Symposium on New Zealand’s Employment Contracts Act 1991, Californian Western International Journal Volume 28, No 1, Fall 1997, p.209-220.
Keywords: Labour Studies;
There have been various claims about the economic impact of the New Zealand Employment Contracts Act, 1991 (ECA). For instance in Free to Work: The Liberalisation of New Zealand’s Labour Market, Australian economist Wolfgang Kasper claims that the resulting industrial relations had economic benefits. He concludes “the Employment Contracts Act has substantially enhanced the productivity of labour and capital, output, and employment growth because it has been an essential ingredient in the transformation of New Zealand’s institutional order to greater flexibility and competitiveness”.1
However, as this review will show, despite using Kasper’s statistical criteria, the empirical evidence does not support his conclusions. There appears to have been little economic benefit, if any, from the ECA, other than perhaps for employers at the expense of workers. In particular there is no evidence of significant productivity gains, an issue that is explored in this paper. International comparisons support the likelihood that the ECA did not have an economic benefit.
Kasper also offers numerous opinions unsubstantiated by any evidence. For example he contends that “[t]he New Zealand workforce has reacted constructively to the market signals.” 2 These are not pursued here, except to note that if the available facts contradict Kasper’s account, it seems unlikely that his unresearched opinions have any greater validity.
Kasper claims the ECA enhanced economic growth: “the projection is for the economy is to keep growing for the remainder of the decade at a trend growth rate of around 4 percent”.3 Figure 1 repeats the first graph of Kasper’s economic evaluation, but includes more recent (and revised) official data, including projecting the volume GDP figures through to March 1999, using the June 1997 NZIER consensus forecasts, which average the predictions of 14 forecasters. 4 In addition, a “trend” growth rate of 3 percent p.a. is shown.
The story is clear enough. The New Zealand economy had been stagnated from 1990 (in fact earlier) through to the end of 1992. From late 1992 the economy began a rapid (and widely hailed) expansion. However this was not long enough to catch up to the 3 percent trend line. After 10 quarters the growth petered out, expanding at about 1.5 percent in the year through to March 1997. Further out they expected growth to hover around 3 percent a year, in contrast to Kasper’s claim of a sustainable 4 percent p.a. GDP growth rate.
Kasper used a different presentation for his second graph of real wages changes, his presentation having the effect of obscuring the minuscule real (income) wage growth over the period. As this paper’s Figure 2 shows, the increase amounted to a total of about 2 percent over seven years. 5 Probably part of the gains are due to labour force composition effects, so there was an increase as the economy contracted and so lower paid workers were laid off, and the fall during the early part of the upswing. Kasper’s own estimate is a .4 percent annual average growth of real wages. In summary, within the margin of error, and allowing for composition effects, real wages hardly increased over the period.
Labour Productivity Growth
As the third of Kasper’s graphs shows, employment numbers rose sharply from mid 1993, as one might expect in a cyclical upswing. Initially firms expanded output by increasing the intensity of labour usage within the firm, and as under-utilized labour became exhausted firms turned to an extensive expansion of hiring more workers.
However, Kasper seems quite oblivious of the implications of high employment growth with modest output growth. As Figure 3 shows, the productivity growth record for the New Zealand economy has been poor. In the seven years from 1990 there was a total gain of around 5 percent. The forecasters do not expect any major increases in the immediate future. It is also evident that the big gains came during the period of the early upswing, when firms used their existing labour force more intensively. It could be argued that the ECA enabled new work methods with the ending of restrictive practices which generated one-off increases in productivity. Distinguishing these gains from those from a cyclical upswing is not easy, and has not been attempted, However that the main gains coincide with the early part of the cyclical upswing rather than the years immediately after the introduction of the ECA suggests the cyclical recovery had the stronger impact. But even if there were gains from the ECA, they were one-time, and not ongoing ones. The advocates of the benefits of the ECA talk as though the latter has happened, but at best they can claim only the former.
One might contrast the events portrayed here with the story which Kasper tells about the Australian economy. It has not been possible to check his statistics, but an eyeball of his data shows almost the same output growth over the period from 1990 to 1995, except the Australian upswing was later and faster than the New Zealand one. 6 However Australia experienced much less employment growth, by about 1 percent a year. Thus Australian productivity growth outperformed New Zealand productivity growth – by the same 1 percent a year.
Kasper not only ignores such data but insists there has been substantial productivity growth. “We can conclude that the Employment Contracts Act has substantially enhanced the productivity of labour …” 7 The data, had he presented it, would have given the lie to such a claim, or at best shown only to small one-time increases. Indeed if Kasper is to believed, the productivity gains are even less. He says “[s]ome knowledgeable observers believe that employment statistics under-report employment growth since the ECA.” 8 He does not, however, say who these people are.
The Productivity Puzzle
Detailed work by Bryan Philpott has provided a productivity series for the New Zealand economy back to 1977/8. 9 Three sectors – importables, exportables, and non-tradeables – are graphed in Figure 4. It is extremely hard to discern any significant change in the trend of any of the three series, once allowance is made for cyclical effects and measurement problems. 10 Despite the economic reforms of the last decade, there is no perceptible impact of the reforms on the long run trend of overall productivity. This is true for the post-ECA era, but it is true for the post-1984 era as well.
Philpott shows that there were significant productivity gains in a set of sectors – mining, forestry, electricity, and communications – whose largely government owned (in 1984) firms were corporatized and privatized. These sectors experienced a substantial increase in their productivity growth following these reforms, presumably as a result of the ensuing labour layoffs. This boost seems to have stopped after 1992/3. However because the restructured sectors contributed only 10.3 percent to GDP in 1977/8 (rising to 15.7 percent in 1995/6), their substantial productivity gains did not impacted greatly on overall economic performance.
As figure 5 (labeled 8) shows there has been a substantial fall in the New Zealand unemployment rate since its peak in 1991 of 11 percent. 11 The fall is not surprising given the sharp rise in employment. Forecasters expect the unemployment rate will hover above 6 percent throughout the late 1990s. In assessing the unemployment rate it should be noted that it was probably below 4 percent in 1984 when the reforms began. 12 As recently as 1988 the unemployment rate was below 6 percent, so that Kasper’s graph does not show the rise which was occurring before 1990. This gives the impression that the fall was to levels that had not been previously attained.
Kasper also compares the patterns of unemployment rates for Australia and New Zealand. Undoubtedly, New Zealand has had a greater fall in its unemployment rate than Australia, since its employment growth has been greater. However, international comparisons of labour markets are fraught with difficulties, because labour market behaviour is partly culturally determined. Figure 6 shows the OECD estimates for labour force participation rates (LFPRs) for Australia, the OECD, and New Zealand. LFPRs are the proportion of the working population who are in employment or unemployed and actively seeking work. They are quite different, partly reflecting different age compositions, but also different social and economic circumstances. It appears that New Zealand LFPRs are below the OECD average, and Australia’s are above. If their LFPRs were the same as the OECD average, given the current employment levels there would be lower unemployment than as reported in Australia, and higher in New Zealand. The Australian unemployment rate would have been 2.5 percent, while the New Zealand one would have been 12.5 percent.
The Maloney Study
Kasper quotes research by Auckland University economist, Tim Maloney, claiming the ECA increased employment. 13 My detailed econometric review concluded that the econometric evidence is flawed because
– some of the coefficients of the reduced form equations are theoretically wrong, implying the remainder may be biased;
– many of the coefficients of the underlying structural form equations of labour supply and demand are theoretically wrong in magnitude and/or sign;
– the unionization data series is problematic, because it derives from two sources, with the juncture at exactly the point of the introduction of the ECA;
– the interpolation of the unionization data gives a spurious level of accuracy.
Thus the paper provides little scientific evidence that the Employment Contracts Act impacted upon the level of employment. 14
Maloney, himself, is aware of many of these problems. Indeed, he does not even reach the conclusion that Kasper suggests he does. Rather, after recognizing some of the weaknesses in his econometric conclusions he writes “[s]uppose we accept that the ECA … has resulted in increases in employment?”. If the paper writer has to suppose a proposition, then it cannot be claimed that he has demonstrated it, as Kasper asserts.
The Economy and the ECA
The data shows the post-ECA economy was in a stagnation phase until late 1992. It then began to expand rapidly, initially by using the internal resources of firms which had not been fully employed during the stagnation, but later by employing more labour. Productivity gains were not high. Those that occurred are of the magnitude and timing to be expected in a normal cyclical recovery of that strength.
It would appear that this extensive rapid growth phase was over by the end of 1995. The forecasters’ consensus is that the New Zealand economy has now settled down to a modest long term growth rate of just under 3 percent p.a., based primarily on increase use of labour and capital, with no substantial increase in productivity growth.
Kasper is keen to credit this not very impressive expansion to the effects of the ECA. He says “[i]t would be hard not to attribute most of this enhancement to the improved institutional framework surrounding labour markets.” 15 Indeed Kasper could have been more explicit and said it was “easy” to explain the enhancement by attributing it to the ECA. But easy explanations are rarely correct ones and often not supported by the evidence, as in this case.
A richer account of the New Zealand growth experience of the mid 1990s is that there was a bounce back from the contraction/stagnation phase of the late 1980s and early 1990s, fuelled by
– a favourable fall in the real exchange rate (which has since been reversed);
– a substantial improvement in the terms of trade (which were about 10 percent higher in the early 1990s compared to when they were in the late 1980s); and
– the upswing of the world economy, especially when the Australia expansion absorbed New Zealand manufacturing exports).
The New Zealand expansion was based on additional applications of labour and capital, rather than improved productivity performance. When the available capital and appropriately skilled labour ran out, economic growth slowed down.
Which of these two accounts is to believed? The poor productivity performance discriminates between them. If the Employment Contracts Act had worked in the way its proponents claim, there should have been substantial an ongoing productivity gains. There has not.
Enthusiasm for the ECA
Despite the lack of evidence of significant improvements in economic performance from the ECA there remains considerable enthusiasm for the legislation in the business community. Undoubtedly some arises as a result of the change in the industrial relations balance in managerial-employee relations. A survey of managers reports “increased productivity and operational flexibility and greater training.” 16 However there is no statistical evidence for substantial gains in productivity above the trend of previous years following the introduction of the ECA. 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.
As Figure 6 (labelled 7)shows, labour costs have been restrained. The real (income) wage (of Figure 3) divided by the labour productivity index (of Figure 2), which gives a measure of the degree to which productivity gains had been shared with workers. 17 The overall pattern is that the index fell about four percent in the mid 1990s, suggesting that workers’ wages have not shared in the (albeit small) productivity gains over the period. It would not be unreasonable to attribute reduction in worker share of prosperity to the Employment Contracts Act. But while reductions in costs to a firm from lower remuneration rates, may be of great importance to a firm, they are not the same thing as improvements in productivity.
I too have been astonished by the ECA’s failure to have had a perceptible impact on productivity since it was implemented. I have kept going back and checking the numbers, fiddling with definitions. What I had assumed – what everyone had assumed – was that work practices workers had been able to impose in the old industrial relations system had reduced output. There are anecdotes to support this, and the generalization seemed safe. It seemed likely mangers would use the greater power the ECA gave them to eliminate such inefficient work practices, thus generating higher productivity. Again there are anecdotes to that effect. But if there were such eliminations, they were apparently insufficient to accelerate overall productivity. Perhaps at best the generated a small one-time gain.
Perhaps insofar as there were worker controlled work practices they did not affect the growth of productivity. On reflection that it is not so surprising. Workers have an interest in higher productivity because it enables them to extract higher pay. Perhaps there were only few or marginal occasions when they restricted efficiency in a way that reduced their pay, or the measures had short term impacts on work effort, but sustained high levels in the long run. Insofar as any of these effects were significant, the primary gains to employers from the ECA have been lower pay and greater freedom to manage, not in higher output per worker.
The International Evidence
The conclusion that the ECA has not contributed greatly to economic performance, except perhaps making the inflation goal easier to attain by increasing managers’s ability to restrain labour costs, is not inconsistent with some of the international evidence on labour market flexibility.
AVERAGE ANNUAL GROWTH RATES
OF GNP, EMPLOYMENT, AND LABOUR PRODUCTIVITY
GNP EMPLOYMENT AVERAGE LABOUR PRODUCTIVITY
|UNITED STATES OF AMERICA|
|WESTERN EUROPE (OECD EUROPE)|
It is often claimed that the US labour market is more flexible that in Western Europe, and the higher US employment growth is a consequence. It is equally true that the US economy experiences poorer productivity growth, as Table 1 shows. That a flexible labour markets need not have a good labour productivity performance is consistent with the New Zealand experience. At this stage two tentative hypotheses are perhaps worth investigating.
It is possible that there is no necessary connection between so-called labour market flexibility, and productivity gains at all. Alternatively it is possible that there is a negative relationship between this labour market flexibility and productivity performance.
Although economists write of “flexibility”, it is extremely difficult to define or measure. As a result discussion tends to be anecdotal, something which the rest of this section cannot entirely avoid. The 7th edition of the Concise Oxford Dictionary defines “flexible” as “that will bend without breaking, pliable, pliant, easily led, manageable: adaptable, versatile; supple, complaisant.” Economists probably have in mind the first group of meanings, specifically the ability of an economy to adjust to a shock without generating unemployment in the labour market, and equivalent disruptions in other markets.
But some economic inflexibility may be no bad thing. If the house the reader is living in were to be totally flexible, it would fall down around her or his ears. Similarly firms consciously build inflexibility into their operations. Physical and human investment activities in a modern economy involve the transformation of resources with many possible uses into ones with much more dedicated uses, a transformation which results in a loss of flexibility.
Labour market flexibility is not an easy notion to capture. The OECD defines the following five types of flexibility:
“External numerical flexibility: the number of employees is adjusted to needs;
Externalisation: part of the firm’s work is put out to enterprises or individuals who are not bound by the contract of employment;
Internal numerical flexibility: the number of working hours is adjusted in line with needs, but the number of workers remains unchanged;
Functional flexibility: workers’ job assignments are modified according to needs;
Wage flexibility: labour costs, and thus wages are adjusted.” 18
To simplify, we need to distinguish between short term flexibility, such as that the ECA promotes, and long term flexibility, which is about how a labour force increases its skills and ability to carry out a multitude of tasks. It is possible that long term flexibility is undermined by short term flexibility, which inhibits the worker from developing a loyalty to the firm, and the acquisition of firm specific skills, while also discouraging the firm developing those skills in its work force.
Insofar as this trade-off exists, the ECA (and, more generally, discussion on labour market flexibility which focuses on short term flexibility) could undermine the development of long term productivity. Advocates of the efficacy of the ECA may prefer to argue that there is no effect of the industrial relations arrangements on productivity which have arisen from the new legislation (i.e. the first possibility), rather than it has been detrimental, in the light of the evidence that they do not seem to have augmented productivity growth.
In terms of the two possibilities, a recent OECD report has taken the cautious line that there appears to be no correlation between labour market flexibility and labour market performance. 19 However the second possibility must be left open. Excessive short term flexibility may damage labour market outcomes.
There has been a tendency by advocates of economic reforms to hypothesize certain benefits and then assume that these benefits have been necessarily realized after the reforms are implemented. Anecdote and selective use of statistics are then used to buttress the case. Systematic empirical investigation, as presented here, often suggests otherwise.
This pattern has been true among advocates of the ECA. On the basis of the empirical evidence it is very difficult to reach, in a systematic way, any strong conclusions about the beneficial economic effects of the Employment Contracts Act. In particular the poor productivity growth rules out the likelihood that the ECA was a major contributor to the macroeconomic expansion of the mid 1990s. The Act would, however, seem to have contributed to the poor real wage growth and the failure of many workers to obtain a share in any increase in the prosperity of the 1990s.
1 Wolfgang Kasper, Free to Work: The Liberalisation of New Zealand’s Labour Market, Policy Monograph 32, Centre for Independent Studies, Sydney, 1996, p.51.
2 Kasper supra at 43-44.
3 Kasper supra at 16.
4 New Zealand Institute of Economic Research, Consensus Forecasts, July 1997.
5 Kasper does not define his variables although there are a number of possibilities. The numerator of Figure 2 is Average Hourly Earnings (ordinary time), the denominator is the Consumer Price Index.
6 Kasper supra at 50-51.
7 Kasper supra at 51.
8 Kasper supra at 49.
9 Bryan Philpott A Note on Recent Trends in Labour Productivity Growth, Research Project on Planning Paper 281, Wellington, October 1996. The labour force unit is employment, adjusted for part-time working.
10 The non-tradeable sector has higher labour productivity levels than the tradeable sectors because it includes the capital intensive energy, communications, and home ownership sectors.
11 Kasper’s data seem to be seasonally adjusted. (They have since been revised.) Indicative of his grasp of much of New Zealand data, Kasper graphs “white” male unemployment rates in his Figure 2 supra at 45. “White” is not used in this context in New Zealand, and rarely in others, because of its racist connotations, New Zealand data is by self-categorized ethnicity, in which case Kasper is probably referring to the European/Pakeha rate.
12 The particular data series does not begin until 1986.
13 Tim Maloney, “Estimating the Effects of the Employment Contracts Act on Employment and Wages in New Zealand,” Australian Bulletin of Labour, Vol 20, No 4, December 1994, p.320-343; Has New Zealand’s Employment Contracts Act Increased Employment and Reduced Wages? Economic Department, University of Auckland, June 1996.
14 B.H. Easton, “Flawed Evidence”, Bad Work, Working Paper 16, Centre for Research on Work and Society, York University, p.57-63.
15 Kasper supra at 45.
16 New Zealand Institute of Economic Research, Quarterly Survey of Business Opinion, March 1996.
17 Real income wages were used here because they were illustrated in Figure 2. Thus the measure indicates that workers have not benefited from the productivity gains in their takehome pay.
18 OECD (1989) Labour Market Flexibility: Trends in Enterprises, OECD, Paris, p.13.
19 OECD Employment Outlook, July 1997.