Economic reform in New Zealand 1984-95: The pursuit of efficiency
Journal of Economic Literature; Nashville; Dec 1996; Evans, Lewis; Grimes, Arthur;
Wilkinson, Bryce; Teece, David; Vol. 34, Iss. 4; pg. 1856, 47 pgs
Abstract:
Triggered by a constitutional and foreign exchange crisis in July 1984, New Zealand
launched into a sequence of economic reforms. These reforms encompassed both
macroeconomic stabilization and structural change. Key aspects of these reforms
are summarized and an attempt is made to draw some conclusions about the
lessons to be learned from the New Zealand experience. The key features of New
Zealand's economy-wide reforms have been their comprehensive and coherent
nature, their emphasis on time consistency, their comparative-institutional analysis
of policy options, and their extensive use of contracts. For the future, the process of
balancing demands for economic efficiency versus rent-seeking and redistribution
will be complicated by the advent of the new electoral system.
Full Text:
Copyright American Economic Association Dec 1996
I. Introduction 1
A. Overview
TRIGGERED BY A constitutional and foreign exchange crisis in July 1984,
New Zealand launched into a sequence of economic reforms which David
Henderson (1995), an experienced OECD observer, has called "one of the
most notable episodes of liberalization that history has to offer." These
reforms encompassed both macroeconomic stabilization and structural
change. 2 This essay summarizes key aspects of these reforms and attempts
to draw some conclusions about the lessons to be learnt from the New
Zealand experience.
Table 1 provides some summary information on New Zealand. Year-by-year
movements in key macroeconomic indicators are illustrated in Figure 1.
The underlying data can be obtained from the authors. The Appendix
provides a comprehensive chronology of the reform measures. Figure 2
depicts the sequence of the reform program.
The early pace of the reforms reflects in good part the deep-seated nature
of the initial crisis, widespread recognition, particularly in the
business community, of the need for change, strong intellectual and
administrative support from key public sector advisers and New Zealand's
constitutional arrangements. In New Zealand a governing party with a clear
parliamentary majority can legislate its program with few constitutional
impediments. The major nonconstitutional constraints on the executive are
internal party unity, electoral support, and the disciplines imposed by
external financial flows.
Section B in this introduction briefly describes the New Zealand economy
prior to the reforms. Section C reviews the scope and sequence of the
post-1984 reforms. It also summarizes the macroeconomic outcomes to date.
Section D discusses the intellectual underpinning of the reforms.
Space precludes detailed consideration in this paper of all aspects of
the New Zealand reforms. The subsequent sections of this paper review the
main features of the reforms and comment selectively on a number of aspects
which are likely to be of international interest.
Section II reviews monetary and macroeconomic policy and the financial
market reforms. Section III discusses the transformation of the public
sector. Section IV covers the more recent labor market and social welfare
reforms. Section V looks at the effect of the program in creating a more
competitive business environment. Section VI draws together our
conclusions.
B. Pre-Reform Background
Annexed by treaty with Britain in 1840, and relying heavily on trade with
that "mother country" for its standard of living, New Zealand entered the
20th century as one of the most prosperous nations on earth. External trade
was dominated by the export of bulk meat, wool, and dairy products to the
United Kingdom and the importation of manufactured products, petroleum
fuels, and materials for local industry.
New Zealand was an early pioneer of social legislation. Following its
first general election based on one-man-one-vote in 1890 it extended the
franchise to women in 1893. It passed an Old Age Pension Act in 1898,
extended benefits to widows in 1911, and passed a Family Allowances Act
in 1926 which financially assisted parents with limited incomes. In 1938
a comprehensive system of social security was implemented by the Labour
Government.
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TABLE 1
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Figure 1
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Figure 2:
The social legislation reflected a widespread expectation that the state
could provide "cradle-to-the-grave" protection against economic
uncertainty, as for instance documented by John Condliffe (1959) and
William Sutch (1966).3 Although government expenditure ratios, in
relation to gross domestic product ("GDP") were similar to those of many
smaller OECD countries, government regulation was more
pervasive-encompassing wages, imports, foreign currency, some commodity
prices, and the methods and manner in which primary products were sold
abroad. Government ownership was also widespread in banking, insurance,
health, education, transport, energy, and utilities.
Prior to the reforms discussed herein, New Zealand's poor economic
performance is illustrated by the following statistics. In 1938, New
Zealand's gross national product (GNP) per capita was 92 percent of that
in the United States. By 1950, relatively strong U.S. growth had reduced
New Zealand's GNP per capita to around 70 percent of the U.S. level. Nearly
half a century later GNP/capita was about half that of the United States,
despite the lackluster U.S. economic growth since the mid 1970s.4
Private and public sector foreign debt combined rose from 11 percent of
GDP to 95 percent between March 1974 and June 1984. Net public debt
increased from 5 percent of GDP to 32 percent during the same period.
Annual inflation remained in double digits for the entire December 1973
to March 1983 period (and was subsequently controlled only through an
extensive wage-price freeze). The current account deficit in the balance
of payments climbed to 8.7 percent of GDP in 1984, while the government's
financial deficit amounted to 6.5 percent of GDP in 1983/84. Unemployment
stood at 4.9 percent in June 1984, up from 1.7 percent in March 1980 and
0.2 percent in March 1974. New Zealand lost its long-standing triple-A
credit rating on sovereign external debt on 30 April 1983--the first of
several downgrades.
When the prime minister called a snap election in June 1984, the likelihood
of a change in government and in the exchange rate (which was widely seen
as overvalued) saw such a rapid outflow of foreign exchange in relation
to available reserves that the Reserve Bank felt obliged to announce on
the day after the general election that it was ceasing to convert New
Zealand dollars into foreign currencies. This provoked a constitutional
crisis during the interregnum until the outgoing prime minister agreed
to implement the instructions of the incoming government.
C. The Scope and Sequence of the Post-June 1984 Reforms and Outcomes to
Date
Following the foreign exchange and constitutional crisis of July 1984,
New Zealand embarked on what evolved into one of the most comprehensive
programs of economic reform of any OECD country in recent decades.
Henderson (1996, p. 10) commented that, while other OECD countries have
carried out, in varying degrees, radical financial market reforms,
privatized and deregulated industry, liberalized international trade,
reformed public finance, and markedly deregulated labor markets, "Looking
across the whole range of economic policies, no other OECD country has
such a portfolio of liberalizing measures to show." He also expressed the
view that New Zealand is a special case which gets its distinctive
character from the range and depth of the reforms and the systematic
attempt to redefine and limit the role of the public sector.
As illustrated in Figure 2, the pace of reform was uneven, being extremely
rapid for the first two and a half years, in some areas, particularly in
the financial sector and with respect to export subsidies and taxes, but
very slow in others. For example, major labor market deregulation and cuts
in welfare benefits did not occur until 1991. Major public sector reforms
started with the StateOwned Enterprises Act in 1986 and largely ended with
the 1994 Fiscal Responsibility Act. Privatization commenced in earnest
following the 1987 general election.
However, the reform process ran into severe difficulties in early 1988
when the prime minister unilaterally aborted a major economic package
announced the previous December. Political momentum and commitment was
lost as New Zealand entered a prolonged recession after the global equity
market shock in October 1987. The new National Government which won the
1990 general election in a landslide had to deal immediately with a sharply
deteriorating fiscal position, rising unemployment, rising debt levels,
and the likelihood of a double downgrading of New Zealand's sovereign debt
rating by Standard & Poor's Corporation. It quickly cut government
expenditures, including welfare benefits, and deregulated the labor
market.
Reducing government expenditure in the midst of a deep recession was
opposed widely and strongly at the time, as is indicated by the following
extract from a letter to the editor of the New Zealand Herald by 15 academic
economists from Auckland University dated 6 June 1991:
We wish to state in the strongest possible terms our view that in the
present state of the economy, and in the midst of an international
recession, the deficit-cutting strategy is fatally flawed. It can only
depress the economy further and because of this it will be to a
considerable extent self-defeating . . .
In fact, strong real GDP and employment growth commenced from about this
time. Kunhong Kim, Buckle, and Viv Hall (1995) date the June quarter 1991
as a trough in New Zealand's business cycle for GDP. The government's
financial deficit of 2.7 percent of GDP in the year to June 1991 became
a surplus of 0.9 percent by the year ended June 1994. Real GDP in 1995
was 17 percent higher than in 1991. Unemployment fell from 10.9 percent
of the labor force in September 1991 to 6.1 percent in September 1995.
Consumer price inflation was first brought within the Reserve Bank's 0-2
percent target range in 1991. Between 1991 and the end of 1995, the Bank's
target measure of annual "underlying inflation" deviated from the 0-2
percent range in only one quarter although it has again exceeded it in
1996. New Zealand's chronic balance of payments deficits, which averaged
5.9 percent of GDP on current account between 1974 and 1988, have averaged
about 2 percent during the economic upturn of the last five years.
This sustained recovery has also been accompanied by signs (discussed in
this article) that New Zealand has yet to make the full changes necessary
if it is to achieve the levels of noninflationary growth which are likely
to be necessary to restore full employment and for it to again enjoy living
standards comparable to those of the most successful countries.
In a changing world, no reform program can be complete.
D. Intellectual Foundations
By 1984, officials and many politicians had recognized that whatever the
source of New Zealand's economic difficulties, the solution to its
critical structural problems must be sought in far-reaching structural
reform and liberalization.
At the political level, the incoming minister of finance, Roger Douglas
(1980) had advocated the case for radical change some years earlier.
Official thinking in favor of fundamental reform was evident in the advice
which Treasury and the Reserve Bank separately tendered to the incoming
government in July 1984. The Treasury's analysis of New Zealand's economic
problems and recommendations for comprehensive and radical reforms in
Economic Management (1984) were supportively critiqued by Robert Clower
(1984) but vigorously attacked for their monetary and macroeconomic
prescriptions by local academic economists (John Zanetti et al. 1984).
Official thinking was influenced by the intellectual developments
internationally, including the advice emanating from international
organizations such as the World Bank, the International Monetary Fund and
the OECD, and by dissatisfaction with the domestic experience with
activist demand management policies and detailed regulation of economic
activity more generally.
On the macroeconomic side, intellectual influences cited, for example by
Roderick Deane (1985), included the changes in thinking emanating from
the work of Edmund Phelps (1967) and Milton Friedman (1968). Such views
favored the design of stable, credible, and mutually consistent
macroeconomic policies which would assist in the efficient allocation of
resources.
Officials, most notably within the Treasury, were also intensively
following developments in microeconomic theories concerning public
choice, market competition and governance: contracting issues including
property rights, asymmetric information and transaction costs; and
institutional economics more generally.5
Reflecting all the above influences, the key intellectual principles
underlying the reforms in New Zealand might be characterized as the
pursuit of: *coherent policies on a broad front; *credibility and time
consistency; *a comparative institutional approach; and *efficient
contracting arrangements.
The coherence and breadth of the reforms evident in Figure 2 reflect the
view of the minister of finance from mid-1984 to 1988, Sir Roger Douglas
(1990), that a comprehensive approach is desirable for the most efficient
outcomes.
Time consistency received a lot of attention. From the outset in 1984,
ministers of finance and their colleagues sought to: enhance policy
credibility and reduce the risks of policy reversals by setting and
achieving targets; achieve consistency across all facets of the reform
program; and enhance market constraints on government through
deregulation and greater transparency. Counter-cyclical demand
management policies were largely eschewed during the reform period.
Fiscal policy, at the macro level was focused largely on reducing the
fiscal deficit in a progressive, credible manner, while monetary policy
was aimed at reducing inflation steadily through time.
Many of the reforms had the effect of increasing economic efficiency while
simultaneously enhancing time consistency by increasing the exposure of
politicians to the constraints imposed by external capital markets.
The comparative institutional approach provided a framework for balancing
the costs and benefits of government intervention. One outcome was a focus
on achieving, wherever possible, a competitive environment in which
markets can operate relatively free from subsequent intervention by
government. For the private sector, great emphasis has been put on
improving price signals through reducing import protection and other such
barriers to competition and attempting to reduce uncertainty through
consistent, medium-term-oriented government policies. Antitrust
policies have sought to provide some constraint on the potential for
monopoly pricing while avoiding industry-specific regulation and price
or rate of return regulation of so-called natural monopolies (Section V).6
The emphasis on the use ot contracting to address incentive and time
consistency problems is perhaps most evident in the reforms in areas in
which privatization could not be the answer. These encompass fiscal and
monetary policy (Section II) and new public sector arrangements (Section
III).
The emphasis on decentralized contracting is also evident in the 1991
Employment Contracts Act discussed in Section IV.
II. Monetary, Financial, and Fiscal Policy: Reform and Experience
A. Principles of Reform
The key theme of the macroeconomic approach of both the monetary and fiscal
authorities through the reform period has been to provide stable policies
rather than stabilization policies. The approach has also been
characterized by attention to microeconomic efficiency when designing the
macroeconomic framework. Fiscal policy was devoted to the reduction of
the deficit and monetary policy to the reduction of inflation with neither
responding significantly to the state of the economic cycle from 1984.
B. Key Reforms
(1) Financial Deregulation. Lifting interest rate controls was the first
key reform of the new government. By March 1985, all wage, price, and
interest rate controls had been removed, as had all foreign exchange
controls and all ratio controls on banks.7 The exchange rate was floated
with no subsequent foreign exchange intervention at all by government.
All these policies have been maintained up to the time of writing.
Some of these steps (such as the removal of wage and price controls) took
New Zealand to a position of orthodoxy among developed countries; in other
respects, New Zealand's financial markets moved to a more deregulated
position than in any other country. New Zealand appears to have been the
first country to remove all monetary policy (reserve) ratio controls on
banks in the postwar period.
(2) Monetary Policy Targets. The reforms clarified the target for monetary
policy. The Reserve Bank of New Zealand Act 1964 had required monetary
policy to be
directed to the maintenance and promotion of economic and social welfare
in New Zealand, having regard to the desirability of promoting the highest
level of production and trade and full employment, and of maintaining a
stable internal price level.
The multiple targets of monetary policy, plus the lack of accountability
and transparency in its implementation, meant there was no consistent
application of monetary policy toward a particular target. With monetary
policy being the most flexible of macroeconomic instruments to implement,
it could be directed at whatever short-term problem was uppermost on
government's agenda (including re-election).
The 1984 Labour Government changed the policy approach. Reflecting the
view that monetary policy had a much stronger and more predictable
medium-term impact on prices than on output, monetary policy was directed
consistently toward containing inflation. This was facilitated by a
policy of fully funding the fiscal deficit by bond tenders at market
yields.
Initially, the credibility of this approach was reduced because the 1964
Act's multiple targets meant it was quite realistic to expect the target
for policy would be changed at some point to a real sector objective. This
was particularly the case given that previous anti-inflationary monetary
policies (as occurred in 1976/77) had been overturned as the initial
depressive effects on the economy were felt. Inflation expectations
remained considerably above the Reserve Bank's own forecasts for
inflation and considerably above actual inflation outcomes. For example,
year-ahead inflation expectations9 stood at 14.1 percent and 10.0 percent
respectively in March 1987 and March 1988, whereas the actual inflation
outcomes during the two years were 7.4 percent and 4.1 percent
respectively.
Such time-inconsistency considerations led policy makers to review the
Reserve Bank of New Zealand Act. They sought to put in place a regime that
was more time consistent, so lowering the expected inflation rate and
thereby reducing the costs of the disinflationary process. The Act was
passed by Parliament in late 1989, taking effect in February 1990. The
key factors underlying the new Act are:
*A clear (single) target: Section 8 starkly states that: "The primary
function of the Bank is to formulate and implement monetary policy
directed to the economic objective of achieving and maintaining stability
in the general level of prices."
*Published specific target: In addition, the Act requires that when a new
Reserve Bank Governor is appointed (for a term of five years), the Governor
and the Minister of Finance agree on specific policy targets (consistent
with the broad price stability objective) to be contained in a published
Policy Targets Agreement (PTA).
Transparent objective-setting: Any government can override the price
stability objective (for a period of up to one year) and replace it with
some other stated economic objective but must do so publicly in advance
and table the decision in Parliament.
*Reserve Bank operational independence: The Reserve Bank is independent
of political direction in implementing monetary policy toward the
specified monetary policy objective.
*Accountability: The Reserve Bank must report publicly (including to a
Parliamentary committee) every six months with respect to its
implementation of monetary policy over the past six months and its future
intentions.
Together, these provisions allow any government to determine the
objective for monetary policy. However, because of the public nature of
this process, it may be difficult for government to change the objective
materially except in an emergency. For instance, the publicity associated
with any government attempt to use the override provision tc stimulate
the economy prior to an election would induce wholesale and retail
interest rates to rise given the unregulated capital market. Thus an
"expansionary" announcement by government may be self-defeating
politically. The opera tional independence accorded to the Reserve Bank,
coupled with its reporting requirements, reduces the likelihood that the
Bank will do anything other than follow its publicly set mandate. Giver
these institutional arrangements anc given the single clear objective for
monetary policy, the public has more certainty about the likely future
course of monetary policy than under most cen tral banking arrangements.
The first PTA (signed in February 1990) contained the explicit 0-2 percent
annual consumers' price index (CPI) inflation target for the Reserve Bank.
The target was supplemented, arguably at some cost to policy credibility,
by certain caveats to deal with situations when the target might not be
met legitimately. These caveats covered large relative price shocks which
might impact temporarily on trends in the general price level. Examples
included a major terms of trade shock, natural disaster, or substantial
changes in indirect tax rates or other government charges (especially
during the switch to a more "user-pays" approach to the provision of public
services). The Reserve Bank is also to target CPI inflation exclusive of
direct interest rate effects (which have a high weighting in the New
Zealand CPI). In practice, these caveats mean that the Reserve Bank
targets its own measure of "underlying inflation." This measure adjusts
the official "headline" CPI inflation rate for the effects of credit
charges, government charges, indirect taxes, and major commodity price
shocks.
Consistent with the Act, the PTAs have made no mention of the state of
the economic cycle. In practice, monetary policy takes real sector
influences into account to the extent that inflationary pressures react
to the state of the cycle. For this reason, monetary conditions do tend
to be more relaxed when the economy is depressed and tighter when growth
is strong-but this is purely for inflation targeting reasons, not because
it is attempting to achieve particular shortterm real sector objectives.
Figure 1 includes a chart of calendar year changes in the consumers' price
index during the reform period. The sharp lift in inflation in 1984-87
reflects variously the effects of the July 1984 20 percent devaluation,
the government moves to user-pays, the wage surge which followed the
lifting of a wage freeze, and the imposition of the 10 percent goods and
services tax (GST)-a comprehensive value added tax-on 1 October 1986.
Headline inflation rose again in 1989 when GST was lifted to 12.5 percent.
The Reserve Bank of New Zealand's measure of the underlying rate of
inflation excludes the direct effects of interest rate changes and changes
in GST on headline inflation. This measure of the underlying rate of
inflation trended down reasonably smoothly, after the burst of inflation
which followed the end of the wage and price freeze, until the 0-2 percent
p.a. inflation target was reached in December 1991.
Underlying inflation remained within the 0-2 percent band from December
1991 until the year to June 1995 when it reached 2.2 percent. It dropped
back to 2 percent in the 1995 calendar year (reflecting the Reserve Bank's
tightening of monetary conditions in 1994). Mortgage interest rate rises
through 1994 were a key contributor to pushing the all-groups consumers
price index above an annual rate of 2 percent for several quarters
beginning in December 1994. Its peak four-quarter rise was 4.6 percent
in the year to June 1995.
The lift in the underlying rate of inflation in 1995 was associated with
two successive years of 5-6 percent real GDP growth. It suggests that it
is more difficult to contain inflation during periods of strong economic
expansion and highlights the fact that the framework of the Reserve Bank
Act has yet to stand the test of a full economic cycle.
(3) Monetary Policy Implementation. While the target for monetary policy
is classically "monetarist," the implementation mechanisms in New Zealand
are eclectic. Unlike the targets, the appropriate implementation
mechanisms for monetary policy are not stated in the Act (except for the
proviso that policy be implemented "efficiently").
Monetary policy implementation methods have evolved through the reform
period. This reflects two interrelated factors. First, the deregulation
of the financial system meant that previous policy instruments (such as
ratio controls and credit restrictions) were no longer available. Second,
the deregulation upset the reliability of historical relationships
between different variables as policy guides. In particular, the
deregulation resulted in huge re-intermediation as money from previously
less regulated sectors flowed back to the banking sector. This contributed
to rapid growth in the monetary aggregates despite the intended adoption
of a tight monetary policy.
Because of these information uncertainties, the monetary authorities were
to a large extent "flying blind" in the early stages of the reforms. For
example, in September 1985: private sector credit and M3 had increased
31 percent and 27 percent respectively during the previous 12 months; the
real interest rate10 stood at 6.6 percent, compared with 2.4 percent a
year earlier; while the real exchange rate11 had appreciated 19 percent
during the year. The monetary aggregates were indicating that policy was
lax, while the interest and exchange rate data and demand patterns were
indicating that policy was particularly tight.
These informational uncertainties made policy implementation difficult,
resulting in some volatility in monetary conditions during the reform
period to 1991, as Figure 3 illustrates. We return to the significance
of the implementation of monetary policy over this period when we consider
sequencing and labor market issues later in the paper.
The Reserve Bank does not adopt any explicit monetary (or interest rate)
target, having found no stable relationship between any aggregate (or
interest rate) and either the price level or nominal GDP. Instead it
targets inflation directly and translates this into its monetary policy
operations using its forecasting framework (Grimes and Jason Wong 1994).
Specifically, it forecasts inflation for the subsequent two to three years
on the basis of its forecasts of domestic costs, profit margins, and
overseas price influences.
Changes in the exchange rate quickly affect consumer prices because
exports and imports each constitute about 30 percent of GDP. Given its
influence, the Reserve Bank adopts an unpublished target band for the
trade-weighted exchange rate (TWI) which is designed to ensure that
aggregate inflation stays within the 0-2 percent range. The exchange rate
band (which allows for approximately 6 percent variation in the exchange
rate) does not constitute a target in itself, but instead varies according
to other inflationary pressures. Because these pressures do not change
quickly, the exchange rate band also does not change quickly so resulting
in a comparatively stable exchange rate. This is in spite of the absence
of any official foreign exchange intervention, a unique feature of the
New Zealand monetary policy approach.
Another unique feature of the New Zealand approach is that the Reserve
Bank does not directly set any interest rate, although it does influence
shortterm rates in order to meet its inflation target. All its own interest
rates-including the discount rate and the (positive, but below-market)
rate which it pays on bank reserves-are set as a fixed margin against
prevailing cash market interest rates. This enables market interest rates
to fluctuate to reflect the demand and supply for wholesale funds, so
providing a signal of changes in liquidity.
In order to influence monetary conditions, the Reserve Bank adopts a
quantity target for "settlement cash" ( a form of bank reserves) and
changes the target if it wishes to influence rates. It can also change
the margin that determines the discount rate relative to cash market
interest rates. Reflecting the credibility gained by the new system,
market participants react to new information which affects the
probabilities which they put on likely future Bank actions under current
market prices. If, for example, the Reserve Bank makes a surprise
statement expressing increased concern about the future inflation outlook,
markets are likely to increase short-term wholesale market interest rates
immediately and possibly the trade-weighted exchange rate. This
market-led setting of interest rates obviates the need for frequent
explicit Reserve Bank instrument shifts.
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Figure
(4) Fiscal Policy. From 1984, government expenditure and revenue policies
set out to reduce the very large initial fiscal deficits, and latterly
to repay debt. After a decade of effort, a central government fiscal
surplus finally was achieved on an accrual accounting (GAAP) basis in the
1993/94 financial year. Early in the reforms, deficit reductions were
achieved largely by revenue increases. Current expenditure (SNA basis)
swollen by interest payments of debt and rising unemployment peaked at
39.4 percent of GDP in the year to June 1991, up from 36.3 percent of GDP
in 1983/84. The persistent deficits were only finally converted into
surpluses after the new National Government's expenditure restrictions
and strong economic growth reduced government expenditure as a proportion
of GDP.
On the revenue side, tax reforms were designed to improve efficiency while
raising more revenue. Broadening the tax base allowed marginal income tax
rates to be reduced for many taxpayers while raising average tax rates.
Top marginal personal income tax rates were halved through the period from
66 percent to 33 percent, and personal tax scales were simplified to just
two statutory tax rates. GST was introduced in 1986 to replace a myriad
of sales and other indirect taxes which previously were levied at
different rates on different items. With the exception of rental houses
and some financial transactions (which are difficult to include
administratively), no significant categories of goods or services are
exempt from GST and all items are taxed at the same rate. The tax was levied
initially at 10 percent, enabling a reduction in income tax rates, and
in 1989 was increased to 12.5 percent for revenue reasons.
These changes to income and indirect taxes reflect a policy approach
favoring broad based, low rate taxes in order to lessen dead-weight losses
associated with high marginal tax rates. In designing the GST two factors
militated against discriminatory Frank Ramsey (1927) taxes. First, the
information necessary to implement appropriate tax rates on different
items could not feasibly be gathered. Second, implementation of different
tax rates would open up a major avenue for ongoing unproductive industry
lobbying regarding appropriate tax rates.
Significant changes in the composition of government spending occurred
during the reform period. One of the biggest falls was in direct assistance
to industry. This reflected the government's stance of neutrality toward
industry (see Section V). Even so, government noninterest expenditure,
after an initial fall, trended upwards through to 1991. Between 1983/84
and 1990/91, government expenditure on social services (including social
welfare payments) increased from 11.2 percent of GDP to 14.4 percent,
government education expenditures increased from 4.6 percent to 6.2
percent, while government health expenditures increased from 5.0 percent
to 5.5 percent. Against these trends, the government worked hard to cut
spending in the remaining areas, until it announced an expansionary budget
prior to losing the 1990 general election.
The incoming National Government set about explicitly reducing the size
of government, partly through asset sales and partly by reducing the
social assistance role of government. In particular, it turned further
toward greater targeting of social assistance. By 1993/94, the share of
GDP being spent by government on social services, education, and health
had fallen to 12.6 percent, 5.5 percent, and 4.9 percent respectively.
Its total (non debt-related) expenditures correspondingly dropped from
35.8 percent of GDP in 1990/91 to 30.8 percent in 1993/94.12
The Fiscal Responsibility Act, passed in June 1994, sought to put fiscal
policy on a clearer contractual basis in order to increase its
transparency and reduce uncertainty about future fiscal management. In
this respect it complements the Reserve Bank Act in relation to monetary
policy.
As summarized by the Treasury (1995, pp. 8-9) the Act requires governments
to: *"follow a legislated set of principles of responsible fiscal
management, and publicly assess their fiscal policies against these
principles. Governments may temporarily depart from the principles but
must do so publicly, explain why they have departed, and reveal how and
when they intend to conform to the principles";
*"publish a `Budget Policy Statement' well before the annual Budget
containing their strategic priorities for the upcoming Budget, their
shortterm fiscal intentions, and long-term intentions, and long-term
fiscal objectives. A `Fiscal Strategy Report' that compares Budget
intentions and objectives with those published in the most recent Budget
Policy Statement is to be published on Budget night";
*"fully disclose the impact of their fiscal decisions over a three-year
forecasting period in regular `economic and fiscal updates' ";
*"require the Treasury to prepare forecasts based on its best professional
judgment about the impact of policy, rather than relying on the judgment
of the Government. It also requires the Minister to communicate all of
the Government's policy decisions to the Treasury so that the forecasts
are comprehensive"; and "refer all reports required under the Act to a
parliamentary select committee."
The five legislated "principles of responsible fiscal management"
comprise:
*"reducing total Crown debt to prudent levels, so as to provide a buffer
against future adverse events, by achieving operating surpluses every
year until prudent levels of debt have been achieved";
*"maintaining total Crown debt at prudent levels by ensuring that, on
average, over a reasonable period of time, total operating expenses do
not exceed total operating revenues". * "achieving levels of Crown net
worth that provide a buffer against adverse future events";
*"managing prudently the risks facing the Crown"; and
*"pursuing policies that are consistent with a reasonable degree of
predictability about the level and stability of tax rates for future
years."
Together these requirements do not bind government to a particular fiscal
policy, but departures from these principles must be accompanied by a
statement of policies showing how prudent management is to be maintained.
They force government to be more open with regard to their actual shortand longterm objectives, so making it more difficult to depart
substantially from a stable policy path.
The shift to accrual (GAAP) accounting in 1994 completed a sequence of
novel reforms likely to improve the quality of government expenditure and
constrain future governments by bringing much greater transparency into
government accounting (see Section III).
C. Sequencing Issues and Macroeconomic Outcomes
Macroeconomic reforms proceeded simultaneously with economic
liberalization. In respect of the latter: financial market liberalization
preceded trade account liberalization (contrary to the widespread
agreement in favor of the alternative ordering reported by Sebastian
Edwards, 1992, but in accord with the dissenting views he reports of Deepak
Lal 1986 and Friedrich Sell 1988); financial markets and the capital
account were liberalized jointly and before goods markets (contrary to
the views reported by Edwards 1992, p. 11); and labor market reform was
long delayed (contrary to the recommendations of Ronald McKinnon, 1982,
and Donald Mathieson, 1986, that liberalization should proceed initially
with labor market reform and a program of fiscal restraint).
New Zealand's liberalization program does however closely resemble what
Peter Murrell (1995, p. 164) refers to as the:
standard reform prescription for an ex-socialist country [which] is to
proceed as fast as possible on macroeconomic stabilization, the
liberalization of domestic trade and prices, current account
convertibility, privatization and the creation of a social safety net,
while simultaneously creating the legal framework for a market economy.
In New Zealand's case the legal framework was already in place, but
privatization was delayed by a pre-election political commitment not to
privatize in the 1984-87 period and by the need to prepare the regulatory
and institutional environment for privatization.
A key focus of many writers has been on the need to achieve an adjustment
path for the real exchange rate which avoids destabilizing appreciations
(resulting from disinflationary policies) or depreciations (arising from
loss of credibility and tariff reductions). Edwards (1992, pp. 8, 21),
in particular, has emphasized the importance of policy credibility in
sequencing.
While New Zealand's structural reform program has so far passed Michael
Michaely's (1987) definition of a successful trade liberalization as "one
that is sustained through time" (as reported by Edwards 1992, p. 8), a
strong case can be made that New Zealand's program fell short of the ideal.
New Zealand's inability to achieve early credibility for its
disinflationary policies and its inability to free up labor markets much
earlier undoubtedly cost it heavily. A 22 percent lift in nominal wage
rates during the year to September 1986 resulted in a 14 percent rise in
real wages relative to producer prices for outputs. This rise exacerbated
the problems faced by industry arising from reducing import protection
and fiscal assistance for industry, greater recourse to userpays, high
real interest rates (Figure 3), and higher average tax rates.
Significant real exchange rate pressures occurred between 1985 and 1989.
These reflected substantial wage increases and the difficulties noted
above in keeping monetary conditions consistently firm throughout this
period. These pressures aggravated difficulties for the tradeables
sector-as predicted in the sequencing literature.
During the period from the third quarter 1984 to the third quarter 1990,
the real exchange rate was on average 19 percent above its 18 July 20
percent 1984 devaluation level, but ranged up to 34 percent above this
level. The standard deviation of the quarterly logarithmic changes in the
real exchange rate was 4.1 percent during this period. In contrast, from
the third quarter 1990 to the third quarter 1995, the real exchange rate
has moved in a 15 percent range around an average level which is only 13
percent above the post-July 1984 devaluation level. The standard
deviation of quarterly logarithmic changes in the real exchange rate
during this period has been 2.0 percent. The better performance for
economic growth since 1990 is consistent with Edward's finding that real
exchange rate volatility adversely affects growth (Edwards 1992, p. 4).
The short-run exchange rate dynamics during this period are consistent
with a monetary policy view of exchange rate determination. Monetary
policy tightenings, exhibited through a rise in nominal and real interest
rates, caused incipient capital inflows and hence nominal exchange rate
appreciation.13
Manufacturing production was volatile during the reform period and
appeared to be affected by volatility in real wage rates, interest rates,
and the real exchange rate. For example, the correlation coefficients
between manufacturing output and each of the real wage, real interest rate,
and the real exchange rate in the September 1984 to September 1989 period
(using quarterly data) were -0.51, -0.67, and -0.71 respectively. The
equivalent correlation coefficients in the September 1989 to September
1994 period were -0.76, -0.50, and -0.33 respectively. These correlations
support the view that each of these factors impacted significantly on the
traded goods sector through the reform period.
This evidence, combined with the theoretical insights, suggests that,
abstracting from political concerns and time constraints, the chosen
sequencing process in New Zealand was suboptimal. A faster reduction in
the fiscal deficit combined with a more flexible labor market arguably
could have induced lower real interest and exchange rates and lower real
wages through the reform period and so have reduced adjustment costs.
Officials recognized the desirability of labor market liberalization at
an early stage. However, a Labour government could not realistically
deregulate the labor market or reduce welfare spending as readily as a
National government. Instead, it started the deregulation process with
the pro-reform financial sector. These reforms were relatively
uncontroversial and were supported by the groups most affected. This set
the scene for further deregulation in more difficult areas. By tackling
many areas quickly there was no stable coalition formed to oppose the
reforms: for instance farmers, who had their subsidies withdrawn almost
immediately, strongly supported faster tariff reform; and farmers and
manufacturers both then pressured government to reduce expenditure so as
to reduce pressure on real interest and exchange rates. Eventually, this
led to sufficient political and economic pressure to enable deregulation
of the labor market and for the welfare benefit cuts to take place.
The New Zealand sequencing program can therefore be characterized as one
in which a series of disequilibria were established which justified the
addition of further deregulatory moves to the government's agenda. The
fact that these moves were undertaken in a relatively compressed
time-frame meant that the deregulatory momentum was not lost.
Partly reflecting the difficulties arising from sequencing issues, growth
outcomes for New Zealand have not been as consistently successful as the
inflation and fiscal surplus outcomes. For the June 1984 to June 1995
period, GDP grew at a compound rate of 1.8 percent p.a., compared with
a 4.5 percent annual growth rate over the June 1991 to June 1995 years
(following the labor market liberalization).
Per capita growth (i.e., the increase in the ratio of GDP to the population
of working age) proceeded at an average rate of 0.37 percent p.a. over
the 1967 to 1984 period. The situation worsened over the first seven years
of the reform period with per capita growth of just 0.04 percent p.a. Per
capita GDP growth of 2.61 percent p.a. between June 1991 and June 1995
changed the situation, producing a 0.97 percent p.a. compound per capita
GDP growth rate over the eleven years to Tune 1995.
This was almost treble the per capita growth rate of the previous 17 years
leaving the level of per capita GDP 6.8 percent higher in June 1995 than
it would have been had the pre-1984 growth rate continued. Further, this
improvement occurred simultaneously with a major reduction in the
overseas debt to GDP ratio (78 percent in June 1995, compared with 95
percent in June 1984 and approximately 20 percent in June 1967). This means
that outcomes through the reform period are likely to be more sustainable
than were pre-reform trends.
Also significant, is the fact that output grew especially strongly toward
the end of the period after the labor market and fiscal reforms had been
fully implemented. This outcome supports the importance attached to these
reforms in the optimum sequencing literature. The New Zealand experience
is therefore consistent with the view that, if it is feasible to do so,
these reforms should be implemented early in a reform process. However
the broadly positive macroeconomic outcomes also suggest that if these
particular reforms cannot be carried out early in a reform period, other
reforms should proceed regardless. Difficulties in reform in some areas
should not be used to procrastinate over other reforms that will be
effective in the medium term.
III. The Public Sector
A. Introduction
The need to reduce the fiscal deficit, projected by the Treasury to be
likely to be between 6.2 and 7.6 percent of GDP for 1984/85, and concerns
about the productivity of government departments14 motivated reforms
aimed at getting better value from government spending.
This section focuses on reforms to government departments. Changes in
social assistance programs are discussed in Section IV. Changes in health
and education are far from complete and are dealt with only briefly here.
As discussed in more detail by Evans et al. (forthcoming), measurement
and asymmetric information problems are probably at their most acute in
these two sectors. Policies in education and health have incorporated the
principles of organizational and managerial devolution and improved
accountability. The separation of funding and provision has been the
central objective of the health reforms. Nevertheless, the changes to date
have been fraught with difficulties and the political sensitivity of these
two areas continues to make change a slow process in both education and
health.
Trading departments were converted into State Owned Enterprises (SOEs)
many of which have since been sold. Sharper lines of accountability,
contracting, more flexible employment conditions, and accrual accounting
were imposed on remaining departments. Departments were forced to meet
percentage reductions in their allocated funds.
Public sector employment fell sharply reflecting employment changes in
SOEs, privatization, and reduced employment in remaining departments.
Statistics New Zealand's Quarterly Employment Survey data indicates that
in February 198915 there were 83,700 employees (full-time-equivalents)
in the central government trading category, which includes SOEs. By
February 1995 this had fallen to 21,600, largely reflecting SOE work force
reductions and privatizations. In the same period central government
nontrading full-time employment fell two percent from 206,400 to 202,800.
Of these, approximately 26 percent were in the public health
classification in February 1989, and 21 percent in February 1995. The
percentage in education rose from 31 to 37 over this period.l6 In
consequence, during this period the core public service, as represented
by nontrading government employment, excluding education and health, fell
by 5 percent. Unfortunately, the trading/ nontrading distinction is not
available before 1989.
Public sector reforms drew on contract theories and institutional
economics and the experience of the U.K. Andrew Carroll (1991) reasons
that, in retrospect, the split into government department
and SOE can be justified on the grounds of principal-agent theory that
treats the multi-objective organizations as the multi-task technology of
Bengt Holmstrom and Paul Milgrom (1991). He argues that the key
ingredients to determining the appropriate organizational structure and
nature of incentives and contractual arrangements, are the variety and
measurability of the outputs. The reform of the public sector reflected
this view to some degree: the production of contestable goods and services
was treated separately from the provision of policy advice, and the
administration of programs. This separation enabled broadly different
organizational structures and operating environments to be provided for
the trading and nontrading activities of government in 1984.
The remainder of this section reflects this separation of tasks;
Subsection B discusses the SOE reforms, and Subsection C looks at the
remaining government departments.
B. Department to SOE
Converting a state department into a corporate entity, followed in many
cases by privatization, has been common worldwide during the past decade.
If there is any distinction in the New Zealand case it is that any legal
entry barriers favoring SOEs were removed and they were subjected to the
same light regulation (see Section V), antitrust, tax, and company law
as private enterprise.
Prior to 1984 government trading enterprises accounted for over 12 percent
of GDP and covered a huge range of activities-from printing services and
agricultural produce, to banking and telecommunications. The objectives
of the supplying entities were unclear; social objectives were not
delineated carefully from trading objectives and some, such as the Post
Office which delivered mail, telecommunications, and banking services,
acted as provider and regulator. Departments were constrained in their
operation by public service terms and conditions of employment and
operating systems. Also, prices and choice of inputs and outputs were very
much determined by government. Departments were thus vulnerable to direct
political pressure, and yet political constraints were not applied in a
transparent way.
The intention to improve performance in the provision of public sector
goods and services was signalled at the onset of the reforms when in the
8 November 1984 budget it was announced that there would be a "user pays"
policy. There followed a series of government initiatives (see Jennings
and Cameron 1987, pp. 124-27, for a detailed chronology). The government
announced a set of reform principles for trading operations which are
encapsulated in the SOE Act of 1986. Each SOE was to function as a business.
Management was to have standard commercial objectives, subject to the
caveat that a Statement of Corporate Intent had to be accepted by the
government each year. It would set corporate policy for the ensuing two
years and other matters to do with facilitating monitoring. The Act
provided for a Board of Directors accountable to the minister of finance,
and another minister who would hold the shares. Employees of an SOE are
not covered by public service terms and conditions of employment. By 1987
there were 14 SOEs, and by 1992 27 had been formed. Crownowned entities
were corporatized to varying extents, and approximately an additional 30
had some corporate form.
Because SOEs are subject to the same competition laws facing private
enterprises and have no contracts giving preferential access to
government procurement or finance, an SOE is on a similar footing to
privately owned firms. But they differ in a number of respects.
These include their untested limited liability status, the reduced
monitoring resulting from nontransferable shares, and the SOE's ongoing
relationship to government, albeit much weaker than that of a government
department. These impediments to efficiency provided arguments for
privatization.
Privatizations commenced in 1987. The SOEs were generally sold by tender.
By 1992 SOE and other asset sales yielded NZ$11 billion which was one fifth
of New Zealand's total overseas debt (Ian Duncan and Alan Bollard 1992,
p. 172). Approximately 15 SOEs remain.
Evidence about the performance of the remaining SOEs and the privatized
SOEs is emerging slowly. The SOEs did act commercially and they eschewed
noncommercial activities. They typically reduced their work forces and
priced more commercially. The 14 SOEs studied by Duncan and Bollard (1992),
since their inception in 1986/87, reduced their work force by 40,000 by
1992; indeed, numbers employed in the central government trading
classification, which included SOEs, fell from 83,700 in February 1989
to 39,400 in 1992.17 Duncan and Bollard report that by 1989 the SOEs were
making a significant contribution to government revenue. In the year to
June 1995 when the Financial Statements of the Government of New Zealand
first published these data, 13 of the 16 existing SOEs made operating
surpluses. The surplus on the 16 SOEs represented 8.4 percent of their
June 1995 equity. This marks a dramatic change from the situation in 1987
when the newly created SOEs were generally making losses (Richard Prebble
1996, pp. 3-23).
Duncan and Bollard also suggest that there has been considerable variation
in performance, some of which is attributable to entity-specific factors
outside the SOE model. They report that productivity indicators improved
significantly in all but one or two of the eight SOEs they looked at in
some detail, and that this was generally accompanied by improved
commercial performance.
The in-depth studies of the telecommunications company, Telecom New
Zealand Limited (Telecom), by David Boles de Boer and Evans (1996) and
the Electricity Corporation of New Zealand (ECNZ) by Barry Spicer et al.
(1991) support the conclusions of Duncan and Bollard that these SOEs
achieved major gains in productivity over the departmental structure, and
that they performed well commercially.
The change in organizational structure and the prospect of privatization
subject to full competitive pressures were not the only factors that
contributed to the improved performance in the transition from department
to (privatized) SOE. Prebble (1996, pp. 58-62) points to the importance
of the selection of the CEO in stimulating managerial and culture changes
which would promote efficiency over a reasonable period of time.
C. New Departments of State The second prong to public sector reform was
provided jointly by the State Sector Act of 1988 and the Public Finance
Act of 1989 and its amendment in 1992.ls The State Sector Act set up chief
executives (CEOs) as the employing authorities for their departments, it
made the executives directly accountable to their Ministers, and required
the State Services Commission (essentially a state department) to report
reviews of the performance of CEOs to Ministers.19
The Public Finance Act provides the basis for the assessment of CEOs. It
draws a distinction between outputs and outcomes-the latter are defined
to be the consequences of the outputs-making the CEOs responsible for
outputs. Outcomes are subject to much less control by the CEO, and that
person is not held accountable for them. Ministers contract with their
CEOs for specific outputs, who now have much more decision-making autonomy
than formerly. All persons with a managerial function in the public
service are on term contracts.
The CEOs are not political appointees but are chosen by the State Services
Commissioner. With the exception of the appointment of the Government
Statistician, the government does retain the right to reject CEOs
nominated by the Commission. The Commission also has the responsibility
of negotiating the conditions of appointment of groups of state sector
employees, such as teachers, which are not employed by institutions to
which management and funding is devolved.
The revamped public service is based on devolution of responsibility and
contracts. Ministers contract for outputs from their departments and for
outputs from nondepartmental sources. The performances of departments and
certain other Crown entities are scrutinized by the ministers of those
departments and committees of Parliament. The Parliamentary committees
take advice from the Audit Office which monitors departmental
expenditures against contractual arrangements for outputs. The Treasury
can be involved through the Minister of Finance, at the time contracts
with departments or Crown entities are drawn up or modified.
The Public Finance Act 1989 enhanced the flow of information to facilitate
tight management of the revamped departments. The introduction of accrual
accounting marked a major departure from the cash-based accounting
systems used by governments worldwide. Every department office and agency
is now required to submit a budget that includes a statement of the
financial position at balance date; an operating statement reflecting
revenue and expenditure for the year; a statement of cash flows; a
statement of objectives, specifying outputs to be produced and financial
performance to be achieved; and a statement of service performance,
reporting on outputs produced. These can be compared with intended outputs
as specified in the budget documents, so that Parliament can obtain a
better view of the performance of the organization. The consolidated
government accounts must also include a statement of borrowings, a
statement of emergency expenditure or costs incurred, and a statement of
trust money held. These measures have made the fiscal position of the
government, based on contractual and realized obligations, much more
transparent. They have thereby made a significant contribution to the
credibility of the Fiscal Responsibility Act of 1992.
Following the principles represented in the SOE Act, the State Sector and
Public Finance Acts were designed to make government departments and
ministries more stand-alone and flexible in their operation, with tightly
specified goals and hence improved accountability. Departments can
implement asset transactions, under a value limit, without requiring
approval, and for larger sums they have explicit capital injections rather
than approvals for specific purchases. They enjoy reduced Treasury
involvement in decision making. In 1991 capital charges on departmental
fixed assets were introduced to promote efficient use of those assets.
Departments which have saleable goods and services, such as Statistics
New Zealand, have to generate revenue exceeding some limit expressed as
a percentage of expenditure. Failure to meet the limit, unless expressly
negated by negotiation, carries with it the obligation to produce the
amount of the shortfall, and accumulated interest payments, in subsequent
years. Any department that has a funding shortfall can get additional
funds only if that department's Minister gains Parliamentary approval.
Two departments illustrate the changes. In 1984 the Ministry of
Agriculture provided policy advice, agricultural research, agricultural
extension services, monitored animal and plant health, and provided meat
hygiene inspection services. In 1996 its services are policy advice and
management of animal and plant health monitoring and meat hygiene
inspection services funded by levies. Agricultural research is now
carried out by other organizations, contesting public funds allocated for
research across a wide variety of areas. The muchreduced advisory services
unit was sold recently.
John Martin (1995) reports that the Ministry of Transport has been reduced
from an organization of 5,000 staff in 1986 to one of 50 in 1995.20 It
is now a small ministry with responsibility for policy and the management
of the Minister's contracts with Crown entities. Its former regulatory
and delivery functions are carried out by statutory bodies under contract
to the Minister of Transport.
Reflecting these reforms and decisions about priorities in the light of
better information, expenditure on departmental outputs has fallen from
27 percent of government expenditure in 1989/90 when government accounts
first measured this category, to 15 per cent in 1994/95. Departments are
now focused on output contracting, monitoring, and policy analysis,
although some of the last is also contracted out.
Concern to contain the politicization of the public service and the
increased autonomy of departments led to greater scrutiny through the
Parliamentary committee system of contractual arrangements and delivery.
There is no doubt that departments are now more focused on achieving
specified outputs, the specification and achievement of these outputs are
now more transparent and are scrutinized by Parliament. Departmental
actions are more responsive to government policy and the implementation
of this policy is more transparent.
The key determinant of the performance of the core public service is now
the effectiveness of contracting, and accountability. Recent events
suggest that improvements can be made on both counts. The Auditor General
(1994) recommends that both contractual arrangements and monitoring of
nondepartmental outputs be improved in a number of ministries. The related
issue of accountability is manifested by Ministers having some incentives
to specify imprecise contracts for outputs. In addition, issues of funding
for contracted outputs and accountability have arisen in a debate about
who is ultimately responsible for the 1995 collapse-with loss of life-of
a viewing platform managed by the Department of Conservation.
Departments now compete for staff. CEOs no longer enjoy security of tenure.
Although 33 existing departmental heads were appointed as chief
executives on 1 April 1988 when the new regime came into effect, only seven
of these remained in 1993. Appointment is not now restricted to state
sector employees and a third have come from outside the core public sector
(see Jonathan Boston 1993). It is becoming unusual for internal candidates
to become CEOs. In this connection it is noteworthy that rates of pay have
not kept up with CEOs of the private sector. There was little change in
the demographic characteristics of the CEOs by 1993.
In its review of the state sector reforms, the Steering Group (1991) drew
the key conclusion that the reforms had significantly improved
departmental accountability with ministers and improved reporting to
Parliament. The autonomy of the departments and ministries was supported
by the CEOs but there was some concern among ministers of the political
risk associated with devolved decision making. The Steering Group
reported some problems with the measurement and specification of outputs
and therefore the monitoring of results.
IV. Social Assistance and Labor Market Policies
A. Social Assistance Structures
New Zealand's 1938 social welfare legislation aimed to provide a basic,
social safety net geared toward "banishing distress and want" among
beneficiaries. In 1972, the government-appointed Royal Commission on
Social Security advanced the much more ambitious principle that the
welfare state should ensure "everyone is able to enjoy a standard of living
much like that of the rest of the community and thus is able to feel a
sense of participation and belonging to the community."
The rapid escalation of social welfare expenditure which followed saw
government social welfare expenditure rise from 5.9 percent of GDP in
1971/72 to 11.6 percent by 1983/84. A major contributor to this expansion
was the introduction in 1977 of a generous National Superannuation scheme,
which provided state-funded superannuation to all people aged at least
60 years.
The initial six years of the reform period saw few substantive changes
to this trend of greater welfare expenditure by government. A notable (but
isolated) move in the direction of withdrawal of universal benefits was
the imposition in 1985 of a 25 percent surtax on superannuitants' other
income. Overall, government social welfare expenditure rose further, to
14.0 percent of GDP by 1990/91.
In 1990/91, the National Government cut benefits and targeted assistance
more tightly. Family benefit (a universal payment made to parents of all
children) was abolished and significant user charges were introduced
(other than for low income earners) for health and other services. Most
social benefit rates were reduced by approximately 9 percent both to
reduce overall government expenditure and to encourage those on benefits
to seek work more actively. The effect of these cuts was to reduce
government welfare expenditure to 12.9 percent of GDP by 1993/94.
However these welfare reforms left in place high effective marginal tax
rates for some groups of beneficiaries. Having achieved a strong fiscal
position, government announced a major tax-reduction package in February
1996. Beneficiaries who previously faced 98 percent effective marginal
tax rates when entering part-time work will have these marginal rates cut
to 30 percent over a significant income range.
B. Labor Market Regulation
It was not until 1991 that significant labor market deregulation took
place. New Zealand's history of centralized labor market structures dated
from the adoption of compulsory arbitration in 1894, and of compulsory
union membership (for most groups of workers) in 1936. For most of the
period from the mid-1930s to the late 1970s, centralized wage orders were
determined by an Arbitration Court.
As a first step toward deregulation, centralized wage determinations
(orders) ceased in 1979; nevertheless centralized union and employer
control of occupational and industry wage settlements remained. A second
deregulatory step occurred in 1983 with the introduction of voluntary
unionism.
The newly elected (and union-backed) Labour Government reintroduced
compulsory unionism in 1985. Between 1987 and 1990 it made some other ad
hoc changes to labor market structures including outlawing unions of less
than 1,000 members, introducing some limited union contestability for
groups of members and limited provisions for initiating
enterprise-specific negotiations. These reforms however were piecemeal.
Major labor market deregulation became possible only after National
convincingly won the 1990 general election. The long title of the 1991
Employment Contract Act (the ECA) stated that its intention was to promote
an efficient labor market and inter alia provide for freedom of
association. It has replaced centralized bargaining structures by
decentralized enterprise bargaining, bringing the labor market
institutions closer to the U.S. model than the European model hitherto
adopted.
Henderson (1996, p. 10) states that: "New Zealand is one of only two
countries in the [OECD] group, the other being the United Kingdom, which
have so far brought in radical reforms" in the labor market. In fact, it
is not the new structure that is "radical," but rather that the reforms
have been comprehensive in comparison with those of other countries which
were based on the principle of centralized bargaining.
Under the ECA, each employee can choose to negotiate either an individual
employment contract or to be bound by a collective contract. Each employer
can choose to negotiate an individual employment contract with any
employee or a collective contract. It is for the parties themselves to
determine whether contracts are individual or collective.
In negotiating employment contracts, each employee and employer can
freely choose his or her own bargaining agent. This can be themselves,
a union, or any other agent (e.g., lawyer or labor relations specialist).
The ECA gives no special status to unions, but ensures that each employee's
bargaining agent has the right of access to the premises in which the
employee is employed. No agent (including a union) can bargain on behalf
of any employee or employer unless he or she has written permission to
do so. Conversely, once permission is granted the employee or employer
must bargain with the specified agent. There is no "good faith" bargaining
requirement.
No contract is permitted which requires any person to join, not join, or
leave a union. No contract is permitted which would create any preference
for or against members of unions-union-only and union-free workplace
contracts are thereby prohibited. No provision in the ECA can be
contracted out of.
The ECA also lays down provisions for the settlement of personal
grievances and of disputes of right. Unjustifiable dismissal is
explicitly determined to be a personal grievance issue under the ECA.
Charles Baird (1996, p. 7) expresses the view that these features, in
conjunction with the prohibition of contracting out, "completely abolish
the at-will employment doctrine in New Zealand." He argues that the ECA
is more restrictive on freedom of association in this respect than the
situation prior to 1991 in which it was still possible for individual,
nonunion workers to be employed on an atwill basis.
Other legislation imposes minimum holiday entitlements, equal pay
requirements for males and females (although there are no "pay equity"
or "comparable worth" provisions), and a statutory minimum wage.
Initially, the latter applied only to adults, but the minimum wage was
extended to include youths in 1994. In March 1995, the adult and youth
(1619 year olds) minimum wage rates stood at 41 percent and 24 percent
respectively of the average ordinary-time wage. Apart from the
restrictions imposed in the ECA and through these minimum entitlements,
all matters concerning pay and conditions are open for negotiation in
employment contracts.
An important further aspect in which employment law differs from other
areas of contract law is in the resolution of disputes. As well as
specifying default provisions for dispute resolution, the Act provides
for a special Employment Court (replacing the earlier Labour Court) to
resolve disputes. The Employment Court can, and does, impose penalties
on parties that have broken employment laws or which do not comply with
its rulings.
While parties normally resolve disputes through the lower level
Employment Tribunal or through arbitration, any dispute "founded on
employment contract" that escalates to the court level must be tried
the Employment Court. This court is separate from the High Court used
settle nonlabor contract issues, although in both cases disputes can
appealed to the Appeal Court.
an
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to
be
The ECA also provided that the personnel of the previous Labour Court
constituted the initial personnel of the Employment Court. A number of
Employment Court decisions have been controversial, with the Court
placing great emphasis on procedural correctness in dismissals and on
"fairness," even when the dismissed worker has been manifestly negligent
or incompetent. The emphasis on fairness has resulted in such outcomes
as the Court finding that an employer must pay compensation to a redundant
worker even though neither the legislation nor the particular contract
has specified any redundancy requirements. Further the Court has found
that an employer who does not re-employ an employee after the expiration
of an explicitly fixed term contract when the position is to be refilled
may be in breach of contract, so giving rise to a personal grievance case
by the employee (Colin Howard 1995).
The findings of the Employment Court indicate that the attitude of the
Employment Court judiciary has not moved into line with the shift in
emphasis of the legislation toward a more flexible labor market
environment, and so has partially undermined the intentions lying behind
the ECA.
C. Labor Market Outcomes
The key labor market and social assistance changes occurred in late 1990
and early 1991 when unemployment was very high and growing and the economy
was in recession. Contrary to the expectations of many of those opposed
to these reforms, real GDP and total employment grew very strongly after
1991, although it is difficult to say to what degree the reforms
contributed to this outcome.
Aggregate Labor Market Outcomes. A dominant feature of the 1985-1991
period was the sharp lift in real and nominal wage rates as New Zealand
extricated itself from the pre-reform wage and price freeze. Aggregate
wage rates, which had averaged 5.7 percent annualized increases in the
second and third quarters of 1985, rose by 19.9 percent in the year to
September 1986. Real wage rates rose 11.8 percent in this year. This
increase in real labor costs was unwound only partially during the
subsequent eight years. By September 1991, real wages had fallen only 0.5
percent compared with their peak September 1986 level.
Employment and unemployment were affected further by an employment shake
out in the state sector and in manufacturing as import barriers were
reduced. In the six years to September 1991 employment fell by 5.6 percent,
a fall unprecedented in New Zealand since the 1930s depression, and the
unemployment rate rose from 3.8 percent to 10.9 percent.
Following the passage of the ECA, employment grew by 14 percent in the
four years to December 1995 to be 6 percent above its previous peak in
March 1987. The unemployment rate fell from 10.9 percent in September 1991
to 6.1 percent in December 1995. These figures provide some a priori
evidence that the shift to the deregulated labor market under the ECA has
been beneficial for labor market outcomes, although it is difficult to
disentangle the effects solely due to the ECA as opposed to those due to
(possibly related) macroeconomic factors.
Wolfgang Kasper (1996) has surveyed two pieces of academic research into
the effects of the ECA. He reports that a study by Tim Maloney (1994)
attributed one percentage point of the subsequent 4.4 percent growth in
employment to the December quarter 1993 to the ECA and found that average
real wages had also fallen by 0.5 percent during the same period due to
that Act. Kasper also reports a study by Hall (1995 and forthcoming) which
made the case that
the ECA has been a key factor in subsequently improved productivity and
lessened pressure on existing labor costs and the costs of hiring. If so,
then it could follow that the costs of New Zealand's disinflation process
would have been somewhat lower if the ECA had been introduced at an earlier
date. (p. 48)
While it is difficult to measure productivity, especially over short time
periods, a number of labor productivity measures indicate that
productivity growth increased immediately following the ECA (although
again macroeconomic versus microeconomic determinants cannot be
disentangled).
We adopt three alternative labor productivity measures to check the
robustness of our results. Each uses annual June-year data with
(production-based) GDP as the measure of output. The three alternative
labor input series are total numbers employed, total full-time equivalent
employees (assuming two part-time employees equals one full-time
employee), and total hours worked.21 In Table 2 we summarize the rate of
annual productivity growth for three periods: 1971-1984 (the period prior
to the major economic reforms); 1984-1991 (the period of economic reforms
excluding significant labor market reform); and 19911995 (the post-ECA
period). In each case we list the range of per annum productivity growth
estimates derived from our three measures, the average of the two
employment-based estimates (for which the data span the whole period),
and (for the latter two periods) the preferred productivity measure using
hoursworked data.
Although strong conclusions cannot be drawn because of measurement
difficulties and cyclical problems,22 the data in Table 2 suggest that
labor productivity growth rose for a period following the ECA and points
also to a minor improvement in productivity growth after 1984. However,
unlike this interim period, employment grew strongly in the post-1991
period indicating that the post-ECA productivity boost was not achieved
as a result of a labor shake-out, as occurred prior to 1991.
Specific Effects of the 1990/91 Measures. The 1990/91 social assistance
changes immediately reduced replacement ratios. Most replacement ratios
dropped by around 8 percent. By March 1995 the ratio of benefits received
by an unemployed married couple with two children to the average weekly
wage stood at 39 percent.
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TABLE 2
With unemployment rates being highest among the low-skilled, some
differential effect on wages for unskilled and therefore incomes during
a period of benefit cuts and high unemployment might be expected. There
is some evidence of a widening dispersion of household incomes during the
period of the benefit cuts and the early response to the ECA. Between
1988/89 and 1993/94, the average weekly household income of the lowest
to the highest income quintiles rose by: 0.3 percent, 2.1 percent, 4.2
percent, 8.0 percent, and 13.2 percent respectively.23 However, the
strong employment growth since 1991 now appears to be favoring lower
socioeconomic groups. For example, Statistics New Zealand's Labour Force
Survey reports that the unemployment rate of Maori (who typically have
higher unemployment) dropped from 25.6 percent to 15.6 percent in the four
years to December 1995 and Maori experienced an employment growth rate
in the year to June 1995 which was double the rate of increase for
non-Maori.
The changes appear to have stimulated more intensive job search by the
unemployed. While it is difficult to disentangle macroeconomic from
search factors, weekly flows out of the pool of registered unemployed
increased from 2.5 percent over 1991 to 4 percent in 1995 (Richard Fletcher
1995).
The role of unions changed considerably following the reforms. Whereas
unions had monopoly rights to bargain on behalf of workers prior to 1991,
this right was contestable from 1991 onwards. As reported by the
Industrial Relations Centre (1995), union membership fell by 38 percent
in the three and a half years following the introduction of the ECA. This
compares with a 7 percent fall in the two preceding years. Union membership
as a percentage of the paid work force as calculated by the Industrial
Relations Centre fell from 42 percent in 1991 to 23 percent in 1994. Using
different work force data, Maloney (1993, p. 11) estimates that, between
the first quarter of 1991 and the fourth quarter of 1993, the ECA
contributed 14.1 percentage points to the 14.8 percentage decline in his
estimate of union coverage.
The number of work stoppages (strikes) also decreased substantially
following the ECA. Statistics New Zealand data show that stoppages in the
four years to December 1994 fell 63 percent compared with the four years
to December 1990.
An outcome directly attributable to the ECA was the reduced role of
collective contracts, and especially multi-employer collective contracts,
in the postreform period. In the year prior to the ECA, 59 percent of all
employees were covered by multi-employer collective contracts (awards),
and a further 13 percent were covered by single employer collective
contracts (Richard Whatman, Craig Armitage, and Richard Dunbar 1994).
These proportions had changed to 6 percent and 35 percent respectively
by August 1993. The proportion of employees on individual contracts
increased from 10 percent to 45 percent over this period, while the
proportion covered by enterprise contracts increased from 23 percent to
over 80 percent. Whatman, Armitage, and Dunbar also report that 80 percent
of employers reported improvements in productivity with a third crediting
the ECA as the single most important influence on their increased
productivity.
A December 1995 survey by Savage and David Cooling (1996) asked businesses
what changes had occurred, as a result of the ECA, in the content of their
employment contracts since 1991. The responses indicate significantly
more flexible work practices (58.4 percent of respondents reported
increased flexibility against 1.8 percent who reported reduced
flexibility); a tendency to increase ordinary time rates of pay (50.7
percent reported an increase, 3.5 percent a decrease) but reduce overtime
rates of pay (6.9 percent reported an increase, 42.8 percent a decrease)
and other allowances including penal rates (6.2 percent reported an
increase, 38.8 percent a decrease); reduced demarcation disputes (2.6
percent reported an increase, 37.8 percent a decrease), greater recourse
to multi-skilling (47.5 percent reported an increase, 0.9 percent a
decrease) and greater use of performancebased remuneration (44.4 percent
reported an increase, 1.8 percent a decrease).
Wage dispersion has increased following the ECA. In 1994, approximately
60 percent of collective contract settlements were for increases within
1 percent of the mode (0 percent) increase, compared with over 90 percent
in the early 1980s (Grimes 1982). In the first two years after the ECA,
wage decreases were recorded by 8 percent and 5 percent respectively of
collective contracts settlements, while a further 42 percent and 33
percent respectively recorded
V. Competitive Industry and Commerce
A. Introduction
Opening the economy to international competition has been a key feature
of the reforms. Removal of foreign exchange controls and quotas, and
reductions in tariffs24 and foreign ownership restrictions have created
an economy which is very open to trade and capital flows. Export
destinations and products diversified in the years following Britain's
entry to the EEC in the early 1970s. But import restrictions, particularly
those aimed at fostering import substitution, largely remained until 1984,
resulting in an economy that produced, or more commonly assembled, a huge
range of consumption goods. For most categories of goods there was little
variety.
The elect of the reforms has been to expand dramatically the range of
consumption goods imported, and to increase the openness of the economy
as represented by New Zealand trade. The OECD (1994) report a measure of
openness (ratio of imports plus exports to GDP) that increased by 42
percent between 1983 and 1993. The increased variety, and changed quality,
of goods means that consumer welfare changes will be underestimated by
changes in aggregate expenditure on final consumption over the period.
The opening of the economy drew on coherence between financial sector and
trade policies, tax policies and competition policy to foster a
competitive environment for industry and commerce.
Industry policy, and competition policy more generally, focused on
developing a competitive environment in which no sector was singled out
for encouragement by policy intervention: rather, the market place was
to be the sole determinant of commercial outcomes. This goal was advanced
by trade and capital liberalization based on the removal of foreign
exchange controls and import quotas; reductions in tariffs; and fewer
foreign ownership restrictions.
It was also furthered by government industry neutrality aimed at improving
the quality of price signals confronting domestic industry. One key result
has been a massive reduction in direct government assistance to industry
from 16.2 percent of government (nondebt) expenditure to just 4.0 percent
in 1993/94, in good part by the almost complete abolition of agricultural
subsidies at the outset of the reforms. Philosophically the fall reflects
a policy view that the government's major role in assisting industry
should be to establish an economic environment that is conducive to
business. The goal of industry neutrality was a foundation stone of reform
of the tax treatment of companies and individuals, and of competition
policy.
Before turning to post-1983 reform policies it should be noted that the
opening up of trade between Australia and New Zealand in the early 1980s
provided some basis for a competitive commercial environment. Development
of more open economic relations with Australia has reduced barriers to
entry in a significant market for New Zealand, and it has provided more
competition for New Zealand domestic firms. It has buttressed industry
policy of the reform period.
Industry and commercial policy is also reflected in the comprehensive tax
reforms that resulted in a tax system described by the OECD as "probably
the least distortive system [of taxation] in the OECD area." The revamped
tax system was indeed designed to minimally distort economic decisions
as the following key features reveal:
*changes to the basic structure that included lowering individual and
corporate tax rates, introducing a comprehensive value added tax (GST)
and removal of the myriad of widely differing sales taxes;
*elimination of across-the-board tax preferences for retirement
saving;25
*elimination of accelerated depreciation and investment allowances and
other particular investment incentives;
*elimination of export incentives;
*introduction of a fringe benefit tax and accrual taxation of interest;
*introduction of full dividend imputation; and
*reform of rules governing taxation of foreign sourced income.
In addition, there was a move from income to consumption taxes. As well
as being justified on intertemporal efficiency grounds, it had the effect
of broadening the tax base. The combined effect of GST and the concomitant
reductions in income tax rates improved efficiency by narrowing widely
disparate effective tax rates on capital income.
The tax changes meant that government was no longer actively using the
tax system to channel investment and consumption decisions in particular
directions. The sharp focus on neutrality led to reduced broad industry
support for, if not active opposition to, any particular concession that
might be advocated: thus, improving the credibility of the government's
commitment to the policy and reducing to a low level the payoff from any
sector-specific lobbying for concessions that were to their potential
benefit. For firms and their industry associations, it altered the balance
between political lobbying and commercial performance in favor of the
latter. Eric Toder and Susan Himes (1992) concluded that the far-reaching
tax changes were implemented efficiently and that this was made possible
because they were part of a coherent package with an accepted theme of
neutrality that affected all individuals and corporations.
Finally, competition policy has, from the enactment of the Commerce Act
in 1986, sought to minimize government and regulatory intervention and
to place reliance on actual and potential competition for the regulation
of prices and monopoly behavior. The Commerce Act is not specific about
the "public benefit" criterion on which firms and individuals' actions
are evaluated but its central component is economic efficiency. The legal
framework was molded by competition policy that rested on much less
regulation in general, and minimal industryspecific regulation in
particular.26 The absence of any industry-specific regulatory body and
the possibility of price control characterize most of New Zealand's
commerce. It has become known as "light-handed" regulation.
For more concentrated industries key parts of the Act are Section 36 and
the option of government imposed price regulations. Section 36, which is
usefully discussed by Vautier (1987), prohibits any dominant firm from
using its position to prevent entry, from deterring competitive conduct,
and from eliminating competitors. It carries heavy company and personal
penalties for noncompliance. Concentrated industries, particularly those
that have in the past been classified as natural monopolies may also be
subject to an industryspecific act. Again turning to telecommunications,
the largest firm in New Zealand, Telecom, is subject to the
Telecommunications Act of 1987, but there is no telecommunications
regulatory body. Apart from the Securities Commission, there is no
industry-specific regulatory body that has been established under
statute.
The trade, tax, and competition policy reforms and the concomitant
regulatory changes promoted an open competitive commercial environment.
The adjustment led to major industry restructuring as Figure 4 illustrates.
Philpott (1995), in one of the few studies of the extent of productivity
change during the period, reports that average annual total factor
productivity growth between 1985 and 1994 exceeds that of any decade since
1965 in agriculture, total exportables, nontradeables, and the total
economy. In primary exportables the rate of total factor productivity grew
at 6.3 percent per annum between 1985 and 1994, faster than at any other
time during his study (starting in 1960). However, his data suggest that
low productivity growth continues in certain nontradeables.
Hall's (1996) index of structural change is based on changing sector
output shares, and it is substantially higher in the period 1985/95 than
1978/85. It remains high in the upturn of 19921995. He notes that sector
growth has varied across sectors and stages of the business cycle since
1984. Sectors with high growth rates and total factor productivity growth
throughout the period included the deregulated transport and
communications sectors.
Section II commented on the effect on manufacturing of restructuring and
relative price volatility. Figure 4 shows that in 1993/4 manufacturing
employment and hours were 80-85 percent of their 1980/81 level. John
Gibson and Richard Harris (forthcoming) report that in the two years
beginning in 1987 manufacturing employment fell by 30 percent: 20 percent
as a consequence of retrenchment and 10 percent as a consequence of plant
closures. Their empirical work suggests that, during the restructuring,
plants with higher costs, larger size, and which were owned by less
diversified firms had a higher probability of survival. These results,
together with the strong export growth of manufacturing shown in Figure
4, point toward significant compositional changes in manufacturing that
may proffer a source of Philpott's (1995) finding of low productivity
growth in that sector during the reform period.27 Adjustment is still
taking place as tariffs continue to be lowered; this will be significant
in the vehicle assembly, textile, and footwear industries until the turn
of the century. B. Light-handed Regulation
The following examples illustrate industry performance under light
regulation.
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Figure 4.
Previously part of a government department holding a statutory monopoly,
telecommunications operations and assets were bundled into an SOE,
Telecom Corporation of New Zealand (Telecom), on 1 April 1987.
Restrictions on the supply of all telecommunications equipment were
removed by mid 1988 and by 1 April 1989 Telecom's statutory monopoly was
eliminated. The terms and conditions of competitive firms' connections
to the network are not subject to an industry-specific regulatory body
but are subject only to the economy-wide Commerce Act 1986.
Some industry-specitic regulation was imposed through the government's
ownership of the SOE and it continued after privatization in late 1990
with the government's retention of a "Kiwi" share which requires that,
for residential consumers, there will be a free local calling option,
rental on a standard line will not rise faster than the Consumers' Price
Index (unless the profits of Telecom's operating companies are
unreasonably impaired), and rural rentals will not exceed urban rentals.
In addition, under the Telecommunications Regulations 1990 Telecom must
retrospectively disclose the terms and conditions of contracts offering
discounts which exceed 10 per cent of listed prices.
Competition by firms with significant New Zealand infrastructure
commenced in 1991 when Clear Corporation used fiber-optic cable of the
then New Zealand Railways to bypass the Telecom network.28 It entered an
interconnect contract with Telecom and has provided domestic and
international long distance services from that time.29 In 1995, an
interconnect contract was agreed between Telecom and Clear which will
enable Clear to offer local service. BellSouth started its GSM cell phone
service in 1994, and now has extensive coverage, in competition with the
cell phone service of Telecom. Further competition is provided by firms
that do not have significant infrastructure of their own in New Zealand.
All these competitors have interconnect contracts with Telecom.
The welfare gains that have occurred between corporatization and 1993 are
reported by Boles de Boer and Evans (1996) to have been substantial. More
than 95 per cent of exchanges were electronic by 1993, and faults are now
monitored from one location. While progress has sometimes been
interrupted in the course of company restructurings, the quality of
service has improved dramatically since corporatization in 1987 to the
point that the International Institute for Management Development's
48-country survey ranks New Zealand telecommunications at the top in the
extent to which telecommunications infrastructure met business
requirements in 1995. Boles de Boer and Evans report that Telecom's
service quality improved substantially between 1987 and 1993, and that
during this period total factor productivity improved to the extent that
real costs per minute of use of the network fell by 5.5 percent per annum.30
They estimate that between 1987 and 1993 the total annual gain from
productivity and pricing improvements was $575m in 1987 NZ$s: the present
value of this at a 10 percent discount rate exceeds the price paid for
the company at privatization. Residential consumers gained at least an
annual benefit of NZ$300m over the six year period.31 Although the price
of access has increased in real terms, the cost of a basket of services
has fallen and the telephone penetration rate of households has not
declined (Evans 1996).
Light regulation has had its most stringent test to date in
telecommunications. It has meant open entry subject only to the contract
for network services offered by Telecom. Under Section 36 of the Commerce
Act 1986, Telecom cannot use its ownership of the network, and hence its
network contract, to inhibit competition. In 1991 Clear and Telecom
rapidly reached agreement on network access for long distance calls.
However, delays in introducing local service have been attributed to a
protracted dispute between the two companies on the terms and conditions
of a network contract. On the advice of William Baumol and Robert Willig
(1991), Telecom proposed the "Efficient Component Pricing Rule" (ECPR)
rule. Broadly, it entails Telecom charging Clear the full opportunity cost
of network services less the average incremental cost (AIC) of network
services provided by Clear.
The proposition that the opportunity cost should include profits foregone
by Telecom and a contribution to any crosssubsidization of residential
services have been central to the action that Clear brought under Section
36 of the Commerce Act against Telecom. Although, the High Court found
that the rule did not violate Section 36, on appeal a judgment striking
down the rule was made. Finally, the ECPR rule was held not to be contrary
to Section 36 by New Zealand's final Court of Appeal: the Privy Council
of Britain. The Privy Council argued that Clear's Section 36 case rested
on showing that Telecom was making excess profits and that the rule itself
was a separate issue.32 The protracted negotiations have been interpreted
by some as a signal that light regulation is too light, and that the
question of industry-specific regulation should be reevaluated. The
report on this issue by Officials of the Ministry of Commerce and The
Treasury of October 1995 was published just as Clear and Telecom announced
a local access network agreement; and there has been no change in the
regulatory regime. The extent of government involvement is, of course,
part of a wider strategic game between the telecommunications companies.
Henry Ergas (1996) concludes that New Zealand's light regulation in
telecommunications has performed better than Australia's
industryspecific regulation.
The electricity reforms have been much more protracted. Prior to the mid
1980s, electricity supply, or distribution, authorities were an odd
mixture of departments within local government (Municipal Electricity
Departments, MEDs) and local body Electric Power Boards whose governing
bodies were elected. The MEDs were in the larger cities. The electricity
supply authorities purchased electricity from the country-wide grid of
the electricity department of central government, and the grid was
supplied by generators also owned by that government department. The
Electricity Corporation of New Zealand Limited (ECNZ) was formed as an
SOE in 1987.
In 1992 the deregulation of electricity continued with the
corporatization of the electricity supply authorities and by giving
customers the right to choose their supplier. This right carried with it,
as for Telecom, the requirement that local grids offer transmission
contracts for any individual wishing to transport electricity.
With just one supplier, ECNZ, the transmission rights were of restricted
use; however, they have presaged planned entry to generation by local
supply or retailing companies who because of transmission rights can sell
their electricity to customers outside their local area, and even
establish generation plants beyond their local grids. They have also
affected the contracts for large consumers of electricity. In the early
1990s the SOE Trans Power was created: as its name implies, it owns the
main grid and carries the responsibility of carrying the electricity of
any (potential) client from an entry point to its destination on the main
arid. Finally, in 1995 ECNZ was further divided by splitting out 30 percent
of its generation capacity into a second SOE. There are no legal
impediments to entry into generation and to the provision of electricity
distribution; at present the industry is dominated by two large SOE
generator companies and a large SOE that owns the main transmission lines.
All networks should not prohibit transportation of any generator's or
consumer's electricity. All companies are subject to the Commerce Act 1986
and light regulation.
In order to coordinate the electricity market a company, EMCO, was
established in 1993. It is owned by purchasing, generation, and
transmission firms. The company has established an electricity exchange
including a physical spot market and forward markets for shortand
long-term tradeable contracts for electricity-specified as to date, time,
and place.33 The market commenced trading in 1995. As part of ensuring
that the electricity exchange rules are enforced, the industry has
established a Market Surveillance Board that has the responsibility of
oversight of the operation of the electricity market. It carries certain
powers of sanction. The market is currently affected by a perceived need
to constrain the market power of the two SOE generating companies, and
this is being done by government insistence on locking up their outputs
in long-term contracts and restricting their ability to expand their
capacities. It is also under transitional arrangements until 1 October
1996. After this date trade will be specified by privately determined
contracts and through the EMCO market.
It has taken ten years of policy deliberation and slow change for the
electricity industry to reach its current state of competition. Its
operation has yet to be tested, but its efficacy to a very large extent
relies on the efficiency of light regulation. A number of electricity
supply firms have merged and this will facilitate exploiting the economies
of scale (see David Giles and Nicholas Wyatt 1992) that were estimated
to be present in the electricity supply authorities prior to the reforms.
The telecommunications, electricity, and gas industries face similar
interconnect and competitive issues. Continuing study of them will
provide insights as to the long-term viability of New Zealand's
"light-handed regulation."
The last example has been included to show that light regulation is
economywide and that the drive for competition appears in legislation of
the reform period in various, often subtle, ways. Good illustrations are
provided by the legal status and rules applying to institutions of the
financial sector. It has been mentioned in Section II that banks face
disclosure regulations rather than activity or quantitative controls.
Their payments system, however, is not subject to bank regulation, but
to that of the Securities Commission. Thus, in contrast to the case of
Canada, there is freedom of entry to the payments system by financial
institutions that want to offer financial services to their customers.
Also the fact that banks can offer insurance, and insurance firms can use
the payments system to access customers and extend their range of services
through ATM machines, improves competition for a range of financial
services.
C. Agriculture
Agriculture's longstanding importance in the economy is reflected in its
provision of the bulk, 90 per cent in the 1960s, of New Zealand's export
earnings. It has consisted primarily of livestock farming-the 70 million
sheep of 1983 represented 23 sheep per person. From 1945 New Zealand meat
and dairy produce had open access to the British market, but access was
increasingly restricted upon Britain's entry to the EEC in 1972. Generally
declining and volatile terms of trade accompanied the market
diversification which followed.
At the onset of the reforms agriculture was receiving substantial
transfers to maintain its production in the face of declining agricultural
terms of trade and of high input costs generated by regulation,
manufacturing protection and subsidies. Certain domestic prices were
regulated and certain activities, egg production for example, were
protected under statutory monopoly. There existed the standard perverse
incentives which have come to be recognized as accompanying economy-wide
regulation and subsidization.
Some of the subsidies were the outcome of mechanisms designed to smooth
farmers' fluctuating incomes. More distinctively, the subsidies were
determined by planners' desires to expand agricultural exports in the face
of the tax on that industry engendered by the protection of
manufacturing.34 Evans and Gareth Morgan (1983) report many of the subsidy
schemes of the late 1970s and early 1980s resulted in user costs of capital
inputs which, at the time of investment, were virtually zero; in some cases
negative.35 This subsidization meant that the marginal rate of return to
investment was much higher than the average rate of return farmers were
experiencing. It had the twin effects of encouraging extra production and
adversely affecting farmers' attitudes to subsidies and the management
of the economy in the early 1980s.
Farmers anticipated higher (average) rewards from comparative advantage
in a deregulated economy. Just prior to the reforms, farmers' average
incomes were supported by direct transfers in the form of price supports,
but by this time subsidies and regulation had reached the point where they
were widely perceived as not sustainable. Farmer special interest groups
have broadly supported the reforms since their inception.
The path of reform was announced at the November 1984 budget. A guide to
the profitability of agriculture is provided by Figure 5. It was thought
that the removal of direct subsidies would coincide with devaluation, but,
on floating the exchange rate, interest rates rapidly moved to high levels.
Figure 5 indicates that although subsidies had been growing to 1984 the
real return per stock unit had declined since the early 1970s. This decline
is in accord with the proposition that many of the subsidies were directed
toward promoting investment.
The graph shows the real decline in sheep and cattle profitability that
took place in 1985/86. Costs that cannot be allocated to livestock, such
as fertilizer, rose with the removal of the subsidy; thus exacerbating
the decline in farming profitability shown in Figure 5. In consequence,
agriculture retrenched. Farm land prices fell by as much as 50 per cent
in real terms. Restructuring was not smoothed by transitional
arrangements, and a proportion of farmers were bankrupted. Others
retained ownership by selling portions of their farms. The terms of trade
for traditional agriculture did improve somewhat in the late 1980s, and
the restructured rural areas led New Zealand's early 1990s recovery.
Agriculture has changed. Its commodities now account for less than 50 per
cent of total exports, and there has been much change in operation and
products. Sheep livestock units fell 30 percent between 1985 and 1995,
in comparison to a fall in all livestock units of 12 percent. The decline
in sheep numbers reflects the low terms of trade for sheep products and
reversion from the high levels of capital stock resulting from the
prereform policy of encouraging extra production with scant regard for
international product price signals. It may also reflect the relative
profitability of sheep and forestry, in part engendered by world prices
and in part by the favorable tax treatment of forestry. Rob Davison (1995)
estimates that farmland planted in trees in 1994 displaced 0.24 million
stock units.
Although diversification into deer farming and horticulture and wine
production started in the 1970s and early 1980s, it has been consolidated
during the reform period. Indeed, horticultural export growth has
accounted for much of the growth in agricultural value added and exports
broadly defined. Forestry is replacing farming in a number of hill country
areas and exports from this rural activity have more than doubled since
the early 1980s. The strong growth of tourism in the 1990s has made it
a major foreign exchange earner, and it has been associated with changes
to farms to meet tourism demands.
The changed operation of farms reflects the need for individual farmers
to manage their own risk rather than rely on government programs,36 and
benefits associated with contracting directly with customers for specific
products.37 Their larger size, permitting specialization of labor and
better access to capital markets, may entail corporate farms having
advantages over the family farm in both these areas. Although they are
very few in number, there are now more public corporations in farming than
in 1984.
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Figure
Industries supplying inputs to agriculture have followed agriculture's
cycle. The meat packing industry, which was once heavily regulated, has
had to undergo major restructuring since entry became open in the early
1980s, as sheep numbers have declined, and in response to demands for
value-added meat products rather than meat as a commodity. The
restructuring has carried with it a number of bankruptcies resulting in
significant losses to shareholders and farmers: the government has not
financially smoothed the transition. The industry still has excess
capacity, particularly under the current more flexible terms of
employment, and is likely to remain volatile for some time.
The statutory monopoly of a number of producer boards is unresolved.
Different boards have different powers, and they retain a significant
place in agriculture and horticulture. Powers include the right to levy
producers, compulsory product purchase, the sole right of export, and the
responsibility for the administration of quotas imposed by foreign
countries. The effect of these boards on competitive supply, price signals,
and efficient provision of supply, marketing, contracting, and transport
services remains under wide scrutiny and debate.
The general reform program also included reconsideration of legislation
controlling town and country development. The Resource Management Act of
1992 replaced all previous legislation and its goal was to provide a
framework for sustainable use of resources. The focus of the Act is to
promote sustainable land use while placing greater weight on effects of
actions, rather than actions themselves, and on property owners' rights
to make decisions. Because the Resource Management Act replaces, rather
than builds on, previous case law its introduction has injected
uncertainty into planning and development procedures for agriculture.
Local government authorities have the responsibility of administering the
Act and they have adopted various positions on the tradeoff between
regulatory restriction and freedom for owners to make choices; although
they are constrained by the requirement that restrictions be justified
by economic analysis. There is uncertainty about the enforceability of
some local government positions. In many regions the new Act has provided
more freedom to subdivide properties for various purposes, and it is
sustaining a trend to smaller farms which really started in the mid 1980s
as farmers sought to restructure their debt.
For agriculture the reforms can be assessed in various ways. The abrupt
withdrawal of transfers and the high real exchange and real interest rates
initially combined to depress agriculture: thus the sequence of reforms
accentuated agricultural readjustment. Farmers' incomes followed this
pattern. Nevertheless, agriculture's contribution to GDP and exports has
grown since the onset of the reforms.38 Average labor productivity of
agriculture has increased more rapidly than in manufacturing over the
reform period.39 The Effective Rate of Assistance (ERA) data of Laurence
Tyler and Lattimore (1990, pp. 72-73) indicates the valuation of the
agricultural contribution to value added at domestic versus international
prices. The 1989 ERA has returned to its 1970 level. The True Level of
Assistance (TAR) for the export sector takes account of the assistance
given to other sectors, and it suggests that the tax on the export sector
has fallen from 11 percent in 1985 to 4 percent in 1992/3 (Duncan,
Lattimore, and Bollard 1992).40 The remaining tax is, in large part, a
consequence of the tariffs which remain on certain manufacturing
industries. Given that support for industries other than agriculture
continues to decline, the TAR will move closer to zero.
The reforms of the past ten years leave rural New Zealand more diversified
and with a continuing decline in the importance of traditional farming
operations and products. The higher, but not high in historical terms,
farm incomes of the 1990s, other demands for rural use together with the
GATT Uruguay-Round agreement have led to rebounding farm land prices. The
extent to which any reduced trade barriers flowing from the GATT agreement
translate into improved farm incomes will depend partly upon their, and
other, effects on New Zealand's real exchange rate: marking the nexus
which bedeviled farmers in the early stages of the reforms. VI.
Conclusions
The key features of New Zealand's economy-wide reforms have been their
comprehensive and coherent nature, their emphasis on time consistency,
their comparative-institutional analysis of policy options, and their
extensive use of contracts. Until 1991, commentary on New Zealand's
reforms heralded the consistent application of economic principles but
could not yet reach conclusions regarding their outcomes, because the
country was in the midst of a painful process of disinflation, fiscal
consolidation, and rising unemployment.
The sustained economic upturn since 1991 provides some basis for an
encouraging conclusion, although there is still room for debate about the
degree to which the recovery is structural rather than cyclical. This
issue is currently being tested as economic growth slows under the
influence of weakening terms of trade and the central bank's efforts to
keep the underlying rate of inflation within the 0-2 percent range.
The political sustainability of the reforms awaits the test of the first
general election to be held under the new mixedmember proportional voting
system. The process of balancing demands for economic efficiency versus
rent-seeking and redistribution will be complicated by the advent of the
new electoral system. Individual political parties seem likely to focus
on narrower constituencies than in the past. For the present, the
convergence of lobbying positions between farmers, the service sector,
and providers of capital for free trade appears to be strong, and this
convergence stands in favor of smaller government, lower taxes, and
incremental rather than radical reform. Those preferences are opposed by
a substantial group, including the elderly, who favor redistribution, and
are a growing proportion of the population.
Whatever the outcome of future elections, the reforms have increased the
constraints on future governments by imposing open financial markets,
formidable disclosure requirements, and formal contractual arrangements
in respect of monetary and fiscal policies. However, the large fiscal
surpluses and low government debt to GDP ratio offer increased scope for
future government spending.
In any case, the reforms are incomplete. Further reform in certain areas,
such as education, health, and welfare, are likely to be necessary if New
Zealand is to achieve its potential.
These qualifications aside, the reforms have markedly improved New
Zealand's economic prospects and represent a radical break from New
Zealand's past policies of heavy regulation and import protection, and
the accompanying, by OECD standards, relatively large fiscal deficits and
high rates of inflation.
The reforms already accomplished in New Zealand yield at least four
important lessons for other developed economies trying to improve their
competitiveness. First, they suggest that the traditional sequencing
literature need not dominate the practicable option of proceeding as
rapidly as possible on all fronts. Consideration needs to be given to the
dynamics of reform processes. New Zealand's reform efforts began in the
financial sector in response to a foreign exchange crisis. Success here
allowed the program to move forward into more controversial areas. By
attacking multiple problems at once, the costs to any one sector, in terms
of lost protection or subsidies, were compensated or obfuscated by gains
to the sector originating from reforms elsewhere. Additionally, each
constituency that lost its sheltered position immediately called for the
removal of protection for its suppliers, thus accelerating the pace of
reform.
Second, the previous comment not withstanding, the reform process would
very likely have carried much lower costs if the labor market had been
deregulated early in the reforms. The New Zealand experience is that the
sequencing of reforms is important.
Thirdly, the potential for market solutions appears to be wider than
commonly believed. New Zealand accomplished government contracting out,
the wholesale elimination of agricultural subsidies, import licensing,
and many tariffs, and the privatization of its national
telecommunications provider without instituting industry-specific
regulation. Reforms in light regulation and agriculture are indicative
of New Zealand's willingness to rely on market forces in ways not yet
attempted by other countries. The result is that New Zealand agriculture
is internationally competitive and the telecommunications industry is a
useful model for policy makers considering privatization or reform of
utility regulation.
Fourth, fiscal consolidation and radical change in the public sector is
possible. A fiscal deficit of 9 percent of GDP has been turned into a
surplus in ten years. The entire tax code can be rewritten to minimize
distortions, and this can be buttressed by a switch to indirect taxes.
Government departments can function through contracts with transparent
objectives and autonomy. Central Banks can reduce inflation by credibly
committing to and unwaveringly pursuing an explicit target. State-owned
enterprises can be restructured to improve efficiency. Given explicit and
implicit competitive pressures imposed by a reforming government on its
private sector to rationalize and restructure, public sector reforms can
be used to demonstrate the potential for rapid and far reaching change.
The New Zealand case is rather different from many lesser developed and
formerly socialist countries. Unlike many such economies, markets in New
Zealand were always secure. Wealth confiscation did occur through
inflation and taxation, but rarely through overt expropriation. Unlike
many Latin American economies where poor performance could be assigned
to the absence of credible commitments from the government that it would
not appropriate wealth once created, the New Zealand case was one where
government displaced the private sector from many important activities
and regulated, coerced, or subsidized it excessively where it was allowed
to operate.
It should also be recognized that as compared to many former socialist
economies attempting reform, New Zealand has the advantage of having in
place much of the machinery needed to support markets such as strong
property rights and an independent judiciary free of corruption. Hence
the lessons from New Zealand reforms, while of certain general
applicability, are likely to be more relevant to Australia, Western Europe,
and the United States than say some South American and East European
countries where there are serious property rights issues and the
independence and objectivity of the judiciary is not assured.
The success of the reforms to date has strengthened support for free-trade
policies within New Zealand's business community, perhaps to an unusual
degree by OECD standards. Many of the lessons from the New Zealand
experience are worthy of emulation by other countries. Others, like its
tardy labor market deregulation, provide a cautionary note. After decades
of policy errors and investment blunders, New Zealand appears to have
finally diagnosed its predicament appropriately and is on a trajectory
to maintain its economy as a consistent high performer among the OECD.
New Zealand once again appears to be emerging as a laboratory from which
results will animate economic debate and policy throughout the world.
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[Footnote]
1 A more detailed account of the material covered in this paper is contained in a forthcoming monograph by the
same authors.
2 Examples of other far-reaching changes include international relations and the facilitation of claims by
indigenous Maori under an 1840 treaty.
[Footnote]
3 Further references on the history of state intervention in New Zealand as a response to economic insecurity
are provided in a review article by Tony Endres (1986) of Sutch's writings.
4 These estimates are computed using the real GDP index and population data contained in Anus Maddison
(1990) rebased into 1980 U.S. dollars using data from the International Monetary Fund (1994).
[Footnote]
5 Refer to Rob Cameron and Sue Begg (1984) and Stephen Jennings and Cameron 1987) for references.
[Footnote]
6 No industry-specific regulators have been established for any of the privatized sectors. Restrictions on foreign
ownership are minimal. In the case of the national airline, Air New Zealand, foreign ownership had to be limited
to protect its access to government-to-government negotiated landing rights in foreign countries. Government
approval is required for a foreign person to hold more than 49.9 percent of Telecom Corporation of New Zealand
Limited.
[Footnote]
7 Details of the deregulatory policies are provided in the Reserve Bank of New Zealand (1986).
8 The history of bank supervision has been more chequered. For details see the Reserve Bank of New Zealand
(1995) and Grimes (1996).
[Footnote]
9 Measured by the National Bank of New Zealand survey of approximately 1,500 businesses.
[Footnote]
10 The real interest rate used in this study is the one year government bond rate (source: the National Bank of
New Zealand) less the one year ahead inflation expectation as per the National Bank of New Zealand's survey of
inflation expectations.
11 The real exchange rate used in this study is the trade-weighted nominal exchange rate adjusted for
movements in consumer prices exclusive of the direct effects on the official CPI of changes in GST.
[Footnote]
12 Revenue also dropped over 1991-93, although this was not by choice. It was driven primarily by company
losses caused by economic stagnation which caused tax revenues to drop. The economic upturn has caused the
revenue share to rise again with a resulting fiscal surplus in 199394.
[Footnote]
13 The close relationship between interest and exchange rate movements is revealed by the correlation
coefficient between the real interest rate and the real exchange rate (using quarterly data) of 0.61 during the
five years to September 1989 and 0.86 during the five years to September 1994.
[Footnote]
14 The term government "department" will be used throughout this section in reference to any entity, except
SOEs, which is directly responsible to a minister of the crown. It includes "ministries" for example.
[Footnote]
15 This is the first date of the series. 16 Approximately 80 percent of health expenditure, and hence
employment, and over 95 percent of education employment is provided by government.
[Footnote]
17 This decline was due to a combination of SOE layoffs and privatization.
[Footnote]
18 These reforms and the motivation for them are described in more detail in Graham Scott and Peter Gorringe
(1989).
[Footnote]
19 New Zealand has had the Westminster system of government, and political appointments are not made to
the core public service.
[Footnote]
20 Part of this change is accounted for by the movement of 1,100 traffic police from the Transport Department
to the Police Department in 1992.
[Footnote]
21 Data were sourced from Statistics New Zealand in early 1996 with employment data backdated by the New
Zealand Institute of Economic Research. All data is available from 1971 onwards except for hours worked which
begins in 1975.
[Footnote]
22John Savage (1996) uses similar hourly productivity data and finds that in the five years to 1991, labor
productivity grew much more strongly than in the five years on either side of this period. Hall's (1996) analysis
of labor productivity spans a longer period and adjusts for the state of the business cycle. It concludes that the
1991-95 labor productivity growth rate was the same as that of 1979-87. However, unlike the earlier period it
was, in 1991-95, accompanied by strong growth in real GDP, labor employed, capital, and total factor
productivity.
[Footnote]
23 New Zealand Official Yearbook, 1995 and 1990, using information from the Household Expenditure and
Income Survey. Bob Stephens, Paul Frater, and Charles Waldegrave (1995) provide evidence that, on a relative
income basis, poverty fell, or remained unchanged, over the full 1984-93 period. When the poverty level was
defined to be 60 (50) percent of median income the percentage of households in poverty changed from 13.7
(4.3) to 10.8 (4.3) over the period. They also discuss poverty from an absolute income standpoint.
[Footnote]
24 Further reductions are scheduled for remaining tariffs on most goods to no more than 5 percent by the year
2000 (Alfred Wong and Grimes 1990). The government intends to announce in 1998 a timetable for moving to
zero tariffs. Tariffs have been reduced independently of the tariff policies of other countries. Antidumping
legislation and its implementation does remain a controversial issue, particularly in certain industries,
[Footnote]
25 Although different savings vehicles are still taxed differently with regard to capital gains.
[Footnote]
26 See the discussion of Kerrin Vautier (1987).
[Footnote]
27 The strength of the growth in exports has been surprising. It has been affected by improved export
competitiveness and manufacturers expanding to offshore markets, particularly the Australian market, in
response to New Zealand's depressed domestic demand of the late 1980s. However, it has been reported
recently (National Business Review, 12 April 1996) that manufactured exports grew 16 percent to South Asia
and 13 percent to North Asia in 1995.
[Footnote]
28 In January 1996 Clear Corporation was held equally by MCI International, Bell Canada Enterprises, Television
New Zealand, and Todd Corporation. New Zealand Railways was purchased by Wisconsin Rail in 1993.
[Footnote]
29 Within two years Clear's share of the toll market exceeded 18 per cent.
30 The Boles de Boer and Evans (1996) total productivity estimate of telecommunications of 9.5 percent is
supported by the Philpott (1995) estimate of 8.8 percent for the communications industry that is dominated by
Telecom.
[Footnote]
31 This benefit is the estimated increase in consumers' surplus, on an annual basis, expressed in 1987 prices.
[Footnote]
32 The issues associated with the realization and form of a network contract have stimulated conceptual work
on this topic. In a model where oligopolistic retail firms must use a network, where a conglomerate may own a
retail firm as well as the network Stephen Burnell, Evans, and Shuntian Yao (1995) point out that where (partial)
bypass is possible the network contract written by the network under light regulation will normally be close to
second-best optimal.
[Footnote]
33 The bulk of New Zealand's electricity is generated by hydro plants.
[Footnote]
34 Duncan, Ralph Lattimore, and Bollard (1992) report true rates of assistance to agriculture of-ll percent in
1985/86 rising to-6 percent in 1992193.
35 User costs were also low because of the low real interest rates prevailing.
[Footnote]
36A number of producer organizations still retain statutory powers over the purchase and distribution of product.
The largest of these is the co
[Footnote]
operative Dairy Board. Because its payment to members is tied to farmers through the price of milk it is a
collective which affects the risk facing farmers.
37 In certain areas, those suitable for cropping, for example, individual farmers seem now to be more personally
involved in beyond the farm gate activities such as marketing and shipping.
[Footnote]
38 Production and export data have to be interreted carefully for livestock farming. Declines in livestock
numbers, for example, may well increase exports in the short term as fewer stock are held for capital stock
maintenance.
[Footnote]
39 philpott (1994) estimates that since 1984 agricultural and horticultural GDP grew by 6.4 per cent per annum,
and total factor productivity by 7.7 per cent, much of it attributable to horticulture.
40 The TRA measures the assistance received by the traded goods sector after allowing for the flow on effects
to domestic nontraded goods of tariffs quotas and subsidies.
[Reference]
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[Author note]
LEWIS EVANS Economics Group, Victoria University of Wellington ARTHUR GRIMES Southpac Investment
Management Limited and BRYCE WILKINSON Economic Advisory Unit, First NZ Capital Limited with DAVID
TEECE Institute of Management, Innovation and Organization, University of Californi, Berkeley