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Are Good Institutions and Policies Enough?

Please find attached an article that appeared in the Otago Daily Times today, 3 November 2006.

Are Good Institutions and Policies Enough?

Last week a report from the New Zealand Institute for Economic Research reminded us that Australians now earn over 30% more than New Zealanders, on average. Gross domestic product per capita in 2004 was NZ$48,000 for Australia and $36,400 for New Zealand. Life expectancy is higher in Australia and infant mortality rates lower. New Zealand is ahead on some other measures of quality of life.

Migration statistics suggest that the balance currently favours Australia. In the last two years, the net loss of people to Australia on a permanent and long-term basis has been 40,000, and on a rising trend.

The NZIER forecasts that the per capita income gap will widen, at least through to 2010. Australia is much more competitive than New Zealand on the World Economic Forum's rankings. It attracts more foreign direct investment per dollar of GDP, invests a greater proportion of GDP, supplies greater capital per worker and gets much more productivity per worker.

So what should the government be doing about this large and widening gap?

The NZIER stresses the importance of free(r) trade and a better regulatory environment for attracting investment. It calls for a return to the light-handed regulation of the 1990s in key infrastructure industries. It considers the Resource Management Act an obstacle to investment and expresses concern about the current regulatory uncertainties surrounding carbon emissions. It argues for an end to government handouts for businesses in the form of 'picking winners'.

A similar prescription comes from the OECD, which regularly reviews New Zealand's economic performance and outlook. In a 2006 assessment it emphasised the need to strengthen incentives to move from welfare to work, reduce barriers to foreign ownership, improve educational outcomes for underachieving groups, reduce restrictive and costly labour market regulation, and address infrastructure bottlenecks, especially in transport and energy.

The Business Roundtable is in the same camp as the NZIER and the OECD. Our major additional recommendation would be for measures to eliminate wasteful or unjustified government spending. New Zealand will not grow fast with total government spending (central plus local) now at 42% of GDP, well above the comparable figure of 35% in Australia. If government spending grew more slowly than GDP, New Zealand could more easily move to lower, flatter taxes, as recommended by the 2001 McLeod tax review. This would reduce the army of tax accountants, lawyers and bureaucrats and facilitate investment.

All these approaches are orthodox and consistent with the large body of economic research that finds that sound institutions and good public policies are more highly correlated with high levels of prosperity than any other factor, such as an economy’s size and location or its endowment of natural resources.

The International Monetary Fund's World Economic Outlook 2003 found that three-quarters of the variation in average income per capita around the world could be explained by differences in institutional quality. Specifically, countries that changed their governments without disruption, limited the power of executive government, respected the rule of law in person and property, and enjoyed low regulatory burdens and an efficient public sector, were likely to be prosperous.

Such findings have led the Business Roundtable to suggest extensions to the key institutional changes of the last 20 years – the Reserve Bank Act, the Fiscal Responsibility Act (now included in the Public Finance Act) and the Employment Contracts Act. We have argued for a Regulatory Responsibility Act and a Taxpayer Bill of Rights, and for including property rights in the New Zealand Bill of Rights Act.

It is puzzling to hear assertions that while good institutions and sound policies are necessary, they 'aren't enough'.

This is a bit like telling Tiger Woods that to perform with as much skill and consistency as he can achieve is 'not enough'. True, on the day, it might not be enough because someone else might do better, but this can’t conceivably be an argument for doing something differently – like allowing his concentration to waver, or deliberately throwing in a bad shot.

Yet such ideas as introducing compulsory savings for households, tax incentives for exports and R&D, and business subsidies would have just that result – they would reduce the quality of institutions and policies and damage economic performance.

Even if such prescriptions were positive rather than harmful, they could not be material, let alone 'transformational' for economic growth. Their impact would be far less than, say, allowing the government spending ratio to fall over time to 30% of GDP or below, reducing income tax rates to a maximum of 25%, getting central and local governments out of running businesses, giving the private sector a greater role in infrastructure, and reforming regulation.

New Zealand would do far better to follow the advice of the NZIER and the OECD and to continue and extend the orthodox policies that have produced today’s better economy.

Roger Kerr is the executive director of the New Zealand Business Roundtable.


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