The New Zealand Macroeconomy, A Briefing on the Reforms
Paul Dalziel and Ralph Lattimore
Oxford University Press, $19.95,
ISBN 0 19 558330 2
GP Print, $19.95, ISBN 1 86956 107 4
Rebuilding New Zealand
Technology Monitoring Association,
no price given, ISBN 0 473 02486 1
Reviews of recent New Zealand economic history typically suffer from two failings. First, they begin with the advent of the fourth Labour Government, as if life was created in New Zealand in July 1984. By doing so they ignore both what had gone before and the extent to which New Zealand has subsequently merely paralleled the world. Second, few such accounts are impartial. Reviews of the past 12 years have tended to be presented either by those who were closely involved with the process or by those on the outside who have been persistent critics.
The former see economic liberalisation as the internationally proven best way to run an economy and therefore view favourably the transformation of the local economy. This group would point to the comparatively excellent macro performance of recent years as justification for the earlier adjustment pains. The latter camp presents a variety of counters: that reforms were poorly coordinated and sequenced, that the limits of market liberalism were ignored (for example, telecommunications regulation) or that the social and redistributive consequences ought to have weighed heavier. Both sets of views can perhaps be criticised as giving too much weight to local policy actions and failing to segregate those trends that would have happened regardless. Such external reviews as have occurred have typically been sponsored from within New Zealand and similarly reflect the vested interests of the sponsors.
All of which makes reading Paul Dalziel and Ralph Lattimore’s The New Zealand Macroeconomy, A Briefing on the Reforms a pleasure. In the preface the authors note the importance of understanding the economic experiences from the 1960s to the early 1980s, so that the pressure for change that existed by 1984 can be properly understood. Further, the authors concede that their own judgments about economic management since 1984 differ, with the consequence that “we agreed we would not publish anything we could not both support”. This inbuilt bias towards objectivity is welcome.
Indeed, the need for balance seems to have shaped the book. What follows is detailed documentation of what decisions were taken and why, accompanied by numerous economic statistics to help the reader judge the results. The clear intent is to let the results speak for themselves by comparing outcomes achieved in recent years with those of the decades before the reform process began. The title of the work is thus well chosen: this is a briefing on the reforms rather than an evaluation.
The text begins in the 1960s. With some nostalgia we recall the policy environment of the Holyoake years. The key policy objective genuinely was full employment. External balance was always a constraint, but was managed by directing agricultural exporters to produce as much as possible and restricting imports. Increasing government participation in industry and regulation of the remainder mopped up any spare labour. Egalitarianism was further promoted via strong, occupation-based unions, central wage orders and government-provided services ranging from state houses to school milk. For two generations after the imaginative Labour administration of the 1930s this regime had enjoyed broad bipartisan consensus. By any standards the system had worked tolerably well. Growth through the 1960s averaged in excess of 3%, whilst registered unemployment did not exceed 1% of the workforce until the late 1970s.
Yet, as the evidence indisputably shows, this framework was unsustainable. The period from the late 1960s to the early 1980s was one of worsening macro performance on almost every count. The fabric came apart when faced by external shocks — two oil crises, Britain’s entry into the EEC in 1973, sharply higher world inflation and a downward trend in our terms of trade. But the policy response amounted to little more than tinkering. It included, at various points, across-the-board spending increases or contractions, major energy projects, a wage/price freeze, generally increasing border protection (CER was a major exception) and increased agricultural subsidies. The Treasury’s characterisation of this period as one where the economy had failed to adjust to changing circumstances, with policy instead cycling from one objective to another with little consistency, seems reasonable.
By the mid-1980s the case for change was overwhelming. Both fiscal and external deficit problems were chronic, unemployment was clearly on an upward trend and the productivity performance had been dismal for a decade. Against this backdrop any incoming administration would almost certainly have moved towards greater liberalisation. Even the detractors of the subsequent reforms agree on this point.
The main elements of the resulting policy upheaval are dealt with succinctly by Dalziel and Lattimore.
The chapter on international trade reminds us of the limitations of the crawling peg exchange rate regime, whereby any devaluation benefits were typically lost through subsequent inflation and monetary policy could not be properly used to fight inflation. Floating the exchange rate appeared a logical response.
The section on monetary policy traces how the traditional three-yearly inflation cycle of the 1970s gradually gave way to the present Reserve Bank Act. It is chilling to recall in the fiscal policy chapter that in each of the seven years before 1984 the Budget deficit exceeded 4% of GDP (around $4bn in today’s terms).
The section on industry policy recounts the dissatisfaction with the performance of government-owned trading operations and their transition to SOEs and subsequent privatisation. There is more evaluation in this chapter than most, the authors noting the generally improved labour productivity since 1985/86 and the surge in private sector investment of the past two years.
The chapter on labour relations is mostly concerned with the industrial relations, the State Sector Act and the Employment Contracts Act, but does note the dramatic decline in (especially full-time) employment since 1986 which has reversed only comparatively recently.
What do we make of this analysis? The account would benefit from a more inside know-ledge of official decision-making. Most of the rationale presented for policy decisions is reproduced from government publications which are often a little bland. A case in point is the floating of the exchange rate in 1985. The authors note that officials at the time hoped this would stabilise the real exchange rate (which had been vulnerable to inflation surges) and would allow monetary policy to be more directed at inflation. At the time there was also much emphasis by advisers on improving price signals and maintaining external balance.
Subsequent experience has shown that, apart from freeing monetary policy for its proper purpose of controlling inflation, many of these hoped-for gains were exaggerated. Indeed, the initial briefing papers of the time look naive a decade later. This is not to say that the decision to float would not have been taken even with hindsight- but merely that some of the early expectations of how the new regime would operate and the benefits it would confer were exaggerated.
The treatment of the reforms on a topic-by-topic basis, whilst probably unavoidable, also misses some of the linkages between areas. For example, the tax implications of liberalising foreign exchange markets were entirely ignored by policy advisers at the time the decision was made. Virtually all OECD jurisdictions which have abolished exchange controls have some form of anti-tax haven legislation, which New Zealand had never needed. Eliminating exchange controls rapidly exposed the tax base, which did not become apparent to tax policymakers until around two years after the float. The loose fiscal/tight monetary mix of the late 1980s and the delayed liberalisation of the labour market are perhaps other examples of poorly co-ordinated policy.
Since the narrative is light on assessment, let me add a few thoughts. There is a strong case that any assessment must be made topic by topic. It is ludicrous to force a single collective judgment on many barely related reforms made by different administrations over many years. Few would disagree, for example, that fiscal consolidation was essential, that the replacement of exploding debt ratios of the 1980s with the Fiscal Responsibility Act goal of balance over a business cycle is a huge improvement. The adoption of accrual accounting with a government balance sheet is a world first for which New Zealand can be justly proud.
There is, however, much scope for debate about the path taken. Was fiscal policy too loose for too long under Sir Roger Douglas’s stewardship? Were the 1989 GST rise and 1991 benefit cuts necessary from a purely macro perspective (as justified at the time)? Likewise, the outcome of low and stable inflation has surely been beneficial but would the costs created by the dramatic exchange rate appreciation in 1986-88 (and 1995-96) have been avoidable if broad policy had been better coordinated? Most would agree that many of the government’s commercial enterprises were serving little useful purpose (and, as Richard Prebble reminds us, viewed close up, many of their operations were bizarre) but why does Telecom enjoy much weaker competitors than almost any other comparable former state monopoly in this sector?
My own view is that a weighted assessment would score New Zealand highly, although we would have to acknowledge a number of policy mistakes along the way. The generally superior macro performance of the mid 1990s is testimony to a number of generally well-taken micro decisions in earlier years. Where there were mistakes it should be remembered that many of these judgments are much easier in hindsight — radical policy reform without some blind alleys and wrong turns is probably wishful thinking. That said, there has not always been complete intellectual honesty by policymakers along the way. For example the “crisis” of 1984 looks much less immediate in hindsight. There was a need for deep-seated change, but it was nowhere near as immediate as, say, that faced by the present Cook Islands government. Likewise, the fiscal “crisis” facing the incoming 1990 government was partly in the same category. Both were in some degree excuses to galvanise momentum behind what the incumbent finance ministers wished to do anyway. Nor should it be imagined that all structural issues are fully resolved, as the apparent currency overshoot of the past year and the steadily deteriorating trade balance may remind us in due course.
The authors are largely silent on the social costs and sharing of the burden of adjustment. The great difficulty here is distinguishing local from global trends. Over the past 20 years most western economies have featured rising structural rates of unemployment (though some, notably the United States, have shown some signs of reversing this in recent years), stagnant average real wages, increasing earnings disparities between top and bottom income deciles, rising costs of income maintenance programmes and resulting pressures to restrict them. Have these trends been any different in New Zealand? It is difficult to judge, given the paucity of local statistics and the difficulty of international comparison. We note that those countries which have moved least in these areas do not seem particularly pleased with the outcomes (notably in Europe, where economic and monetary union is becoming a battering ram to accelerate change) and that New Zealand’s present unemployment rate of a little over 6% compares reasonably favourably.
In judging the worth of this particular book, the criteria should surely be what it has added to our assessment of the past 12 years. As a comprehensive and objective record of macro trends it must score highly. We can see at a glance that inflation, the fiscal balance and productivity have all improved greatly, though at some apparent cost to the external balance. This is no small achievement and one senses that the authors lean towards a favourable assessment — though at no stage does this work purport to be a final scorecard on economic management over the past decade, which task is left to the reader. But, bearing in mind the ideological divisions I referred to at the outset, perhaps such a conclusion is beyond the ability of any author to deliver convincingly.
Perhaps a weighty discussion would narrow the appeal to a handful pernicious economists. This would be a shame. As a very readable, accurate and digestible record of New Zealand’s experiences in the post-1984 environment, I recommend this work.
If Dalziel and Lattimore lack controversy, the same cannot be said for the two accompanying efforts I was asked to comment upon. Len Bayliss’s Prosperity Mislaid is grounded in conventional macroeconomics and argues that recent economic management has damaged growth prospects by excessively tight policy and by imparting a bias against external sectors of the economy. John Robinson’s Rebuilding New Zealand is rather different, arguing (inter alia) that new right policies have seen a massive rise in inequality and dominance by capitalism with interests far removed from those of the wider community plus a simultaneous disregard for environmental sustainability. Both were published in 1994 and are thus now a little dated.
Beginning with Prosperity Mislaid, the basic charge is that macro policy has been always been poorly implemented, with this record showing little change over the past decade. In particular, monetary policy is singled out for criticism. Policy is described as excessively narrowly based, causing a bias against all sectors exposed to external competition via an excessive real exchange rate, contributing to poor savings and a deteriorating national balance sheet position. These general criticisms are extended to a number of other sectors, from education to the media.
No economist I know denies the hardship suffered by the tradable sector industry over the past decade. It is probably a legitimate criticism that policymakers, whilst aware of what was happening, could have done better in terms of macro balance. Bayliss correctly points to the late 1980s real exchange rate appreciation as an example.
However, one must acknowledge that there was bound to be a sizable wrench, given the hugely inefficient industry structure which had built up and the extent of the disinflation that was needed. Certainly, investment in tradeable sectors slumped for a lengthy period but this has not proven permanent. As Dalziel and Lattimore point out on p69, private sector investment has been very strong in the subsequent expansion. Perhaps a truer conclusion would be that where conflicts arose between objectives, such as the need to disinflate competing with the desire to direct resources back towards areas where New Zealand is internationally efficient, macro management tended to drift uncertainly. Accordingly, although the eventual outcomes may have been satisfactory, the dismal period of zero growth between 1987-91 was probably longer than it needed to be. But by how much is difficult to say.
Even accepting past failings, it is difficult to generalise from these to conclude that there is something fundamentally wrong with the current broad macro objectives. The notions that fiscal policy should aim for balance over the cycle, and that monetary policy be aimed solely at price stability are widely accepted internationally. Compared with the position even 10 years ago, much of the debate on macro issues has become narrower (for example, how to measure inflation). Bayliss’s criticism is therefore that those who have erred in the past will do so again, making poor policy and judgments an ongoing drag on the economy. He does, however, acknowledge a willingness of policy-makers to learn from their mistakes.
The past decade has seen its share of judgment errors, misplaced expectations and hiccups coming to grips with how the new environment works. But short-term forecast accuracy is not a sensible method to judge policy regimes. Incorrect readings of the economy will always be with us. Policymakers are especially vulnerable to such criticism because their results are highly visible.
Would others have done any better? The strength of the economic upturn since publication sits poorly with Bayliss’ analysis. The claims (p91) that “productivity, exports, savings and non-residential investment are extraordinarily poor” are at the least debatable. Forecasters who have argued major structural imbalances in recent have performed dismally compared with more balanced commentators, on occasions producing some bizarre projections. IES, of which Bayliss has been a member, has for a period consistently been too negative on almost every economic variable. What fun we could have dissecting its projections through this period and arguing that those responsible should never be allowed anywhere near economic policy.
Bayliss makes numerous appeals to improve policy making via more reliance on foreign rather than local advisors. The motivation is laudable but I suspect both the case for doing so and possible benefits are overstated. To my know-ledge both the Reserve Bank and Treasury (the two institutions specifically named) have attempted extensively to recruit externally over the past decade. Success has been modest and usually at more junior levels. Such senior appointments as have been made have been mostly uninspiring. The supply of world class policy analysts who are prepared to interrupt their careers and head down under is not large.
In lieu of this both organisations have always maintained contacts with their offshore counterparts and rotate their own staff externally where possible. In certain areas both are leaders in their fields. In others I have found the technical expertise of their (usually larger) opposite numbers more impressive. But as a generalisation local policymakers are in no way systematically inferior to international norms. Bayliss’s implication that local policy is detached from international best practice and prone to amateurish errors of judgment is difficult to sustain, as well as being a charge to which the author is not immune.
John Robinson’s work is more difficult to debate, if only because of a large philosophical hurdle. If one begins from a position that “the arguments of the free market are simply a cover for power grab and the amassment of wealth” (p163) or that “there will be no solution to social, political or environmental problems unless the heights of capitalism are tamed”(p165), then one is unlikely to be impressed by the past decade’s developments, in New Zealand or elsewhere. From this starting point springs an analysis of New Zealand’s recent history rich in conspiracy concerns in areas from hospitals to privatisation.
This fundamental difference is unlikely to be resolved here. I merely offer the observation that globally nations from a wide range of backgrounds appear to be converging on a similar type of economic structure, namely market liberalism. From the ex-communist states of eastern Europe, to the extensive welfare economies of Scandinavia, via ex-military dictatorships in South America to the curious bundle of histories within southern Asia, opening of markets, regulatory reform and recognition of the limitations of government are emerging as the accepted norm. Either the capitalist conspiracy is widespread indeed or the benefits that stem from well-defined property rights, incentives and disciplines imposed by market transactions have proven robust in terms of delivering results that broad populations seek. I leave it to the reader to decide where the balance lies.
Paul Dyer is head of investment strategy for AMP Investments Ltd.