THE TRUTH ABOUT PRIVATISATION: BLOG # 11

One of the difficulties of debunking myths about privatisation is that some people do not get basic factual or economic points even when they are clearly explained.

Thus in a recent letter to the Dominion Post, investment analyst Garth Ireland wrote:

Labour leader Phil Goff says that, under Labour, there will be no asset sales (May 2). He says: “It is economic madness. The power companies return $700 million in dividends every year – that is lost forever”. But is it?

Surely the sale price received today is equivalent to the future expected dividends? Nothing is lost. Dividends of $700m a year at a rate of return of, say, 10 per cent are equivalent to $7 billion today.

Mr Goff claims that the dividends “pay for 10,300 teachers, 12,600 new police officers or 33,000 hip replacements”. He can still spend the $7b sale proceeds or the $700m each year forever. They are equivalent.

This drew the following comment on the Dominion Post website:

“Surely the sale price received today is equivalent to the future expected dividends?” I think you sir may in fact not get it. “The future expected dividend” is infinite. Inflation happens, and so does increasing dividend.

If we sell it for 7 billion, that is ALL we ever get and it will end up like kiwi rail, run down by the owners to maximise profit. The 7 Billion will become worth less and less. And we will become asset poor.

If we keep it, the value will increase, dividends will increase as electricity becomes our primary fuel source (Oil crisis), and because we (the NZ government, and by default the NZ people) will invest in it, it will not become run down.

Would you sell your kidney for short term profit? I think you would. Think long term, thinking short term led to the current problems.

The future expected dividend may indeed be infinite (if the SOE performs well). But what Garth Ireland was pointing out is that to compare the value of the asset to the Crown if it remained in public ownership with the value to the Crown of a sale, you have to discount the future (infinite) dividend stream to express it in net present value terms. People value a dollar today more than they value a dollar in 100 years’ time.

On that basis, the Crown’s financial position is no worse as a result of the sale. In fact Garth Ireland could have made a stronger point: because the new private owners of the business are likely, on average, to operate it more efficiently, the Crown is likely to be better off financially (relative to keeping the asset) because in a competitive sale process it will capture some of the likely efficiency gains.

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FRIDAY GRAPH: STUDENT LOANS

Here is another graph from last week’s Budget.

The accompanying text states:

In 2010/11 the Crown will lend almost $1.6 billion to assist students, up 50% over the past five years. There are currently more than $12 billion of loans outstanding. However, at present, for every dollar lent out the Government receives only around 55 cents back in 2011 dollar terms.

The previous government (Steve Maharey) maintained that making student loans interest-free (first, while students were studying and then on an open-ended basis) would not encourage students to borrow more.

This was the height of naivety.  Economics teaches that incentives matter.  The skyrocketing amounts borrowed were utterly predictable.

Debate about taxpayer subsidisation of higher education should focus on fees: how much should students pay for the private benefits they enjoy from higher education, and what should taxpayers contribute on public benefit or equity grounds?

The loans scheme is not the right vehicle for subsidisation.  Interest on loans should approximate market rates, otherwise over-borrowing and other distortions are inevitable.

Other than in an economic crisis, will a future government be able to overturn this egregious 2005 election bribe?

ECONOMIC GROWTH IN ASIA

The IMF’s twice-yearly World Economic Outlook is always a rich source of economic data and analysis.

The following table on the economic situation in selected Asian economies is informative.

The dynamic non-Japan Asian economies are a far better benchmark for New Zealand than the ‘old’ OECD members. Hong Kong and Singapore have per capita incomes that are much higher than New Zealand’s and Korea and Taiwan are fast out-pacing us. Growth rates in China and India are changing the face of the world economy.

The table shows that New Zealand’s economy is projected to grow more slowly in the three years to 2012 than all other Asian countries and sub-regions in the table.

Hong Kong and Singapore are still notching up fast growth rates (a phenomenal 14.5% last year in Singapore) and very low rates of unemployment.  The main concern in the region is over-heating.

Another table in the report shows that the sub-Saharan African economy is showing extraordinary promise, with annual growth rates rising to around 6% in the period.

PORTUGAL’S FUGA DE CÉREBOS

A new lament is sweeping around the world. Already viewed close to a million times on several YouTube clips, Que Parva Que (What a Fool Am I) is a song mourning the plight of Portugal’s young generation hit by their country’s economic disaster.  The song speaks of a generation studying but with no prospect of paying work, putting off relationships and children, the ‘parents’ house generation’.  

There is much to lament. Portugal’s unemployment rate stands at a record 11.2 percent and among 15 to 24 year-olds the rate is 23 percent.  In the words of one young Portuguese university graduate, demonstrating recently against unemployment along with hundreds of thousands of others: “The only work we can get is ‘work experience’, the only future we are offered is emigration”.

In Sad Songs from Portugal, Oliver Marc Hartwich writing in the Business Spectator found plenty more to be sad about.  As early as 2006 – well before the current Euro crisis – with the country’s cost competitiveness declining, productivity stalled and its economy sluggish, Portugal’s fuga de cérebos (brain drain) was already visible:

[A survey published in 2006] found that hardly any other developed economy had lost as many of its university educated workers to migration as Portugal. Almost a fifth of Portugal’s graduates had left the country. Even poorer Cambodia, Senegal or Zambia were better at retaining their best qualified workers. ….

The loss of the country’s best qualified people is a disaster for the Portuguese economy – especially because Portugal has the least qualified population in the OECD. A mere 28 per cent of all working age adults have completed high school. This compares to 51 per cent in neighbouring Spain, 70 per cent in Australia or 91 per cent in the Czech Republic. If there is one country that cannot afford a large loss of its young graduates, it isPortugal.

Oliver notes that as well as the fuga de cérebros to EU countries, many young Portuguese migrants have headed for Brazil, where the number of registered Portuguese citizens has risen by 9 percent to 705,615 since 2008.

The same development could also be observed in other traditional migration countries. In just the last two years the number of Portuguese nationals jumped 6.3 per cent in the US, 16.0 per cent in Canada and 4.8 per cent in Australia.

The European rescue package will do little to make Portugal more attractive to its young generation. They only have to watch the news from Greece to see their own future. Overly indebted, unable to fund itself at reasonable interest rates in capital markets, the government will become dependent on funds from the European rescue funds almost indefinitely. And yet within the monetary corset of the euro there is little hope to regain competitiveness without resorting to a massive and painful internal devaluation – if this strategy will work at all.

At the risk of being melodramatic, it’s a story we should heed. With our own rate of unemployment for the latest quarter standing at 6.6 percent, youth (15 to 24 year-old) unemployment at 18.8 percent, and Maori youth unemployment at a shocking 28.8 percent, we should be very concerned. And with a net outflow of 3,200 permanent or long-term NZ migrants departing for Australia in the month of April (up from 1,500 in April 2010 and the highest for an April month since 2008) we should perhaps be writing our own sad song.

FRIDAY GRAPH: THE FAILED POLICIES OF THE PAST DECADE

The following page from yesterday’s budget illustrates the dismal economic trends of the past decade.

Click to enlarge

The text on the previous page elaborates on these charts:

Real GDP per person has not grown since 2004. The economy was in recession even before the global financial crisis. The downturn in economic performance coincided with:

  • a construction and housing market boom, with the prices of existing houses increasing 115% between 2001 and 2007. Household debt as a share of disposable income rose from 105% in 2001 to almost 160% in 2009
  • a significant increase in government spending. Core Crown expenses as a share of GDP are 6% of GDP (about $13 billion) above the 1994 to 2004 average
  • a sustained high real exchange rate, with the average level of the real exchange rate over the five-year period ending in 2010 being the highest since the 1960s
  • real export growth averaging just under 1.4% a year, compared with 5.4% in the previous 15 years, and
  • a decline in national savings, reflecting an initial steep decline in household savings, followed later by a decline in government savings. This was reflected in the current account deficit averaging 8% of GDP from 2005 to 2009.

In summary, the economy continued to perform relatively well in the first years of the decade aided by the economic framework established by the earlier reforms, a cyclical rebound after the Asian economic crises and a buoyant world economy.

From about 2004, however, the impact of the Labour-led government’s focus on income redistribution rather than economic growth, with ever-higher government spending and costly regulation, began to be felt.

The economy entered a recession in 2008, before the global financial crisis hit, and the government is still struggling to reverse these trends.

This was unquestionably the worst period of economic mismanagement since the Muldoon years.

BUDGET 2011: THE VISION THING

As background to today’s budget, this is an interesting analysis of the New Zealand economy by London-based investment advisory firm Independent Strategy.

The author was probably David Roche who has followed New Zealand closely and is attached to the country, as he states:

We all love to love New Zealand — a fine and beautiful place — but is the object of our affections one-eyed; lacking a chunk of the vision thing?

His answer is:

The lack of a vision or a radical plan to deal with the fiscal debt and deficit problem and, by connection, with the excessive level of foreign liabilities, leaves us unenthusiastic about NZ’s sovereign debt.

Like the 2025 Taskforce, he notes:

NZ’s official aim is to close its 35% income (GDP per capita) gap with Australia. Policies do not seem to match this ambition.

The paper makes an important point about New Zealand’s sovereign debt which is often overlooked:

A number of Kiwis have likened NZ’s fiscal and external liabilities to that of Greece. This seemed glib. So on a recent visit, we checked and were gobsmacked to find that NZ’s net external liabilities are as high as a percentage of GDP as Greece’s (Figure 2)!

 However, they don’t mean the same thing. Statistically, the overall net figure for NZ and Greece looks much the same. But much of NZ’s gross external liabilities are composed of equity (40%), namely the foreign ownership of NZ companies. And much of the debt represents the external funding of Australian-owned banks in NZ (34%). The former never causes credit crises and the latter is unlikely to do so — unless the Aussie banks are in deep trouble themselves.

Nevertheless, the debt issue is serious:

According to our estimates, based on unchanged policies, NZ will reach a 50% gross sovereign debt to GDP ratio by end 2015. That may seem way better than Japan or the US, but it is nevertheless the beginning of a long day’s journey into night and not somewhere NZ wants to go, particularly as economies with small financial markets reach the critical tipping point for a sovereign debt crisis much earlier than countries like the US or even the UK.

The underlying problem is correctly seen as excessive government spending:

NZ’s sovereign debt to GDP ratio is rising inexorably and is being driven by a rising trend of government spending as a share in the economy, not by the impact of recession. The NZ government is a big spender when placed beside Australia, even if it has not been so by OECD standards until recently (Figure 9).

But comparing government spending in NZ to the OECD is probably the wrong benchmark for a country that wants to make a growth sprint to catch up with Australia. Europe, the US and Japan are not paragons to be imitated if this is the objective. It is like comparing the fitness of an ambitious sprinter to that of a dowager lady walking her lap dog.

When it comes to remedies the report endorses the government’s broad direction but is concerned about the slow pace of reforms:

But the government and civil servants are aware that the state of NZ’s public finances cannot go on deteriorating. So there is considerable focus on getting more out of public resources; prioritising spending better as well as maximising its efficiency; and of shifting the tax system at the margin to encourage higher savings, better labour participation and more productivity.

But the government’s approach is an incremental one economically and gradualist politically. The problems it seeks to address are not. They will be in your face but a historical jiffy away. They are deep and structural. By the time they are incremental, they will be exponential.

There is still ample opportunity for radical reform — even in a country with a great civil service and clean government and where much has already been achieved. In a recent paper, the NZ Treasury demonstrated that economies with small government have higher (annual) GDP growth and that the growth cycle lasts longer. Of course, the policy mix of how taxes are raised and how money is spent matter too. New Zealand has the scope for improving all items. But the focus has to be on the size and scope of government.

The paper goes on to endorse the recommendations of the 2025 Taskforce and mentions ‘tax churn’ which “promotes inefficiency by taxing the middle classes and returning the taxes to them as subsidies and transfers”.  It also points to the problems of the Resource Management Act, local authority control of land for housing, and restrictions on foreign direct investment.

On privatisation it states:

The government owns assets worth NZ$223bn, or 118% of GDP. This figure has almost doubled in the last decade. These publicly-owned assets include a wide range of state enterprises in power generation, banking, coal mining, TVNZ and a controlling interest in Air NZ. Many of these would be better in the private sector and could add substantially to productivity and growth.

It goes on to advocate changes to the eligibility age for New Zealand Superannuation, student loan policies and the minimum wage, which it notes is the second-highest in the OECD (on a relative basis).

On present policy settings the report concludes:

… it probably means that NZ living standards will continue to slip relative to Australia and non-Japan Asia. It’s cold comfort that, given the worse policy denial and fiscal dilemmas of Japan and the US, NZ’s slippage relative to the OECD may be less.

And it grades New Zealand’s present policy settings about five out of ten.

All this is consistent with views the Business Roundtable, other business organisations, the OECD and the 2025 Taskforce have expressed.

Will today’s budget surprise on the upside?  We will soon know.

REALITY BREAKS THROUGH AT GENERAL ELECTRIC

This is an interesting report on remarks by General Electric CEO Jeff Immelt.  He confessed to Reuters that GE’s focus on the environmentally friendly aspects of its wind turbines and high-efficiency appliances might have led his critics to believe he was more interested in saving the planet than growing the company.

If I had one thing to do over again I would not have talked so much about green … I’m kind of over the stage of arguing for a comprehensive energy policy.  I’m back to keeping my head down and working …

Renewable energy makes good sense when it is commercially viable (within a framework that takes account of environmental externalities).  But as a recent Financial Times article noted:

Since at least the 1970s, greens have argued that wind and solar, when combined with energy efficiency, could meet our energy needs without resort to nuclear power or fossil fuels. Faith in what is called the ‘soft energy path’ has taken on an almost religious quality among green activists. Yet, despite decades of subsidies, solar and wind still make up a tiny percentage of energy virtually everywhere in the world.

General Electric may have learned the lessons of BP, Enron and other companies that over-egged their green credentials.  Critics dubbed BP’s rebranding as ‘Beyond Plausibility’.  This looks even more valid in the light of the Gulf oil spill and BP’s expansion into oil and gas in Russia.

Business executives should know better than to be caught up with fads and fashions.  How often do we hear about ‘triple bottom line’ accounting these days?

Low Cost Living in the Lone Star State

 

I have spent much of this week in Houston, Texas. Texas is the go-ahead large state in the United States today, and Houston is the oil and gas capital, America’s second largest port and home to a huge medical complex.

With it’s business-friendly environment, Texas is attracting firms and people from other states, notably over-taxed and over-regulated California, in large numbers. It has no state income tax. The state legislature only meets for 8 weeks every two years – and without air-conditioning so that politicians do not get too attracted to the place.

Houston is famous for having no zoning (land regulation). Yet it looks pretty much like many other US cities. Without controls you do not find an oil refinery next to prime residential real estate and the expected collection of businesses cluster around the port. But there are many neighborhood associations that set their own rules about things like how close to a boundary you can build or what colour you can paint your house.

The absence of land supply restrictions makes housing (and much else in Houston) incredibly cheap. You can get a very nice two-garage, four-bedroom house for as little as US $200,000. Some 500,000 ‘refugees’ from New Orleans moved to Houston after Hurricane Katrina without putting any significant pressure on house prices or the land market.

If ever the government gets around to a fundamental review of our dysfunctional Resource Management Act, there would be many lessons to be learned from Houston.

FRIDAY GRAPH: MANUFACTURING SHARE OF GDP

Another graph courtesy of University of Michigan professor of economics and finance Mark Perry and his blog Carpe Diem.

The chart above shows manufacturing output as a share of GDP for both the world and the United States using United Nations data for GDP and its components at current prices in US dollars from 1970 to 2009.

Perry notes:

We hear all the time from Donald Trump and others about the “decline of U.S. manufacturing,” about how nothing is made here any more, and how everything that used to be made here is now made in China …  In reality, the decline in U.S. manufacturing as a share of GDP is really a global phenomenon as the entire world becomes increasingly a services-intensive economy.

As a share of GDP, manufacturing has declined in most countries since the 1970s.  A few examples: Australia’s manufacturing/GDP ratio went from 21.3% in 1970 to  9% in 2009, Brazil’s ratio went from 24.6% to 13.3%, Canada’s from 21.7% to 11.3%, Germany’s from 35% to 19%, and Japan’s from 35% to 20% …

The standard of living around the world today, along with global wealth and prosperity, are all much, much higher today with manufacturing representing 16-17% of total world output compared to 1970, when it was almost twice as high at 26.7%.  And for that progress, we should applaud, not complain.

The same trend has occurred in agriculture in most countries over the last 100 years – there has been a dramatic decline in agricultural employment.  Would we really be better off if more people worked on farms?

Note also that the decline in the manufacturing share of GDP is to some extent a statistical artifact.  Many functions, such as accounting and IT, that were once performed in-house by manufacturing firms have been outsourced to service sector providers.

Using Mark Perry’s numbers, the share of manufacturing in GDP for New Zealand has fallen from 21.6% in 1970 to 14.9% in 2009.  Manufacturing is still a major sector in the New Zealand economy and bigger as a share of GDP than in the United States and Australia.

FRIDAY GRAPH: TAX RATES AND TAX REVENUE

In a recent article Is ‘Tax the Rich’ Good Policy? (ODT 25 April 2011), I made the point that those in the top income brackets in New Zealand are already taxed relatively heavily by international standards.

I also noted that because cuts to high tax rates encourage economic growth and reduce tax avoidance, they may actually produce more government revenue.

And I quoted President John F Kennedy who said, when cutting US tax rates in the 1960s, “It is a paradoxical truth that tax rates are too high today and tax revenues are too low, and the soundest way to raise revenues in the long run is to cut rates now.”

This chart from Mark Perry’s blog Carpe Diem illustrates these points.

 

As Perry comments:

The chart above shows the relationship over time (from 1979 to 2007) between: a) the top marginal income tax rate, and b) the share of total income taxes paid by the top 1%). In 1979 the top marginal income tax rate was 70% and 18.3% of the total taxes paid were collected from the top 1% of taxpayers. By 2007 the top tax rate was 35% (half of the 1979 rate), and the tax share of the top 1% had more than doubled to 39.5% (from 18.3% in 1979).

The historical record shows an inverse relationship between the highest marginal income tax rate and the share of taxes collected from “the wealthy.” It’s a relationship to keep in mind during the current tax policy debate, where Obama wants to increase tax revenues by raising tax rates for “the rich,” and Rep. Ryan alternatively suggests a cut in the top marginal rate to stimulate economic growth, which would likely increase tax revenues from the wealthy, and increase overall tax revenue.

Note that this is not a Laffer curve argument that tax cuts are self-funding.  Normally they aren’t.  However, the loss of revenue over time from cutting inefficient taxes is less than the initial static loss because they encourage economic growth and expand the tax base.

Note also that higher income people pay more – a lot more – even with a flat or proportional tax.  Leaving aside the likelihood in practice of more favourable treatment for those at the bottom, a person on $25,000 pays $2,500 in tax under a simple flat 10% rate whereas someone on $250,000 pays $25,000.