published 4-Mar-1998, under headline "'Fiscal Responsibility' lead to buck-passing"; © 1998 New Zealand Herald
letter in reply from the Reserve Bank, NZ Herald, 13 March 1998
Auckland's Power Debacle:
Why Mercury Energy should not take all the Blame
Keith Rankin, 24 February 1998.
While Mercury Energy surely deserves a great deal of opprobrium as a consequence of the failure of its cables to supply electricity to the centre of Auckland, I believe we need to look at the bigger picture.
The problems stem from the growth of Auckland at the expense of the rest of the country, and from the effects of two cultures now widely pervasive in New Zealand.
The first culture, that of commercialisation of all aspects of life, treats public infrastructure as no different from other commodities that are bought and sold. While the commercialisation and partial privatisation of public utilities is an important part of the problem, there is no reason to believe that Mercury Energy has done anything significantly worse than the reformed utility sector as a whole.
The second culture, a recent reinterpretation of "financial responsibility", suggests to us that not spending money is generally more responsible than spending one's income. A financially responsible enterprise is one which is seen to have cut its workforce to the bone.
The Government has taken a strong lead in spreading this culture, both through its Fiscal Responsibility Act, and through its campaigns to encourage if not force overstretched New Zealand families to save more. Budget surpluses are seen nowadays more as means to cutting taxes than to any future commitment to investment on the social or physical infrastructure of the nation.
Financial responsibility has come to mean maximising surpluses and externalising costs. Externalising costs means making someone else pay for the catastrophes and the lesser more regular disasters (such as Auckland's commuter gridlock) that arise either from chance, from negligence, or from a bit of both.
With respect to public utilities, we have seen the culture of financial responsibility transform itself a culture of cost-cutting, redundancies, buck-passing, and risk-taking rather than planning for the adverse contingencies which, more often than not, do not happen. The motive of income maximisation - of maximising surpluses - is not compatible with the motive of security of supply. As we noticed with Electricorp in 1992, and Auckland's water services in early 1994, it was less costly for the supplying utilities to pray for rain than to prepare for its absence.
Another part of the problem is that, thanks to the devolution of responsibility, public utilities are constituted to "defend their patch", even if it means legal disputes with other utilities. Mercury Energy found itself in a legal dispute with a public agency, Transit New Zealand, causing a long delay in commencing the long term tunnel solution. Whereas the coordination of infrastructure is of paramount importance to the public, this bigger picture is often lost on the utilities themselves.
The devolution of responsibility that created this situation now affects all areas of public life. Ironically, it has coincided with the rapid expansion of executive central government. As each devolutionary reform has taken place, the government has been increasingly able to stand aloof from failures in the supply of public goods.
The most important cause of the present problem is the regional imbalance in New Zealand's economic growth; an imbalance that is seeing Auckland grow at the expense of the rest of the nation.
This unbalanced growth is perhaps more a result of the Reserve Bank Act than any other piece of legislation. Since the late 1980s, New Zealand has been plagued by chronically high real interest rates, and an exchange rate that has been overvalued more often than not. Furthermore, when interests rates and exchange rates do fall, we know that they will never be allowed to fall very far. Falling interest rates no longer inspire confidence in the foreign-exchange earning sectors.
In a healthy functioning market economy, economic activity is attracted to regions where the potential standard of living is high but the cost of living is relatively low, and where there is an underemployed workforce. The maintenance of infrastructure in the South Island and the North Island "heartland" is critical. In New Zealand, however, a "fiscally responsible" government shuts down infrastructure in the areas that are losing population, thereby making permanent the flow of economic activity into a grossly overstretched Auckland. The persistent flow of labour and capital into a single high cost centre is an indicator of a very sick market economy.
Under a high interest and exchange rate regime, money was sucked into New Zealand at the same time as it was being denied to the vital tradeable sectors. Where did that money go? Into Auckland's central business district, of course. Some of it was spent on imported energy-hungry air-conditioning units used to service buildings whose windows cannot even be opened.
The electricity supply problem is simply another chapter in the problems of water shortages, overstretched schools, public hospitals, inadequate public transport, and gridlock on Auckland's roads. The latter problem includes the appalling logjams on the main highway north, from Albany to Waiwera. Just when is the Orewa by-pass going to be built?
Auckland is now less a mini-Sydney and more a micro-Buenos Aires. New Zealand is starting to display the regional imbalances characteristic of South American countries. Like Buenos Aires, Greater Auckland has one-third of its nation's population.
Auckland's problem is New Zealand's problem. An essential part of the solution is some planning in Wellington, leading to policies that favour regionally balanced growth. A second part of the solution is to develop a new quite different fiscal contract, and hence a new culture of what it means to be financially responsible. A new fiscal contract might associate fiscal responsibility with higher taxes and more social investment spending on infrastructure, on families, and on the environment. A programme of social investment has the added socially responsible advantage of creating full employment.
I am an owner of Mercury Energy. While I neither live nor work in Auckland's central city area, I am nevertheless inconvenienced by the shutdown of the city. I don't want to have to pay twice, by having to share in the payment of compensation to central city businesses; compensation that will arise if Mercury Energy is forced to become the sacrificial lamb.
Rather than focusing on blame, I want to see something good come out of this crisis; something like a national commitment to public utilities as public utilities. A start might be an end to the pressure from Wellington to privatise the Auckland Regional Services Trust.
Reply by Paul Jackman, Communications manager, Reserve Bank:
Keith Rankin's suggestion that the Reserve Bank Act caused the Auckland power crisis is astonishing. In essence Mr Rankin is saying that high interest rates, required to contain inflation, have massively overstimulated growth in Auckland's central business district, based on overseas money. As a result, he says, the city's infrastructure, including power supply, has been unable to cope.
What are the facts? High interest rates discourage spending,1 and have been restraining economic activity in Auckland, as in the rest of the country, in the last two or three years. Yes, Auckland has had a speculative boom, now over, but this has been in spite of Reserve Bank policies.
If the Reserve Bank had gone soft on inflation and adopted an easier monetary policy, accelerating inflation would have encouraged investors to get out of financial investments and into inflation hedges, such as commercial real estate.2
If we had had more inflation, real estate investment in Auckland's central business district would have expanded even faster, at the expense of the real economy elsewhere. This would have required even more power in central Auckland and, by Mr Rankin's logic, the lights would have gone out even sooner.3
Of course I didn't say that "the Reserve Bank Act caused the Auckland power crisis", as the Reserve Bank's Paul Jackman claims (letters 13 March). Rather, I said (Herald 4 March) that a substantial contributing cause was regionally imbalanced growth. I used the Reserve Bank Act as an important example of a macroeconomic strategy that, in the 1990s, discouraged spending much more in other parts of the country, leading to relative growth in Auckland.
I went further, suggesting that there was a positive stimulus to the central business district arising from the influx of overseas money chasing high interest rates in the mid-1990s. It is disingenuous for Mr Jackman to suggest that a greater influx would have taken place had interest rates been lower. The appreciation of the $NZ exchange rate coinciding with a balance of trade deficit serves as proof that the influx resulted from high interest rates, as it did in 1985-87 when spending in Auckland was even more conspicuous.
I would like to challenge Mr Jackman's view that inflation in mid-90s' New Zealand was lower than it would have been had monetary policy not been tightened in 1994. In the USA, the Federal Reserve took a different view of the extent to which GDP growth would lead to inflation. As a result, the United States continues to experience low interest rates, and high growth without inflation.
1. There are several instances where the opposite is true. First, where a person is a creditor rather than a debtor, high interest rates mean more income and more spending. Second, where high interest rates attract a net monetary inflow from overseas, then more money means more spending. Third, high floating interest rates do not deter spending because the borrower expects them to fall, and expects a capital gain on the asset acquired. [back]
2. In 1985-87, there was a huge boom in Auckland's commercial real estate, coinciding with very high interest rates. With the dramatic commercial real estate bust in 1988, few investors would think of such investments as being a hedge against anything. [back]
3. Of course the timing of a set of cable failures was always likely to be a result of an immediate "trigger" event. In this case the unexpected departure from the cool "El Nino" weather pattern that prevailed through most of January (a sustained hot and humid spell, coinciding with reduced capacity arising from the random cable failure in January), significantly aggravated the impact arising from the high annual growth rate of the CBD. It is likely that the trigger would have been February 1998, even if Auckland's CBD had grown faster than it had. [back]