A single buyer for electricity?

Last night I went along to the latest evening seminar run by the Law and Economics Association of New Zealand (LEANZ). If you're at all interested in LEANZ's mission in life - "the advancement in New Zealand of the understanding of law and economics" - then it's well worth signing up. It won't break the bank ($75 a year for those in work, $50 for students, $750 for corporates who covers 25 staff). You can find out more at the LEANZ website.

Its main activities are seminars (in both Auckland and Wellington). Last night's was presented in Auckland by Ben Gerritsen of Castalia, on the topic, 'NZ Power: Mainstream or Mad?', 'NZ Power' being the name Labour and the Greens have given to their proposed single buyer of electricity, to replace the current wholesale electricity market. You'll recall this is the proposal that nearly scuppered the Might River Power float, and required the issuing of supplementary information to make it clear to potential investors that there was a material risk to the current power generation regime.

As you can imagine, a lot of people are interested one way or another in the idea, and the seminar was well attended (and thanks to Chapman Tripp for hosting it at their offices).

Ben's main points? First, he looked at why electricity policy changes have reared their head in the first place. The chart below (this and the subsequent ones are from Ben's presentation, which he kindly sent through to me) gives a good idea why, which shows a substantial rise in real electricity prices paid by households over the past 16 years.

One thought I had about this pattern is that it might have been an unwinding of a previous cross-subsidy of electricity to households - we wouldn't have been the only country in the world that arranged affairs to get cheaper power to the voters at the expense of dearer power to industry. I could be wrong: Ben's view was that this may also reflect markets working effectively, in the sense that the more expensive-to-service households end up carrying more of the costs.

Then, after going through the details of the current regime and the proposed changes, Ben looked at whether the NZ Power idea was mainstream, in the sense that it was used by a decent range of other countries. Short answer: no. Brazil is close, and Ontario looks very like the NZ Power idea. That's it. Not that widespread adoption of anything is a guarantee that it's a good idea (look at protectionism) but this isn't a model many other countries have signed up for.

He then went through the various ways in which a single buyer might theoretically work out better than the wholesale market - it might make better investment decisions, it might lower operating costs, it might drive out excess returns, or it might redistribute normal returns (effectively taking the SOE generators' profits and giving them to consumers). None of these looked a goer, and indeed Ben's argument was than neither Brazil nor Ontario had anything good to show for going down this route.
Here's his conclusion on Brazil.

And here's the outcome in Ontario.

Before the presentation, I might have leant towards the view that an oligopolistic generator market might well have been able to sustain excess returns, especially in an environment where barriers to new entry are reasonably high (eg through the laborious consent process). But Ben showed a chart (below) illustrating that various measures of electricity prices (actual contract prices, and measures of what people expected the price to be) actually tracked quite closely to the long-run marginal cost (LRMC) of new generation.

Brent Layton, the chair of the Electricity Authority and the author of the paper ("The Economics of Electricity", available here) that Ben sourced for this graph, also chaired a Ministerial Review of the Performance of the Electricity Market in 2009. He (Brent) concluded from this that "The data very strongly suggests that wholesale prices were accurately reflecting LRMC and led the Ministerial Review to conclude from the data for the period to 2008 “there is no clear evidence of the sustained or long term exercise of market power.""

In sum, for Ben, the NZ Power idea didn't have much going for it.

Next up in the LEANZ seminar series, by the way, is a special event on September 10, 5.15pm for 5.30pm start, at Russell McVeagh's offices on L30 of the Vero Centre, 40 Shortland St, on  the Commerce Commission's new, improved  Mergers and Acquisitions and Authorisation Guidelines, drinks and nibble after. Two great speakers, too - David Blacktop, Principal Counsel, Competition, at the Commission, and Lilla Csorgo, Chief Economist, Competition, also at the Commission. Trust me: these are two very, very capable people who have the law and the economics of the thing nailed. It'll be well worth your while.

Look out - the termites are coming

David Lange famously once remarked about Roger Douglas, "He's like rust, he never sleeps".

I'm beginning to feel the same way about the folks, in academia and in the commentariat, who are insistently trying to undermine the market-friendly and consumer-friendly reforms the Labour government of 1984-90 brought in, and which the National government of 1990-99 extended.
We're not alone in this, by the way: the termites are on the march in Australia and the UK as well.

The line of argument here and overseas generally runs like this (it comes with variations, but this is the general gist). It's a three-step.

Step 1. The GFC was a disaster brought about by deregulation of the finance sector.
Step 2. Therefore deregulation is a bad thing everywhere.
Step 3. Therefore it must be rolled back.

Even if you subscribe to Step  1 - and even though deregulation may have played its part in it, you'd have to observe that financial booms and busts have been happening for centuries under every sort of regulatory regime - the real sleight of hand comes at Step 2.

That's a big step, and it's not supported either by any great body of principled reasoning. Quite the opposite - at the level of theory, economists would generally say that workably competitive markets tend to work better for consumers and suppliers than anything else. As one of my favourite quotes puts it (from Oxford's Prof George Yarrow), "Market processes are often messy:  outcomes can be both inefficient and unfair.  The soundest argument for markets ... is simply that, very frequently, they are the least bad of the alternatives.  To paraphrase Churchill's remark on democracy, markets are the worst method of resource allocation, except for all the others that have been tried".

As economists or intelligent folks interested in economic issues, you probably know that, so why am I banging on about it?

What's got me sounding off  was a new opinion piece on a Stuff blog, 'Espiner: Deregulation's unfortunate experiment'. Espiner acknowledges, fairly, that New Zealand, pre-reforms, was in a bad way - "Back in the early 80s, New Zealand had one of the most regulated economies in the western world. You had to order a new car in advance... You couldn't take money out of the country without permission, employ anyone who wasn't in a union or put a café table on a footpath" - but argues that the proposed solutions made things worse, and were responsible for everything from Pike River (no, really, that's what he argues) to the Fonterra product contamination.

In his words: "We've had to endure the meltdown of our finance companies, the fleecing of thousands of investors of their retirement savings, a $6 billion leaky homes fiasco, the worst and least competitive telephone service in the western world, some of the highest electricity prices, the deaths of 29 miners at Pike River and most recently, the severe shock to our dairy industry.
Light-handed regulation has, in short, been an unmitigated disaster".

I'm not going to say that New Zealand's various regulatory regimes were all up to the mark. It doesn't look as if they were. But as for the rest of Mr Espiner's arguments, they're codswollop*.

I've written before, in Deregulation - how quickly we forget, about how people's memories are very short when it comes to the benefits of the liberalisation and deregulation we introduced, so let me remind people of just some of the things that have changed for the better.

Ordinary folk can get a mortgage. When I came out to New Zealand, to work for the Bank of New Zealand, it had virtually no housing mortgages on its books. You had to have an 'in' with a firm of solicitors to get them to lend you money from their trust accounts. How do you reckon that worked for many people?

People can buy cars and clothes and household appliances and electronic gizmos at a sensible price, instead of the limited quantities of highly expensive products the Men from the Ministry condescended to allow them to have. Espiner is, for some reason not obvious to me, particularly scathing of our lowered barriers to imports, saying we were "performing a down-trou on the world stage that was again vigorously applauded by an audience that then went home wrapped up in its nice warm tariffs". You know what? It actually doesn't matter a damn whether those other countries kept their tariffs or not (and he's factually wrong anyway, many other countries have liberalised their trade over the past couple of decades): we won even by moving on our own.

And who do you think most benefitted from cheaper imports? The politically connected businesspeople with the valuable rip-off import licences awarded to them by their mates in Wellington? Or ordinary families who can now buy clothes and shoes and televisions in The Warehouse at affordable prices?

And how'd you like to be back in the days when Prime-Minister-and-Finance-Minister Muldoon could simply announce that you wouldn't get getting any pay rise this year. Or next year. And that interest rates have just gone down 4% because I said so in the Budget last night (a true example). But they might go up 4% tomorrow if I feel like it. And the Kiwi dollar is worth whatever I say it is. And sorry about the 11% inflation rate.

Like to go back to that, from today's world of low and steady inflation? An outcome we have got, by the way, by adopting one of those newfangled experiments in economic theory (inflation targetting in this case) that Espiner so dislikes?

66% top rate of income tax do anything for you? No, I didn't think so. Like to go back to having the pubs shut at 6.00pm? When you couldn't buy wine in the supermarket? When the shops were closed on the weekend? How about giving Air New Zealand back its monopoly on domestic air travel?

Yeah, right.

And why not give Telecom its monopoly back, too (on mobiles as well as landlines, of course - the Ministry can't have you making choices for yourself, can it)? Yes, I can see that bright idea fixing "the worst and least competitive telephone service in the western world" that Espiner is so worked up about.

As regular readers of this blog will be aware, I'm no booster for the telcos, and there's still a way to go before we have the sort of choice I'd like to see, but Espiner is barking mad if he thinks (a) telco services have got worse since deregulation or (b) they'd improve if we went back to the old state monolith. And don't take my word for it - go and read the Commerce Commission's annual monitoring reports on the telco market and see for yourself how (for example) mobile prices have been falling now that we've got greater competition (I reproduced one of the Commission's graphs showing it happening here).

I could go on, but I doubt if any amount of compelling evidence would make much difference to the white anters steadily gnawing away at markets, flexibility and choice.

*Original text amended in light of feedback

Some perspectives on the Reserve Bank's high LVR controls

The Reserve Bank's plan to put limits on how much of their new lending banks can do on a high Loan-to-Value-Ratio (LVR) basis has been widely discussed in the New Zealand blogosphere and the mainstream media, and I don't think I need to add too much more to the coverage. If you missed RBNZ Governor Wheeler's speech when he announced the plans, here's the Bank's press release, which also has a link to the speech itself. Governor Wheeler used some OECD calculations on house prices to show that New Zealand houses are unusually overvalued at the moment (shown below).

If this looks familiar, it's because you may have seen the same data in my earlier post on the OECD's numbers, where I had concluded that "when you see us like this, well out on the left-hand edge of the developed world with unusually expensive house prices, you begin to have rather more sympathy for moves to curtail high loan-to-value-ratio lending".

That's still my view, though I have some sympathy for first-time buyers who are likely to be the group most hit by these new controls, and I also wonder why, if the problem is principally people buying very pricey homes in Auckland (mainly) with a low deposit, why the controls couldn't have been more targetted at the red-hot market rather than at everyone. But on balance the LVR controls probably take a bit of financial risk out of the banking system, and that's welcome. It also gets the Bank out of the tight spot where its normal way of dealing with an exuberant housing market (higher interest rates) would have worsened its other problem, namely a very high Kiwi dollar. If you like graphs, I've discussed the Bank's housing/currency dilemma here.

Once you start introducing direct controls on bank lending, it's easy to wade in deeper. But I'd be very wary, though, of direct lending controls that went any further than this. As Governor Wheeler said, "Rising house prices in Auckland and Christchurch are mainly a result of supply shortages, although demand-side pressures are also a factor due to pent up demand, the lowest mortgage rates in 50 years, and aggressive competition among banks for new borrowers, including borrowers with low deposits". "Mainly" is the key word here, in my view, and I'd have used something a bit more emphatic: while supply and demand are the two blades of a scissor, and it can get semantic trying to disentangle their contributions, I'd have said that the desperately low level of supply is easily the most important moving part here.

As the Governor noted, "Auckland’s Council suggests that Auckland’s current housing shortage is 20,000 - 30,000 houses with 13,000 houses needing to be built each year to meet future demand.
Christchurch’s shortfall is around 10,000 houses.  Strikingly, for a city with geographical boundaries equivalent in size to Greater London, and a population of 1.5 million (a sixth of Greater London), Auckland has only produced an average of 4300 new houses annually over the past three years". Even if, through the 'Auckland Accord' between Auckland Council and the national government, housing supply expands, it will be a long time indeed before building even matches annual new demand, let alone erodes the existing shortage.

There's also, frankly, not a lot of evidence of a general blowout in the volume of lending. In the year to June, lending to the resident private sector is up by only 3.9%, not a lot in the context of an economy in quite a strong cyclical upswing. Lending on housing is up by a bit more (5.1%), but that's not a lot, either, when house prices in Auckland are up by about 16% and in Christchurch by about 10% (I'm using the Governor's estimates here). And if you look at the growth in households' non-housing borrowing, which is where you might find evidence of a general splurge by households, it's up by only 1.9% over the past year. Modest growth in the high-level credit aggregates can, of course, hide some lower-level problems (eg if all of that modest credit growth was to shonky borrowers on poor security), and some 30% of the banks' new lending is (apparently) at high LVRs. So, as I said, there's a case for a small touch of the brakes - but not much more.

I'm also not too sure that the household sector as a whole is in a dangerously indebted position. The Governor did say that "Household debt, at 145 percent of household income, is also high and, despite dipping during the recession, the percentage is rising again", and that also caught others' attention - Bernard Hickey, in his column 'Brave move to dodge bust' in the Herald, said Wheeler's speech showed that "our household debt is now higher relative to our GDP than the US, Australia and Greece" (I couldn't find the reference in the speech, myself, though Wheeler certainly made the 145% point).

In a way, though, that is like saying, Bill Gates has maxxed out on his credit card. So what, in the context of the rest of his financial position? New Zealand households' debt to income ratio may have crept up a bit, but New Zealand households' assets to income ratio has climbed even faster.
In March this year, households had $194 billion of financial liabilities (the vast bulk of it, $180.8 billion, being housing borrowings). But they had $245.9 billion of financial assets: their net position (financial assets, less financial liabilities) was in the black, to the tune of $51.9 billion. What's more, that surplus of assets over liabilities is up by $15.7 billion over the past year.

Households also have massive amounts of home equity ($477.4 billion at the end of 2012). That is flattered by the current level of house prices, but it's still a sizeable buffer.

There will, of course, be some low-equity borrowers within those aggregate healthy home equity figures, and there will also be some borrowers who can make a go of loan repayments at current low interest rates (current average floating mortgage interest rate, 5.87%) who will struggle at higher interest rates. While I can see the case for a small tweak to what banks can do, I still don't see an overly fragile, overly extended household sector in these numbers, nor do I see runaway growth in banks' lending.

One thing that did somewhat appal me, though, when I went back to look up that 'Auckland Accord' on freeing up more land for housing in Auckland, were the truly dire statistics on how long it has been taking to get planning approval for new housing - in the proposed new Special Housing Areas (I'm quoting from the government's May announcement of the Accord), "New greenfield developments of more than 50 dwellings will be able to be approved in six months as compared to the current average of three years and brownfield developments in three months as compared to the current average of one year" [my emphasis added]. You can point fingers at the banks, if you like, or at households and their love affair with property, but if you want to find the real culprit behind Auckland's housing shortage, look no further than your friendly local council staff.

Economic Value Subtracted

We've all heard of Economic Value Added (EVA) - it's not often, though, we see such a spectacular example of Economic Value Subtracted as Steve Ballmer's stewardship as CEO of Microsoft.

Last Friday  (August 23), he announced he would be retiring within the year. Microsoft's share price immediately jumped from US$32.39 (its close on Thursday) to US$35.21 (at the opening on Friday) and finished the day on US$34.76, up 7.3%. With 8.33 billion shares on issue, the gain in capitalisation meant that the financial markets believed that Microsoft was US$19.7 billion worse off with Ballmer than without him.

Perversely, Ballmer himself became a beneficiary of his own departure: his 3.9% stake in the company went up in value by some US$770 million.

The price of your broadband (5)

I know I've been banging on a bit about broadband policy, but bear with me: we're talking about one of your bigger household bills, not to mention what fibre-based broadband might or might not mean for you (or the country at large), plus there's the little matter of the government spending $1.35 billion of your money and mine to help pay for this new fibre network.

It's also something of a dramatic business story. The government and its fibre-laying partner companies (mostly Chorus, but also others) have basically taken a giant Field of Dreams style punt: build it, and they will come. Lay the fibre, and people and businesses will flock to it for superfast, high bandwidth usages of all kinds. And the payoffs - while highly uncertain - could be huge. One often quoted study from Alcatel-Lucent found that there would be benefits of close to $33 billion over 20 years to business, education, the health sector, and the dairy industry: the annual benefit would be about 1% of GDP. And there's also a sizeable shorter term boost to GDP from the engineering works to lay the fibre.

I don't have any problem with the decision to give this project the green light. You could call it a big gamble - nobody knows for sure what people or businesses will use it for, or even whether they will give it a go at the price it will cost - but you could say that of many large scale commercial investments that work out just fine in the end. You could even argue that the biggest rewards (for both the investors and their customers) come from precisely this sort of high stakes, visionary leap into the unknown. Personally, I'm inclined to the view that fibre-based broadband is on the way to becoming a necessary part of any developed country's infrastructure, if only to stay competitive with the other countries that have it. But who really knows? I'm no more of a successful futurist guru than anyone else involved in this project.

The big point is that it is a lot of money, riding on a great deal of uncertainty about its potential attraction, take-up, use and payoff.

So, recapping the story thus far: the government held competitive auctions for the right to lay fibre in different parts of the country, and out of that process came a wholesale price for what Internet Service Providers (ISPs) will have to pay to use the new fibre facilities: $37.50 per customer per month to start with, rising by $1 a year to $42.50 a month.

In the meantime, you've still got the copper-based broadband network. And that's where things have got messy. As I posted previously, last December the Commerce Commission provisionally reset the prices that your Internet Service Provider will pay to get access to the copper network. The old copper price had been $44.98, comfortably above the $37.50 fibre price, but the new copper price is $32.45 - some $5 a month cheaper than fibre.

You'd think there would be a chorus of approval from end users, welcoming lower copper-based prices. Well, there's been some of that, but as is always the case, the reaction of the few bodies adversely affected tends to be a good deal louder than the reaction of the many diffuse, small-scale beneficiaries (you and me), who tend not to get involved in these esoteric subjects. It's sort of similar to the fuss that happens with trade liberalisation - the four million people who benefit from cheaper T-shirts don't get heard from, but the 500 people employed in doomed domestic T-shirt factories most certainly do.

In any event, the government (among others) has been fuming.

Its biggest concern is that the price advantage that copper will have at these proposed new prices will mean fibre take-up will be modest and slow, undermining the appeal of fibre and doing a lot of damage to the economics of the project. Things like fibre have network effects, for example, where the thing becomes progressively more attractive the more people use it. That won't happen if people don't move in numbers to fibre to start the ball rolling.

And it's right to be concerned. Local research has shown that both consumers and businesses are quite price sensitive when it comes to broadband. In last year's High speed broadband services demand side study the Commerce Commission found (see p36) that 40% of households would pay $0 to $5 more a month for high speed broadband, and another 37% would pay between $5 and $10 a month more: 77% of the population, in short, have a very modest appetite for paying much more for the likes of fibre . Businesses were the same: the study found (p38) that "the cost of high speed broadband services is likely to be a significant issue for many SMEs".

The Commission said at the time that these results were more indicative than anything, but they do agree with what little overseas research there is on broadband price sensitivity. One study by three Japanese researchers of migration from copper to fibre across the OECD in 2000-08 found (p18) that "the price elasticity of FTTx [i.e. fibre] shows -6.39 (p<0.01) which is elastic, and the cross price elasticity with regard to DSL [i.e. copper] 1.19 (p<0.10) which is also elastic". In other words, consumers are very sensitive to the price of fibre and to the difference between fibre and copper. Granted, this was a few years back, and at an earlier stage of adoption of broadband, and things might have changed since then, and New Zealand might be different, but all the evidence is nonetheless pointing to the fibre price, and the relative copper-fibre price, being a hot button for both families and businesses.

The government's response to all of this has essentially been an ultimatum to the Commission: raise those prices, or we'll do it for you. It's proposed three options, shown in the diagram below.

On the left is the status quo - the prices the Commission has proposed ($23.52 for the copper lines 'UCLL' service, plus $8.93 for the electronic gear or 'UBA' service, giving a total of $32.45).
Next is the government's Option 1 - the Commerce Commission is directed to set the total copper price somewhere in the $37.50 to $42.50 range (in other words, at the fibre price). To make things simple, I've assumed the Commission (if this option eventuates) will pick $37.50. In that case the UBA part of the total cost will stay the same, meaning that the UCLL price (as a residual) goes up from $23.52 to $28.57.

Option 3, on the right, is exactly the same - except that this time the government simply decides the pricing, and cuts the Commission out of the loop. Not a good look for the Commission, but not a good look for the government, either.

Option 2 still has the same total price ($37.50), again set by the government, but this time the UBA price is the residual: the UCLL price is set at the Commission's $23.52, so the residual is a UBA price of $13.98.

Under all scenarios, your ISP has to pay $5.05 a month more than it would have otherwise for its wholesale copper services, and that's the cost it will be passing on to you. Your broadband will not go down in price. Nor will you be getting anything by way of extra service or quality from this above-cost charge to you*.

I can't say I like this very much as a policy response. It's as if the government ran an airline with a fleet of older, slower, noisier, fuel-inefficient but cheap and cheerful planes, and then decides to spend up large on a fleet of new, fast, quiet, efficient but more expensive planes. All well and good, but why should airfares on the still serviceable old planes be raised to the level of fares on the new ones? Other than in the commercial interest of the new fleet owner?

The government says two things. One, if we don't do something like this, the new planes won't arrive for years, if at all. And two, it's had second thoughts about whether the Commission's copper prices are in fact right, and whether they are genuinely lower than the fibre price.

The government has come to think that the whole basis of the Commission's copper price setting is, essentially, pointless. Why, the government asks, is the Commission wasting everyone's time going through these benchmarking exercises (if you haven't followed these posts thus far, then benchmarking is covered here and here), when we actually know what the real costs of running out a network are? And we know this (the government says) because we've just had a competitive bidding process where fibre-laying companies told us what the efficient costs of running out a network must be. Plus who'd bother finding out the cost of running out a copper network these days, when any modern cable-layer will be laying fibre, not copper?

This, I think, is rather disingenuous of the government. For a start, the Commission is applying the pricing principles that the government required. And the government itself says that "The pricing principles (the use of forward looking costs for network replacement) remain sound, and reflect international best practice" (p14 of the government's discussion paper).

Plus there's the little matter of one price being all about copper networks and one price being all about fibre networks. Perhaps the government's right, and they might well be similar: one of the odder things, in this sophisticated 21st century, is how much of the costs of this advanced technology come down to the very mundane matters of digging and trenching, which might well be common to both copper and fibre. On the other hand, I've been a participant in several of the Commission's benchmarking exercises, and I've come away with the view that they do, in fact, get approximately close enough to the 'real' cost to be reliable. At this point, I'm somewhat inclined to endorse how the Commission goes about this exercise, though I'd accept that this time round, it is a somewhat more questionable process than usual. The Commission was able to find only two overseas jurisdictions, Denmark and Sweden, to use as sighting shots for the likely cost here, which is a much smaller amount of data than it typically has.

For me, I'd like the final outcome to be two networks, both offering cost-based prices, each acting as a competitive discipline on the other, and offering greater consumer choice. There are people who'll argue that this is productively inefficient: I'm not sure that it is, or, if it is, that the productive inefficiencies aren't outweighed by the competition benefits.

We'll see how it plays out: I'm not especially hopeful at this point that we will see the best result.
At a personal level, I'm the living embodiment of that research that says, households and businesses are going to be very price sensitive to the new fibre products. I looked up Telecom's fibre offerings: for the full-speed (up to 100Mbps downstream) fibre service (including a home calling package), the price is $125 a month. There is a crippleware version, offering up to 30Mbps, at $95 a month.
I'm not impressed.

And I'm especially not impressed by the data caps. Yes, folks: in this wonderful new world of massive fibre data-carrying capacity, the data caps are still there. The $125 full-speed version has an 80GB data cap. If I only got half the maximum download speed, 50Mbps, at non-stop use I'd run through that monthly data cap in 27.3 minutes.

What a deal.

*Original text amended to make it clear that the Commission's lower prices would not have kicked in till next year

Which famous economist are you most similar to?

That's the heading of an article that appeared yesterday in the Moneybox business and economics blog at Slate magazine, which is written by the consistently interesting Matthew Yglesias. In turn it leads you to this interactive multiple-choice quiz where, by answering the questions, you appear on a graph showing which famous economist's views are most similar to yours.

It may be the most awful time-waster, but it's too fascinating to avoid - do it anyway. You'll need to answer at least 20 questions to get a reliable result, and yes, I did indeed do all 105 of them. There's my morning shot to pieces.

I won't spoil anything for you, but I'll just say this: pause for a moment when you come to the paired 'Question A' and 'Question B' ones.

The name of the economist you're most like will show up under the graph. You might appear to be close to someone else on the graph, but that's only a 2-D representation of who you're closest to. Across all dimensions of your answers, you're closest to the person named under the graph.

You have the option (see on the right hand side of the quiz screen) to 'Highlight [your] past responses that strongly deviate from expert consensus'. It's worth doing. I found that virtually all (100) of my answers were somewhere near the consensus, with only five different - the likely effects of a minimum wage, whether CPI indexation of social security benefits overcompensates recipients, the impact of cutting tax rates on US GDP, the main adverse effect of school vouchers, and the impact of raising marginal tax rates on the tax take. With hindsight, I could well be wrong on two of those, I think two of the questions are entirely empirical issues that could go either way though again I could just be plain wrong, and I think the expert consensus is itself flat out wrong on one of them. But that's for another day.

Who did I most resemble? Kenneth Judd, at Stanford and the Hoover Institution. I was somewhat surprised: Hoover, on Wikipedia, is described as "a conservative American public policy think tank located at Stanford University in California", which is not normally where I'd expect to find myself. But then (still with Wikipedia here), "Its mission statement outlines its basic tenets: representative government, private enterprise, peace, personal freedom, and the safeguards of the American system". Not sure I'm on the same hymn sheet as "the safeguards of the American system", whatever that means, but yes, I can sign up for the rest of it, especially the private enterprise bit.

And I note that Hoover had appointed the late Christopher Hitchens as one of its Media Fellows, in which case I'm pleased, however remotely, to be in good company.

Three different views of the Australian outlook

Last week, as part of some regular work I do for a consulting client, I went fossicking around the economic forecasts of the major Aussie banks. Or three of them, at any rate: the ANZ makes its forecasts available only to its own customers (you have to register, and give a contact name at the ANZ, to see them). It's one way of playing things: if the stuff is seen as valuable or exclusive, then it could swing business ANZ's way. Does it work as well as being seen as more accessible and informative would? Who knows. In any event, here are the forecasts of the other big banks.

What's interesting here is that, although the numbers at first blush don't look that different, you've actually got three qualitatively different views of the outlook for the Aussie economy.

As background, the latest 'official' view of the outlook (as seen in both the Aussie Treasury's Pre-election Economic and Financial Outlook, and in the Reserve Bank of Australia's latest Monetary Policy Statement) is for a somewhat sub-par year for the Aussie economy this year, with GDP growth of 2.5%, picking up to a more normal 3% rate of growth in 2014 (the RBA has a range of 2.5-3.5%).
None of the major banks quite buys this story, however.

For the Commonwealth economists, it's a case of "Slowdown? What slowdown?" They have the economy growing at close-to-trend pace throughout, unemployment holding at current levels, and inflation potentially becoming an issue by late next year.  in the table I haven't shown the three banks' views of likely monetary policy, but they are fully consistent with their macro view: in the Commonwealth's case, they see no change in monetary policy in coming months, as (on their read of the economy) there's no need for one.

For the Westpac team, it's "Pickup? What pickup?" They have growth slowing this year, and slowing even more next year, unemployment consequently rising, and inflation not an issue. They think the Reserve Bank will have to make two more 0.25% cuts in the cash rate to support a weak economy.

The NAB folks are harder to describe in a nutshell. They have a slowdown, and they have a pickup. But the slowdown is quite pronounced, and the pickup isn't up to much, either, so they too have unemployment rising, and inflation no biggie. They're picking one cut in the cash rate from the RBA.
They're all nice,consistent and plausible scenarios, and they got me thinking a few things.
One, obviously enough, is which one looked most likely? I'm leaning at the moment towards the NAB view: the latest business opinion surveys are on the saggy side, which suggests a weak 2013 outcome, but there are good reasons to expect at least modestly  better things next year (a lower A$, the lagged effect of easier monetary  policy).

The other thought I had was: I wonder to what extent each of these banks is using their in-house views to guide their business strategy? When I was a bank economist - with the BNZ, in the '80s and '90s, both before and after its acquisition by NAB - the economists' read of the outlook was quite well integrated with the bank's business plans. These days, I appreciate that banks have less leeway, and probably less inclination, to take big positions in the marketplace on the strength of a house view of the likely outlook, than they used to pre-GFC. But I'd like to think senior management at the three banks are still paying some attention to these numbers.

After all, there's a fair bit of difference between an Aussie economy that has around 5½% unemployment and one with around 6½% unemployment. In the one, you'd be more minded to go for market share, in the other you'd be more focussed on risk management. You'd also have quite different views on the direction of interest rates. In sum, the economics team that gets it right, and gets listened to, has considerable potential, at this point in the Aussie cycle, to add quite a bit of value to its bank's outcomes.

And conversely, of course.

The price of your broadband (4)

Previous posts (here, here and here) covered how the Commerce Commission sets some wholesale prices that play a big part in the retail price you pay for your current copper-based broadband.
Here's a quick diagram (from page 48 of the government's recent discussion paper on broadband pricing options) setting out what these prices are.

By taking the combined UCLL and UBA package, at the Commission's regulated wholesale prices, a telco gets access to the data stream to and from your computer, and can get into the broadband game.

Right.

Apologies for the long lead-up to the nitty gritty, but we're finally there, and here it is. This chart comes from page 50 of the discussion paper.

On the left hand bar, you've got what telcos will pay to get into the broadband business using the flash new high-speed high-capacity optical fibre network that's currently being rolled out up and down the country (what's usually called UFB - ultra fast broadband). This price (which goes up over 2015-2019) was agreed between the government and fibre-laying companies as part of the bidding process when companies tendered for the fibre-laying in different parts of the country. All these prices, by the way, are the cost per customer per month.

On the middle bar, you've got what telcos pay today to get into the copper-based broadband business. The total comes out more expensive than the fibre option. As noted in previous posts, the two components of the total $44.98 cost were set by reference to what sort of costs telcos pay for the same services in comparable countries overseas ("benchmarking").

And on the right hand side, you get to the numbers that have caused a great deal of ruckus and angst in the telco business and telco policy worlds.

These are the prices that the Commerce Commission has proposed for future pricing of access to the copper network. They're not only substantially lower than the current cost of copper access, but are also lower than the access prices for fibre.

Why?

As you can see, the thing that's changed is the proposed new price for the UBA service - what a telco pays to use Chorus's electronic gear. And it's changed because the Commission was directed to change from one way of benchmarking, to another (under legislation governing the separation of Chorus and Telecom)*.

The current price was benchmarked by looking at overseas prices that were calculated, at the wholesale level, as a discount off the overseas retail price (a process known, unsurprisingly, as "retail minus").

The proposed new price, on the other hand, was also benchmarked, but this time by looking at overseas wholesale prices that were cost-based - ones that had been set by overseas regulators on what they thought was a fair estimate of the actual costs involved.

Why is the cost-based number ($8.93) so much lower than the "retail minus" number ($21.46)?
Mainly because the "retail minus" approach to price setting has big deficiencies.

Suppose, as a hypothetical example, you've got an inefficient, profiteering incumbent with a monopoly or near-monopoly on a particular service. Let's say this dominant company sells something, at retail level, for $100, when an efficient level of costs would be (say) $50, and the remaining $50 is a combination of the excess costs it runs as a slack monopoly business and the excess profit it makes as a monopoly.

Suppose now, as a regulator, you want to let potential competitors to get access to some of this lazy incumbent's infrastructure. "Retail minus" means the new competitors get access, all right, but at a price which is likely to be high, and potentially way above the real costs of efficiently providing it. "Retail minus" takes the incumbent's (excessively high) retail costs, and subtracts what overseas regulators have decided is a fair or efficient level of marketing costs. Let's say they are $15 dollars. The resulting wholesale price ($85) is therefore very likely to be an excessively high estimate of the true cost of providing a wholesale service. It's still way above the $50 an efficient provider would sell it for.

So there's a lot of sense in the Commission's having to use what looks like a better way of benchmarking.

It's also the case that moving to a cost-based form of benchmarking ought to be relatively straightforward (as benchmarking exercises go) in the case of the UBA service, where the costs are largely concerned with the costs of the electronic gear used to handle the data traffic. That's something where you could expect to get a reasonable sighting shot on things like what the gear costs and how much data it can handle.

The Commission's approach, in principle, made sense. But the lower UBA prices it came up with have set off a firestorm.

You've got Chorus complaining. Its revenue (from charging the higher "retail minus" price) is going to be chopped back, its share price has taken a hit as a result, and, it says, it was relying on that higher "retail minus" revenue to fund its fibre-laying programme.

You've got the government complaining. It's put a lot of money into this new fibre network, when it didn't look as if copper would be an attractive alternative, and now the Commission has gone and made the old-fashioned copper a more competitive alternative,  damaging the attractiveness of fibre to consumers and so damaging the likely rates of fibre take-up.

And you've got consumers, you and me, complaining. Because the government's reaction has been, damned if we're going to let the Commission set copper prices lower than fibre. In fact, we're going to make them set higher copper prices, roughly equal to fibre prices, and if they don't, we'll set them ourselves at the fibre level.

You've had the strange outcome that a government which has asked the Commission to be the guardian of consumers' interests, and to set prices at levels that don't allow incumbents to rip us all off, and at levels that allow more competition, is now insisting on higher prices to users than the Commission would have set. The government says that its proposed approach will actually work out in consumers' longer term interests (for example, by helping the new fibre system arrive faster and offer more), but it does seem an odd way to do it.

If you feel that there is an Alice in Wonderland feel to all of this, and that somewhere along the way someone - or several people, or indeed everyone - has lost the plot, well, I sympathise.
The next post will try to make more sense of why the various protagonists have taken the positions they have, and how things are likely to play out from here.

*Original text amended to make it clear that the benchmarking change was a legislative requirement