Is New Zealand really doomed by distance?

11 December 2009

A reply to Brian Fallow in the "New Zealand Herald" of 10 December 2009, who argued that in the new global economy New Zealand suffers from some huge disadvantages

Brian Fallow is one of New Zealand’s best economic journalists.  But his article on 10 December dismissing the report of the 2025 Taskforce as “1980s thinking”, under the headline “Old prescription unlikely to fix new ills”, misses the boat completely and demonstrates that he is out of touch with mainstream professional opinion.  The arguments for reducing the tax burden caused by low quality and poorly targeted government spending, for privatisation, and for better quality regulation are absolutely consistent, for example, with the OECD’s 2009 report on New Zealand.

In his article, he cites at length the work of the economic geographer Philip McCann.  McCann has argued that since the 1980s the world has changed profoundly – China has abandoned communism, India has abandoned autarky and the Soviet empire has collapsed.  McCann accepts that over the past century transport costs have fallen by some 95%, while telecommunication costs have fallen by that much in just three decades.  This has provided a huge advantage to “the geographical dispersion of activities which are not particularly knowledge-intensive and do not add a lot of value”.  By contrast, what McCann calls “spatial transaction costs” have, he argues, become more important for knowledge-intensive high value-added activities because of the premium attached to face-to-face contact.

He argues that the increased importance of “spatial transaction costs” means that economic growth and globalisation over the past 20 years have favoured large urban centres in almost every country (large and small).   But he goes on to argue that an implication of this is that, within the Australasian region, Sydney and possibly Melbourne are growing in wealth and size at the expense of the periphery – which in this case, he asserts, includes New Zealand.  The further implication is that at this stage in the development of the world economy there are factors which drive us inevitably to have incomes lower than those in Australia.

Professor McCann is a serious researcher, and deserves to be heard respectfully.  It is probably true that large urban centres attract a disproportionate share of a country’s innovation and entrepreneurship. 

But one implication of his argument is that small countries, and especially those which are distant from world markets, are inevitably doomed to grow more slowly than larger more densely populated countries – and that simply does not seem to be borne out by the facts.  Over the last 20 years during which Professor McCann claims the world has changed, small countries tended to perform a bit better than large countries – even New Zealand has grown slightly faster than the OECD average over that period. 

Compared with large countries like France, Italy and Japan – all countries with large conurbations – New Zealand has also done better, increasing from 82% of the simple average of the incomes of those three countries in 1989 to 87% in 2007.

Moreover, if geography were really an important part of the story, no one would have predicted Australia’s impressive performance relative to the rest of the developed world in the last couple of decades.

Professor McCann and Brian Fallow also suggest that in the brave new world after 1989 capital is likely to be flowing out of New Zealand to places like Australia.  In fact, of course, it is well-established that capital is flowing into New Zealand, especially from Australia.  Thus, we have one of the largest current account deficits around – and, by definition, one might expect us to be running surpluses if capital were leaving New Zealand for ever better opportunities abroad.

The report of the 2025 Taskforce acknowledges that smallness and distance may indeed be impediments to our growth.  But let’s suppose for the moment that our size and location have become a much more important barrier to the development of knowledge-intensive industries in the “periphery” than they were prior to 1989.  Do we have to wait until the global economy changes, until, as Brian Fallow suggests, we get the benefit of our “combination of ample rainfall, temperate climate and skilled farmers” as the world’s population climbs and more and more people move into income brackets which enable them to afford the foods of affluence?

Or are there things we can do to actively lift our living standards?  The 2025 Taskforce is in no doubt about the answer to that question. Distance is what it is.  Our population is what it is.  But we don’t need to have a company tax rate which is now well above the average of other OECD countries.  We don’t need to discourage people who have dependent children with effective marginal tax rates of well over 50%.  We don’t need to hobble our businesses with needless red-tape.  We don’t need to inflate the cost of housing by tightly constraining the supply of residential land.  Our government doesn’t need to squander capital in low-yielding but politically-popular projects.  And we don’t need a size of government that is materially larger than that in Australia.

Yes, Australia and other developed countries also do some of these dopey things.  But the Government has set a goal not just of holding our position on the OECD ladder – a position which has us well below the average of other developed countries – but of catching up with Australia by 2025.  We won’t do that with policies which are merely as good as the average of other developed countries; we will only do that with much better policies.  If distance is a significant impediment to our growth, that simply means that our policies have to be of absolutely top quality.  Right now, they are not, and in recent years they have gone backwards in several important areas even as other countries have continued to reform.  This slippage is totally omitted from Brian Fallow’s account.

Do we need 1980s thinking?  Of course, where it is still relevant; absolutely not where it isn’t.  The recommendations of the 2025 Taskforce are absolutely consistent with orthodox economic thinking about how to accelerate economic growth and, as noted, are consistent in particular with the recommendations made by the OECD report on New Zealand a few months ago.


Don Brash

Chairman of the 2025 Taskforce


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