What is the Truth about our Record on Economic Growth?
Listener: 17 December, 1994.
Keywords: Growth & Innovation;
This is an update on the original graph.
Many people think that our post war record has been one of continuous economic decline relative to other rich countries of the OECD. The accompanying graph tells a different story. The black lines show the volume GDP (production in constant prices) growth paths for the OECD as a whole. The top line is indexed at 1000 in 1955, the middle at 790 in 1955, and the bottom at 700. Over these three lines is superimposed the red volume GDP growth path for New Zealand.
Since the red line of New Zealand follows the black one between 1955 and 1966, we grew about as fast as the OECD then. In per capita terms it was a little slower, but the difference was small, more than explained by measurement error, catchup by war recovering economies, and the like.
In 1967 the New Zealand economy began growing perceptibly slower than the average. It did this for just on a decade. This was the result in the fall in our terms of trade, the price for exports relative to imports, which occurred in late 1966. With pastoral farming less profitable, economic growth slowed down, and the economy began to diversify.
By 1977 the transition phase was over, and once more the economy began to grow along an OECD path again. But it was a 21 percent lower path. This is a period in which it is frequently claimed the New Zealand economy was doing more poorly than the rest of the OECD. But the statistics used to “prove” the claim, mix the previous diversification phase with the second growth phase. In addition the OECD economy was growing slower in the late 1970s and early 1980s than it was in the 1950s and 1960s.
The tracks diverge in 1986, when the OECD continued to grow, but New Zealand entered a long period of stagnation. There was no fall in the terms of trade to explain the divergence this time. Perhaps they even improved. Why then the poor performance?
The conventional wisdom blames the post 1985 stagnation on Rob Muldoon’s economic policies in the earlier period. But it does not explain precisely how the slowdown came about. Blaming it all on “think big” gives those projects a significance out of proportion to their size.
One explanation is that the diversification phase should have been longer, but Muldoon prematurely expanded the economy. A decade later the over expansion caught up with us. If he were here, Muldoon might well say that having proved his ability to defy slow growth between 1977 and 1985 he would have continued to do so had he remained in power.
In fact there is hardly any systematic evidence to support the conventional wisdom’s explanation. Muldoon did a lot of stupid things while he ran the economy, but he looked after the external (tradeable) sector which produces exports and competed against imports.
His successor, Roger Douglas did not. It was not just a matter of stripping out the export subsidies and border protection with which Muldoon nursed the growth generating external sector. Douglas allowed the exchange rate to rise, when it should have fallen to offset the loss of profitability as the interventions were removed. Predictably, and predicted at the time, economic growth slowed down to zero.
The conventional wisdom argues that the stagnation phase has ended, and we have returned to the third post-war growth phase. Suppose they are right, and New Zealand will grow again at the OECD rate, as is predicted by most major forecasters including the Treasury. The graph projects the red and lowest black track run together. In essence the conventional wisdom is saying that the loss from the stagnation period will never be replaced. We grow, but 12 percent below the level when the rogernomics policies took over.
What seems to determine which of the (black) growth paths the New Zealand economy runs on is the effective size of the external sector. The fall in the terms of trade in 1966 was equivalent to the destruction of capital stock and skills we had in the pastoral industry. It was still there but the world no longer valued it as highly. Thus we shifted down to a lower path, reflecting the reduced effective capital stock.
Rogernomics had a similar impact, although this time it was the government’s economic policies which destroyed the productive ability of the external sector. We have now right-sized the economy down to the level the residual external sector can sustain. And so we may be back on the OECD growth path again, poorer but wiser.