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What ails the economy: turning New Zealand’s small size from a weakness to a strength 16 th March 2011 New Zealand Institute, Wellington Nicholas Gruen.

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Presentation on theme: "What ails the economy: turning New Zealand’s small size from a weakness to a strength 16 th March 2011 New Zealand Institute, Wellington Nicholas Gruen."— Presentation transcript:

1 What ails the economy: turning New Zealand’s small size from a weakness to a strength 16 th March 2011 New Zealand Institute, Wellington Nicholas Gruen @nicholasgruen

2 Outline The facts Looking for suspects My best guess What to do about it –Capital flows, tax competition and finance –Broaden (not necessarily intensify) economic reform –Exporting from bases of domestic excellence


4 GDP per capita ('000 constant USD) Reform


6 A diagnosis There has been more continuity in Australian policy. The political consensus for change has been stronger, and there has been limited backsliding despite changes of government.... Indeed, by contrast with New Zealand's record of stop-start reform... Australia has adopted a remarkably consistent, coherent and credible strategy of economic reform over the last two decades. Roger Kerr, NZBR Australia is a much lower taxing country, especially in terms of income tax, CIS

7 What’s driving this? –Not lack of funds but –Lack of investment opportunities What’s driving lack of investment opportunities? –Lack of political consensus – stop start reform

8 But... Timing problems with the explanation “New Zealand halted most major reform in 1993, and has increased tax and regulation since 2000.” Phil Rennie, Why is Australia so much richer than New Zealand? CIS

9 Did MFP rise mainly because ECA took investment pressure off business?

10 But... Big access to capital differences

11 Sharemarket capitalisation/GDP


13 Gross Savings rate

14 Current account deficit

15 Gross external debt

16 Building knowhow R&D/GDP (%)

17 Business expenditure on R&D/GDP

18 Services exports/share of exports

19 Sophisticated services exports/share of exports


21 21 Reduction in inequality due to public cash transfers and household taxes Point reduction in the concentration coefficient


23 Gravity theory of trade The estimated negative impact of distance on trade rose around the middle of the century and has remained persistently high since then. –Distance effects decreased slightly between 1870 and 1950 and then began to rise. –Distance impedes trade by 37% more since 1990 than it did from 1870 to 1969. “The Puzzling Persistence of Distance on Bilateral Trade”, Disdier and Head, 2006

24 GDP per capita (% deviation from OECD ave)

25 New Zealand has a more ideological political culture – RBA v RBNZ Ideological purity => two extra recessions – BCA v NZBR – Douglas v Keating Top tax rate 62-49.5% v 66-33% CGT and FBT v GST R&D concession (1985 v 2007) Compulsory super Labour market reform Welfare reductions Gini coefficient during reform


27 BCA’s Policy Agenda A Role for Business Emissions Reduction Global Engagement Healthy Australia Tax Reform Business Regulation Education, Skills and Innovation Infrastructure Workplace Relations Workforce Participation

28 Solutions Australia/Global GDP = 1.3% New Zealand/Global GDP = 0.17% Political Stability, English language and institutions Small size and distance from markets a huge problem Also an opportunity –Unitary Parliament –Unitary State

29 Solutions Small countries can compete for – Financial capital – Financial Skills A new kind of reform: Which targets improved domestic outcomes (both economic and social => excellence => exports

30 Solutions Am I in favour of governments picking winners? No The opportunities I’m talking about are all there for the taking – they require governments facilitating, not subsidising – they are in areas in which output is a joint product of government and the private sector

31 Tax An ideological focus has the New Zealand debate focused on –Total tax take (which only matters at extremes) –Top Marginal rate (which only matters at extremes) –Domestic capital gains still untaxed (distorts domestic investment) –Capital taxation of foreigners not a major focus

32 The open economy argument: Tax and foreign investment A substantial body of research considers... the effects of taxation on investment.... The first generation of these studies... reports tax elasticities of investment in the neighborhood of –0.6. [So] a ten percent tax reduction (for example, reducing the corporate tax rate from 35 percent to 31.5 percent) should be associated with six percent greater inbound foreign investment. More recent evidence suggests that foreign direct investment is even more tax sensitive than this. Hines, J and Summers, L, 2009. “How Globalization Affects Tax Design”, NBER

33 Djankov, Shleifer et al, 2008, NBER Company tax and growth - empirical evidence

34 Tax cuts and growth - empirical evidence –Lee and Gordon (2005) Strong negative correlations between company tax rates and economic growth –10 percentage point cut in the company tax rate increases per capita annual growth by between 0.57 and 1.82 percent Little or no correlation between top personal tax rates and economic growth –Hassett and Mather (2006) Strong negative correlations between company tax rates and wages and Little or no correlation between personal tax and wages

35 Labour supply response according to MITTS

36 Lifting thresholds versus cutting top rates

37 The case of Ireland Ireland’s economic renaissance dates to 1987 when it aggressively courted foreign investment with tax cuts Its out-performance is commensurate with Lee and Gordon’s and Djankov, Shleifer’s results Ireland has a huge gap between top personal (42%) and company rate (12.5%)



40 Dividend Imputation Credit for company tax payments is passed on to shareholders with their dividends –We know its theoretical justification To improve tax neutrality between debt and equity investment To reduce double taxation of dividends –But is it cost effective as a capital taxation expenditure? –It now costs over $20 billion –How much does it lower the cost of capital?

41 Dividend Imputation in economic theory Foreign investors are the marginal, more elastic investor => So they disproportionately determine share prices. => But they don’t benefit from imputation credits. => So imputation credits are not represented in foreign demand for shares and so in share prices => Dividend imputation doesn’t lower cost of capital

42 Dividend Imputation – the evidence Most reputable studies suggest imputation credits worth 50 cents in $. Cannavan, Finn and Gray 2004 had zero valuation. Introducing imputation didn’t increase share prices (Ickiewicz, 2006) Removing similar credits to UK super funds produced substantial reallocation of ownership, with negligible price effects. (Bond et al, 2005)

43 Recycling imputation revenue as lower company tax So we could ‘cash out’ an inefficient tax expenditure for an efficient company tax cut. Allows cuts of up to 11 percentage points (Hathaway and Officer, 2004) Company tax could go as low as 19% even without behavioral responses Ireland cashed out its own dividend imputation system as lower company tax

44 Abolition of DI => sale of NZ equities to foreigners. Produces negligible price falls With lower company tax, FDI would rise substantially. Improved post tax return on foreign investment in NZ lifts foreign investment and NZ share prices –Lowers cost of capital. –Increases investment Improves equity by increasing effective tax on NZ capital owners, compensated by increased share prices Abolishing imputation to lower company tax

45 Sophisticated services exports/share of exports

46 Successful exporters of financial services –Traditional centres London, New York –Legitimate low tax high service financial centres Ireland, Luxemburg –Offshore tax havens Macau, Bermuda, Cayman Islands and many others Traditional centres of large countries or empires Small countries

47 Successful exporters of financial services –Almost all a product of government involvement –Luxemburg took action in the 70s –Ireland took action in the 80s Britain's most lucrative industry owes its dynamism to many things, including globalisation, innovation and the good fortune to be based in an old imperial trading city that sits handily between Asia and the Americas. But there was nothing pre-ordained about London's success as a financial centre: it happened largely thanks to an inspired piece of state intervention 20 years ago that opened the doors to foreign talent and foreign capital. The Economist, October 19th 2006

48 Tax Treaties The tax jigsaw for global funds Asset Fund Investor

49 Regulation as a service –Sounds like a contradiction –But regulation as a service is very common Telecommunications firms compete with standards being provided collectively – by government and/or industry standards bodies ASX is a private provider of regulation of corporate governance Delaware is the corporate regulator as service provider par excellence –Irish financial regulation is tough on basics of investor protection, but flexible and responsive to collective industry needs –Firms and their collective regulation co-evolve

50 Co-evolution

51 Regulatory co-evolution in global financial centres

52 Co-evolution of finance and financial regulation Hosting global funds, Ireland’s and Luxemburg’s regulators construct new corporate forms to optimise tax transparency –Luxemburg’s special tax exempt vehicle for foreigners rendered void by European Commission –New compliant regime introduced in four months Note Luxemburg residents pay tax on receipts but not in the vehicle

53 Tax transparency In addition to trusts and companies, Luxemburg has a contract based fund structure Recently imitated and improved on by Irish regulators over several years of close collaboration with major global firms Irish common contractual funds (CCFs) create a network of contractual relations rather than a new entity which enables cross border pooling –This enables tax authorities to ‘look through’ the fund at the investments and apply taxes (including withholding taxes) at rates appropriate to the investments’ and the investors’ domicile – not the fund’s domicile

54 Sticky fingers We don’t mind paying Australian tax. We don’t want tax breaks on our profits in Australia. We’ll pay the going corporate rate. What we can’t live with is the Australian government taking a cut of our investors’ money on the way through. Foreigners won’t invest with us and we can’t build serious capacity to export funds management from Australia if there’s even a hint of sticky fingers. If we can’t get that certainty, we’ll just keep doing it from Dublin. CEO of a foreign owned Australian fund manager

55 What is at stake –Global financial centres are almost uniformly very wealthy –Finance employees earn almost twice Australian average, ~ three times the New Zealand Average –Margin remains even after allowing for education and skill –Tax incentives could assist in transforming NZ into a financial centre As they did in Ireland and Luxemburg –But they’re not the most important thing –And will fail if we can’t generate a responsive tax and regulatory regime for global funds Hint – don’t guarantee foreigners’ deposits or banks’ wholesale borrowing (See Ireland and Iceland)

56 GDP per capita (1980 = 100)

57 Absolute GDP per capita (US$ in 2000)

58 Regulation as a service: Co-evolution in Delaware

59 Regulation as a service: Co-evolution in Delaware Source: US Institute for Legal Reform

60 Regulation as a service: Co-evolution in Delaware Source: US Institute for Legal Reform

61 Delaware: It’s lonely at the top Source: US Institute for Legal Reform Where is the jurisdiction of choice for Asia Pacific litigation?

62 Information, reputation and exports from domestic excellence Hayek 1936, Stigler, Arrow, Akerlof and Stigliz 50s-80s The new information economics substantiates Hayek's contention that central planning faces problems because it requires an impossible agglomeration of information. It agrees with Hayek that the virtue of markets is that they make use of the dispersed information held by different participants in the market. But information economics does not agree with Hayek's assertion that markets act efficiently. Joseph Stiglitz

63 Information and reputation

64 Reputation is the principal means through which a market economy deals with consumer ignorance John Kay Yet we regulate against the grain of this insight We make investment decisions via a combination of: –100 page product disclosure statements no-one reads –advised by advisors whose quality no-one knows The alternative – regulate to enhance reputational quality

65 Investment advisors Encrusted in regulation But it’s more about conflict of interest than advisory skill or value Regulation could require advisors to keep sample portfolios

66 With reputation suasion can achieve a lot Can investment advisors meet John Key’s challenge and keep a sample portfolio? Governments can lead in getting standards to form without regulating.

67 Windows on Workplaces: Job satisfaction and management quality Most firms survey their employees Why don’t they release the information –The good ones have an incentive –But to compare requires a standard –And a standard is a public good Government suasion and leadership – eg with public agencies could help one form And we could have ‘excellence driven’ improvement

68 Health exports Apollo Hospital, New Delhi, charges $4,000 for cardiac surgery v $30,000 in US. –Global medical tourism grossed ~ $60 billion in 2006. –Will rise to $100 billion by 2012 McKinsey

69 Health exports and quality assurance Health exporters often have physicians with internationally respected credentials, with training in the United States, Australia, Canada or Europe. Accreditations –120 hospitals accredited by the US Joint Commission International (JCI) –20 accredited through ISO; –Some countries are adopting their own accrediting standards. Some exporting hospitals owned, managed or affiliated with prestigious American universities or health care systems eg Cleveland Clinic, Johns Hopkins International. Several US companies operating hospitals in Mexico to American standards for American (and wealthy Mexican) patients. Patients also use online communities to inform themselves.

70 Health information regulation Just as in finance, strong regulation for integrity and transparency enhances competitiveness


72 Gruen Tenders Provide unbiased estimate of the prognosis of a clinical procedure. This can be used for –measurement of clinical safety, –allocation and –funding of clinical work Well suited to self contained clinical event with reasonable chance of undesired outcome from which full recovery expected - obstetric delivery, setting a fracture, cardiac surgery

73 Real estate or other sales Indicated Service provider

74 Litigation Indicated Service provider

75 Medical procedure Indicated Service provider

76 Gruen tenders and reputation Normal reputations – Usually based on poor information – Backward looking – Crude and undifferentiated – doctor’s good or bad Gruen Tenders enable fine grained reputations to form – Based on considered prognoses and comparative prognoses –Not just for types of clinical activity but for individual patients or groups of patients – Enable forward looking prognoses, facilitating innovation

77 Gruen tenders minimise perverse incentives There is no incentive to turn anyone away, just to reduce the attractiveness of the ‘bid’ No incentive to ‘reclassify’ risk rating –Because risk rating is not imposed extrinsically, but intrinsically to the clinical unit –In the ‘prognostic bid’.

78 Gruen tenders reinforce intrinsic motivation Information that aligns with intrinsic motivation should reinforce it Increasing the intrinsic motivation of the best Identifying worse performers for redeployment and specialisation

79 Gruen tenders assist central funders and managers, and educate patients Gruen Tenders generate a mass of data on top of the basic performance data currently used for report cards. – Data from prognoses, and availability of comparative prognoses on the same case Re the lack of consumer response to report cards, Gruen Tenders put the info – and the issue in front of patients. Health is a ‘big data’ business

80 Global Competitions State of the art 70% 1½ weeks 70.8% Competition closes 77% Predicting HIV viral load Accuracy of Prediction (1 – 100%) Revenue or sales forecasts Traffic forecasting Energy demand Predicting crime Tax/social security fraud Hospital casualty demand Identifying great Teachers Schools Hospitals and their best practices US$500

81 We could not be happier with the result. The Kaggle approach has set a new benchmark in Government for the development of successful predictive models, delivered quickly and very cost effectively. In particular, the flexibility of the winning predictive model will enable its application to other major transport routes to the CBD and allow for the addition of other factors such as weather and incident. Susan Calvert Director, Strategy and Project Delivery Unit

82 Forecast Eurovision Voting Dr. Derek Gatherer, UK Take on the Quants 1 & 2 John Blatz Baltimore Edmund & Adrian London & USA Jason Trigg Pennsylvania Chih-Li Sung & Roy Tseng Penghu & Taipei Jure Zbontar Ljubljana Thomas Mahony Canberra Emir Delic Australia Glen Maher Canberra Predict HIV Chris Raimondi Batimore Claudio Perlich USA Gzegorz Swiszcz Gera Edmund & Adrian London & USA Tourism Forecasting Part 1 Rajstennaj Barrabas USA Jason Trigg Pennsylvania Felipe Maia Uppsala University Lee Baker Las Cruces, New Mexico INFORMS Cole Harris Texas Nan Zhou Pittsburgh Chess Ratings Uri Blass Tel-Aviv Giuseppe Ragusa Rome Robert Warsaw Tourism Forecasting Part 2 R Package Recommendation Engine Ivan Russian Federation The top 3 competitors for: Philipp Emanuel Widmann Heidelberg, DE Dr. Christopher Hefele, New York Chris DuBois Portland Where’s Wally? Jeremy Howard Where’s Jeremy?

83 Where’s Wally from?

84 Why am I telling you this? Because New Zealand has a unitary health system – unlike most other places on earth You are in control of the whole system!

85 E T @nicholasgruen

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