Advice to the new government from Sir Humphrey

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There is panic in the streets of Wellington over the rising road toll

Deaths_caused_by_road_crashes_relative_to_the_vehicle_fleet_size_in_New_Zealand

Peak hour traffic congestion is inevitable and efficient

In 1962, Anthony Downs put forward the fundamental law of peak hour congestion on urban commuter expressways: peak-hour traffic congestion rises to meet maximum capacity. Larger bus and train networks and more cycle-ways are never the solution. Just as more highways leads to more congestion because more people drive to work, with fewer people driving to work if they fit enough to ride on the new cycle-ways, other people will start driving to work, instead of taking public transport (Downs 2005).

Downs’ law of peak hour congestion or “triple convergence” means that road will be as congested as before after any new investment in capacity because fewer people are taking public transport or postponing their trips to outside the peak hour times. More commercial driving in peak hours by trucks and delivery vans is an obvious response to more road capacity (Downs 2004). Increases in road capacity do not reduce congestion because of a triple convergence of new users from buses, trains and off-peak.

If an expressway’s capacity were doubled overnight, the next day’s traffic would flow rapidly because the same number of drivers would have twice the road space. Word will soon spread that this highway is less congested. Drivers who used that road before and after the peak hour to avoid congestion will shift into the peak hours. Other drivers using alternative routes will shift to this more convenient expressway. Bus and train passengers will start driving on the upgraded road in the peak periods. In a short time, this triple convergence of bus, train and car users onto the improved or new road in the peak hours will make that road as congested as it was before its expansion. Duranton and Turner (2011) found that vehicle kilometers travelled increases proportionately to increase road space for interstate highways and slightly less rapidly for other roads. The increased vehicle miles travelled is a mix of more driving by current residents, more commercial traffic and some migration from other types of roads.

Increases in bus or train capacity had the same triple convergence effect at peak times as new roads. Duranton and Turner (2011) found that increased provision of public transport does not relieve road congestion. The road space freed up by the motorists who switched to the additional buses or trains is filled by other motorists and commercial transport who previously planned to travel outside of the peak hours. Downs considers that peak-hour congestion is inherent to how modern societies operate:

…congestion exists because societies organize economies so most people will work during the same hours each day. This makes interaction among firms and agencies possible, thereby increasing society’s productivity, and raising overall efficiency. But it also requires most workers and students to travel to and from their places of activity at the same times. This overloads ground transportation systems during the morning and evening peaks, and often longer.

No large metropolitan areas have enough infrastructure to transport everyone who wants to move during peak hours simultaneously; nor do they have enough resources to build it. Hence some travelers must wait until others have moved. That waiting constitutes traffic congestion. (Downs 2006).

Road capacity expansions and extensions to bus and train networks do not reduce congestion. The added space means the extra traffic can be handled with still tolerable congestion. Judiciously selected road investments are still value for money because the additional road space allows more commuters to travel by the fastest, most convenient, most flexible method of urban travel, which is in a car.

But is a living wage policy still worth a try?

Demands for massive pay rises for the low-paid are not just confined to New Zealand. The US debate is worth reviewing because their living wage advocates are so upfront about the job losses.

US living wage activists such as Fight for $15 want to double their federal minimum wage from $7.25 per hour to $15 per hour. California, New York, San Francisco and Seattle are among the states and cities increasing their local minimum wages, currently of up to $12, to $15 by 2021 or 2022.

Some such as Arindrajit Dube say that these very large wage increases by cities and states in their federal system are experiments “worth running and monitoring” (Lane 2016). As Dube said recently:

“… 30 to 40 percent of the California workforce will get a raise … This will be a big experiment. It’s far outside of our evidence base…

If you’re risk-averse, this would not be the scale at which to try things. On the other hand, if you think that wages are really low and they’ve been low for a really long time and we can afford to take some risks, doing things at this scale will get us more evidence” (Lee 2016).

Noah Smith (2016) concluded that the empirical literature on minimum wages suggests that a 10% minimum wage increase would reduce employment by about 2% so doubling the federal minimum wage would see the employment of young people go down by one-fifth. Smith (2016) said this is a “small but real effect — a $15 federal minimum wage might throw a million kids out of work”.

Should activists use minimum wage breadwinners for policy experiments? Noah Smith (2016) considers balancing the one million unemployed teenagers against the wage gains for adults as “necessary for a decision”.

Smith suggests that the large minimum wage increases in some US states and cities will tell us how big this welfare trade-off between jobs and wage rises is:

We don’t really know what happens when you raise the minimum wage to $15 — but soon, we will know. We will be able to see whether employment rates fall in L.A., Seattle, and San Francisco. We will be able to see whether people who can’t get work migrate from these cities to cities with lower minimum wages.

We will be able to see if employment growth suddenly slows after the enactment of the policy. In other words, federalism will do its job, by allowing cities to act as policy laboratories for the rest of the country (Smith 2015).

“Big experiments” involving large minimum wage increases to “provide clear evidence” to quote Dube’s words (Scheiber and Lovett 2016) are wrongheaded as Robert Lucas has explained:

I want to understand the connection between in the money supply and economic depressions. One way to demonstrate that I understand this connection–I think the only really convincing way–would be for me to engineer a depression in the United States by manipulating the U.S. money supply.

I think I know how to do this, though I’m not absolutely sure, but a real virtue of the democratic system is that we do not look kindly on people who want to use our lives as a laboratory. So I will try to make my depression somewhere else (Lucas 1988).

Leading reasons for economic theory, empirical research and the study of economic history are to warn the present against repeating past errors and not try experiments that are folly (Rosen 1993). There is too much group think and not enough courage of your vocation (see Dylan Matthew’s tweet below).

Australian-born economist Justin Wolfers is frank about the wishful thinking in the US debate:

But if you are interested in what level to set the minimum wage, the existing literature is nearly hopeless. Plausible reforms lie far outside the bounds of historical experience.

We don’t have useful estimates of the extent to which employment effects vary with the minimum wage. Since policymakers tend to implement short-run fixes, we know a lot about the effects of temporary reforms, but very little about the consequences of lasting reform (Wolfers 2016).

Most of the empirical studies are of the jobs lost over the next few years. When estimates have a 10 to 15-year horizon with time enough for entry, exit and technological adaptation and automation, a “long-run disemployment effect that is five times larger than the short-run effect” is in evidence (Aaronson, French, Sorkin 2016; Aaronson, French, Sorkin and To forthcoming; Sorkin 2015).

Investing in roads is the only sustainable solution to commuting dilemmas

Better value for money for the taxpayer from road investments is vital because few New Zealanders (barely 4.5%) commute to work via public transport – see figure 1. Public transport simply does not make the grade for the great majority of New Zealanders as a way of carrying out their daily lives. The policy question therefore is providing the necessary roads in a more cost-effective manner than now.

Figure 1: Modes of travel to work, New Zealand, 2013 Census

Source: Statistics New Zealand, 2013 Census.

A small minority of New Zealand adults commute by bus or train even in the big cities. Figure 2 shows that even in Auckland, for those that left home for work, only 8.3% commute via public transport. In Wellington, 14.1% commute to work from home via public transport – see figure 3.

Figure 2: Modes of travel to work, Auckland, 2013 Census

Source: Statistics New Zealand, 2013 Census

Figure 3: Modes of travel to work, Wellington, 2013 Census

Source: Statistics New Zealand, 2013 Census.

Has @WJRosenbergCTU shown @jacindaardern’s first lie in office?

Ardern said there had been market failures in New Zealand such as … most people’s incomes not keeping up with inflation…


Source: Economist Bill Rosenberg details how low and middle-income wages have been hollowed out as higher earners experienced greater growth while those below them had to work more hours each week | interest.co.nz.

Only Nixon could go to China, only @PhilTwyford could reform the RMA?

Right-wing politicians can sometimes implement policies that left-wing politicians cannot, and vice versa under Cowen and Sutter’s only Nixon can go to China theorem:

The point is that politicians with a previous record of opposing a policy shift are often the only ones who can bring it about, because their policy support provides a credible signal of policy quality to the relevant interest groups who would otherwise oppose the policy.

Contemporary wisdom has it that only Nixon could go to China and make a deal because his decades of fierce anti-Communist stance gave him credibility with fellow conservatives and shielded him from any domestic attack.

Cowen and Sutter say that a policy could depend on information – on which policies or values everyone could potentially agree, or on which agreement is impossible.

Politicians, who value both re-election and policy outcomes, realise the nature of the issue better through inside and secret information and superior analytical skills (or access to those skills), whereas voters do not have access to such information base or skills.

Only a right-wing president can credibly signal the desirability of a left-wing course of action. A left-wing president’s rapprochement with China would be dismissed as a dovish sell-out. Nixon must be going to China because that is the best possible policy choice and he would never do so otherwise giving his previous record of firm anti-Communism.

Left-wing parties adopt right-wing policies because they are good ideas that will get them re-elected. Bob Hawke, Tony Blair, and Bill Clinton were centre-left economic reformers who can credibly signal the desirability of their economic reforms because of the brand name capital they invested in distributional concerns and protecting the poor.

The same goes for reforming the Resource Management Act (RMA) in New Zealand. Only a left-wing government can implement major reforms such as abolishing the Auckland urban limit and other restrictions on land supply. Deregulation is normally a right-wing policy.

When a left-wing policy undertake reform of land use regulation, things must be so bad on the housing affordability front that they accept that the reforms must be done despite their natural reluctance to deregulate anything on ideological grounds.

Up until past the 2014 New Zealand election, the Labour Party undertook scare tactics on land use regulation reform as a way winning votes from environmentally leaning voters.

Housing affordability situation is now so bad, with a whole generation locked out of housing, that even the ideological opponents of deregulation accept that restrictions on the housing supply are a bad idea.

Naturally the Greens continue to have their head in the sand. That is the big difference between them and the Labour Party. The Greens are policy dilettantes. The Labour Party is made up of people who believe in making difficult choices and the need for trade-offs.

Brexit will lower company tax rates everywhere

Brexit will turn the British Isles into one great big offshore tax haven. The post-referendum plans for a 15% company tax rate (and the Australian plans for a 25% company tax rate) will put pressure on New Zealand to follow suit.

A common argument against a much lower company tax in New Zealand is the clipping of the ticket argument. A lower company tax rate in New Zealand is said to mean no more than the higher after-tax dividends are taxed at a higher tax rate in the home country of the foreign investor. Less company tax is paid in New Zealand but more tax is paid back home for no net gain to the investor.

The 12 ½% Irish company tax rate attracted investment

The strongest evidence against this is the Irish were relentlessly bullied by the rest of the European Union over its 12 ½% company tax. The other EU finance ministers rightly feared a loss of investment to Ireland. This 12.5% rate applied initially to exports, then manufacturing and then trading profits. The fiscal bounty of the Celtic Tiger years allowed the Irish to finesse these complaints based on EU laws about fiscal discrimination by phasing their 32% general company tax rate down to 12 ½ %.

Our Minister of Finance certainly would not welcome the plans (Senate permitting) for a 25% company tax rate in Australia by 2026. Rather than rubbing his hands in anticipation of more tax revenues on dividends repatriated from New Zealand subsidiaries in Australia, Mr. English will worry about loss of domestic and offshore investment to a more competitive neighbouring tax jurisdiction.

Source: OECD Stat.

The first big country low company tax rate

The British already have the lowest company tax of any major economy with the 20% company tax rate that started on 1 April 2016 (see graphic). This rate will fall to 19% on 1 April 2017, and 17% on 1 April 2020. Brexit will take that rate down to 15% at a date to be determined.

No Minister of Finance welcomes the prospect of a leading world economy and Europe’s key financial centre having by far the 2nd lowest company tax rate of any developed economy by 2020. They will worry about lost investment rather than expect a higher local tax take.

High company tax rates lower wages

Too many people mistakenly believe that company taxes are paid by shareholders through lower dividends. With capital highly mobile across borders, countries with high company tax rates attract less investment because of the lower after-tax returns relative to competing destinations.

This capital flight means lower wages in high company tax jurisdictions because their workers have less capital to work with. A lower company tax means higher wages because of more investment.

Even the USA is under pressure

The US got away with a very much above average company tax rate (38%) because its economy is so large relative to the rest of the world but it too is under pressure from footloose capital and corporate inversions. The US company tax system is so full of holes that if all tax loopholes were closed, its federal company tax rate could be cut from 35% to 9% with no net loss of revenue.

Leading US tax economist Laurence Kotlikoff estimated that this tax reform would increase wages by 8%, output by 6%, and the amount of capital invested by 17%. Australian Treasury modelling found that a 10-percentage point cut in their company tax rate would increase wages by 1.4% to 3%.

The race is on

The British company tax rate is now well below anywhere else bar one. That will force other countries, other big economies, to reconsider their position. New Zealand should not be left behind in harvesting the large wage increases that flow from a much lower company tax rate.