Why have kiwis not become tigers? Reforms, entrepreneurship, and economic performance in New Zealand.

• Author: Sautet, Frederic

The New Zealand economy is now famous in policy circles for its turnaround during the 1980s and 1990s. Starting from a state of semiautarky in the early 1980s, New Zealand now has one of the most vibrant economies in the world. In fifteen years, successive governments reformed the country's institutional environment by injecting high doses of deregulation and opening the economy.

Following these changes, the New Zealand economy climbed the ladder of the Index of Economic Freedom: New Zealand's score increased from 5.9 in 1985 to 8.2 in 2002 (Gwartney and Lawson 2004). Yet its average growth rate in the past decade does not compare to that of the Asian tigers, Singapore and Hong Kong, or that of Ireland, Estonia, and Luxembourg, countries that share some of the best ranks in the index.

In addition to the modest growth in the past decade, the relatively poor growth prospects for the years ahead have fueled the debate about the success of the New Zealand reforms. Some economists think that New Zealand's less than stellar economic performance results from the failure to complete the reform process. Others believe that New Zealand's current situation is the result of too much reform: New Zealand has been a "laboratory" for free-market policies, and it went too far. Some maintain that it is now time to go back to more middle-of-the-road policies, taking into account not only economic efficiency, but also income distribution, the environment, and many other issues left out by the reform process. In this view, better "management" of the economy should help to improve growth prospects. The Labour government espoused this opinion when it was elected in 1999 (Kay 2000). Still others think that owing to New Zealand's cultural heritage, its inhabitants are relatively uninterested in high levels of economic growth. (1) New Zealanders, it is said, do not need much money to be happy because they hold dear some egalitarian ideas that go back to the nineteenth century, reflected today in the romantic search for a peaceful and green New Zealand and perhaps also in the revival of Maori tikanga. (2)

It is now becoming clearer that in spite of the modest achievements and low productivity growth, the reforms have been hugely beneficial to the economy. (3) In opposition to its earlier views, the Labour government now recognizes the importance of the reforms, as a 2005 Budget Policy Statement shows: "NZ's recent growth performance can be attributed to past structural reforms that began in the mid-1980s, which have resulted in a trend increase in NZ's growth rate since the early 1990s ... a more flexible economy better able to absorb adverse shocks and take advantage of favourable shocks, and sound macroeconomic policy settings" (qtd. in Kerr 2005c, 1). This support is not wholehearted; the phrase "failed policies of the past" has been used at times to characterize what was done during the reforms of the 1980s and 1990s. However, a consensus is now emerging in regard to what has made the economy more vibrant and prosperous. The reforms have had a very positive impact on the entrepreneurial environment; unemployment is low, and growth is reasonably rapid. Most commentators today recognize this situation.

In the long run, what matters is the quality of the entrepreneurial environment. When the institutional and cultural environment enables individuals to discover and seize profit opportunities, growth occurs (Boettke and Coyne 2003; Sautet 2005). Taking this factor into account, I argue here that

* The reforms have vastly improved the entrepreneurial environment, and, as a result, given the starting point, they have greatly enhanced New Zealand's economic performance.

* To go beyond current levels of economic performance, New Zealanders need to improve the entrepreneurial environment further. New Zealand failed to become a growth miracle because the reforms that were implemented, though good, were not exceptional.

I first describe briefly the context in which New Zealand's reforms took place and then, second, consider the five main reforms that changed the New Zealand economy positively. In the third section, I examine the reasons why the New Zealand economy is failing to perform like that of an Asian tiger. Before concluding, I offer some policy implications.

Background of New Zealand's Reforms

Much has been said about New Zealand's reforms of the 1984-96 period. In the words of David Henderson of the Organization for Economic Cooperation and Development (OECD), the reform period in New Zealand was "one of the most notable episodes of liberalization that history has to offer" (qtd. in Evans et al. 1996, 1856). Let us consider the context in which these reforms took place (for more on the context, see especially Evans et al. 1996).

A Long Time Ago in a Country Far Away

To understand the context of the 1980s, one must go back one hundred years. At the end of the nineteenth century, New Zealand was, along with Germany, one of the first countries in the world to implement comprehensive social legislation. Even before the ravages of World War I created a demand for social assistance in Western countries, New Zealand stood at the forefront of social policies. For example, women obtained the right to vote in 1893. Labor-market reforms were introduced in 1894 in the form of a compulsory arbitration system, and a pension scheme was set in place for the "deserving poor" in 1898. The expectation slowly developed that the state should provide "cradle to the grave" protection against life's hazards. (4) From the late nineteenth century to the 1920s, the country was one of the five richest countries in the world as measured by gross domestic product (GDP) per capita. This wealth came from exports of farm produce to England (thanks to the advent of refrigeration) and from a high productivity in agriculture, which reflected a small population and an abundance of fertile land.

In New Zealand during the 1930s, as in many other countries, a rise of protectionist policies (for example, import licensing in 1938), along with a surge in the welfare state, had a negative impact on economic performance. During World War II, many controls were introduced, and the economic decline so prominent in the 1930s continued. In the post-World War II period, New Zealand's international ranking deteriorated further because the wartime controls were kept in place.

As Evans and his coauthors explain, New Zealand's gross national product (GNP) per capita in 1938 was 92 percent of that in the United States. By 1950, the ratio was 70 percent, and by the 1980s it was 50 percent (1996, 1860). In other words, over a period of almost fifty years, New Zealanders experienced constant relative decline in their standard of living. Whereas Australia's relative income per capita leveled off in the 1970s and the United Kingdom bounced back in the 1980s, New Zealand continued to sink, to around the twentieth rank by the time the reforms started in 1984.

By the 1970s, New Zealand had the most regulated economy in the OECD. Until 1973, when the United Kingdom joined the European Community, it represented the main export market for New Zealand products. Afterward, however, that export market disappeared, and the consequences of the policies of the postwar period surfaced. In the 1970s, New Zealand emerged as a semiautarkic economy, the so-called Fortress New Zealand. By the end of that decade, more and more young people were leaving the country to gain work experience abroad. For the first time, a generation of New Zealanders found overseas experience not only necessary but also preferable to the opportunities offered at home.

Besides imposing high tariffs and employing import licenses to control the balance of payments, the New Zealand government adopted many other harmful policies. Revenues from high taxes were used to provide subsidies to many major industries. Agriculture, for example, enjoyed large subsidies and had many producer boards protected by law. The government used the public-employment model of welfare to maintain high wages and employment among the masses by employing people in government-owned enterprises, thus keeping the unemployment rate artificially low. As in many Western countries at the time, inflation was rampant (between early 1970 and late 1984, it averaged almost 12 percent per year), and wage and price controls were (unsuccessfully) employed to limit its effects. The labor market was highly regulated. The exchange rate was fixed and set at levels that eventually were no longer credible, given the loose monetary policy and the weak terms of trade.

As a result of such policies, government spending rose from approximately 22 percent of GDP in 1970 to more than 35 percent by 1983, and government debt rose from approximately 5 percent to more than 30 percent of GDP; it continued to grow to 51 percent by 1992. Although these trends were not exceptional--indeed, they were common to most countries in the Western world--their effects, combined with extensive market regulations in a semiautarkic economy, stifled growth and led to the relative impoverishment of New Zealand's people. Unemployment, negligible in the 1960s, was pushing higher than 4 percent of the labor force by the late 1970s.

"There's Got to Be a Better Way!"

The first attempts to reform the economy were made in the early 1980s. Roger Douglas, an opposition politician who would later become the architect of the first wave of reforms, proposed important economic changes in 1980. (5) The Treasury had been giving advice for a few years on regulatory and tax reforms without much success before Prime Minister Robert Muldoon implemented the first serious change, signing the Closer Economic Relations Treaty with Australia. Moves toward freer trade were in the air, but not until 1984, with the change of government, did deeper and more comprehensive reforms became part of the agenda.

In 1984, New...