Re-opening the Debate
Something important has happened in New Zealand politics. After two and a half decades in which economic policy has been a no-go area for political discussion, we have at last seen the beginnings of a debate about what is potentially the central issue of our politics.
“There is no alternative” was very much Mrs Thatcher’s mantra, but it held equal sway in New Zealand. Indeed, it has been even more significant here, because the aggressive free-market orthodoxy first introduced by a Labour government was then reinforced by their National successors. As a consequence, the major parties chose not to engage each other over the basic principles of economic policy, and the whole question of how our economy should be run was consigned to the sidelines.
The reluctance to discuss economic policy was nevertheless surprising, given the constantly expressed concern and disappointment at our poor economic performance. As the gap between New Zealand and Australia widened, and our productivity figures remained stubbornly unimpressive, the finger was pointed at every conceivable explanation – bar the obvious one. It is only now that the realisation seems at last to have dawned that our comparative economic decline might – just might – have something to do with the economic policy settings we have faithfully followed for twenty five years.
For most of that period, we have slavishly adhered to the view that government’s involvement in the economy should be limited to regulating monetary conditions and that even that limited function should be delegated to unelected bankers charged with the equally limited goal of controlling inflation. Beyond that, the rest of the economy could safely be left, it was thought, to look after itself.
It turned out that things were not so simple. The apparently simple and technical question of controlling inflation through interest rates and exchange rates proved to have important and unfortunate consequences for the real economy. The productive sectors of our economy were constantly handicapped by high interest rates and an overvalued dollar, and by secondary consequences like the relative attractiveness of investing in property as opposed to productive capacity and of bingeing on cheap imports as opposed to saving. There was, in other words, a price to pay for using instruments like the exchange rate for purposes they were not meant for.
Government over this period, of course, was let off the hook, disclaiming any responsibility for managing the economy as a whole. It was content to dabble in micro-economics, and in balancing its own books, but showed no interest in issues of competitiveness or demand management. Macro-economics simply did not exist.
So, what has changed? The Labour opposition has been thinking. They seem to have grasped that there is no upside in either electoral or practical terms in simply agreeing with the government, and that the evidence before our eyes demands that New Zealand should strike out in a new direction.
So, the two-party consensus on economic policy is at an end. It is proposed that the purpose and techniques of government’s involvement in economic policy should change. Macro-economic policy is back.
What are the chances of the debate taking off? They are better than one might imagine. The current government continues to stick to orthodoxy, but they are led by a pragmatist. Sooner or later, and hopefully sooner, John Key is going to realise that he and his government will get nowhere near the goals they have set themselves if they continue to slog along the same road that has led nowhere for so long. That would mean just watching the Australian tail lights disappearing into the distance.
There is also reason to hope that the official mind might be less rigid than it has seemed for so long. The regime at the Reserve Bank under Alan Bollard is clearly less doctrinaire than it was under Don Brash. Even the Treasury cannot be entirely immune from common sense.
To get the debate under way is not of course to win the argument. But whatever the outcome, our public life will be stronger for re-opening a real discussion about the role of government in achieving economic success. And not for the first time, we might even lead a world-wide trend.
The voters may or may not reward Labour for its courage in challenging an orthodoxy that has prevailed for so long. But we all owe Labour a debt of gratitude for starting a debate that is long overdue.
Bryan Gould
25 October 2010
This article was published in the NZ Herald on 27 October.
Recovery? What Recovery?
It is surely beginning to dawn on us, nearly three years after our recession began, that anything approaching a full recovery is still a long way off.
It is now clear that unemployment remains stubbornly high, that the housing market is depressed, and that property values have fallen sharply so that most people no longer feel as wealthy as they did. Lower housing values and employment uncertainties explain why domestic demand is sluggish so that – barring an unlikely pre-Christmas boom – we can expect to see increasing numbers of empty retail premises in our high streets in the New Year. Little wonder that confidence in the economy is ebbing and that employment and investment intentions are at low levels.
As a consequence, the exodus across the Tasman has resumed. Australian living standards continue to rise faster than our own, as both demonstrated and assisted by the growing strength of their dollar against ours.
Yet a great deal is going right for our economy. Our major export markets in Australia and China are performing strongly and demand for our goods is buoyant. Commodity prices generally and dairy prices in particular are at historically high levels. Our trade figures mean that a trade imbalance is not so much a constraint on expansion as it has been over such a long period.
Inflation is not an immediate problem and the Reserve Bank governor has signalled his intention to keep interest rates at low levels. Our banks are in good shape (though, sadly, the same cannot be said of our finance companies). The warnings of the “bond vigilantes” that increased government borrowing to fund their deficits will mean rapidly rising long-term interest rates around the world have not materialised. Our own government’s finances are stronger than forecast and are in any case among the healthiest of any advanced country; most European governments can only dream about our relatively and historically low levels of government indebtedness
In these unusually favourable circumstances, there is something wrong with us if we cannot make a good fist of coming out of recession in good order. So, what is going wrong?
What we are seeing, I believe, is a simple failure of analysis. An economy in recession is by definition an economy in which there is a deficiency of demand. If we want to recover from recession, we have to see somewhere a lift in demand. The question is, therefore, where is it to come from?
For once, a partial answer is provided by the export sector. The improvement in export prices is helping to re-balance the economy towards exports and away from domestic consumption –something the government is keen to see and a process that could be made even more beneficial by a more competitive exchange rate.
But is the relatively strong performance of the export sector enough to counter the impact of lower levels of activity in the other two sectors – the private sector and the government? If the answer to that question is no, then we have our answer as to why our recovery is so sluggish.
It is of course only too evident that activity and confidence in the private sector have suffered during the recession. Consumers are keeping their wallets closed, and businesses are cutting costs rather than taking on employees and investing in new capacity.
So, if we are to lift ourselves out of recession, we need the government sector to be playing its part in stimulating the level of demand, so as to offset and eventually reverse the current depressed state of the private sector. Yet, when we look to what the government is doing, we see priority given to the government’s finances rather than the health of the wider economy – to getting the government’s deficit down, rather than on using fiscal policy to stimulate the economy as a whole. The effect is that depressed demand in the private sector is reinforced rather than offset. The government is not, in other words, helping towards a solution but contributing to the problem.
The government says of course that it must cut back because it has to borrow just to maintain current spending, let alone spending at a higher level. But that is simply to re-state the problem rather than resolve it. The government has a deficit because a depressed economy means that its revenues are down. If the government is not helping but hindering recovery, then it will take longer to reduce the deficit and the recession will drag on for longer. And the longer it takes, the greater the risk that less than optimal levels of employment, investment and output will become permanent features of our economy.
The government is quite right to insist that it must, like the rest of us, get value for every dollar it spends. But isn’t it time that ministers took a wider and longer view of the role they must play if we are to shake off the shackles of recession?
Bryan Gould
2 October 2010
This article was published in the NZ Herald on 12 October.
The Lump of Labour Fallacy
Popular wisdom and what passes for common sense are not always the best guides to running a successful economy. That is why businessmen who have a good practical grasp of what it takes to run a successful business are often wide of the mark when it comes to making policy for a whole economy.
An economy, contrary to what is often asserted, is not like a business. Particularly in down times, the measures that might be required in the interests of an individual business are the very reverse of what is needed by the economy as a whole. Cutting costs, deferring investment, and laying off workers will help to balance a single set of business accounts but are the last thing that a whole economy needs if it is to avoid continued recession.
It is often the case that good economic management may seem counter-intuitive. A case in point is what economists call the ‘lump of labour” fallacy – the belief that there is a fixed amount of work available and that the task is to decide how that is to be shared out fairly.
The fallacy is alive and well in the minds of even experienced policy-makers. We saw shades of it in the “nine-day fortnight” that emerged as a counter-recessionary strategy from last year’s job summit. The idea, which not surprisingly had little impact in practice, was based on the notion that if a fixed amount of work could be shared out, more jobs would be created, or at least saved. By diverting attention from what was really required – a policy which would increase the number of jobs – it actually hindered the fight against unemployment.
The fallacy rears its head unhelpfully in other contexts as well. In the perennial debate in developed countries about immigration, one of the main arguments advanced against allowing an inflow of newcomers is that they will “take our jobs”. There is little recognition of the real possibility that a controlled rate of immigration could create jobs and expand the economy.
There are of course many considerations in determining what are appropriate levels and kinds of immigration; but we would no doubt reach better decisions on matters such as this if we could free our minds of intuitive fallacies and look at the practical evidence. The great economic success of a Hong Kong, for example, was greatly helped by the constant inflow over many years of (often illegal) immigration from across the Chinese border.
The “lump of labour” fallacy also underpins an important current debate in our own country. The stubborn refusal of comparatively high unemployment to melt away has again prompted discussion of what the government could or should do to “create” jobs. The very suggestion that something could be done has, however, been greeted – even by very experienced commentators – with the apparently incontrovertible objection that “the jobs just aren’t there.” And that means, it is said, that there is nothing the government can do.
If that were really the case, of course, the government’s push to get people off benefits and into jobs would be futile. The jobs cannot both be non-existent for the purpose of getting unemployment down, yet waiting there for lazy beneficiaries to take up. And while it is certainly true that there are strict limits as to how far (if at all) governments should try to create jobs by putting in place “make work” schemes, that is not the real issue.
The reality is that the number of jobs in an economy is not a given, but is a function of the level of demand and therefore of economic activity. The number of jobs falls in a recession and rises in better times. If we want to recover from recession, we need policies that will stimulate demand and purchasing power so that people will buy what producers make, and retailers can boost sales, and employers can see that it is worthwhile to take on more staff, and more people earning good wages will keep the virtuous circle going – so that the government’s finances benefit as well through a higher tax take.
There is no mystery about this. And the level of demand is very largely determined by policy. A government that provides stimulus to the economy through maintaining or increasing its own levels of spending and investment, as the Australians did, can achieve a great deal in avoiding recession and fighting unemployment.
If the policy priority, however, is to get the government’s (perfectly manageable) deficit down, the outcomes are equally clear. We may comply with good business practice by pleasing our bankers in the short term, but our economy will be smaller, unemployment will be higher and the recession longer. If we really want to please our bankers in the longer term, we should be growing the proportion of our resources devoted to production and exports. That will not be achieved by allowing a prolonged recession to close down parts of our productive capacity.
Bryan Gould
15 August 2010
This article was published in the NZ Herald on 31 August.
It’s The Economy, Stupid
A week, as Harold Wilson famously said, is a long time in politics, but the day-to-day ups and downs that hog the headlines rarely determine the outcome of elections. Voters’ preferences are usually shaped over longer periods and reflect underlying perceptions about the competence of governments and the preparedness of oppositions to meet the challenges of running the country.
Recent reports of government policy reversals or of Labour’s disciplinary problems matter less, in other words, than what is happening over the long term to the issues that really matter – and principal among those, as Bill Clinton’s campaigners declared, is “the economy, stupid”. For as long as the economy is seen to be on the right track, the Prime Minister will retain a good deal of political capital in the bank, and the government will not be too worried by the kind of occasional, short-term difficulty that afflicts all administrations.
But that scenario could change if, over time, the perception should grow that the economy is heading nowhere. A better economic performance, even if the goal of closing the gap with Australia is now said to be only “aspirational”, is after all at the very core of the government’s agenda. Other disappointments might well be accommodated without difficulty, but an economic policy that was seen to take us down a dead-end would be serious for any government, not least this one.
That is why the faintest of alarm bells might now be audible in John Key’s office. It is bad enough that the steady recovery from recession now looks as though it might have stalled. The current economic news suggests that, whatever the statistics might show, people are now much less confident that their economic circumstances will improve over the next year or so. And that is exactly the kind of perception that can have a big influence over election outcomes.
What will worry the government even more is that they seem to have few weapons left to try to improve matters. Even our relatively benign experience of recession over the past couple of years is now seen as owing more to the buoyancy of our major export markets in China and Australia than to any initiatives taken by the government. And, as those markets falter, the heat will turn up on the government to find its own way forward.
The trouble is that they have already fired what seem to be their best shots, to little avail. The jobs summit produced little. The priority to getting the government deficit down is said to preclude any further stimulus to demand and economic activity. The welcome focus on funding for research will take some time to bear fruit.
In the meantime, almost all of measures they have turned to have failed to carry conviction. They have either been tried before without achieving much or have provoked such opposition that they have been abandoned before they even got started.
So, removing “labour market rigidities” through amending employment law in favour of employers is a favourite nostrum of neo-liberal ideologues but has stubbornly failed to produce any benefits to productivity or growth when it has been tried before. Pressing on with the free trade agenda looks and sounds good but – in a country which has given it a more extended trial than almost anywhere else – has resulted over a couple of decades in a more rapid growth in imports than in exports.
The move to attract foreign capital by increasing our willingness to sell even more assets into foreign ownership seems to have stalled in the face of the Prime Minister’s recognition of the political risks involved. The attempt to transform our tiny financial institutions into world players in capital markets seems unlikely to get off the ground. And the latitude planned for international mining companies to prospect in prime conservation land quickly flew in the face of environment sensitivities.
The danger for the government is that these abortive steps will be seen not just as failures but as having been ideologically driven – reflecting the belief that economic salvation lies in tilting the balance in favour of employers – rather than directed at solving real economic problems. And that problem will be compounded as we seem to be preparing yet another re-run of measures – high interest rates and an over-valued dollar – that have already been seen to make the problems worse rather than better.
John Key has so far shown a sure political touch. He will know that perceptions about the government’s ability or otherwise to kick-start our economy will be critical to his chances of re-election. Stand by – if we are lucky – for an “agonising re-appraisal” of economic policy.
Bryan Gould
1 August 2010
The Productivity Puzzle
As the latest indicators show our economy struggling to escape recession, it is widely accepted that the key to improving our economic performance is to raise our productivity levels; and this is very much the focus of the government’s efforts to close the gap with Australia. But there is a mystery at the heart of our productivity performance. If we could solve that mystery, we might see our productivity performance lift very quickly.
One of the reasons that high levels of productivity are important is that, by improving our competitiveness in the internationally traded goods sector, our exports are stimulated – and buoyant exports, by removing a balance of trade constraint on growth, allow us to grow faster both at home and in overseas markets. That faster growth in turn promotes productivity improvements and – hey presto – we are in a virtuous circle of export success and productivity growth.
And this is indeed the experience of successful exporting economies. Their export industries exploit the larger markets and higher margins offered by the internationally traded goods sector, with the result that those industries grow quickly and lead the rest of the economy into productivity growth, rather as a locomotive leads a train. There is then a strong market imperative to move the economy’s best resources – of capital and skill – to those growth points in the economy.
Those factors can become so powerful that a country like Japan in the 1960s and 1970s will develop virtually two economies; statistics from that era show that the Japanese domestic economy was very similar to other economies, with normal inflation, growth and productivity levels, whereas the export economy showed rapid growth, low inflation and high and fast-growing productivity. That experience has been shared, perhaps not quite so dramatically, by other successful exporting economies ever since.
Some research* conducted two or three years ago on the New Zealand economy, however, suggests that we have not, for some reason, been able to tap into that successful experience. The research showed that – as expected – our exporting firms exhibited significantly higher levels of productivity than the generality of New Zealand firms. This is not surprising, since in general terms, only the more productive and therefore competitive enterprises can foot it in international markets.
But, unexpectedly, the research showed that – for the period covered by the research, from 2000 through 2005 – productivity in our exporting firms grew no faster than in firms in the rest of the economy. The boost to growth and productivity as a consequence of exporting seems simply not to have materialised. Our exporters, despite being our best performers, were not able to gain the benefits from exporting that exporters elsewhere had found so valuable. This begs the obvious question – why?
The question surely suggests that there are factors at work in our economy that inhibit our exporters but that are not evident in other more successful economies. Those factors, whatever they are, seem to mean that even our best firms, ready and primed to take advantage of export opportunities, cannot make them count.
There is of course always a small number of firms that will make a breakthrough in terms of a new technology or a new product and will be able to sell successfully in overseas markets without worrying too much about price competitiveness. It is then tempting (and the temptation is often yielded to) to be diverted into concluding that such firms show the way to successful exporting, productivity and growth, and that that is the course the rest of the economy should follow.
But most international markets are extremely price sensitive, and success in those markets depends crucially on the price competitiveness of the individual exporter, and even more of the export sector as a whole. Only if exporters are competitive in price terms can they grow market share and boost profits through healthy margins. Otherwise, they must choose between maintaining prices and losing market share, or dropping prices and taking lower margins.
That is, indeed, what seems to be happening to New Zealand exporters. They get to the export starting line, but something then stops them from running a successful race. Their failure, or inability, to kick on means that they do not derive the expected advantage from faster growth, better returns, and higher productivity. The virtuous circle eludes them.
We do not need to look far to identify the culprit. We have run, and have done for many years, a policy of perennially high interest rates and consequently over-valued exchange rates that has meant that our exporters are always fighting a head wind. They struggle to the starting line but are then weighed down, in price competition terms, by a dollar rate that cuts their margins and shrinks their markets.
Our narrowly focused macro policy may, in other words, be more than an obstacle to individual exporters, but the major factor in our productivity disappointments. The key to our economic salvation may be a willingness to think again. Mystery solved?
Bryan Gould
6 July 2010
*Some Rise by Sin, and Some by Virtue Fall: Firm Dynamics, Market Structure and Performance, by Richard Fabling (Reserve Bank of New Zealand), Arthur Grimes (Motu Economic & Public Policy Research), Lynda Sanderson (Ministry of Economic Development), Philip Stevens (Ministry of Economic Development)
This article was published in the NZ Herald on 12 July.