Matt Nolan

Pulling out the comparative advantage card

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Since everyone is talking about the drop in manufacturing output and employment and trying to figure out “how to fix it” I thought I’d pull out the old comparative advantage card to show why it may not be a problem.   In case you are wondering what it is, Wikipedia is always rock and roll.

New Zealand is a sparsely populated country that is far away from most large international markets. With fuel prices going up, increasing vertical integration (when different aspects of the production process are joined together in the same firm) and the rise of just-in-time inventory management, more and more manufacturers are positioning themselves “close” to market.

This trend, combined with the benefits of agglomeration in production and the improving use of technology overseas, has made manufacturing in countries like New Zealand less and less competitive.

This is tough for people who have invested time and skills in specific forms of manufacturing, but in so far as these changes are the result of changes in technology and the habits of global consumers, we cannot stand in the way of them.

…

And this is the flipside – although New Zealand is comparatively bad at manufacturing things that require large scale (such as say cars) it is comparatively good at other things (producing milk).

Other countries having become more productive in the export manufacturing space it actually a good thing for New Zealand as a whole – as it has driven down the price of what we buy from overseas relative to the price of what we sell.

This can be seen in our terms of trade (the ratio of export prices to import prices), which has risen 10% since manufacturing activity peaked.

No doubt my article may overstate the case – I would prefer not to make a policy based conclusion until there is some data heavy analysis of the issue.  However, given that changing technology and production patterns around the world will be a major driver of what is going on I felt that the argument actually needed to get some air.  I have noticed that it is popular to focus on esoteric issues when looking at what is going on – among both economists and non-economists.  However, doing so often leads us to lose sight of some of the most important issues!

As people who have done training in economics we have covered this issue a number of times on the blog (eg *,*,*,*,*) – the key point is that we need to understand “why” something is going on before we can truly define whether it is good or bad, change in itself is not bad.  Some people may not like the “descriptive” vs “prescriptive” split economics pushes, but it is the most transparent and honest, and dare I say it scientific, way of doing things.

Matt Nolan

Profits as evidence of bank competition or collusion?

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In New Zealand there are often complaints that bank profits are exorbitant – especially given that profitability rose during a massive financial crisis.  While there is an argument that banks are backed by a lender of last resort, and that they should pay for this (such as through a tax) this doesn’t tell us too much about profitability … remember a tax on bank transactions, or margins, will in part be passed on to borrowers and lenders through an increase in gross margins!  Furthermore, the increase in profitability can be seen as banks taking into account the fact that lending was now more risky (after all, the LOLR only functions when the bank collapses – making a bad loan and losing some money is still a cost that is fully faced by trading banks!).

Still, I’m not actually going to discuss any of this.  I’m hear to say that the increase in banks margins during the crisis and the corresponding drop as financial conditions have improved can be analysed in the same we economists analyse any sector.  And it may well point to a special type of “tacit collusion” in the banking sector.

We have talked about tacit collusion on the blog before, it is a fascinating issue – note that it is’t explicit collusion, it is just an illustrate of how the individual choices of banks regarding their strategy is setting price may in some situation mimic collusive outcomes.  The key example I’ve provided was the price of Nurofen but there are many examples.  If we have the type of competition modeled by Rotemberg and Saloner, then firms will tacit collude during periods of “low demand” and this collusion will break down during periods of high demand – when the size of the “pie up for grabs” is larger.  Given that banks compete on price, have a very clear idea of when a shift in demand is for their firm or for the market as a whole, and don’t face significant capacity constraints, this type of argument is actually pretty relevant!

So what does this tell us about bank lending behaviour?  Well in a situation where we do have multiple banks, lending behaviour during booms may act as if the industry is competitive, but during slow downs it will act as if it is more of a monopoly – as a result, the quantity of credit provided will fall more sharply during a slowdown and the price of credit will be higher compared to the case when the industry is just magically always competitive.   Interesting stuff!

Matt Nolan

Discussion on policy in NZ for the week

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This is a list post – so make of it what you will.

Bill Kaye-Blake has been discussing the macroeconomy in New Zealand (*,*,*), and hunting for a way to make the narrative clearer – I’ve been chatting about it with him in commetns, and Eric Crampton listed up some points here.  Reframing the narrative is important to me, and has led me to experimenting with ways of communicating ideas about the macroeconomy.  Brian Fallow shows the importance not just of clarity, but of indicating that there is no “silver bullet” in his great op-ed.

Grant Spencer has also made a point of communicating about “other tools” that the RBNZ might use, and why they would do such a thing.  The Bank knows that outside their role as protectors of monetary policy, they have to take into account the general stability of the financial system – and they want measures that they use for this to be as transparent as possible.

On the not of communication and narrative, Norman Gemmell has started a series of articles on the NZ Herald discussing issues of the day.  He is an awesome economist, and I’m greatly looking forward to these posts.  The first post tries to lay out the idea of asset sales on more objective grounds!

This brings me to Treasury.  They have noted the mixture of calls about austerity, the economic cycle, structural problems, and decided to spark things off with a piece that looks at the impact of “fiscal policy” in a macroeconomic sense.  This is a piece I intend to go through and write about in time 🙂

All in all, a good week for discourse.  Nice.