Peter Lyons: NZ still floundering on buzzword of '70s

In failing to expand beyond farming, we have not come far enough from when Robert Muldoon was Prime Minister. Pictures / Steven McNicholl

We have signed countless free trade agreements but continue to rely too heavily on commodity exports

I tell my students that my initial enthusiasm for economics was sparked by the most attractive female teacher at my school. Unfortunately they will need to find other reasons for enjoying the subject.

It was the 1970s and the buzzword in New Zealand at the time was diversification. Britain had recently joined the European Community so we needed to find new products and markets to earn our way in the world. Robert Muldoon was Prime Minister.

During the 1980s, the statism of Muldoon's era was swept away by Rogernomics. Privatisation, deregulation and liberalisation became the buzzwords. The constraints of state intervention were to be dismantled and entrepreneurial flair was to be unleashed in a market-friendly environment. Trade liberalisation was introduced. The reforms were so rapid and widespread there was little informed public debate.

Thirty years later, after countless reforms and restructurings, we remain heavily reliant on commodity exports such as dairy products.

New Zealand has been a case study on the effects of trade liberalisation. Just as the economic theory suggests, we have ended up continuing to largely specialise in production, such as dairying, where we have a comparative advantage.

Unfortunately there are a few issues we failed to take into account in our zealous pursuit of free trade. None of the dominant world powers have ever adopted such a policy until it suited them. In the mid-1800s Britain adopted and enforced free trade on other countries only after it had developed its powerful manufacturing base. The United States developed its industrial base behind high trade barriers and still exercises extensive protectionism. China has used mercantilist policies in recent years such as an artificially low exchange rate to maintain massive trade surpluses. It is recycling these surpluses by buying land and other productive assets in other countries including New Zealand.

The secretive Trans Pacific Partnership talks reveal another issue for New Zealand. Developed countries such as the United States are demanding that their copyrights, patents and other intellectual property are strictly protected and enforced under any agreement. This is because the stuff they make is subject to increasing returns. Pharmaceuticals, software and other high-tech output has high initial costs, particularly in research and development.

But average costs of output fall rapidly as production increases and this generates high profits. Countries that produce commodities such as milk powder, meat and butter are subject to diminishing returns. These countries eventually run out of productive land, causing average costs of output to rise. Under free trade it is possible for a country to specialise in areas of production that are very finite in their ability to generate a higher standard of living.

New Zealand is subject to a further problem in being an exporter of primary commodities. We are price-takers on world markets. These prices tend to fluctuate wildly. As world dairy prices have plummeted in recent weeks this has the potential to suck a large amount of demand out of our economy. We have no control over these fluctuations in our economic fortunes.

New Zealand has been the Zsa Zsa Gabor in trade negotiations with other countries. We have signed countless agreements with many nations. Because we have already removed most trade restrictions our attitude has been that we have little to lose and much to gain by increasing access for our exports to other markets. While this is true, we are still confronted with the same problem of the 1970s. We need to develop other things to sell, preferably subject to increasing returns. Commodity exports will not deliver a guaranteed first-world lifestyle.

A solution in generating higher living standards lies in adding value to our commodities. There is nothing new in this statement. The question has always been how do we go about this? The answers may lie in examining the history and policies of other nations.

Peter Lyons teaches economics at St Peter's College in Epsom and has written several economics texts.