Friday Graph: Freedom, Poverty and Prosperity

This is the Business Roundtable’s last Friday Graph, and it is appropriate to end on an uplifting note on the Business Roundtable’s major themes of the link between increasing prosperity and increased economic freedom – freedom of trade and contract backed by sound laws and regulations and excellence in the provision of public goods, through sound policies and institutions.

Late last month the UK magazine, The Economist, reported here that new World Bank estimates showed that between 2005 and 2008, poverty fell in every region of the world, for the first time ever.  This is the chart from that article.

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The Economist‘s article notes that half of the long-term decline in poverty is attributable to China, which has taken 660 million of people out of poverty since the 1980s.  The critical role that greater openness to trade and commerce has played in that is obvious to all.

Less well known is the recent decline in poverty in sub-Saharan Africa and its relationship to economic freedom.  Continuing gains in economic freedom in this region were highlighted in the Heritage Foundation’s 2012 Index of Economic Freedom.  A chapter here in this publication authored by Obiageli Ezekwesili, vice president of the African region at the World Bank reported that a World Bank research report had ” found new empirical evidence supporting the idea that economic freedom and civil and political liberties are at the root of reasons why some countries achieve and sustain better economic outcomes while others do not”.

Stephen Jennings alerted New Zealanders to the exciting developments in Africa in delivering the 2009 Sir Ron Trotter lecture.  Overall, he considered that, “the next several decades of accelerated economic convergence will see the fastest growth, most rapid structural change and greatest economic inclusion in history”.  He concluded that New Zealand could and should be a global success story if it did two things: (1) embrace change based on enterprise and competition and be willing to acknowledge and celebrate economic and business success, “rather than regarding it as something it is impolite to dwell on”, and (2) move back to a system of government that allows democratically elected leaders to make performance-enhancing changes, “without excessive pandering to narrow sectoral interests”.

New Zealand made great progress in improving prosperity and economic freedom over the past 25 years.  It is timely to record Roger Kerr’s leading role in researching, devising, advocating and defending the critical reforms throughout that period as executive director of the Business Roundtable. Among his  lasting achievements was his insistence that the result of each reform must be to make enduring improvements to the lives of ordinary New Zealanders.  Roger’s published research, thinking and forthright advocacy of sound public policies – in terms of quality, rigour, depth and reach – is unmatched in this country’s history.

But the task of further improving competitiveness, resilience and flexibility remains.  That work will be continued by the new merged think tank whose new name and executive director will be announced next week.

Friday Graph: Latest GDP Figures Confirm Weak Rebound

This week’s Friday Graph uses Statistics New Zealand’s newly-released estimates for real GDP for the December quarter 2011 to show how weak real GDP growth has been since around 2005.

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Real GDP was 1.4 percent higher in the 2011 calendar year than in 2010 and real GDP per capita was 0.6 percent higher.

This represents a much weaker two-year recovery from the 2009 downturn than after each of the 1991 and 1998 downturns.  (Real GDP rose by 5.2 percent in 1993 and by 3.9 percent in 2000.)

Given the debate around the world currently about the effects of budget tightening on economic activity, in looking at this chart it is useful to bear in mind that the strong recovery after 1991 contradicted the expectations of 15 economists at the University of Auckland who wrote a public letter in June 1991 declaring “in the strongest possible terms” that the June 1991 budget cuts were “fatally flawed” and could “only depress the economy further”.

The chart also shows a poor growth performance generally since 2005, compared to the post-1991 period as a whole.  This is consistent with the slowdown in productivity growth that was the topic of last week’s Friday graph.

Closing Books and Opening Doors: Creative Destruction

For those interested in creative destruction, we note, courtesy of Carpe Diem, two major milestones: a great icon giving way to the digital world after 244 years: R.I.P. Encyclopedia Britannica (print edition): 1768 – 2012, and the reopening of the world for some seriously disabled people with the replacement of a cumbersome $15,000, 20 pound communication device by a $7 iPad app.

Friday Graph: Weakest Productivity Growth Cycle Recorded

In an article Setting the Sails in late November 2011, Business Roundtable chairman, Roger Partridge observed that the two main economic problems the country faces are structural imbalances and the slump in productivity growth.

Yesterday Statistics New Zealand updated its most accurate estimates of productivity growth for New Zealand to include the year ended March 2011.  These estimates exclude the areas of economic activity in which productivity is hardest to measure, which is primarily in the public sector.

The results were very poor being no change in multifactor productivity and a drop of 0.1 percent in labour productivity.  (Productivity measures the volume of output per unit of input.  Multifactor productivity uses a weighted sum of the volume of labour and capital for the unit of input.)

Productivity is difficult to measure and is cyclical.  It is more important to look at the trend as well as at the latest figures.  Statistics New Zealand has attempted to address the cyclical problem by identifying start and end points for each cycle between 1978 and 2011.  The latest cycle is for the 2006-2011 period.

This week’s Friday Graph plots the annual change in multifactor productivity growth and its average annual growth rate during each cycle, as calculated by Statistics New Zealand.

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The graph shows that the average annual growth rate of minus 0.6 percent during the 2006-2011 cycle was the worst recorded, but it was not aberrant.  Instead it followed a markedly poor outcome during the 2000-2006 cycle.

Because the timing of these cycles is inevitably somewhat problematic, it is pertinent to note that there is strong evidence that the productivity performance during the 1990s has been vastly superior to that since 2000.

The key policy features of the 2000-2011 period have been renationalisation, a deluge of intrusive regulation and one of the biggest five-yearly increases in government spending in New Zealand’s history.  That increase has been associated with pressure on the exchange rate and a weak traded goods sector performance, despite very favourable prices for exports relative to imports.

Ports of Auckland Case Illustrates the Problem of Government Ownership

Shippers and freight handlers would like lower port charges, port employees would like better wages and conditions, and investors in the Port of Auckland would like a higher return.

Much the same could be written about any firm in any industry, yet as written it looks like a ‘zero-sum’ battle between opposing interests; as if one party’s gain must be at another party’s cost.

Why then is all the current media attention on the Ports of Auckland situation?  Why are most firms in all industries not in similar strife?

One answer is that in normal competitive situations the common interest of these parties is far greater than the opposing interest.  Customers prefer a competitive service to no service, workers prefer productive work to no work, and firms can’t reward investors without productive workers and satisfied customers.  Provide a competitive environment and a co-operative solution is the norm in which each group can expect to be better off than if the job, investment, and customer service opportunity does not exist.  Firms that can’t make the grade are replaced by ones that can.

The cooperative norm can break down when some form of intrusive government regulation politicises or polarises one or more of the relationships, usually by artificially restricting one group’s ability to exit, or another group’s ability to enter.

Government ownership of a commercial operation is at the extreme end of the range of intrusive government regulations. It typically disenfranchises investors, being the potentially hapless ratepayer or taxpayer. The Auckland Council’s ownership of Ports of Auckland Limited forces Auckland’s ratepayers to be captive investors, as long as they reside in the Auckland rating region.

Ratepayers are at risk that port charges will be too low and/or port costs too high because the Auckland Council is not focused on controlling costs and demanding an expected return that covers the opportunity cost of the capital to the ratepayers who are effectively supplying it.

Part of the problem is lack of knowledge.  The Auckland Council probably does not know how many of its ratepayers are borrowing more heavily on mortgages, credit cards, or worse, because the Council has invested so much of their money unnecessarily.  It will almost certainly not know what risk premium it should add to such interest rates to reflect the equity risk of its investments, as perceived by the same ratepayers.  Nor can councillors be expected to know much about port costs.

The port’s customers and employees may fear the opposite risk – that the Council will use the port as a cash cow to fund other Council activities at their expense.  This would normally be a lesser risk because customers and employees can vote with their feet.  But this process can take time.

Another risk for ratepayers, and for the community overall, is that the Council may spend unwisely whatever return it gets from its commercial investments.  After all, councillors are not usually elected for their commercial expertise, fiscal prudence, and lack of obligation to partisan interests.

Privatisation would eliminate the problem of involuntary captive ratepayer investors.  Returning the net proceeds to ratepayers would allow those with a mind to do so to reduce their debt burdens.  Those who chose to remain invested would have much greater control over the risk-return trade-off.

But privatisation is no panacea.  It does not solve the problem of intrusive government labour market regulation that disempowers individual workers, some of whom might now lose their jobs through no fault of their own.

Seventeen-part Tests Are Not Rules

Today’s insightful “Perspective” article by Richard Epstein, ‘The rule of law can only survive where there are rules that guide and limit government conduct’, includes the comment:

The rule of law can only survive where there are rules that guide and limit government conduct.  Seventeen-part tests are not rules.  In many cases, they are not even intelligible standards

Epstein illustrates the point by referring to convoluted provisions in the US Patient Protection and Affordable Care Act 2010 (the ‘PPACA’ in the last paragraph of his article), colloquially known as Obamacare.  Plenty of New Zealand examples immediately spring to mind.  See for example, section 17 of the Overseas Investment Act in the context of this article and the Crafar Farms case.

Friday Graph: NZ’s Relatively Inflexible Hiring and Firing Practices

The ‘creative destruction’ of competitive processes requires labour and other resources to be continually shifted from contracting areas of the economy to expanding areas.  Rigid labour markets impede this process, with government regulations being a common cause of inflexibility.

A March 2012 IMF Working paper here uses statistics on 97 countries between 1980 and 2008 to assess the importance of labour market flexibility.  It finds that financial crises initially have a large negative impact on unemployment, but this effect rapidly disappears in the medium term in countries with flexible labour markets.  There is less pronounced, but more persistent, unemployment in countries with more rigid labour market institutions.  No surprises there.

A second March 2012 IMF Working Paper here by the same authors, also using a panel of 97 countries but this time spanning the period from 1985 to 2008, suggests that improvements in labour market flexibility, particularly in respect of hiring and firing regulations and hiring costs, reduce unemployment, youth unemployment and long-term unemployment.

Given the importance of ease of hiring and firing for flexibility, it is regrettable that New Zealand ranks so poorly in the world (86th) in respect of such practices – according to the latest World Economic Forum’s Global Competitiveness Index 2011-2012 (see the graph below).

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More happily, New Zealand ranks much better for other aspects of labour market flexibility in this index, being 10th in the world overall.

Note that the ranking for hiring and firing is based on surveyed opinion rather than ‘hard’ data.

Readers can create their own charts here using this database.

Two Cheers for NZ’s Fiscal Responsibility Act

Researchers associated with Stanford University have produced a Sovereign Fiscal Responsibility Index that is an assessment of the strength of a country’s current and projected fiscal outcomes and the quality of its fiscal governance arrangements.

The 2011 rankings here put Australia top of the 34 countries in the index for 2011 and New Zealand second to top.  Australia and New Zealand have relatively strong existing fiscal positions, fiscal projections (to 2050) that look relatively sustainable and relative good fiscal institutions.

The achievability of fiscal projections out to 2050 is clearly a matter of opinion, and New Zealand’s fiscal outlook looks problematic to many given our history of government spending blowouts.

Less problematic is New Zealand’s top score for the fiscal governance component of the index.  Much of the credit for this must be given to the provisions put in place by the Fiscal Responsibility Act 1993 that are now in the Public Finance Act.  Its focus on achieving and sustaining debt at a prudent level through fiscal surpluses on average during each economic cycle could have been (but was not) tailor made for the purpose of giving New Zealand its top ranking.  It surely also deserves some credit for New Zealand’s relatively strong fiscal position, including, the battle by each of the main political parties in the last general election to establish themselves as the party best able to restore fiscal surpluses.

So why the current drive to improve the fiscal position and New Zealand’s underlying fiscal governance arrangements?  Here are two reasons:

  1. A responsible fiscal position is one thing, fiscal settings conducive to greater prosperity and a better quality of life for New Zealanders is another.(The Fiscal Responsibility Act was silent on the question of whether a large amount of low quality spending and unnecessarily high effective marginal tax rates were making New Zealanders at large worse off.  Yet these things matter.)
  2. The enormous increase in government spending in New Zealand between 2005 and 2009, in conjunction with the Christchurch earthquakes, and the drop off in tax revenues have spilled New Zealand into large, fiscal deficits that threaten to persist.(This is a problem independently of New Zealand’s ranking and it is an open question as to whether the Stanford ranking (based on 2010 statistics) fully captured the current extent of the problem.)

See here for an article on the proposed cap for government spending.

Subsidies Down, Productivity Up: NZ Agriculture (again)

The Institute of Economic Affairs, a United Kingdom think tank, has published a discussion paper, Liberating Farming from the CAP.  Its main purpose is to explain the need for Europe to reduce subsidies for agriculture under the Common Agriculture Policy (CAP) in order to raise productivity and innovation.  It reports that the annual cost of the CAP is set to rise from its current €55billion (about NZ$87 billion) to €63billion (NZ$100 billion) by 2020.

While reduced CAP subsidies would certainly help make New Zealand exports more competitive in the short term, the article is also a reminder that such a move would surely force major changes in European agriculture further out.  Indeed, at pp 18-19 the paper uses the removal of agriculture subsidies in New Zealand in the 1980s to illustrate how dramatic the structural changes can be.

The graph below (not from the IEA paper) illustrates just how dynamic New Zealand agriculture has been since 1985 in terms of multifactor productivity growth, both relative to the overall growth rate in Statistics New Zealand’s measured sector (4.5 percent pa vs 1.7 percent pa) and in a ‘before and after sense’ (4.5 percent pa vs 1.3 percent pa between 1978-1985 and 1985-2006).  Note however, that the 1978-1985 period is considered by Statistics New Zealand to be less than two complete cycles, so there is an ‘apples vs oranges’ aspect to the ‘before and after’ comparison.

Would a relatively poor widow be better off if she were richer but still relatively poor?

A columnist in the New Zealand Herald on Monday last week argued, in response to this Policy Matters Blog, that health researchers are right to focus on inequality and relative poverty because the columnist’s widowed relative could not afford to send her 11-year old son to school camp.

However, the suggestion that it is inequality that precludes the widow’s son going to school camp is oxymoronic.  She can’t afford to send him because she doesn’t have the money, which is a matter of absolute, not relative, income.

The focus on inequality and relative poverty implies that the widow would be no better off if everyone’s incomes were quadrupled.