Economic Reform in New Zealand (1984-1999): A Retrospective
By James E. Alvey
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New Zealand was once regarded as one of the most interventionist welfare states in the western world. How did it switch from being a model of the welfare state to a model of economic liberalism? And how permanent will this switch be under the new government?

The ÔNew Zealand modelÕ of heavy government intervention was once celebrated as a leading example of socialism. In 1984, however, the newly elected Labour government introduced a wave of economically liberal reforms that not only saved New Zealand from becoming an economic museum, but also earned it a reputation as one of the western worldÕs leading economic reformers. When the Labour Party lost office in 1990, the Nationals, who had adopted many of the economically liberal reform policies enacted by Labour, began implementing a second wave of reforms.

Despite these two waves of reforms, the former reformist New Zealand Finance Minister, Ruth Richardson, has argued that a third wave of reforms is needed to tackle incomplete privatisation, agricultural producer boards, the Employment Court, social welfare, education and health (Kasper 1996a). Security of property rights also needs to be restored after being undermined by two sources: extensive Maori land claims and settlements, and local government zoning and environmental interference through the Resource Management Act.

The obstacle to further economic reform, however, and the main reason why the Nationals were unable to continue their reform programme, is essentially political. In 1996, New Zealand changed its electoral system, with the Mixed Member Proportional (MMP) system replacing the British first-past-the-post electoral system. MMP is based on the German electoral system and combines electorate seats with proportional representation. Generally, electors have two votes: one for the party and one for the electorate contest.

As has happened with proportional representation in the Australian Senate, the new electoral system in New Zealand virtually ensures that no party can govern alone. This is why the Labour and Alliance Parties formed a coalition after ousting the Nationals at the 1999 election, although this coalition then fell short of the required number of seats. The new government now has a parliamentary minority and depends on the support of the anti-business Green Party to pass legislation. What the new government thinks of the economic reforms will be discussed later, but first we need to take a closer look at the economic reforms.

The reforms

During the reform era, the rules of the game were changed in many ways. The old rules (pre-1984) were geared towards a guiding role for the state. Individual initiative and entrepreneurship were restrained and individuals were dependent on the state. Losses incurred in competition were often compensated by the redistributive actions of government. There were also many exceptions to the rules. As a result, much activity was devoted to gaining special privilege, or rent-seeking, rather than developing markets and increasing efficiency. New ZealandÕs Ôconstitution of capitalismÕ was effectively undermined during this period (see Kasper 1998: 3).

The reforms initiated in 1984 tried to restore this ÔconstitutionÕ. They increased the coordinating role of pricesÑrelative to that of governmentÑin the market. They applied universal principles with no exceptions. They aimed to increase the scope for individual initiative instead of government direction, and also competition and efficiency. Their ultimate purpose was to increase sustainable firms, industries and employment, and hence increase living standards over the longer term.

By 1991, the OECD reported that Ôthe changes implemented since 1984 have formed the most comprehensive microeconomic reform programme undertaken by an OECD country in recent yearsÕ (OECD 1991: 82). Within just a few years, New Zealand had switched from being a model of the welfare state to a model of economic liberalism. What follows is a summary of some of the main reforms enacted during this period.

The five wave (1984-1990)

In the first wave of reforms, New Zealand opened up to the world. Markets were deregulated, taxation principles and rates were improved, and government interference was largely removed from monetary and exchange rate matters. Most subsidies and incentives were removed in late 1984. The exchange rate was floated in 1985. The GST was introduced in 1986 with virtually no exemptions (unlike the Australian case). The top rate of personal taxation was reduced in two stages from 66% to 33% in 1988. The Commerce Act (1986) introduced a regime of light-handed regulation of industry and the liberalisation of merger and takeover restrictions.

Accompanying this were deregulations in a wide range of specific sectors, including energy, telecommunications, airlines and financial markets. The comprehensive system of quantitative controls on imports was converted into tariff equivalents immediately, with those tariff rates being reduced over time. The public sector was reorganised along market principles wherever possible; much of this sector was either corporatised or privatised. The Reserve Bank Act (1989) gave the Bank operational autonomy in pursuing the goal of monetary policy, which was price stability.

The second wave (1990-1994)

In the second wave of reforms, the labour market was reformed, sound public finance management was legislated, and several of the reforms initiated by the Labour Government were taken further. Large privatisations continued. Further significant tariff cuts were announced, and today residual tariffs are minimal. Industry deregulation was initiated in several new areas. The Employment Contracts Act of 1991 abolished compulsory unionism, ended centralised wage fixation and encouraged the development of individual contracts between employers and employees. In 1991, welfare eligibility was tightened and welfare payments were reduced. The Fiscal Responsibility Act (1994) required the government to set ten year fiscal goals in each annual budget; deviations from balanced budgets and prudent levels of debt would have to be explained.

The reformsÕ achievements

The longer term achievements of these reforms can be grouped with reference to five macroeconomic standards: inflation, economic growth, unemployment, external balance and the fiscal position.

1.Inflation has been tamed by the reforms. In the 1980s inflation was dangerously highÑit tended to be above 10%Ñand threatened to undermine New ZealandÕs market economy, which depends on price stability. Yet when the prices and wages freeze, which began in 1982, was lifted, inflation soared to over 18%. This serious situation required dramatic changes; the establishment of the Reserve Bank Act, with its inflation-targeting, was the appropriate response. By the end of 1991, inflation had been brought under control (see Graph 1 -see PDF version of this article). Since then inflation, as measured by the CPI, has not risen above 5% p.a. and since September 1995 it has been below 3%. The inflation rate for the 1999 calendar year was 0.5%. The reduction of inflation to low levels is a fundamental achievement of the reforms; it has brought about a dramatic change in the expectations of price changes. The outlook for 2000 is for a slight rise in the inflation rate to a little under 2%.

2.Economic growth has been subject to the usual fluctuations through the business cycle but the average real rate over the period since 1984 (2% p.a.) has been somewhat disappointing. Due to the extensive restructuring of the economy, which followed the reduction of industry protection and the corporatisation of the public sector, economic growth during the period 1988-1992 was either extremely low or negative. A series of years with high or moderate economic growth then followed. In the year to March 1994, for example, real economic growth was 6.3%. This growth period was cut short by a cyclical downturn and, shortly after, the Asian economic crisis. As a result, New Zealand experienced negative economic growth in late 1998 and early 1999. The latest figures show New Zealand just emerging from the effects of the crisis with an annual growth rate of 1.9% in the year to September 1999. The National Bank of New Zealand, in its November 1999 Quarterly Economic Forecasts, presents a very rosy picture of the state of the economy. It states that: ÔJust about every piece of economic news is positive.Õ The consensus on economic growth seems to be that it will peak at a little under 4% growth in 2000.

3.Unemployment levels have fluctuated, but have not dropped to an ideal level. Unemployment fell in 1985, but rose constantly from then until March 1992 when official unemployment reached 11.1%. The good economic growth mentioned above led to falling rates of unemployment until September 1995, when unemployment was 6.1%. The unemployment rate rose subsequently to 7.7%. Seasonally adjusted official unemployment was 6.3% in December 1999. Overall, there has been significant growth in employment but this has not matched the growth in the labour force. A fairly high natural rate of unemployment seems to have been established. The outlook for 2000 is for a slight improvement in the unemployment rateÑto a little below 6%Ñas a result of the predicted growth in GDP.

4.The external balance, which has historically been a major concern in New Zealand, remains a problem. In the quarter that the reforms began, the current account deficit was 7.9% of GDP. This deteriorated to 8.9% of GDP by the March quarter of 1986. It then improved greatly over the next few years until external balance was almost achieved in 1989. Since 1994, however, the current account problem has worsened almost every quarter. In the September quarter of 1999, the current account deficit had reached 6.5% of GDP. Throughout the entire period since 1984 New Zealand has run current account deficits and the external balance remains one of the major weaknesses of the economy. As Australian readers know, this problem is not unique to New Zealand. The outlook for early 2000 is for the current account deficit to rise to nearly 8% of GDP, before declining to perhaps 5.5% of GDP by the end of the year.

5.The fiscal position has been dramatically improved. The budget deficit was 8.9% of GDP in 1983/84 and rising; the net public debt was 32% of GDP in 1983/84 and rising; and the gross public debt/GDP was 63% in 1983/84 and rising. Government deficits were gradually brought under control and, since 1992, surplus budgets have been produced (see Graph 2 below). Net and gross public debt levels have also been significantly reduced. The governmentÕs operating balance was a surplus of 3.5% of GDP and net crown debt was 22% of GDP as at November 1999 (NZ Treasury 1999). The OECD says that Ôthe governmentÕs financial position has improved substantially, assisted by the Fiscal Responsibility Act which emphasises prudent budgetary management. This is reflected in public debt levels that are now lower than the OECD averageÕ (1999a: 13). The outlook for 2000 is for a small fiscal surplus, albeit significantly less than would have occurred without the change of government.

Overall, the performance of the New Zealand economy after 1984 has been less than spectacular, given the dramatic nature of the reforms. What are we to make of this? It suggests to me that New Zealand was in terrible shape in 1984 and that much pain had to be endured to put things right. The gain started to appear in the early to mid 1990s. By the time the 1997-1998 Asian crisis hit, New Zealand was in fairly good shape. It survived that crisis and is now back on track.

It must also be remembered that the period from 1994 onwards witnessed various u-turns and zig-zags in government policy. Such developments led to uncertainties for business and rising transaction costs, and must have had adverse consequences for entrepreneurs with mobile resources, who were looking at where to invest. The events during this period may even partially explain the slow economic growth in recent years.

Perhaps it is more pertinent to ask what New Zealand would have been like without the reforms. We do not know, but probably it would have been hit much harder than it was in 1998. The robustness and flexibility of the New Zealand economy was seen in the speed of its recovery from the Asian crisis. Strong patients survive on the operating table, but weak ones do not. Hence, medical practitioners exhort us to exercise, eat appropriate foods, and so on. The analogy can be drawn to the economic structure and the economic reforms. The economic reforms from 1984 until the Asian crisis were the equivalent of healthy exercise and diet. The New Zealand economy survived the ÔoperationÕ of the Asian crisis and recovered quickly.

Reform casualties of the new government

What does the new government think of the reforms? Generally, the Labour Party only questions the extent, not the broad direction of, the reforms after 1984. Overall, however, the direction of the policy changes under the new government is already fairly clear, and in the next three years we are bound to see the reversal of some foundations of the reforms.

Even the return of the Nationals to power would not necessarily lead to a dramatic resurrection of a reform programme. The present leadership of the National Party was unenthusiastic about reform by the end of its tenureÑreform along the lines suggested by Ruth Richardson was considered off the agenda. The best possibility for a return to economic reform along the Richardson line is if the Nationals are galvanised into action by a new coalition partner. The ACT Party, which grew out of the Association of Consumers and Taxpayers and is led by the former reformist Minister Richard Prebble, may wish to push the Nationals in the reform direction, but will only be effective if the two parties combined can muster a majority in the parliament.

Meanwhile Labour will come under pressure from its junior coalition partner, the Alliance, to undermine the foundations of the reforms. In turn, the coalitionÕs own minority status means that concessions will have to be made to the unpredictable, anti-business Green Party. The Prime Minister has indicated she may expand the coalition to include the Greens, in order to gain a parliamentary majority. This would shift the balance of the government away from the more moderate Labour Party. The creation of such a coalition would be a cause for even greater concern than the present arrangement.

The rollbacks

The election of 1999 has already led to a major set of reversals by the new government, as we can see from the list below. The consequences can only mean further uncertainties and rising transaction costs for business.

¥ It plans to scrap the Employment Contracts Act, for instance, which brought a great deal of decentralised bargaining into industrial relations. The Employment Relations Bill has been designed to replace it, and is currently being debated in the Parliament. More power will be given to trade unions, but the details are still unclear.

¥ A new personal tax bracket has already been introduced with a rate of 39% for income above $NZ60,000. This decision, the expectation of which was a major campaign issue, raises the highest tax bracket by six percentage points. Effective from April 2000, it represents a major departure from the past pattern of flattening personal tax rates. International observers have already expressed concern that the marginal tax rates on earnings of an average production worker are too high in New Zealand (OECD 1999b: 31). The tax increase also opens up a gap between the highest personal tax rate and the corporate tax rate (33%). A lot of energy will be sunk trying to rearrange finances so that income will be taxed at the corporate rather than the personal income tax rate. This will not aid economic efficiency or economic growth. The fringe benefits tax will also increase from 49% to 64% in April 2000.

¥ A new interventionist body, called Industry New Zealand, will be set up to provide industry assistance and export aid. ÔStrategic economic developmentÕ or Ôpicking winnersÕ is a significant departure from the approach of the reform period, which was based on government neutrality.

¥ Tarrif reductions will be viewed more cautiously. A more nationalistic approach will be adopted towards the local music, publishing, and film industries. A hint of the protectionist stance of the Alliance can be seen already.

¥ The government is dedicated to significantly increasing government spending on education and health. It will also reintroduce a government monopoly on accident compensation, which was opened to competition in the last parliament.

¥ Unlike the past 12 years, there will be no public asset sales in this parliament. The previous government was planning to privatise some power stations and some prisons. There seems to be little electoral support for the latter measure.

¥ The former governmentÕs plan to ÔcommercialiseÕ roads, with State Owned Enterprises (SOEs) being formed to run the highways and public roads, will be stopped. There is little electoral support for this policy either.

The fallout

Given these changes, what we now need to ask is how entrenched are the reforms? Let us assume, for instance, that the government can muster the parliamentary votes to overthrow the Employment Contracts Act. This opens up scope for unions to seek special privilege and the undermining of individual responsibility. Nevertheless, because obtaining parliamentary majorities will not be easy for this government, it is difficult to see a major legislative programme being delivered.

Legislative changes aside, there are some changes which can be made without parliamentary approval, such as the plans to establish Industry New Zealand. This would allow considerable scope for individual firms and industries to seek the subsidies, taxation concessions and special deals that were characteristic of the pre-1984 era.

There is also room for new government regulations and administrative rule changes. During the reform period, new formal rules were established which provided neutrality between industries and firms; they did not allow much scope for privilege-seeking groups. Considerable scope has now opened up for groups seeking rents. Furthermore, firms and industries may no longer feel the need to strive to adapt quickly to the changing external environment. They may now anticipate that government will assist or bail them out. Finally, we need to ask whether the period 1984-1999 was sufficiently long enough for a new mentality and set of expectations to take root in New Zealand. In other words, will old work practices rise again or have they changed sufficiently to make legislative changes by the new government ineffective? At this stage, there is no clear answer, but there is considerable cause for concern.

Conclusion

The New Zealand reforms after 1984 were dramatic, and became a model for other countries. The fruit of the reforms began to appear in the early to mid-1990s. In terms of price stability and budget balance, the results have been dramatic. Other indicators have been disappointing, but will improve during the present economic upswing. It must also be recognised that economic growth suffered from the recent Asian crisis.

Generally, the reforms were in the right direction. Mixed signals were given about the reform agenda in the period after 1994. The more dramatic change of direction after 1999 will do more damage. Worse still, the long term benefits of the 1984-99 era are now under threat.

References

Dalziel, P. and R. Lattimore 1999, The New Zealand Macroeconomy, Greenlane, N.Z., Oxford University Press.

Kasper, Wolfgang. 1996a, ÔResponsibility and Reform: A Conversation with Ruth RichardsonÕ, Policy, Spring: 25-31.

ÑÑÑ. 1996b, Free to Work, Centre for Independent Studies, Sydney.

ÑÑÑ. 1998, Property Rights and Competition, Centre for Independent Studies, Sydney.

National Bank of New Zealand Ltd. 1999, Quarterly Economic Forecasts 39, November.

New Zealand Treasury. 1999, Financial Statements of the Government of New Zealand for the Five Months ending 30 November 1999, Wellington.

OECD. 1991, OECD Economic Surveys: New Zealand 1990/91, Organisation for Economic Cooperation and Development, Paris.

ÑÑÑ. 1999a, OECD Economic Surveys: New Zealand 1998-99, OECD, Paris.

ÑÑÑ. 1999b, OECD Economic Outlook, OECD, Paris, December.

James E. Alvey is Lecturer in the Department of Applied and International Economics, Massey University, New Zealand. Unless otherwise stated, statistics come from Statistics New Zealand publications. Thanks are due to Wolfgang Kasper and Gary Buurman for useful comments on an earlier draft.

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