Tuesday, July 25, 2017

Politics and Public Finance in New Zealand’s Election Year

Surely no one likes poverty. Politicians of different parties might share the same preferences, but they have different budget constraints. The recent Green’s stump speeches call for ending poverty by significantly increasing social benefits paid for by higher taxes on the “rich.” Rhetoric aside, a tax increase is not a good economic idea especially when our productivity is already sluggish. Social benefits do not end poverty.

For example, over the period 2001 to 2015, the New Zealand government’s average tax revenue as a percent of GDP (29 percent on average) is higher than Australia (23 percent on average); it is significantly higher than Singapore (13 percent on average), Germany (11 percent on average), and Switzerland (9.5 percent).[1] For New Zealand, the tax revenues are mostly from taxing consumption, labor income and company profits. Australia’s average tax revenue is less than New Zealand’s even though it taxes capital gains and New Zealand doesn’t.[2] The figure below plots the World Bank Development Indicators data (July 2017).

So why does New Zealand, which is the least populated among all these countries, has such high tax revenue/GDP ratio? More spending! Typically, government’s major expenditures are on health, education, social services, and the military. Our military spending is trivial, about 1 percent of GDP so I will ignore it.[3] However, on average over the period from 2001 to 2015, New Zealand spent 9.45 percent of GDP on health (about 26 billion dollars), more than Australia (8.79 percent), only slightly less than Germany (10.7 percent) and Switzerland (10.9 percent) and significantly less than Singapore (3.75 percent).[4] See the figure below.

On education, New Zealand’s spending is the highest, nearly 6.5 percent of GDP (about 16 billion dollars). Australia (5 percent), Germany (4.7 percent) and Switzerland (5 percent) spend less than New Zealand. Singapore spends the least, 3.25 percent only.

The Labour party says (here) that it will “address chronic under-funding of health, education…” even though the data suggest that there is no such under-funding! New Zealand spends more than Australia on health, just as much as Germany and Switzerland, and three times as much as Singapore. On education, spending surpassed all of them.

More public spending on services does not necessarily mean better outcomes. There is a strong empirical evidence for that. In education, our students do not do as well as Singaporeans. Performances in standardized tests such as PISA, for example, indicate that Singapore, which spends much less public money on education, is always on the top of the world.[5]

Also, Singapore’s average annual labor quality growth, although small, 0.9 percent (see the Conference Board data), still the highest comparably.[6] Germany and Switzerland have an average annual growth of labor quality of 0.1 percent only. New Zealand’s average annual labor quality growth is 0.6 percent, still slower than Singapore, but much higher than both Germany and Switzerland. The average annual growth rate of labor quality in Australia is half that of New Zealand (source: Conference Board).

The same is true for public health. Although it is difficult to measure output, there is no credible empirical evidence that more spending on national public health systems improves outcomes.

Government spending is a function of the size and the scope of market failure. The question is how much market failure is there in education and health to justify more public spending. I do not think we answered this question in New Zealand.
Here is the big spending item. OECD data show that average net total social expenditure as a percent of GDP for New Zealand is 16.5 percent (43 billion dollars). New Zealand is not alone: it is 19 percent in Australia, 25.4 percent in Germany, and nearly 22 percent in Switzerland.[7] And here is the difference: Singapore spends only 3.5 percent of its GDP on social programs!  

Nevertheless, some expenditures on social benefits could be justified. However, benefits raise the reservation wage and increase unemployment. Singapore, which spends the least on social benefits has the lowest unemployment rate, 1.7 percent in 2015.[8]    

Before getting excited about increasing social spending, note that taxes reduce labor productivity.[9] The plot below shows that Switzerland, Germany, and Singapore, which tax the least, have higher GDP per capita than us.

My advice to the politicians who advocate more taxes is to consider alternative policies to help the poor without taxing potential productivity of the whole country.  
New Zealand already has the highest tax revenue as a percent of GDP. They could reallocate expenditures, e.g., increase X and reduce Y. There must some waste in the public sector; cut it. Better, think about firm productivity-indexed wage subsidy (See the Nobel Laureate Edmund Phelps).      

[1] I chose Singapore because the data are available. Korea and Hong Kong would be just as good examples to use for comparisons regarding tax and spending issues. I chose Switzerland because there has been some public interest in this country as a model that New Zealand should emulate. 

[2] Since 2009 Germany levies a flat rate tax on private income from capital and capital gains. The tax rate is 25 percent plus 5.5 percent solidarity surcharge. The tax is levied at German sources as capital yields tax. There is a tax refund for personal income tax rate below percent.

[3] Australia spends about 1.8 percent, Germany 1.2, and tiny Singapore spends 3.5 percent of its GDP on defense.

[4] The IMF World Economic Outlook data (2017) estimated GDP at current prices in 2016 to be 261 billion New Zealand dollar.

[6] “Measure of the changes in the composition of the workforce. This indicator is based on underlying data on employment and wages by educational attainment, which are estimated econometrically in some cases.”

[7] Data for Switzerland correspond to 2013 which the last data published on the OECD stats.

[8] The average unemployment rate for the period 1970-2015 (a proxy for the natural rate) is 3.78 percent. Unemployment in Germany, Switzerland and Australia are similar to New Zealand on average.

[9] For international evidence see for example, Razzak and Belkacem (2016), Taxes, Natural Resource Endowments, and the Supply of Labor: New Evidence, in Handbook of Research on Public Finance in Europe and the MENA Region, IGI Global Research Publishing, USA, (eds.,) M. Mustafa Erdoğdu and Bryan Christiansen, Chapter 23, PP 520-544, May 2016.

Friday, July 14, 2017

Marginally Attached Workers in New Zealand

Discouraged workers are those who have actively searched for jobs in the past 12 months but believe that there are no jobs for them. OECD publishes data on what they call marginally attached workers. They are defined Marginally attached are persons aged 15 and over, neither employed, nor actively looking for work, but are willing/desire to work and are available for taking a job during the survey reference week. Additionally, when this applies, they have looked for work during the past 12 months. This measure is broader in scope than the discouraged worker data-set and may be used to produce alternative measures of labor underutilization.” 

The figure below plots New Zealand, Australia (shorter sample), and the United States OECD data as a percent of working age population (15-64) from 2000. New Zealand and Australia are on the primary axis and the U.S. is on the secondary axis. The picture is rather dramatic and alarming. The trend is rising in New Zealand and falling in Australia and the United States. We have nearly 300,000 marginally attached workers in New Zealand. Given the relatively smaller size of New Zealand labor market, that amount to more than 10 percent of the working age population. The number of workers in the U.S. is really a small relative to the size of the working age population. On average, Australia’s rate of marginally attached workers is more than 10 times as large as that of the U.S. New Zealand’s is more than three times as large as Australia’s.[1]

These workers could have been unemployed for a long time; or do not have the updated skills needed to get a job; or have suffered from sort of discrimination. These people would take a job if it were offered. Usually the number of such workers falls during the recovery as in the case of the U.S. and Australia in the figure below. Surprisingly, the number increased in New Zealand. Discouraged workers do not include those who have dropped out of the labor force because they went back to school, disables, and women who are on maternity leave.

New Zealand's labor statistics appear healthy, except for this strange statistic. The upward trend is alarming because there might be thousands of highly skilled and productive workers who are discounted for other reasons. I did not find any papers on the subject in New Zealand Ministry of Business, Innovation, and Employment.


[1] New Zealand sample is 2000-2014, Australia and the U.S. 2007-2014.

Sunday, July 2, 2017

The Missing Productivity Conundrum

Why has productivity been falling everywhere?

The latest issue of the Journal of Economic Perspectives has two papers on this problem.[1]The first is by Martin Feldstein, who focuses on the mismeasurement of real GDP, hence the mismeasurement hypothesis.[2] He says, “After studying the methods used by the US government statistical agencies as well as the extensive previous academic literature on this subject, I have concluded that, despite the various improvements to statistical methods that have been made through the years, the official data understate the changes of real output and productivity.” He emphasizes the inability to measure the “improvements in the quality of goods and services,” and especially for new goods and services.  

The second paper disputes the mismeasurement hypothesis.[3] Chad Syverson focuses on ICT. He shows evidence that the slowdown in productivity has occurred in many countries and not only in the U.S. and perhaps long before 2004. (See (Haldane) for the same in the U.K.) He also shows that the surplus created by the new goods and services (i.e., ICT) is far less than the missing output, which caused the slowdown in productivity. He also makes other points worth examining.

My argument is that mismeasurement explains a lot of the missing productivity in OECD countries.

First, labor productivity, measured by the ratio output/input, is pertinent to profit-maximizing firms. It makes no sense to talk about productivity, and to invest in non-profit maximizing firms and sectors.  

Second, GDP data include both profit-maximizing firms (and sectors) output and non-profit maximizing public sectors and government agencies’ output. Inability to measure the quality of goods and services notwithstanding, services output in particular is very difficult to measure, especially in non-profit maximizing sectors. Imagine the difficulty of measuring output in the public sector and government administration and services. It might be easier to measure the output of a private school or a private hospital services by inferring output from the profit function. The data, however, do not allow for such classification. Therefore, I argue that aggregate output (total real GDP) is not the right measure to use for calculating labor productivity because it includes a lot of “hard to measure outputs.”  

Third, the higher the share of services in GDP the lower measured labor productivity.

To illustrate, for New Zealand, I measure labor productivity using the sectoral data ANZSIC06 published by Stat NZ and employment by sectors (data for hours by industry are unavailable). The data are available from 2004 to 2017. Then I modify this labor productivity by subtracting the following “services” sectors data from total industry output and employment: Professional, Scientific, Technical, Administrative and Support Services, Public Administration and Safety, Education and Training, Health Care and Social Assistance, Arts, Recreation and Other Services, rental and real estate activity, and a column labeled “Not Specified.” I did not remove: Financial and Insurance Services because I think that this sector’s output could be measured or inferred from the firm’s profit function.[4]

I convert the two productivity measures to indexes (2004=100). Here is the plot.

It is clear that labor productivity (less services) is significantly higher than the conventional measure which includes public sector services.

Caveat: there must be a number of firms and agencies within the services sectors, which I removed, that are profit-maximizing. For example, in the public service sectors there are private schools, private hospitals, private arts and recreation etc. I cannot separate these from the data because I do not have enough information.

The average share of these services in GDP over the sample is 52 percent. It has been relatively stable.

This graph plots the growth rate of NZ labor productivity.

New Zealand missing growth is nearly 1 percentage point on average, which is quite a significant mismeasurement.

Labor productivity will continue to be understated until measurements of services are addressed by statistical agencies.  


[1] Journal of Economic Perspectives Vol. 31, Issue 2, Spring 2017.
[2] Underestimating the Real Growth of GDP, Personal Income, and Productivity.
[3] Challenges to Mismeasurement Explanations for the US Productivity Slowdown.
[4] The Conference Board data KLEMS report figures for they call Market Activity whereby these sectors are subtracted from the total industry data.