Matt Nolan

In defence of the “low wage advantage call”

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I don’t like politics, and I get a peverse pleasure from attacking things that political parties say – what can I say, I’m human.

However, I can’t say I agree with the attacks on Bill English’s comment that NZ has a comparative advantage over Australia because labour is cheaper.

He was talking about this in the context of “attracting capital”.  He was saying that the labour quality was similar, the regulatory environment was similar, but because of a lack of investment wages were 30% lower.

How does this work?  Well, capital increases the “marginal product” of workers, the higher the marginal product of workers the higher their wages will/can be.  We know that Bill English believes that NZ hasn’t been investing enough – a point I find interesting, even if I don’t completely agree.

However, this is consistent with what he believes – he thinks investment in NZ has been too low, and that is why wages are too low.  As a result, by saying “hey our workers are cheaper” he is in one sense telling people overseas that the return on capital in NZ is higher – and that they should invest here.  If they invest, they will in turn push up wages helping NZ to “catch Australia” as he loves to say.

Now I don’t believe this – I think there are likely to be fundamental reasons we can’t “catch Australia“.  However, if Bill English believes that low investment has lead to lower wages, going out and telling investors about this IS consistent with their goal of catching Australia. [It is consistent with the long running productivity discussion in recent years (see here and here) – a discussion that has “morphed” into a focus on savings more recently]

I’m sure it doesn’t seem like a good statement to make in a “marketing/political” sense – but at least its honest and consistent.  Surprising for a politician …

Update:  It appears that John Key made some comments as well – it looks like he had the same idea about it being a push to increase the flow of capital to drive higher wages in the future.

Update 2:  Whole situation is discussed here.  Just as a note, I have no problem with foreign investment – yes foreign investors want a rate of return, but by definition they can only get that return if they are creating value …

Matt Nolan

More on AMI

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I am surprised that no-one has mentioned the idea of a “bank run” on AMI in the comments to this previous post.  Surely the justification for government action is that, without it, non-claimants would pull out of AMI due to concerns about AMI’s stability following the quake.  If AMI was still SOLVENT but lacked sufficient LIQUIDITY to get through this period, they may fail for seemingly no reason.  As a result, the government comes in, provides liquidity, then disappears for no cost!

Now this is the ideal situation and justification that SHOULD have been provided.  All this crap (yes, I’m using a strong word 😉 ) about “giving certainty to the people of Christchurch” is politics in my opinion – they are selling an idea about the bail out being to support a community in an attempt to numb criticism as to whether this is the most appropriate way to help.

I can understand my opinions seem harsh, hell something has to be done right. Maybe something should be done, after all if we genuinely feel concern about the people of Christchurch and think that losses from such an event should be ALL socialised then we should pay for ALL the losses through higher taxes – not just the losses of people associated with one specific insurance company.

I am surprised to see the left come out in support of this.  What about the poor people who were living on the breadline and couldn’t afford insurance – the left is happy to support the middle classes who could afford insurance and are unwilling to take on the risk associated with it, while simultaneously not helping the genuinely poor.  This is the type of left wing view point I grew up hearing.

Yes, the left wing people I grew up with would want AMI bailed out – but they would also want national insurance for all the residents of Christchurch and they would want the Banks and insurance companies nationalised to avoid this “too big to fail” issue althogether (not saying I agree – but at least the views are consistent).

Did AMI need it

So the fact that the intervention is terribly targeted if it is meant to help anyone is one point.  However, lets also ask whether we need a implicit guarantee from government in this case.  Two points to think through:

  1. If AMI is insolvent then no guarantee is necessary – they need to value.  If they are suffering from liquidty, then a temporary loan at market rates of interest which they can choose to go for will be accepted – and all will be well.  This is why I’m confused that the government isn’t calling it a loan.  Another point on this is the the government should expect to lose a grand total of nothing if intervention is necessary.  However, if they are spending money to help provide “certainty for Christchurch” they would be better off … giving money to people in Christchurch, rather than bailing out a firm.
  2. Even if it is a liquidity issue, this doesn’t mean we should intervene.  What happens if another firm can buy them out.  This shows that they are solvent, and it ensures that government (and so society) doesn’t bear the risk – hell, the other firm would get the purchase for a good price, but that is just a loss for the shareholders of said company so who cares 😉 .  Now this is what got me annoyed – Tower is signaling interest.  Now instead of making this the “first port of call” the government has guaranteed AMI, meaning that the shareholders of AMI are unwilling to listen to a Tower offer – a sale should have been the FIRST thing the government looking into, but instead they are effectively BLOCKING one.

Now I have heard mummers they are thinking of a white knight investor now, etc etc – but can’t they see that how they have set up their policies is making this possibility more difficult, not easier.  Hopefully there is a switch of tack, the government can put the hard word on AMI to force it into a sale (if it is truly insolvent).  However, from where we are sitting now I find it important to lay down what I have found inappropriate around recent announcements.

Update:  Eric Crampton discusses here.

Matt Nolan

AMI and moral hazard

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So when a disaster hits, the government is willing to bail out domestic insurance companies to “provide certainty for claimants”.  Ok.

As a result, insurance firms will discount these large scale low probability events – and take on more risk when providing loans.  Their willingness to take on more risk than is socially optimal will be paid for by tax payers.

I wonder how big this effect is – and I wonder why it hasn’t been raised in conjunction with these movements.  If we are determined to provide a backstop for a number of New Zealand industries we will probably need higher taxes – this is something that the government should probably articulate to people if it wants to be transparent – then if society is willing to socialise losses they can …

Matt Nolan

Quake levy and timing

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Kiwiblog states that he disagrees with the Herald on a tax levy being introduced now.  I think his points on it slowing the economic recovery are valid – increasing taxes to pay for investment when the government can borrow the money at a lower rate of interest AND many consumers are actually locked out of credit markets AND incomes are well below what the economy can achieve is bad policy for economists of all political stripes (ceteris paribus).

But lets say that we currently have spending and taxes balanced over their lifetime IGNORING one-off events.  As a result, we want to pay off one off events with a temporary levy.  Ok, I’ve assumed that.  Now assume that we want two other characteristics of the levy:

  • The current generation wants to pay for the rebuild – even though it is their capital stock that got smashed.  As a result, it must be a relatively short-term levy.
  • We are concerned about the economic recovery, and would prefer to not delay it if possible.

Ok, so I’ve made a bunch of huge assumptions that point to us, at some point, HAVING to have a temporary earthquake levy.

However, even with these big assumptions there is no reason to put in such a levy right now.  We should say “we will introduce the levy on consumption goods from December 2013 till blah which is the period when we think the economy is back at its “potential” level”.  Advantages are:

  1. The impact on economic activity is indeterminate instead of negative.  Future wealth for this generation is lower, however the relative price of consumption now is lower.  As a result, the net impact on spending could go either way – when we have insufficient aggregate demand having an indeterminate impact is better than having a negative impact.
  2. This is a relatively short time horizon, so the current generation is paying for it.
  3. We make the levy money.

So if we have to have a levy, why don’t we do it when the economy is on an even keel – rather than during a point in time when we are in a historically potent recession.  Unless the people claiming that we need a levy don’t actually think the recession is particularly large … in which case a lot of other things that have been said about NZ’s economic performance by these people would be inconsistent 😉

Update:  Eric Crampton covers the issue more widely here.

Matt Nolan

Question on the power price spikes

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So some businesses are complaining that the spot price of electricity occasionally spikes when there is a shortage (and that these spikes are inconsistent).  They want government intervention.

My question is, if these spikes are such a concern – why don’t the businesses set up fixed price contracts with electricity retailers in the same way household do.  Also, the retailers are complaining about the wholesale price spike – but couldn’t they also set up contracts on a fixed rate?  Ultimately, knowing that the price can spike heavily in the face of a shortage of power, these businesses are CHOOSING to buy at the spot price (I guess it must be cheaper) – if that is what they choose to do then they should really face the risk of it.

Now if there was something anti-competitive about the setting of wholesale energy prices sure, go ahead and complain.  But if they spike because there is a significant shortage – and this price is just representing the underlying opportunity cost associated with providing that power – then having the spike occur is a GOOD thing.

This is because the price is saying “hey, at the current time there is a severe shortage of power, and unless you can create oodles of value from it you should think about stopping power usage for a short period of time”.  When it is placed in that context the spike seems reasonable, and all the complaining about it seems weird – so what is going on?

FYI:  Good comments from Rauparaha.

Matt Nolan

Central Banks: Second best policy and operational separation

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Following a major crisis, such as the one we’ve just experienced, it is easy to get into a situation where the goal of policy is to “avoid another crisis”.  However, this is not a trap that our fine readers fall into – so we don’t need to worry about it here 😉 .

This isn’t to say that we shouldn’t take things from a crisis – far from it.  A crisis gives us information about the behaviour of the macroeconomy, about the feed-back loops that may exist that we may not previously pay attention to, and about the process people use for forming beliefs.  But we still need to say why these things occur – and hopefully make our given hypothesis testable – before we can decide to do anything.

So well prior to the crisis there was a string of micro-prudential policies introduced.  In truth, the retail banks have been grappling with the introduction of many of these policies during the crisis – and the Reserve Bank has stated that part of the reason the OCR is so low is because these policies have, in of themselves, tightened credit conditions.

Now all this is fine, when it comes to cyclical policy the impact of both micro and macro-prudential regulation has been widely discussed.  However, what bugs me is the lack of heavy discussion and analysis is the lack of significant discussion around the structural impact of said policy.

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