On the subsidies for The Hobbit

It does have a familiar Winston Peters ring to it. Peters’ proposal earlier this week that Warners should repay its Hobbit subsidies taps into (a) a pre-existing vein of resentment in the guise of (b) upholding a principle that all but disintegrates on closer inspection. Not to mention that – also as per usual with Peters – the remedy for the alleged wrong would be virtually impossible to implement. (Solutions have never been his forte.)

True, The Hobbit has been successful. Box Office Mojo shows that as the film nears the end of its US domestic run this week in mid January, the film has grossed $278,869,783 in the US, and a further $608,000,000 in markets outside North America, for a grand total of nearly $879 million. (That ratio of US to foreign earnings mirrors the performance of say, Harry Potter and the Deathly Hallows : Part Two which grossed an even more impressive $381 million in the US, and a massive $947 million elsewhere in the world.) Such figures are before the downstream returns on DVDs, television screenings, books, toys and related merchandise deals are factored in. So far, the production has reportedly received $67 million in grants from New Zealand, presumably with more to come in costs accruing on future installments. Peters’ argument is that Warners should now reimburse New Zealand taxpayers for the contribution that we made.

That would be fine :
(a) if it were possible to make a case for why film industry corporates should re-imburse the state when other corporate beneficiaries of state largesse (eg in r&d spending or prior state capital investment) do not have to repay the government aid and benefits they receive. (There’s a case for starting somewhere, I suppose.)

(b) if it were possible to formulate this as a contractual obligation at the outset, as you would need to do. Should the repayment obligation kick in from the first dollar of net profit after the theatrical run once all the production/promotion costs are met and distributors and other investors are paid out? Or do we allow a set level of legitimate profit (say, a 10% net return, after production/promotion/investor/distributor costs?) Or do we set the timer on repayment only after the tertiary income streams from DVDs etc come in? Point being, while it may not be impossible to calculate a repayment formula and include it within the Large Budget Screen Production Grant Scheme (LBSPGS) criteria, this wouldn’t be an easy thing to devise, and it would be even harder thing to monitor, given the proven ability of Hollywood accountants to hide profits.

(c) if it were possible to prevent a repayment provision from disqualifying New Zealand as a film-making destination, given that other competing countries are not demanding it. Clearly, this is merely a ‘real world’ practical problem, and not a matter of high principle. Yet it would quickly become a problem, if repayment was ever seriously contemplated.

Lets look at (a) first. For all the talk about free markets and bold entrepreneurs, the state has always bankrolled capitalism in this country. Spending on r&d for instance by the New Zealand government dwarfs the private sector r&d spend, and always has done – even if the rates of investment in both cases lag well behind the OECD averages. Moreover, the current share market is full of companies like Solid Energy, Air New Zealand, Telecom etc that owed their origins to the state. The DSIR and MOW were springboards for any number of private enterprises in the past, and the asset sales programme today is based on the apparent inability of the New Zealand private sector to create a sufficient number of lucrative sharemarket investment opportunities. Overall, our private sector tends to be parasitic on the state, even as it lectures the government about its alleged inefficiency, and brags to the public about its own (illusory) entrepreneurial panache.

How does this relate to The Hobbit situation? Well, of the many examples of government/corporate collusion in this country’s history, the meagre levels of film industry support seem to have been one of the most beneficial to New Zealand. (I’m talking only about the subsidies, not the gratuitous change to our employment laws that the Key government threw into the Hobbit mix.) There appear to have been significant benefits to this country from the state’s LOTR/Hobbit investments and I say” appear” only because of the lack of public transparency in the amounts involved. Is, for example, the $217 million cost often cited for the LOTR tax cuts an accurate figure ? No one knows, and nor is there any reliable estimate of the subsequent economic and social benefits. Policy in this area is made entirely in the dark.

If, as Peters suggests, there is a moral principle of payback involved then why single out Warners? Almost every successful business in the country has enjoyed some benefit from state support. Making an example of one may be politically expedient, but has little to do with upholding a “principle”. Rather than bitch and grumble about the need for payback, it would be more useful to treat these outlays as state investments, learn from the example, and make other state investments in future that are equally as rewarding. That’s how state capitalism is meant to work.

After all, New Zealand has rattled in for at least 30 years about the need for freeing our economy from its dependence on primary exports and building a knowledge economy. The film industry is an example – probably the only example – where we have successfully done this, and have created an industry cluster along the lines mooted 25 years ago by Harvard gurus like Michael Porter. Despite the legitimate criticisms that can be leveled at how the Jackson empire operates, it has become a world-leading film-making enterprise that attracts foreign capital to these shores. That doesn’t mean we should throw into his lap whatever Jackson demands – like say, changing our tax laws and our employment laws to suit. (Capitulation is not a form of negotiation.) On the upside though… by shifting from a tax-based subsidy (eg the LOTR deal) to the grant-based system that Jim Anderton erected in its place (eg the Hobbit deal) the state has vastly improved its ability to protect taxpayer interests.

That switch from the LOTR tax scheme to the Hobbit’s LBSPGS method is worth underlining if we are claiming the Hobbit deal entails an onus of repayment. On the available evidence, New Zealand gets back far more in local spending on wages and downstream services from the LBSPGS than it pays out in film incentives. There’s not even much of an opportunity cost involved, because what else would Treasury be willing to spend this money on? Nothing. Personally, I can’t see a case for compensation when the donor has already received back more in value than what they contributed, and especially when the subsidy in this case wasn’t the initial seed money for the venture. In essence, the LBSPGS is a virtuous grant scheme paid out only after (a lot more) money has been spent here. It is not a shonky tax dodge that raids the revenue beforehand.

What I’m getting at is that while Warners and Co certainly can factor the LBSPGS into the production budget, for us it is not money at risk up front. The 15% rebate kicks in only after the beneficial ripple effects to the economy have already taken place. If you are going to offer a subsidy at all, this is definitely the kind to have. I mentioned before the industry cluster effect this investment has helped to achieve in New Zealand. Here, for instance, are three examples of small firms spun off from the technology and the networks that the LOTR films have generated:

As for the Jackson empire itself, Weta evolved quite some ago to a point where it has work for several projects on the go at any one time. That’s one reason why the 3,000 plus job creation estimates for The Hobbit production made by the government (and released to Peters under the OIA) are so fatuous – in that they assume the Hobbit contract related work force can be readily added and subtracted from the firm’s work force as a whole. That might have been possible to do back in the LOTR days, but no single project – however important – is as crucial these days to the Weta enterprise, any more than Industrial Light and Magic has remained solely dependent on the Star Wars franchise.

In that sense, Weta now operates much like a studio, with The Hobbit being the current tentpole around which other activity occurs. Also, most of the foreign film projects coming here are arguably doing so despite the level of our production incentives, and not because of them – and the real magnet drawing them here is Weta, for whom the state subsidies are only one, albeit important, element in its ability to attract and generate productions here. (New Zealand does not seem to be getting quite the extent of independent major location shoots it used to attract only a few short years ago.)

In other words, credit where it is due. For a relatively paltry amount of state assistance, New Zealand has gained an entire, highly skilled industry – but one which is almost solely dependent on Weta. That’s the unhealthy reality. Ironically, Weta’s successful evolution into a multi–project enterprise means that it has become a far less mobile operation as a result. (That’s another good reason why we didn’t need to change our employment law. The Hobbit wasn’t going anywhere.) So… despite what Peters says, New Zealand is kidding itself if it thinks that somehow, it has been a major player (much less a major loser) within The Hobbit equation. The argument for payback in any loss-to-the-nation sense is weak to non-existent. The film incentives are simply one cost among many of doing business and personally if we’re talking payback I’d much rather it occur in the environmental sphere in stronger polluter pays provisions. Or be reflected in a more realistic royalties scheme for the extraction of natural resources.

In sum, the real self-damage re The Hobbit has been over our change to employment law coverage for workers in this industry – and not the level of subsidies paid to the project. There was a choice involved. Rather than increase the incentives to keep New Zealand globally competitive, the Key government chose instead in 2010 to make it easier and cheaper for foreign studios to hire and fire our work force. That’s a better reason to hold a grudge on election day.

In passing, one should also probably note that tossing around the $1 billion box office figure as if this was all money in the Warners/Jackson bank accounts is probably a bit unfair. As this article in Business Week indicates, The Hobbit has a lot of heavy lifting to do. The film – along with the James Bond film Skyfall – has had to restore to solvency an MGM that declared bankruptcy in 2010 at the outset of The Hobbit process. MGM was also engaged last July in a highly expensive buyout of its fractious shareholder, the corporate raider Carl Icahn. As I wrote in 2010:

The rate at which Icahn has been buying up MGM’s senior debt means that it will cost an arm and a leg for….the re-constituted MGM to buy him out, which will in turn make those [New Zealand] production incentives even more important than they are already.

Interestingly, the film industry business analyst Jeff Bock cited by Business Week treated a $300 million domestic gross as being at the bottom end of projections for The Hobbit:

“Three-hundred million dollars is the low end. It’s possible people are really attracted to the 3D, and that might boost grosses, so the financial curve is there…”

The circa $300 million US domestic gross for The Hobbit – inflated by those higher 3-D ticket prices – should also be compared with the $313 million domestic gross for the first LOTR film. Allowing for inflation as well, that looks like a solid, but significantly lesser performance by The Hobbit, which should be of concern to our tourism industry types. As for Warners… Time Warner will be looking to The Hobbit to restore the company’s fortunes after it has lost the Harry Potter and Christopher Nolan Batman franchises, and as it struggles to regain its former status. As Business Week adds:

Warner Bros. led the U.S. box office from 2007 to 2010, but slipped to second last year and is third so far in 2012, behind Sony and Walt Disney. In addition to The Hobbit, Warner Bros. is mining its DC Comics library to revive the Superman series and bring together several DC superheroes in 2015 for a joint adventure in Justice League, as Disney did last spring with the hit Marvel’s the Avengers.

In other words, yes… Warners could afford to repay the NZ subsidy it has had so far, just as it could also afford to forego the further amounts it will receive for post-production costs on future installments of The Hobbit. It seems unlikely though, to be feeling under any obligation to be generous. Jackson too, will undoubtedly be earning big money from The Hobbit franchise, which has restored his status as a Hollywood player that had been blunted by King Kong and The Lovely Bones. Jackson will not be out of pocket, especially by the time Bilbo finally heads back to the shire in 2015. Still, the bulk of my conclusion from 2010 about likely profit sharing on The Hobbit still probably holds true:

All along, a factor in reducing the attractiveness of The Hobbit package has been the number of players – MGM [which reportedly holds 50% of the rights], Warners, the Tolkien estate, Saul Zaentz (who had long ago bought the film rights to Middle Earth from the Tolkien family) Harvey Weinstein (who still presumably has something like a 5% cut based on his role in the LOTR transition from Universal to New Line) who have claim on a slice of the returns.

There is a question that some of the film rights on The Hobbit actually expired in 2010. Even so, the various shares of that rights pie have to be sorted before you even begin to divvy up the money available for the creatives like Jackson and his colleagues – which would have to include Guillermo del Toro, who will need to be rewarded for his creative input. Is there also an exit fee for him, covered by his contractual conditions in the event of delays not of his making? Reportedly, some of the recent dealing with respect to The Hobbit has had to do with trying to get the queue of profit participants to reduce their claims. For these and other reasons, Jackson would probably struggle to achieve the same sort of upfront deal ($20 million against 20 % of the grosses) that he got from Universal on King Kong.

Ultimately, it seems petty and fruitless for New Zealand to be nursing a grudge over the money it put into The Hobbit, and a sense that it has been slighted. Any slights that New Zealand suffered over The Hobbit have been entirely self inflicted, and the subsidies were the least of them. That money was and is an investment – and a downstream one at that – from which we continue to derive economic activity, skills enhancement and other benefits.

What could we more profitably learn from The Hobbit? Well, lets list a few possible items :
(a) how to negotiate, rather than simply cave in to whatever foreign investors ask of us. In particular, we should resist further moves to turn this country into a low wage economy where employment rights get treated as an expendable, no cost item
(b) how to select other enterprises worth state support in order to grow a skilled economy, and finally
(c) how to be far more transparent, so that the taxpayers actually footing the bill for state subsidies can readily find out how much money they are paying out, and what returns they are getting on their investment.

Realistically, none of this is likely to happen of course, so I guess I can hardly fault Peters for being impractical. As the dwarves and Lakemen learned from bitter experience, no one ever managed to do much about income inequality in Smaug’s wasteland simply by talking things over with the dragon.


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