Calm down, folks

Yesterday Stats told us that inflation in the June quarter was 0.3%, a little less than the 0.4% that forecasters and the Reserve Bank had expected. And out came all sorts of OTT reactions, mostly along the lines that the RBNZ would now hold off on some interest rate hikes, or had been running too tight a monetary policy all along. The kiwi dollar dropped a cent against the US dollar.
Puh-leez. Let's get a grip here.
One. Even in a world where Stats measured the CPI with complete precision, there is no real difference from any perspective whatever between a 0.3% inflation rate and  a 0.4% rate. Especially as the numbers have the capability of setting off entirely spurious tripwires because of the rounding process. Yesterday's "0.3%" was actually 2.517%. If the CPI index had been the teentsiest bit lower, it could have been 2.499%, in which case we'd have had a headline rate of 0.2% and forex dealers leaping to their deaths from their dealing rooms. All on the basis of the third decimal point in a percentage change between two large numbers. Give me a break.
Two. Stats doesn't measure the CPI with complete precision (and this, I think, is going to be my only original input into the conversation). The CPI numbers come from a survey, and just like opinion poll surveys get reported these days with their "margin of error", the CPI number has some uncertainty around it. Somewhat oddly, after I read all the CPI release stuff, even the rather boring and technical (but important) bits way down the back, I couldn't find what the CPI's margin of error was.
So I rang The Man, who in this instance is the ever helpful CPI guru Chris Pike at Stats (and everything from here on is my view, not his, by the way). It transpires that I hadn't made a cockup of browsing the Stats website: there aren't, in fact, published estimates of the margin of CPI error.
The reason is that the CPI isn't a random survey, where you can use standard statistics to estimate sampling error: it's a purposeful survey that decides on certain outlets and certain product lines. But just because we don't know exactly what the survey error is, that doesn't mean there isn't any. There surely is, for example because the CPI relies on other surveys such as the Household Expenditure Survey which have their own sampling errors. The HES might say, for example, that households spend 23% of their income on food, and Stats will use that as an expenditure weight in the CPI,  but it might be 22%, or it might be 24%. And of course the CPI will have its own survey errors as the price collectors wander through the aisles and misread the label on the baked beans. And so on.
So not only would a real difference between 0.3% and 0.4% not matter a damn,  there may not even be a real difference in the first place. Allowing for survey error, 0.3% and 0.4% could well be statistically indistinguishable. I don't know what that margin of error is, but it's highly plausible that numbers only 0.1% apart fall within it.
Three. Even if 0.3% is absolutely beyond doubt the right number, and definitely different to 0.4% or 0.2%, the over-excited "lower than expected inflation" and "pressure off the Bank" and "overzealous inflation fighting" reactions don't make much sense to me. Brian Fallow, as is his balanced wont in his article in the Herald, made the key points: the headline figure is being flattered by the high NZ$, which lowers import prices,and in any event it's more important to look at non-tradables inflation (the inflation in purely domestic sectors, like most of the services sectors). And there you don't see inflation at a comfortable level. The CPI may be running at a 1.6% annual rate. But non-tradables inflation, which for monetary policy matters more, is running at a 2.7% rate. Even if you take out the housing and household utilities bits (which are running hot at the moment), core non-tradables inflation is either 2.2% (ex housing and household utilities) or 2.6% (ex purchases of new houses).
I've gone on about this before (here and here, for example) but our domestic non-tradables inflation keeps trundling along, as the chart below shows (the hump in 2010-11 is the effect of GST going from 12.5% to 15%, so don't pay that too much mind), and generally towards the top of the RBNZ's 1%-3% target band.

It's pretty evident that as and when the kiwi dollar goes for a burton, we're going to see some very ugly headline inflation numbers indeed, unless the non-tradables inflation rate drops, and so far it's shown a remarkable ability to hang in there. I'd also point out the sizeable and unhelpful contribution of central and local government charges to the non-tradables inflation. Okay, there's an element of sin taxes in there that maybe I can go along with (ideally if it's taxes on the other fellow's fags and not on my Côtes du Rhône). But it looks very much to me as if large swathes of central and local government still feel as if they can write any number they like on the price ticket.
Bottom line - park all that guff about unexpected victory in the battle against inflation.

Drug deals busted

A wee while back I posted about obnoxious "pay for delay" arrangements between drug patentholders and generic drug manufacturers, which involved the patentholders paying - I would say bribing - the generic makers not to produce when the patent expires, thereby extending the patentholder's monopoly pricing power.

I didn't know about these kinds of arrangements before the Economist wrote about them, but to my mind they are such a breath-taking interference with competition that I've done a bit of mugging up since.

My first reaction had been that they were clearly, and rightly, illegal under New Zealand's competition law (bang to rights under s27 of the Commerce Act), but that I didn't know what the legal state of play was overseas. Here's an update.

It's illegal in the European Union under Article 101 of the Treaty on the Functioning of the European Union which says "The following shall be prohibited as incompatible with the internal market: all agreements between undertakings...which have as their object or effect the prevention, restriction or distortion of competition within the internal market, and in particular those which:...(b) limit or control production, markets, technical development, or investment" (italics mine). And often enough it'll also trespass against the misuse of substantial market power provision in Article 102.

The Europeans have been able to sheet the law home, too. According to this press release from the European Commission, just this month Servier, a French drug company, and five generic manufacturers got pinged nearly €430 million (call it NZ$670 million): "Servier made payments to the generic companies against the certainty that they would not enter the market and refrain from legal challenges [to Servier's patents]  for the duration of the agreement. In one case, the settlement was not based on cash payments but on a market-sharing arrangement with the generic company".

The Commission (which has a couple of other pay for delay scalps on its belt) summarised by saying that Servier "tried hard to unduly prolong its exclusivity. And it managed to do so not through innovation or the strength of its patents, but thanks to its deep pockets and in complicity with its generic rivals. Such behaviour is prohibited in the European Union. When companies break these rules, they will be pursued and penalised accordingly. Pharmaceutical companies should focus their efforts on innovating rather than attempting to extract extra rents from patients and taxpayers". I'm no great fan of the Brussels machine, and even in the competition area I think they've lost the plot from time to time, but on this one they've nailed it.

In the States, it's not so clearcut. There, the case that matters, at least for now, is last year's Federal Trade Commission (FTC) vs. Actavis Pharmaceuticals (in the background I can hear the collective heavy sigh of competition lawyer readers as yet another economist clambers awkwardly over the fence into their territory). Competition tragics can find the full decision here: if life's too short, it has a summary at the front, and there's a good Wikipedia article on it, but in any event the gist of it goes like this.

The drug companies said they had a patent dispute, that the supposed "pay for delay" payments were part of the patent settlement, and that what was legal under patent dispute litigation was home free and not subject to antitrust litigation review. The FTC wanted "pay for delay" ruled always and everywhere illegal.

The FTC lost in its first two outings in lower courts, but won the penalty shoot-out 5-3 in the Supreme Court. Or sort of: the court didn't go the whole hog and say "pay for delay" was always wrong - "This Court declines to hold that reverse payment settlement agreements are presumptively unlawful" - but it did say that they couldn't hide behind the skirts of patent law and could be found to be anti-competitive if challenged. There could be “potential for genuine adverse effects on competition", and "Payment for staying out of the market keeps prices at patentee-set levels and divides the benefit between the patentee and the challenger, while the consumer loses". Sometimes the arrangements might be okay, but it would come down to the facts, and the court was minded to look especially sceptically at large brown paper bags being passed under tables: "The size of the payment from a branded drug manufacturer to a generic challenger is a strong indicator of such  power", "such power" meaning the power "to work unjustified anticompetitive harm".

There was a withering dissent from three of the judges (including the Chief Justice), so who knows how settled the matter is. But at least it's good to see that the FTC has been given the opportunity to take on these rorts. I'm sorry for any genuine patent disputes that might end up wearing some collateral damage by having to go through the antitrust mill to prove they're above board. But I haven't a skerrick of sympathy for the collusive jack-ups.

How fast can we grow?

John McDermott, the Reserve Bank's Chief Economist, gave a speech to the Wellington Chamber of Commerce today, about 'potential output', which he said is, colloquially, "how fast the economy can expand without generating inflation" (you can read the speech on the Bank's website here, or download it as a pdf). There is that inflation angle, but I was more interested in the Bank's estimates of potential output for other reasons.

Here's the Bank's take on how fast the economy can grow on a sustainable basis.

The grey bars show how much extra we could produce in any given year, and the three coloured lines show the contribution of three different things to that increased ability to produce. We can put more people to work (the red 'Labour' line), we can give them more equipment to work with (the blue 'Capital' line), or we can work more cleverly (the black 'Productivity' line). The three lines add up to the grey bar. John, I'm sure, would be amongst the first to agree that estimates of potential output, let alone of its components, are very much a work of art, that different researchers can (and do) come up with sometimes very different results, and that the estimates in the graph are more in the nature of indicative than accurate to two decimal places, but even so, let's go with them as being more or less the underlying reality.

My first thought, when I saw the estimates for the latest few years, is that they're not that flash, are they? Being able to generate growth of 2.75% a year leaves many parsnips unbuttered, especially if you take off population growth, since per capita incomes would only be growing by something like 1.75% a year.

You look, in particular, at the contribution of investment. Right now, the high exchange rate is making capital equipment (which is largely imported) cheaper than usual, the interest cost of financing it is also unusually low, and the economic cycle is very strong. If ever there was a time for a bigger than usual boost to growth from a surge in capital spending, this is it, but it doesn't seem to be happening. The contribution from capital isn't significantly up from previous levels, and that's a bit of a bijou problemette, since that's the only lever you can pull on in the short-term. Higher immigration tends to take a while to organise (even if you can find a political way to sell it to the xenophobes), and how to boost productivity is still something of a mystery.

All up, it leaves you feeling a bit downbeat about our longer-term growth prospects, and wondering what we'll do for an encore when the Canterbury rebuild winds down. And others, I see, are starting to feel the same way. The latest forecasts from the economists at the BNZ have GDP growth of 4.1% this year (excellent), 3.5% in 2015 (jolly good), and 1.8% in 2016. Oops.

That's the pessimist's reading of John's results, but there's also an optimist's version. John produced an alternative way of measuring potential output, namely what the economy actually managed to do over extended periods, since almost by definition "The average rate of output growth over longer periods of time can provide us with a rough gauge of the growth capacity of an economy", as he put it. So he showed a series of 10-year averages, in the chart below.

This seems to me to accord with the stylised facts of the economic history of New Zealand over the past 50 years - good performance in the Sixties, progressively worse performance in the Seventies and Eighties thanks to external shocks, grossly inept domestic economic management and the upfront disruption of structural reform, slightly better performance in the Nineties, and somewhat better again more recently.

The bad news may be that we still haven't built - or rebuilt - up to the sorts of rate of growth that would make a real difference to living standards in short order, but the good news is that we're in better shape than we've been.

Though that tangentially reminds me of the old joke about Brezhnev's economist, who came to him with good news and bad news.

"Give me the bad news, comrade", says Brezhnev.

"Well, comrade General Secretary, the bad news is that Soviet GDP this year is well down on last year", says the economist.

"I know that, dammit, give me the good news".

"Comrade, this year's GDP is much higher than next year's".

A great paper on global income inequality

Last week's annual conference of the New Zealand Association of Economists was a big success - you can see the programme here (click on '2014 Conference Programme' and select '2014 Timetable'), a fair proportion of the papers have downloadable links if you'd like to follow them up - and as usual the papers covered a very wide variety of topics. Rather oddly, though, there was almost nothing on competition or regulation (one paper by AUT's Lydia Cheung on the use of the Upward Pricing Principle in analysing the competitive effects of mergers), a gap I'm planning to fill at next year's conference.

At wide-ranging conferences like this, there tend to be moments where you come across something startling or significant that you didn't know before, and for me - and quite a few others, going by the tweets (#NZAE14) at the meeting - the real stunner was a graph showing trends in global inequality over the past 20 years. Covec's Aaron Schiff called it 'The graph of the century', and I've discovered that a Financial Times columnist has called it 'The chart that explains the world'.

It took me a little while to track down the source, but its origin was an event at Columbia University's Heyman Centre for the Humanities in February 2013, where three speakers - Prof Joseph Stiglitz, Prof James K Galbraith, and Branko Milanovic, lead economist in the World Bank's Research Department - spoke on the topic of 'Global Inequality' (this was pre-Piketty, by the way). Of the three presentations, only Milanovic's has been archived, and we're fortunate it was, as it was the source of the graph.

On the face of it the paper doesn't sound a thriller - 'Global income inequality by the numbers: in history and now - an overview' - but it's terrific from various perspectives. Not only does Milanovic explain different concepts of inequality in a remarkably accessible way - a secondary school class in economics could easily follow it - but he's got some fascinating results to show. You can download it here:  it's well worth doing.

Here's the graph that had conference attendees oohing and aahing.

The graph's reasonably self-evident: the main thing you need to realise is that this is the global distribution of individual incomes, and it only runs from 1988 onwards because for large parts of the world there weren't good official national surveys of income distribution before then.

Isn't it fascinating? You might have thought that the very rich were going to be the big beneficiaries of the globalisation of recent years, and it's true that they've done well, but they haven't done quite as well as the big surge in income for the world's  lower and middle classes, which in turn is principally explained by strong rising incomes in China and India.

And there are two groups that have missed out.

One is the very poorest, where the bottom 5% of the global population have had no growth in income for the past 20 years, and for which we can point the finger (or, better, the rifles of the execution squad) at the Mobutus and the Mugabes of this world.

And the other group - including, very likely, a fair few of the readers of this post - is in the vicinity of the global 75th to 90th percentile. Milanovic says "These people, who may be called a global upper-middle class, include many from former Communist countries and Latin America, as well as those citizens of rich countries whose incomes stagnated". It's an odd grab bag - the nomenklatura and the apparatchiks, the hangers on of the juntas, the semi-skilled in the developed world whose jobs can be done in the developing world, the managerial jobs that have been automated away - but they've all been left behind by the surge in a global middle class and what Milanovic calls "probably the profoundest global reshuffle of people’s economic positions since the Industrial revolution".

He also suggests, albeit on quite a short time series for this measure of global income inequality, that "perhaps for the first time since the Industrial Revolution, there may be a decline in global inequality. Between 2002 and 2008, [the] global Gini [coefficient] decreased by 1.4 points. We must not rush to conclude that what we see in the most recent years represents a real or irreversible decline, or a new trend, since we do not know if the decline of global inequality will continue in the next decades. It is so far just a tiny drop, a kink in the trend, but is indeed a hopeful sign. For the first time in almost two hundred years—after a long period during which global inequality rose and then reached a very high plateau—it may be setting onto a downward path". The world, in short, may not be developing as all the acolytes of Piketty might believe.

There's lots more - the much greater importance these days of where you live, for example, as opposed to the lower importance of where you are in your country's income distribution, in determining your income level - and if you've got any interest at all in the great sweep of human economic development, this paper's a must read.

"I can't be bothered..."

People have been banging their heads for some time against New Zealand's "productivity paradox" - we've got good institutions, good policies, and ready access to the best technology, but can't seem to generate the same income from those opportunities that other developed countries do - and often the search for answers starts pointing towards innovation creation and uptake, or in other words to that vast area of general ignorance known to economists as "multi factor productivity".

I got thinking about this over the weekend when I re-read one of the more startling items to come out of the Productivity Commission's recent report on raising productivity in the services sector. I'd noted it myself first time I saw it, and thought "that's odd", and put it aside, but the other week I was in a group talking about the services report and found the other group members all thought it was pretty strange, too, so I thought I'd draw it to more people's attention.

But before going there, a preamble on innovation.

You're having a barbecue. Everything's good to go, till you fire up the burners and discover the LPG bottle has run out. Quick dash to the nearest petrol station where, until recently, this happens.

You get the attention of one of the attendants (sorry, "forecourt concierges"), they kit themselves up in goggles and gloves, check your bottle is still fit for use, weigh your empty gas bottle on the gas machine, figure out (with a calculator) how much gas it would hold, attach it to the machine, fill it up, detach it, test it for leaks with soapy water, you pay, and away you go.

Then some bright person brings in Swap'N'Go. You give your old bottle in, they give you a full new one, you pay, done.

God knows how much cost has been taken out of the LPG bottle business by Swap'N'Go, but I'd bet it's very large. One central depot to fill the bottles takes out all the sets of petrol station filling equipment, plus all the training costs at the stations, plus the cost of attendants' time spent doing gas bottles. Plus it's safer (I'll bet the training at the one specialised depot is a lot better than it used to be when you were trying to train multiple shifts of transient attendants), and quicker for everyone involved. Quality up, costs down, time shortened, productivity an order of magnitude higher.

And it's a completely low tech (or even no tech) innovation, entirely down to smart business reorganisation. I seem to remember one of  the more recent Nobels in economics going to someone who'd figured out that business innovation along these lines had made a very large contribution to economic growth over the ages - no doubt someone will remind me who it was - and I'm not surprised.

Right. Back to innovation in New Zealand. If business innovation is important for growth, then we need to be alert to the need for continuous innovation, and we need to be as diligent at it as other places if we want to match their living standards.

But the Productivity Commission came across this rather suggestive piece of evidence that says New Zealand businesspeople's heads aren't in the right innovation space at all. They ran a survey which among other useful things asked businesses that hadn't invested recently in ICT, why not.

What would you think the lead answer was? Cost? Complexity?

Not a bit of it.

The top answer was, "I couldn't be arsed", which is my rough translation of the complacent result shown below.

"It would be cause for concern", the Commission said (pp177-8), "if this response reflects a large number of firms with no aspirations to expand or that face little competitive pressure". Indeed, and with knobs on when it comes to that point about "little competitive pressure", though as the Commission says, in what's either judicious analysis or one of the longer kicks for touch you've ever seen, "The response is, however, challenging to interpret. It could also cover cases where respondents are simply unaware of the possibilities of using ICT to improve their business. Equally, it could cover businesses that invested significantly in ICT more than two years ago or where there are small benefits from investing in ICT. Without further information it is hard to read more into this result".

My feeling is that the Commission was onto something important, and I think it could have been very productive if the government had chosen, as the Commission's next line of enquiry, some deeper analysis of what's going on here. Maybe economists aren't the best people to investigate business management - with exceptions (eg Baumol, Varian), economists tend to see the business production function as a "black box" with inputs in and outputs out, and they don't typically take the lid off the box - but this looks to me like one of the more likely keys to fit the productivity paradox lock.

Drug deals gone bad

I was shocked - shocked! - to read in the Economist last week that drug companies, faced with the prospect of superprofits on patented drugs evaporating when the patents expire and the off-patent drugs can be substituted by much cheaper 'generics', have been paying generics producers not to enter the market.

The Economist says "Since the early 2000s “pay for delay” agreements have become more common. A company with a patent due to expire strikes a deal: it pays potential entrants a fee not to compete, preserving its monopoly. A pay-for-delay deal between AstraZeneca and three big generic manufacturers helped to protect Nexium from competition between 2008 and May 2014".

I don't know what the legal status of these contracts is in the US, but I do know what our competition law says. "No person", says s27 of the Commerce Act, "shall enter into a contract or arrangement, or arrive at an understanding, containing a provision that has the purpose, or has or is likely to have the effect, of substantially lessening competition in a market", and if "pay for delay" isn't one of those contracts, agreements, or understandings, then I don't know what is.

The American Constitution wisely forbids "cruel and unusual punishments", which is just as well, as otherwise there would be a good case for tattooing the words of s27 or its American equivalent in large letters on the foreheads of the corporate executives involved.

Updates from the NZ Association of Economists conference

I'm at the NZAE's annual conference in Auckland over the next three days. I'll likely post some longer pieces on the conference later, but in the meantime if you'd like some on-the-hoof coverage, head to #NZAE14 on Twitter where I and a bunch of others are doing some running commentary.

What is it about transport?

So Uber, the DIY taxi service app, is up and running in Auckland, according to this report this morning from Radio New Zealand.

Good.

More competition is just what's needed, especially in Auckland. When the taxi fare from Auckland Airport to our place on the North Shore routinely runs to $120-140 - sometimes more than the return airfare to Wellington - some additional competitive alternatives are a jolly good idea. There are some already - I've recently shifted to a shuttle bus service, which costs $62 - but more won't hurt.

I have some sympathy, though, for the incumbent taxi companies who claim to be competitively disadvantaged by the regulatory overhead they've got to carry. Ideally, this could be resolved by lessening the burden on the taxis rather than piling regulatory requirements onto Uber drivers.

But I can't say I'm optimistic about seeing rational, efficient, pro-competition transport policy. Globally, transport seems to be one of those sectors where policymakers can't leave the damn thing alone - either lumbering it with excess regulatory baggage, or, alternatively, favouring the producer interest of transport incumbents with anti-consumer jackups.

A classic example is the Irish taxi industry. As detailed in this new (short) report from my old stamping ground, Dublin's Economic and Social Research Institute,  the Irish have gone back to the bad old system they used to have, of limiting the number of taxi licenses, with the explicit aim of assisting the taxi trade, and despite the clear evidence that consumer service worsens with reduced taxi availability.

What is it about transport that attracts these bad policies?

It's not as if there's some sort of market failure that these policies, however cackhandedly, are trying to solve. There are perfectly adequate and economically efficient mechanisms for the market to work its own problems out if it's got any - prices can fall, taxi drivers can leave, shipping lines and airlines can add or subtract routes - whereas the regulatory routes are typically inefficient (in all three senses of the economics term) and often inequitably anti-consumer. And there are functioning secondary markets for transport equipment - not just for taxis, but also for aircraft and ships - which means there are no issues of catastrophically stranded sunk costs to bother about.

Perhaps the answer is that passenger safety is the Trojan horse that's being used as the pretext for producer protection or superfluous regulation of transport businesses, in the same way that patient safety has been misused as a pretext for anti-competitive behaviour in the medical profession.

In any event,  I wish Uber well - and I hope the policy environment let's us enjoy a good, clean contest between Uber and the rest of the industry.