Microeconomic Reform and Productivity Growth: Workshop Proceedings, proceedings of a conference “Microeconomic Reform and Productivity Growth”: 26-27 February 1998. (Productivity Commission and ANU, 1998) p.155-181.

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

Prologue

This being the first occasion which I have visited the Australian National University since the death of Professor Fred Gruen, may I briefly pay him a tribute. When we first met, Fred was suspicious of my approach, thinking I was anti-market. Over some long discussions he came to recognize I have a deep Marshallian respect for the market, even though we might not always agree on the details of policy. I would have appreciated a continuation of our intermittent dialogue with his response to this paper. It would have been thoughtful and shrewd. I would have responded in my revision, each of us shifting our position in the light of analysis and facts. I am sorry he is not here, except in spirit.

Introduction

Economic reform in New Zealand has been unusually comprehensive and thorough. For the scientist it provides a test of the theory which underpinned the reforms. The overt theory was essentially that which is known in Australia as “economic rationalism”, the consistent application of modern neo-classical market theory. At the practical microeconomic policy level this has been the withdrawal of government interventions which preferred one firm, industry, or sector (relative to others), in favour of market regulation of economic activity. Thus import licences have been abandoned, tariff levels steadily reduced, subsidies and tax incentives withdrawn, the tax regime made more uniform with exemptions barriers to entry eradicated, corporatization and privatisation of government trading activities, and greater reliance on competition law.¹ There remain some (now much lower) tariffs, a few special taxes, occasional interventions, and so on. Nevertheless the extent of the microeconomic reforms is such to that they become a test of the theory which underpins them.

However, testing the theory raises the difficulty that the reforms are so comprehensive, it is not possible to discuss all the issues in a single paper. This paper therefore concentrates upon the productivity implications, focusing on the theoretical proposition that greater use of market regulation ought to lead to productivity improvement, increased output per unit input in the economy as a whole.

This means the paper is not primarily about whether the reforms have generated more output, – whether they increased the growth rate of GDP. However it is useful to begin with the macroeconomy to provide a context for assessing the microeconomic performance.

Macroeconomic Performance

It is becoming increasingly accepted in New Zealand that the reforms which began in 1984 have not markedly increased the growth rate of GDP, nor of economic performance generally (other than price stability). Table 1 gives a comparison of the change in major macroeconomic indicators for New Zealand, Australia and the OECD since 1984. Except for a reduction in the rate of inflation, the New Zealand record is disappointing.

OECD Economic Outlook, June 1997. The New Zealand figures do not always correspond to the official figures, but are used here for consistency. The OECD consists of 28 economies.
* Estimate

It is, of course, possible to select a few indicators for a few years to argue that there has been an improvement in the underlying growth rate. In particular a strong cyclical upswing in the mid-1990s when volume GDP did increase by 6.2 percent in the year to March 1994 and 5.5 percent in the year to March 1995, almost comparable in strength to the 1984 and 1985 upswing which preceded the reforms (and perhaps as little longer), was heralded as a shift into a high growth sustainable economy. For instance Vivian Hall (1996) wrote “… it is suggested that on balance there is scope for cautious optimism on the sustainability of New Zealand’s recently improved economic growth.”

Yet it was evident at the time to careful observers that the upswing was a response to the long five year contraction which preceded it. Not surprisingly then annual GDP growth rates after 1994 have been more subdued: 3.1 percent to March 1996, 2.4 percent to March 1997, and around 2 percent to March 1998. While there is always disagreement about future growth rates, the consensus seems to be that New Zealand’s future GDP growth rate is about the same as the OECD’s, or perhaps a fraction lower. Hall’s “cautious optimism” (published after the growth boom had ceased) would now be considered optimistic rather than cautious.

So, it would seem that after nine years of stagnation beginning in late 1985, New Zealand is back on a modest growth trajectory, not unlike that which preceded 1984, obscured by a strong cycle. Even this may prove optimistic for the consensus sees a continuing deterioration in the current account deficit and a rising foreign debt to GDP ratio, which requires ongoing overseas financial investment which may not occur to the extent assumed in the forecasts. (I have a little more later to say about the prognosis after 1997.)

There are a number of explanations for this poor performance. among the most vigorously argued are

(1) The reforms are fundamentally flawed (e.g. Kelsey 1996).

(2) The promise that the benefits of the reforms are yet to come has been a constant theme of the pro-reformers since 1985, with a constant shifting into the future of the date at which any benefits will become apparent. Perhaps the best response is that of historian G. M. Trevelyn who in 1945 said “[i]t is still too early to form a final judgement on the French Revolution.”

(3) The economic record would have been even worse without the reforms. Unfortunately it is not easy to agree on an appropriate counterfactual scenario. After all Muldoon indicated in 1984 he was fundamentally changing policy by eliminating export subsidies. Even so Evans et al ( 1996), when correct data is used (Dalziel 1997), show the New Zealand economy grew more slowly after the reforms than before. Contrawise, before the reforms and hence lacking the benefits of hindsight, Bryan Philpott (1985, 1990) projected an economic track on the then existing policies which was better than the actual outturn.

(4) Moreover any counterfactual scenario needs to take into account the international environment. The approach of Evans et al involves the pretence that external events have no impact on a small multi-sectoral open economy such as New Zealand. In fact the terms of trade deterioration in the early 1980s including higher world interest rates (New Zealand being a debtor nation). (Easton, 1997a ²) Important here is the third oil shock of the mid 1980s, when the oil price fell just as New Zealand became increasingly self-sufficient in hydrocarbons. (The issue is further discussed below in regard to the Major Projects.) Note however New Zealand experienced a terms of trade lift in the early 1990s, which would have contributed to the cyclical boom of shortly after, and so to the prospects of the late 1990s. In any case as Easton and Gerritsen (1995) have noted, the Australian terms of trade seem to have suffered more in the 1980s, and yet the Australian economy did better. (See also Table 1.)

(5) The experience of disinflation, as New Zealand’s inflation rate came down from one of the highest in the OECD in the 1980s to one of the lowest in the 1990s. The cost of this disinflation was a loss of output. (Hall 1996)

(6) An overvalued exchange rate ( especially if measured net of subsidies and protection) compared to the pre-1984 real exchange rate (which was considered overvalued at the time) inhibited the growth of the tradable sector which is the center of growth in a small open economy such as New Zealand. (Easton 1997a)

The last two explanations may seem two aspects of the same phenomenon, since the main mechanism for disinflation was the over-valued exchange rate. However the disinflation explanation (5) sees the experience as a transition one, whereas the inhibition of the tradable sector explanation (6) argues there has been a hysteresis effect.³ In which case there is likely to be long term damage to the tradable sector which will affect the performance in the long term after the disinflation is over.⁴

While obviously the writer of this paper has a view on the relative importance of the various explanations, it is unnecessary to pursue them for this paper . However there is a seventh which overhangs any paper about productivity performance.

(7) The poor economic performance occurred because there where not the expected gains in productivity .

The paper returns to it in the conclusion.

The Productivity Measure

This paper measures (labour) productivity by output per labour input, rather than by total factor productivity. Output is measure as value added (GDP for aggregate output) unless otherwise stated, while the labour input is typically worker years. The paper will refer to work using TFP, but for reasons that will become apparent it is appropriate to give separate consideration to the capital input. The paper also largely analyzes aggregate productivity: but there is a section on productivity at the sub-aggregate level.

An annual series from March year 1978 to 1996, based on Philpott (1996), is shown in Figure 1. It is the longest, consistent, reasonably up to date, series available. Basically it suggests a constant secular trend, with a little noise perhaps due to contemporary events such as the business cycle and policy changes. In order get a better view, Figure 3 shows a shorter quarterly series from June 1985 to September 1997 series, which also suggests a more complicated pattern than the relatively smooth trend of Figure 2.

The Course of Productivity

As reported in Table 1, New Zealand has had a low annual increase in labour productivity compared to Australia and the OECD in total for the period 1985 to 1996. The increase of .7 percent p.a is less than half of the OECD average for the period, and about two thirds of the Australian experience. (Note this includes the boom years of the early 1990s.)

SourceOECD Economic Outlook, June 1993. Their New Zealand figures do not always correspond to the official figures, but are used here for consistency. The OECD consists of 24 economies.

Table 2 gives comparable data (over a slightly smaller number of OECD countries) for the period 1978 to 1985 period, when the New Zealand labour productivity growth rate was 1.9 percent p.a., about the same as (or slightly higher) than Australia and markedly higher than the rest of the OECD. This may be partly a cyclical effect, for 1985 is the top of the New Zealand cycle while 1978 was a trough. ⁵ Nevertheless the data raises questions about those who argue, without data, that New Zealand was doing poorly before 1984. In fact the story is a complicated one, including major unfavourable external shocks, especially of a secular downward drop in the terms of trade in 1966. Indeed New Zealand’s volume GDP growth rate was comparable to the rest of the OECD before 1966. (Easton 1997a)

A number of studies looking at earlier productivity growth (Marks 1983 (labour); Orr 1990 Philpott 1996 (TFP); Easton 1997a) found no evidence for a change in the secular trend (after cyclical adjustment) from the late 1950s and early 1980s. This is inconsistent with the common finding of some sort of OECD climacteric in the mid 1970s. The growth rate was about the same as, perhaps fractionally below, the OECD average over the period (Easton 1997a), consistent with the shorter (and not-cyclically adjusted) record in Table 2.

One might predict that the microeconomic consequence of the various reforms were to increase the rate of productivity growth (even if the macroeconomic outcome was poor). In fact as Table 1 indicates (and discernable in Figure 3), there may have been an aggregate productivity growth slow down in the late 1980s. Possibly, New Zealand’s productivity clicmacteric took place a decade later than the OECD, although the paper by St4ve Dowrick in this volume warns about coming to too hasty a conclusion. ⁶

This does not necessarily mean that the microeconomic reforms have had no impact on productivity. Microeconomic studies show some (limited) effects.

Sectoral Studies

Philpott (1996) disaggregated his data (on which Figures 2 and 3 were based) into three sectors. of exportables, importables and non-tradeable sectors. ⁶ (Figure 4) Each of the three sectors shows a secular trend in its productivity growth, although the trends are different. Non-tradeables grow steadily but slowly, there is a clear cyclical swing in the rapidly growing importables, and there is a discernable deceleration in the rapid exportable productivity growth in the late 1980s (and less evidently in the importable sector).

The importable productivity record is particularly surprising. From the mid 1980s to the 1990s import protection was systematically withdrawn from importable sector. One would predict that this would increase sectoral productivity as businesses whose low productivity had been sheltered behind import controls and high tariffs either closed down or introduced higher productivity methods following exposure to overseas competition.⁸

But there is no sign of significant productivity acceleration in the graph associated with removal of protection. Reasons why the effect may not be evident include:

– the gains may not be great. In any case there has been a degree of trade liberalisation since the late 1970s – or even earlier – so that some of the productivity gains from trade are occurring from then. While the trade liberalisation may have been timid in scope in the 1970s it often involved the most anomalous interventions, whereas the later reductions while more dramatic may have resulted in smaller productivity gains;

– the business cycle may obscure the underlying change in trend (although if anything, the productivity trend appears to a decelerate similar to that experienced by the exportable sector);

– there is no simple connection between labour productivity and protection. For instance while the elimination of protection may affect most the poor productivity plant in each industry, it is conceivable that the structure of protection could be such that the protected ones were high productivity compared to those that were unprotected.

A more dramatic productivity change occurred in those industries Philpott separated called “restructured”: mining, forestry, electricity, and communications. These were industries which were largely government owned in 1984, and experienced substantial corporatization and privatization. It is evident from Figure 5 that the sectors experienced a substantial subsequent increase in their productivity growth, although this boost seems to have stopped after 1992/3, and the productivity trend seems to have returned to its pre-1984 trend.

However the restructured sectors contributed only 10.3 percent to GDP in 1997/8 rising to 15.7 percent in 1995/6, so their substantial productivity gain did not impact greatly on aggregate economic performance. Had the restructured productivity grown after 1987/8 as it had before that date, (average) labour productivity for the whole economy would been only 2.8 percent higher in 1995/6 (assuming that the sector’s output would have grown at the same rate without the additional productivity growth). On this measure the corporatization and privatization program added a fraction under .5 percentage points to annual aggregate productivity growth between 1987/8 and 1993/4. (However if we take this figure as accurate, the productivity growth for the rest of the economy must have been abysmal, since the figure for the entire economy was about .7 percent p.a. (see Table 1).

A caveat here is that some of the apparent gains may have occurred by outsourcing to other industries. For instance the result of outsourcing may be that cleaning and financial services provision may have diminished the net labour (and capital) inputs in the telecommunications industry without affecting gross output. Thus part of the productivity gains of an industry may be a statistical illusion. ⁹

An example of this growth of specialisation from outsourcing may be evident in the financial industry. Figure 6 shows how in the mid 1980s the share of GDP (measured in added value terms) of the financial sector in total GDP rose sharply, and has since flattened out at some quarter higher. We might ask why the economy is sustaining so much extra financial activity. One explanation is that it is doing a range of activities which were once in-house (including activities which were once government responsibilities). On the other hand it is possible that resources are being used in the financial sector with little benefit to the economy (as they were in March year 1988) which would lower aggregate productivity.

Industry Studies

This section deals only briefly with industry studies because they involve the inherent difficulty of the New Zealand economy that it is so small that single events which would be trivial in a larger economy such as the US can affect the data in a major way. My point is not to be dismissive of the technical quality of the work, so much as cautious as to its practical interpretation.

Färe, Grosskopf, and Margaritis (1996) use a relatively sophisticated procedure to calculate indices of the (Malmquist) technical change, efficiency change, and scale change for 20 industries from 1973 to 1994. When I began to assess the estimated parameters I found myself observing that in virtually every industry there had been massive structural changes occurring over the period, ¹⁰ which left one with thinking the statistics were but summaries for very complicated changes.

Philpott (1993) observed that the apparent gains in the agriculture sector in the late 1980s were due to gains in the horticultural sub-industry, as the result of a major (and heavily subsidised) planting program which occurred in the 1970s. The same problem of long lead times for capital investments which lead to industry restructuring also affects mining and quarrying, paper products and printing, chemical and chemical products, basic metals, and electricity, water and gas. As a result their 1980s productivity was influenced by policies of government support in the 1970s. Other special cases include: agriculture affected by the weather cycle, fishing as a result of the EEZ, forestry affected by plantings made three decades earlier, food processing affected by higher international quality standards …

Another problem is that in 16 (out 20) industries a rise in technical change in the mid 1980s is associated with a fall in the scale index, which suggests some statistical interdependence between the two measures.¹¹

It is true that 18 industries show a sharp increase in technological productivity in the mid 1980s, but we knew that already from the Figure 2. Sadly, there are no new insights from the study. Nor do the study’s authors draw any significant conclusions, suggesting that “the economic reforms had an overall positive impact on the productivity growth of the New Zealand market sector. This impact has, however, been quite uneven …” (1996:96-7) But they do not estimate the impact, and in fact the first conclusion is based on a temporal association, and does not consider alternative explanations.

Chapple (1994) calculates TFP growth rates from 1972 to 1991. However in 8 of the 20 industries there is a decline in the TFP index between 1984 and 1991 and in a further two there is a reduction in its growth rate compared to 1972 to 1984. Färe et al (1996: Table 3) find reductions in their Malmquist index between 1984 to 1991 in 9 industries, and a further 3 experience decelerations.

The Labour Market

The impact of the 1991 Employment Contracts Act (ECA) on productivity has been a matter of some interest, and a little research. Kasper claimed “[w]e can conclude that the Employment Contracts Act has substantially enhanced the productivity of labour …” (1996:50-1) However he provided no data, and the data he uses to describe GDP and employment growth implied there has been little productivity change since the ECA was introduced, a conclusion consistent with Figure 3. ¹²

It is true there was a sharp rise in labour productivity in late 1992. This is over a year after the introduction of the ECA and coincides with the cyclical expansion of the mid 1990s, and is characteristic of the early stage of a cyclical upswing when output gains arise for more intensive use of the existing workforce. Kasper claims that the ECA caused the upswing, but provides no analysis or evidence for his assertion. A more orthodox explanation, already mentioned, is that following a long contraction there was a cyclical upswing (in part a consequence of the terms of trade rise of the early 1990s). Although the upswing had come to an end by the time Kasper wrote, he gives no indication why it occurred, whereas treating the experience as a standard New Zealand business cycle (see Easton 1997a), the end was predictable and predicted.

One anecdotal source for these productivity improvements as a result of the ECA is a survey of managers which reports “increased productivity and operational flexibility and greater training.” (NZIER 1996) Since there is no statistical evidence for substantial gains in productivity above the trend of previous years there are three possibilities to explain this apparently misconceived enthusiasm:

– Managers are attributing normal productivity gains to the ECA;

– Managers have greater freedom to manage than in the past, because they are less constrained by law and by unions. They assume that these benefits to themselves must result in improved benefits to the firm in greater productivity;

– Management may confuse productivity with labour costs.¹³ As Easton (1997b) shows, labour costs relative to labour productivity fell shortly after the introduction of the ECA, but this seems to be more to do with wage restraint and repression which may have been facilitated by the ECA (but also may be a cyclical effect).

There may have been small productivity gains. Anecdotes abound: one major industrial site used the new industrial framework to “buy the book” of workplace rules.) However they in total are not very evident in the aggregate data. Moreover there is no evidence that they were anything more than one-off or that they led to an acceleration of productivity growth.

One argument which has not been explored, but offer some promise is that the a lower real product wage, encouraged labour intensive production methods, which would appear as a fall in labour productivity (or a depressing of the trend over a transition). There is little agreement among New Zealand economists of the significance and size of any real wage effect (Easton 1990), and thus far enthusiasts for the real wage effect have not considered its productivity implications.¹⁴

In summary, there is not much evidence from the New Zealand experience that increased labour market “flexibility” generated productivity increases. That is consistent with the overseas experience, for while it is true that the more “flexible” labour market of the US is associated with greater job creation than in Europe, it is equally true that Europe has experienced higher labour productivity. (Easton 1997b: Table 3). Part of the resolution of this paradox is that too often the expression “flexibility” is used rhetorically rather than as a careful analytic notion. (Easton 1997a)

This draws attention to one further aspect of the labour market. Suppose New Zealand had had the sort of labour productivity growth that the OECD averaged between 1985 and 1996. Assuming this did not affect the growth of GDP nor labour force participation rates, employment would have been broadly constant over the period, and the unemployment rate would have been over 15 percent. While there may be dispute over the assumptions, it is undisputable that the labour market performance over the period looked reasonable (if worse than before 1985) was in part due to the poor productivity record.

Source: Easton (1997b)

The Capital Measurement Problem

Those interested in the New Zealand economy are indebted to Bryan Philpott for his laborious (and rarely adequately funded) construction of estimates of capital stock, which are used, among other purposes, for the TFP estimates. (1994a, 1994b, 1995, 1996) However they suffer from a major weakness where market liberalisation is being studied.

Philpott’s capital estimates are based on cost of installation adjusted for inflation and depreciation using a perpetual inventory method. At any point in time the values need not reflect the actual market value of the capital. This is especially true following microeconomic reform where, for example, the New Zealand Steel plant at Glenbrook was worth $3 billion plus in the capital stock estimates, but became virtually worthless in market terms following the removal of protection. This massive reduction in the market value of the productive capital of New Zealand applied to most industries where market liberalisation occurred. While the scale of the write-downs elsewhere was generally smaller, the number of plant and processes that were involved means the total magnitude was probably enormous. Some productive capital may have had enhanced value as a consequence of the liberalisation, but almost certainly the devaluations exceeded the revaluations by a large margin.¹⁵

What is the meaning of TFPs based upon this capital measure? One way of interpreting what happened was that the market liberalisation is a little like a war, in which vast quantities of physical and human capital are destroyed, but are continued to be recorded in the capital (and hence TFP) measures. In which case “post-war” productivity growth could be spectacular, but the available measures conceal it because of this fictitious capital.

Maybe, but that does not assist evaluating the benefits of market liberalisation per se, just as we would not support a repeat of the Second world War to obtain the high growth rates of post-war recovery in the 1950s of the devastated countries. The image of war destruction, is of course, not a perfect one, but it is a reminder that much physical and human capital is process specific, and cannot be easily converted to other uses after the removal of protection. ¹⁶

Alternatively we may think of market liberalisation involving a transition. A relevant question is whether the costs of this transition are offset by the long run benefits. No one has attempted to carry out a sophisticated evaluation of this for the New Zealand case, perhaps because there is still no compelling evidence for an acceleration in productivity or growth.

Another feature of the TFP method is its assumption that capital is fully operational shortly after it is installed. For many big projects – power stations, the major projects (see below), forestry, horticulture and livestock expansion – the assumption is not true. Lags of up to seven years may be common (more for forests). If there is any bunching of investment, as occurred in the late 1970s and early 1980s, the TFP profile in the mid and late 1980s will be misleading, and the average labour productivity hard to interpret.

The Major Projects (“Think Big”)

As it happens I invented the term “Think Big” in 1980 as a device for rhetorical criticism of the strategy. (Easton 1980a) Regrettably the rhetoric still dominates analysis, especially in the arguments which amount to “Think Big was the ruin of the New Zealand economy”. Indeed the term may be used widely for any project which the rhetorician disapproves (including in the agriculture sector) to the narrow group of large projects which was precipitated by an energy surplus from the Maui Gas coming ashore in the North Island and the overbuilding of hydro-power stations in the South Island.

Even confining ourselves to the latter definition, usually labelled “Major Projects” to distinguish them from the rhetoric, there has been surprisingly little sober evaluation. ¹⁷ Here is a brief framework.

(1) New Zealand had a burgeoning energy surplus in the late 1970s, partly through good fortune (the finding of the giant Maui Gas field) and partly forecasting failure (the overbuilding of hydro-stations in the Waitaki and Clutha).

(2) The energy surplus was absorbed by a number of energy intensive major projects. ¹⁸ The alternatives to these projects are far from clear (other than spilling water and flaring gas).

(3) Some of the projects were known to be inefficient at the time (the ammonia-urea plant, the NZ Steel extension) depending upon protection for commercial viability.

(4) There were severe construction cost over-runs for some (the oil refinery and NZ Steel expansion), but not for others (the syngas plant).

(5) About the time most came on stream in the mid 1980s the world price of oil fell, so many activities became unprofitable, an effect that was compounded by the removal of protection. (The syngas plant was economic for oil prices as low as $US25, when expectations were they would exceed $US35. It came on stream when they had fallen to around $US12.)

(6) It proved that in almost every case, there was some sort of government guarantee, which meant that the downside risk was borne by the public either fiscally or in higher prices¹⁹ when it eventuated.

The last point involved an unforgivable mistake, although the point was not made in the “Think Big” debate of the early 1980s. In direct productivity terms the big costs were the cost over-runs (but recall this did not happen for every one), and the third oil price shock (which did).

Hazeldine and Murphy (1996) suggest that the effect of having the Major Projects was significant but not as large as other effects, and certainly not as large as the rhetoric would have it. ²⁰ Regrettably the paper does not pay enough attention to the distinguishing of whether the projects were fatally flawed in the context of what was known in the early 1980s when they were initiated, and to what extent cost over-runs and the third oil price shock ruined them.

Fiscal Issues

The current debate in New Zealand on the allocative and growth effects of tax is confused and uninspiring. The conventional wisdom is that the tax system is now more efficient as a result of the introduction of the comprehensive valued added tax, GST, the removal of (often erratic) exemptions and discriminations, and the lowering of top tax rates (although EMTRs remain high on the poor). However there is a group who argue that New Zealand is over-taxed, but in doing so they generally conclude that the burden of taxation has risen since the reforms. This is largely because of peculiar assumptions and methods. For instance Diewert & Lawrence (1994) found the unit burden of taxation more than doubled during the 1980s, but this proves to be an artefact of the assumption that all unemployment was caused by tax wedges, and since unemployment had risen in the 1980s the alleged burden had also. Scully (1996) regresses a tax rate on a transformation of itself, and claims the estimated parameter indicates the optimal tax rate.

Measurement Issues

Wolfgang Kasper suggests “[s]ome knowledgeable observers believe that employment statistics under-report employment growth since the ECA.” He does not, however, say who these people are, nor what were their claims to be knowledgeable. (Kasper 1996) He is probably not correct, but if he were, the productivity record would be even worse.

A more serious problem is that the labour measure may be problematic if there were significant changes in labour force composition (if for instance less productive/effective workers were laid off, while the gender composition is constantly changing), or if hours of work have changed dramatically. To my knowledge, no-one has investigated these issues post 1984.²¹

I looked at the accuracy of the Volume GDP statistics, my attention having been drawn to the apparent deterioration in labour productivity in much of the service industry. (Marks 1983) There appears to be slightly downward biased, by perhaps .3 percent p.a., compared to best OECD practice. largely arising from the difficulties of measuring service sector output. Easton (1997a) Although there have been improvements in GDP measurement, the statisticians involved tell me they are doubtful they have markedly overcome the problems, partly because any improvements are offset by increasing service sector complexity.

While this measurement problem may have led to underestimating New Zealand’s economic performance compared to the rest of the OECD, the effect is very small, and not crucial for the story. (Easton 1997a) For the purposes of this paper it makes no contribution to explaining why there was no acceleration in productivity after 1984, compared to the rate before.

A study which looked at five pre-1984 market liberalisations (foreign exchange market, the freight haulage industry, the meat processing industry, imports of canned beer, and bread price controls), suggests however that the measurement problem may be more complicated than the issues discussed above. (Bollard and Easton 1985, Easton 1997a) There was little evidence of simple efficiency gains, although this may have been the consequence of the study coming too soon after the liberalisations, and inadequacies in the data base. It found price reductions, but typically these were the consequence of the ending of cross-subsidisations with concomitant price increases elsewhere.

However the studies also found increases in the quality of the products, and the choice of consumers, which seemed to be a result of liberalisation. For instance bread price controls seemed to inhibit the introduction of new types of bread (e.g. hot bread and french bread shops). Such quality changes are notoriously hard to incorporate into price and volume indices, and increased choice is even more difficult. One might argue that the liberalisation often resulted in the New Zealand quality and choice catching up (and sometimes exceeding) other OECD countries, but this is not properly reflected in the measures.

While one may be comfortable with such a conclusion, there are a couple of caveats. The first is that while there may have been such improvements to purchasers, many people were worse off over the period of liberalisation, because of rising unemployment or reduced employment, or because of falling measured real incomes. ²² Even adjusting for the greater potential choice the market liberalisation created, it seems likely many people were worse off as the liberalisation progressed. However it may be factors other than liberalisation which made them worse off.

Second, it seems likely in some areas, especially in the government sector with spending under severe downward pressure, there has been a widespread deterioration in the quality of service.

Source: Insight Research New Zealand Ltd, Supplementary Tables, August 1993, by permission.
Notes: Nets are calculated as percentage of total less “unsure”.

The third caveat is the most troubling. A one-off 1993 survey by Insight Research New Zealand Ltd, asked respondents to their regular survey “[l]ooking back over the last 2 or 3 years do you think the quality of service you usually receive when you purchased goods and services has improved a lot, a little, stayed about the same, got worse or got a lot worse?” A majority, but not overwhelming majority, said yes, as one would expect, although this cannot all be attributed to liberalisation per se, because there would be other factors (including normal change). What is fascinating is, as Table 4 shows, that low income households were markedly less favourable than high income households. The table also shows that in regard to three of the four industries where a specific question was thought to have deteriorated. I have no doubt a typical New Zealand audience would overwhelm a listener with anecdotes of what are thought to be deteriorating service provision, often unfairly. It is the distributional implications which are intriguing. (Easton 1996)

What Has Happened to Productivity in New Zealand?

The above discussion has been deliberately over-deterministic in offering far more theories than are perhaps necessary to explain productivity change in the 1980s and 1990s. That is because I am more interested in promoting, rather than eliminating, discussion, although I have not hesitated to rule out theories which do not connect with the known facts, and can only be sustained in ideological terms. But we have reached the stage where the author’s account has to be presented.

I am inclined to the view on the basis of the evidence that the best interpretation is there is a long term constant trend in labour productivity (or TFP), which is largely exogenous. ²³ There may have been a climacteric in the late 1980s, but until there is more data, but the sort of issues discussed in the previous section are the most parsimonious explanation of what is observed. To complicate matters the burst observable in the mid 1980s before the climacteric may be due to the investment activities of the late 1970s and early 1980s (as well as the cyclical upturn of 1984 and 1985).

There are only limited direct policy influences over the productivity trend. The evidence is the corporatization of government trading activities did lift it a little, but there is little other evidence for any other significant gains (other than in improving quality and choice). Certainly any gains from the introduction of the ECA were one-off and small – if any.

While it is proper to postulate gains from market liberalisation, the scientist need not be surprised if they are small, as appears in the New Zealand case. Economic theory usually only predicts direction not magnitude. In a review I did in the gains from trade I found no outcome exceeded 1 percent of GDP, despite high ERPs. ²⁴ Easton (1980) The theory says that under certain assumptions there is a peak on the output hyper-surface at the free trade point: it does not say whether that peak is a razor edge or a gentle hummock.

The one phenomenon which seems to shift productivity from the trend is economic growth itself. As a general rule there is an acceleration of productivity with growth, especially in the early part of the cycle, as the labour force is employed more intensively and as producers introduce new procedures to increase output and remove bottle-necks. The timing evidence which supports this puts me in the camp of those who argue growth causes productivity rather than the opposite, that the macroeconomics dominate the microeconomics. But any support has an important caveat, especially in regard to market liberalisation.

For while I have found it very difficult to find evidence that market liberalisation generated significant productivity gains in the New Zealand case (corporatization aside, and allowing the quality and choice gains), market liberalisation may be important for flexibility reasons. An economy is subject to many exogenous shocks – some small but some large – especially if the economy is a small open multi-sectoral one. A less bureaucratically administered market is often better at absorbing these shocks than a more bureaucratically controlled one. As every engineer know some flexibility has to be built into a structure to enable it to survive. The first trip on a 747 can be nerve-wracking as it shudders about in the air, but the experienced traveller knows that flexibility adds to the safety.

This greater flexibility of the market may lead to better economic growth in a practical way, insofar as it allows the cyclical expansion to continue a little longer. New Zealand cyclical downturns are usually associated with rising bottlenecks which precipitate either an inflation or external deficit blow out (or both). Easton (1997) Flexibility should reduce or delay the bottlenecks, thus prolonging the growth, enhancing the accumulation of productivity. This is not a negligible gain from market flexibility, although less than some advocates of liberalisation claim.

This theory may be tested over the next year or two, albeit at a different phase in the cycle. New Zealand seems to be moving into a consumption led expenditure expansion (from tax cuts and the AMP demutualization) with an export led production deceleration or contraction (from the Asian crisis). The outcome is uncertain but I conjecture that providing the financial system is sound (it was not in 1987) firms will scrape through with less pain (such as closure and bankruptcy) than if the market liberalisation had not occurred. ²⁵ More gloomily, the considerable associated reduction in social protection may mean that while firms may better cope with the next two difficult years, people may not.

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Endnotes
1. For a details of the scope of the reforms see Silverstone et al (1996), especially Chapter 1.
2. Easton (1997a) is based on a major research program, which is cited in the book. For a post-publication report on the macro-economic issues see Easton (1997d).
3. Mayes (1996).
4 An extension of (5), although not fundamental to the argument, is that the anti-inflation stance will continue to depend upon an overvalued exchange rate and high real interest rates which together will continue to inhibit growth. This is not necessarily an argument that growth requires inflation: rather the policies to control inflation in New Zealand have affected – and will continue to affect – economic growth.
5. The data has not been projected further back, because there is a severe problem over the GDP estimate for 1977/8. Easton (1997a)
6. A structural factor, throughout the OECD, is the shift to depress aggregate productivirty. Again this has not been properly investigated in New Zealand.
7. The non-tradeable sector has the highest level of labour productivity because it includes capital intensive electricity and house ownership.
8. This is not discriminating between the productivity change which occurs when there is a shift along the production curve from where there is a shift of the production curve. The rhetoric is often in terms of the latter, although clearly the former happens at the industrial level, and may well be beneficial if the released resources move to higher productivity activities – rather than become unemployed.
9. de Boer & Evans (1994) use data from a single ex-public sector firm to calculate technical progress. The result is of little value for our purposes, since the study does not begin before the business was corporatized, so we cannot tell whether there is a change in the productivity growth rate as a result of the corporatization. In any case the method is fatally flawed, because a firm can change its internal productivity measured by the ratio of net output to factor inputs, by outsourcing some low productivity activities, converting a factor input to a goods and service input. To work the method needs to treat goods and services purchased from other firms as an input, which is part of the contribution to gross output.
10. See Easton (1997a) for further detail.
11. A number of industries – 8 in the mid 1980s – show some deterioration in the efficiency index.
12. Kasper cites work by Maloney (1994, 1996), which however does not address productivity, so we need not review it here, but refer to critiques in Easton (1997b, 1997c).
13. Ian Castels makes this point in his commentary in this publication.
14.The Australian productivity growth patterns Steve Dowrick observes (this publication)may be attributed to real wage effects, which suggests that a revisiting of the New Zealand data may be worthwhile.

15. Chapple (1994) attempted some preliminary estimates to assess the effect of writing down the asset values.
16. Or for change in relative prices. I use the explanation for the deterioration in New Zealand’s economic performance following the terms of trade change of the late 1960s. (Easton 1997a)
17. But See Easton (1997a), Hazeldine and Murphy (1996).
18. For a list see Easton (1997a).
19. Including from a tax impost.
20. The rhetoric also over-emphasizes the contribution of the Major Projects to the rise in public debt.
21. For earlier periods see (Easton 1997a)
22. Only the top ten percent of households have had increases in real incomes over the period, the second decile largely stagnated, and the remainder experienced falling incomes. Easton (1996)
23. I would not rule out that the secular growth rate is slowly decelerating, but not fast enough to be easily measured.
24. Note the ERPS have been over-estimated in New Zealand because various tariff exemptions were ignored. (Easton 1997a)
25. Noting of course, that the closures and bankruptcies should have occurred in the heavily intervened market of the 1970s, but were delayed by subsidies (and other interventions) which generated fiscal pressures.