New Zealand Economic Growth:
On the Road to Helsinki or Hobart?
Thank you for the honour of asking me to give this keynote address. I must, however, admit up-front that my first reaction to your Convenor’s invitation was to go into hiding!
One reason was that almost everyone here knows more about the New Zealand economy than I do. Another is that, at first sight, the Kiwi growth experience challenges my pet message, namely that when growth is poor, it is “poor institutions and deficient economic freedom, stupid!” New Zealand continues to be rated highly on its institutional quality in most international surveys. The best of these surveys, which Fraser Institute in Canada published yesterday at the G8 Summit in Calgary – Economic Freedom of the World for 2000 – New Zealand is ranked 5th of 123 countries (after the two East Asian city states, the UK and the US (Gwartney-Lawson, 2002, p. 11).
Yet, real per-capita incomes grew a modest 1.3% pa. during the 1990s.
One is therefore justified to ask, as many New Zealanders and foreign observers do:
• Why have the economic reforms of the mid-1980s and early 1990s not produced faster and more sustained economic growth, and not twice or thrice the actual rate?
• What could be done to propel New Zealand’s economy into a higher growth league?
To tackle these questions, we first need a plausible growth theory.
The phenomenon of economic growth is extremely complex. One cannot simply aspire to ‘dial up’ a higher growth rate. And understanding economic growth is not just a matter for professional economists, let alone econometricians. Rather, it requires the integration of sociology, jurisprudence, history and technological evolution with economics.
Over a lifetime of research and consulting, I have learnt to reject the neoclassical paradigm as too narrow and I have come to see close and compelling connexions between the quality of rules, institutions, and economic performance.
Let me first document New Zealand’s long-term growth record and outline my own theory of productivity growth.
Graph 1 (not shown) depicts New Zealand’s growth record against a long-term, global perspective, using Angus Maddison’s seminal PPP-adjusted data on per-capita income (Maddison, 2001).
During the 19th century and the first half of the 20th, the traditional, present-day OECD countries, ie. western Europe and the ‘western off-shoots’ in North America and Australasia[1], showed wide income discrepancies between rich and poor. Only in the second half of the 20th century, when overall growth was high, did the range narrow, as the poorer economies caught up. On the other hand, the fast-starters of the 19th century – Australia and New Zealand – fell back against the field. We note that, Downunder, this was a period of inward-looking development and state paternalism, at least to the 1980s. By 2000, Australia had regained the relative position it had held in the 1950s; the economy outperformed most in OECD during the 1990s. But New Zealand has been falling back within the affluent-country league since 1913. The divergence has become quite pronounced over the past generation (Barry, 2001).
From a global point of view, it is also worth noting that Asians and Africans remained relatively poor up to the middle of the 20th century, ie. at little above the living standard at which most humans had subsisted since antiquity. The first non-Western growth region to ‘take off’ was Latin America, starting steeply after 1870, but slowing down again long before reaching a par with ‘the West’. The most noteworthy feature however, is the difference of experience between East Asia on the one hand, and Africa and South Asia on the other after 1950 –– what people with wrong-headed theories of growth called the ‘East Asian economic miracle’.
One possible explanation for New Zealand’s relatively poor growth record could be its geographic isolation and small size. This explanation can, however, be quickly dismissed.
Here we compare the relentless rise of average per-capita incomes in “the West” (the OECD average) with a number of selected small and peripheral economies, including those around the Antarctic Rim. Some peripheral economies have managed much faster growth than the West, beginning with the original peripheral country, Japan. Later, the small economies of Chile, Singapore and Finland repeated the feat of rapid and sustained ‘catch-up growth’. Yet, other small countries have done as poorly or worse than New Zealand. Look at Argentina and South Africa. If an analysis of New Zealand on its own does not yield plausible answers, it may be worth exploring whether the peripheral fast-growers got something that the peripheral slow-growers have not.
Can the evidence be explained by a plausible, realistic theory of economic growth? Let me start in present company with what economists profess to know about economic growth:
Some economics lecturers ‘explain’ growth by demand expansion. This (paleo-Keynesian) approach does not deserve any credit, because demand expansion alone cannot boost the long-term growth of the supply apparatus. They have been trying it in Japan for over a dozen years now, and have only harvested rising unemployment, bad debts and drooping credit ratings! You have to be steeped exclusively in ex-post national-accounts macro mechanics, to confuse ex-ante supply and demand!
Many economics courses – if they deal with the long-term, sustained rise in productivity and hence living standards at all – relate output growth to the mobilisation of labour and natural resources, the accumulation of skills, capital, and technical progress (Kasper-Streit, 1998, ch. 1). Many cast the relationship in terms of the Swan-Solow production function, and some reduce the analysis to a Denison-style analysis of labour, capital and ‘third factors’ – a passive residual!
This is an odd approach: These 50-year old theories offer only proximate explications and immediately beg the question: Why do people work, tap into natural resources, save and learn?
The answer that this is driven by entrepreneurs, who act as catalysts, points in the right direction. But it also begs a follow-up question: Why does entrepreneurial behaviour permeate some societies, but not others? Can policy makers create entrepreneurial attitudes?
There is something else that is mightily odd about the Solow approach to growth: These neoclassical growth theories are cast in static, mechanistic terms, but economic growth is a dynamic, organic and evolutionary phenomenon. The neoclassical models focus on the elusive concept of equilibrium and some even call stagnation “the Golden Age”! Yet, the growth process is driven by dissatisfaction and disequilibrium. The great Austrian-American economist Joseph Schumpeter was right: “The only equilibrium I know is death. And that is probably quite boring!”.
Moreover, the neoclassical growth models are macroeconomic, anaemic by their very conception, whereas growth happens through a million small trials and errors in production and markets. It is a fundamentally microeconomic phenomenon. Macro-mechanics only leads to superficial policy advice.
Let me take this opportunity to invite economists, who are still attached to neoclassical modelling in the Solow-Denison tradition, to a creative destruction of some of their intellectual capital! I know it is a big ask!
Economic growth has to be developed from a microeconomic, evolutionary conception of the economic problem. It is not a matter of maximising human satisfactions from given resources. It is a matter of the discovery of new wants and new resources to satisfy them. Economic life is an open-ended evolutionary process, in which the fogs of human ignorance are gradually pushed back little by little and new knowledge is tested and shared.
The neoclassical assumption of perfect knowledge – made ‘for simplicity’s sake’ – is in any case an absurdity. And no theoretician or policy maker should be so arrogant as to pretend that we can maximise something that we do not even know!
I am of course speaking from the viewpoint of the economic approach that is now going through a mighty renaissance: Austrian, evolutionary-institutional economics. It recognises other modes of rational behaviour than the narrow neoclassical end-means rationality, namely Simon’s bounded, adaptive rationality and Schumpeter’s entrepreneurial rationality. Entrepreneurs – one day – reject hitherto-accepted constraints and risk their own resources to surmount them (Kasper-Streit, 1998, 42-69). It would be wrong to imply that entrepreneurial risk-taking is irrational, as standard textbooks all too often imply!
Economic growth is the sum total of decentralised discoveries of human wants and resources, and most such discoveries are motivated and shaped by competition, on the demand and the supply side.
When I checked the 30 best selling introductory economics textbooks in America, Europe and Australia a few years ago, not one of them gave a satisfactory definition of competition.
Allow me therefore to define it: People on each side of the market compete with each other to place themselves in an advantageous position to attract bids from the other side. This creates transaction costs, foremost the fixed and vexatious costs of information search, which Kenneth Arrow described (Arrow paradox). Once one has found a contract partner, there are the variable transaction costs of negotiating, contracting, supervising and enforcing contracts, which Ronald Coase first described. Similar costs arise within organisations (organisation costs). In a modern economy with a sophisticated division of labour, the coordination costs amount to half, or more of all costs (North, 1992). In the dynamic service sector, mere production and transport costs are completely overshadowed by coordination costs.
Entire professions – traders, lawyers, financiers, administrators, managers, planners and advisers – deal with transacting and organising the division of labour, and discovering better ways of doing business. These professions are not charmed when economists simply assume them away with the naive assumption of perfect knowledge. The assumption allows economists to construct simplistic models, such as Marshall’s ‘market cross’, where the demand price equals the supply price – as if there were no transaction costs! Little wonder that traders, bankers, lawyers and corporate managers have little time for mainstream economics and that enrolments in economics courses plummet. At the same time, evolutionary-institutional and transaction-cost economics is gaining ground in business and law schools overseas!
In reality, a major part of the business of business is concerned with economising on transaction and organisation costs. The most keenly sought-after cost savings relate to the fixed Arrowian costs of knowledge search. These have to be incurred before one can even know whether the new knowledge is of any value. There is no ex-ante trade-off (or production function) between these fixed transaction costs and the pay-off from incurring knowledge search costs. The most important way of saving on the costs of knowledge search in competition is to invent and enforce rules of behaviour, whose violations attract informal or formal sanctions. We call these rules ‘institutions’. They facilitate or hinder innovation and the division of labour, the central aspects of economic growth. Institutions determine the evolutionary (or discovery) potential of an economic system.
Economic rules, which are ‘universal’ – that is certain, stable, general and open (Leoni, 1961) – are conducive to economic competition and discovery. Uncertain, changeable, case-specific and ad hoc rules hamper growth. Secure private property rights, the even-handed enforecement of the freedom of contract, and the equality of all before the law are such time-tested universal rules that correlate closely with economic performance.
We now have a burgeoning and exciting literature about institutional growth theory; the written paper contains my recommended reading list[2].
Numerous empirical studies now relate the quality of institutions to the level and growth of productivity. A recent study by Richard Roll and John Talbott (2001) shows that 85% in the differences between the richest and poorest countries on earth can be ‘explained’ by differences in the quality of institutions that underpin economic and political freedom.
This is good news! The rules are man-made and can therefore be changed by human will. In other words, economic growth is not a question of luck or fate. The school of third-world economists, who assert that the Europeans were just lucky, are wrong (Jones, 2002). Europe – and later others – prospered, because they had established expedient, reliable institutions, normally discovered over generations of pain, conflict and reform.
We distinguish between internal and external institutions. The former cover – among other things – ethical rules, customs, work and trade practices. They evolve in the light of experience in societal processes of catallaxis, and they are mostly enforced spontaneously and informally (eg. by reciprocity, criticism, loss of reputation or shunning – if you like: by ‘tit-for-tat’, ‘tut-tut’ or ‘out!’). They are cheap to operate and effective.
External rules, by contrast, are formulated and imposed by external, political authorities – the legislature and administrative regulators – and are formally enforced by coercion. They come with high information and agency costs and are often prejudiced by the opportunistic behaviour of the agents of government (eg. rent seeking).
Modern democratic governments tend to impose ten times more rules than they can ever monitor or enforce – unless internal rules ensure spontaneous, voluntary compliance. External rules that run against the grain of internal rules and the values of society (social engineering) are typically doomed to failure. Reliance on external rules also tends to reduce an economy’s evolutionary capacity. This is so partly because all political agents suffer from limited cognition and are influenced by yesteryear’s organised interests (Olson, 1982; Kasper-Streit, 1998, pp. 395-406).
Individual rules are more stable and can be reformed in more predictable and trust-inspiring ways when they are subordinated to more abstract higher-level rules and agreed meta rules. We call these constitutional rules. They ensure consistency over time and among different rules. Thus, in most countries, rules of constitutional quality govern how lower-level statute laws and administrative regulations are adapted to new circumstances. These considerations are now the subject of the burgeoning discipline of constitutional economics.
These insights – rather than sterile neoclassical economics – have in recent decades informed economic reforms around the world and explain why centrally coerced, socialist economies collapsed (scobie-Lim, 1992; Scully, 1992; Kasper-Streit, 1998, ch. 13 and 14).
New Zealand’s Growth Potential Through the Institutional Looking Glass:
Can this help to elucidate the New Zealand growth performance and, more importantly, can it inspire policy prescriptions, in case New Zealanders wish to raise their productivity at a faster clip?
New Zealand’s is a rather resource-rich economy, similar to other ‘Antarctic Rim countries’ with late white settlement. Thanks to good imported institutions made in Britain, economic growth came fast and easily in the 19th century.
In the post-pioneer generations in New Zealand (as in Australia, South Africa and Argentina), many took economic growth for granted and were soon able to focus on redistribution. These countries were thinly populated and governments wanted to attract migrants. So, it followed that labour-intensive industries should be protected from international competition to ensure high wages and good profits. But border protection gradually destroys economic freedom and the incentives for competing suppliers to incur knowledge search costs. It protects inefficiencies and diseconomies of small scale. More importantly, it breeds a deeply ingrained culture of non-competitiveness and reliance on the visible hand. Underlying institutions and fundamental values favour the unenterprising. Satisficing behaviour and mediocrity become the norm; striving for excellence only inspires suspicions. Add to this subsidised immigration; and the internal and external institutions in the economy, in social and political life shift to non-universality and politicisation. Isolation and lack of military threats then ensures that complacency and the enemies of progress dictate the norms(Postrel, 1998).
When I first visited New Zealand in the 1970s, this unenterprising culture was palpable and pervasive.
The contrast to the East Asian countries, where I had then just worked, could not have been more dramatic. There, the economies had been opened by autocratic leaders, who had opted for fast growth as a means of funding a strong defence. Like in the small, warring European jurisdictions of the 16th, 17th and 18th centuries before them, the East Asian rulers entered into inter-jurisdictional competition: They supplied enterprise-friendly institutions to attract and retain mobile capital, knowledge and enterprise (Kasper, 1994; 2002; Jones, 2002). Local interest groups were weak; and (different from Latin America or Africa) there were no powerful Feudal cliques that kept governments from encouraging economic freedom, excellence, competitiveness and openness. These were the pre-crony days, the days of take-off and fast learning of productivity. Periphery handicaps, which might have impeded Asian economic growth, were overcome by heavy investment in transport and communications and agile management. Within a generation, the East Asian periphery became an affluent new growth pole of the global economy.
The Asian take-off was part of the incipient wave of globalisation. Within a generation, the number of eager workers who compete in world markets has more than trebled. As a consequence, low-skilled, less competitively-inclined and less well-managed New Zealanders had to face stiff new competition. They were unwilling to do so by cutting their wages or foregoing government-provided comforts. But it was only a matter of time until self-satisfied old ways could no longer be protected. The only solution was to upgrade skills and reform the institutions, so that higher wages could be justified in the global market place. People found the new competitive race often rather trying, like convalescents after a long illness. While sometimes exhilarated, many among them yearned for the warm doona of protection and socialised welfare. Such contradictory reactions to fast change are understandable. After all, institutional change inflicts learning costs, especially after a long time of top-down protection and comfort.
Periods of unsettling economic and social change tend to offer great opportunities to political entrepreneurs. They come up with political programs and propose rule changes to win electoral support. Labour won in the 1980s because Rogernomics promised ordinary voters a combination of partial economic reform – of capital and product markets – with continued top-down protection: regulated labour markets and socialised welfare (Kasper, 1996, ch. 1). The Conservatives then began to compete with some political entrepreneurship of their own. When the institutional inconsistencies between free product and capital markets on the one hand, and regulated labour markets and costly government on the other, started to hurt, the voters endorsed the Nationals’ reform program and allowed a second, short wave of institutional reform. The late 1980s had been a demonstration of the verity, well known to liberals, that inconsistent sub-orders are ineffectual, unstable, and bad for competitors and investors.
From the institutional viewpoint, the New Zealand reformers of the 1980s and early 1990s did the right thing by formally instituting the new rule set. Legislation made the new economic rules clear and promoted consistency and acceptance. The milestones towards a new liberal ‘economic constitution’ were: Making of the Reserve Bank independent of the administration of the day and giving it transparent riding instructions in 1989, the Public Finance Act of 1989, which introduced output-based monitoring and clear responsibilities for the public service, the Employment Contracts Act of 1991, and the Fiscal Responsibility Act of 1994. In addition, product market liberalisation was to some extent credibly underpinned by GATT/WTO rules, which make the reversal of tariff cuts difficult.
The reforms are reflected in the afore-mentioned Fraser Index. Economic freedom ratings of New Zealand improved strongly between 1985 and 1995. They have slipped a few notches to 2000 (Gwartney-Lawson, 2002, p. 18).
The new economic rules were not accompanied by corresponding reforms of socialised welfare and a sufficient reduction in the size of government. The long New Zealand tradition of the state as carer of last resort continued. The shares of government consumption and subsidies in the national product are still higher than in Australia. A closer look at the Fraser Index shows that New Zealanders bear a relatively big burden of government (ranked 38th out of 123 countries in 2000) and do not have as good an ‘access to sound money’ as the citizens of other free countries have (ranked 42nd, Gwartney-Lawson, 2002, p. 14).
This is of course a matter of social and political choice, but one that has pervasive effects on how people respond to new rules in the competitive economic game. To give an example for what I mean: the incentives for household saving, which is quite low in New Zealand, would have been increased by a re-privatisation of welfare, in particular education, health and old-age provision. Such social reforms would have brought the attitudes of New Zealanders to working, competing by shouldering knowledge search costs and being self-reliant more in line with the norms in the wider Asia-Pacific region. Individual responses to the new labour-market incentives and in daily life would have been more entrepreneurial, immediate and pervasive.
To be quite explicit: this is a statement in positive economics: Millions of such responses determine the growth rate. It is not meant as a normative statement – me telling New Zealanders that they should want more growth and less transfer payments. I will return to this point later.
Rule changes always need time to shape popular attitudes and the crucial internal institutions of society. Inconsistency between institutions and inconstancy over time are not unique to New Zealand. We have observed similar and costly institutional flip-flops in Eastern Europe, Russia, Latin America and elsewhere.
What is fairly unique to New Zealand is a naďve institutional design, which allows the slim parliamentary majority of the day to alter the underlying constitutional rules almost without checks and balances. In the unicameral parliament, it is often a sub-committee or a group of dedicated activists who recast fundamental economic rules and then rely on party discipline to get away with it. The economic order lacks the usual stabilisers that normally make it hard to change fundamental rules in haste and by stealth – e.g. a written constitution, a multi-cameral parliament, a stricter division of powers than in the Westminster system, federalism, and an assertive constitutional court.
In most countries, fundamental rules of coordinating economic life – rules of constitutional quality, such as the Employment Contracts Act – are altered only after intensive public discourse and after scrutiny whether there is strong and irresistible evidence for change. (In the Appendix, I discuss some constitutional devices that are used in other democracies to anchor the economic and political rules).
High-order constitutional rules also have the function, which Ulysses relied on when he had himself tied to the mast before visiting the syrens. They provide restraints that sometimes protect us from our opportunistic selves. When one embarks on reform, the going during the transition can get tough. It is then tempting to bail out. Constitutional safeguards then protect the long-term course from the political opportunism that wants to avoid short-term pain.….. New Zealanders had no constitutional mast, so to speak, to which to tie their leaders!
The absence of constitutional stabilisers made it easy for the reformers of the 1980s and early 1990s to implement far-reaching reforms and to avoid the costs of time-consuming public debates. But when a simple majority can rewrite the rule book for the next game, political entrepreneurs are never properly challenged to explain themselves to the wider public. Both waves of economic reform – Labour’s in the mid-1980s and the Conservatives’ in the early 1990s – were pulled off by a small policy elite within their own parties and with little cause to engage civil society at large. The external institutions were re-engineered with relative ease. But then, the changes connected only rather superficially with the internal institutions and the values of the population at large.
New Zealand’s lack of constitutional stabilisers went probably unnoticed, as long as policy was conducted within a corset of dense regulation. But with globalisation, accelerating technical change and the cross-currents of freed-up markets, the lack of a constitutional backbone led to a bad loss of trust.
We know that rule changes easily overtax the cognitive capacity of entrepreneurs. Just recall the growth costs of Britain’s post-war nationalisation, de-nationalisation and re-nationalisation of certain industries and banks. Movement in one direction in an evolutionary reform process can be digested, but not institutional zig-zags. The costs then weigh heavily on local entrepreneurs. But when small, peripheral economies, such as New Zealand, which get five minutes per annum of CEO attention in New York, display institutional inconstancy, this repels international investment!
A less changeable and more consistent order would have been more effective and stable in raising economic welfare and fostering those enterprising, competitive attitudes that are the very basis of economic growth.
New Zealand’s new liberal order would have had more – and more rapid – impact, if the reform agenda had been supplemented by better and more explicit protections of private property rights from parliamentary opportunism, along the lines of a Regulatory Constitution, as proposed by Richard Epstein (Epstein, 2000; Kasper, 2000, pp. 94-95), if there had been some political decentralisation along the lines of ‘competitive federalism’, and if the centrality of secure property rights and free contracting had been stressed time and again by the reformers and their successors in public discourse. There was no Margaret Thatcher or Ludwig Erhard, who repeated the simple messages again and again!
The 1990s also illustrated another problem of system inconsistency. While the economic order became more universal – indeed more so than in most other affluent countries – the political sub-order, too, remained inconsistent with a free and open economy. In some respects, the political sub-order was even made less consistent, and New Zealand’s entire rule system became less stable and less confidence-inspiring. Rule changes and reversals were adopted when the political class, including the unions and many academics, discovered that the free-market reforms had shifted some influence away from them. Self-doubts about the merits of competing on the part of many voters gave the classe politique the chance to introduce electoral (MMP) and other changes.
Recent political experimentation has confused the fundamental institutional setting of the New Zealand economy, such as the re-regulation of labour markets, the creation of a nationalised retail bank, the re-nationalisation of the major airline, or the reversal of competitive disciplines on public services (OECD, 2002). Race-based redistribution (such as the preferential 19% corporate tax rate for Maori corporations) also signals a lack of commitment to the principle of equality before the law. New social and environmental regulations (based on the Bill of Rights Act, 1989, and the Human Rights Act, 1993), and the Fair Trading Act now create the impression that New Zealand is following in the tracks of the increasingly uncompetitive, collectivist, top-down ‘European style of governance’; sharing in the ‘New Millennial Collectivism’ of the UN and the NGOs. The European style of governance is increasingly becoming ‘post-democratic’, as more and more policy-making is passed to unelected, collectivist elites[4]. The European collectivist regimes nowadays attract little foreign investment and are not exactly brimming with small-scale enterprise. They contrast with the British-American individualistic-competitive tradition where voter-controlled parliaments still have a real say. Alas, New Zealand is not located between Sweden and Holland. Its institutions are measured against the standards of the Asia-Pacific, where the American and Australian style of parliamentary democracy and shirt-sleeve competitiveness prevail. The conservative governments of the 1990s, as well as the socialist-Green one that followed, have abandoned the competitive, liberal vision and drifted back to mediocre collectivism. The drift has at times been supplemented by the judiciary, which is no more economically literate here than in other countries.
To my mind, New Zealand’s political constitution exposes its good economic ground rules to an extraordinary degree to the winds of electoral and political whim. It is not surprising that surveys show that New Zealand governments are rated poorly when it comes to honouring the commitments of previous governments (World Economic Forum, 2002).
To a mind trained in constitutional economics, New Zealand looks like a man, who has cast the crutches of artificial regulations aside, but discovers that he lacks the constitutional backbone strong enough for running. Alas, it is immensely hard to strengthen a weak backbone.
Markets are not self-sustaining, and competitive markets can self-destruct. A free market order therefore has to be anchored in a competition-friendly political and social culture. We know many cases in history in which governments failed to defend the principle of free competition, and in which social barriers to competing and exploring new ideas led to stagnation. Latin America’s many aborted episodes of liberal reform and short spurts of growth illustrate the point. And I am not sure that the New Zealand episode of 1985 to 1995 will not – from a historic perspective – look like another such interlude.
History has a tendency to re-assert itself, and political failure can easily frustrate the quest for growth.
Many New Zealanders seem to sense the problem and are now searching for ersatz stabilisers, for example a currency board with the Australian or US dollar, or even joining the Australian federation. As Argentine’s dollar-peso link demonstrated yet again, these are escapist props. They are poor substitutes for designing your own system. They would not find much favour in Australia; we already have one Tasmania too many (Rae, 2002).
I have strayed far from economics into constitutional design. But, after long reflection, I have come to the conclusion that here lies the fundamental explanation why New Zealand has wrested timid growth from bold reforms.
‘Good Policies’ versus ‘Good Rules’:
Can Government Do Anything to Promote Growth?
My focus on institutions may well provoke the question: Should everything be left to laying down enterprise and growth-friendly institutions? Is there no room for informed government intervention to promote economic growth?
My response is that, essentially, the government’s role is indeed to provide and credibly enforce innovation and enterprise-friendly rules. This is how governments compete internationally. And this is what Aristotle preferred when he asked whether the community’s welfare should be entrusted to good men or good laws. Good men (and women), when they intervene politically to accelerate growth, simply lack the knowledge about the complex, ever-changing growth organism to judge whether specific actions help or hinder. The cognitive limitations of those who govern (and their advisers) are real, as the history of industrial policies to ‘pick winners’ amply demonstrates. The evidence also demonstrates that self-seeking re-election motives ever so often overshadow rational economic considerations in public choices (Burton, 1983; Kasper, 1985). The proponents of selective industry policies should just be laughed out of court by the economics profession!
The exception to the general rule is the case of underdeveloped East Asia: In Japan in the 1950s and early 1960s, in the four ‘Tiger economies’ of the 1960s and their imitators subsequently, bureaucrats were able to pick winners. They simply copied what had been successful in countries higher up the development ladder and what could be imitated with low wage rates, hard work and tax concessions. Over the longer term, this of course led to sclerosis nipponica, crony capitalism, a business culture that often shirks genuine enterprise and entrenches corruption (Kasper, 1994; 2002). The proliferation of imitative industry policies also led to excess capacities and profit compression in supposed ‘winner industries’.
A highly developed, high-income country like New Zealand cannot profitably engage in such selective industry policies.
There seems, however, some room for generic supply-side policies to assist with mobilising human and financial capital, knowledge, land and natural resources (remove the environment-regulatory handicaps which are growing faster than trees!) Governments can also facilitate the private supply of productive infrastructures, especially those that reduce transport and information costs. Taxation policy in tandem with social welfare policy could be made much more growth-prone.
Whether such shifts win the support of the electorate and the political elites is another matter.
Conclusion: How Badly Do You Want the Economy to Grow?
I am told that many New Zealanders are nowadays attracted by the policy design of Scandinavian countries. Finland seems the current flavour. The gameplan is retain high or rising levels of general government spending (Finland 1998: 48.6% of GDP, compared to 36.1% in New Zealand), high or rising pensions (typical pension in Finland: 60% of per-capita GDP; in NZ 49%) and high economic growth. But make sure that the grass does not appear greener in far-away places: In reality, Finland had 1.4% growth pa during 1990s; New Zealand 1.3%. (WEF, 2001). There is always some escapism in arguing with foreign models. Let us not forget that the small and peripheral Finnish economy is fairly close to big global centres, and that Finland does not mandate a minimum wage. The Finns have an impressive tradition of incurring the transaction costs for industrial and design innovation and have learnt that you need to prosper to defend your national security. Now compare this with attitudes to competing and the flabby defence posture in New Zealand.
If some political leadership were to set out – figuratively speaking – on ‘the road to Helsinki’, there is a fair chance in my opinion that without a broad-based popular and elite commitment to economic freedom, with New Zealand’s low savings rate, with easy emigration for the young, the impatient and the enterprising, with a penchant for redistribution and kindness, and with an enviable history of being free of external threats you run a very high risk of driving into a dead alley: A slow-growing, government-burdened, pessimistic, Green economy, something like Tasmania. But while Hobart can maintain certain standards thanks to being a fiscal mendicant in the Australian federation, New Zealand has no such option.
Let me conclude on a humble note.
No elite can make the people more competitive and self-reliant. Economic growth may not be for everyone. I for one respect popular sovereignty and would say: If New Zealanders vote for predominantly redistributive governments, they also vote for slow economic growth. That must be respected!
In any case, it is definitely not for an outsider like me to tell you what you should want!
Appendix: Some Constitutional Stabilisers Used Elsewhere
In most countries, ideologically or pressure-group driven revolutions in the external institutions are constrained and the reforms tied down by a number of constitutional devices, which are largely missing in New Zealand:
• The division of political power between several houses of parliament or a federal structure makes rash changes less likely. In America or France, executive and legislature are often forced to cohabit and negotiate more stable compromises. Friedrich Hayek made a case for a separation of an assembly that conducts the recurrent political business from a rule-making assembly elected by age cohorts (Hayek, 1979; Kasper-Streit, 1998, pp. 326-332). Such a separation of powers may well hamper reform compared to New Zealand a dozen years ago, whose speedy and wide-ranging reforms were admired. But few observers understood that the lack of checks and balances also spells institutional fragility and inconstancy.
• In all Westminster systems, the division of powers is weak, with the elected majority of the day enjoying a temporary dictatorship over both legislation and the administration. Parliaments no longer control an arbitrary executive, and the party system has entrenched the institutional lack of parliamentary control (Ratnapala, 2002). This makes for institutional inconstancy in all Westminster-style democracies and explains in part their weaker long-term growth performance.
• Modern party democracies often do not rule on the basis of representative majorities. In reality, small, intensely interested groups capture a few parliamentarians who volunteer to serve on the decisive committees. Party loyalty and the sheer volume of legislative diarrhea then ensure that plenary sessions pass the interest-group sponsored, political favouritism into law. In a multi-stage deliberation process, 51% of 51% of 51% (12.3% of the plenary assembly) can determine external rule making in specialised areas. The bigger the government and the more prescriptive the rules, the more will interest groups capture the fundamental rule making and destroy economic freedom.
• Most countries have written constitutions and explicit rules which distinguish between constitutional and ordinary rules. The former can be changed only with high majorities or other safeguards.
• Most parliaments have and enforce strict procedural rules that protect the integrity of the legislative process. Thus, parliamentary and cabinet standing orders demand repeated readings and prescribed processes of consultation. Such rules ensure scrutiny in committees and by cabinet, and comment by public-service advisers. It seems to outside observers that such procedural protections are at times handled in a cavalier manner in Wellington. For example, the Employment Relations Bill of 2000 was reported as having bypassed various institutional trip wires (Kasper, 2000, p. 1).
• In most jurisdictions, high courts defend the constitution and review changes in the ordinary rules for compatibility with more stable constitutional rules and consistency among different institutions or sub-orders.
One could think of further such devices to address New Zealand’s apparent institutional weaknesses (Wilkinson, 2001).
Endnotes
[1] excl. Hungary, South Korea, Mexico, Poland and Turkey
[2] The literature now does not only yield much inductive reasoning, but also compelling deductive insights. Here is a selection: Baumol, 2002, Beach-Davis, 1999, Edwards, 1997, Gwartney-Lawson, passim, de Haan-Sturm, 2000; Hodgson, 1993; Friedman, 2002; Kasper, 1994; Kasper-Streit, 1998, ch. 1; Knack-Keefer, 1995; Metcalfe, 2002; Nelson, 2002; North, 1990, 1992; Olson, Sarna, Swarmy, 2000; O’Driscoll et al, passim; Pipes, 1999; Roll-Talbott, 2001; Scully, 1992; Scobie-Lim, 1992; Thorstensson, 1994; Weede, 2002.
There is nothing very new in institutional growth theory. Both the old Austrian economics (Menger) and the German historical school stressed the role of institutional evolution in the growth process. And the effect of institutions which underpin economic freedom on the growth record was expounded forcefully, for example, by Ludwig von Mises in the 1920s when he confidently explained the cost of paternalism and repression in terms of growth in the Soviet Union. He concluded in 1927: ‘If the Russians had pursued capitalist policies…, they would be the richest people on earth now. Despotism…. made them the poorest people.” (Mises, 1927; p. 27; repr. 1978).
The trouble is that Anglo-Saxon modellers banned sociology and law, and indeed history, from growth theory and managed for most of the 20th century to turn Austrian institutionalists into a quaint, marginal school of thought.
[3] It should be mentioned in passing that the Fraser measures of economic freedom also correlate positively with income levels, life expectancy, and the absolute income of the poorest 10% of the population (p.20).
Reading List
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W. Kasper (2000), Gambles with the Economic Constitution, The Re-Regulation of Labour in New Zealand (Sydney: Centre for Independent Studies).
W. Kasper (2002), ‘Rapid Growth, Institutional Evolution, and Corporate Governance in Asia’, Asian Development Bank, 35th Annual Meeting, Forum on Corporate Governance, Shanghai, May
W. Kasper–M.E. Streit (1998), Institutional Economics––Social Order and Public Policy (Cheltenham, UK–Manchester, MA: E. Elgar).
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About the Author:
Wolfgang Kasper is a Senior Fellow of The Centre for Independent Studies, and professor emeritus at the University of New South Wales. He was Professor of Economics at the Australian Defence Force Academy from 1977-1999 and has worked and lectured in Europe, the US and Asia.
© Copyright; Foundation for Economic Growth and various authors. Individual authors retain their own copyright.
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