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.

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.

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.

2012 BPS: Treasury’s GDP Growth Projections Since April 2011: Timing Problems

Treasury’s macroeconomic forecasters have had the unenviable task of having to publish three sets of macroeconomic forecasts within around seven months.

Two major sources of uncertainty during this period have been the timing of Christchurch rebuilding and the evolution of the debt crisis in Europe.

The following chart compares the forecasts for the annual growth in real GDP (production side) in the recently released Budget Policy Statement 2012 with the corresponding projections in the pre-election economic and fiscal update and in Budget 2011.

The projections tell a common story of slow recovery, a peak with the Christchurch rebuild, followed by a tailing off to of the order of 3 percent pa growth.  The pre-election update forecasts stand out for being relatively bullish about growth in the first two years in the chart.

The marked difference between the forecasts at the start of this period (the blue columns) and those at the end (the green line) is that the peak growth rate has been pushed out for a year.

One can look at these projections and feel for the citizens of Christchurch – and for those in the construction sector who are no doubt trying to manage their capacity to participate in the Christchurch rebuild while avoiding major losses in the interim.

The Myth That SOEs Return 18.5% when the Borrowing Rate is 4%

Last year Roger Kerr wrote extensively on the myths of privatisation.  Two relevant pieces in relation to the above myth were: Privatisation Myths Need to be Busted and The Truth About Privatisation # 13: Government Finances Benefit

The fallacy arises from the failure to spot that if a SOE returned 18.5%, with the same certainty as the 4% return on government stock, the market value of the SOE would be so high that its rate of return to the owner would be only 4%.  To illustrate:

Maths Teacher:  If one unit of government stock provides an income of $4 a year, how many units would you have to buy to get an income of $18.50 a year?

Pupil:  Let’s see, 18.5 divided by 4 equals 4.625 units.

Maths Teacher:  That’s right.  So if the government sells any other asset that pays an income of $18.50 a year, and uses the proceeds to repay government stock, how many units of government stock could be repaid and what would be the reduction in the annual interest income paid on government stock?

Pupil:  4.625 units could be repaid, reducing annual interest paid by $18.50.

In short, under these assumptions the government would be selling the SOE at a 4 percent yield to the buyer, reducing its dividend income by $18.50 and using the proceeds to repay public debt at an annual savings on interest paid of $18.50.  The posited transaction is fiscally neutral.

Yet here is the widely respected Jane Clifton, The Listener, 3 March 2012 on exactly this point:

The opposition is asking why we would sell something earning us 18.5% because we are terrified of borrowing at 4% to keep it capitalised and performing?  The question [that] has to be asked of the Government … [is]: Are you mad?”

And here is Tracy Watkins, The Dominion Post, Saturday 25 February implicitly propagating the same fallacy

Given the healthy dividends paid to the Government by the state-owned power companies, selling them makes about as much sense to most people as hocking off the family business to pay your credit card

In a less myth-dominated public discourse, public debate would be able to focus to a greater degree on the national interest arguments for and against privatisation.

What if Bell Labs is Right?

The Dominion Post reported on Monday this week that a Bell Labs report has assessed that the current investment in New Zealand of $3.5 billion in rolling out fibre for telecommunications will produce a benefit of nearly $33 billion in 20 years.

If we accept this at face value, what major telecommunications company would fail to make this investment, and why would the Crown need to be an investor?

Privatisation Reduces Crown’s Conflicts of Interest – Crown Fibre Illustration

An article in a weekend newspaper asserted that the best argument for privatisation was that it would deepen New Zealand’s capital markets.

Regardless of whether it is the best political argument, it is not the best public interest argument.

The fundamental problem with government ownership of commercial operations is that politicians have neither the skills nor the incentive to run commercial operations successfully.  There can be exceptions, for a period of time, but they are exceptions rather than the norm.

One aspect of the incentive problem arises from the conflict between political ownership and regulatory interests.  A government might be tempted to regulate in favour of its own operation either for revenue purposes or to make its performance look more respectable.

The conflict of interest issue was raised in Monday’s DomPost which carried an article on the apparent inability of Crown Fibre, the state company set up to oversee the government’s $1.5 billion of spending on the $3.5 billion fibre network, to work satisfactorily with the country’s top telecommunication companies.  The article identified the Crown’s conflict of interest problem as a constraint on its options for rectifying matters.

If this were the case, it would not be dissimilar to the problems that have prevailed with many SOEs over the years.

High Court Ruling on Crafar Farms: Good Decision, Bad Legislation

Justice Forrest Miller’s High Court’s judgment in the Crafar Farms last week that a cost-benefit assessment should be assessed by reference to some other state of affairs – that is a counterfactual – is standard economics, as is his conclusion that this is not commonly achieved by a ‘before-and-after’ comparison.

A commentator in a weekend newspaper suggested that the Ministers would find it hard to establish a net economic gain for New Zealanders from the sale to a foreign buyer, as any New Zealand buyer could similarly improve the land.

The rebuttable presumption from a national interest perspective should surely be that the sum of the net worth of all New Zealanders is maximised when a New Zealander sells any asset to the highest bidder, foreign or domestic.

To rebut that presumption requires some material considerations that were not priced in the auction process to be identified, followed by a convincing case that the benefits from interfering with the outcome of that process exceed the costs.  It is easy to envisage circumstances in exceptional cases, for example those relating to national security, when this might be justifiable.  It is much harder to envisage over-turning the presumption in the typical case.

Under schedule 1 of the Overseas Investment Act 2005 (OIA) farm land of more than 5 hectares is deemed to be sensitive.  The cost in dollars to New Zealanders of an action that reduces the value of all such land is potentially very large.  A 2009 Treasury/Inland Revenue paper for the Tax Working Group, put the value of agricultural land at about $105 billion.  There are also intangible costs in the form of worsened China-New Zealand relations.

In the current situation, it was Westpac who called in the receiver and Westpac is an Australian-owned bank.  A New Zealand interest arises because actions that reduce the sale price unreasonably in the eyes of lenders will make lenders more cautious to lend on farm land in the future.  That, in itself, could depress the value of farm land owned by New Zealanders.  This is in addition to the China-New Zealand relations issue.

Unfortunately, the relevant statutory framework provides some justification for the above commentator’s view.  Section 14 of the OIA restricts the grounds for consent to matters in other sections that when examined that do not mention the consideration received for selling the land, but they do permit considerations of benefit to a subset of New Zealanders.  Justice Millar documents this in paragraphs 13, 17 and 20 of his judgement.  He records that the assessment of the Overseas Investment Office (OIO) did not make any mention of this benefit in its recommendation.

To ignore the value of consideration when assessing the value to New Zealanders from selling an asset to a non-New Zealander is bizarre.  It is akin to seeing someone trying to assess the benefits to New Zealanders of exporting while ignoring the exporters’ revenues.

Perhaps the OIO ignored the sales proceeds because of its reading of the legislation or perhaps it was because of the Westpac foreign ownership consideration.  Yet it was for the latter reason, was it effectively saying that the land was already foreign owned?

A related concern arises from the OIA’s treatment of New Zealanders’ property rights.  Section 3 of the OIA expressly states that it is a privilege for overseas persons to own or control sensitive New Zealand assets.  The corollary is that New Zealanders don’t have a clear-cut right to sell their land to the highest bidder. (The issue here is not with the tests of good character or compliance with immigration act conditions, it is with other aspects of section 16 of the OIA.)

Paragraph 58 of the judgment explains that the overseas bid offers “numerous non-economic benefits which no New Zealand buyer must offer”.  It states that riverbeds are to be offered to the Crown, along with a historic pa site, public walking access, habitat protection and riparian planting.

To an economist’s eye such considerations look like a non-transparent tax on the New Zealand vendor, since overseas bidders can’t be expected to pay for something that they won’t own.  Such hidden taxes are likely to be unfair since they are highly discriminatory and bypass normal processes for scrutinising tax proposals.  They are also likely to be inefficient because the Crown and the other interested parties are not confronted with the opportunity cost of what is being effectively confiscated from the vendor.  This means there is no transparent test of whether the new uses for the land are the best use from a national perspective.

Richard Epstein, in his introduction to A Primer on Property Rights, Takings and Compensation, here criticised the New Zealand Bill of Rights Act 1990 and the Resource Management Act 1991, the first for refusing to treat the right to private property as one of the fundamental freedoms in New Zealand and the second for the way in which it limited the future use and development of property.

The OIA appears to be another example of the neglect of the need for clarity and respect for private property rights including greater transparency in the taking of rights in land use.

Free Market Capitalism Did Not Cause the Global Financial Crisis

Economists will no doubt be debating the causes of the recent and ongoing global financial crisis a hundred years from now.  It is far easier to identify likely contributing factors than it is to ascertain their relative significance.

But one proposition (made by a prominent political figure in a recent Herald article) can be confidently rebutted: it is that the crisis was caused by free markets, meaning the absence of a plethora of specific and intrusive government interventions.  This situation can’t have caused the crisis – because it did not exist.

This article, entitled The Real Causes of the Financial Crisis, by a leading US businessman in the Winter 2012 issue of Cato’s Letter attributes the crisis in good part to the undesirable unintended consequences of specific, intrusive government interventions, based on his own experience and observations.  In a nutshell, he identifies a ‘free-lunch mentality’ in government interventions that reduced personal responsibility.