A tale of two cities

Grant Spencer, Deputy Governor at the Reserve Bank, gave a speech, Trends in the New Zealand housing market, to the Property Council earlier this month, and I have to confess that I've only just got round to reading the full thing. I'd seen the press coverage (for example Reserve bank boss backs loan rules in the Herald), which had focussed on the LVR points in the speech, and I'd wrongly assumed that there wasn't much else in the speech.

So, belatedly, I'd recommend reading it. It makes the point, in particular, that "The underlying issue in the New Zealand housing market is a shortage of supply. In Christchurch there is a specific housing shortage as a result of the earthquake-damaged housing stock. In Auckland, the shortage has been growing over a much longer period, with weak or declining rates of house building since 2005", as shown in the chart below.

Grant said that "Low rates of building have led to a gradually increasing shortage of homes in Auckland" and that "A significant limitation on new home building in Auckland appears to be a scarcity of available land" due to restrictive planning rules. And he's realistically downbeat about the likelihood of the 13,000 new homes a year that are needed to be built in Auckland happening any time soon: "meeting the combined three year targets of Christchurch and Auckland would require a major mobilisation of national construction resources. In all likelihood, the build will be stretched over a longer period".

You might well wonder, if the big issue is on the supply side, why the Reserve Bank came up with its LVR rules. But Grant went on to say that the supply side of the market isn't the only thing that's happening: "the supply of houses is an important determinant of house prices – but it is only one side of the story. We have seen the shortage of homes in Auckland emerge due to low construction rates over many years. But house price inflation has accelerated only over the past two years, over the same period that credit conditions became easier and population growth picked up with stronger net inward migration".

There's not a lot they can do about the migration demand - which as I posted here is getting stronger all the time - but they have felt they've needed to lean against the easy-credit demand pressures a bit with the LVR rules: "Expanding housing demand through easy credit will do nothing to speed up the housing supply response [i.e. house prices are already so high that builders will still be incentivised to build new ones even if the RB reins in the market]. It simply adds to housing demand, pushes up house prices and makes housing less affordable"
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I was also encouraged to see that the LVR rules have a use-by date: "As the imbalance between demand and supply is reduced, we will look to lift the LVR restrictions...We will be looking for clear signs that excess demand pressures have substantially reduced and that a removal of the restrictions will not result in a return of such pressures".

Overall I was left with the impression that our central bank's analysis of the housing market, and the responses it's come up with, look both reasonable in themselves - and a good deal closer to reality than what their counterparts in Australia are up to.

I've posted before - Someone else is developing a housing headache, too...- that I think at least parts of the Aussie housing market are clearly overheating. The median house price in Sydney has just gone over A$700,000 for the first time, and the median apartment price has cracked A$500,000 for the first time (both estimates from Australian Property Monitors). And while RBA Governor Glenn Stevens isn't too perturbed about the national Aussie housing picture - "My own view, thus far, has been that some rise in housing prices is part of the normal cyclical dynamic, that it improves the incentive to build, and that a price rise reversing an earlier decline probably isn't something to complain about too quickly...it has been a little too early to signal great concern", as he said in a speech yesterday - he is beginning to cast a beadier eye on some of the hot spots: "Investor participation in housing in Sydney, in particular, is becoming noticeably stronger. Over the past year, the rate of finance approvals for this purpose has increased by 40 per cent".

Even so, the RBA doesn't look minded to deal to what looks to me to be a market getting completely out of hand in places, and is staying in 'on your own heads be it' mode, or in the Governor's words, "lenders and borrowers alike would be well advised to take due care".

I wonder if that's adequate.

Leopards and spots, Japanese style

Here's a potted (though I think fair) summary of the current consensus view on Japan: Prime Minister Abe's got his "three arrows" (monetary expansion/reflation, fiscal stimulus, structural reform), he's successfully fired the first two, but the third is still sitting in its quiver.

There's certainly evidence that the first two are working. The Economist's latest (October) poll of international forecasters has Japan growing by 1.8% this year, and 1.6% next year, and price deflation is being turned around, with consumer prices expected to be essentially stable this year (+0.1%) and to rise by 2.2% next year.

What's somewhat bothering me, though, is that second arrow of fiscal stimulus through public works. And not for the reason you might have expected (the wisdom of running more deficits when already heavily indebted).

What's bothering me is the likely gross inefficiency of the spending. And maybe what it says about the underlying ethos of the Abe administration.

Now, I know that from some perspectives (eg immediate job creation) it doesn't matter what the money is spent on. As Keynes put it, "If the Treasury were to fill old bottles with bank-notes, bury them at suitable depths in disused coal-mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again...there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing" (General Theory, p129).

More sensible, indeed - but that's not what the Abe administration is doing. It's gone the old bottles route: more roads to nowhere that aren't needed, more civil engineering works that achieve nothing of lasting worth.

It's straight back to the worst practices of the Liberal Democratic Party, when the construction companies and the LDP were deeply in each others' pockets, when rivers got paved over, and bridges and motorways to nowhere were built everywhere.

Here's an illustration of how bad it has been. Earlier this year the McKinsey Global Institute and the McKinsey Infrastructure Practice published a fine report, Infrastructure productivity: How to save $1 trillion a year, well worth reading in its own right. Along the way, though, the McKinsey folk came up with this.

Spot anything strange about the relative scale of Japan's spending on roads?

So what this says to me is that, when given the option of what to spend the fiscal stimulus on, the LDP went straight back to what they used to do in the bad old days before the electorate chucked them out in 2009.

And that's a worry on two fronts. Unproductive 'scratch my back' pork-barrel deficit spending was one of the things that got Japan into its mess in the first place. And if it is indeed an unreconstructed LDP we are seeing, as beholden to special interests as it ever was, then I wouldn't get too optimistic about the prospects for the third arrow of structural reform.

The Meridian float - a reality check

There has of course been the usual political finger-pointing going on since the just-got-it-away Meridian float. There's even some truth to some of it.

But it looks to me as if the real reasons for the lukewarm outcome are much simpler.

One, most families don't want their (limited) direct equity holdings to be all power companies. I know we didn't: we went for Mighty River Power, and enough is enough.

Two, we might have nonetheless have been persuaded, if MRP had been a roaring success. It hasn't been.

End of analysis.

One final thought, though, and I accept it's totally with the benefit of hindsight. Why the decision to do MRP first, and Meridian second?

If I had to take a guess, I'd bet someone said, "Let's test the waters with the smaller one, and if we can get that one off our hands, we can get the bigger one away". And if I'd been sitting around the table in risk-management mode, I probably would have gone along with it, too. As it transpired, I wonder if it wouldn't have been more cost effective to have done them the other way around: the cost of the sweeteners needed to get the second one away could well have been less.

As for getting Genesis away in the light of all this - I can't see the current sales process delivering a successful float any time soon.

X marks the spot

A wee while back I posted a graph that Treasury had prepared showing the link between net migration and house prices. Yesterday we got the latest net migration numbers. So I've updated Treasury's graph: X is the annualised rate of net migration based on the last quarter.

Good luck to the RBNZ with this one.

We look to have our labour market arrangements broadly right

I was browsing the Vox ("Research-based policy analysis and commentary from leading economists") site over the weekend and came across Unemployment, labour-market flexibility and IMF advice: Moving beyond mantras by the IMF's chief economist and two IMF staff economists (which in turn is a shortened and popularised version of Labor Market Policies and IMF Advice in Advanced Economies During the Great Recession). It's interesting in itself, but doubly interesting in that it features two graphs that show New Zealand in international comparison.

Here's the first of them.

Okay, when I saw this graph at first, I didn't know what was going on, either.

Let's start with those red ("Unemployment at 5%") and green ("Unemployment at 10%") lines that look like isoquants (and are). Ignore the country data points just for a moment.

Each of these isoquants traces out those combination of inflows into unemployment (as a percentage of the labour force per month, on the Y-axis) and the duration of unemployment (in months, on the X-axis), that keep the unemployment rate steady. 

The red line shows, for example, up the left hand side of the curve, that a 5% unemployment rate could be maintained indefinitely if 3% or so of the labour force lost their jobs in any given month, but only spent about a month or a month and a bit in unemployment. Or, out the right hand side, that there would be a steady 5% unemployment rate when only about 0.5% of the labour force lost their jobs in any given month, but stayed unemployed for about a year.

And the green line shows the same thing for a 10% rate of unemployment, obviously lying well outside the 5% one. You can imagine a whole series of isoquants for different rates of unemployment, but only two are shown here.

Okay - now we know what the isoquants are, we can start thinking about the data points, which represent where countries have actually been over the period 1995-2007. 

Note first that you ideally want to be on an isoquant closer to the origin rather than further away. On that basis we scrub up reasonably well. In this data set (which is the G20 plus a few odds and sods like us), there aren't many countries on isoquants clearly closer to the origin than us (other than Norway), quite a few similar, and a fair number markedly worse.

What about the significance of where you are along any given isoquant?

Here it's probably best to look at the labour market theory behind all of this. You'll see that 'Perez and Yao' are credited in the graph, and that's a reference to Can Institutional Reform Reduce Job Destruction and Unemployment Duration? Yes It Can. Perez and Yao call each isoquant an 'IsoUnemployment Curve', or IUC.

The isoquants can be used (they say, p21) "to classify countries according to their preferences over the job destruction-unemployment duration trade-off", i.e. where they are along any one isoquant shows "each economy’s revealed social preferences over the destruction-duration mix". And different countries clearly prefer (or at a minimum end up with) particular combinations: "Some countries seem to tolerate relatively high destruction rates as long as unemployment duration is short [that includes us, and Australia]. Others are biased towards job security and do not mind financing longer job search spells. A few unfortunate countries [Spain, for example] are trapped in a high inflow-high duration combination, seemingly condemned for long periods of high unemployment".

Which combination a country chooses is not necessarily linked to its unemployment rate. "The upshot of this analysis is that labor markets characterized by high levels of job destruction but brief unemployment spells [like us] do not necessarily outperform countries characterized by the opposite behavior". Canada, for example, is on a worse isoquant than Japan. 

Personally, I quite like where we have been revealed to be - some unemployment, more widely but more briefly spread, seems better to me than some unemployment, heavily borne by the long-term unemployed.

I said there were two interesting graphs: here's the other one.

In the original Vox paper, the IMF economists were saying that the IMF probably ought to "tread carefully" if tempted to advise countries on how to run their collective bargaining arrangements, because "trusting partners can make widely differing combinations of institutions work well", and they use the graph to show that it is the level of trust that can be as important as anything else. 

That makes broad sense, even if you're immediately tempted to observe that trust isn't an exogenous manna from heaven and to wonder about chains of causation (does trust make structures and processes work better? Yes. But do good structures and processes engender more trust? That too).

In any event, we again show up down the desirable end of the spectrum.

We look to have our labour market arrangements broadly right

I was browsing the Vox ("Research-based policy analysis and commentary from leading economists") site over the weekend and came across Unemployment, labour-market flexibility and IMF advice: Moving beyond mantras by the IMF's chief economist and two IMF staff economists (which in turn is a shortened and popularised version of Labor Market Policies and IMF Advice in Advanced Economies During the Great Recession). It's interesting in itself, but doubly interesting in that it features two graphs that show New Zealand in international comparison.

Here's the first of them.

Okay, when I saw this graph at first, I didn't know what was going on, either.

Let's start with those red ("Unemployment at 5%") and green ("Unemployment at 10%") lines that look like isoquants (and are). Ignore the country data points just for a moment.

Each of these isoquants traces out those combination of inflows into unemployment (as a percentage of the labour force per month, on the Y-axis) and the duration of unemployment (in months, on the X-axis), that keep the unemployment rate steady. 

The red line shows, for example, up the left hand side of the curve, that a 5% unemployment rate could be maintained indefinitely if 3% or so of the labour force lost their jobs in any given month, but only spent about a month or a month and a bit in unemployment. Or, out the right hand side, that there would be a steady 5% unemployment rate when only about 0.5% of the labour force lost their jobs in any given month, but stayed unemployed for about a year.

And the green line shows the same thing for a 10% rate of unemployment, obviously lying well outside the 5% one. You can imagine a whole series of isoquants for different rates of unemployment, but only two are shown here.

Okay - now we know what the isoquants are, we can start thinking about the data points, which represent where countries have actually been over the period 1995-2007. 

Note first that you ideally want to be on an isoquant closer to the origin rather than further away. On that basis we scrub up reasonably well. In this data set (which is the G20 plus a few odds and sods like us), there aren't many countries on isoquants clearly closer to the origin than us (other than Norway), quite a few similar, and a fair number markedly worse.

What about the significance of where you are along any given isoquant?

Here it's probably best to look at the labour market theory behind all of this. You'll see that 'Perez and Yao' are credited in the graph, and that's a reference to Can Institutional Reform Reduce Job Destruction and Unemployment Duration? Yes It Can. Perez and Yao call each isoquant an 'IsoUnemployment Curve', or IUC.

The isoquants can be used (they say, p21) "to classify countries according to their preferences over the job destruction-unemployment duration trade-off", i.e. where they are along any one isoquant shows "each economy’s revealed social preferences over the destruction-duration mix". And different countries clearly prefer (or at a minimum end up with) particular combinations: "Some countries seem to tolerate relatively high destruction rates as long as unemployment duration is short [that includes us, and Australia]. Others are biased towards job security and do not mind financing longer job search spells. A few unfortunate countries [Spain, for example] are trapped in a high inflow-high duration combination, seemingly condemned for long periods of high unemployment".

Which combination a country chooses is not necessarily linked to its unemployment rate. "The upshot of this analysis is that labor markets characterized by high levels of job destruction but brief unemployment spells [like us] do not necessarily outperform countries characterized by the opposite behavior". Canada, for example, is on a worse isoquant than Japan. 

Personally, I quite like where we have been revealed to be - some unemployment, more widely but more briefly spread, seems better to me than some unemployment, heavily borne by the long-term unemployed.

I said there were two interesting graphs: here's the other one.

In the original Vox paper, the IMF economists were saying that the IMF probably ought to "tread carefully" if tempted to advise countries on how to run their collective bargaining arrangements, because "trusting partners can make widely differing combinations of institutions work well", and they use the graph to show that it is the level of trust that can be as important as anything else. 

That makes broad sense, even if you're immediately tempted to observe that trust isn't an exogenous manna from heaven and to wonder about chains of causation (does trust make structures and processes work better? Yes. But do good structures and processes engender more trust? That too).

In any event, we again show up down the desirable end of the spectrum.

Explaining the GFC

I've discovered the hard way (from relatively low levels of page views) that few people want book reviews, not even economists on economics books. So this isn't one. It's just a pointer to what Bill Clinton has called "a masterpiece - simple, straightforward, and wise", what Paul Volcker has described as "a comprehensive and, mirabile dictu, engagingly readable analysis of the great financial crisis" and what Bob Woodward has said is "the best account available of what really happened in the 2008 financial crisis, why, and what it now means for the future".

I finished it over the week-end, it's as good as they say, and it's Alan Blinder's After The Music Stopped: the financial crisis, the response, and the work ahead.

And if you like it, try one of my all-time favourite economics books, Blinder's Hard Heads, Soft Hearts: Tough-Minded Economics for a Just Society.

Are we as committed to free trade as we think?

The latest print edition of the Economist has an article, 'The gated globe', which makes the case for increased globalisation and in particular for renewed liberalisation of international trade. All good.

Along the way the article mentioned an organisation called Global Trade Alert. I looked them up: their mission in life is "Independent monitoring of policies that affect world trade", and they do a fine job of it. It's a very interesting site.

I wondered, as you do, if I could break out how New Zealand was travelling in terms of liberalising or impeding global trade. And I could, using a box on the left of their home page, where you can 'Search [trade policy] measures by...'. I put 'New Zealand' in the 'Implementing jurisdiction' box, left everything else set to 'Any', and hit 'Search'.

I hoped and expected that we'd come out on the side of the angels. The answer is, we kinda did, sorta.

The search returned 12 results. Sadly, only two of them were liberalising. One was an APEC initiative in 2012 to reduce tariffs on a range of environmental goods (wind turbines, solar heaters and the like). The other was a unilateral initiative in 2011 to make business immigration a little easier.

That left 10 on the protectionist side of the ledger.

Six of them were anti-dumping measures, against Chinese preserved peaches, Chinese wire nails, Italian tomatoes, Malaysian galvanised wire (what's with the wire?), Spanish canned peaches (what's with the peaches?), and Thai plasterboard. Incidentally, there seem to be a few more that Global Trade Alert may have missed: on the 'Imported goods subject to duty' page of the MED website I found peaches, yet again, from Greece and South Africa; diaries, of all things, from China and Malaysia; hog bristle paintbrushes from China; and reinforcing steel bar and coil from Thailand.

The other four measures that Global Trade Alert reported were a mixed bag.

Two of them were GFC-response measures to guarantee the deposits and the wholesale funding of New Zealand financial institutions. Global Trade Alert put them in the bad column because they felt they discriminated in favour of New Zealand entities. That might be formally true, and probably undesirable, but I honestly don't believe there was a skerrick of protectionist intent behind either measure in the circumstances of the GFC, so I'm going to put those to one side.

The last two were a 2009 toughening of immigration law, making it harder for seasonal migrants to get in, and a 2012 amendment to the customs and excise legislation, introducing much higher penalties on importers for making "materially incorrect" entries on their import forms, with the maximum penalty going up from $50 to (wait for it) $10,000.

It's regrettable we've done any of this, but it's especially regrettable that we've made use of these anti-dumping measures. The MED's website says all the right things - its FAQ says "Trade remedy investigations ensure fair competition, and should not be seen as trade restrictions", and "There is a difference between imports that are low-cost and those that are dumped or subsidised. Anti-dumping or countervailing action does not remove a foreign producer's competitive advantage, and is not designed to prevent imports from any given country" - but the reality is that anti-dumping provisions have little underlying logic. They're on the same, generally shaky, ground as 'predatory pricing' cases are in a competition law context.

And even if they might be worthwhile in some situations (and I'd emphasise the 'if' and the 'might'), the regularity with which they are abused, as covert protectionism, outweighs any good they might do. And we should know: we've been on the receiving end of the abuse in the past, notably over kiwifruit exports to the US in the 1990s.

So I'm sorry to see us making regular use of them. I know, there aren't pages and pages of them, it's not the end of the world, these are relatively small niches, and you couldn't argue with a straight face that we are erecting Fortress New Zealand behind a barricade of anti-dumping duties. But even a few of them are in my view a few too many.

You might wonder why I summarised our overall position as 'sorta' on the side of the free trade angels, since we haven't done much on the plus side of the ledger and an assortment of (admittedly modest scale) stuff on the wrong side.

That's because you haven't seen the scale of what other countries have been up to. Australia, for example, features 80 times in the Global Trade Alert database. Only 10 of the mentions are in the liberal column. The other 70 were on the protectionist side, including 34 anti-dumping cases.

So we're not perfect. But we're a great deal less imperfect than a lot of places.

Call off the dogs

The morals police are in full hue and cry in pursuit of newly re-elected Mayor of Auckland, Len Brown. They're trotting out the supposed link between moral purity and professional ability. Not, I strongly suspect, that they ever apply it to themselves.

So here by way of more compassionate perspective is some data.

Whenever I see this sort of mob clamour, I'm also reminded of Abraham Lincoln's response, when scheming rivals wanted Union commander Ulysses S Grant replaced because (they said) he drank too much: "I wish some of you would tell me the brand of whiskey that Grant drinks. I would like to send a barrel of it to my other generals".

Mind the gap! - New Zealand's experience

Earlier I wrote up a piece from the Bruegel think tank's blog about the fallibilities in the European Union's way of measuring the output gap, and the problems it causes in trying to estimate how much of a country's fiscal deficit might be structural or cyclical.

Bluntly, big problems with estimating the 'normal' state of the Eurozone economies, and what the 'structural' or 'underlying' fiscal balances look like in that 'normal' state, would make you very wary indeed of basing fiscal policy decisions on them.  And I wondered whether these issues tend to crop up elsewhere, and whether this exercise is a sensible goer anywhere.

As it happens, one of Treasury's officials had a close look at these issues in a New Zealand context. It was one of the papers presented at Treasury's 2011 conference New Zealand's Macroeconomic Imbalances – Causes and Remedies Policy Forum. Anne-Marie Brook's paper, Making Fiscal Policy More Stabilising in the Next Upturn: Challenges and Policy Options, was on the general topic of fiscal policy as a tool of macroeconomic stabilisation, and included both a literature review and empirical analysis of how fiscal policy has actually played out in New Zealand.

Here are two graphs that I thought especially interesting (from p14 and p18 of her paper).

The one above charts the fiscal impulse on the vertical axis. The fiscal impulse is the year to year change in the structural (cyclically adjusted) fiscal balance, i.e. how much of the change in the fiscal position is down to fiscal policy decisions as opposed to cyclical (or unusual one-off) factors. It is therefore a measure of whether fiscal policy is more expansionary or contractionary.

The horizontal axis charts the state of the economy - a negative number for the output gap means the economy is running below full potential, relatively weak in other words, and a positive number means it's running hotter.

You can see the logic of the four quadrants - for macroeconomic stabilisation purposes, you want to see the data points turning up in the countercyclical upper right and lower left quadrants, and not in the procyclical other two. On these numbers, in practice you see clear patterns: no instances of tightening in bad times (excellent), quite a few of tightening or loosening when you should have (jolly good), and a bunch of procyclical easings (not good at all), what Anne-Marie summarised (p14) as "a tendency towards asymmetric Keynesianism, in the sense that procyclicality is successfully avoided during downturns, but not so consistently during good times (too many outturns in the bottom right quadrant)".

At face value, this looks moderately encouraging for folks who might be inclined to estimate potential output, the output gap, structural fiscal balances, and the fiscal impulse, and use them for cyclical stabilisation purposes.

Except that Anne-Marie also provided one of the best graphs I've ever seen, which showed the difficulties in trying to do this exercise in real time. Here it is.

The graph shows what Treasury thought the output gap and fiscal impulse were a year before the Budget (green dots), around Budget time (red dots), and, crucially, what the situation actually was, as measured later with the benefit of hindsight. And it transpires that three of those procyclical fiscal stimulations were actually completely unintended: the economy was actually in better nick than Treasury realised at the time.

Not that Treasury ought to be hauled over the coals for it. "The magnitude of such forecast errors is not Treasury specific or New Zealand specific. It is well known that empirical estimates of the output gap are subject to significant and highly persistent revisions for all economies", Anne-Marie concluded (p17), and she recommended among other things that Treasury should therefore "expand the repertoire of indicators so that advice on the fiscal stance is less reliant on any single measure, with particular care taken to augment fiscal impulse measures with complementary measures" (p26).

Our experience would tend to confirm the international experience: estimating output gaps and structural fiscal deficits is iffy at the best of times (though the EU estimates take iffyness to a whole new level), and you wouldn't want to base cyclical fiscal policy solely or heavily on them.
All fair enough. But even if you conclude that the state of the art in cyclically adjusted fiscal deficit analysis isn't up to much heavy real-time or short-term stabilisation usage (or possibly not up to any real-time usage at all), the concepts are good ones. They still tell us important things about the profligacy or otherwise of the government's books over the longer haul.

Here's Ireland's recent story (data taken from the latest IMF World Economic Outlook database, accessible here if you ever feel like playing with it yourself).

We know, from the Bruegel piece and from other commentators, that the precise numbers may not be right. But they're not so bad that they can't tell us the broad high-level picture. Through the boom years (to 2007 or so) Ireland looked as if it was running a responsible fiscal ship, if you went by the headline numbers that got reported at Budget time. But cyclically adjusted, the government was running a decent sized structural deficit, one that would be exposed if the cyclical revenues dried up. As they did. More recently the graph is again telling us the fundamental truth: Ireland's run a massive fiscal restructuring exercise, which shows up in the hugely improved structural position, even if it's yet to be seen in the cyclically depressed headline balance.

So I still hold out some hope for intelligent use of output gaps and structural/cyclical splits, especially if there are more sanity checks (for example, from business opinion surveys of capacity utilisation rates) around the plausibility of the numbers.

When the diagnosis is worse than the disease

Bruegel is an excellent policy-focussed think tank based in Brussels. It doesn't seem to get much coverage or attention down our part of the world, partly because much of its work is Eurozone-centric, but it's well worth following for its analysis. I've got their blog running here in 'The latest posts from these good blogs' and here's the link if you'd like to follow it for yourself.

The latest piece on the Bruegel blog, Mind the gap! And the way structural budget balances are calculated is on a topic that's been of interest to me for some time - calculation and policy use of the structural fiscal deficit. If you're not a fiscal policy wonk, and things like the cyclically adjusted fiscal deficit or the fiscal impulse aren't at your fingertips, I wrote up some explanatory pieces based on this year's Budget here and here.

The Bruegel piece essentially says (though it's much more restrained in how it says it than I'm going to be) that the official European Union way of measuring potential output produces results that are complete nonsense. And in turn these nonsense numbers risk leading to catastrophically bad fiscal policy.

First, here's some evidence of the nonsense, as shown in a graph from the Bruegel piece.

The graph shows the EU estimates of the 'NAWRU', the Non-Accelerating Wage Rate of Unemployment. This is a key input into measuring potential output, because it is the measure used to estimate what the 'normal' or 'equilibrium' or 'trend' unemployment rate would be. This in turn gives you the 'normal' or 'trend' measure of labour supply to feed into the production function that gives you the 'normal' or 'trend' or 'potential' level of GDP.

Self-evidently, these NAWRU numbers are not to be trusted for any purposes, other than demonstrating the incoherence of their calculation. For a start, it's wholly implausible that NAWRUs could have changed so much, so quickly. It's beyond credibility that the 'normal' or 'trend' rate of unemployment in Ireland, for example, was around 4% in 2005-08 and is 15% now, and the figures for the other countries pictured are equally fantastical.

The corresponding estimates of potential output, and hence the output gap (whether there is spare capacity or whether the economy is at or beyond sustainable full capacity) are also completely off the wall. The EU's 2007 stab at it led you to believe, for example, that Ireland, at the peak of its completely over-the-top Celtic Tiger property bubble (2005-07) was operating below capacity. And the EU's 2013 estimates, made when Ireland was beginning to emerge from a very grim recession indeed, was operating 4% above full capacity.

Yeah, right.

These numbers lead you up the garden path towards dreadful fiscal policy conclusions. Or as the author of the piece puts it in a deadpan way, "If the actual unemployment rate is close to the NAWRU, actual employment is close to potential and thereby actual output is also close to potential, i.e. the output gap is small. If the output gap is small, the structural budget balance is close to the actual budget balance, and therefore a large actual budget deficit implies a similarly large structural deficit. In turn, the estimated large structural deficit requires large fiscal consolidation needs, according to the EU fiscal rules".

If you embrace these delusional numbers, you grossly overestimate the poor state of the underlying fiscal balance, and hence grossly overstate the need for austerity, while simultaneously badly misreading the state of the economy to withstand it. You believe, for example, that there's very little cyclical unemployment, and that virtually all the unemployment you actually observe is structural. Now, nobody can deny that many of the Eurozone's labour markets do not work well, and that NAWRUs are higher than they would be with better functioning ones. But even so it's very unlikely that Spain's structural or natural rate of unemployment is 25%, as these EU calculations allege.

This, to me, was a devastatingly effective critique of the EU's model. I'm sure the EU's experts are well-meaning and sophisticated modellers, but how could they have landed where they have? It leads you (among other things) to wonder whether other countries' efforts to estimate output gaps and to split fiscal balances into cyclical and structural components are equally flakey. Or, indeed, if the whole exercise is always doomed to be too unreliable to be trusted for any sensible purpose.

As it happens, we have some specific New Zealand evidence on this point, which I'll cover in my next post.

The economics of the asset sale referendum

The leaflet from the Electoral Commission arrived today with the details of the Citizens Initiated Referendum on the government's asset sales: do I support the government's selling up to 49% of assorted companies?

I certainly do, and if (as seems likely) the referendum is threatening to go the other way, here's why a Yes vote makes more sense.  In my view, there isn't a single good economic argument for the government continuing to hold its current commercial portfolio.

Let me lay out the reasons, and also point out I'm recycling (with their okay) a piece that I wrote back in 2010 for the excellent Unlimited magazine.

For a start, would any of the goods and services produced by government-owned entities not be provided, but for state ownership?

No. The government's got an airline, a bank, coal mines (now, apparently, co-owned with Solid Energy's banks), dairy farms (!), electricity generators, an insurance company (ACC), media companies (Radio NZ, TVNZ), some network infrastructure (Kordia), railway tracks, a postal service, and a trustee company. Every single one of these services can, and routinely is, delivered overseas by the private sector. Even postal services: right now, the UK government is privatising the Royal Mail. Even railway tracks: the UK's were laid by the private sector in the first place.

Nor is it obvious that there are market failures or some other sort of special feature that requires the state to be involved in this portfolio of activities. Some of these activities - state-run dairy farming being the most egregious - have no public policy rationale whatever for public ownership.

Do we need to own any of these companies to prevent them ripping us off?

No. There are at least two better ways of dealing with whatever rorts they might get up to. First best, self-evidently, is competitive markets: if you want some plumbing done, you don’t buy and operate your own plumbing company, you get three quotes. And second best is good regulation: keep the profits to a reasonable level that works for both provider and consumer.

We also know that privatised companies tend to perform better. The evidence from formal research is that state entities are less efficient than private ones, which we discovered for ourselves when we corporatized the SOEs in the first place and shook out their massive overstaffing.

And why were they overstaffed? Partly because it was politically convenient to put grateful voters on the payroll. Governments aren't philosopher kings, running operations from first principles of icy purity. They have an eye for the main chance, and if the SOE's payroll run helps, so be it. As the Arab spring got underway, I wasn't surprised to see that one of Hosni Mubarak's early moves was to award the already bloated Egyptian public sector workforce a large pay rise. It didn't do him any good in the end, but even if it had, who wears the cost of this kind of political largesse? You and I do, as consumers of needlessly inefficient and expensive public services.

And anyone who believes in a public service “quality” that won't be delivered by lowest common denominator profit-grubbing capitalists hasn't been watching the tat that TVNZ produces (both when it had its "public charter" role and since). There are exceptions - I've got the Concert Programme playing in my office as I write this - but it doesn't make a good general case.

There’s also a lot of evidence from overseas that access to the services that privatised companies provide gets better post-privatisation: you don’t see customers of private sector utilities waiting five years for a phone line or a water connection, for the obvious reason that there’s a buck in it for the supplier to do it now.

Opponents of privatisation tend to be keen in particular on various permutations of the "you're selling the cash cow" argument. None of them makes much sense.

You're giving up the dividends you would have got by keeping them in public ownership? Well, yes you are, but so what? Every time anyone sells a share, that's what they are doing. And the price they get includes the value today of those dividends they expected to have got tomorrow. If that stream of dividends looked to be a real goer, with prospects of higher and higher profits in the future, the price today is fairly steep to give them up. It's a fair trade. If it wasn't, we wouldn't have willing buyers and willing sellers in sharemarkets in the first place.

The fiscal balance gets worse, opponents claim, typically by arguing that the dividend income the government gets is greater than the cost the government pays on its debt. Well, there are two things wrong with that. The first one is the point made a moment ago - the government is being well-paid in the share price today for what it might have earned in the future. And the second is that the empirical evidence is against the idea, since in the longer run the government's tax take from profitable companies in the private sector tends to be larger than the dividends it would have got from less profitable companies in the public sector.

I suppose what baffles me most about the opponents of privatisation is why they are so keen to keep wholly commercial activities in public ownership, when genuinely public services are short of funds. Which would they rather have: another bank, another 'reality TV' programme, another dairy farm, another coal mine? Or another (or better) hospital, another (or better) school for kids with special needs, another (or better) university, more (or better) public transport?

Because that's the reality. The government's got a budget constraint, like the rest of us, and a dollar in one direction is a dollar that isn't going in the other. You can watch 'celebrities' rolling in mud on TV2, or you can have cataract operations for older folk.

What'll you vote for?

The curious case of the concierge and microeconomic reform

Many years ago, I fetched up in Paris on a quiet summer Sunday afternoon, and went to look up a friend who was living there at the time.

When I reached her address, I found it was one of those old Parisian houses converted into apartments, with a large central door which (I guessed from the outside) would lead, on the typical Paris pattern, through an archway into an interior courtyard and to staircases up to the apartments.
The door was closed. Nobody came or went. I couldn't get in. And this is long before you'd get your mobile out and ring up to be let in.

In those days - and for all I know, still - Parisian apartment blocks tended to come with a live-in manager cum overseer cum general busybody, the concierge. I took a punt that the shuttered windows on the ground floor might be the windows of the concierge's apartment, and knocked on them.
Nothing happened. I knocked again.

The shutters banged open and the concierge appeared: indeed, the concierge of all concierges, a wizened old hag with a voice that could file horseshoes at a hundred metres.

I did my polite best to explain that I was a friend of Mademoiselle R, but she interrupted me.

"Do you work on Sundays?"

"No, Madame..."

"Neither do I!", and she slammed the shutter in my face.

In her grizzled Parisian way, she was doing no more than stating the law of the land: Sunday trading was (in theory) not allowed, until liberalised to a degree in 2009. The sorts of places you might imagine should be open on Sundays (cafés, restaurants, petrol stations, museums, markets, and places like florists and fish shops with perishable produce) were allowed to be open on Sundays as of right (there's a bit of extra legal hoo-hah, but that's the gist), and other places could apply for permission.

Fast forward to today, and France is embroiled in a series of industrial disputes over both Sunday trading and late night opening.

Sephora, a fancy jewellery store, used to keep its flagship Champs Elysées outlet open till midnight: it's been forced to close at 9.00pm instead (never mind that it did a good slab of its trade after 9.00pm). Two DIY/hardware places, the likes of our Bunnings or Mitre 10, have been told to stop trading on Sundays at their outlets around the Paris region, much as our own Ministry of Labour dogsbodies harass garden centres that open on Easter Sunday (to their credit, they've told the local tribunal of jobsworths to stick their ban).

Maddeningly, the latest dispute is about exactly the sort of place you'd imagine should be open 24/7. Monoprix runs a chain of those centre-city mini-supermarkets you pop into when you need to pick up dishwasher powder or a pint of milk on the way home. Now, it's been told that the stores that used to open till 10.00pm (and a few that used to open till midnight) will have to close at 9.00pm.

Even more maddening again, the court only got involved in the first place because of a demarcation dispute. Younger folk will likely not know what a demarcation dispute is: it's when there's industrial action because of a fight between unions as to who's got the right to something. We used to have a lot of them, as did Australia, as we'd both imported the virus from the UK. In Monoprix's case,
management had actually cut an entirely voluntary deal with some of the unions representing its workforce, which had included sizeable pay increases (the company says 25% to 35%), time off in lieu, and other bits and bobs. But the biggest union, the CGT, wouldn't go along. And under French law, it can stymie the arrangements Monoprix made with the other unions.

There's good news here, and there's bad news.

First, the bad news. If there's a single thing that many of the Eurozone economies could do to revitalise their moribund economies, it would be to deregulate their service industries, and on this evidence they're still not doing it. They're riddled with inefficient, inequitable service industries that are a drag on the economy in multiple ways (I'll do a post shortly on 'employment protection' arrangements). Every man and his dog, from the IMF and the OECD and the European Commission to their own 'wise man' panels have told them the same thing, and they're still resisting despite the damage the existing arrangements are doing to consumer welfare, employment, cost competitiveness, innovation, flexibility, and economic growth.

But second, on the more positive side, there is, perhaps, a smidgeon of evidence emerging that the great European public is getting mightily sick of all of this.

In the sidebar on the left there's one of those online opinion polls that newspapers run (in this case from L'Express). It asks for readers' views on Sunday opening.

Only 9% took the unions' line ("une atteinte" etc, "an attack on workers' rights"). 9% were opposed on the reasonable enough view that "Sundays should be special". And 12% couldn't give a damn either way (that's the "cadet de mes soucis" answer).

But 9% said it was handy for shopping (the "bien pratique" answer, which includes one vote from me). And fully 67% of the responses were in favour of Sunday trading as "makes good sense in a period of high unemployment" (I didn't pick that one, because my view is that it makes good sense at any time).

Maybe we're seeing the beginning of a pushback from consumers finally pushed too far by one idiocy too many. Maybe. We'll see how it plays out.

A sanity check on using statistics

The Aussie media are all over the latest Aussie retail sales statistics, which came out yesterday. And you can understand their interest: the big issue in Australia is whether or when the non-mining economy will pick up, and compensate for the drop-off in mining investment projects. Whether people are starting to spend more in the shops is currently one of the key cyclical indicators.

Trouble is, everyone seems to have lost sight of some of the inherent limitations of the retail sales numbers, and they're reading things into the numbers that the numbers can't reliably bear.

First thing is, they're a sample survey, and sample surveys necessarily come with sampling error. The Australian Bureau of Statistics (ABS) says that its raw (not seasonally adjusted) estimate of retail spending in Australia in August was A$21,871.1 million, and that the standard error associated with that estimate was A$177.2 million, or 0.8% (this is in para 37 of the 'Explanatory Notes' accompanying the release). Assuming for a sec that we've got a normal distribution of estimates here, then we know that we can be 95% confident that the true number lies within a range of plus or minus 1.96 standard errors, in this case plus or minus 1.6%.

Statistics NZ, by the way, have a similar sort of precision around New Zealand's aggregate retail sales, where they have organised the quarterly survey so that "there is a 95 percent chance that the true value of total retail trade sales lies within 2 percent of the published estimate" (I'm quoting from their 'Information about the Retail Trade Survey').

So the first take-away point is that plus or minus 1.6% is quite a wide band. I'm not criticising either the ABS or Stats NZ for that size of band: larger surveys with smaller bands are more expensive, you have to make a cost/precision trade-off somewhere, and for many uses the retail sales estimate is perfectly serviceable and fit for purpose.

But not for the purpose of purportedly detecting small monthly changes, which is how they're being used in the media headlines in Oz.

The same point comes across when you look at the ABS's estimate of the standard error associated with the month-on-month change in retail sales. In August the estimate was that sales were up A$543.1 million on July, a rise of 2.5%. The standard error around that estimate, however, is A$105.2 million, so we can be 95% confident that the true increase was between A$337 million and A$749 million. Or in percentage terms, we are 95% confident that the increase was between 1.5% and 3.4%. Again, this is a wide band within which a large number of real outcomes might be lurking.

And then there's seasonal adjustment.

The unadjusted rise in retail sales was 2.5%. The seasonally adjusted rise was 0.4% (mainly because July's unadjusted data gets a big leg-up from the seasonal adjustment process). This is, self-evidently, a big change to the raw number. Commentators are taking this completely for granted, and assuming that it is some kind of magically perfect transformation. It isn't. Seasonal adjustment is an art, and while it does a fine job overall, it introduces its own imprecisions.

What you've got, in sum, is an unadjusted number that we can be pretty sure rose by between 1.5% and 3.4%, and (after taking off 2.1% for seasonal adjustment) an adjusted number that very likely ranges from a decline of -0.6% to a rise of 1.3%. That's no firm basis for making any kind of strong statement about the actual outcome, especially when you add in that the 2.1% seasonal adjustment might as readily have been 1.8% or 2.4%.

Bear that in mind, next time you see the naive media comments on how the actual adjusted outcome (+0.4%) compared with the economists' consensus forecast beforehand (+0.3%).

If you do want to get some feel, however loosely based, for what is happening month by month in Aussie retail sales (or similar numbers at home), probably the least unsatisfactory of the numbers is the 'trend' estimate, which tries to take out more of the random 'noise' than the seasonal adjustment process does. These days the ABS leads off with the trend number in its media release, but it hasn't done them much good: most commentary still focuses on the seasonally adjusted estimate. The ABS said, by the way, that the trend estimate in August was actually unchanged on July.

One final thought: over the years I've generally argued, when Stats have asked, for more monthly statistics than we currently have, mainly because I've thought it important for us, from various perspectives, to get as good a handle on the business cycle as we can. But after this little exercise with the Aussie retail numbers, I'm beginning to wonder if I was misguided: when you look at the likely imprecision that would come with the sorts of monthly surveys we could realistically afford to run, you'd wonder if they'd be worthwhile.