Ruth Richardson and fiscal austerity in New Zealand

Responding to finance minister Ruth Richardson’s May 1991 budget which cut government spending, 15 academic economists from the University of Auckland wrote a letter to the editor of the New Zealand Herald on 6 June 1991. It read: “We wish to state in the strongest possible terms our view that in the present state of the economy, and in the midst of an international recession, the deficit-cutting strategy is fatally flawed. It can only depress the economy further and because of this it will be to a considerable extent self-defeating.”

In fact, strong real GDP and employment growth commenced from the time the letter was written. A 1995 article by Victoria University economists Kunhong Kim, Bob Buckle and Viv Hall dates the June quarter of 1991 as a trough in New Zealand’s business cycle for GDP. Real GDP in 1995 was 17% higher than in 1991. Unemployment fell from 11% of the labour force in September 1991 to 6.1% in September 1995.

Far from being self-defeating in fiscal terms, the outcome of the budget was to turn a deficit of 2.7% of GDP in the year to June 1991 into a surplus of 0.9% of GDP by the year ended June 1994.

That is from Roger Kerr.  For the pointer I thank Steve Hanke and Mark Skousen.  For a different point of view, here is Paul Krugman.

Comments

Well, Mr Roger Kerr has a barrow to push. He casually dismisses external factors, but doesn't explain why. NZ's economy is small relative to everything else, so external factors should not be dismissed so casually. Another factor he doesn't discuss is that in the early 80's NZ had very high interest rates (I recall investing my holiday earnings at 25%). It took some time for the drop in rates to get "locked in" in peoples minds - and the fiscal austerity did impress a number of investors, encouraging them to keep their money at home.

Well, there's supposedly 548256 Kiwi's like me here in Australia - about 1/6th of all kiwis. I left just prior to this budget you are talking about, but my impression is that I left at the tail end of the "brain drain". Just based on personal observation - when I first came here, I faced considerable prejudice as a kiwi, but this tailed off greatly over the next few years. I looked for stats records of immigration between Aus/NZ, and nothing came up quickly - except http://www.immi.gov.au/media/fact-sheets/17nz.htm

What is so surprising about the result? Government grows well beyond its core mission, providing services like courts and roads and defense, into areas which are net negatives for the economy (such as taking from the productive and giving to the unproductive). Reducing the budget items that retard economic growth actually resulting in more growth? Mirabile dictu!

IMO We do not know much about Macro!

Consider Japan in the 1990s and the USA in 1920-1921 depression etc.

Lowering Labor Costs and Devaluation of the Currency are generally attempts to make your goods cheaper relative to others. You can sell more of your goods and attract investment. Cutting Govt is often an attempt to lower Govt Borrowing Costs by reassuring foreign investors that, in the future, their profits won't be devalued away. In that sense, they would prefer Lowering Labor Costs right now.

The problem is that this Competitive Strategy needs the forbearance of other countries. Otherwise, you could cut Labor Costs and contribute to Debt-Deflation.

As for the situation right now in Europe, it is just this forbearance by Europe's Competitors that's being questioned. They are likely to take steps to thwart this Competitive Strategy, leaving Europe to face Debt-Deflation in the near future. In this view, cutting Govt Spending is what's worrying investors.

If there is one particular area of Govt Spending that is seen as causing terror about the future fiscal situation, dealing with that particular area can be wise. But that's different than a general cut.

Michael-

NZ government statistics show the battle against inflation was largely over before 1990.

Rich

Yes, inflation had fallen a long way by 1990. But the target was 0-2% inflation, and that was only achieved in late 1991, and it was only from around Dec 1990 that NZ interest rates began falling dramatically from the levels they'd been "stuck at" (we didn't officially set them in those days) for a couple of years. RBNZ data show the 90 day bill rate (benchamrk rate) averaged 13.98% in Nov 1990, and 8.18% in NOv 1991. Fiscal consolidation was part of that story, but only a part.

There were no interest rates in NZ remotely near 5% in 1990. And 90 day bill rates were around 14.3% in Nov 1988, and still almost 14% 2 years later. Yes, with hinsight, the back of inflation was brokeen by the time of the fiscal consolidation, but that was not apparent to either markets or the central bank, so the sharp fall in interest rates in 1991 was a big fall in real rates and a significant part of the recovery story. As, of course, were structural reforms (wideranging labour market liberalisation) going on at the same time.

As long as your country isn't the reserve currency, you have much more flexibility in fiscal measures. We all cannot export more than we import.

British Columbia in 1984. Alberta in 1985. The Canadian Federal government in 1993.

The question isn't whether stimulus works, Keynes is right, or whether exports helped New Zealand. The question is what will happen when (not if, it is inevitable) a Treasury auction fails. The US is rolling vast amounts of money in 2-6 month terms, and adding to the churn by $1.5 trillion per year.

That is why New Zealand and Canada and many other countries did their austerity programs back then. They had no choice, just as Greece has no choice. They could no longer either borrow or afford to borrow money. The US is in the same position.

Derek

Roger Kerr and the NZ Business Roundtable have been lobbying for small government for well over 20 years now. Roger's answer to everything has become so tiresome one is tempted to give him his own country to play with.
Even a stopped clock is right twice a day.

Tracy, a little context here - Yes I agree in the no-subsidies approach and believe in open competition. US Farm subsidies are a clear case of porkbarrel being stronger than intelligence, and don't get me started on those bloody Frenchies and the CAP.
Having lived through the slash and burn of Rogernomics the problem at the time was that we took away all of our barriers too fast and the economy stalled.I'm not talking indicator stalled but social fabric stalled.
We needed the medicine but it was done ramrod style and, when we look around, other countries snuck the pill under their tongues and only pretended to swallow.
No-one here wants to go back but there's our boy Roger, bless his cotton socks, always saying that he wants to cut the government down to libertarian levels and very few here agree with him.
We've had plenty of "refreshing contrast" here already - let's see the rest of the world cut subsidies out and open up trade barriers.

Ok Tracy I'll try to make this clear - Roger Douglas and Roger Kerr took this country a long way down the track towards their belief in small government.
No matter what the problem may be, their answer to it is always the same. We here in NZ are sick of these idealogues saying the same thing all the time no matter what happens.As a case in point, John Key (current PM) was quick to assure voters that although his party are in coalition with the ACT party of which Roger Douglas is a member, Roger would never sit in Cabinet.John has a good feel for the zeitgeist in that way.

We have tried, under Rogernomics, what they wanted and find that we have been an economic guinea pig for their reforms and here amongst those who have lived through it we are, as the teenagers say, over it.
You may not be from NZ so may not understand what it was like to live through Rogernomics, I don't know if you did or not.
I understand that you may well admire the theory of free trade and open barriers and I agree that they are good things - my point about that is that it was done in a rip,sh*t and bust style here and that I still do not see other countries (ie the US and France for example) having gone as far as we have.
I was not aware of Labour introducing "plenty of subsidies" and note that we have a free trade agreement with China now which is going some ways towards opening our markets up even more in that direction.
The bottom line for me is that it may look all lovely from a distance but it wasn't that pretty to get done and now that we have, where's everyone else?

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