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This is the pre-copy-editing text of the article appearing as: "Can Orthodox Stabilization and Adjustment Programs Work? Lessons from New Zealand," International Organization 45:2, Spring 1991, pp. 221-256. Unfortunately it lacks tables and footnotes.  The PDF version here is complete.

CAN ORTHODOX STABILIZATION AND ADJUSTMENT PROGRAMS WORK? LESSONS FROM NEW ZEALAND, 1984-1990

Herman Schwartz
Politics Department

PO Box 400787
University of Virginia
Charlottesville VA 22904-4787
434 924 3192 (x3359 fax)
e-mail: hms2f  @  virginia  .  edu
http://www.people.virginia.edu/~hms2f

Author Bio note

Herman Schwartz is Professor of Politics at the University of Virginia. He is author of In the Dominions of Debt, States vs. Markets, a bunch of articles and currently is working on a book comparing public sector reorganization in Australia, Canada, Denmark, New Zealand, and Sweden in the 1980s and 1990s.

Abstract Most debate about the efficacy of orthodox (IMF-style) stabilization programs has been fruitless. First, rarely are programs fully implemented or sustained for long periods of time. Second, defenders and critics hold differing premises about the nature of capitalist economies. The debate thus is not over the appropriate balance of supply and demand side measures, but rather over what sort of demand and supply side measures will address the supply and demand side problems each side perceives. Successful and sustained implementation of an orthodox stabilization program with demand and supply side elements in New Zealand, 1984-1990, reveals the limits to these programs. New Zealand, a primary product exporter, suffers from a structural imbalance of payments and a Latin American scale external debt burden, but does not have the serious supply side constraints on growth critics claim typify underdeveloped economies. This makes it an appropriate test of the typical orthodox stabilization program. Despite levels of political will, domestic support, administrative capacity, and access to external resources far in excess of the typical would-be LDC stabilizer, New Zealand achieved only a precarious macro-economic and international payments stability. Moreover, the inflation control and financial liberalization policy components of orthodox plans have contradictory consequences for payments balance. This suggests that long term stabilization, in New Zealand and elsewhere, cannot be achieved solely by internal reforms.

Author's note I would like to thank Richard Bensel, John Echeverri-Gent, Stephan Haggard, Louis Pauly, Elizabeth Sanders, and two reviewers for comments and criticism. I am also indebted to large number of people interviewed in New Zealand regarding this and other issues. Earlier versions were presented at the Center for Study of Social Change at the New School for Social Research, and at the 1989 APSA Annual Meeting. Some research for this paper was supported by the NEH.

 

CAN ORTHODOX STABILIZATION AND ADJUSTMENT PROGRAMS WORK? LESSONS FROM NEW ZEALAND, 1984-1990

Can orthodox economic adjustment and stabilization programs work? Two factors made most debates about this during the 1970s and early 1980s a dialogue of the deaf. First, because defenders and critics of orthodoxy held contrary initial assumptions, they interpreted the same data in contrary ways. Second, and more important, because hardly any peripheral or less developed country (LDC) had ever successfully implemented and sustained an orthodox program, most of the evidence, even in aggregate quantitative studies, was weak and contradictory. Nevertheless, two things now allow us partially to resolve this debate. First, the practical policy advice proffered by critics and defenders alike has converged during the past two decades, allowing us to construct an image of a "typical" orthodox program for stabilization and adjustment. Second, such a program has been implemented and, more important, sustained in New Zealand since 1984. Just as the failure of heterodox stabilization in Peru shows the limits to the heterodox model in general, the very qualified success of a sustained orthodox stabilization program in New Zealand shows significant outer limits to what is possible with orthodox stabilization and adjustment.

Why is stabilization in New Zealand a suitable test of the orthodox model? First, despite its image as a developed industrial economy, New Zealand actually has an economic structure similar to a better off middle income developing country, combining an internationally competitive primary sector with a largely uncompetitive and sheltered manufacturing sector. 1965 on, New Zealand faced declining terms of trade for its primary product exports, and also had a structural, but sustainable, balance of payments deficit. But between 1975 and 1984, its payments and fiscal deficits grew unsustainably in a fashion typical of most developing countries. Similarly, New Zealand tried to overcome this structural tendency towards imbalance through foreign debt financed import substitution industrialization (ISI). But, as in Latin America, ISI created uncompetitive industries whose inefficiencies and tax funded subsidies hurt export (agro-)industry, leading to a large fiscal deficit, relatively high levels of inflation, and growing foreign indebtedness. By July 1984, New Zealand's external debt had reached Latin American proportions. (Table 1 provides comparative data). New Zealand is thus an apposite test of programs which for the most part are going to be applied in less developed countries.

TABLE ONE: EXTERNAL DEBT OF SELECTED COUNTRIES, 1985

 

Net Foreign Debt as % of:

Debt Service as % of:

 

GDP

Exports

GDP

Exports

New Zealand

51

164

4.6

14.7

Australia

25

157

2.8

17.7

Denmark

40

108

4.2

11.5

Finland

14

46

1.9

6.3

Sweden

22

62

2.5

7.0

Portugal

43

111

5.6

14.5

Spain

8

36

1.1

4.9

Turkey

48

189

2.5

9.8

Average of highly indebted LDCs*:

46

271

4.9

27.9

* Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Ivory Coast, Ecuador, Jamaica, Mexico, Morocco, Nigeria, Peru, Philippines, Uruguay, Venezuela, Yugoslavia
Sources: OECD, Economic Survey - New Zealand 1988/89 (Paris: OECD, 1989); World Bank, World Debt Tables 1987/88 (Washington: World Bank, 1988).

Nevertheless, despite this strong resemblance to the typical supplicant to multilateral lending agencies, New Zealand possesses a developed economy in so far as massive structural unemployment and/or concentrated patterns of landownership do not impede productivity enhancing investment. The most extreme critics of orthodox programs argue that in the periphery these impediments to investment prevent market signals from calling forth investment and an expansion of supply. These critics therefore posit severe constraints on a supply side response to orthodox programs, arguing that orthodox stabilization has perverse consequences. These kinds of impediments to greater investment, and therefore greater output, should not be very powerful in New Zealand. Thus a sustained orthodox demand side stabilization program (including market led supply side responses) should rectify macroeconomic imbalance in New Zealand. Typically orthodox stabilization programs try to solve short run imbalances between aggregate demand and supply by combining demand reducing and supply enhancing measures. Demand is reduced by lowering the fiscal deficit, decreasing the rate of growth of the money supply, currency devaluation, and de-subsidization of economic activity. Supply is enhanced by price reform and decontrol, which should permit more efficient market allocation of investment and other resources. Adjustment, the long term process of accommodation to the new, post-stabilization level of aggregate supply and demand, relies more on supply side measures. For defenders, successful demand reduction primarily requires administrative capacity and state strength. In contrast, they see supply expansion as a market driven phenomenon.

Conditions in New Zealand are highly conducive to attaining macro-economic balance through a standard orthodox program, because supply side constraints are weak and the administrative capacity to constrict demand through tight money and fiscal policy exists. The effort to attain economic stabilization in New Zealand is thus close to being a "crucial case" for some critics' and many defenders' arguments about the probable outcomes of stabilization policies -- it would be very surprising if stabilization did not occur. New Zealand's stabilization efforts should demonstrate the best possible potential outcome for orthodox stabilization. If orthodox stabilization efforts are only mildly successful (or pari passu unsuccessful) in New Zealand, then we can only expect worse outcomes elsewhere, where supply side constraints loom larger and administrative capacity is weaker.

The argument below first delineates the economic and political debates over orthodox stabilization programs, focussing primarily on defenders' arguments. (Because International Monetary Fund (IMF) programs are the focus of this debate, we will take its programs as typical of the orthodox approach; however, the IMF did not have any role in designing New Zealand's program.) Second, it shows why the origins of economic crisis in New Zealand make it an appropriate test of most defender and some critical propositions. Third it sketches out the stabilization program implemented by the Labour government. Finally, it assesses defenders' and critics' premises and prescriptions in light of New Zealand's experience. To telegraph the conclusion, New Zealand achieved only a precarious stabilization after six years of reasonably sustained policy, and the process of stabilization revealed an unsuspected contradiction between orthodox prescriptions for increased financial liberalization and disinflation -- the core of orthodox policies.

Beneath the Debates: contrary premises

Because critics and defenders of orthodoxy start from different basic premises, they disagree profoundly about the fundamental nature of capitalism in the periphery. Their differing initial assumptions in turn lead them to contrary conclusions about the probable consequences of orthodox stabilization programs. Most discussions about differences between defenders and critics see those differences as a function of defenders' focus on issues of demand and monetary control, and critics' focus on supply side issues. But over the years supposed "monetarists" have added more and more supply side elements to their programs, while "structuralists" have acknowledged more and more the need for reducing demand to sustainable levels. This demand vs. supply side contrast obscures a more fundamental division. Orthodox defenders believe that all capitalist economies behave similarly. Consequently, orthodox policies should have the same results in developing economies as they do in developed. Persistent payments imbalances and inflation in developing economies thus reflect failures of political will. In contrast, structuralist critics see peripheral economies as fundamentally different from core economies. Social impediments to investment and supply bottlenecks create persistent tendencies towards unbalanced payments and inflation in peripheral capitalism. The usual orthodox package thus aggravates rather than ameliorates existing imbalances and inflation in the periphery, making growth impossible.

Are there "intermediate" positions in this debate? The steady incorporation of supply side arguments and policies into neo-orthodoxy and demand side arguments and policies into neo- structuralism seems to suggest a convergence along some continuum stretching between extremes composed of orthodox-demand siders and heterodox-supply siders. In this view, the Killick "real economy" approach, with its effort to reconcile stabilization and growth objectives, would constitute some golden mean balancing supply and demand concerns. This may be true at a policy level, but is not true for the underlying premises. The basic premises of 'critical defenders' and 'defensive critics' do not differ greatly from those held by the extremes in this debate. It is those basic premises that have produced the seeming opposition of demand and supply side concerns. Let us look at defenders' and critics' premises to see why.

Defenders

Defenders of orthodoxy believe that only one "economics" exists. They do not believe developing economies have any structural features predisposing them to macro-economic disequilibrium. Rather, as in any developed economy, any persistent, unsustainable imbalance of payments reflects a macro- economic disequilibrium between aggregate demand and domestic supply. Excess aggregate demand results from excessive central bank credit and money creation, including government borrowing overseas to cover current account deficits. Simultaneously domestic supply shortfalls result from government price subsidies, maintenance of artificial exchange rates, and the general inefficiencies associated with public, as opposed to private, enterprises. All these measures allocate resources inefficiently, reducing supply and exacerbating demand driven macro-economic disequilibrium. Uncontrolled aggregate demand and inefficient resource allocation cause rising inflation and in turn rising overseas debt as the trade imbalance grows. Unlike critics, then, defenders cannot a priori reject New Zealand as a test case because of its economic structure; all economies fall under the purview of this argument.

For defenders, the solution to these compounding disequilibria is to constrict aggregate demand, bringing supply and demand back into balance. Institutionally this usually takes place through conditional lending by the IMF. This, however, does not mean that the IMF or orthodoxy's defenders abjure supply side measures in favor of purely monetarist policy. The IMF recognizes that a new equilibrium could emerge from increased supply, too. But because, as two IMF staffers said, "many types of supply-side measures improve output only after a significant delay," and because the IMF is institutionally concerned with alleviating short-run payments imbalances, the IMF is to an extent disinterested in supply side measures. Nevertheless, as the IMF and defenders are careful to point out, in recent years all programs have had a significant 'supply side' component. However, as defenders of orthodoxy and the IMF both believe a priori in the relative inefficiency of government economic intervention to increase supply, both prefer to encourage supply side expansion by eliminating demand side distortions like price controls, not by active intervention in markets.

Thus defenders do not see controlling demand as an economically problematic enterprise. Typically they recommend decelerating or constricting monetary growth to slow inflation or produce deflation; devaluing to encourage redeployment of economic resources into tradable goods so as to balance international payments; and freeing the market from government and political interference to promote long run growth through efficient resources allocation. A crucial component of demand control is the reduction of the fiscal deficit. Though responses to this typical program might vary in degree there should be no qualitative differences in response among the various economies in the world. For defenders, developing economies contain sufficient resources and productive capacity to service debt and provide for a modicum of growth over the long term once inflation, resource misallocation, and inherently inefficient public enterprises are removed. Institutionally, the IMF provides short term loans to resolve immediate payments problems and, more importantly, to attract foreign private lending to LDCs adhering to these conditions.

Critics

Unlike this orthodox "monoeconomics," critics argue that the structural differences between peripheral and core economies constitute a qualitative difference, not simply quantitative differences in the number of machines employed, etc. The structural critique has two distinct lines of argument. The stronger version, which stands in stark opposition to the orthodox view, makes a supply side argument, while the weaker version, which is akin to the modified orthodoxy that has motivated programs like the IMF's Compensatory Fund, Extended Fund and Structural Adjustment Facilities (discussed below), makes a demand side argument.

The strongest and most elaborate structural argument posits that the nature of social relations in the periphery creates severe supply side constraints, and that these in turn make the "peripheral capitalist mode of production" qualitatively different from the core's "capitalist mode of production." In core capitalism, wage pressures and competition lead naturally to innovation, investment and increased productivity. But in the periphery a vast oversupply of labor causes low wage levels. In turn, these inhibit the investment in the labor saving devices essential to capitalist development. Social factors related to labor oversupply reinforce this pattern. In the core, wage regulation by workers is possible through unionization and the scale and scope of corporate organization. Rising wages in the core lead to higher prices for core goods as firms engage in mark-up pricing. Consequently, as both Samir Amin and Raul Prebisch argue, terms of trade for both peripheral agriculture and industry ineluctably deteriorate as core productivity outstrips peripheral productivity. For structuralists this tendency towards declining terms of trade is worsened by the juxtaposition of export oriented commercial mono-agriculture and subsistence agriculture, which creates supply rigidities. Juxtaposition immobilizes agricultural resources and thus reinforces barriers to investment. This creates inflationary pressures whenever domestic or foreign demand rises, because land cannot be shifted from one use to another without significant social disruption. Structuralists thus foresee steadily worsening balance of payments situations for the periphery. Note that the structuralists' premises lead them to view supply side constraints differently from defenders. For structuralists supply side constraints emerge from social conditions; for defenders from political intervention in markets. This structuralist model has no relevance for New Zealand, as the conditions limiting supply are not present.

The weaker, demand side structural critique, however, is relevant. This critique argues that the structure of demand in either the global economy as a whole or individual peripheral economies makes peripheral economies structurally different from core economies. The former, global demand argument derives from traditional arguments about prisoners' dilemma and is best seen in a denatured version of Prebisch. Peripheral countries at best had competitive agricultures and uncompetitive industrial sectors. In the latter argument, the wage induced terms of trade problem Prebisch notes is aggravated by the differing demand elasticities for manufactured and agricultural goods. Weaker demand for "engels' goods" meant peripheral agricultural exporters faced ineluctably declining terms of trade. In turn, falling terms of trade created either a payments deficit, as agricultural exports failed to cover "socially necessary" manufactured imports, or declining growth and living standards as imports contracted. This argument rested on the nature of total global demand -- it was insufficient to induce greater peripheral exports. Just so any expansion of agricultural exports in the face of stagnant demand would lead to declining prices as markets glutted.

The latter, domestic demand argument derives from a long tradition of writing on late development stretching from List through Gerschenkron to Senghaas, and is best exemplified in Albert Hirschman's work on ISI and the structure of peripheral income distribution and demand. Hirschman argued that the relatively small size of peripheral economies meant weaker demand for industrial goods, thus making forward and backward linkages from agriculture to industry difficult. State efforts to overcome bottlenecks in manufacturing and create the linkages necessary for future development were thus justified, even though they naturally resulted in inflation and (temporary) international payments imbalances. As doing nothing led to stagnation and suboptimal use of resources in the absence of backlinking, credit driven inflation and payments disequilibria were a reasonable price to pay for more development. Contemporary (friendly) critics like Killick typically agree with Hirschman's prescriptions.

Given their assumptions about the nature of peripheral economies, the supply side and both demand side critiques naturally predict perverse effects from implementing orthodox programs via the standard IMF package. All three see social impediments to supply side responses which cannot be ameliorated by solely demand based or indeed solely economic remedies. Devaluation, for example, causes increased exports and decreased imports, and thus helps balance payments, only if productive capacity can be increased in the tradables sector. But with no incentive for productivity enhancing investment (and indeed, in the case of most primary products, easily saturated overseas markets) exports respond only sluggishly to the higher relative prices devaluation brings. Internally devaluation multiplies the difficulties domestic industrialists face. First, by raising the cost of imported capital goods, it makes labor replacing investment even more irrational. Second, making post-devaluation exchange rates credible through tight monetary policy increases credit costs and forces enterprises out of business, shrinking rather than enhancing absolute domestic capacity. Slashing the state's budget is also partly self-defeating, for it is unlikely that private sources will invest to create backward linkages. Today's tight money only creates future bottlenecks and more cost-push inflation. Both sorts of structuralist thus claim orthodox policies are unlikely to work in the periphery until certain structural conditions -- labor surplus or over-reliance on agricultural exports -- are remedied.

Different premises, different answers

The discussion above shows why the debate between defenders and critics, at least at the theoretical level, is not simply a debate about the appropriate proportion of supply and demand side mechanisms in adjustment policy. Instead, it is about different types of demand and supply side policies. Defenders' and critics' different premises lead them to locate the specific demand and supply side problems in different places. Consider inflation, which most econometric studies of developing economies show comes from domestic sources. Structuralists (with differing emphases) claim this inflation originates from the bifurcation of agriculture into subsistence and commercial/export segments, or from industry's reliance on imported capital and intermediate goods. Let us consider the former argument. Any expansion of external demand for commercial agricultural goods creates extra wages in that sector. In turn this creates extra demand for food products from traditional, or subsistence agriculture. Low productivity there, and the difficulty in shifting land from commercial cum export use to subsistence use (especially when export demand is rising) mean that food prices rise, leading to inflation. Since export agriculture is monocultural and sometimes inedible (e.g. rubber, coffee) it cannot provide any increment to food supplies. If demand for food results in extra imports, this will of course ameliorate inflation, but reduce any balance of payments gain from extra exports. A reduction in external demand for commercial agricultural exports also raises inflation in structuralists' view! Workers expelled from commercial agriculture as production declines compete for the limited supply of subsistence land, causing rents to rise. As demand for primary products is highly volatile, it is not particularly surprising to structuralists that inflation is a permanent feature in underdeveloped economies.

In contrast, defenders argue that inflation has no domestic economic roots, and is caused only by monetization of the fiscal deficit or (the fiscal deficit's flip side) by excessive credit creation for the private sector. They can argue this because they assume, in sharp contrast to structuralists, that surplus capacity exists in non-tradables (which includes what structuralists call subsistence agriculture, and what defenders call "domestic use agriculture"). If such surplus capacity did not exist, then devaluation could not be a viable anti-inflationary and export promotion strategy. Such a strategy is premised on the ability to shift domestic demand from tradables to a non-tradable sector in which, because of inflation driven exchange rate overvaluation, capacity utilization is low. In that situation, increased external demand for tradables subsequent to a devaluation would lead to increased investment in the tradables sector and thus growth. Meanwhile increased domestic demand for non-tradables would be absorbed in a non-inflationary way by existing surplus capacity in that sector.

This consideration of the origins of inflation shows why the differences between critics and defenders are not simply differing emphases on supply and demand side policies and problems. Instead, their different initial premises lead them to see different supply side constraints, which in turn give rise to different policy recommendations, and finally structure different interpretations of data about outcomes. The gap between the premises held by "critical defenders" and "defensive critics" is thus larger than those between them and their respective "orthodoxies." And, most important for our purposes, the inability to distinguish between implementation failure and program failure means those premises can never be assessed.

A preliminary practical assessment

Despite this theoretical tension, both sides have made significant policy retreats when faced with the complexity of the real world and the outcomes of policy experiments. The greatest weakness to the critics' position is their inability to come up with practicable alternatives to the typical deflationary package. Making some bows in the direction of being "patient monetarists," virtually all structuralists agree that real wages cannot be sustained at the unrealistic levels often preceding the internal or external crisis leading to imposition of austerity regimes -- the excesses of Diaz-Alejandro's "populist euphoria" inevitably must give way to "economic retrenchment." Most structuralists also concede that there is such a thing as too much inflation, even if they simultaneously argue that the IMF's orthodox programs involve "overkill" in their efforts to extirpate it. Finally, as defenders point out, maintaining a given level of investment will not produce the growth structuralists desire if such investment goes into unremunerative or unproductive areas.

Meanwhile, despite steadfast adherence to orthodox, monetarist premises, the IMF steadily created new facilities addressing the demand based critique. In this movement the IMF actually has anticipated some of the criticisms and suggestions Killick made. The Compensatory Fund Facility, created in 1963, helps offset large shifts in the terms of trade of primary product producers; however it understands these shifts as a short-run volatility inhering to the prices of primary products. The Extended Fund Facility (EFF) and Oil Fund Facility extended this principle to cope with the 1970s oil shocks. The EFF, which lends on a medium term (three year) basis, also represented a concession to the argument that production bottlenecks can slow economic adjustment, and thus that in the short run orthodox policies might have negative consequences for output and employment if pursued too vigorously. Additionally, the presence of inflationary expectations required a sustained stabilization program to have any effect. Institutionally, the EFF represented a loosening of conditionality so as to give developing economies more time for lasting structural adjustment. The Structural Adjustment Fund (SAF) and the Extended Structural Adjustment Fund (ESAF) provided concessional variations on the EFF in 1986 and 1987 respectively. But beneath these programmatic concessions, the IMF retained its fundamental belief that a quantitative difference in response time between LDCs and developed countries does not correspond to any qualitative difference that might require a different strategy. The EFF and SAFs simply provide more time to bring economies back into line using the same old policy tools of demand compression, economic liberalization, and deflation. IMF programs thus remained firmly orthodox, despite inclusion of more supply side components.

Critics and Defenders: Politics

This essay will not look at the debate about the political outcomes of stabilization, although it will make some comments on this subject in the conclusion. Because we are using New Zealand as a test of defenders' arguments, the relevant question is not whether stabilization produces authoritarian outcomes (as some critics have argued), but rather what are the political preconditions for successful stabilization. Unsurprisingly, given their belief in a capitalist monoeconomics, defenders see policy as the independent variable, economic outcomes as dependent. Proper policy produces proper outcome. Stabilization therefore requires proper program implementation rather than any particular form of government. Recent research by self-conscious critics of the IMF, like Stephan Haggard's analysis of the political determinants of success for the IMF's EFF, and Karen Remmer's study of stabilization in Latin America, seem to support the defenders' view that state capacity and autonomy are the crucial variables, not state form per se. Haggard, for example, rejects any simplistic notion that authoritarian governments are any more capable than democratic (or patrimonial) ones: "Authoritarian or one-man rule does not necessarily facilitate adjustment, particularly where resource constraints are severe." Instead, he argues, political will, the availability of resources, and the ability to mobilize political support behind adjustment projects bear heavily on the chances for success or failure, especially since stabilization has such high political costs. The various case studies reported in Nelson, Fragile Coalitions, and Nelson, Economic Crisis and Policy Choice also suggest that the management of political demands during either heterodox or orthodox stabilization requires the insulation of government from social forces. Haggard suggests three things are critical for success: the availability of non-conditional resources to buy off political opposition, an ideological orientation of political and bureaucratic elites in favor of stabilization, and the administrative strength to carry out reform. From our point of view then, the proper questions are whether or not New Zealand's "stabilizing coalition" was able to sustain its program long enough to bring the economy around, whether sufficient administrative capacity existed to implement a program in technically correct ways, and whether policy makers were insulated enough from popular pressures to sustain rational -- in terms of the stabilization effort -- policy. As we will see, all conditions were met. Therefore let us look at the degree to which New Zealand ought to make an ideal test of the typical stabilization program.

New Zealand as a crucial case

New Zealand should provide a crucial case for defenders' argument; economically and politically it represents the most favorable kind of circumstances for a stabilization effort of the sort that takes place in LDCs. Like most semi- industrialized developing countries, New Zealand has a structural tendency towards an imbalance of payments because its highly competitive agricultural export sector is paired with a small, sheltered, and inefficient manufacturing sector. By 1984 New Zealand's situation had led to high levels of foreign debt, a high fiscal deficit, high inflation, an inefficient state sector, and political crisis. But, because the mechanisms of capitalist competition should generate productivity increasing investment in New Zealand, an orthodox program biased towards demand limitation ought to result in stabilization and adjustment. Neither critics nor defenders would be surprised by successful stabilization.

New Zealand resembles many middle income developing countries. Its economy, roughly the same size as Israel's, largely revolves around the highly efficient transformation of grass into wool, meat and dairy goods. Agricultural activities comprised roughly 9-10 percent of GDP in the early 1980s, two to three times larger than in most developed economies. Manufacturing is heavily oriented towards food and wood processing -- food processing accounted for 27 percent of manufacturing activity, above the OECD average, while in contrast machinery and equipment production, at 25 percent, was below average. The manufactured products most competitive in world markets are all closely linked to the agricultural sector -- dairy production and processing equipment, sawmill equipment, animal control systems, and carpets. The relatively small size of the economy prevented the emergence of any industries in which economies of scale are critical. Thus a car assembly industry (from knock down kits) emerged only by virtue of tariffs and quantitative import restrictions.

The weakness of the manufacturing sector means slow growth and a low standard of living in nominal terms. Up to 1975 the growth rate of per capita GDP was well below EEC and OECD averages, and 1975 to 1984 per capita real growth was flat. Wage levels approximate Spain's, with per capita GDP in 1987 around US$ 7,850. But geography (a pleasant climate and plenty of space), the social organization of production around small factories and family farms, and a welfare state which insures that income disparities stay at developed country levels and that health and education are evenly distributed all contribute to a subjectively high standard of living. But Singaporean per capita GNP surpassed New Zealand's in 1987, and with a faster rate of growth. Why?

Like many developing countries, New Zealand's agriculture is both efficient and competitive in world markets, but its manufacturing sector is largely inefficient and uncompetitive. The three largest exports (at a three digit SITC level) accounted for almost 40 percent of total exports in 1981, higher than for any other developed country. All together, various forms of meat, milk, wool and wood usually account for two-thirds to three-quarters of exports. This reliance on primary product exports creates the kind of economic stagnation and tendency towards unbalanced payments that the weak version of Prebisch described. 1965-1982 terms of trade for New Zealand's three largest exports, meat, dairy and wool products, fell 30 percent (albeit with large fluctuations in both directions). Politically, New Zealand's customers all pursued economically irrational agricultural promotion programs, limiting New Zealand's market access. But even without these, agricultural specialization meant that New Zealand's exports grew more slowly than world GNP. Studies suggested that a 1 percent increase in world GNP only called forth a 0.6 percent rise in New Zealand exports. At the same time, a 1 percent increase in New Zealand's GDP created a 1.2 percent increase in its imports. Finally low demand elasticity for agricultural exports meant that expanded export volumes only caused long run price declines, particularly as New Zealand's major exports usually account for a large proportion of the world's traded production in specific commodities. New Zealand thus has a structural tendency towards an imbalance of payments.

As in much of Latin America, the state tried to compensate for this structural imbalance by promoting import substitution industrialization (ISI) as well as more manufactured and agricultural exports. Both National Party and the less frequent Labour Party governments subsidized rural investment and manufactured exports, while sheltering the domestic market with quantitative import controls. These gave the manufacturing sector effective rates of protection of about 60-70 percent. To finance the imported capital goods needed to create this industrial sector, New Zealand needed to export more agricultural products or to borrow overseas. But as in Latin America, the structural payments imbalance constrained ISI. Efforts to boost manufactured exports while retaining protection created inefficient and fiscally costly industries. Manufactures did rise from 6 percent of exports in 1975 to 22 percent in 1985 (a level Australia, another weak exporter of manufactures, already had attained in 1970). But subsidies provided over 18 percent of the value of those exports, straining the state's budget. Meanwhile small domestic markets inhibited upstream investments. In the 1980s the state, under a National Party administration, started an ambitious ISI program called "Think Big," investing roughly NZ$ 5 billion of borrowed money in heavy industry.

Export subsidies for manufacturing, the interest costs of Think Big, and the cost of compensating export agriculture for the costs imposed by protection swelled the fiscal deficit to 8.7 percent of GDP in fiscal year (FY) 1983/84. Partial monetization of this deficit fueled inflation, which averaged 15 percent per annum 1976-1982. In turn, increased domestic incomes resulting from government stimulation of the economy caused a disproportionate increase in imports. These combined with "Think Big" capital goods imports to swell the current account deficit to nearly 6 percent of GDP by 1984. Trying to control the fiscal and current account deficits, the National Party imposed wage, price and interest rate controls, and substituted a crawling peg devaluation of the New Zealand Dollar for a fixed exchange rate.

Unable to balance payments with increased exports, burdened by the cost of subsidizing agricultural and manufactured exports, and unwilling to attack consumption levels, the populist National Party administration also borrowed extensively overseas to make ends meet. This borrowing increased public overseas debt from 5.3 percent of GDP in 1975 to 24.2 percent in 1984, and total overseas debt to 45.8 percent of GDP. By comparison, Mexico's total foreign debt amounted to 34 percent of GDP, Brazil's 58 percent in their crisis year of 1982. (See Table 1 above, also).

By 1984, then, New Zealand resembled the typical Latin American suppliant to the IMF -- a protected, overcontrolled, inflationary economy, with large 'twin' fiscal and payments deficits, that was on the verge of falling into a self-sustaining overseas debt trap. In early 1984 Standard and Poor downgraded New Zealand's credit rating from AAA to the lower ranges of AA. Simultaneously, a highly critical internal IMF report, arguing that "further borrowing should be limited to economically viable investment, rather than to sustain[ing] the level of consumption," was leaked during the run-up to the July 1984 election. International capital markets pushed over the house of cards after Labour won the July 1984 election. Speculators, correctly assuming that the incoming Labour Government would substantially devalue the New Zealand Dollar, exhausted the Reserve (i.e. Central) Bank's supply of foreign exchange by swapping New Zealand Dollars for hard currency at the pre- election fixed rate. International credit markets rebuffed the Reserve Bank when it turned there for emergency loans. New Zealand thus experienced the typical crisis cycle of the third world, albeit in a milder form: political responses to worsening terms of trade create a combined fiscal and trade deficit, growing foreign debt, and inflation; these problems accelerate; foreign creditors pull the plug. (Tables 2, 3, and 4 provide data on these trends.)

TABLE TWO: NEW ZEALAND GOVERNMENT FINANCIAL POSITION AS % OF GDP

fiscal year ending 31/3

 

 

 

 

 

 

1983

1984

1985

1986

1987

1988

Revenue

33.8

32.5

35.3

37.9

39.3

45.0

Expenditure

34.5

35.0

35.1

33.5

35.1

38.6

Current Balance

-0.7

-2.5

0.2

4.4

4.2

6.4

Less Interest

5.0

6.5

6.5

7.4

7.7

8.3

Deficit

-5.7

-9.0

-6.3

-3.0

-3.5

-1.9

Source: OECD, Economic Survey New Zealand 1988/89)

TABLE THREE: BALANCE OF PAYMENTS NZ$ millions

calendar year

1984

1985

1986

1987

1988

1989

Exports

9.4

11.3

11.2

12.2

13.4

14.8

Imports

10.3

11.2

10.8

11.3

10.4

14.7

Trade balance

-0.9

0.1

0.4

0.9

3.1

0.1

Invisibles, net

-2.7

-3.2

-3.5

-4.1

-4.6

na

of which

net interest

-1.9

-2.6

-2.9

-3.5

-3.7

na

Current balance

-3.9

-2.9

-2.8

-2.9

-1.2

na

(Source: OECD, Economic Survey New Zealand 1988/89)

TABLE FOUR: FOREIGN DEBT LEVELS, % of GDP

year ending 31/3

1983

1984

1985

1986

1987

1988

Total foreign debt

47.3

47.7

63.7

58.9

68.4

56.4

of which:

Public

36.6

35.4

47.9

47.9

55.0

43.0

Private

9.9

11.3

14.1

11.7

13.4

13.4

Official Reserves

3.5

3.2

4.9

6.0

14.2

9.0

Net Debt

43.8

44.5

58.8

52.0

54.2

47.4

Source: OECD, Economic Survey New Zealand 1988/89

Labour and New Zealand's "Economic Stabilization"

International banks' refusal to extend credit during the July 1984 crisis solidified the desires of the state financial bureaucracy and the incoming Labour Cabinet to reorganize the entire economy around an orthodox deflationary, monetarist stabilization program. Table 5 compares the policy content of typical, orthodox programs administered by the IMF with policy in post-1984 New Zealand. Program content overlaps enough to claims that New Zealand's program is a fair test of the orthodox program.

FIGURE ONE is unavailable at this time

Consonant with orthodoxy's market oriented attitude, the Labour administration introduced market regulation to virtually all areas of economic life. The wage, price and interest controls imposed by the prior administration were all removed over Labour's the first year. Domestic and international financial transactions were completely deregulated, excepting only prudential regulation. Virtually all subsidies for agriculture and manufacturing have been phased out. Government supplied services and goods are now sold at market prices. The only place where Labour failed to introduce a full market regime was in the labour market. Despite some moves towards decentralization and enterprise bargaining, the old system of juridicized collective bargaining at the industry level, with wages and conditions officially set by the Arbitration Court, more or less continued intact. Rapidly increasing unemployment moderated union wage demands, though, and, consistent with orthodox policy, the wage share of GDP fell steadily over the next four years.

In the area defenders of orthodoxy have come to regard as most important, New Zealand substantially reduced its fiscal deficit, mostly by increasing taxation faster than either interest payments or social spending. (See Table 2). Taxation rose three ways. First, an essentially unavoidable 10 percent Goods and Services Tax (i.e. VAT), raised to 12.5 percent July 1989, was instituted in October 1986. Second, this was made politically palatable by the lowering of marginal rates on personal income tax. As in the United States, elimination of most loop-holes partially offset the drop in marginal rates. Third, this kind of overt 'revenue enhancement' was combined with covert 'tax' collection by the transformation of public firms into profit making corporations (explained below). All told these three efforts expanded revenue from 32.3 percent of GDP to 41.4 percent from FY 1984/85 to FY 1987/88. On the expenditure side, Treasury recommended and Labour executed a steady removal of production subsidies. Savings here, though, were offset by the expansion of welfare spending, particularly for unemployment benefits. Overall, the fiscal deficit has come down from 9 percent of GDP to rough balance, and while current data indicate a shift back into deficit, it is at sustainable levels.

These market led, deregulatory policies are best seen in the public sector itself. In 1984, State Owned Enterprises (SOEs) accounted for over 20 percent of investment in New Zealand and employed over 60,000 people, but generated only 12 percent of GDP and, despite their monopoly position, access to low cost debt, and favorable tax situation, consistently lost money. Treasury and the Cabinet reconstructed the SOEs and government departments along corporate lines, using private sector management techniques. Resources (i.e. tax and trading revenues) were allocated via the market, SOEs and departments attempted to recover the full cost of their services from consumers and other government agencies, subsidies were made visible and justified in terms of explicit social policies, and management set performance goals for itself and lower levels of management using private sector notions of profit. If Departments and SOEs could not compete with privately provided goods and services they would be disbanded; if they could, then the revenues and taxes they generated would be returned to the state for debt service and reallocation on a rate of return basis among the SOEs. Market based reforms reversed the public sector's situation; output rose December 1984 to December 1988, despite 18,000 redundancies. SOE dividend, tax, and interest payments to the state equaled 2.0 percent of GDP in FY 1987/88, providing nearly 6 percent of total state revenues. This SOE contribution was the fastest growing part of revenues, and privatization of SOEs enabled retirement of NZ$ 767 million and NZ$ 656 million of overseas public debt in FY 1987/88 and FY 1988/89. New Zealand has privatized proportionally more of its public sector than has Thatcher's Britain; most recent has ben the sale of New Zealand Telecom, the domestic phone service.

Monetary policy also imitated the usual orthodox program in substance and intent. Like defenders, Treasury argued that devaluation and a clean float coupled with steady elimination of trade protection would shift productive activity into tradable goods. The New Zealand Dollar was floated March 1985. Treasury also recommended an extremely tight monetary policy to be achieved largely by eliminating overseas public borrowing. Labour raised the domestic share of newly issued public debt from 37.6 percent in FY 1984/85 to 100 percent in FY 1986/87. This dramatic increase in the government's demand for domestic funds drove domestic interest rates to a peak in mid-1987, when the Reserve Bank's discount rate reached 27 percent. Tight money and increased taxation slowed inflation from 16 percent in FY 1985/86 to an annualized rate of 4.4 percent in the middle business quarters of 1989 by constricting domestic purchasing power. Since then inflation has revived and is now running at about 6 percent.

Labour also tried to close the balance of payments gap. As with all developing debtors, the key goal is to maximize the merchandise surplus (technically: non-interest current account) to generate currency for debt service. By FY 1988/89 the current account deficit had receded to roughly 2 percent from its 6 percent peak in FY1984/85. At that point, the imbalance of payments reflected a current invisibles deficit of NZ$ 4.2 billion -- mostly debt service -- offsetting a large merchandise surplus of about NZ$ 3.1 billion. But this success reflected not an increase in exports caused by devaluation and deregulation, etc., so much as it did the coincidence of a significant recession induced reduction in import demand with a temporary recovery in the terms of trade. While exports rose slightly in real terms under Labour (reflecting a rise from NZ$ 9.3 billion in 1984 to NZ$ 13.4 billion in 1988 in current terms), imports fell in real terms (reflecting a small current dollar rise from NZ$ 10.3 billion to NZ$ 10.4 billion). During this period the increasing strength of the New Zealand dollar made imports relatively cheap, reflected in the displacement of some domestic manufacturers by imports (particularly in car assembly). The absence of import growth signaled strongly that the positive trade balance in 1988 and early 1989 was a function of depressed incomes and not an export success. Though manufactured exports grew slightly, especially during FY 1987/88, most of the increase in export revenues was a function of the commodities boom in wool and meat, which caused export volumes and more importantly prices to rise for these goods. Following a 10 percent rise from 1988 to 1989 alone, New Zealand's terms of trade were at their highest level since 1975. (However, they were still below the average levels of the 1950s and 1960s, reflecting a consistent downward secular trend). In other words, growth in export value was largely due to external circumstance -- the high level of demand for raw materials that typically exists towards the end of the industrial countries' economic cycle. When domestic demand recovered and world demand softened at the end of 1989, imports quickly caught up with exports, erasing 1988's large merchandise surplus -- indeed, New Zealand actually ran a merchandise trade deficit through the last two quarters of 1989. Over those quarters, on a seasonally adjusted basis, imports nearly doubled from an average of NZ$1.1 million per month to NZ$1.9 million in December 1989. Overall, imports in the last half of 1989 were 21 percent higher than in the first half, while exports, hurt by falling world market prices for New Zealand's major exports, stagnated.

What happened to reverse the apparent stabilization achieved from 1985 to 1988? Obviously the answer has two parts, one explaining the relative failure on the supply side to expand exports and one explaining the sudden surge in demand. Let us start with supply.

Beyond stabilization, Labour's policy did aim at structural adjustment in order to facilitate an expansion of supply. Much as defenders expect, deregulation and tight monetary policy did cause a shift of resources, primarily labor, out of inefficient enterprises and increases in productivity. Tight money, an end to subsidies, and the removal of protection cleared out inefficient manufacturing enterprises, particularly in textiles and garments. Roughly 12 percent of manufacturing jobs disappeared between February 1986 and February 1988. This reflects an 8.4 percent decrease in the absolute volume of production from 1985 to the end of 1988, and substantial increases in productivity, up 9.3 percent alone in 1988. But manufacturing fixed investment in current terms during FY 1987/88 was actually slightly lower than in FY 1984/85, as were imports of capital goods. While both recovered somewhat in 1988/89, they are still well below real 1984/85 levels. Historically New Zealand's 'welfare system' operated by providing jobs for everyone through overmanning; clearly what has happened is the elimination of feather-bedding. Overall unemployment doubled under Labour, stabilizing at 7.5 percent by mid-1989 (historically very high by New Zealand standards). The average period of unemployment has tripled, and most new job creation is part time work. But there has not been any substantial expansion of manufacturing output despite increased productivity per employee.

A similar process occurred in agriculture. Far fewer producers "exited," although they did cut employment by 15 percent 1983/84 to 1987/88. Desubsidization, rising interest rates and the subsequent appreciation of the New Zealand Dollar led to plummeting real income and land values. Negative net worth encouraged farmers to hang on, for exit would have left them indebted and without income. Instead farmers responded by cutting back investment, particularly in fertilizer application, to half its historic levels. As New Zealand's exports largely depend on the transformation of grass into saleable commodities, this reduction in fertilizer use signals a potentially serious decline in future output and thus export capacity. So in both agriculture and industry tight money did clear out inefficient and/or highly indebted operations, but in neither did an increase in productivity translate into an increase in absolute production. Demand side policy reestablished a market based profitability, but this profitability did not motivate new investment and increased output.

Labour's market oriented supply side measures succeeded in increasing productivity, but not production. Firms, farms, SOEs, and government departments all shed unneeded labour - 93,000 jobs in all since December 1984 - but production did not expand much. The imbalance of payments in 1989 came mostly from the demand side, despite the demand and import constraining aspects of the stabilization program. Why? Disinflation combined with financial and trade deregulation to produce a wealth effect driven consumption boom. Disinflation increased the real income stream from various assets, increasing their capitalized value. Owners withdrew part of this increased capital value from the liberalized financial sector as credit, and then spent it on imported goods. Successful implementation thus had unexpected side effects that ran contrary to policy intentions.

To sum up, over a period of five years New Zealand's Labour government managed to reduce its twin deficits with a program virtually identical to classic orthodox programs. The fiscal deficit came back to the more normal levels of the 1960s, and, more importantly, in line with the general expansion of the economy. The current account deficit by 1989 reflected a substantial merchandise surplus offset by a net outflow of interest payments, and also was back to levels typical of the 1960s. Inflation also came back in line with the average OECD rate. Nevertheless in 1989/90 the wealth effect induced consumption completely undid the trade 'success' of the first five years, requiring renewed efforts at import suppression. It remains to be seen if these will be politically viable, as elections are due by October 1990. In the meantime, what were the political preconditions for policy implementation mid-1984 to late 1990?

The Politics of Stabilization

The politics of stabilization and adjustment support defenders' logic, and in particular Haggard's analysis of political preconditions for stabilization. Political and administrative cadres favoring stabilization held power, and they received substantial support from external financial markets and certain domestic social groups. Let us first examine the emergence of pro-stabilization cadres and their efforts to concentrate power.

As in Latin America, the sources of economic "distortion" had been as much political as economic. However economically irrational National Party policies were, they were politically popular, for "many of the market overruling measures...had the effect of both underwriting the return on capital while allowing...firm[s] to pay the centrally set wage rate." Treasury and Reserve Bank bureaucrats rebelled against state economic intervention after the National Party rejected Treasury analyses and approved the Think Big ISI projects for obviously political reasons. Bureaucrats assisted Labour in the 1984 election beyond accepted norms, and after the election they provided both a blueprint for stabilization and a coherent administrative cadre to enact it.

Inside the Labour Party, a close-knit group of ministers favoring an orthodox stabilization program emerged by 1984, centered around then Finance Minister Douglas. 1981-1984 Labour Party factions fought over the role of consensus and public participation in economic decision-making. The "more consensus and participation" faction lost this debate, foreclosing an Australian style social pact linking jobs to wage restraint. Instead, a tight bloc of six future ministers arguing for depoliticization of policy making dominated the party, and, with the help of the July 1984 crisis, the Cabinet. Those six, with intellectual backing from Treasury and the Reserve Bank, dominated the key cabinet portfolios up until the October 1990 election despite several intra-party struggles. This inner Labour cabinet systematically concentrated real power, insulating the state's economic policy apparatus from outside pressures. They restructured the Cabinet to give Treasury/Finance the predominant say in economic policy-making. A new Cabinet Policy Committee, charged with assuring the clarity and coherence of all policy, was given control, as one analyst gently put it, over the "overall resource limits for the major areas of the Government programme." The Finance Minister and his two deputies sit on the Cabinet Policy Committee, and one of them sits on every subordinate policy committee. The Finance Minister has a half say in the direction of all SOEs. Finally, in 1989, legislation turned the Reserve Bank into a miniature "bundesbank," with a formal legal obligation to secure inflation rates below two percent.

Power in the Labour Party, as distinct from the government, also has been concentrated. Prior to 1984 the Party was very responsive to bottom-up 'remits' sent to its annual policy conferences because the Party needed campaign workers to flood the eight or ten key swing electorates. After 1984 the Party ignored remits, which were almost uniformly against the inner cabinet's orthodox program, despite a fall in Party membership from 77,000 in 1984 to roughly 10,000 in 1988. The inner cabinet could afford to do this because they received NZ$ 3.7 million in campaign funds directly from the newly concentrated financial sector, allowing them to finance an American style, capital intensive, media oriented electoral campaign in 1987. Strict spending limits made individual parliamentary candidates dependent on the inner cabinet's "generic" advertising.

Finally the presence of external resources bought time for Labour and helped create a new social base for itself. FY 1984/85 through FY 1986/87 high interest rates attracted a net NZ$ 5.9 billion of short term capital - equivalent to roughly 3 percent of GDP per year - into New Zealand. This capital inflow had three social faces. First, it cheapened the real cost of debt service as the New Zealand Dollar appreciated. Second, it touched off a construction and stock market boom that obviated the immediate pain of the state's tax increases, and contributed to Labour's 1987 electoral victory. Finally, it facilitated a centralization of economic power that in turn created a new social base for the Labour Party. Labour's market deregulation enabled large financial empires to emerge (at least temporarily). Takeover artists, using euromarket funds, gobbled up firms stricken by the tight money policy. These new financial firms provided the Labour Party with both election cash and a series of willing CEOs to run newly corporatized SOEs.

In sum, political and administrative centralization, the nominal depoliticization of the state's economic policy making, and external resources all were essential to the success of Labour's stabilization effort. New Zealand's experience tends to confirm Haggard's study of political constraints on the success or failure of EFF loans during the early 1980s. All three of Haggard's keys were present in New Zealand, particularly during the first four years. Tight monetary policy attracted significant amounts of international speculative capital. This money facilitated the construction of a new base of support for the Labour Party that offset the losses caused by alienation of traditional Labour supporters. Treasury and the Reserve Bank provided the necessary administrative cadres to enact reforms, and had helped to construct a base for free market policy within the Labour Party prior to the 1984 election.

Conclusions

The defenders of orthodoxy have persistently and correctly argued that the only proper way to evaluate the relative success and effectiveness of programs is through counterfactual comparisons. Rather than comparing outcomes with some idealized situation, critics must show that some better policy path existed. Precisely this request has forced much of the movement by structuralist critics towards an acceptance of parts of the orthodox policy package -- because they have no reasonable alternatives. We will not present a counterfactual here, because we have sought to take defenders at their word, and assume that no better policy alternative exists. With the exception of the wealth effect-import boom, we have accepted defenders' argument that the major problem with program effectiveness is not program design but failure to actually implement programs. What New Zealand's experience shows is that even when a program is implemented and sustained for a significant time period, there are severe limits to what can be attained by the orthodox program even under the best possible circumstances. This implies that the IMF, given the limited resources it currently possesses relative to its institutional mission, would be unable to effect much change in crisis prone LDCs even if its orthodox programs actually were implemented. What this suggests is that it is time to move beyond an inherently irresoluble debate about stabilization (and the assignment of blame for its consequences) and look for broader solutions.

New Zealand's relatively successful effort at stabilization suggests that defenders correctly argue that political will and a largely demand based policy can bring about a degree of economic stabilization. While stabilization does have perverse economic effects, critics using a demand based analysis clearly suggest wrong reasons for why this is so. But New Zealand's experience also suggests three fundamental limits to orthodox and by extension IMF policies. First, there is a significant contradiction between deflationary policy and financial liberalization, heretofore unobserved in LDCs because inflation never really has been lowered to trivial levels, and because so much LDC wealth is held overseas. Second, there are serious limits to the emergence of long term structural adjustment or growth from a policy based on demand compression as a matter of deliberate policy but supply expansion through market stimuli; while productivity may increase as distortions are eliminated, this does not guarantee any expansion in production. Third, simply achieving stabilization requires a longer time horizon and more resources than the IMF currently permits. We will discuss each problem, starting with the simplest, and then contrast New Zealand's experience with similar events in developing countries.

The IMF argues that "a viable balance of payments...implies that the balance of payments problems will not merely be suppressed but eradicated, and...that the improvement in the country's external position will be durable." But despite administrative, financial, and economic circumstances more favorable than any developing country, New Zealand's balance of payments situation is barely 'durable' by this definition. Internally, payments balance clearly rested on an unstable suppression of import demand through an expansion of unemployment and a diminution of the wage share of GDP. Once the modest 1989 economic recovery stabilized unemployment, and as wealth effect consumption flowed through into more imports, the balance of trade situation deteriorated. Clearly a durable balance of trade will require another round of import suppression. Stabilization in New Zealand thus took longer and required more external financing than the IMF allows for. The IMF's stand-bys run for one year, and its EFF allots 3 years for structural adjustment (and even friendly critic Killick calls for five years). After five years New Zealand managed to get both the fiscal and payments imbalances back to sustainable, but unstable, levels which were then disrupted by "wealth effects." Barring an internally contradictory resort to direct credit controls or some other form of financial regulation, the combination of deregulation and disinflation means programs will have to be sustained over six to ten years. As Latin American experiences in the 1980s show, this is an extremely difficult task.

Though we have not discussed at length the external financing required during the stabilization period, foreign debt did rise significantly in absolute and relative terms despite Labour's efforts to minimize foreign borrowing (see Table 4). Even following the expansion of quotas in 1990, IMF has neither the resources nor the time horizon to support this. Were the IMF to attempt to support restructuring on a New Zealand scale for even a portion of the developing world it would soon exhaust its resources, particularly since most developing debtors lack New Zealand's creditworthiness.

Second, structural adjustment policies clearly have not caused any expansion of supply. Once the temporary improvement in terms of trade gave out, the absence of any supply side surge in export volumes became obvious. Rather than diversifying and expanding exports, New Zealand continued exporting traditional commodities at somewhat better prices than usual 1986-1988. In the medium run an expansion of traditional exports is unlikely because of investment cutbacks 1985 to 1988. No significant non- traditional exports have emerged. Here the only gain is that such exports are certain to be profitable at foreseeable exchange and interest rates.

New Zealand also suggests severe limits to any IMF sponsored "adjustment with growth" strategy based solely on internal changes. Real incomes in New Zealand, particularly for workers, were slightly lower in December 1987 than they were in March 1981; the mild recovery of late 1989 did not offset income declines in 1988. Furthermore, while real investment levels have recovered to the pre-Labour trend, they are sufficient only to assure modest levels of growth well below OECD average. The only bright spot -- which demand side critics should note -- is that this investment will generate a real return, unlike the disastrous pre-Labour "Think Big" ISI investment. New Zealand's economy has been stabilized at a somewhat higher level of productivity per employed person, but without any gross increase in production. Like most of the developing debtors, New Zealand's future economic expansion seems mortgaged to uncertain (and domestically mortgaged) growth elsewhere in the "core" of the world economy. The doubling of unemployment which followed the stabilization program's demand compression is unlikely to reverse itself.

New Zealand's experience suggests that to whatever extent any of the structural impediments critics posit exist in peripheral countries, economic stabilization will be compromised. And lacking New Zealand's considerable advantages in administrative strength and capacity, it is not surprising that stabilization in developing countries seems difficult even in the rare cases where it is politically sustainable. In New Zealand, most of the population is "on the books" as wage and salary earners, tax withholding is long established, and a bureaucracy existed to run the sizable VAT imposed in 1986. The situation is precisely opposite for most developing countries. In most, bureaucratic capacity for revenue extraction is not institutionalized, much of the economy goes unrecorded, and the wealthy evade taxes easily. The simplest method is merely to delay payment until inflation has rendered payment valueless. Furthermore, customs duties -- which fall during orthodox stabilization as imports are compressed -- provide roughly 30 percent of taxes in low income developing countries and 20 percent in middle income countries, compared with an average 4.1 percent in developed countries.

Briefly turning to one recent, relatively successful LDC example demonstrates this. The Collor de Mello administration in Brazil has attempted to implement an orthodox austerity program since early 1990. An initially total freeze on liquid assets -- a much more extreme measure than any taken in New Zealand -- managed to bring inflation down from 84 percent to "only" 14 percent per month. Even so, a substantial part of the frozen assets have "melted" and leaked back into circulation, threatening a revival of inflation. Similarly, efforts to shrink the public sector have run into resistance. At the time this was written, New Zealand's public railroads so far had dismissed more public employees than the entire Collor de Mello administration. And Brazil, despite a more varied export mix, has experienced even more volatile terms of trade than New Zealand, including, for example, a 45 percent decline 1977 to 1985. Despite all this, so far Collor de Mello has done much better than, for example, Argentina's Menem.

On the whole then, New Zealand's experience suggests that the typical orthodox stabilization policy cannot be expected to deliver much in the way of real world stabilization. In a situation in which all the political and most of the economic preconditions for successful stabilization were present, in which virtually all that defenders of orthodoxy could have asked for in terms of demand and supply side measures was undertaken, and in which international credit markets continued voluntary lending, the outcome has been a highly unstable equilibrium. This equilibrium, which took over five years to achieve, depended on increased external debt to finance continued, if shrinking current account deficits. While those deficits might have been sustainable given a stable external environment, the permanence of commodity shocks and the business cycle suggests that in the long run external debt will again become unbearable. Finally, 'successful' disinflation turned out to have unforeseen and detrimental consequences that make disinflation a dangerous tool for stabilization of current account deficits.

Elsewhere, the relative weakness of developing country states, greater potential for wealth effect-induced consumption and import sprees (given higher inflation rates and inflationary expectations), and the likelihood of structural impediments to investment and productivity increases, mean that outcomes as 'good' as New Zealand's will be hard to attain. This relative weakness in defenders' case for the efficacy of traditional stabilization and adjustment programs suggests what has been obvious for a long time. Long term payments equilibria for not only the indebted developing countries, but also some of their highly indebted but developed cousins like New Zealand, Australia, and Ireland, depends just as much on economic restructuring, trade liberalization, and debt write downs among the creditor countries as it does on debtors' restructuring, tax hikes, and political reforms. This is particularly obvious with regard to agricultural trade. The OECD estimates that agricultural protection (and consequent overproduction) costs Australia, New Zealand, the United States, the European Community and Japan roughly $72 billion per year. Somewhat symmetrically, the Australian Center for International Economics estimates that developing countries, Australia, New Zealand, and the United States -- all of which have substantial current account deficits -- stand to gain $76 billion annually from liberalization of agricultural trade. Of this, developing countries would accrue $26 billion, roughly equal to a fifth of their current interest payments, and a bigger help towards achieving a sustainable balance of payments than virtually anything the IMF could do itself or induce through conditionality. Once this kind of 'structural adjustment' is made, the IMF can return to the limited, and perhaps more easily achieved mission envisioned by Harry White - temporary balance of payments finance. Return to home page


last modified 9/10/98