KEY POINTS:
At first glance it is encouraging that New Zealand has lifted its ranking from ninth-equal to fifth in the Heritage Foundation's index of economic freedom this year, because of the strong correlation of economic freedom and prosperity.
But complacency would be misplaced.
The index compiled by Heritage, a
conservative Washington think tank, and the Wall Street Journal, grades countries on such things as how easy it is to start or close a business, trade barriers, how open investment and banking markets are, how well property rights are protected, the prevalence of corruption, price stability, marginal tax rates, Government spending as a proportion of gross domestic product, and the flexibility of the labour market.
New Zealand scored below average on tax rates and size of government, which dragged down the overall ranking.
Traditionally New Zealand has ranked close to the top of the Heritage index, after Hong Kong and Singapore, as it does in a similar one compiled by Canada's Fraser Institute.
But its score had slipped over the past three years and this year's recovery may have more more to do with methodological changes in the way the index is compiled than any improvement in policy or institutional arrangements.
There is a strong relationship, Heritage says, between the level of economic freedom and the level of prosperity. A graph plotting the economic freedom scores of the 157 countries it looks at against their per capita GDPs bears out that claim.
Countries in the top quintile (20 per cent) of countries in the economic freedom rankings have an average per capita GDP more than twice that of the second quintile and five times than of the lowest quintile. It is a similar story for unemployment and inflation.
But the correlation should not be overstated. New Zealand ranks just one down from the United States in economic freedom but our per capita GDP is about 40 per cent lower.
And many European countries which rank lower than New Zealand on the "denounce freedom" measures are significantly richer than we are.
Clearly other factors, such as scale and proximity to markets, matter.
But it is telling that the gap between US and New Zealand incomes widened from 14 per cent 50 years ago to 40 per cent by the late 1980s - the period of a fortress economy and high levels of government regulation and control.
The reforms of the late 1980s and early 1990s seem to have at least stopped the gap from growing wider.
The width of the income gap that has opened up with our erstwhile peers, most notably across the Tasman, is an ongoing challenge reflected in the migration statistics. On average New Zealand loses three Kiwis for every four immigrants.
And it is a matter of simple arithmetic that from our relatively low base we have to notch up higher growth rates than richer countries to stop the income gap from growing wider.
So it is troubling that in a key driver of growth we seem to be going backwards.
In the five years to March 2005 (the most recent data available) the average growth rate in multifactor productivity was only 1.1 per cent, little more than half the average rate of 2.1 per cent in the 10 years before that.
Multifactor productivity is that part of growth in output that cannot be explained by increases in inputs of labour and capital. It reflects the extent to which we are getting smarter at using those inputs.
Some of the decline in productivity between 2000 and 2005 is likely to be the flipside of a positive development, the strong increase in employment and decline in unemployment, over the same period. New workers tend to be less productive than existing ones so there is a bit of a dilution effect.
The decline in productivity growth is partly cyclical, says ANZ National Bank chief economist Cameron Bagrie, but the extent of the decline raises a red flag that something structural may be happening as well.
The bank's economists have been reflecting on possible reasons for the troubling productivity trend and are inclined to pin some of the blame on regulation and regulatory uncertainty.
Identifying the economic costs of poor regulation is difficult, they concede, because you cannot observe or measure what would have happened without it.
"The cost of poor regulation is typically investment that never takes place, jobs never created or income never earned."
But they point to some indirect evidence in the economic data that suggests distorting effects - footprints in the sand, you might say.
The stock of capital goods has been shrinking, relative to the size of the economy, in recent years while indicators of uncertainty in the regular surveys of business sentiment have been increasing.
At a sectoral level, while there is little apparent impact in transport or non-residential construction, they detect signs of an adverse effect on investment in telecommunications and energy.
"If our uncertainty gauge was back at the level prevailing in 1995 (ie there was less uncertainty) the level of investment would be $350 million per annum higher."
Allowing for the fact that a lot of capital goods are imported that still represents a net 0.1 percentage points a year shaved off economic growth. It may not sound like much but the cumulative effect is substantial, not least in relieving the sorts of capacity constraints that boost inflation, interest rates and the dollar.
Policymakers need to take more account of the negative impact of uncertainty on economic performance, the ANZ National Bank economists say. For businesses a delayed decision is better than a bad one.
They recommend that all new or revised regulations require quantitative cost-benefit analysis, with particular emphasis on the costs.
And they advocate an independent body like Australia's Productivity Commission to undertake authoritative analysis of the merits and drawbacks of regulation.
