Economic Policy: Ideas, Implementation, and Consequences

I am back in New Zealand and I am now an external observer (after having lived there for years). It is now 15 years or so since the economic reform period came to an end. NZ is unique in the world for its history of social change. I have argued elsewhere (here and here) that NZ didn’t become a Pacific tiger because the reforms, while extensive, zigzagged for too long and stopped short of the radical turn necessary to transform a heavy social democracy into a speed boat.

I believe NZ is now on the path of “political normality.” That is, the reform period was an outlier in the history of the country. Instead what we now observe is politics the way it is practiced in any parliamentary democracy with active interest groups and policies moving towards the center of the electorate.

The good news is that the political center, as a result of the reforms, has moved tremendously in the last 20 years, and in the right direction. The two main parties in NZ (Labour and National) now converge around policies that are friendlier to free markets than they were in the 1980s. They include a tax system that is somewhat respectful of wealth accumulation and entrepreneurship, pro international trade policies, pro doing business regulations (NZ ranks 2nd this year in the Doing Business project), balanced budgets, and so on. So it is true that the battle of ideas that was won in the 1980s and 1990s has had the effect of moving the political center in NZ (and other countries) in the right direction. (This gave rise to the so-called Washington consensus for instance.)

However, in spite of the results NZ now shows, the battle of implementation was, to a large extent, lost. NZ never seriously reduced the size of its government expenditures. Instead, its coalition governments have been careful to squeeze as much as possible of the social surplus accumulated thanks to the reforms without entirely destroying it. Today Labour’s policies are in the mainstream. They include savings incentives, carbon taxation, tax credits for families, etc. While the political center has shifted in the right direction, there is plenty of room for interventionist policies to be developed.

It is hard to see the beginning of the 21st century as a period of victory of the free-market (at least in the West). The current meltdown of the financial system in the U.S. is seen by many as the result of too little regulation of banks and other financial institutions. The World Bank is now moving back to a more interventionist stance as advised by Dani Rodrik and others. While the 1980s and 1990s were a period blessed with many pro-market reforms throughout the world, they were never fully implemented and we are now starting to live through the consequences of this lack of full implementation. Countries of Latin America have suffered from this problem for years and are currently paying a high price. The rest of the world may follow a similar path. While NZ is still a very prosperous country, the dark forces of political economy have almost annihilated any desire for pro-market change and have strengthened the status-quo.

The lesson is that half-baked free market policies may be worse, in the long run, than the status-quo: they may backfire because they lead to unstable situations. This is a bit like taking antibiotics: if one only takes half of what the doctor prescribed, one may feel well in the short run, but when the decease comes back, it is stronger and the antibiotics have lost their effect.

The battle of ideas was won in the 1980s and 1990s. However, the battle of implementation was never fully won (see Peter Boettke’s interesting speech on this subject in NZ two years ago). This is now coming back to haunt us and, as a result, the battle of ideas is on the verge of being lost again. The debate may move towards another chapter in the socialism vs. capitalism story with those in favor of markets explaining that the problem was that we didn’t go far enough (i.e. implementation was incomplete) and those in favor of dirigisme explaining that we didn’t regulate enough (i.e. free market ideas were wrong in the first place). The age-old question of sustained prosperity is not yet solved— at the practical level at least.

Comments

[Frederic Sautet]

I am leaving a comment for Paul Walker who posted a comment on my post—see: http://antidismal.blogspot.com/2008/02/frederic-sautet-on-new-zealand.html
(Commenting on Paul's blog necessitates setting a password, which I can't be bothered to do, sorry Paul).

Thanks Paul (if I may) for your post. I still think that the political center has moved tremendously in NZ compared to the 1970s and 1980s. This doesn't meant that interventionism is not a political option for the main parties, as they need to satisfy reasonably broad constituancies (and this include cases where National claims that it won't undo some of Labour's policies).

Interesting stats on the ratio of tax to GDP and the difference between Australia and NZ.

The last point you make is right: under what conditions could the battle of implementation have been won? If we want to progress, we must treat "the lack of political will" as an effect and not as a cause. The problem of reform and implementation is one of the most important questions of social sciences today. This is the line of work I am pursuing at the moment.

[Paul Walker]

Hi Frederic

Thanks for your comments. The political center has moved to a degree, and in the right direction (in more ways than one?!). But I don't think it moved far enough for the reforms to be fully implemented and as the loans example shows it can move back. I take your point about "the lack of political will". But if it is an effect then how do we change the incentives for the politicians? Must we move the median voter even further? If so, how?

[Acomplia]

Thanks for sharing!