Did the reforms work? Yes and no Paul Dalziel

A Study of Economic Reform: The Case of New Zealand
eds Brian Silverstone, Alan Bollard and Ralph Lattimore
Elsevier North-Holland, $US145.25,
ISBN 0 444 81985 1

Between 14 July 1984 (when the electorate decisively rejected Sir Robert Muldoon’s approach to economic management) and 1 July 1994 (when Ruth Richardson’s Fiscal Responsibility Act came into effect), New Zealand experienced what one contribution to the volume under review describes as “perhaps the most radical and comprehensive market-orientated reform programme ever implemented in the OECD”. Much has been written on the pros and cons of each reform but economists are now beginning to evaluate whether the programme itself, taken as a whole, can be judged a success.

At the 1996 conference of the New Zealand Association of Economists, for example, one of the sessions produced a lively exchange between Rufus Dawe (author of From Hope to Glory: The New Zealand Economic Miracle) and Jane Kelsey (author of The New Zealand Experiment: A World Model for Structural Adjustment?). Dawe argued that New Zealand had been “on the very brink of international bankruptcy in 1984” and that the reforms had turned this around to produce the best performance in the OECD less than 10 years later. Kelsey (who is not an economist but has a lawyer’s eye for evaluating the use or misuse of evidence) observed that the 1994 and 1995 growth rates did not endure and that “whatever the economic outcomes, the country and many of its people were a great deal worse off” after the reform programme.

Such diverse viewpoints are by no means unique to Dawe and Kelsey. To give another notable example, three Wellington economists (Lew Evans, Arthur Grimes and Bryce Wilkinson) published an essay late last year in the authoritative Journal of Economic Literature which concluded that the reforms have put New Zealand “on a trajectory to maintain its economy as a consistent high performer among the OECD”. That conclusion was strongly criticised in two columns for The Listener by another Wellington economist, Brian Easton, who argued instead that “we are poorer as a result of the reforms and appear likely to remain so”.

That debate will be greatly assisted by this collection of essays produced by one of Europe’s leading academic publishers, Elsevier Science. The editors, Brian Silverstone (University of Waikato), Alan Bollard (Commerce Commission) and Ralph Lattimore (Lincoln University), explain in its preface that their aim is “to provide a platform for further research” based on “a coherent and consistent study of the ‘reform decade’ from a range of viewpoints”. Their objective has been achieved magnificently and this volume should set the standard for all subsequent work by economists on this question.

It must be said that the essays have been written by economists for economists and the general reader may struggle with concepts such as sacrifice ratios, Gini coefficients, Malmquist productivity change indices, Engle-Granger approaches to estimating cointegration relationships and the Harrison-Kreps equivalent martingale theory of no-arbitrage pricing. The price of the book (close to a week’s basic benefit for a single parent with two children) will also restrict its audience. Nevertheless, the contents of this volume make for fascinating reading.

As the editors observe, “the reforms were notable for being based on an integrated theoretical framework”. Thus, it is not just New Zealand’s experience that is under scrutiny in this study but also established economic theory. If close observance of current economic theory really does have the potential to enhance the wellbeing of a society’s citizenry to a significant extent we should be able to measure the improvement after New Zealand was transformed “from one of the most interventionist OECD economies to one of the most open, market-based, economies”. Yet this is still not the case, as the editors again observe:

If ever the impact of economic reforms was going to be identified and studied in a developed economy, New Zealand provides that opportunity. Even such a “big bang” shock on the scale that New Zealand experienced, however, has proved surprisingly difficult to measure. The reforms themselves were clearly major, yet a number of performance variables did not register the expected impact. If the effects of such sizeable shocks have been difficult to measure in the near-laboratory conditions presented by a small, open economy like New Zealand, then they could be even more difficult to measure in most other OECD-type economies.

Of course, the editors are not claiming an absence of change over the last 13 years. After decades of high inflation, the reformed Reserve Bank Act has achieved its objective of maintaining price stability. Fiscal reform to halt the growth in public debt has eliminated the chronic budget deficits of the 1980s. The reform of the government’s former trading departments, now corporatised or privatised, has produced sometimes spectacular increases in profitability and economic efficiency. Industry deregulation and trade liberalisation have increased the price system’s ability to signal where scarce resources are most highly valued.

These are important achievements. The surprising feature of the reforms, however, is that they have not led to clear improvements in what the editors call the “final outcomes”; that is, economic growth, worker productivity, income distribution and the rate of unemployment. Four separate chapters of the book are devoted to these topics, in which sophisticated methods are used to analyse the respective changes — a welcome contrast to the widespread practice of using simple comparisons over carefully selected periods to promote or denigrate the reforms.

Economic growth is examined by Viv Hall (Victoria University of Wellington) who finds that “there is, as yet, insufficient evidence to conclude that growth performance in the 10 years since 1984 has been both significantly and sustainably higher than the previous decade or that any difference can be conclusively associated with the (still ongoing) reform process.” Hall nevertheless goes on to suggest that “on balance there is scope for cautious optimism”, a theme that is picked up by the editors in the opening chapter’s overall assessment.

Hall’s data end in December 1993. Over the next three years, the trend in real gross domestic product justified both his optimism and his caution. Growth remained positive for every quarter (until the sharp fall in March 1997) but the rate of growth slowed significantly after the end of 1994. Thus critics can still claim that much of the high growth between 1992 and 1996 was “catch-up” after zero growth during the previous five years and that the economy has still to demonstrate a sustained improvement on its pre-reform performance.

Dimitri Margaritis (University of Waikato), in association with two economists from Southern Illinois University, examines productivity growth in 20 production sectors from agriculture to community and personal services. In each case 1984 marked a significant turning point in productivity growth but the data reveal that the productivity improvements were almost entirely technological gains that had been achieved by 1988 (which the authors attribute to “openness to foreign knowledge and technology — through the creation of a freer trade environment, financial deregulation, privatisation and access to foreign direct investment”). The data do not suggest ongoing improvements in productivity growth in the 1990s.

This last observation is confirmed in the chapter on labour markets and policy by Tim Maloney (University of Auckland) and John Savage (Institute of Economic Research) and by Tim Hazledine and Andrew Murphy (both at the University of Auckland) in their examination of the manufacturing sector. Maloney and Savage find a sharp increase in labour productivity between 1984 and 1990 (2.2% a year, compared to Australia’s 0.5%) but this growth did not continue over the next four years (0.4% in New Zealand; 2.1% in Australia). Hazledine and Murphy do not measure productivity directly but analyse the manufacturing sector’s performance in maximising profitability from their product markets after the reforms. Their conclusion is sobering: between 1984 and 1992 “the mainstream manufacturing sector has, on balance, failed to improve its allocative efficiency”.

Unemployment is analysed by Simon Chapple (Institute of Economic Research), Richard Harris (formerly of the University of Waikato, now at the University of Portsmouth) and Brian Silverstone (University of Waikato). Their analysis concludes that economic restructuring was not an important cause of rising unemployment over the reform decade. This is described as an interim result pending econometric evidence but the authors’ preferred explanation for the higher unemployment rate after the reforms was the enduring impact of the government and private sector cutting back on expenditure during the policy-induced recession after 1987.

This study may help reconcile a major argument among economists during the reforms. One school hypothesised that the traditional low rate of unemployment was an artifice of unproductive employment in government trading departments (the Railways and the Forestry Service, for example), so that restructuring would allow such workers to transfer to more productive jobs without any overall rise in unemployment once they upgraded their skills. Another school hypothesised that it was folly to introduce shock after shock to aggregate demand for more than half a decade since the loss of skills in workers unemployed for lengthy periods of time would cause a persistent rise in unemployment. The Chapple, Harris and Silverstone study lends support to both theories which are not mutually exclusive.

Finally, Easton examines changes in income distribution in chapter 4. Easton also finds that the market liberalisation reforms did not have a significant effect on income distribution compared to the higher unemployment created by tight macroeconomic policies but reports that the greatest impacts were produced by the income tax changes in 1988 and the benefit cuts in 1991. “Without question,” Easton concludes, “the benefit cuts reduced the incomes of the poorest, increased household income inequality and added to social hardship.”

This last point is particularly troublesome for economists schooled in the “Pareto efficiency” approach to policymaking. Essentially, a policy is more Pareto-efficient than the status quo — and so is recommended by economists —— if it improves at least one person’s wellbeing without harming anyone else. If the reform programme has produced a group of people who are unambiguously worse off as a result (and Easton concludes it has) this violates a fundamental norm of economic policy advice. This may explain why arguments about poverty tend to be downplayed or overlooked by advocates of the reforms but to my mind this is the most important criticism of the reform programme to date.

So what are we left with from this book? The reforms have achieved significant improvements in important economic indicators such as price stability, fiscal balance and market liberalisation. Economic theory states that this should have increased the potential for economic growth and indeed the economy did grow at very high levels by New Zealand standards in 1993 and 1994.

Those high rates did not endure, however, and may simply have been compensation for the negligible growth experienced while the reforms were being implemented. Unemployment is now higher than when we started and there has been a sharp increase in poverty, principally as a result of the 1991 benefit cuts.

Thus, the essays in this volume will not settle the debate about the reforms’ success or failure. Advocates can point to improvements in price stability, fiscal balance and market liberalisation and can claim from theory that these improvements have increased the potential for higher economic growth. Critics can point to increases in unemployment and poverty and can claim that there is no empirical evidence that higher growth (when or if it arrives) will trickle down to those marginalised by current poverty.

At the risk of perpetuating a stereotype about economists, therefore, my answer to the question posed at the beginning of this review (was the reform programme successful?) is: yes and no. Yes, important efficiency gains were made, but no, this was not sufficient to preserve or improve the material wellbeing of everyone in New Zealand.

Paul Dalziel teaches economics at Lincoln University, and is co-author with Ralph Lattimore of The New Zealand Macroeconomy: A Briefing on the Reforms (Auckland: Oxford University Press, 1996). reviewed in New Zealand Books December 1996. 

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Posted in Economics, Non-fiction and Review
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