Freakonomics 5 (The price of safety)

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#GarethMorgan wants sitting tenant laws

Morgan wants to restrict the ability to evict tenants for reasons other than damage to the property and non-payment of rent. This includes not been able to evict a tenant on sale of the property.

We intend to change the regulations around residential tenancy law so leases make it far easier for a tenant to remain in the premises long term…

This will be achieved by restricting the conditions under which a landlord can evict a tenant to those of non-payment of rent or property damage. Sale of a property is not necessarily a legitimate reason for eviction. Tenants will be able to give 90 days notice.

That policy will make winding up of estates difficult. Houses will be have to be left vacant rather than rented while affairs are put in order. That is to name one of many flaws in a policy announced by a party that prioritises being different over been useful and right.

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Source: RENTING Werner Z. Hirsch at encyclopedia of law and economics.

Seinfeld Economics: The Shower Head (black markets)

Does @nztreasury @moturesearch understand its own 90-day trials research?

Media reporting and Motu’s own tweet on its research contradict its own conclusions about what it found about the introduction of 90-day trial periods for new jobs in New Zealand.

Motu’s executive summary is both as bold as the Motu tweet and directly contradicts it

We find no evidence that the ability to use trial periods significantly increases firms’ overall hiring; we estimate the policy effect to be a statistically and economically insignificant 0.8 percent increase in hiring on average across all industries.

However, within the construction and wholesale trade industries, which report high use of trial periods, we estimate a weakly significant 10.3 percent increase in hiring as a result of the policy.

No evidence means no evidence. Not no evidence but we did find some evidence in two large industries – evidence of a 10.3% increase in hiring. That is a large effect.

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Both economic and statistical significance matter. Not only is the effect of 90-day trial periods in the construction and wholesale trades other than zero, 10% is large – a hiring boom. No evidence of any effects on employment of 90 day trial periods means no evidence.

Neither Treasury nor Motu understand their own research and the evidence of large effects in two industries. Can you conclude you have no evidence when you have some evidence, which they did in construction and wholesale trades? There is evidence, there is not no evidence.

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The paper was weak in hypothesis development and in its literature review. It was not clear whether the paper was testing the political hypothesis or the economic hypotheses. Neither were well explained or situated within modern labour economics or labour macroeconomics. If a political hypothesis does not stand up as a question of applied price theory, you cannot test it.

The Motu paper does not remind that graduate textbooks in labour economics show that a wide range of studies have found the predicted negative effects of employment law protections on employment and wages and on investment and the establishment and growth of businesses:

1. Employment law protections make it more costly to both hire and fire workers.

2. The rigour of employment law has no great effect on the rate of unemployment. That being the case, stronger employment laws do not affect unemployment by much.

3. What is very clear is that is more rigourous employment law protections increase the duration of unemployment spells. With fewer people being hired, it takes longer to find a new job.

4. Stronger employment law protections also reduce the number of young people and older workers working age who hold a job.

5. The people who suffer the most from strong employment laws are young people, women and older adults. They are outside looking in on a privileged subsection of insiders in the workforce who have stable, long-term jobs and who change jobs infrequently.

Trial periods are common in OECD countries. There is plenty of evidence that increased job security leads to less employee effort and more absenteeism. Some examples are:

  • Sick leave spiking straight after probation periods ended;
  • Teacher absenteeism increasing after getting tenure after 5-years; and
  • Academic productivity declining after winning tenure.

Jacob (2013) found that the ability to dismiss teachers on probation – those with less than five years’ experience – reduced teacher absences by 10% and reduced frequent absences by 25%.

Studies also show that where workers are recruited on a trial, employers have to pay higher wages. For example, teachers that are employed with less job security, or with longer trial periods are paid more than teachers that quickly secure tenure.

Workers who start on a trial tend to be more productive and quit less often. The reason is that there was a better job match. Workers do not apply for jobs to which they think they will be less suited. By applying for jobs that the worker thinks they will be a better fit, everyone gains in terms of wages, job security and productivity. For more information see

  • Pierre Cahuc and André Zylberberg, The Natural Survival of Work, MIT Press, 2009;
  • Tito Boeri and Jan van Ours, The Economics of Imperfect Labor Markets, MIT Press, 2nd edition (2013);
  • Dale T. Mortensen, “Markets with Search Friction and the DMP Model”, American Economic Review 101, no. 4 (June 2011): 1073-91;
  • Christopher Pissarides. “Equilibrium in the Labor Market with Search Frictions”, American Economic Review 101 (June 2011) 1092-1105;
  • Christopher Pissarides, “Employment Protection”, Labour Economics 8 (2001) 131-159.
  • Eric Brunner and Jennifer Imazeki, “Probation Length and Teachers Salaries: Does Waiting Payoff?” Industrial and Labor Relations Review 64, no. 1 (October 2010): 164-179.
  • Andrea Ichino and Regina T. Riphahn, “The Effect of Employment Protection on Worker Effort – A Comparison of Absenteeism During and After Probation”, Journal of the European Economic Association 3 no. 1 (March 2005), 120-143;
  • Christian Pfeifer “Work Effort During and After Employment Probation: Evidence from German Personnel Data”, Journal of Economics and Statistics (February 2010); and
  • Olsson, Martin “Employment protection and sickness absence”, Labour Economics 16 (April 2009): 208-214.

In the labour market, screening and signalling take the form of probationary periods, promotion ladders, promotion tournaments, incentive pay and the back loading of pay in the form of pension vesting and other prizes and bonds for good performance over a long period.

There is good reasons to have strong priors about how employment regulation will work. Employment law protects a limited segment of the workforce against the risk of losing their job. These are those who have a job and in particular those that have a steady job, a long-term job.

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The impact of the introduction of trial periods on employment will be ambiguous because the lack of a trial period can be undone by wage bargaining.

  • If you have to hire a worker with full legal protections against dismissal, you pay them less because the employer is taking on more of the risk if the job match goes wrong. If they work out, you promote them and pay them more.
  • If you hire a worker on a trial period, they may seek a higher wage to compensate for taking on more of the risks if the job match goes wrong and there is no requirement to work it out rather than just sack them.

The twist in the tail is whether there is a binding minimum wage. If there is a binding minimum wage,  either the legal minimum or in a collective bargaining agreement, the employer cannot reduce the wage offer to offset the hiring risk so fewer are hired.

The introduction of trial periods will affect both wages and employment and employment more in industries that are low pay or often pay the minimum wage. Motu found large effects on hiring in two industries that used trial periods frequently. That vindicates the supporters of the law. 

Motu said that 36% of employers have used trial periods at least once. The average is 36% of employers have used them with up to 50% using them in construction and wholesale trade. That the practice survives in competition for recruits suggested that it has some efficiency value.

The large size of the employment effect in construction and wholesale trades is indeed a little bit surprising. Given that a well-grounded in economic theory hypothesis about the effect of trial period is ambiguous in regard to what will happen to wages and unemployment, a large employment effect is a surprise. If Motu had spent more time explaining employment protection laws and what hypotheses they imply, that surprise would have come to light sooner.

Motu’s research for the remaining New Zealand industries was a bit of an outlier. It should have spent more time explaining how to manage that anomalous status in light of the strong priors impartial spectators are entitled to have on the economics of employment protection laws.

A conflicting study about the effects of any regulation should be no surprise. If there are not conflicting empirical studies, the academics are not working hard enough to win tenure and promotion. Extraordinary claims nonetheless require extraordinary evidence.

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Dr Mark Pennington – ‘Robust Political Economy’

Will @JulieAnneGenter’s KiwiBank plan bankrupt KiwiPost? @JordNZ

The Greens are followed up on an earlier suggestion by Julie Anne Genter, the Green’s Shadow Minister of Finance, that KiwiBank should be refocused to keeping interest rates low. To that end, it would not be required to pay dividends to the government to help fund the effort. KiwiBank has only just started paying dividends to its parent, KiwiPost.

If that were to be the case, that KiwiBank was no longer be required to pay dividends, that would blow quite a hole in the balance sheet of its parent company KiwiPost.

KiwiPost owns the share capital of KiwiBank, which must be valued on a commercial basis to pass auditing as a state owned enterprise which is commercially orientated.

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Source: Historic $21 million dividend paid by state owned bank Kiwibank | interest.co.nz.

That share capital owned by KiwiPost in KiwiBank would be have to be written off if KiwiBank were to pay no further dividends because it is no longer commercially orientated entity. Such a write-off of its investment in KiwiBank would write off most of Kiwi Post’s equity capital.

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Source: Some 14 years after it launched and nearly NZ$830 mln later, Kiwibank predicted to become a self sustaining dividend payer in 2016 | interest.co.nz.

The reason why state owned enterprises are required to be valued on commercial principles is to ensure that any subsidies or other favours sought by politicians show up in the profit and loss statement or the balance sheet through asset write-offs. Section 7 of the State-Owned Enterprises Act 1986  non-commercial activities states that:

Where the Crown wishes a State enterprise to provide goods or services to any persons, the Crown and the State enterprise shall enter into an agreement under which the State enterprise will provide the goods or services in return for the payment by the Crown of the whole or part of the price thereof.

This statutory safeguard ensures that the cost of any policies proposed by ministers, and the Greens are very keen on transparency and independent costing of political promises, are plain to all.

@NZGreens expand KiwiBank into wrong market to cut mortgage rates @JulieAnneGenter

The Greens want to cut mortgage rates by having KiwiBank expand in business lending. Wrong market.

This expansion into a market that is not the mortgage market is to be underwritten by a capital injection as the Greens explain:

    1. Inject a further $100 million of capital in KiwiBank to speed its expansion into commercial banking;
    2. Allow KiwiBank to keep more of its profits to help it grow faster; and,
    3. Give KiwiBank a clear public purpose to lead the market in passing on interest rate cuts.

Note well that the $100 million capital injection is to expand in to commercial banking. More aggressive passing on of interest rate cuts may jeopardise credit ratings if this lowers the profitability of KiwiBank. KiwiBank has an A- rating

The bigger hole in the policy is the more aggressive mortgage rate setting by KiwiBank will be done by keeping more of its profits and paying fewer dividends to its parent company Kiwi Post and through that to the taxpayer. There are next to no dividends currently to stop distributing to fund a more aggressive mortgage rate setting policy.

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Source: KiwiBank pays its first dividend of $21 million to Government | Stuff.co.nz.

KiwiBank paid its first dividend last year. Prior to that, the bank kept all profits to allow it to expand its lending base. $20 million in foregone dividends does not go far given the actual size of all  lending markets in New Zealand.

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Source: G1 Summary information for locally incorporated banks – Reserve Bank of New Zealand.

KiwiBank is minnow in the mortgage market and a pimple in commercial lending. Rapid business expansion is risky in any market, much less in banking.

The government has declined further capital injections so profits were retained to meet capital adequacy ratios. The government in 2010 earmarked NZ$300 million for an uncalled capital facility for NZ Post to help maintain its credit rating and KiwiBank’s growth.

Saving the best for last, KiwiBank last year announced plans to borrow up to $150 million through an issue of BB- perpetual capital notes to be used to bolster the bank’s regulatory capital position.

The Margin for the Perpetual Capital Notes has been set at 3.65% per annum and the interest rate will be 7.25% per annum for the first five years until the first reset date of 27 May 2020. Kiwi Capital Funding Limited is not guaranteed by KiwiBank, New Zealand Post nor the New Zealand Government.

The Perpetual Capital Notes have a BB- credit rating compared to KiwiBank which has an A- rating. These capital notes were issued in addition to prior subordinate debt in the form of CHF175 million (about NZ$233 million) worth of 5-year bonds.

I doubt that KiwiBank can raise capital through subordinated debt under normal commercial conditions if it does not plan to seek profits in the same way as other commercial banks do. The current issue of Perpetual Capital Notes are already rated as junk bonds:

An issue of $150 million of perpetual capital notes from KiwiBank with a speculative, or "junk", credit rating have been priced at the bottom of their indicative margin range.

The closest the prospectus for these Perpetual Capital Notes got to complementing KiwiBank changing from a normal business to being a public good is the following risk statement:

Kiwibank’s banking activities are subject to extensive regulation, mainly relating to capital, liquidity levels, solvency and provisioning.

Its business and earnings are also affected by the fiscal or other policies that are adopted by various regulatory authorities of the New Zealand Government.

The interest rate on this subordinate debt will go up to offset the additional risk  of aggressive lending and aggressive expansion, which will cancel out many of the advantages of not having to pay for dividends and the capital injection.

That discipline is one of the  purposes of subordinate debt in the regulatory capital of banks. This is to provide another pair of eyes and ears to watch the performance of the bank and through rising costs of lending and risk ratings, signal trouble of imprudent lending and lack of cost control.

The proposal to use KiwiBank to lower mortgage rates does not add up. KiwiBank does not pay much in the way of dividends to fund such a foray.  KiwiBank is already far more leveraged than any other New Zealand major bank.

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Source: NZ trading bank leverage | interest.co.nz