1 http://en.wikipedia.org/wiki/Rent_seeking
2 This document synthesises work by other authors. In particular it draws heavily on three sets of authors – Carlaw, Lipsey and Bekar; Haussman, Rodrik and their co-authors; and Douglas North. Some of their work is cited in the bibliography. The document focuses on telling a story of what occurs when we get economic growth, and what that implies for policy. The evidence for this story varies. Some parts of the story have an extensive empirical justification, whereas others are largely judgement, based on whatever evidence is available.
3 Annex 1 lays out why I assume that high and increasing material well-being should be the central objective of economic policy.
4 These other issues include many that are central to well-being, as well as being related to economic performance (see for example Treasury 2001). They are worthy of extended discussion in their own right. They include the relationships between material well-being, welfare, happiness, freedom; sustainability, discount rates, intergenerational equity, interpersonal equity and social cohesion and its impact on economic growth, and so on.
5 The description of economic growth presented here can be thought of as being part of the literature known as heterodox and/or evolutionary economics. (See Nelson and Winter 1982 page 35 ff for a summary of these schools). My presentation is similar to, but presented in a different way from, the determinants of the competitive advantage of nations, as described by Porter 1990, page 72ff. Annex 2 gives a description of the Porter framework and its findings about New Zealand. It asserts that the broad conclusions of the 1991 Porter study of New Zealand – that New Zealand has not developed the multiple sources of competitive advantage necessary to create sustainable competitive advantage - remain broadly valid.
6 Upgraded production includes the use of upgraded inputs, which has been a critical source of competitive advantage in New Zealand's pastoral industries.
7 I make little distinction in what follows between entrepreneurs and businesses. Sautet 2000 gives a fuller description of the relationship. He makes the point that almost all economic agents are entrepreneurs in the sense described here. For example, workers must try to sniff out what jobs are available to them, and choose amongst those that they can identify on the basis of incomplete information. Sautet distinguishes these from the entrepreneur-promoter, who is the one that coordinates resources, including other entrepreneurs, in a planned entrepreneurial way within a business.
8 North explores in detail how entrepreneurs make sense of the world (North 2005, for example at page 38ff). In effect they create models of the world from experience and then behave as if that model were reality.
9 Corporate strategies will often emphasise approaches that focus primarily on product quality or technology leadership, with profit as a spin-off. For example, Angus Tait argued that you focus on the functionality of the product you are delivering to a customer and profit will come from that further down the track. That is, a primary focus on profit takes the eye off the innovation that is needed to create consumer value and so sustained profitability.
10 This has meant that even supposed experts have made predictions that turn out in retrospect to be wildly inaccurate. See http://www.didyouknow.cd/predictions.htm for some examples
11 Provided the incentives are right – see section 3.3.2 below.
12 Although successful innovation typically leads to an increase in productivity, these are not identical. The increase in productivity will typically lag the innovation (Lipsey et al 2005, appendix to Ch 4).
13 The commercialisation of electricity is an example that started with basic science for its own sake. The opposite direction of causality is also common. For example, Pasteur was tackling very practical quality control issues in the French wine industry and as a spin-off created much of the basic science underpinning biochemistry.
14 It is immediately obvious from this discussion that those who led the initial discovery and development of electricity would have had no idea of, and could not profit from, the myriad uses to which it would subsequently be put. The spillovers from the discovery of electricity have vastly exceeded any return that was gained from those who first discovered and commercialised it. This is an example of the more general point that innovation can and generally does lead to substantial spillovers.
15 This is their example:
"Let us consider, for example, a market as apparently simple and straightforward as the real estate market. In this market, assets already exist, they just need to change hands. Buyers need to find out what properties are on sale and what their specific characteristics are. Sellers need to transmit that information to buyers. So a market of real estate brokers develops to achieve these goals. Now, not all the characteristics of a house or apartment are easily visible to a naked untrained eye. There may be hidden defects in the house that the owner knows about and has an interest in concealing from the buyer. This creates an asymmetric information problem that is addressed through a market for inspectors. These inspectors are licensed by some entity and hired by the buyer to report on the conditions of the property and its abidance by the building code.Then it is important to know whether the seller has full rights to the property and that there are no liens or other impediments on his right to sell. This implies that a buyer may pay, only to find out that others also have a legal claim on the property. A system of property registries and a system to track financial and tax claims are needed. But it may be inefficient for the buyer to bear the risk of any surprises, so a market for title insurance is helpful. Also, public authorities may have imposed some easements on that property to secure some public interest, or there may be municipal plans to change the conditions around the property that may significantly affect its value.In addition, the buyer needs finance to purchase the home, for which he needs a market for loans. To address willingness to pay and other incentive and information problems in this market it is convenient to be able to pledge the house as collateral to a lender with a set of rights in case the buyer does not abide by the mortgage contract. A legal system needs to enforce these rights. The lender may also require insurance against fire, storms, etc, lest the collateral blow up in smoke. Hence, a home insurance market is needed.Furthermore, the sale takes time because after an initial agreement has been reached, the inspection needs to take place and the buyer needs to secure financing, title insurance and home insurance. Many unexpected events may happen during that process and it is important to clarify how to deal with them. It may be helpful to require a deposit, a down payment or establish an escrow account to deal with some of these contractual problems, for which a real estate lawyer is needed. The real estate lawyer in turn needs to be accredited (by some body) to carry these functions. If the property is an apartment in a condominium, it is important that the rights and obligations of the apartment owner vis-a-vis the rest of the condominium be clearly established and understood.The previous paragraph shows how complex a simple transaction such as the sale of an existing property actually is and how it is related to a network of markets and institutional arrangements that must co-exist. We described not just a market for homes, but also a market for brokers, mortgage loans, inspections, title and home insurance and lawyers. It involves registries, municipal rules, accreditation of the different specialized agents, rules on creditor rights and condominiums, etc. And this is just some of what is required for trade in existing homes. Imagine now the added complexity involved in urban development and construction."
16 Strictly, because comparative advantage is a relative concept, so is this statement about capabilities and resources. We only need it to hold true in a relative sense. But for a first world country, it will be approximately true in an absolute sense as well.
17 The institutions that a country has depend on its history, and are difficult to change. Thus, like growth itself, the institutions a country has are path dependent. New Zealand is ranked 24th in the world in global competitiveness by the World Economic Forum, behind many OECD countries but ahead of most middle and lower income countries (World Economic Forum 2008).
18 Provided non-material incentives are also consistent with the pursuit of profit seeking behaviour, as is discussed in section 2.42.3 above.
19 That of course is the approach adopted in this paper.
20 See http://www.economist.com/research/Economics/alphabetic.cfm?term=rent#rent for a definition of economic rents.
21 See the discussion in Annex 1, particularly the quote from North, for a fuller discussion of this point.
22 In using the term "market failure" here, I am adopting a more extensive use of the term than is common. As the subsequent discussion makes clear, it includes, for example, measures promoting macro-economic stability to reduce uncertainty and consumer protection legislation designed to stop businesses competing along inappropriate margins.
23 Because humans have bounded rationality, a typical individual simply cannot know all the legislation that governs their behaviour. As a result it is important that if an individual acts as they believe a reasonable person should, they will typically be complying with the legislation governing their behaviour – hence the need for regulation to be "intuitive".
24 As with most innovations, the production line was refined over time, and it actually had its origins in earlier manufacturing processes – for example, in the meat industry and in firearms manufacture.
25 This is not to claim that it is easy to predict paths of future growth potential: it is much easier to look back and explain where we have come from and how, than to look forward to where we will go. However, the foregoing evidence does suggest that it is likely to be difficult for the government to attempt to create a "new" cluster in an area not closely linked to one in which the country has demonstrated capabilities. Porter makes a similar point. His view is that government policy will be far more likely to succeed in reinforcing an existing or nascent industry cluster than in trying to promote an entirely new one, however tempting it might be for national prestige. Perhaps the most beneficial way is through investments to create specialised factors and specialised infrastructure. (Porter 1990, page 655-657)
26 A simple example of such welfare improving government intervention is the law requiring drivers to drive on the left of the road. Agreement on this would be just about impossible to achieve without government action, and it would be very difficult for anyone to profit from achieving it.
27 Rent seeking occurs when an individual, organization or business seeks to make money by manipulating the economic and/or legal environment rather than by trade and production of wealth. See http://en.wikipedia.org/wiki/Rent_seeking.
28 That is, evaluation that is in the top two or three steps of Storey's "Six steps to heaven" (Storey 1998). An example of such an evaluation in the New Zealand context is to be published shortly as an MED Occasional Paper.
29 I use the novel terms "broad-based policies" to refer to more generic policies, rather than the more normal "framework policies" or "regulatory policies". Likewise, I use the term "fine-grained" rather than the more normal "facilitative policies" or "industry policies". The reason is that industry policy can be non-discretionary and quite broad (e.g., export market development assistance). Likewise, regulation can be both discretionary and very fine grained – for example, the so called "rifle shot" provisions in the US Income Tax Legislation (these appear to be drafted in a generic way, but are actually drafted to apply to one particular company).
30 Areas highlighted by the indicators include:
31 The distinction between broad-based and fine-grained policies is not clear cut as this discussion implies. Rather there is a range of policies, across several dimensions. Policies can be more or less broad-based (e.g., general competition policy versus regulation of natural monopolies), evidence can be more or less robust and applicable to New Zealand, and so on. This merely reinforces the point that we have no option but to choose where and where not to intervene.Related to this, it is important to realise that no policy, no matter how designed, is "neutral". Even in as seemingly an innocuous policy as a rule for filing tax returns that applies equally to small and large businesses, tend to favour large businesses over small, because the ratio of compliance costs to profits is less. The same is true of more substantive policies. Thus an appeal to the neutrality of generic policies is essentially vacuous.
32 Some empirical evidence may be available. For example, there may be evaluations of relevant policies that have been applied in other jurisdictions. Micro-data analysis and case study analysis can also provide useful information.
33 In assessing the comparative performance of successful and unsuccessful economies, Struan Little makes clear that both successful and unsuccessful economies have adopted fine grained policies, and indeed many other policies (Little 2001). The detailed design and implementation of policies, and the context in which they are implemented, are important.
34 For example, any attempt to determine likely future areas of competitive advantage should avoid "picking winners" but instead try to identify areas which New Zealand is more likely to be competitive in the future, if we applied a level playing field. By focussing effort on those areas, we are "going with the flow" rather than against it, and therefore we are more likely to generate the momentum (clusters etc) that will yield success. At the same time, we need to be humble about our ability to predict the future in the face of radical uncertainty, so this is about slanting our effort to areas where the potential payoffs are likely to be best, rather than picking winners. We might, for example, put 50% more effort in research, training, industry policy, etc, into those areas than comparable areas where New Zealand had only average prospects (and vice versa into areas where New Zealand had probable competitive disadvantage).
35 It is perhaps worth making the point that adopting any objective for economic policy, including traditional ones such as the "Washington Consensus", relies on judgement. This is because the only formal proofs are based at models that are clearly at odds with reality. That is not a criticism of the models. As the quote attributed to George Box, the industrial statistician, states "all models are wrong, some are useful". The trick is to work out which models are useful in which circumstances.