Wednesday, October 28, 2009

The Lucky Country?

This post follows my previous post that was considering the question of how much influence agricultural resources influence New Zealand's economy. This post considers the influence of mineral resources to Australia. Both posts are in reaction to a speech by Dr Don Brash available at:

In looking at the Australian statistics differences to Statistics NZ are interesting. Australia's GDP is better broken down into component industries but New Zealand has more imformation on the contribution to manufacturing and trade categories. The statistics only seem to be broadly comparable. ABS (Australian Bureau of Statistics) seems to be partial to nominal dollars while Stats New Zealand seem highly partial to their 95/96 real dollars which can also make things tricky.

The first obvious thing is that Dr Brash had incorrect information in his speech. He claimed that mining is about 5% of Australia's GDP but it is closer to 8%. It will be no surprise to anyone that Australia's mining industry is very much larger than New Zealand's, so big in fact that it would be fair to say that (compared to Australia) New Zealand doesn't have a mining industry. If we add agriculture, forestry, fishing and mining together to arrive at a ball park number for the current annual value of developed natural resources then New Zealand has about NZ$37billion (nominal) and Australia about A$133billion (nominal). Using an exchange rate of 84c and with population estimates of 4.3million for New Zealand and 22million for Australia then New Zealand currently has natural resource wealth of roughly NZ$8,600 per capita and Australia NZ$6,100 per capita. So Dr Brash seems to be correct. If anything New Zealand has the natural resource advantage in wealth per capita. But does Australia's mineral wealth leverage greater wealth overall?

Another obvious factor in Australia's GDP is their construction industry. Compared to New Zealand it is massive, approximately 12 times New Zealand's (way more than can be explained by population). The Australian electricity, gas and water contribution is also significantly higher than New Zealand's. Australia also seems to perform better in personal and community services (education, health, recreation, culture, etc). Most other parts of the economy seem to be broadly comparable.

I don't have the time or energy to put much more effort into investigating the leverage of mineral wealth in the Australian economy; and I still have to look at exports. If my assertion holds from my previous post; that it makes sense that an economy would naturally become expert in industries surrounding its natural resources then perhaps it shouldn't be a surprise that Australia does so much construction. In theory developers should consider the opportunity cost of minerals (ie compare their internal use to what they could sell the resources for). In practice, however, people (and politicians) will want to use cheap resources to their personal direct benefit. Perhaps this is why there is so much construction in Australia. Some forms of energy are not easily transported great distances. Electricity and natural gas have, effectively, far lower opportunity cost than easily transported oil and coal. This gives Australia very cheap access to energy and this must stimulate significant output leveraged value adding activity in Australia.

I am not going to put much effort into exploring the input industries for Australia's mining activities. Mining is a resource intensive activity and it must drive significant levels of economic activity to supply. Australia's mineral exports are A$140billion compared to a GDP mining value add of A$85billion. Therefore, without even considering internal consumption, mining must generate at least A$55billion of other economic activity in Australia. New Zealand's whole economy (in GDP terms) is currently NZ$180billion. It seems intuitively obvious (my empirical analysis isn't comprehensive enough to be conclusive) that Australia's mineral wealth does translate to relatively more financial wealth than New Zealand's agricultural resources.

In the area of personal and community services these are not, as a rule, stimulated by resource availability. They tend to be, predominantly, luxuries (there is of course a basic level of need in health and education but I suspect that Australia's health system is supported by far more elective procedures than New Zealand's). Luxuries (especially imported luxuries) are funded by cash surpluses and cash surpluses generally come from exports. Not surprisingly Australia's exports are much larger than New Zealand's. For the purposes of this debate I will only look at goods, although services also seem to be consistent with the export story in goods. Australia has A$230billion of goods exports compared to New Zealand's NZ$43billion. Normalised for currency and population this gives Australia about a quarter more export dollars than New Zealand. Not massive but significant. Interestingly mineral and metal exports contribute 60% to Australia's exports but agriculture only contributes something in the order of a quarter of New Zealand's exports.

On the face of it Dr Brash is correct but I think he is wrong. Australia's mineral wealth does give it a large advantage over New Zealand in terms of financial wealth. How does this resolve to New Zealand's greater natural resources per capita? It does because financial wealth is different to the total consumer benefit (the totality of health, wealth, well-being and happiness). Australia's financial wealth directly affects their consumer benefit. Money can't buy you happiness but it sure can buy you a lot of things that make you happy. New Zealand, on the other hand, has a lot of things that make you happy. This is why New Zealand regularly features at the top of lists of desirability to live despite relatively low first world levels of financial wealth.

This will make it very hard for New Zealand to grow financial wealth. Our natural resources seem to be fully leveraged with only marginal opportunities available. We don't appear to have any other strategic international advantages. We are still wealthy in a consumer benefit sense and we are a lucky country in that sense. However, if we want to increase our GDP per capita comparably to other first world countries (and avoid diluting our consumer benefit) then increasing the GDP bit probably isn't going to work. It's time to look at the per capita bit.

Monday, October 26, 2009

The role of resources: NZ vs Australia

I recently read Dr Don Brash's speech on "NZs economic outlook - Can we ever catch Australia?" available at:

I found the speech quite interesting, especially his analysis that some of the problems that are perceived to be problems actually don't seem to be. He is concerned about debt, as anyone should be, although my latest analysis on the debt problem lead me to conclude that debt, in and of itself, may not be a fundamental problem but that area needs a lot more work yet. The most interesting piece in Dr Brash's speech was the identification of a phenomenon in the Australian economy that was already perplexing me about New Zealand.

The popular opinion on Australia is that it is the lucky country due to its mineral wealth. Likewise the accepted mantra in New Zealand is that agriculture (and dairying) is the engine room of our economy. One might say that Australia is a giant mine and that New Zealand is a giant farm. The problem is that neither of these assertions appears to be true.

Dr Brash makes the assertion that the entire Australian mining industry only contibutes about 5% to the Aussie GDP. Likewise, from Statistics NZ, agriculture is the same about 5% of Kiwi GDP. So, which is it? Logically natural resources should be a significant driver on financial wealth but the statistics suggest that neither of New Zealand's or Australia's perceived main industries is actually our main industries.

The most likely reason I can think of that each of our main industries may hit above their weight is leverage. By leverage I mean that each of our main industries stimulates other commercial activity in significant volumes. Such leverage can either be what I call output leverage or input leverage.

There are a number of ways in which GDP can be calculated. It appears that Statistics New Zealand uses the value add method where the GDP contribution of a category is the direct cash sales less direct cash costs. In theory the resulting number is the value that that activity adds to the cash economy.

My definition of output leverage is that the output from an industry stimulates other commercial activity. For example, tourism not only generates its own direct sales but also stimulates retail and service trade. Here it seems agriculture generates signicant economic activity in New Zealand. Manufacturing and retail trade seem to be particularly driven by value adding on agriculture production. In New Zealand perhaps a third of retail trade and approaching half of manufacturing is oriented around food production and agricultural products.

My definition of input leverage is where the commercial activity around providing input to an industry stimulates business activity. It is very hard, from the available statistics to work out how much of New Zealand's economy is driven by providing goods and services to agriculture. It is reasonable to assume that infrastructure type services such as electricity, communications and construction support agriculture roughly in proportion to its economic activity. Therefore, agriculture may, prima facie, contribute as much as 30-40% to the New Zealand economy.

Federated Farmers suggest that the actual contribution of agriculture to GDP is 17% (, but without sources. This is a credible number as my analysis includes activity that would occur anyway (people need to eat). Coming up with a real number is very hard as there is no way to properly consider dynamic effects. In theory New Zealand could still add value in the economy if it imported the agriculture produce. Japan, for example, imports raw material and exports high technology products. But one has to consider the degree to which having the resource stimulated the value adding industries that we now have. It seems intuitively obvious that if someone has an excellent agricultural resource that they would become very good, and continue to be good, at manufacturing excellent valuable food products.

One must also consider other welfare effects that come from having access to relatively low cost, high quality food with little external dependancy. Having a major industry based on primary agricultural produce may limit the opportunities for financial wealth but, with a partisan strategic hat on, having a surplus of good food is a significant benefit to any country. It seems to me that most countries protect their agriculture because the strategic implications of being able to be cut off from the food supply are huge.

But is agriculture the engine room of New Zealand's economy? What else drives the economy? Well agriculture seems to be the largest grouping of economic activity (and dairying and meat in particular). We seem to do a lot of other things but nothing particularly large. We make machinery, we make chemicals and plastics, we do a lot with wood and paper, we certainly build a few houses. We seem to do a lot of things. On the whole we seem to be a nation of small business people. Even farming is predominantly built on the small business model, although there has been signficant rationalisation in recent years.

That we would be a nation of small business people makes sense to me. New Zealand is a country of relatively well educated people far from international markets with substantially pastoral resources. It makes sense that much of our economic activity (apart from agriculture) would be based on being flexible opportunists.

I'm not sure whether agriculture is the engine room of our economy but one thing does seem clear to me. It is the only industry in which New Zealand has a clear strategic advantage of any scale.

As this post is now seems large enough as it is I will consider Australia in a new post.

Wednesday, October 21, 2009

The ACC question

There was recently a useful contribution to the ACC debate in the New Zealand Herald.

In this article Simon Collins sought the opinion of Sir Owen Woodhouse, who chaired the Royal Commission that proposed the Accident Compensation Commission in 1967. This was a useful thing to do. Not because we should necessarily cling to history for history's sake but because it helps us remember why things were done in the first place. In this regard I think the current debate is missing a few important points.

The so-called solutions for the ACC budget blow out include increasing levies (including differential levies for high risk categories) and reducing entitlements. In considering the merit of these solutions we should compare them to the counterfactual, that is to say what might have happened if the ACC hadn't been put in place.

One key point in the debate is that ACC was not put in place because of insurance or funding efficiency. It was put in place to reduce litigation. This is a point made by Sir Owen. The two models at the heart of the debate were either:
  1. A fully socialised accident compensation mechanism with no rights to sue, or
  2. Fully privatised compensation decided through the civil courts.

Hybrid options could also be chosen and one could argue that the opening of ACC to competition or the third party provider scheme were hybrid options in that they partially privatised some of the compensation scheme.

The main reason for choosing the socialised model for ACC was that it was assessed that the reduction in litigation costs would make the ACC scheme the least cost overall. The ACC scheme would also have significant implications for insurance eliminating the need for workers compensation insurance and aspects of medical and public liability insurance.

In all other respects, that is to say, that people would be entitled to full compensation for accidental injury caused by others was held to be roughly equivalent between the two options. This is a very important point when considering the proposal to reduce entitlements (in particular). Reducing entitlements is reducing the rights of people compared to both original major models. To simply reduce ACC entitlements would constitute an reduction of New Zealander's rights. The correct policy option that leaves rights broadly intact is to reintroduce, with the reduction of ACC entitlements, a limited right to sue. If the original Royal Commission was correct (and remains correct) then this would reduce ACC's costs but increase costs to New Zealand overall.

When it comes to the issue of increasing levies then I think the real problem becomes more relevant. In the Herald article Sir Owen makes comment, "Sir Owen said he saw the scheme as part of the social welfare system, not as an "insurance" scheme in which all future costs of this year's accidents needed to be funded immediately." In this I think that Sir Owen misrepresents his own reforms. At the heart of the debate there was no issue of people not being compensated for accidental injury but whether the mechanism would be public or private. The public mechanism was chosen mainly to reduce the total cost of litigation but the ACC scheme also constitutes mandatory socialised insurance. The equivalent counterfactual would be mandatory private insurance. In this regard I think the limited privatised model is superior to Sir Owen's original scheme. ACC, as an insurer, is expensive. It is after all one of our most monolithic bureaucracies. And here in, in my view, is the real problem with ACC.

Thirty years ago a friend of mine made an excalamation in a movie theatre. My friend was in the middle of a personal experience with ACC. For some reason ACC had decided they needed to advertise and had the catchline in television and movie adverts something like getting people back to work is our first priority. On this occasion the advert drew the response, and keeping people tied up in paper work forever is their second. In thirty years they have not improved and this is, I believe, directly affecting their costs and the health of New Zealanders.

It is current conventional thinking, and obvious common sense, that the best results from injury occur when diagnosis, treatment and rehabilitation are done as quickly as possible. The ACC fall well short of the as quickly as possible criteria. They don't even meet the as quickly as reasonable criteria. Not responding quickly to the medical needs of injured people has real and significant consequences. Untreated conditions of even a relatively minor severity can become long-term ailments. In addition, when left without treatment or rehabilitation and in relative isolation, injured people can develop other long-term ailments (such as chronic pain syndrome).

ACC's chronic bureaucracy leaves health professionals with a dilemma. If they treat patients quickly and enthusiastically attempt a comprehensive diagnosis then they risk not being paid. However, if they wait, then the patient is at risk of developing a long-term condition with possible complicating syndromes. As Tim Harford and Steve Leavitt would point out health professionals (in aggregate) rationally respond to their incentives.

I strongly suspect that ACC, and New Zealand overall, is the victim of its own bureaucratic inefficiency. Not just in the huge overhead costs that are incurred but, far more importantly, in the long-term obligations to people whose enduring suffering was entirely avoidable.

Sir Owen and his commission made a well reasoned policy judgement in 1967. On balance, though, I can't help but wonder if mandatory insurance and a few more rich lawyers may actually have been the lower cost.

Back to today. A response to the ACC problem that only looks at increasing levies and reducing entitlements is a cop out. As is policy based on soundbites and populist opinion. This is a major societal issue. What is needed is quick and proper diagnosis, treatment and rehabilitation. But, for goodness sake, don't leave this to the ACC.

Wednesday, October 14, 2009

Increase the numerator or decrease the denominator?

Obviously I am not going to win the headline title of the year awards with my obscure effort above. I remain concerned with New Zealand's standings and efforts with regards to its productivity. I am not alone in these concerns. The current National government has the explicit objective of increasing our wealth (and productivity) to being equal again with Australia by 2025. While not always a good measure of prosperity the key statistic used to compare ourselves to the Australians (and others) is GDP per capita. GDP per capita is a measure of production and consumption arrived at by comparing payments to producers (either for production input or direct consumption) to population. New Zealand's GDP per capita isn't particularly bad but neither is it particularly good. And, it is decreasing quite quickly if normalised against other developed economies.

As with any ratio GDP per capita can be influenced in two ways. First by increasing the numerator, increasing GDP. Or, second by reducing the denominator, decreasing population. All public policy efforts are focused on increasing the numerator GDP. My concern is that this is a vain endeavour.

Reviewing the excellent CIA World Factbook (available at begins to help illuminate the relative strength of all the world's economies. The Factbook has many useful statistics but also very well written, concise and well considered commentaries.

It soon becomes obvious by comparing various attributes and characteristics what indicates likely success for a country in terms of either high per capita GDP or high growth. High growth is the easiest by far. To be a high growth economy you need to be a developing economy. The global recession is obviously a factor currently but in some ways this reinforces the message. Many developing economies are surging ahead despite the recession. Whereas we have to drop to number 122 (Liechtenstein) on the list to find a western developed economy on the growth table (depending on your definition of developed). Historically this makes sense. All historical economic growth spurts have been driven by the development of economic resources (as opposed to the ongoing consumption of a developed resource).

When it comes to the GDP per capita standings then being a developing economy isn't so handy, which also makes sense because the cumulutive benefit of developing resources must be at a maximum at the point where they are fully developed. Nevertheless, the GDP per capita standings make for interesting observation and the following generalisations can be made.

Being small and opportunist makes for high wealth. Liechtenstein, Bermuda, Jersey, Guernsey and the Cayman Islands are all good examples. Each one has substantial protection and patronage from a powerful neighbour and each one benefits from leveraging the wealth of its powerful neighbours by undercutting them on tax, corporate accountability and/or financial regulation.

Being awash with resources is a big factor, particularly if the resource is oil or natural gas. This factor gets relatively small countries like Qatar, Norway, Kuwait and Brunei near the top and is a major factor for the large lucky colonials Canada and Austalia. Canada also benefits from being both politically and geographically close to a rich and very hungry neighbour.

The final 'natural' factor is found in those economies who have significant economic power from their development history. The United States of America and most Western European nations fall into this category.

Well none of these natural factors work to New Zealand's advantage. New Zealand is too large to be a small opportunist, and this wouldn't sit well with us culturally in any event. We are not awash with resources compared to our population, and we did not have the size to build a huge residual economic heritage through our high development years. If New Zealand is going to seriously increase GDP then it will need one of the new methods.

The knowledge economy is touted as being our strategic saviour but I have my doubts here. The top knowledge economies are the US, Japan, Germany, the UK and France and there is no doubt their economies are held up (to some extent) by their high technology industries. I don't have room to explore the argument in this post but the prerequisites for high technology excellence on any scale is large populations of highly educated people in high density population centres with lots of stake capital. I don't see how New Zealand can compete on the world stage here. We do not have the large populations to allow for the highly educated large centres of urban density and we do not have good access to capital. Even if we did have these attributes in a relative sense we would still be well below the absolute levels needed to be globally competitive. In any event the high technology industries are suffering badly in the global recession and this is a factor affecting even those knowledge economies that were not caught up in the financial credit crunch, such as Japan and Singapore both of which are now trying to diversify. A knowledge economy may not even be the right goal for New Zealand.

The final way then seems to be the way of Iceland and Ireland. At least New Zealand is broadly consistent with the naming format. The two I-lands embraced globalisation with open arms. Nevertheless, in Iceland's case in particular, this was to some extent done by the development of resources (eg Iceland's significant geothermal and hydropower resources). Both countries made it very easy, even very attractive for the big global industries to set up shop. They gave particular ease of access to high technology industries and high technology people and they were the darlings of economists for their reformations. New Zealand has had its own experiences with this globalisation approach, which was a feature of Think Big, but this was a fairly clumsy effort. New Zealanders in general tend to be anti-big business and one does wonder how much sovereignty Iceland and Ireland have foregone in their modernisations. However, most New Zealanders tend to believe that such global businesses are inherently inequitable whereas, interestingly, Ireland is significantly better than New Zealand in the GINI index (the GINI index is a measure of how well income is distributed across the population) and Iceland is a great deal better.

Both Iceland and Ireland have been hit hard by the global recession. Iceland's banking system completely crashed. This is a stern warning against their strategies although, even with significant wealth contraction, their GDP per capita still well exceeds New Zealand's. It is too early to call the I-land experiments a success but it is also too early to call them a failure. I sincerely doubt that New Zealand has the appetite to pursue these strategies in any event.

Our politicians and policy makers are currently clutching at straws when it comes to increasing New Zealand's productivity. I do not advocate that they give up but, as a credible alternative, perhaps we should consider what level of population New Zealand's natural resources can comfortably support. Then, maybe, our immigration policies should reflect this goal rather than continually fuelling consumption driven growth for growth's sake.

Monday, October 12, 2009

Debt may not be such a big deal

There has been a great deal of news and discussion around New Zealand's debt. This is also a significant feature of my September 2009 "Where is the wealth going?" series. Now, however, I am not so sure that debt is the problem that I first thought.

In an attempt to understand the place of debt on the relative performance of economies I went searching for more data. One of the best sources for data, which I found somewhat surprising, is the CIA's information site. Interestingly the CIA has more useful information tabulated in one place than can be easily found on our own government website.

I have used the CIA information to try to normalise debt for population. A table of the results is displayed below:

The source is the CIA world factbook and ED (External Debt) is "This entry gives the total public and private debt owed to nonresidents repayable in foreign currency, goods, or services. These figures are calculated on an exchange rate basis, i.e., not in purchasing power parity (PPP) terms." ie US dollars. The population numbers are taken from the same site as of today.

The timing of the data isn't quite right but this would only introduce at most a year's growth worth of error, about 1-2%.

What is clear is that debt on a per capita basis doesn't seem to be a factor in prosperity. Although the above table includes a number of countries with poor current account balances (including New Zealand) it also features countries who have very strong economies, such as France and Germany.

It still seems to me that the problem with New Zealand's economic performance is likely to be a fundamental mismatch between consumption and production; and debt seems to be a factor in our consumption. Nevertheless, debt may not be the primary cause of concern.

What is strange is that it is quite difficult to find statistics that directly compare productivity and consumption. Most measures of economic prosperity, such as GDP, treat them as equivalent. Admittedly consumption drives production; and this must be true globally over time. A single nation can develop consumption without production, though, and this combination is not good.