Holiday reading

Every summer for the past 25 years my wife and I have blobbed out in a bach in the backblocks of Golden Bay. We’re still there, doing the things we usually do: long walks along the golden sands of Pohara Beach, a couple of pints of Captain Cooker manuka beer to go with the mussel chowder at the Mussel Inn at Onekaka, lunch at the Wholemeal Café in Takaka (the new lamb pie is very good), tramping trips up the Cobb Valley (the landscape around the Fenella hut is the prettiest spot I've found in New Zealand), exploring (the Aorere Goldfields Track) and, of course, going to the A&P Show (third Saturday in January, this year graced by the Motueka Marching Ladies).

Mostly we read: we bring some books of our own, and supplement it with our $10 summer visitor memberships of the Takaka Memorial Library. Each year I read, or re-read, one of Charles Dickens’ books: last year I re-read Our Mutual Friend (his last finished novel, and my current favourite), this year I finally finished The Pickwick Papers, which I’d struggled with before but found easier going this time. It was an early work and his first big commercial success, and it’s interesting to see how he was already preoccupied with some big themes of his later novels (the cruel treatment of the poor and indebted, and the injustices of the law).

I'm a bit of a Great War buff, in an amateur way, and with the centenary of 1914 now close upon us there’s plenty of good new stuff out. Max Hastings’ Catastrophe 1914: Europe goes to war is a highly readable account by a prolific military historian, with good pen pictures of the main personalities and a generally poor opinion of everyone (including, gratuitously, economists). He is especially critical of the role of the British Expeditionary Force (the “Old Contemptibles”) in the early days of the war, when (he says) Sir John French was keen to avoid action. And his account, which goes up the end of 1914, is a reminder of the appalling casualties involved: we tend to think of the Somme, Verdun and Passchendaele as the killing grounds, but the Marne is up there with them.

Christopher Clark’s The Sleepwalkers: how Europe went to war in 1914 stays with the diplomacy leading up to the outbreak of war, and as the title hints the general theme is one of unintended consequences – with the exception of Serbia. It knew what it was doing, and was perfectly happy to bring ruin on everyone else if it enlarged an autonomous Serbian homeland (there’s a book still to be written about the misery Serbian ultranationalism caused throughout the whole of the 20^th century).

Clark’s also very good at drawing modern parallels, for example noting that in our own day acts of standalone terrorism – 9/11 being the prime example – can have the same geopolitical impact as the Sarajevo assassination did. I've got Margaret Macmillan’s widely praised The War That Ended Peace: the road to 1914  still to go.

I enjoyed Helen Castor’s She-Wolves: the women who ruled England before Elizabeth (Elizabeth I, that is), which you may have seen adapted for Sky’s History Channel, and on a much less serious note, Bernard Cornwell’s 1356, a swashbuckler about English archers in the Hundred Years War, culminating in the Battle of Poitiers. In the notes at the back I found reference to Peter Hoskins’ In the Steps of the Black Prince: the road to Poitiers 1355-1356, which I gather is the author’s personal retracing of the Prince’s war raid route and is now on my short list of things to read next. And while I'm in the mood for historical fiction, Robert Wilton’s Traitor’s Field (England, 1648) looks promising.

Summer wouldn’t be summer without a good wallow in your favourite authors: on the private eye front, there’s Robert Crais’ Elvis Cole series (I'm halfway through Voodoo River) and Sue Grafton’s Kinsey Millhone (Q is for Quarry up next), and no holiday should miss another visit to Terry Pratchett’s Discworld (Small Gods this time). On spec at the library I picked up Maurizio de Giovanni’s The Crocodile, a translation of a prize-winning police thriller set in Naples: it was excellent.

Normal economics posts resume shortly…

The economics of Game of Thrones

I'm a reader, the old-fashioned kind. The house is full of books, there's a stack of unread ones beside the bed and a Unity Books loyalty card in my wallet, I've got accounts with Amazon, and Barnes and Noble, and The Book Depository (NB no postage charges to New Zealand). I've got nine library books currently checked out, and another five books stacked up as requests on the (excellent) Auckland Library system.

And normally I wouldn't give you tuppence for the film or TV adaptation of any book I've read, as I like to think the images you create for yourself when you read are better than the ones confected for you by someone else. Especially when the confections are by the big US studios, where you're pretty much guaranteed a dumbed down slab of sugary pap.

With one big exception.

I passed on the books. And I let three and a bit seasons of the TV series go by before deciding to give it a try. And then I got hooked on - well, you saw it in the title of this post, it's Game of Thrones. I binged on the thing, two or three episodes a night till I'd done the lot.

Why, you ask, is this in an economics blog?

First up, because I was kind of intrigued by the reaction of the makers of Game of Thrones (HBO) to the news that GoT was the most pirated TV show of 2013 (ditto in 2012). Instead of the "piracy is killing Hollywood" moaning you might have expected, they were upbeat about it. In this article, for example, we got the views of the top brass:

Similar to Game of Thrones director David Petrarca, [Jeff] Bewkes [CEO of HBO's parent company, Time Warner] believes that the free word of mouth advertising eventually leads to more paying subscribers.

“Our experience is that it leads to more paying subs. I think you’re right that Game of Thrones is the most pirated show in the world. That’s better than an Emmy,” Bewkes said.

I'm aware, from expert economic evidence given in legal proceedings, that there are theoretical arguments that piracy may not in fact harm the copyright holder, though I have to say it's always looked a bit of an uphill argument when stacked against what looks like a more immediately obvious "taking the bread from our mouths" line. I suspect that economists in the expert witness game who take a benign view of piracy will be making good use of this latest GoT evidence. And I also suspect that we are in the absolute infancy of internet business strategy: when the makers of a red-hot series are relaxed about piracy, you sense that they are on to something that isn't yet in the Harvard Business Review.

And second, what's all this about piracy?

Did I go trolling through the deepest darkest internet for GoT? Visit dubious torrent sites? Set up some devious VPN workaround to convince US sites I wasn't in New Zealand?

No. I went to Polly Streaming. I've no idea who they are, and their 'About us' page is uninformative, but they offer basic free services (which include the whole of GoT) plus a premium subscription, and have a Facebook page, so they're hardly lurking in some shadowy internet lair. And they don't seem to care where in the world you are. All of which tends to suggest that the GoT folks know all about them, and either don't give a damn, or reckon it's a good thing, or are actively in on it with them. Every which way, you sense, again, that there's a cunning strategic plan behind this "piracy".

And then there are the economic lessons from GoT itself.

The big lesson from GoT is that if you're spending up big, spend the money on the right things. If the choice is (and it often seems to be), (A) spend US$20 million on the bankable name that you think will put bums on seats no matter what the movie is, or (B) spend US$20 million on sets, locations, effects, no-name but highly competent actors and a quality product, then HBO has successfully demonstrated that the second choice works better, no matter what the bean counters might advise. The more I look at successful products, the more I'm convinced that out of the SPQR mix (service, price, quality, range), quality trumps all in the longer run.

Another lesson is that the public is not made up of ninnies in a convent school. Do we want to watch only MLVS movies? No. But do we want to see sanitised, infantilised, prettified versions of MLVS issues? No we don't. GoT treats its customer base like adults. And like most business strategies that rely on people being intelligent judges of the product, it's a winner.

Another is that it made me wonder about the supposed wonderfulness of our new Ultra Fast Broadband (UFB) rollout. My copper-based ADSL internet service delivered GoT to my laptop, with completely acceptable video quality (and I'm not even getting the top end of copper-based delivery). Remind me why I need to pay more for the same experience delivered over fibre?

Finally, I was struck by the quality of the GoT opening credits. And it seemed to me that there was a good economic motivation for the high quality (as there was for the equally stunning opening credits for the Rome series). Bankers used to adopt the same strategy, and for the same reason. How do you signal to new customers of an intangible service, who know nothing of you or your reputation, that you are a quality service provider? In the case of banks, and I'm thinking here of the likes of Irving Trust and Morgan Guaranty and their erstwhile palazzi on Wall Street, by having extraordinarily opulent-looking head offices. Look how rich we are! How dependable!

And so it goes with the opening titles. Put your production values into the opening - sophisticated computer graphics, lush colouring, an original and striking theme tune, a bit of ambiguity, a hint of special effects - and before they see the rest of it, consumers are convinced that here's a quality product that's had thought and money spent on it.

Maybe, to come full circle, you can't judge a book by its cover. But you can choose a TV series by its opening.

Phone line rentals are still too high

Just before Christmas the Commerce Commission came out with its latest report (carried out for them by Teligen) which benchmarks retail prices for fixed line phone and broadband services against the rest of the OECD (here's the media release and here's the full report). There'll be a similar one on retail mobile prices in February 2014.

There are so many interesting results in this report that it's hard to know where to start. Why don't we start with a good outcome, from p16 of the report (especially as the telco folks at the Commission likely regard this survey as in some sense a report card on outcomes from their work).

For various reasons the Commission's reports don't allow tracking of how prices of comparable products have evolved over time, but there is one that appeared in both the 2011 report and this latest one, and it's the price of a 60GB broadband plan, either bundled with voice calling or standalone ('naked'), and it's shown below.

In both cases prices have fallen (-14% for bundled, -41% for naked) though the naked result is somewhat misleading as it is typically available as a product only when you're an on-account mobile customer.

It's hard to keep going with the good things, though, as the rest of the report leaves you with two disquieting thoughts - the extent to which we are still being ripped off by high copper line rentals, and the heavyhanded price discrimination against power broadband users (who want a lot of data at high speed).

The line rental issue shows up implicitly and explicitly. Here, for example, is how New Zealand rates on voice-only fixed line products. I know, few households these days buy standalone voice, but (as the report shows) typically buy a bundled broadband and voice package. And yes, in our household too the bulk of the voice calls we get are cold-call marketers, robot diallers and wrong numbers ("Anecdotal evidence indicates that many households now make very little use of their home phone for conventional voice calls", report, p17). But the Teligen voice data still throw light on the issue of relative line rental costs: here's a service where the line rental is most of everything. The table below shows four levels of phone calling: typical New Zealand usage is somewhere between the 60 call and 140 call baskets.

We're being stiffed. The value on offer is dire by OECD standards. And don't be misled by the apparently good outcome vis-a-vis Australia for the bigger call baskets: that's only because "Australia is also a poor performer" (p18).

And why is this? In Teligen's words, "The poor ranking is largely driven by the high monthly line rental charged in New Zealand, which in turn has largely been driven by the TSO price cap, which allowed line rental to increase by the CPI every year" (p18). The good news is that in Teligen's view "competition from alternative voices services such as mobile is now constraining the price of the fixed-line voice service", and copper line owners are no longer able to keep ratcheting up the rental. But you are still left with the strong impression that there is a good deal of legacy fat in the copper line rental charges. And it corroborates the Commission's other benchmarking work, which has shown that the cost of access to the local copper and its electronics is too high.

This next table is arguably the key result in the report - how we compare for the typical bundled voice/broadband package that NZ consumers use.

Relative to the value on offer elsewhere in the developed world, it's not great for any package, and it gets worse the bigger the package you want. "Some of this differential", Teligen say (p12) "could be attributable to price discrimination by retailers to recover the relatively high wholesale costs of providing a voice plus broadband retail service. Only the wholesale price of unbundled lines is currently cost based".

I'm left with three thoughts about this result.

One, obviously, is that we need more cost-based pricing rather than the legacy write-your-own-rental prices we are still paying - ideally brought about by infrastructural competition, but if not, then by the kind of regulatory cost-modelling the Commission does.

Two, the degree of price discrimination.  We know that price discrimination is not a problem in itself. It can be good, neutral, or bad from an efficiency or equity point of view. And higher-spec products often go for higher prices, for obvious reasons. And yet: in the earlier days of broadband, it seemed to me that Telecom was trickling out broadband as slowly as it could, minimising the pace of its capital spend and soaking the most desperate-to-have-it users (monopolists limit quantity as well as raising prices). So I'm agnostic, to say the least, about whether this price discrimination is more of the same exercise of market power, or an efficient way of recovering costs.

Three, the pattern of price discrimination. If the providers of copper and fibre based broadband are going to hit the heaviest users of big fast broadband really hard, then you can kiss goodbye to the "build it and they will come" dreams attached to the UFB network. Build it, price it like this, and they'll walk away. And how many of the benefits of UFB are predicated on precisely this group of intensive users?

Good papers from the Reserve Bank

I like the Reserve Bank's series of 'Analytical Notes' (you can subscribe to the Bank's e-mail update service here if you'd like to know when new ones come out). They're good, practical, background papers which don't have to be scrubbed up to peer-review publication status, don't commit the Bank's policy arm to anything ('views of the author, not the Bank'), and generally have something interesting to say about topical issues of the day.

Two more came out this week, Chris McDonald's 'Migration and the housing market' and Elizabeth Watson's 'A closer look at some of the supply and demand factors influencing residential property markets'.

From the migration paper, here's the overall relationship between net migration and house prices.

And if you're more of a numbers person than a graphs person, here are some numerical estimates of the impact of net migration both on house prices and (on the supply side) new housebuilding consents.

More info is better than less, and I'm glad this research is out there, but I also hope it isn't abused by the troglodyte protectionists in several of our political parties, who are already liable to blame high house prices on people arriving at the auction with suitcases full of Korean won. As the paper notes, there's more going on here than the suitcase story: generally good economic conditions in New Zealand (as right now, for example) simultaneously drive up local consumer confidence, reduce emigration, and encourage immigration, all of which are likely to feed through to house prices. 

The supply and demand paper is also full of interesting stuff. Before reading this paper, I'd have said that house prices relative to some set of fundamentals were at an all-time high, but perhaps the perspective from my home office has been distorted by the beyond-white-hot North Shore property market outside my window. Here's one chart from the paper, which shows that prices appear to have been even more out of whack in 2007. That's not to say we shouldn't worry about some aspects of where we are now, but we've seen worse.

Another thing that emerges, to me, is the role of local authorities in impeding housebuilding. In a previous post I'd concluded that "if you want to find the real culprit behind Auckland's housing shortage, look no further than your friendly local council staff". This paper shows that residential building consents (including apartments) dropped sharply in Auckland from 2002-04 to 2008-11: some of this reflected cyclical conditions, and slower population growth in Auckland than previously (from the paper, 1.2% a year 2006-13 compared to 2.4% a year 2001-06), but the consents drop was bigger than the population slowdown. You'd wonder (my take, not the paper's, just to be clear) if there wasn't an anti-development ethos gaining force in Auckland's planning offices. 

Beyond higher prices than necessary because of the supply constraints, another outcome (as the chart below shows) was that Auckland people were getting more cramped in their living arrangements, just when the rest of the country was getting more room to live in.

I've got one small question about one of the conclusions of the paper. It quotes some earlier research from Arthur Grimes and Andrew Aitken at Motu that "relative to population growth, districts in Auckland had the lowest supply responsiveness in the country during that time [1991-2004]. Grimes & Aitken (2006) estimate that Manakau, North Shore, Auckland City and Waitakere are the areas that have the least responsive housing supply in the country and that, within Auckland, areas with lower supply responsiveness tend to have higher house price inflation", and then it graphs these four least-responsive regions (in the top graph) against four other regions in Auckland (bottom graph), as shown below.

It might be down to my advancing decrepitude, but if there was a pattern there before, I can't see it now.  

In any event, have a look at these Notes for yourself - you're bound to find something interesting and informative. And I'd also like to commend them, and the Bank, for adopting the very useful practice of including, upfront, a 'Non technical summary' for the intelligent lay reader. It seems to be spreading as good practice across a variety of media, and not before time. You've probably been as maddened as I've been by those useless 'summaries' in some of the academic journals (of the "In Section 5 we present our results and in Section 6 we present some conclusions" variety - what results? what conclusions?). 

The journals are getting better - I've just gone through all the articles in the latest American Economic Review, and every single one had a meaningful summary - but the non-technical summary goes one step better again. 

Another quiz

The Herald's Viva magazine this morning had a round-up on the past year's restaurant scene, 'The Year in Food: What we loved and loathed in 2013'. It's a good article, even if I disagree on the attraction of communal tables in restaurants. And 'raw' cooking, if it comes to that.

It also provided the opportunity for another quiz, so here it is.

Context (quote from the Viva article):

"Failed restaurants ... yes, we love a new restaurant as much as the next person but if the council keeps granting permission, without a massive influx of people to Auckland to support them, expect to see some close. Better planning please".

Q1 What happens when supply of a service is restricted?
A Prices go up
B Choice goes down
C Potentially better providers get shut out
D Businesses unproductively invest in the approval process
E Incumbents get an unfair advantage
F The planning process gives market power to functionaries, who may abuse it
G All of the above
H Consumers benefit

Q2 Is keeping every incumbent business going a good aim of public policy?
A No
B No
C Both of the above

Q3 Why should new restaurants, or any other licit business, have to get local authority planning approval?
A Buggered if I know
B Sounds daft
C Mostly A
D Mostly B

A flight of fancy

As I mentioned last week, I said I'd start to have a look at the submissions various parties have made to the Productivity Commission on our regulatory institutions and practices.

Air New Zealand wants to escape from the ambit of the Commerce Commission and be primarily regulated by the Ministry of Transport, because the airline business is allegedly different to others ("international aviation is a unique market operating outside the normal influencers of a domestic economic or consumer environment") and the Ministry knows the scene best ("The Ministry is the national centre of expertise in international aviation and is the incumbent authority for alliance approvals").

On the other hand it wants precisely the opposite to happen to the airports. They should be taken out from under the shelter of the Airport Authorities Act ("permissive legislation designed for a time when airports (and indeed airlines) were state-owned and operated and therefore allows airports to ‘set prices as they see fit’") and policed more toughly by the Commerce Commission ("the light handed regulation of airports has failed and heavier handed regulation is required. Air NZ advocates the use of the negotiate / arbitrate provisions from the Commerce Act").

Good luck keeping both those balls in the air, lads!

Follow the money...

I know I've said it before, but there really are so many business surveys around these days that even dedicated economy-watchers can't keep track of all of them. Inevitably some slip under the radar.

One you might have missed (and I came across it only accidentally while foraging a while ago for something else on the bank's website), is the quarterly ASB Kiwi Dollar Barometer. It's well worth having a look at: it's quite a decent sized survey (390 firms with turnover of at least $1 million) of businesses' exchange rate expectations and their forex hedging plans.

The latest one came out last week. The headline result was that businesses (averaging out both importers’ and exporters’ views) expect the Kiwi dollar to peak against the US$ around the 81 cent mark  in the March ’14 quarter, and to decline to 76.5 cents by the end of next year. Currency forecasting, many would say, is a complete waste of time, and perhaps these businesses' expectations will prove just as wide of the mark as any other forecaster's. But I doubt it.

For one thing, consensus forecasts across wide groups tend to do better than a single guy with his spreadsheet.

And for another - and this, to me, was the really interesting bit - the businesses are putting their money where their mouths are, as this graph shows.

Notice that the percentage of importers planning to hedge has hit a new high: in real time, with real dollars, import businesses are increasingly taking out protection against the Kiwi dollar falling.

You might wonder (as the ASB economists did) why the proportion of exporters planning to hedge also ticked up a bit in this latest survey - if they really believed the Kiwi dollar is going to fall, they'd be planning to do less hedging. The ASB team commented that "It is likely the recent strength in the NZD has seen exporters look to protect themselves against further increases in the NZD, even if their core view is that the currency will ease over the year ahead".

I think this is absolutely right, because I've seen this happen before. Years ago I worked for a forex consultancy business in London, and our customer list looked like a hospital ward: every corporate in Europe that had run into financial grief appeared to be on our books as clients. Why? Because they were already in such a difficult position that the last thing they wanted was to have forex losses on top of everything else.

And that's where Kiwi exporters are right now. They might believe the Kiwi dollar is going to fall - but they can't live with the risk that it might tighten the screws even further on them with another bout of appreciation.

No surprises from the Bank

I'll summarise quickly because the media and the bank economists are already all over it, but the guts of this morning's Monetary Policy Statement from the Reserve Bank was straightforward and as expected: "it is becoming unnecessary to maintain the OCR at 2.5 percent, with GDP growth becoming increasingly self-sustaining. The Bank's assessment is that ... growing demand and inflation pressure should warrant a withdrawal of stimulus beginning in 2014" (p5). The Bank's forecasts have the 90 day bank bill rate rising from 2.7% currently to 3.8% by this time next year and to 4.6% by December '15.

Rising interest rates might sound like bad news (at least to borrowers), but let's note the big picture, which is a strong economic outlook. Here's the Bank's forecast for unemployment.

Anything interesting in the details?

A few things. The Bank reckons that its LVR loan restrictions will take between 1% and 4% off the rate of house price inflation - okay, that's a wide and uncertain band, and it's early days, but if we take the mid-point as a guess, 2.5% off house price inflation is a pretty big impact.

The Bank also played with a scenario where world commodity prices don't actually come off their current high levels, but hold up and even press on a bit more (see Box C on pp24-5). Good news for New Zealand, sure, but a mixed bag for the RB. Higher incomes from fancy export prices boost the economy and domestic inflation pressures (bad news for the RB) but the high commodity prices also likely lead to a higher Kiwi dollar (which restrains the economy and dampens inflation, good news for the RB). Net effect? The net upward pressures on inflation mean that interest rates would need to rise more than the RB currently plans, as shown below.

While it's mostly a benign outlook, there's still one thing that bothers me. I've blogged about it before, but here it is again in its latest version.

It's that forecast for non-tradables inflation, the cost pressure that arises in those parts of the economy not facing import competition. Yes, you'd expect it to pick up as spare capacity gets used up: that's an understandable cyclical process. But it might also rise for structural reasons: inflexibility, insufficient domestic competition, a 'cost plus' mentality. If we do get lumbered with domestically sourced inflation of close to 4%, let's hope it's wholly or largely cyclical.