This section looks at the New Zealand reforms from the point o f view o f the four hypotheses outlined in chapter 3. These hypotheses are explained in the following order: lobbying by domestic interest groups, pressure from international financial markets, the ideas promoted by an epistemic community and politicians 'tying their hands' for electoral gains.
27 Two National Party MPs did not attend the vote, Sir Robert Muldoon and one other National Party opponent who was sick in hospital.
Interest Group Lobbying
The facts o f this case speak for themselves. Central bank independence did not result from lobbying by domestic interest groups, either in favour or opposed to central bank independence. While domestic interest groups had proved successful in lobbying the Muldoon government, they lost all influence with the appointment of Finance Minister Douglas. O f the many accounts documenting interest group reactions to Labour's economic reforms, only a few look at the RBNZ reform in any depth.28 Based on a review o f these works, it is possible to paint a broad picture o f the lobbying activity under the Labour government, in order to demonstrate the limited effectiveness of interest group activity during debates on the RBNZ Act 1989.
Douglas was ideologically opposed to what he saw as the rent-seeking activity o f interest groups, and viewed them as part of the problem (Douglas and Cullen 1987). Associate Finance Minister Prebble puts it bluntly: "Interest groups, so influential under Sir Robert Muldoon, had little sway over the Lange government. I rarely met with them... Their advice was self-serving. It was a waste o f time".
Douglas adopted a ‘crash through’ strategy to economic reform designed to shut interest groups out o f the process. Reform would advance in quantum leaps, not allowing interest groups time to mobilise to slow the process down (Douglas 1993). Instead economic policy reform was determined by a small policy community in the Cabinet, the Treasury, and the Reserve Bank (Bollard 1993; Douglas et al. 1987; Easton 1989; Goldfinch 2000; Goldfinch et al. 1993; Jesson 1989; Whitwell 1990).30 While interest
28 For general accounts of the economic reforms, see Bollard 1993, Bremer 1993, Castles, Gerritsen, and Vowles 1996, Deeks 1992, Easton 1987, Gold 1989, Goldfinch 1998, Jesson 1989, Kelsey 1996, Mulgan 1993, Nagel 1998, Roper 1992, Roper 1993, Whitwell 1990. For discussion of the RBNZ reform, see Dalziel 1993, Evans et al. 1996, Goldfinch 2000, Lawn 1994.
29 The Hon. Richard Prebble, former Associate Minister of Finance , correspondence dated 2 August 2001.
30 Douglas's key supporters in Cabinet were his Associated Finance Ministers, David Caygill and Richard Prebble.
groups in general were ineffective for influencing the economic reforms, the New Zealand Business Roundtable ("NZBR") is seen as providing valuable support to the reforms, under Director Roger Kerr - one o f the authors o f Economic Management 1984
- who left the Treasury in 1986 to take up this post.
Apart from Douglas’s disposition against their efforts, interest group lobbying was hampered by collective action problems. The associations representing business, the financial sector and trade unions suffered from fragmentation, overlapping memberships and a lack o f consensus on policy direction. Business was represented by the Federated Farmers, the Manufacturers Federation and New Zealand Bankers' Association which overlapped with the Employers' Federation, on one hand, and industry-wide associations like the NZBR and the Chambers o f Commerce on the other.31 The trade unions were equally fragmented, represented by the Federation o f Labour, the Combined State Unions and the Public Service Association among others (Bray et al. 1996, p.71). The situation improved in 1987 following the merger o f the Federation of Labour with the Combined State Unions to form the NZCTU, but this new association could not control its affiliated unions.32 None o f these groups was represented by a peak association capable o f speaking with one voice, mitigating its influence in the policy process.
In addition, the trade unions had no special access to the Labour government. Unions had weak institutional links with the NZLP. Union affiliates controlled less than half the votes at the NZLP annual conference, leaving policy formulation in the hands of the
31 Around one-third of the NZBR's members were from the financial sector.
32 A number of blue-collar unions refused to join, leading to the formation of a competing peak organisation, the Trade Union Federation (Bray et al. 1996, p .79).
Cabinet.33 The trade unions also had few personal links with the NZLP leadership, making them an ineffective voice for organised labour (Bray et al. 1996, p.68; Easton et al. 1996, p.35). As a result unions were excluded from the process o f policy formation during the 1980s when Labour was in power (Castles et al. 1996, p. 11).
Business groups were divided over central bank independence. Export-oriented groups led by the Manufacturers' Federation were opposed to RBNZ independence and a narrow mandate o f price stability.34 Their submission to the Committee on the bill was so critical, that the RBNZ took the unusual step o f rebutting these views in a separate submission to the Committee (Lawn 1994, p.49). By contrast, the Federated Farmers, the New Zealand Business Roundtable and the financial sector associations endorsed the proposed changes (NZBR 1989). The trade unions were predictably vocal critics of central bank reform. The NZCTU argued in its submission that the shift to a narrow mandate of price stability was misguided and dangerous as greater independence would favour a recessionary policy (Kelsey 1996, p. 163). The NZCTU, together with the Public Service Association and the Service Workers Federation, painted an independent RBNZ as ‘anti-democratic’. Based on the final outcome, it is clear that the voice of organised labour was not influential in this debate.
33 In fact, the NZLP had unsuccessfully tried to disaffiliate unions following the 1981 electoral defeat (Bray et al. 1996, p.73).
34 These exporting branches later accused the RBNZ of causing an overvaluation of the New Zealand dollar in 1995, which contributed to the current account deficit (Caesar 2000)
Table 40: Interest Group Submissions to the Committee on RBNZ Independence
In Favour Opposed
Reserve Bank of New Zealand New Zealand Treasury
Federated Farmers
New Zealand Business Roundtable New Zealand Bankers Association Financial Services Association Mortgage Lenders Association
Manufacturers Federation
New Zealand Council of Trade Unions Public Service Association
Service Workers Federation National Council of Women
Source: Brash (1996), Kelsey (1996), Lawn (1994) International Financial M arkets
RBNZ independence may be seen as a reform designed to signal the creditworthiness of New Zealand to international financial markets. The related argument can be made that New Zealand's left-wing politicians were pressured to introduce these reforms by international creditors who were suspicious o f the NZLP's partisan biases. International financial markets have the ability to sanction policy through two main avenues: pressure on the exchange rate and the interest premium charged on foreign debt. An examination o f these two channels suggests that the 1984 currency crisis was influential in stimulating Finance Minister Douglas’s reform program, but it did not dictate the content o f reform or determine the timing of individual reforms. Likewise the cost and size o f New Zealand foreign debt may have been a significant constraint on the government’s room to manoeuvre, but it did not lead the government to introduce central bank independence. This reform was designed to send a signal concerning the NZLP's anti-inflationary credibility, but this signal was directed at a domestic audience composed largely o f actors in the real economy, not the financial one. These arguments will be developed below.
The 1984 currency crisis is portrayed as a primary source o f international pressure that forced the Labour government to adopt neo-liberal reforms. This position is overstated. First, it fails to recognise that the source o f speculation on the exchange rate is believed
to have been domestic, not international. New Zealand businesses, banks and citizens appear to have been the major actors speculating against the currency prior to the election (Brash 1996a). Floating the currency in 1985 was designed to reduce this source of pressure, by eliminating the external anchor that served as a focus for speculation (Deane 1985, p. 14). Second, it is inaccurate to say this policy was forced on the Labour government. Douglas favoured reform as did the Treasury and the RBNZ. He took steps to make the currency float inevitable by removing exchange controls, which then created momentum behind a broader reform process.
The importance o f the 1984 currency crisis was as a catalyst for reform. It forced the public to recognise the need for reform and created an opportunity for a policy entrepreneur like Douglas to pursue it (Bollard 1994; Goldfinch 2000). Under the Muldoon government, domestic industries and interest groups had grown accustomed to being protected from competition. New Zealand's ’cradle to the grave' welfare system had led to the same expectation among the public. These arrangement became increasingly unsustainable during the 1970s and early 1980s, as witnessed by rising public debts and budget deficits. Douglas and other reformers within the Treasury and the RBNZ recognised the need for reform, but this view was not shared within the NZLP as seen by their reaction to his Economic Policy Package (Douglas and Cullen 1987; Goldfinch 2000, p.88). The currency crisis following the election, accompanied by the so-called 'constitutional crisis' during the 10-day interregnum, changed the public mood. It vividly demonstrated to the public and reluctant politicians that New Zealand's interventionism and 'cost-plus' economy were no longer viable. Douglas and his Treasury advisers seized this window o f opportunity to push forward with rapid and widespread deregulation, first announced in the November 1984 budget four months
after the election. This reform then created its own momentum as discussed in the section on interest groups.
While the currency crisis was the catalyst for reform, it did not explain the content of policy reform or the timing o f RBNZ independence (Bollard 1994; Goldfinch 2000). Douglas had outlined his proposals in 1980 in his pamphlet There's Got To Be A Better Way. Likewise the Treasury had put together 352-pages of post-election briefings providing a comprehensive economic reform program. These proposals were combined and determined the substance of Rogemomics. The content o f reform was therefore put together in the years leading up to the 1984 election, not in the weeks following the currency crisis. The crisis only gave Douglas the opportunity to pursue his reform proposals. By the time the RBNZ bill was introduced in 1988, currency pressure was not a concern as the New Zealand dollar was floating and had appreciated steadily from
1985 to 1988.
The second potential channel for international financial market pressure was through New Zealand's external debt, which was high and rising during the early 1980s, as seen in table 6. This situation led the rating agencies to downgrade New Zealand’s foreign currency rating repeatedly between 1983 and 1986. In 1984, New Zealand total government debt was NZ$ 22 billion or 57% o f GDP, o f which almost 40% was borrowed overseas. By 1987 total debt had risen to over 70% o f GDP, due to the government assuming the debts from Muldoon’s ‘Think Big’ energy project, o f which 50% was borrowed overseas. Following the 1984 devaluation, the spread on New Zealand government debt relative to the US increased dramatically from 0.50 per cent to almost 9.0 per cent by 1986. From this peak it halved to 4.25 percent in 1988. This incremental cost represented a significant penalty on such a significant debt load.
Table 41: New Zealand Exposure to International Financial M arkets
Year Exchange rate
per USD Total Debt, Gross (NZ$ bln) Foreign Debt, Gross (NZ$ bln) Total Debt % of GDP Foreign Debt % of GDP Current Account Balance % of GDP 1975 0.8323 4.2 0.9 36% 8% n.a. 1980 1.0267 10.3 3.6 45% 16% n.a. 1984 1.7640 21.9 8.2 57% 21% n.a. 1985 2.0234 45.0 12.4 63% 28% n.a. 1986 1.9132 52.2 14.7 61% 28% n.a. 1987 1.6946 59.7 21.7 71% 36% -5.0% 1988 1.5264 65.9 17.0 59% 26% -1.0% 1989 1.6722 69.9 16.5 57% 24% -3.9% 1990 1.6762 72.8 20.6 61% 28% -3.3%
Source: IMF, New Zealand Debt Management Office, and OECD.
Figure 7: New Zealand Public Sector Debt
80% 70% 60% 50% a Q 2 40% o 3* 30% 20% 10% 0%
The size o f the external debt and its associated cost was a significant source o f weakness for the New Zealand government, and one that could not be ignored. Former RBNZ Deputy Governor Deane recalls:
New Zealand politicians certainly needed to be responsive to international financial markets at the time o f the 1984 currency crisis and the election, if for no other reason that our overseas borrowing was so huge, our external deficit
□ T otal G r o s s D eb t (% o f G D P)
probably the highest in the OECD region relative to GDP, and o f course it coincided with a huge fiscal deficit. In the weeks leading up to the July 1984 Election, we were faced not just with a huge borrowing programme but with a number o f international banks who were either unwilling to lend to us or proposed to do so on terms which were patently unacceptable and non commercial, thus giving us a powerful signal about the need to abandon Muldoon's ‘borrow and hope’ policy.
The cost o f foreign borrowing and the downgrades by the rating agencies signalled the need for economic reform, but they did not dictate the content o f economic policy. International financial markets did, however, change the incentives facing politicians by charging an interest rate penalty on government borrowing. However, provided New Zealand politicians were willing to pay this penalty, they retained the ability to pursue distinctive macroeconomic policies (Garrett 1998; Mosley 2000, Oatley 1999). The Labour government did pay this penalty in the short run, and so introduced economic reforms based on domestic political imperatives such as deregulating the financial markets and traded sector but protecting the labour market from reform. Finance Minister Douglas also took steps to reduce the external debt by selling state owned enterprises, introducing a GST and reducing government deficits. By the end o f the 1980s the budget was in surplus and total debt was brought down to around 60 per cent o f GDP, where it remained until 1994.35 Likewise foreign debt was stabilised and remained constant in absolute terms, but declined as a share o f both GDP and total debt.
35 Following the introduction of the Fiscal Responsibility Act in 1994, the debt declined steadily reaching 38% of GDP in 1998.
The RBNZ Act 1989 was not designed to signal the government's creditworthiness to international capital markets.36 Instead, central bank reform was directed at a domestic audience and was designed to signal the government's anti-inflationary commitment to primarily non-fmancial actors. Deane states:
I did not see [international financial markets] as a major pressure point with respect to the decision to give the Reserve Bank independence in 1989, which arose much more from the... need to not only reduce inflation but to ensure that it remained at a sustainably low level in the belief that this would create more satisfactory conditions to enhance our international competitiveness on the one hand and our rate o f economic growth on the other hand.
Governor Brash agrees, arguing that neither the RBNZ Act 1989 nor the Fiscal Responsibility Act 1994 were enacted with foreign investors primarily in mind. However, both pieces o f legislation were hugely important for maintaining the confidence of overseas investors in New Zealand (Brash 1996a).
Id eas of an Epistem ic Community
This case study o f the RBNZ supports the hypothesis that politicians give independence to their central banks in response to academic ideas promoted by an epistemic community o f monetary experts. During the late 1980s, a new paradigm came to dominate monetary policy that prescribed delegating to an independent central bank with a single mandate o f price stability. This paradigm was promoted in New Zealand by an epistemic community located in the RBNZ and the Treasury, and championed through parliament by Douglas and his supporters. Each o f these points will be addressed in turn.
36 Former Associate Finance Minister Prebble points out that if international financial markets had been hostile to an independent Reserve Bank, it might not have happened.
First, the detail of the RBNZ Act 1989 reflected the state o f the economic paradigm circa 1988, particularly the work on time inconsistency and principal-agent problems. The choice o f price stability as the sole goal o f monetary policy reflected the monetarist view that monetary policy could not affect real variables in the long run. It also reflected the neo-classical view that delegation to an independent central bank would bolster the government’s anti-inflationary credibility. The literature on principal-agent problems led to the contracting arrangement agreed between the Governor and the government, whereby the Governor is held personally responsible for outcomes. During the debate over the RBNZ bill, Associate Finance Minister Neilson made reference to this new ideological paradigm. “It appears from the discussion this afternoon that there is considerable consensus within this body about the way in which monetary policy, at least in an institutional framework, should be carried out. I believe that that in part reflects the generation that makes up the composition o f the House”. 37
Second, this paradigm was promoted in New Zealand by an epistemic community o f monetary experts located in the RBNZ and the Treasury.38 Experts at the RBNZ came up with the main features o f the institutional design and later drafted the legislation. This design was then debated with the Treasury and a compromise was reached. This domestic epistemic community actively sought the advice from international experts, bringing in external advisers from the UK and the OECD, and speaking to officials at the BIS and other central banks. What is striking about this case is the lack of involvement of New Zealand academics, apart from Professor Holmes o f Victoria University. In fact, most New Zealand academics opposed the reform. The epistemic community that supported RBNZ independence was therefore transnational in
37 Hansards, 12 December 1989, “Report of Committee”, Speaker: Hon. Peter Neilson.
38 The key officials involved were Dawe, Grimes, Nicholl and Brash at the RBNZ; Scott, Fancy and Atkinson at the Treasury; and former RBNZ Deputy Governor Deane.
composition, but not all embracing. It was elitist, with its members sharing both an understanding o f the problem and a prescription for fixing it. The influence o f this epistemic community increased following the 1984 currency crisis and the deregulation of the financial sector, both of which created a high level of uncertainty in the conduct o f monetary policy over this period.
Third, this policy reform suited the worldview of Finance Minister Douglas and his desire to ‘Muldoon-proof monetary policy (Brash 1996b). Political interference in