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.


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.

II. New Zealand’s Growth Experience in Comparative Perspective: Stylized Facts and Policy Lessons1

A. Introduction

6. Measured in terms of purchasing power parity (PPP) adjusted per capita income, New Zealand held a position slightly above the OECD average in the early 1970s—comparable to Australia, slightly below the U.S. and Canada, and far above currently high performing countries like Ireland and Finland. Around the late 1970s, New Zealand began to steadily lose ground, and by the mid-1980s, its PPP adjusted per capita income had fallen below the OECD average. A large part of the reason for the initial decline lies in the loss of preferential access for its exports, when the U.K. joined the European community in 1972 (Figure II. 1).

Figure II.1.
Figure II.1.

New Zealand: Per Capita Income in PPP-adjusted U.S. dollars, 1973–99

Citation: IMF Staff Country Reports 2000, 140; 10.5089/9781451830262.002.A002

Source: IMF, World Economic Outlook database.

7. Also, by the mid-1980s, in part because of the failed “think big” development strategy of the period 1976–84, the New Zealand economy was faced with severe macroeconomic problems—high and variable inflation, rising public debt (gross government debt peaked at 80 percent of GDP in 1986), rising unemployment (from close to zero in the early 1970s, to 5 percent in the late 1970s and further to 7 percent in 1983) and mounting external pressures (the current account deficit had widened from 2 percent of GDP in the first half of the 1970s to 6 percent of GDP in first half of 1980s). A loss in international confidence in the economy in 1984 triggered a foreign exchange crisis.

8. It was against this background that the economic reform program in New Zealand was launched. The first reforms were the floating of the exchange rate in March 1985, and liberalization of interest rates and financial markets and the capital account of the balance of payments. These were followed by successive steps of removing distortions in and deregulating goods markets, including through trade liberalization; tax reform, including the introduction of the GST, public expenditure cuts and budget management reforms; downsizing of the public sector through an aggressive privatization program; and path-breaking reforms of the accountability and incentive structures in all parts of the public sector. Key legislative reforms in the latter area were the introduction of the Reserve Bank Act of 1989 making the Reserve Bank of New Zealand (RBNZ) operationally independent and setting the stage for inflation targeting as the monetary policy framework; and the Public Finance and Fiscal Responsibility Acts of 1989 and 1994, that provided a clear and transparent framework for fiscal policy (Box II.1).

9. The reforms have been successful in improving overall macroeconomic performance by opening the economy up to competitive pressure and market forces both domestically and internationally, and substantially improving the credibility of economic management. Inflation fell to low and stable levels—from around 8 percent in 1989 to 1½ percent by 1992—and low inflationary expectations are now entrenched; fiscal consolidation has taken the public sector’s finances from a peak deficit of 6 percent of GDP in 1983/84 to sustained surpluses by 1993/94 and public debt has fallen sharply with gross debt now at 35 percent of GDP and net debt around 21 percent of GDP. After an initial increase from 4 percent in 1984–85 to over 10 percent in 1991–92, unemployment has shown what appears to be a trend decline to around 6½ percent at present.

New Zealand—A Snapshot of Key Reforms Since the mid-1980s

The first wave of reforms was implemented in 1984–87 and covered a wide range of measures:

  • Removal of interest rate and foreign exchange controls, and the floating of exchange rate in 1985.

  • Trade liberalization and a phased removal of external trade distortions. All export assistance was removed by 1987, import licensing by 1989 and import tariffs were steadily reduced through the 1980s and 1990s to the present low levels.

  • Liberalization of the foreign direct investment regime.

  • Shift from the approach of multiple monetary policy targets to a single focus on containing inflation. The fiscal deficit was required to be fully financed through sales of government bonds to financial markets.

  • Taxation reform (broadening the tax base, lowering marginal income tax rates and simplification of the tax system), including removal of tax concessions for saving to put it on a neutral footing. Introduction of the Goods and Services Tax (GST) in 1986.

  • Implementation of the first major step in the process of public sector reforms—with the passing of the State-Owned Enterprise Act in 1986. Many government departments were transformed into state-owned enterprises (corporatization) and a multi-year process of privatization started.

  • Product market deregulation and the termination of all state regulated monopoly rights in many industries.

  • Passage of the Commerce Act and adoption of a light-handed regulatory regime, the main feature of which is the absence of industry-specific regulator.

Between 1988 and 1990, key reforms related to the monetary policy framework and public finance management:

  • Approval in late 1989 of a new Reserve Bank Act making the Reserve Bank instrument independent, providing for a clear, single target (inflation), requiring specific targets in a Policy Targets Agreement between the Governor of the Reserve Bank and the Minister of Finance to be published, and requiring accountability to Parliament.

  • Approval in 1989 of the Public Finance Act, providing the legal framework for all aspects of public financial management. It defined performance in public entities by outputs and outcomes; made the chief executive responsible for departmental financial management and subject to performance-based employment contracts; and introduced accrual accounting. These reforms enhanced accountability and the incentive structures for improved management in government departments and SOEs.

The next round of reforms came between 1991 and 1994:

  • Introduction in 1991 of a major reform of the labor market, replacing centralized bargaining structures with decentralized enterprise bargaining, bringing the labor market institutions closer to the U.S. model than the previous European model, and making the labor market became one of the most flexible ones among OECD countries.

  • Tightening of requirements and reductions of levels of unemployment benefits and other social transfers.

  • Also in 1991, the new government started a process of cutting fiscal expenditure while continuing to implement the phased reforms set in motion by the previous government (tariff reductions, goods markets reforms and reforms in public sector management).

  • Passage of the Fiscal Responsibility Act in 1994 to put fiscal policy on a clear contractual basis between principal and agent; to increase transparency of policy making and policy makers’ accountability to the public; and to reduce uncertainty about fiscal management over the medium term.

10. However, a major disappointment to policy makers and observers alike is that although the reforms—by helping to get the “signals” right and improving the efficiency of resource use—have succeeded in slowing the decline of New Zealand’s position vis-à-vis the OECD average, they have not yielded growth rates that are sufficient to significantly narrow the income gap with its OECD counterparts.2

11. This paper has three basic aims: the first is to review the record on growth and productivity outcomes in New Zealand since the period when the wide-ranging reforms were launched in the mid-1980s; second, to try to understand why the growth payoff has been smaller and slower than expected and to identify areas where New Zealand falls behind other successful countries; and, third, to draw on the experiences of countries that have been successful in raising their growth rates to distill policy lessons that might be applicable and relevant for New Zealand.

12. 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, as well as 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 the industrial countries, but of catching up with a moving target.

13. The rest of the paper is organized as follows: Section B presents a broad brush picture of the evolution of growth, factor accumulation and total factor productivity through the reform period. Where relevant, this performance is also placed in comparative perspective with the OECD average, as well as with some high performing OECD countries—Finland and Ireland, and countries that are similar to New Zealand in their basic structure, i.e., with a relatively high proportion of economic activity in the primary sectors—Australia and Canada. Section C examines the record of macroeconomic and structural policies in an attempt to identify reasons why growth in New Zealand still lags the group of comparator countries and the OECD average, and draws on the experience of the high performing comparator countries to distill relevant lessons for New Zealand. Section D contains some concluding remarks.

B. The Record of Growth, Factor Accumulation and Productivity

14. By now, much has been written about New Zealand’s economic reforms and their wide-ranging, and in some cases, unique nature, but much less seems to be known outside a small group of researchers about how measurable economic performance has evolved since the reforms. This section attempts to provide a broad brush picture of the facts about New Zealand’s growth performance over time and across a small group of comparator countries.

The Growth Record

15. Table II.1 shows the evolution of average annual growth in real per capita income. The starting point is chosen as 1973, when the economy experienced a sharp structural break—the U.K. joined the European Community in 1972. which resulted in the loss of preferential access by New Zealand to its major export market. New Zealand’s performance is shown relative to the OECD average, and that of a group of economies that are either structurally similar or that have performed very strongly in recent years, and from which there may be some policy lessons to learn. The year 1985 is treated as the first year of the reform period in New Zealand.

Table II.1.

Annual Average Growth in Real Per Capita GDP

(In percent)

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Source: WEO database.

Noteworthy points about this table include:

  • Based on long period averages, there appears to be little difference in New Zealand’s growth rate between 1973–84 (“pre-reform”) and 1985–99 (“post-reform”). But such long averages tend to mask some important trends, especially in the post reform period.

  • A division of the “reform period” into five-year subperiods reveals that, after a period of low growth in the late 1980s, real GDP growth has been accelerating.

  • A comparison with OECD averages during the 1973–84 and 1985–99 periods suggests that the gap with the OECD average growth rate has not changed in the two subperiods.

  • However, the comparative experience in the “post” reform period is more complex—New Zealand lost considerable ground vis-à-vis the OECD average in the late 1980s immediately after the reforms were launched, regained some in the early 1990s, but has begun once again to lose ground in the second half of the 1990s.

16. A decomposition of per capita GDP growth into output growth and population growth reveals that most of the divergence in per capita growth rates can be attributed to differences in population growth. The marked increase in New Zealand’s GDP growth rates from the early 1990s coincided with a sharp increase in population growth rates—mostly from net inward migration—which was exceeded only by Australia and Canada.3

Table II.2.

Annual Average Growth in Real GDP

(In percent)

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Source: WEO database.
Table II.3.

Annual Average Population Growth

(In percent)

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Source: WEO database.

17. An important element of the growth record relates to the extent to which the structure of the economy has become diversified. A more diversified structure tends not only to provide greater stability and resilience to variations in the terms of trade, but possibly also a more dynamic economy. The main conclusion from an examination of the data is that there has been diversification in the New Zealand economy, but that the process started much later than other industrial countries. A somewhat unusual feature about New Zealand, relative to the comparator group, is the small increase in the share of the primary sector in GDP, reflecting a continuing comparative advantage in this area, and strong productivity growth since the reforms (as discussed below). Although these figures mask the extent of diversification that has taken place within the agricultural sector—the movement from low value-added basic commodity production to higher value-added, more sophisticated products within the sector (e.g., the shift from frozen to superior quality chilled meats, etc.)—it is clear that New Zealand remains relatively concentrated in primary goods and their processing and thus remains vulnerable to volatility in international commodity prices.

Table II.4.

Sectoral Composition of GDP 1/

(In percent of total)

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Source: OECD Quarterly National Accounts; CEIC database.

Numbers may not add to 100 percent due to the statistical discrepancy.

Data are for 1990 and 1999.

Accounting for Growth

18. This section turns to an examination of the evolution of the “components” of growth—accumulation of physical and human capital and the efficiency with which resources are used to produce output, or total factor productivity—using the growth accounting framework.

Capital accumulation
Table II.5.

Gross Fixed Capital Formation

(In percent of GDP)

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Source; WBO database.
  • New Zealand’s investment rates have been broadly similar to investment rates in the comparator countries throughout the period. This suggests that the gap in growth performance must reflect more the quality rather than the quantity of investment. As noted by Galt (2000), “one point of near unanimity amongst New Zealand analysts is that while New Zealand has undertaken a reasonable amount of investment, it has suffered from poor investment quality in the past.”

  • There has been a marked decline in investment/GDP ratios in New Zealand between the 1973–84 and 1985–99 periods, with virtually no change in average growth, suggesting, prima facie, that, for a given size and quality of labor, the quality of investment has likely improved since the mid-1980s.

19. The most robust evidence on the improvement in investment quality since the economic reforms comes from a detailed and careful study conducted by Diewert and Lawrence (1999) on New Zealand’s productivity growth. The key findings are:

  • like other industrial countries, there has been a trend decline in capital productivity from the early 1970s reflecting an increase in the capital intensity of production;

  • from around 1991, there has been a sharp pick-up in capital productivity in New Zealand;

  • real after-tax returns on capital rose from 2.9 percent in the 1970s and 1980s to 5.3 percent in the 1990s.

20. Key factors that are likely to have contributed to the past low productivity of investment in New Zealand in the past include (1) the plethora of producer subsidies and other industry protection measures and financial market controls that are likely to have distorted price signals and resulted in higher investment in the protected sectors which were not always the most productive (e.g., some of the investment associated with the “think big” projects of the late 1970s and early 1980s); and (2) the relatively heavy investment in residential property could also be a determinant of the quality of investment as measured by the growth stimulus. During the 1970s, nominal interest controls coupled with rising property prices as well as the interaction of the tax system and high rates of inflation on real after-tax returns, tended to tilt investment toward real estate.4 The removal of credit constraints after the financial market liberalization of the mid-1980s also boosted investments in real estate. The improvement in investment quality during the 1990s is likely to have been driven by the scrapping of capital stock that had been employed in previously protected and low-return sectors, and the improvement in resource allocation associated with the greater role for price signals and the market mechanism.

21. Other insights on the contribution of capital to growth can be obtained from examining the role of foreign investment in New Zealand. Foreign direct investment (FDI) into New Zealand has been sizable and has been amongst the highest in the group of comparator countries (Figure II.2). However, the growth stimulus appears to have been lower in comparison to other countries, especially Ireland, where FDI inflows and foreign owned firms are widely acknowledged to have played an important role in Ireland’s rapid output and export growth (Box, 1998). In part, this is because FDI in New Zealand has been the result of considerable foreign involvement in the privatization program and as well as in mergers and acquisitions of existing private firms, rather than in so-called greenfield or start-up investments or expansion of capacity. Also, in contrast to Ireland where FDI is concentrated in the export-oriented sectors, FDI in New Zealand is relatively more focused in serving the local market (Cartwright, 1998). Where it is export-oriented, FDI in New Zealand tends to be concentrated in resource based industries, and has thus contributed little to diversifying the structure of the economy. In the recent past, there has been an increase in FDI in export-oriented high-tech activities in electronics, software development and other IT sectors, but the high-tech sector is still relatively small in New Zealand.

Figure II.2.
Figure II.2.

New Zealand: Foreign Direct Investment Inflows, 1980–99

Citation: IMF Staff Country Reports 2000, 140; 10.5089/9781451830262.002.A002

Source: IMF, Balance of Payment.
Human Capital Accumulation

22. The second major influence on growth is labor accumulation, which depends both on the number of workers as well as their “quality,” the latter being broadly measured by educational attainment and skills. The table below shows that labor force growth (the quantity measure) in New Zealand has been quite strong in the 1990s, both due to increases in both male and female labor force participation rates, and due to net migration inflows. Despite differences in female labor force participation rates and relatively sharp cyclical swings in net migration flows, New Zealand’s labor force and employment growth record is not much different from that of other comparable countries, with the exception of Ireland.5

Table II.6.

Average Annual Labor Force Growth

(In percent)

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Source: OECD Employment Outlook database.
Table II.7.

Average Annual Employment Growth

(In percent)

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Source: WEO database

23. However, of much greater relevance to the contribution of labor force growth to output growth is its quality. Human capital, particularly that attained through education, has been emphasized as a critical determinant of growth, in large part, because an abundance of well-educated human resources helps to facilitate the absorption of advanced technology. Despite this eminently appealing conclusion, the link between education and growth in cross-country growth regressions is tenuous, primarily because of serious measurement errors in the indicators that have traditionally been used in cross-country regressions—namely initial levels of education (Krueger and Lindahl, 2000). At the same time, however, there is strong microeconomic evidence of the positive effect of the stock of education on income growth. In general, there is little consensus about how best to measure human capital accumulation, with some researchers focusing on initial levels of education and others using years of schooling, and more detailed surveys of literacy and numeracy.

24. In the past, a consistent theme in the New Zealand growth literature was that the relatively slow progress in accumulating skills and educational achievement has been a contributor to New Zealand’s modest growth performance. However, marked strides have been made in improving human capital in recent years. This paper looks at a number of measures of human capital accumulation—conventional measures such as rates of participation and attainment in tertiary education, as well as survey based data on a variety of aspects that describe labor force skills, broadly defined to include technological advancement and management proficiency in the economy. The broad conclusion of the examination of these data is that New Zealand has recently (since about the mid-1990s) made significant strides in raising educational achievement, although there is some question about the overall quality of skills in the labor force. Given the lags between measured attainment rates, human capital improvement and growth, the relatively recent gains in New Zealand suggest that the benefits in terms of higher productivity growth are likely to flow through gradually over the coming years.

25. Typical measures of human capital accumulation are educational attainment or school enrollment ratios. Conway and Orr 1999 present evidence that in 1966 almost three quarter of New Zealand’s population aged 15 and over had no recognized educational qualifications—the latter defined as education levels of secondary school or above (Table II.8). In light of concentration in agricultural production, and generally low unemployment until the 1970s, there appeared to have been limited incentives for people to accumulate human capital. However, by the mid-1980s, educational attainment rates showed a marked improvement, with only 40 percent of people over the age of 15 having no formal qualifications. A further discernible improvement took place by the mid-1990s, when about one third of the working age population were without formal educational qualifications, as defined above.6

Table II.8.

New Zealand: Educational Qualifications of the Population Aged 15 and Over

(In percent of total)

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Source: Conway and Orr (1999) from New Zealand Census data.

26. A number of other indicators confirm that New Zealand has recently made significant gains in this area, including against the comparator countries. Tables II.9 through II.12 below suggest that the quality of human capital in New Zealand has improved over the past few years to reach the OECD average, and more generally, to narrow the gaps with other comparator countries.7

Table II.9.

Tertiary Education Attainment, 1998 and Average Years of Schooling, 1995

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Source: OECD (for Tertiary Education data), and Barro and Lee, 2000 (for years of schooling data).

Includes advanced research programs, theoretically oriented programs, and practical, technical and occupation-specific education.

Data refers to 1997.

27. Other measures from the International Adult Literacy Survey, which collected data on work-oriented literacy and numerical skills in the mid-1990s for 12 OECD countries are shown in Tables II.10 through II.12 and generally do not suggest a significant variation between the comparator group.

Table II.10.

Scores of the Adult Literacy Test, 1995

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Source: Literacy Skills for the Knowledge Society, OECD and Human Resources Development, Canada.
Table II.11.

Participation in Adult Education and Training, 1994–95

(In percent of population aged 16–65)

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Source: Literacy Skills for the Knowledge Society, QECD and Human Resources Development, Canada.
Table II.12.

Share of Employer-Sponsored Education and Training

(In percent of employed population)

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Source: Literacy Skills for the Knowledge Society, OECD and Human Resources Development, Canada.

28. However, there is some question about the quality and relevance of the increase in literacy and skills in New Zealand. Information from Global Competitiveness surveys conducted by the World Economic Forum measure a range of dimensions such as management training and quality, technological advancement through R&D, and science and other technical education (Tables II.13 and II.14).8 Other indicators that cast doubt about the quality of educational attainment in New Zealand include the data from a survey that measures the quality of secondary school education in mathematics and science which indicates that New Zealand consistently ranks the lowest in the comparator group.9

Table II.13.

Global Competitiveness Survey Result on Labor Quality, 1989 and 1999 1/

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Source: The World Competitiveness Report 1989 and the Global Competitiveness Report, 1999.

For 1989, 22 are countries ranked from 1 (most competitive) to 22 (least competitive) for the specific factor, and for 1999, 59 countries are ranked from 1 (most competitive) to 59 (least competitive).

Table II.14.

Global Competitiveness Survey on Technology, 1989 and 1999 1/

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Source: The World Competitiveness Report 1989 and the Global Competitiveness Report, 1999.

For 1989, 22 are countries ranked from 1 (most competitive) to 22 (least competitive) for the specific factor, and for 1999, 59 countries are ranked from 1 (most competitive) to 59 (least competitive).

Total Factor Productivity

29. The final component of the growth accounting framework is total factor productivity (TFP), which measures the efficiency with which an economy combines its capital stock and its labor supply to produce final goods and services. In presenting their findings from the study of TFP in New Zealand, Diewert and Lawrence divide the period under study into four periods based on trends in TFP growth (Figure II.3).10 From 1972 through 1982, TFP declined markedly. This was followed by a brief period of strong TFP growth between 1982 and 1984. Next came a period of flat TFP between 1984 and 1992, and finally, from 1993 onwards, TFP growth has again improved. Diewert and Lawrence were however unable to find conclusive evidence of a structural break in 1993, in part because of the small number of observations since that time.11

Figure II.3.
Figure II.3.

New Zealand: Productivity Indices, 1972–98

(Base year: 1972)

Citation: IMF Staff Country Reports 2000, 140; 10.5089/9781451830262.002.A002

Source: Diewert-Lawrence, 1999.

30. Diewert and Lawrence also attempt to compare New Zealand’s TFP performance with that of Australia.12 They find that there was a sharp divergence between TFP growth, in Australia and New Zealand in the 1970s, with Australia’s TFP growth increasing steadily and New Zealand’s TFP growth being much more volatile. Beginning in 1984, the differences in trend annual growth were considerably reduced. Excluding the poorly measured financial and community service sectors, New Zealand’s TFP performance closely mirrored Australia’s until 1993, but since then, Australia’s TFP growth has been more rapid.

31. Another recent study (Conway and Hunt, 1998) examines New Zealand’s productivity performance in relation to that of the U.S. economy using a cyclically adjusted measure of TFP through 1996. Their results indicate that the trend growth rate of TFP in New Zealand does shift upward around the end of 1991, and they interpret this as encouraging, if tentative evidence that some convergence has begun to take place between New Zealand and the technology leader, the United States.

32. The main findings of this section can be summarized as follows:

  • There has been a pick-up in per capita growth in New Zealand in the later part of the post-reform period suggesting “convergence” with the OECD.

  • However, there is also tentative evidence to suggest that New Zealand may be chasing a moving target in the last few years, this process of “convergence” may have slowed because growth in the rest of the OECD has once again accelerated.

  • The quality of physical capital investment was low in the 1970s and 1980s, but there is some evidence of an improvement in the 1990s.

  • There has recently been a substantial improvement in the quality of the labor force by some measures, suggesting that there is likely to be a productivity payoff in the future.

  • However, the gap between New Zealand and other OECD countries in technical and management skills may still be large.

  • There seems to be encouraging evidence of a pick-up in TFP growth, although, with the data available, as in the case of output, it is difficult to disentangle cyclical from structural shifts.

  • Moreover, as with growth, data from recent years suggests that labor productivity and TFP growth in comparator countries has begun to again outpace that of New Zealand.

C. Policies and Their Impact on Growth and Productivity Outcomes

33. Thus far, the paper has described trends in the components of growth as identified in the neoclassical growth accounting framework—an exercise which essentially depicts what happened to growth in output and productivity and factor accumulation but says nothing about why those developments took place. There is, by now, a vast body of empirical literature examining the links between policies and growth and whether these links operate by enhancing capital accumulation or TFP or both—as hypothesized in the endogenous growth literature. This section examines how New Zealand fares with respect to policies that have been identified to be correlated with growth with a view to identifying factors which could explain both its own growth record as well as the gap in growth rates with the comparator group.

34. The literature on factors that influence growth finds that sound and stable macroeconomic policies are the necessary foundation for growth, but there is growing recognition that an economy’s competitiveness and productivity growth also depends on such “micro” factors as how rapidly it can upgrade itself and move to more sophisticated ways of competing. Success in upgrading the competitiveness of an economy in turn depends on a host of factors such as openness to international trade and investment, deregulated product markets, access to smoothly functioning financial and labor markets, infrastructure quality, availability of a highly skilled labor force (including both technological and management skills),13 and well-functioning institutions and strong governance.

35. Where does New Zealand stand with respect to these policies? In several areas, New Zealand has made significant and impressive performance, and New Zealand has likely still not seen the full benefits of those reforms. However, in other areas, there remains an agenda of “unfinished business” that is likely to pay a significant growth dividend.

Areas in which New Zealand has achieved significant progress

Macroeconomic Stabilization

36. A major achievement of the reform process in New Zealand has been the attainment of a sustained period of macroeconomic stability—whether measured by the level and variability of inflation and interest rates, or by the level of fiscal deficits and public debt. As shown in Figures II.4 and II.5, New Zealand started the reform period with high and variable inflation rates, which put it in a substantially worse position than the group of comparator countries. Since the late 1980s, however, both the level and variability of inflation have been brought down dramatically, and low inflationary expectations have become entrenched.

Figure II.4.
Figure II.4.

New Zealand: Inflation Rates, 1970–99

(Period average)

Citation: IMF Staff Country Reports 2000, 140; 10.5089/9781451830262.002.A002

Source: IMF, International Financial Statistics.
Figure II.5.
Figure II.5.

New Zealand: Variability in Inflation, 1979–99 1/

Citation: IMF Staff Country Reports 2000, 140; 10.5089/9781451830262.002.A002

Source: IMF, International Financial Statistics; and Fund staff estimates.1/ Defined as rolling 16-quarter standard deviation.

37. Significant progress has also been made with previously persistent fiscal deficits, although the process has not been completely smooth, suggesting that the gain in fiscal policy credibility has been a relatively recent phenomenon. The initial progress in fiscal consolidation was driven by the privatization program. However, between 1988 and 1991, fiscal consolidation stalled.14 Ideological differences emerged within the government about how far to push reforms in social policy and whether to subject social expenditures to cuts similar to other expenditures. These events coincided with a stock market crash which raised questions about the economy’s growth prospects, and an adverse shock to the terms of trade in 1990s. Together they resulted in a sharp fall in business confidence, which weakened growth and set off a period of fiscal weakening. The resulting deterioration in public finances was arrested in 1991/92 and the stage was set for the major progress that has been made since then. The passage of the Fiscal Responsibility Act in 1994 was clearly instrumental in this progress as it provides for an open budgetary process and much greater transparency (and therefore accountability) in both the government’s intentions and achievements with respect to near-and longer-term fiscal policy.

38. A comparison of the path of fiscal consolidation in New Zealand and in the comparator group suggests that New Zealand did at least as well or better than the other countries in moving its fiscal balances into surplus and making marked progress toward fiscal sustainability through a reduction in public debt (Figure II.6).

Figure II.6.
Figure II.6.

New Zealand: Fiscal Indicators, 1970–99

(In percent of GDP)

Citation: IMF Staff Country Reports 2000, 140; 10.5089/9781451830262.002.A002

Source: IMF, World Economic Outlook database.
Openness to trade

39. New Zealand has also made considerable strides in other key structural areas such as opening up its economy to trade and competition and in improving its financial sector. Tariff barriers were brought down markedly and New Zealand has moved far ahead of the comparator group in many aspects of trade reform (Table II.15).

Table II.15.

Indicators of Openness, 1988–1999

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Source: Indicators of Tariff and Nontariff Barriers, OECD 1997, and WEO database.

Last observation is for 1996.

40. However, indicators of the impact of opening up such as the share of trade in GDP suggest that, notwithstanding the virtual elimination of external trade barriers, the increase in the share of trade to GDP was smaller than all the comparator countries, with the exception of Australia. However, even when compared to Australia, New Zealand’s performance, by other measures, was less favorable. For example, since 1984, New Zealand’s export to GDP ratio has increased by 2 percentage points, compared to an increase of 19 percentage points in Australia. Australia has also diversified its trade more with the proportion of exports purchased by its top three trading partners falling steadily, while New Zealand became more concentrated in its trade destinations (in large part due to the CER arrangement).

41. Potential causes for New Zealand’s relatively poor external performance include the fact that New Zealand faces significant protectionist barriers in its trading partners for most of its agricultural exports, as well as movements in the real effective exchange rate in the late 1980s and early 1990s. In the late 1980s, reflecting the difficulty in bringing inflation under control, a nominal depreciation of the exchange rate was not translated into a real depreciation, while the opposite was true in Australia. Moreover, during most of the 1990s (until the onset of the Asian crisis), New Zealand experienced a real appreciation of the currency which could also have contributed to slow growth in trade.15

Financial sector development

42. New Zealand’s financial sector is also quite well developed and sophisticated. Its rankings vis-à-vis other countries vary substantially depending on the indicator used, but taken together, it is difficult to argue that the level of financial sector development in New Zealand is likely to have been a significant explanatory factor in the gap in growth rates. One area where New Zealand appears to lag other countries is in the development of capital markets—venture capital, and equity and bond markets. In this context, a recent study commissioned by the New Zealand authorities (Infometrics, 2000) suggests that New Zealand’s venture capital market is maturing. In particular, the study points out that the supply of capital has increased significantly over the past three years with the entry of new listed venture capitalists, large institutions, banks and corporate venture capital funds. The establishment of the Stock Exchange’s New Capital Market has also increased potential funds available.

Table II.16.

Indicators of Financial Sector Development, 1998

(Rank from l=most competitive to 53=least competitive)

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Source: Global Competitiveness Report, 1998.

43. The main conclusions of the discussion above are:

There can be no doubt that the institutional and policy reforms to restore stability, open up the economy and the financial system, and enhance the development of human capital have had positive results, but more time is needed to see the full effects of the reforms.

  • As already noted, compared to many OECD countries, New Zealand’s reforms are relatively recent, and the economy has been subject fully to market forces for a relatively short period of time. There is, by now, ample evidence in the literature showing that, in the aftermath of a substantial restructuring of the economy, there could be a period during which firms and industries incur significant adjustment costs from scrapping redundant capital and gear up to new signals and incentives. During this period, there could be a decline in investment rates (a so-called investment pause) and a decline in output growth. For example, in the Australian context, Anderson and Gruen (1995) estimate that it could take between 5 and 16 years to recoup the initial output loss of reducing inflation. In the same context, Salgado (1999) shows that there is a lag of around 10 years or more before trade and product market reforms have a positive impact on productivity growth.16 The data on growth, investment and TFP discussed above suggest that the early years of the post-reform period in New Zealand were characterized by such a phenomenon. Also, as shown by Gregory (1999), a common feature of the U.K. and New Zealand post-reform experience is that both had weak employment outcomes in the 5–7 years after reforms began—1979–84 in the U.K. and 1985–92 in New Zealand. However, as the OECD Jobs Strategy Report shows, the U.K. and New Zealand have been successful in lowering structural unemployment since the mid-1980s and early 1990s, respectively.

  • The relatively recent improvements in the quality of human capital as measured by education and training and the well-known lags between the accumulation of human capital and economic growth provides further support for the “it takes time” hypothesis.

Part of the reason for the slow growth response to the reforms could be their sequencing.

  • Some analysts of New Zealand’s reform process have advanced the hypothesis that the initial response to the reforms was not as large as would be expected because they were undertaken in a less-than-optimal sequence. Bollard (1994), for example, states that there are several lessons that can be learned from New Zealand’s experience about sequencing reforms, including that stabilization should be achieved before attempting structural reforms; product and labor markets should be deregulated before those for financial resources; and deregulation of domestic markets should precede opening up externally.

  • Likewise, Joumard and Reisen (1992) suggest that opening New Zealand up to external trade and finance before stabilizing inflation, and undertaking labor market reform produced a classic Dornbusch-style “overshooting” of the real exchange rate (i.e., an exchange rate appreciation) and produced hysteresis effects in manufactured exports, and the extent of diversification, more generally.

  • Others have contended that the positive impact of opening up of the economy to external trade, and the deregulation of domestic markets of the late 1980s was constrained by the fact that labor market reform did not take place until the early 1990s.

However, the point about inappropriate sequencing should not be overstated.

  • There is little consensus in the literature on the optimal sequence of reforms, with many arguing that without fundamental structural reforms, stabilization may not even be possible and others arguing that, given the difficulty in reaching political consensus about reforms, it makes sense (if only in a second-best sense) to proceed with reforms whenever possible. As noted by RBNZ Governor Brash in Julyl998, “As several of those most closely involved in the reform process have pointed out…reforms have to be undertaken when they are politically feasible which is not always the same as when they are economically optimal.”

  • Moreover, it is not clear that if the sequence had been different, there would have been no adjustment costs or that there would have been a larger growth dividend. Indeed, as argued above, no matter how they are sequenced, the results of structural reforms take time to materialize.

A final point about New Zealand’s experience with reforms is that there remain important elements of the agenda to be completed.

Elements of the unfinished agenda

44. In what follows, the paper focuses on two elements of the unfinished reform agenda: upgrading the quality of skills and technology, especially important now in light of evidence that there are new factors—broadly termed technology and innovation—driving countries’ growth performance, and completing the process of deregulating domestic product markets.17

Technology, Innovation and R&D

45. Recent research has been focused on sharpening the understanding of the specific elements of skills and technology accumulation that are likely, in the present rapidly changing environment, to be the most effective in boosting productivity growth.18 These studies typically find that TFP growth is highly correlated with technological development, managerial practices, and, more generally, improved ways of producing goods and services as important factors in countries’ recent growth performance. These studies also find that the relationship between technology, innovation and growth appears to have changed in the 1990s. In this changing environment, innovation has become more market-driven, more rapid and intense, more closely linked to scientific progress, and more widely spread throughout the economy.

46. Broad conclusions of this work point to the following areas where policies can usefully be focused; the experiences of some of the high performing comparator countries—Finland and Ireland—as briefly outlined in Boxes II. 2 and II. 3 may also be instructive in this regard.

  • Strong positive relationships exist between R&D and output and productivity growth especially at sectoral and firm levels. The correlations between TFP growth and R&D growth appears to have increased dramatically in recent years. Evidence also suggests that basic research has higher returns than applied R&D, and that process R&D has higher returns than product R&D. Also, the role of R&D differs between small and large countries—in large countries, R&D mainly helps to increase the rate of innovation, while in smaller countries, R&D serves to facilitate the transfer of technology from abroad. Finally, existing evidence indicates that the magnitude of R&D spillovers may be quite large, implying that social returns to R&D may be much higher than private returns and suggesting a role for government involvement.

  • Facilitating close and synergistic links between industries, research facilities and universities to foster an emphasis on innovation and R&D. In the United States, the Bayh-Dole Act of 1980, which extended patent protection to publicly funded research, is credited with helping to strengthen the innovation process and facilitating industry-university collaboration.

  • Public support for basic scientific research and for R&D to increase the stock of fundamental knowledge and to provide highly skilled labor, with the caveat that the appropriate amount of resources that are devoted to this will need to be chosen carefully, with particular emphasis on cost-sharing by the private sector. A recent study by the Ahn and Hemmings (2000) cites an OECD study of the relationship between public R&D and business R&D which finds (a) direct government support to business R&D has a positive impact on private sector R&D, (b) support through direct funding or tax relief appear to be fairly close substitutes; and (c) the impact of government funding appears to be nonlinear—funding too much or too little appears to be less effective than somewhere in the middle.

  • Greater recognition that initial levels of education are no longer sufficient and that life long learning is increasingly important. This has led to greater emphasis on industry-relevant vocational education, workforce training to constantly upgrade skills of all segments of the labor force, and greater emphasis on “active” labor market policies where the focus is on reducing the incentives to remain a ward of the welfare system and providing much greater incentives to rejoin the workforce.

Policies to Enable Technological Development

This box compares policies used by New Zealand and the other high growth countries in the group to encourage technology transfer (i.e., transfer either from abroad or from domestic research environments to industry). In relative terms, New Zealand has in general provided lower public support to private enterprises for R&D and product development. Research collaboration between universities and industry, the extent of public resources committed to non-military R&D activities, and private sector spending on R&D are all low relative to comparator countries; the latter probably reflecting that firms’ in New Zealand are predominantly small and medium-sized which generally have limited R&D resources.1/ As for its foreign direct investment regime, the authorities believe that economic growth, macroeconomic stability and a liberal investment regime will attract serious and committed foreign investors. Thus, special incentives for domestic or foreign investment into specific sectors are generally not provided.

The review of policies in high performing countries such as Ireland and Finland may provide useful lessons for New Zealand:

  • Public/private cost sharing of R&D has been successful in promoting technological capacity building in industries but because there are likely to be diminishing returns to such investments, governments need to carefully consider the level of their involvement. The governments of Finland and Ireland see a role for subsidies or government grants for private R&D and believe that without some government support for these activities the country would lose valuable spill-over effects. Finland gives subsidies for building a broad range of intangible, knowledge-based assets including R&D, product development, education, training and acquisition of entrepreneurial and marketing skills, Private sector spending on R&D has risen rapidly in Finland, possibly as a result of these policies. Ireland provides grants for R&D in certain industries, in general of a high-tech nature. New Zealand has recently established a small fund (about $NZ 12 million) to provide grant support for private sector R&D.

  • An integrated set of policies is needed to strengthen the technological capacity and foster Innovation by improving and reorienting the educational system to meet businesses’ needs. Finland’s innovation strategy integrates industrial, education, R&D, tax and employment policies. Ireland’s industrial and technology policy has been complemented by early implementation of a focused education policy with increasing emphasis on tertiary education over time. The experience from these countries suggests the importance of improving and reorienting the educational system to meet businesses’ needs as well as establishing close links between universities, technical research centers and industry.

  • Close links between universities, technical research centers and industry have been very useful in promoting innovation. In Finland the university system is well integrated into the wider research environment, and many of the state-funded research projects are carried out through the universities. Both aspects of higher education—teaching and research—are being positioned to deal with the needs of employers. The strategy promotes close links between corporations, research centers and universities aiming at innovation and product development. These links were important factors behind the Finnish telecommunications industry’s success internationally. Ireland also has developed close links between universities, technical research centers and industry.2/

  • Use of fiscal incentives to attract FDI has not generally been successful with the possible exception of Ireland. Ireland has been successful in attracting export-oriented FDI, especially in high-tech products, with a positive impact on growth, exports and employment While the fiscal incentives certainly increased profitability, it is not clear whether Ireland’s strong fundamentals and its favorable location and duty-free access to the major Single Market in the EU would not have been sufficient to attract FDI without the incentives. Moreover, Ireland’s policy can not easily be replicated by other countries—an important factor contributing to Ireland’s attractiveness as an investment destination is its low corporate tax rate (10 percent until 1999 and 12.5 percent since).

  • Notwithstanding Ireland’s particular success in attracting FDI and basing its development strategy largely on this factor, evidence from a broader group of countries does not support the use of fiscal incentives and other selective intervention (Ostry, 1993). For example, in the case of Taiwan, Jenkins and Kuo (1997) find that fiscal incentives had less of an impact on investment decisions than trade and macroeconomic policies.

1/ It is possible that New Zealand’s tax treatment of R&D may encourage underreporting. Research spending is expensed in the year that it is incurred whereas development expenditure is amortized over the appropriate length of time from when the product or process begins to generate income. This tax treatment is amongst the least favorable in the OECD.2/ In New Zealand, the following, albeit limited, links between universities and industry are in place. A tripartite system exists for scholarships involving industry, government (funding) and doctorate students. Some post-doc positions are funded through the New Economy Research Fund with links to industry, and the Crown Research Institutes now provides some industry funding.

Policies to Develop Skills in the Labor Force

Policies in New Zealand

Education reform in New Zealand started in the late 1980s when concerns about the adequacy of education and training became more pressing as New Zealand was exposed to greater domestic and international competition.

  • Greater self-management for public tertiary educational institutions and schools as well as enhanced school-level accountability and incentives to perform were introduced through a variety of mechanisms including “bulk funding”, the tatter aminly to tertiary institutions.

  • Curriculum, assessment and certification were reformed in order to improve educational standards by specifying key learning areas and groupings of essential skills.

  • A system of national monitoring of schools to assess their performance was established.

  • The pay structure for principals and teachers was linked to performance.

  • Other major education reforms comprised: (a) in the compulsory school sector: abolition of zoning and increased grants to private schools to enhance competition; raising the compulsory school age to 16 in 1993; merging of schools; and individual employment contracts for teachers and voluntary bulk funding of teacher salaries; and (b) at the tertiary level: extending subsidization to students at private tertiary institutions to increase competition; sharply reducing subsidies for tertiary education closer in line with the perceived net public benefits of further education; and introducing student loans to pay for the increased tuition costs.

  • Beginning in 2000, the new government has announced an increased focus on raising the educational attainment of the Maori and Pacific Islander population.

New Zealand has also reformed industry training and is currently modernizing and expanding its system for apprenticeships.

  • Prior to the early 1990s, government support for employee training was mainly offered through the apprenticeship system, both through administrative support and off-job training in polytechnics. The passing of the Industry Training Act delinked subsidies from apprenticeship per se; subsidies were provided to help industry training organizations to develop training arrangements linked to a new qualifications framework. The sponsored training is in general arranged by approved Industry Training Organizations leading to national qualifications.

  • From early 2000, the government has launched the Modem Apprenticeship Program, new workbased education initiative aimed at training younger workers in the labor force.

Main policy lessons from high growth countries in the comparator group are:

  • The importance of early reform or strengthening of the educational system: Ireland undertook an education reform in the 1960s and increasingly devoted more resources to tertiary education. This raised secondary and tertiary education attainment considerably and the availability of higher-skilled labor in the following decades. In Finland, the university system (state-run) has been expanded significantly in the last 30 years and has been subject to considerable reform in the last decade. New Zealand’s late start on education reform postponed its catch up with comparator countries with regard to higher education attainment which was lagging until the mid-1990s.

  • Reorientation of the educational system towards producing output that meets the needs of an increasingly knowledge-based economy. In the case of Finland and Ireland this has involved strengthening the technology basis of the future labor force, and they are ranked by the IMD Competitiveness Report (1999) as having the two most relevant education systems in the world for a competitive economy whereas New Zealand is ranked lowest of the comparator countries. Finland has been reorienting its educational system by putting more emphasis on science related subjects, educating more engineers and strengthening business and administration skills. Ireland has emphasized math and basic science education and is ranked first in this area in the comparator group (GCR 1998, 1999).

  • Improve training promotion of the labor force, including by support for enterprise specific training. Most comparator countries, including New Zealand, believe raising the general skill level through training of firms’ employees provides valuable spill-over effects that the country would lose without some government support for these activities. Ireland promotes training of employees through several government grants schemes and provides fiscal incentives to investors for employee training in certain priority sectors. Finland subsidizes training and other human capital development activities by firms. Australia had a levy scheme in place from 1990 to 1994 which required firms to spend a minimum level on staff training; any unspent amount became a tax paid to consolidated revenue. Reviews of such schemes find that they increased average hours of training per employee and training expenditure per employee. While the New Zealand government promotes staff training through subsidies—and certain forms of such training have increased markedly in recent years—expanding the cost sharing to cover enterprise specific training would likely increase more rapidly the skill level of the labor force. The current subsidized training is required to follow industry standards which are perceived by employers as not sufficiently specific to meet the needs of individual firms.

  • The use of skilled human resources from abroad (which appears to have played a beneficial role in Australia, the United States and Ireland).

47. New Zealand has made important progress in many of these areas in recent years. For instance, investment in ICT (including IT hardware and software and telecommunications) can make an important contribution to labor productivity growth and, in this area, New Zealand has made rapid progress in recent years with amongst the highest ICT expenditures as a share of GDP in the OECD. This process has been helped by low-cost and open access to the internet and high quality telecommunications services. However, making the most effective use of the opportunities offered by ICT depends on the availability of the right set of skills.

48. New Zealand’s efforts in the area of raising skill and technology levels are relatively recent. In the early 1990s, industry training was strengthened through the establishment of the National Qualifications Framework, the Industry Training Framework, and, in 2000, the Modern Apprenticeship Program. However, there are areas where these frameworks can be strengthened to make them more relevant to the needs of employers, to raise the technological competence of those with low and intermediate skills and to overcome the disadvantage to higher investments in training and R&D that come from the typical small-size of most New Zealand firms.

Completing the process of product market deregulation

49. New Zealand has implemented far-reaching reforms of the regulatory and competition regime to give much greater play to market forces and price signals in most sectors of the economy, with the notable exception of the agricultural sector. Most of New Zealand’s agricultural output is exported, either as unprocessed commodities or after further processing, which makes the export marketing structure of this sector potentially important for the national economy. For example, dairy exports account for some 15–20 percent of New Zealand’s exports. A key feature of the important agricultural subsectors has been the existence of Producer Boards. Typical statutory powers given to producer boards include monopsonistic acquisition and marketing of all produce intended for export; determination of quality standards and payments to producers; decisions on the amount of marketing revenues to be used for industry-wide activities such as promotion and R&D; and other industry wide commercial functions. According to OECD (1999), almost one-fifth of New Zealand’s total merchandise exports comes from industries that were controlled by three large producer boards with statutory export monopolies (the Apple/Pear, Kiwi and Dairy Boards).

50. Of these characteristics of producer boards, the one that has most often been criticized on the grounds of efficiency is the monopsonistic buyer/single seller characteristic of the relationship between the Boards and producers. Advocates of reform have therefore focused on removing this barrier to contestability in agricultural export marketing. In contrast, proponents of the single-buyer boards argue that, in the context of distorted world markets for agricultural products, these arrangements serve to maximize export returns for the benefit of domestic producers. A strong case can be made for the latter argument only if New Zealand can exercise market power in world markets; however, the notion that New Zealand can exercise sufficient market power to increase returns to New Zealand has been challenged by many observers. As noted in Sinclair (1999), on balance, the findings of recent studies of this issue do not provide substantial evidence that New Zealand can exercise market power in its export markets.

51. The study of deregulating producer boards by Sinclair (1999) addresses two basic issues: first, “if New Zealand can exercise market power, is a statutory single-buyer the best way of doing so?,” and second; what are the sources of dynamic efficiency gains from deregulating producer boards? Based on the experiences of deregulation in South Africa, Chile, Israel, and Australia, Sinclair makes the following points: (a) producer boards have limited incentives to be efficient because they do not have to compete for supply; (b) producers operating in deregulated markets tend to receive higher returns for comparable quality products than those in New Zealand; e.g., Australian dairy farmers—who operate in contestable export markets—receive significantly higher returns than do New Zealand dairy farmers.

52. Sinclair thus concludes that there are significant potential dynamic benefits to producer board deregulation, both from changes to the single-seller aspects as well as to the corporate structure of these entities. In the main, these derive from:

  • greater opportunities and incentives for innovation and to add value—deregulation will reduce restrictions on innovation in products, market development, and marketing techniques;

  • greater responsiveness to market signals—the unbundling of prices for dairy products will provide greater incentives for producers to adjust quickly to changing market conditions;

  • more investment and technological development—the experiences of South Africa and Israel indicate that there can be considerable new investment, including from foreign investors in the case of South Africa—in production and downstream processing technology in a deregulated environment;

  • more efficient capital utilization, arising from greater incentives to focus on value creation, which could, in turn, have wider economy-wide benefits. In addition, a change to the compulsory cooperative structure could release producers’ capital, lead to the formation of companies that are traded on the stock exchange, and thus boost the performance of equity capital markets in New Zealand.

D. Conclusions

53. This paper has presented evidence to show that New Zealand’s reforms have indeed paid a dividend in terms of macroeconomic stability and an increase in productivity and output growth, and lower structural unemployment. There is little or no evidence that the reforms have not “worked” or that the model was wrong, suggesting the need for a change in course.19

54. The challenge for the future is to continue the process, that appears to have been underway since the early 1990s, of recovering the ground lost during the 1970s and 1980s vis-à-vis New Zealand’s OECD counterparts. Some of this recovery of lost ground is likely to be still coming through the pipeline as a result of the earlier reforms. But there are other areas of unfinished business where New Zealand could usefully focus its future policy efforts, especially as there seems to be a new set of forces—broadly termed technology and innovativeness—that could be once again causing a divergence between the “haves” and the “have-nots.” Indeed, these new developments have added some urgency to addressing this agenda.

55. A key message is, however, that there is no “silver bullet” which would guarantee that New Zealand would rapidly close the gap with the ranks of the technologically advanced countries, indeed there are many factors over which New Zealand has little control which are likely to continue to act as a restraint on growth. Distance and size and their implications for exploiting economies of scale are two important factors. As noted recently by RBNZ Governor Don Brash in a speech in January 2000, “drawing a circle centred on Christchurch with a radius of 2100 kilometers will always encompass only a few million New Zealanders and a lot of seagulls. Similar circles centered on Dublin, Helsinki or Singapore encompass hundreds of millions of people.”

56. However, technology is making the world a much smaller place and the strategy for New Zealand must be not only to continue to more effectively leverage its traditional and continuing comparative advantage as a primary goods producer and manufacturer, but also to rapidly put itself in a position to take advantage of technological advancement in areas where distance and geography are becoming increasingly irrelevant. Also, the experience of Australia, which suffers many of the same geographical and location disadvantages as New Zealand, suggests that it is not unreasonable to expect to move back into the league of above average performers in the industrial group.20


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Prepared by Kalpana Kochhar (ext. 38770) and Paul Wade (ext. 38994), who are available to answer questions.


Although it is very difficult to pin down the starting date of reforms for different countries, many researchers have noted that New Zealand began its reform process somewhat later than others in the OECD (Gregory, 1999), but moved quickly to implement the reforms in a shorter period of time. Also, reforms were not as dramatic in Australia, for example, because imbalances were not as large and the impetus for radical reforms was not as obvious (Bray and Walsh, 1998).


The relationship between population growth and economic performance is ambiguous as is the direction of causality. On the one hand, there is evidence of a weak negative relationship between population growth and changes in TFP. However, there is also evidence that the negative effects on per capita growth is partly mitigated through changes in labor force participation rates (discussed below). Overall, the popular belief that population growth is economically harmful is not yet well supported by statistical evidence (Temple, 1999).


See Conway and Orr (1999).


The volatile nature of net migration flows is closely linked with the “brain drain” problem, which suggests that the effect of policies that are seen as unfavorable to growth can be intensified by a pick up in outward migration, especially of the higher skilled segments of the labor force.


It should be noted that these aggregate data mask important differences across ethnic groups in New Zealand. In particular, a much larger proportion of the indigenous Maori and Pacific Islander population—who currently account for some 20 percent of the population—leave school without qualifications, work in low-skilled jobs or are wards of the welfare state.


The data for Ireland in Tables II.9 stand out as being low and appear somewhat inconsistent with priors about the instrumental role that the education system is believed to have played in Ireland’s success. Box (1998) notes that although New Zealand has higher participation rates and a larger proportion of students attaining higher levels of education, there is a larger emphasis on business studies and technical and scientific disciplines in Ireland.


Survey data are necessarily subjective and especially in some areas, may be subject to large measurement errors which could, in turn, lead to a misleading picture of relativities across countries. However, they do provide information on a number of dimensions of human capital and technology accumulation that would be difficult to measure otherwise.


Barro and Lee (2000). In terms of science scores, New Zealand ranked 23rd, behind all the comparator countries (Australia, 12, Canada, 13, and Ireland, 16). Finland was not included in the survey.


There are numerous other studies of TFP in New Zealand—Smith and Grimes (1990), Sarel (1996), Janssen (1997) and Hall (1996)—but it is impossible to cover these in detail in this paper. See Diewert and Lawrence (1999) and Galt (2000) for a good discussion of these studies.


However, when overall TFP is recalculated excluding the financial services and community services sectors (the ones with the most poorly measured inputs and outputs), Diewert and Lawrence are in fact able to find evidence of a statistically significant structural increase in New Zealand’s TFP growth after 1993.


Because of the wide variety of estimates of TFP growth in different countries, and lack of consensus on methodology and the resulting difficulties in cross-country comparisons, this paper does not attempt to go beyond comparison of Australia and New Zealand from the Diewert and Lawrence study.


Some new work in identifying factors contributing to TFP growth points out that there is growing evidence that levels of per capita GDP, which had been converging for many years, may no longer be doing so (OECD, 2000). The main factors behind this slowing of convergence relate to differences in skills, technology and the culture of innovation—the so-called “digital divide,” There is now growing evidence that productivity growth is increasingly being driven by upgrading human capital, especially through enhancing technical and management skills of the work force.


See Scott (1996) for a detailed discussion of government reforms in New Zealand and their economic impact.


Some observers contend that the variability in New Zealand’s exchange rate (see Chapter IV of this volume) may also have had a negative impact on trade. However, there is inconclusive evidence in the literature about the impact of currency volatility on trade, with many studies finding no significant effect (Cote, 1994).


It is interesting to note the conclusions of a McKinsey report on Australia, published in less than 5 years ago in March 1996, entitled “What Ails Australia?”, which states that despite wide-ranging reforms in the financial system, business regulation, industrial relations and trade protection, “the nation’s relative economic prosperity has not altered since 1970. Its gross domestic product is still 30 percent behind that of the United States, the most prosperous country in the world.” Studies of the Australian economy during the past 2–3 years take a distinctly more optimistic tone than this one and show clear evidence of “convergence” with other high performing industrial countries.


There are other areas including reforms of the welfare benefit system and the interaction between active and passive labor market policies—which may have strong links with incentives to work, save and invest, but a discussion of these is beyond the scope of this paper Chapter II of this volume contains some discussion of these issues.


Griliches (1998), Hall and Jones (1996 and 1999), Sachs, 2000, Porter (1998)


Some observers have recently gained some attention by contending that New Zealand’s reforms have not worked and that it was a “failed experiment” (Hazledine, 1998 and 2000, Kay, 2000). A careful evaluation of this hypothesis would require a discussion of the elusive “counterfactual”. What would have been the outcome if New Zealand had not embarked on these reforms when it did? Wide-ranging experience from countries at all income levels and in all regions of the world suggest that severe macroeconomic imbalances of the type that had developed in New Zealand in the mid-1980s were not sustainable and adjustment would have been needed sooner or later. Another important lesson from these countries’ experiences is that delayed adjustment is costly, because stabilization policies undertaken in the context of a macroeconomic crisis will generally have deeper contractionary effects than otherwise, and because credibility, once lost, is very difficult to regain (Goldsbrough et al., 1996). Finally, even if one were to find evidence that the reforms in New Zealand were “wrong”, the major weakness in the arguments of those who espouse this hypothesis is that no advice is offered on an alternative path that is more likely to guarantee success.


Some observers have questioned whether it makes sense for a country like New Zealand to aspire to become a technology leader, in terms of research and innovation, as in the U.S., or whether the focus should be on technology adoption. Clearly, for most countries, it would make sense to focus efforts on the best and most innovative use of technology that has been developed by the “leaders”. Nevertheless, it is worth noting that “technology adopters” of the past such as Israel, South Korea and Taiwan Province of China are rapidly moving up to the status of innovators and technology “leaders.”

New Zealand: Selected Issues
Author: International Monetary Fund