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Professor Roger Bowden

Is there a Euromess in our own shop?

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On the face of it, the euromess is an old story. Populist governments and rampant bureaucrats are expensive indulgences at the best of times. With the global economic hangover we call the global financial crisis (GFC), to spend too much and save too little is downright dangerous, and not just for your own taxpayers.

Here in NZ, the government seems to have taken the principle on board, even if some of the budget measures look like simply reshuffling the deckchairs. [Yes, the Families Commission won’t be missed, but just look at what’s going to replace it, the ‘Social Policy Evaluation Research Unit’! The uncharitable might wonder a bit just how that one got off the ground.]

But I think the real lessons of the euromess lie elsewhere, with structural changes precipitated in this case by global economic realities. The tradable product menu of Spain and Portugal is not all that distinctive and is shrinking, as with the fate of the once proud motor industry in Spain. Even Italy is in some strife with motor cars, though it still has some very tradable differentiated products e.g. fashion apparel for the Chinese upmarket. Of course, there’s always tourism, and that’s a natural endowment for the likes of Italy or Greece (17% of GDP). Living in the past can be profitable, though the packaged holiday market is more subject to competition e.g. as between Italy and Croatia in the Adriatic, or Greece and Turkey in the Aegean. Moreover, spending on holidays is highly discretionary, so the GFC amounted to double jeopardy for such countries. The deflated building boom for all those yucky holiday apartments predisposed the Spanish economy to collapse.

It does look like some of the Southern European countries and perhaps Ireland, need to reinvent their economic mix (or for the latter, a bit of Irish luck with oil). Something of the same is true of France as well, especially the industrial south east and the ring of social depression that now circles major cities. A pessimistic outcome is that some of these regions become remittance economies, gastarbeiter sending money from Germany (or the UK and Sweden) to support the folks back home.

So what are the structural implications for Godzone, if any? In the short run, not much, even given the euro-driven Chinese slowdown, though I note commodity prices have come well off the boil in the interim. But the NZ dollar is a commodity currency with some interesting dynamics all its own, so this can buffer any adverse shock to commodity prices, in the absence of interest rate pressures. Having our own currency is a help in bad times.

On the other hand, the long term is problematic. It is troublesome that so many of our best and brightest are leaving for economic –and I suspect social – reasons, for that does close off a few differentiated product options for the economy’s future. It amounts to a drain on our stock of productive human capital. The resulting age distribution will also raises the cost of medical and other services, which in turn will be a drain on the taxpayer. And there may be adverse implications for the real estate market, already hit by tax changes.

But human capital aside, right now we have a distinctive trade profile, based on commodities and tourism, amounting to a comparative advantage, in trade theory terms. (We also have other exports like education services, though this is really just selling residence). Especially over the last 13 years it’s been a highly productive profile, in spite of doomsayers of the ‘sixties like the World Bank’s Raoul Prebisch. Tourism is a global growth industry; and if you want to see just how efficient you can be about milking cruise ships (which we don’t), visit Dubrovnik on the Adriatic coast.

However, the first thing that gives me pause is the issue of ownership of the factors of production. That’s the real payoff to our comparative advantage, and it’s what we may be about to screw up.

The Crafar farm sale, now. The farms will evidently be managed by Landcorp, so the labour side of things we’ll hang on to, more or less as a fixed base return component. But the returns to capital, which is the real option from growth, will accrue to Shanghai Pengxin (or whoever they sell to). That includes the growth return from the rising prices of dairy products in China, and we could also think of rising meat prices by way of scope extension.

Well, this might be OK for just one sale, but how about more? That’s a prospect as milk powder prices come off their temporary high, and there are more farm sales, whether distressed dairy farm conversions, or old cow cockies retiring and cashing in. The point is that we don’t have all that much really productive farmland. Does the Overseas Investment Office have a model for the point at which a halt might be called, and how could such a decision ever be defended in litigation?

Factors of production can also encompass natural monopolies. In this context you might think of one or two of the forthcoming state asset floats, e.g. Mighty River or Meridian in the context of electricity generation. I suspect these governmental rushes of blood to the head are about to get extremely expensive for both consumers and taxpayers, with some actual or implicit ‘compensation’ contingencies for iwi not priced into the original decision, on top of the deadweight flotation costs.

I do not mean by all this to weigh in against all state asset sales. Solid Energy is more solid in this respect, though I wonder whether the float price will correctly price in the option to convert coal to urea, which is having a real boom on world commodity markets. Likewise, I can see no real reason for hanging on to Air New Zealand, especially given the way they annoy their adult passengers (e.g. that deafeningly unfunny safety video and the rap music!).

Then there’s oil and gas, now correctly recognised as a key resource, a bit late I suspect. The max (5% ad valorem or 15-20% accounting profit) royalty rate on oil strikes me as low by international standards; by way of contrast the 2009 Review actually increased the royalty for minerals. The Government cites NZ’s ‘isolation’ as a discouragement. Hang on, what about Alaska, Siberia, the Amazon, and Make Benefit Glorious Nation of Kazakhstan? Moreover, NZ’s (relative) political stability must count against the potential danger of ex post non contractual tax hikes or expropriation. If Tag Oil and Apache do strike it big with tight oil onshore in Hawkes Bay (my guess is they will), then a royalty of 20% of accounting profits will look overly generous.

The moral of all this? If you want to sell the shop, price it to span all the future real options and true costs; and identify correctly what those might be. If you can’t, don’t sell.