Moving into the Fast Lane
March 1996

1 Overview

Over the past decade New Zealand has implemented a macroeconomic stabilisation policy, liberalised trade, reduced agricultural and industry subsidies, reformed labour and capital markets, corporatised and privatised many state-owned enterprises and reformed the tax system-to name a few of the major changes. For some years the reforms appeared to yield limited success. Economic growth was lacklustre and unemployment continued to rise.

The picture has, however, changed markedly. Economic activity stopped contracting around June 1991 and began to expand strongly in late 1992. Since then, New Zealand has had one of the fastest growing economies in the OECD. The fiscal balance is in surplus. The balance of payments position is sound and the rate of inflation is low. There has been a resurgence in business confidence and investment. These are the most promising conditions for sustained growth in at least 20 years.

Employment has expanded strongly. Over 1.6 million people are employed, more than at any other time in New Zealand's history. Shortages in certain skilled categories are emerging. Unemployment has reduced from a peak of 10.9 percent in September 1991 to 6.1 percent in the September quarter of 1995 and further decreases can be expected.

These results point to an economy that is performing well. However, if New Zealand is to enjoy living standards similar to those of other successful countries and to achieve full employment, a superior perform-ance will be required for many years to come.

There is a risk of complacency-a feeling that 'we've done it all, now we can sit back and enjoy the benefits'. Reform fatigue was apparent by 1988 when prime minister David Lange announced a 'tea-break'. The political will to embrace continuing change waned because the social costs of adjusting were large, as anyone who lost his or her job would testify. The costs of not changing, which are often overlooked, would have been much larger. To achieve the prosperity that most New Zealanders aspire to-more jobs, better quality health and education services, and rising personal incomes-New Zealand will need to embrace continuing change.

Recent growth is from a smaller income base than would have been the case had New Zealand not mismanaged its economy before 1984. The high level of net public debt, although falling, leaves New Zealand vulnerable to adverse economic shocks. Unemployment remains a serious problem.

There is still a very large gap in productivity levels-which ultimately underpin living standards-between New Zealand and the top-performing economies (see Table 1.1). New Zealand's average per capita income ranks 24th in the world, behind Australia (20th), Israel (21st), Spain (22nd) and Ireland (23rd). Some Asian countries are performing better than New Zealand. Singapore (14th) and Hong Kong (19th) enjoy much higher incomes than we now do. New Zealand's present per capita income ranking is well down on the 8th place which it held in 1955 (Crocombe et al. 1991). Furthermore, New Zealand's average per capita income is equal to only 35 percent of that of Switzerland, which is ranked 1st, and 72 percent of Australia's.

TABLE 1.1 An international comparison of New Zealand's per capita income

* National incomes have been converted at market exchange rates.
Source: World Bank (1995), World Development Report 1995.

If New Zealand's average per capita income were to grow by 4 percent a year, a high growth rate by the standards of the 1970s and 1980s, it would take almost nine years to reach the average level of income enjoyed currently by Australia. It will require an even higher rate of growth for New Zealand to achieve parity with Australia by 2005 because Australia's per capita income will increase in the meantime. New Zealand should aim at achieving a per capita income level at least equal to that of Australia on average within the next 10 to 15 years.

Put another way, at a 4 percent growth rate the economy would be about twice as large by 2012. The gross income of an average household would rise from nearly NZ$40,000 today to around $78,000.

In a 1994 Business Outlook, the National Bank described New Zealand as a 'Porsche economy', with the potential to expand at a speed not previously thought possible. After a decade of reform, the New Zealand economy is capable of moving into the 'fast lane' provided that the momentum is maintained.

Policies for the fast lane

Faster growth in output and incomes requires additional resources, principally human and physical capital, combined with policies and techniques which make better use of available resources. This requires New Zealand to:

The broad policy prescription that is necessary to encourage a better use of resources and to expand them is well established. It includes:

Proper role of the government

Central and local governments must limit their activities to those necessary to fulfil their proper role in the economy. They should estab-lish institutional arrangements which facilitate voluntary transactions (including a sound legal system), assist in organising the provision of a range of public goods and services (such as law and order and defence) which may not otherwise be appropriately provided, and, in the case of central government, provide a safety net for people who cannot be supported in other ways. An excessive government role, with its inevitable costs, crowds out the private sector (including personal and community initiatives) and leads to poorer economic and social outcomes.

Price stability

High and variable rates of inflation dampen economic growth, at least beyond the short term. This view is widely supported by economic research and is illustrated by New Zealand's recent experience. Very high rates of inflation were recorded in the two decades to 1994 when growth averaged a meagre 1.5 percent a year. The framework to enable price stability to be achieved is in place. It should be retained.

Government expenditure, deficits and debt

Unjustified government expenditure displaces income-creating projects in the private sector. It has to be funded by taxes that inevitably discourage investment, saving and the willingness to work, and distort many other choices. High deficits and public debt lead to an unstable and unpredictable business environment.

The government still plays far too large a role in the New Zealand economy. A wide range of services that are presently provided by the public sector, ranging from postal services and accident insurance to many health and education services, should be supplied by the private sector. The government should concentrate on financing those services where appropriate, particularly in the case of people with low incomes. Welfare arrangements, for instance New Zealand Superannuation, extend currently well beyond the provision of a safety net.

Spending by central and local government, and by other tax-funded agencies, should be reduced from its present level of around 40 percent of GDP to 20 percent or below by 2005. Strong growth, a more focused government role, greater reliance on individual responsibility, the elimination of involuntary unemployment, and lower interest costs as debt is repaid would readily enable this target to be met. Outlays on core government activities could be expanded without compromising the achievement of this target. Successful Asian countries typically commit no more than 20 percent of their GDP to government expenditure.

Public debt should be reduced to help restore New Zealand's AAA international credit rating, not achieved since 1983. Foreign currency debt, net of comparable investment, should be extinguished. This requires sizeable fiscal surpluses to be maintained for an extended period. Once public debt is reduced to a prudent level, the ratio of tax to GDP should be reduced in line with the falling share of government expenditure in national income.

Privatisation

The privatisation programme has lost momentum, at a time when other nations' governments are pressing ahead. The central case for privatis-ation is that in general privately held enterprises are more efficient and productive, and ultimately more accountable to consumers, than those run by bureaucracies. There are no valid grounds for continued govern-ment ownership of many entities, businesses and assets. A vigorous privatisation and asset sale programme is required to substitute full commercial disciplines for political control, and to allow debt and taxes to be reduced. Unresolved regulatory issues, if any, should be addressed before government businesses are sold.

Important candidates for privatisation include the following entities or their assets: the Accident Rehabilitation Compensation and Insurance Corporation; Coal Corporation of New Zealand; crown health enter-prises; crown research institutes; electricity generation and transmission businesses; Forestry Corporation of New Zealand; Government Property Services; Housing Corporation of New Zealand; Housing New Zealand; Land Corporation; New Zealand Post; Public Trust; Radio New Zealand; Television New Zealand; and the Crown's interests in inter-national airports at Auckland, Wellington and Christchurch. In addition, units within departments and crown entities which essentially supply private goods and services should be privatised. In many countries most of these activities are now undertaken by the private sector. Social objectives in any of these areas are better pursued through contracts with private providers than government provision.

Regulation

Regulatory reform initiatives being implemented in many countries reflect a heightened appreciation of the costs of unjustified constraints on the private sector. Excessive regulation blunts competition and innovation and encourages lobbying and other socially wasteful activities.

The operation of labour and capital markets-which has a pervasive effect on the allocation of resources-and the efficiency of many product markets has been improved by more appropriate regulation. However, the task of eliminating excessively costly forms of regulation is incom-plete and has slowed. Regulatory reform should be accelerated to move New Zealand into the fast lane.

Although the Employment Contracts Act 1991 is an outstanding success, important impediments to employment remain. They include mandatory and inflexible personal grievance procedures, the separate Employment Court jurisdiction, statutory holidays, stautory minimum wages and welfare disincentives. These aspects of the labour market need to be addressed to strengthen its improved capacity for job creation.

Investment has been encouraged by the establishment of a more stable economic environment and the deregulation of capital markets. A priority issue is the international tax regime where appropriate policies could lower the cost of capital and increase investment, employment and growth.

There have been concerns that New Zealand's investment in infra-structure may not be adequate to support continued growth. However, few bottlenecks are likely in respect of activities that are now in the private sector or operating in commercial structures such as telecom-munications, rail, airlines and ports. Problems are most likely to arise in those areas that are still subject to political and administrative decision making or where prices are not set on a commercial basis, and private investment is thereby deterred. Examples include electricity, water supply, roading, health care and schools.

A large number of occupations are regulated. A systematic review of occupational licensing should be undertaken. Those arrangements that impose the highest net cost on the community should be examined first.

Many regulations impose large compliance costs on businesses and individuals. Although the government is committed to reducing these costs, it has focused on the paperwork involved rather than on a 'first principles' examination of the issue.

The problem of inappropriate regulation and excessive compliance costs requires changes to the regulatory process. Proposed regulations should be subjected to an independent cost/benefit assessment that is available for public scrutiny. If this process is not observed, narrow interest groups tend to be advantaged at the expense of the wider community. Many existing regulations would fail a cost/benefit test.

Human resources

Rapid increases in the workforces of developing countries, freer trade, and even freer movement of capital and technology will affect New Zealand and other developed countries. As a result of these global developments, the demand for skilled workers in New Zealand will be higher than for other classes of labour.

A better education and training system is required to raise New Zealand's skill base and thereby increase productivity and real (i.e. inflation adjusted) wages. Many initiatives have been taken by the government. Most involve higher government spending which has not solved the problems or eliminated community dissatisfaction with education performance. More fundamental reforms are required.

On the supply side, steps such as performance pay and more flexible, school-based employment arrangements for teachers need to be introduced. The provision and funding of education should be separated so that public and private institutions can compete on even terms. On the demand side, school funding should be redirected to parents and equal entitlements, which could be augmented to reflect special needs, should be provided regardless of where children are enrolled. This would give consumers a greater stake in the quality of their education and encourage schools to focus on satisfying the needs of students and parents.

The councils of tertiary institutions need to be reshaped and reduced in size to reflect a clearer distinction between governance and manage-ment roles, to give priority to relevant expertise in appointments and to permit more effective oversight and decision making. There is no long-term need for the government to remain the owner of tertiary institutions. Funding and regulatory arrangements that facilitate fair competition between public and private institutions should be imple-mented. The present level of per-student subsidies for tertiary education cannot be justified on efficiency and equity grounds.

Open economic policy

In an increasingly integrated global economy, the community's interests are best served by open policies in respect of international flows of goods, services and capital, and a welcoming approach to immigrants. An outward-looking policy encourages efficiency and facilitates the adoption of new production techniques, management practices and ideas. It leads to a more dynamic economy and society. While progress has been made in integrating New Zealand with the world economy, further steps are necessary.

Tariff reductions are a proven recipe for increased efficiency. The perceived cost of adjustment has constrained the pace at which protection has been reduced. A loss of jobs in affected sectors, even though more jobs are created overall, is the principal cost. But the position has changed. The politics of adjustment are very different in an economy growing at a solid pace with improving employment prospects.

The government should take advantage of these favourable conditions by confirming the elimination of all tariffs in the 1998 review, consistent with its stated policy. If the policies advocated in this report are adopted, the adjustments required by affected industries and employees would be offset by lower tax and regulatory burdens and by the increased opportunities that higher growth and a more dynamic economy provide. For this reason, a broad set of mutually supportive policies that would lower business costs is proposed. In this context, a somewhat faster reduction of tariffs than that foreshadowed would be desirable.

Consistent with this outward-looking stance, most restrictions on businesses that wish to export agricultural and horticultural products should also be removed and statutory marketing boards should be corporatised.

Benefits of continuing reform

It is understandable that some New Zealanders, particularly those that are better off as a result of the recent reforms, may be reluctant to contemplate further changes. The benefits are also continuing to spread through the community with employment growth and the planned tax cuts. However, there are still significant numbers of people unemployed or on low incomes, and there is a large gap between average New Zealand incomes and those in the wealthiest countries. The prospects of those who are still struggling and those who wish to improve their position further will not be helped by policies of inaction or timid gradualism. Continuous improvement is needed for New Zealand to keep pace with other countries and realise its full potential.

If the economy moved into the fast lane, New Zealanders could expect their average per capita income to double every 10 to 15 years, at least for the foreseeable future. This would offer new opportunities for the consumption of goods and services and the satisfaction of non-material wants, such as increased leisure, environmental protection and conservation.

A fast-growing economy, coupled with a return to full employment, is the only sustainable way of increasing the welfare of people on low incomes. An extended period in the fast lane would create a more vibrant and diverse society.

Outline of the report

The balance of this report discusses the policies that are necessary to move the New Zealand economy into the fast lane. Many of them have been examined in greater detail in other New Zealand Business Roundtable research studies, and this report provides an overview. The next section (section 2) examines macroeconomic settings. Monetary and fiscal policies are discussed and government expenditure targets are proposed. Section 3 examines the development of thinking on regulatory policies and outlines the background to deregulation in New Zealand.

The following four sections (sections 4 to 8) examine regulatory reforms since 1984 and consider further policy changes. The labour market is discussed in section 4. Proposals which would improve and complement the Employment Contracts Act 1991 are considered. The potential for improvement in the quality of human resources through education, training and immigration is addressed in section 5. The capital market is reviewed in section 6. The need for further changes to the regulation of the market for goods and services is the focus of section 7. Improvements to the regulatory decision-making process are examined in section 8.

The final section (section 9) is devoted to public sector reforms. Spending reductions, additional privatisation initiatives and public sector management reforms are proposed. Suggestions for improving the efficiency of local government are also presented.