The Treasury

Global Navigation

Personal tools

4.3 The Reddell hypothesis

Two recent discussion papers by Reddell (2013a, 2013b) which raise the possibility that immigration could cause potentially large negative macroeconomic effects in New Zealand have generated considerable debate. Given the policy implications should the hypothesis be correct, this paper discusses Reddell's ideas, and responses to them, in some detail.

Reddell sets out to explain several key stylised facts about New Zealand's economic performance: that despite far-reaching economic reforms, New Zealand has had weak productivity performance, consistently high real interest rates, and a high average real exchange rate (along with a large negative Net International Investment Position (NIIP)).[140]

Reddell explores the possibility that persistent excess demand created by high levels of inward migration in an economy with quite a low national savings rate could explain why New Zealand's increasingly large productivity gap has not led to the fall in the real exchange rate that theory would predict.[141]

The Reddell story is not about immigration generally being bad or economically negative. In fact, Reddell states that “in general, my reading of the evidence is that it makes quite a small difference either way.”[142] Rather, Reddell argues that in assessing the potential impact of migration, it is important to pay attention to the characteristics of individual country experiences, and the possible role of combinations of circumstances. In New Zealand, migration policy has made a large difference to population growth, throughout history and over the past 20 years.

In the late 19th century and early 20th century, immigration to New Zealand could be seen as reflecting a favourable shock to the tradable sector. Opening up new lands to production, falling transport costs, refrigerated shipping combined to lift the population capacity of New Zealand while still offering high wages and high rates of return.

By the middle of the 20th century, New Zealand was settled and producing, and technological change in the key export sectors was no longer as rapid (relative to other producers). The factor price equalisation justification for strong population growth had dissipated, yet population growth remained high. Across the OECD, there is some evidence that rapid population growth in post-war advanced countries was associated with an apparent cost to per capita growth rates.[143]

Indeed, in the period between the end of the Second World War and the late 1970s, the New Zealand debate about immigration was primarily about its macroeconomic impact. Economists such as Belshaw (1952), Gould (1982), Holmes (1966), Hawke (1985, 1981) and others warned that immigration shocks in a supply-constrained economy with low unemployment would generate excess demand, inflationary pressure and a deterioration in the balance of payments.[144]

In 1974, New Zealand tightened eligibility for entry, and began focusing more on the skills of migrants instead of favouring particular source countries. Soon after, in response to declining economic prospects in New Zealand, large numbers of New Zealand citizens began to leave. A marked liberalisation of arrivals policy began with the passing of the Immigration Act in 1987 and continued with the introduction of the points-based system in 1991.[145] As Figure 4 shows, a pattern of large departures of New Zealand citizens compensated for by large inflows of non-New Zealand citizens has continued, albeit with cyclical fluctuations, for many years.

Figure 4: Net Permanent and Long-term Migration per year by Citizenship
Figure 4: Net Permanent and Long-term Migration per year by Citizenship.
Source: Updated from Reddell (2011), p. 10, using Statistics New Zealand (Infoshare).

Reddell's hypothesis is that substantial inflows of non-New Zealand citizens (comprising around 80% of average population growth over the past two decades) have resulted in pressure on infrastructure (housing, local government services, schools and hospitals) and capital in the workplace.[146] The real investment needs of a rising population have outstripped the available (quite modest) rate of national savings. The reason for focusing on non-citizen arrivals is that these reflect a policy choice: in the absence of these inflows, New Zealand would still have experienced a rise in population from natural increase.[147]

Since New Zealand's national savings rate has not been sufficient to meet the increased demand for investment at given interest rates, some of that excess demand has been met from imports of financial capital, and some crowded out through higher interest rates (or, pre-liberalisation, tighter financial sector controls). As the increased investment has not generated export revenue sufficient to cover its cost, the current account deficit has widened, contributing to a persistently large negative NIIP position.

The role of the Reserve Bank of New Zealand in this hypothesis has simply been to respond to incipient excess demand by raising short-term interest rates to keep inflation within the target range. In turn, this has led foreign investors to bid up the exchange rate until (by uncovered interest parity) the expected future depreciation of the New Zealand dollar offsets the yield gains on the higher New Zealand interest rates.[148] Because the inflows of immigrants and thus demand for infrastructure have continued for more than two decades, sustaining demand for imported capital notwithstanding higher interest rates, the Reserve Bank has been forced to keep short-term interest rates relatively high by international standards to maintain price stability.[149]

Reddell argues that the resulting higher exchange rate has meant that tradables are less price competitive than they would be otherwise. At the same time, higher real interest rates have crowded out domestic investment in general, but particularly investment in the tradables sector, since investors considering investing in that sector face both a high real exchange rate and higher real interest rates, while investors in the non-tradables sector face only the relatively high real interest rates. As there is no independent evidence that immigrants have had a transformative effect on productivity or net exports, and as new immigrants require supporting physical capital immediately while their labour input is supplied over time (and immigrant consumption must also be financed), Reddell argues that the net effect of immigration has been to divert resources from more productive uses that could have lifted labour productivity and incomes.[150] In particular, Reddell (2013a) notes that New Zealand has the second highest ratio of public investment to GDP in the OECD, but has devoted a relatively low share of GDP to business investment over recent decades.[151]

In the absence of high inflows of non-New Zealand citizens, Reddell maintains that the net effect of departures of New Zealand citizens and natural increase would have been lower, but still positive, net population growth. This would have led to reduced aggregate demand, leading to lower real interest rates and exchange rates. With a lower exchange rate, the economy would have rebalanced toward tradables and experienced more productive investment than that required to service a fast-growing population.

Critiques of the Reddell hypothesis have focused on five main angles: the possibility that supply effects could dominate demand effects; alternative explanations for high real interest rates and exchange rates; the extent to which there are other plausible explanations for the persistent productivity gap; the extent to which crowding out is likely; and whether migration constitutes an unexpected demand shock or can be controlled.[152] Each of these is discussed below.

Notes

  • [140]High NIIP levels are not the key focus of the Reddell hypothesis. Although a formal investigation by Makin et. al. (2009) found New Zealand’s net overseas debt levels to be sustainable, that study did not assess the appropriateness of the starting position for the stock of debt, and there remains debate over the extent to which New Zealand’s high NIIP is a cause for concern.
  • [141]For a brief and accessible explanation of the Harrod-Balassa-Samuelson theory, see Tille et. al. (2001).
  • [142]Reddell (2013a), p. 36,
  • [143]See Dowrick and Nguyen (1989) Note that this study focuses predominantly on natural population increase. This is consistent with the more recent findings of Brunow et.al. (2014).
  • [144]For a summary of how various economic historians have approached the issue of immigration, see Reddell (2013c). Reddell (2013b) notes that relative to New Zealand's population, immigration flows were substantially larger between the 1950s and early 1970s than they are now. However, United Nations figures show that the relationship between New Zealand's average population growth and that of the rest of the advanced world during that period is similar to that in the last 20 years or so.
  • [145]For more detailed information on policy change throughout this period, see Trlin (1997).
  • [146]Reddell (2013a), p. 28, suggests every new person requires an addition to the capital stock (houses, roads, hospitals, schools, electricity supply, offices, factories and shops) roughly equal to 3-4 years income to maintain the existing capital-output ratio.
  • [147]Reddell (2013a). p. 35.
  • [148]An alternative approach is to think of the real exchange rate as the price of non-tradables relative to tradables. The latter are largely fixed in international markets, while the former respond to domestic demand pressures.
  • [149]Long term interest rates are set by the market, and largely reflect expected future short-term rates. In New Zealand, long-term interest rates have typically embodied an expectation (so far not realised) that future short-term interest rates would converge to the levels of the rest of the world.
  • [150]There is no robust information on the amount of financial capital migrants bring with them. However, even if all migrants brought adequate financial resources into New Zealand, real resources are required to build schools, roads, houses, factories, shops and other necessary physical capital, and it is this that generates the crowding out that Reddell identifies.
  • [151]Reddell (2013a), p. 19. This is despite New Zealand’s population growth having been materially above that of the median OECD country (ibid, p. 29).
  • [152]The material in this section reflects comments from a range of sources including participants in seminars, and both formal and informal reviewers of the present paper.
Page top