A Sick Economy Was the Impetus for Reform

Changing economic course is not easy for democratic governments, especially when it entails breaking past commitments and long-established practices. In the face of adversity, politicians are likely to settle for incremental or piecemeal measures. An OECD study of economic policy reversals in eleven countries found that the government took strong action only when existing conditions became unsustainable. Political leaders did "not seriously tackle the root cause of their problems until the situation approached crisis conditions and the need for remedial action became evident and broadly accepted by the unions and the population at large" (Why Economic Policies Change Course, OECD, Paris, 1988).

Economic conditions were not sustainable in New Zealand when the reform process was initiated in 1984. The economy was in disrepair and conventional remedies - more fiscal stimulus and more governmental intervention - had not worked. The government faced high budget deficits, and interest rates were soaring while the value of the New Zealand dollar was plummeting. Doing nothing - or as little as politicians could get away with - was not a viable option. When they acted, beginning shortly after the 1984 election and continuing into the next decade, political leaders moved in three overlapping stages. First they freed the private sector from extensive government regulation; then they restructured the commercial operations of government along market lines; and, finally, they decontrolled the State sector and the labour market. Most of this was accomplished in about half a dozen years, though fine-tuning the reforms has been ongoing. Looking back at the exhilarating pace of reform, one can discern the logic of proceeding in this sequence. It enabled politicians to build on success in deregulating the market economy before they came to grips with more contentious changes in the State sector.

The shocks of economic distress were so unsettling because in the post-World War II era New Zealand had one of the most sheltered economies in the Western world. Generous welfare schemes protected households against the financial strains of unemployment, illness, and old age. These and other social expenditures were financed by a protected economy that benefited from preferential ties with Britain which bought just about all the agricultural products that New Zealand wanted to export to it. The economy was heavily regulated. Exports were subsidised, imports were controlled, as were foreign exchange transactions. Major transport, energy, communications, and other enterprises were owned and operated by government entities. The economy operated in a governmental cocoon that sought to buffer it against competitive pressures. Sheltered from much of the outside, New Zealand probably did not perceive the extent to which it was losing ground. During boom times in the 1960s, as Table 1 shows, the country's real growth was significantly below the OECD average.

Table 1. Comparison of New Zealand and OECD Economic Trends (percent)

 

New Zealand

OECD

Average Annual Real GDP Growth

   

1960-68

3.3

5.1

1968-73

5.1

4.7

1973-79

0.2

2.6

1979-85

2.9

2.2

Average Annual Unemployment Rate

   

1968-73

0.3

3.4

1974-79

0.8

5.2

1980-85

7.6

7.8

Average Annual Change in Consumer Prices

   

1960-68

3.3

2.9

1968-73

7.4

5.6

1973-79

13.8

10.0

1979-85

12.8

7.6

Source: OECD, Historical Statistics, 1960-87

   

In fact, it ranked near the bottom of OECD countries (22nd out of 24) in the rate of economic growth. But unemployment was negligible and inflation was moderate.

The cocoon economy was brought to an end by two 1973 shocks that have had a lasting impact on New Zealand. One was the entrance of Britain into the Common Market, the other was the OPEC oil crisis. The first deprived New Zealand of its protected market for agricultural exports, the second drove up the price of energy and led to worldwide economic stagnation. Table 1 indicates the sharp deterioration in the country's economic performance after 1973. Growth came to a virtual halt; economic activity declined in four of the ten years between 1974 and 1983 and grew 2 percent or less in two other years. Inflation soared, as it did in other countries, but it persisted in double digits even after cost pressures moderated elsewhere. The official rate of unemployment was much lower than that of most OECD countries, but the actual rate was higher. Substantial unemployment was hidden in make-work schemes and by padding the work rolls of government enterprises.

The government's initial responses to the bad news were to provide some old-fashioned fiscal stimulus by investing in large energy projects and by adding subsidies for domestic industries and tightening regulations. Because the viability of some public works investments depended on a steady rise in energy prices, the government was left with uneconomic projects and heavy debt when oil prices tumbled in the early 1980s. The government had short-term success with a wage and price freeze introduced in 1982, but this only worsened the structural distortions in the economy. Interest rates spiralled, as did the budget deficit. Most ominous was a run on the New Zealand dollar, which lost more than half of its value against the U.S. dollar during the 1974-83 decade.

The progressive deterioration in the country's economic performance left New Zealand much poorer than it would have been had growth matched the OECD average. In the 1960s, New Zealand's per capita income ranked among the highest in the OECD community; in the 1980's, it ranked among the lowest. This slippage was due to meagre gains in productivity. During the quarter of a century from 1960 through 1985, real GDP per worker advanced at about only one-tenth the OECD average.

This sorry state of affairs might have been permitted to continue for a while were it not for a currency crisis that coincided with the 1984 Parliamentary election. There was a substantial outflow of foreign exchange during the first half of 1984; the outflow accelerated as election approached in July. In the election, the National Party lost its majority in Parliament and was replaced by a Labour government. The foreign exchange market was closed immediately after the election; when it reopened three days later, the New Zealand dollar was devalued by 20 percent.

Devaluation brought some breathing space, but it did not resolve the structural problems that beset the New Zealand economy. Many New Zealanders viewed the election as a mandate for change, though at the time few could foresee how far-reaching the changes would be. The 1984 election signalled a basic shift in attitudes toward government. The intellectual and political consensus which underlay postwar New Zealand policy had collapsed.

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