The 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.