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?