By Eric Crampton*
When I took the job at the University of Canterbury back in 2003, my dissertation advisor told me that New Zealand would teach me the importance of fixed costs. He wasn’t wrong.
Economists typically split costs into two parts: fixed and variable. For a firm, in the short run, rent on the factory is a fixed cost while the number of shifts is a variable cost: if you’re going to be in business at all, you have to pay the rent, but you can scale production up or down by varying the number of shifts.
While day-to-day operations focus on the variable costs, in the longer run, many fixed costs can become variable, as you can decide to move to a larger or smaller facility. And when you’re just starting up, you have to decide which fixed costs to incur. If you’re starting small, there’s generally little sense in buying a huge factory and hiring a large IT team on long-term contracts rather than renting a smaller facility and contracting in IT support from an IT provider.
So for a small firm, so too for a small country. New Zealand suffers from rather too generous a helping of fixed costs – some of which are really our own fault.
American retail, in the 1990s, enjoyed a massive increase in productivity, largely on the back of Sam Walton’s discovery of an incredibly efficient retail distribution and supply-chain management technology. Wal-Mart has made America an incredibly more productive place, but it’s only been able to do it because America is a very large place. The substantial fixed costs involved in Wal-Mart’s distribution system and supply-chain management techniques work when the costs can be spread across a huge number of potential customers. They likely wouldn’t have paid off in a market of only four million customers.
New Zealand’s relatively small size means that fixed costs cannot easily be spread across a large customer base. Unless your firm has export ambitions, it’s harder to justify large up-front fixed cost investments.
New Zealand’s small size then results in a higher overall cost structure. Retail costs here are often much higher than prices elsewhere, and often by multiples of the difference in cost that you might expect elsewhere: when I parallel import a book from Book Depository, I enjoy lower prices because customers around the world each share a tiny fraction of Book Depository’s fixed costs in IT and warehouse systems.
The American version of Netflix fronted the fixed costs of negotiating rights to a huge catalogue of movies because they’ve a potential customer base of hundreds of millions; the New Zealand version, soon to launch, is almost guaranteed to be worse because the fixed costs of negotiating film rights for a country of four million will greatly restrict the range.
Some aspects of government policy rightly work to mitigate New Zealand’s high fixed costs. Our parallel importation regime provides some competition in industries where a small domestic market might otherwise limit options and increase costs. But in other areas, the government has seemed determine to impose pretty substantial fixed costs for no good reason.
Case in point? New Zealand’s film rating’s regime. If you want to legally distribute a film or TV show in New Zealand, other than by broadcast, you have to get the programme rated by the New Zealand Office of Film and Literature Classification. The Censor’s Office decides whether the film gets an unrestricted classification, or the age below which it is illegal to supply a programme. An RP13 film is legal to watch with your 12-year-old, so long as the child is under adult supervision. An R13 film is illegal to watch with your 12-year-old, but legal to watch with your 13-year-old. But if the same film airs on broadcast television, instead of being bought on DVD or streamed from abroad, it’s not illegal to watch with your 12-year-old as a different legislative regime applies.
Why does a country of four and a half million people have an office for film classification?
We could argue about the ridiculousness of the implementation of the New Zealand regime, or we could ask the more important question: why does this office exist at all? Why does a country of four and a half million people have an office for film classification when so many neighbouring countries, similar to New Zealand in culture and norms, already have their own systems? Every rating decision involves cost to the would-be distributor: the classification fee charged by the Censor’s Office, plus the hidden cost of the time, effort, and hassle involved.
In a better world, the government could simply require that programmes distributed in New Zealand carry the classification of any other trusted country’s ratings board: Australia, Canada, America, the UK, or others. It’s pretty rare that a locally produced film wouldn’t be intended for eventual international release; if the filmmaker weren’t already seeking an international classification, self-rating by the local producers could also work well.
Worse, when a body like the Censor’s Office exists, local industry can use it to try to block competitors’ imports.
Slingshot and other ISPs’ global-modes, allowing Kiwi customers to sign up for Netflix as though they were American, is just parallel importation applied to digital content. Local rights-holders supported the Censor’s Office attempts at blocking those services, with pious appeals to protecting the children from unrated content. We should properly see the Censor’s Office as a non-tariff barrier to trade in film and literature, which locals can exploit anti-competitively.
New Zealand has rather a few of these local fixed-cost-raising regulations. If you’re a doctor with a stellar reputation in Canada, you still need to go through New Zealand registration; that requires placement in a New Zealand hospital, and placements are limited. Would you, as a tourist in Canada, be at all worried about being treated by a Canadian doctor in a Canadian hospital? No. But that same doctor cannot move to New Zealand and set up a General Practice without jumping through the hoops.
Perhaps there could be reason for a short course training foreign physicians to recognise diseases prevalent here that aren’t as common elsewhere, but beyond that, the government’s increased the cost of medical services in New Zealand by imposing an unnecessary fixed cost on the system. Similarly, I simply cannot understand why building materials that have been deemed suitable for other wet and shaky environments, like Japan, British Columbia, or the American Pacific Northwest, aren’t simply deemed to be good enough for the New Zealand market as well.
Firms well recognise that building a factory scaled to produce a million units a year is a pretty dumb idea if the potential market is only five thousand. Too much of New Zealand’s regulatory apparatus would suit a country of forty million rather than the one we have. We should try to rely on the certification efforts of others who’ve already incurred the high fixed costs rather than reinvent expensive wheels here.
*Eric Crampton is Head of Research at the New Zealand Initiative. The NZ Initiative writes a weekly column for interest.co.nz.