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May 25, 2014 | by  | in Features | [ssba]

An Interview with the Chief Economist

Duncan and Cam chatted to Girol Karacaoglu, the Chief Economist of the Treasury, and the man who controls the levers of power.

What is NZ’s economic position at the moment? How is NZ faring?
We just completed our economic forecast. If you look at the timeline for this forecast it is about 5 years. In the next two or 3 years we are definitely seeing a significant recovery in the economy, in fact even exceeding what we refer to in economics as our potential growth rate. The growth is going up to about 3% but stays there for only 2 or 3 years. The fundamental challenge therefore for the economy is how do you increase that growth rate so that it is at a sustainable level and it does not peak and then come back. And during this phase when it is actually pretty strong what measures do you put in place to make sure it doesn’t damage the possibility of getting to a higher plateau? And that’s why there is a lot of focus on controlling the level of government expenditure and its composition and repaying debt because all these things put pressure on growth prospects.

The other point is that in thinking about what we need to do especially when you are thinking 40 year ahead, 50 years ahead, it’s not only about how fast we grow, it’s all about  the other things that we care about. Is it sustainable? Or are we just cutting down trees? I mean you can always you can always grow faster by cutting down all the trees and selling them. You need to think about further future generations and their sustainability. You need to make sure its not just the average numbers that you are looking at its the distribution of that. are all the people benefiting and contributing? wet hink about alot social cohesion we call it. in other words think about immmigration, you can use it as an engine for increasing our population and also the skill base but it creates pressure on the economy in the short term on housing and all that and in the medium term on social infrastructure. Think of nz in the 1950s. we had the Maori and the Pakeha. Now play it forward to now and we have a much mroe diverse population and then play it forward if you make it a policy of increasing population you have the benefit of technical know how that comes with an increased population but it puts pressure on your social infrastructure.

And finally we think about the risk side of things. so as we found out in the global financial crisis, you lower interest rates you encourage a lot of people to borrow. They buy houses and seemingly everything is going well and then all of a sudden everything blows in your face because you didn’t focus enough on the wider risks. These risks can come from not only the finance side but also environmental risks, it could be social risks, it could be a disease coming from overseas. So the risk dimension of the thinking is what are the big risks that can affect our overall wellbeing. It could be natural disasters. What kind of institutions do you create to make sure someone is watching that big picture? So that’s really the policy challenge. and the other thing we did which does look 40 or 50 years ahead. You may have seen the long term fiscal statement ‘affording our future’. Under the law of the land every four years we have to look forty years ahead and identify the key issues ahead and then say what are our policy options. We again framed it not only as what are the options to live within the budget but also to think of what are the other elements such as the environment, social infrastructure, equity especially in the retirement area, is there equity between generations? Because the young pay and the old benefit. And if you have a population where the old relative to the young is exploding over the next few years then you have huge challenges. How do you pay for that? Starting today, so it is not only can we afford it but also there is an intergenerational issue of fairness.

So do you think the current superannuation scheme is unfair in that it places too much on youth?
No no superannuation is absolutely fair. in the sense that everyone is aware of those long term challenges. No one denies that when you look 50 years ahead, we have these pressures coming. The debate, which is a fair minded debate, is what do we do about it? And secondly how urgent is it? Do we need to start facing it right now or can we wait a bit longer? And the third element (which is the how) is there already natural behavioural dynamics which people are adjusting to? Do we need to play with any policy levers? Those are the issues. For example raising the age of retirement but the debate in NZ is really do we need to raise it in NZ? And if so when do we need to start? how quickly do we need to raise it? and if we don’t raise it what are the other options? There are so many strong tradeoffs that only the elected representatives of the people having seen all the consequences and they say this is what we want to do and this is when we want to start.

And as we understand it, the Minister has said that for the foreseeable future the current superannuation plan is affordable but it may have to be looked at in the next couple of budgets?

Yeah everyone is saying we will have to look at it but how soon do we need to do that? Because the other debate is if you want to worry about superannuation, do you want to encourage people? Do you need to force people, or do people actually look after themselves? Our role is to say let’s look at all the options and do the proper analysis and say these are the areas where people agree. These are the areas where disagreement, where you have to use your judgment. There is nothing you can really do.

And i guess its quite a big exercise to do these predictions?
This is one area we work on. There is one the projections piece. In other words Statistics New Zealand does projections on how long people live. What’s the gender mix? There’s the age mix. All these are projections. We take it. Where the analysis comes is given all these projections and the pressures they imply, what are the kinds of policies that can address these. In the health area, it’s not just the retirement age, we have an ageing population with people expecting the latest technology. So if someone can have a hip that goes on for 50 years and NZ is still using one that goes for only 15 years people now know that and say why aren’t we doing that? So that is another cost pressure. But again there are options and we just say these are the alternatives and then when you come to kiwisaver versus the other dimensions you say how will it play against the other dimensions of the Living Standards Framework. Kiwisaver can be compulsory or it could be encouragement. Or you could do it through taxes. There are all sort of combinations you can use.

Of course if the government says you give me your best policy advice, we give it. So one area we are giving it is in the macro fiscal area where we are saying to the government if you actually use the surpluses that we expect over the next few years to repay debt and then eventually to start contributing to the New Zealand Super Fund, that’s one scenario. If you actually allow that surpluses to be distributed through various benefits and all that putting pressure on interest rates, that is another scenario. Here are the consequences of that. And here our advice is clear. Repay debt, focus govt expenditure on where it adds most value also eventually start putting more money to the New Zealand Super Fund.

It sounds like the NZ economic forecast is pretty positive, what are the real impacts of that growth on our daily lives? How does growth make our lives better?
For young people like you it is two or three things. Because I have children your age. one is obviously employment prospects. one of the things that is happening right now is all of a sudden instead of a lot of young people leaving to australia now net migration figures have started positively increasing. Young people are now finding prospects here better relative to Australia.

The other element is of course income. because if the economy picks up hopefully wages or real income should be higher.

The third element is how it affects a New Zealander owning a home. Is it making homes more or less expensive?

The fourth area is where do you want to live within NZ. I mean there is a lot of movement to Auckland and regional policy offers the prospect of people living a good life in all parts of NZ.

So the living standards framework, step us through that?
At this point the living standards framework is nothing more than an encouragement to all our analysts across the treasury and also in our interactions with people from across the public sector to think of the impact of policy as well as the way that we develop policy and its broader consequences. And we are also saying to these people we are not templating how you use it. We are just encouraging you to think more broadly and those dimensions you have are not going to be the be all and end all this is just a suggestion.

So for example some people put a culture dimension onto it. If you are using it in an economic sense you may ask can we afford it? In our environmental discussion, what is the impact on the environment? We have about 10 teams in the treasury who are trialling it. The other thing that it does which is very heartwarming is it surprises you with what you come up with. For example when the defence team used it, the starting point was always to the risk management side of the living standards because defence is all about protecting. After a lot of conversations among themselves they quickly came to the decision that if anyone seriously wanted to invade New Zealand they will do it in two hours. So this defence thing is not about risk management and protecting us. It is all about social infrastructure in the wider Pacific actually. Most of the effort goes into working with those communities building bridges etc. The other thing is that it brings people who start from totally different corners in a discussion and say okay if we were to use this framework and have a rich discussion about this what sort of policies may help us? We quickly for example chose education. Especially education spent on the lowest income people, getting them into school and into jobs as being the main one of our policy levers. And that is where we are focussing.

Do you think it will result in more politicisation not in the treasury but of the treasury when the governmentt can say well we went with this because it produces the most growth where as the opposition can say well you went with it even though you knew it was going to damage social infrastructure in the country. Do you think that treasury reports will be used as more of a political tool?

If there are tradeoffs then of course different governments will have different weighting put on those different dimensions. Some government might say they care more about economic growth. Other governments will care more about the environment. The other thing we are trying to do is finding a way of asking the people how they will weight these things. We are trying by very clever questioning to reveal your preferences. So that would be another way of holding the mirror and going okay if we have a choice between a person having another ten dollars in their pockets or someone else not going home with food then how would you, as a New Zealander react to that and trying to ascertain that?

Do you think this will help in the long term help dispel the perception that the treasury is just a right wing think tank?
Well there was that perception. I am hoping that in the last few years that has disapated, because we have done a lot of talking about these. And yes it will be because the living standards framework has been very well received. Both across the public sector and in the wider public arena. The challenge we face however to actually be really informing and framing policy advice and that is really difficult because as you can imagine it is very easy to solve a problem if you are optimising one function versus trying to come up with an optimal policy solution when you have five dimensions. And that is very messy. It just relies on people’s acceptance that not everything will be solved quantitatively. So in a few policy discussions, what we did was we said lets accept that some. It’s getting to a point where analysis doesn’t have to be purely technical analysis.

From your perspective is the government investing enough in the tertiary sector to create the knowledge economy that it wants?
I gave a presentation to a gathering of tertiary sector people and I presented the living standards framework. When we think of the role of the tertiary sector, it is true that we are interested in whether the tertiary education is producing graduates that are employable but also we care about other things. So we talked about economic growth for example it’s obvious it builds human capital. But then we talked about sustainability and equity. So in the equity space tertiary education’s considerations under access and funding. This is the way we are bringing the framework to the tertiary sector.

When I presented at that gathering in Auckland nobody pushed back. I thought they may that we were emphasising job prospects for graduates. In fact they were talking about second chances about people who want to re-skill. Whether we are putting enough emphasis on that. They didn’t push us we can just teach anything because it is good to know about literature. They understand the tradeoff between that and job prospects.

So I guess in a real world setting, the increased STEM funding came out of that. It was considered that those are the job areas where you have the most job prospects?
That’s right and also if you look at the government’s Business Growth Agenda there is a technology element and within that there is funding for research. So clearly there is an awareness of funding that goes to encouraging research and linking that up to universities that encourage that research is going to to be a serious investment in terms of generating economic growth. And good economic growth because it creates jobs, higher real wages, sustainable, and connects us to the rest of the world.

I guess one of the main things that our generation is very aware of is inequality. Where does the treasury stand on it? What is the more pressing issue inequality or poverty?
To me there are two or three issues. The one that we are really focussing on is the concept of dynamic inequality. In other words, at any point in time you can measure the extent to which somebodys income is 60% or less of the income of the median. That’s relative inequality. The point is if you look at across time and you monitor the same people through their lifetime what proportion of the population, if you think of an apartment block with ten levels, people start with the basement and then move up to the 2nd and then up to whatever you call the top floors of these things. As long as they are moving up this thing that’s okay because it is a dynamic society: different life choices different stages. I wouldn’t worry about that. However if you have 7%, 8% of the population stuck permanently in the basement, that is a problem. So our focus is on that basement. Let’s identify those who don’t have the opportunities to move up and give them the focus of education and health and everything else. We focus on that dynamic inequality. The key issue here is how do you make that money be directed to the right people.

Free doctors visits to those under 13: a lot of people would say that was good but in terms of targeting it at the group of people that need it most, do you think it would be better to have it as means tested?

If you could zoom in and really give the money to the people who really will benefit from it and can do effectively then probably most reasonable people would support it. Evidence from around the world is whenever you try and do it that way, human resources are wasted by people trying to find there way around. So for targeted things the main argument there is not the intent of it. Of course you want to give help to those who really need help. But the more you go out into that mode, evidence from around the world is that in fact the cost benefit is hugely costly. Because people are figuring out how to get around it. That’s why in policy people always think run it flat so that you don’t kill the incentive to keep working but also don’t overcook the pea size targeting because one it is difficult, the other is that it creates the wrong incentives.

So there are always unforeseen circumstances:
That’s right and the buzzword is unintended consequences. GST is a good example. You know should we exclude food? We find that NZ is one of the cleanest no exclusions and anyone who tried to do it is creating a mess for themselves. It’s not because in spirit its not the right thing to do its because tax systems have to be simple flat and be aware of the need to raise revenue but also be aware of the need to not create incentives for people.

I guess it’s the difference between the ideal and the real world. That must frustrate you a lot
Oh it drives me crazy. That’s the unintended consequences.

Do you find that there is lots of work going on between the Australian and New Zealand treasury?
There is a huge amount of work going on between the NZ, the UK, US, Canada, Australia. Direct work and learning from them. With the Australian treasury we have lots of interactions. The current theme is we are saying we should not limit ourselves to just looking at those countries, which we are culturally aligned at and all that because there are fascinating things happening in Asia and in the Nordic countries. And all around the world.

You’d hope that the chief economist of the treasury would be slightly more prudent about the way that they personally spend. Do you have any tips for students about the way that they personally spend? what are your top budgetary tips?
This is very dear to my heart because I have lived with three teenagers and all their friends because our home was like an open home for all those people. And my obsession with all those kids was to talk to them about saving. And because I used to do it towards the end of the meal they would always say, “That was a really fantastic meal thank you,” and leave the table. They knew that that lecture was coming. The basic wisdom is whatever income you are earning whether it is one dollar or a million dollars, try and put ten to twenty percent into savings and don’t touch it. That’s my philosophy. Now what form that takes is your call. I am a very conservative person, I go into banks and all that. But if you want a share in the sharemarket that’s another thing. My advice is be aware of the difference between saving and investing. Saving is building an estate that is protected. Investing is about growing wealth and with investing comes its risks. The discipline of living within your means and saving is the main lesson, I give people, and I apply it all the way in my life. This simple message seems to annoy young people.

Do you think the government should do the same?
Our advice now is to repay that debt, go into surplus and get back to a position where you have that cushion. Because when you need to borrow imagine if you have borrowed to your tilt and then you can’t borrow when you are ill. It’s the same here. That’s what we always advise the government and draw parallels between the government and individuals. Saving, investing it’s all about the same thing.


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