Matt Nolan

New Zealand budget 2009: Is there a cost from a downgrade?

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I have noticed only two extreme positions in the media about a downgrade:

  1. It will be terrible – it will cost the govt alone $600m pa
  2. It doesn’t mean much – the credit ratings are “dis-credited”

Let me tell you something – the truth is inbetween.

Treasury’s estimate of the cost of a credit downgrade are based on the downgrade to Ireland.  As we are already facing a fairly high price for the globe underlying belief of our risk, and as it is unlikely we will be knocked down and put on negative watch AGAIN (like Ireland was), the cost will not be this heavy.

However, there is a cost!  It would lead to higher interest rates, restrict access to international credit, and prevent some possible capital investment from overseas.  It doesn’t matter that the credit rating agencies didn’t pick the subprime crisis – investors still stick to their recommendations for what is going on in the little backwater parts of the world (like NZ).

As a result, I wish Labour would shut up about this being a “budget to satisfy S&P rather than to help people”.  If they don’t I wish National would respond by saying that they are trying to stop interest rates going up – which would hurt people, instead of saying that it is “their budget”.

Matt Nolan

New Zealand budget 2009: Is increasing GST the solution?

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In New Zealand we are currently concerned about a downgrade from S&P.  They want us to be running operating surpluses from 2014, and we aren’t quite sure how to do that in the face of a massive global recession.  The suggestion I have is to increase GST rates from 2011.

Now, if we believed that Ricardian equivalence was holding in its entirety any solution with taxes would be silly – as higher taxes would merely lead to higher private borrowing.  As S&P is truly concerned about our national debt position this wouldn’t help.

However, pure Ricardian equivalence does not hold – especially in the face of a highly uncertain and credit constrained economic environment like the one we have now.

If the government can commit to increasing GST rates from 2011 they can both:

  1. State that they are increasing taxes in a way to fill the budget hole – taking us back to operating surpluses in our forecasts and preventing a downgrade (which would have a similar cost except that all the money would be heading offshore),
  2. Reduce the relative price of spending now compared to the future – increasing “aggregate demand” now at the cost of demand in the future.  Given that prices are sticky in the short-term, and the increase in GST rates enters firm and household expectations of future prices, we only really care about movements in “aggregate demand” in the short term – so this seems super.

The main concern would be that a lift in GST would increase long-run taxes.  However, if the economy moves back to potential (output) and the tax take becomes too large we can just can personal income taxes – thereby flattening the tax base and reducing the tax on savings.  Sounds good to me.

Matt Nolan

New Zealand budget 2009: Expectations

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Defective equilibrium points out that there has been little discussion about expectations for the budget around the NZ blogsphere.  As a result, let me lay down some expectations here.

These are the things I strongly suspect will be in there.

  • Future tax cuts to be postponed into the indefinite future,
  • Provisions for future spending to be slashed further IN REAL TERMS (note that provisions should have been cut because of lower inflationary pressures in the first place),
  • An increase in short-term spending on state houses (mainly refitting) beyond that announced,
  • Further shifting forward of infrastructure projects,
  • A REDUCTION in medium term infrastructure spending – implying that any investment now is taking away from future budgeted spending,
  • Increased funding for the establishment of PPP’s,
  • A funding freeze for most departments,
  • A “shifting forward” of welfare entitlements – implying that future real welfare spending will be cut.

These are random possibilities (although fairly unlikely):

  • A lift in GST rates (to 15%) from 2011,
  • A freezing (or cut) on the income level and entitlements for WFF and some benefits,
  • A PPP involving ACC,
  • A complete withdrawal from the Cullen fund to pay for near term spending promises,
  • An expanded program of state house BUILDING.
Matt Nolan

New Zealand budget 2009: Downgrade alert?

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From a member of S&P, Mr Curry:

It is hard to put a timing on it, but we would expect that over the cycle of the Government [it] would be recording operating surpluses within, I guess, the next three to five years.

So that is the requirement to avoid a downgrade.

From the government:

Asked if surpluses could be achieved in five years, Key it might take longer.

Hmmmm.  Thursday will be very very interesting.

(ht Nigel Pinkerton for the pointer to these quotes)

goonix

In defence of the New Zealand wholesale electricity market

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Recently the New Zealand electricity sector has been taking a bit of a hammering. According to a Commerce Commission sanctioned report, consumers have been overcharged by $4.3b over a six year period (how’s that for a headline!). More specifically, the report concluded each of the four big generators – Meridian, Contact, Genesis and Mighty River – has been exercising the power the market’s design gives them to command unjustifiably high prices, at least during years when inflows to the hydro lakes are low as they were in 2001, 2003 and 2006.

New Zealand has two markets in electricity – the wholesale market and the retail market. The wholesale market is where generators sell their production to retailers (often the seller and purchaser are one and the same). These prices vary significantly depending on the conditions of that particular period (for example, how dry Southern Lakes are or whether a generation unit is out service). That’s why, as a consumer. it’s clever to be informed with details like Business Energy costs.

The second market is the retail market, where retailers sell electricity to consumers. Prices here are typically very stable, with consumers seldom exposed to the vast variation that takes place period-on-period in the wholesale market.

In the long-run, the prices in the wholesale market feed through to the retail market. In other words, if a generator/retailer found themselves short of generation and thus had to buy excess generation on the wholesale spot market at relatively high rates, they would eventually pass through these additional costs to their consumers in the retail market.

The report is essentially saying that generator/retailers were able to use their dominance in the wholesale market to push up prices during periods of constrained supply, which consumers then ultimately had to pay for in the retail market.

The report also says that pricing in the wholesale electricity market is, in the absence of dry periods, typically competitive. A very important point made in the report is that no market is ‘textbook’ perfectly competitive and this is certainly the case in electricity, given its unique characteristics (in particular the need for supply to continuously meet demand).

Indeed, I would say that the wholesale electricity market is working almost exactly as intended. Pricing is commonly competitive except at times of tight supply, when generators are able to reap higher rewards that incentivise continued investment in generation (which is extremely expensive) so that ever-growing demand can be met into the future. And the Commerce Commission determined that the generators’ actions were a “lawful and rational exploitation of the opportunities the market gave them”. I doubt you’d be able to make nearly as impressive a headline out of that though…

Matt Nolan

Cruelty to pigs, willingness to pay, and intrinsic animal rights

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Brad Taylor has an interesting post discussing how New Zealand pig farmers are using the issue of stall vs non-stall pigs as a way to increase protectionism in the New Zealand pork industry.

Now if all that matters is how humans value the issue then Brad is right – the efficient solution requires no regulation.

Why? If people value pigs not being hurt, they will be willing to pay to eat non-stall pigs. If all overseas pigs are stall pigs (as the farmers are saying) then this creates an opportunity for NZ farmers to differentiate and tap into this market. If people aren’t willing to pay sufficiently enough more, then there is no market for it.

As a result, as long as all that matters is how humans value and the choice of conditions is observable there is no need for “protection against overseas pork”.

However, we may instead believe that animals have some intrinsic right not to be tortured. As pigs don’t actually have a choice in the matter we may require regulations if we want their rights to be valued.

In this case, a tax on stall pig meat that captures the value of the pigs suffering WOULD be the solution – as there is a clear externality on pigs that cannot be solved through Coase bargaining.

As a result the key question we have to ask is, what intrinsic right to the lack of torture do pigs have?  If we can define that then a mixture of clear labeling and a tax on pork from stall pigs could be the solution.