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This week's guest piece is a letter written by The Hon David Butcher, to Bryan Gould. Although it was written in 1995, it outlines the risks associated with politial interference in the economy and the importance of having a sound economic policy framework - the Reserve Bank Act in particular.  (No reply was ever received. Bryan Gould recently expressed the view that the international financial crisis is the result of the banking industry being “free and unregulated”. )

9th August, 1995

Bryan Gould
Vice Chancellor University of Waikato,
Private Bag,
HAMILTON

Dear Bryan,

It was a great pleasure to meet you at the former MPs Association Meeting last month and I hope that when you are in Wellington you will take up my idea of coming and joining me for lunch one day.  The reason why I am writing at the moment is to comment on some views you expressed on a recent TV programme.  I was in Vietnam during May, and while I was away my wife videoed the profile of the Reserve Bank that was screened at that time.  When I returned home I had a look at it and was surprised to hear your comments on the Reserve Bank Act.

After thinking about it for some time it suddenly dawned on me that you were not in New Zealand during the Muldoon era and were perhaps not familiar with the background to the Act.  Some of the things that went on under Muldoon came to light when a select committee of parliament had a look at the advice that he received in the period leading up to the devaluation in 1984.  This showed the extent to which the decisions made by the Finance Minister were not in line with any coherent policy, lacked any purpose or direction and were totally removed from the cabinet and caucus gaze, let alone from any public debate.

Accepting that this was the position over devaluation it rapidly became clear that the position with respect to monetary policy was no better.  Much of the money supply was beyond the control of any official, elected or appointed.  Several of the producer boards could demand cash from the Reserve Bank at 1% on demand.  Drastic economic consequences, including the 10% plus inflation we had experienced for virtually the whole of the 15 years from about 1968, could be laid at the door of conflicting policy objectives and ineffective monetary instruments.  It was this experience that led to the decision to sort out what could be controlled from what could not be.  We set up a policy framework within which somebody could be held accountable for the things that could be controlled.

In my view the Reserve Bank Act achieves that.  The Government is accountable for the policy, be it a 0-2% inflation target, a -1%-3%, or a 45% target, whatever.  The officials of the Bank are then accountable for implementing the policy.  There is a mechanism provided whereby the government can modify the policy and there is a mechanism whereby the government can overrule decisions of the officials.  In each case these decisions become a matter of public record.  None of that was possible before, and very often policy was decided by a “nod and a wink”.  It may be that these mechanisms are difficult to use because money markets will take fright at their consequences.  If that is seen as a disadvantage of the policy, then it seems to me we are saying that money markets function best on ignorance of govenment policy, a proposition I certainly do not believe!

The crux of the debate over the Reserve Bank Act is often whether there is any advantage to be gained by extending the things for which the bank is accountable.  The unions and the Alliance have been pushing to have employment added to the list of things that the Bank must consider.  The reason why these things were excluded was that there was nobody who could give us any evidence that any long term improvements in the employment position could be obtained by short term adjustments to monetary policy.  Indeed, the evidence was very strong in the other direction.  At that time short-term commercial interest rates were still well above 15% and the effect of the introduction of the Reserve Bank Act was to drop both short and long rates by 1-2% within a few months.  Shortly after that, the government brought the Bank and Unions together in the 1990 Growth Agreement, where the unions affirmed that they and their members were not anticipating cost of living wage rises at all that year, and the Bank was able to relax monetary policy, followed by a further perceptible reduction in long term interest rates soon after.

The evidence at that time was strong, and since then has got stronger, that long term improvements in employment in an economy like New Zealand’s has to come from improvements in competitiveness.  This means effecting real reductions in business costs so that we can offset the disadvantages of distance from which our industries suffer.  Costs have proven singularly unamenable to influence through macro policies but have responded well to more attention to micro reforms.  The list here is endless:  The abolition of farm subsidies induced massive reductions in the farm costs with all servicing sectors having to improve their efficiency.  Before deregulation butter prices in New Zealand were high and always increased in line with world prices.  Now they respond mainly to the price of margarine and have been stable and fallen in real terms.  Postal charges were increasing at 10-40% a year for most of the 1970s but have fallen considerably with the introduction of competition.  The forestry industry could not export logs from more than 80 miles inland but now can export them from 100-120 miles inland because of the reduced cost of putting them across the wharf.  We see the effects of competition on telecom prices on TV every night and similar benefits have been felt in electricity. 

One of the main areas where micro reform has not been very successful is in the area of professional qualifications.  There is no doubt that most professions from real estate through to doctors impose restrictions on entry to benefit themselves, justifying the restriction in the name of public safety.  Our attention was focused on this by the efforts of the Muldoon Government to gain support from music teachers with a more restrictive piece of legislation.  We found from Hansard that M J Savage had opposed the original legislation in 1928 as being unnecessary and had an hilarious debate!  We managed to devised a procedure to examine and differentiate the economic elements and the restrictive practice elements and were working through each sector in turn.  I personally wanted to put the Ministry of Commerce in charge of the whole process and have one piece of legislation for Public Safety.  The Cabinet chose the incremental approach and unfortunately the benefits have been loss in a morass of bureaucratic delay and obfuscation!

There are just some of the many areas where the efforts of the 4th Labour Government were driven by gross policies that had preceded it.  For example the extensive tax deductions that Muldoon and Birch and introduced in the tax code in the 1970s and early 1980s, to try and stimulate investment, meant that many rich people paid no tax at all.  A Dr in Hastings had a $ 1.4 million deer farm and in 13 years of professional practice had never paid a cent.  The best way to deal with this was to remove the worst deductions and devalue the rest by reducing the top tax rate.  The attached article shows the result.  It took some while for the accumulated tax losses to work out of the system but the results have been spectacular.  When we took office company tax accounted for less than $ 800 million a year!

I could go on for some time but I think I have said enough to background the reasons why the Reserve Bank Act was passed.  In my view it has considerably enhanced democracy by defining who is accountable for what and making the outcomes public.  In what other country do we have the spectacle of the Governor of the Central Bank being called to groups of farmer to account for his actions!  Not because they shouldn’t be, but because nobody has the foggiest idea of what it is he does and what he is supposed to do!  I hope you do not mind my writing at great length, but I thought some of this background could be useful it you are called upon to speak on this subject again.

Looking forward to seeing you again soon,

Kindest regards,

DAVID BUTCHER

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