The London Economist and the New Zealand Economy

A response to an Economist article of 30 November 2000.

Keywords: Growth & Innovation; Macroeconomics & Money; Political Economy & History;

A summary of The Economist’s position of the New Zealand economic reforms might be:

New Zealand had to change its economic policies from at least the early 1980s. The path of the reforms was riddled with ‘blunders’ and ‘hubris’. The Economist enthusiastically supported them at the time, despite warnings of the weaknesses that the microeconomic reforms were extremist and the macroeconomic reforms faulty. The outcome has been a much poorer performance than other countries – such as Australia – which tackled the same problems with a more thoughtful, incremental and technically competent approach. This conclusion applies even ignoring the rising inequality and the social distress. Nevertheless, The Economist thinks New Zealand should continue to pursue the policies which have failed in the past. Victory is about implementing ‘right’ policies, not getting better outcomes.

In its issue of November 30th, 2000, The Economist of London once more reviewed the New Zealand economic reforms. From an early stage The Economist was an uncritical (and often uninformed) enthusiast for ‘rogernomics’. Fifteen years on it is beginning to acknowledge that the outturns have not been as successful as it hoped, although it continues to praise the reforms.

It does this through a neat logical twist. Comparing the rogernomics policies with those policies which preceded it is no great challenge (especially if the earlier policies are presented as a parody). Indeed, the Rogernomic policies of the 1980s were also better than what the Vogel-Atkinson policies of the 1880s would have been, had someone attempted to implement them a century later. However, the issue has never been whether the pre-1984 policies were to be continued, but what policies would follow them. Even Rob Muldoon, the architect of the pre-1984 policies, would agree since he was seeking a post ‘freeze’ strategy when he called the election in 1984. In any case, he had changed his economic policy following winning the two previous elections, so one may have expected him to change it in the (unlikely) event he was returned in 1984. At issue was which of the alternative policy options would be the most beneficial. By reducing the argument to TINA (there is no alternative), The Economist misses the point (again).

After the 1984 election the policy process was captured by a group – rogernomes – who were ideologically extremist and economically wrong, who thought TINA (apparently because they could not envisage there could be other policies). The resulting the economic management of the economy was incompetent, and the economic record disappointing in comparison to what less extremist more technically expert policy would have achieved. To New Zealander’s chagrin, one need only to look across the Tasman to see a far higher standard of economic management, and a better economic performance as a result (even though on some measures the Australian economy sustained worse external shocks than New Zealand over the period).

In one sense that is all that needs to be said about The Economist’s views. It set the reformers a very low hurdle of doing something different from the Muldoon era. The dwarves managed to just get over it.

But here follows a detailed commentary.

New Zealand, a small, far-off country of which most people know little, has attracted disproportionate interest from economists over the past two decades. It was once one of the most protected and regulated economies in the developed world. But in the 1980s and early 1990s it became the liberalisers’ darling, as it pursued market reforms more dramatically than any other economy—including Margaret Thatcher’s Britain. New Zealand was hailed with promises that it would change from ‘the Poland of the Pacific’ into another Hong Kong.

Yet today, 16 years after the reforms began in 1984, the economic rewards seem disappointing. Several recent articles have gone so far as to conclude that the reforms were misconceived. For instance, John Kay, a British economist, argued in the Financial Times that ‘the New Zealand experiment has failed’ and that ‘liberalisation has left it poorer than before’.

On the surface, the justification for such claims is strong. Since 1984, the growth in New Zealand’s GDP per head has been the slowest in the developed world. And, even more embarrassingly, the country’s nearest neighbour, Australia, which for years was lambasted by commentators (including The Economist ) for not pursuing reform with the same vigour as New Zealand, has actually experienced much faster economic growth over the past decade.

A reasonably uncontroversial opening. Note the acceptance that Australia with its cautious reforms has done better.

Most New Zealanders accept that some reform was necessary, but many feel that it went too far and too fast; and some think that the social cost, notably through increased inequality, has exceeded any modest economic gains. Indeed, since last December, a Labour-led coalition government has started to reverse some of the previous reforms. Trade unions have been given more power in wage negotiations; the top rate of income tax has been raised from 33% to 39%; workplace accident insurance has been renationalised; further privatisation has been ruled out; and the government is considering tougher regulation of business.

In practice, the government’s new measures only modestly reverse the reforms of the previous decade and a half. But they have created the perception that the government is anti-business. Business confidence has plunged on fears that the government plans to do more to undo the reforms. Consumer confidence has also dived, and GDP fell in the second quarter of this year.

This looks out of date even as it is published. In early 2000 the New Zealand economy went into a classic cyclical downturn, probably as a result of a cutback in government spending and some activities coming off the boil (house building, the America Cup, activity associated with the millennium). So too did a number of other economies. It suited the rogernomes to blame the downturn on the government (and in truth its handling of its political relations with business in its first nine months was clumsy). Now the economic cycle has hit the bottom – as it always does, has stayed at the bottom for about one quarter – the usual length of time, and is back into upswing – as is normal, with a recovery in business and consumer confidence.

Note that the article says there is only a modest reversal of the past measures. But the effect of the reversal is to move New Zealand economic policy to where it is considered orthodox in most of the world. For instance the rogernomes have much criticised the recent labour market reforms but industrial relations are now on a footing similar to elsewhere in the rich world (and consistent with the ILO conventions – the rogernomic arrangements did not).

Incidentally, this is the only reference in the article to the increase in ‘inequality’ which has accompanied the reforms, apparently a matter of no moment to The Economist. There have been two main factors causing this increase. By far the most important is that the reformers gave themselves large tax cuts, and had to cut social spending and raise taxes on the rest of the community to pay for them. The second is that for the first time since the war, the market mechanisms seem to be systematically increasing inequality in the 1990s, probably because of the ripping out of the social mechanisms which ameliorated the market in the past and the impact of globalisation. (The research has yet to separate out the two effects.) Thus the incomes of 80 percent of the population have fallen over the years of the reforms (generally modestly) while the top 10 percent have had average income increases in the order of 25 percent.

Who called Roger?

Yet the current gloom needs to be compared with the conditions that led to the reforms in the first place. In the 1950s, when it functioned largely as Britain’s larder, New Zealand was the world’s third-richest country. By the mid-1980s, it had dropped to around 20th; and its GDP per head had fallen from 20% above the OECD average to one-third below. The country suffered two severe blows in the 1970s. Not only did oil prices soar, but Britain’s entry into the European Community meant that New Zealand lost its preferential access for farm produce into the British market (then 35% of its exports, now 6%). The government of Robert Muldoon responded with massive fiscal expansion, including big subsidies for industry and farming, and heavy public investment in industrial projects. As inflation soared, the government froze wages, prices and rents.

The figures in this paragraph come from the standard rogernomics rhetoric and are not quite right. New Zealand had around the sixth to highest GDP per capita in 1950, not third (and per capita income does not equate with wealth). Note that while New Zealand was about 20 percent above the (24 country) OECD average in 1950 (for the war torn economies were still recovering), but it was only about 13 percent below average in 1980 and 20 percent in 1990. (See In Stormy Seasfor details.)

The paragraph ignores that the 20 percent structural fall in the terms of trade in 1966 which markedly slowed down the GDP growth rate for the next decade – evident in the statistics if one cares to look. But it does recognize something the rogernomes did not. New Zealand’s economic difficulties had largely arisen from external circumstances – the pastoral terms of trade fall, the oil price shocks, the loss of markets and foreign market protection. Poor economic management can compound these difficulties. The rogernomic policies are proof enough of that.

The reason the rogernomes could not admit to the significance of the external shocks is that their diagnosis of the poor post-war economic performance was entirely in terms of the failure of domestic policies, which they promised to remedy. The sad consequence of their introversion was they ignored the external sector, and so damaged the New Zealand economy. The irony of the rogernomics record, is that is when the external circumstances are allowed for, this is the worse economic management as measured by outcomes. There have been worse outcomes, but they were when there were difficult external circumstances. The rogernomic failure occurred in a period of favourable external circumstances.

By 1984 New Zealand’s economy was on an unsustainable course, with enormous budget and current-account deficits (8% and 9% of GDP, respectively) and mounting inflationary pressures that were masked by price controls. It was also the most distorted economy in the OECD. Almost all its prices, which in market economies are supposed to send signals to firms and individuals, were controlled, and high trade barriers shielded inefficient producers from competition.

I don’t want to challenge this too much, except to draw attention the early 1980s current account deficit being the consequence of a spectacular investment boom (so called ‘Think Big’, detailed in In Stormy Seas, for the story is much more complicated than the rhetoric). The internal deficit was being covered to a large degree by the inflation which reduced the value of the government liabilities. That was the ‘unsustainable’ element in 1984. There is more credit to be given than this Economist article does for the rogernomic success in bringing inflation down. However, the cost to the tradeable sector of the consequential overvalued exchange rate and resulting damage to economic growth was horrendous (acknowledged later in The Economist article).

A comprehensive view must cover the economic growth record before 1984. In the post-war era until 1966 New Zealand GDP grew at much the same rate as the rest of the OECD (but because its population growth was higher at a slightly slower per capita rate). Following the permanent terms of trade shock of 1966, the New Zealand growth rate slowed down (as one would expect because the main – indeed almost only – export drivers suddenly became unprofitable and capital obsolete). The transition was largely through by the mid 1970s, after which New Zealand GDP began tracking at the OECD growth rate again, albeit at a lower level. Indeed for the seven years from 1978 to 1985 (when the reforms began) New Zealand grew fractionally faster than the OECD, albeit in part dependent upon heavy overseas borrowing.

Enter Roger Douglas, finance minister of the Labour Government after 1984. ‘Rogernomics’ consisted of both microeconomic reform and macroeconomic stabilisation. The exchange rate was floated, foreign-exchange controls were scrapped and financial markets were deregulated. Trade tariffs were slashed and import licences abolished. The top marginal rate of income tax was cut in half, to 33%. Subsidies to farming and manufacturing were eliminated, and many government activities, which then spread far and wide, were privatised.

Although Mr Douglas subsequently fell out of favour with his party and lost his job in 1988, the National Party government that took office in 1990 continued with the reforms he had begun. Their most important measure was the Employment Contracts Act of 1991, which decentralised wage bargaining, putting contracts on an individual basis between the worker and employer.

Notice that the two year period from Douglas’s fall to Richardson’s rise is not classified as a reforming one. That is not what the record shows. (For instance, the main privatisations occurred then). Moreover, extremist reforms continued to made about the post-Richardson era, although not as comprehensively. The Economist’s distinction seems to be that the intensity of the reform fell off a little, so implicitly it considers only extremist reforms are valid.

The ECA was not ‘the most important measure’, except ideologically. Future generations are likely to see it as another example of an extremist policy which did not deliver the promises advocates made for it. More significant were the structural cuts in government expenditure, even though they precipitated the unnecessary 1991 recession and caused an immense amount of social hardship.

There is no mention of the health system reforms, which are an example of the extremist ideologically driven reforms, which were so typical of the rogernomes, and which fell unsuccessfully apart. The Economist could also have learned much from the electricity reforms, which again were extremist and poorly thought through, and resulted in outages, including a prolonged one to the Auckland CBD. Today’s government is trying to remedy these failures, and a good few other such messes.

At the same time the framework for macroeconomic policy was radically reformed. In 1989 the Reserve Bank won full independence to set monetary policy, with an explicit inflation target. This model has been widely adopted elsewhere, as has the Fiscal Responsibility Act, which helps to impose budgetary discipline by making policy more transparent and making governments take more account of the future implications of today’s policies. After two decades of double-digit price rises, New Zealand’s inflation rate has averaged just under 2% over the past decade. The government has run a budget surplus since 1994, reducing its ratio of net public debt to GDP from 50% to 20%.

The Reserve Bank does not independently ‘set’ monetary policy. It independently ‘operates’ monetary policy. One is astonished that The Economist does not know the difference.

A major source in the reduction of the public debt to GDP ratio has been the sale of public assets part of the proceeds from which were used to repay public debt, so the relevant assessment is the public balance sheet (the statement of assets and liabilities) which did not improve nearly as much. Moreover it seems likely that some public assets were sold at price below their true value. There are credible (but not universally accepted) estimates that the loss to the government was up to $20 billion. If true, that means had the public assets been at full value, there would be a near zero net public debt.

A few myths about these reforms should be laid to rest. Although they were radical in their speed, their extent can be exaggerated. New Zealand is often portrayed as undergoing a decade and a half of non-stop change. In fact reform occurred in two brief waves: ‘Rogernomics’, under the Labour government of 1984-87, and ‘Ruthanasia’, under the National government’s finance minister, Ruth Richardson, in 1990-91. In both cases, after an initial spurt, reforms stalled during their governments’ second terms of office.

The notion that little reform occurred in each governments’ second terms is a historical nonsense. (Did the writer knew that social policy in the early 1990s was called ‘Jennicide’ after Jenny Shipley?)

The reforms also appeared more radical because the economy was so tightly regulated to begin with. New Zealand required much more extensive restructuring in 1984 than did other developed economies, such as Britain’s in 1979. British politicians and civil servants used to visit New Zealand to seek tips on economic reform, yet the country remains more regulated in several ways than Britain, let alone the United States. Take, for instance, agricultural producer boards, which act as monopoly sellers of produce in foreign markets—at a high cost to the economy. With no competition, the dairy board, which accounts for one-fifth of exports, has little incentive to innovate and shift to higher value products.

Have you noticed the only example people ever give now is producer board reform? Are there no other ‘big’ ones? Or is the rest of the agenda too publicly unpopular to mention publicly. (The claim that dairy products are a fifth of exports is wrong, because it ignores service exports. Tourism is a big foreign exchange earner than dairying, for instance.)

Another myth is that New Zealand’s welfare state was largely dismantled. In the early 1990s, benefits were cut and stricter eligibility rules introduced. But government spending still accounts for more than 40% of GDP, higher than the OECD average and well above Australia’s 32%. By international standards, New Zealanders still enjoy generous state pensions. Even today, New Zealand is hardly a test-case of the economic benefits of small government.

The dismantling was not for want of trying.

According to the OECD the General Government Total Outlays by New Zealand come to about 40 percent of GDP (depending on the exact year – 40.2 percent in 2000) as does the average for all OECD countries (39.5 percent). So New Zealand is near the OECD middle, not an at extreme, and in any case the magnitude is dependent upon institutional arrangements.

The scorecard

Which, it will be noted, does not include assessments of income inequality, social cohesion, or the impact of the reforms on ordinary New Zealanders. As the colonel said to his economic advisers some years after the coup, ‘you say the economy is doing well, but the people are not.’

Judged by average growth since the reforms began, they might appear to have failed. Since 1984 GDP per head has grown by an average of only 0.9% a year, even slower than the 1.5% average in 1971-84. But it is unfair to judge the reforms over the whole period since 1984. One of the biggest reforms, labour-market deregulation, did not occur until 1991. The urgent need to reduce inflation and government borrowing also depressed growth during the early years.

It is a standard rhetorical device to omit any years which undermine the thesis.

Between 1984 and 1991, the economy broadly stagnated. But since 1992, GDP has grown by an average of 3% a year and GDP per head by 2.2%—slightly above the OECD average. The OECD reckons that New Zealand’s potential growth rate has risen to 2.5% a year, compared with about 1.5% before the reforms. New Zealand’s income per head has stopped falling relative to other economies, after doing so continuously since 1950. Unemployment, now 6% of the labour force, is roughly the same as in 1983, but over the past decade New Zealand has seen one of the fastest rates of growth in employment of all OECD countries.

The current OECD Outlook shows an average growth for all OECD countries (including those which have recently joined) of 2.9 percent p.a. from 1992 to 2000. The choice of period is from the bottom of the New Zealand downturn in 1992, whereas the OECD came out of its recession a year later and so has one additional poor year. Notice that The Economist acknowledges that the OECD thinks New Zealand is actually capable of only 2.5 percent p.a. in the long run, which is lower than the OECD potential. This contrasts with the fact that for most of the postwar era New Zealand GDP grew at the long term growth rate of the OECD average or above. (1945-1966, 1978-1985, 1993-2000. The gaps are the transition period after the terms of trade shock of late 1966, and the rogernomics policy intensity period).

There is not an international standard statistic for unemployment in New Zealand before 1986 (when the HLFS commenced). The OECD gives an estimate of 1983 (at a cyclical peak) of 5.3 percent (although domestic estimates put the true figure closer to 4 percent), compared with the comparable March 2000 figure of 6.4 percent. Adjusting for the falling New Zealand labour force participation rates (from 65.3 percent to 64.7 percent) relative to the rising OECD ones (from 68.6 percent to 70.8 percent) would add another 3.5 percentage points on to the rate. So the underlying unemployment rate rose about 86 percent.

To make a proper assessment of the reforms one needs to consider what would have happened had New Zealand stuck with its previous policies. And the truth is that those policies were unsustainable. Underlying problems were hidden by subsidies, protection and price controls, but public-sector debt and inflationary pressures were exploding. Eventually they would have had to be corrected—and the longer the delay the more painful the adjustment would have been.

As already pointed out, a comparison is between the actual policies and the previous policies is hardly a demanding one. It is not what the debate is about.

Critics point out that New Zealand’s labour-productivity growth has actually slowed since its reforms began. That is true, but it partly reflects a big increase in hiring after the 1991 labour-market deregulation, which reduced labour costs for lower-skilled workers. In any case, a better gauge of productivity performance is total factor productivity (TFP), which measures the overall efficiency with which inputs of both labour and capital are used. And the most comprehensive study of this finds that, if TFP is measured on a comparable basis to that in Australia (ie, excluding certain hard-to-measure sectors), TFP growth in New Zealand spurted in the 1990s, broadly matching productivity growth in Australia.

The implication in the first two sentences is that real wages fell for many New Zealanders. Correct.

The so-called ‘most comprehensive study’ (by E. Diewart and D. Lawrence) is well documented to involve mistakes in the calculation of real output, the capital price index and capital series, and the labour force series. The effect of these mistakes is to bias up the Diewart and Lawrence TFP figures in the 1990s. There is no evidence of any productivity acceleration in the 1990s, when it is properly measured. Probably there was a slowing down.

Moreover, official GDP figures almost certainly understate recent gains in New Zealand, because they fail to take full account of improvements in the quality of products, which have been much bigger than elsewhere. Since opening up to foreign competition, New Zealand has enjoyed huge gains in the quality of goods and services, along with a vast increase in consumer choice. Restaurants, telephone services and air travel have all improved out of recognition. The scrapping of import controls has given New Zealanders access to foreign (and typically better-quality) goods that once they could only dream of. There used to be only two sorts of refrigerator on sale, made by the same manufacturer and to the same specifications. If you wanted a foreign car, you faced a long waiting-list. New Zealanders even had to get foreign-exchange-control approval to subscribe to The Economist .

The problem of the measurement of quality changes in GDP is not unique to New Zealand. Many of these statements are also true for other OECD countries, and would have happened under a less extremist liberalisation. But two points:
– ‘Choice’ is only meaningful when one has income, and many New Zealanders are worse off in income terms than when the reforms began. (One study found that the beneficiaries of these quality improvements tended to be in the higher income brackets.)
– The rogernomes’ list never includes where there is a deterioration in the quality of service. For instance the public sector financial cutbacks have led to major reductions in the service to the public – a commonly cited statistic is that a third of callers to the IRD hang up because the underfunded department is taking so long to answer calls. But there are private sector failures too. Few New Zealanders are happy with their bank’s service.

Inflated expectations

It is nonsense, therefore, to argue that the reforms have failed and that New Zealand is worse off than it would have been had they never happened. Doing nothing was not an option. And growth in output and total factor productivity have increased, not fallen.

A profoundly confused paragraph. Let us agree on the second sentence, since even Muldoon would have said to do nothing was not an option. But there were alternatives from that which the rogernomes pursued. It is far from nonsensical to argue their reforms have failed, in the sense that other options would have resulted in better outcomes. (One could cite Australia’s approach as an alternative.) As for the statement that growth in output and total factor productivity have increased. (I think that is what the last sentence is trying to say.) Not true. Their levels have increased, but the growth rates have fallen.

Nevertheless, it is true that the rewards of the country’s reforms have failed to live up to their promises. The OECD, in its latest economic report on New Zealand, forecasts average annual growth of 3% over the period 2000-06. But because of rapid population growth, that would imply no significant narrowing of the large gap between New Zealand’s income per head and the average for all developed countries.

New Zealand’s population growth rate is about .8 percent per head, about the same as that of the OECD. (However the writer may have had in mind ignoring some of the poorer OECD countries with their higher population growth rates.) But if high population growth rates are a drag on convergence in this decade, they were also presumably a drag before 1984 (as argued in In Stormy Seas). Too often the special justifications for poor post-reform performance are equally (or more) true in the pre-reform era.

One lesson is that initial expectations from the reforms may have been too high. Indeed, international hubris about the Kiwi experiment may have exacerbated a financial bubble in the 1980s that left the economy horribly vulnerable when global stockmarkets crashed in 1987. There is a parallel here with Thatcherism in Britain, whose effects have also been more modest than many had hoped, and which also was associated with a financial and asset-price bubble. Britain, like New Zealand, has halted its relative decline, but it has not experienced the economic miracle that some were looking for.

The Economist was among those whose initial expectations were too high. One notices it gives no credit to those who said so at the time.

With hindsight, it takes a long time for an economy to change. One reason is that the economic pay-off does not flow direct from the reforms themselves, but rather from companies that take advantage of the new opportunities they offer. And after decades of protection and state coddling, it is bound to take time for managers to learn new rules. This is one reason why comparisons between New Zealand and Australia may be unfair. New Zealand started off far more regulated and protected than Australia.

Ah, editorial hindsight is the privilege which allows one to overlook those who correctly showed foresight. The last two sentences are a wonderful reversal of the traditional rogernomic argument. In the past the argument was that liberalisation would benefit over-regulated economies most greatly. Now it is the opposite. (A less surprising conclusion after the disasters that occurred to the economies east of the collapsed iron curtain, and in Latin America – as another article in the same Economist points out).

Nevertheless, New Zealand’s reformers made some serious blunders, which must carry some of the blame for the economy’s performance. The biggest mistake may have been that the reforms were done in the wrong order. The exchange rate and financial markets were set free before the budget deficit and inflation had been brought under control, and before product and labour markets had been deregulated.

The failure to eliminate the government’s enormous budget deficit early meant that interest rates had to be pushed even higher in the late 1980s to hold down inflation. With capital controls removed, foreign money flooded in, resulting in a massive appreciation of the exchange rate. This savaged many industries that might otherwise have benefited from the reforms, and it also discouraged investment in new industries. Increased competition certainly drove out inefficient producers, but few new industries sprang up to take their place. Worse, because the labour market was not yet deregulated and wages, set by a national system, continued to rise rapidly, unemployment soared, deepening the recession of the late 1980s and early 1990s.

Oops. So our reformers made serious blunders. So there were more options than the one the article has focussed on.

As for the sequencing argument. The blunderers were told at the time. A 1983 column in The New Zealand Listener raises the issue. In an article on the New Zealand economic reforms in the Journal of Economic Growth in 1989/90, Alan Walters, economic adviser to Mrs Thatcher, said there was no sequencing issue.

With better sequencing of the reforms, the costs of adjustment could have been smaller. As it was, the overvalued exchange rate during the 1980s and much of the 1990s largely explains New Zealand’s poor export performance. Since the early 1980s New Zealand’s volume of exports has grown at only half the pace of Australia’s.

This argument has been around for at least 15 years. Good to see The Economist has now begun to understand it. Indeed it seems to be arguing if it and its friends had not been so ideological in the 1980s and technically more competent, New Zealand would not have suffered to the extent it did. Well, well, well.

Many economists (especially in Australia) reckon that another serious policy error was made by New Zealand’s Reserve Bank during the Asian crisis. In 1997 the bank adopted a ‘monetary conditions index’ that combined interest rates and the exchange rate into a single measure of monetary tightness. As the New Zealand dollar fell in response to the problems in Asia (the destination for one-third of New Zealand’s exports), this forced the bank to raise interest rates sharply. Yet this happened at the very moment when demand was being squeezed by the slump in exports to Asia. In contrast, the Australian Reserve Bank left interest rates unchanged even though its currency also sank. Unlike Australia, New Zealand dipped into recession in 1998.

Let us not disagree, but instead raise the question whether the ideology and technical incompetence from the rogernomics/ruthanasia era has persisted through to the late 1990s. Does it continue today?

The extent to which monetary policy was to blame for New Zealand’s recession is debatable, however. After all, during the Asian crisis, New Zealand’s farmers were also hit by two successive years of drought. Nevertheless, the argument suggests that it is as important to get macroeconomic policy right as to introduce microeconomic liberalisation: indeed, if the first is wrong, it can dilute any beneficial effects of the second.

The argument that macroeconomic policy is more important than microeconomic policy has been around for over fifteen years in New Zealand (and Keynes made it in The General Theory).

A third explanation of why the growth dividend from the reforms has disappointed is that New Zealand suffers such huge inherent disadvantages. In theory, free trade and deregulation should boost growth by encouraging a shift of resources to industries in which the country has a comparative advantage. The snag is that New Zealand’s main comparative advantage lies in agricultural produce (two-thirds of total exports), and trade barriers in global markets prevent New Zealand from fully benefiting from it.

New Zealand’s small population and geographic isolation from large markets also limit its scope for exploiting economies of scale. As ‘the last bus stop on the planet’, New Zealand is at a disadvantage compared with other small economies such as Ireland or Finland. A circle with a radius of 2,200 kilometres centred on Wellington encompasses only 3.8m people and a lot of seagulls. A circle of the same size centred on Helsinki would capture well over 300m people. Even if New Zealand had the best economic policies in the world, its isolation would probably still constrain its growth rate.

In 1950, when The Economist thinks New Zealand was the ‘third richest in the world’, that same circle encompassed less than 2 million people (but possibly more seagulls). So what is new?

The Economist may be skating on very thin ice here. Perhaps what is new is that there have been major falls in transport costs in the fifty years (including falls in the costs of information transmission). Thus the natural protection has been reduced and the economy has suffered, possibly because of strong economies of scale in key industrial processes and high international mobility of factors, both of which undermine the standard results which favour the free trade polemic which is so basic to The Economist’s editorial vision.

Never-the-less, changes in the world protection and subsidisation of pastoral products have exacerbated New Zealand’s difficulties. That was as true before the 1984 era as after. The post 1984 reforms ignored this fundamental fact that external circumstances were significant. No wonder they went wrong.

Unfinished business

Having admitted there was blundering and hubris, one might have expected The Economist to have shown a little humility when it came to the future policy course. But …

To the extent that the mis-sequencing of reform and New Zealand’s inherent disadvantages may have reduced the growth dividend so far, the country’s relatively disappointing performance should not be seen as a verdict on free-market economics. It does not, in short, prove that the model is wrong. But other changes may be needed to improve New Zealand’s performance.

It does prove The Economist’s particular interpretation of the model was wrong.

Michael Cullen, Labour’s finance minister, accepts that the reform programme was necessary to open up the economy to competition. But he says it was not enough by itself. He favours a more active industrial policy to promote growth, along with government measures to address structural problems, such as education standards (New Zealand performs badly in international tests) and low saving. Thanks to inadequate saving, New Zealand still has an alarmingly big current-account deficit (almost 7% of GDP in 1999), which leaves it vulnerable to the whims of foreign investors. The country’s net foreign liabilities amount to a horrendous 90% of GDP. To reduce the deficit New Zealand needs to boost private savings or run a bigger budget surplus. Instead, the budget surplus has fallen.

Mr Cullen is really worried about skill levels and saving, he should pay more heed to the latest reports on New Zealand from the IMF and the OECD, both published during the past month. The IMF warns that the recent increase in top tax rates could accelerate New Zealand’s brain drain and further reduce the incentive to save. It also frets that there is a risk that new labour laws and increased regulation could reduce flexibility of labour and product markets. The OECD also reckons that recent policy has moved in the wrong direction, making New Zealand a less attractive place in which to invest.

Having got the policy prescription wrong for the last fifteen years, why will a repeat get it right this time?

While the higher income tax rates reduce the incomes of the rich by 9 percent at most (6/67), The policies which we are now told were blunders are associated with a relative reduction in New Zealand’s per capita incomes by around 15 percent. Did that have no effect on migration?

Note The Economist’s concern for the current account deficit. Earlier it observed that New Zealand has an inferior export performance compared to Australia (and just about everyone else in the OECD). In fact the deficit is comparable to the levels of the early 1980s (after adjusting for changes in definitions), except this time it is not associated with an investment boom. So just as it was argued earlier that New Zealand’s rapid GDP growth rate in the late 1970s and 1980s (slightly faster than the rest of the OECD) was in part due to the sizeable current account deficit, the same analysis largely applies for the New Zealand growth rate in the 1990s.

The current gloom about the ‘New Zealand experiment’ is, however, overdone. The reforms could have been better managed, with better results, but the economy would today be in a worse state had the reforms never taken place. It is alarming, therefore, that the government believes that some reforms need to be reversed. If anything, New Zealand should do the reverse: press on with reform, as most other economies around the world are now doing.

But we have just been told that doing nothing was not an option. Repeating the TINA mantra, as does the second half of the paragraph will just get us back to the poor economic performance The Economist now acknowledges happened under rogernomics.

New Zealand’s smallness and remoteness mattered less when it produced mainly for the British market and when people had less choice about where to work and invest. But in today’s more integrated world it is a serious handicap. As the OECD points out in its report, to offset its natural disadvantages, New Zealand needs to have better economic policies than other countries, if it is to be an attractive location for investment and for skilled workers to live. As other countries, notably in continental Europe, continue to liberalise their own economies, New Zealand’s policies are no longer so exceptional. By reversing its reforms now New Zealand could snatch defeat from the jaws of victory.

Earlier it said that recent changes were only modest reversals. A better balanced analysis would see them as correcting past failures (and worry that other measures to correct past failures are still not being addressed). The Economist’s wonky logic of the last sentence is that implementing its ideologically extreme policy prescriptions is the victory, irrespective of their impact on economic performance and the people. Reversing them, even if it gave a better economic and social outcomes, would be a ‘defeat’ for The Economist and their ideological travellers, if not for the people of New Zealand.

So here is a summary of the article. New Zealand had to change its economic policies from at least the early 1980s. The actual reforms were riddled with ‘blunders’ and ‘hubris’. The Economist enthusiastically supported them at the time, despite warnings of the weaknesses that the microeconomic reforms were extremist and the macroeconomic reforms plain faulty. The outcome has been a much poorer performance than other countries – such as Australia – which tackled the same problems with a more thoughtful, incremental and technically competent approach. This conclusion applies even ignoring the rising inequality and the social distress. Nevertheless, The Economist considers New Zealand should continue to pursue the policies which have failed in the past. Victory is about implementing ‘right’ policies, not getting better outcomes.