Friday, 23 March 2018

Inside the consensus

The consensus economic forecasts collated by the New Zealand Institute of Economic Research (latest one here) are a remarkably useful tool.

The overall picture from the latest one makes a fair deal of sense, with ongoing growth expected of about 3% a year. In per capita terms, allowing for population growth of say 2% a year, it's not outstanding, but at least the current cyclical expansion, which started back in early 2011, has still got legs.

We've got fiscal policy delivering a decent-sized (and pro-cyclical) boost to the economy, monetary policy is also supportive, the world economy is showing every sign of strengthening, as you can see from the latest forecasts from the big multilateral organisations (the OECD's is here) and from global business surveys such as the J P Morgan / Markit one, and at home we've got, I reckon, fairly strong wealth effects from the national rises in house values.

The consensus numbers themselves are obviously of interest in their own right - and over time are likely to prove better than any individual forecaster's - and it's good to know that on the latest consensus view we are in for further economic growth, a falling unemployment rate, modest inflation, and the fiscal books in good shape. But the most interesting things, for me, lie in the fine detail of the outlook rather than the consensus numbers themselves.

First thing I always check for is revisions to people's thinking: that's because it's surprises that tend to move markets, rather than the eventuation of the widely anticipated, which tends to be already baked in. This time round, there's not a lot of change to the expected GDP track compared to what the forecasters thought last December: no joy, then, for the equity markets which might have been looking for some signal of stronger than expected corporate profitability.

The second thing I look for is where there is most uncertainty or disagreement amongst the forecasters. This time round (as it has been before) the key moving part is housebuilding.

At one extreme we've got the view that we'll have trouble even maintaining the current volume of house construction - the most pessimistic view is that it'll ease off a little as Auckland new builds don't fully compensate for the rundown of the Canterbury reconstruction - and at the other we've got the view that we are off to the races, with substantial increases in coming years. Presumably that view is some combo of a judgement that the Auckland building trades are not at full capacity and that KiwiBuild kicks in big and early. Can't say I see strong evidence for being down the gung-ho end of that spectrum.

One oddity is the reasonably modest consensus outlook for non-residential investment. You'd wonder why - if we're reaching labour market capacity constraints, as we may be - businesses aren't splurging more on gear, especially as the Kiwi dollar is reasonably high (the bulk of our capital gear is imported) and (to the degree that investment is interest-rate sensitive) financing costs are at unusually low levels. We're also starting from a position where we're not hugely equipped with gear in the first place: one researcher has calculated that we could close 40% of our productivity gap with Australia if our workforce had the same level of capital equipment as theirs.

I also wonder about the implied rates of productivity growth in the consensus outlook. In the year just finishing, GDP growth is expected to have been 2.9%, and employment growth 3.0%, which means that labour productivity will have declined a smidgen. But in the March '19 year, on the consensus view GDP growth will be 3.1% and employment growth will be 2.0%, so labour productivity will rise by 1.1%, and there are 1.7% and 1.5% productivity gains expected in the following two years as well. I'd love to see it happen, but right now I can't see what the mechanism is that will get our productivity performance improving so much so soon.

And maybe I'm cynical, but in our political system I simply don't see how fiscal surpluses will be allowed to grow and grow, from $2.7 billion now to an expected $5.7 billion in three years' time. Three billion more of the folding stuff available - I'll be mightily surprised if it withstands the clamour for increased spending.

Thursday, 8 March 2018

Unintended consequences?

The bill that aims to rein in non-residents buying New Zealand houses - the Overseas Investment Amendment Bill - is currently before the Finance and Expenditure Committee.

It's had a lot of submissions - 239 of them, available here - and hopefully this point will already have been registered by the Committee, but if not I'd like to alert the members to the reality of housing development in our neck of the woods.

We live on Auckland's North Shore. It's an established area, which means that any extra housing comes from infill redevelopment. I can't speak for the whole of the North Shore, still less for Auckland more widely, but in our East Coast Bays the reality is that this redevelopment is largely being done by Asian developers with Asian crews. The typical projects aren't large - an existing house on a large section bowled and replaced with three new ones, two adjoining houses bought at the same time and their combined back gardens used for three new houses (both real examples) - but their aggregate contribution to expanding housing supply is significant.

There is provision in the Bill (sections 16C and 16D) for this sort of activity to continue, by way of approval from the Overseas Investment Office. But how many developers are going to go this route, which involves both uncertainty around an eventually positive vetting outcome and possibly some significant delay in the interim while the OIO mulls the decision?

My guess would be, not many. Maybe New Zealanders will end up better off in some affordability sense if foreign buying demand is taken out of the North Shore equation. But the evidence of my own lying eyes is that foreign supply is also being taken out of the market, and in our area at least it's not obvious that New Zealand will be the winner in any sense at all.

And what's true here may be true more widely. As the submission from the New Zealand Institute of Economic Research puts it
as well as preventing single-purchase investments by overseas persons, the Bill also makes it more difficult for foreign investors, including New Zealand-domiciled companies with more than 25% foreign ownership, to invest in large-scale residential projects. This is at a time when New Zealand has relatively few large-scale property development companies and New Zealand banks are increasingly tightening up on development funding.
This will reduce the supply of housing beneath what it might otherwise have been, pushing up prices for New Zealand resident and citizen buyers, including first home buyers. The Bill could therefore have precisely the opposite effect of what is intended. 

Monday, 5 March 2018


For a while there, it looked as if the dairy sector was going to be one of the quieter stretches of the regulatory front line: our regulatory regime was running smoothly along a pre-planned route.

The regulatory scheme of the Dairy Industry Restructuring Act - DIRA, pronounced "dye rah" if you've been lucky enough not to encounter it before - had, sensibly, included provision for a review of the Act if it looked as if it might no longer be needed. If at least 20% of the market for collecting milk from farmers was in non-Fonterra hands, North and South Islands considered separately, DIRA triggered a review of the state of competition. That review could then recommend whether regulation was still necessary, could re-address the 20% threshold, and could suggest routes to deregulation. In default of any new bright ideas, parts of DIRA would automatically lapse.

The 20% trigger was reached in the South Island in 2015 and the Commerce Commission duly published a competition review in March 2016 (the full thing is here and there's a handy summarised briefing here).

Overall, the Commission judged DIRA should be left much as is, but with limited recommendations for improvements, which were mostly around some modest deregulation of "DIRA milk". That's the milk Fonterra is required to supply, at a regulated price, to domestic processors of raw milk (cheese makers and the like), a requirement intended to counter what would otherwise be Fonterra's ability to ramp up the input price to processor buyers. The Commission also said that the 20% threshold for adequate non-Fonterra market share was too low, and suggested 30%, and recommended another look at the Act in any event by 2021-22, or when the 30% threshold was reached if it was triggered earlier (the Commission expected it wouldn't be).

All this looked sensible and it very largely was, though I'm not convinced about one proposal giving Fonterra the discretion not to accept new large dairy conversions as shareholder suppliers. The government of the day thought the package looked sensible too, and it consequently introduced the Dairy Industry Restructuring Amendment Bill in March 2017 to implement it. The Bill had gone nowhere, however, by the time the general election came round.

Which left room for the incoming Minister of Agriculture Damien O'Connor to say, on December 19, forget all that, nothing's getting deregulated, there'll be no change for dairy conversions, and no bits of DIRA are going to lapse for the time being. The Minister's statement is here (it includes a helpful Q&A) and the replacement Dairy Industry Restructuring Amendment Bill (No 2) is here.

The stated rationale was that "The Government wants to take a strategic view of the dairy industry", and limited changes now might get in the way of a big picture rethink later: "The intention is simply to prevent expiry at this time, and then take a holistic approach to all other dairy-related issues. There is little merit in taking a piecemeal approach to parts of the 2017 Bill, as opposed to a comprehensive review of all interrelated issues". There will be "a comprehensive review of the DIRA as a matter of priority" carried out this year.

So my question is, wazzup? It's fair enough to want to review how one of our major industries is performing, but it's still not clear exactly what's bothering the government about DIRA.

It could be that Fonterra's set it off.  For example it pursued a doomed attempt to discriminate, in breach of the 'open entry, open exit' regime, against former suppliers who'd rejoined Fonterra, and over 2015-17 lost all the way to the Supreme Court. And it decided to slow down payments to its trade suppliers  which got it bad press in 2016 and 2017 and suggested that, despite regulation, it still possessed the ability and the incentive to give less and take more. It looked as if they were reading from my DIY playbook,  'How to get regulated'. More recently Fonterra has woken up to playing a more strategic regulatory game, and has been running a charm offensive with its TV ads, but the harm may already be done.

Or it could be that the government is having a rethink about the big regulatory bargain struck at the start. Left unregulated, the merger that created Fonterra would have been bad for New Zealand: the Commerce Commission, in its draft decision in 1999, said there would be a net cost to the economy. The numbers are highly squishy but, the Commission said, there would have been a cost to the country ranging from around a smallish $75 million to around a sizeable $450 million. The overall Fonterra/DIRA deal was consequently an attempt to bank the benefits while containing the costs, turning the combo into a net plus for the economy. And irrespective of the net benefit calculus, it also got the support of those infected by the National Champion virus.

But did the benefits eventuate, were the costs contained, and did the National Champion sweep all before it? There's certainly room for a rethink on the benefits side. In 1999, for example, the Commission noted at para 624 that "The goal is to expand the present business, which currently has revenues of $8 billion per year, to one of $30 billion in ten years, an ambitious target which some have argued lacks specification of the means by which it is to be attained". Quite. In the event, 18 rather than 10 years on, Fonterra's revenues have reached $17.9 billion.

And still on the benefits side, why has the biggest financial payoff from marketing innovation come from outside the Fonterra stable? A2 Milk, currently worth $9.5 billion, is roughly equal to the value of Fonterra. If you take the view that one of the downsides of creating monopolies is a loss of dynamic efficiency, the value of A2 is a chunky bit of circumstantial evidence.

If they'd known then what they know now, it would be an interesting question what dairy farmers would have gone for back in 1999. Would the industry behemoth still look as good an option, compared (say) with creating two decent sized entities, each competing for the farmers' custom, and each with its own approach to product innovation, marketing, and overseas investment? But even if with hindsight some alternative might have been better, it's hard to see how that particular cake can now be unbaked.

All that said, there have been positives from the current regime. Fonterra has come up with some good ideas: Trading Among Farmers for one, and the listing of the Fonterra Shareholders' Fund for another. And DIRA has handled some issues a good deal better than the Aussies have been able to manage theirs. The ACCC's draft report last November on the Aussie dairy industry found that Aussie dairy farmers were at the bottom of a totem pole with the supermarket duopsony at the top and the processor oligopsony in the middle: "Unlike others in the supply chain, most dairy farmers have no bargaining power and limited scope to reposition their businesses to mitigate this ... Imbalances in bargaining power between processors and farmers result in practices that reduce competition for raw milk and transfer disproportionate levels of risk onto farmers" (pages 12-13). Kiwi farmers, with their right to join Fonterra and get a price policed by the Milk Price Manual, are in a better place.

It's also unfair to see everything that happens - good or bad - as down to what Fonterra did or didn't do. The reality is that Fonterra is a middleweight player in a big global market: what it can do is heavily circumscribed by global demand and supply factors. Rather than assuming that Fonterra is an unconstrained free agent, and playing the blame game New Zealand is so good at, the better questions are, has it played the hand it's been dealt as well as it might have? And has it worked the strategic angles so that the next deal of the cards falls more its way? I've no idea, and without good evidence people shouldn't be jumping to any premature conclusions.

In any event we'll know what precisely was on the government's mind when we see the terms of reference for the dairy review, which can't be far away. And the whole episode, by the way, is yet another example of why we need a 'market studies' power for the Commerce Commission. The last government, in what had become sadly typical of its too little too late approach to competition policy, had reached the point where it was prepared to give the Commission some circumscribed powers to look at how industries were travelling. This new government is more friendly to the idea, and rightly so: if there are competition issues in any industry, the specialist in the competition game should be able to take a proactive look and come up with some fixes.