Are NZ First really as xenophobic and economically illiterate as this makes them sound?

An article at Voxy.co.nz tells us that English concedes NZ farms better off in NZ ownership - NZ First. The article states,

The government has finally admitted its folly over foreign ownership of New Zealand’s farms, says New Zealand First.

"When questioned in Parliament yesterday, Finance Minister Bill English first parroted the government line that Landcorp buying Crafar farms is not an obvious advantage to Landcorp or the New Zealand economy," says Spokesperson for Primary Industries Richard Prosser.

"However, Mr English then confirmed what farmers know but the government would not admit, until yesterday. He compared foreign corporate ownership of NZ farms to a fashion trend that came and went, but then revealed his own view that the ‘New Zealand owner-operator model - those who live it and love it - tend to be the only ones who can make money out of NZ farmland’.

First, a little knowledge of economics would suggest that the fact that the owner-operator model, normally a family-owned model, tend to be the ones to make money out of framing should not surprise anyone.

In New Zealand, and most other places, it is obvious that family-based firms still dominate in agriculture. Which is odd if you compare agriculture with, say, manufacturing, investor-owned firms predominate in manufacturing, So why not farming?

The short answer given by Allen and Lueck (1998) and Allen and Lueck (2002) is "nature". They argue that farms operate in unique circumstances defined by nature, in particular seasonality. This is the main feature that distinguishes farm organisation from industrial organisation. For farmers a season is a distinct period of the year during which a given activity is optimally undertaken.

This is key to understanding the why the incentives generated within agriculture favour family farms. The two basic issues are opportunities for hired workers to shirk due to random production shocks from nature and the limits on the gains from specialisation and the timing problems caused by seasonality. The trade-off between effect work incentives and gains from specialisation help determine the costs and benefits of different farm organisational types.

The family farm model provides the best work incentives since the owner is the sole recipient of the benefits, but this model misses some benefits due to specialisation. This follows from the fact that the farmer must engage in numerous different tasks during each stage of production, and in addition, numerous production stages throughout the year.

On the other hand, large factory-style corporate farms gain from a specialised labour force and lower cost of capital, but suffer from bad worker incentives since hired workers, not being one of the owners, have an increased incentive to shirk.

To some degree all firms are governed by the trade-off between gains from specialisation and work incentives. For the case of farming it is the unique, large impact of nature that biases it towards family operations.

An obvious, but key, feature of agriculture is that it involves a living, growing product. In the case of livestock, for example, you have breeding, husbandry, feeding and slaughter. Such a cycle is largely governed by nature. In principle there is no reason that a different farmer could not own each stage. But timing difficulties between stages result in high costs of engaging in market transactions. Such timing issues are particularly severe in farming because the inventories of the intermediate goods cannot be held given the living nature of the product.

There are a number of factors, such as the number of crop cycles, the length of the production stages and the number of tasks within a stage, which also influence wage labour incentives. When cycles are few, stages are short, random shocks are large and the tasks are few, there is little to gain from specialisation and labour is especially costly to monitor. Thus family farms.

If these issues can be overcome, that is, if farmers can mitigate seasonality and random shocks to output, farm organisation starts to look much like that in the rest of the economy. Under such conditions farm organisation will gravitate towards factory process and develop the large-scale corporate forms of other sectors of the economy. But thus far this hasn't happened.

Given the nature of farming, corporate ownership, be it local or foreign, isn't yet the most efficient form of ownership and thus it hasn't penetrated agriculture to the degree it has in other sectors of the economy.

So farms being in family ownership is simply a result of the economics of farming. It is the fact that the owner-operator model is the most efficient that is important here, not the nationality of the owner.

The economics of farming will give the result that most farms are in New Zealand hands, since family-owned business are most likely New Zealand owned business. There is no need for any xenophobic ownership restrictions to keep farms in New Zealand hands, the market will achieve this.

Also putting restrictions on ownership can prevent foreign investment in the situations where it is needed.

The Voxy article continues,

"Ownership of New Zealand property, be it residential or farmland, needs to be restricted to New Zealand citizens and permanent residents only, the end," says Mr Prosser.

Such restrictions are not need since as noted above when local ownership is efficient you get it, and there are times when you want foreign ownership. The point is that New Zealand gains the most when you get assets into the hands of those you value them most, who will use them most efficiently, and the restrictions on ownership can prevent this.

References:

• Allen, Douglas W. and Dean Lueck (1998). "The Nature of the Farm", Journal of Law and Economics, 41: 343-86.
• Allen, Douglas W. and Dean Lueck (2002). The Nature of the Farm: Contracts, Risk, and Organization in Agriculture, Cambridge Mass.: The MIT Press.

Competition and productivity

An obvious and important question in industrial economics is does competition raise productivity and if so, through what mechanism? In a 2010 working paper, Does Competition Raise Productivity Through Improving Management Quality?, John Van Reenen sets out to answer that question. He writes,

I discuss recent empirical evidence from both large-scale databases and specific industries which suggests that tougher competition does indeed raise productivity and one of the main mechanisms is through improving management practices. To establish this, I report on new research seeking to quantify management. I relate this to theoretical perspectives on the economics of competition and management, arguing that management should be seen at least in part as a transferable technology. A range of recent econometric studies suggest that (i) competition increases management quality and (ii) improved management quality boosts productivity.

Thus Van Reenen's argument is that competition does indeed increase productivity and a major mechanism for this is via improved management practices. He says that management is a transferable technology and that competition fosters the adoption of better management practices through both selecting out the badly managed firms (reallocation) and giving incumbent firms stronger incentives to improve their management practices. He argues that this perspective is supported by a range of new evidence both from new ways of measuring management and from more robust forms of identifying the causal impact of competition changes on productivity outcomes.

This has important implications for a small trading country like New Zealand. Given our small internal market how do we increase competition? One way is to open our markets to foreign trade and investors. Yes, allow foreigners to trade here and to buy assets here. Yes I know, certain political parties will not be too pleased with this idea.

Allowing foreign companies to trade here increases competition in our market in general and thus forces improvement in terms of management on local firms. But as my previous posting on the example of France showed foreign ownership can also improve a firm's productivity. Foreign investors are more likely to takeover firms that are currently under-performing and thus are open to productivity improvements. Such investors are more likely to buy firms that aren't working, right now, as well as they have in the past. The targets of foreign buyouts normally had experienced substantial productivity decline in the years prior to the foreign takeover. The foreign buyers then use their expertise, including improved management practices, to correct things and thus increase productivity. Of course this performance improvement puts additional pressure on other firms to up their game as well.

Thus foreign trade and ownership can both improve productivity by increasing competition in the local market and thus putting pressure on local firms to improve the quality of their management.

Are foreign takeovers getting domestic cherries or lemons?

The concerns of economic nationalists - read NZ First, the Conservatives, Labour etc in the case of New Zealand - about foreign takeovers of assets, including land, are rooted in the idea that foreign enterprises extract the most valuable assets from top performing domestic firms. This argument puts to one-side for now the ever present xenophobia which underlies much of the anti-foreign investment rhetoric in New Zealand. Practical concerns about economic efficiency of cross-border mergers and acquisitions markets hinge on whether takeovers transfer underperforming domestic economic resources toward more productive uses at foreign enterprises. How then to reconcile these concerns when forming policies about cross-border activity? Well in a new column at VoxEU.org Farid Toubal , Bruce Blonigen, Lionel Fontagné and Nicholas Sly argue it’s all in the timing.

One of the big questions about foreign investment is are the foreign firms picking cherries or choosing lemons?

For many years the evidence about targets of foreign acquisitions has been mixed. Some theories and data suggest that ‘lemons’ – domestic firms with relatively weak performance – are the most likely targets of foreign acquisition. Yet more recent empirical studies have pointed to ‘cherries’ as the most likely targets for takeover by foreign firms. The disagreement about which type of domestic firms – cherries or lemons – are pursued by foreign enterprises made it difficult to answer policy makers’ question about which of their assets, economic networks, and production possibilities were suddenly in the hands of foreign ownership.

The doubt over which types of firms were being acquired also raises concerns about the efficiency of international merger and acquisition (M&A) markets. Ideally, market transactions should transfer resources toward their most efficient use. The same holds for M&A markets, which should transfer the assets of lesser performing firms to enterprises that can make better use of them. If domestic firms are high performing cherries, it is not evident that a transfer of ownership of their resources to a foreign enterprise is optimal; being a cherry implies that a domestic firm is already using its resources effectively. Poor performing lemons might seem to fit the bill. Yet the question remains open as to why a foreign enterprise would choose to enter a market using resources that even a domestic firm – which had more familiarity with resident consumers, regulations, and distribution networks – could not use profitably.

Blonigen, Fontagne, Sly, and Toubal argue its all in the timing.

In Blonigen, Fontagne, Sly, and Toubal (2014), we show that the conundrum over whether domestic cherries or lemons are targets of acquisition can be resolved by considering not only the types of assets that foreign acquirers seek, but also the timing of takeovers. Indeed, foreign firms seek domestic targets that are historically high performing. In fact, when we look at foreign acquisitions that occur in the French manufacturing sector over the last decade, we find that even the least productive domestic target outperforms the typical firm in its sector in the years prior to acquisition. See Figure 1 below, which takes advantage of detailed administrative data from France to illustrate systematic changes in firm characteristics as they transition from domestic to multinational status. We plot total factor productivity (TFP) for all manufacturing firms that are acquired by foreign owners between 1999 and 2006 relative to sector and year averages, from three years prior to the acquisition to four years after the firm is acquired. The middle line shows the relative detrended TFP for the average French firm acquired by a foreign owner, whereas the lines above and below show the relative detrended TFP for the 95th and 5th percentiles, respectively. In the years prior to acquisition, domestic targets of foreign acquisition do appear to be ‘cherries.’ They have all a TFP that is above industry-year average.

Figure 1.

Yet despite the high performance of target firms observed several years prior to acquisition, Figure 1 shows that, prior to acquisition, targets realize significant productivity losses relative to other firms in their sector. The losses in productivity are so severe that by the time they are acquired, targets of foreign acquisition no longer appear to be cherries; on average they are indistinguishable from the typical firm from their sector. Put differently, in the years leading up to acquisition domestic targets are underperforming relative other firms in their industry. In these years, targets do look like ‘lemons.’

Rather than targets of foreign acquisition being characterized purely as top performers or underperformers in the market place, foreign enterprises seek out domestic firms that were previously the stars of their industries but then suffered a recent series of negative shocks. Hence, the targets of foreign takeovers are ‘Cherries for Sale.’

This timing of cross-border acquisition activity is quite intuitive. Foreign enterprises seek out targets that have the best and most valuable assets. And not surprisingly, it is the most productive target firms that had the largest incentives to invest in developing such assets. However, foreign enterprises can only offer viable takeover bids once the domestic firm has suffered a turn in fate, and is underutilizing it valuable assets. In this case it is better for the domestic firm to sell its assets to a foreign acquirer that can make better use of them.

So what is the upshot of all of this?

This timing of takeover activity implies that policy makers should have fewer concerns about relinquishing national ownership of its domestic enterprises, as the ‘Cherries for Sale’ are no longer the best and most valuable economic agents within their economic sectors. The observed timing of takeover activity also suggests the efficiency of cross-border M&A markets. Cross-border acquisitions appear to transfer productive assets, technologies, and distribution networks toward enterprises that can make better use of these valuable resources.

So foreign ownership may be good for you after all. The assets being bought by the foreign companies are those not preforming well under their current owners and the foreign owners can make better use of those assets. This is a gain for the local economy.

Ref.:

• Blonigen, B A, L Fontagne, N Sly, and F Toubal, “Cherries for Sale: The Incidence and Timing of Cross-Border M&A”, Journal of International Economics, 2014, forthcoming.

Xenophobia is not a good basis for economic policy (updated)

Isaac Davison writes in the New Zealand Herald:

Economic Development Minister Steven Joyce has accused Labour of "xenophobia" in their opposition of the potential sale of Lochinver Station to the Chinese company that bought the Crafar Farms.

Mr Joyce and Grant Robertson, economic development spokesman for Labour, appeared on TV3's The Nation this morning and discussed the sale.

Mr Robertson said under Labour the sale would not go ahead.

"Our criteria would definitely mean that a sale like this would be highly unlikely."

Mr Joyce said the opposition were "electioneering" in relation to the issue.

"When did [Labour] go out and oppose the purchase of James Cameron's land?"

"A little xenophobia from the Labour Party to start the day," he said.

Let me make a couple of points here. For efficiency reasons we want resources to be in the hands of those who value them most highly and the way to do that is sell them to the highest bidder. We want land (and other resources) to be used in the most efficient manner and the country of origin of the buyer is irrelevant to this. A thought experiment: ask yourself, Why are auctions used for so many goods? Its a way of finding out who values the good most highly. Whoever bids the most gets the goods. This is how we maximise the probability of getting an efficient allocation of resources. Secondly would a Labour government compensate the seller of the land for their policy? Under the Labour policy the seller would be forced to sell their land at a lower price than they would otherwise get (or not sell at all) and would a Labour government make up the difference between the actual sale price and the highest possible price? And if not, Why should the seller receive a lower return than they otherwise would?. And if this is a good policy for land why not implement it for other goods as well? What makes this idea land specific?

While I'm thinking about this let me add that the "logic" of our xenophobic friends must be symmetric. That is, if it is bad for foreigners to invest in New Zealand it must be equally bad for foreign counties to have New Zealanders investing in them. So why are New Zealand First, the Conservatives and Labour not announcing their intention to introduce legislation preventing New Zealanders from investing overseas?

Update: There are comments on this issue at Kiwiblog and Homepaddock and by Tim Worstall.

Economic stupidity? Yes ..... by the Greens

From TV3 we learn,

The Green Party is criticising the latest sale of land to foreign investors, calling it "economic stupidity".

Yesterday the Overseas Investment Office approved the sale of more than 14,000 hectares of prime forestry land, previously owned by the New Zealand Superannuation Fund, to a company owned by the Chinese government.

The blocks of land are located in Kaipara, Coromandel, Waikato, Rotorua, Gisborne and Wairarapa.

Speaking on Firstline this morning, Green MP Steffan Browning said the sale would send profits offshore, and make it harder for Kiwis to own New Zealand land.

"Every time we sell off some land to foreign interests, we are stopping New Zealanders being able to do that purchase," says Mr Browning.

"It automatically cranks the price up that New Zealanders would have to pay, and for New Zealanders to be able to stay on the land whether they be foresters or farmers."

As to the money goes overseas bit I have said this before but let me say it again: Let us assume for a moment that evil foreigners make a NZ$1 profit which, in an effort to piss-off Steffan Browning, they wish to take it back to, say, China. How do they do it? Clearly a New Zealand dollar isn't worth anything in China so the Chinese holder of NZ currency will have to sell their NZ$1 to buy Yuan. But why would anyone want to buy said NZ$1? The only use for a NZ$s is to buy something made in NZ. Thus the buyer of the NZ$s must want it to buy a NZ export of some kind. What is Steffan Browning's problem with this? The NZ$1 doesn't go overseas in any meaningful way, it gets spent on New Zealand produced goods and services no matter who gets the profits from the ownership of local firms. If a New Zealander gets the profits they spend them on New Zealand made goods and services, if a foreigners gets the profits they sell the NZ$s to someone who wants to buy New Zealand made goods and services.

Also to the bit about "it automatically cranks the price up that New Zealanders would have to pay", that is exactly the point, the New Zealand Superannuation Fund sold the land to the Chinese company because they got a better price. If we had stopped foreigners from being able to buy land the New Zealand Superannuation Fund would have gotten a lower price. How does that help the fund and the New Zealanders who rely on it for an income in old age?

You have to ask, Why do people sell assets to the highest bidder? One reason is that it allocates those assets to whoever thinks they can utilise them most productivity. You pay a higher price for an asset than another bidder because you think you can use that asset in a way which in more productive than the other bidder. Your knowledge and skills are such that you can produce more at a given cost or produce a given amount of output at a lower cost. Methods of production and asset utilisation that are highly productive are what makes a country "rich" and thus exactly what New Zealand needs. So let us sell land to those most likely to use it most productively, no matter where they come from.

I do have to ask, Just who are the Green's economic advisors and why do they think that xenophobic scaremongering is a reasonable basis for making good economic policy?

Farm sales to foreigners

David Farrar makes two points about foreigners buying farms in New Zealand.

Foreign investment is generally beneficial to New Zealand. If you restrict foreign owners from purchasing land in NZ, there are two potential negative impacts:

1. The current owner of the land is unable to sell the land for as much as they otherwise would have got. This means less wealth in NZ.
2. The foreign owner of the land, as they valued it more highly, may be able to put it to better economic use (as they need higher returns to cover the higher capital) and this can contribute to a more efficient economy.

He is right on both points. I'm not sure why people think selling land to foreign investors is so bad. Do they think these evil foreigners are going to dig the land up and take it back to their homes in their suitcases? Also why are the people who want to stop foreigners buying "our" land also not trying to stop New Zealanders buy foreign land? It's just economic xenophobia.