Monday, December 7, 2009

Catching up with Australia

New Zealanders have a little brother relationship with the continent sized nation next door. We feel smaller and less confident. We hate it when they beat us at sports and we we hate it that they have warmer weather and a bigger economy. But what we really hate is that Australia is so much richer in terms of GNP/Capita than we are.

"no fair" we cry. How can we catch up? politicians demand to know. And so various pointy heads are dispatched to return a solution.

Perhaps the pointiest head in New Zealand, belongs to former National Party leader and Reserve Bank Governor, the ultimate uber-geek, Don Brash. He leads the 2025 Taskforce ( ) which was set up by the Government as part of deal with ACT ( ) to study ways to catch up with our Aussie big bro.Their report ( ) effectively comes down to better government management, incentives for research and development and more incentives for making money - starting with a lower tax rate for the highly paid

Now it certainly is true that those earning over $100,000 pay one helluva lot of tax in this country. This table from Treasury( ) shows that the top three percent of income earners pay 26% of the 23 billion dollars of income tax earned by the Government. (roughly half the total tax take). Were I in this select minority doubtless I would feel somewhat aggrieved as well. However I find it hard to believe that, fringe benefit taxes not withstanding, anyone earning over $100,000 from a productive enterprise can't find ways of investing it in that enterprise to their own advantage. As a Cockie I knew once memorably said
"Income tax ? I'll pave the drive before I pay income tax!".

And the biggest problem with the argument is that the effective tax rate in New Zealand is actually lower than the effective tax rate in Australia. Now it wasn't me who said this. This was the argument of a much cleverer person named Professor Philip McCann who economic consultancy Motu has trotted around the country speaking to audiences interested in such things.

Professor McCann's point is that New Zealand scores really well on a bunch of very important indicators for public policy. We have a rational tax system. We have bugger all corruption. We actually do pay relatively low taxes. But despite doing much that is right in terms of the Institutions that the 2025 taskforce speaks of ( and certainly better than Australia) we still don't show any signs of catching up ( See Gapminder ). Why not? His answer is actually very simple:

You are too small.

His point is that the biggest growth in GNP/Capita (GDP per capita counts money exchanged in a country but not repatriated wealth) has come from cities which have grown the fastest. It's called the agglomeration effect. Where you get a lot of people exchanging ideas and interacting value per hour worked increases fastest. Its why an apple in Tokyo costs $7 and you can get just about any kind of sandwich in New York.

What he is talking about is employment. It is easier to get work where there are lots of people than where their are none. Hence the formation of megacities over the past fifty years. Of course having a big heap of people doesn't automatically mean wealth. The top Megacity is Tokyo (33m) but Mexico City is number 3, Dehli number 4 and Mumbai number 5 and their income per capita is certainly not as high as New York (number 6).

In fact if you want to worry about wealth or income you can't go past cities like Copenhagen, Zurich, Geneva and New York. Indeed if you look closely at UBS's survey wealth isn't really about agglomeration its about industries. And what are the main industries of these cities? Well the Gnomes of Zurich are already well known and New York's financial centre needs no introduction. But Copenhagen is also a finance and distribution centre of consequence as well. Interestingly Copenhagen, Zurich and Geneva are tiny cities all much smaller than Auckland. In short wealthy cities are banking cities because big piles of cash always have a habit of lining the pockets of those looking after them.

But Professor McCann says that like it or lump it New Zealand has to coalesce with Australia just as the Netherlands has coalesced with the rest of the European Union. And he says we have to get used to the idea that there are no "strategic assets" like Auckland Airport. In fact they are just assets which need investment and (as they aren't going anywhere else anytime soon) so we should get used to them being traded, just as the British have had to get used to Heathrow being owned by the Spanish.

So who is right? Is it time to form the United States of Australasia ? Is it possible to catch up with Australia ? What is our place in the world anyway?

I am not an economist. There is something about economics which seems to elude me. My belief is that money follows industry, not the other way around. Economists, however, seem to think industry follows money. They therefore worry a lot about money rather than industry. I personally think this is hogwash. Worry about industry first (including the finance industry) and the money will sort itself out.

Now there are some industrial fundamentals that Prof McCann, despite his erudition, did not talk about. The most important of which is the debasement of intellectual capital since China joined the WTO. What do I mean by this?

I used to get very grumpy that New Zealand exports Pinus Radiata logs. We have no Ikea to add value to them, we just strip the bark and branches and sell great lumps of tree. However if you look at MAF log prices ( ) you'll soon see that a tonne of wood is worth around $100 and that is about two cubic metres, so a stem of about ten cubic metres is worth about one ipod (retail). [I mention Ipod's because they are now used in the Ipod index].

Now compare the two. Believe it or not there is a bit of technology in a lump of pine tree. Its been genetically cloned and managed. But in the end most of the work is done by the tree itself. The wood becomes more valuable with every passing year while the Ipod factory depreciates rapidly. The Ipod can be reverse engineered in less than six months while the log is just a log. In short my point is that in an environment when engineers are a dime a dozen logs have a surprising amount of value for not very much effort. Even more if you start adding carbon prices into the equation.

My point is that there is no point competing in the engineering space when everyone else is competing there too. It all comes down to what the world is short of has more value than what it has lots of. The world has lots of people. We don't. We have lots of space. To Professor McCann that is a less than optimal thing. To me, well, that's just the way it is and we should be thankful for it.

So let's look at Australia and New Zealand from an industry perspective. First of all Australia industrially is one humungous great mine. 41% of Australia's exports by value are dug up. The Diggers are digging up their vast continent and racking in Chinese cash. They can probably do that for a very long time because Australia is enormous. New Zealand has a lot of minerals too but we aren't digging ours up. We hide them in national parks which we treat as holy and sacrosanct places (which the Australians don't).

Australia has a number of manufacturing industries which contribute to 29% of exports by value nearly all of which have some kind of assistance or protection. The Australian trade unions are way tougher than ours and fight to maintain employment and working conditions. Despite dire warnings that such behaviour defies economic rationalism it hasn't done the Australians any harm at all. Why not? My belief is that manufacturing enterprises have to be regarded as training establishments. That's why it doesn't really matter who owns them initially. Unless a nation has a working manufacturing base it has nowhere for workers to learn the most basic routines of manufacturing practice. Thus while one wouldn't want to prop up completely uneconomic industries there is a point to preserving knowledge bases if they can springboard into broader industries.

Australia is also an agricultural nation, although agriculture is less than 5% of exports and 5% of GDP. This doesn't prevent the Diggers getting weirdly protective of their Apples or their Mac's Fries or their yoghurt every time a New Zealander shows up who might want to compete with them.

Australia also has banks. Believe it or not they aren't insignificant banks either. Westpac is no.9 in the world with the other three of the big four around 15-17th ( The stability of Australia's banks is actually what is keeping New Zealand out of the Nightmare on Wall Street that has hammered the United States and Britain.

On the other hand the $155 billion in mortgages we owe to (mostly) Australian banks is about the same as New Zealand's GDP. Australia's bank's 1 million odd mortgages means they practically own a lot of New Zealand already. Moreover it means we pay Australia for the benefit of living in our own country!

Looked at industrially its pretty bloody obvious that a country which relies on cheese and tourism for the bulk of its income is not going to be as rich as a nation which is literally a gold mine, protects its industries and keeps us in hock to them.

Does agglomeration matter? In a New Zealand context, frankly I think not. Auckland is a poorly integrated large city and its always going to be beaten by Sydney which is three times larger. For all his erudition I am afraid that Professor McCann's insight is only of marginal interest because it has no heuristic value. New Zealand is small Professor, get used to it.

However in the unlikley event that anyone gives a toss what I have to say about catching up with Australia here are a few random thoughts:

1. Fonterra needs a bank. Why not sell it Kiwibank on reasonable terms. That would give Kiwibank industrial backing and solve its capital structure in one fell swoop. Let's not forget Rabobank is owned by Dutch dairy farmers.

2. Keep the immigration valve wide open. If they want to come and have the money, let 'em in.

3. Its not central Government mismanagement that holds us back it's local government which is close to dysfunctional. We seriously need a new model for local Government that is 1. no longer reliant on rates, 2. entrepreneurial 3 far more efficient. To me that means Government taking in rates revenue and local Government getting funded by central Government. It means far more centralised expertise for some functions and local decision-making for others. It means joining up local oversight of health, transport and planning, education and police through regional level Government and the re-emergence of the local borough for the "pot-hole on whatsit road" issues . It means serious responsibility and accountability.

4. The IRD kills policies because of its own structural inflexibility. Its computer system is a tottering tower of COBOL and it needs re-piling. Indeed the Government needs to invest far more in managing its software asset and its software renewal programme. This should involve Treasury, the Audit Office and State Services Commission.

5. The Resource Management Act. Good grief.

6. We need an infrastructure development plan based on making money. Agglomeration is nice but its not everything. We need to worry about improving land values through improved incomes. Its why we used to have a Public Works Department. We need a Treasury/MED equivalent.

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