Read the label carefully

This month's publication of the OECD's latest product market regulation indices came up with a few surprises (here are the key takeaways across all the countries surveyed, and the country note on New Zealand. Tragic regulation wonks might like to look at the questionnaire questions and the note on methodology).

Overall the OECD's overall measure of product measure regulation put New Zealand essentially at the OECD average. That's not too shabby, but arguably not good enough. As the OECD said, "Competitive product markets can boost productivity, employment, and living standards", and if you are a country which already has a productivity problem, you ideally would be better placed to be well down the more competitive end.

Fortunately, it's likely that New Zealand's performance, at least on some metrics, is actually better than the OECD statistics suggest at first glance.

We can unpick what's actually happening by looking at the sub-indices that make up the overall result (see chart below). To be fair, a lot of them show things as they indeed are. Most of us would have guessed our clearly pro-competitive positioning on avoiding retail price regulation: in fact it is currently the best out of the 43* countries surveyed . It is comparatively very easy for people in New Zealand  to set up a new business: if you're minded to jack in the corporate job and go out on your own, you'll have a company established in an afternoon. We have relatively low trade tariffs. At the other end of the scale it's been well known for a long time that we have one of the developed world's most restrictive approaches to foreign direct investment. 

But the survey also threw up some surprises and apparent anomalies, in particular our very poor rankings on 'Administrative and regulatory burden' and 'Licenses and permits'. Intuitively I wouldn't have picked either of those: ever had to deal with the bureaucracy in France? (They have the lovely word paperasserie to  describe the admin flimflam you have to go through). As for 'licences and permits', it didn't seem to me we have got anywhere near the barriers to entry that have proliferated overseas in recent years, where over-rigorous qualification requirements make entry difficult and not coincidentally protect incumbents. .

But look more closely and there's a bit of a labelling issue. Some of those very poor rankings don't really correspond to what they say on the tin. 'Licences and permits' doesn't actually mean, "relative to other countries, people have to get more permits and licences to do what they want rather than just getting on with it". It means, in the OECD's words, do "countries keep an inventory of all licences and regularly review it, adopt the 'silence is consent' principle, and tailor the length and complexity of licences to the risks inherent in the licensed activities". We probably ought to do those things, but that's a long way from having a thicket of licencing barriers to entry.

The low ranking on 'Administrative and regulatory burden' includes how we shape up on "the administrative requirements necessary to set up new enterprises ... with a focus on two specific legal forms: limited liability companies and personally owned enterprises". Given that we score well on ease of setting up a new business - 6th out of 43 as the chart shows - I'm frankly baffled how the overall measure comes out as badly as it does. 

In any event, when the person in the street thinks of "regulatory burden", they think of the whole nine yards of doing everything from your GST to paying your ACC levies and compliance of all sorts, not just how easy is it to get started in business. And if the OECD asked that question, I suspect that while we're not perfect - holiday leave payroll calculations, anyone? - we'd show up a lot better. The French labour code alone (never mind tax and everything else) runs to over 3,300 pages.

While the survey, in my view, shows us a bit more over-regulated than we really are, that doesn't mean we should sit on our hands and ignore the bits where we are genuinely off the pace when it comes to good but not over-intrusive product market regulation. The recently created Ministry of Regulation says that its "Regulatory reviews enable the Ministry to engage with people impacted by regulation and to identify how existing regulation could or should be improved" and that "We are currently developing a framework to assist in the selection and prioritisation of future sector reviews".

Why not junk the thinking about a framework and just pick off the issues the OECD has already identified for us?

* Some charts show rankings based on 43 OECD members, others show rankings based on 48 countries, i.e. the 43 OECD members plus five non-members.

The ComCom session at the NZAE conference

Last week the New Zealand Association of Economists hosted a Commerce Commission themed session at its annual conference. It's become a fixture in the past few years, I'm pleased to say, after a drought period where industrial organisation, competition and regulation didn't quite get the focus they deserved.

The Commerce Commission team - Diego Villalobos, who chaired the session, Geoff Brooke and Rae Rho - talk about productivity trends in the regulated electricity lines business, the regulatory cost of capital, and the competitive effect of new unmanned petrol stations

Geoff Brooke's presentation showed the large increases in allowable revenue for the electricity lines businesses (ELBs) which the Commission has proposed for the forthcoming 5-year regulatory period (from the Commission's draft decision). They're stonking great rises - more than a billion dollars extra in what makes up about a quarter of a household's electricity bill - and they add to all that upward pressure on domestic non-tradables prices that is already giving the Reserve Bank conniptions.

But they're justified, as you can see in the graph below which shows the underlying drivers: input cost inflation, a substantially higher weighted average cost of capital ('WACC') reflecting the rise in interest rate costs as ultra-easy monetary policy has changed to the current post-Covid tightening, and provision for increased opex and capex spending.

Diego Villalobos talked about a productivity study that ComCom commissioned from Cambridge Economic Policy Associates (CEPA), and which looked at the productivity trends in the electricity distribution business (i.e. the ELBs again). As ComCom's cover note about the research said, "The productivity of Electricity Distribution Businesses (EDBs), measured as their outputs relative to inputs, is an important performance indicator. Over time, we and other stakeholders expect EDB productivity to increase as they become more efficient and able to deliver the same services using fewer inputs".

Unfortunately the exact opposite has been happening: productivity has fallen, and sharply, as this extract from the CEPA work shows. 'Non-exempt' EDBs in the table are those directly revenue-regulated by ComCom, 'Exempt' are ones owned by local consumer trusts and which are only subject to an information disclosure regime. But either way both groups have shown steadily lower productivity.

And it doesn't seem to be an oddball result of anything weird CEPA has done: Stats NZ data for a broadly comparable sector (electricity, gas, water, waste services, the yellow line in the graph below) show a similar pattern. It's still possible that both CEPA and Stats are missing a trick somewhere along the line - I'd argue that in some sectors of the economy, particularly those closest to the internet and other IT, productivity is being systematically underestimated - but the first best guess looks to be that there is something sector-specific happening.

It would be nice to say we know what's going on here, but we don't. CEPA canvas some explanations in their Section 6, so have a read for yourself and see what you think, but thus far there don't seem to be any smoking guns.

And finally Rae talked about her research on the competitive impact on incumbents of new unmanned petrol stations opening up (full thing here, summary here). Here's her key result. Look at the red dots, which are the price responses from incumbent petrol stations within five minutes' drive when a new unmanned station opens: you'll see a 2-3 cents per litre reduction in the weeks after the new competitor opens. The black* dots are the response by incumbents who are five to ten minutes' drive away: zilch,  nicely demonstrating the geographical market definition for petrol.

As well as this event study examining response to new entry, there was also a cross-section analysis comparing petrol prices where incumbents face at least one unmanned competitor within a five minute catchment: "On average, Regular 91 prices are 6.1 cpl [cents per litre] lower in local markets where at least one non-supermarket unstaffed site is present, compared to those with staffed sites only". 

There was a bit of discussion in the Q&A about whether ComCom ought to go around the country telling local authority land use planners about these results, and encouraging them to free up areas that new unmanned petrol stations could use. Quite right, too: if the councillor for a particular ward would like the credit for petrol becoming 6 cents a litre cheaper for his or her constituents, there's an easy way to help bring it about.

*A correction, I'd earlier mistakenly repeated 'red' again

Something will have to give

This week's online seminar from Treasury had its chief economics adviser Dominick Stephens recapping the economic and fiscal outlook as laid out in the Budget Economic and Fiscal Update (the 'BEFU').

It drew a big crowd - I counted close to 330 online, and 20 or 30 or so in person - and was a well-laid-out reprise of Treasury's thinking heading into the Budget. I could have done with an update on how data since the BEFU had or had not changed Treasury's thinking. I'd guess, given things like the really poor BusinessNZ/BNZ Performance of Services index for May which had appeared just before Dominick got to his feet, that there's now a bit more downside risk to the Budget forecasts for real activity.

What struck me most, though, were some of Dominick's concluding graphs, reproduced below. The first two come from He Tirohanga Mokopuna 2021 (The Treasury’s combined Statement on the Long-term Fiscal Position and Long-term Insights Briefing): a new Statement is due this year and likely will show the same broad picture. As the Statement said, back in 2021, 

"the gap between expenditure and revenue will grow significantly as a result of demographic change and historical trends, in the absence of any offsetting action by governments. This will cause net debt to increase rapidly as a share of GDP by 2060 ... Changing tax rates or restricting expenditure growth can help close the growing gap between revenue and expenditure. However, analysis in this Statement shows that one policy change by itself is unlikely to stabilise debt over the long run. This means that future governments will likely need to draw on multiple levers and consider trade-offs across different policy options in responding to our fiscal challenges".

Dominick also showed this chart, which illustrates one of the demographic drivers: as people age, they drift into the brackets that attract most government spending support. 

My opinion (just to make clear that it wasn't Dominick saying it) is that it's becoming obvious that at least some of the elements of the government's current fiscal strategy - especially the longer-term commitment to keep spending around 30% of GDP - are going to have to give way. And it's not just the demographics and the climate transition impacts that will eventually force public spending higher: it's also the large bill that's going to fall due to keep the country's infrastructure in good operative nick.

I've been struck in recent days by how many examples there are of investment spending falling short of what's needed. According to this report from Radio New Zealand,  the public health IT system has "more than 6000 apps; 1000 servers, almost half of which were so old they were "out-of-support"; a quarter of databases out-of-support and half on "extended" support; 1000 devices over a decade old". From this report in the Herald, we know that the Cook Strait ferries are approaching terminal clappedoutedness. It's been widely reported (for example here by 1News) that the aging Air Force plane supposed to take the Prime Minister to Japan broke down. And in Auckland the shiny new North Shore hospital has been sitting largely idle because the funds haven't been raised to pay for its operation (as reported for example here).

You'll notice the common theme, writ even larger again in sectors like the dilapidated Three Waters and the potholed roads: failure by successive governments, not just this one, to invest enough to keep capital equipment in good, reliable, up to date order. It's a classic example all round of Stephen Covey's adage that when you classify things that need to be done by whether they're urgent or not, and by whether they're important or not, it's the important but non-urgent stuff, like maintenance, that tends to get neglected.

The current fiscal strategy may limp on for a wee while yet: more equipment may be left to get even more obsolete, the waiting lists for medical procedures may be allowed to blow out even longer, the schools' teaching performance and physical premises can become even shabbier. But it's unsustainable. 

Budget 2024: tough choices deferred

There’s a big bunch of Budget documents handed out to the serried ranks of analysts packed into the pre-Budget ‘lock-up’ in Parliament’s Banqueting Hall, and the place I always like to start unpacking them is the economic forecasts: are they reasonable, or (in particular) are they flattering the prospects for the fiscal accounts? I’ve shown the main forecasts below, and they look more or less reasonable. I reckon the immediate economic outlook could be a bit weaker than allowed for – consumer spending, in particular, could turn out weaker (while there was a lot else also going on, Smith & McCaughey closing was just another indicator of households pulling back from spending), and we’ll have to wait and see whether the expected improvements in corporate profitability and national productivity growth materialise as anticipated. I have my reservations about the predicted track for the fiscal deficit (the ‘OBEGAL’ in the chart), as discussed later in this post, but as far as the economic forecasts go, the overall picture of difficult conditions now, ho-hum conditions in 2024-25, and rather better times beyond that, looks a commonsensical enough take.

A lot of attention will no doubt be given to the headline OBEGAL balance and in particular to the fact that it will not be back in surplus until the 2027-28 June year, a year later than previously anticipated. I don’t think this is a big issue, even if it continues an unhelpful recent tradition of pushing the “we’ll be in surplus” year out by a year, every year. I’m not sure an over-aggressive return to surplus would have made much sense in a weakish economic environment, and even at this slower-pace return to surplus we would end up with net government debt still at relatively low levels by the standard of other developed economies.

And in any event the fiscal balance, while it’s relevant to eventually stabilising government debt and later starting to pay it back, isn’t the best guide to one of the more important aspects of the Budget, namely whether it boosts or brakes the economy, and whether that boosting or braking helps or hinders the Reserve Bank’s job, which is also simultaneously trying to steer the near-term course of the economy. That’s better captured by the ‘fiscal impulse’ (shown below), and the good news is that the Treasury and the Reserve Bank are no longer so obviously at loggerheads. The previous government’s 1.7% boost to GDP from fiscal policy in 2023-24, which clearly complicated the Bank’s job, has been followed by a more or less neutral stance in the current June 2024-25 year, and by fiscal tightening in the years beyond that. The Reserve Bank’s job is now a bit easier. There is a wrinkle – the Reserve Bank may well have been expecting an outright tightening of fiscal policy over the coming year as opposed to the broad neutrality that’s now on the books – but I’ll settle for the two of them no longer being at odds.

The improved coordination of fiscal and monetary policy is a distinct plus in this Budget, as is the reversal of the stealth tax ‘bracket creep’ of recent years when income tax thresholds were not raised in line with inflation. As Nicola Willis pointed out in her Budget speech, “The median full-time wage and salary earner now earns $73,000 a year and is in the one of the highest tax brackets. A minimum wage worker can face a marginal tax rate of 30 per cent”. That needed fixing, and has been to a degree, though I would (perhaps unrealistically given the limited room for fiscal giveaways) have liked to see a commitment to keep on adjusting the thresholds in the future.

But there are also issues that bother me.

One is that there has clearly not been enough money allocated to keep government services going at their current levels or pay for new programmes. The Budget Economic and Fiscal Update (the ‘BEFU’) says (p37) that “the Government has $0.9 billion average per annum available to fund all new initiatives and other cost pressures at Budget 2025  … It is difficult to estimate how much of the Budget 2025 operating allowance will be needed to meet future cost pressures. However, in recent times a large portion of the funding allocated at Budgets has been used to meet cost pressures faced by existing services”. In other words, just paying the higher wage bills will likely eat up all (or more than all) of what’s budgeted.

And beyond 2025 it’s also likely there won’t be enough money to keep everything running unless something else gives. To be fair, the Budget fesses up: “The high-level analysis indicates that the future budget allowances are unlikely to be sufficient to cover future cost pressures on existing services. This means any shortfall and spending on new initiatives will need to be offset by expenditure savings, reprioritisation or revenue raising policy changes for each of the next three Budgets for the Government to manage within the signalled budget allowances. This will involve difficult choices and trade-offs for the Government which are likely to become harder over time”. The Fiscal Strategy Report says (p4) that “Managing within $2.4 billion [operating] allowances will therefore be challenging”: “challenging”, I’d suggest, is a euphemism for “impossible” (especially if you look at the long list of ‘Specific Fiscal Risks’, ‘Committed or Announced Intent that may have Fiscal Implications’ and ‘Time-limited Funding’ from p65 in the BEFU, and which will very likely put even further pressure on the public purse). Maybe there will indeed be enough savings or extra revenue found somewhere to make everything add up, but I for one wouldn’t be surprised to see the OBEGAL turn out worse than currently forecast, continuing the pattern of kicking the fiscal issues can down the road a bit further.

Another is the infrastructure spend. Yes, the Budget speech said that “In 2024, the Government is overseeing a record level of capital investment to deliver the infrastructure on which New Zealand’s growth depends. More than $68 billion is forecast to be spent on infrastructure by the Crown, Crown entities and KiwiRail over the next five years”. That’s great, and to be fair (just looking at transport) in recent years we’ve seen things like the Waikato Expressway, the extension of the Northern Motorway to Warkworth, and easier access to the airport via the Waterview tunnel which have eased previous bottleneck nightmares. But while $13.6 billion a year in new stuff is all good, you have to remember that depreciation (the cost of keeping the existing stuff going) is a sizeable $8.0-8.5 billion a year (see Note 10 to the government’s Forecast Financial Statements): the net addition of infrastructure is a rather less impressive $5.0-5.5 billion a year. I very much doubt if that’s enough given the existing infrastructure deficit and likely new commitments (eg funding the electrification of cars).

And finally, one of the biggest issues for successive government of all stripes has been the quality of outcomes from every public dollar spent: you only have to look at falling educational standards, or the unavailability of medical specialist advice within reasonable timeframes. The Budget is singing the right song – in the Budget speech, “the Government has a clear expectation that public agencies must strengthen their focus on delivering results. We have set clear targets to improve results in health, education, law and order, employment, housing and the environment, and we are focused on delivering them” – but I struggled to see the initiatives or new ways of working that would make the aspiration more credible.

How's my driving?

At the end of February the Commerce Commission published an interesting "look back" review of what it could learn from how its merger decisions have been made. As the Commission said, "The purpose of our ex-post merger reviews is not to determine whether the original decision of the Commission was correct or incorrect, compared to alternative decisions available to the Commission at the time. Instead, our reviews evaluate key factors of a decision and assess whether the Commission’s predictions have eventuated as expected".

That's fair enough. It's always going to be hard to figure out, with the passage of time, what would have happened (the 'counterfactual') if the Commission had made a different call. That's not to say it's a completely hopeless exercise. It could well be worthwhile at least looking for some (however inconclusive) indications of correctness: post-merger, did prices go up for reasons that weren't obviously related to the likes of input costs? Did innovation slow down? Did consumers see the benefit of the efficiencies the merger claimed to enable? But I accept that you may not get any clearly definitive answers, unambiguously linking the merger to unwelcome outcomes, and in that case the more limited objective of seeing whether you read the winds right at the time may be the best you can do.

And it is well worth doing. For one thing, there's been something of a global pushback against competition authorities that may have been too "soft" on mergers - wrongly seeing, for example, adequate competitive constraint on the post-merger entity when, in fact, there wasn't a realistic prospect of new entry or of expansion by existing competitors. For another, we don't do enough in New Zealand to go back and see if policies and plans and decisions worked out like we thought they would, and if not, why not. And finally it shows a pleasing openness to shed some light on the Commission's processes in an environment when some other agencies have been unnecessarily secretive (eg in their recent round of Briefings to Incoming Ministers) on what the issues are in their bailiwick and what they think about them.

The Commission has, apparently, been doing these post-merger reviews quietly in the background for a while: "The Commission first undertook some ex-post reviews of past merger decisions in 2015 [I'll come back to that one in a moment], focussing on cases between 2011 and 2013. A similar exercise was undertaken in 2016, looking at merger decisions made in 2013 and 2014. The Commission renewed the practice in 2019 with a review of six merger decisions made between 2014 and 2016. This process was replicated in early 2023, looking at merger decisions made between 2017 and 2019". But this is the first time the Commission has officially published its findings, and it covers the six reviewed in 2019 and the seven reviewed in 2023 (although in the end the Commission wasn't able to finish reviews of two of them, so 11 made it through to the final analysis).

The big takeaways? The Commission thinks that market participants are too blasé about the likelihood of new entry/expansion and about the ability and incentive, post merger, of consumers being able to exercise countervailing power, and it's going to be asking for harder (and preferably documentary) evidence on both fronts. And in dynamic markets - where there may be rapidly changing consumer fads and fashions (like tastes in the yoghurt market, in one of the reviewed cases) or where new technologies are being rolled out every other day - it may not make much sense to spend a lot of time on market definition, and it would make more sense to ask, post merger, will the merged entity be better able to get away with bad stuff or will it still face adequate competitive constraint.

The Commission said that this is the first time it has published the findings of these post-merger reviews, and strictly speaking that's true, but the results of the 2015 review are also in the public domain: I wrote about them at the time ('More on entry'). They were given as a presentation at the New Zealand Association of Economists' 2015 annual conference, very likely on the basis of "these are the views of the presenters not the Commission's". Interestingly, it came to similar conclusions about being suitably hardnosed about the likelihood of new entry, particularly where there may be high sunk costs (which might deter a potential entrant if entry were at risk of going pear shaped) or where entry is from overseas (particularly if they have bigger fish to fry than the New Zealand market).

Unfortunately the presentation isn't on the NZAE website (only a short and not very informative abstract), and while it used to be on the Commission's website, it doesn't appear to be now. If you're trying to track it down - I found it as an e-resource on the Auckland Library website, or you may have academic access to the paywalled economics journals - then you're looking for Lilla Csorgo and Harshal Chitale, "Targeted ex post evaluations in a data-poor world", in the 'Special Issue on Advances in Competition Policy and Regulation', New Zealand Economic Papers, 2017, Vol. 51, No. 2, pp136–147. 

Hemmed in

Yesterday's Budget Policy Statement, the BPS, as expected, showed that the government's fiscal options are heavily hemmed in. As Jenée Tibshraeny put it in the Herald, "even if economic growth hadn’t slowed as much as it has, it was always going to be difficult for the coalition Government to cut taxes, reduce public sector spending, ramp up the delivery of infrastructure and get the books back to surplus by 2026-27" (her earlier piece in reaction to last December's Half-Yearly Economic and Fiscal Update or HYEFU is worth a look, too).

There's also another factor in play. It's right for the BPS to say that "Tight fiscal policy in the near term will also support monetary policy to bring inflation within target, and maintain it there", but you wouldn't want to push your luck over-aggressively tightening fiscal policy when monetary policy has also tightened substantially. A combo of monetary and fiscal over-ease got us into too-high inflation territory, but we don't want to make the opposite mistake and have the combo of over-braking on both fronts. It's another reason why deferring the planned surplus a bit further into the future makes cyclical management sense.

Fiscal policy faces tough trade-offs, and they may even be a tad more hemmed-in again than the BPS expects. Treasury, in the placeholder forecast update it issued to go with the BPS, has already heavily revised down its estimate of GDP growth in the year to June '24, from 1.5% in the HYEFU to 0.1% now, but there's still downside risk to that estimate. Treasury said that "We expect pressure on household budgets from the erosion in real wages over the past few years, and the decline in household wealth from past falls in house prices, to contribute to declines in real consumption spending until the second half of 2024. On a per capita basis, consumer spending has fallen rapidly, and this scenario envisages that continuing over 2024". 

There's clearly a retail recession of some severity underway, and it could get worse. It's not just the real wage erosion and wealth effects that Treasury mentioned, it's also the hit from monetary policy (the peak pain of mortgage repricing hasn't quite been hit yet), the latest rise in petrol prices, and the imminent bill shock from next year's rates demands. Some ratepayers will be lucky to get away with a high-single-digit percentage, and a lot more will be looking down the barrel of a double digit increase somewhere in the teens. Walk around any shopping strip these days, and you'll find more store windows have gone dark: the chocolatier near us in Warkworth closed this month, and the jeweller flagged it away towards the end of last year. The outlook for the GST take on discretionary consumer spending is going to be distinctly soggy.

There's also downside risk to tax revenues from businesses and the self-employed. Treasury's already well aware of weaker than expected tax inflows: in the financial statement for the first seven months of the year, Treasury noted that "Corporate tax revenue and net other individuals’ tax revenue were $0.5 billion and $0.3 billion below forecast, driven by lower terminal tax revenue for corporate tax and reduced assessed and estimated taxable profits". On Stats NZ's figures, business operating profits in the December quarter were only 0.5% up on a year later, whereas provisional tax paid (as I understand the system) is based on the assumption that profits will have risen by 5%. Overpayment versus the actual outcome triggers tax refunds. There are tax boffins within Treasury who live and breathe this stuff, and maybe they're already onto the scale of it, but I do wonder if they're downbeat enough.

More positively, there was quite a lot to like about how the government intends to go about resolving the trade-offs they face. In particular I liked the look of "Improving public services by shifting spending to higher-value areas and focusing on results": there was a strong theme at this year's Waikato Economics Forum (as I reported here and here) that current programmes are not delivering the value they should, and that better designed, innovative and cost-effective 'social investment' initiatives need to get more support. And while, personally, I wouldn't be putting the highest priority on tax cuts, I can see the merit of one proposal, namely reversing the stealth tax of the past decade that happened as a result of not indexing tax rate thresholds for inflation.

If I was to push one priority over others in this forthcoming scrum, it would be infrastructure. Yes, it's clearly a fact that everyone can't have what they would ideally want from fiscal policy, given our starting point and the economic outlook, and no doubt us infrastructure enthusiasts will take our lumps, too. And I understand that we have currently limited capacity (what with low unemployment and other constraints) to make a big immediate splurge on fixing our infrastructure deficit. 

But there has to be a more serious attempt to fix our infrastructure than we've managed so far. As this report by Sense Partners for the Infrastructure Commission showed, we're already $110 billion odd short of what we need, and if we're not careful that could blow out to some $230 billion (in today's money) over the next thirty years. And quite apart from the new stuff that's needed, we're not even spending enough to keep the existing stuff in good working nick: this report by the Infrastructure Commission found that "renewal spending is below depreciation for state highways, local roads, water supply, wastewater and stormwater infrastructure, and gas distribution infrastructure".

The BPS talked about "Developing a long-term, sustainable pipeline of infrastructure investments"; it said that the government "will top up the multi-year capital allowance (MYCA) by up to $7 billion, with the final number to be confirmed in the Budget"; debt will be used inter alia "to fund high quality investments that provide benefits to New Zealand over time, including those that increase the productive capacity of the economy"; and the government will be "unlocking new funding and financing models to catalyse private investment". That's all good on paper: I just hope that between now and the Budget on May 30, when the decisions on competing claims get thrashed out, we don't do what we've always done, and kick the infrastructure can even further down the increasingly potholed road.

Inflation and the output gap

Yesterday's Monetary Policy Statement from the Reserve Bank said (eg at p ii) that "a sustained decline in capacity pressures in the New Zealand economy is required to ensure that headline inflation returns to the 1 to 3 percent target": the economy needs to move from a hothouse above-capacity state (a 'positive output gap' with people trying to chase after scarce resources, driving up their prices) to a below-full-capacity state (a 'negative output gap', where resources are more available and less in demand).

Here's what the relationship that's being relied on has looked like over the past twenty odd years. It shows how the output gap has affected domestically-generated ('non-tradables') inflation. The numbers come from the underlying data supporting the Statement, which the RBNZ helpfully supplies as a spreadsheet. I've taken the impact of the 2010 GST increase out of the inflation data. I've also advanced the output gap by three quarters, which looks to be a good stab (tested by a couple of quick regressions) at the lag between the hot or cold state of the economy and subsequent heating up or cooling down of inflationary pressures.

It's a reasonably robust relationship (a simple regression had an R squared of 0.54) but it's obviously not infallible. In the mid 2000s for example the economy ran quite hot but non-tradables inflation never picked up, and the years immediately before Covid also saw the economy in reasonably good fettle without provoking the inflation genie. But that said, and especially when there are really large moves (the post GFC slump, the post-Covid fiscal and monetary policy fuelled boom), it holds up pretty well.

Two things struck me when I looked at the chart. One is that the RBNZ is projecting a large move in the output gap by historical standards. Peak to trough, the GFC setback amounted to a 5.8% of GDP swing, from 2.8% above capacity to 3.0% below it. The projected move in coming years is almost as large: a 5.5% swing from 3.9% above full capacity to 1.6% below. Maybe that will indeed happen as monetary policy continues to bite, fiscal policy very likely turns less supportive and strong net immigration swells the available labour supply. I wouldn't say it's an implausibly big or improbable ask to see a turnaround of that order, but getting on top of inflation is reliant on a pretty large change in economic conditions coming to hand.

The other thing that struck me is that if the output gap does indeed evolve as the RB expects, non-tradables inflation might even drop more than projected. My little regression says that if we get down to a negative output gap of -1.6%, non-tradable inflation (with a three quarter lag) would get down to 2.3%, a bit lower than the 3.0% the RBNZ anticipates. Or put it another way: the 3% or so non-tradables inflation the Bank expects is the sort of outcome you'd get if the economy was roughly at a Goldilocks zero output gap, neither too hot nor too cold. If we actually stay below that level (as the Bank thinks), non-tradables inflation could well recede more than currently anticipated.

The New Zealand Economic Forum - Day 2

We kicked off Day 2 with a keynote speech, "The monetary policy remit and two percent inflation", by Adrian Orr, governor of the Reserve Bank, delivered online (full text here or watch the video here) after Adrian came down with a late lurgy (a pity, as I'd looked forward to chewing the fat about the forthcoming NRL season with my fellow Warriors tragic).

Adrian Orr with one of his slides, showing that core inflation as it actually transpired over 2020-22 was stronger than the lower real-time estimates available when decisions needed to be made (with Waikato's Prof Matt Bolger as moderator)

Takeaways? Some sympathy for the RBNZ's (and other central banks') challenges over the past few years: Covid, where Adrian reasonably asked, which mistake did you most want to avoid in the high-uncertainty crisis, and the answer was too-tough policy that might aggravate a downturn, hence the almost universal let-it-rip of both fiscal and monetary policy; the Team Transitory/Team Core debate; the interruption to normalisation from the Auckland lockdown; the Ukraine; and a recent rise in household inflation expectations. 

Expectations - which are interlinked with people's trust in the competence of a central bank (what us older folks used to call 'credibility') - look high on the bank's agenda. I noted in the speech that while inflation has come down, "tackling the tail end of these persistent inflation pressures in the domestic economy remains key to achieving 2 percent inflation. Just how persistent these pressures might be depends on how factors, such as capacity pressures and inflation expectations, evolve going forward". Adrian was giving nothing away about the next monetary policy decision (February 28) but if I were in the room I'd be looking at the latest annual non-tradable inflation rate (5.9%) and wondering if those capacity pressures and expectations levels needed a further knock on the head.

Onwards to fiscal policy, first with a keynote from Caralee McLiesh, Secretary to the Treasury, followed by a panel discussion on 'Treasury and the state of the books'.

Caralee's speech doesn't appear to be up on the Treasury website, but you can get the gist of it from the excellent 'Economic and Fiscal Context Slide Pack' which was part of Treasury's Briefing to the Incoming Minister of Finance. A key point was that our fiscal deficit is structural, not cyclical: as Caralee said, it tends to be easy to loosen fiscal policy in a downturn, and a lot harder to wind back the spend in better times, and we've now reached the point where belated policy tightening is needed (we'd got the same message from Nicola Willis the previous day). "Difficult distributional decisions lie ahead": quite.

Treasury Secretary Caralee McLiesh speaking to our rise in net public debt

The 'State of the books' panel - Craig Renney from the CTU, Eric Crampton from the New Zealand Initiative, Sarah Hogan from the New Zealand Institute of Economic Research - may have been intended to have been a battle of "duelling economists", as one person put it, but it turned out to be a lovefest of harmony and mutual understanding which coalesced around the theme of the importance of getting the best value for money from the public spend. 

As Craig said, there's nothing inherently "right-wing" in demanding value for money and nothing inherently "left-wing" in spending the right amount. Sarah pointed to health as one area where we are not getting value for money: Pharmac (she said) may take its lumps from its critics, but on the other hand it is a rare example in the sector when it comes to revealing its prioritisation. Other areas are either not transparent, or may not even prioritise in the first place. Eric would like us to retreat from the post-Covid spending bloat, perhaps to the same share of GDP that the Wellbeing Budget of 2019 represented (core crown spending of 29.1% of GDP, compared to the 33.0% expected for 2023-24 in last year's Budget forecasts): one reason was that people would be less likely to sign up to future rainy day spendups if they see previous ones sitting there unpaid for. And all the panellists were very keen on a really rigorous framework of prioritisation and evaluation: as Craig put it, "Think hard, and then think hard again".

The "duelling economists": Craig Renney, Eric Crampton, Sarah Hogan, with (on left) panel moderator Waikato's Prof Anna Strutt

Then we got a panel on 'Infrastructure: Unclogging the arteries', a topic close to my and I'd guess every other New Zealander's heart, given the increasingly shabby state of virtually all the infrastructure we use, from hospitals, classrooms, and roads to those infamous three waters. I drove down to Hamilton from outside Warkworth. The good news is that Warkworth to the approaches to the Harbour Bridge went fine (thanks to the new Puhoi motorway extension, even if it took forever to build), and Drury to Hamilton was fine (thanks to the new Waikato Expressway, also remarkably protracted). The bad news was that the intervening Harbour Bridge to Drury stretch remains an absolute nightmare, undoing a fair amount of the Puhoi/Waikato benefits, and the throttleneck looks like staying that way for some considerable time. There's a huge deferred bill looming: one speaker mentioned the Infrastructure Commission's estimate that we will need to spend $30 billion a year for the next 30 years.

Alison Andrew, CEO at Transpower, told us that while the current transmission grid is in good shape, (a) most of it was built in the '50s and '60s and is getting to its use-by and (b) there's an opportunity to green the country through electrification, but we will need 22 gigawatts of generation (and associated transmission) compared to today's 10 gigawatts. She didn't say it, but I personally wondered why the Commerce Commission regulates Transpower in 4-5 year bites, rather than over a longer-term horizon. Chris Joblin, CEO at Tainui Group Holdings, said it wasn't so much unclogging the arteries that's needed, but more like a double or triple bypass after being on the fags since the '70s: we just haven't being looking after our infrastructural health. And when we do bestir ourselves,  the consenting takes forever: he mentioned that it took 17 years to get Tainui's inland port at Ruakura (just beside Waikato University, as it happens) up and running. Among the issues: we look for perfection, which causes procrastination, and we load too many objectives onto projects, blowing out the costs and causing further rethinks. And Nick Leggett, CEO at Infrastructure New Zealand, agreed that we need to get our project management process right: we can occasionally rise to the occasion but mostly we're bad at it.

In passing, if the planning and project mismanagement omnishambles gets your goat, too, you'll like Daryl McLauchlan's piece for Democracy Project, 'Unjarndycing the State'. And if you'd like a piece on how we might do better, here's one I prepared earlier for Acuity magazine, 'Getting results'.

Life's too short, so I'll just pass briefly over the final two sessions. 'Climate & Weather: So what happens if we don't curb emissions?': answer, bad stuff,  and for some of the same reasons that our infrastructure record is so poor. As Sir Brian Roche said, we make a virtue of recovery from disasters, but we don't provide for preparedness in the first place. If 'value for money' was a recurring theme of the Forum, 'dynamic inefficiency', not investing enough to keep the show on the road, ran it a close second.

And in 'Fintech Futures: The end of cash?', no, cash is not dead, with the RBNZ's Karen Silk reminding us of why we still use it (full and final settlement, in privacy, plus benefits when, say post-Gabrielle, the ATMs and EFTPOS go down). And on the fintech side, we've had some successful financial innovation - we heard from Brooke Roberts, co-CEO of one of the successes, Sharesies - and while Brooke hoped that we will eventually have a global fintech come out of New Zealand, it's generally not as easy to get things up and running as it is in, say, Australia. Shane Marsh, cofounder of DOSH, also wondered about us falling behind. In my mind, I've always thought of New Zealand as a digitally advanced place - we were using EFTPOS for everything when our friends and rellies in Ireland, the UK or the US were still writing cheques - but the world's moved on, and we haven't. In Shane's view, our payments landscape is now well behind the rest of the world and even behind some of the 'developing' world .

Matt Bolger, Pro Vice-Chancellor of the Waikato Management School, sent us on our way with an uplifting message. While it's tempting to think that today's rate of change is unprecedented, Matt said we shouldn't get so up ourselves: how do we compare, really, with the generations who went through the Great War, the Depression, fascism and communism, and World War Two? And despite our current inability to plan properly for tomorrow's challenges, maybe he's right that we shouldn't get overwhelmed, and we should stay optimistic. It would be nice to think that New Zealand Economic Forum 2025 will be able to document that we're getting more of a grip on the issues that face us.