Economic and Other Ideas Behind the New Zealand Reforms

Oxford Review of Economic Policy, vol 10, no 3. pp.78-94 ( This article benefited from comments by Keith Jackson and John Martin, and from the symposium editor Gerry Holtham,)

Keywords: Growth & Innovation; History of Ideas, Methodology & Philosophy; Macroeconomics & Money;

I. Introduction

From 1984 to the early 1990s New Zealand undertook a major reform of the mechanisms used to govern the economy and the public administration. These reforms are often called ‘rogernomics’, after Roger Douglas, the Minister of Finance who instigated them, and the reformers are known as ‘rogernomes’. The reforms might be called the application of “economic rationalism”, which Michael Pusey defines as the “doctrine that says that markets and prices are the only reliable means of setting a value [for public purposes] on anything, and … that markets and money can always, at least in principle, deliver better outcomes than states and bureaucracies” (Pussey 1993:14, original’s italics).

The New Zealand reforms were motivated partly by orthodox economics and the desire to apply its precepts to government. However, they were also influenced by the political ‘New Right’, which, on philosophical grounds, sought a smaller role for the public sector than perhaps could be justified from conventional economic theory alone. Hence policies were implemented as near a New Right or Chicago approach as political circumstances would allow (Easton 1989b). Paque (1985) and Reder (1982) give general accounts of these ideologies. While exemplifying an international movement towards market liberalism and away form dirigism, the reforms were, therefore, unusually thorough.

Section II of this paper examines the factors which precipitated the direction and radicalism of the reforms. The tactics and process of reform are significant themselves, and discussed in section III. Subsequent sections discuss the reforms themselves. They can be loosely grouped into three stages each roughly corresponding to a parliamentary term: 1984-1987: The increased use of the market mechanism in the regulation of business (including publicly owned business) activities (Section IV); 1987-1990: state sector reforms (Section V); 1990-1993: Reform of the welfare and related systems. (Section VI). The classification is not precise: in practice there was overlap, and the “more market” reforms began somewhat before 1984.

II. Before the Reforms

In July 1984 a Labour government came to office. Labour had generally been in opposition since 1949 with just two three year stints in 1957-1960 and 1972-1975. The first Labour government, from 1935 to 1949, had constructed an economic and administrative mechanism involving a high degree of government intervention, and a low use of the market mechanism, by the standards of the OECD. The National government, which dominated the period from 1949 to 1984, began a process of hesitant market liberalization. However there was a relapse towards the end of the period, with a price freeze for almost two years from 1982, plus loose fiscal policy and widespread monetary controls. The government was still very involved in detailed market intervention in 1984.

Over the early part of the post-war period the New Zealand economy grew at about the same rate as other OECD countries. Because its population grew faster, per capita volume GDP grew slightly slower, but not much less than would be predicted as a result of high population growth and some measurement difficulties (Easton 1995). However, for a decade from the mid 1960s the New Zealand volume GDP grew about 1 percent a year slower than the OECD, almost certainly as a result of a dramatic 25 percent fall in its terms of trade as the world price for its main exports – wool, red meat, and dairy products – fell.

The fall in external market profitability generated the standard market response. The economy diversified away from its traditional pastoral products to a much wider range – horticulture, fish, wood products, some energy related products, light manufactures, tourism. Gould (1986) suggests that the export diversification – measured by commodity or destination concentration indexes – exceeded that of any other OECD country between 1965 and 1980.

This external diversification in a country desperately dependent on its tradeable sector put consequential pressure on the domestic economy and the mechanisms which regulated it. From the late 1970s “more market”, as McLean (1979) called it, was both a public demand within the informed elite, and a policy direction – albeit a cautious incrementalist one. The Prime Minister and Minister of Finance, Robert Muldoon, was however much less persuaded, and on occasions intervened for political purposes in ways which seemed economically arbitrary.

For cutting across the economic pressures were political imperatives. The National Government between 1975 and 1984 represented a political economy that was becoming outmoded. Maintenance of its power base required the support of an elite whose significance was diminishing with the changing economic structure, most notably pastoral farmers and associated rural commercial interests. Thus its tendency was to slow down all change inimical to its vested interests. This was, perhaps, an instance of the Olsen (1982) thesis that growth is lsowed by long-established pressure groups.

From the late 1970s the New Zealand economy began to expand faster in per capita volume GDP terms than the, albeit sluggard, OECD average. Higher world energy prices, following the oil price hikes of the 1970s, and increased local energy supply. There was an an energy led industrialisation called “Think Big involving the overbuilding of hydro-electricity generation plus production from the giant Maui gas field. The high (“double digit”) inflation rates of the early 1970s, which were probably an inevitable – if uncomfortable – outcome of the terms of trade fall, continued through to the early 1980s. Inflation pressures were compounded by a fiscal and monetary management. Very large budget deficit from the late 1970s primarily funded by inflation, devaluing the real value of government bonds, which institutions were compelled to buy at controlled interest rates. It was an unsustainable policy stance, which the controls shored up in the short run.

In 1984 Muldoon imposed a comprehensive price freeze which was to last with only the smallest exceptions for almost two years. Orthodox economic management was suspended. Instead there was widespread intervention, a loose fiscal policy, and a monetary policy dependent on controls which were being increasingly evaded. The business community and the government economic advisers were marginalised. Labour took office in July 1984, with a substantial parliamentary majority, following a snap election.

III: The Process of Reform

Initially the most prominent advocates for widespread market liberalization were from the public sector. Later they were joined by supporters in the private sector. There is no work in New Zealand comparable to Pusey (1991) whose detailed survey of public servants in Canberra shows the deep and widespread penetration of public sector economists in Australia by economic rationalism. However, there is little doubt that a study of their New Zealand equivalents would find broadly the same conclusion. (Coleman (1992) reports a survey of the position of the New Zealand economics profession.) Politicians had little to say of significance at the time. The autobiography of Douglas (1987) written during his term of office, does not set out an explicit economic account of his beliefs nor of his approach.

Nor do the officials’ documents throw little light on the implementation strategy, though the radical approach to reform was summarised in the 1987 Treasury Briefing: ‘Government policy needs to move towards a comparative systems approach. This approach invites assessing alternative institutional structures (both private and governmental) according to the processes and outcomes they involve, utilising generally accepted criteria for making social choices’ (1987:47).

However after he was dismissed from the cabinet in 1988, Roger Douglas set down his strategy. Its key points were:

“If a solution makes sense in the medium term, go for it without qualification or hesitation. Nothing else delivers a result which will truly satisfy the public.

“Consensus among interest groups on quality decisions rarely, if ever, arises before they are made and implemented. It develops, after they are taken, as the decisions deliver satisfactory results to the public.

“Do not try to advance a step at a time. Define your objectives clearly and move towards them in quantum leaps.

“Vested interests continuously underestimate their own ability to adjust successfully in an environment where the government is rapidly removing privilege across a wide front.

“It is uncertainty, not speed, that endangers the success of structural reform programmes. Speed is an essential ingredient in keeping uncertainty down to the lowest possible level.

“Once the programme begins to be implemented, do not stop until you have completed it. The fire of opponents is much less accurate if they have to shoot at a rapidly moving target.

“The abolition of privilege is the essence of structural reform.” (Douglas 1993: 215-238)

Such a strategy depends on the lack of checks and balances in the New Zealand constitution. In contrast to Australia for instance, there is no written constitution, no upper house, no federal structure, and voting has been on a first-past-the post rather than any form of proportional representation.

The Douglas analysis requires that the policy advocate is certain and correct. The formulation shows no introspection as to how one might decide that a reform is beneficial. Given that uncertainty of purpose is the greatest threat, the approach requires that all opposition to the reforms must come from ‘privilege’, or vested interests, for there is no room for reflection or an alternative analysis. Once the commitment is made, speed and quantum leaps are essential: anything less is vulnerable to resistance from the vested interests. Instead it is believed that the public will support the reforms as it sees the benefits, including the ending of privilege. It is ‘Plato’s dream like the Leninist actuality … of an elite political order guided in the exercise of absolute political power by its supposed insight into essential reality’ (Flew 1989:17).

Because of this orientation, published advice from government officials often adopted an approach of advocacy rather than dispassionate consideration when applying the ‘comparative systems’ method. In practice the comparison was between the existing system with its (known and enumerable) flaws emphasised, and an idealised characterization of the preferred alternative.

One of the features of a democracy is the process of consultation detects flaws in any analysis. In the New Zealand reforms there were numerous examples of official’s arguments which were flawed and yet were implemented unmodified. (Easton 1989b,c, 1990b). In evaluating reforms, therefore, it is not only the underlying beliefs that must be considered but also the manner of their implementation. Of course, it is arguable that vested interests were such that no alternative method of reform was available., that the alternative to summarily considered reform was no reform at all. However, the more consultative-corporatist approach of the Australian government indicates that there were other options.

IV Restoring the Market Mechanism: 1984-1987.

The three years after the 1984 election were primarily concerned with reducing the role of the government in the functioning of individual markets. The most conspicuous examples include the rapid abandoning of a myriad of controls in financial markets, the almost complete abolition of price controls, a programme to replace import controls by tariffs and the subsequent substantial reduction of tariff levels, the removal of producer subsidies, and the corporatization of government trading activities (Bollard & Buckle 1987). Some notion of the extensive scope of reforms is evident in Table 1.

Wherever possible restrictions on entry were abandoned (e.g. the abandonment of import licensing). Where necessary licences such as resource entitlements for fishing or the broadcasting spectrum were made tradeable. The same spirit can be seen in tax reforms, which aimed to reduce exemptions and incentives, broaden the tax base, and lower top rates. The almost comprehensive GST (a “value added” tax on all transactions except in the financial sector and rental housing), not only funded income tax reductions (mainly on higher incomes) but also removed a complicated sales tax structure with often arbitrary categorization (e.g. adding water to a pure fruit juice incurred a higher rate of sales tax).

Such measures could be justified by the Austrian economic analysis of the dynamic merits of competitive markets, and the orthodox analysis of the welfare losses from tax and other intervention wedges.

One issue the reformers faced was that a historic justification for some of the market interventions had been that the small, 3½ million people, New Zealand market, was often supplied by only one or two firms so competition was an imperfect regulator. This was addressed in two main ways. First, a major reason for the reduced border protection was to increase alternative market suppliers. Especially successful was CER (Closer Economic Relations) with Australia, an enhanced free trade area. Bano and Lane (1987) show that intra-industry trade between the two nations is at levels comparable for other OECD trading interchange, the only such case in New Zealand’s international economic relationships.

Second, the doctrine of contestability – market competitiveness being maintained by the existence of potential hit-and-run entrants – was widely relied upon to justify the moves to liberalize markets, even where there were few active players in the market. In the early 1980s this seemed to economists to be a promising extension to the theory of market regulation. While it makes good sense to reduce barriers to entry to enhance competitiveness, it is now evident that the conditions for contestability to discipline successfully an imperfect market are much more stringent and less frequent in practised than was first hoped. The theory is not robust. Unlike the theory of competition small deviations from its required assumptions can lead to quite different market outcomes (Baumol & Willig 1986).

Nevertheless, in the New Zealand reforms the doctrine was widely invoked. In introducing marjet mechanisms into the operation of state-owned enterprises (SOEs), it was combined with an explicit aim of commercialization. The so-termed “corporatization” is described in Easton (1989a) and Bollard & Duncan (1992).

Unquestionably there was a need for the reform of the management of the SOEs which had evolved haphazardly.

However the new form of management was deliberately that of a private enterprise subject. The corporations were set up with two shareholders, the Minister of Finance and (typically) the Minister of State Owned Enterprises. The assets of the previous government entity were purchased from the Crown, in exchange for equities and government debt, thus setting up a balance sheet. The corporations are managed by a board of directors appointed by the shareholders (i.e. ministers). The shareholders also set a target rate return (based on the application of the Capital Asset Pricing Model, using the experience of overseas equivalents to define such parameters as the debt to equity ratio, and the beta coefficient) which the corporation is expected to attain. The SOE also pays tax exactly like any other corporation.

This practical consequence of this balance sheet (set up from the purchase of the assets), and the shareholder target return is that pricing and investment rules of the enterprise were no longer subject to arbitrary government direction, but reflect the same situation as if it were privately owned. A second consequence is that the new structure set the corporatized SOEs up for a further stage of privatisation, despite the government at the time stating that was not the purpose of the exercise.

The corporations are regulated by general economic law, including the Commerce Act which deals with mergers and restrictive practices, and by the minimization of barriers to entry. There is no separate legislation for utilities and, for instance, there has been an ongoing and costly court battle between incumbent Telecom and new market entrant Clear over the approach to the common carrier local network and related elements in Telecom’s supply. The objective is light-handed regulation. There are no price controls on privately owned utilities (or anywhere else). Publicly owned utility prices are set subject to costs and the government determined target rate of return, and, if relevant, prices of competitors.

The SOEs do not have any significant social objectives, their primary objective being profitability. At the time of the reforms the government announced that where it had social ends which it wanted its SOEs to pursue it would purchase them in a contractual relationship, in the same manner it would do so to with a private firm. In practice, perhaps because of financial stringency, it has rarely done this.

V. Reforming the Core Government Activities: 1987-1990

In the second term of the Labour Government reform shifted to the core government activities. As well as privatisation we shall be concerned with two central legislative changes during the period: the State Sector Act of 1988 and the Public Finance Act of 1989. We will not discuss in this section the social policy content of the 1987 PEB, just as we do not discuss the 1987 labour market reforms, because in both cases the post 1990 changes were more dramatic.

The Treasury used its 1984 and 1987 post-election briefings to Ministers (PEBs) to set down its economic vision. The 1984 PEB Economic Management is basically a justification of the ‘more market’ drive, with a tendency to be on the Chicago school side of orthodoxy. The 1987 PEB was entitled Government Management. Unfortunately the analysis underlying the key statutes is generally implicit, while Government Management, though a large document (472 pages, plus a 295 volume on the education issues) is without references to intellectual antecedents. Fortunately senior Treasury officials – including the Secretary of the Treasury at the time – have published papers on related topics which prominently mention Alchian, Cheung, Demsetz, Easterbrook, Fama, Jensen, Meckling, Benjamin Klein, Posner, Tullock and Williamson (Scott & Gorringe 1989; Scott, Bushnell, & Sallee 1990).

There are three intellectual threads, of different strengths, discernibly interwoven into the 1987 PEB and these papers (Boston 1991). The first, and strongest, is the public choice theory of Downs (1957), Buchanan and Tullock (1962) and Olsen (1965). Second is agency theory (e.g. Jensen & Meckling 1976, and Williamson 1975) in a somewhat wider context than just the firm (Gorringe 1987). Third is the work on property rights of Coase (1960), Demsetz (1967), and Posner (1986) and the related transaction costs theory of Williamson (1975, 1985). As already mentioned, contestability was also widely appealed to.

Boston (1991) also asserts the doctrine of the new public management. This is not strictly an economic theory (not that the reforms should necessarily have been dominated by economic theories). Is essence is there is ‘something called “management” which is a generic, purely instrumental activity, embodying a set of principles that can be applied to public businesses, as well as private business’ (Painter 1988).

The intellectual antecedent led to a distrust of public bureaucracies with poorly defined objectives. That, in turn, led to a preference for private operations, even where there was the probability of (mild) market failure. Where public operations were unavoidable, the State Services Act and the Public Finance Act gave greater discretion to the heads of government agencies (chief executive officers) in the use of resources (including staff) for objectives (‘outputs’) which were intended to be more precisely identified. The aim was to improve efficiency for more clearly defined ends through tile introduction of contractual relations between tile minister and chief executive officer.

Apart from reforms to core government departments, there was a major privatization of SOEs after 1987. Two main justifications were cited for it. The Treasury was of the view that private ownership would generate more efficient performance by tile firm than public ownership for any given market structure. The politicians’ argument was more in terms of the need to reduce debt by tile sale of public assets. An economic rationale for the politicians’ argument certainly existed. As throughout tile rest of tile world, real interest rates had risen in tile 1980s. The disinflation from a very high inflation rate to a very low one by OECD standards, which New Zealand experienced, meant its real interest rates were especially high. In such a situation governments might be expected to rearrange their portfolios. Moreover, higher interest rates implied greater financial risk. The New Zealand government had recently suffered severely from unexpected events, and it might well be expected to adopt a more cautious investment policy, which would include reducing its exposure to risky ( especially commercial) assets.

Despite the government saying it was selling the assets to reduce public debt, there seems to have been no reserve price set for most sales, while usually there were only one or two bidders which, as two Reserve Bank economists warned, meant that there was no guarantee of maximum price (Harrison & Grimes 1989). In at least two cases the price seemed very low; a parliamentary select committee concluded so in one case. This was not a government selling assets cheap to political friends. Rather it seems that the Treasury’s preoccupation dominated that of the politicians and the policy became, in effect, to dispose of the assets as quickly as possible for reasons not all to do with debt concerns. If as the Treasury believed, private ownership was inherently superior to public ownership, giving the assets away would promote efficiency, which in due course might enhance government revenue from additional taxation.

A different sequence of reforms may well have undermined the debt justification for privatisation even further. New Zealand has introduced probably one of the most rigorous and comprehensive reforms of its public accounts, moving them from a cash to an accruals basis. As for public accounts in most OECD countries, neither practice nor principle had kept up with the increasing complexity of government activities. The result, before reform, were accounts which were not only misleading, but enabled politicians to obscure sensitive issues. For instance, in the course of the developing of the Think Big energy projects, the government had provided guarantees, but there was no mention of the public’s contingent liabilities in the government accounts, except at the vaguest level. (They came to book in the mid 1980s when world oil prices fell.)

The proximate justification for the reform of public accounts was that it was necessary for other reforms to increase the accountability of public officials. The Financial Statements of the Government of New Zealand aim to provide a complete balance sheet (i.e. Statement of Financial Position) including contingent liabilities, and a revenue and expenditure account (i.e. Statement of Cash Flows) on an accrual basis. Their comprehensiveness is such that they show a much higher proportion of the government’s liabilities than is common elsewhere, especially as many below-the-line and contingent liabilities are included. (Even so New Zealand’s public debt to GDP ratio is only a little above the OECD average.) If the accounts had existed at the time of the major privatisation decisions, there would have been a constraint on selling for debt reasons, since the offsetting reduction in assets would have been evident.

Since the framework of the accounts is that of private commerce, they are in some respects misleading. For instance many of the assets are “non-performing” that is providing no cash flow (e.g. National Parks, the heritage collection in the National Library, and road system), but are included with the same solemnity of valuation as assets with a more commercial significance (e.g. the electricity system and the government’s office buildings). On the other hand some assets with barely any commercial parallels are omitted. There is no inclusion for the intangible assets of the nation’s good reputation (which almost certainly reduces New Zealand’s costs of borrowing) nor of its sovereign power to tax. As presented government liabilities exceed assets, but of course the New Zealand government is not insolvent, having the power to tax future production. These features stem from the purpose of the accounts, which is to improve the management of assets within government departments. It is not primarily to address the macroeconomic issues of identifying the optimal amount of government net debt, given objectives of intergenerational resource allocation, distribution, and macroeconomic stabilization.

Individual government agencies have been put on a similar accounting basis, including being required to depreciate and pay a return on their capital. Usually profit is not an objective (but see below about the health sector).

The changes in accounting were designed to underpin fundamental changes in the ways in which agencies operate. Ministerial policy objectives are described as ‘outcomes’, to which the agencies respond with ‘outputs’ which are ‘purchased’ by the minister. Agency heads are not in general responsible for outcomes, but they can in principle be held to account for outputs. We can see here the application of agency theory, especial y its emphasis on transparent contractual relations. In the past, the purpose of many programmes. and even agencies, was unclear, often because there were multiple, overlapping objectives. In some cases original purposes were lost in a series of shifting decisions, and programmes were maintained by inertia. By stating the objective of each agency, and its relations with the minister, it was intended to clarify the situation and enable the agency performance to be assessed.

The effectiveness of the new system in practice can be undermined by the ambiguity of the outputs and the difficulty in defining and measuring them. How would one, for instance, evaluate this first output of the Treasury?

“The output class involves the provision of advice spanning the whole economy … The quantity and nature of advice to be provided … will be explicitly agreed with the Minister and time frames specified … Managers … will maintain oversight of appropriate quality assurance processes by signing out all reports to the Minister. These process range from reliance on managerial oversight to seeking internal peer review … and external review;” (Estimates 1993:841)

Often the effect is to separate agency accountability for vague outputs from ministerial accountability for even vaguer outcomes. New Zealand does not have a history of ministers taking responsibility and resigning (or even taking responsibility and not resigning), so it is hard to judge the real effect of the changes.

The search for ‘accountability’ has forced agencies into one of two models. Either each government agency is directly accountable to a minister (who has a constitutional, if tenuous, accountability to parliament), and to the Treasury with its formidable powers arising from its control of agency spending; or the accountability is to the market. This contrasts with the previous regime where there were non-commercial public agencies with some independence from direct government control: research, the arts, the media, education. Where quasi-autonomous non-governmental public organizations (quangos) exist they are now generally subject to commercial disciplines or pressures. For instance National Radio, the public radio equivalent of the BBC, is expected to make a profit, and does not receive the broadcasting licence fee direct, but is funded by an independent broadcasting commission, embodying the principle of a purchaser-provider split.

One aim of the changes was to increase transparency of the relations within the public system, a concept which originally arose from concerns about the lack of transparency of the industrial assistance (dependent on import and other licensing arrangements, and the like). Transparency is not independence. In some ways it is the opposite, for an agency may have less discretion. For instance the universities are increasingly fearful that the new accountability requirements are compromising such academic independence as they have (Butterworth & Tarling 1994).

Much international attention has focused on the granting of specific, contractual responsibilities to the New Zealand Reserve Bank. Since these give to the bank sole control of short-term interest rates to be employed in pursuit of its contractual obligation (i.e. maintaining very low inflation), the measure is known abroad as ‘central bank independence’. This is not independence as the Bundesbank would understand it, since the target is set by government and the Bank is responsible to government for achieving it. The Bank is an agent, not a principal.

The management of government agencies is modelled on the practices of commercial firms as far as possible. The agency heads are now Chief Executive Officers (CEOs) each of whom has a specific performance agreement with the relevant minister. The CEOs’ powers are comparable with those of the commercial equivalent, including the management of labour relations. Parliament votes funds for the outputs from the agency, so the CEO usually has considerable discretion in the deployment of resources within the budget (and may also be able or required to raise revenue through commercial operations).

In the widespread restructuring of government agencies, another general rule was to separate policy from operations, apparently to prevent operator-capture of policy. Thus there is a Ministry of Defence and a separate New Zealand Defence Forces although the clarity of the division is confused by the operational forces still having their own policy unit. One prominent exception is that the Treasury is not required to separate out its operational responsibilities (in the way the Australians have a separate Ministry of Finance).

Martin (1994) argues that a consequence of this feature of the reforms was to ‘decouple’ ministers from the agencies within their portfolios, diffusing the location of political responsibility. He goes on to argue that there are limitations to “the extent with which private sector management principles or precepts (or people) can replace the distinctive ethos and culture of the public sector” (Martin 1994).The justification for commercial models was almost invariably their alleged efficiency relative to traditional government or public-sector ones. The claim was rarely underpinned by any empirical evidence. Closer inspection suggests it is tautologous, with ‘efficiency’ corresponding to that which (good) firms exhibit by definition. Moreover, compared with government agencies, firms generally have clear, simple objectives – notably to make a profit. In agencies with multiple objectives, some are likely to be more easily measurable and ‘verifiable’, in the jargon of game theory, than others. To replace an ethos of public service with explicit contracting regulated by some form of audit can easily result in a decline of performance along the less verifiable dimensions. That is for two reasons. First, people naturally concentrate on those elements of their duties according to which they are assessed and second, the implicit mistrust of their motives implied in a move to more explicit contracting can lead to a withdrawal of voluntary effort. To what extent these concerns are important is still not evident.

It is, therefore, hard to judge the success or otherwise of the reforms. Undoubtedly there has been some elimination of wasteful and redundant practices. However, radical reform and the increased turnover among civil servants has caused some loss of institutional memory , which may prove damaging in the long run. The prevention, or effective resolution, of a major crisis may be far more important then a myriad of small efficiency gains. One consequence of the transformation has been to play down the traditional public policy concern with equity and related objectives. Similarly, quality which cannot be judged commercially was sometimes neglected. (For an example from broadcasting see Easton, 1990a.) Those maybe instances of important objectives with low ‘verifiability’ being neglected in a contractual framework. At any rate, the lower priority assigned to equity lay behind tile policy responses of tile third phase.

VI. Redesigning the Welfare State

The Treasury post-election briefing which greeted the incoming National government in October 1990 was more subdued theoretically (and substantially smaller) than its predecessor three years earlier. Except in the case of labour market reform, which has been an integral part of the New Zealand (and Australian) welfare state (Castles 1994), it is somewhat harder to describe the underpinnings to the policy responses of the following years. Their general direction was to ‘redesign the welfare state’.

(i) Social Policy Reforms

The key elements were: a reduction in the scope and scale of social security benefits; tile introduction of user charges for welfare services previously provided free; the targeting of remaining benefits on the poorest; and the withdrawal of the state from the production of welfare services as far as possible. In labour markets, the guiding principle was to replace collective institutions and agreements with individual contracts.

The welfare-state changes reflected three motives. First was the need to restrain the government deficit by finding economies wherever possible. Second was the view that a market between purchaser and provider of welfare services would lead to more efficient resource allocation and production. Third – and one may dispute how important this has been – there was an ideological preference for individual over collective decisions in both the purchase and provision of services.

It had been a principle of the traditional welfare state, codified by the 1972 Royal Commission on Social Security, that benefit levels should be set according to the principle of need, on average, of the class of person who qualified for the benefit. The redesign was much concerned with the actual or theoretical effect of welfare on behaviour. The April 1991 benefit cuts, for example, were deeper for the unemployed than the sick, while some of the invalided had small increases. There is no evidence that the needs of the three groups of beneficiaries are different, or that the relativity of their needs had recently changed. Evidently, the government believed that the unemployment benefit level was discouraging active work-seeking and perhaps propping up the lowest wages, discouraging job creation by firms. Undoubtedly the government saw its benefit cuts and labour-market reform, as a part of the same package, although there was not a lot of official documentation of the underlying economic principles. Nevertheless, we can see behind them an economic inference that the traditional welfare state was generating unemployment.

A strategy of commercializing provision was extended into the social services (and government research institutions). A key element was the introduction of user charges, which by giving service providers a source of revenue put them closer to private-sector models. That potentially increased the demand for and supply of private provision. The reform’s first significant user charge was a small charge for doctors’ prescriptions, imposed in the 1984 budget. Subsequently. the application of the user-charge principle has become widespread. Government departments frequently charge one another for services provided between them.

As far as the public is concerned the most controversial areas of user charges have been in the provision of health, education, accident compensation, and public housing. At one stage the government imposed a (‘hotel’) charge for accommodation in public hospital, but this was dropped because of the poor revenue return, partly because many people refused to pay. However, prescription charges have been raised, and other charges (e.g. for specialist consultation in a public hospital) imposed. The charges for tertiary education have been steadily rising. Students now pay an average of 20 per cent of the estimated costs, with an expectation the ratio will rise to 25, and perhaps 50 per cent, if current policies are pursued. Whereas the original conception of the accident compensation scheme involved all medical and similar services being provided free, today there is often a charge. State housing rentals are now set at :market’ rates.

In each case there is some mechanism for those most in financial need to have the charge reduced or eliminated altogether. Overall the changes have resulted in a reduction in costs to the government. In the case of health sector, the reform also reflected the internationally fashionable idea of the purchaser-provider split. In principle, four government purchasing agencies (RegionaJ HeaJth Authorities) purchase health services from the government-owned hospitals corporatized as ‘Crown Health Enterprises’ (CHEs) or, if they offer more competitive terms, from private suppJiers. There is evidence in the government documents setting out the reforms that their ultimate intention was privatization ofboth purchasers-via the introduction of private health insuranceand producers-via the sales to private enterprise of the CHEs, whose corporatization paralJeJed that of the SOBs (e.g. Upton, 1991).

Perhaps because of the haste in which they were introduced, the health reforms have left unresolved administrative difficulties and remain politically unpopular. In contrast with other changes to the welfare system, they have also yet to produce the fiscal savings expected. The problems stem from difficulties of implementing the principles on which the reforms were based. The separation of responsibility between purchaser and provider remains highly imperfect as the purchaser announces ‘provider’ decisions (like closing a hospital), while the providers make decisions on the mix of health care. Ministers are closely involved, despite the original idea of distancing them. An interesting innovation was that two health ministers sit in cabinet, one to represent the purchasers the other the providers. In fact the latter rarely appears publicly, while the former comments on provider decisions, such as hospital closure. Meanwhile waiting lists increased and the government has had to increase its funding, disappointing hopes that the productivity gains from the reforms would reduce waiting lists and the need for additional public funds.

A difficulty is that there is a surplus of hospitaJ beds, which has arisen from technical innovation (e.g. day surgery) and a tendency for the old system to overbuild hospitals. Getting CHEs to compete for funds did not solve that problem and arguably reinforced a producer interest in maintaining overcapacity. The CHEs were given a profit objective, which should have resulted in spontaneous downsizing in response to commercial imperatives. But the profit motive had to be disguised as ‘operating as a successful and efficient business’, after protest by the public, which was concerned that clinical decisions would be distorted by a quest for profit. (In other words, the public recognized that the quality of care being less verifiable than its cost might suffer under the new arrangements.) Public unease has reinforced producer and political pressures to maintain over-capacity.

The boards of the CHEs were manned with businessmen (and an occasional woman) ‘ few of whom had medical experience. They generally appointed CBOs in their image. Yet within six months of appointment, the organization representing the boards had occasion to caution: ‘The CHE group are of the view that the business of providing [health services] is nota genuine commercial mode’ , explicitly contradicting the principles on which the reforms were founded, and the CHE boards appointed (Wilson, 1993). There is also a widespread feeling that the boards are too inexperienced in health matters to have come to grips quickly with the issues, so that improvements in health service performance have been delayed.

The experience of the health reforms, and elsewhere-because the commercialized Housing Corporation also had a senior executive resign because commercial objectives were interfering with the social objectives of providing housing to those in need-is that it is not easy both to run social services on commercial principles and meet social objectives which the public continues to demand.

Generally, there have been no detailed empirical studies of the putative improvement in efficiency or equity as a result of introducing user charges in health and elsewhere, so hard to judge their efficacy except in fiscal terms. The reforms, including the cuts in benefits, have certainly saved money and could be justified by fiscal requirements-the need to raise revenue to restrain a large budget deficit. The cuts, none the less, represented a choice to cut the standard of living of the poorest rather than to raise taxation on the better off, despite the latter having benefited from significant tax reductions. The top income-tax rate has been reduced from 66 per cent in 1984 to 33 per cent. There have not been comparable reductions at lower levels. As long as substitution effects dominate income effects on the work/leisure decision, that strategy can, of course, be justified in terms of the effect on work incentives at both ends of the income scale. Nevertheless, it has had some adverse consequences. The measures, plus the contemporary contraction of the economy, appear to have raised the numbers below the poverty line (established by the 1972 Royal Commission on Social Security) by about 40 per cent (Easton, 1994) .The rise in hardship was so evident that the leaders of ten major churches published a series of statements in 1993 urging the government to address the problem. There is also some evidence that reported crime rates have risen since 1990, after being stagnant through much of the 1980s, although this may be due to increasing the numbers of police. There are not sufficient health data yet to assess whether morbidity has increased, especially among the poor.

Economies have been effected but the evidence is that any improvements in efficiency of provision have not yet been enough to negate the effect of those economies on the recipients of welfare.

(ii) Labour-market Reforms

That labour-market reform was needed in the 1980s is little disputed. Before 1966, when most of the economy was shielded from external pressure, the labour market was organized horizontally (i.e. economy-wide on an occupational basis) with many unions covering firms in any industry, and with a system of fixing the wage structure relatively rigidly and indexing it to the price level. Trade diversification and liberalization exposed more sectors, industries, and firms, to external pressures, but existing legislation frustrated the evolution of an industrial relations structure which gave firms required flexibility.

Not only was a reorganization necessary in general, but there was probably a particular need for a realignment of relative wages following the increasing levels of unemployment from the late 1970s ( and especially after the mid-1980s ). Under the double-digit inflation of the 1970s and 1980s there was considerable scope for adjustment by delay. For instance, a settlement which was 3 months late could result in a 2.5 per cent loss in relative wage levels if inflation was 10 per cent p.a. However, once inflation came down to around 1 per cent p.a., reductions in real wage rates, especially of the unskilled, required nominal cuts, which would be evident in a national award system, and strongly resisted by the unions.

In 1987 the Labour government passed the Labour Relations Act (LRA) facilitating the grouping of unions into a few, large, industry-based organizations which were moving towards vertical arrangements, on an industry and firm basis (Walsh, 1990). However, the direction of reform was changed in 1991 when the National government passed the Employment Contracts Act (ECA) which based industrial relations on individual contract between employer and employee, and made it very much more difficult for unions to function.

It is not necessary for the purposes of this article to detail the nature of the reforms and it is also too early to assess their full impact. The changes, however, illustrate the application of the comparative systems approach to government policy and the fact that the comparison often took the form of advocacy based on philosophical preference. The Treasury Briefing to the Incoming Government in 1990 compared the industrial relations regime of the LRA with the alternative ECA system. The LRA was criticized without a favourable comment or any serious consideration of whether it could be adapted in the light of the criticisms. On the other hand, the advocated regime, which was to develop into the ECA, was presented with no acknowledgement of possible problems.

The following gives a flavour of the argument:

The (ECA) approach would. more likely than current arrangements to ensure that wage deals ~d the related work practices reflected the value of the Contribution of workers to the firm … make innovation and investment more likely … Decentralized bargaining arrangements are also more likely to allow employers and employees to strike deals which facilitate training and improve productivity.
(Treasury, 1990, p. 152)

In practice, while flexibility is desirable in any market, the difficulty in tying down trained employees creates an externality to firms which may lead to sub-optimal amounts of training. Moreover, external impediments to labour turnover can discourage employment but can also give the employer/employee relationship more of the character of a repeated rather than one-shot game. It is well known in game theory that repeated games are more likely to result in mutually beneficial co-operation and are less likely to result in prisoner’s dilemmas than single games. Internationally there is little consensus about the empirical evidence on labour market institutions with the United States and Japanese models both having their supporters.

The point is not that the Treasury Briefing was wrong or right, since the jury is still out, but that no attempt was made to provide evidence for the assertions or to weigh the arguments for one system against another. The report failed to mention any dangers or disadvantages to the proposed changes, even those which soon became evident after the implementation. For instance, in the late 1980s the Engineering Union had been building into its industrial agreements procedures for the development of industry-wide occupational classification and training. It was argued that this was needed on an industry-wide basis because small individual firms could not afford the cost of training, only to find the worker recruited (poached) by some less committed firm. The institution of the BCA so radically transformed industrial relations that these developments have largely lapsed. Four years later the conventional wisdom bemoans the lack of upgrading of skills in the work-force (and fears the consequences of skill shortages) because as yet no one has been able to develop industry-wide training under the ECA. The ‘more likely’ of the above quotation from Treasury ( 1990) has simply proved wrong, as was predictable at the time in view of the externalities involved.

VII. Conclusion

There are two sorts of conclusions to this paper. One concerns the policy process, the other the outcome of the policy process, the microeconomic reform as it was implemented in New Zealand.

It is clear that the work of such theorists as Buchanan and Olsen was influential on the reform process. But they are outside the policy context looking in, not policy creators themselves. Policy-makers are subject to the same claims of representing vested interest as they make about others. An awareness of the ubiquity of vested interest and a stated determination to oppose it does not in itself put any player outside the analysis he or she seeks to apply to others. Nor is it sufficient for that player to claim to know the public interest, because other interest groups make exactly the same claim, and they may be better informed, as was demonstrably so in the case of the health reforms (Easton, 1995). There is admittedly a difficult balance to maintain between high-minded insensibility to criticism and surrendering continually to populist pressures which make decisive reform impossible. But when the balance was lost in New Zealand it was generally on the former side.

It is. harder to assess the outcome of the policy reforms. There is surprisingly little systematic evidence of the efficacy of the microeconomic reforms. One complication is the absence of clear criteria for assessment. Duncan and Bollard (1992) usefully review the corporatization – but not privatization – process, and conclude that the result was increased economic efficiency. However, the pre-corporatized SOEs were given a number of objectives, including job creation and equity. If they were given a single objective (e.g. commercial efficiency) it would be surprising if they did not then do better on that measure. Equally, it is not at all surprising that in practice they did worse on the measure of the objectives they abandoned. How are we to offer a comprehensive evaluation of the change, without an agreed set of objectives and priority weights?

Another complication is that any improvements from the reforms are dominated by the macroeconomic stagnation evident in Table 2. While over the 7-year period from 1984 the OECD expanded its volume GDP by 19.7 percent, and Australia, facing a deteriorating external environment, expanded by 16.8 per cent, New Zealand GDP contracted in absolute terms.

Unlike that of the 1966-76 period, this poor performance cannot be explained by the external situation. In fact the terms of trade improved slightly over the period. Macroeconomic policy, which concentrated on disinflation, bears much of the responsibility. Monetary policy was tightened in some sense faster than fiscal policy, resulting in an over-valuation of the exchange rate at the same time as protection and export subsidies were being removed. That combination seriously damaged the tradable sector which had been the engine of growth in the New Zealand economy.

It has been argued that the reforms were well conceived, but they were implemented in the wrong sequence. Factor markets-especially the labour market-should have been liberalized first, not last, and conversely the financial markets and the exchange rate last rather than earliest. Instead of following the sequence from sluggish-price to flexible-price markets, the government operated in order of political ease or administrative simplicity-in effect, the opposite to the counsel of perfection. However, Hanke and Walters (1990) argue that sequence is not as important as ‘credibility’, which may dictate making the politically easier changes first.

Most aspects of the sequencing issue can be subsumed under the central one of finding the best way to maintain a realistic exchange rate as external protection and its internal equivalents are stripped out. Given the sequencing order adopted, macroeconomic policy resulted in the exchange rate being used to disinflate while the consequences for economic growth were assumed to be temporary and negligible.

The policy and the reforms were certainly successful in reducing the rate of inflation. However the official statistics show that labour productivity growth was only half the OECD average, output measured by GDP was stagnant, and employment fell, so that unemployment rose to post-war record levels, above the OECD average. Consequently, the budget remained unbalanced and throughout the 1980s the New Zealand economy was under persistent fiscal stress, which itself markedly affected the reforming process. In a stagnant economy there could be no increase in government spending to ameliorate any social and/or political problem. Instead there was an increasing search for efficiency, through which the public sector could respond better to the increasing pressures on it. In that climate, it is arguable, new policies were introduced with inadequate testing or tuning.

At the time of writing in mid-1994, the available indicators suggest the New Zealand economy had been expanding for around eight quarters, the strongest since the 1983-5 boom which preceded the new policies, and perhaps as strong as the short-lived upswing of the 1972-3 world commodity boom. This, in combination with low inflation, has been claimed as evidence of the eventual success of the reforms. That is premature, since the economic configuration-measured by GDP per capita and unemployment-is still not as favourable as in 1990, after which the economy went into its sharpest post-war contraction. Moreover, most forecasters (including the Treasury) are apparently projecting long-run GDP growth at about the same rate as they do for the OECD as a whole. Implicitly they seem to be assuming that the GDP loss from the 7 year period of stagnation is permanent and some increase in unemployment will be permanent too.

If we attempt to set aside consideration of macroeconomic policies, which are distinguishable in principle from the microeconomic reforms, how are we to assess the reforms themselves?

Recall Mr Douglas’s objective of ‘truly satisfy[ing] the public’ .What is the verdict of public opinion? In 1990 the Labour government, which had instigated so many of the reforms, was voted out of office. Its voter share decreased from 48.0 per cent to 35.1 per cent. In the following election, in 1993, the National government saw its voter share cut from 47.8 per cent to 35.2 per cent, although the first-past-the-post electoral system left the government with a slim majority of seats.

Such electoral outcomes could be attributed to the poor macroeconomic performance. But a referendum to reform the electoral system to proportional representation (mixed member proportional, similar to that in Germany) was handsomely passed, despite being opposed by the great majority of the advocates of the economic reforms. Most electors were clearly aware that the change would make policy radicalism less easy, an implicit verdict on the reforms.

Since the election the government has continued to shift its strategy to one of cautious incrementalism, following the departure of the radical-Right Minister of Finance of its first 3 years of office. The relatively new Alliance party, which is broadly opposed to the reforms, has been increasing its voter share in the opinion polls and with Labour, which is attempting to distance itself from its Rogernomics era, shared around 55 per cent of public support in the opinion polls in mid-1994. Despite the strong economic expansion National is still around 35 per cent in the polls, though this could, of course, improve with continued growth.

The public verdict on reform at present seems to be that much was clearly necessary and there is little appetite for wholesale reversal. But the experience was not entirely positive and far from all aspects of the reforms have won general support. If the reforms of the first phase have been assimilated and the second-phase reforms to core government operations have made relatively little impact on the general public, attitudes to the third phase of welfare reform remain divided, with widespread scepticism or hostility. Given electoral reform it seems likely that the future development of policy in New Zealand will follow a different pattern from that of the last decade. It seems most unlikely that there will be any major retreat from the orthodox market liberalization measures since they reflect the altering political economy of New Zealand following the structural changes of the last quarter century and are widely regarded as inevitable. Yet the radicalism appears to be exhausted.

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Table 1: Market Liberalization Examples of the 1980s

Restoring the Market Mechanism
Deregulation of entry licensing into industry.
Partial deregulation of occupational licensing.
Removal of other operating barriers to industry.
Removal of price control.
Removal of import licensing.
Significant decrease in import tariffs.
Establishment of Closer Economic Relations (C