New Zealand’s Far-Reaching Reforms: A Case Study on How to Save Democracy (notes)

Roger Douglas and Ruth Richardson…although they represented opposing parties, the two ended up making common cause in a fight against their own party leaders, delivering lasting reforms that reverberate to this day.

Roger and Ruth’s story, and the story of New Zealand’s transformation into what may be the most responsible and well-run democratic government in the world, provides a powerful example for the transformation of other troubled democracies.

Comparison with the USA.

But it wasn’t from always model country! From solid economy based on agriculture New Zealand went into prolonged crisis during the 1975–83

“the government tried everything that didn’t work.” Increased protectionism, an expansion of entitlement benefits, wage and price controls, central economic planning, and Keynesian stimulus in the form of extensive deficit spending and the printing of money by the central bank all contributed to driving the country toward bankruptcy.

Then, how NZ became model country?

A move to honest and open accounting was pivotal; one of the key takeaways in what became the miracle of New Zealand. The sea of red ink convinced the public that dramatic action was required…

Ruth’s work on education reform ultimately became a Labour government initiative called Tomorrow’s Schools, which in effect made every school in the country a charter school overnight. Each school became a separate entity directly answerable to the parents of the students who attended, because parents were given the exclusive right to elect the board of trustees that governed the school. Education boards, school boards, and other bodies were terminated and parents were given the right to choose which school their child attended. What was politically interesting during this reform period was that good ideas developed by a political opponent were picked up by governments and implemented without embarrassment.

Agricultural subsidies were terminated. Protectionism was vastly reduced. Capital controls were removed. Marginal income tax rates were dramatically cut and the tax base was widened through the introduction of a comprehensive consumption tax. Capital gains taxes and estate taxes were eliminated. Foreign exchange controls were removed and the kiwi was allowed to float.

But the rapid rate of reform raised the question, what would make them stick? Ruth began thinking about ways to institutionalize reforms that would make it harder for future parliaments to backslide, another important element in the program.

During and despite this period of political turmoil — though some might argue because of it — New Zealand enacted its most lasting reforms when advocates for efficient government, free markets, free trade, sound money, and prudent fiscal policy came together from both parties to pass the State-Owned Enterprise Act of 1986, the State Sector Act of 1988, the Public Finance Act of 1989, and the Reserve Bank Act of 1989. These forever changed the way New Zealand’s government did business, and were Roger Douglas’s lasting legacy.

The State-Owned Enterprise Act was designed to accomplish three major goals. The first was to corporatize former government departments and agencies to get them running more efficiently, such as the national airline (Air New Zealand), the national railroad (KiwiRail), the national television network (Broadcast Communications Ltd., now Kordia), the Telecom monopoly (now Spark New Zealand), the Post Office, and various electrical power generation utilities, banks, insurance companies, forestry services, and shipping companies. The second was to introduce competition. The third was to prepare many of them, though not all, for privatization.

The overarching goal was profitability; that is, rather than serving as a base for unaccountable civil service sinecures that drained resources from the public fisc while providing indifferent services to the public, each organization was expected to stand on its own and to satisfy the needs of its customers without requiring perpetual subsidies. Most importantly, subsequent to the passage of the act, competition was allowed into many sectors that were formerly government monopolies.

The founder shares and equity bonds held by the government were constructed to be easily transferable to the private market should the company become privatized. And a lengthy set of accountability requirements were built into the statute that allowed the company to be monitored in a manner that would be transparent to the public…

The State Sector Act shifted the operation of all government departments from a best-effort input budgeting regime to a monitored output targeting regime. The key was moving the national civil service to a performance management system rather than awarding each department a pile of money every year hoping they would do their best, and letting intentions guide the process rather than results.

An essential element of this initiative was a change in the budget process that converted each appropriation into a “purchase agreement” that specifically detailed what the department was to produce. The teeth to this innovation was that the CEO of the agency could be terminated for not producing the outputs specified in the purchase agreements. In most intentions-driven systems, failures usually lead to calls for larger budgets and a repeat of the cycle of failure. Under performance management systems, failures more often lead to a sacking of the responsible bureaucrats and/ or a re-examination of the premises and objectives of the program.

To enable this, all civil service employees were moved from job-for-life union contracts and a seniority based advancement regime to individual employment contracts and a merit based regime.

Assembling and publishing the annual reports from all the government departments produced a constantly evolving picture that gave incumbent politicians, opposition, taxpayers and voters the ability to see if the country was actually getting its money’s worth from government services. The effect was electric.

If private businesses kept their books the way most governments keep their books, our jails would be full of CEOs. The purpose of the Public Finance Act was to transition all government accounting over to a more transparent and honest format by using the same generally accepted accounting principles (GAAP) required by businesses.

The bottom line is that while New Zealand’s politicians haven’t fundamentally changed — the species is pretty much the same the world over — politics has. Despite the fact that the finance minister that succeeded Ruth when she left the cabinet in 1993 was in the vanguard of Muldoonism, he was bound by the key pillars of legislation put in place. He couldn’t take the party back to its destructive ways. Of course there has certainly been backsliding, economic ups and downs, and unpredictable events (such as the disastrous Christchurch earthquake that required dramatic emergency relief). Nonetheless, most elections since the mid-1990s have been carried out against a backdrop in which both parties try to outdo each other with claims that they will be more fiscally responsible than the other.

…the overall policy framework is based on high-quality information and transparency, which leads to direct political accountability. A rhythm of public disclosure is respected by both parties during each election cycle. It starts with standardized briefing documents provided to every incoming government.

Despite ample warnings, most failing democracies wait far too long to heal themselves.

Even the most well-meaning politicians are human, which means they respond to incentives. If they are rewarded for lying, they will lie. If they are rewarded for sacrificing their integrity, they will become duplicitous. If they are rewarded for obscurantism, inefficiency, unaccountability, and profligacy, that is how they will behave. If they are permitted to sacrifice their citizens’ freedoms to satisfy their will to power, it is only a matter of time before that happens.

Unfortunately, politicians are rewarded for dispensing largess to their particular constituents, and doing so in a way that disguises the costs not only to others but to those constituents and sometimes even themselves. This is the problem that New Zealand fixed.

Politicians of all stripes and parties will hide the true cost of government if they are allowed to get away with…By insisting that all government financial statements conform to GAAP accounting, New Zealand broke the mold.

It’s one thing to keep honest books using proper accounting. It’s another to make sure these books are accessible and not locked behind closed doors.

New Zealand reformed its civil service by replacing job-for-life union contracts and a seniority-based advancement regime with individual employment contracts and a merit-based system.

Then it shifted from an input-driven budget management system to an output-driven system, which allows ministers to contract with the agencies under their responsibility and demand measurable deliverables.

But when reform is comprehensive and many different kinds of government subsidies are removed simultaneously, the political calculus shifts. A cacophony of voices — each trying to preserve their own privileges at the expense of others — tend to cancel each other out.

The disgruntled soon learn to point to additional groups with special privileges that should also be thrown off the dole, a welcome development.

The faster reforms progress, the sooner tangible results begin to accrue, offsetting the initial pain. In the end, action must be fast enough for the benefits to arrive before support for reform collapses.

As Roger Douglas puts it, “the dog must see the rabbit.” That is, when pursuing change, reform leaders must craft and promote a narrative using quality messaging that describes the breadth and arc of the program as it unfolds, and this narrative must be seen as coming to pass each step of the way.

New Zealand today operates under a system described as designed by Hayekians, run by pragmatists, and populated by socialists.

Does this mean that New Zealand has solved all its problems? Of course not. Health, education, and retirement policies continue to suffer from the usual depredations of denial, demagoguery, marginal adjustments, and budget gimmicks. Readers who are interested in that ongoing struggle might want to read Roger Douglas’s book Unfinished Business. The country also has native ethnic minority issues that continue to fester. The capacity to resolve these problems is a lot easier when a country is experiencing economic growth and fiscal strength, rather than mired in a zero-sum fight over a diminishing pie.

p.s. Read the book in pdf. here.