Downfall of an economic experiment

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According to conventional wisdom, New Zealand has done everything right in its economic policies: rolling back the slate in industry and welfare, establishing an independent central bank, repaying its public debt. Yet over the fifteen years of reform its economic performance has been dismal. New Zealand is the new Argentina, a once-rich state.

If ever a country has been run by economists, it is New Zealand. In 1984, the colourful Roger Douglas became Finance Minister. He began the most comprehensive programme of economic reform seen in a developed country.

According to current orthodoxy, New Zealand has done everything right. The central bank is independent and its governor’s pay is linked to the inflation rate. State industries have been comprehensively restructured and privatised. With none of the regulatory supervision found elsewhere.

What was one of the world’s most comprehensive welfare states has been dismantled. The Employment Contracts Act insists that conditions of work are a private matter between employer and employee. In surveys of the “economic freedom of the world” New Zealand is ranked with Hong Kong and Singapore, ahead of Britain and the United States, and well ahead of continental Europe.

After fifteen years, the electorate delivered its own verdict on the reforms by returning an old labour style government, led by Helen Clark. If we look coldly at New Zealand economic data, the voters are right. Since the experiment began, economic growth in New Zealand has been much slower than in the rest of the developed world. Productivity and living standards have barely risen while almost all other rich countries have enjoyed sustained expansion. The past fifteen years have completed New Zealand’s transition into a very select group of states: those that were once rich but are rich no longer. The standard of living has fallen from 1.25 times the average standard of living in high-income countries in 1965 to 0.62 last year. New Zealand is the Argentina of the second half of the twentieth century. What went wrong?

The world has treated New Zealand badly. Its economy was oriented towards Australia and Europe, especially Britain. It was and is the most efficient producer of lamb, wool and milk. The rise of agricultural protection, and the UK’s accession to the EU, was deeply damaging.

But this happened some time ago. Between 1965 and 1976 the price New Zealand received for its exports, relative to what it paid for imports, fell by more than one third. Since then, New Zealand’s terms of trade with the rest of the world have improved slightly. Economic performance since 1976 is the responsibility of New Zealanders themselves.

Between 1976 and 1984, premier Robert Muldoon urged his compatriots to ‘think big’, and gave them aluminium smelters and petrochemical plants. Most of these schemes failed, at large cost to the taxpayer. The liberalisation which followed was an understandable reaction but it was no more successful.

The programme is still widely admired outside New Zealand. As was true of Margaret Thatcher’s Britain, the success of reform is often measured by the extent to which it has occurred rather than the benefits which have flowed from it. The US Central Intelligence Agency claims in its 1999 factbook that the reforms have boosted growth and moved incomes towards the levels of the big West European economies but its statistics provides show the opposite.

The more serious challenge is to those international economic agencies – World Bank, International Monetary Fund and Organisation for Economic Co-operation and Development – which have advocated everywhere the reform programme that New Zealand adopted so enthusiastically. Unable to ignore the evidence the OECD waffles.

‘It is difficult to reach definite conclusions about why economic performance has not improved to a greater extent in the light of the substantial policy changes that have taken place, not least because it is hard to be precise about the counterfactual to be used for comparison’. (OECD Economic Survey, New Zealand, 1999) That means things have been bad, but they might have been worse. ‘The reforms are on balance, commendable for the application of a broad set of consistent principles and the extent to which announced measures were actually implemented’. You might equally congratulate a man jumping off a cliff for his firmness of purpose.

Still, like all peddlers of panaceas, the OECD’s conclusion is that the patient has not believed strongly enough. ‘Despite the enormous strides made to date, there is unfinished business as to structural policies.’ it says. After fifteen years, it cannot seriously be argued that more time or more reform is needed before benefits emerge. The New Zealand experiment was a test of the claim that government is the source of most economic ills and the withdrawal of government is a solution to them. The New Zealand Treasury adopted that argument with almost obsessive zeal. And it is clear now that the experiment failed.

The electricity supply disruptions which blacked out much of central Auckland for five weeks in 1998 resulted from a sequence of managerial and technical failures that might have happened anywhere. But the place where they did happen is the only advanced country in the world where electricity distribution is neither owned nor regulated by government.

Before economic reform, New Zealand had effectively no unemployment. The price was that many people were employed in not very productive jobs. But perhaps that was a better answer, economically as well as socially, than putting them out of work.

As Tim Hazledine has shown, New Zealand’s reforms have not been cheap. There has been a substantial increase in the numbers and earnings of managers and in financial and business services. This is not wrong in itself, but it has to be justified by a corresponding rise in the productivity of those they manage, advise, and finance. And this has simply not happened.

Russia was not the place to have tested socialism. And New Zealand – an isolated easy-going country with impressive social cohesion – was the wrong place to try out economic libertarianism. Economists must be grateful for such experiments. But it is usually better not to live in the countries where they take place.

Tim Hazledine Taking New Zealand Seriously Harper Collins 1998

A note on New Zealand’s economic performance, which examines the statistics behind the conclusions of this article, is available at www.johnkay.com

This note provides background and explanation for the comments about New Zealand’s economic performance made in my article in the Financial Times on Wednesday 30th August 2000.

The comments on living standards are chosen as the simplest available illustration drawn directly from international sources. They are based on (Table 1)

New Zealand: GNP per capita from World Bank in current NZ $,converted to US $ at OECD PPP exchange rate

Rich countries: GNP per capita in current US $ for World Bank “rich countries”.

For 1965, no OECD PPP exchange rate is available: the earliest is for 1970. As consumer price inflation in New Zealand and US was very similar over the period 1965-70, the 1970 PPP exchange rate is used for 1965.

For the reform period itself, the headline conclusions are:

  • economy wide labour productivity has risen by around 10% between 1984 and 1999 (Table 2)
  • average living standards have risen by rather less (Table 1)
  • real wages have not yet regained the 1984 level (Table 3)

  • The political background and the period of analysis

    It is obviously easy to lie with statistics, especially economic statistics, and possible to give a distorted picture of what has happened in New Zealand, or elsewhere, by a suitable choice of base period. New Zealand can be shown in a particularly favourable light by choosing the period 1992-7 or a particularly unfavourable light by selecting 1984-93. Anyone who does either of these things is making debating points rather than a serious contribution to analysing what has happened.

    The decisive event in this phase of New Zealand economic history was the election of 1984, in which the National Party government led by Robert Muldoon was defeated and Roger Douglas became the Labour Party’s Finance Minister. It was therefore a Labour government which initiated the reform process. By the late 80’s, however, the pace and effect of the programme led to divisions within the Labour party, and a National Party government was elected in 1990.

    This government continued the reform process under the direction of Ruth Richardson as Finance Minister. At the next election, in 1993, the National Party majority was much reduced and a referendum supported electoral reform abandoning the ‘first past the post’ Westminster system: this result was widely seen as an expression of dissatisfaction with strong, ideologically driven government. Richardson was replaced as Finance Minister. The bulk of the reform programme had been carried out by this time but the strong emphasis on economic liberalism of the period 1984-93 continued until the National Party government was defeated in 1999. The new Labour government is reviewing important aspects of the experiment, such as the absence of specific utility regulation and the Employment Contracts Act.

    I have stuck carefully to looking at the entire reform period, 1984-99, estimating where necessary to ensure that the complete time period is used. There are several strong reasons for doing so. In particular,

    • this is the only time period whose limits are not arbitrary — those limits defined by the relevant external political events rather than subjective judgement. But fifteen years is also a period sufficiently long for cyclical factors have a small effect
    • fifteen years is also long enough, given New Zealand’s experience, to judge the effects of the experiment. If, as it appears, output growth over the period was lower than in advanced countries with more conventional policies by a figure in the range 20% – 25%, then it would require a similarly long period of outstanding economic performance — growth 1% – 2% above the norm — to eliminate the gap. If the cumulative output losses throughout that period are measured, it would require perhaps a fifty year period before these could be regained, and the process, taken as a whole, would yield net benefit. In other words, the impact of underperformance of this magnitude over this period of time is essentially permanent.

    • There are some points of particular importance in reviewing New Zealand economic statistics. The exchange rate for the New Zealand dollar is and almost always has been low relative to its value in purchasing power terms.

      The undervaluation was most extreme in 1984, after the devaluation which followed immediately on the National Party’s election defeat. At that time, you could buy more than two New Zealand dollars with one United States dollar although OECD estimates of purchasing power suggested little difference in the local purchasing power of the two currencies. In 1997, just before the Asian crisis, purchasing power and actual rates came closest to equality. But the recent decline in the NZ dollar has again established a very wide gap between the market exchange rate — currently 2.3 to 1 — against a PPP rate of approximately 1.5 to 1. To put the point more simply, New Zealand is a cheap as well as a pleasant place to be a tourist.

      New Zealand also has an unusually large gap between GNP and GDP. (The difference is net property and investment income from abroad). In 1997, when the difference was widest, GDP exceeded GNP by around 10%. GNP is the most appropriate measure in assessing the standard of living of the New Zealand population, GDP in measuring New Zealand output. New Zealand is a richer country than New Zealanders. There are several associated reasons why this difference is so large (some connected to the reform programme, some not) New Zealand has run a persistent balance of payments deficit: in part, presumably, as a result of consumption being maintained despite falling or slow growing incomes. There have been substantial capital inflows and there is extensive foreign ownership of New Zealand debt. While the reduction of New Zealand’s public overseas debt has been a policy priority (and largely successfully achieved), private overseas debt has risen very rapidly.

      New Zealand productivity for purposes of productivity measurement, the appropriate denominator is the labour force. The labour force statistics include, as is normal, unemployed people looking for work. When we measure the productivity of firms, it is obviously only the work force actually employed that matters. For the economy as a whole, however, unemployment reduces its average productivity.

      Within the New Zealand labour force, there has been a significant increase in the proportion of people working part-time. (There have been increases in this proportion in most other countries also). This is not easy to interpret. If most people working part-time are doing so because they want part-time jobs, then it is better to measure the labour force in FTE (full-time equivalent) terms. If, on the other hand, most of them would like full-time jobs then they are partially unemployed as well as partially employed/ In many countries, the rise in part-time work is largely associated with increased labour force participation by women, but this is not true in New Zealand to any large extent. There has been a small increase in female participation, more or less offset by a decline in male participation. These facts, the overall rise in unemployment, and other developments in the New Zealand economy over the period, point to discouragement rather than choice in the form of labour force participation. For this reason, I have used the raw labour force figures without adjustment.

      In general, I think it appropriate in valuing output to use market rather than PPP exchange rates. For Switzerland, for example, the rise in the US dollar price of Swiss exports reflects product quality which is not measured in output based measures of GDP at constant (local) prices and thus understates Switzerland’s underlying productivity and growth rates. The situation of New Zealand is rather different, because of the importance of primary exports. If the US $ price of New Zealand milk rises, this is likely to be the result of world commodity price movements rather than a change in the quality of New Zealand milk. In any event, because of the persistent gap between New Zealand’s actual and PPP exchange rates, measures of output per head at market exchange rates seem improbably low (as well as being volatile). On balance, therefore, I have preferred to use PPP rates in making productivity comparisons as well as comparisons of living standards.

      Productivity growth in GDP/labour force

      New Zealand

      GDP, market prices, 1984/5, current NZ $ 39346

      GDP, market prices 1984/5, 1999/2000 NZ $ 79290

      (using implicit GDP deflator)

      GDP, 1999/2000 current NZ $ 103857

      New Zealand labour force, 1999/2000, HLFS data 1880-5

      HLFS not available for 1984/5

      HLFS labour force, 1986/7, 1611-9

      estimated 1984/5 labour force 1577

      (growth of QES labour force would suggest a lower figure

      but shows an odd trend in 1984/5)

      GDP/labour force, 1999/2000 NZ $, 1984/5 50279

      GDP/labour force, 1999/2000 NZZ $, 1999/2000 55228

      Increase +9.8%

      World high income countries

      GDP, market prices, 1995 $US, all high income countries

      1984 17 252 929

      1997 24 848 389

      1999 (est) 26 213 000 (using OECD GDP growth rate)

      (22402 23633)

      Labour force

      1984 390481

      1997 449397

      1999 (est) 455000

      1999 GDP/labour force, 1995 US$ 57611

      1984 GDP/labour force, 1995 US$ 44183

      Increase 30.4%

      Comparison of productivity levels

      New Zealand

      NZ GDP 1984/5 current NZ $ 39346

      GDP per worker NZ$ 24950

      GDP per worker US$ (P Parity rate 1.12) 22277

      NZ GDP 1999/2000 per worker NZ$ 55228

      GDP per worker US$ (P Parity rate 1.48) 37316

      World Bank high income countries

      GDP current US$ 1984 899162

      labour force 390481

      GDP/labour force, current US$ 23027

      GDP, current US$, 1997 2284846

      OECD growth rate, 1999/1997gives

      GDP, current US$ 1999, 247174

      GDP/labour force, current US$ 54324

      NZ as % of high income in 1984 97% 1999 69%

      Table 1

      New Zealand Living Standards Over Time

      GNP per capita relative to GNP per capita of all “high income” countries, 1965-69

      1965

      1976

      1984

      1997

      1999 (est)

      GNP per capita (Current NZ$):

      New Zealand

      1,530

      4,258

      11,481

      24,255

      24,743

      GNP per capita at PPP US$:

      New Zealand

      2,530

      5,581

      10,251

      16,500

      16,718

      GNP per capita at US$:

      High income

      2,023

      5,796

      10,620

      24,668

      26,328

      Sources: World Bank, OECD

      Table 2

      New Zealand Productivity in the Reform Period

      GDP/labour force: growth and relative level for 1984-99

      Growth for New Zealand over period

      +9.8%

      Growth for all high income countries

      +30.4%

      New Zealand as % of high income average — 1984

      97%

      New Zealand as % of high income average — 1999

      69%

      Sources: World Bank, OECD, Statistics New Zealand


      Table 3

      Real wages, New Zealand (1984 = 100)

      1984 (fiscal year average)

      100

      December 1992

      90.9

      1999 — 2000 (fiscal year average)

      91.0

      To December 1992, Weekly Wage Rate Index deflated by CPI, From December 1992, Salary and ordinary time wage rates, deflated by CPI

      Source: Statistics New Zealand

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