Frederic Sautet: Kiwis into tigers - hardly likely

Sam Morgan converted a good idea into a successful venture. Picture / Daily Post.

It's strange but true: Only one sentence in the Treasury's economic briefing after last year's election refers to the role of the entrepreneur or entrepreneurship in the economy.

Strange, because the briefing is entitled Sustaining Growth; because economic growth is the Government's "top priority"; and because entrepreneurship should be centre of any talk about economic growth.

Recent Treasury work on growth has been cast in a so-called "growth accounting" framework based on insights from neoclassical economics. Important as these insights are, they are not particularly helpful in thinking about growth issues because they don't explain what causes growth.

Traditional economic models leave no role for the entrepreneur or entrepreneurial judgment. Technological innovations and business opportunities are either assumed as existing from the start or left out of the models as unexplained. They are never discovered.

By contrast, growth economics that focuses on entrepreneurship recognises that successful entrepreneurs discover profit opportunities that others overlooked, and set up business firms contributing to technological innovation, capital accumulation, job creation and productivity increases. In time, entrepreneurial profits may be competed away, but they are what drive investment and innovation.

Entrepreneurial activity is the engine of growth. It follows that the entrepreneurial environment (that is, the context in which entrepreneurial profit opportunities are discovered and exploited) should be the main concern of governments seeking higher incomes for their citizens.

Sam Morgan typifies the entrepreneurial business person: Someone with a good idea who converts it into a successful venture that creates wealth for investors, value for consumers and broader growth.

The economic reforms in the 1980s and early 1990s vastly improved the entrepreneurial environment and, as a result, greatly enhanced New Zealand's economic performance. Trade Me, for instance, was a product of the new environment.

Since that time, however, little further progress has been made and, in recent years, backward moves have made the economy less conducive to entrepreneurial activity.

The upshot is that productivity and per capita income growth rates have risen in New Zealand, but it has not become a tiger economy. Projections in the Budget point to a deterioration in trend growth rather than an improvement. Why?

Some may be misled by the annual World Bank survey, which in recent years has rated New Zealand highly as a place to do business.

However, this survey is motivated primarily by problems facing the developing world such as the paperwork involved in starting a business, access to credit, protecting investors and enforcing contracts. New Zealand no longer has serious problems under these headings, nor do most advanced countries.

By contrast, the World Bank research does not address the problems of government spending, tax and regulations that are limiting New Zealand's growth prospects.

More telling than this research is the evidence that New Zealand has been falling in the indexes of economic freedom - to ninth equal from second equal a decade ago in the Heritage Foundation/Wall Street Journal survey. This is concerning because the best environment for entrepreneurial discovery is one relatively free of tax and regulatory burdens.

To be fair to the Treasury, it does recognise in a sentence in its briefing that high marginal tax rates "discourage people from becoming entrepreneurs and starting their own businesses, inhibit the growth of these businesses, and increase the likelihood that entrepreneurial businesses will exit the market".

It advocates cuts to the top personal (39 per cent and 33 per cent) and company tax rates to create better incentives for wealth creation.

The Treasury paper also points to problem areas such as excessive and poor quality government spending, Kyoto Protocol commitments, employment law and state ownership of businesses.

Importantly, and contrary to the views of commentators such as Rod Oram - who think that all that is needed is for New Zealand businesses to pull their socks up - the Treasury emphasises that "sound domestic policies are essential".

There is no shortage of potential entrepreneurs in New Zealand and most other economies - consider the street vendors, money changers and peasant farmers in places such as Bangladesh or Ethiopia. The problem there is the absence of high-quality institutions and policies that allow a spirit of enterprise to be translated into sustained growth through continual exploitation of opportunities and capital accumulation. Entrepreneurs cannot perform miracles if the environment for doing business works against them.

Similarly, New Zealand's problem is not its relatively small size and distance from markets, as some like David Skilling have argued.

At most, these are minor handicaps, which did not stop New Zealand becoming one of the wealthiest countries in the world at a time when transport and communications barriers were much greater than they are today. The West became rich not because of geographical advantages or natural resources but because of the quality of its institutions which enabled people to become entrepreneurs by betting on their ideas.

Modest growth here is not the result of an overdose of economic reforms or bad cultural attitudes. New Zealand has not become a growth dynamo because the reforms did not go beyond standard OECD practice and have not been carried forward in a stable, predictable way.

As Martin Wolf put it in the Financial Times in November 2004: "It is simply wrong to describe [New Zealand's] reforms as delivering a laissez-faire paradise. The end point is, rather, a reasonably deregulated, competitive market economy, with prudent monetary and fiscal policies and a better-run government."

A "reasonably deregulated competitive market economy", however, is not enough to generate a high rate of growth in income per capita. The only way to achieve better performance is to improve the institutional environment in which entrepreneurial activity takes place.

If Kiwis are to become tigers, a rollback of recent trends towards bigger government and greater regulation, and the resumption of a programme of market-oriented reforms to encourage and reward entrepreneurial success, are required.

* Frederic Sautet is a senior research fellow in the Mercatus Centre at George Mason University and the author of a report, Why Have Kiwis Not Become Tigers?: Reforms, Entrepreneurship and Economic Performance in New Zealand, published by the New Zealand Business Roundtable.