Friday, 28 February 2014

Level airfields

I don't normally have a lot of sympathy for incumbents with large market shares, least of all for ones who have a long history of looking for and getting sweetheart regulatory protection from their governments, and airlines are amongst the worst serial offenders: I've blogged before about How governments rort their own countries' airline passengers, and have asked Is this the world's stupidest economic policy? when protectionist Aussie regulation means potential competitors to Qantas have to get the Aussie government's permission to expand capacity.

And yet. In fairness to Qantas, there's some justice to its complaint that in some respects at least the regulatory landscape is tilted against it. It's certainly ironic, since Qantas (and many other airlines) are recidivist exploiters of their regulatory environments, that regulation has blown up in Qantas's face. But it has. And it's possible that Qantas has other regulatory advantages in its backpack, unavailable to its competitors, that outweigh the grief the Qantas Sales Act 1992 is causing it. Even so Qantas, I reckon, has a decent case to make.

The Act (brought in when Qantas was privatised) creates two problematic issues
One is ownership. The Act has limits on total foreign ownership (49%), on ownership by foreign airlines (35% in aggregate), and on ownership by any one foreign airline (25%). That contrasts with the ability of Virgin, Qantas's domestic competitor, to pick the pockets of three government airlines (the UAE, Singapore, and our own) when it needs money for investment.

The other is operational. Qantas can't outsource the bulk of its international operations: s7(1)(h) of the Act says Qantas's articles of association must "require that of the facilities, taken in aggregate, which are used by Qantas in the provision of scheduled international air transport services (for example, facilities for the maintenance and housing of aircraft, catering, flight operations, training and administration), the facilities located in Australia, when compared with those located in any other country, must represent the principal operational centre for Qantas". Its international competitors can organise their international affairs more efficiently, while Qantas is forced to employ a local workforce who are relatively expensive in the first place, and more expensive again because they've managed to build some of the benefit of this (and other) regulatory protection into their terms and conditions of employment. Qantas might think it's smart every time it gets some regulatory protection, but the reality is that the benefits of protection don't all flow through to the corporate bottom line: they get hijacked along the way by the likes of the pilots and the baggage handlers.

I'm not saying that all the problems that Qantas has are down to not getting a fair suck of the regulatory sav. When you find that you can lose 5,000 staff out of a total of 35,000 or so, you haven't exactly been on top of the cost control game (even accepting that Qantas hasn't had a fully free hand on what it can do), especially as 1,500 of those are apparently in back office management roles. And I just don't understand Qantas's core commitment (which you can find for example listed as a strategic priority on p5 of the company's Data Book) to a "profit maximising 65% market share". Maybe the financial models really do suggest you maximise profits at 65% of the market. Or maybe the real game is to protect market share, irrespective of its profitability consequences.

What I am saying, though, is that fair is fair, and if there are regulatory anomalies that have left Qantas disadvantaged, they ought to be remedied.

Of course, there are two potential ways of doing that. The self-evidently preferable one is to stop hobbling Qantas, and deregulate. The other is to hobble everybody more equally.

I wonder how it will play out: fewer market distortions, or more?

Thursday, 27 February 2014

Have your say on the CPI

It's not every day you get your chance to have some direct influence on the production of our national statistics, so don't miss out on putting in your thoughts on the Consumer Price Index (CPI).
Last year Statistics NZ convened an advisory panel on the CPI, which produced a report in July: here's the link to the news release which in turn has links to the report itself and the submissions made to the panel, if you really want to get stuck in.

Now, in case you missed it, Stats is consulting with the public at large on the panel's recommendations: here's Stats' announcement about the consultation including the big questions they are asking for feedback on, and here's the full consultation document which includes details on how to put in your views. They've got to be with Stats by close of play on Friday March 14.

You'll have your own ideas, but for what it's worth here are my takes on the bigger issues.

1. Does New Zealand need a monthly CPI? Yes. It's the norm in the developed world, and in any event a quarter can be a long time in a business cycle for a central bank (and the rest of us) to have to wait for readings on inflation.

2. Which regions should we collect CPI prices from? Fewer - 10 would be fine. There's negligible difference in the measured CPI between having 10 price collection points and 15, but it costs more to have 15.

3. Should we produce price indexes for particular groups of households? I'm ambivalent about this. There are some genuine reasons to (what if the real value of super is being eroded by rocketing health costs?) but it also looks like a Trojan horse for every lobbyist in the country to inflict costs on Stats to no great purpose.

4. Should we produce a seasonally adjusted analytical CPI series? Yes, and adjusted at a groups or lower level rather than adjusting the overall CPI.

5. Should we produce indexes that compare price levels of different regions at a single point in time? Perhaps occasionally, but not as a regular commitment. As I've said before, we're too small a country to be bothering with an expensive infrastructure of regional data.

6. Should the scope of the CPI be extended to include overseas purchases by New Zealand households when travelling abroad? No, but counting domestic purchases made over the Internet (as we do now) makes sense to me. Or in the jargon I'm for a 'domestic' criterion (things bought in NZ) being used for the CPI as opposed to a 'national' one (things bought by NZers).

Monday, 24 February 2014

Am I missing something?

Chorus came out this morning with its half-year results to December 31 '13. It made a profit after tax of $78 million.

Let's suppose it has a tougher second half of the year, and only nets (say) $50 million. Let's also suppose that all those second half profits get kept as retained earnings, boosting total equity from the $673 million at end December to $723 million at the end of June '14.

Then on these conservative assumptions Chorus's after-tax profit for the full year would be $128 million, making an after-tax return on closing date equity of 17.7%. Using the average equity level during the year (opening equity $624 million, closing equity $723 million, average $673.5 million), the after-tax rate of return would be 19%. Pretty impressive returns for an infrastructural utility company.

So explain to me again: what's wrong with the argument that Chorus is milking the lines business by charging way-above-cost?

Saturday, 22 February 2014

The real issue with Hugh Laurie

There's been quite a lot of media coverage about who said what to whom in the supposed stoush between Hugh Laurie and Immigration New Zealand  over a work visa - see, for example, Hugh Laurie's spat with Immigration NZ - and I've been waiting for someone to make the most obvious point of all, and the only serious takeaway from the whole thing, but nobody has. So here it is.

Why on earth does Hugh Laurie have to apply for a work visa in the first place?

Or the Rolling Stones, or the Berlin Philharmonic, or JK Rowling, or Billy Connolly, or the Indian cricket team, or anyone else coming for a concert, or performance, or sports or book tour?

Nobody seriously imagines that Immigration is going to turn down any of these applications: they're a completely futile formality. So why do them?

Presumably (if there's any good policy reason at all) it's because if we let Hugh Laurie in to work, next thing the country will be swamped by itinerant Indian applepickers.

Well, I've got three thoughts about that.

One, I've got no problem with the applepickers arriving, either. And neither do the farmers who'd like to employ them. And I don't see long queues of the New Zealand unemployed waiting at the farm gate for those applepicking jobs.

Two, why hasn't someone had the wit to devise a visa-free process for the Berlin Philharmonics of this world instead of the makework nonsense we currently have?

And three, what sort of image do we want to present to the rest of the world? We're supposed to be on the side of the non-protectionist angels when it comes to free movement of goods and services, money, and people. Why are using this footling process that achieves nothing except the occasional burst of bad PR?

Thursday, 20 February 2014

New data on interest rates - regulators, please note

If you head over to the RBNZ's statistics on wholesale interest rates, and you have a look at the spreadsheets with 'Close' in their title - B2 Daily close (2010-current) or B2 Monthly close (2010-current) - you'll find that the RB has compiled some new series on 'swap rates'. There are swap rates for 1, 2, 3, 4, 5, 7, 10, and 15 year maturities, and for convenience a measure of the steepness of the swap rate curve (10 year swap rate less 2 year swap rate).

What we've got, in short, is the local equivalent of the Libor yield curve in the UK - the rates at which the most creditworthy institutions are prepared to lend to each other for different maturities. They're essentially the bedrock rate for corporate borrowing: all other corporates (lesser quality banks, non-bank corporates) will pay the swap rate plus a credit margin on funds they borrow.
It's useful info that hasn't been readily or conveniently available to the public up to now, so well done the RB.

Here's a comparison, by the way, using this new data, of the 10 year government stock yield with the 10 year swap rate. If this seems esoteric, there is a potential regulatory point lurking in here.

You'll see that the swap rate generally lies a little bit above the government stock yield - which it should. There's usually a small element of credit quality difference between the government and the highest quality banks, which interbank lenders need to charge for.

But occasionally the gap widens quite a bit - as it did, for example, in the April-June '13 period. The government stock yield dropped quite sharply, on this occasion because the world's markets were going through one of their intermittent jitters (the MSCI World index of global share prices dropped by over 8% between late May and late June '13). Government bonds were seen as the "safe haven" asset par excellence in times of equity volatility, so consequently their price got bid up and their yield got bid down. Banks' funding costs dropped too, but by nowhere near as much, so the gap between government bond yields and swap rates widened. The difference between the price of government risk and the price of corporate risk, in short, is not a constant. It changes, sometimes at one end, sometimes at the other, sometimes both ends at once. The likes of a GFC, for example, saw government bond yields drop sharply, but corporate credit spreads rise very sharply.

Which brings me to my regulatory point.

When they are figuring out the allowable rate of return on a regulated asset base, regulators set an allowable rate of return on equity, and an allowable cost of debt (combined, they make up 'WACC', the weighted average cost of capital). On the debt side, and for reasons never obvious to me, regulators typically do not look at the actual costs of debt for a regulated entity (which ought to be directly observable in many cases). Instead, they often like to express the cost-of-debt element as a formula, namely the "risk free" rate plus a credit margin appropriate for the regulated entity. Typically, the "risk free" rate is taken to be the government bond yield.

Aha! You see the problem.

Let's say a regulated entity's actual cost of debt is 7%, when the government bond yield for the same maturity at the time is 5% and the swap rate is 5.5%. To a regulator, the cost of debt is the "risk free" 5% plus a credit margin of 2%. All good.

Now along comes a regulatory price reset. In the meantime, as in the chart above, the government bond yield may fortuitously have dropped to an unusually low level, say to 4%. The swap rate may have dropped a bit too, to 5%. But nothing has changed to the corporate's credit rating - it was paying 1.5% over swap before (i.e. over the best-quality corporates), and it is paying 1.5% over swap now. Its cost of debt is 6.5%.

Allowing the regulated entity the cost of debt from the government stock formula, 4% plus 2%, will undercompensate it by 0.5% - which would be a large amount for an entity with a lot of physical capital funded by debt.

So my suggestion would be, if regulators must use a formula, use the swap rate plus a margin.

Friday, 14 February 2014

The inflation we haven't been able to control

I've been bothered for a while about the way we have a reasonably high (2.9%), and rising, inflation rate when you look at price rises in the domestic non-tradable part of the economy. And it's going to get worse, with the economy continuing to strengthen: as you can see in the graph below (from the RBNZ's December Monetary Policy Statement), the RB has non-tradables inflation rising steadily over the next while to close to 4%.

What I didn't appreciate, until I read the latest Australian Monetary Policy Statement, was that the Aussies have got an even bigger issue than we have. Here's a table with their latest numbers (circled), and a couple of graphs.

Their non-tradables inflation rate is 3.7% - higher than our 2.9%, and in a cyclically weaker environment than ours (we have faster GDP growth, faster employment growth, an unemployment rate that's heading below theirs, and house prices rising at a faster clip). The RBA rightly says that "it is somewhat surprising that non-tradables price inflation has not eased given that growth in labour costs has been weak in recent quarters".

The RBA had a bit of a closer look at where this stubborn non-tradables inflation has been coming from, in these two graphs.

The top chart shows the stubbornly high level of non-tradables inflation (roughly 4% a year over the past decade), compared with the more volatile but generally much lower tradables inflation.  It also shows, in the left panel, that what they call "administered" prices - which is, I take it, a euphemism with prices you're lumbered with on effectively a no-choice basis - have been helping keep non-tradables inflation high.

The bottom chart splits out housing-related non-tradables inflation and inflation in domestic services markets. Again, the left panel shows that housing-related "administered" prices have been making things worse. And the right panel shows that, even if some of the current non-tradables inflation can be traced back to more expensive housing, the rest of the non-tradables economy has generally been chugging along at about a 3% inflation rate, year in and year out, only briefly interrupted by the GFC.

I'm left with three thoughts.

One is that there could be a mistaken degree of complacency about the inflation outlook in both Australia and New Zealand. There's a stubborn core of domestic inflation that doesn't appear to have been squeezed out even (in our case) after two decades of inflation-targetting (the Aussies came later to the inflation targetting game). There's often criticism of central banks for being spooked by inflation that mightn't actually be there - on this showing, it could well be lurking.

Two, persistent non-tradables inflation leaves you asking whether extensive microeconomic reform in both countries has actually succeeded in budging some behaviours. Have we still got a core of unreconstructed, inflexible sectors?

And three, I look at that contribution from "administered" prices (and I'd bet the same would be true here in NZ) and wonder why it is that the prices of "utilities, education, health services, some motor vehicle services, property rates & charges, pharmaceutical products, child care, urban transport fares and postal services" can simply be announced on high for consumers to have to swallow. I said the other day that our Productivity Commission had made a jolly good case for the economy-wide benefits of greater services competition: here's another reason why it would be a good idea.

Wednesday, 12 February 2014

Another example of how to measure competition

In my previous post I was making the case for the Commerce Commission, and others, to have a stab at measuring the levels of competition in our major markets, as I reckon it's increasingly becoming more of a practicable option.

I'd no sooner posted the piece when another example of how you can do it came to hand. I found it in Sapere's report for Business NZ, 'Achieving policy goals for the electricity industry', where Sapere were talking about the state of competition in the electricity retailing markets, and they included three bits of data that the Electricity Authority had compiled.

Here are two of them: the first is the evolution over time of the HHI concentration indices in the market, and the second is how often, over time, consumers got approached by retailers looking for their business (I haven't included the third - regional consumer switching rates - because, while it's interesting, it was a single snapshot of 2012 and didn't give you the same feel for how things were changing over time).

Purists might argue that each of these indicators, on its own, isn't a clearcut measure of the degree of competition. And those of us who live in the real world would answer, actually, taken in the round, they paint a very convincing picture of competition increasing over time. They don't imply that there isn't more that could happen, and they don't imply that the current state of affairs is acceptable, but they do show clear movement in the right direction.

And so I say it again: we need more people, doing more of this competition analysis, across more of our industries.

Monday, 10 February 2014

Yes, you can measure competition

I was really pleased to see the strong pro-competition messages in the Productivity Commission's recent Boosting productivity in the services sector, 2nd Interim Report, Competition and ICT topics. Competition-enhancing or competition-friendly voices don't always get their fair share of the airwaves against the noise kicked up by interests who'd prefer the competitive scrum to be screwed their way, so it's great to see the Commission bluntly saying that "Over the past two decades, evidence has mounted that intensity of competition is a key influence on the level and rate of productivity growth. Competition drives the efficient use of resources and the innovations that sustain productivity growth over time. Barriers that prevent new firms from entering a market (or prevent existing firms from exiting a market) dampen competition, and the contribution it makes to lifting productivity" (from the 'Overview' section).

There's been a far bit of publicity already given to the Commission's draft recommendations (which sensibly include doing something about the currently virtually toothless s36 of the Commerce Act, which in theory aims to prevent parties with market power from using that power to obstruct the competitive process and which in practice is like nailing jelly to the wall), so I won't revisit them. But I would like to point out some very interesting work the Commission did which hasn't got the same amount of attention.

Here, for example, is the Commission's attempt to measure the degree of competition in the different sectors of the economy. I know, I know, it's a bit of a heroic ask in the first place, and arguably you really want to look more at competition in markets than competition in sectors, which aren't the same thing, but it's a valiant start.

The Commission calls it a competition "heatmap", with the whiter bits representing the cooler, less competitive sectors and the darker bits the hotter competition areas, when measured against six potential indicators of the degree of competition (the six columns in the body of the table), such as the degree of entry and exit, and pricing relative to cost.

There isn't any enormous road-to-Damascus revelation in the table - the Commission rightly says "The overall picture across mixed" (p38) - but some service industries show up down the less competitive end (finance and insurance; rental, hiring and real estate; and professional, scientific and technical services), and the Commission concludes that it "gleans an overall message from the research....This message is that scope exists to sharpen competition in service industries. Policy makers should seek policy changes to achieve this outcome and implement them when doing so would yield net benefits" (p38).

Right on, folks!

The Commission also had a different go at assessing the level of competition, by getting Colmar Brunton to run quite a large survey (1,526 senior decision makers across a sample of middle to larger business), asking the question, how hard did various providers of business services fight to keep the decision makers' business?

Here are the results, pretty much self-explanatory - brown/pink is not much effort put into fighting for business customers, light/dark blue is lots of effort.

It's not a great overall picture. As the Commission said, "Respondents rated as “limited” the efforts of many service providers to gain or retain the respondent’s business", and that "Providers of legal services were perceived to put in the least effort (38% were rated as having made no effort), followed by freight, equipment rental, and accounting services" (both quotes from p37). Elsewhere in the report the Commission raised the possibility of "market studies" (studies of the levels and process of competition in different markets), an idea I and others had recommended to them in earlier submissions: it seems to me that four sectors have just self-selected themselves onto the market study short list.

Finally, these indicators of intensity of competition show that, while it's far from being a precise exercise, you can make a reasonable stab at figuring out what the state of competitive play is in any given marketplace (the Electricity Authority has also had a go, as I blogged in 'Measuring the degree of competition'). And it's high time for the Commerce Commission to do the same.

Thus far, the Commission has shied away. In the outcomes listed in its..

Hang on, quick bit of jargon explanation needed here.

When public bodies commit to reporting on what they've been up to, or plan to be up to, in the likes of their Statement of Intent, they can report on four things: inputs (we hired more eye surgeons), outputs (we did more cataract operations), impacts (more people had their sight restored) and outcomes (the quality of people's lives improved). Things can be a little blurry at times, especially as between impacts and outcomes, but that's the overall scheme of things.

What's ultimately important for the Commerce Commission (and practically all other public bodies, too) is outcomes, as the Commission says on its home page - "Achieving the best possible outcomes in competitive and regulated markets for the long-term benefit of New Zealanders" - and as it also says on p8 of its latest Statement of Intent, where "Markets are more competitive" is one of the outcomes it is aiming for.

But the Commission doesn't currently have any measures of changes in competition outcomes included in its planning. Its rationale (p7 of its SOI) is that "While these high-level outcomes guide our work, it is not practical or cost-effective to directly measure our performance against them. We have chosen instead to measure the direct impact of our work, as this demonstrates how we are contributing to achieving our outcomes" (I've added the italics to make the whole input/output/impact/outcome thingy clearer).

Maybe that rationale was marginally true last May when the SOI was put to bed. But with other public bodies now making the first exploratory stabs at the levels of competition in various marketplaces, it's looking increasingly passé. I reckon it's time for the Commerce Commission to belly up to the bar and tell us what real differences are happening in our markets.

Monday, 3 February 2014

Why are we where we are on this league table?

League tables are always fascinating, and I came across a rather suggestive one in the January 11 issue of the Economist, in an article, 'Setting out the store', which was making the case for governments to sell off more of their assets.

The Economist didn't give the exact source for its cross-country comparisons (just citing "an IMF paper") but I've tracked it down and here's the data from the original source (Another Look at Governments’ Balance Sheets: The Role of Nonfinancial Assets). It shows the amount of government-owned (central and local government) non-financial assets (everything from land and sub-soil assets through buildings, roads, and infrastructure, through to non-tangibles like software and films), as a percent of GDP.

This is an area where cross-country comparisons (as the authors stress) are fraught, due to assorted and significant data problems, but even so I think it's fair to ask why we seem to have a relatively high share of our resources tied up in state-owned non-financial assets.

The data we supply to the international statistical agencies don't help a lot with the answer, as they aren't split out into categories like dwellings or structures (which is why we are a grey bar in the chart above), so you can't tell, for example, whether we have an unusually high stock of government-owned housing or an unusually large set of roads. The only split we provide is between central and local government, shown below compared with other countries that also provide the same split.

There's clearly a big chunk of local authority assets in our total. That's not unusual: as the authors note (p10), "On average, subnational governments hold more than one-half of total nonfinancial assets. The share of regional and local governments is particularly high in federal states". 

But it does leave you wondering. To date, our privatizations - asset sales, whatever - have been at central government level. But you'd begin to wonder if local authorities aren't similarly sitting on superfluous assets that could also be sold off.

Saturday, 1 February 2014

How tight is tight?

Everyone is primed for higher interest rates: some folks thought the Reserve Bank would even start the process last week, but in any event there's a near-universal consensus that the next Monetary Policy Statement (March 13) will see the first hike in the Official Cash Rate.

Over at The Visible Hand In Economics, the question's been asked, ''Should we hit inflation hard and fast?', if you'd like to contribute to the discussion. My own view is that we've got some potential inflation problems emerging - non-tradable, domestically generated inflation is 2.9% already, and rising -  but even so I'd be concerned about a sharp and quick rise in interest rates, mainly because I'm not sure everyone realises how much monetary policy has effectively tightened already, through the mechanism of the higher Kiwi dollar.

Here's that old measure of overall monetary policy, the Monetary Conditions Index, updated to the present.

It combines the 90 day bank bill rate and the trade-weighted index of the Kiwi dollar into an overall measure of the bite of monetary policy. I know, it's not perfect, but it's a better view of the policy setting than you'd get by looking at interest rates alone. And what it shows is that we're already near the kind of monetary policy tightness that was appropriate towards the end of the strong economic cycles of the mid 1990s and mid 2000s. So in my view it would be easy to overtighten by mistake - especially, as seems likely, if rises in the OCR translate into an even stronger Kiwi dollar.