My previous posts put up various bits and pieces about the sharp economic divergence between NZ and Australia, but I didn’t say much about why this topic is of interest right now. The issue has come up in several different contexts, where the contrast between the two countries, starting from fairly similar positions, seems to me to provide some pretty strong evidence. The questions include
* Do recessions have sustained effects on income levels, or does the economy rapidly return to its previous growth path? The evidence from NZ (six recessions since 1975) and Australia (two) suggests that effects are sustained
* Is market-oriented microeconomic reform a major determinant of economic growth? NZ reformed more, and more vigorously than did Australia and did drastically worse in economic terms.
* Do more flexible labour markets yield better macroeconomic performance? Again, the evidence from NZ and Australia suggests the answer is No.
Obviously, given the points above, I take the view that bad macroeconomic policy in NZ, particularly during the reform era of the 1980s and 1990s, is an important reason for poor economic performance. Important examples include the adoption of a contract-based 0-2 per cent inflation target in the early 1990s, and the misconceived idea of the Monetary Conditions Index at the time of the Asian crisis. I don’t think bad macro policy is a sufficient explanation, but the gap is so large and persistent, it’s hard to explain in terms of standard microeconomic analysis.
I also took the time to look harder at the idea that New Zealand’s problems can be explained by the loss of agricultural markets arising from UK entry into the (then) EEC. Along with the oil shock of 1973, and the immediate macro responses (a failed attempt by Labour to stave off adjustment, followed by a sharp contraction under the Muldoon National government), this helps to explain NZ’s relative decline up to 1984, when the Lange government started the reform process.
* The shock wasn’t nearly big enough to explain a sustained 30 per cent divergence in GDP per person. Agriculture was only about 12 per cent of GDP at the start of the process, and is only about 8 per cent now.
* The loss of market access was temporary, and the restoration of access coincided with the reform period. The EU butter mountain reached its maximum height in 1986 and has now disappeared. NZ is now the main exporter of lamb to the EU as a whole, not just the UK and in addition has an export wine industry that didn’t exist in 1970
* Even the most sclerotic economy shouldn’t take 40 years to adjust to a terms of trade shock, and the whole point of the reforms was to make the economy flexible enough to respond to such shocks.