Speech to the Pacific Rim Policy Conference in Honolulu
Mr Chairman, Ladies and Gentlemen,
I feel deeply honoured to have been invited to address you today.
This is an important forum for those who fight for economic freedom, not with guns or with bombs but with ideas and with words.
I haven’t had the privilege of meeting most of you before this conference, but if you’re like the three New Zealanders who share the programme with me, you’re a mightily impressive army:
Thank you for inviting me to address you.
Today, I want to share with you a little of New Zealand’s experience with moving to much freer markets, to assess the size of the dividend from that move – indeed, to assess whether there was a dividend!
I know that some of you are well familiar with the dramatic moves taken by the Labour Government of New Zealand after 1984 – the Government of which Richard Prebble was a senior minister – and continued for a year or two after the change to a National Government in 1990. But for the sake of those not so familiar with the story, let me summarise briefly what was done.
Prior to 1984, the New Zealand economy was probably the most tightly controlled and regulated economy outside the Soviet Bloc – rightly compared by the incoming Prime Minister as being run along lines similar to a Polish shipyard.
Under the ostensibly centre-right government of Sir Robert Muldoon, prices were controlled, wages were controlled, rents were controlled, imports were controlled, the exchange rate was controlled – indeed, almost everything was controlled.
You needed approval from the central bank to remit more than a small amount of money overseas, and buying shares overseas was essentially prohibited.
Those lucky enough to have been granted a licence to import a restricted quantity of some product were effectively granted a licence to print money – as were those able to produce import substitutes behind very high barriers to imports.
Because the exchange rate had been pegged at a rate which failed to reflect the fact that inflation in New Zealand was higher than that overseas, exporters depended on subsidies to survive.
But between the actual subsidies to exporters and the effective subsidies to those protected by import controls and high tariffs, nobody had the faintest idea who was actually the net recipient of state assistance.
The tax system was an absolute mess, with hugely variable sales taxes and a personal tax scale which reached a 66% rate at a level of income equal to not much more than twice the average wage.
The government owned the largest commercial bank in the country, and three other banks; along with a shipping company, the national airline, the only railroad, an insurance company, a huge area of forestry, the monopoly phone company, the entire electricity industry, and much else besides.
The government was running a very substantial fiscal deficit, and the central bank adjusted monetary policy to suit the political needs of the government – with the inevitable result that New Zealand had one of the highest rates of inflation in any developed country throughout the seventies and into the eighties.
It was compulsory to belong to a trade union, and there was a highly centralized system for determining wages with an elaborate system of relativities which saw an increase in wages because of pressures in one sector flow on through much of the economy. Because imports were so tightly controlled, neither employer nor employee were terribly worried about settling wage negotiations at a rate which would have cost jobs in a more open economy.
I could go on, but I’m sure you get the picture. New Zealand was a highly controlled economy prior to 1984.
And the result? That way of running the cutter saw New Zealand’s productivity growth fall to the lowest in the OECD, and our living standards fall steadily below those in countries like Australia – countries which we’d tended to regard as our equals.
At the beginning of the seventies, average after-tax incomes in Australia were virtually identical to those in New Zealand. By 1984, average after-tax incomes in Australia were 20% above those in New Zealand.
And then came the Lange/Douglas/Prebble Government – an ostensibly left of centre government.
Helped by the fact that the general election of 1984 was held earlier than anticipated – which meant that the incoming government had not been obliged to be too specific about what they might do if elected! – and by a serious balance of payments crisis, that Government set about moving the economy more decisively towards greater freedom than any New Zealand government before or since.
Controls on prices, wages and rents were removed within months.
Government bonds were sold to finance the fiscal deficit at whatever the market-clearing interest rate was, with the result that interest rates on bonds jumped sharply.
All controls on capital moving in and out of the country were removed, and the exchange rate floated. (I think New Zealand remains the only country in the world to have had a freely floating exchange rate for more than 22 years.)
Export subsidies were quickly abolished on the grounds that a floating exchange rate should take care of the viability of exporters; quantitative controls on imports were phased out; and a programme of tariff reductions was stepped up.
The company tax rate was cut from 45% to 33%, and the top personal tax rate was cut from 66% to 33% – at the same time as a large number of tax avoidance loopholes were removed. (The Minister of Finance, Roger Douglas, whose vision and commitment lay behind most of the Government’s economic programme, even announced his intention to move to a flat personal income tax rate of 23%, but that was over-ruled by the Prime Minister.)
Variable wholesale sales taxes were abolished, and a single-rate Value Added Tax introduced, designed by a three-person committee chaired by one of the Government’s political opponents – me!
Government trading operations were first put into corporate structures, with a majority of directors appointed from the private sector, and then many of them were privatized – including three of the four banks owned by the government (the Post Office Savings Bank, the Rural Bank, and the Development Finance Corporation), the national airline, large areas of forestry, the telephone company, and the government-owned shipping company.
The Government didn’t dare to abolish compulsory unionism, but radically reduced the power of the union movement to hold the country to ransom by reducing barriers to imports and refusing to get involved in industrial negotiations. Special legislation transformed the nature of the employment relationship in the public sector, with those we used to call “permanent heads” of government departments being put on fixed term contracts. Even the waterside unions – what you in the US call long-shore men – had their power clipped (by Richard Prebble and his successor) when ports were turned into competing companies.
The central bank, of which I was appointed Governor in 1988, was instructed to focus on getting inflation to between zero and 2% and to do it without any reference to the government. A law was passed – without dissent in Parliament, thanks to the advocacy of Ruth Richardson within the National Party caucus – requiring the achievement and maintenance of price stability to be the primary focus of monetary policy, and making it clear that, once a definition of “price stability” had been publicly agreed between Minister of Finance and Governor, the Governor was both independent of government in delivering the agreed target and liable to dismissal if he failed to do so without very good reason.
Incidentally, as an aside, there are those, perhaps following Hayek, who believe that having a central-bank-issued currency is somehow a restriction on economic freedom. I don’t share that view. Every country in the world uses a central-bank-issued currency – either issued by their own central bank or by the central bank of another country. What is important for those of us who value freedom is that citizens are free to hold their financial assets in any currency of their choosing – and that is certainly true in New Zealand, and has been since December 1984. New Zealanders are totally free to remit money abroad, in any amount, and most New Zealand banks offer deposit facilities in a range of overseas currencies.
For the first few years, these drastic reforms, these radical moves to free up the New Zealand economy, were hugely popular, especially among those who had traditionally supported the centre-right party. The Labour Government not only won re-election in 1987, they won re-election with an increased Parliamentary majority!
But then it all turned to custard. Tension between the Prime Minister and his Minister of Finance (which eventually saw both lose their jobs), the share-market crash of late 1987 (more severe and more prolonged in its impact in New Zealand than in any other country), the high nominal interest rates as the Reserve Bank fought to get inflation under control, the appreciating exchange rate which saw no-longer-subsidised exporters under huge pressure, the sharp downturn in the property market, and rising unemployment all took their toll on the Government.
The Labour Government was heavily defeated in the election of 1990 and the country expected a “gentler, kinder government”, which would reverse at least some of the “harsher” measures taken by the Labour Government.
But the incoming National Government found itself confronted with a serious fiscal deficit, made worse by the need to bail the government-owned bank – the largest in the country – out of a serious financial crisis caused by imprudent lending in both New Zealand and Australia prior to the share-market crash. Far from reversing the measures taken by the Labour Government, the National Government pressed ahead with them – paring back the generosity of social welfare benefits, introducing much-needed freedom into employment law and – again thanks largely to Ruth Richardson, by now National’s Minister of Finance – putting fiscal policy on a sustainable basis.
By the time of the 1993 election (which the National Party very nearly lost), New Zealand had seen some nine years of policy changes designed to establish macro-economic stability and free up markets for goods, services, labour and capital.
And let’s be honest. For many people, those policy changes were very traumatic.
By 1991, unemployment had reached 11%, and the reforms had lost their allure.
Today, the New Zealand Labour Government – a genuinely left of centre government now! – routinely decries what they call the “failed policies of the eighties and nineties”, conveniently forgetting that the present Prime Minister was a Cabinet Minister in the Labour Government of the eighties, and indeed for a time the Deputy Prime Minister.
And nobody in the media seems to see anything much wrong with that description.
Even the right-of-centre party, the National Party, which I lead for more than three years, is reluctant to defend the reforms of the eighties and early nineties.
So the question which must be asked by those of us who believe in economic freedom is: did the New Zealand reforms of the eighties and early nineties work, or did they not? If they did not work – as the present Labour Government clearly wants the public to believe – that has very serious implications for the value of economic freedom because few other developed countries moved as far or as fast towards economic freedom as New Zealand did over the years between 1984 and 1993. Certainly, the speed and extent of the moves towards economic freedom in New Zealand were more remarkable than those undertaken by Margaret Thatcher in the UK or Ronald Reagan in the US – though to be fair we had further to move!
Well, we know first that between 1984 and 1999 the gap between after-tax incomes in Australia and after-tax incomes in New Zealand fluctuated a bit, but was the same in 1999 as it had been in 1984 – Australian after-tax incomes were 20% above those in New Zealand in 1984 and they were still just 20% above those in New Zealand in 1999, despite New Zealand’s being hit by two successive droughts and the Asian crisis (which had a much more serious impact on New Zealand than on Australia) in the late nineties. Put another way, the reforms were successful in stopping the increase in the gap which had emerged between 1970 and 1984.
We also know that, after a period of adjustment in the late eighties and early nineties during which growing sectors were offset by industries which shrank or disappeared, growth in real incomes has been strong – averaging 3.8 per cent annually from 1993 to 2006.
Part of this growth – rapid by the standards both of New Zealand’s previous experience and of growth in other developed countries – was a result of bringing back into employment those made unemployed in the late eighties and early nineties (0.9 per cent annually on average); part a result of additional investment (1.2 per cent annually); and part a result of what we economists call multifactor productivity (1.7% annually).
And interestingly, the sector where productivity growth was most rapid was agriculture, the sector which went cold turkey with the abolition of subsidies in the mid-eighties, to the point where New Zealand agriculture is virtually totally devoid of any kind of subsidies – perhaps the only agricultural sector in the world of which that can be said.
We know that the reforms produced a quantum leap in the quality of many goods and services, something not easily measured by conventional statistics: more convenient shopping hours, no more getting down on bended knee to get a bank loan, no more waiting for years to get a phone connection. Many New Zealanders forget these benefits, or are too young to remember just how frustratingly inconvenient life was for many people in the years before 1984.
Another thing we’ve seen is the flowering of an extraordinary number of highly entrepreneurial companies – a company which used to assemble cars which now produces a large part of the world production of devices (I’m not even sure what they’re called!) for lifting containers on and off trucks; a company which provides broadband services to rural customers in New Zealand using a Thai-owned satellite high over the west coast of Australia; a company which produces a significant fraction of the ion diffusion devices used by the multinationals which produce silicon chips for computers; a company which supplies merchandising display cabinets to some of the largest companies in Europe because they can design, produce and install the cabinets many times faster than the competition; a company which produces crystal oscillators used in GPS systems around the world; and many more.
So for those of us who believe in economic freedom, that’s all good news: the policies of the eighties and early nineties worked in providing a significant lift to New Zealand’s growth rate, a significant improvement in the convenience of modern life, and a significant flowering of entrepreneurial activity.
But wait: why has there recently been a tapering off in productivity growth, with after-tax incomes in Australia now estimated to be not 20% but some 37% above those in New Zealand, and that gap projected to widen further over the next few years – with total growth projected to be faster in Australia than in New Zealand, and Australian tax rates coming down and New Zealand rates remaining higher on all incomes up to some $210,000 annually.
Why does the New Zealand Treasury itself concede that while “New Zealand will continue to experience reasonable rates of economic growth”, this growth will probably not be sufficient to shift the country into the top half of the OECD within the next decade?
For a time, with New Zealand’s growth running at slightly better than the OECD average thanks to the reforms of the eighties and early nineties, it looked as if the goal would eventually be in sight. But right now, we aren’t moving up the rankings at all!
When we look more carefully at the whole period from the early nineties to the present, we find that it was actually a “game of two halves”. In the period 1992 to 2000, labour productivity grew at an annual average rate of 2.7%, but since 2000 it has averaged just 1.2%. Similarly, in the earlier period, multifactor productivity growth averaged 2.3%, but it’s been just 0.7% since 2000.
Indeed, in the latest year for which figures are available, the year to March 2006, labour productivity growth in what the Statistics Department calls the “measured sector” – essentially the business sector – was the lowest since the series began in 1988, while multifactor productivity was actually negative!
The Reserve Bank of New Zealand has recently suggested that the country’s sustainable rate of economic growth is not the 3.8% average growth achieved over the years between 1993 and 2006 but about 3.2%, and this is expected to fall to 2.6% by next year.
Last week, the Government brought down its 2007 Budget. The projections on which it was based assume real growth will average just 2.3% annually in the five years to 2010/2011. We certainly aren’t going to move up the OECD rankings too quickly at that rate!
It is not the policies of the eighties and nineties which have “failed” but the policies which have been implemented much more recently.
And the explanation for this dismal situation is absolutely consistent with the views of those who see economic freedom as good for growth, because there’s been a marked reduction in economic freedom over the last few years.
As one leading businessman wrote in a letter to me last year, “by far the most worrying economic trend for the future is the extensive and pervasive re-regulation which is occurring in all manner of areas, such as the resource management arena, local government, Commerce Act, securities and capital market regulations, the Kyoto Protocol, employment relations, and individual industries such as telecommunications, banking and electricity”.
Another businessman, in the marine industry, advised me that “New Zealand has the most negative, difficult, destructive, unhelpful and impossibly bureaucratic environment in the world to develop aquaculture”.
The way the Government is administering the so-called Hazardous Substances and New Organisms Act – admittedly passed under the previous National Government in 1998 – means that there’s been an almost total halt to the importation of new plant species, on which the future of New Zealand agriculture partly depends. Prior to the passing of that legislation, an estimated 500 to 600 new plant species were brought into the country each year. As of 2005, only two new species had been introduced for public release since the Act was passed because the exorbitant cost of the environmental assessment has successfully stopped the regular flow of plant material. A senior official in the Ministry of Agriculture told me, on the occasion when New Zealand celebrated the centenary of the introduction of kiwifruit to New Zealand, that the plant would never be allowed into the country under present rules.
New employment laws strengthen trade unions, and make it more difficult to dismiss unsatisfactory staff. There is a push to reintroduce centralized wage settlements, and an increase in strike activity, especially in the public sector.
New holidays legislation not only mandates an additional week of paid annual leave but has had a dramatic effect on the number of those taking sick leave, with one major company advising in its annual report that the frequency of sick leave has increased by more than 70% as a result of the passage of the law.
In 2005 alone, 9,327 pages of new legislation or regulations were published, the most in New Zealand’s history.
So-called resource management legislation deserves a special mention because that is blamed by many businesspeople and economists for discouraging investment and hampering growth. A year or two back, the Forest Industries Council observed that there were 21 major wood processing plants under construction in Australia and none at all in New Zealand, and they laid most of the blame for that situation at the feet of the resource management legislation.
The same legislation inhibits investment in electricity generation – even so-called sustainable electricity generation, based on wind and water – slows investment in roads, and pushes up the cost of housing. The legislation urgently needs a radical overhaul, but the present Government has made matters worse by providing taxpayers’ funds to support those who would protest almost any kind of investment activity.
Recently, the state-owned coal company has incurred an estimated cost of $35 million because of concern that a species of snail – alleged to number only some 500 – would be at risk of annihilation if coal mining began at a particular site. To date, 5,600 of the creatures have been carefully moved, with a further 1,900 expected to be moved before mining begins – at an average cost to the company of nearly $5,000 per snail!
Sometimes, the application of the resource management law borders on the utterly absurd. Some months ago, a property developer wanted to erect a sign announcing his project to people passing on the nearby road. When the municipal government failed to give him consent to erect the sign, he decided to mow a sign into the long grass on his property. The municipal government told him he was in breach of the Resource Management Act because the “sign” was visible from a public place – namely by those flying over his property!
The present Government has made the tax system much more complicated – though it’s simplicity itself compared with the US tax system! – by abandoning the situation which had prevailed since 1989 of having the company tax rate identical to the top personal tax rate; and greatly extended the range of incomes at which people face very high effective marginal tax rates through the way in which they’ve sought to redistribute income towards families. By so doing, they have created greater disincentives to work and invest, and moved further away from the recommendations of the Tax Review Committee which they themselves set up – which advocated a lower, flatter income tax structure.
Government spending has gone up not only in absolute terms but relative to the economy, despite the economic growth of recent years. And it’s entirely unclear what benefits have been obtained by that increase in government spending. Phil Rennie, of the Sydney-based Centre for Independent Studies, has observed that government spending is some $20 billion a year higher now than it was when Labour came to office in late 1999, with no discernible improvement in any of the major social indicators. Had that $20 billion been devoted to reducing taxes instead of increasing government spending, Mr Rennie calculated that virtually the whole of the government’s operations could now be funded from a low company tax rate and the existing indirect taxes, with no personal income tax at all!
Between re-regulation, the Resource Management Act, increased taxation and increased government spending, it’s not at all hard to believe that economic freedom has declined in New Zealand in recent years, and growth potential with it. Certainly, New Zealand has gone backwards over the last few years on most of the international measures of economic freedom.
Having said all that, it’s still a puzzle to many observers, including the OECD in Paris, why the dividends from New Zealand’s reforms have been so modest. After all, we’re not the only country which has excessively intrusive regulations and a tax system which is a pain in the neck for taxpayers. New Zealanders work longer hours than do people in most other developed countries, and yet the level of output per person remains stubbornly below that in most other developed countries, and growth in productivity seems at risk of again falling below the OECD average.
Various explanations have been put forward.
Perhaps New Zealand’s small size and distance from world markets count against us. Yes, though it’s not clear why that should be a bigger problem in the age of jet aircraft and internet than it was in an earlier era when we ranked much more highly on the international ladder.
Perhaps New Zealand’s exchange rate is more volatile than that of other trading countries, and because New Zealand is so heavily dependent on trade that has an adverse effect on our growth. A plausible theory, and the strong exchange rate is currently making life very difficult indeed for many exporters; but actually the New Zealand dollar is not notably more volatile than other currencies, and we are much less heavily dependent on trade than most other small economies.
Perhaps the New Zealand tax system creates a bias in favour of investment in property and away from sectors which have greater potential for long-term growth. Yes, but that bias is probably less than it is in countries such as the US, where interest on residential mortgages is deductible against other income.
Perhaps New Zealand has the misfortune to have a comparative advantage in producing goods and services for markets which other developed countries tightly protect. That’s certainly true, and that could be part of the problem.
And perhaps at the core of the issue is a cultural or political problem.
Too many New Zealanders look to government to solve their problems, even the absolutely predictable ones, like the loss of income following eventual retirement.
I recently listened to a discussion on radio on the desirability of providing better insulation in New Zealand homes. It was argued that this made good sense because the initial cost of insulation would be quickly recovered from reduced heating costs. And then somebody argued that the government should subsidise home insulation. But why, if the cost of insulation is really going to be quickly recovered by reduced heating costs?
Determining how much compensation should be paid to the indigenous Maori New Zealanders for injustices suffered in the past is taking decades rather than years, and one of the sad consequences of that is that far too many Maori New Zealanders are deluded into thinking that compensation will solve all their economic problems. Compensation should certainly be paid, but it is a cruel hoax to let Maori New Zealanders imagine that a cheque from the government will raise their living standards to that of other New Zealanders.
Michael Bassett, another of the senior Ministers in the reforming Labour Government of the eighties and now one of New Zealand’s most respected historians, has written a book in which he argues that the tendency of New Zealanders to look to government for the solution to every problem goes right back to the very beginning of European settlement in New Zealand in the middle of the 19th century.
And most New Zealand governments, depending as all governments in democratic countries do on the votes of the public, have been only too happy to bend over backwards to try to meet those expectations while hiding the true cost of doing so.
Want more leisure and less work? Certainly, have an extra week’s annual leave, and try not to notice the lower wages you’ll be getting to pay for that extra leave.
Want the university education of your children to be even more heavily subsidised than it is now? By all means, and try not to notice the increased taxes and higher mortgage interest rates you’ll pay as a consequence.
Want nothing to do with correct road pricing? Fine, and try not to notice your rapidly increasing municipal government property taxes (what we call “rates” in New Zealand) and regional gasoline taxes.
Want to continue with the tax preferences for property investment? OK, but try not to notice when an increasing fraction of the companies on the share-market are snaffled by foreigners because locals are investing all their savings in property.
Want to ignore the recommendation of the Government’s own Tax Review Committee to limit the income tax paid by any one person to $1 million per annum because you think it fair that some people should pay hundreds of times more in taxes than they will ever cost the community in government services? Good idea, but try not to notice that most of the very affluent have left the country, taking their capital, their entrepreneurial skills, and their tax obligations with them.
Want to keep the top tax rate at 39% in case my successor, John Key, gets a bigger reduction in his tax bill than you do? Happy to oblige, but don’t read the Treasury paper which suggests that a lower/flatter tax scale could add between ½% and 1% to our per capita growth rate, something which would make us all much richer.
Want to save nothing for your children’s education, for your own healthcare, or for your own retirement? Fair enough, spending everything you earn is OK – in fact, spending more than you earn is OK too, if your house is going up in value – but try not to notice that we will keep increasing the taxes you pay to fund all those things – and then deliver the services which we, the government, think are right for you and not the ones you choose for yourself.
Want to ignore the overwhelming evidence, from New Zealand and other countries, that having governments run commercial enterprises rarely works well in the long term? OK, and try not to notice the gradual increase in political interference in the way those operations work, and the gradual decline in their efficiency – which ultimately flows on in the form of higher prices for their goods and services.
Sadly, there is an ever-present temptation for governments in all democracies to buy votes with taxpayers’ money. By taking $50,000 in taxes off Peter and using that to hand $9,000 to five Pauls (using $5,000 to collect the taxes and hand out the benefits!), governments hope to gain a net four votes. Only the governments of benevolent dictatorships, and perhaps those of countries where the voice of the people has been deliberately muted in the constitution (like the United States), can, it sometimes seems, ignore that arithmetic.
Two things nevertheless make me an optimist.
The first is that, in an increasingly integrated world, no government can indefinitely rob Peter blind to pay five Pauls. Peter will eventually leave, and find a more congenial fiscal environment.
I’m sure everybody in this hall knows the story of the 10 men who regularly ate at a restaurant for a total cost of $100, with four men paying nothing of the bill, five paying small amounts, and one paying over $50. When the restaurant owner reduced the bill by $20 as a discount for good customers, those who had paid nothing originally got no benefit from the discount, while the man who had paid over $50 got a reduction in his bill of $10. Those who had gained nothing or very little from the discount were angry, and set upon the man who had got a $10 benefit. The next time the men met to eat, there were only nine of them, and they were all left wondering who was going to pick up most of the tab.
That is increasingly true of the real world, at least in New Zealand: those who have been paying the most in taxation are increasingly leaving the country or finding other ways of ensuring that they minimise their tax bill. Beyond some point, governments simply will not be able to rob Peter blind to pay five Pauls. And when Peter has gone, the Pauls who are left behind will be left wondering how to attract him back again.
The second thing which makes me an optimist was the New Zealand experience in 2005. In that year, the centre-right party which I was privileged to lead went into the election with a policy platform which included:
No, it wasn’t a perfect platform: in particular, the tax scale would have been quite a distance from the “lower/flatter” scale which the Tax Review Committee and the Treasury both recommend; and we were too timid to argue the case for further privatization. But it was a substantial step in the direction of greater economic freedom, and would have yielded a useful growth dividend.
We came within a hair’s breadth of winning the election, and indeed I believe we would have won it had the governing Labour Party not seriously broken two laws during the campaign (using a large amount of taxpayer funding to pay for their campaign and substantially exceeding the legal limit on total spending).
I don’t doubt that, explained with vigour and imagination, a policy platform based on the principles of freedom can be made very attractive to a majority of voters.
Copyright © 2024 Don Brash.