Thursday, 11 October 2018

I've tried to stop...

...writing any more posts about market studies, but events have intervened. The government announced that it's going to fast track the Commerce Amendment Bill, which will give the Commerce Commission the powers to do studies, and also that the first one will be an inquiry into the petrol industry (which was always on the cards anyway).

So I headed smartly to the Transport and Infrastructure Select Committee's website to see where the Bill had got to, and found its final report (published on September 12). Market studies - or "competition studies" as we've elected to call them - have got the tick, though the Committee members divided on party lines on who should be allowed to initiate them. The majority backed either a Minister or the Commission (I'm with them), in line with MBIE's advice in its advisory report on the bill. The National members would have let the Commission initiate only with ministerial approval.

The Committee also went with another good MBIE recommendation. The Committee said (p3):
We consider that it would be appropriate for the legislation to require a government response to the final report. We do not consider it necessary to specify a time frame or process for the response. We recommend inserting new section 51E to require the Minister to respond to the commission’s final report on a competition study within a reasonable time frame.
I was really pleased about this. Of the 15 market studies submitters on the Bill (6 for, 6 broadly neutral, 3 against), only two folks had pushed for it - ASB Bank (submission here, the Ministerial response bit is on p7) and me (ditto, pp18-19). But MBIE thankfully saw enough merit in the idea to run with it. To my mind, it made no sense to set up a studies regime but not address the risk that they would be ignored.

There is also a useful focus (again following MBIE's sound advice) on following up what actually happens after the studies come out. As the Committee put it (p3)
We would like to see evaluations carried out to assess the effectiveness of each study and of the regime as a whole. We do not propose any legislative amendment in this regard. However, we suggest that, as part of the commission’s accountability arrangements with the responsible Minister, one of its performance measures should be to evaluate each competition study and report the results in its annual report.
I also learned from para 20 of MBIE's report to the Committee that "Cabinet has directed MBIE to carry out an evaluation of the competition studies regime after it has been in operation for five years". That's good practice. As I mentioned in a telco context ('Regulation done right'), it's easy to set up regulatory regimes and processes, and then forget to go back and check whether they've done any good or are still needed.

It's a pity in a way that it needed soaring petrol prices to be the catalyst that propelled competition studies up the legislative queue: they deserved a faster track than they'd got up to now. But that's realpolitik, and there's no point being naïve about it. If it took politicians' squirming to get a faster result, let's bank it and get the Commission underway that much quicker.

At the petrol pump

You don't - for good reason - get much of a chance to quote reams of facts on the radio. So for those of you who were listening to my stint on the National programme's 'The Panel with Jim Mora' on Tuesday, here are the numbers on what's driven the rise in petrol prices this year.

Conclusion - roughly two-thirds of the rise is down to the increased cost of the imported fuel, which has been hit by both a markedly higher world price in US dollars, and a markedly lower New Zealand dollar against the US dollar. It's not down to a big rise in petrol companies' margins, which is the story being used to frighten the children.

Most of the rest is down to taxes, by the way, and even more so in Auckland. The numbers above come from MBIE's weekly petrol price monitoring which as MBIE says "assumes retail petrol price are uniform nationally. Auckland City has recently introduced a regional fuel tax that will increase fuel prices in the Auckland region. Our currently methodology does not accommodate regional prices or regional fuel taxes. We are developing a new methodology ... that will include regional retail price differences". Aucklanders can add 11.5 cents to the increase in taxes, meaning that, for them, tax increases have been of the same order of importance as higher import costs.

The MBIE data are a great resource if you'd like to keep tracking developments for yourself. There was also an excellent explainer on the Newsroom website from Bernard Hickey, 'Q+A: Are petrol retailers profiteering?' which provides a lot of useful background.

Tuesday, 2 October 2018

A good follow-up

The New Zealand Institute of Economic Research has followed up on an idea I threw out here in August, suggesting that somebody ought to ask New Zealand businesses exactly what was bugging them when they reported low levels of business confidence (and thanks for the credit in the latest Quarterly Survey of Business Opinion, guys, it's appreciated).

Here are the answers to the special question the NZIER included this time round.

While it's good to know more precisely what's on businesses' minds, in the event it's not hugely surprising. Most people had suspected that businesses were not enormously enamoured of various current economic policies, and sure enough government policy topped the list. The tightness of labour markets (staff availability, wage pressures) and its impact on profitability, are also right up there, as is profitability more generally.

As NZIER said in the media release, "Profitability continued to worsen, reflecting intensifying cost pressures for many businesses. Businesses remained pessimistic about an improvement in profitability", and the overall results in the QSBO were downbeat. Looking just at the "own activity" results, which track GDP pretty well, "Firms’ own activity for the September quarter and expectations for the next quarter both fell, indicating a slowing in economic growth over the second half of 2018".

Hopefully the support from still very supportive fiscal and monetary policy will carry us through whatever slowdown occurs in coming months: in particular, the lower Kiwi dollar has tilted overall monetary conditions in businesses' favour, even as the RBNZ has stood pat on already low interest rates. And let's trust that the long-running  post-GFC global business expansion will not blow a gasket, despite the best efforts of American tomfoolery to derail it.

That's the upbeat take. But if there's one thing that would give you special pause for thought, it's "consumer confidence" turning up in the graph above as businesses' third most pressing worry. I didn't expect it to rate so highly, but looking at it now, I can see why it's there. I'd finger the petrol price as one big factor: here in Auckland the regional tax, the general rise in fuel excise, the high world price of oil, and the weaker Kiwi dollar have resulted in a litre of 91 costing $2.35 - $2.40, and households aren't in a great place to absorb a thumping great whack like that. I also suspect that housing wealth effects, again maybe more in Auckland than elsewhere, have stalled or even reversed.

So the state of consumer confidence is something I'll be watching a bit more closely. Hopefully rising wages in a tight labour market will alleviate some of the budget pressures from the petrol station forecourt, and the September QSBO result of no rise in employment likely reflected firms' inability to find scarce labour, rather than any cutback in hiring intentions, which remain positive. I certainly wouldn't want to see any job insecurity thrown into the already fragile household mix.

Monday, 1 October 2018

What do devaluations achieve?

Perhaps unwisely, over the week-end I queried a bit of logic I saw on Twitter which had argued that a lower domestic currency makes a trade deficit worse.

The reply that came back to my query said that a lower dollar makes imports more expensive, QED.

And although I tried to point out that other things start happening, too, to my surprise I got further pushback in support of the the lower-dollar-makes-a-deficit-worse theory.

Maybe it's a generational thing. Back when I was starting out in economics, exchange rates were typically fixed or managed, currency changes were an actively deployed policy tactic, and the conventional thinking was that you reached for a devaluation to improve your trade deficit.  These days, exchange rates typically float, and the effects of devaluation as an option have, maybe, been forgotten about.

So here's a numerical example of what I always thought was the orthodox way of looking at it. It starts with New Zealand running a small trade deficit - our export revenue from wine doesn't quite match our import bill for oil - and it traces what happens when the New Zealand dollar drops against the US dollar. For dramatic effect I've made it a big fall, from parity with the US dollar to only 50 US cents.

The first panel is the starting point. The second panel shows the immediate impact of the fall in the Kiwi dollar. As the people on Twitter rightly feel, the first impact is of course to make imports more expensive, and the trade deficit does indeed get worse. What we're seeing at that point is the downward, or worsening, part of what used to be called the 'J curve' effect, and these days would probably be called a 'hockey stick' or 'Nike swoosh' effect - things get worse before they get better.

If that's all that the Twitter people were saying, fair enough, though I get the clear feeling that they also believe that the lower dollar will lead to a permanent worsening of the deficit, and that things won't actually get better later on.

But get better, they do, thanks to two responses to the lower dollar.

Panel three shows adjustment on the import side. Oil used to cost NZ$60; now it costs NZ$120. That's a powerful incentive to use less of it - by car pooling, by trading down to smaller car engines, by putting in solar panels, by using more energy-efficient public transport, whatever.

One respondent on Twitter argued that "How do you propose we "cut back" on imports without local industry to meet the demand? Should we just tell people to have less goods and medicines because they've become more expensive?". Well, the answer to that is that people routinely change their patterns of consumption to big price changes. If tickets to the big match get too pricey, you do something else for the weekend. If avocados are $7 each (as they were), you don't make guacamole. But I'll come back to that behavioural response at the end.

In panel three I've assumed that a variety of energy-saving measures in response to much more expensive oil lead to a reduction in demand from 400 barrels to 300. And we saw precisely that response in the real world to successive jack-ups in prices by OPEC, though it took quite a while for people to reorganise their affairs (eg by junking gas guzzlers and designing more fuel-effective engines).

That alone starts to eat into the initially higher trade deficit, which comes down from NZ$28,000 to NZ$16,000. The exact numbers don't matter: what does matter is that we've started going up the swoosh.

But there's also a response on the export side, which I've shown in the bottom panel. Before, the American buyer of our wine was paying US$200 a case. After the devaluation, he's only paying US$100 - it's a complete steal. He could well increase his order significantly - if he was profitably shifting New Zealand wine at US$200 a case, he'll have them flying off the shelves at US$100.

Or it's possible that the winemakers will raise their prices a bit. In the panel I've assumed they raised the Kiwi dollar price from NZ$200 to NZ$250, which for the US buyer means he's still paying a lot less (US$125) than the US$200 he used to pay. I've assumed that there's a mixture of more wine sold, as they are now a lot cheaper in US$ for US buyers, and a somewhat higher NZ$ price.

And hey presto, the overall outcome after both imports and exports have adjusted is a small trade surplus.

"Hey presto" may get you thinking this is all a sleight of hand, and indeed there is an assumption in the background here that those behavioural responses actually happen, and happen strongly enough, to turn things round. And there's a bit of economics (the 'Marshall-Lerner condition') that's figured out exactly how strong those responses need to be.

If you're what used to be called an 'elasticity pessimist', you don't believe the responses will in fact be large, and maybe that's where my Twitter correspondents are. Maybe, on the import side, we're always going to have to buy those medicines, and we can't skimp; maybe, on the export side, some wowser wine-shunning import monopoly won't order more cases then it used to. There's nothing logically wrong with that line of thinking, and at the end of the day the actual effect will turn on the size of the responses. Me - I'm more of an elasticity optimist, and especially over the longer run.

Before leaving what will be ancient history for some and the bleeding obvious for others, I'd just add that back in the day I was never a great fan of devaluations as a policy option. Can they improve the trade deficit? Yes, over time. But should you go there?

Mostly no. Devaluations can come with unpleasant side effects, including the ever-higher-inflation ever-lower-dollar spiral that New Zealand actually fell into. They can degenerate into tit for tat zero sum games (everybody can't simultaneously devalue against everyone else). And they encourage - or at the very least perpetuate - the idea that price is the best way to compete in world markets. So, at most devaluation makes an expedient policy tactic, but it's a poor economic strategy.