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The Role Of Government In A Modern Economy

The Role Of Government In A Modern Economy

(Paper commissioned from Peter Harris by the PSA, August 2005)

The coming election will in large measure be a contest of philosophies, which in turn will focus on what the role of government ought to be in a modern society.

The 1990s were dominated by a view that the government should have a “minimalist” role in economic and social life. Welfare benefits and income supports were cut, employment rights were determined by a regime of direct contracting between employers and employees, markets were generally deregulated, and public assets were sold to private interests.

From 2000, there has been a return to a more active and participatory role for the government in economic and social life:

- Income supports were restored or strengthened (the rate of NZ superannuation was restored to “65 at 65”; income-related rents were introduced for state house tenants; interest payments on student loans were suspended while they were studying; the Working for Families package was introduced to support those with dependent children and so on).
- The government intervened where the market was failing (recapitalising Air New Zealand and rescuing the rail service are examples).
- There was a much more active industry and regional development programme introduced.
- Employment rights were boosted (higher minimum wage, extra holidays, paid parental leave, restoration of collective bargaining, improved health and safety protections etc).
- Health and education spending have been boosted substantially and there is a more active investment in infrastructure (roads, upgraded hospitals, refurbishment of schools).

The 2005 election asks the question of whether the “lean and mean” state sector of the 1990s offers a more prosperous future than the recipe of a more interactive state sector that is being applied at present.

Different theories can be found to support either the current “private public partnership” approach to managing economic and social affairs, or the “more market, less government” offering of a return to the 1990s.

This report looks at the record rather than the theory, and looks ahead to some of the challenges that need to be faced regardless of which party or parties form the next government.

Economic performance: the nineties versus the current decade

The theoretical justification for the minimalist state is that a larger or more active role for the government crowds out private sector investment and initiative and slows economic growth, thereby cramping the growth of living standards.

The record says that:
- During the 1990s, the economy grew by 29.5 percent, after adjusting for inflation

- In the first five years of the current century, the economy grew by 19.5 percent .

In other words, in the five years of the “balanced government” model, the economy grew by two thirds of the growth achieved over the entire decade of the 1990s with its minimalist state setting.

This growth record has been achieved in spite of difficult world trading conditions (9/11, slow growth in the major northern hemisphere markets, rising oil prices).

Effects on employment

A more active role for the government and more effective employment protections and social supports have not cost jobs.

Between the time of the previous election (December quarter 1999) and now (latest available statistics, June 2005):

- Employment grew by 298,000 (by 17 percent)
- Unemployment fell from 119,000 to 78,000 (by 34 percent)
- The unemployment rate fell from 6.3 percent to 3.7 percent (and is now the lowest in the developed world).

These numbers have also been accompanied by a substantial increase in the quality of employment. In December 1999, there were 123,500 people underemployed: they were working part time but wanted longer hours. By June 2005, this number had fallen to 77,900 (a 37 percent decline).

Much of the job growth has been in full time employment. The number of paid employees in full time jobs increased by 21 percent, those in part time jobs by 9.3 percent .

The decrease in unemployment and the reduction of underemployment have been achieved in spite of an increase in the participation rate. This is the proportion of those of working age who are looking for work at any time. In December 1999, 65.3 percent of the working age population were working or looking for work: in March 2005 that figure was 67.7 percent.

Effect on incomes

The combined effect of more people working hours of their choice in better jobs has substantially increased the total amount of wages that people collectively take home.

Total gross weekly earnings have increased by 41 percent between November 1999 and February 2005 . By comparison, consumer prices increased by 14 percent over this period.

Social indicators

The Social Report commissioned by the Ministry of Social Development tracks a number of indicators on social wellbeing, and identifies progress on a number of fronts, including:

- Higher incidence of early childhood education
- Reduction of child poverty (with this likely to fall further as the Working for Families package is rolled out)
- Increased life expectancy
- Greater satisfaction with work/life balance.

Benefit statistics also show substantial improvements such as:

- Reduction of working age residents on benefits to a 17 year low
- DPB numbers on an 11 year low.

Future challenges

While the “more active” model of the role of government in contributing to improved economic performance has delivered both better economic results and improved social indicators, the pressures on public finances are never static.

Those that are likely to intensify in the near future are those associated with changes in the age structure of the population. In strictly financial terms, these are the “golden years”.

In the 1950s and 1960s, there were relatively large numbers of children compared to those of working age, putting pressure on the government to build state houses and new schools. In future, there will be relatively large numbers over 65, who will be eligible for New Zealand superannuation and who (as a group) tend to be higher consumers of health services. The country is currently in transition from a relatively young to a relatively older population structure, with relatively few young and relatively few old people.

Moreover, in that transition, the change is from a population structure where the costs of dependency are largely privatised (parents meet the costs of housing, feeding, and clothing children, and for their recreational spending), to one where the costs are largely socialised (the state meets around 60 percent of the costs of living of the retired directly through NZ superannuation and other benefits, and additional costs indirectly through home support, health services and residential care) .

Retirement income

From 2011, the baby boomers become eligible for New Zealand superannuation. The addition to the numbers over age 65 in each five years after then are shown below:

Period Increase in population over 65

2006 – 2011 63,000
2011 – 2016 101,000
2016 – 2021 102,000
2021 – 2026 123,000

NZ superannuation qualifiers increase by about 12,000 a year over the next five years, rising to around 20,000 a year after that. The rate of superannuation varies depending on the status of the recipient (married, living alone etc), but assuming it averages about $12,000 a year after tax, the net cost of superannuation increases by roughly $140 million a year, each year, in the near term, rising to around $240 million from 2011.

Health costs

A much more substantial pressure will be maintaining adequate levels of health services as the population structure ages. Health costs are highly correlated with age, but have been rising anyway as new technologies have developed, increasing the number of interventions that are available to improve the quality of life. The new techniques have increased the costs of equipment, pharmaceuticals and medical specialists.

Appropriations through Vote: Health have increased by 51 percent between the 2000/01 and 2005/06 financial years, (to $9.7 billion) and that is before the population structure changes to its older profile.

One indicator of how health costs might increase with changes to the age structure is given by the formula used to calculate the age based proportions for population based District Health Board funding. These are shown below.

Estimated NZ$ per capita health spending per annum

Age range Spending per head ($)

Under 15 949
15 – 64 1,329
65 – 74 3,643
75 – 84 6,863
85 and over 13,568

From age 65, health costs basically double for each decade of age. Meeting those costs as larger numbers move into those age brackets will require robust public finances, and a secure tax base backed by a strongly performing economy.

Role of government agencies

Government agencies need to be equipped to support continued economic development and social enhancement in areas such as research and development; improved trade access; biosecurity; education and training; sound public administration, responsive social services and the like.

Instead of focussing on rolling back service provision as happened in the 1990s, the agenda going forward needs to concentrate on:

- Improving the effectiveness of public agencies in making a difference in their areas of operation
- Increasing whole-of-government co-ordination of effort
- Extending the linkages between private and public inputs to support economic growth and enhance social development.

The “new model” of the role of the state in the economy and society is not perfect, and can be fine-tuned, but it has generated stronger results on both economic and social fronts than did the minimalist government agenda of the 1990s.

On the record, rather than the theory, there are major risks with a return to the policies of the previous decade.


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