?

Some observers point to the dividends being paid to foreign owners by former SOEs  as ‘proof’ that privatisation has increased New Zealand’s current account deficit. But privatisation is not to blame for the deficit.

With a floating exchange rate, when a foreigner buys NZ$1 of New Zealand assets, they must exchange it for a NZ$1 claim on foreign assets. The net claims on New Zealand from the rest of the world are unchanged. It is only if subsequent returns on the New Zealand or foreign assets are different from those expected at the time of the sale that there will be a (positive or negative) effect on the current account. Returns on individual investments by foreigners in New Zealand and by New Zealanders offshore will, in some cases, have exceeded average market returns and in other cases they will have been below average market returns.

But, as noted in response to question 2 above, there is no reason to expect that the returns on investments in privatised assets in New Zealand will have systematically been above average market returns.  As noted in response to question 4 above, privatisation did not increase (or decrease)  the country’s net foreign liabilities. If the assets had not been privatised, it is true that there would be less dividends going offshore, but there would also be more interest payments going offshore as New Zealand’s overseas debt would be commensurably higher. The overall effect on the current account would be very similar.

I can see that demythologising privatisation myths among journalists (and many members of the public) may be a lengthy process.  I might start a special blog on it.