Prescription or poison, Brian Easton

New Zealand Can be Different and Better
Wolfgang Rosenberg,
New Zealand Monthly Review Society

Those who wish to challenge Wolfgang Rosenberg’s policy prescriptions must confront the outstanding performance of the New Zealand economy in the first part of the postwar era. In the three decades from the mid-1930s, following the recovery from the depths of the interwar depression: the economy grew as fast as – or faster than –  the rest of the OECD; the rate of inflation was slightly below the average; the overseas debt was not compromising; and there was full employment. (Rosenberg puts the break point in 1975, although the last decade was not as good as the period up to 1966.)

Rosenberg explains this nirvana by the economic policies pursued at the time. They involved a commitment to policy goals such as full employment, an expansionary fiscal stance, a high level of government intervention in markets and – most notably – border protection by import controls. He argues that as we have moved away from this policy mix, the economic performance has deteriorated. The further we have moved, the worse the outcome.

There is a danger of post hoc ergo propter hoc, but Rosenberg tries to fill in causal steps. Even were the argument fallacious, there would still be the task of providing an alternative account of what happened.

The conventional wisdom ignores this task, offering instead an incomplete and incoherent analysis of our economic past. For instance, suppose it were true that we had the world’s third highest per capita GDP in 1950. (It is not true – being more like sixth or seventh, and towards the bottom of the OECD countries not ravaged by war.) It would be the pheph fallacy to argue that interventions damaged the subsequent performance. Moreover, one has to explain the high ranking in 1950, when during the previous 15 years the interventions by governments were even more onerous.

It is not this review’s task to bash the misconceived accounts of the economy which led to Rogernomics, Ruthanasia and economic stagnation, which Rosenberg does well enough. What has to be done is to respond to the task which Rosenberg implicitly sets us. Can we give an account of the economy which explains the good and subsequently deteriorating performance, but offers a different policy interpretation?

We might begin with the perhaps controversial point that the interventionist policies of the three decades after the election of the first Labour Government did not markedly harm the economy. Rosenberg’s case that they were positively beneficial is not unconvincing and there has been no serious analysis arguing the contrary.

However, one period’s prescription may be another period’s poison. By the late 1960s the New Zealand economy was changing and the policies less effective. The most notable precipitant was the fall in the terms of trade (price of exports relative to imports) in the late 1960s. Except during the 1972 commodity boom they have been markedly below the earlier level ever since.

Pastoral farming became less profitable. The economy diversified out of its emphasis on sheep and cattle to a more varied export base of horticulture, trees, fish, tourists, mineral/ energy and general manufactures. The outcome was a more subtle – more fundamental – change.

High prices for pastoral farming generate high land rents (using the term in the sense which David Ricardo – and Henry George – would recognise). The return from the rents was not left with the farm owners, but shared through the entire community, by border protection and by other interventions.

It would have been more efficient, for distributional purposes, if the land had been owned by the state and the rents accrued into general revenue. But that was not an option, nor is it obvious that public ownership would be more efficient than owner farming for productive purposes. Instead, farmers were forced through internal and external protection to pay more for their goods and services (including the cost of after-farm processing). The additional payments went to workers and domestic capitalists. Thus, the land rents were shared throughout the community.

There are limits to the ability to do this without severely damaging the productive capacity of the economy. (Argentina exceeded the limits.) Only rents may be redistributed without adverse effects. The fall in the terms of trade reduced the true land rents and the redistributive role of the interventions was undermined. It did not happen overnight. The protective structure of the economy steadily crumbled, not because of the wickedness of an alternative economic policy, but because the material base of the economy was changing.

Export diversification rescued us. Were New Zealand as dependent upon pastoral farming as it was a quarter of a century ago, the economy would be in an even sorrier state. Now economic management has to respond to the new circumstances. No longer could export supply be driven by biology and technology, as had happened for pastoral farming, while import controls guarded the domestic sector. The external and domestic sectors became more integrated – as evidenced by the tensions within the manufacturing lobbies as exporting became more important. ‘More-market’ policies prompted by diversification of the external sector percolated through the whole of the domestic economy. The beneficiaries of the old regime – most notably workers – were squeezed.

A further long-term structural change needs to be added before we consider the policy implications. Rising affluence, coupled with technological change, created a diversification of another sort – lifestyles. There is not the space here to discuss the evolving class structure in New Zealand, but the diversity in consumption also had an important impact on economic policy. For instance, rising expenditure on foreign travel meant that import controls could not restrict foreign exchange outlays on the single largest item of overseas spending (excluding debt servicing). The travellers came home asking why things could not be done here as they were elsewhere (for example, shopping on Saturdays and Sundays).

So while the interventionist policy regime may have served New Zealand well in the first two decades of the postwar era, it became increasingly antiquated as the economic structure changed. What was the alternative?

The conventional wisdom says as little intervention as possible, leaving as much as possible to the commercial market. The evidence is that such policies have not been especially effective. Indeed, the slightest review of recent history shows the economic performance (except inflation) has been disastrous. Most of the critics of the Rosenberg thesis threw the baby out with the bathwater. It may well be that past government policies will not work today. That does not mean all active government policies will not work, that all interventions are a failure.

What might a modernised form of the old policy regime look like? Superficially, very different, although there remains the same commitment to unfashionable social objectives – full employment, support for the poor and social justice – as well as sustainable, efficient growth. However, its interventions are ‘more-market’, using a pragmatic (rather than ideological) test which favours the market mechanism unless there is a good contrary reason. There are many places where the market mechanism does not work well: distributing income, building up human capital, research and development, the labour market, health services… But even here the approach is to use the market where possible.

Thus, this approach prefers tariffs to import controls. Rosenberg passionately and lengthily argues that high border protection (especially import controls) are fundamental to any full employment policy. I happen to think there may be structural reasons for some border protection. Peter Elkin’s 1976 study, The Meaning of Protection, provides some insight into how technological conditions in one sector (manufacturing) may justify sectoral protection. (Other technical conditions, such as monopoly export supply, may also be relevant.) These suggest a case for moderate rates of protection.

But Rosenberg is concerned with macroeconomic reasons for border protection, arguing they are necessary to maintain full employment.

The standard economic models, on which those passionately opposed to Rosenberg’s diagnosis depend, are of no help because they assume the labour force is automatically fully employed – exactly the issue which Rosenberg is denying. It maybe protection lowers productivity, but if the numbers employed increase sufficiently, the outcome can be a net economic benefit.

When I try to write down a formal model to characterise Rosenberg’s argument, I cannot demonstrate import controls to be the best option. Instead, the model favours managing the exchange rate aggressively (after allowing for structural protection/ industry assistance). I can report that the conditions in my model where high protection is most likely to work are where export supply and demand are insensitive to price changes. This may reflect reasonably well the pre-1966 situation in the medium term. In such circumstances protection can transfer income to domestic producers, that is, workers, at a small loss of productivity.

My model does not include the effect of import controls decreasing the uncertainty which manufacturers face. This is likely to encourage (or force) investment in the manufacturing sector (rather than disinvestment and supply from overseas). With a guaranteed domestic market (to some extent) the domestic manufacturer is less subject to various shocks, especially those from overseas competitors and international price swings.

The objectors’ response is that reducing risk to import substituters, increases the exposure to shocks of exporters who find it more costly to deal with the risk. Again the caveat of ‘in a fully employed economy’ applies. It is not obvious the economy-wide cost of risk management would be more if the protection increases output and employment. My intuition is that, compared with import controls, a policy based on exchange rate management and market industrial assistance would increase risk to domestic-oriented manufacturers. But there would be an overall reduction in the cost of risk management. However, I acknowledge that the effects are complex and it is possible my intuition is wrong. So might Rosenberg’s be.

Perhaps this analysis puts me at the Rogergnome rather than the Rosennome end of the spectrum, although my distance is great from either extreme. Yet the macro-economic approach is perhaps closer to Rosenberg, because it recognises that the government must actively manage aggregate demand instead of relying on monetarist mumbo-jumbo. The practicalities of management are quite different from Rosenberg’s.

Because we no longer can rely on supply-driven pastoral exports and limiting foreign exchange outlays by import controls, we cannot simply absorb unemployment by using a Budget deficit to expand the economy. This was Sir Robert Muldoon’s misunderstanding in the late 1970s.

First, the increased domestic activity blows out through increased imports, while export responses are sluggish. (Hence, the increasing export incentives and subsidies of the Muldoon era.) Second, especially given the high world interest rates since 1980, the additional borrowing leads to additional government debt servicing, which is ultimately unsustainable. Third, the large internal (Budget) deficit blows out into a large external (balance of payments) deficit as imports hugely exceed exports. This pressure cannot be avoided in the long run by import controls because the economy will inflate.

So instead of the Muldoon strategy of domestic expansion or the Sir Roger Douglas strategy of ignoring the issue and letting unemployment rise, the alternative strategy uses an aggressive (managed) exchange rate to expand through increased exporting, buttressed by selective government assistance and a tight fiscal stance. This is different from the Rosenberg proposal. In common is acceptance the government must manage aggregate demand (with social objectives in mind). The disagreement is about the policy measures, reflecting different accounts of the workings of the economy.

There can be little disagreement with Rosenberg’s main thesis: New Zealand can do better. Indeed, one wonders whether it could have done much worse over the last decade. Many of his criticisms of current management are justified.

But can we go back to the old approach which Rosenberg advocates? It was not abandoned because it was wrong or that new generations were overcome by a corrupt alternative. It was abandoned because the economic structure changed dramatically. This does not mean we need to abandon the objectives of economic policy, only the ways we pursue them.

 

Brian Easton is an economic consultant.

 

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Posted in Non-fiction, Politics & Law and Review
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