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Roger Douglas: How to judge the 2014 budget

First publshed on the National Business Review

Budget day is coming up. Finance Minister Bill English has promised that this will be yet another "responsible budget".

But what does it mean for a budget to be responsible? How can we tell if a budget is responsible or reckless?

Unless we understand some fundament economic truths, then we will not be able to determine whether Mr English delivers on his promise. Set out below are a number of principles that we must keep in mind when assessing this year's budget.

Principle 1 - There should be no free lunch

A government should only take an extra dollar from the private sector if it can show the money will return more to New Zealand than it would have returned had it been left in the private sector. Every dollar of government spending is a dollar that is not being spent by an individual in the private sector. When a government borrows to spend, it is only deferring tax increases.

Principle 2 - All spending has an opportunity cost

Whenever the government spends money, it is necessarily not spending it elsewhere. When the government spends money, the question is not "does this spending have benefit?" but is instead "does this spending have more benefits than any alternative way of spending this money?" For example, when it comes to tertiary education, is it right for the government to not only forgo $500 million plus in revenue (interest free loans) but also make the poor pay for the tertiary education of the children of the wealthy?

Principle 3 - Incentives matter

The determining factor that explains how people behave is the incentives they face. When work pays, people are likely to work. If you punish hard work and subsidise idleness, you should not be surprised when you see more people out of work. A good example of the power of incentives can be seen by the consequences of Labour introducing free physiotherapy as part of ACC in 2004. It was meant to cost $9 million; by 2009 it was already costing $139 million. An increase of 1400%.

Principle 4 - Demographics matter

The costs attributable to one generation should be paid by that generation and not loaded on to the next in an unsustainable way. Most people know the makeup of the nation is changing. The effect of rising health costs when combined with an older society will be massive. Changes must be announced to entitlement programmes such as superannuation and health to ensure they are affordable in the future. To continue to run them as de facto pyramid schemes is the height of irresponsibility.

Principle 5 - Focus on the dollars

Focus on what's important. That means seriously looking at the big spending items and considering all the options. Ask the hard questions - is what we are doing actually working and is it returning value for money? Should this department exist, what programmes if any should we open up to a competitive bid process? The reality is close to 70% of government spending takes place in health, education and welfare. Refusing to change the funding or delivery these services is giving up on fiscal prudence; government spending will continue to increase.

Principle 6 - Productivity matters

The link between output and income is important if we want to understand the source of economic growth. Without an increase in real output, there can be no increase in income or living standards. One of the biggest areas where we can address output is in the public sector where productivity growth has at times been negative. Sorting out this problem will enable all of us to be better off. Cutting waste has real benefits to the ordinary person - be it in higher wages, better jobs or better goods and services.

Principle 7 - Transaction costs

Reducing transaction costs would enable New Zealand to achieve higher levels of economic growth. Greater investment in key infrastructure will allow us to expand our productive capacity and stripping away manmade barriers to growth such as tariffs would enable us to achieve gains from trade.

Principle 8 - Tax reductions

When Mr English says tax cuts may be unaffordable, he has it the wrong way round. Only high levels of government spending are unaffordable. If we continue to indulge the whim of every special interest group with tax money, then taxes will be higher; for example, superannuation at 65, interest-free student loans, Working for Families for high income earners and subsidies for industry. When taxes are cut, it is often pointed out the wealthy benefit most. In reality, progressive tax rates discourage work and innovation from the most economically productive. High taxes on the wealthy do not just mean less money for them; they mean fewer goods and services for all to consume.

Conclusion - The choices

This year's budget can continue down the redistribution path as they have for the past 20 years. But long-term that is a path to low growth and poverty.

Alternatively, we could aim to increase our productivity and stimulate economic growth. That will require a change of direction and a change of culture, change I do not believe Prime Minister John Key and Mr English are capable of.

This year's budget should celebrate free enterprise and entrepreneurship. It should adopt policies that encourage innovation and competition. New Zealand should move away from tired, old state monopolies (education, health, welfare, etc) and introduce new ways to deliver our social services. We can be wealthy again but only if we are prepared to change.

Sir Roger Douglas is a former minister of finance

 

Allowing Kiwis to sell their homes to foreigners benefits Kiwis

Winston Peters has apparently convinced David Cunliffe that when foreigners buy New Zealand property they make New Zealanders worse off. Mr Cunliffe has announced his intention to adopt Winston Peters’ policy of banning foreigners from buying homes. Even John Key is now saying he will look into the matter.

There is no need to. Mr Peters and Mr Cunliffe are wrong: allowing New Zealanders to sell their homes to foreigners benefits New Zealanders.

To see why, start with the benefit to New Zealanders that occurs when one Kiwi buys a house from another Kiwi. To make the matter simple, suppose Kiwi John buys a house from Kiwi Jane for $500,000.

John must value the house more than the $500,000 he paid for it, otherwise he would have been unwilling to swap this amount for the house. Suppose the maximum he would have paid is $510,000. Then he benefits $10,000 from the purchase, this being the difference between the $500,000 he lost and the value (to him) of the house he gained.

Similarly, Jane must have valued her house at less than $500,000, otherwise she would not have been willing to swap it for this amount. Suppose she would have sold it for no less than $490,000. Then she benefits $10,000 from the sale, this being the difference between the $500,000 she gained and the value (to her) of the house she sold.

So the total benefit of the transaction to Kiwis is $20,000, split evenly between the buyer and the seller.

Now suppose instead that a Foreigner Fred had out-bid Kiwi John. To do this, he must have paid at least $510,001 since, by hypothesis, John was willing to spend up to $510,000. What is the benefit to New Zealanders in this case?

Well, John is where he started, still with his $500,000 and no house. He gets 0 benefit from the sale of Jane’s house to Fred. But Jane’s benefit has risen from $10,000 to $20,001. In other words, the total benefit to New Zealanders has increased by at least $1. (In reality, the net gain will usually be in the thousands.)

Some will be tempted to say that when Foreigner Fred buys the house Kiwi John is $10,000 worse off because he has lost the $10,000 benefit he would have got if Fred had not bid. Fine. But then you must say that, in the initial case, where Fred does not bid, Jane is $10,001 worse off because she has lost the extra $10,001 she would have got if Fred had bid. So the net result ends up the same, with New Zealanders being better off when Fred bids.

And let’s not forget the benefit to Fred, who must have valued the house at something more than $510,001 to have paid this for it. Fred is not a New Zealander, of course, but he is still a human being and his welfare should still be a matter of concern to civilized people.

As this example should make clear, Mr Peters’ policy simply creates a transfer of wealth from Kiwi house sellers and foreigners to Kiwi house buyers, and one that makes New Zealanders worse off as a group. The cost of this transfer is not worth incurring, if only because, over the long run, house sellers and house buyers are the same people.

Indeed, the policy is so economically ludicrous that I suspect its real motivations lie elsewhere. To mangle Samuel Johnson’s famous saying, xenophobia is the last refuge of the political scoundrel.

My challenge to David Cunliffe

The Labour Party has announced a return to “industrial policy”. If elected, they will decide which businesses and sectors of the economy will deliver the highest returns and promote them in various ways – most obviously, by subsidising them with taxpayers’ money. 

This policy effectively replaces the decisions of private investors with the decisions of Labour Party politicians. It would be a foolish policy if Labour Party politicians were not better investors than the private investors they will replace.

So, before asking people to vote for the policy, shouldn’t David Cunliffe prove that he and his colleagues really are better investors than those who do it professionally?

He could do this easily. Mr Cunliffe could set up a small investment fund – $5,000 would suffice to get started – and trade it in the months before the election. Since he claims to know better than private investors which businesses will give the best returns, his fund should massively outperform the NZX 50 and other stock market indices.

Mr Cunliffe will surely leap at the opportunity to establish his credentials as an economic planner. If he won’t take the opportunity, then we must conclude that he is only pretending to know which investments are best.

Mr Cunliffe talks a good game when it comes to investing. And he plans to put your money where his mouth is. But before anyone goes along with him, they should insist that he puts his own money where his mouth is.

So I challenge Mr Cunliffe. Trade the stock market in the months before the election. Publish your trades as you make them and explain how you arrived at your supposed knowledge of which investments are best. By the election we will be able to see if you really do know what you claim to.  

If you won’t accept the challenge, then withdraw your proposal to use taxpayers’ money to invest in the businesses that take your fancy.

The Left trying to solve problems created by their own policies

The Greens today claimed that the appreciation in Auckland property prices shows that a capital gains tax is needed. They claim that that the profits earned from investing in rental properties “draws more and more money into the market, pushing up prices at an unsustainable rate”. Taxing the capital gains on rental properties would supposedly discourage this investment and bring house prices down.
 
This ought to strike The Greens as strange. Investment should push prices down, not up. If the returns on rental properties are very high, profit seekers will build new rental properties in an attempt to capture a share of them. This will increase the supply of housing and bring prices down. That is how markets normally work.
 
The Auckland housing market doesn’t work this way because restrictions on land use, of the kind favoured by The Greens, make it hard to build new homes. As so often, the Left recommends meddling in markets to solve problems created by their prior meddling.

New Zealand's manufactured education scarcity

The Herald reports that Auckland's growing population is putting pressure on its schools. Low decile schools are losing students to high decile schools. Parents shift their children because there is not enough of the education that parents want.
 
A growing population also increases demand for shoes, for flat-whites, for hairdressers and for just about everything else. Yet there is no shortage of these things. Why not? What is the difference between the supply of education and the supply of hairdressing?

The answer is that education supply is controlled by the government. In a normal market, increased demand first pushes up prices. This increases profits and encourages additional supply of whatever consumers want but has been in shortage.
 
In New Zealand’s state controlled education system, however, supply does not respond to demand in this way. Instead, students and parents clamber over one another to get into schools that they see as desirable.
 
Astonishingly, the officialdom simply dismisses parental concerns. They huff that the schools that parents are pulling their children from are perfectly good. The problem, they believe, is that parents are overly preoccupied with decile rankings.
 
The system is simply not responsive enough to the desires of parents and children. The preferences of bureaucrats and teachers unions are given too much weight. It is a cumbersome and unreliable process, as the current shortage of education in Auckland testifies.
 
Partnership Schools show the alternative. Take the example of South Auckland Middle School. The proprietors of Mt Hobson Middle School innovated and created education that parents wanted. Parents paid to send their children to this independent school. Then ACT’s Partnership School policy allowed its supply to expand.
 
South Auckland Middle School is taking an education innovation from Remuera to Manurewa. It is the flexibility of the Partnership School model that’s allowed this to happen.

The government should do what it can to draw the private sector into the business of supplying education in Auckland through initiatives like Partnership Schools. The creativity of social entrepreneurs is what we need to address New Zealand’s social challenges.

Labour and Greens serving business interests

David Cunliffe has decided to direct great wads of taxpayers’ money to the forestry industry. According to the Otago Daily Times, when “asked about the response from the industry to the policies, Mr Cunliffe said it had been ‘bloody good’, but that was not surprising, as the party had consulted widely with industry in putting the package together”.

What an astonishingly stupid question. Of course those who are about to be in receipt of taxpayers’ money think the policy is a bloody good idea. The questioner should have asked people in other industries, who will now face an unfair competition for resources, if they think it is a bloody good policy. Or he might have asked us taxpayers.

The Greens pulled the same trick last week when they boasted on Facebook that a solar panel producer had spoken favourably of the party's solar subsidy policy. Could politicians cosying up to business become the new norm under Labour and The Greens?

The harm done by industrial policies of the kind Mr Cunliffe and The Greens promote cannot be observed in the fortunes of the firms favoured by the government. For example, the Detroit car manufacturers bailed out by Obama may now be thriving. But that doesn’t show the policy worked. The cost of the policy is the opportunities for other productive activities that have been forgone because of the forcible transfer of resources to Obama’s favoured firms.

Alas, those lost opportunities are invisible. Whereas the joy of those being offered a meal at the tax-funded trough is all too obvious.

On Cunliffe's policies of forced consumption

Yesterday my 10-year-old told me she had a brilliant idea to boost economic growth. She had learnt at school that much of the money earned in New Zealand comes from the food industry. So, she figured, if the government just forced people to buy more food, then even more money would be made from food and we would all be richer.

Only joking. My daughter isn’t that stupid. But apparently David Cunliffe is. On Wednesday, in a speech to ForestWood 2014, a gathering of the forestry industry, he began by observing that forestry is a big part of the New Zealand economy. He then claimed that he could make it an even greater source of wealth to New Zealanders by forcing us to buy more wood.  He would do this by using taxpayers’ money to build government offices and 100,000 “affordable homes” out of wood. 

Many of the assembled wood growers must have been thrilled. How delightful to hear a politician’s plan to force people to buy your products! But I hope that at least a few of them were disgusted. Mr Cunliffe’s policies are not merely a path to national economic decline. They appeal to immoral and anti-social urges: vote for me and I will prey on others for your benefit. 

Benjamin Franklin said that democracy is two wolves and a lamb voting on what to have for lunch. Mr Cunliffe should be ashamed of confirming this cynical view of his job.  

On house prices and anti-foreigner sentiment

The prices of residential homes are high because land use restrictions, of the kind supported by the Greens, create an artificial scarcity. But the Greens don’t see it that way. They think the problem is not insufficient supply but excessive demand. So Russell Norman today announced a plan to get land prices down by stopping New Zealanders from selling their land to foreigners.
 
According to Russell Norman, “if you took 10% out of the demand side, you would go a long way to stabilising prices”.
 
Perhaps you would. But there are many alternative ways of doing this. Mr Norman might have suggested a ban on selling your home to a woman in her 30s. Or he could seek a ban on selling your home to anyone over 180cm in height or to natural blonds.
 
Of course, such prohibitions would be morally outrageous. And Mr Norman would never suggest them. But what makes a ban on selling your property to foreigners any less outrageous?
 
This combination of state-directed capitalism and anti-foreigner sentiment has a very ugly history. I am amazed that the Greens, who I had always taken to be misguided but decent people, should wish to tread that path.

Greens and National failing to commit to cost-benefit ratios

The government has spent $3.4 billion on Roads of National Significance. Yesterday the Greens announced their discovery that the benefit-to-cost ratio of the spending on these roads has been either “low” or “medium”. Since the money could have been spent on projects with high benefit-to-cost ratios, it has been ill-spent on these roads.

Transport minister, Gerry Brownlee, replied that the Auckland rail loop that the Greens want brought forward has a benefit-to-cost ratio of 0.8, which is not just low but negative.

It is a shame that the Greens cannot avoid making the very mistake they criticise. But that is irrelevant to the matter at hand. That your critics are keen on wasting money doesn’t mean that it is OK for you to waste it too.

Government spending is apt to be wasteful because the people who make the decisions are not spending their own money. That is why government spending should have to pass a benefit-to-cost ratio test.

According to Radio New Zealand, Gerry Brownlee said that the government is not fixated on benefit-cost ratios because there are clearly benefits from having a good roading network around New Zealand. This is hard to understand. If there are clearly these benefits, they should already be included in the benefit-to-cost analysis.

I fear that when politicians talk about benefits over and above those included in the benefit-to-cost ratio they are talking about political benefits. That is precisely why taxpayers should demand that the government be fixated on benefit-to-cost ratios.

The Land Transport Management Act 2003 was drafted, under the influence of the Greens, to allow more political input into land transport decisions though a Government Policy Statement (GPS) on land transport.  The NZ Transport Agency must now take into account the wishes of politicians in the GPS whatever their cost-benefit analysis says about the wisdom of these projects. 

The GPS has opened the door to extraordinary political discretion and potential waste.  We should close that door by amending the Land Transport Management Act 2003 to ensure that its prime objective is to provide New Zealanders with an efficient land transport system. That means applying the cost-benefit analysis to the pet projects of politicians in the GPS, not exempting them. 

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