New Zealand: Selected Issues

This Selected Issues paper discusses the issues related to reforms and growth in New Zealand. The paper analyzes the record on growth and productivity outcomes in a comparative perspective. The study provides a brief history of the industrial relations in New Zealand leading up the passage of the employment contracts act. The paper assesses the monetary policy framework, central bank decision-making processes, and also reviews the possible extensions to full funding of the country's future superannuation expenditures.

Abstract

This Selected Issues paper discusses the issues related to reforms and growth in New Zealand. The paper analyzes the record on growth and productivity outcomes in a comparative perspective. The study provides a brief history of the industrial relations in New Zealand leading up the passage of the employment contracts act. The paper assesses the monetary policy framework, central bank decision-making processes, and also reviews the possible extensions to full funding of the country's future superannuation expenditures.

I. Executive Summary

1. This paper was prepared as background to the 2000 Article IV consultation with New Zealand.

2. Chapter II (“New Zealand’s Growth Experience in Comparative Perspective: Stylized Facts and Policy Lessons’”) discusses issues related to reforms and growth in New Zealand, An issue that has preoccupied policy makers and observers alike is why, in spite of the wide-ranging macroeconomic and structural reforms implemented since the mid-1980s, growth in New Zealand has not been sufficiently high to narrow the income gap with its OECD counterparts. The paper reviews the record on growth and productivity outcomes in New Zealand in the period since the mid-1980s, explores reasons why the growth payoff has been smaller and slower than expected, and draws on the experiences of a group of comparator countries that have been successful in raising their growth rates to distill policy lessons that might be applicable and relevant for New Zealand. The main conclusions of the paper are: (a) the reforms have begun to pay-off, but the dividend has been slow to be realized for a number of reasons, including the expected lagged response to macroeconomic stabilization and reestablishment of credibility, relatively slow progress in enhancing human capital, and issues related to the sequencing of the reforms, including the introduction of labor market reforms relatively late in the reform process; (b) there remains an agenda of unfinished business especially in upgrading technical and management skills, and in completing the process of deregulating product markets. The urgency of addressing this unfinished agenda is heightened by the fact that the rest of the industrial world is, once again, on the move—driven by technology, entrepreneurship and innovation—so that the issue for New Zealand is now not only of “convergence” with other advanced economies, but of catching up with a moving target.

3. The Employment Relations Act (ERA) was passed into law in August 2000 following a contentious national debate. The new legislation is intended to level the playing field in the area of employment relations, which the newly-elected government feels had become unbalanced since the passage of the Employment Contracts Act (ECA) in May 1991. On the other hand, the ERA is seen—particularly by the business community—as a significant step backward in the trend toward labor market liberalization which culminated with the passage of the ECA. The ECA effectively ended nearly a century of centralized industrial relations in New Zealand, including by stripping unions of the legislated advantages they had enjoyed under previous labor market regimes. In light of these strongly held views and the uncertainty surrounding the effects of the ERA going forward, Chapter III (“Toward Assessing the Impact of the Employment Relations Act”) takes a wider look at labor market reform efforts in New Zealand with a view to identifying areas to watch as the ramifications of the ERA unfold. The paper suggests that an assessment of the ERA would depend both on the evolution of employment growth, productivity, wage dispersion and contract structure—which can be observed relatively quickly—as well as on other effects, such as the evolution of case law in respect of the notion of “fair bargaining,” which will take years to unfold. Even with the passage of time, however, it will likely be difficult, as in the case of the ECA, to make a definitive judgement on the effects of the ERA.

4. The move to inflation targeting followed the approval of the Reserve Bank Act in 1989 and aimed at delivering price stability in an economy that had experienced double digit inflation for most of the period since the first oil shock, but New Zealand has managed to achieve and maintain low rates of inflation, monetary policy has been often blamed for contributing to the economic instability experienced during the 1990s. Partly in response to these concerns, the modus operandi of monetary policy has been altered over time to make it more flexible and to take greater account of the concern about economic instability. The most recent change comes with the latest Policy Target Agreement (PTA), the contract between the Treasurer and the governor of the RBNZ that defines the operational aspects of inflation targeting in New Zealand. The new PTA states that in pursuing its price stability objective the RBNZ “shall seek to avoid unnecessary instability in output, interest rates and the exchange rate”. Further, a review of the conditions of monetary policy has been announced by the government. A decade after the Reserve Bank Act, this review raises the opportunity to look back and assess the experience with the monetary policy framework. Chapter IV (“New Zealand: Monetary Policy Framework and Central Bank Decision Making Processes”) has three objectives. The first is to assess whether there is a problem of excessive economic volatility in New Zealand and how the RBNZ operational approach to inflation targeting deals with it. The second is to look at the recent change in the PTA and analyze its consistency with the current institutional monetary policy setup. The third is to focus on possible modification of the current monetary policy institutional framework, namely, the move toward a committee-based decision making process. This paper argues that inflation targeting is unlikely to be responsible for an excessive degree of output and instrument volatility in New Zealand. While acknowledging that the most recent change in PTA formalizes the existing modus operandi by making explicit the RBNZ’s concern for economic stabilization, the paper argues that this explicit formalization may in principle expose monetary policy to tensions from which it was previously more protected. On the question of whether the responsibility for monetary policy decisions should be delegated to a committee, the paper concludes that there appears to be no compelling reason to change the current structure of monetary policy decision making.

5. Like most OECD countries, New Zealand faces an aging population over the coming century, which implies pressure on the public finances, including from pension-related expenditures. To address these pressures, the newly-elected government has announced that it will begin to allocate budgetary surpluses to and build up assets in a Crown entity (or similar arrangement) to “pre-fund” some future pension spending. Such a policy would be a significant departure from the present pure pay-as-you-go system. Chapter V (“New Zealand Superannuation—Possible Extensions to Full-funding”) takes the view that the recent policy change can be seen as the first step in a sequence of actions to further improve the long-term financing of the public pension system, including through a move toward full funding, perhaps combined with further parametric benefit reforms. In this spirit, the paper looks at “costing out” the shift to a fully-funded pension system considering: (i) various objectives as to what proportion of future pension expenditures should be fully funded; (ii) to what extent investments in equities could be used to bolster returns and achieve “politically feasible” transition paths to a fully-funded system over the long run; and (iii) to what extent further parametric benefit reforms would contribute to such paths. The results show that while fully funding all future increases in pension spending is likely to be feasible, fully funding all future pension expenditure would likely require some combination of further benefit reform, optimistic assumptions on asset returns and a long transition period. The paper also looks at the probable macroeconomic impacts of fully funding pension expenditures, including the effects on national saving, labor supply and the current account. Finally, operational issues likely to be important in defining and implementing a pre-funding strategy are explored.

New Zealand: Selected Issues
Author: International Monetary Fund