Business Cycles – Edward C. Prescott

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98% top US economists disagree @NZSuperFund strategy @VernonSmall @JordNZ

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There is always one. Liran Einav had to be the only economist out of 100 or so top American and European economists who disagreed with the proposition that:

In general, absent any inside information, an equity investor can expect to do better by choosing a well-diversified, low-cost index fund than by picking a few stocks.

The New Zealand Superannuation Fund’s policy of active investing has one supporter out of 100 surveyed by the Initiative for Global Markets. I suppose it is better than none.

The chief executive of the fund quibbles by claiming there is a 3rd way between active and passive investing but there is not as William Sharp explained in his timeless 1991 article, The Arithmetic of Active Management:

    • A passive investor always holds every security from the market, with each represented in the same manner as in the market. Thus if security X represents 3 per cent of the value of the securities in the market, a passive investor’s portfolio will have 3 per cent of its value invested in X. Equivalently, a passive manager will hold the same percentage of the total outstanding amount of each security in the market2.
    • An active investor is one who is not passive. His or her portfolio will differ from that of the passive managers at some or all times. Because active managers usually act on perceptions of mispricing, and because such misperceptions change relatively frequently, such managers tend to trade fairly frequently — hence the term “active.”

An active fund is a fund that is not a passive fund. If you do not own a balanced portfolio of every security in the market, you are an active investor.

The majority of the New Zealand Superannuation fund is passively invested but some of it is not. It is invested in dogs like KiwiBank, in Z service stations and even in some bad Portuguese loans.

It’s "threadbare" to question @NZSuperFund’s investment strategy @TaxpayersUnion

It’s "threadbare" to question @NZSuperFund’s investment strategy @TaxpayersUnion

Letter to @DomPost on @NZSuperfund performance @Taxpayersunion https://t.co/MgUwqwn29I pic.twitter.com/wxo6F1zZn5 — Jim Rose (@JimRose69872629) March 18, 2017 There really is an issue on which economists are unanimous, a big issue to boot. Source: Diversified Investing | IGM Forum. Actively-managed mutual funds … Continue reading

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How much is Working for Families per year?

The last Labour Government so hated tax cuts that it would not call its family tax credit a family tax credit. For those on the minimum wage, it could increase your income by 1/3rd. Oddly enough, because of abatement rates of 22.5% after $36,000, two minimum wage earners do not get much at all.

working for families

Shouldn’t @NZSuperfund be funded by earmarked taxes? @TaxpayersUnion

Pre-funding of New Zealand’s old age pension obligations requires contributions to the New Zealand Superannuation Fund now, higher taxes now in return for lower taxes later through the joys of compounding of the returns on the investments. If that is so, when the contributions are not made, the $3 billion in annual taxes should not be collected.

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Source: Andrew Coleman, PAYGO vs SAYGO: Prefunding Government-provided Pensions, Motu Economics and Public Policy 26 Oct 2010.

There should be a separate New Zealand superannuation fund contribution levy that should lapse when contributions are suspended, as they were from 2009, and the pay-outs start after 2036? Otherwise, taxpayers will never see the promised lower taxes in the future. Never?

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Source: Andrew Coleman Mandatory retirement income schemes, saving incentives, and KiwiSaver at http://www.treasury.govt.nz/publications/reviews-consultation/savingsworkinggroup/pdfs/swg-b-m-mris-24dec10.pdf 

Constitutional political economy matters despite the reluctance of most who specialise in Social Security reform to think about that backend public choice risk. Unless there is iron-clad guarantee of lower taxes in the future, the whole deal about pre-funding superannuation pay-outs is a con.

That politicians can pass a law in 2003 to pre-fund old-age pensions 40 years hence and expect the politicians of 2036 and onwards to honour the deal with tax cuts is politically naive.

My favourite @FairnessNZ graphic

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Source: Low Wage Economy | New Zealand Council of Trade Unions – Te Kauae Kaimahi, with extra annotations by this blogger.

To paint pre-1984 New Zealand, pre-neoliberal New Zealand as a fairly egalitarian paradise, Max Rashbrooke is an example, is to ignore two thirds of the population and the inequalities they suffered:

“New Zealand up until the 1980s was fairly egalitarian, apart from Maori and women, our increasing income gap started in the late 1980s and early 1990s,” says Rashbrooke. “These young club members are the first generation to grow up in a New Zealand really starkly divided by income.”

Racism and patriarchy can sit comfortably with a fairly egalitarian society if you are to believe the vision of the Twitter Left as to their good old days.

John Quiggin refers to the period in Australia known as the Menzies Era as part of his golden age of the mixed economy. The Menzies Era was most of the 23 years of uninterrupted conservative party rule between 1949 and 1972. The actual Menzies Era was the period up to 1966 when Liberal Party Prime Minister Sir Robert Menzies retired

Sectoral shifts in labour demand and the business cycle

Random sector-specific technology shocks

New technologies unfold daily, and consumer tastes change with rising incomes and the arrival of new products. Jobs will open in the expanding industries and disappear in the shrinking sectors. This chapter is about how these sectoral reallocations of labour can cause a recession or prolong existing recessions.

A quarter or more of unemployment rate fluctuations over the business cycle could be due to variations in the rate that labour demand shifts across sectors. These sectoral reallocations in labour demand do not arise from mismatches between entrepreneurial forecasts and actual consumer demand. The higher unemployment rate is not due to a bunching of technological upgrades in a recession. The above average number of sectoral shifts in labour demand is an independent cause of a temporarily higher natural rate of unemployment.

To a significant extent, observed fluctuations in the unemployment rate can be fluctuations in the natural rate of unemployment rather than deviations from that natural rate due, for example, to aggregate demand shocks. There will always be some unemployment. There will be new labour force entrants looking for jobs and workers who are between jobs.

The natural rate of unemployment is a long-run level of unemployment that cannot be altered by monetary policy. The natural rate of unemployment depends on the flexibility of wage contracts and labour market institutions, variations in labour demand and supply in individual markets, demographic change, the mobility of workers, unemployment benefits, the cost of gathering information about vacancies and available labour, labour market regulation and random variations in the rate of reallocation of jobs across industries and regions as technology advances and consumer tastes change.

Sectoral shifts and delayed recoveries in employment

Some years can see relatively uniform growth in labour demand across sectors. Other times can see more dramatic sectoral shifts in labour demand arise out of technological progress and changes in consumer demand.

Instead of significant but steady amounts of unemployment because of labour reallocations across sectors, these job reallocations can vary significantly from one year to the next. The natural rate of unemployment can be higher in these intervals because more job seekers are undertaking the more time-consuming process of searching for jobs in new industries and/or occupations, are relocating or are undertaking retraining.

Sectoral shifts in labour demand has a randomness about them because the size, pace and diffusion of technological advances across firms and industries is uneven (Andolfatto and MacDonald 1998, 2004). The implications of technological progress for jobs has a further randomness because new technologies can displace existing jobs and create new jobs or renovate and update current equipment and employee skills (Mortensen and Pissarides 1998).

As a new technology diffuses, productivity will grow faster in the sectors that are adopting the new technology. During this implementation phase, which is slow, costly and may require considerable learning, there will be reorganisations to capitalise on the impending productivity gains.

New technologies differ in the size of the improvement over existing methods and designs and in the difficulty of adopting the new methods. There will be lower growth in years where new technologies offer comparatively minor or less broadly applicable improvements on existing methods.

Learning consumes resources, and attempts to learn a new technology through innovation or imitation diverts the resources of firms and workers away from production (Andolfatto and MacDonald 1998, 2004). This unevenness in the pace and sectoral diffusion of technological progress will introduce unevenness in the rate of labour reallocation across sectors.

With both growing and shrinking sectors, employment may stagnate or fall for a time because the unemployed are searching for new jobs in different industries and perhaps in new occupations or are retraining. A revival in growth in output and productivity in conjunction with initially poor employment growth is possible and has the attributes of a delayed recovery in employment (Andolfatto and MacDonald 2004). Cross-sector job searches and the redirection of careers is a longer process than job search in the same industries and occupations. Job migration is more time consuming than the more traditional process of layoffs and rehiring by the same employer or in the same industry and occupation.

Labour reallocation and mismatch unemployment

During periods of more intensive or above-average sectoral reallocation of labour demand, a mismatch can arise between the skills and experience of the workers who have exited the shrinking sectors and the immediate requirements of the expanding sectors. More workers than average can be moving into new sectors. Some of these job seekers may not be immediately viable candidates for the available jobs and may exert little downward pressure on wages.

There can be mismatch unemployment because the skills and locations of job seekers can be poorly matched with the locations of vacancies. Some local labour markets will have more workers than jobs. Others will have shortages. Job finding can depend on the rate at which the unemployed can retrain or move to locations with unfilled jobs, the rate at which jobs open in different locations and the rate at which workers vacate jobs in places with ready replacements (Shimer 2007).

A New Zealand candidate for frequent sectoral shifts in labour demand is terms of trade shocks. Grimes (2006) found that half the variance in GDP growth rate over a 45-year period is explained by the level and volatility of the terms of trade. He found that the terms of trade have been high and remarkably stable since the early 1990s, and since the early 1990s, New Zealand has also experienced an unusually long period with high GDP growth and low GDP volatility.

Responding to aggregate versus sectoral shocks

Recessions mix cyclical and structural changes in labour demand. The aggregate demand and sectoral shift explanations have different implications for the role of monetary and fiscal policy in moderating cyclical unemployment fluctuations.

Cyclical unemployment is a reversible response to lulls in aggregate demand. At the start of a recession, there is a general decline in demand, with few industries creating jobs to replace those that are lost. As a recession ends, the unemployed are recalled by old employers or find new jobs in those industries as demand renews. Monetary and fiscal policy can aim to smooth these temporary job losses.

Job losses from structural changes in employment and technology are permanent. The sectoral location of jobs has changed. Workers must switch to new industries, sectors and locations or learn new skills. A role for public policy is to facilitate this process of reallocation to new jobs and retraining.

Much of the higher unemployment during the 1970s stagflation could have been due to a burst in sectoral shifts in labour demand. The 1973 and 1979 oil price shocks are common examples of real shocks that required lasting changes in the sectoral distribution of consumer demand, production and employment. The more energy-intensive industries had to adapt to the suddenly much higher oil prices.

Adding to this 1970s global restructuring in labour demand was the widespread introduction and adaptation of computer technologies. Bessen (2003) and Samaniego (2006) link the 1970s productivity slowdown to the widespread adoption of information technology.

Major economy-wide reorganisations were required because of the incompatibility of substantial accumulations of plant level expertise with many existing technologies with the incoming technologies. A major new technology can initially reduce measured productivity because of plant-level learning costs, the obsolescence of old technologies and skills, the time and resources diverted to develop and introduce the many complimentary innovations that implement a major new technology and the reallocation of labour to new industries.

These technological upheavals of a grand scale can cause a temporary spike in the natural rate of unemployment. Bessen (2003) estimated that, from 1974 to 1983, annual technology adoption costs spiked from 3% to 7% of output, explaining most of the 1970s productivity slowdown. It was decades later before the initially contractionary effects of major new technologies were well understood.

Summary

There is no reason to believe that the distribution of employment across sectors and industries will change at an even pace through time. If there are an above average number of sectoral shifts in labour demand, such as in the 1970s, there can be a significant increase in the natural unemployment rate while workers find new jobs, retrain and relocate. An above average number of sectoral shifts in labour demand during the current recession could delay the recovery. These sectoral shifts are difficult to forecast.