Alex Sundakov
Director, New Zealand Institute of Economic Research

Government in the shadow of the global economy

It is very humbling to come on stage after two speakers who have generated such incredibly powerful imagery. I think I will struggle with the concept of orthogonal cleavages for some weeks to come. The idea of President Clinton rampaging through the streets of Wellington while carrying a mobile phone manufactured by Carter Holt Harvey made out of best New Zealand pinus radiata I think doesn’t even bear thinking about. It is even more humbling given that I can’t even aspire to the title of doctor, I stand before you as a simple mister.

What I would do is to try to reflect on why is it that there seems to be an incredibly high level of dissatisfaction with what it is that the State has been able to achieve either in New Zealand or around the world. Trying to understand what have been the constraints and the key challenges for public sector performance that have generated such very high levels of dissatisfaction from the general public. I guess what I start from is a bit of a disagreement with Leslie Young who describes New Zealand as an economic failure. I don’t think that New Zealand has been an economic failure. I think that it is precisely the fact that it hasn’t been an economic failure that poses so many questions. Why is it that despite a relatively good economic performance, perhaps even quite spectacular in the mid 1990s, and I think that one shouldn’t be too depressed by the more recent slow down, why is it despite economic growth both here and overseas that governments have in many senses failed to deliver on the expectations about what the governments can do, that people have generated from looking at government achievements in perhaps the ‘40s, ‘50s, and ‘60s. If we look at the picture of economic growth, economies around the world have been cyclical in the last 20 years or so, and these cycles are not surprising, but by and large I think it is difficult to describe the 1980s and 1990s as being a failure from the point of view of economic performance. If you look at how New Zealand fits into it, we’ve had relatively bad 1980s as we obviously went through a very difficult transition process. It is true that in the last year, or so, we have under performed compared to the countries that we tend to look to, but that follows a period of a few years in the mid 1990s where we have quite significantly over performed. I think by and large when you look at the bunching of growth it is difficult to see New Zealand as a really dramatic economic outlier. I don’t think it is the economics that are really at the root of concern. The issues about what the State is about and what the State is supposed to do and how it does it I think arises right across the world, almost regardless of how well the economies have performed.

Almost everywhere in the world we find that inequality of incomes has been rising in the recent decade. This table puts together information on Gini co-efficients. Gini co-efficients measure deviation from absolute proportionality of income. Income is absolutely equally distributed, absolutely proportional, if the bottom 10 percent of the population earn 10 percent of income, the next 10 percent of the population earns 10 percent of income, and so on. The higher the Gini co-efficient the wider the dispersion of income among different income groups. What they show us is that with the exception of France and Sweden, most Western countries, most countries that we tend to look to as our comparative economies, have suffered a widening of the income gap. It is true that New Zealand has been probably the most dramatic in that regard, but New Zealand still remains I think very much within the ballpark in terms of its income distribution, certainly of other Anglo-Saxon nations. France and Sweden, while they have been able to maintain approximately the same levels, or perhaps reduced levels of income dispersion have certainly not been successful societies in the broader economic sense. So the sort of fundamental expectations about what it is the government is about really haven’t been fulfilled I think around the world.

The plaintive cry about the pressures that are coming on governments is coming from just about everywhere. This is a fascinating quote from a recent American paper, and the US has been a society that has enjoyed quite spectacular and some people call it a miraculous growth period, the US budget has by and large performed very well and went from a very large deficit into surplus, not by concentrated expenditure cutting of the same kind as we experienced in New Zealand but by gradual filling up of the State coffers on the back of a strongly growing economy. Yet, the perception of how the State is performing and the pressures that the State is under that comes from this American quote, I think, would sound very familiar to most New Zealand public sector managers. So something that is happening to the public sector is happening right around the world and these pressures are pretty universal. So what I would like to do is to speculate about what these pressures may be, and try to suggest some possible responses, which may be relevant to the New Zealand public sector.

I think that governments around the world are increasingly operating under a series of constraints and I will go through them in some more detail. These include world wide mobility of resources, the need to respond to ongoing change, the fact that we’re increasingly dealing with intractable problems, we’re dealing with increasingly global expectations and the perception of what constitutes good life I think is very much formed by a view of what is happening around the world and that impacts on what we expect from our governments domestically. I think increasingly also we are dealing with a situation where domestic policy has to deal with global commerce and that clearly has very important implications for how the Government operates. Let me take you through these issues step by step.

Let’s look at mobility of resources, which I think is fundamentally about constraining the capacity of governments, either to raise revenue in a way that they perhaps thought they were capable to in the past, or to act in a way that creates environments that are different from what other countries face. What I did here was to track the long-term departures from New Zealand and look at the skill mix of departures month by month during 1999. I then compared this with the skill mix as reported in the 1996 Census. Now what is fascinating from this is that we don’t get a picture of brain drain by and large. Now it is true that, of course, there are some very skilled people that are also leaving New Zealand, but interestingly enough they are disproportionately under represented in the long-term departures from New Zealand. The group that is remarkably disproportionately over represented are the really unskilled people, the very low-skilled people who are heading out in search of opportunities. Now in part this reflects the fact that with the more competitive global market for skill New Zealand businesses and to some extent New Zealand Government have been responding by increasing the skill differentials in pay levels, so that a lot of skilled people are choosing to remain in New Zealand because the pay differentials with other countries are probably not quite as great as Leslie Young suggests. But more importantly, what I take from this table is the fact that if the very unskilled in New Zealand are already incredibly mobile and we know that the very skilled are potentially very very mobile, that suggests that the movement of people, the flexibility of the labour market is probably not to be underestimated and that has very severe implications for the sort of issues that New Zealand is currently facing in terms of thinking about what to do with taxation. Now we also know, of course, that capital is highly mobile so if you add mobility of capital and mobility of labour together, the capacity to raise tax over and above what comparable nations are able to do is very very limited.

If we look at how we have been raising tax, and again track it over the last 10 or so years, what we find if we compare Australia and New Zealand, by and large if you ignore the cyclical variations, we have been raising about the same proportion of GDP in corporate tax as Australia has. So in other words, the overall tax burden in New Zealand and Australia from a commercial point of view, from the corporate point of view, has been about comparable. Now the tax burden may be implemented in different ways, we have very different tax systems in terms of base rates, in terms of deductions that are available to people, and companies and so on, but once the calculations are done and our calculations are significantly more simple in New Zealand, what comes out is fairly similar. That probably explains why we really haven’t seen a tremendous exodus of capital from New Zealand to Australia. Sure some companies move on, but they move on for a variety of reasons, which probably do not have very much to do with tax. What has been very interesting though, is the consistent differential in personal income tax. Even though our tax rates sound lower than they are in Australia, because we don’t offer the same range of deductions and because our tax system captures a much broader base we have actually been able to collect more tax. In other words, we are imposing a higher tax burden on the wage and salary earners. I think that is very much at the limit of what we can do in the medium term, because with highly mobile labour our capacity to deviate from Australia is going to be very restricted.

If you take a longer term view of the total tax revenue collected in New Zealand compared to Australia and the US, you can see that through the 1970s and 1980s we have increasingly deviated from the comparative countries. What we are seeing now is the compression of that difference. It is that compression that obviously presents particular challenges to New Zealand. It means that the pressure on our New Zealand Public Service to perform in some ways I think is going to be even greater than the corresponding pressure on the public services of Australia and the US. So if we can’t raise more revenue, in other words, if our capacity to keep up public services with increasing economic prosperity is limited, that is only one constraint that we are faced with. That alone probably wouldn’t be so much of a problem if we didn’t have to deal with increasing demands. The fact that our supply is constrained I think is only just one underlying problem. So what are the demands that we are dealing with?

Well first, I think the world is subject to much more rapid change than it has been in the past and change is very expensive, so there are tremendous demands on the public services in terms of coping with change and that has to do both with management costs and the internal cost of running a public service that is constantly adapting to change. It also has to do with what people expect in terms of public assistance as change takes place. I think that there are two kinds of change. The sort of change that we have focused on in New Zealand in particular has to do with policy adjustment and that has been very much the New Zealand experience of the 1980s that having delayed significant policy adjustment and having fallen behind the rest of the world in terms of economic structure, in terms of protection levels, and so on, we went through a period of very rapid change that was essentially policy induced and we had to cope with that change. That itself placed very significant demands on the public sector. But even as policy adjustment may be coming to an end, we are still dealing with tremendous pressures coming from constant market changes. As relative prices change, as the nature of market changes, as the sort of industries that New Zealanders are involved in changes all the time, that does place pressure on the Government as well. It places pressure in terms of demands for education, it places pressure in terms of geographical mobility of the New Zealand population and the need for geographic mobility and the fact that a very large proportion of our unemployment is regional unemployment has a lot to do with the fact that there is this ongoing economic change to which society is constantly having to adapt. And, just to emphasise it again, change is costly.

I think the other issue we’re facing is that in terms of public policy, in terms of what the Government can achieve there are really no low-hanging fruits left. If you think about the sort of great public policy triumphs of the Twentieth Century in terms of elimination of basic poverty, in terms of sanitation, improved education levels, improved diets and health of the population at large, most of these achievements came fairly early in the Century and they solved the kind of problems that I think people often associate with poverty, the sort of problems of fairly widespread disadvantage and of issues that place significant constraints on people taking advantage of opportunities. In many ways having done that, though, what we are left with are the social problems that are much, much less amenable to solution and require often more resources to solve. We are now dealing I think with more intractable cycles of disadvantage, we are dealing with poverty problems that are much more endemic to the populations that are suffering from these problems and so it is no longer quite as easy to address them.

I apologise for the quality of this table. It was scanned from a recent book that has come out and I didn’t have the base data to put it together. What this table does is, for a variety of countries, plot the changes in non-employment with individuals on the horizontal axis and households on the vertical axis. In other words, individual unemployment, the proportion of individuals who don’t have jobs, and changes in individual unemployment are plotted along the horizontal axis, whereas vertically this graph represents households in which nobody works. What we have seen is that for a fairly large group of countries, and New Zealand is on the right, right at the top there, but for a very large group of countries almost regardless of whether they have suffered slight deterioration in employment at the individual level between 1985 and 1996, or even slight improvement in employment at the individual level, there is increasingly a larger proportion of households where nobody works, so poverty is becoming much more fenced off and there is a kind of a division of society that is happening between those who are enjoying opportunities and those who are losing opportunities. That concentrates the social problems we are having to deal with. That, to me, is part of the reason for this growing dissatisfaction with what the Government is able to achieve.

Of course, you remember who said that. Well, the problem is I think that increasingly we do know how lucky we are and our expectation of how lucky we should be is being influenced by growing world-wide media, by our growing perceptions of what world-class standards mean. That creates enormous difficulties for public sector management and, to me, is one of the key causes of this growing dissatisfaction. When you think about how people form their expectation of what they should get from the health service, subliminally it is formed by constant exposure to the media, to the sort of coverage that they get on television and the newspapers. What we expect, what we think is normal, what we think is world class, are the high-tech interventions of the American health system, the universal access of the Canadian health system, paid summer vacations of the German health system, and so on. There is a whole range of expectations of what is normal, what is to be expected that are constantly derived from sampling bits and pieces of information from around the world and, not surprisingly, we tend to sample the best, we tend to concentrate on the sort of things that we like. We don’t really focus on the kind of trade-offs that other societies make and the difficult issues that they face. We, as consumers of public services in New Zealand, are very much focused on the best that we see in different parts of the world and the same is probably true of education and a variety of other public services. Our expectations of the quality of service, the speed of service, the sort of responses that we get from the State sector are also very heavily influenced by our constant contact with international companies, with the market economy that is becoming more competitive and therefore more customer friendly, and therefore, on a daily basis educating us to be more demanding customers. So here we have a State sector that is only able to expand supply at a very slow rate (in real terms expenditure on health care has been rising in New Zealand, but fairly slowly and steadily); against that we have this very rapid expansion of our expectations and of our demands. Increasingly, these are problems of distance between possibilities of supply, particularly within the context of the New Zealand economy, and the growing demands that are based on our perceptions of being part of the first world and plucking out world-class solutions from around the world.

This cartoon is fascinating; it comes from a website that is run by a bunch of people who broadcast to the world on the web a warning about the "New Zealand experiment". I thought though that it expresses popular concerns about increasingly global economy and increasing exposure to decision-making that is done outside of New Zealand. To me, when I think about the role of the public sector and the challenges facing the public sector I think that what it comes down to is that it is very difficult to think about national policies in the context of a commercial world, and the public policy particularly through regulations constantly interacts with the commercial world where the decision-making is not national. So many of the issues that we have grappled with in the past as a nation and are continuing to grapple with, often attract solutions that are no longer feasible, or no longer have the same effects as they had in the past. Just let me give you a couple of examples. The sort of debate that is emerging now on New Zealand content on television seems to me to be very rapidly overtaken by the fact that we no longer have a number of fixed television channels being beamed to every New Zealand household and the question is, what do you fill those channels with. We have a very rapidly changing technology where a large and growing proportion of New Zealand households has access to either cable television or to Sky, where there is a growing possibility of television broadcasts via the internet where, just simply having a channel, no longer has the same policy implications as it has had in the past. So thinking about how one maintains national character I think is being very much challenged by these technical changes. Yet, the policy debate that we have in New Zealand is still very much done in terms of the technology that existed perhaps 5 to 10 years ago. When we think about competition policy, what are the implications, for example, of a New Zealand competition authority declining a merger in New Zealand of a global entity that it is merging around the world. Is it feasible to do that? If two international companies for both of whom New Zealand may be a very minor operation decide to merge, is it possible for New Zealand to stand out and to say well, no, the merger of your New Zealand entities will reduce competition. Even if we do that, even if we manage to enforce that will that make any difference? If those companies now operate as an integrated business world-wide, integrate their brands, integrate their technologies, does it make sense for us to keep trying to enforce their competition within New Zealand. So I think that all of these issues on a daily basis are challenging the sort of things that we can do at a policy level in New Zealand.

Let me try to draw out a couple of lessons from this. I think that they do not necessarily need to be negative, I don’t think that it is necessarily an admission of what we can’t do. It is rather a focus on how we should be thinking a little bit more creatively about what we can do in this very global economic environment. I think the first challenge is that the public sector really needs to shift towards policies that across the board facilitate change rather than protect people from change. In the past, a lot of what we have been doing was about maintaining lifestyles, maintaining past habits and the ways of living and the ways of going about business that have been acquired in the past. I think, for example, the unemployment benefit, the way it currently operates has been to a very large extent about maintaining people in a fairly static fashion, whereas more and more we need to be thinking about how do we direct public policies towards constantly facilitating this change that will keep coming at us. I think that the public sector has to increasingly prioritise and pick its fights. In other words, it seems to me that one has to take great care to ensure that where public resources are devoted to something they are devoted for very good reason, not just because we think that something should be done about it, but we have to be very clear that this is the area where by doing something we can get the greatest pay-off. The example I can think of is the fact that the Reserve Bank has essentially voluntarily stepped back from closely supervising New Zealand banks by saying, well these are global institutions and our capacity to watch them in New Zealand doesn’t really help us very much because we don’t know what is going on with them internationally and what is going to happen to them in New Zealand is probably going to be much more affected by the international performance rather than by the domestic performance. So, we can save the resources that used to be devoted to very close supervision of the banking system, even though, as a national policy, it would be great if we could have more prudential supervision of the banking system. I think that choices have to be made and one of the choices or in many cases frequent choices that we would have to make is that we are not going to do it because that is not really our key area of priority, where we can get the biggest bang for the buck. I think the final lesson I would draw is that in all my experience in working in the New Zealand Public Service I think we have been incredibly good at looking over the fence. We have been very good in New Zealand at learning from international experience, looking at how others do things and translating that to the New Zealand environment and seeing if we can pick out the best. But while obviously that needs to be maintained, the next step is not just looking over the fence and seeing what they’re doing, but increasingly importantly, looking over the fence and seeing how what they’re doing is affecting us. Policies in other countries are entering New Zealand through a variety of ways. So I think that the next step in learning from international experience is not just translating it to New Zealand, but rather being very careful about how we observe what happens in the rest of the world and designing New Zealand policies in the context of how we are constantly, on a daily basis, being affected by the policies of others. Thank you very much.