Matt Nolan

A couple more points on milk

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We wrote about the milk price investigation here, all very exciting.

However, a new article on the stuff site started with this:

Dairy market heavyweight Fonterra is artificially inflating the price of milk in New Zealand in a deliberate campaign to lessen competition

What?  This is beyond my understanding – I need someone to get in here and explain to me how increasing the wholesale price of milk will lead to a reduction in competitive pressures.

My first thought was that there was some Green and Porter esque competition issues (eg – such that the loss of competition is the result of tacit collusion) – then I realised that we are saying Fonterra is a monopoly, so I can’t see too much in the way of strategic interaction …

[Update:  Glad to see that Anti-Dismal also finds the claim strange (here and here), especially since he is actually an industrial economist – which implies he has more idea about these things then I do.]

Anyway, on the note of Fonterra setting prices there is this interesting point from Fonterra:

New Zealand manufacturers have to pay the same price Fonterra pays its farmers for export returns.

Given that the export prices are set on world markets where Fonterra’s market power is severely crimped (due to competition, or effective competition, in many markets) and given that this is the price it is sold at in NZ – we can say that Fonterra is effectively competitive right.

So if we are going to moan about milk prices we have to blame supermarkets, which I’m still not convinced on to be honest.

Matt Nolan

Thoughts on milk

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There is talk about the Commerce Commission investigating milk prices in New Zealand.

An interesting passage from this piece states:

At the moment, we basically have a monopoly supplier of milk and two supermarkets selling it,” she said. “I think an inquiry could be a really good thing for consumers.

I think this is a bit over the top, and plays on how poorly the idea of a monopoly is understood in general parlance.  There is a general impression that the existence of a “monopoly” along some attribute indicates that we need government intervention – when the case is actually a lot more complicated then that. We need to ask why the market has a monopoly, what the characteristics of the market mean, and whether there a policies that can then genuinely improve outcomes – in many cases there are not.

Now note that I don’t necessarily disagree there might be issues – but we can’t just scream monopoly to ask for intervention.  So lets do a primary run down ourselves shall we 😉

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Matt Nolan

An illustration that using data for a conclusion is not objective

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There is an interesting post over at John Taylor’s blog (ht Greg Mankiw). In it he shows that government spending as a % of GDP has a strong positive correlation with unemployment, and that investment as a % of GDP has a strong negative correlation.  His conclusion is to focus on cutting taxes to increase investment instead of spending.

Update:  Here is the point I’m trying to make written up more clearly and completely.

Now, this way of viewing the data is consistent with the model he has in his head – but it is only by stating that model that we can look at the value judgments involved to figure out what we agree with or disagree with.

Looking at the data alone, we cannot make this conclusion – we can just say there are correlations.

For example, I would note that investment responds disproportionately to the economic cycle – this is a well known “stylized fact”.  The excuse economists often use is that businesses and households cut back on durable good expenditures most heavily when we enter a downturn – as the durable products they already own act as effective substitutes for new durables.

As a result, assume that government spending is a constant (so the government is doing nothing to smooth the economic cycle).  When GDP falls, investment falls more steeply.  When GDP falls, unemployment rises.  In this case, even with no government smoothing, the existence of an economic cycle will lead to BOTH of the observed correlations above (note that GDP is a denominator) – there is no way we can reach any policy conclusion from them.

We need a model, with a counterfactual – then we can use the data, and value judgments, to reach policy conclusions.  His model says that these correlations are causal.  My model would probably say that all these correlations suffer from too much endogeniety, and I would state that appropriate monetary policy is the best way to move forward – as it would reduce the observed variability in investment, unemployment, and GDP.  Both conclusions use the same data, the underlying models are just a bit different.

He is of course world famous and ridiculously intelligent, while I’m an arbitrary blogger – but I still prefer my conclusion, that’s what value judgments are for right 😉

Matt Nolan

Fiscal spending: Cycles and structures

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No, I’m not talking about the cycleway – although if Bill English does want to cut “nice to haves” surely this is a place to start 😉

I’m talking about this comment from Ganesh Nana, where I both agree with him and disagree with him simultaneously.

The plans (to cut spending) were criticised by BERL chief economist Ganesh Nana, who said cutting more state sector jobs and squeezing spending further at this point in the cycle risked keeping the economy down for longer.

It is true that when we have a cyclical downturn, cutting spending without a coordinated cut in interest rates from the central bank is likely to exacerbate the cycle.

And it is true we are in a cyclical downturn – output in the economy is below its potential level.

However, there are three factors that could well justify SOME cuts to government spending – as long as they don’t try to close the deficit immediately.

  1. The Reserve Bank still has the ability to respond by loosening monetary policy (although the effectiveness of cutting at current lows is a matter of debate),
  2. The cuts are focused on extremely low productivity elements of spending, as a result the contractionary impact will be smaller than in the case of indiscriminate cuts.
  3. Most importantly, the focus of the cuts are to remove the “structural” deficit.

The third point needs more explanation.  Fundamentally, the “potential size” of the New Zealand economy is now believed to be smaller than it previously was.  As a result, in order to have government taking up the same share (a share that is determined by the tax take, which is hopefully set according to the share society desires) the level of government spending does need to be lower – or else we run a structural deficit.

Structural deficits are not cool, it implies that the government won’t balance the books over the economic cycle and will cause unnecessary disruption to economic activity when it does try to – and as a result, it is often seen as a good idea to minimise them.

Now, for an economist I am actually relatively comfortable with short-term structural deficits.  I believe that estimating “potential” is tough, and as long as spending is transparent small structural deficits and surpluses are hard to separate from cyclical ones.  However, while the government should buffer the economy over the “cycle” it is true that in its structural sense it does need to balance its books like a household.

As long as any tightening is based on the three points listed above, I don’t think Dr Nana needs to be too concerned regarding the impact on the broader economy.  However, if they do go further just for the kicks, then his concerns are very relevant.

Matt Nolan

Why we always need a “why”

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I found this write up strange.  We are being told that student that are overseas should pay back their student loan more quickly to “help Canterbury”.  We are told that it is a “win-win” because it gets money into the economy, it lowers the budget deficit, and it means the students don’t need to pay back the interest as quickly.

Typifying this is the quote “It’s in your own interest, but an opportunity to be seen as a hero.”

This is where doing things without a full model/conception in mind is problematic – there is no such thing as a free lunch.

The student isn’t paying back the interest, because they are making sacrifices now to pay back the debt.  The government gets the cash now instead of later, so the cash balance improves but the set of non-cash assets declines – given that the interest exceeds inflation the real value of their asset position is likely to be lower.

What we SHOULD ask is:  Why aren’t the students paying it back now?  Is the policy that was introduced sensible?

Students overseas aren’t paying it all back now because the cost of doing so exceeds the benefit.  If we were to start pushing them to pay it back, we would likely be causing harm on New Zealander’s who have moved overseas – is that something we want to do?

If we don’t think that it is “fair” that students are paying back their debt at the rate they are, and we think the rate of interest is favourable (it definitely is on students who have stayed in the country) then isn’t the solution to increase the interest rate – not to start dancing around and talking about the deficit and Christchurch to guilt people into it.

Now just talking at people doesn’t cost much – there isn’t a policy failure from doing that.  But it doesn’t make it a “win-win” that we are missing out on – if students aren’t paying off their loans, they will have a reason.  Trust me.

Matt Nolan

Understand before you tinker

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I would be lying if I said this didn’t depress me.  Economists, great economists, economists I idolize stating that there are “imbalances” we must solve – and then telling us how to solve them without actually describing what the imbalance is and why it exists.

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