Chris Worthington: Transformation by policy a pipe dream

Optimus Prime Minister: The idea that the economy can be transformed distracts the country from the policy improvements we could make. Photo / Supplied

Opinion

There's no magic formula to put us on a path to utopia, says Chris Worthington, senior economist at Gareth Morgan Investments.

Budget season, especially in an election year, is the time for political parties to lay out their vision for transforming New Zealand. That proposed transformation may be a knowledge economy; a financial hub; laissez-faire capitalism or a socialist utopia.

But what these grand visions have in common is that they are all, more or less, wrong - or more specifically, that they have little chance of delivering what they promise. New Zealand needs less big picture and more gritty detail.

Let's take stock on what politicians want New Zealand to look like. All parties seem to agree with the uncontroversial idea of being more like Australia, which is to say, richer (well, maybe not the Greens).

Left-leaning parties draw further inspiration from Scandinavian countries, which in general enjoy higher taxes, larger welfare systems and score highly on social measures.

Right-leaning parties previously looked to Ireland's model of low corporate taxes and openness to foreign direct investment, but, mysteriously, not so much lately. Singapore is the new free-market darling, with ultra-low income taxes, a minimal public sector and fast economic growth.

The common error in these approaches is that the focus on the policies of these countries ignores the importance of social and cultural institutions.

Critically, it is the interaction between policy and social institutions that determines the country's success or failure. France, for instance, has a very efficient public sector, so a large role for Government works.

The social safety nets enjoyed by Scandinavia require a willingness to pay high taxes and a culture that is reluctant to exploit social welfare. For the incredible work ethic found in Singapore, a policy of low taxes and self-sufficiency may well be ideal.

Therein lies the problem - we can adopt the policies of other countries, but unless we import the people, culture and social institutions, there is no guarantee that their policies will succeed here.

Institutions do matter, and it is normally a safe bet that the existing policy mix is better-tailored to local institutions than a foreign policy mix would be.

But even then, the long-term evidence is extremely unconvincing on what combinations of policy and institutions work. This shouldn't surprise us: it is hard to forecast the economy a year into the future, let alone 30 years.

Every so often, a study may find that certain levels of government, or investment policies, or taxation systems, or inequality levels may be associated with particular economic and social outcomes.

But such cross-country studies all suffer from the same core problems: the sample of comparable countries is small, the history is short (from a long-term growth perspective), and the potential confounding of variables is endless.

For example, is it the level of tax, who we tax, the taxation mechanism, or how that tax is spent that affects growth? Of the relationships that have been identified, the question of cause and effect is hard to establish.

So even if our country was run by a dictatorship of macroeconomists, with unlimited power to make politically unpopular decisions to deliver long-term gains, there seems little guarantee that the optimal policy prescription would add much, if anything to trend economic growth.

Now clearly we know the difference in policies that create a South Korea rather than North Korea. But within the set of policies that aren't blatantly stupid, the variance in policy is fairly minor.

Quickly, off the top of your head, name the key policy differentials between Australia and New Zealand.

Struggling? Objectively, Australia and New Zealand probably share a more similar mix of policy and institutions than most other country pairs, and yet the results of those similar policies, as measured by income, differ substantially.

Transformation by policy is a pipe-dream. There is no five-step process that will put New Zealand on the path to being richer and better in every way.

Worse still is that the vision of transformation distracts from the policy improvements that we could make. Reduced solely to the metric of productivity, the difference between being the top and bottom of the OECD ladder comes down to differences in annual productivity of less than a per cent, compounded over time.

Framed like that, the challenge of increasing our position doesn't seem impossible - most people can probably think of changes they could make in their own workplace to make themselves 1 per cent more effective at their jobs.

Ultimately it is these incremental steps in policy effectiveness that should be the main focus of the Government's efforts. Frankly, it's fairly immaterial whether the public sector is 30 or 35 per cent of GDP.

It is hugely material if the effectiveness of public policy, and public sector workers, increases by 2 per cent a year instead of 1 per cent.

The political environment for achieving greater efficiency is not one where parties pitch their big policy changes, or offer competing "visions". It is one that emphasises evidence over ideology, and slow gradual improvement.

This means more trials of policies before they're implemented - even if that means waiting five to 10 years to find out what works (rather than spending billions and hoping it pays off).

Another possibility is using prediction markets (like NZ's iPredict) to weed out pet policies with woefully optimistic assumptions from the more sober policy prescriptions on offer.

But what are the chances of the "transformation" to evidence-based policy-making occurring while the political environment is primarily adversarial in nature, and elections remain a contest of big ideas?