Trailblazers: The New Zealand Story – trailer

Best defence of Employment Contracts Act is a @FairnessNZ graphic

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Source: Low Wage Economy | New Zealand Council of Trade Unions – Te Kauae Kaimahi, with extra annotations by this blogger.

@Income_Equality there’s an Internet you know – was there next to no unemployment prior to the mid-1980s in New Zealand?

Today, Closing The Gap – The Income Inequality Project boldly claimed today that there was next to no unemployment in New Zealand prior to the onset of the curse of neoliberalism.

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There is an Internet on computers now where it is easy to find data showing that the unemployment rate was rising rapidly in New Zealand in the 1970s and in double digits by the end of the 1980s – see figure 1.

Figure 1: harmonised unemployment rates, Australia and New Zealand, 1956-2014

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Source: OECD StatExtract.

Figure 1 shows unemployment was rising rapidly in the 1970s and wasn’t much different by the end of the 1970s to the unemployment rates recorded after about 2000 in New Zealand.

One of the reasons that Sir Roger Douglas wrote There’s Got To Be A Better Way was the rapidly rising unemployment in New Zealand and the stagnant economic growth in the late 1970s and early 1980s.

New Zealand was one of the most regulated economies, so much so that Prime Minister David Lange said:

We ended up being run very similarly to a Polish shipyard.

As for those jobs on the railways, the then Reserve Bank Governor Don Brash said in 1996:

Railways cut its freight rates by 50 percent in real terms between 1983 and 1990, reduced its staff by 60 percent, and made an operating profit in 1989/90, the first for six years.

Greece’s far left government must out-do Maggie Thatcher and Roger Douglas all by Wednesday to qualify for their bailout!

The timing of major economic reform programmes

There are plenty of critics of deregulation, albeit enough for them are smart enough to realise they cannot restore the lost monopolies and high marginal tax rates on the middle-class. They admit in their hearts that deregulation and other economic reforms worked as did inflation targeting.

The common force behind economic reform from 1980 onwards was the growing deadweight welfare losses of the pre-1980s status quo.The pressure for reform came from the rising burden that increases in taxes and regulation placed on economic growth as evidenced by the 1970s productivity slowdown and stagflation.

George Stigler argued that ideas about economic reform need to wait for a market. As Stigler noted, when their day comes, economists seem to be the leaders of public opinion. But when the views of economists are not so congenial to the current requirements of special interest groups, these economists are left to be the writers of letters to the editor in provincial newspapers and run angry blogs.

Post-1980 trends in taxes, spending, and regulation in New Zealand and abroad reflect demographic shifts, more efficient taxes, more efficient spending, a shift in the political influence from the taxed to the subsidised, shifts in political influence among taxed groups, and shifts in political influence among the subsidised groups (Becker and Mulligan 1998, 2003).

The common forces behind economic reform across the OECD area have subtle implications for the size of the reform dividend for New Zealand

  • The deadweight losses of taxes, income transfers and regulation are a constraint on inefficient policies (Becker 1983, 1985; Peltzman 1989).
  • This deadweight loss is the difference between winner’s gains less the loser’s losses from a tax or regulation-induced change in output. Changes in behaviour due to taxes and regulation reduce output and investment.
  • Policies that significantly cut the total wealth available for distribution by governments are avoided because they reduce the payoff from taxes and regulation relative to the germane counter-factual, which are other even costlier modes of income redistribution (Becker 1983, 1985).

Certainly, in New Zealand, the post-1984 economic reforms followed a good 10 years of economic stagnation and regular economic crises.

In the early 1980s, New Zealand’s economy was in trouble. The country had lost its guaranteed export market when Britain joined the European Economic Union in 1973. The oil crisis that year had also taken a toll.

The Labour Party Minister of Finance, Sir Roger Douglas, prior coming to office in 1984, wrote a book called There’s Gotta Be A Better Way.

The rising deadweight cost of taxes and regulation due to technological change, and the dissipation of wealth through rising cost structures progressively enfeebled the subsidised groups, allowing others to win the initiative after the 1970s in many countries including New Zealand.

The Labour Government radically reduced the size and role of the state. It corporatised and restructured government departments, often in preparation for privatisation, and sold some state assets to private investors. It abolished many economic controls and removed farming subsidies.

The additional political pressure that the winners had to exert to keep the same dollar gain from income redistribution had to overcome rising pressure from the losers to escape their escalating losses.

Eventually, the fight was no longer worthwhile relative to the alternatives. Taxed, regulated and subsidised groups can find common ground in wealth enhancing policies and an encompassing interest in mitigating any reduction in wealth from income redistribution policies.

One barrier to reform is the transitional gains trap. The capitalisation of rents from taxi licenses is a classic example of the transitional gains trap.

Those who purchase the medallions from the owners at the time of initial regulation will pay the market rate for them and therefore will not receive any special rents.  Yet, they will fight to prevent the taxi medallion system from being eliminated, since these owners will be harmed by such elimination.  Thus, the city will be stuck with an inefficient medallion system that will be difficult to eliminate.

Eliminating the medallion program will harm existing taxis, many of whom did not lobby for the system in the first place and do not receive super competitive profits. The resources used in establishing the regulation or other programmes are lost forever.

Termination of a particular regulation or subsidies will nonetheless cause large capital losses for the incumbents. This will motivate incumbents to oppose reforms that jeopardise the income stream that has been previously capitalised (Tullock 1975; McCormick et al. 1984; Tollison and Wagner 1991). Any resources wasted in fighting economic reform must be deducted from the net gains from economic reform.

The literature on the transitional gains trap suggested that economic reform does not necessarily make society better off (Tullock 1975; McCormick et al. 1984; Tollison and Wagner 1991). The rent-seeking costs of the original privileges are capitalised and are lost forever. They are not regained by reform. The transitional gains trap is just a subset of a more general phenomenon indicating that deregulation can never replicate the status quo ante.

Too often it is assumed that deregulation can replicate the status quo ante. The prevailing model of deregulation is essentially a nirvana model, in that the gains from deregulation can essentially be had without cost. Further rent-seeking costs are incurred in lobbying for and against proposed reforms and these too are lost to forever.

The standard analysis of deregulation too easily treats reform as a return to the status quo ante. Fred McChesney observed

The airline industry of 1999 is not the airline industry of 1978 minus the Civil Aeronautics Board.

The wealth lost in rent seeking is not recovered, or even recoverable by deregulation. Production possibilities have been irretrievably diminished (McCormick et al. 1984; Tollison and Wagner 1991).

Reform is not a free lunch. To the extent that specialised resources were involved in the rent seeking–resources that could have been devoted to amassing specific capital in producing the regulated good–the deregulated relative price must be higher than the pre-regulation or competitive price. The abstract of the relevant article by Tollison and Wagner is as follows:

This paper applies the theory of rent seeking to argue that economic reform, in the sense of correcting past deformities in the economy, does not pay from a social point of view. Economic reform, at best, should focus on the prevention of future deformities.

The analysis is developed in terms of the example of monopoly, but its applicability extends to any example of economic reform. The general principle underlying the analysis is that reform is not a free lunch, all the more so when the costs of the reformer and the resistance of the object of reform are taken into account.

Despite this, new institutions arise when social groups notice opportunities for new gains which are impossible to realise under the prevailing institutional arrangements (Diana Thomas 2009). The chances that new institutional frameworks may develop increase when these alternative technological opportunities and export markets become available.

Reform is more likely when the net benefits of reform become large because there is plenty left over for credible compensation of the losers who could block change (Acemoglu and Robinson 2005; Acemoglu 2008). An example is if taxes or regulation causes cost padding or delay new technologies. Shedding these inefficiencies are potential benefits for all.

The political secret of the East Asian economic miracles was the focus on export led industrialisation. Because the new industries were exporting rather than entering and competing with domestic suppliers to home markets, these domestic special interest groups had no reason to lobby against the establishment of these export industries and otherwise blocked both their entry and the adoption of new technologies. The social change is much more subtle. The local industry is simply had to pay more for contract as the export industries grew and bid away their labour force with higher pay.

Successful subsidised groups are often coalitions of sub-sets of producers, consumers, employees and input suppliers and deregulation is always a possibility if some members can benefit from joining another coalition (Peltzman 1976, 1989). A surprising number of incumbents of regulated and state-owned industries were unprofitable – some close to bankruptcy – because of rising cost structures, the growing losses from mandated services and erosion of rents through non-price competition with existing firms. They would have closed anyway but for bailouts.

The economic reforms that picked up pace around 1980 were a success as Andrei Shleifer’s paper
The Age of Milton Freedom begins

The last quarter century has witnessed remarkable progress of mankind. The world’s per capita inflation-adjusted income rose from $5400 in 1980 to $8500 in 2005.Schooling and life expectancy grew rapidly, while infant mortality and poverty fell just as fast.

Compared to 1980, many more countries in the world are democratic today. The last quarter century also saw wide acceptance of free market policies in both rich and poor countries: from private ownership, to free trade, to responsible budgets, to lower taxes.

What is neoliberalism? Please tell me – show me one.

I want to meet someone who believes neoliberalism was the leading light of the economic reforms since 1980. They can then tell me what neoliberalism is. Please, tell me.

The prefix “neo-” makes “neoliberalism” sound like something that morphed into something bad. Is neoliberalism something more than a sustained sneer – a personal attack as a way of avoiding debate?

Not only is there no single definition of neoliberalism, there is no one who identifies himself or herself as a neoliberal. At least communists and socialists were proud to be called so.

In Neoliberalism: From New Liberal Philosophy to Anti-Liberal Slogan, Taylor Boas & Jordan Gans-Morse went in search of anyone who identifies one’s self as a neoliberal:

  • They did not uncover a single contemporary instance in which an author used the term self-descriptively, and only one – an article by New York Times columnist Thomas Friedman (1999) – in which neoliberal was applied to the author’s own policy recommendations.
  • Digging into the archives, they did find that while Milton Friedman (1951) embraced the neoliberal label and philosophy in one of his earliest political writings, he soon distanced himself from the term, trumpeting “old-style liberalism” in later manifestoes (Friedman 1955). See “Neo-liberalism and its Prospects”, Milton Friedman Papers, Box 42, Folder 8, Hoover Institution Archives. 1951. Hardly a smoking gun?

What Boas and Gans-Morse found, based on a content analysis of 148 journal articles published from 1990 to 2004, was that the term is often undefined. It is employed unevenly across ideological divides; it is used to characterise an excessively broad variety of phenomena.

That is academic speak for neoliberalism is an empty slogan.

Neoliberalism was supposed to rule the roost under Reagan, Thatcher, Hawke and Lange-Douglas. The local branches of neoliberalism were Thatchernomics, Rogernomics, and Reaganomics.

Milton Friedman is said to have mesmerised several countries with a flying visit. The Friedman Monday Conference on ABC in 1975 and by Hayek in 1976 are still ruling the Australian policy roost, if some serious public commentators are to be believed.

In the 1980s and up to the mid-1990s, despite all the neo-liberal deregulation and Milton Friedman taking over monetary policy, mentioning Friedman’s name at job interviews would have been extremely career limiting, and that was at the Australian Treasury.

Back then, the much less radical Friedman was just graduating from being a wild man in the wings to just a suspicious character.

If you name dropped Hayek in the early 1990s, any sign of name recognition would have indicated that you were being interviewed by educated people.

When the Left gets on its high horse and goes on about Hayek and Friedman running neoliberalism, with Hayek as Friedman’s mentor, it is refreshing to remind all how little they had in common on macroeconomics. The University of Chicago Department of Economics did not offer Hayek a job in the late 1940s despite his outstanding record at LSE as Keynes’ principal critic in the 1930s.

While working at the next desk to a monetary policy section in the late 1980s, when mortgage rates were 18%, I heard not a word of Friedman’s Svengali influence:

  • The mantra for several years was that the market determined interest rates, not the Reserve Bank. Joan Robinson would have been proud that her 1975 Monday conference was still holding the reins.
  • Monetary policy was targeting the current account. Read Edwards’ biography of Paul Keating’s time as Treasurer and Prime Minister and his extracts from very Keynesian treasury briefings to Keating signed by David Morgan that reminded me of Keynesian Macro 101.

As a commentator on an Australian Treasury seminar paper in 1986, Peter Boxhall – freshly educated from the 1970s Chicago School – suggested using monetary policy to reduce the inflation rate quickly to zero. David Morgan and Chris Higgins almost fell off their chairs. These Treasury Deputy CEOs had never heard of such radical ideas.

In their breathless protestations, neither Morgan nor Higgins were sufficiently in tune with their Keynesian education to remember the role of sticky wages or even the need for monetary growth reductions to be gradual and, more importantly, credible, as per Milton Friedman.

By the way, Friedman’s presidential address to the AEA in 1967 is now recognised as perhaps the single most influential journal article of the 20th century. That article is the essence of good communication and empirical testing of competing hypotheses as was his 1976 Noble Prize lecture. No wonder both were hidden from impressionable undergraduates such as me a few years after.

Director’s Law of public expenditure and the survival of the modern welfare state

Sam Peltzman pointed out that most of modern public spending is supported by the median voter –  the ‘swinging’ voter. Governments at the start of the 20th century were a post office and a military. At the end of the 20th century, governments are a post office, a larger military and a very large welfare state.

Studies starting from Peltzman in 1980 showed that governments grew in line with the growth in the size and homogeneity of the middle class that was organised and politically articulate enough to implement a version of Director’s Law. George Stigler published an article on this law because Aaron Director published next to nothing for reasons no one understands. Director founded law and economics through teaching at the University of Chicago law school.

Director’s Law of public expenditure is that public expenditure is used primary for the benefit of the middle class, and is financed with taxes which are borne in considerable part by the poor and the rich.

Based on the size of its population and its aggregate wealth, the middle class will always be the dominant voting bloc in a modern democracy. Growth in the size of governments across the developed world took off in the mid-20th century as the middle class blossomed. Peltzman maintained that:

“the leveling of income differences across a large part of the population … has in fact been a major source of the growth of government in the developed world over the last fifty years” because the leveling created “a broadening of the political base that stood to gain from redistribution generally and thus provided a fertile source of political support for expansion of specific programs. At the same time, these groups became more able to perceive and articulate that interest … [and] this simultaneous growth of ‘ability’ served to catalyze politically the spreading economic interest in redistribution.”

After the 1970s economic stagnation, the taxed, regulated and subsidised groups had an increasing incentive to converge on new, lower cost modes of income redistribution.

  • Economic reforms ensued, led by parties on the left and right, with some members of existing political and special interest groupings benefiting from joining new coalitions.
  • More efficient taxes, more efficient spending, more efficient regulation and a more efficient state sector reduced the burden on the taxed groups.
  • Most of the subsidised groups benefited as well because their needs were met in ways that provoked less political opposition from the taxpaying groups.

Sweden, Norway and Denmark could be examples of Gary Becker’s idea that political systems converge on the more efficient modes of both regulation and income redistribution as their deadweight losses grew in the 1970s and 1980s and after. Unlike some of their brethren abroad, more of the Nordic Left and, more importantly, the Nordic median voter were cognizant of the power of incentives and to not killing the goose that laid the golden egg. Taxes on income from capital are low in Scandinavia.

The rising deadweight losses of taxes, transfers and regulation all limit the political value of inefficient redistributive policies. Tax and regulatory policies that are found to significantly cut the total wealth available for redistribution by governments are avoided relative to the germane counter-factual, which are other even costlier modes of redistribution.

An improvement in the efficiency of either taxes or spending reduces political pressure from taxed and regulated groups for suppressing the growth of government and thereby increases total tax revenue and spending because there is less political opposition. Efficient taxes lead to higher taxes.

Improvements in the efficiency of taxes, regulation and in spending reduce political pressure from the taxed and regulated groups in society. This suppressed the growth of government and thus increased or prevented cuts to both total tax revenue and spending since 1980. Economic regulation lessened after 1980 and there were privatisations, but social and environmental regulation grew unabated.

The post-1980 reforms of Thatcher, Reagan, Clinton, Hawke and Keating, Lange and Douglas and others saved the modern welfare state for the middle class. Most income transfer programmes in modern welfare states disproportionately benefit older people. With an aging society, that trend can only continue.

That is why these reforming policies survived political competition, election after election. The political parties on the left and right that delivered efficient increments and streamlined the size of government were elected, and in turn, got thrown out from time to time because they became tired and flabby.

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