Read the inflation culprits the riot act

Annual inflation rates for local government rates, electricity prices and telecommunications prices since 2004 - Westpac

For the convenience of email subscribers and browsers, here's my weekend opinion piece arguing the electricity and local government sectors are the inflation culprits underneath our painfully high interest rates and currency.

New Zealand's inflation rate has been significantly higher than it should have been for the last decade because two major semi-regulated and mostly publicly-owned sectors raised their prices by around 5% to 8% each year for that decade.

Local Governments and electricity companies are those culprits. They have become the silent killers of our manufacturing export sector and our tourism sector. Their persistent inflation has acted like a type of plaque in the arteries of the economy, putting up it's 'blood pressure' of inflation, interest rates and the exchange rate.

Without that persistent inflation at two and three times the rate of inflation in the rest of the economy, New Zealand's interest rates and its currency would no doubt have been significantly lower.

I've always wondered why the Reserve Bank Governors Graeme Wheeler and Alan Bollard haven't at some point in the last ten years convened a conference of mayors, council CEOs, electricity generator-retailer CEOs and lines companies CEOs to read them the riot act.

These mayors and CEOs have no doubt acted in good faith and had plenty of good reasons to increase those prices. They believed they were doing the right thing in the long term for their shareholders, ratepayers and customers.

They argued they needed to increase those rates and electricity prices to justify investing in infrastructure that had been under-invested in through the 1980s and 1990s. Councils said they had extra responsibilities under the 'four well beings' policy of the 2002 Local Government Act to improve the social, economic, environmental, and cultural well being of their communities. Electricity generators, lines companies and Transpower argued they needed to lift prices to pay for extra generation and more reliable networks to ensure the five week-long power shutdown central Auckland endured in 1998 never happened again.

These were all laudable aims. It's debatable whether the extra charges have worked to produce the commensurate extra value of all those council services and reliable power networks, but there were consequences and I would argue they were much worse than the benefits gained.

These two uncompetitive sectors imposed a massive price on the tradable sectors of the economy -- exporters and those competing with imports. The Reserve Bank's hard-wired focus on keeping inflation between 1% and 3% meant it had no choice but to react with higher interest rates that helped make the New Zealand dollar between 10% and 25% over-valued relative to commodity prices and our current account deficit.

This crunched the size of New Zealand's tourism sector down from almost 10% of GDP in the early 2000s to around 8% now. Manufacturing's share of the economy has suffered a similar fate. In response, and unlike the local government and electricity sectors, these tradable parts of the economy rolled up their sleeves and whittled down their costs. They came up with innovative ways to use technology and have improved their productivity because they had do.

It need not have been like this. In any area where there is no competition, the regulators and policy-makers should be hard at work keeping the pressure on to improve productivity and ensure the price-setters don't take the easy path of just increasing prices to solve any problem.

Until recently, Local Government fees and charges were essentially unregulated. In theory, the electricity industry is regulated by the Commerce Commission, but its mandate was to ensure generators and lines companies didn't make too much money and ran reliable networks. There appeared no mandate to keep price inflation under control.

The best example of where regulation did work to bear down on prices was telecommunications. Repeated and persistent interventions to ensure number portability, the breaking up of Telecom and the encouragement of mobile competition all helped keep inflation low and actually create deflation since 2011. The Reserve Bank refers to this structural fall in telecommunications costs as the '2 Degrees effect' and it helped keep interest rates low since 2008.

If only the Reserve Bank could encourage regulators, politicians, ratepayers and voters to intervene as effectively with local governments and electricity companies to create many more such '2 Degrees effects' then New Zealand might not have the structurally inbuilt high currency and interest rates that are so damaging to the real economy.

A summit might do the trick, if only to shame these two culprits into acknowledging the pain they have caused consumers and producers alike.