Transcript Risk, capital markets and the future: a new generation

What ails the economy: turning New Zealand’s small
size from a weakness to a strength
16th March 2011
New Zealand Institute, Wellington
Nicholas Gruen [email protected] @nicholasgruen
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
Australia
OECD Ave
New Zealand
2009
2006
2003
2000
1997
15
1994
1991
1988
1985
1982
1979
1976
1973
1970
'000 USD, constant prices
GDP per capita ('000 constant USD)
35
30
25
20
Reform
10
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
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
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
Did MFP rise mainly
because ECA took
investment pressure
off business?
Australia
New Zealand
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
But . . .
Big access to capital differences
7
6
5
4
3
2
1
0
Sharemarket capitalisation/GDP
200
150
100
50
Australia
New Zealand
2009
2006
2003
2000
1997
1994
1991
1988
0
Australia
New Zealand
2008
2005
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
Gross Savings rate
30
25
20
15
10
Current account deficit
5
0
-5
-10
Australia
New Zealand
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
-15
Gross external debt
160
140
120
100
80
60
40
20
0
2004
2005
2006
Australia
2007
2008
New Zealand
2009
2010
Building knowhow
R&D/GDP (%)
Australia
New Zealand
2008
2005
2002
1999
1996
1993
1990
1987
1984
1981
2.50
2.00
1.50
1.00
0.50
0.00
OECD Ave
Business expenditure on R&D/GDP
2.00
1.50
1.00
0.50
Australia
New Zealand
2008
2005
2002
1999
1996
1993
1990
1987
1984
1981
0.00
OECD Ave
Services exports/share of exports
30
25
20
15
10
Australia
New Zealand
2009
2006
2003
2000
1997
1994
1991
1988
1985
1982
1979
1976
1973
1970
5
Sophisticated services exports/share of exports
30
25
20
15
10
Australia
New Zealand
2006
2003
2000
1997
1994
1991
1988
1985
1982
1979
1976
1973
1970
5
Reduction in inequality due to public
cash transfers and household taxes
Point reduction in the concentration coefficient
Public transfers in cash
Household taxes
SWE
SWE
DNK
DNK
BEL
BEL
CZE
CZE
IRL
IRL
AUS
AUS
SVK
SVK
NOR
NOR
DEU
DEU
GBR
GBR
NZL
NZL
NLD
NLD
OECD-22
OECD-22
ITA
ITA
LUX
LUX
FIN
FIN
CAN
CAN
FRA
FRA
AUT
AUT
JPN
JPN
USA
USA
KOR
KOR
0.00
0.05
0.10
0.15
0.00
0.05
0.10
0.15
21
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
GDP per capita (% deviation from OECD ave)
30
20
10
0
-10
-20
-30
1950
1960
1970
Australia
1980
1990
2000
New Zealand
2010
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
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
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
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
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
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
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
Company tax and growth - empirical evidence
Djankov, Shleifer et al, 2008, NBER
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
Labour supply response according to MITTS
Elasticity
1.3
0.8
0.3
-0.2
1
2
3
4
5
Household Income (Quintile)
Married men
Married women
Single men
Single women
Lifting thresholds versus cutting top rates
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%)
-50
-100
Australia
Ireland
New Zealand
Australia
Ireland
New Zealand
200
20
150
100
10
50
0
0
-10
GDP per capita growth (%)
2009
2007
2005
2003
2001
1999
1997
1995
1993
1991
1989
1987
GDP per capita (1987 = 100)
300
30
250
30
200
20
150
100
10
50
-100
2009
2007
2005
2003
2001
1999
1997
1995
1993
1991
-50
0
1989
0
-10
Australia
New Zealand
Luxembourg
Ireland
Australia
New Zealand
Luxembourg
Ireland
GDP per capita growth (%)
250
1987
GDP per capita (1987 = 100)
300
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?
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
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)
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
Abolishing imputation to lower company tax
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
Sophisticated services exports/share of exports
30
25
20
15
10
Australia
New Zealand
2006
2003
2000
1997
1994
1991
1988
1985
1982
1979
1976
1973
1970
5
Successful exporters of financial services
– Traditional centres
• London, New York
Traditional centres
of large countries
or empires
– Legitimate low tax high service financial centres
• Ireland, Luxemburg
Small countries
– Offshore tax havens
• Macau, Bermuda, Cayman Islands and many others
Small countries
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
The tax jigsaw for global funds
Tax Treaties
Asset
Fund
Investor
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
Co-evolution
Regulatory co-evolution in global financial centres
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
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
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
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)
GDP per capita (1980 = 100)
350
300
250
200
150
100
50
Austria
Finland
Greece
Italy
Norway
Sweden
Belgium
France
Iceland
Luxembourg
Portugal
Switzerland
Denmark
Germany
Ireland
Netherlands
Spain
United Kingdom
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
0
Absolute GDP per capita (US$ in 2000)
70000
60000
50000
40000
30000
20000
10000
Austria
Finland
Greece
Italy
Portugal
Switzerland
Belgium
France
Iceland
Luxembourg
Spain
United Kingdom
Denmark
Germany
Ireland
Netherlands
Sweden
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
0
Regulation as a service: Co-evolution in Delaware
Regulation as a service: Co-evolution in Delaware
Source: US Institute for Legal Reform
Regulation as a service: Co-evolution in Delaware
Source: US Institute for Legal Reform
Delaware: It’s lonely at the top
Source: US Institute for Legal Reform
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
Information and reputation
Information and reputation
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
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
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.
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
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
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.
Health information regulation
Just as in finance, strong regulation for integrity
and transparency enhances competitiveness
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
Real estate or other sales
Agent 1
Agent 2
Agent 3
Accuracy of past
prognoses
Prognosis
5%
$ 420,000
-2%
$ 415,000
$ 450,000
-15%
Indicated Service provider
Expected
price
$ 441,000
$ 406,700
$ 382,500
Litigation
Provider A
Provider B
Provider C
Correction for
Raw
accuracy of past
Prognosis prognoses
13%
85.0%
0%
91.0%
-5%
95.0%
Indicated Service provider
Expected
chance of
success
96.00%
91.00%
90.00%
Medical procedure
Hospital A
Hospital B
Hospital C
Correction for
Raw
accuracy of past
Prognosis prognoses
-30%
2.0%
25%
4.0%
30%
1.5%
Indicated Service provider
Expected
chance of
adverse event
1.40%
5.00%
1.95%
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
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’.
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
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
Global Competitions
Predicting HIV viral load
Competition closes 77%
1½ weeks 70.8%
State of the art 70%
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
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
Where’s Wally?
Jeremy?
The top 3 competitors for:
Forecast
Take
Chess
RINFORMS
on
Package
the
Eurovision
Ratings
Quants
Tourism
Forecasting
Predict
HIV
Recommendation
Voting
1 & 22
1 Engine
Part
Edmund & Adrian
London & USA
Dr. Derek
Gatherer, UK
Felipe Maia
Uppsala University
Dr. Christopher
Hefele, New York
Cole HarrisChris DuBois
Texas
Portland
Ivan
Russian Federation
Philipp Emanuel
Widmann
Heidelberg,
DE
Gzegorz
Swiszcz
Gera
Jure Zbontar
Giuseppe Ragusa
Ljubljana
Rome
Robert
Warsaw
Chih-Li Sung & Roy Tseng
Penghu & Taipei
Claudio Perlich
Edmund
USA& Adrian
Jason Trigg
John Blatz
London & USA
Pennsylvania
Baltimore
Chris
Raimondi
Jason Trigg
Batimore
Pennsylvania
Nan Zhou
Pittsburgh
Uri Blass
Tel-Aviv
Lee Baker
Las Cruces,
New Mexico
Jeremy Howard
Thomas Mahony Glen Maher
Canberra
Canberra
Emir Delic
Australia
Rajstennaj
Barrabas
USA
Where’s Wally from?
E [email protected]
T @nicholasgruen