U3A; Christchurch, 6 July 2010

Keywords: Political Economy & History;

The continent Zealandia, on which New Zealand sits, is the eroded soil from the Australian continent which, over hundreds of millions of years, was swept down the rivers to the sea along its eastern coast where it compacted and solidified. About 70 million years ago it unzipped from Australia, drifting eastwards. Zealandia runs from New Caledonia to the Campbell and Macquarie Islands – about 3000 kilometres long and 1500 kilometres wide. It is about half the size of the Australian continent. Because it is light eroded soil, today it is 93 percent submerged under the sea, with New Zealand the main highlands of the sunken continent.

The Tasman Sea between them did not quite end relations between the two continents – there is much flora and fauna blown across to New Zealand, adding to its Gondwanaland originated biota. But the Australian indigenous people dont ever seem to have reached here, despite being in Australia for 100,000 plus years. Polynesians got to Norfolk Island, but no further west.

Human engagement began with the arrival of the European in the Pacific. Australia was settled first, in part because the Maori were thought to be too fierce. For a while the British designated New Zealand as a part of the New South Wales, although Maori were not consulted; the constitutional link came to an end in 1840.

There was however considerable economic and social intercourse across the Tasman. A good answer to the question of where were New Zealand’s first important goldfields, is the State of Victoria. Male immigrants left the New Zealand settlements to prospect there and later, as opportunities ran down in Australia, miners and those that serviced them came here. The Victorian goldfields were also a market. Canterbury was the only New Zealand Company settlement not to lapse into depression after a couple of years, because it began exporting food there. The gold from the West Coast went through Melbourne, to the regret of Christchurch. Earlier, Australia had been the source of the business men who took over Wellington in 1842, seizing power from the English ‘born-to-rule’ aristocracy which arrived to run the first New Zealand Company settlement. They brought their sheep with them, although the Australian merino did not thrive in wetter New Zealand and later sheep were sourced from Britain – the Romney thrived because it came from the Romney Marsh in Kent and was less prone to footrot.

About three quarters of the way through the nineteenth century, New Zealand was almost two distinct economies. South of Taupo, sheep thrived and their wool was shipped to England. North of Taupo footrot and bush sickness inhibited sheep, so Auckland remained a quarry, shipping gold and gum north; but timber was shipped to Sydney (and south) for building purposes. This meant there were two different experiences of the senteen year Long Depression from 1878 to 1895. The south of New Zealand suffered from the difficulties of obtaining international capital right from the beginning; the north fared better because New South Wales boomed until 1888 after which it, and Auckland, collapsed into depression too.

Fortunately, from 1882, refrigeration provided new opportunities for New Zealand pastoral farmers; as its momentum built up it dragged the whole of New Zealand out of the slump. Australia did not grow as quickly. When the Australian states joined in federation in 1901, prospering New Zealand turned down the opportunity, although there remains a provision in the federal constitution for it to become a state of the federation.

From 1900 the two countries went on economically separate paths for the next sixty odd years. Other sorts of relationships were thin too. It is true that the countries fought side by side in Gallipoli, but the experience of the Second World War is probably more typical. It began with diplomatic relations operating through London – there was no Australian representation in Wellington, nor New Zealand in Canberra until 1944. There was a lack of coordination of the war effort at the beginning, which probably contributed to the divergent strategies later on – New Zealand staying in Europe, Australia withdrawing to the Pacific.

Up till then both Australia and New Zealand had depended upon Britain, but the war and its aftermath left Britain, economically, militarily and diplomatically weaker. It clearly no longer dominated the globe as it had in the nineteenth century; the United States took over. The story of how we adapted to this new environment is a complex one; I shall just talk about New Zealand’s economic response.

By the late 1950s, New Zealand faced a number of related external issues. One was to find a new patron to replace Britain, a country which would look after our interests in return for our loyal support. Let me give an example. New Zealand is not a member of the G20, which is one of the world groups (in this case of 20 countries) which discusses international economic and financial matters. It would require a G60 before we were at the table. We work hard before the meetings to ensure that a number of key countries know what our position is, but we rely on Australia – which is a member – to keep us informed during and after negotiations. At forums which we attend we are a small voice. We claim to punch above our weight, but even if we doubled it we would still be equivalent to only 0.6 percent of the world’s economic activity.

The second challenge was that it was evident from about 1960 that Britain, which was the main market for our pastoral products, would soon join what today is called the European Union, which is highly protectionist against our pastoral products. Even before that, open access to the British market was being restricted. We had to find new markets; in any case we certainly could not rely on Britain, with so many other diverse interests, to be our patron in lots of fora important to us.

The resulting market diversification was impressive, as we moved in the late 1960s from one of the most extreme OECD economies in terms of export market concentration, to somewhere in the middle at the end of the 1970s. While in 1960 we sent over 80 percent of our exports to the countries which now make up the EU, fifty years later it is less that 20 percent. Just a few years ago the EU was our single largest market; there was hardly a mention when Australia overtook it.

The third issue was product diversification. The Great Depression had taught us the difficulties of being dependent upon a narrow range of commodity exports whose price could jump around, and which tended to mainly jump down in the long run.

The wisdom of the strategy became evident when the price of wool collapsed in 1966. I shant go through the details but we also developed an impressive diversification of commodities, not only other farm and resource products, but into manufacturers and services.

When addressing the patron problem, our thinking had been so dominated by the experience of dependence on Britain that many could not envisage an alternative to a patronage relationship. They thought mother Britain may have run off with that not entirely acceptable Continental gentleman; we needed someone else to mother us. The possibility that we could function as independent adults did not occur to them. When Britain went, they looked for a replacement.

A possibility was to become an acolyte of the US, which was now the global hegemon – dominating the world on most dimensions – but it had restrictions on our meat exports and even tighter restrictions on our dairy products. In any case it had a range of other countries to deal with, and it was not clear that our military interests aligned with theirs, as the swamp of the Vietnam war was to demonstrate.

A second response was to align ourselves with Australia. Certainly we have worked closely and generally cooperatively with Australia on a wide range of international issues, but there is not always an exact alignment. For instance, the big four banks in New Zealand are all Australian owned and there has been quite a bit of tension between the two countries on banking policy, as when on occasions the Australian banks asked the Australian government to represent their interests to New Zealand.

The third option was that we would have to work with a number of countries to pursue our interests. There would be no patron to replace Britain, but numerous bilateral, plurilateral and multilateral arrangements.

The practicalities were that there was not really a replacement patron as long as we wanted to claim some sort of independence. I am not sure that there ever was an explicit decision, but the outcome of a myriad of them in particular situations was that while Australia would be our closest ally, it would not be an exclusive relationship on either side.

So it made sense to begin extending our economic relations with Australia. First, there was the New Zealand and Australian Free Trade Agreement (NAFTA) in 1966, which was a very limited trade agreement. Each year the two countries would come together to eliminate the tariffs on further products. It was described as a deal between the highest cost and second highest cost manufacturers in the world, although nobody was so impolite to say which economy was which. Sometimes the list of additional tariff-free products was pathetically trivial. One year they agreed that seawater be traded across the Tasman would no longer be subject to a tariff.

In the early 1980s NAFTA was revolutionised by the Closer Economic Relations (CER) agreement. This was much wider than simply reducing tariffs and phasing out import licences because it involved other aspects of the cross-Tasman economic relationships, including services, standards and mutual occupational registration. However it is not full economic integration; I have already mentioned that the banking systems are distinct. But when there is the identification of a problem, the two countries look for a common solution, although it may not always be found. There are, for instances, differences in the two competition policies.

Part of the idea behind NAFTA was to build up the manufacturing sectors of the two economies by increasing market size, thereby enabling them to reap economies of scale, increase productivity and be more competitive against third country suppliers. In the 1960s it was seen as desirable to have, as much as practical, a manufacturing sector which produced most things. In fact both economies have experienced considerable reduction in the size and scope of their manufacturing sectors, reflecting a world-wide trend of globalisation. Today manufacturing sectors in rich countries tend to be quite specialised; in small countries they tend to be export oriented rather than domestic suppliers, except where the costs of transport are high.

At about the time that CER began, there was the rarely articulated strategic view that exporting to Australia should be seen as a step on the way to exporting to the world, not as the final end. That stepping is ongoing, although my impression is that firms rarely go to Australian markets to practise moving on; nowadays they tend to tackle the new markets directly, like the big planes they use, leaping over the continent.

When Australia settles a free trade agreement with China, we can expect Chinese manufacturers to increase their penetration at the expense of existing Australian manufacturers. But also of some New Zealand exporters to Australia – in effect their FTA will cause layoffs in New Zealand. This is a common feature of the impact on third parties of a bilateral free trade arrangement. Exporters who stopped in Australia may find themselves stopped all together.

New Zealand did not involve Australia in its free trade deal with China, nor did Australia in its US deal. That marks a difference between CER and the arrangements for the EU countries, where trade deals are for the lot and not just the individual economies. The Trans-Tasman arrangement gives each country greater autonomy, but perhaps less negotiating power.

CER was really about opening up the New Zealand economy and the Australian manufacturing sector to the globalising world; it should be only pursued as long as that purpose is enhanced. Whenever we are in negotiations, we should assess outcomes by this criteria. It would be pointless to adopt Australian standards if they took us further away from the standards that the world eventually adopts.

A Monetary Union?

This limits the extent to which we should seek greater integration with Australia. Consider monetary integration, which would mean New Zealand adopting the Australian dollar as its currency and the Reserve Bank of Australia running New Zealand monetary policy.

It does not seem to be a well-thought through proposal. As far as I can judge there are two reasons for doing it, aside from cosying up to a patron. The first is that is would give stability to those who export to Australia – they would face a fixed exchange rate. However they only represent a fifth of exports by value, and the likelihood is the other four-fifths would experience greater exchange rate volatility.

The second reason is that while New Zealand is a small economy, its currency plays a far greater role in the world financial system which is unlikely to be a good thing. (There is a whole theory of optimum size of currency areas, which seems to suggest New Zealand is too small to be one.) We need to respect this argument but there are other ways in which we can downgrade the world’s interest in the New Zealand dollar other than by abolishing it, such as some sort of financial transaction tax.

To understand the case against the currency union, you need to know that much of the economic debate is about whether to design policy for when there are calm seas or when there are stormy ones. The case for a currency union is finely balanced when economic times are relatively normal –  say four years out of five. It is in that last year that the currency union looks less promising, as the Cook Islands found in the mid 1990s with their currency union with New Zealand, Argentina found with its currency union with the US in 2001 and 2002 and, more recently, Greece found with its currency union with the EU. I’ll use the Argentinian example, slightly simplified, because it is the best worked through.

Basically the Argentineans adopted the US dollar as their unit of currency in 1991, locking the peso to the dollar via a currency board. That meant its peso rose and fell with the US currency, so when in 2001 the US dollar appreciated for reasons which had nothing to do with the Argentinian economy – it being too small to have any significant influence on the US economy – the peso had to follow, making their exports more expensive and encouraging imports; so much so that beef began to flood into the economy from Brazil (which is about as economically intelligible as New Zealand importing butter).

You can imagine the havoc that this caused to the Argentinian economy. To cut a long story short, Argentina had a massive currency crisis – and a political one; they had five presidents in a fortnight. With much pain – from street demonstrations to unemployment – the peso’s convertibility with the US Dollar ended, and Argentina made a slow recovery from the collapse.

The situation where a region, such as a state of the US, in a currency union suffers from an unintended currency appreciation is well understood by economists. There are a number of mechanisms which can offset it. The first is exports to the metropolitan regions. However only 10 percent of Argentina’s exports went to the US, so there was little contribution from them (and in any case the US restrains Argentinian beef exports). The second is that labour moves to the metropolitan region. Argentinian migration was limited by US controls, although some people went to Spain. Third, the metropolitan core either automatically or deliberately transfers income to struggling regions, such as when the unemployed receive benefits. But there is no such mechanism between the US and Argentina, there is no ‘fiscal union’, where taxes go into a central pool and the public spending takes place out of that central pool.

The export proportion to its EU metropolitan centre is larger for Greece, and in principle Greeks can migrate more easily to other parts of Europe, but again there is no fiscal union. The same applies to the Cooks, although in this case migration is easier. (Did you know that not only are there three times as many Cook Islanders in New Zealand as in their home country; there are also more in Australia?) Nevertheless there is no fiscal union, so that The Cooks were hit harder in the mid-1990s than some of New Zealand’s regions which suffered the same structural pressures but received fiscal support from the centre.

What does this say about a currency union between New Zealand and Australia? We export proportionally more to them, than the Argentinians did to the US but less than Greece to the EU; labour is relatively mobile across the Tasman. But there is no fiscal union. The implication is that without fiscal union, New Zealand could not comfortably survive the shock of a currency appreciation due to particularities in Australia – say a mining boom. To be clear about it, an effective currency union requires New Zealand becoming a state of Australia.

That is an issue we may want to discuss, but lets do it openly, not sneakily by suggesting that New Zealand should be the junior partner of a currency union with Australia and then, when the crisis comes, cap in hand we plead with Australia to let us join their federation. They will levy a hefty price for us to join.

The 2025 Task Force

The final issue I want to discuss is about New Zealand catching up to Australia in GDP per capita terms by 2025. This is an aspirational goal of the government and, in truth, no one expects it to be attained, unless something very unusual happens. Business seems to need such unattainable goals – recall the early 1990s ‘10 in 2010′ which is roughly the same target, and was missed by miles.

You may wonder why bother? or even more fundamentally, why focus on Australian productivity as the target? After all, life is more than material consumption, and New Zealand does well on other measures such as schooling performance; it would be really interesting to get a complete set of indicators; not just the economic ones.

As I was preparing this paper, the Gallup Polling Organisation reported New Zealand was the eighth happiest country in the world, a decimal point ahead of Australia. As a measure of the quality of life, happiness is probably about as reliable as GDP per capita –not much. But I want to draw two conclusions. First, the measures do not correlate well with each other, so we need to be careful to assume material income generates happiness. Second, even if we dont get chauvinistic about such things, and skite that New Zealand is (marginally) above Australia in the happiness stakes, we can conclude the two countries are about as happy, even if their material incomes differ. So we need to ask whether any policy recommendations would make us even happier. Perhaps they will make us worse off, even if we increase material standards of living.

The quality of life is not a concern of the government appointed 2025 Taskforce, chaired by Don Brash, charged with advising on how to attain the impossible target. How they went about it tells us a lot about the purpose of the exercise.

To begin with an obvious question: If you wanted to close the gap with Australia, wouldn’t you want to know why the gap exists? The Australian economy has been growing faster than New Zealand’s since the late 1960s, and Australia’s per-person income has been higher since the mid-1980s.

The next step is surely to gather the evidence explaining why the gap has occurred. Astonishingly, the taskforce report is almost totally bereft of such evidence. The complete lack of reference to scientific studies might lead one to conclude that no serious research has been done on the problem. Of course it has.

Instead, the taskforce makes the desultory claim that none of the differences it identifies explain the income gap – without looking at them in any depth or at any alternative coherent explanations. Yet with no evidence to explain the past differences, the taskforce announces its policies are necessary to address it. How do we know its solutions will work? Trust it. This is ideology bereft of evidence.

Why the difference in material standards of living? New Zealanders and Australians have had similar income levels measured via per capita GDP as far back as 1870s when the comparative data is available. Sometimes one is slightly higher than the other; sometimes it is the other way around.

In the mid 1960s, Australian incomes were below New Zealand’s but they began to grow faster. The best explanation for the divergence in growth rates, which began in the late 1960s, is that is when the Australian mineral boom began, while New Zealand suffered a palpable shock when the price of its wool, which made up two fifths of export revenue, fell 40 percent. New Zealand is unlikely to have an Australian-style mineral boom because that require deposits brought up by volcanoes, and ours are too young and buried deep. (They did not suffer the wool price collapse because they produce mainly the fine wools for clothing, whereas we produce strong wools for carpets.) The Australian mining boom kick-started their economy, whereas the collapse in price of a major industry was a kick in the guts for New Zealand.

After a while New Zealand adjusted and began to grow at the Australian pace. By the early 1980s the two economies were at about the same income level. In 1986 New Zealand took another hit. Australia and the rest of the world kept growing, while the New Zealand economy stagnated for seven years in the Rogernomics Recession. There was a 15% income fall relative to Australia; it is this gap we are being asked to catch up.

You can see the taskforce’s problem. A rigorous analysis would result in acknowledging that

New Zealand has not got the mineral base for an Australian style performance. We are looking in National Parks for some resources, and there may be some minerals in the undersea part of the Zealandia continent, including hydrocarbons. But the taskforce would also have to acknowledge the Rogernomics Recession; three of the five members of the taskforce were then involved in the management of the economy.

Some would even argue that it was the Rogernomes’ policies which caused the stagnation. Ironically the taskforce is arguing that the same policies are being pursued again – lower taxes, less government spending, more privatisation, less government regulation.

At the very least the taskforce needs to explain why prescriptions that seemed poison then won’t do similar damage if they are applied in the future. But that involves addressing the Rogernomics Recession, explaining how it happened, and why their policies did not exacerbate it. That is a tougher scientific standard than the taskforce expects of itself.

What is happening is that the income gap with Australia is being used to advocate policies despite there being no evidence they will address the gap. The electorate told them in 1990 and 1993 (and in favouring MMP) what it thought of that.

Sure there is an income gap. Because of the open labour market across the Tasman, New Zealanders can migrate to Australia for the higher income. But is it as simple as that? Do migrants simply make income decisions, or are they more concerned with the overall quality of life? Do they want to be less happy?  These are serious issues, and we should be thinking about them, even if the Taskforce does not. But to do so, we need to start off with an unbiased account of the facts, and a review of the various scientific accounts of why there are the differences, and then to consider the policies which may address the problem.

That is not how the taskforce has responded. It started off with its policies, and so had to disregard the facts. That is why it did not bother with an inventory of the research and why it was uninterested in the quality of life. It is surely an extraordinary waste of public money and raises questions about the seriousness of the government’s desire to improve the quality of its spending.

It is also a lost opportunity. It may well be that in the near future China will take over as New Zealand’s most important market for exports and supplier of imports. That reflects the way the globalised world is moving. But even when that happens, Australia remains an important part of our future in a whole variety of ways – the fluid Trans-Tasman labour market is but the most important economic reason.

Australia is not going to be our patron, its is not big enough. It is said of China and Hong Kong that they are ‘one country; two systems’. We might say of Australia and New Zealand that they are ‘two countries; one system’. The two countries have different interests as well as common ones. So that while we need to work closely with Australia, sometimes our diverging interests will result in a friendly agreement to disagree.

The cautious but proud independence which has characterised New Zealand’s international and political relations in the last fifty odd patronless years will continue. There is not a half-baked alternative to this. In my view the only alternative is to become a state of the Federation of Australian States. My fear is that if we adopt the inept economic policies which advocates of monetary union and the 2025 Taskforce policies propose, we may end up begging for Australian state status. We can do better than that.

Spirited Conversations, 23 June, 2010, Nelson.

Keywords: Political Economy & History;

Being Able to Predict Government Policy

The topic initially suggested for tonight’s Spirited Conversations was to talk about the 2010 budget. I knew that this event would be two months later, by which time things would have moved on. So I chose instead ‘Does the government know what it is doing?’ as a provocative way of discussing wider issues which I hoped the budget would shed some light upon.

Less provocatively, my interest is the government’s policy framework. I am frequently involved in giving advice as to what policy might be ‘acceptable to the government?’ To answer I need to know something about how the government thinks about policy generally, so for some decades I have had to think about the policy framework of successive governments.

I am particularly anxious to be able to see through the hype, relayed by journalists, of promises of radical policy change. As far as I can see they are usually made by people who have little understanding of the issues, and think slogans are policy. Often it is wishful thinking, say someone with a radical policy agenda, typically with little understanding of the real issues. At the moment there are all sorts of claims being made for the review of long-term dependence on benefits, many of which are not about the long-term. What will be eventually decided depends on some technical issues on which I have some competence, but I also need to know about the politics of the likely decisions. That is where the policy framework is important.

The Policy Framework

A policy framework includes a vision – this government talks of ‘aspirations’ – but it also has a set of principles which help decide the policies which are chosen and ensure they are consistent. A set of policies need not be a framework; they may well be incoherent and even in conflict. Thus a political party’s election manifesto does not give you the framework, particularly if the party is in opposition. Bill English, as National’s deputy leader, admitted as much when he said that his party needed to be in government to develop its policy.

The sentiment was echoed last year by Rodney Hide, one of the ACT cabinet ministers , who said that John Key ‘doesnt do anything’, adding that his party ‘ACT did everything and we are hated’. It is perfectly true that ACT has a policy framework, and so it is relatively easy to predict what its stance on a policy issue will be. But having a policy framework does not mean the policies will work. They may be coherently wrong.

The Continuation of Uncontentious Programs

The focus tonight is the National government’s policies. First, there are a number of practical and politically uncontentious programs that the previous Labour government had underway and which are being continued. A good example is that involving Stephen Joyce who as Minister of Transport has been deservedly applauded for the progressing the development of of the transport infrastructure. The issue arose in 2002 – I was on the government committee which initiated the policy development. It took about six years to get the program underway and, fortuitously for Joyce, it was there when he took over the portfolio. On the other hand, the central management of the Tertiary Education Sector was in a mire at the time of the 2008 election, and it still is; so its minister Joyce has not been nearly as successful. Certainly a minister can be praised or damned for the way a portfolio is handled, and they may accelerate or delay the ongoing program, but success usually means that officials have been working on it long before the minister took over.

Official’s Preoccupations

Some policies are primarily the concern of officials. Eventually they persuade their minister to adopt one, although there may be nothing in it for the politicians and even political downsides.

An example is the merger of Archives New Zealand and the National Library into the Department of Internal Affairs. The cabinet paper’s arguments for the merger are transparently weak, and the merger itself evidently misconceived. It seems barbarians at the gates want to downgrade culture and heritage as a national objective So what is going on? The answer is not in the cabinet paper; the State Services Commission wants to reduce the number of government departments.

Somehow ministers were seduced with nonsensical reasons; they are going to face the humiliation of having to argue them in public. As it happens there are some vociferous lobbies outside government – not particularly political ones; many resisters will be National supporters – and the government is likely to pay a heavy and unnecessary political price for fronting for the SSC. Never forget that the mandarins are always there, treating politicians as dispensable.

Ministerial Style and Taste – and Competence

So there are ministers who are there on top of their portfolios and leading officials, and there are ministers who are not. Additionally ministerial taste and style matters – Chris Finlayson on Treaty settlements is an example; the way Nick Smith handles his portfolios is another, Gerry Brownlie shows yet a third way.

That makes policy prediction much harder, and is why a person in my position has to monitor ministers. But my experience is that in the long term their foibles dont matter quite as much.

The Party Supporters

I would have given greater weight in the transport infrastructure development to public urban transport and the long distance connections between urban centres. That illustrates another feature which is helpful when you are trying to predict policy. The government’s perception of its constituency is more important. As well as being beholden to certain pressures groups – which I will come back to – this government judges that its supporters are less green than those that support Labour and its allies. Hence the downgrading of public urban transporting its infrastructural planning.

Another example is the mining of national parks. This is a desire of the business sector, but politically it has been very badly handled, causing a far greater outcry than was necessary. The government failed to observe there has always been a strong national commitment to conservation even among their supporters– Forest and Bird is hardly a bunch of commies.

Who Wins; Who Loses?

Another place where the constituency matters is when making judgments about winners and losers from a policy change. National and ACT obtain most of their support at the high end of the income and wealth spectrums so when they make a decision they tend to favour the rich at the expense of poor and of greater inequality, as we saw in the budget.

There are some issues here that are subtle, although the arguments usually used to justify favouring the rich are not. Key’s counselling that New Zealanders should not envy them for getting more from the tax cuts was simply crass, as the hurried backdown illustrated.

The widely argued case that lower taxes promote economic growth has little empirical foundation and some evidence contradicts it. Its purpose is to provide a justification for the rich paying less; the rich are an important part of the government’s supporters.

Sadly, many of the rich are out of touch with the rest of the community. During the Rogernomics Recession average incomes fell for seven years in a row. Because the tax cuts favoured the rich, their incomes grew as if they had been no recession – so everyone else’s incomes fell even further. But the rich only remember what happened to them, that they had income growth – not the difficulties that most New Zealanders faced. That is why they can talk about Rogernomics being a success – it did not hurt them. However the claim that Rogernomics was an overall success is objective nonsense (other than for inflation). Those that say otherwise show just how out of touch they are with society as a whole.

Recently a Statistics New Zealand survey found only a quarter of those with household incomes above $150,000 a year – that’s about 10 percent of the population – thought their material standard of living was ‘high’; the remaining three-quarters found thought it was ‘fairly high’ or ‘medium’. The government has responded to these rich strugglers by giving them an additional tax break of at least $117 a week (less GST), although some are not going to benefit from the tax cuts because they dont pay any tax anyway.

There was a case for eliminating some of the exemptions on taxation on property which distorted the market and encouraged a property bubble, although I would have paid more attention to the consequential impacts on the rental housing market. The political issue is what to do with the revenue, at which point the subtlety comes in.

A different political coalition might have used some of the revenue to increase the stock of rental properties or on other public services, or more for the poor and beneficiaries. National chose to use it primarily to cut upper income taxes. Since there are few rich, they do not have much voting power. So some has to be spread among those in the middle incomes who are important politically as they tend to be swing voters.

If you are giving to the deserving rich and the politically powerful middle incomes, it follows that you are not giving the revenue to the poor, to others on lower incomes and to the powerless. It is not just that they got little from the tax rebalance after you allow for the GST, but public sector services and benefits are being restrained or cut back.

The Fiscal Stance, Public Spending Restraint and the Decision Horizon

As it happens, there are strong reasons for reducing the government’s borrowing and debt. In the turbulent international economy in which we live, too much debt is unwise. But the restraint should be on both sides of the budget. Instead the government is putting all the pressure for restraint onto government spending while indulging in unbalanced tax cuts.

That is the way the government thinks. Its preference is for private market solutions to economic issues. Many would say that is National’s raison d’Ltre – its reason for being. So when it has to make a judgement it favours private provision.

I just mentioned that the powerless suffer most. The least powerful are those who dont, or cant, vote. That is why we have so much child poverty and why the government gave so little attention to their interests in the tax cut. Even less powerful are those yet to be born.

This government’s approach is short term, often making a policy decision to be reversed the following week, or even day. I have little sense that there is a policy framework concerned with coherence and consistency in the long term, except perhaps for the fiscal decisions where legislation requires detailed projections with a statement of its medium-term debt policy.

The Influence of the Support Parties

The Government’s handling of its support parties can be equally short term. That National went with ACT was perhaps understandable, even though on more than one occasion John Key has distanced himself from ACT’s philosophy (I think him sincere in this). The relationship with the Maori Party is more intriguing. It seems to have arisen first as an insurance; National may need the Maori Party to form a coalition government in a second term, even though it is not needed this term; and second, National wanted a centre party to balance ACT.

The Maori Party is not strictly a centre party; it is a broad spectrum one with a different concern from the other parties. So while much of its policy is predictable, there are areas where there is no ‘Maori’ perspective and it is hard to guess their stance. When there was not a ‘Maori’ perspective on ACC, the party caucus was conflicted and did not know what to do, leaving the National government to obtain its parliamentary support from ACT, biassing the outcome towards the right, which National’s agreement with the Maori Party was intended to avoid.

The Maori Party is a coalition between the left of Maori voters and the right of the Maori elite. While the Party won five of the seven Maori electorate seats, half of the Maori electorates’ list votes went to Labour. The Maori Party’s largest group are natural Labour supporters; without them it could not hold its seats. But it depends on other groups for its funding.

A nice illustration of this is the frequency with which the Party says it is consulting with the Iwi Leadership Forum which probably supplies the bulk of the party’s funding. Such openness is heartening. But the Forum is hardly aligned with the natural Labour supporters which make up the bulk of the Maori Party voters.

National seems to have gone into the coalition without having given much thought to the complications of the third rail. (You touch the electrified third rail in train system at your peril; going near it, you do so with great caution.) Our third rail is race relations. I would not go as far as Helen Clark to say that a lot of New Zealanders are racist, except when the term is used in a generically meaningless sense.

What I think Clark was saying is that New Zealanders are troubled by race relations at a national level – although most not so much in their personal relations – particularly by the issue of Maori rights and responsibilities. Often they simply do not understand the issues, and react against the demands. Given the shallow level of the public media discussion, one is not surprised.

That is for another Spirited Discussion. My point here is that the National Government does not seem to have thought about the third rail when it formed a coalition with the Maori Party. Instead it has been clumsy. Their opinion polls must be showing that numerous National supporters are troubled by various decisions involving Maori; decisions which in my opinion are not bad in themselves but which have been poorly explained. Since their regional conferences, the Government appears to be taking a harder line on Maori issues.

(Given they have rejected Labour, the troubled National supporters have nowhere to go, leaving an opportunity for a centre-right party which takes a different line on Maori issues. We may see a resurrection of New Zealand First, which was closer to crossing the 5 percent electoral threshold than was ACT. It is not impossible that New Zealand First will determine which major party will form the government after the 2011 election.)

The Failure to Anticipate the Voters

What interests me about National’s failure to anticipate the Maori issue is that it is not unique; on other occasions the government has been just as obtuse. The issue of the privatisation of Kiwibank and the proposal to mine in National Parks are examples.

The government does not seem naturally in touch with its voters. Sometimes John Key can react brilliantly – taking the little girl to the Waitangi Celebration; sometimes he can be crassly blundering – as in the farce over Kiwibank. This suggests his intuition is only tangentially sympathetic with his voters. (Don Brash was even more disconnected, Helen Clark – perhaps the greatest political calculator in our times (challenged only by Muldoon) – may not always have been empathetic, but she knew about her supporters’ beliefs, often before they did.)

This disjunction reflects two trends, First, there is the evolution of career politicians who have not spent much time in their early life with ordinary people. Second, the social evolution of New Zealand is creating politically powerful social groups who are hardly in contact with the rest of the community, let alone empathising with them.

The Auckland Business Community

I illustrate this with the group which is most influential on the government. The business community – especially the Auckland business community – are Key’s friends, his community, and major funders of the National Party. Their account of the world forms a foundation in his and the government’s thinking, even if outcomes do not always meet their expectations.

(National continues to have a rural base, but while it continues to be supportive, Auckland is given greater support, and there appears to be growing rural disenchantment.)

The ABC is not the same thing as the Business Roundtable. It was once, but most serious businesses no longer belong to it, and many of the business people I meet are dismissive of it as having passed its time. The BRT remains vocal, and it is influential on the ACT Party. Sometimes its views align with that of the ABC, although one businessman told me that they were embarrassed when the BRT did, because it turned off the rest of the polity. (I know the feeling.)

The ABC are not the cowboys that ran finance companies. They are mainly people who run real businesses well and New Zealand is the better off for them. They have no representative organisation, although there are other those which sometimes reflect their view – such as the Auckland Chamber of Commerce and the Herald. Think of it more as a network of like-minded people, often with similar problems, who meet in all sorts of venues and in the business pages. Out of this discussion evolves a common view.

I agree with Roger Kerr, executive director of the BRT, that it is rare for someone to be a good business manager and a good economist – although given the ones he has mentioned (always members of the BRT you will observe), it is much rarer combination than he thinks.

Yet business is vitally dependent upon the economy, so it is inevitable that the business community will have a view of it. Where it directly connects with their business they can be very perceptive. As an economic issue becomes less directly connected with their business and more contextual, their insights become – shall we say – aspirational. Their political judgement is hardly better. The ABC’s basic vision is that if you look after business then everything else will come right too, although just what ‘right’ means is vague. Of course we should ensure that business functions well. But that does not mean that looking after business is the ultimate policy objective and business becomes the end in itself, not the means to the end.

Business ends are only part of the way we pursue the goal of the nation; sometimes business cannot have what it wants because that does not contribute to the desired end. That also means that sometimes business models are not the best way of pursuing things. Business does not always understand this.

So the ABC tends to pursue a narrow self-focussed policy agenda. Sometimes it is reasonably effective as with the tax cuts and the ACC changes, and sometimes it takes the government down a track which with hindsight it wishes it had not gone.

The confluence of ACT’s Rodney Hide being Minister of Local Government and Key’s natural empathy with the ABC, meant that initially the government followed the business community’s prescription for the reform of Auckland local government; that where it was not possible to shift the decision into corporate-like agencies which was based upon a business model – then the rump should be managed by a Mayor with powers similar to a corporate chief executive. While there has been some watering down towards a more democratic form of governance, this business-based model for Auckland is still the framework.

Add the ACT propensity to crash through – which in the past has far too often led to crashes. What we have here is all the characteristics which marked the great health redisorganisation of the early 1990s. We await a far from successful – but very expensive – outcome. I dont know what will happen in the local body elections – my main source of Auckland news is the Herald, which is hardly unbiased – but we can expect many expensive systems failures after it.

It is not the only case of the government starting out along the ABC line and has to change course because its voters dont like it. You get a good sense of the disappointment of the ABC from the Herald columnist Fran O’Sullivan who constantly berates the government for not pursuing the business community’s agenda. Her sub-theme is that Key is one of them, but he is too timid to take the course he – and they – believe in. That the public is not as enamoured with the business agenda as business is; that democracy gets in the way of a pressure group pursuing its self interest does not seem to have occurred to Ms O’Sullivan.

A key element of the business agenda is the demand to catch up with Australia – in per capita GDP terms by 2025. We had the ineffective – and largely ACT driven – committee chaired by Don Brash, which made various policy recommendations of benefit to the business community, claiming that it would accelerate economic growth without providing a skerrick of empirical evidence of the effectiveness of their policies.

In fact any orthodox economic analysis shows that there is little chance that we can meet the target. Ironically, the proposed policies are a continuation for the policies which were administered during, and caused, the Rogernomics Recession, which put us so far behind Australia. That is the reason the committee was unable to provide empirical for the effectiveness of its policies, the evidence from the past points to their failure rather than success.

Catching up to Australia is an aspiration, not a policy. As English said, National had no policy in opposition, and it hoped that the officials would find it one. For a quarter of a century officials have been thinking about the objective, had advised previous governments on how to accelerate economic growth relative to the rest of the world, but with little success. Which should not surprise us; if a policy to accelerate economic growth worked it would be adopted by every other country, everyone would grow faster and no-one would catch up.

Why the focus on GDP per capita? The one group in New Zealand who are closest to direct beneficiaries of material economic growth is the business sector. In the long run the profit rate is roughly equal to the growth of GDP. Profits are the objective of business. By arguing for a higher growth rate, it is arguing for a higher profit rate. They may want to have a high profit rate, but that does not mean it should be the ultimate objective of government. Business is a means to an end, not the end in itself.

Predicting Policy Outcome

It is not possible to predict a policy outcome with precision. But I will list some general guidelines for this government. First to set aside some of the more obvious ones which apply to all governments: the continuation of uncontentious programs; officials’ preoccupations; the effects of ministerial style tastes and competence.

What I have argued here is that every government has to balance the tensions between its core support from whence comes its funding and ideas, and its voters and potential voters. National’s core support is the Auckland Business Community although there is also rural group who think it is getting left out.

The ABC does not have a lot of votes and does not seem to be particularly connected to National’s voter base. There are commonalities – they both favour the upper end of the income distribution at the expense of the lower end and the poor. They will do that directly by tax changes, but also by cutting government spending. And of course the preference for private rather than public solutions is an integral part of the National Party’s thinking.

I’ve identified two weaknesses in their policy framework which makes prediction hard. There is a repeated failure by the government to anticipate what their voters think, which means that they frequently announce policy and then to have to back down, after consulting the polls. Additionally the government tends to make very short term decisions, so that there may be policy inconsistency in the long term and policy reversals. Children and the future particularly get discounted.

Policy prediction is not an easy task, but it is proving particularly difficult in the case of this government because of these two effects and the resulting instability of decision outcomes. This amounts to there being no coherent and comprehensive policy framework. If you like, you can say that the government does not know what it is doing. My hope is that as the government settles in, the reservations in this paper will no longer be necessary.

This was an entry for a venture which did not proceed. (April 2010)

Keywords: Political Economy & History;

Introduction

While New Zealand has about 0.1% of the world’s population, its economy produces about 0.3% of the world’s material output. Based on this material output (GDP per capita) the OECD places it in the middle to lower end of its middle rich countries. New Zealand’s distinctive (and in some ways relaxed) lifestyle with a moderate climate, open environment, reasonable public services, and relative security from war and terrorism probably means its quality of life – if that could be measured – would rank it more highly .

New Zealand’s economy is primarily market based, However in some sectors – most notably education and health – the government is the most important funder and provider. A few businesses are also publicly owned. Although the market mechanism has always been dominant since European settlement from the early nineteenth century, the degree of government involvement has varied. New Zealand’s post-war market liberalisation was relatively late, which in part explains the vigour of the reforms from the mid-1980s.

Among the distinctive features of the New Zealand economy are

– it is distant from the world’s economic heartlands, although improvements in transport and communications have reduced that handicap;

– it is relatively small;

– it lacks some of the prestige industries, such as jet aircraft construction.

The biggest difference is in the external sector which reflects New Zealand’s specialisation in the world economy. It is dominated by resource based exports from farming, fishing, forestry (and to a lesser extent energy and mining) together with tourism based on its landscape. There is some general manufacturing exports, but the most important contribution to exporting from the secondary sector is the sophisticated processing of the resources. Contract services, education of international students and some advanced technology products and services also contribute to exports. The film industry has been especially successful in recent years.

There is no distinctive Maori economy, but Maori based enterprises are concentrated in farming, fishing, forestry, tourism and some suppliers of personal and community service.

Agriculture, Forestry, and Fishing

The early nineteenth century economy was based on the exploitation of seals, whales, gold, and timber. As these became exhausted, farming dominated the economy and exports with just under a third of employed directly in that sector from the mid-nineteenth century into the middle of the twentieth. Many more would have been employed servicing the farms or processing the farm output. For most of this period the dominant products were wool and, from the introduction of refrigeration in 1882, sheepmeats, beef and dairy products which were sold mainly in Britain. The high performance was made possible by a temperate climate, heavy capital investment and skilled and innovative farm management. Almost all the livestock is grass fed. New Zealand farming gets negligible public subsidies but its efficiency is such that it competes successfully against subsidised foreign producers. Following the collapse of the price of wool in 1966, there was increased diversification, including goats and deer, horticultural products (notably kiwifruit) and wine. Export sales are now also greatly diversified by destination, especially to emerging economies such as China. The largest single exporter is Fontera which grew out of the cooperative New Zealand Dairy Board, but does not have a statutory monopoly.

The primeval native forests (bush) were largely cut down or burned off in the nineteenth century; the remnants are jealously protected. Wood is supplied by huge forest plantations mainly of radiata pine (originally from California). The ‘wall of wood’ – including pulp, paper and board – also goes to many markets.

New Zealand also has one of the largest Exclusive Economic Zones in the world, with the fish stock conserved by a system of ‘individual transferable quota’ which limit harvesting to sustainable levels. Aquaculture is developing rapidly.

Minerals

New Zealand’s most valuable minerals may well be its water, of which rainfall provides an abundance although irrigation for farming has been exhausting supplies in some regions. There are substantial supplies of coal and some hydrocarbon production, mainly from Taranaki and its seas, with significant prospects of other offshore reserves. But New Zealand remains a net importer of oil. Because of its diverse geology and dynamic tectonic history, there are other minerals but few are sources of significant activity except two major gold mining operations and iron from iron sands. (Gold was very important in the middle of the nineteenth century.) It seems likely that there are substantial mineral reserves in New Zealand’s continental shelf , but except for oil and gas this is hardly exploited.

Energy

New Zealand is self-sufficient in energy except for oil. About a third of the total (including transport fuels) are renewable, with hydro-electricity generation historically important. Wind power is becoming increasingly important, and there are experiments with tidal power. New Zealand is a world leader in the exploitation of geothermal energy.

Because of the high ratio of livestock (which emit methane) to the population, New Zealand has a particular problem with global emissions. It is phasing in what may be one of the world’s most comprehensive emissions trading schemes.

Manufacturing and Construction

The manufacturing sector began developing with the end of alluvial goldmining in the nineteenth century. Partly because of geographic isolation (in addition to temporary isolation in the two world wars) it covered a lot of activities. Much was sustained by high levels of protection following the introduction of import licensing in the 1938.

With the unwinding of border protection and cheaper transport (and more recently cheap Asian sourcing) the contribution of the manufacturing sector to GDP has fallen from the 20 to 25 percent of the first three quarters of the twentieth century, to below 15 percent at the beginning of the twenty-first. There is now little import competing production. The textile industry is increasingly designing in New Zealand, and producing offshore perhaps using New Zealand raw materials, and importing some product back to New Zealand, while exporting the rest to the world.

The largest subsector in manufacturing is food processing, which is dominated by (large) export oriented meat freezing works and dairy factories. All the biggest factories are export focussed with the exception of those processing hydrocarbons. They include wood processing, aluminium utilising New Zealand electricity, and steel. There are also specialist exporters which have prospered initially by supplying domestic needs – such as dairy machinery and electric fencing (for improving pasture management). Luxury yachts exports have grown out of New Zealanders’ recreation interests in the sea.

The housing and construction sector makes up about five percent of GDP, and there is some exports of construction services. Home ownership is high, but has been falling slightly in recent decades.

Finance

At the centre of the New Zealand financial system is the Reserve Bank of New Zealand which is a ‘full menu’ central bank. In 2010 it regulated 17 registered banks only two of which were not wholly owned overseas. It has independence from central government in the management its monetary operations, but the goal – currently a (low) inflation target – is set by a contract with the Minister of Finance.

The core banking system has shown considerable stability even during the Global Financial Crisis of 2008 and 2009. However some of the less closely regulated financial institutions outside the core, mainly investing in property, collapsed.

The New Zealand dollar floats, with negligible government intervention. There has heavy overseas borrowing, not all of which has been invested in business enterprises – much in housing. As a result New Zealand net foreign liabilities are high (around 100 per cent of annual GDP in 2010) although public debt is low by international standards because the government ran a fiscal surplus in most of the 1990s and 2000s.

Much New Zealand industry is overseas owned. This partly arises from the vertical integration of overseas companies purchasing local resources, but many businesses oriented towards domestic markets are also foreign owned, or have a substantial proportion of their equity owned by offshore shareholders.

Trade

As already explained New Zealand’s international export trade has become increasingly diversified since the mid 1960 by product and destination. Today the main markets are Australia, the European Union, China, the United States and Japan, with other Asian economies becoming increasingly important. Import sources follow a similar pattern.

New Zealand is involved in a number of (enhanced) free trade arrangements with an increasing number of Pacific and Asian economies, the most important of which is Closer Economic Relations (CER) with Australia. It is a very active member of the World Trading Organisation (WTO) and has vigorously advocated reductions in protectionism on farm products, which is particularly detrimental to New Zealand exports.

Restrictions on imports to New Zealand are not high, following the import licensing regime introduced in 1939 being replaced with low tariffs. It is relatively easy to invest in New Zealand, but sometimes approval from the Overseas Investment Commission is necessary.

Services

Like other affluent economies the service sector forms the largest part of the economy – over 70 percent of net output on some definitions – and its share is growing. Tourism is the largest foreign exchange earner in the service sectors (and the first or second largest foreign echange earner) but significant contributions also come from educational services and consulting services. New Zealanders also travel widely purchasing tourist services from other countries.

Labour

As for most other high income economies, the New Zealand labour force is skilled, and it is more flexible than many others. The unemployment rate is at the lower end of the affluent economy range, although it fluctuates with the business cycle.

The deployment of the labour force approximately matches the pattern for production sectors. In comparison to the OECD New Zealand businesses tend to be small but in contrast total worker numbers tend to be in the larger firms.

Historically following the Industrial Conciliation and Arbitration Act (1894) the New Zealand labour force was highly unionised, although self employment was (and is) high. With the Employment Contracts Act (1991) unionisation was dramatically reduced, and now tends to be concentrated in larger private businesses and the public service. There as been only a marginal recovery in union numbers following the passing of the Employment Relations Act (2000).

Taxation and Public Spending

The main taxes are income tax (including a corporation tax) and Goods and Service Tax (GST – a value added tax) which is applied on almost all goods and services. Other significant taxes include customs duties, taxes on motorists, and on alcohol and tobacco. There are no wealth taxes, no inheritance taxes and (almost) no capital gains taxes. A major source of the second government tier local authorities is local body rates on real estate.

Public revenue from taxation is below average in comparison to other OECD economies, even including the GST on public expenditure and the income tax on social benefits and pensions.

Public sector spending is particularly strong on social security and welfare, health services and education which make up two thirds of core Crown expenses. Because there were fiscal surplus in the 1993 to 2007 period, financing costs are not high, but began growing when the public account went into deficit following the Global Financial Crisis.

Transportation

Being an archipelago distant from other economies (the nearest Australia is over 1400kms away), New Zealand is very internationally dependent on shipping, airlinks, and telecommunications. There are eleven significant seaports. The largest export port is Tauranga (mainly dairy and wood) but, including inbound goods, Auckland is the largest port by value. The second largest on this measure is Auckland International Airport, and there are two other major international airports at Christchurch and Wellington although, increasingly, provincial centres have passenger connections to Australia. The main oil terminus is at Marsden Point (Whangarei) where there is an oil refinery.

Given a rugged topography and a scattered population, New Zealand is mainly connected by roads plus an inter-island ferry link between Picton and Wellington. The roading networks is generally funded by levies on users (most notably a petrol tax) and local body rates (for urban streets); there are very few toll roads.

There is a main trunk railways system from Invercargill to Whangarei, plus branches to the West Coast (of the South Island) to Gisborne and to New Plymouth, and through the Wairarapa. There are urban railway services in Auckland and Wellington.

Because of the terrain and Cook Strait, there is a network of domestic air links with all provincial towns having airports, although some are serviced by quite small planes. The predominant aircraft on the main trunk route – Auckland-Wellington-Christchurch – are of the size of Boeing 737s. The main domestic and international airline is the largely government owned Air New Zealand, although smaller airlines vigorously compete domestically and major international airlines also provide foreign connections. The Trans-Tasman market is particularly competitive.

There is a general view that there has been insufficient investment in transport infrastructure in the past, and most urban arterial routes are jammed during peak hours. A major investment program in roading (and a rail upgrading) began in the mid -2000s.

Telecommunications

Historically the telecommunications industry was dominated by monopoly Post Office. In the 1980s, the telecommunications division separated out as Telecom New Zealand and then privatised after opening the industry to competition. Telecom is still the largest firm in the industry, but is under competitive pressure from Testra-Clear (its Australian equivalent) while Vodaphone is the largest mobile phone provider. Smaller (quirkier) companies are also aggressively active.

New Zealanders tend to be very quick to take up new technologies. By the mid 2000s, over 80 percent had internet access, and 85 percent a mobile phone. New Zealand is rapidly rolling out broadband access but the low density of the scattered population makes this difficult. 3G is widespread.

Regulation of the telecommunication system was ‘light handed’ in the early 1990s, but since 2000 there has been increasing active government involvement.

Thanks to Geoff Bertram for some corrections