Peter Lyons: So long as you catch the mouse ...

A pragmatic approach recognises that the colour of the cat doesn't matter, but whether it catches mice. Photo / Getty Images

In a country as small as ours, a lack of competition sometimes means market forces are not enough.

I was working as a young economist on Muldoon's Think Big projects in 1985. The fourth Labour government had just gained power. I have a distinct memory of walking down Lambton Quay in Wellington one sunny afternoon thinking that I was living through an amazing transformative time in our history.

The statist policies of the Muldoon era were being dismantled in a blitzkrieg of policy reforms. Massive changes were being implemented on an almost weekly basis. New Zealand was embarking on an unprecedented economic and social experiment based on the ideology of free markets. Now, almost 30 years later, the outcomes of this experiment are apparent.

I have always been a sceptic of ideologies. History shows that those with all the answers to how a society should be organised should be treated with extreme caution. Failed ideologies include mercantilism, communism, fascism and nationalism. Ideologies are often used to support the interests of those in power to the detriment of the majority. Real life societies are too complex to be reduced to simple solutions based on a set of rules implemented from above.

One of the most fascinating questions in economics is why some countries are rich and others poor. The answer cannot be reduced to a simple prescription. The reality is that economic prosperity for a country is the outcome of myriad factors. These include history, culture, geography, resource endowment, politics, institutions and good fortune.

The historical prosperity of nations such as England from the industrial revolution and the United States in the 20th century was the outcome of incremental changes often based on pragmatic policies as well as happenstance.

Their success was not the product of an ideological adherence to free markets. Both of these nations used activist government policy to achieve desired outcomes when it suited. These policies included protectionism, regulations, colonisation, government-funded research and development and explicit support for key industries.

The Chinese approach to attaining economic prosperity in recent decades has been based on pure pragmatism as opposed to ideology. While the reforms introduced by Deng Xiaoping from the late 1970s supported the introduction of market mechanisms, this approach is very much based on activist intervention when it suits. As Deng famously stated, "It doesn't matter if the cat is black or white, provided it catches mice."

Many unsavoury events that have occurred in New Zealand over the past few decades can be attributed to our faith that free markets, private enterprise and deregulation always achieve outcomes that are in the best interests of society. These events include the 1987 share market crash, the sale and buyback of the rail system, the finance company debacles and even the Pike River tragedy. The severe distortion of prices in our housing market can be partially attributed to the lending practices of a deregulated financial sector.

Market forces work well in certain sectors. These are characterised by many firms competing to serve the needs of consumers. Firms are forced to be efficient in their production methods and this ensures that resources are used wisely. Prices and profits are determined by competitive pressures. Deregulation has generally worked well in such markets.

Unfortunately in a country the size of New Zealand many of our markets are characterised by one or a few large firms that are able to influence prices and extract monopoly profits. This is why we are a nation of phone texters. In many less developed countries people actually talk on their cell phones.

The pendulum has started to swing against the ideology of the market. The Commerce Commission has recently imposed price controls on Chorus which controls the copper phone lines. Chorus shares have been in free fall. Chorus argues that these controls will prevent its roll-out of ultra fast broadband. Meanwhile, Labour and the Greens are proposing the introduction of a government-controlled buyer of wholesale electricity to prevent possible price gouging. This has created huge uncertainty for firms in this sector.

As the pendulum swings back towards government intervention there is a risk of over reaction and shoddy policy based on political expedience. In those sectors where market forces are not delivering optimum outcomes there is a need for pragmatic policy based on hard data and sound analysis. There is also a need to minimise uncertainty. Smarter regulation is crucial to our prosperity and wellbeing.

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