The visible hand in economics

Archive for July 2007

I’ve always had a soft spot for the idea of creative destruction, even though my understanding of the it is well below par.

I found the following article interesting, in the way it used the idea of job creation and destruction to describe the process of changing unemployment.  It gives us a good idea about the massive flows associated with input changes in the labour market.

Using this concept, it describes how the composition of employment in NZ is changing, with more highly paid, high value jobs being created, at the expensive of low value, low skill jobs.  In my opinion, and the opinion of the article, this is a good thing.  What do you think?

“New Zealanders have been showing early signs of moderating their borrowing.”

Does anyone know what these early signs are. From what I can tell, the growth in household borrowing is at record highs, in fact todays M3 data confirms that. If anything, household borrowing seems to be accelerating, I’m sure it will slow eventually, but why did the RBNZ say that if they didn’t mean it.

My suspicion is that the RBNZ wanted to talk the exchange rate down. They said that the level of our exchange rate was the result of New Zealanders borrowing too much, and buying things from overseas. As a result, higher interest rates will stop New Zealanders doing this, helping the exchange rate.

Now that is a load of crap. Our Reserve Bank needs to take a big long look at itself, and realise that it has been acting like a 14 year old girl who got a pimple just before the big ball. Stop making excuses for our inflation and just deal with it! I wish the Reserve Bank governor was a computer.

So, our dollar has fallen 5% against the US, and 8% against the yen in the last few days. While some people may think that the prospect of no more interest-rate hikes is the driver, the truth is that market participants have become a bit more risk-averse.

A little bit of wobblying in the US stock markets, and suddenly a bunch of people have decided to unwind carry trades, and as we are the number one carry trade country, our exchange rate eased. That is why we are only down by 2% against the Aus$ since Thursday, they were a carry trade currency as well.

I expect us to stay around in the mid-70′s, we might even climb up a bit against the US. After all, this new found risk is based on subprime lending worries in the US, and the fundamentals of the strong NZ$ (high interest rates, strong commodity prices) are still in place. However, if asset prices (especially housing) start to ease too quickly, our exchange rate might be in for a bumpy ride.

I was reading a quick little post on Econlog. In it they say that you should not tax income, you should tax consumption. Ergo we should remove income taxes and replace them with a higher rate of GST.

The main criticism I often hear about this is that GST is regressive. Now I used to spout that line as well, after all poor people have a lower marginal propensity to save then wealthy people, as a result they spend more of their income, and so more is taxed.

However, then I was told to think about it a different way. Over our lifecycle we should spend all our money, so that we are on the boundary of our budget constraint. As everyone spends all their income over their lifetime, GST must be a flat tax.

Now you could make GST a progressive tax by having a higher rate of tax on luxury items (although that distorts the market by changing the relative price of goods). As a result, changing from income taxes to GST seems to make sense, if you think it is more efficient.

In the above article they said that income=consumption+savings+charity. They said that savings and charity should not be taxed, and that is why we need a GST tax. Now, as we have said that savings become consumption over time, that doesn’t hold, and you can get tax rebates on charity. As a result, the only reason I can see to switch to an only GST tax will be if it is easier and cheaper to administer, and I seriously doubt that setting up a progressive GST schedule will be easy or cheap to administer.

Note: The labour market distortion still exists with a GST tax, since even though your disposable income is higher, the cost of everything is also high, so the real return for an hour worked is the same.

Arnold Kling at EconLog isn’t impressed by Planktos who claim to

…restore damaged habitats in the ocean and on land. Through iron-stimulated plankton blooms in the oceans and afforestation projects in Europe, we are able to generate carbon credits. We then sell these offsets to individuals and businesses that are looking to reduce their carbon footprint and lower their impact on climate change.

He claims that this ‘nonsense’ is the product of artificial markets created by the government and should really be the preserve of charitable organisations. I can’t see how leaving the externality damage of markets to be cleaned up by charities is a particularly efficient solution. Surely, the creation of these ‘artificial’ carbon markets internalises the pollution externalities and results in increased market efficiency. It’s a textbook government intervention to correct a market failure. Planktos’ idea seems to be the exact sort of thing that everybody hopes such markets will generate, and excellent evidence that they work to stimulate innovation in environmental protection. The sooner NZ gains a few of these artificial markets, the better, I say.

Well, I don’t always agree with Gary Becker but he has a nice post on carbon taxes and why they could be George W Bush’s friend. He says

A tax on carbon emissions from business and household production would not only help reduce global warming–by how much is still controversial–but it would also lower the world prices of these fuels through reducing the demand for fossil fuels. Lower prices would cut the revenues received by Middle Eastern states from the sale of oil and natural gas. This is why a carbon tax receives support from many environmentalists and national security advocates.

National security isn’t such a big deal for NZ when it comes to energy supply, but it’s nice to know that even conservative economic commentators in the US are starting to favour emissions taxation. Hopefully the NZ government doesn’t need quite as much prodding as Dubya before it implements a decent scheme to meet our Kyoto obligations.

  • An increase in the OCR to 8.25%, on the back of increases in food and oil prices
  • The year end merchandise trade balance worsened to -$6,230m
  • The exchange rate broke through $0.81US this week, just to fall back to $0.78US now.

As most analysts expected, the RBNZ lifted interest rates. They also said they were unlikely to raise them again. The big jump in the merchandise trade deficit was the result of a fall in export value from March, following a fall in Dairy volumes. This isn’t particularly surprising as this quarter often provides low dairy volumes, and high dairy prices had lead to a run down in stocks earlier in the year.

I’m not too concerned about exchange rate movements, except against the AUS.  Have you seen the volatility in NZ$/AUS$ trading today, its been crazy.  I just don’t like volatility, hurts my head.

An interesting new blog on stuff tells us why interest rates had to rise. Now I agree that people in the public service are being paid too much (as I don’t work there ;) ). However, I’m not sure that public sector core wages are the main reason for inflationary pressure (although they do play some part in the wage bargain in the private sector as well). I think that it is a broader issue, with wasteful government spending in health and education the major drivers of our inflationary mess, along with low rates of productivity growth (in both the private and public sectors).

Ultimately, much of the current inflation problem comes from government failure. There is a role for government in society, but I’m not sure that the Labour government recognises the appropriate boundaries associated with that role.

As I was waiting in line to grab some McDonalds before going to see the latest Harry Potter movie I got to thinking about why the line was so long.  In fact, I got to thinking about why, when there are other perfectly good foods around the food court, was half the place lining up to grab some greasy McDonalds.

I realized the best way to analyze this is to think about my own behaviour.   Now I virtually never go to the McDonalds in the food court (that day I just had a hankering for a Boss burger), I usually go to the Chinese place.  However, when I’m in some foreign land (such as Hamilton), I always go for McDonalds or Subway.

When I go to buy food in a foodcourt in Wellington, I know I will be going back there again soon, so their is an incentive for me to experiment, find out what I like and then stick to that.  Simply put, its a repeated game.  When I arrive at a foodcourt in Hamilton, this is a one-off experience, I have no intention to come back to the city of the future.  So this is a one shot game.

Now, franchises like McDonalds offer a standardized product, I know what I will get.  The rest of the shops could sell anything.  As a result, McDonalds is the less risky option, there is less variance in the quality of McDonalds meals.  So even if the average food court meal is better, as long as i’m risk averse there is scope for me to grab MiccyD’s.  If it is a repeated game, then experimenting gives me information for future periods, as I know that some of the food is better than McD’s food, I’ll try things until I hit something (or a bundle of foods) I like, then I will repeatedly consume it (or repeatedly consume some time varying combination of fast foods based which is dependent on previous consumption).

By virtue of this blog I have to bring this rant back to government.   I think I can do that with health standards.  By setting and enforcing health standards the government cuts out the worst foodcourt places, and as a result lifts the average standard and reduces the variance/risk of eating at other stores.  Now even if McD’s was within the health standards before these regulations, they will be forced to up the quality of their product, or risk losing their one off customers.

So govt. health standards lift the standard of franchises, and reduce the risk of getting killed when you go for a meal.  That sounds like positive government intervention to me.

On the economist blog they decide to talk about carbon emissions. Everything they said was simple 1st year economics, I completely agree with them. But they say it so well, and in so few words.

Now they might make the odd mistake (such as inverting the exchange rate and saying we are 72% over-valued against the US$ when it was actually about 9%), but they write so well. I know its not much of a compliment from someone as illiterate as myself, so I was wondering what everyone else thinks.

Bollard has shown who wears the pants. In raising the OCR today, he has shown his disregard for Dr Cullen’s mischievous feints at invoking his powers to override the price stability objective. He has also shown the market that he’s willing to back up his tough talk on the housing market – now on its “third wind”- even if this means ratcheting up interest rates even further as the Kiwi dollar reaches record highs.

Ultimately these actions will help bring the currency down. The Kiwi is underpinned by interest rate expectations, and only by raising rates today could he claim – credibly – that inflation is coming under control, meaning further hikes were unnecessary. So far the market appears to have believed him.

Perhaps this was unnecessarily hard on the housing market. The higher rates will bite hard as fixed rate mortgages continue to roll off over coming months. But then again, why not? A few months ago, a sharp correction in the housing market would have spelt disaster for the economy, with only government spending staving off risk of recession. But now a dairy commodity boom is underway, providing a massive boost to the incomes of farmers and wider economy. This means Bollard can afford to be more aggressive with domestic demand, coming down harder on the housing market. Showing that he is, indeed, still the Guv’nor.

While I am all for supporting the domestic economy, I think that a strict interpretation of the requirements for a good to be labelled “Made in New Zealand” actually harms our exporters. People get upset when they find out that something that is “Made in New Zealand” is manufactured using inputs purchased from another country. Any attempt to put pressure on exporting firms to use entirely NZ inputs is detrimental given that we are a small open economy with a very volatile exchange rate. The argument I’m making has absolutely nothing to do with price or quality but instead centres on a corporate finance concept known as “Natural Hedging”. Put simply if you have a company that sells its output in a foreign currency, purchasing your inputs in that currency naturally hedges movements in the exchange rate.  A good example of this is Navman who appear to be doing fine because they purchase a lot of their inputs in US$

While I accept that a good should still in essence be New Zealand made, I  believe that when the firm is an exporter, they should outsource as much of their inputs as possible.

So the RBNZ lifted rates. However, they said this is the end, no more hikes this year.

I’m can understand why Bollard wanted to lift now, Cullen threatened his manhood and Bollard had to show he had some balls. I still think this lift is unnecessary, house sales are easing and firm profit margins have recovered, easing inflationary pressure over the next few months. Furthermore, even in the June quarter when retail sales were red hot, core inflation showed signs of easing.

Bollard has said no more rate rises will happen, however I think he’s taken one more than he needed to. Remember, the OCR hits inflation with a lag, it takes 12 months for effective mortgage rates to peak, and some say the full effect of tightening can take 18 months to come into effect. 2008 looks like it will be a difficult year.

Matt posted recently about environmental taxes on petrol. The
comments section contains some discussion about whether taxation
is a good idea or whether it’s just bureaucratic meddling. This
sort of politico-vs-economist tax argument inevitably involves
people talking straight past each other so perhaps this is a good
time to discuss what we mean when we say `taxation’.

When libertarian types talk about taxation they mean
distortionary, revenue-gathering taxes that form the majority of
the government’s taxation scheme. When Matt (and pretty much all
economists) gets his tax-’em-harder hat on, he’s referring to
corrective Pigouvian taxes that remove distortionary
externalities. Unfortunately, the government doesn’t seem to
listen to economists much when it comes to designing their
taxation mechanisms: rather than taxing methane emissions and
other serious externalities they tax income. Hmmmm…

It’s about a virtual world, similar to our own but slightly removed from it. It purports to have a set of rules that are internally consistent but has to constantly resort to ad hoc explanations for unusual behaviour. Yet, still, there is a lot of stuff that happens that is inexplicable within the rules of the universe and the powers that be tell us that we just have to accept that that’s the way it is.

So runs Megan McArdle’s critique of the new Harry Potter book. I agree with her but it didn’t spoil the book for me. Frankly, critiquing the economics of a book for essentially resembling the current state of the economics profession seems a bit rich to me.


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