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Cunliffe's economic confusion

Cunliffe's economic confusion
Jamie Whyte, ACT Party Leader

David Cunliffe today gave a speech to the New Zealand Initiative, an economics think tank. The talk outlines the Labour Party’s economic policy. It displays so much economic confusion that it will take several posts to get through it all. Today I want to identify a fundamental conflict between Labour’s economic goal and its proposed monetary policy.

Mr Cunliffe begins his speech by saying that New Zealand businesses produce too much low value stuff. Labour wants to “support New Zealand business in the journey from volume to value”. He then claimed that “the biggest obstacle to our exporting businesses is the consistently over-valued and volatile exchange rate. Labour has long signalled it will review monetary policy to ensure our dollar is more fairly valued to help business and lower our external balance”.

A devalued dollar helps exporters sell more overseas by reducing the price foreigners pay for our goods. For example, if the NZ dollar fell from US$0.85 US$ 0.70, what an American pays for a NZ$1,000 widget would fall from US$850 to US$700. So Americans would buy more of those NZ made widgets. But, of course, the value of those widget sales would have fallen. The reduced exchange rate increases the volume of what we sell overseas by decreasing its value – the exact opposite of Mr Cunliffe’s goal.

Such confusion would be funny, if only there weren’t a chance, however small, that these people will get a chance to act on their ideas.

Cunliffe peddles foreign ownership myths

Many on the political Left complain about foreign ownership of New Zealand businesses on the ground that the profits are “sent overseas”. This is a foolish misunderstand of what happens when foreigners buy New Zealand businesses. But not too foolish to be repeated by David Cunliffe in his speech today about Labour’s economic policy: “right now [foreign direct investment] is poorly managed, and it’s Kiwis who are losing out. Overseas investors are buying up land, farms and good companies, then sending the jobs and profits overseas”.

The value of a business depends on its expected future profits. The seller of a company is in effect swapping the profits she would have got over future years for a lump sum she gets today. The lump sum (the purchase price) represents the present value of the future profits.

When a foreigner buys a New Zealand business, all the expected future profits of the business come into the country in the purchase price. When the actual future profits then go out to the new owner overseas, there is no net loss.

In fact, the transaction must involve a net gain for New Zealand. This is because, if the purchase price were exactly equal to the present value of the expected future profits, the Kiwi owner would have gained nothing from the transaction and would not have sold. The Kiwi seller must have valued the purchase price higher than the future earnings. So the transaction creates a net gain to New Zealand.

If Mr Cunliffe does not understand this, then he learnt little from his days at the Boston Consulting Group. If he does understand it but still peddles the popular myth of profits lost overseas, well, that is even worse.


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