A comparative analysis of the 1984 economic reforms in New Zealand

Abstract

Beginning in the mid-1980s New Zealand underwent a comprehensive set of economic reforms, which were remarkable for their breadth and sequencing. However, particularly between the years 1984-90, the short-term adjustment costs of the policy changes in terms of the decrease in output and employment levels was higher than anticipated. Furthermore, there was also a delay in the macroeconomic improvement. In other words, the economic reform process in New Zealand appeared to induce a long economic recession. The economic reforms were commenced in 1984 but economic growth did not recover from the initial shocks until 1993.

This research proposes to answer the question "what would have been the outcomes of the economic reforms, if the policy changes had been applied in a different sequence and if the timing of the policy changes had been different?" For this purpose, a three-sector econometric model was estimated to find the determinants of the real exchange rate, output, demand and employment. Based on the theoretical discussions in the literature, five policy scenarios were developed, which were designed with different policy sequencing and timing. These counter factual scenarios describe in a dynamic fashion the impact on the real exchange rate and the resulting effects on output, demand and employment levels in the post-reform period in New Zealand.

The results indicated that the particular policy sequence followed during the reform process yielded temporary appreciations in the real exchange rate. In the context of this research, it was found that a policy setting that gave priority to the changes in the government's expenditure and monetary policies in the initial stage of the reforms could have avoided the destabilizing impact on the real exchange rate. In addition, a delay in the timing of the liberalization of restrictions on the movement of financial capital could also have postponed and decreased the size of the real exchange rate appreciation, providing the trade liberalization preceded the capital market liberalization and was completed rapidly. The sectoral timing of trade liberalization applied to the exportable and importable industries was also found to be significant in terms of its effects on the real exchange rate. It was found that the short-term adjustment costs, particularly the output contraction and employment loss in the exportable industry, could have been lower if the liberalization of the exportable and importable industries had been similarly timed. Furthermore, it was found that a weaker real exchange rate during and after the reforms would have yielded lower short-run adjustment costs and higher long-run returns by creating an increase in output and employment levels, particularly in the tradable sectors of the economy.