A step too far: The case against pursuing direct capital/trade/currency controls

To start off with I have to admit I like Bernard Hickey.  I like the fact he has got out there, written about New Zealand economic issues, and pushed to add an open debate type platform to the discussion regarding the New Zealand economy.  As a result, I may have not been critical enough when I read his posts in the past – as I did not see this coming.  In truth, the calls for exchange rate, trade, and capital controls is a massive step too far in what could well be the wrong direction.  Let me talk about the points Hickey has raised:

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A note on GDP

Anti-Dismal points out the fact that Colin James seems to have run into a little confusion around the GDP statistics.  Now, I can understand this confusion AND I agree that we need to think more sensibly about what income is before we run around making comparisons.  In this sense, all I want to point out is how the confusion came about.

Now it is true, Australia releases production, expenditure, and income measures of GDP.  However, I would note that they set the chain volume measure of these indicators equal with a “statistical discrepancy” figure.

In New Zealand, our statistics department releases production and expenditure GDP, but does not force them to be equal.  They state that they believe the production figure is more reliable overall – and that is why people discuss this figure.

Of course, GDP misses many “non-market” forms of value-added, it is a measure of “production” so misses the fact that a higher terms of trade increases NZ’s implicit income, furtermore it misses “international transfers” which are highly negative for an indebted nation like NZ.

Furthermore, we have to ask why we are looking at the figures.  Is our concern that someone in the same role gets more $$$ in Aussie and so has the incentive to move over there?  If that is the case, why not just compare the PPP adjusted wages for those professions?  Simply looking at GDP misses the fact that our two economies produce different things, and hire different types of labour.

I am not a fan of cross-country comparisons at this type of aggregate level, and I think we should be thinking carefully a little more carefully about what our concerns are regarding the NZ economy directly – rather than focusing on the arbitrary target of our relative living standards compared to other nations.  I realise these relative standards might give us some information on “what we could do” – but unless we are careful when looking at the NZ economy they will lead us towards policy mistakes.

Three open economies walk into a bar …

There has been an interesting discussion comparing the recession in three open economies, Australia, Canada, and New Zealand.  It started with the Canadians, but a couple of New Zealanders then became involved.

The facts are that:

  1. Headline inflation in all three countries is currently close to target (implying that we all made our inflation targets),
  2. New Zealand experienced the largest declines in GDP – Australia the lowest,
  3. The relative price of NZ housing declined, it was stable in Canada, it rose in Australia (all three countries were seen as “over-valued”)
  4. Canada hit the “zero bound” on monetary policy, and it didn’t seem to matter.  New Zealand had room to move, but we stopped and got beaten around the head.

This list of facts suggests one of two things to me:

  1. Demand management in NZ was poorer then in other countries
  2. NZ faced a larger supply shock.

Now, I’m willing to rule out the first one – as we did keep inflation near the target band, and to be honest inflation expectations have held up a little too well …

So this implies that NZ had a larger supply shock.  Here are some reasons I think was the case:

  1. New Zealand’s recession started with a drought, and the required restocking of agricultural breeding stock following the drought.  This was a pain.
  2. New Zealand’s national net debt position is worse than the other two countries (Note:  In NZ when I say national debt I mean private debt + public debt).  With a lot of our debt on a relatively short maturity this was problematic for a few quarters there.
  3. On that note NZ’s financial sector was more strongly hit than the other regions.  It started back in 2005/06 with the “finance company collapse” and got heavy just before our drought induced, striking in late-2007 (here and here).
  4. Terms of trade:  New Zealand’s terms of trade fell to its lowest level since 2004, Australia’s fell to its 2007 levels.  I do not know about Canada – however, the decline in our terms of trade can be seen as a massive supply side shock.
  5. Trade exposure:  Here I am conjecturing, as I am tight for time, but it is possible that NZ could be more trade exposed then the other countries.  If NZ is, it would only be a minor matter anyway I suspect.

Now while these factors explain why NZ declined more sharply than other countries, I don’t think they explain why we are still lagging behind.  Our TOT is recovering fast – it will be back at its peaks mid year.  The drought is over and restocking has been completed.  And our debt position is less of a hazard than it was 12 months ago.  Interesting.

If NZ doesn’t recover to trend (which is very much the consensus forecast out here), it is because New Zealand faced a permanent supply side shock BEFORE the global crisis – we were struggling before things hit the fan overseas, with only a strong lift in the TOT saying us.  When that flooded out at the closing stages of 2008 New Zealand dropped like a stone.

So for Australians and Canadians looking for a point of comparison with New Zealand, just remember that NZ faced a few other issues 😉

Globally contracting money stocks

In a chart on the Rates Blog today they point out that the money stock (note not really the money supply, depending on how you define it) in the Euro Zone is declining.  The indication then is that “Europe looks bad”.

However, the money stock is also dropping in Australia and New Zealand.  If there were figures for the US, I suspect we would see some contraction there as well.

Does this mean economic activity is taking a sharp turn downwards?  Not necessarily – we may be seeing a sharp uptick in the velocity of money or a movement in reserves as global interest rates tick up.  Furthermore, remember that growth in the money stock in many countries ACCELERATED in the middle of the great financial crisis – so to be honest, it is hard to tell exactly what is going on with these figures.

Overall, falling money stock (in conjunction with an easing in borrowing statistics) suggests we should be cautious – it looks like deleveraging is happening.  However, it is not a clear indicator of where the economy is directly going – if relative prices in the economy are adjusting then activity could still be rolling along nicely.

RBA, what the …

Ok ok ok, so trimmed mean consumer price inflation is running at 3.2% (ht Institutional Economist), house prices rose by 12% on a year earlier (around 18% annualized), my favourite measure of inflation expectations – the labour cost index – rose by 3.5% on a year earlier.  So given the RBA expects trend real growth (3%), the premium on credit has fallen to about 50bps, and the cash rate is only 3.75% a rate increase is in the bag right!!

No – they left rates unchanged.  The statement seems to indicate that an increase is coming next time, why they didn’t now I have no idea 😛

As far as I can tell this is why:

Concerns regarding some sovereigns have increased

If you are worried about the world RBA just say so, we’re friends and transparency is a great thing in a friendship.

Furthermore, you have an inflation problem.  As a concerned party I would love to intervene on your behalf but I can’t.  You are going to have to get rates up and get this inflation down.

In New Zealand inflation is contained and the Bank does have some time to think.  In Australia they need to keep moving.

Update:  My impression is that a decline in the money stock could also engender caution – broad money declined by 0.8% (sa) in the December quarter, the fastest rate of decline since July 2002.  They may feel that this is an indicator of weakness in Dec quarterly activity rather than a run down in reserves on the back of rising interest rates.

Film incentives are trade protectionism

If we follow Australia down the road of trade protectionism for movies, then we all lose out.  What do I mean?

Well the incentives for trade protectionism is a prisoner’s dilemma.

As Peter Jackson says, if Australia starts subsidising movies we need to do the same or we will miss out on productions – as a result our best response to their protectionism is more protectionism.  Furthermore, if we start subsidising and Australia doesn’t then we get a relatively larger share of the movie industry – assume that this occurs to the point where the tax revenue from the movies exceeds the cost of the subsidies.  In this case our best response is to ALWAYS subsidise.

However, there are two issues.  Firstly it is in Australia’s interest to subsidise (it is also their “dominant strategy”).  And secondly, the decision to subsidise pays off because it hurts Australia.  In the end both countries end up subsidising movies, and both sets of taxpayers end up worse off than in the case when neither country subsidises.

This is the issue, not only with the subsidies on movies, but on all trade protectionism.  That is why we need international co-operation to avoid this type of beggar thy neighbour behaviour.