Closing The Trans-Tasman Gap

It was good to see the New Zealand Herald editorialising today on the need for new policy to close the income gap with Australia.

The editorial made some good points:

Two years on, after a fall resulting from the global financial crisis, the move westward is growing again, up 16 per cent from 2009 to last year according to the statistics department. And National, too, is reduced to waving at the departees, our economy marooned in low growth and higher unemployment than across the Ditch. The number of New Zealanders returning from Australia is relatively static.

And again:

In government its answers have been limited: reducing company tax, shifting some direct income tax to indirect GST, tinkering with labour and planning laws, trying to hold the annual increase in state spending rather than cutting it, but ruling out big ticket changes such as to Working for Families, interest-free student loans and raising the entitlement age for superannuation.

But then it rather lost the plot:

The economic growth and prospects of a small, primary-produce-exporting nation are not directly comparable to those of a big, diverse, less indebted neighbour.

Hang on a bit!  New Zealand was once a wealthier country (in terms of income per capita) than Australia.  Its geographical position hasn’t changed.  Australia has always had those minerals in the ground.  Australia and New Zealand are both relatively small countries but small countries can do just as well as large ones (think Luxembourg, Switzerland, Hong Kong and Singapore) provided their markets are open and competitive.

Now consider this statement:

New Zealand’s options for revival are relatively limited by lower productivity, high private foreign debt and an almost cultural aversion by the state and individuals to cutting spending in favour of saving and productive investment.

Options limited?  But it is institutions (like electoral systems) and policies (spending, tax, regulatory, social) that mainly determine whether countries prosper or not in today’s world.  New Zealand’s productivity growth performance was slightly better than Australia’s in the 1990s but fell sharply in the last decade as economic reform stalled and reversed.  Decisions on institutions and policies are for us to make.  The question to ask is: If New Zealand moved in the direction of the policy settings of countries like Hong Kong or Singapore, why wouldn’t the income gap with Australia close quite rapidly?  (Think Ireland when it had its act together.)

Another argument:

Little is being achieved in catching up with Australia and it is possible that no policy setting, short of changes that would spark far more serious social upheaval than a brain drain will deliver parity in the foreseeable future.

 [The government’s] … 2025 productivity task force, headed by former leader Don Brash, twice predicted that major change was needed, and was given an almost unseemly short shrift. Dr Brash’s prescription suffered from a political tin ear, unaware or unpersuaded by the risks of a voter backlash to wholesale cuts to welfare programmes and taxes and sales of state assets.

This is hyperbole.  There is no need for wrenching economic change (unless we dither and it is forced upon us again).  The Brash prescription was orthodox, not radical.  It was entirely consistent with OECD prescriptions. It wasn’t the Taskforce’s job to play at being politicians; it was to deliver economic advice on how to close the gap.  And the government has on its agenda a number of possible initiatives which, if adopted, could make a difference, as I noted in this article.

Finally, somewhat contradictorily, the editorial concludes:

For its own sake, New Zealand needs bold economic initiatives that will position the country for sustained growth.

Sadly, the Herald put forward no suggestions at all for “bold economic initiatives”.  If it disagrees with the 2025 Taskforce, what is its alternative programme?  How can citizens and voters buy into the idea of “bold economic initiatives” if our leading newspaper does nothing to point the way?  And it doesn’t help if its op-ed pages are littered with articles like those of Bryan Gould (13 last year, two already this year) and Peter ­­­Lyons whose economic prescriptions would see us falling further and faster behind Australia.

What grade for the editorial?  Could do much better.

What’s Wrong with Neoclassical Economics?

A new Occasional Paper on the Business Roundtable website should be a useful resource for teachers of economics and participants in economic policy debates.

Written by Wolfgang Kasper, emeritus professor of economics at the University of New South Wales, Australia, an earlier version was delivered to the joint conference of the New Zealand Association of Economists and the Law and Economics Association of New Zealand in June this year.

For years I had urged Wolfgang to write a paper spelling out the limitations of neoclassical economics in understanding how the world works.

He resisted the idea (“nobody believes in neoclassical ideas any more”).  I told him he was wrong: various economics educators in New Zealand continue to teach on the basis of defunct human capital, and politicians attack free-market policies on the false assumption that they are grounded in neoclassical economics.

Finally Wolfgang relented and wrote the paper.

Neoclassical economics can be traced back to the work of British economist Alfred Marshall and to some extent even further back to ‘classical’ economists such as Adam Smith.  It is characterised by a focus on static equilibrium conditions in markets and the economy – like how supply and demand are matched and at what prices.  It does not explore the dynamics of the economic system, and in particular has little to say about entrepreneurship and economic growth.

As Wolfgang says in his paper:

The poverty of neoclassical economics becomes evident when one realises that key concepts – such as competition, enterprise, profit, the costs of transacting business, the need for law and other rules of coordination (institutions) – have simply been ‘assumed away for simplicity’s sake’. It is also imbued with a wrong-headed pessimism, derived from nineteenth-century agricultural reality (law of diminishing returns).

Almost as though on cue, a classic example of the persistence of neoclassical misunderstandings came to light just as Professor Kasper’s paper was being printed.  The New Zealand Herald, which features a constant diet of op eds by anti-market critics such as Jane Kelsey and Bryan Gould, printed this article by Auckland secondary school economics teacher Peter Lyons, whose articles also appear frequently in Herald columns.

It was entitled ‘Mantra of free market ideology wearing thin’ and contained a familiar theme: “In the past 25 years New Zealand has embraced the free market ideology of of neoclassical economics.”

As someone involved in some of the reforms, I can certify that none of the economic advisers of the governments concerned were slaves of neoclassical economics.  While recognising its insights they were well aware of its limitations as identified by Wolfgang Kasper, and drew on a far wider and richer body of economic literature.  A reading of relevant official documents would make this immediately apparent.

Similarly, governments in the United States, Britain, Australia and many other countries that embarked on liberal economic reforms around the same time as New Zealand were not driven by narrow neoclassical economics.  Again a reading of official documents would quickly confirm this.

Professor Kasper responded to Peter Lyons in this article.  Regrettably, the Herald declined to publish it.

I worry about bad economics teaching in our classrooms and lecture rooms.  I worry too about the effect of bad economics on public understanding when newspapers do not publish critical responses.

Professor Kasper’s paper should demonstrate that those who attack liberal economic policies on the grounds that they are based on neoclassical economics are attacking a straw man.