The Trouble with New Zealand: Part II

Last year I wrote about the fundamental problems with the NZ economy in the brief post The Trouble with New Zealand (incidentally this blog's most read). And also in another post A New Tax System for New Zealand. 

The NZ economy has been on a serial decline for years. A rare window of opportunity of being able to do something about it is beginning to close. There is multi-party support for radical change to the tax system, the findings of the multi-partisan Tax Working Group recommended a radical tax system overhaul, and the Prime Minister (the first one in a long long time) comes from a global financial markets career and understands the problem as well as anyone. Moreover, the PM has had the populist political capital and the cover of the GFC (Global Financial Crisis) to instigate and execute change. He has failed on all counts and decided to do next to nothing. Now he's either lacking the balls, or is playing a smart long game and intends to execute a more elaborate plan in his second term. After all, perhaps he figures that the lowest common denominator voting public need some warm-up time to be educated around to such a big change? Time will tell. . . 

Two things will save NZ's economic prosperity if anything is going to. One, a structural shift from private investment in non-productive asset classes (like domestic housing) to productive asset classes. Correcting the skewed incentives in a messy tax system is the easiest way to do this. Two, the further engendering of innovation and a commercial platform to monetise and scale it. Creating juicy tax breaks for different types of early stage venture investors is both an easy and high-octane solution. 

IdeaLog (where I ripped the above graphic from) have a very readable article explaining what a mess NZ has managed to create and how to sort it out. Well worth reading. 

John Key (NZ's current PM) postured himself as the new hope and the man to drive change after 9 consecutive years of Helengrad and the gross ineptitude of Michael Cullen her Finance Minister. He can still deliver. Time is running out, both for him and NZ's economy.

A New Tax System for New Zealand

For those who follow what's happening in NZ, the Tax Working Group (TWG) has submitted its recommendations to government. The TWG was set up to review the NZ tax system and provide advice for reform. Bernard Hickey's written a good break down of the report and what it means. For those of you who are interested but uninformed, there's plenty of previous articles from Bernard on the issues here.

As I've written before, there are structural problems with the NZ economy restricting growth and fueling inefficiency. Of these, arguably the most significant is the skewed investment preference of retail investors for residential real estate. This preference is driven by tax incentives and at a deeper level, ignorance.

If the government follows the TWG's advice, the tax incentive will change to a disincentive - with the intention of driving investment from non-productive to productive asset classes. But it won't fix the ignorance problem. Well, not immediately anyway. NZers' proclivity for buy-to-let residential real estate, junk debt (via finance companies), and over-priced domestic corporate bond investment is firmly ingrained. Market efficiency will deal with the ignorance and punish those slow to learn and adapt through poor returns for the risk assumed.

When the reality of the likely tax changes takes hold and domestic retail investors learn that diversification out of their favourite asset classes is helpful, that wall of equity will have to go somewhere. My guess is a good chunk of it will flow into the NZ Stock Exchange. The NZSE provides one of the consistently highest dividend yeilds in the developed world. Offering tax free With capital gains, the retail yield seekers that want their capital return cake too might find this too good to turn down. The NZSE has been under capitalised compared to its developed world peers since the '87 crash when retail investor aversion set in. My bet is things are about to change commencing with a structural break in the tax system - and the NZSE will be on the winning side of the bet.

Kiwi Retailus Investo-Erectus: Part II

As a follow-up to my earlier Retailus post, (Infometrics economist) Matthew Nolan has just posted an excellent piece here.

Furthering the theme I laid down, Nolan also notes the confusion around risk/ reward trade-offs:

The lack of income growth stemming from this investment suggests that something is amiss – even if New Zealand has not really “over-borrowed” in the strictest sense, it appears we may have invested poorly. This misallocation of investment is the unfortunate result of a policy failure, bad luck, and further misinformation regarding the return/risk to investment.

Let's be clear - there's not only misinformation disseminated by under-educated and shady personal financial advisors/ retail brokers - the much bigger problem is retail investors' lack of understanding and knowledge of sound investing. This is compounded by the laziness in performing due diligence.

And then Nolan goes on to state (in far more polite terms than I did) how stupid NZ retail investors have been with their investment choices:

Ultimately, this implies that it is not even the fact we have accumulated debt that is of concern for New Zealand; it is what we have done with it. And in this sense it appears that New Zealand [retail investors] as a whole has made poor investment decisions. We have collectively whittled away a golden opportunity to improve the New Zealand economy by borrowing to invest in things that offered very little return.