Growing Our Economic Capital: Investing in Sustainable Improvement in Our Wellbeing
Published 3 Nov 2016
Speech delivered at Victoria University by the Secretary to the Treasury, Gabriel Makhlouf, 3 November 2016.
Good afternoon, it’s a pleasure to be here.
The personal and professional ties between Victoria University and the Treasury are very strong. A lot of people at the
Treasury are Vic alumni, and each year more join us as graduate analysts or in other roles. And we have Treasury alumni
at Vic, people like Professors Bob Buckle, Norman Gemmell and Girol Karacaoglu to name just a few. We benefitted from
their thought leadership in the areas of public finance, economics and public policy, and clearly the university values
it too.
Much of their thinking has contributed to what I’ll be covering today. I’ll talk about how the focus of public policy
should be on enabling a more prosperous, sustainable and inclusive New Zealand, now and into the future. I want to
discuss how New Zealand can invest in sustainable improvement in our wellbeing, in particular through growing our human
capital, natural capital, social capital, and financial and physical capital.
That’s a formidable goal for public policy to achieve. The challenges are many, they are difficult, and they are not
just economic. The discipline of economics has brought a lot of good to the world, but like any healthy discipline it
recognises that it has to challenge itself and grow. To solve society’s most ‘wicked problems’ and make the most of
opportunities, we need to continue our good efforts to apply an open mind, long term thinking, and a multidisciplinary
approach.
Let me start with one of those opportunities: our country is in comparatively good shape with a solid economic
foundation to build on.
The New Zealand economy has been performing well over the past 4 years, relative to both the potential growth rate of
the economy (of around 2.7%), and to most advanced economies. Over this period, our economic growth rate has averaged
2.8% while the average growth rate of OECD economies has been around 1.7%. Just yesterday we heard that our unemployment
rate was 4.9% and our participation rate 70.1%. And of course we’ve seen the Crown’s books return to surplus, debt kept
under control, and New Zealand in the position to start rebuilding our buffers against future shocks.
These are commendable achievements, in a very challenging global environment. We should recognise that and celebrate it
– there are no more than a handful of countries that can. But while we have earned the right to feel good about the
current situation and recent past, as policy advisers we also need to continue to keep a focus on the medium to
long-term. We need to look as much to lifting the economy’s long-run average growth rate, one of the main sources of a
sustainable increase in our collective wellbeing, as we do on worrying about whether the economy is operating at or
close to its short term potential growth rate.
So there are two fundamental questions I wish to address:
are we doing enough long-term thinking and, if and when we do, how are we approaching it, and
are we learning from, and adapting to, our experiences as we move through time?
If I take media commentary as an indicator, it does look like we are spending a lot of time and energy on analysing
whether the economy is operating at, or close to, its current potential growth rate, and whether inflation is or is not
responding to lower interest rates. In a way, that’s understandable, given the role media commentary plays in reporting
on factors that could have an impact on financial markets. And of course it’s important that we scrutinise the current
cyclical position in New Zealand and elsewhere. The downside is that we see far less emphasis and effort on
understanding how we can lift the sustainable growth rate of the economy, whether we’re making good investments as a
community and what the changing global environment means for our living standards. In short we don’t appear to be
spending enough time thinking about how to invest in lifting intergenerational wellbeing on a sustained basis.
Perhaps I shouldn’t take media commentary as an indicator! Or perhaps it’s just an inevitable feature of life, that we
think about the here and now rather than the future. But public policy can’t afford to limit itself this way. Back in
August the Prime Minister commented that one of the most valuable things that officials can do is filter out some of the
noise of social media and the relentless 24-hour news cycle, and help ministers focus on longer term considerations.
Underpinning the long-term growth rate of an economy are a range of fundamental factors, some of which don’t get much
time in the public spotlight. These include the quality of political, economic and social institutions; the quantity and
the productivity of the workforce; the quantity and quality of the (human and physical) capital stock; the availability
of land and natural resources; the state of technical knowledge; the creativity and skills of entrepreneurs and
managers; and, for a small open economy, our ability to connect our people, our ideas, our trade and our investments
with the rest of the world. These are all valid potential targets for public investment because they have significant
public good attributes.
So how does the Treasury approach the consideration of what matters for the long term? We start with the fundamentals of
what we’re here to do. The Treasury sees its job as improving the living standards of New Zealanders, helping people
live better lives, now and into the future. In other words, to increase people’s wellbeing on a sustained basis. That
provides the frame for our long-term thinking, not a narrow focus on economic growth per se, which is very important but
only one source of wellbeing. Using such a frame reinforces the need for an integrated and multi-disciplinary approach
to economic, social and environmental policy.
I should say that we do not judge how people should be living their lives. We’re not a curtain-twitching neighbour, or
the nosey relative at a family reunion who asks why you’re not married with kids yet. Our focus is on expanding the
opportunities and capabilities of people to live the lives they have reason to value. We also care a great deal about
making sure that we have institutions that motivate people to increase their capabilities, and that we have incentives
in place that convert opportunities into outcomes that increase wellbeing. Undeniably, wellbeing will be significantly
and positively affected by improvements in people’s material living conditions. But we also know that there are other
dimensions of wellbeing that are not very highly correlated with material conditions.
As The Beatles once said, “money can’t buy me love,” and they were right.
Based on extensive international research, we do know that the so-called domains of wellbeing are good enough for the
practical purpose of influencing policy decisions. These are well summarised by the components of the OECD’s Better Life
Index, which are classified into two broad categories:
quality of life, based on things like health status, work-home balance, education and skills, social connections, civic
engagement and governance, environmental quality, personal security, and subjective wellbeing, and
material conditions, such as income and wealth, jobs and earnings, and housing.
The things that need to be in place to promote wellbeing are the capital stocks which collectively comprise
“comprehensive wealth”: human capital (including education and health), natural capital, social capital (including
culture), and financial and physical capital. I like to describe this “comprehensive wealth” as our “economic capital”
although I know some prefer to see the latter phrase used more narrowly.
That’s probably enough on the theory behind sustainable wellbeing, so let me turn to what’s actually being done about
it.
In the last few years you may have heard Ministers and others in central government talk about the investment approach,
and wondered what it’s all about. In my view it’s at the heart of the modernisation of policy-making.
The investment approach to policy focuses on what we should be investing in, and how, to achieve a sustainable
improvement in our collective wellbeing. The areas we invest in, how we invest in them, and how these investments are
funded (for example, by borrowing or taxing), have very significant implications for the level and distribution of
intergenerational wellbeing.
These decisions are by no means straightforward. At the very least, we need to recognise that there are
interdependencies between the outcomes of various investments.
As an example, let’s take a look at education. We believe that investing in education generates economic, social and
environmental benefits. It raises skill levels and hence productivity. It is also arguably one of the most effective
ways of raising awareness of the environmental consequences of human actions. And of course it broadens access to
opportunities and helps those in persistent disadvantage, thus enhancing social cohesion. So undoubtedly it is one of
the most important investments we can make in improving wellbeing on a sustained and intergenerational basis.
We need to be able to compare the long-term wellbeing impact of investing in education, through all these channels – and
no doubt others – with the wellbeing impact of investing the same dollars on, say, building a road, or investing towards
conservation projects, or investing in increasing our cybersecurity, and so on.
The key point to note is that the metric of comparison should be long-term wellbeing. And if we are to do a good job of
assessing the wellbeing effects of one investment choice against several other worthy choices, then we need the
collaboration of multidisciplinary teams bringing their economic, environmental, social, psychological and other
perspectives to bear on policy design and delivery.
It’s hard, but it is happening. There is a rich and growing literature on using subjective and objective wellbeing
metrics to do cost-benefit analysis in terms of the long-term sustainable wellbeing impacts of policy options. We are
actively exploring ways of incorporating such tools into our policy advice and cost-benefit analysis. The Treasury’s own
cost-benefit analysis tool, CBA(x), is a very good example of an attempt to value non-market goods and services.
If all this sounds like a tricky job for policy makers, it gets trickier still. An additional challenge we face is
highlighted by the implications of complexity theory for designing and implementing policies.
The economy, society and the environment are all complex systems that are constantly interacting with each other. All we
can hope for is to invest in environmental, economic and social infrastructures – including institutions – that increase
opportunities and build resilience to manage the consequences of radical uncertainties. It’s about being prepared for
the unknown unknowns. And I should add that part of this preparation is making sure our institutions are fit for at
least the next 25, 30 or 40 years.
If we simply focus on preserving institutions we may in fact be weakening them.
The bigger, and more complex, the problems we face, the greater the temptation to tighten one’s grip on decision-making.
In fact, what we learn from complexity theory is that the optimal response to increasing complexity (especially when it
comes to decisions relating to social investments and outcomes) is exactly the opposite. It calls for more devolution of
responsibilities (and funding), supported by more investment in capability building in the devolved areas, but packaged
with very tight specification of outcomes to be delivered.
I’ll leave complexity theory there and move on to a higher magnitude of complexity still: people.
If we agree that the purpose of public policy is to ensure government’s contribution supports sustainable improvement in
people’s lives, we can focus policy towards supporting people and communities in their efforts to raise their living
standards.
What does all this mean in practice, from a public policy perspective in general, and for the investment approach in
particular?
The focus of public policy should be on governing and investing, on behalf of people today and into the future, towards:
enhancing resilience to systemic risks
sustaining social cohesion
increasing the growth potential of the economy
improving equity across society and generations, and
ensuring sustainability of wellbeing as people go about their daily business of living and improving their lives.
These dimensions are the ones the Treasury considers in its Living Standards Framework when we assess policies.
Government strives to take a system view. A system approach underpins the direction the public service has been moving
in following the Better Public Services report in 2011. It reflects the fact that central government is well-positioned
to observe and monitor the system dimensions that influence our collective wellbeing. It also has system-level
instruments that can help make a difference, some of which are about devolving power and using the energy of
communities.
At the centre, technology enables us to collect and share information on what various communities are doing to improve
their lives. We also have the analytical capabilities to assess what works and does not, but we need to do the hard work
of converting that potential into practical initiatives through appropriate investments in economic, environmental and
social infrastructures.
A critical ingredient of these infrastructures, underpinned by social capital, is networks. Public policy can play a
critical role in making networks function better. I believe that to do that the state sector firstly needs to be more
flexible in response to evidence, and secondly needs to be focused on outcomes, not delivery lines. What we’d then be
likely to see is better co-ordination and greater efficiency and effectiveness.
Let’s examine social investment to think about what better coordination and greater efficiency and effectiveness might
look like.
For example, I’ve been told that there are 83 social service agencies of all sorts operating in Feilding and that many
people would like to have a “one stop shop” service. But if we want to focus on better outcomes for people, it’s not
just a question of whether or not there should be a one stop shop; the bigger question is whether or not funding almost
seven dozen NGOs is the most effective way to deliver the services people need.
The investment approach is not only about generating good public policy ideas. It’s also about effective and efficient
policy implementation and delivery so that good ideas actually result in improved outcomes. This is precisely why better
coordination of community, regional, and central activities and investments is so critical. In practice, policy design
and implementation should be people-focused; we should worry both about our investment in services to people and our
investment in relationships with them.
Thinking more broadly, better coordination and greater efficiency and effectiveness may also be a critical part of the
solution to the so-called “productivity paradox”. The ultimate source of productivity increases is the efforts of
individuals, working together, in their various capacities, to improve their lives. We cannot second-guess how this will
happen, nor can we manipulate it. What we can do is observe and support – through reducing the costs of cooperation and
coordination – the emergent social and business initiatives towards the wider good. Our primary focus should encourage
investing in opportunities and capabilities, and build resilience to systemic risks.
This (especially the resilience building dimension) brings me to the second fundamental question that I referred to at
the very beginning of this talk: are we learning from, and adapting to, events as they unfold?
For example, one of the main events of the last ten years has been the global financial crisis. This was system failure
par excellence. It showed us that a combination of placing too much weight on the wrong indicators, guided by
mis-specified models, could lead to disastrous policy decisions being made in many countries and outcomes affecting
millions of lives. These models ignored the critical role of financial markets and networks. The policy prescriptions
they led to misjudged how complex systems work. They resulted in coordination and communication failures, among other
things.
People are still trying to understand the lessons from the GFC. One area of learning which has had international
attention is the critical role of better coordination of fiscal, monetary, financial and broader macroeconomic policies
in order for those policies – whether fiscal, monetary, financial and broader macroeconomic – to be implemented
effectively when one of them faces constraints. It can be the difference between a well-conducted orchestra playing a
symphony and ninety disorganised musicians creating a cacophony. This area has been a focus of the G20 and IMF since
2008.
I should emphasise that New Zealand was one of the countries that coordinated fiscal and monetary policy effectively
over the course of the GFC. Fiscal policy supported monetary policy through the crisis by being stimulatory when needed
and then contractionary once the economy was recovering. But that doesn’t give us an excuse to cut class when experience
delivers useful lessons and poses questions, including on policy coordination. And we should also make sure we learn the
lessons of putting too much weight on simplified economic models.
Here are a few examples of the types of policy coordination that may be needed to deliver outcomes that can lift our
wellbeing for the long haul.
Building on what I said earlier, my first example relates to the coordination of monetary, financial (including
prudential) and fiscal policies towards not only keeping the economy operating close to its current growth potential,
but doing so in a way that does not cause harm to the growth potential of the economy. Indeed it can enhance it.
International experience over the past 10 years and maybe more casts increasing doubts about the effectiveness and
efficiency of monetary policy alone in managing the economy’s performance relative to its current growth potential when
it is adjusting to a large structural shock. In fact, relying on monetary policy alone to do that job risks the longer
term growth potential of the economy as well, by leading to the misallocation of resources towards investments such as
residential investment that are comparatively less productive in terms of generating wealth and well-paid jobs.
Equally important are the consequences of such a policy on wellbeing across society and generations. We know that, as
interest rates rise towards more ‘normal’ levels, a lot of low-income people who have over-borrowed get severely hurt.
Would better coordination of fiscal, monetary, and financial/prudential policy – especially the physical, social and
environmental infrastructure investment component of fiscal policy – help the economy’s performance over the cycle as
well as help lift the economy’s sustainable growth rate? How could we achieve that better coordination?
My second example relates to the interface between broader economic policies, infrastructure investment and regional
economic policies. The importance of co-ordination around housing, transport and water infrastructure may be obvious.
But let’s look at tourism, one of our biggest earners. Tourism growth, if managed well, can keep generating substantial
economic growth in New Zealand. But to extract most value from it on a sustainable basis, the tourism footprint needs to
be better spread across the country. That’s going to need deliberate and coordinated promotion of attractive New Zealand
tourist destinations around the world, supported by investments in infrastructure across the country, so that they can
accommodate the needs of more tourists while taking some of the load off currently popular tourist destinations.
A third example relates to the combination of environmental, economic and social policies. There is an ongoing debate in
New Zealand between environmentalists and business people about the merits or otherwise of economic growth. To be clear,
I’m not suggesting at all that being an environmentalist or a business person is mutually exclusive. One question being
debated actively is whether we can keep increasing our milk production without causing damage to the environment. The
question tends to be presented in a way which is a false and unnecessary dichotomy.
The right mix of incentives can encourage a switch to the use of cleaner technology, higher-value-add milk products, and
overall increasing economic growth on a sustainable basis. If also supported by investment in education and new skills,
it would also enhance the skill base and productivity of our wider workforce.
Finally, consider the mix of social investment, fiscal and economic policies. Targeting the most at risk children of our
society with education, housing, and family support initiatives is first and foremost about improving the quality of
their lives and opening up opportunities. It would at the same time increase equity, productivity and economic growth,
while also reducing the present value of medium- to long-term fiscal costs on society.
The point of these examples is to reiterate that a policy framework that focuses on increasing our collective wellbeing
on a sustainable basis requires a mix of complementary economic, social and environmental policies.
A further point I’d like to make is that policy design needs to be complemented by outcomes-based policy implementation
to have any lasting impacts. It’s got to make a real difference in the real world, or as someone once said, “Great ideas
need landing gear as well as wings.” In my view, the types of ‘wicked problems’ we are having to deal with can have a
better chance of success if they are addressed by an integrated approach to public policy design and delivery.
In summary, I come back to the importance of learning from experience. A system that learns from, and adapts to,
knowledge, whether from successes or failures needs to respond through all channels: reviewing and revising economic
theory and economics teaching, extending policy models, better coordination of policies, adopting the expertise of a
broad range of disciplines in policy design and delivery, and learning the lessons from both successful delivery and
implementation failures. We need to embrace complexity and act accordingly.
As Keynes once said: "the difficulty lies, not in the new ideas, but in escaping from the old ones". Escaping can indeed
be difficult, but it can also be exciting. For those of us developing economic policy advice it’s about taking the
knowledge we have and building on it, incorporating insights from other areas of expertise, and drawing on the work of
economists who are pushing economics into the field of the human science that it actually is.
Growing our economic capital and investing in sustainable improvements in our wellbeing – the objective of economic
policy – requires a multidisciplinary approach to solving economic and social problems.
There are signs that all this happening around the world. We are in a new era of policy frameworks and I’m proud to say
the Treasury’s Living Standards Framework is at the forefront of economic thinking. We want to stay at the leading edge,
working together with others. In particular, I’d like to see universities – both their students and their staff – play a
leading role in developing these multidisciplinary frameworks, creating momentum for a redefinition of how we design and
deliver policy, and how we create feedback loops that help to ensure its effective implementation. I hope, whatever
sphere you are operating in, you will be enthusiastic participants in this collective effort.
ends