14 December 2007

The Real Downsides of Remoteness

This article was first published in the Otago Daily Times

The downsides of being a small and remote country are often misunderstood.

Its small population and distance from markets did not stop New Zealand being one of the world’s wealthiest countries a hundred years ago. Small, open economies can do just fine.

Much more important are the problems of not knowing at first hand what other countries are doing, and failing to absorb into local institutions and policies the lessons from their successes and mistakes. This is true even in an age of easy international communications and travel.

This dimension of remoteness helps explain why New Zealand governments were able to maintain unorthodox and damaging economic policies for decades up to the 1980s.

Many people saw nothing wrong with Robert Muldoon’s eccentric brand of economic management: he kept on assuring voters that he was a competent and successful prime minister, and for three elections they believed him.

I participated in a radio debate with unionist Bill Andersen 20 years ago in which he nominated East Germany as the world’s most successful country – just months before the Berlin Wall came down and its economy collapsed.

Opposing labour market reforms around the same time, Council of Trade Union president Ken Douglas saw them as leading to what he thought were the ‘coolie’ wages of Hong Kong, not realising that its free-market economy had lifted average incomes from the poverty levels of a generation earlier to around New Zealand’s levels.

Today annual average per capita income in Hong Kong (PPP basis) is around US$38,200, some 40% higher than New Zealand’s US$27,200 level, according to World Bank data.

In pre-reform New Zealand, relatively few people believed the economy could operate like other countries without import protection or foreign exchange controls.

That helps explain why the reforms were controversial, and remain so in some quarters despite the fact that moves towards greater economic freedom have been a worldwide phenomenon and that recent governments have largely kept them in place.

Lately, however, the New Zealand habit of overlooking lessons from abroad seems to have returned, and failure to absorb them is seeing a deteriorating economic trend relative to the better growth and productivity performance of the 1990s.

Finance minister Michael Cullen has kept assuring New Zealanders that the country is doing as well as Australia economically.

Superficially, the argument is plausible. Taking the last decade as a whole, Australia has averaged 3.4% annual economic growth compared with New Zealand’s 3.3% rate.

But whereas New Zealand’s economic and productivity growth rates have been declining, and the Treasury forecasts annual growth of only 2% over the coming few years, the Australian economy has accelerated to over 4% growth and looks set to continue at around that rate for some time.

Newly elected Labor prime minister Kevin Rudd has embraced the Hawke/Keating reform legacy (which parallels the Lange/Douglas legacy in this country). He has pledged to cut government spending and taxation and has appointed a minister for business deregulation. State Labor governments in Queensland and New South Wales are promoting electricity privatisation, despite union resistance. Victoria and New South Wales are lifting their bans on genetically modified crops.

The contrast with policy directions on this side of the Tasman is striking.

Australia is by no means a standout performer. Over the past decade, Ireland achieved an average annual growth rate of 6.0%, Hong Kong 5.3% and Singapore 5.8%, demonstrating that economies much wealthier than New Zealand can still achieve fast growth.

It is no coincidence that Hong Kong and Singapore have maintained their position as the world’s freest economies. Ireland has risen in the rankings while New Zealand has declined.

Greater economic freedom is also behind the spectacular growth rates of China and India, even though these countries remain highly regulated.

The advance of economic liberalism is often unsteady and there have been reversals in some countries, not least in the United States with the ’big government conservatism’ of the Bush Administration.

Yet the evidence of its importance for prosperity (and democracy) continues to mount, with many countries cutting corporate tax rates, adopting flat taxes, moving state-owned businesses to the private sector and deregulating industries (in Australia the wheat export monopoly looks set to go).

And it is surprising how little social democratic policies such as school choice in the Netherlands and Sweden and the welfare reforms of the Clinton Administration resonate in New Zealand politics. The tyranny of remoteness remains formidable.

The path New Zealand is on seems unsustainable. If per capita incomes in Australia were to grow at, say, 2% a year on average and only 1% a year in New Zealand, the current gap of 30% in Australia’s favour would widen to 40% in less than a decade. On current policies, the outflow of enterprising young New Zealanders to Australia looks set to surge.

Roger Kerr is the executive director of the New Zealand Business Roundtable.