Another example of why we need a full story

I was sitting around working the other day, and at that point in time it involved downloading and playing with PPP (purchasing power parity) data in order to compare a bunch of GDP and consumption figures for work.  All very exciting.

At that moment I looked around the internet a bit, and noticed people complaining that we needed to be more like Australia as they were richer, and that our exchange rate was too high.  Having these points put together illustrated to me how policy prescriptions can often be based on reactive thinking, without truely asking “why” this is the case.

Why did I think this?  Well, Australia’s exchange rate has been “over-valued” relative to the New Zealand exchange rate in PPP terms for a long, long, time (the last time it was close was about 1995).  In fact, if we were to go solely off PPP terms for the NZ/Aus exchange rate the New Zealand dollar should be worth more than the Australian dollar – true story.  And yet, Australia is one of the wealthiest countries in the world (on a per capita basis).

This is why, when discussing what is going on in New Zealand I prefer to focus on a clear narrative that is based on a mixture of what we see in data (the persistent current account deficit, low savings) and a consistent theory that bases these stylized facts.  Just saying that our manufacturers are uncompetitive and trying to mess around with the nominal exchange rate misses a lot of the macro story here – it misses the idea that the returns to manufacturing may be falling (due to easing scarcity), it misses that we may not have the scale for such things, it misses that we may have a comparative advantage in other place (see the trend of our rising terms of trade), it misses the fact that returns to manufacturing have been hit by a global recession, and it refuses to acknowledge possible policy settings in the country that have created the underlying and persistent low level of savings relative to investment.

There is no silver bullet, instead if we are going to implement policy we should first ask “given trade-offs that exist, where does current policy differ from policy that may be seen as socially desirable”.  To ask this, we need a clear conception of what society values and what the trade-offs are.  Chasing silver bullet policy that will “save the NZ economy” is simply a way for the loadest interest groups in society to steal resources from everyone else.

People may complain about economists here, why haven’t they been saying anything!  Well, they have – well before I was wearing my economics diapers New Zealand economists were complaining about the persistent current account deficit, the lack of savings, and NZ’s uncomfortable investment balance.  These issues are worth more discussion – and I’ll consider doing that once my sore throat has cleared up and Christmas is over ;)

  • http://offsettingbehaviour.blogspot.com/ Eric Crampton

    Sore throat eh? I was out most of last week with same. Try gargling with whiskey. I wish I had figured that out on the first rather than last day of ill .

    • http://tvhe.co.nz/ Matt Nolan

      It’s summer time, why do I have a cold – I’m sure you felt the same way. I will do all the drinking I can to help, and see what happens ;)