A Matter of Luck?
As the Australian economy motors forward, while we continue to bump along the bottom of the recession, it is not surprising that envious glances are cast across the Tasman. How, it is asked, have the Aussies managed it?
The most obvious explanation is that they have a huge mineral resource that the world – and particularly the Chinese – are keen to buy. If only we were similarly blessed, so the argument runs, we would do just as well. That, presumably, is why such high hopes are pinned on the discovery of new oil and gas reserves, and why it is proposed to dig up some of our most beautiful and vulnerable landscapes in search of coal and other minerals.
I take leave to doubt, however, that success in these ventures would improve our fortunes. Each economy has a different mix of components, and it does not matter very much whether – over the longer term – one component is bigger in one economy than in another. What matters is how we respond in policy terms to the mix we have and to changes in that mix. It is not the hand we are dealt but how well we play that hand that counts. And the omens in that respect are not encouraging.
A classic case in point was the UK experience with North Sea oil. By the time the oil came on stream, in the early 1980s, the UK had adopted a monetarist policy stance. Monetarist theory predicted that an increase in oil production would lead to a rise in the exchange rate. A higher pound would make manufacturing less competitive, with the net effect that the oil production would simply replace a swathe of manufacturing capacity with little or no gain to total production. As the oil revenues began to flow, policy-makers – convinced as they were by the theoreticians’ predictions – were content to watch the exchange rate rise and did nothing to counteract it, with the result that manufacturing did indeed contract as oil production rose. The Dutch had a similar experience – to the point that the adverse effects for their economy were dubbed the “Dutch disease”.
The Norwegian experience of North Sea oil was very different. They paid no attention to monetarist theory. They succeeded in ring-fencing the proceeds of the oil (largely by using them to buy assets abroad) so that their exchange rate remained stable. The benefit to the trade balance allowed them to grow faster than would otherwise have been the case, and – as growth in oil production eventually slowed – the repatriated profits from overseas assets were re-invested in the Norwegian productive economy so that good levels of growth were maintained.
There are no prizes for guessing which course we would follow in the event that we discovered major new sources of mineral wealth. We do not need a crystal ball when we can read the book. Not only have our policy-makers slavishly followed monetarist prescriptions over a long period, but we have some useful case studies of our own to guide us.
Those instances exhibit the same errors in policy-making as those made by the British and the Dutch. A recent example has been the rise in world dairy prices. Our response was to allow the exchange rate to rise (thereby wiping out any gain to domestic profitability, investment and growth) all because we see high dairy prices as an inflationary problem – requiring a tighter monetary policy – rather than as a stimulus to better economic performance.
Even more telling – and depressing – is another instance. It can be argued (and I am indebted to my colleague, Brian Easton, for this point) that we have already discovered a new source of wealth – not new mineral discoveries or even higher prices for our primary produce – but overseas borrowing and the sale of our assets to foreign buyers. The impact of this “new income” on our productive capacity – under the current policy regime – is just the same as the impact that North Sea oil had on the British and Dutch economies. The only difference is that, unlike them when the oil began to run out, we will find when our borrowing capacity is exhausted that we not only have to do without it but have to pay it back.
Our policy settings ensure in other words that, even if we suddenly discovered huge reserves of oil or gold or whatever, we will waste the potential for growth by taking the benefits in higher consumption (through a higher exchange rate and therefore cheaper imports) rather than through production-focused investment. Moreover, the new wealth would actually displace productive capacity – the very reverse of the priority that the government believes it is giving to the productive economy. If we want to do better, we need not complain that we have not been as fortunate as the “lucky country”. We should be making our own luck.
Bryan Gould
7 February 2010.
This article was published in the New Zealand Herald on 23 March.
There Are Other Options
The Reserve Bank Governor, Alan Bollard, used a speech last week to defend the policy that has been applied in this country for over two decades – a policy that he inherited and has since perpetuated. That approach to running the economy essentially revolves around monetary policy – and Alan Bollard’s advice to his critics was that they should accept a monetary policy framework which takes inflation targeting as its central element as the best means available of achieving good economic outcomes.
His critics are unlikely to be convinced. It is not just that our economic performance over more than two decades has been less than impressive and has seen us slide down the OECD tables. It is also that the Governor seems to misunderstand the nature of the criticism.
If we are to take his argument at face value, he is rather like a pastry chef who – using only flour – produces a flat and tasteless cake and then tries to rebut critics by insisting that flour is a very important and valuable ingredient. Most would argue that eggs, butter and sugar might also be helpful – just as, in economics, the Governor’s critics would say that to rely entirely on monetary policy is to ask it to do too much, including much for which it is not suited, and its exclusive use therefore prejudices the chances of achieving a buoyant and successful economy.
No one says, in other words, that monetary policy should be abandoned. But what the critics do say is that we would do better if we used other policy instruments as well.
The irony is that, if we read the Governor’s speech carefully, he seems to agree with this. And it may be better to watch what he does, rather than what he says. Whatever the headlines may say, Alan Bollard indicates very clearly that he is increasingly looking to other elements of policy, even while still focussing on the very narrow definition of his responsibilities with which he is saddled by our legislation.
Let us take, for example, the Governor’s plea to the government that it should get fiscal policy under control by mid-year. We can put to one side whether or not he is right to call for a reduction in government spending, which seems a little misplaced, given that we are still bumping along on the bottom of the recession. What is significant is his argument that an effective fiscal policy will reduce the burden that has to be carried by monetary policy – an acknowledgment that monetary policy needs help from an integrated fiscal policy, even when the policy focus is as narrow as simply controlling inflation. How much more true would that point be if we widened the focus to the wider and proper goals of economic policy?
He is also right to call for a re-appraisal of taxation policy, particularly as it affects the taxation treatment of housing as an investment proposition. This again is a recognition that taxation policy, by focusing on the micro-economic mainsprings of inflation, might have a useful role in a counter-inflationary strategy.
And, the Governor’s rehearsal of the tighter regime he has applied to the banks in respect of their lending policies may find its justification on prudential supervision grounds, but it also has the merit of addressing one of the most significant of factors contributing to inflation – excessive bank lending, particularly for residential property. Again, the Governor has identified an important and additional ingredient – beyond interest rates -in a sensible policy mix.
Alan Bollard, in other words, may talk a good fight against the critics of an exclusive reliance on a monetary policy focused on inflation targeting, but his actions tell a different story. The call for a new debate about macro-economic policy has not fallen – in his case – on entirely deaf ears.
It should be acknowledged that the Governor made some points in his speech that even his fiercest critics would support. His rejection of an Anzac currency, as a means of achieving greater currency stability, is entirely right. A common currency could only work within the context of a common monetary policy; and a common monetary policy could be applied in a democracy only by a common government. Unless we see our future as an Australian state, we should maintain our own monetary policy – and currency.
He was on less convincing ground when he also rejected the kind of competitiveness target that has worked so successfully for Singapore. But whether or not he is right in this, he has at least recognised that a debate on these issues is desirable and appropriate. We are at last making some progress by consigning the mantra that “there is no alternative” to the dustbin of history!
Bryan Gould
1 February 2010.
This article was published in the NZ Herald on 8 February
Macro Economic Policy Is What Counts
As we begin the New Year with the hope of climbing out of recession, we are in danger of overlooking – or misunderstanding – one of the lessons we should have learnt from the global downturn. What the meltdown should have taught us is that economics, as Keynes insisted, is a behavioural science. It is not subject – like physics – to inexorable scientific laws, nor is it to be captured or foretold through mathematical formulae. Economics is the attempt to account for and predict how people – with all their foibles – will behave in response to the stimuli that economic circumstances provide to them.
Governments, and economic policy-makers, understand this, even if they say they don’t. Otherwise, they wouldn’t bother with changing those stimuli in the hope of improving economic performance. Even monetarists, whose basic attitude is that all governments can do is to hold the ring and let people get on with it, are keen interventionists when it comes to pushing this button or pulling that lever.
What we seem to have difficulty in grasping, however, is that the most powerful economic stimuli are those provided by macro-economic policy – the way in which we manage the economy as a whole. We insist on treating that as a given, beyond the reach of policy-makers to influence. “There is no alternative” we are told, either explicitly or implicitly; the ability of governments to influence economic developments is said to be limited to pushing or prodding at specific supposed pressure points. Even 25 years’ experience of the failure of such measures to raise our overall economic performance does not deter us from pushing on doggedly with new versions of old and usually failed remedies.
But this represents a total failure to understand Keynes’ basic insight. The most important economic function of government is to adjust the macro-economic context so that – in a market economy – the overall market and the response people make to it will do the job for us. If macro-economic policy settings allow the market to function efficiently, then much specific intervention will be rendered unnecessary.
Conversely, the less attention we pay to the macro-economy, the greater will be the apparent need and temptation to intervene with specific measures, in an attempt to make up for the deficiencies in economic performance that our macro policy – or lack of it – has made inevitable, and the greater will be the (repeated) disappointment when those measures prove ineffective.
The basic concerns of macro-economic policy should be the overall competitiveness and profitability of our productive sector. The focus should not be any particular firm or industry but the economy as a whole. If those concerns were properly addressed, our productive industry would – without specific intervention – help us to balance our current account, invest in new capabilities for the future, provide worthwhile job opportunities to the whole population, pay proper attention to sustainability, produce buoyant tax revenues to the public purse, and generally produce a more successful and easily managed economy and society.
So, set alongside these goals, how does our macro-economic policy shape up? Does it provide the stimuli that will produce the right responses?
Well, we begin by defining macro-economic policy virtually out of existence. We insist that it is really just a question of monetary policy, and monetary policy for a very limited purpose – the control of inflation. We pay no attention to other policy objectives like competitiveness, profitability or full employment. We have, in other words, fallen at the first hurdle.
We then engage the limited tools of monetary policy – principally interest rates but also exchange rates as an inevitable concomitant – to do a job they are not designed for. Instead of helping efficient market operations by providing market-clearing prices, interest rates and exchange rates are used to distort the market in the interests of controlling inflation – and not very well at that.
Macro-economic policy thereby becomes, not an instrument for promoting the overall economy, but a guarantee that it will not be allowed to prosper. If, by virtue of superhuman efforts by our farmers and manufacturers, or of strokes of good luck such as the rise in dairy prices, we manage briefly to improve our trading performance, the response of our policy-makers (with the help of the foreign exchange markets) is to stimulate a rise in the exchange rate which will wipe out any gain in profitability. And that is a problem because unless there is improved profitability which can be re-invested in productive capacity, there is no escape from our disappointing economic performance.
We insist, in other words, on delivering the message to our most dynamic producers that there is no point in investing in New Zealand’s productive capacity because our policy-makers have other priorities. The power of the overall market forces we set in motion as a result of our neglect of macro-economic policy is such that no amount of poking or prodding at small parts of the economy will have much effect. Little wonder that Kiwis conclude that housing is a better investment than productive capacity.
The stimuli our macro policy provides to our overall economy are, in other words, the very converse of what Keynes would recommend. It is time to recognise that the Keynesian approach offers not just the only way of escaping from recession (as is now reluctantly recognised by most commentators) but is also a long-term blueprint for the health of our economy. If we want a better economic performance, we need to think harder about the “behaviours” that our policies make inevitable.
Bryan Gould
29 December 2009
This article was published in the New Zealand Herald on 4 January 2010.
We Owe the Brash Task Force A Debt of Gratitude
Don Brash and his Task Force, with their bizarre ragbag of extreme nostrums from thirty years ago, have – in at least one respect – done us all a favour. We now know that we can safely consign to history the doctrines that have dominated our economic policy for so long. If we are to make any sense of the goal of closing the gap with Australia, we need to look forward rather than backwards.
Even without the Task Force, it has become clear that the landscape of economic debate has changed substantially. The global recession has forced an “agonising reappraisal” of what works and what doesn’t. Phil Goff recognised this when he proclaimed that the consensus of the last 25 years was ended; and the Prime Minister was not far behind him in quickly acknowledging that the Brash Task Force report would be largely ignored.
So, the search is now on for a policy agenda that will make the difference. In that search, there is an immediate obstacle to overcome. We have been told for so long that “there is no alternative” that we are inclined to think that any departure from the former orthodoxy will require something dramatic and revolutionary. Nothing could be further from the truth.
The effective and sensible course that this country should now follow requires nothing more than the application of common sense and tried and true policies. It is only the absence of any real debate in New Zealand about economic policy over the past 25 years that has made them seem unfamiliar.
The first step we should take is to re-focus our macro-economic policy. The Brash theory has been that, if we focus exclusively on controlling inflation and leave the rest to market forces, everything else will fall into place. The problem has been that the counter-inflationary instruments we chose – ever higher interest rates and a consistently overvalued exchange rate – distorted the operation of market forces and did enormous damage to our productive economy. Little wonder that, by loading the dice against ourselves so that we made it difficult to develop export markets or to resist import penetration, we fell behind those who did not handicap themselves in this way.
What we need now is a better balanced, broader-based policy which treats inflation not as the sole focus of policy but as just one of the targets we should aim at. We need a macro-economic policy that aims at full employment, so that we fully use our resources, and above all maintains and improves the competitiveness and therefore profitability of New Zealand industry.
This requires both monetary and fiscal policy to be integrated so that a stable level of demand is maintained and New Zealand’s competitiveness in world markets is improved. Interest rates and the exchange rate should be allowed to do their proper job and set accordingly. Government has a role to play in doing those things that private industry finds difficult. Other countries, like Singapore – more successful than we have been – have shown how this is done. Only if we can set ourselves on the path of export-led growth can we expect to arrest the long decline in our comparative economic performance.
Oddly enough, this approach places more faith in the capacity of the market to show the way forward than the Brash-inspired distortions implicit in manipulating interest rates and the exchange rate for counter-inflationary, non-market purposes for which they are not intended. Only if our producers – in industry and agriculture – are able to compete effectively in world markets, including our own, can we expect them to make a return which will finance the investment in our productive capacity which is the key to better productivity and rising living standards.
None of this means that we should abandon the fight against inflation – far from it. To stop prostituting the whole of macro-economic policy to the single, narrow task of controlling inflation does not indicate that we need not bother about it. It simply means that we should use all the instruments of macro policy for wider purposes – the health of the economy as a whole – and deal with inflation through measures specifically targeted at inflationary pressures.
There is no shortage of appropriate measures available, if we are prepared to analyse carefully what stimulates inflation. It is increasingly clear that, with the prudent management of public finances over the last decade and the demands necessarily now made on public spending in recessionary times, it is not – as Don Brash continues to maintain – government spending that is the culprit.
What we need to target is the excessive investment in non-productive assets, like housing, that is both the consequence and cause of the bias in our economy against productive investment. The fastest- growing element in our domestic money supply has been bank lending on housing. That is where we should be concentrating our counter-inflationary attention; it is no accident that the tax treatment of housing as an investment and the restraint of bank lending are rapidly moving up the agenda.
A less doctrinaire and more commonsense approach to economic policy would, as a start, give us a level playing field on which to take on the Aussies – and, as we know, that’s all we need to give us a fighting chance.
Bryan Gould
6 December 2009
Closing the Gap
Successive governments have repeatedly expressed their concern at our slide down the OECD economic tables and their ambition to see us climb back up again. But over the last few years, they have focused that concern more precisely; it is the growing gap with Australia that they now target. The present government has committed us to catching up with Australian living standards by 2025.
Identifying a target is commendable but that is the easy bit. Things get harder when we ask ourselves just how we are going to do it.
The starting point is to measure accurately just how wide the gap is. On the basis of comparative GDP figures, it is said that we would have to raise our incomes by over 30% in order to match Australian levels, or – in other words – the average New Zealand family would have to be $50,000 a year better off.
This is daunting enough, but the worse news is that these figures understate the problem. GDP figures include that sizeable proportion of our national output that is actually exported overseas to foreign owners whose stake in our economy is now proportionately greater than in any other comparable economy. If we exclude those repatriated profits and other payments to overseas owners, and count only that domestically produced output that we ourselves enjoy (as is done with the Gross National Product figures), we find that we would have to increase our output by nearly 50% to match Australian levels and that an average New Zealand family is actually $80,000 a year worse off than their Australian counterparts.
If we are to close and eliminate that gap, the frightening challenge is that we will have to make up ground while the Australians will actually be growing – by world standards – pretty fast. We will be chasing a train that is leaving the station at a rapid clip. So, how well are we placed to do so?
The early signs are not promising. The first thing we must recognise is that – as both economies look to emerge out of recession – the Australians have had a flyer. They have already moved smartly into growth mode, while we bump along on the bottom, still not sure whether recovery is really around the corner. The gap, in other words, is already widening as we speak.
The Australian recovery is a function, of course, of the greater economic stimulus provided by their government by comparison with ours – and that reflects not only the stronger starting point they enjoyed but also a different approach to economic management. We, on the other hand, have been largely content to let events take their course and to wait for the recovery of others to restore export markets to us.
Even more depressing is the fact that – even when recovery arrives – we seem determined to return doggedly to the self-same policies (and policy mistakes) which have seen us fall so sadly behind over the past 25 years. It is perfectly clear where we are heading – back to an obsession with inflation above all else, a total reliance on interest rates to regulate the macro-economy, and the destructive impact of an overvalued exchange rate on our productive economy.
We seem to be sleep-walking towards a complete re-run of all our mistakes and failures. The authorities shrug their shoulders; there is, we are told, nothing they can do. Those who – against all the odds – continue to produce our national wealth complain bitterly and warn of dire consequences, but their pleas fall on deaf ears. We are trying to catch the train while running on the spot.
The target set for us of closing the gap with Australia is laughable, and no self-respecting commentator should be heard to lend it respectability, unless we are prepared to take a hard look at what we must do to achieve it. Even then, even if we get everything right, it must be very doubtful that we can do much more than prevent the gap from widening further. Ministerial exhortations, endlessly worked over plans and strategies, constantly repeated targets, will not do the trick. What is needed is a fundamental re-think of macro-economic policy.
Everything we do should be focused on improving the competitiveness and profitability of our productive economy. That means that policy targets should be set in terms of competitiveness rather than inflation, and that interest and exchange rates should be allowed to do their proper job of striking a balance between the interests of lenders and borrowers (in the case of interest rates) and clearing our current account while achieving a satisfactory rate of growth (in the case of exchange rates). Inflation should be constrained by specific measures designed to address inflationary pressures – excessive bank lending on housing and the favourable tax treatment of housing amongst others.
A better economic performance is by no means unobtainable, provided we make the most of our advantages – political stability, a corruption-free and business-friendly environment, an educated and responsible work-force, huge natural advantages and great experience in producing the goods that the world’s fastest-growing markets will increasingly want. All we have to do is to avoid heading back to the dark ages.
Bryan Gould
17 November 2009
This article was published in the NZ Herald on 27 November.