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Lessons for Europe from New Zealand's liberalisation experience.


A. Bollard (1992), 'New Zealand: Economic reforms 1984-1991', Country Studies, no. 10, International Centre for Economic Growth, San Francisco.

I.G. Begg and D.G. Mayes (1992), 'Cohesion in the European Community: a key imperative for the 1990s?', Regional Science and Urban Economics (forthcoming).

I.G. Begg and D.G. Mayes (1993), 'Cohesion, convergence and economic and monetary union in Europe' Regional Studies, April. The whole of Europe has embarked on a major programme of economic change. The former CMEA countries are trying to move rapidly from state planning to market economies. In the west, not only is the European Community well down the road to removing a large number of non-tariff barriers between the member states through the Single Market programme--extended to EFTA through the European Economic Area agreement(2) but it has also agreed, through the Maastricht Treaty, to try to converge to an economic and monetary union with low inflation, low public sector deficits and controlled public debt, before the end of the century.(3) Negotiations are beginning over extending this, through full membership of the Community, to Austria, Finland, Norway and Sweden.

These processes of change have a lot in common, particularly in two respects:

stabilisation--they seek to create low inflation economies where public borrowing is strictly controlled

liberalisation--they seek to remove a wide range of barriers to freer international competition.(4)

As a result the countries hope to speed the process of restructuring and to enhance their long-term growth through achieving greater international competitiveness. In particular, those countries and regions with below average GDP/head and above average unemployment rates hope to converge towards averages which are themselves expected to improve through better performance in the higher GDP per head/lower unemployment regions.

The European Community's approach is firmly based on the hypothesis that co-ordination and mutual help are necessary if the disadvantaged regions are not to lose out in the process of change. The Edinburgh Summit reaffirmed the commitment to provide what is effectively a second doubling of the Community's structural funds. Furthermore, the new cohesion fund (Begg and Mayes, 1993) has established the principle that while member states with GDP/head over 90 per cent of the EC average can afford to tackle the problems of their disadvantaged regions with their own resources, those states which are worse off merit further help.(5)

The problems in central and eastern Europe are, however, largely being tackled separately by each country, with increased division following the break up of the former Soviet Union, Yugoslavia and now the Czech and Slovak republics. Some external assistance has been made available through the European Bank for Reconstruction and Development and the agreements between some states and the EC but the onus for change lies with the individual states. Only the former DDR has followed a route of direct integration with the West.

Although there has in recent years been an explosion in the amount of advice on offer to countries about how to liberalise, deregulate and restructure economies in order to improve international competitiveness and long-run growth prospects,(6) it is already apparent that the process of change in Europe has been markedly different from that envisaged by many of the advisers and by the politicians involved in trying to implement the reforms.(7) Part of the reason for this divergence is that advisers have not found examples of previous successful implementation of these policies on such a large scale.(8) Such examples as have been widely used either relate to less-developed countries, such as those in South America, or to particular sectors (eg financial services) or much more limited episodes (such as the turn round in policy in France in the 1980s). However, there is one example, which has been widely neglected, that does provide illustrations of many of the problems facing industrialised countries wanting major structural change and liberalisation; that is New Zealand.

In less than eight years New Zealand has swept from being the most heavily controlled of the OECD economies to being among the most liberal and that process is continuing.(9) Of course the problems are an order of magnitude different from those facing much of eastern and central Europe, and New Zealand, as a small nation on a group of islands over a thousand miles from the nearest foreign market, is not an ideal comparator. Nevertheless, most of the major ingredients of the changes required of others have been undertaken.

New Zealand is particularly interesting for six main reasons:

* because it has seen the changes through over a sustained period (reform attempts tend to be characterised by substantial setbacks (see Hunn et al. 1989)

* because it has followed a course of rapid change rather than gradualism (the accepted wisdom seems to favour the rapid route ('cold turkey' as van Wijnbergen, 1992, puts it) largely because it is more credible--democratic governments have a limited life expectancy so change has to be fast if it is to be implemented)

* because the economy is only now beginning to turn round and move into growth--so we have some estimates of the costs to be incurred before it is clear what the long-term benefits are--(this is an indication of the political bad news that has to be absorbed if the programme is to be completed)

* because there have been some clear mistakes and unfortunate experiences from which others can learn

* because there has been a clear political price, with the initiating government eventually being defeated, in a large measure due to the poor economic performance of the economy, and yet the programme has continued

* because the process of closer economic integration with Australia has been a major saving grace through stimulating trade and factor movements.(10)

The impact of the change has also been unevenly distributed by industry, income class and region. There are thus lessons for both Western and Eastern Europe.

In this note we begin by outlining the changes that have taken place in New Zealand and then move on to consider the main lessons which we can draw for Europe.

Why New Zealand acted

In the 1950s New Zealand enjoyed one of the highest standards of living in the world, based on its role as a supplier of food and raw materials to the UK market.(11) The country has since paid dearly for its dependence on Britain as a single market and its consequent reliance on primary production for the bulk of its foreign exchange earnings.

In 1973 Britain joined the European Community, and since then access for New Zealand exports to that market has become increasingly restricted. This marked the early signs of the country's long-term slide into declining competitiveness and a relative drop in living standards. This has been characterised by falling terms of trade, continuing balance of payments problems, declining value of the New Zealand dollar, low levels of productivity, and growth below trading partner levels. In contrast to its eighth highest per capita GDP in 1955, by 1990 New Zealand had fallen in relative terms to be ranked 24th in GDP per capita in the world.(12)

New Zealanders have long felt a mounting sense of frustration about the international trading system as they view continued Northern Hemisphere agricultural protectionism and subsidies. The country has struggled to find new export markets, but has continued to be locked in to commodity-type agricultural products with a long-term declining terms of trade.

New Zealand was badly hit by the OPEC price shocks in 1974 and 1979, and by persistent domestic inflation. The economic problems were exacerbated by the response of the government, which took a highly interventionist attitude and funded a major energy investment programme known as 'Think Big'. By the early-1980s it was clear that these direct government interventions, which included a wage and price freeze, capital controls, market and investment regulation, and monetary controls, were increasingly ad hoc in nature and were not resulting in the desired productivity and economic growth. As shown in Table 1, the government was running a significant budget deficit, and public debt had reached 36 per cent of GDP by 1983. The growth rate is shown in Figure 1.

There was thus common agreement about New Zealand's unsatisfactory economic performance, and in addition some consensus on the need for reform amongst the New Zealand electorate. Furthermore civil servants had become very cynical about the value of the 'hands on' style of economic management.

In 1984 a new Labour Government was elected, and proceeded to put in place a rapid programme of economic liberalisation. The election also sparked off a monetary crisis and a subsequent constitutional argument. The debate proved to be a suitable springboard for the radical new policies that were to follow.

The theoretical framework for reform

New Zealand's reform programme is set out in the appendix. The policies were broadly in line with the approaches suggested by both the OECD and the IMF in their policy prescriptions for structural reform in developed countries, though with less attention being paid to stabilisation and sequencing. However more importantly, in New Zealand's case, the vision for reform was based on a comprehensive theoretical paradigm constructed principally around new microeconomic models, loosely speaking a 'Chicago School' view. The most important aspects of this paradigm were:

* A new theory of public funding based on public choice theory, transactions costs and a theory of bureaucratic failure that pointed towards smaller government and less acceptance of market failure as a justification for intervention.

* A new theory of ownership based on principal-agency theory that rejected traditional reasons why TABULAR DATA OMITTED government should own trading activities and looked to corporatisation and privatisation for improved efficiency.

* A new theory of public provision that appealed to supply-side public sector crowd-out arguments to support a view that, with a lower tax burden, the private sector might prove more capable and efficient in providing trading services.

* A new theory of regulation that used contestability and other new theories of the firm to place more trust in market allocation and the power of actual or potential competition to regulate firm behaviour.

The overall objective of this framework was to achieve efficiency; there was an implicit assumption that clearer market signals would prompt a private sector response that would result in allocative efficiency (in some undefined way). Macroeconomic policy was always seen as being secondary to and supportive of this goal. In particular, monetary policy was to be devoted to achieving price stability, primarily to allow businesses to gain in international price competitiveness.

It was felt that fiscal policy should be as neutral as possible in its impact on the production sector, removing distortionary subsidies and incentives for private sector investment: the so-called 'level playing field' approach. Much less attention was given to typical stabilisation policy or equity objectives, which have long been the traditional concerns of government in New Zealand. The main proponent of this theoretical approach was the New Zealand Treasury which had built up and propagated a consistent and focused (if uni-dimensional) model of economic reform by the early-1980s.

The policy reforms

The election of the 1984 Labour Government provided a chance to apply this model of structural change. The period 1984 to 1991 was an unprecedented time of policy review and reform. On the advice of Treasury, relatively little attention was paid to timing or sequencing problems: changes were put in place quickly, often the constraint being how quickly they could be enacted into new law. New Zealand's thin political system (uni-cameral parliament, no economically-important state or local government, no proportional representation, no written constitution) allowed the statutory reform to proceed much faster than would have been possible in many countries.

The reform programme was based on a view of firms competing within industries, buying in factor markets, selling in product markets indirectly regulated by government. This is the framework we use to classify the reforms and the details are set in the same format in the appendix.

Factor market deregulation

Reform of the factor markets was an important early focus: the government viewed finance, transport and energy as three key sectors of strategic importance and concentrated its attention on these. This involved the removal of most market entry restrictions, price controls, regulatory monopolies and operating restrictions. Such traditionally difficult and restricted areas as banking, aviation and electricity generation have now been effectively deregulated.

The only important factor market issue that was not seriously addressed early on was the labour market. Minor reforms were carried out in 1984 and 1987; however in 1991, the newly enfranchised National Government enacted the Employment Contracts Act, a more radical piece of legislation providing for deregulation of employer-employee bargaining arrangements.

Industry deregulation

In contrast to input markets, product markets have never been as heavily regulated in New Zealand. The main focus for reform has been in the agricultural sector which had enjoyed some price support and concessional financing in the past. In contrast to the slow reform of the CAP, New Zealand's agricultural total support was removed within a few years. It is estimated that the effective rate of assistance to agriculture was 50 per cent in 1982 and had dropped to a negative figure by 1990. Almost the only continuing area of regulation, the compulsory Producer Export Marketing Boards, has been retained.

The general wage and price freezes were terminated, price controls on a specified list of products removed, quantity licensing in key industries was terminated, and state-regulated monopoly rights (eg in electricity, telecommunications and postal services) were removed. In addition, occupational licensing in a range of professions and trades has been deregulated and tight restrictions on shop trading hours were liberalised.

Mergers and trade practices are now governed by the 1986 Commerce Act which takes a liberal efficiency-based approach in comparison with most Western antitrust laws. Utilities now face no special regulation other than the Commerce Act. There is still some debate over an appropriate companies and securities legislative regime.

International trade and monetary reform

New Zealand had traditionally sheltered its domestic manufacturing sector behind a high protective wall of tariffs, import licenses, capital controls and fixed exchange rates. This insulating barrier has now been removed, driving domestic prices towards international levels. Import licensing has been phased out over a four-year period and the tariff structure rationalised and reduced. Tariffs are now down to the OECD average and due for further reduction, although they still have a high variance.

New Zealand's tight regulation on the movement of international capital has now been almost totally lifted: foreign investment into New Zealand in almost any form, portfolio or equity, is virtually free of restriction. In 1984, following the financial crisis, the incoming government devalued the New Zealand dollar by 20 per cent. The following year the currency was freely floated on foreign exchange markets without direct controls. Monetary policy was simplified, the principal objective to be deflation with a single price target of price stability (defined as a 0-2 per cent target zone). In 1989 the Reserve Bank was reorganised on the Bundesbank model to become more independent of government, with the Governor under personal contract to achieve the targeted price stability.

Government sector reform

In New Zealand the government had long been a key provider of services in a wide range of areas. During the reform period the government corporatised almost all its trading activities, setting them up with boards of directors on an arms-length basis from the shareholder. One of the objectives of corporatisation was to prepare for privatisation and since 1987 almost two-thirds of these assets have been sold. These sales have totalled $NZ10 bn, and these funds have been devoted to reducing public debt.(13) Details of corporatisation and sales to date are shown in Table 2.


More recently pressure has been applied to local and regional authorities to follow a similar path. Many local government services have now been corporatised into local authority trading enterprises and service provision is to be tendered out. Local electricity supply authorities are being set up as public companies. The public provision of research and development through government departments has been reorganised into corporatised crown research institutes. State schools have been reorganised, responsible to local boards of trustees with increasing powers over their staff. Currently hospitals are being reorganised as crown health enterprises on a corporatised basis. They will bid against private providers of health to provide the health services contracted by regional authorities.

Core government departments have been reorganised along corporate lines with chief executives on contract and departmental outputs clearly specified, contracted for and measured. The user-pays principle has been introduced for many government services. A large number of quasi-governmental advisory and operating organisations have been abolished. This year the government published a balance sheet of its own assets and liabilities on an accrual basis, the first country in the world to do so.

Considerable fiscal reform has been undertaken: the tax base was reorganised through a universal value-added tax on final domestic consumption (in contrast to VAT, there are almost no exceptions). Income tax rates were flattened and reduced, then standardised with corporate rates. Other indirect taxes and tax concessions have been generally removed, in order to set up as neutral as possible a tax system with neither incentives nor disincentives for saving and spending decisions.

By 1990 the government was concentrating on reducing its growing social spending. Among Western countries New Zealand had pioneered a comprehensive social security system as early as the 1880s. The prolonged recession in the 1980s has put these under considerable fiscal strain. The National Government since 1990 has concentrated its restructuring efforts on reducing this social spending by limiting the unemployment benefit and restructuring the universal non-contributory superannuation system. However public spending has taken a long time to respond to these reforms and the country has continued to suffer a persistently high financial deficit (currently around 3 per cent of GDP).

Figure 2 gives a conceptual representation of how these reforms were phased, together with the government in power at the time.

How the economy responded

Some basic economic indicators of how the economy responded during the restructuring period are shown in Table 1. There were three principal channels through which the shocks of the structural reforms were signalled to the domestic economy.

Interest rates

Despite its objective of reducing government expenditure, the government commenced and continued through the reform period with a high fiscal deficit and a high public debt. In the earlier years the deficit was reduced, but from the late-1980s began to grow again because of high social spending and poor tax revenues during the recession.

The public sector continued to have a strong demand for funds to finance its deficit which contributed to bid up interest rates. At the same time the Reserve Bank was running a tight monetary policy in pursuit of price stability. Tight monetary policy and loose fiscal policy typically encourages a high interest-rate regime, and New Zealand's real and nominal rates remained stubbornly high, discouraging investment for restructuring or growth.

Exchange rates

The New Zealand dollar was floated in 1985 and, contrary to some expectations that it might depreciate, it rose strongly against the trade-weighted index. This was due to the high interest rates, the government's demand for funds, the newly deregulated financial sector, and foreign perceptions of investment opportunities in New Zealand. Real exchange-rate measures indicate the very high real rates until mid-1988, considerably impairing New Zealand's trading competitiveness. As a result, New Zealand farmers went into recession and many New Zealand manufacturers gave up domestic assembly, becoming importers or distributors. The manufacturing sector decreased by a third between 1985 and 1988 in employment terms. Some of these firms had only existed under protection and could never hope to become internationally competitive.

Contraction in trading conditions

As a result of the high interest-rate and exchange-rate regimes, together with increased competition in the open economy and a loss of business confidence, domestic suppliers suffered from stagnant demand. The 1987 stock market crash was felt badly in New Zealand, and it transmitted these shocks from the traded sector through to the non-traded sector. Consequently by 1988 most businesses were operating under severe economic pressures. These stagnant trading conditions continued throughout most of the adjustment period. The recession has not been deep by historical standards, but it has been extremely long. By one measure, from 1985 to 1992, there was no per capita growth in New Zealand.

Firms generally responded by initially supporting the concept of structural change but underestimating the effect on their own profitability. As the magnitude of reform became clearer, they progressed to more and more costly restructuring decisions. There were high rates of closure and large layoffs. Unemployment grew from 4 per cent in 1987 to 10.5 per cent in 1992.

Following the pressures on the business sector, the household sector found itself increasingly pressured: as unemployment rose and real wages dropped, real disposable income reduced. One result was a savings crisis: for several years the already low savings rate declined rapidly.

By 1990 prices in the economy were considerably more conducive to competitive production. However the economy remained in severe recession, caught also by an untimely terms of trade drop, following political disruptions affecting the wool market in China and dairy and wool markets in the Soviet Union.

By 1992 the nominal exchange rate had reduced nearly 20 per cent from its 1988 peak, helping restore competitiveness for the traded sector. Inflation had dropped from 19 per cent to 1 per cent, real wage growth was negative and nominal interest rates had halved. Those surviving producers had now become very competitive by world standards, and while domestic production remained stagnant, exports boomed.

By late 1991 GDP had started to increase and the economy appeared to be entering a business sector-led recovery period, with significantly improved business confidence being recorded.

Table 3 gives an assessment of the progress of economic liberalisation in New Zealand.(14)

An assessment of the success of New Zealand's liberalisation programme will depend on the country returning TABULAR DATA OMITTED to sustainable and improved economic growth over the next few years. The economic liberalisation process has already brought marked improvements in technical efficiency, observable and measurable at plant level through gains in productivity and managerial efficiency. However this is only now translating into an economy-wide improvement in allocative efficiency, and has yet to produce the conditions for dynamic efficiency.

Lessons for Europe

The speed of change

We consider five important facets of the New Zealand experience for the changes in progress and planned in Europe in this note. The first concerns the speed of change. The existing literature tends to emphasise the importance of acting both quickly and comprehensively. Much of the argument relates to credibility (van Wijnbergen, 1992). New regimes lack a track record and experience in government. They are also faced by major problems and know that the experience of the coming years will be unpleasant as there will be a downturn before the structural and regulatory improvements begin to pay off. They are also very well aware that the success rate in seeing these reforms through to completion has been low.

As a result there is a temptation to rush at the process of liberalisation, tackling those areas where change can be readily implemented first and tackling the more difficult areas, particularly those which the government does not control directly, later in the process. The question of speed is thus bound up with issues of sequencing. In the New Zealand case the government moved rapidly on a number of fronts, tackling external liberalisation and deregulation right from the beginning. Thus New Zealand industry was faced rapidly with fiercer competition from abroad as tariffs were lowered, quantitative restrictions removed and government subsidies ended. These moves were particularly swift for agriculture, but also reasonably rapid for much of manufacturing industry, other than some sensitive sectors where a programme was phased over a longer time period. However, it was not so much the trade restrictions which had a rapid effect as the freeing up of capital markets, both internationally through the floating of the dollar and the ending of most capital controls, and domestically, through the deregulation of financial markets.

The New Zealand constitutional arrangements, with a single chamber parliament of less than a hundred members in which the government has a clear majority, enable swift action and its three-year electoral cycle encourages it.(15) Having a small population makes it possible to communicate and implement changes swiftly and effectively. On the whole, political structures in Western Europe make such swift and sustainable decision making more difficult. Legislative processes are more complicated, in some states complex deals have to be struck among coalitions of parties, while others have a more federal structure which limits the power of the central government to achieve its aims. On top of this, despite CER and its openness to international trade and investment, New Zealand can choose most of its policies to suit itself without having to have regard to its Community partners and to the joint policies implemented through the Commission. Measures of trade liberalisation and deregulation can be accomplished at a speed which would be unthinkable in the European Community. The position in Central and Eastern Europe is different. There in many cases it is possible to take swift decisions; however, the ability to implement them tends to be much more limited.

Much of the problem is that the process of rapid restructuring usually only takes place when an economy is in serious trouble. New Zealand had reached the end of the line in trying to fight against the injustices of overseas trade restrictions and the difficulties of being a small-scale remote producer by trying to intervene in the market and introduce compensating subsidies and restrictions. This had resulted in a cumulating problem of debt and an unsustainably large budget, with consequent inflation.(16) The process of rapid change requires major investment and the resolution of distortions between supply and demand caused by previous regulation will inevitably be a combination of price as well as quantitative responses, which will have a net inflationary impact as prices (particularly wages) tend to be sticky downwards. A government therefore has to take decisions which will have a harsh impact on much of the population in the short run. That can only be achieved and sustained if it has a firm basis of power and considerable reserves of popularity.

The 1984 Labour Government had both of these in its favour. It was elected with a clear majority and, since it was the more left wing of the two parties, implementing a set of policies more usually associated with the radical right it in effect trumped the Opposition and was able to get elected for a second term. That election came before the worst of the news about the economic downturn became available. Timing in Europe has not been so fortunate, although the sheer size of the European economy has meant that it has itself contributed to the worldwide slowdown. The ability to achieve the substantial and quite rapid changes required in the EC to continue the path to integration and convergence appears to face considerable difficulties. The events before and after the French referendum showed that gradualism may prove much more difficult to achieve. Operating a halfway house in which exchange rates are constrained within reasonably narrow limits and yet capital is highly mobile has proved impossible with the current levels of policy coordination. With full monetary union the problems of real structural adjustment would not have disappeared, but one source of instability in policy could have been removed. So this could be interpreted as an argument for more rapid change in one dimension of integration to reduce the chances of failure while the system is still readily reversible. New Zealand's position of a free float without exchange controls was at least sustainable even if the interest rate consequences were unpleasant.

Despite very considerable resolve, the new government in Italy is finding it very difficult to implement the fiscal reforms required to stabilise the economy. The government has recognised that part of the solution is to have the ability to act swiftly in adverse economic circumstances but it is not yet clear whether it will get the necessary powers. Furthermore there is a widespread feeling that the process of European integration has become an elitist activity which is leaving the bulk of the population behind as economies slow, unemployment mounts, interest rates remain high and problems of migration are encountered. The Danish referendum is but one reflection of it.

There is no requirement for the fears of difficulty to be soundly based. The fact that they are held is sufficient to interrupt the process of change, unexpectedly early in the case of referenda, but in any case through elections, whether for the country as a whole or part of it or through collapse of the ruling coalition. In the case of New Zealand unpopularity of the government was a major contributory factor to a backing away from the policies of radical change in the second electoral cycle. Two prime ministers resigned, as did the major architect of the liberalisation policies, Roger Douglas. Even on the most optimistic timetables the transition to EMU is expected to last another five years. The chance of diverting it as a result of an economic shock or the loss of the political will in parts of the Community bearing the highest transition costs is considerable (Mayes, 1993a).

However, the problems for Central and Eastern Europe are much greater. They have much more fundamental changes to implement. They have new democratic systems, governments trying to build credibility and economic systems not used to operating with turbulent market forces. Here the fear that unless change is rapid the reform programme will not be sustained is very real. One lesson from the New Zealand experience is that, although the government may not have survived, the reform process has continued under the National administration and its scope has been extended.(17) The programme has lasted for eight years so far and it still has some way to go, particularly in the fields of privatisation and stabilisation. If the bulk of the changes in Eastern Europe could be achieved by the end of this century that would be a remarkable achievement, yet that would be a time horizon well beyond that widely hoped for in those countries. Even for East Germany the process of transition is proving protracted and extremely expensive, despite the major resources being made available from the West. The low point has not yet been passed.

The New Zealand experience thus prompts us to ask whether the transition programmes in many of the Eastern and Central European countries will be carried through successfully, given both their costs and the length of time they are likely to take. There have already been signs of apprehension in Russia with the change in Prime Minister. Given that any failures will have external repercussions, this may increase the incentives for the West to assist the East as the problems become more apparent. However, as we noted above, the slow speed in New Zealand, despite the 'cold turkey' approach, was in part the fault of the sequencing of the reforms and there is a further set of lessons which can be learned there which may assist adjustment in Europe.


If we take the work of Genberg (1991) as an illustration of the generally recommended path for Eastern Europe it is clear that New Zealand's choice differs in the early stages in three important respects. First of all capital market reform came very early and even trade barrier reduction started early. The general suggestion in the figure is that the domestic house should be put in order first. This New Zealand failed to do at the macroeconomic level. There were three reasons for this. One was the size of the existing problem, which meant that there was a rather large existing budgetary deficit which had to be reduced; secondly, the government was much too optimistic about the growth prospects of the economy; thirdly, many of the structural changes themselves required costly spending programmes. In common with many European countries the government thought that there would be little if any recession and a fairly rapid expansion activity as the frustrated forces of competition were released as the controls fell away.

In practice the forces of competition proved much more effective at closing down uncompetitive enterprises than they did in the process of encouraging growth and setting up new activities. In part this stems from the asymmetries in the process of change (Mayes, 1986). First of all, it is actually quicker to shut down and scrap old plants than it is to build new ones, and easier to fire workers than to hire and train new ones. However, the process of exit tends also to be less costly than the process of entry, at least at the firm level. Many assets cannot be transferred between activities and hence rapid change both reduces the capital stock and increases the investment needs for the future.

The studies of structural change in New Zealand show that, faced with declining competitiveness, firms initially cut back on inventory and overtime and redeployed workers.(18) It was only gradually, as the enormity of the adjustments required dawned on them, that they were prepared to incur the high sunk costs involved with laying off skilled workers and closing down specialised plant and equipment. Having experienced this, the business recovery has come slowly: despite the recovery forecast for 1992, firms have proved hesitant about committing funds for costly investments.

The New Zealand experience also illustrates that even when the principal signal to restructure is a generalised one, like a rising real exchange rate, the sectoral impact can vary considerably. The shock transmitted to each sector depends on the extent to which it is traded internationally, the import-intensity of inputs, the currency of trade, the destination of exports, and the source of imports: these factors produced large differences in sectoral real exchange rates. For example, from 1985-9 the petroleum and chemicals sector suffered badly from declining competitiveness, whereas the wood products sector actually gained in competitiveness.(19)

The failure to control the deficit adequately meant that New Zealand had to set high interest rates both to encourage confidence and to finance borrowing. This drove the interest rate up rather than down after the initial devaluation, thus both deflating the domestic economy and making it even more difficult to sell abroad than the reduction of trade barriers already entailed. Thus there was not so much a dynamic Schumpeterian process of the new competitive ideas driving out the old as a decline in existing activity with relatively little to replace it. Reisen and Joumard (1991) suggest that the high real exchange rate has resulted in a structural break in export behaviour in New Zealand and a level of exports of manufactures 20 per cent below that which would otherwise have been expected.(20)

In part this was due to the relatively low importance given to labour market reform. Other markets had to overadjust in order to compensate and the skills of existing workers seeking new jobs rapidly depreciated. As in the case of the UK, many lower income occupational groups were hard hit and found difficulty in retraining and locating new jobs. Job loss was particularly severe amongst the Maori who were concentrated in specific areas like forestry, meat processing and public transport. This process of shaking out, although necessary, ultimately exacerbates the recession if it occurs early on.

Subsequent steps in the sequence then cumulated the problems. Financial deregulation led to a blossoming of debt and rising stock market values. The 1987 worldwide stock market crash hit the economy hard and it has been slow to recover, unlike most markets which recovered reasonably quickly. The parallels for Europe are obvious, particularly the unpleasant lesson from continuing high exchange rates and the lack of take off into sustained growth. The EC has been very successful in liberalising capital markets and there will be little trouble extending this through the European Economic Area. However, it is equally clear that adjustment in labour markets has been relatively slow by comparison, both within economies and across the Community. Unemployment remains high and mobility relatively low. Where mobility has been more successful, in Germany for example, this has created its own problems and led to resentment against immigrants. The New Zealand economy suffered heavily from unemployment but the problem would have been much worse had it not been for the opportunity of migration to Australia and a well-known tradition for seeking 'overseas experience'. However, outward migration also tends to lead to a loss of skills as it is the more enterprising and employable who tend to move (Stark, 1991, for example).

Corporatisation and privatisation

Although it also appears from Figure 2 that New Zealand was relatively slow in embarking on the process of corporatisation and privatisation this has in fact proved to be a major area of success and one of considerable innovation. In early discussions New Zealand separated the issue of the efficient operation of public sector enterprises from the question of ownership. The initial aim was to get the public sector enterprises to operate on similar commercial criteria to that of their private sector counterparts. Their management structure was therefore overhauled to try to place it on a similar basis through the creation of state-owned enterprises (SOEs). Here decision-making and operational management levels of the SOEs were intended to mimic the private sector. Ownership by the state was exercised through the relevant minister and the attempt to try to encourage strong performance through monitoring and requirements for financial performance. SOEs borrow in open markets without government guarantee.

However, the difficulties in stabilisation meant that the government needed to use every opportunity to reduce the deficit. Privatisation was therefore followed partly because private ownership was thought capable of providing the necessary incentives but also because it would provide the necessary funds. New Zealand faced the traditional problem that many state trading activities were publicly owned because they were unlikely to be fully viable in the private sector or indeed had been shown not to be so in the past. Furthermore, SOEs were also expected to show a degree of social responsibility (State Owned Enterprises Act, 1986). However, natural monopolies providing essential services were much more promising candidates (Table 2 sets out the progress of sales of SOEs) and a successful sequence of privatisations has followed.

No single route has been used to implement this but in general the state has sought to mobilise capital from three main sources: customers--so that users can have a stake in the companies they have to buy from--domestic firms and foreign investors. The use of domestic and foreign companies was often motivated by the desire to help the New Zealand enterprise gain access to foreign markets but also to enable the importing of the appropriate commercial expertise. Existing managers of state activities, even if they are well-motivated and highly competent, face a difficult task in changing the way they operate. This difficulty may face employees at all levels of the organisation and anyone who continues to work in the same job across the period of change faces a difficult problem of credibility to establish that they really have been able to adjust.

Some foreign ownership was necessary if for no other reason than the scale of the financing required. There were considerable advantages in encouraging direct investment rather than just portfolio participation, as that tended to encourage the funds to remain in the country and made exit rather more difficult. Loss of control to foreign interests, although the subject of debate, was treated remarkably leniently. Some government trading activities, like State Insurance and Post Bank, became totally foreign owned, others, like Air New Zealand and Telecom NZ, had major foreign shareholders. Central and East European countries have been somewhat reluctant to see foreign interests take over too much of their major industries and there has been some reluctance in the West as well over airlines and car producers, for example.

New Zealand's experience shows, on the one hand, that there is not necessarily the need for privatise when this generates neither significant new capital nor management expertise nor indeed has much impact on the incentives facing managers. The issuance of paper to small shareholders is unlikely to do much to change the way an SOE operates, unless they then resell their stake.(21) The chances are, under those circumstances, that the government will both forego revenue it could have earned from a sale and that the nature of the new control which is generated will have less strategic logic than an organised sale to larger investment interests. In the organised case it may be possible to enter into longer-run operating agreements to help safeguard what are regarded as vital interests. On the other hand, the NZ experience shows that very considerable foreign participation can be achieved with benefit, both to the stock of outstanding debt and to servicing costs. The Treuhand seems to have behaved in this manner but a large proportion of sales, even in open competition, has gone to West German interests. Elsewhere the approach has tended to be rather more cautious.

The competitive environment

With a highly regulated system, competitive influences had been subdued in New Zealand. One of the surprises has been the speed with which they have been introduced, not just in the public sector but in the private sector, where monopolies have been removed and price controls abolished. In part this has been due to the active policy of the government in introducing the Commerce Act in 1986 to regulate monopoly and anti-competitive practices and in the introduction of competition in areas such as the national airline and the breaking up of the Post Office into three constituent companies. In general, however, it has been a straight-forward response to the incentives. The rapid increase in efficiency has meant a major shake out of labour across the whole of the economy but it has led to the rise of some new companies, which have been particularly successful in exporting.(22) A further reason for the growing competitive environment in New Zealand was the long recession in trading activity from 1985-91 accompanied by the reduction in licensing and trade barriers to entry to most industries, resulting in competition from foreign suppliers and foreign capital.

This response will help act as a reassurance to those worried that competitive and efficient behaviour will be slow to emerge in parts of Central and Eastern Europe. However, this could be a case where New Zealand's starting point was too different to be a useful comparator.

Trade and integration

The simultaneous development of CER during the period of New Zealand's structural adjustment played a major role in helping many firms survive. Just at the time that they faced increasing competition from overseas, the Australian market was opening up. Although over 1,000 miles away, the Australian market is very accessible to New Zealand producers, first of all because tastes are fairly similar and products saleable in one market can frequently be sold without modification in the other; second because the population is spread out in a series of well separated urban centres round the coast, which means that most Australian producers are also faced by substantial transport costs outside their local markets (see Mayes, 1990).(23)

It must also be admitted that the Australian market has been characterised by substantial protection, subsidy and inefficiency, which may have eased the task. With the Australian market being so much larger, even modest rates of penetration meant that New Zealand's trade balance in manufactures with Australia moved from substantial deficit to approximate parity in just a few years.

The fact that the integration process has been extended to services, technical specifications and business law means that the stimulus continues. A similar ray of hope is important for Eastern and Central Europe in two respects. First, although the CMEA system may have broken down, these countries still have considerable ability to supply each other and the degree to which mutual trade has collapsed may be rather overdone in the first rush to get access to Western goods. Free trade among them will help restore it. Secondly, trading agreements between the EEA and the former CMEA countries can provide an attractive way forward. The existing agreements of association with the EC are not particularly generous, restricting access in agriculture and sensitive products, where the greatest likelihood of competitive exports lies. One of the most important factors in generating recovery is to have some external source of growth as internal forces are so affected by the reduction in activity caused by the opening of the market.

This same argument can be applied to the regions within the EC (NIESR, 1991). The major hope for the recovery of the less favoured regions in the Community lies in the feeding through of demand from the regions where the initial benefit is concentrated. However, the chances of that happening on a sufficient scale seem slim, although the ability of those regions to respond through the application of the EC's structural policies is likely to be steadily improved over the coming years, particularly if the Maastricht Treaty and the new cohesion fund are implemented. New Zealand did not have the benefit of any such transfers or even loans and other assistance on favourable terms. In fact, to the contrary, New Zealand's restructuring programme was carried out under hostile trading conditions in the EC. This contrasts with the trade reward (accession to NAFTA) granted to Mexico for its liberalisation programme. Those benefits exist to a limited extent for Central and Eastern Europe, hence integration in Europe may provide a strong force towards recovery, even if that integration falls a long way short of full membership of the EC. The New Zealand experience at least gives hope that the transition may be achievable.


New Zealand's experience has shown that it is possible to implement most of the textbook measures of macro and micro-economic reform recommended for achieving the transition to a liberalised market economy in a hectic period of change lasting less than ten years. However, this has been at considerable cost. The New Zealand economy has hardly grown over the period, unemployment has soared and a recovery into sustained growth, let alone a growth rate fast enough to restore some of New Zealand's lost position, is yet to be achieved. Manufacturing industry has fallen in size by a third and private investment has also fallen steeply. With world markets for traditional agriculturally-based products still heavily protected there is a question mark over the source of the recovery. Certainly a favourable outcome to the Uruguay Round would make a significant different to growth prospects.

However, in the process of achieving this radical change New Zealand broke most of the accepted rules about the sequencing of change. Many micro-economic reforms were implemented faster than macroeconomic stabilisation. Financial markets were liberalised before product markets and liberalisation of the labour market came towards the end. As a result the economy faced high real exchange rates and real interest rates, depressing both exports and investment. External markets were deregulated at an early stage before allowing internal markets to adjust. All of these helped contribute to there being large costs to adjustment.

However, many of these inversions in sequencing were the result of political necessity and the speed with which changes could be implemented. Following the recommended order would not only have meant that the process became much more gradual and drawn out but that it would probably have been stopped at a fairly early stage when sensitive measures like labour market reform or the reduction in universal social benefits were implemented. In practice the democratic constraints are all important, encouraging governments to do as much as they can early in their administrations and to avoid unpopular measures too close to elections.

The lessons for Europe from this experience, while sombre, are at least encouraging. They are encouraging simply in the sense that the changes can be implemented. Most experience from other countries has shown a faltering and reversal before the sequence is completed. However, the costs involved and the lessons of sequencing need to be examined very closely. Western Europe has also followed the course of liberalising financial markets early, certainly before the process of stabilisation has been completed. We therefore see the same problems of high real exchange rates and interest rates. In these circumstances the macro-economic policy works against the needs of the micro-economic, making the various supply-side adjustments more difficult to achieve. In particular the high levels of unemployment which result are an ominous warning given how high these levels are in the less favoured parts of Europe already.

This gives a mixed message if the Maastricht Treaty has to be renegotiated. Slowing down the pace of financial integration a little to allow the single market to develop rather further may be no bad thing. Secondly, assisting the less favoured regions in their attempts to increase investment in both infrastructure and private industry may help provide the basis for sustained growth and convergence. However, if stabilisation is to be a prior condition the problems in New Zealand do not bode well, given the problems that are already being encountered in much of Europe.

There are three further lessons which Europe could take to heart in dealing with the problems of transition in the former CMEA countries. First, there is the important role that closer economic relations with Australia has played in providing a source of growth and mitigating the depth of the recession in manufacturing. Europe has scope to improve liberalisation both among the Eastern countries and between East and West. Second, in separating the issues of corporatisation from those of privatisation, New Zealand shows that considerable efficiency gains in publicly-owned enterprises can be achieved without the need to privatise. However, it has also shown that privatisation is necessary to generate the inflow of investment and expertise necessary for recovery in many of those industries and that this can be achieved without either selling them too cheaply or encountering problems from excessive foreign control. Lastly, the New Zealand experience shows both the importance of implementing clear rules for orderly market behaviour and the speed with which those previously subject to a non-competitive regime can adjust and show very considerable entrepreneurial flair. New Zealanders have always had a reputation for resourcefulness and the practical ability to put things right, stemming from their need to be able to cope while so cut off from the rest of the world.(24)

However, it is unlikely that this spirit is unique and other countries no doubt have similar traditions to draw on, despite years of control and repression. There is a bout of initial enthusiasm accompanying these programmes of radical change. However, even a 'big bang' approach is not very quick to achieve positive results and does not avoid major costs. The real test is to maintain the impetus. New Zealand has managed it so far but not without major political casualties along the way. A similar experience is likely in Europe if the policies are carried through. However, for some that threat will be too great and the fact that we cannot find many examples like New Zealand suggests that this risk may be high.

Appendix: New Zealand economic reforms



(1) The National Institute has been undertaking a major programme of research into European integration through a wide range of projects. Recently, one focus of that research has been on problems of achieving both nominal and real convergence in the European Community, in the latter case by improving the relative economic performance of the regions with the lowest GDP per head (Barrell, 1992; Barrell and Whitley, 1992; Begg and Mayes, 1992, 1993; Britton and Mayes, 1992, NIESR, 1991). Research is also developing on a wider front, exploring the lessons that the European experience has for others (Mayes, 1992, 1993; Stanford, 1993) and conversely the lessons the Community can learn from the experience of other countries. This note reports on the implications from the New Zealand experience, developing earlier work by Bollard and Mayes (1992a,b).

(2) A referendum in Switzerland has recently rejected ratification of the EEA agreement. This does not invalidate the agreement for the remaining signatories.

(3) Even if ratification of the Treaty ultimately escapes the Community these policy objectives will remain for most member states.

(4) It is more arguable whether this process of liberalisation also implies general deregulation, as although this is widespread, much of the change can better be described as reregulation (see Shipman and Mayes, 1991).

(5) The 90 per cent division is clearly arbitrary and is chosen so that there is no doubt that Greece, Ireland, Portugal and Spain qualify and that no other states come within range of doing so. NIESR (1991) and Mayes (1992a) suggest some more sensitive means of choosing the circumstances under which further assistance is needed.

(6) We have ourselves done this for Spain in Ahijado, Begg and Mayes (1992).

(7) The consequences stemming from what in many respects might have been thought one of the easier cases--the integration of East and West Germany --is already leading to a slowdown in much of the European economy, tensions within the ERM and is a contributory factor to the difficulties facing the Maastricht Treaty on European Union.

(8) The post-war reconstruction in Europe offers a number of parallels, certainly in terms of scale and the wish for rapid change.

(9) According to the OECD Economic Survey (OECD, 1991) it is the 'most comprehensive economic reform programme undertaken by any OECD country in recent decades'.

(10) The process of integration between the two countries, usually refered to as Closer Economic Relations (CER) is described in more detail in Bollard and Mayes (1992a) and Mayes et al. (1993b). It is in some respects more advanced than that of the EC or EEA because there is a common labour market, characterised by considerable movement between the two countries, in addition to agreements over trade services, competition policy, public purchasing, etc. There is also a wider trading area which includes most of the smaller islands of the South Pacific, SPARTECA. For details see Bollard and Mayes, 1992a.

(11) See Mayes (1990) for an exposition of the evolution of this dependence.

(12) OECD Main Economic Indicators.

(13) For details see Duncan and Bollard (1992).

(14) For a more detailed assessment of the programme of liberalisation, see Bollard (1992).

(15) Partly as a response to the very rapid changes over the past decade, the New Zealand public has recently voted in a referendum to change to a mixed member proportional representation system similar to that of Germany.

(16) The biggest single contributor to this problem of indebtedness had been a series of major projects largely financed by the government to improve the balance of payments through import substitution or exporting. In general these were not successful although, by the time of their completion, New Zealand was well equipped to withstand a major rise in energy prices.

(17) That is scant comfort for most politicians, who want to have more than one term of office. It emphasises both the need to act quickly for political survival and the real danger that the instinct for survival may cause governments to halt or slow the process, as with the final period of the second Labour administration.

(18) These studies are summarised in Harper and Malcolm (1992).

(19) See for example Hunn et al. (1989).

(20) Because of the forces which lead to hysteresis the mere ending of overvaluation will not immediately solve the problem and a sustained period of stability (some argue undervaluation: Collignon, 1992) will be necessary to provide the necessary investment, building up of marketing contacts and networks and the recovery of employment.

(21) If the point of giving the stake to small shareholders is because they have derived a right to ownership and control through working in the company or through the payment of taxes which led to its development, then sale of that stake removes much of the rationale for its creation, particularly if the financial proceeds are small.

(22) Metro, 1992, 'Is there light at the end of the tunnel?', pp. 41-70.

(23) Transport costs across the Tasman also tend to be lower than internal transport costs in Australia.

(24) It is said that there are few problems that cannot be solved by use of a piece of '4 by 2' and some number 8 fencing wire.


M. Ahijado, I.G. Begg and D.G. Mayes (1992), La Competitividad de la Industria Espanola en los Anos 90 Liberando el Potencial, Spanish Ministry of Industry, Madrid.

R. Barrell ed. (1992), Economic Convergence and Monetary Union in Europe, London: Sage.

R. Barrell and J. Whitley, eds. (1992), Macroeconomic Policy Co-ordination in Europe: the ERM and monetary union, London:
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Author:Bollard, Alan; Mayes, David G.
Publication:National Institute Economic Review
Date:Feb 1, 1993
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