We’ve finally set up our own hosting and have a new site  at www.tvhe.co.nz, if you could be so kind as to set your links/bookmarks/feeds to the new web address it would be much appreciated!

We have lots of exciting things planned for the blog in the future (including some new commentators and some tax calculators for you to play with!), we look forward to seeing you there:)

Cheers,

The TVHE team

Now even though it would be nice if those people hadn’t been left high and dry after all their years of commitment, it is important that we try to get an objective idea about the costs associated with the scheme.

Have compulsory redundancy payments in a contract implies that either:

1. People receive a higher effective wage,
2. People receive the same wage – but the make-up is different.

If the first scenario the cost to businesses is higher, and as a result unemployment will be higher. Furthermore, if workers are more expensive to “try out” then firms will be less likely to hire workers because of “asymmetric information” – leading to a further pull back in employment (same argument that agnitio uses for the 90 day firing bill).

In the second scenario people are forced to accept a worse contract makeup (given that they could negotiate a contract with a severence package in the first place).  As a result, workers are less happy with their total pay package. Furthermore, the fact that employers are forced to pay based on severance instead of on effort makes it harder for them to incentivise work – which will reduce productivity.

In reality, we will have a combination of these costs, all coming into effect. The issues associated with the first impact benefits the employed above the (now larger) people outside employment. The second impact is a cost to people who are employed and receive this in the contract.

What other costs, or even benefits, do you guys see from this policy?

Note:  You could use an “anti-signaling” argument as either a cost or benefit in this case – really this is pretty closely related to (in theory) the 90 day bill.

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A few of the stories I saw when Iceland first went into massive trouble were here, here, and here.  At the time the comparison was so popular that there was a Dom Post article on the risks of New Zealand’s current account.

However, I think by now it is obvious that I am not going to agree   Our stock of debt is equal to one years income – I don’t see how this is unsustainable!

So tell me – are we heading towards bankruptcy, are we heading towards a bumpy ride, or are we heading towards more “golden weather”

I think that Treasury (or some mix of part of Treasury and IRD) should function at arms length in the same way as the Reserve Bank, and that they should set tax rates in the same way that the RBNZ sets interest rates.

Now, let me discuss why.

In a recent article on stabilisation policy I put forward that, as long as we can use monetary policy we should prefer it. Now I critiqued other assumptions that I made, but I did not attack this or explain it.

Fundamentally, my mistrust of fiscal policy is two fold:

1. The “inside lag” associated with fiscal policy – namely it takes a long time to sort out what policy is appropriate.
2. The “pork barrel politics” associated with fiscal policy expansions, where a politically expedient expansion is not the same as the best type of fiscal expansion.

Without these type of issues, fiscal policy has a role as a potentially “more timely” way to get a stimulus rolling.

Now, if we accept that a “fiscal stimulus” can increase demand in the economy, either by propping up demand for under-utilised resources or countering some sort of household level credit constraint then there could be a role – but that role will never be useful in the face of government bureaucracy.

One way to deal with this that has been suggested is more “automatic stabilisers” such that taxes and spending change when GDP growth falls to a certain level, or unemployment rises. However, given the subjective nature that is required to evaluate this data it seems difficult to set appropriate stabilisers.

As a result, I am suggesting the separation of Treasury, and tax setting, from the actual government, which determines spending.

But no tax with representation!

A common argument against this sort of thing is “no tax without representation“. Technocrats are not elected so why should they determine our tax burden. Well they aren’t really.

The government sets a level of spending, the technocrats merely figure out how and when we should raise the funds to meet this level of government spending. As a result, the elected official do determine the tax burden – however, the “cost” of this spending (the impact on taxes) is now MORE TRANSPARENT than it currently is.

As a result, not only can taxes by changed to provide stabilisation (or not changed when the government adjusts fiscal policy), but the tax burden the New Zealand public faces will be more directly shown to be a determinant of the level of government spending.

Imagine – political campaigns will no longer be about “tax cuts” themselves – but on the quality and quantity of spending.

But it doesn’t seem right that the Treasury can change the price of goods/labour

At the moment the RBNZ transfers funds between savers and borrowers in order to stabilise the economy. In a similar fashion the Treasury will be doing this for income earners and consumers. The main goal is that the impact of these redistributions cancel out over time – then we are left with a situation where (hopefully) no group is made worse off and the cost of uncertainty from the economic cycle is diminished.

Truly, if we are fine with our interest rate being set centrally by technocrats, I can’t see why we wouldn’t do the same with taxes – the government will maintain control of spending, which allows it to redistribute to its hearts content, which is really the primary purpose of the elected officials.

Update:  Accomplice in the Wood Chipper muses on the same issue.

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h.t. Nigel Pinkerton.

Now, if the Reserve Bank had known exactly what was going to happen in the world and decided to hike rates for the hell of it I would agree – but ex-ante they (like the majority of other people) had no idea what was going to happen.

Steve appears to believe that the Reserve Bank was lifting rates to fight an increase in the relative price of petrol even though it was “obvious the economy was in dire straights”.

However, from what I remember the Reserve Bank was lifting interest rates because actual inflation was too high (non-tradable inflation is still well outside the band), and capacity constraints inside the economy were being stretched by a resiliant housing market, and most importantly, a sudden huge terms of trade boost.

Before criticising the Bank for targeting inflation, Steve should look at the Bank’s statements and get a feeling for what the Bank terms “inflation” – a place to get a run down on this is here

Now I am going to defend it.

Say that we have a situation where firms in the economy are all oligopolies, and all set prices as their “‘choice”. When demand was rising these firms increased prices, and furthermore managed to implicitly collude to some degree (tacit collusion).

Now, when demand falls, each firm still has their “high” price but their output declines markedly. These firms realise that they each face a “relatively elastic” demand curve – such that they can cut the price they charge and the increase in revenue they experience will dwarf any increase in costs from having to produce more (especially as they will have capacity for this extra production, given that they were previously producing at an even higher level). So it is in the individual firms interest to decrease prices!

However, the firms in the industry realise that this incentive also holds for all the other firms. As a result, they know that if everyone acted on this incentive the demand that a specific firm faces would decline (as the price of substitutes would fall) and overall they would EARN LESS than if the whole industry kept prices up.

So we have a prisoner’s dillema, if the firms can co-operate and keep prices up they are all better off. However, there is the incentive for an individual firm to “deviate” by cutting prices.

As a result, we could be in a situation where, given the history of competition, firms in these industries are still “tacitly colluding”, and are thereby holding up prices in the face of falling demand.

When the Bank then tells people that prices are unfair, they increase the elasticity of the demand curve near the current price by even more – as people value “fairness” and they inform the consumer that things are unfair – this increases the incentive to deviate. Also, by doing so they make the firms feel bad – which further increases the incentive to deviate.

Once one firm has deviated, the collusion is likely to collapse like a pack of cards – as a result it may only take a small push by the RBNZ to get us from the collusive equilibrium to another equilibrium with lower prices and higher output.

This is my defense of the speech against the railing criticism I raised yesterday.

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Prescott to an Obama supporter who emigrated from Russia in 1990:

With people like you I understand why Ruyssians can not governed themselves.
. . .
Are you Russians goiung to getogether with the Germans again and split up Poland again? You invade Georgia.
. . .
In economics there is almost always one theory or no theory. You and your think a likes destroyed Russia and now are destroying the United States. Society needs religion to get around the time inconsistency problem. Your religion of Statism is a not a good religion.

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We would hope that the electricity industry does not take advantage of its market position and keep increasing rates, that local authorities realise they need to set rates increases below inflation for a change, that the construction materials industry respond to much weaker demand, that the food industry react to lower international commodity prices with price cuts, that petrol companies keep cutting forecourt prices, that the transport industry pass on fuel price cuts, and that the banks pass on interest rate cuts. Only then will all these firms be playing their proper role in New Zealand’s recovery.

Now, putting the hard word on industries that do not face market pricing (like local councils) is fine – but attacking businesses for setting prices in their own interest – what the hell!

Firms aren’t passing on costs because they aren’t. If they had increased prices as strongly as cost pressures demanded on the way up then the inflation figure would be a lot worse than 5.1!

Think of it this way – if businesses are pricing “too high” they will face a situation where prices are “relative elastic”. Then it is “in their own interest” to cut prices. If they aren’t doing so, then prices aren’t too high, and if the RBNZ is really worried about inflationary pressure they should batter away with their own instrument instead of making arbitrary calls about “sharing the pain”. If there is a competition problem, complain to the commerce commission, otherwise stop trying to create scapegoats because of the fear surrounding a potential policy failure!

Other comments: Inquiring Mind, Rates Blog.

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As a result, I expect some beers from Rauparaha, Agnitio, and Goonix on Saturday

This post is the 678th post on this blog overall. Note that we will be changing the format soon – so keep your eyes peeled

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In the comments on this post I stated:

When people make a contract they are agreeing (to set) down things that they are willing to accept given bargaining power etc – but ultimately they will only accept a contract when it makes them better off.

Now if the employer really values the probation period and the employee doesn’t care it should be allowed to happen – and it can in current law. If the employer doesn’t care and the employee does, the employee will take a lower wage to avoid it – all good, and as long as the firm is over the size of 20 employees the new law is cool with that.

However, there is a signaling issue because of a market imperfection – asymmetric information. In this case, the existence of a pure probation option leads to “too many” people getting stuck in these types of contracts, compared to the socially optimal level.

As a result, legislation to decrease the usefulness of probation periods could be socially optimal – however, the magnitude of these costs is the debatable issue.

Fundamentally the signaling issue is that the firm will assume people who do not want a probationary period are “bad employees”, even if in actuality they are just really don’t like the probation period! As a result, some employment relationships will end up with a probationary period, even if both the firm and employee don’t want it! This implies that the use of probation periods will be GREATER than the socially optimal level. Current costs surround the use of such contracts reduced the use of such a clause – which could have increased social welfare.

Given the prevalence of small firms in New Zealand, and the sensitivity of a “signaling equilibrium” to small shocks, a small change in labour law could lead to a significant increase in the number of contracts with probation periods. With my value judgment that the current number of probation contracts used is close to optimal (this is something we can debate ) any law that increases the number significantly is no good.

Discuss

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I know about economics, but these subjective terms like “natural justice” do not have a clear meaning to me .

I was all ready to rail against the scheme this morning because I thought they were making probation period compulsory – however, now that I can see that isn’t the case I need to find out more about it before I say what I think.

Tane at the Standard states that:

All National’s proposed legislation would do is remove the right to fair process and natural justice

So how exactly does this impact on policy. What are the definitions of “fair process” and “natural justice”. Once I have an idea I’ll talk about the policy, and I’ll compare it and the current scheme to the extremes of “compulsory” and “no probation” – using economics to frame the issue.

Update: I have been informed that the main differences are:

The 90-day provision will apply to any workers employed by businesses with fewer than 20 staff. Workers who are sacked by their employer in their first 90 days on the job will be unable to challenge their dismissal or take a personal grievance case.

Is there anything else?

Kiwiblog has a good run down here.

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Now this is something that, at first, might seem unusual. New Zealand relies on exports so much, and if the global economy is collapsing surely we will have no-one left to sell too.

However, it is important to remember the difference between “prices” and “quantities”.

When thinking about our place in the global market, we need to think of what happens when there is a market with large and small firms. In such a market, when a large firm changes how much they produce they also change the price. However, when the small firm changes its quantity, it is such a small part of total demand that the price does not change.

These small firms are called “residual claimants”, and they simply face the price that is determined by the major players in the market.

For many goods the New Zealand sells overseas we are a “residual claimant” in the market (which is specified by its location). As a result, when demand collapses in these areas we face lower prices, the the quantity we sell does not change because of demand – it must be because of supply!

If the supply of New Zealand’s export goods is also highly inelastic in the short-term, then in the face of a collapse in global demand we would not expect to see the quantity of exports collapse straight away – instead it would occur overtime as New Zealand producers cut back on production.

Note:  We will get a better idea of this when the trade index numbers come out later today!

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Analysts naturally factor in the number of people who are out of work when they try to figure out future consumption patterns. But there is more to it, of course. People who are afraid they might lose their job are just as likely to economize or clamp down on spending as those who have no real choice in the matter. In fact, some might say that changes in the attitudes and behavior of the 85-95 percent (depending on which statistics you believe) of those who are employed matter much more than the financial wherewithal of those who aren’t

Now this implies that analysts don’t look at the feeling of those who are employed and as a result will not expect as sharp a fall in consumption. However, as an analyst I can say that we do pay attention to this fact – which is why we put such a weight on the unemployment rate when we forecast.

If we only believed that a weaker labour market caused lower consumption through the “people having lower incomes” channel, we would not expect a very big movement in consumption from rising unemployment. The fact that higher unemployment leads to lower job security is taken account of when economists use unemployment as a variable in their models – when we “factor in” unemployment we are taking into account the direct and indirect impact of this variable on consumption activity. (Note: A good way to partially separate these impacts might be to look at how both aggregate income growth as well as unemployment influence consumption – however, there are … issues.)

In fact, during the recent recession may analysts “over-estimated” the fall in consumption, at least here in NZ – as a result, I do not think this criticism is correct of analysis in New Zealand – it is more of a straw man argument that is trying to make us sound silly

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The Commerce Commission is concerned about the monopoly position that the manufacturers have but, recognising the convenience of a single contractor, recommends that the schools use a tender process to ensure value for the parents. The problem with this suggestion is that the school’s incentives are not aligned with the parents’ incentives. Schools place a higher weight on the revenue received by the school, while the parents place a high weight on having low priced uniforms.

What I don’t understand is why the schools choose to raise revenues by selling monopoly rights to their uniforms. Surely the school and the parents both want high quality, well funded schooling and are natural allies here. The parents also want cheap uniforms, but neither of them have an incentive to pass surplus to the clothing manufacturer. The obvious solution would be for the parents to pay the school the money that it would have received from the most ‘generous’ clothing manufacturer, and for the school to then award the clothing contract to the cheapest manufacturer. That way the school would be no worse off, the parents would be better off and they would not have passed surplus on to the manufacturer.

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