Australia v New Zealand – ideology to the rescue: Part Two

nx-v-aust.gifThe story so far: The CIS publishes a paper discussing the deviation between New Zealand’s and Australia’s economic performance, and ends up blaming the usual suspects. Your correspondent wonders whether the paper could be improved. Things get interesting when the paper cites the possibility that one reason for Australia’s increased capital labour ratio – the paper’s explanation for the deviation in the two countries’ performance might be Australias more rigid, unionised system of industrial relations than New Zealand, with a high minimum wage and national awards that set pay levels.

Australia’s higher level of intervention in the labour market makes it expensive to hire staff, and therefore more rewarding to invest in capital. This is reflected in Australias higher unemployment rate. As the paper concludes, “clearly, many of its workers are being priced out of the labour market.”Hmm . . . now that looks interesting doesn’t it? Perhaps the opponents of further labour market reform were right. I’m not amongst them. I’ve got an open mind leaning towards more deregulation, but I must say the evidence looks to be quite persuasive in this case? Having raised the subject the author isn’t too interested in pursuing it’s possible implications. I think that might be because the observation provides circumstantial evidence that an old shibboleth of left of centre economists (which turns up as the ‘cold shower effect’ when the PC is arguing for faster liberalisation) might be right. If you put firms under pressure they invest and innovate to increase productivity. (And less controversially, higher wages obviously provide greater incentives to invest capital in their productivity – including in labour saving investment.)

The paper makes the point that NZ has higher labour utilisation than Australia – so perhaps there’s a trade-off. Labour market liberalisation (along with lower welfare in NZ) promotes employment and participation but depresses investment per worker.

What side are you on as this trade-off is made? Personally I give getting people on the fringes of the labour market a job a very high weighting. The paper solves the problem with a quick change of scenery. It argues that, stronger labour market regulation might be responsible for increasing investment per hour worked in Australia but that (what I’m thinking is probably relatively mild swinging of the pendulum back towards stronger labour market regulation in NZ when their Labour Party won office is depressing investment in NZ. Funnily if you look at the diagram of capital per hour worked (in the earlier post) it seems to do just what it seems to have done in Australia. It seems to have picked up.

So what are the lessons from all this? The paper takes no interest in various things that occur to me as worthy of further thought.

  • Compulsory super as a way of increasing savings and marshalling more equity capital
  • Independent fiscal policy to vouchsafe higher surpluses than fiscal policy set by politicians can sustain
  • Better investment in human capital
  • Tax distortions – NZ has no capital gains tax which I expect diverts domestic investment into fancy schemes to launder income as capital gain rather than in productivity enhancing investment. It’s also notable that NZ property investors don’t seem to have been scared off real estate investment despite RBNZ ramping up of short term interest rates. Maybe they’re hanging out for those tax free capital gains.
  • Research and development, innovation and entrepreneurialism (though it’s admittedly a difficult thing to measure properly or for policy to influence directly)
  • Labour market diversity. I wonder if the diversity of Australia’s workforce may be generating opportunities for it. As I understand it NZ’s population is less diverse. Also I think our skilled migration program is more aggressive than New Zealands – certainly our ability to pay higher wages can’t hurt in attracting better migrants!

Instead the paper has five policy suggestions. These can be grouped under two headings and the first and second and fourth and fifth are related.The fourth and fifth suggestions are for better regulation. Suggestion four is for more ‘light handed regulation’. Now I have nothing against ‘light handed regulation’. As Ghandi said when asked what he thought of Western civilisation – I think it’s a great idea. But you need a lot more detail to make sense of the proposal.

I don’t think we’ve got more light handed regulation than NZ. In fact given the way the complications of federation bugger up the best laid plans and some good things I’ve heard of various NZ regulatory and management regimes, I expect NZ has always been somewhat in front here, though I guess it depends on what areas you look at.Suggestion five is that the Regulatory Responsibility Bill be passed into law. This is a harmless piece of red tape which cranks up the requirements on regulators to come up with even more paperwork than a regulatory impact statement. Introduced by the libertarian ACT party this is how the CIS paper describes it.

The bill would require the government to clearly explain the purpose of each new regulation, as well as its cost and what it will achieve. It would also involve regular reviews of the governments compliance with the law and the effectiveness of regulations. To some extent, the Productivity Commission in Australia serves this function.

Proposals to beef up regulatory impact statements which is essentially what we’ve got here are a walk in the park for the regulators of this world – a case of ‘been there, done that’. And with no disrespect to the Productivity Commission, I don’t think anyone would describe its role or the role of its Office of Best Practice Regulation hitherto as having had any big success in its role as a bulwark against over regulation or in stimulating investment.The third suggestion is that the quality of public spending should be improved. I have no doubt it should. But then ours hasn’t been too flash for quite a while either. But it might be a good idea.

The first two policy suggestions argue for – you guessed it – lower taxes. Australia has a lower tax burden than NZ – and that the gap has been larger in the past (though part of this is a result of NZ’s higher surplus which I support – the gap is reduced by several percentage points of GDP if you look at size of government expenditure) I don’t know if taxes should be lower in NZ, but the author claims that that “[c]learly, this [New Zealand] level of taxation will have an impact on economic growth.” It may be clear to the author but it’s very hard to find strong evidence backing it up. And it’s also clear that even if there is such a relationship, the difference between the government share in NZ and Australia is inadequate to explain the difference in performance.

But the second proposed policy really stood out for me.

Raising the top rate of tax to 39% for income over NZ$60,000 was symbolic, destructive, and completely unnecessary. This rate was originally intended to catch the top 5% of taxpayers, but it now applies to the top 14% (nearly half a million workers). Removing this rate should be the first tax priority because it will have the strongest impact on growth. High-earning individuals are the entrepreneurs, savers, and employers in the economy, and usually respond strongly to any changes.

There are a bunch of things that are amazing about this proposal. Firstly there is no mention of corporate tax. If you’re interested in the evidence there’s a strong correlation between countries’ rates of economic growth and their corporate tax rate. Personal tax rates? Nup. Here are the findings of Hassal and Mathur (2006) from a source that the CIS would find congenial.  They’re worth taking on board precisely because of the authors’ candidness in reporting a result that was contrary to their ideological priors.

Our empirical results indicate that domestic corporate taxes are negatively and significantly related to wage rates across countries Further, high corporate taxes in competing countries also lead to higher domestic wages. Taken together, our results suggest that capital moves from high tax to low tax countries, and affects wages.Our results for personal income taxes are surprising. We find that tax rates do not significantly impact wage rates. (pp. 4-5).

And Lee and Gordon (2005) likewise find a strong correlation between a country’s economic growth and its company tax rate – but virtually none between its economic growth and its top marginal tax rate.

So there you have it. In a study of what we can learn from Australia’s out-performance of New Zealand during a period in which their top marginal rate diverged substantially, is to move further away from Australia’s policy and back towards the policy that New Zealand had when it was under-performing.  I guess it could have been worse.  New Zealand might have compared its performance to that of a country of similar population size (though a country in a very different location and economic circumstance).  If there’s one country that’s clearly out-performed Australia during the relevant period, indeed a country that has roughly doubled our growth in per capita GDP growth it’s Ireland.  It’s corporate tax rate is 12.5%.  When I last looked it’s top personal marginal rate is 42%.

ReferencesHassett, K.A. and Mathur, A. 2006, Taxes and Wages, American Enterprise Institute, AEI Working Paper No. 128, June, 2006Lee, Y., and Gordon, R.H. 2005, Tax Structure and Economic Growth. Journal of Public Economics Vol. 89: 1027-1043.

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11 Responses to Australia v New Zealand – ideology to the rescue: Part Two

  1. Patrick says:

    If youre interested in the evidence theres a strong correlation between countries rates of economic growth and their corporate tax rate. Personal tax rates? Nup.

    Our results for personal income taxes are surprising. We find that tax rates do not significantly impact wage rates. (pp. 4-5).

    Easy answer – if you are really rich, and not salaried (ie you own companies), you only pay corporate tax. In Australia a discretionary trust receives the dividends from the company and distributes them to another company. That other company might not pay any tax because the dividend is franked, or receives enough cash to pay tax but no more. The trust then loans the unpaid but taxed (except not really) money to you.

    That is really simple and I don’t recommend precisely that to anyone – especially in terms of asset protection – but it goes to illustrate the principle.

  2. Douglas Irvin says:

    Greetings,

    The Per Capita GDP table overlays text. This occours on some of the other postings too.

    Douglas

  3. backroom girl says:

    It’s an interesting thing that NZ’s higher labour force participation is only among people aged, from memory, over 45. Below that age, their labour force participation is lower than Australia’s, between 45 and 65 it is a bit higher and it is only among those aged over 65 that it is really a lot higher.

    Some might interpret this as meaning that NZ retirees can’t afford to live on their equivalent of the Age Pension.

    Similar arguments might also apply to the fact that more people work full-time in NZ – it might be because you need to work full-time in order to survive, whereas for many in Australia this is clearly not the case.

  4. Have you seen Peter Lindert’s work on taxation, welfare and economic growth? Suggests that the type of taxation rather than absolute level is crucial. Increased labour market participation could reduce productivity.

  5. wilful says:

    CIS produces dodgy, meaningless study. News at 11.

    Actually the study got a reasonable run in the kiwi press last week. One of the highlighted items was no compulsory superannuation, so less $$ to invest.

  6. Wilful – can you give us any links to coverage?

  7. Phil Rennie says:

    Hi Nicholas thanks for your thoughtful comments on my paper. Ive been away (in NZ) so apologies for the delay, and the length of this post. Here goes.

    Believe it or not, I started this study with a completely open mind. Ive heard arguments before that government policy is the major difference, and I was kind-of hoping I could discover a new, original, ground-breaking answer.

    Butthe more I looked at all the possible suspects, the more I kept getting drawn back to policy – as a sum-total over the last 30 years, not just the last 10. The other possible reasons (mining boom, size, compulsory super etc) just do not have enough evidence to back them up, and your posts seem to acknowledge this.

    Perhaps I should have expanded further on the incompetence of Rob Muldoon (PM from 1975 to 1984) who really shafted the economy. NZs reform/transition period was painful largely because of him he drove us so far down the wrong way street that it took us a long time to turn the car around and get back on the main road, by which time you Aussies were well ahead of us.

    And even then, in some respects we have never caught up. If we look at size of government (measured by tax take) then the NZ and Australia were almost equal in 1975, at 28% and 25% of GDP respectively. By 1990 it was 37% and 28% respectively, most recently it is 37% and 31%. I believe size is important and have argued this in previous papers.

    I think its a little unfair to say Ive cherry picked arguments. Ive tried to include different views and theories in the paper, including those from people who are staunchly anti-reform (like Chris Trotter) or have completely different solutions (e.g. the NZ Institute who push savings).

    Some of the alternative ideas youve raised, I did look at in depth but left out for reasons of brevity. The paper is about 7000 words and I could have written the same again on any of these issues, but here is a quick summary:

    *Does the higher cost of labour in Australia encourage more investment, and therefore more capital investment than in New Zealand? This is an increasingly popular view amongst the Left, who therefore argue the way to close the productivity gap is legislate for higher wages.

    Im very sceptical about this, for a number of reasons. Firstly, Australia also went through a period of low wage growth in the early 1990s, mirroring what was happening in NZ at the same time. In this study by John Edwards, he argues that the refusal of the AIRC to give wage increases from 91 to 93, and enterprise bargaining, is one of the biggest reasons for Australias subsequent boom. Why? Because wage increases without productivity increases were causing massive inflation.

    Secondly, a NZ Treasury study from 2005 considered NZs capital shallowness and found that NZ firms are slower than Aussies to respond to changes in relative prices, even when all other things are equal. From the summary: Whether there are impediments or greater uncertainty in New Zealand that limit the ability of firms to respond to economic signals as much as their Australian counterparts remain as possible explanations requiring further investigation. http://www.treasury.govt.nz/publications/research-policy/wp/2005/05-05

    So what are those impediments? The New Zealand Institute for Economic Research has argued that regulation is important here http://www.nzier.org.nz/includes/download.aspx?ID=20248. Ive argued for tax and the size of government as significant reasons.

    *Could there be cultural differences holding back growth and investment?? I consider this in an article to be published in Policy magazine this week, the short answer is not really.

    *Compulsory super: Ive been unable to find any studies which give this as a major reason for Australias long boom, but Id be very interested if you know of any. The NZ Institute (a centrist think tank) is a fan of this scheme, but Im sceptical about the economic benefits, as I outline on pg 8. As this paper from the NZIER points out, NZ firms have plenty of access to development finance, and forced savings has a cost. Is relying on overseas finance a bad thing? This Treasury paper is sceptical.

    *Better investment in human capital: I couldnt see any evidence of this from either country, but would be interested in anything youve seen.

    *Capital gains tax; yep this is a really tricky one and thereotically I have a lot of sympathy for this, but in practice is a bit harder to implement. In any event, the housing market seems to be slowing down now, and its unclear what impact a CGT has had on house prices/booms in Australia??

    *Innovation and entrepreneurialism; NZ scores highly on these kind of international studies. I dont have any links or evidence off-hand, but I know that our level of patent registration (for new inventions etc) is about the same as Australia.

    *Workforce diversity; interesting point, I dont have data but NZ has reasonably high migration as well.

    *Policy suggestions yes I was fairly brief on these points, again for brevity, and because I have covered these issues (size of govt, quality of public spending, how to improve it, tax cuts) to death in my previous papers see here http://www.cis.org.nz/nz_policy/nz_policyunit.html.

    *The importance of corporate tax? OK, you got me. I really should have included a quick discussion of that, as I have in previous papers.

    Feel free to get in touch with me at the CIS if you want to continue the discussion!

    cheers
    Phil Rennie

  8. Talisker says:

    What an extraordinarily sensible and measured response to a post and some comments with a few cheap shots. On media, Google will probably turn up what you want Nick.

  9. Thanks for your response Phil – and my own apologies for delay in replying – as you can see from a few posts up, the server was down – I actually penned this response last night and managed to rescue it as it spun out into the ether.

    As I said in the posts, I certainly don’t want to appear to be an expert on NZ. I was offering a critique of your paper largely from within the resources it offers itself, and with a few things I did know about NZ along with some things I looked up. So you’re the expert on the evidence – not me.

    That having been said, like I said in the pieces, I felt that the piece itself was tendentious and unconvincing. You rely on the NZ Treasury paper to dismiss the ‘lack of capital’ hypothesis. There are a couple of responses. Firstly it’s not really a lack of capital. It’s a question of what price it’s offered at. Most firms feel they’re starved for capital most of the time, so at a time when there’s a glut of the stuff around, I guess it’s not surprising that – relative to their own past experience they didn’t report a lack of the stuff when asked by Treasury.

    More importantly as the paper often does – it moves around from its diagnostic mode to something else, and so, though I’m not arguing it’s deliberate – it seems to cherry pick. During most of the period under study there wasn’t a savings glut, so if the availability of capital hypothesis doesn’t fit the most recent period (during which growth was better in NZ) it seems to fit the earlier period.

    Certainly the figures I’ve found suggest a (relative) lack of capital. Long bonds have higher yields of around 50 basis points in NZ over the last four or five years – not trivial when the total yield is around 600 basis points. The difference has fallen to about half that over the last year or so. You have very little investment abroad (around 10% of GDP – which seems very low for such a small country). Australia had around that in the late 80s and has roughly tripled that figure. So that’s a huge difference right there. Our stock market has doubled in relative size compared to yours – from approx 50% to 100% of GDP. So that looks to me like a big difference in the amount of capital washing around. Then there’s NZ’s savings rate and current account deficit – both of which look awful.

    As I think you can probably tell, I’m not arguing any of this from a strong set of presuppositions about what conclusions you should have come to. But surely these things are worth mentioning. On a couple of hares you set running in your comment – I don’t think there’s anything necessarily wrong with using foreign savings or capital. But as you do more of it you’re going to start paying above the odds. And some of it won’t be as good capital as it would be from NZ – because of NZ’ers better knowledge of investment opportunities etc. So you want a healthy mix and plenty of foreign and domestic capital and it looks like NZ doesn’t have it.

    But if you want to make the ‘lack of investment opportunities’ case, it seems to me that you’ve got to demonstrate it. All you’ve got it seems to me is the allegation of ‘stop start’ reform – as demonstrated by what look to my untrained eye as some fairly normal hiccups – like directing Telecom around, and rescuing the odd company that’s fallen over. The latter is perhaps more than we’ve done but it’s hardly much of a big deal in the scheme of an economy. However sill it was (and I’m assuming, but don’t know, that it was) I can’t imagine some NZ company holding back from investment because Air NZ was rescued by the Govt.

    And if one can demonstrate a substantially greater ‘stop start’ approach to reform, then one has to demonstrate some causation doesn’t one? If ‘stop start’ reform is the critical problem wouldn’t one expect to find the footprints of this explanation in financial stats – investment and/or other cost of capital measures? I don’t think you’ve provided any evidence of this kind.

    On wages, like you say it seems to me you’re afraid of the left wing interpretation of the finding that Australian labour market reform may underpin higher investment. Again, I’m not a fan of the left wing interpretation – for reasons I explained in the post – I give greater weight to the ‘outsiders’ locked out of a job. I don’t know what I’d do and my instincts tell me that regulating wages back up in NZ wouldn’t work too well. But it seems to me that right now NZ is in a real bind – the better, brighter employees with more getup and go just . . . . get up and go . . . to Australia where they get much better pay. This creates a vicious spiral.

    I have really no idea what the NZers should do about that but it’s a real problem and I think it might be worth putting and trying to think about. I suspect it’s a dynamic problem. Perhaps NZ needn’t be in this position but like the Irish joke goes – if I were you I wouldn’t start from here. NZ might have avoided its current fate, but it’s now in a pickle and I don’t think it’s easy to work out how to get out of it.

    Further, I’m not so enamoured of policy to think that it can be only policy that explains the performance. When differences of this magnitude occur it’s often something more. Like you I don’t think it’s ‘culture’ – except that to my surprise I’ve found NZ a more ‘ideological’ place and I think that contributes to the ‘stop start’ problem.

    But I wonder whether NZ is suffering from some geographical problem in which its distance from the rest of the world has started to matter more. An analogy is what’s happening in regional Australia where small towns are dying but regional centres are growing. It may be that something is happening between NZ and Australia a bit like the struggle between Geelong and Melbourne to be the major town/city in Victoria. Both couldn’t win and Melbourne won. Australia may have sufficient scale to attract its share of regional headquarters, retain at least most of its manufacturing, have a capital market that’s growing faster than many . All this adds to its agglomeration economies. Perhaps NZ is just finding it harder and harder in these areas.

    Also, I don’t follow you when you say that CGT is ‘hard to implement’. What do you mean?

    I’d be very happy to follow up – are you in Sydney or NZ? (If the latter that would make it harder!!)

  10. Pingback: Club Troppo » The cold shower effect – alive and well and living in twelve European economies.

  11. Dean Ashby says:

    The deviation between Australia and New Zealand’s per capita GDP is definitely caused by several factors. Yes, New Zealand hires more people and Australia’s unemployment rate is high. However, the growth in Australia is still more because of the amount of wages they are receiving monthly. It is relatively high as compared to the salaries paid to workers in New Zealand. That is one of the main factors that affect the deviation in GDP growth between the two countries.

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