Economic Integration, Sovereignty and Identity: New Zealand in the Global Economy

Claridge, Megan; Box, Sarah Working Paper Economic Integration, Sovereignty and Identity: New Zealand in the Global Economy New Zealand Treasury Working Paper, No. 00/22 Provided in Cooperation with: The Treasury, New Zealand Government Suggested Citation: Claridge, Megan; Box, Sarah (2000) : Economic Integration, Sovereignty and Identity: New Zealand in the Global Economy, New Zealand Treasury Working Paper, No. 00/22, New Zealand Government, The Treasury, Wellington This Version is available at: https://hdl.handle.net/10419/205437 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ TREASURY WORKING PAPER 00/22 Economic Integration, Sovereignty and Identity: New Zealand in the Global Economy Megan Claridge and Sarah Box* Abstract Markets are becoming more integrated. Whilst governments have limited influence over this process, they can hasten or hinder the pace of integration and will need to respond to the implications of integration. This paper provides a framework for thinking about the benefits and costs of market integration. It analyses how cross border flows of goods, services, capital and labour affect the living standards of New Zealanders in terms of both productivity and incomes as well as other, broader, aspects of living standards. Particular attention is paid to the areas of spatial economic analysis and national sovereignty and identity. Governments must consider a number of factors when thinking about their stance on integration. Further economic integration promises economic benefits for New Zealanders in terms of greater productivity and higher incomes. One risk, however, is that with increasingly free factor flows, government pursuit of integration may increase the risk of activity relocating offshore. The evidence on the overall effect of integration on income distribution is unclear, however we do know that there will be winners and losers. Decision-making power and feelings of identity seem to be important components of well-being – integration brings with it both risks and opportunities in these areas, as pressure is put on traditional forms of governance and identity, and new forms develop. Deciding how the costs and benefits of integration stack up ultimately involves a number of value judgements – the paper provides a framework and a summary of empirical evidence to help inform those judgements. * The authors would like to thank John Carran, Benedikte Jensen, Lesley Haines, Struan Little, Mario di Maio, Peter Martin, Jim Rose, Grant Scobie and Andrew Sweet for assistance in writing this paper. Disclaimer: The views expressed are those of the authors and do not necessarily reflect the views of the New Zealand Treasury. The Treasury takes no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers. Contents Summary......................................................................................................1 1. Introduction..........................................................................................6 1.1 Context.........................................................................................6 1.2 What the paper does.....................................................................6 1.3 Structure of the paper...................................................................7 2. Integration............................................................................................9 2.1 Market integration.........................................................................9 2.2 Policy openness and integration ..................................................10 2.3 Social integration........................................................................11 3. Analytical Framework.........................................................................12 3.1 Higher living standards for New Zealanders..................................12 3.2 A new perspective .......................................................................13 4. Integration, Incomes and Productivity.................................................16 4.1 Productivity and living standards.................................................16 4.2 What improves productivity?........................................................17 4.3 What effects do cross border flows have? .....................................26 4.4 Empirical evidence......................................................................43 4.5 Integration and productivity: conclusions.....................................45 5. Integration and Income Distribution....................................................48 5.1 Widening income distribution ......................................................49 5.2 Winners and losers......................................................................51 5.3 Conclusions ................................................................................53 6. Integration and Decision Making.........................................................55 6.1 New Zealand the nation state: questions of sovereignty................55 6.2 New Zealand the region: questions of levels of governance ...........68 7. Integration and Identity ......................................................................74 7.1 The threat to national identity......................................................75 7.2 Some observations about national identity...................................76 7.3 New Zealand as a nation or a region: the challenge ......................80 8. Conclusions and Implications for Policy..............................................82 8.1 Costs and benefits of market integration......................................82 8.2 How do we decide the matter?.....................................................83 8.3 Implications for policy questions .................................................85 8.4 Key themes.................................................................................91 APPENDIX 1: Input Accumulation...............................................................93 Bibliography...............................................................................................95 Summary 1. Introduction Markets are becoming more integrated. Whilst governments have limited influence over this process, they can hasten or hinder the pace of integration and will need to respond to the implications of integration. This paper provides a framework for thinking about the benefits and costs of market integration. It analyses how cross border flows of goods, services, capital and labour affect the living standards of New Zealanders in terms of both productivity and incomes as well as other, broader, aspects of living standards. Particular attention is paid to the areas of spatial economic analysis and national sovereignty and identity. 2. Integration Market Integration occurs when two or more economies function as a single market. It is likely to be evidenced by high flows of goods, services, capital and labour and convergence of prices. Policy Openness and Integration are means governments might use to encourage, impede or direct market integration. Openness involves goods, services, capital and labour being free to move across borders and is a necessary condition for market integration. It is evidenced by lack of barriers to cross border flows. Policy integration is evidenced by similarity or compatibility of policy settings between countries. Even with high policy integration, market integration may not occur because of lack of social integration. Differences in culture, language and values make it unlikely that two economies will function completely as a single market. 3. Analytical Framework We adopt two conceptual windows for analysis. The first is the traditional ‘New Zealand as a nation’ view, where the world is divided into sovereign nations with borders that clearly differentiate each from the rest of the world. The second is a newer ‘New Zealand as a region’ perspective, where the world can be viewed as a series of concentric groupings, starting with the individual and moving out to international groupings including all of humanity. We find that removing the focus from the nation state, as in the ‘New Zealand as a region’ analysis, reveals the implications of spatial location to a much greater degree and provides a new view of the effects of openness and integration. 4. Integration, Incomes and Productivity The key to higher incomes is productivity. Higher productivity means that more goods and services can be produced from the same amount of resources and effort. As output increases, so too do incomes and employment. Productivity is therefore central to living standards. 2 What improves productivity? Productivity results from high quality decision-making about the use of valuable assets. We identify seven mechanisms through which openness and integration may affect productivity: resource allocation; scale, scope and specialisation; technological advance; accumulation of human capital; accumulation of physical capital; firm organization, management practices and work arrangements; and plant/firm turnover. Importantly, there is also a spatial dimension to productivity. The agglomeration of resources and production in a particular location can improve productivity as greater density leads to lower transport costs, greater specialisation of production and labour, labour market pooling effects and knowledge spillovers. While domestic policy has an influence over the productivity-improving mechanisms, and the spread of activity across space, openness is also important. For smaller countries, such as New Zealand, openness may assume greater significance than it would for a larger country that suffers less from market-size and resource constraints. What effect do cross border flows have? Looking at the theory on cross border flows of goods, services, capital and labour through the ‘New Zealand as a nation’ lens, we find integration generally yields productivity improving effects. However, looking at New Zealand with a spatial perspective highlights some additional risks as well as benefits of integration. In particular, capital and labour could move out of New Zealand to more agglomerated places, in search of the higher productivity and wages associated with density. While these firms and workers may be more productive offshore, the benefits of their productivity improvements are lost to New Zealand. From the literature we identify four factors that are key in estimating the size of the ‘spatial’ risks of integration. The factors are technology, critical mass/agglomeration, absolute advantage and border effects. 1. Will technology reduce the need to be in an agglomeration to tap into productivity benefits, and so make it easier for firms to locate in the periphery? 2. Are firms able to find suitable levels of density for their needs in New Zealand cities and towns, or do they have to go offshore to access that density and its benefits? 3. Integration will push countries’ pattern of specialisation towards those activities where they have an absolute advantage – what are the implications for the level and type of activity that New Zealand might sustain in the future? 3 4. ‘Border effects’ can be thought of as less explicit barriers to integration which place an upper limit on the amount of activity that flows out of a country – how will these operate in New Zealand? More empirical work around the mobility of firms and people would shed valuable light on these issues. Empirical evidence At a broad level, the empirical evidence on the effect of openness and integration on growth and productivity is mixed. Cross-country regressions tend to find positive relationships but there are concerns over the robustness of the methodology. More specific case studies of countries or industries tend to support openness. 5. Integration and Income Distribution A classic critique of openness and globalisation is that they cause the distribution of income to become more unequal. Income distribution in New Zealand has widened over the past two decades. Part of this may be due to increased economic integration, although it is very difficult to disentangle from the many other factors influencing income distribution. International evidence has attributed perhaps 5 to 20 percent of the change in the distribution of earnings to trade. Although the effect of integration on the overall distribution of income is unclear, trade liberalisation is likely to change the position of individuals and groups within the distribution, and result in winners and losers. Consumers will benefit, through access to lower priced goods. Costs are likely to be concentrated on relatively small groups of workers in sectors that are no longer competitive. A key question is: are the losers permanently disadvantaged, or is the dislocation a relatively temporary one? If labour markets adjust rapidly, through people moving or retraining or both, the effect of the shock will be temporary. Government may still want to consider temporary assistance to help people cope with the effects of integration. For some the shock may be permanent and they may not be able to recover. We need to study more closely mechanisms of labour market adjustment in order to know what sort of policy response is appropriate. 6. Integration and Decision Making Sovereignty There is a concern that national sovereignty – the decision-making power of nation states – is diminished in an increasingly integrated and global world. One facet of the concern is that increasing cross border flows of capital and labour generate economic pressures that place limits on domestic policies. To some degree global capital markets do limit choices. This may not be a bad 4 thing if it supports domestic policy and binds commitment from successive governments. More fundamentally, sovereignty does not require limitless choices. Nations have always operated within the parameters of the options actually open to them and the pressures upon them. In a changing world these options and pressures have changed, but the effect on sovereignty is unclear. Another focus for concern is that the increasing trend toward international decision-making represents a transfer of power from nation states to international organisations, and therefore harms national sovereignty. Again, use of the concept sovereignty is problematically imprecise. Signing up to international norms sets parameters on domestic policy. It will therefore only be undertaken for a greater expected benefit. This may amount to a loss of sovereignty (in the same sense that signing a contract limits an individual) but the real question is whether the benefits to New Zealand outweigh the costs of signing. Developing a framework or taxonomy for how we think about the costs and benefits of international cooperation is an important area for further work. Levels of governance If we change our perspective to ‘New Zealand as a region’ we see that there are a number of different possible levels of decision-making, and the nation state is only one. Rather than trying to decide when New Zealand should give up some of its sovereignty to international fora, the question can then be recast as an issue about subsidiarity: at what level of governance should decision-making be carried out. It may then be possible to apply the principles that guide decisions of devolution to lower levels of government, to decisions of ‘devolution up’, to international cooperation. The paper discusses how the principles of balanced, informed and cost effective decision-making might be applied in the international context. 7. Integration and Identity Identity, a sense of who we are, seems to be important to us. There is a multitude of ways that we define ourselves; national identity is one that has been particularly powerful. To the extent that we value it, national identity represents a limiting parameter for policy. Policy integration can only occur to the degree that people feel comfortable with it. Nevertheless, there are a number of points to keep in mind. Firstly, identity is dynamic. Identity and culture have always evolved over time. It may be the rapid speed of evolution in culture and identity that causes us particular dislocation and concern. Secondly, change can be beneficial in terms of opening New Zealand to new ideas and different perspectives, which may make us more tolerant as well as innovative. Finally, national identity can also be a powerful negative force when directed against those identified as not belonging. The challenge for the future is: how do we foster an evolving sense of identity in a world of increasing mobility and merging of cultural influence? 5 8. Conclusions and Policy Implications We have identified costs and benefits of integration across goods, services, capital and labour markets in terms of both material, and less tangible, aspects of living standards. A simple calculus of the relative weights of various considerations is not possible because it involves empirical uncertainties and political judgements. Integration is good for productivity. However, much of the analysis about the productivity advantages of integration hinges on how seriously we view the risk that economic activity will locate offshore as factor markets free up, and how much we can influence this. A particular development priority is work aimed at understanding the nature of capital and labour mobility between New Zealand and other countries. Concerns about income distribution centre on the fact that some will suffer as a result of a changed environment. How much of a problem this is may depend, to a large degree, on the speed and nature of labour market adjustment. Research on labour market adjustment in New Zealand is another area for further work. At the centre of the analysis lie matters of value, which cannot be resolved by applying economic, or other, arguments. Are we aiming to maximise the welfare of residents or citizens? Do we value places as well as people? What does it mean to be a New Zealander? These sorts of questions concern the preferences and attitudes of New Zealanders and should be vigorously debated in the public sphere. This work provides new perspectives to apply to policy problems. It reminds us of the importance of clearly identifying goals and objectives and making linkages across policy areas. It highlights the need to distinguish between what we can’t control and must simply respond to, and where we do have choices. It raises questions such as: how do we think more clearly about the benefits and costs of being different?; and how do we think more clearly about the benefits and costs of signing up to international agreements? Objectives canvassed in the paper now need to be combined with practical considerations to determine what might be desirable and achievable in policy terms. 6 1. Introduction 1.1 Context Integration is occurring. Every day individuals and businesses are making decisions and taking actions that cross national borders. In this environment the government has some degree of influence over the pace and nature of integration, but by no means total control. Policy can oil the wheels of integration, or put sand in the wheels; it cannot drive the machine. Government roles include: • setting the environment for openness unilaterally, eg setting tariff levels, immigration rules, statements on the desirability or otherwise of foreign investment, and exchange rate policy; • engagements with other countries – this involves choices about how much and where policy resources and discretionary powers are to be deployed, eg deciding who to pursue integration with, whether bilaterally, regionally or multilaterally; what agreements should cover; and what sectors should be prioritised; • domestic policies to manage the consequences of integration, eg assisting with adjustment for workers and regions affected by changes. The policy areas pertaining to these three roles are numerous. External economic strategy can, most broadly, be understood as encompassing all topics relevant to the cross border flows of goods, services, capital and people. Thinking about external economic goals at a broad level will help us to identify linkages between various areas of external economic policy as well as provide a systematic basis for allocating limited resources, making trade offs and prioritising policy initiatives. It should also assist us in determining the relative importance of integration in achieving higher living standards compared to domestic policy, and ensure that domestic and external policy settings are aligned. There are costs and benefits of any course of action, including changing nothing. However the costs of the status quo often become starker in an environment of crisis. How likely we are to change our external economic strategy depends on how well we think we are doing with our current policy settings. We live in a dynamic environment and things can quickly move on and off the agenda. 1.2 What the paper does The paper provides an analytical structure for clarifying external economic goals, by discussing the benefits and costs of market integration. It analyses how cross border flows of goods, services, capital and labour affect the living standards of New Zealanders in terms of both monetary aspects of living standards (productivity and incomes) as well as other, broader, values. 13 Whatever view one takes about living standards, income is important. A large proportion of what matters to individuals and families has to be paid for. Income brings choices; it allows greater levels of consumption, more leisure, greater capacity for individuals to help those less fortunate than themselves, and greater means for the economy as a whole to provide education, health and other social services. The key to higher incomes is productivity. Higher productivity means that more goods and services can be produced for the same amount of resources and effort. Whatever mix of outcomes New Zealanders choose, longterm growth in production and incomes is the foundation upon which higher living standards are built. Economic theory has taught us that integration and openness are likely to have positive effects on productivity and growth. Section 4 below reviews the evidence on the links between cross border flows of goods, services, capital and labour, and productivity. Other, broader, aspects of living standards, however, often fuel concerns about trade, integration and globalisation. Some argue that openness has contributed to growing income disparities. Many are worried that globalisation has compromised, and will continue to compromise, our control over our lives and erode both our personal and national sovereignty. This fear is linked to a vaguely defined, but deeply felt, concern about who we are as New Zealanders. In Section 5 to 7 we discuss the effects of integration on income distribution, decision-making/sovereignty and identity. These three issues have been selected because they seem to be particularly high profile concerns associated with integration and globalisation.2 Sovereignty and identity in particular are new areas for us: the paper offers some initial thinking and ideas on these topics, but we are by no means experts! 3.2 A new perspective In our analysis we employ two conceptual windows. View One: New Zealand as a Nation State We can think of the world as comprising sovereign nations with borders that clearly differentiate each from the rest of the world. Traditional trade literature puts the focus on New Zealand as a nation, experiencing flows across its borders but not experiencing any effects from the particular spatial patterns of the flows. Traditional political thinking takes the nation state as its base unit of analysis and concerns itself with what the appropriate role and powers of this state should be. 2 Concern about globalisation is also associated with environmental issues. Choosing to discuss decision-making and identity rather than environmental issues in this paper reflects our view that these issues have been less well canvassed elsewhere. 14 View Two: New Zealand as a Region Alternatively we can think of the world as a series of concentric groupings. At the most basic level is the individual, or the family. Beyond that there are local groupings at various levels, such as community, city or region. Nations with a federal system include government at province or state level. Beyond state government is national (or federal, or central) government. Beyond nation states there are international groupings, bilateral and regional. Finally, at the widest level, there are international groupings including all of humanity. New Zealand the nation state is but one level of social organization – we are a region within larger regions, and we contain smaller regions within our borders. View Two takes the focus off the nation state and views New Zealand as a sub-region within larger, and smaller, areas. Figure 2: Conceptual framework – taking the emphasis off the nation state More recent literature in economic geography takes this view. It puts the focus on New Zealand as a region of a larger space, say, the Australasian region or the Asia-Pacific, or the world. This reveals the implications of spatial location for cross border flows to a much greater degree and provides a different view of the effects of openness and integration. If we apply this perspective to issues of political governance we also gain new insights. Questions about the role of the state broaden to include questions about the level of governance at which decision-making is best carried out. International groupings Nation State Local region Community Family Individual 15 View One is the more traditional way of looking at the world. We are accustomed to thinking of our planet in terms of political, nation state shaped, chunks. This is to be expected; over the last 200 years, nation states have been the dominant political unit of social organisation. However, it is important to keep in mind that nation states are a modern phenomenon. Prior to the nineteenth century, social organisation was based on agrarian social structures that were both smaller than nation state units (city states, feudal principalities) and larger (empires, both secular and religious). What View Two helps us keep in mind, is that nation states are not ‘naturally’ privileged. They are one level of social organization – a particularly important one in the modern world – but there are others. Furthermore, in an increasingly global world, nation states may be losing their primacy. There has been a trend in recent years toward both devolution to lower levels of government and cooperation with higher levels. What these developments have in common is a de-emphasising of the nation state.3 Looking at issues of integration from the perspective of View Two sheds a different light on many of the issues. In particular, there are implications for the location of economic activity, governance and identity. Let’s keep these two conceptual windows in mind as we proceed with the analysis. 3 There may be debate about the degree to which nation states are actually losing their primacy. This is a matter for historians and political analysts and, in any case, is secondary to this discussion, since what is being advanced is an analytic tool rather than a statement of empirical fact. 16 4. Integration, Incomes and Productivity As discussed in Section 3, living standards have many elements, tangible and intangible. This section focuses on two tangible elements of living standards – higher incomes and employment opportunities – and the role openness and integration play in relation to these elements. It also looks at the ability to purchase a greater variety of goods and services, though in less depth. This section is structured as follows. • To set the scene, section 4.1 briefly looks at the link between productivity and higher living standards and argues that productivity is the key to higher incomes. • Section 4.2 discusses what general effects might improve productivity, introduces some spatial economic ideas and weighs up the importance of domestic policy versus openness in achieving productivity improvements. • Section 4.3 looks at whether cross border flows of goods and factors can lead to these productivity-improving effects. The discussion is split in two: first we look at New Zealand as a nation, secondly at New Zealand as a region. • Section 4.4 surveys some recent empirical literature on the relationship between openness and growth. • Section 4.5 concludes. 4.1 Productivity and living standards Higher incomes are an important component of rising living standards. They allow: • greater levels of consumption for individuals; • more leisure, for example taking more holidays or working fewer hours; • greater capacity for individuals to help those less fortunate than themselves, through donations of either time or money; and • greater means for the economy as a whole to provide education, health and other social services, as well as support for cultural activities4. The key to higher incomes is productivity. Productivity is a measure of the rate at which outputs of goods and services are produced from given amounts of inputs. Higher productivity means that more goods and services can be produced from the same amount of resources and effort. As output increases so too do incomes, as more wages are paid and profits rise. Using more inputs can also increase output. However, this implies a cost – that of using the input. It is also possible that increasing inputs may raise overall activity but not increase per capita incomes5. Galt (2000) says that productivity is particularly relevant as a contributor to raising GDP per capita or other welfare 4 Industry Commission (1997), pg 79 5 For a discussion of growth and the contribution of increased inputs see Appendix 1. 17 related measures of performance, as it does not necessarily require additional inputs to achieve gains. He notes that total factor productivity (TFP) has historically been the single largest contributor to GDP growth in New Zealand6. For Australia, productivity growth has accounted for around half the growth in output between 1964-65 and 1995-967. It has also accounted for around twothirds of the increase in Australian living standards over the same period. Productivity also affects employment. In general, productivity growth over the long term creates the opportunity for new demands to be created and realised, leading to changes in the pattern of employment, but not necessarily long-term reductions in employment. For OECD countries as a whole, since the early 1970s declining rates of productivity growth have coincided with increasing rates of unemployment, and the period of highest productivity for most OECD countries coincided with the period of lowest unemployment8. It appears that there is a positive relationship between productivity and employment. 4.2 What improves productivity? What are the linkages between openness, integration and productivity? Figure 3 lays out the framework we have chosen to use in this section – it shows how cross border flows affect productivity and ultimately the goal of higher living standards for New Zealanders. 6 For a discussion of productivity performance in New Zealand see Diewert and Lawrence (1999) 7 Industry Commission (1997), chapter 3. 8 Industry Commission (1997) pg 104 18 Figure 3: Linkages between higher living standards and cross border flows of goods, services, labour and capital Cross-border flows of goods, services, labour and capital Adapted from Productivity Commission 1999, pg 155. Goal To raise the living standards of New Zealanders • Higher incomes • Employment opportunities Productivity improvements Economic effects • Resource allocation • Scale, scope and specialisation • Technological advance • Accumulation of human capital • Accumulation of physical capital • Firm organisation, management practices and work arrangements • Plant/firm turnover within industries POLICIES • • • • • • • • • 19 Cross border flows are defined as those flows of goods, services, labour and capital that move across New Zealand’s internationally recognised boundary. These cross border flows set off various reactions in the economy. We are interested in knowing whether these reactions are productivity-improving effects. As discussed in section 4.1, if there are productivity improvements then it is possible to raise living standards. Affecting this is the policy environment relating to cross border flows – policies will alter the effects of cross border flows and hence affect productivity. There are a number of ways that one can classify the various mechanisms for improving productivity. We chose to consider them under the following headings: resource allocation; scale, scope and specialisation; technological advance; firm organisation, management practices and work arrangements; and plant/firm turnover within industries, as outlined in Figure 3. However, in using these headings, we should not lose sight of the fact that all of these ways of improving productivity share a fundamental common component: the importance of high quality decision-making by the firms, individuals and institutions involved. Ultimately, improved productivity stems from better decisions about the use of valuable assets. Of course, Figure 3 is simplified. We have chosen to focus on the productivity linkages as this provides a dynamic analysis. It is likely that the dynamic story surrounding cross border flows may be more interesting than the static story, with the dynamic benefits of cross border flows outweighing the static benefits due to their ongoing nature. There are other aspects that could be included in Figure 3, for example, the presence of welfare effects. Trade in goods and services allows consumers to enlarge their consumption possibilities, thus improving living standards. This is an important benefit of openness beyond productivity improvements and is mentioned briefly later in the chapter. However, given the static nature of the benefits we chose not to make it a central element of our framework. The central question is how is productivity affected by openness and integration in the goods, services, capital and labour markets? We approach the answer in two stages. First, in this section, we take a closer look at the ‘economic effects’ box in Figure 3 – how do we get productivity improvements? Secondly, in section 4.3, we look at how cross border flows affect productivity via our ‘economic effects’. Through both of these stages we attempt to distil some key messages. The impact of policy on cross border flows will be addressed briefly in Section 9 later in the paper – this is certainly an area for further reflection and work. It is important to note that a country’s level of integration is only one factor affecting productivity. Domestic policy is also important. At the end of this section we attempt to weigh up the relative value of openness against the value of domestic policy, in order to provide a balanced view of the merits of openness. 20 4.2.1 Resource allocation The importance of allocating resources well for ensuring high levels of productivity is intuitively obvious. Essentially, it can be summed up in the statement that "you've got to make the most of what you've got". Economists have a number of concepts for thinking about resource allocation. The first is simply that resources should not be used wastefully; that one should use the minimum amount of resources to produce a given output, in accordance with technology. This is referred to as technical or productive efficiency. The second is that resources should be used in the areas where they can be of most value, given the skills and preferences of the population. This is known as allocative efficiency. Note that this idea of allocative efficiency is pertinent both within firms (eg are our productive processes geared in the right way?) and between firms (eg are resources flowing to the right parts of the economy?). The third concept is that, as time passes, external factors change, for example other countries become more competitive or relative prices for exports change. The economy should be flexible enough to allow changes in resource allocation (structural change) at low cost. This is known as dynamic efficiency. Improvements in all these types of efficiency can lift the productivity performance of a country. While the importance of good resource allocation may seem obvious, it is important not to underestimate its value. Getting resource allocation right over the long-term is crucial to ensuring maximum growth, incomes and employment. 4.2.2 Scale, scope and specialisation Scale, scope and specialisation offer significant abilities for individuals and firms, and therefore nations, to improve productivity. Specialisation is probably the most fundamental. The concept holds at the level of the individual, firm and country. For an individual or firm, specialisation suggests focusing on performing a specific task, becoming expert in a particular field, or producing just a few products or services. This allows the individual or firm to become skilled at their chosen task and more productive at carrying it out, particularly as they learn better ways to operate. For a country, specialisation suggests producing a limited number of products or services but producing more than is required to satisfy domestic demand, and then trading this surplus for other things not produced domestically. The payoff of this ability to specialise is particularly important for such a small nation as New Zealand. By way of illustration, when New Zealand continued to assemble (not actually make) cars in the mid 1990s, it was calculated that car buyers had to pay many thousands of dollars in tariff revenue per car over and above the price other countries could produce and ship the car for. Specialisation at the country level has traditionally been thought of as being driven by comparative advantage, that is, focussing on what we are good at making and importing what we are less good at. However, the rapid growth of intra-firm trade and the 21 observable patterns of countries selling similar products to each other have led to other models of the drivers of specialisation and trade being considered important. Scale is also an important contributor to productivity. Economies of scale exist when the expansion of activity within a firm allows it to enjoy reduced average costs of production. Higher productivity results as fewer inputs are used per unit of output. The level of output where this effect stops will vary from industry to industry, however, there is no doubt, for example, that the New Zealand dairy industry would not be able to produce milk and dairy products as cheaply as it does if it only produced, say one-tenth, of the current amount. Economies of scale can also encourage further specialisation, unleashing another round of productivity-improving forces. Finally, scope can have a positive effect on productivity. Economies of scope exist when a firm’s cost of producing a unit of output can be reduced due to the range of activities carried out by that firm, or other firms in the region. Such effects are the key drivers behind the clustering of firms in a region. 4.2.3 Technological advance Technological advance is widely recognised as being a central driver of productivity improvements and economic growth. It encompasses the ideas of invention, innovation and diffusion. By definition it helps to improve productivity, as technological advance improves processes for making existing goods and services and creates new goods and services that better satisfy consumers. This improves the efficiency of resource use and helps to make more from resources over time. Technological advance comes through many avenues. Science based innovation can be very risky and may account for only about 20% of all technical progress9. Non-science innovation generally happens within firms and is less risky than science generated innovation. 4.2.4 Accumulation of human capital The accumulation of human capital is vital for increasing productivity. It is not enough simply to have more workers – those workers also need to be highly skilled and better educated10. More educated workers are better at making, using and improving new knowledge, which stimulates technological advance and thus productivity. They are also better at adapting foreign technologies to local conditions – an important factor for a small country such as New Zealand. Skilled workers tend to be more flexible to changes in tasks and processes. More skilled people also tend to be more discerning consumers. This is also beneficial to productivity as it puts additional pressure on producers to make 9 Salter & Martin (1999) 10 See Appendix 1 for a discussion of input accumulation and growth. 22 quality products, use resources efficiently, and come up with innovative new ideas. 4.2.5 Accumulation of physical capital As discussed in Appendix 1, higher inputs of capital can contribute to economic growth by increasing productive capacity. However, higher levels of capital can also directly help to improve productivity. Firstly, labour productivity is increased as workers each have more capital to work with. This is known as capital deepening. Secondly, investment in capital equipment may create knowledge spillovers as skilled workers seek to understand and improve on technologies embodied in capital equipment11. This ‘spillover’ effect can help to increase total factor productivity (TFP). 4.2.6 Firm organisation, management practices and work arrangements The way in which New Zealand firms are organised and managed will affect their profitability, and ultimately the nation's productivity. There is a great deal of evidence internationally that attests to the importance of firm organisation, management practices and work arrangements. Firm organisation refers to organisational structure – a good structure will allow and encourage flexibility and cross-fertilisation of ideas so as to enhance innovation and creativity. Management practices refer to such things as Total Quality Management, strategic planning and human resource management. Practices should support long-term planning and innovation and the ongoing improvement of processes and workers. Finally, work arrangements refer mainly to industrial relations. Workplace and individual bargaining give more scope for flexibility, enables firms to better reward productivity improvements and allows the scope to introduce bonuses and other performance related measures. In New Zealand, studies suggest that management practices and work arrangements have steadily improved over the last decade, but still fall some way behind international best practice12. 4.2.7 Plant/firm turnover Many of the firms that now dominate certain sectors of the economy did not exist 20 years ago, particularly in the "new" technology sectors. It is relatively widely agreed that new firms are the key providers of innovation, and hence that a healthy supply of new firms is essential for a flourishing economy13. The flipside is that older, less productive firms need to be able to decline so that resources are released to new firms. 11 Productivity Commission (1999) pg 151 12 Healy (1999). Also see, for example, Campbell-Hunt, Harper & Hamilton (1993) “Islands of Excellence? A study of management in New Zealand.” Also, CampbellHunt & Corbett (1996) “A season of excellence?” An overview of New Zealand enterprise in the nineties.” 13 Levehsohn & Petrin (1999) 29 Industry Policy – A Discussion Theory suggests that, under certain circumstances, government support of a domestic industry against foreign competition can reap net benefits for the country. The benefits stem from the increased scale and market share of the industry. There are several considerations that undermine this direction for government policy25. Firstly, the policy recommendations are sensitive to the industry’s market structure – competition based on price suggests a tax on the home firm, whereas competition based on output suggests a subsidy. Government would have to hold extremely accurate information about firm behaviour in order to determine the policy intervention. Secondly, government subsidies can induce excessive entry into the industry, leading to resource misallocation and failure to achieve economies of scale at the firm level. Thirdly, there is a risk of foreign retaliation. Fourthly, there is a risk that special interest groups, whose lobbying can compromise the effectiveness of policy and whose ‘noise’ makes it difficult to collect accurate data and information, will capture policy. Finally there is the fiscal cost of paying for industrial support. At a practical level, there are difficulties in selecting the right industry to support. There are also costs if chosen industries fail to reach independence, or if supported industries fail to advance. In short, the theoretical ideas about economies of scale and trade do not lend themselves to clear and simple policy implications when we look through the traditional ‘New Zealand as a nation’ lens. Nonetheless, many countries choose to undertake industry policy. Some have had more success than others. The interesting point to note is that many developing countries choose to use trade policy as their industry policy lever to encourage manufacturing over agriculture in order to ‘catch-up’ to developed countries. Some countries use tariffs and other protective policies to encourage the replacement of imported manufactures by domestic products. These policies have been successful in encouraging manufacturing in some countries but in others there has been stagnation in per capita income growth and lack of catchup to advanced countries. The policies can also give rise to a dual economy where one section of the economy and population is doing well while the other struggles. The policies can lead to a widening distribution of incomes. Often the export sector suffers. Other countries follow a more export-oriented policy. This is not strictly free trade, but rates of protection are lower and less variable across sectors. Countries that fall into this category would include Korea, Taiwan and Singapore. All these countries have had quite successful economic growth stories. In general though, using trade policy tools for industry policy purposes is costly. There are other policies that aim more directly at industry policy goals and these will be more efficient and effective. It may be that for a developing country, the tax base is too unstable to sustain subsidies to industry, and so trade policy is used instead. But for a developed country, direct tools should be used. Industry policy and trade policy should not be confused. Should industry policy be used at all? From these arguments, the answer seems to be ‘no’. But when we look through our ‘New Zealand as a region’ lens? Read on… 25 See Cheng (1999) 30 Analytically the story about services trade is similar to that for goods trade. There are gains from specialisation, the reallocation of resources, economies of scale and innovativeness stemming from competitive pressures. Competition in the service sector can also reduce costs for other businesses that use services as an intermediate input into their own production. However, the movement of services across borders additionally implies the movement of people and/or extensive use of telecommunications networks. The movement of people would usually be only temporary, for example, an engineering consultant from New Zealand going to Asia for a few months, or an American tourist coming to New Zealand for a holiday. Temporary foreign workers can be an important source of new ideas and New Zealanders who work temporarily overseas can also pick up new ideas and contacts that can later benefit activity in New Zealand. The movement of labour will be discussed in more depth later in this section. Unilateral Liberalisation – What are the Gains? The discussion in this section has implicitly assumed that New Zealand is liberalising goods and services trade in concert with its trading partners. But unilateral liberalisation can also allow us to tap into some of the gains from trade, even if our partners keep their barriers up. New Zealand’s high rate of protection in the 1960s and 1970s led many commentators to call for liberalisation. Carpinter (1979) concluded that the method of protection in New Zealand, specifically quantitative import controls, was detrimental to economic performance. Local price signals were distorted and international competition stifled, leading to unprofitable enterprise, distorted investment, stunted exports, inefficient use of resources, poor productivity growth and continued Balance of Payments problems. Lloyd et al (1980) agreed, saying that major structural change was a necessary condition for acceleration in the rate of growth of real output. Government assistance to industries in the form of restrictions on import and export trade distorted the allocation of resources between and within the export and import-competing and non-tradeable sector. This reduced the level of international trade and the size of the tradeable sector and slowed the rate of growth of productivity by restricting competition and hindering adaptation to structural change. Lloyd saw the removal of this government assistance as important in promoting structural change and economic growth. Unilaterally removing layers of protection allowed New Zealand to access the benefits of openness. It also paved the way for more far-reaching liberalisation, for example, CER with Australia. 31 Capital Once we allow factors of production to move the analysis becomes more complex. In this section we look at the impact of allowing free movement of capital across borders. This includes movement of both direct investment funds and portfolio investment funds. There are a number of general benefits of allowing free capital flows26. To begin with the domestic cost of capital moves closer to the global cost of capital. The true value of an investment opportunity will be judged more accurately and resources will therefore be better allocated. Also contributing to better resource allocation is greater transparency, which reduces favouritism and corruption in the system; fewer resources are wasted on attempting to dodge controls through bribery for example. Secondly, countries may be able to borrow and lend on more favourable terms. This flows through into lower costs for firms sourcing capital. This gain stems from breaking the constraining link between domestic saving and investment as countries and firms can draw on foreign savings to finance domestic investment. However, pushing against this, there is evidence that home bias in portfolio investment remains, even with free capital flows, due to the perceived advantages of dealing with the ‘familiar’ outweighing the perceived benefits of diversification27. Allowing firms and countries to access foreign savings also raises issues around the level of the current account – a large appetite for foreign borrowing may increase the current account deficit to such a level as to increase the cost of borrowing for the country as a whole. Another general benefit of open capital markets is the greater level of portfolio diversification available. This can reduce the volatility of investment returns and even increase actual returns if higher returns may be gained on foreign asset holdings. Open capital markets also encourage innovation and efficiency in domestic financial markets, as well as supervision and good regulation of the financial sector. Finally, the multilateral trading system is supported by free capital flows, since payments for goods and services can be made freely, and more sophisticated financial arrangements (e.g. futures) can be entered into, which stimulates further trade. There is some debate over whether capital flows are a substitute for trade. Trade theory tells us that movements of factors of production can alter production in such a way as to remove the need for trade in goods and services. However, given the simultaneous rise in both levels of trade and levels of capital flows over history, one could suggest that capital flows are a complement to trade, hence the idea that capital flows support the trading system. There are some particular benefits to be gained from allowing free movement of direct investment funds. Inward direct investment often brings with it new technology and ideas, management competency and formal training of the workforce. It can also lead to greater competition in the marketplace. These factors all contribute to productivity improvements. The benefits can also 26 Box (1999a), Chapman (2000) 27 Helliwell (1998) pg 69-72 32 spillover to domestic firms as people move and ideas disperse, initiating further productivity improvements. A good example of the benefits of inward direct investment is provided by Ireland – foreign firms in Ireland employ highly skilled people and tend to pay significantly higher wages than domestic firms28. Outward direct investment brings benefits as well. Most importantly, New Zealand firms offshore may transfer new technology or knowledge back to New Zealand. Being located in an offshore market not only offers opportunities to pick up new ideas, it may also provide greater impetus to innovate if the market is large, as the potential to appropriate the gains is bigger. Secondly, offshore firms may provide domestic firms with access to networks of suppliers, distributors, researchers and other important contacts that provide valuable externalities that are inaccessible from a New Zealand base. Thirdly, it may be easier to access offshore markets via direct investment in the market, and it may also get around domestic production and marketing constraints and allow greater economies of scale. Finally, investing offshore may allow New Zealand firms to experiment with new techniques for management and with new organisational options, which can then be brought back to New Zealand and operationalised. However, there are concerns over both inward and outward foreign direct investment. Inward foreign investment raises issues such as the ownership of assets and sovereignty, while outward investment raises issues such as the loss of domestic jobs. The first two concerns will be explored in more depth in Section 6. The loss of domestic activity will be discussed later in this section in the context of ‘New Zealand as a region’. There are also potential costs of having open capital markets29. These costs have taken on greater visibility of late with the financial crisis in Asia and earlier difficulties in Latin America. To begin with, capital flows may harm domestic economic activity. There are a number of reasons why this might occur. Firstly, capital flows cause adjustments in the real economy, that is, production and employment. As the real economy responds to change more slowly than financial capital there can be real adjustment costs imposed by volatile flows of capital, or by a sudden outflow of capital. A greater amount of liquidity will magnify any change in market sentiment and increase the risk of contagion. Secondly, capital flows may cause excessive changes in, and misalignment of, domestic asset prices and may lead to inflationary pressure. Excessive interest rate variability may lead to under-investment in real capital. Thirdly, free capital flows imply a freely floating exchange rate. New models of exchange rate determination that are based on the process of information gathering and expectation formation show that the exchange rate can get severely out of line with fundamentals, leading to the exchange rate being a source of shocks in the economy rather than an absorber of shocks. It can also cause resource misallocation, particularly between the tradeable and non-tradeable sectors30. 28 Barry & Bradley (1997), see Box (1998) for more information on the Irish economy. 29 Box (1999a), Chapman (2000) 30 See Coleman (1998) 33 However, others argue that strong institutions and well governed banking sectors will lessen the risk of open capital markets imposing costs on economies. Another argument against free capital flows is that they may act as a constraint on government actions. International credit ratings affect the cost of capital faced by a country, thus monetary and fiscal policies come under the spotlight. On the other hand, free capital flows could be seen as positive constraints on government behaviour by making the costs of decisions more transparent. Other concerns are that the accumulation of foreign liabilities may also cause difficulties with the current account, as mentioned earlier in this section. Capital flows may also be a source of inequality within a country if foreign interests cause rapid asset price inflation, for example in land. There are also issues over ownership31. These latter issues will be discussed in more depth in Section 7. To conclude, free flows of capital, both inward and outward, are another important source of productivity improvements. But they have potential costs. Better resource allocation and new sources of ideas and technology must be weighed up against possible greater volatility and uncertainty. Strong institutions and well-governed banking sectors may reduce the risks. A degree of home bias exists, which reduces the total volume of cross border capital flows. Labour The final stage of the analysis is to allow free flows of labour across borders. Of all the flows we have looked at, labour is the least likely to ever achieve full mobility. There are important cultural reasons why people stay attached to their homeland, and feel threatened by outsiders moving in. This section seeks to set out the benefits and costs of cross border labour movements. The macroeconomic effects of inward flows are difficult to pin down32. Empirical estimates of the growth effect of immigration are highly dependant on the starting assumptions, particularly whether immigrants increase economies of scale. The overall effect is regarded as a small positive; economic activity overall will increase but the effect on per capita incomes is ambiguous, with the effect depending on migrants’ personal profiles (skills, assets, education), saving and investment habits and consumption habits. New Zealand seeks immigrants with high human capital and entrepreneurial skills in order to maximise the chances of positive growth effects. These attributes also contribute positively to productivity. Indeed, evidence shows that immigrants to New Zealand who have higher skill levels and good English proficiency have better labour market outcomes, and the intergenerational transmission of skills suggests their children too will perform better in the labour market. Entrepreneurship is more difficult to assess, as asset accumulation does not necessarily lead to investment in active ventures. Many wealthy migrants to New Zealand seem to prefer passive investment. However, even if high human capital and entrepreneurship could be easily assessed, New Zealand 31 Chapman (2000) 32 See Box (1999b) 34 still faces the problem of attracting this type of migrant against competition from other migrant nations such as Australia, Canada and the US. Immigration may also improve productivity by contributing to labour market efficiency. Migrants make up a disproportionately large fraction of marginal workers whose location decisions arbitrage differences across labour markets. US evidence has shown that new immigrants are more likely to choose the location that maximises their income, whereas residents and previous migrants tend to get stuck in a location and not respond immediately to wage differentials33. The distributional effects of inward flows of labour may be more important than the overall macroeconomic effects. Theoretically, free labour flows will increase pressure for wage equalisation as people move from places with low returns to places with high returns. There is some evidence from the US that immigrant inflows depress the employment rate and wages of natives in the same skill group34, but overall there are still vast differences in wages across countries. However, there is evidence that wage equalisation already exists if one takes labour productivity into account – there are higher wages for labour with higher productivity across all countries, suggesting that the global labour market is at work35. Outward flows of labour also have important implications. Emigration of skilled people is often referred to as ‘braindrain’ and is considered to be a negative influence on growth and productivity in the home country. Yet these people often return to their home country with new skills, knowledge and networks of colleagues that have a positive influence on productivity. This suggests we need to think more broadly about what benefits the New Zealand economy. Contributions such as overseas experience and lifting New Zealand’s profile offshore may be just as important as fiscal measures such as tax paid. This discussion also raises the question of what it means to be a New Zealander – whether once someone leaves the country they cease to exist in the official statistics and so we lose sight of their achievements and contributions. This is an extremely thorny question, as it ultimately asks of policy – ‘whose welfare are we trying to maximise?’ This area is certainly worthy of more discussion and debate, and the question of identity is traversed in Section 7 of this paper. As with flows of capital, we can ask whether labour movements are a substitute or complement to trade. We suggest the latter probably holds, particularly since labour maintains an immobile element due to cultural reasons. As alluded to above, emigrants can raise New Zealand’s profile offshore – this may be invaluable in building greater trade linkages and demand for New Zealand products. Immigrants can also assist in building trade linkages with other countries if they bring entrepreneurial skills, market knowledge and contacts/networks from their home country. It may be important for immigrants to have business skills to complement their language skills in order to fully 33 Borjas (1999) 34 David Card seminar – see Box (1999b) pg 11 footnote 35 Trefler (1993) 35 exploit these trade opportunities. Empirical evidence suggests there needs to be a critical mass of immigrants from a particular country before trade is stimulated, but the exact number is unclear. These immigrants may also need to be in the same place/city. The process of building trade linkages is a longterm one, requiring on-going effort. Summary: New Zealand as a Nation Free trade in goods and services yields productivity-improving benefits in the form of better resource allocation, specialisation, economies of scale and impetus for innovation. There are also consumer welfare benefits from increased choice in the marketplace. The temporary movement of labour associated with goods and services trade brings additional benefits in the form of new ideas and foreign contacts and networks. New Zealand’s program of unilateral liberalisation allowed it to start tapping into these productivity benefits despite slower movement by trading partners. Both interand intra-industry trade will take place. Intra-industry trade leads to smaller income distribution effects as this type of trade involves shifting resources between different varieties of the same industry, rather than shifting resources between whole industries. Free flows of capital, both inward and outward, are another important source of productivity improvements. But they have potential costs. Better resource allocation and new sources of ideas and technology must be weighed up against possible greater volatility and uncertainty. Strong institutions and wellgoverned banking sectors may reduce the risks. A degree of home bias exists, which reduces the total volume of cross border capital flows. Free labour flows bring productivity benefits in the form of efficient labour markets, human capital accumulation, innovation and scale. However, labour flows are more emotive than flows of goods, services and capital – different cultures, languages, attitudes and institutions hold the world back from complete labour mobility. Greater movement of people around the world raises issues of national identity and what it means to be a New Zealander. This creates tricky questions for policy, around whose welfare we are trying to maximise. We believe this is an area ripe for debate. 4.3.2 New Zealand as a region Now let’s change our perspective and look at New Zealand as a region within a larger geographical and economic area. When we begin to think about New Zealand as a region, we need to employ some spatial economic ideas. Goods and services From the discussion above we know that trade in goods and services will see countries specialising and perhaps ceasing to produce in certain industries or certain niches of industries. Resources will shift towards the area of specialisation. Adding in the spatial dimension suggests that export-oriented firms will feel a greater push to locate in places within New Zealand that have good market access, for example close to a port, or particularly good access to 36 raw materials. This will help to lower costs and improve productivity. Their choice of location will also influence the location decisions of other firms that provide goods and services to those exporters or to the workers employed there. The benefits from agglomeration, as discussed in section 4.2.8, all suggest there can be significant productivity improvements if firms, as a result of free trade in goods and services, decide to co-locate in particular areas. These productivity improvements are over and above those obtained from simple specialisation and resource reallocation between industries. As only goods and services are moving in this initial stage of the analysis, the shifts in the location of resources we will see are within New Zealand, rather than between New Zealand and other countries. This has implications for New Zealand’s regional activity levels – some areas may decline while others grow. While these shifts will generally have positive effects on productivity overall, equity concerns may be raised about regions experiencing a loss of activity. The use of telecommunications technology to link producers and consumers is good news for New Zealand – despite our geographic disadvantage, the use of technology may allow us to compete in foreign markets. However, this must be tempered by caveats around how far technology can go in removing the need for proximity. Human contact is still extremely important due to the way information and knowledge flow between people. The most important flows are of tacit knowledge and since such knowledge is vague, difficult to codify and often only recognised by accident, it is important to transmit it face to face. It is likely that telecommunications will remain a complement to face-to-face contact rather than a substitute36. For regions within New Zealand, technology could be a double-edged sword. On one hand, technology could allow declining regions to maintain activity levels through, for example, providing remote services to the rest of New Zealand and perhaps foreign consumers. On the other hand, given the importance of agglomeration benefits, even firms that provide their services remotely may still choose to locate in a dense area. They may need access to technology support services, or feel that the business network available in an agglomeration will help them identify new customers. Dense areas also offer consumption benefits, which are attractive to workers who like greater variety and diversity. This leads cities to have a larger pool of prospective employees, again making dense areas attractive to firms. These effects would work against declining regions. Capital When we allow the free movement of capital across borders we can begin to ask interesting questions about firm location decisions. With the free movement of capital, firms are free to come to New Zealand but are also free to leave. Taking the argument from the ‘goods and services’ section further – if firms choose their location based on market access and access to raw materials and factors of 36 Box (2000) 37 production, and if they take into account agglomeration benefits and costs, then would they choose to locate in New Zealand? One way to examine this question more closely is to think about the level of trade costs (trade barriers and transport costs) in trade between countries37. These countries can be described as either ‘core’ or central countries, or as ‘periphery’ countries. When trade costs are high, activity/firms will spread across the core and periphery so that dispersed or immobile consumers can be served. At this point the benefits of agglomeration are not high enough to outweigh the costs of getting goods to dispersed consumers from a central production point. When trade costs start to fall it becomes easier to separate production from consumption and firms that operate under scale economies will choose to gain the benefits of agglomeration by clustering in the core. However, when trade costs fall to extremely low levels, the net benefits of agglomeration and proximity to others may diminish. Firms will be less willing to pay high wages in the core and may choose to disperse out to the periphery again. These relationships are illustrated in Figure 4 below. The effect of technology on the relationship between trade costs and agglomeration is unclear. As suggested in the previous section, technology can act as a double-edged sword. It can make it easer to access agglomeration benefits remotely and provide goods and services locally (i.e. locate in the periphery), or it can make it easier to agglomerate and provide goods and services remotely (i.e. locate in the core). It is up to individual businesses to assess their own situations and choose the scenario that best serves them. Figure 4: Trade costs and firm location 37 Venables (1998) High Low Trade costs Dispersed Agglomerated Location of activity 38 The questions are: where on this diagram is New Zealand; and how fast are we moving along the curve as trade costs fall? As a small geographically distant economy we could realistically describe ourselves as belonging to the periphery. Are firms at the point of wanting or needing to be in New Zealand; that is, are the dispersion forces pushing firms to locate in New Zealand? Or are agglomeration forces dominating, and if they are, is New Zealand able to sustain an agglomeration of its own or will the country become a declining region on the periphery? Will technology ever reduce the need for proximity enough to make mass dispersion to the periphery a viable option? These questions could reveal a sombre scenario – one where firms seek to locate in regional hubs rather than New Zealand so that they may enjoy the benefits of agglomeration. That is, resources may be reallocated and achieve higher productivity, but at the same time the overall level of activity in New Zealand may drop as these productivity improvements are gained from resources moving offshore. This is even more of a concern if cumulative causation sets in. This would happen when regional decline makes a region even more unattractive, with the result being a negative spiral ending perhaps in regional death. Another concern is that increased specialisation resulting from firm exit may make New Zealand more fragile and vulnerable to external shocks. However, we must be careful to conduct a reality check. The scenario above is based in theory. While theory works on the basis of free capital flows, in reality there are often practical reasons for firms to be wary of offshore operations – it is harder to operate in a foreign market with different rules, regulations and approaches. These ‘barriers’ to cross border integration are referred to as border effects and they play an important role in determining trade and investment flows. These border effects may place upper limits on the movement of activity offshore. Different industries will also prefer different levels of density, depending on the type of operation. This means that those firms who are happy operating in a less dense environment will be more inclined to stay within New Zealand. It would be interesting to know how various levels of density appeal to different types of firms, both within New Zealand and offshore. And of course, some firms, particularly those involved in natural resource based activities, have less ability to relocate. Empirically, the evidence on ‘footloose’ firms is mixed – some industries, such as assembly, seem to follow lower costs around the world, while others seem very loyal to their home market. A recent survey of manufacturing exporters in New Zealand found many owners would choose to remain in New Zealand for lifestyle reasons or because they felt some sort of ‘social conscience’ in supporting the local economy. This was true even if there were opportunities offshore38. This is an important reminder that location decisions are complex and the result of many factors. More analysis is needed in New Zealand to determine just how mobile firms really are, how many firms move and where they go to and the effects of firm departure on remaining activity. It will also be useful to monitor progress in the European Union, as a large natural experiment in the effects of integration. 38 Infometrics (1999) 45 4.5 Integration and productivity: conclusions Productivity is the key to higher incomes, and is thus very important in securing higher living standards for New Zealand. We identify seven mechanisms through which openness and integration may affect productivity: • resource allocation; • scale, scope and specialisation; • technological advance; • accumulation of human capital; • accumulation of physical capital; • firm organization, management practices and work arrangements; and • plant/firm turnover. Importantly, there is also a spatial dimension to productivity. The agglomeration of resources and production in a particular location can improve productivity as greater density leads to lower transport costs, greater specialisation of production and labour, labour market pooling effects and knowledge spillovers. This spatial dimension was a motivating factor for splitting the analysis into ‘New Zealand as a nation’ and ‘New Zealand as a region’, as we sought to understand the implications of viewing New Zealand through different conceptual windows. While domestic policy has an influence over the productivity-improving mechanisms and the spread of activity across space, openness is also important. For smaller countries, such as New Zealand, openness may assume greater significance than it would for a larger country that suffers less from market-size and resource constraints. Significantly, there may be diminishing returns to openness. If a country is open enough to receive knowledge transfers of the sort required to achieve convergence to higher growth and productivity, then further integration beyond that may not be important for growth. It is unclear what the optimal level of openness is for New Zealand and so the remainder of the discussion focuses on the effects of varying degrees of openness in order to inform the debate. Looking at the theory on cross border flows of goods, services, capital and labour through the ‘New Zealand as a nation’ lens, we find openness generally yields productivity improving effects. However, looking at New Zealand with a spatial perspective highlights some additional risks as well as benefits of openness. In particular, capital and labour could move out of New Zealand to more agglomerated places, in search of the higher productivity and wages associated with density. While these firms and workers may be more productive offshore, the benefits of their productivity improvements are lost to New Zealand. From the literature we identify four factors that are central in estimating the size of the ‘spatial’ risks of openness. The factors are technology, critical mass/agglomeration, absolute advantage and border effects. 1. Technology is important because it can reduce the need for face-to-face contact. However, this can work two ways – it may reduce the need to be 46 in an agglomeration to tap into productivity benefits, and so make it easier for firms to locate in the periphery, or it may reduce the need to be near the consumer, thus enabling firms to locate in the core and service the periphery market from a distance. The response of firms to technology improvements is crucial for understanding location decisions. 2. Critical mass or agglomeration levels in New Zealand are another key factor in location decisions. The important question is whether firms are able to find suitable levels of density for their needs in New Zealand cities and towns, or if they have to go offshore to access that density and its benefits. Different firms have different needs – this has implications for the type of firm that may be attracted to New Zealand and therefore the structure of the economy. 3. Absolute advantage is important as it gives an indication of the types of activity that would be sustainable in a fully integrated market. An integrated market with full labour mobility will not sustain wage differentials, thus those locations that do not have an absolute productivity advantage in some activity will decline. The implication for countries is that integration will push their pattern of specialisation towards those activities where they have an absolute advantage. If the country as a whole does not have absolute advantage in some activity then it will fail to attract firms or workers and will decline. Again this idea has implications for the level and type of activity that New Zealand might sustain in the future. 4. Finally, border effects will affect the amount of cross border flows that occur. Border effects can be thought of as less explicit barriers to integration, and include such things as different languages, institutions, trust and social capital. Countries tend to maintain some level of home bias because of these border effects – put simply; there is a higher degree of comfort in dealing with the familiar. This may act to place an upper limit on the amount of activity that flows out of a country. We believe more empirical work would shed valuable light on these issues. In particular, work on mobility of firms and people, the levels of density needed for various firm activities and the response of firms to technology would be extremely useful. On a broad level, the empirical evidence on the effect of openness and integration on growth and productivity is mixed. Cross-country regressions tend to find positive relationships, but there are concerns over the robustness of the methodology. More specific case studies of countries or industries tend to support openness. We believe the ideas in this section are an important step in understanding the implications of openness and integration for New Zealand. While we cannot conclude what the optimal level of openness is for New Zealand, we can clearly see the benefits and risks of different levels of openness. The difficulty in assessing an optimal point is attaching a level of welfare to each level of 47 openness and its associated risks and benefits. Not only is utility or welfare extremely hard to pin down, we have also raised in this section the question of whose welfare we are trying to maximise in an increasingly globalised world. We leave this as food for thought for the reader! 48 5. Integration and Income Distribution The discussion thus far has focussed on the effects of economic integration on productivity. Higher incomes are a central component of higher living standards and productivity was identified as the key to higher incomes. As discussed in Section 3, however, there are many other components of well-being. We now turn to the relationship between economic integration and income distribution. A classic critique of openness and globalisation, is that openness makes the distribution of income more unequal. It is important to note at the outset that there is no objectively ‘correct’ income distribution. It is a value judgement and reasonable people differ. What we think about distribution and fairness might depend on whether we compare ourselves to other countries (and which countries), to our own past (and which time period), or use some other yardstick. As a nation we have traditionally had a strong egalitarian ethic and have favoured some degree of redistribution. However, not all New Zealanders would view a wider distribution as a bad thing. Whatever our views and preferences on this issue, we make them felt through the political process. The job of this section is not to take a position on what a preferred income distribution might be, but to draw out evidence about the links with openness and highlight issues. The claim that economic integration causes more inequality is often focused on the effect of imports. The argument is that competition from cheap imports puts pressure on wages and jobs in firms that compete in these industries. Affected workers and business owners become poorer as resources are shifted to other areas of the economy. We think of car plants in Thames, woollen mills in Mosgiel, and Bendon factories in Te Aroha. Open capital markets are also cited as cause for concern. Global capital flows permit movement of activity and firms. While the effect on income distribution within New Zealand is unclear, it is argued that global capital flows make redistribution more difficult. The cost of imposing relatively high tax rates in an open economy is the risk that investment may flow out of the country in favour of economies with lower tax rates. Some argue that this precludes domestic governments from certain policy options and amounts to a loss of national sovereignty. These issues will be discussed in Section 6. Many also associate income distribution issues with integration in the labour market. The fear is that cheap migrant labour will compete with domestic workers, particularly for unskilled jobs. This seems to have been less of an issue for New Zealand than for other countries such as the US, possibly because we do not have a large, poor pool of potential migrants on our doorstep.44 It is true that income distribution in New Zealand has become more unequal. 44 Although we do have Pacific Island nations, we seem to be less concerned about this than the US is about poor migrants. It may be the case that New Zealand has embraced such a strong pacific identity that we accept further Pacific Island immigration as natural and appropriate. 49 How much of this, if any, is attributable to increased economic integration is much less clear. Let’s review the trends and survey evidence on the relationship between trade and income distribution. 5.1 Widening income distribution Relative to the early 1980s the distribution of incomes in New Zealand has become more unequal. In other words, the spread between the highest and the lowest annual incomes has been widening. The timing of increased inequality is concentrated in the late 1980s. Statistics on the earnings of individuals, the market incomes of households and the disposable incomes of households all reveal a similar pattern.45 Rising inequality has been a worldwide phenomenon in industrialised countries. However, the increase in New Zealand seems to have been proportionally larger than in countries such as the UK and Australia, although direct comparisons are problematic. Changes in income distribution result from the complex interaction of many factors. These include changes in household composition, changes in labour force participation and qualifications of the population, technological change and deregulation in the domestic economy as well as changes to external policy. Some of these factors are within the control of government policies, however many are beyond government’s control. Government directly affects the distribution of income through tax and transfer policies. Government policies may also have an indirect effect on the distribution of earnings (for example where deregulation of product markets alters the relative demand for different skill groups). However, many of the factors driving distributional changes arise from market forces, often global in nature, such as technological changes driving up the demand for skilled workers. Furthermore, it is extremely difficult to determine empirically how these causal factors interact, and measure their relative impact on income distribution. The timing of growing inequality in New Zealand suggests that policy changes may have been a contributing factor. However, disentangling the effect of policies such as trade liberalisation, from other factors influencing the distribution of income, is not straightforward. Despite the complexities involved, some studies have attempted to unpick the causes of changes in income distribution. Traditionally research has looked at the relationship between ‘trade and income distribution’, or ‘immigration and income distribution’ separately, rather than looking at ‘economic integration and income distribution’ as a whole. When thinking about the effect of openness on income it is important to bear in mind that even if some people are worse off in nominal income terms, it is not immediately clear that their welfare has diminished. Openness brings many consumption benefits in the form of cheaper products. People may be able to 45 O’Dea (2000) 50 buy more goods with less income and this should be factored into the analysis when looking at the effect of, say, a tariff reduction. To get a more accurate picture, studies would need to examine changes in terms of purchasing power rather than simply income. 5.1.1 Overseas evidence International research on earnings distribution finds that trade effects play quite a small role in increased earnings inequality over time. Much of this research investigates the effect of trade on the relative earnings of different groups of workers in the United States. The consensus appears to be that trade can explain between 5 and 20 per cent of the overall changes in earnings inequality. Technological change appears to have had the largest effect on earnings inequality.46 International research is not directly applicable to New Zealand, given differences in the degree of openness, and the speed of policy change. However, the international findings suggest caution in attributing too much of the increase in inequality to trade liberalisation. 5.1.2 New Zealand evidence New Zealand evidence on trade and income distribution is almost non-existent. The main exception is recent research by Deardoff and Lattimore47, which finds that trade liberalisation might actually have improved the distribution by increasing returns to unskilled labour. They show that New Zealand industries protected under the import-licensing regime were relatively intensive in their use of skilled labour. Conversely, export industries that expanded following liberalisation were relatively more intensive in their use of unskilled labour. They conclude that trade liberalisation skewed wage differentials in favour of low skilled workers, especially women, and owners of the factors used in export production (owners of land and capital). Conversely, trade liberalisation reduced relative wage rates for qualified workers (especially male workers) employed in industries such as metal fabricating that had been protected by import licensing regimes. More research is necessary to assess the full impact of trade liberalisation on income distribution in New Zealand. The Deardoff and Lattimore research does not investigate the distributional consequences of changes in who is employed and who is unemployed, or the extent to which this was driven by trade liberalisation, other regulatory change, or broader economic factors such as terms of trade shocks. Their research concerns the distribution of labour market earnings, whereas income also includes the social assistance income received by people outside the labour market, and income from capital or other sources. Nevertheless, change in the distribution of labour market earnings has been 46 See Borland (2000) 47 Deardoff A and Lattimore R (1999), 71-91 51 shown to be the main driver of overall changes in New Zealand income distribution.48 5.2 Winners and losers Although the distribution of income in New Zealand has certainly widened over the past two decades it is difficult to determine how much of this is due to increased openness and economic integration. International evidence suggests trade liberalisation plays a relatively modest role and that a key driver is technological change. Nevertheless, even if openness does not significantly widen the income distribution, it is likely to alter the position of individuals and groups within it. Some individuals and groups within New Zealand will benefit; others will not. Change almost inevitably brings winners and losers. Let’s consider the case of a tariff reduction. This one change will affect the distribution of income through a variety of channels. Access to cheaper foreign goods such as clothing, footwear and cars confers a gain in real income on households as well as direct consumption benefits resulting from access to a wider range of goods. Which consumers benefit most from this depends on the particular goods that now face lower tariffs, and the consumption patterns of different households. Typically, however, these items represent a large share of expenditure for low income households, so there is an inherent bias in the benefits of liberalisation towards these households. There will be winners and losers in business. In some cases lower tariffs and increased competition may expose a lack of international competitiveness, forcing businesses to become more efficient or cease trading. In other cases lower tariffs may reduce the costs of importable inputs to farms and businesses, making them more internationally competitive and allowing them to expand their output. Some industries and sectors are likely to benefit, while others are likely to lose viability. Workers will, of course, be affected. These changes in the mix and level of output across firms, industries and sectors will change the demand for labour in different industries and different skill levels. Who wins and loses will depend on whether the trend is toward industries employing higher skilled workers or those employing relatively large amounts of unskilled labour. The second round effects of a tariff reduction on income distribution flow throughout the economy. It is possible that the real exchange rate will alter, again sending signals to some industries to expand and others to contract. Different expansion paths may imply differences in the amount of part time employment available and lead to changes in labour force participation rates. What this example illustrates is that, while the net impact of trade liberalisation on New Zealand is unclear, there are likely to be distributional consequences for particular groups. Even determining what these distributional consequences are 48 O’Dea (2000) 52 is not obvious. However, in general winners from trade liberalisation tend to be firms and workers (and potential workers) in exporting industries, as well as all consumers of imported goods. Losers tend to be firms and workers in import competing industries. Part of the problem with the change in income distribution resulting from increased openness, is that the costs are likely to be concentrated on relatively small groups of workers, while the benefits are more diffuse. This means that the costs are often more visible than the benefits. It is important to recognise both: those who oppose integration on the basis of groups who are negatively affected need to be aware of the benefits. On the other hand, government needs to acknowledge that there are likely to be losers as well as winners and consider policy responses to ease adjustment for these groups. 5.2.1 Adjustment A key issue for policy is whether the losers are permanently disadvantaged by the change, or whether the dislocation is a relatively temporary one. A large firm may go out of business as a result of being unable to compete with cheap imports, and all its employees may lose their jobs. This is a serious blow to those concerned, however many may be able to find other jobs in their area, or retrain, or move to locations where there are jobs, either in their field or in new sectors. If labour market adjustment mechanisms are working well, then although the immediate costs for individuals and their community may be high, the long term effect is less serious. Government may nevertheless want to consider transitional assistance to help people cope with the temporary shock. For others, however, the shock may be permanent. Some individuals and groups in society may have limited ability to retrain (eg, unskilled labourers in their 50s). There may be inadequate employment locally, and moving location in search of work may not be an option (eg, some may have cultural or historical connections with particular areas perhaps, or strong family ties). If the mechanisms for labour market adjustment are unavailable then these groups may not be able to recover. The policy responses in this scenario will differ from those in which the shock is a temporary setback – some groups may need permanent assistance. The economic gains arising from increased integration will be adequate for the rest of society to assist in this way if required. The ability of displaced groups to adjust, through finding alternative employment, will depend on opportunities available elsewhere in their locality, their ability and willingness to move to job-rich locations, and their ability to retrain. We need to investigate more closely mechanisms of labour market adjustment after a shock. Do people retrain? How costly is it? Do people move? It would be illuminating to know the current situation of former Thames car plant workers. Answers to these questions will help us understand the nature of shifting patterns of income distribution as a result of openness, and types of policy responses that might be appropriate. 53 5.2.2 Regions There is an important regional dimension to this issue. Regions tend to have fewer and less diverse employers than larger cities. Small rural towns will sometimes be dominated by only one major employer. People living in these areas are therefore more exposed if this employer closes down.49 For them, getting another job will often require a change of location, quite possibly to a larger town in the region or a city.50 Theory would suggest that government ensure that there are no impediments to movement of labour. It might provide information on training and employment options in other locations, or even assistance with transport and relocation costs. The aim would not be to influence people to move to a particular place, but rather to not distort the location decision.51 People should not be trapped in depressed areas if they would like to relocate in search of employment, but lack the information or means to do so. However, many would like to see regions within New Zealand survive and prosper because they are interested in the place in and of itself. We may value a New Zealand that has people living and working in Southland and the Far North as well as the main centres. Individuals may have strong attachments to certain places. This would lead to quite different policies – government might attempt to attract industry to the regions, sometimes in quite direct ways. There is a tension between helping the people (which may imply assisting them to move to other areas where there is employment) and valuing the place (which may imply some form of regional assistance). It is important that policy is clear about which objective it is pursuing. 5.3 Conclusions Income distribution in New Zealand has widened over the past two decades. While part of this may be due to increased economic integration, it is very difficult to disentangle from the many other factors influencing income distribution. International evidence has attributed perhaps 5 to 20 percent of the change in the distribution of earnings to trade. There is little New Zealand evidence on trade and income distribution. One study finds that trade liberalisation in New Zealand might have actually improved the distribution by increasing returns to unskilled labour. Even if some people are worse off in nominal income terms, it is not immediately clear that their welfare has diminished. Openness brings many consumption benefits in the form of more and cheaper products. Income distribution may not 49 This does not imply that regional based industries are necessarily more likely to be losers than those in cities. However in cities the adjustment mechanisms are likely to operate faster and more effectively. There are many alternative employers, training opportunities etc. 50 For the economic advantages of agglomeration see Box (2000) 51 In this context it is an interesting question whether regional policy will help or impede labour market adjustment. 54 be the best measure – one would need to look at the effect of changes in terms of purchasing power. Openness, particularly tariff reductions, may not have noticeably widened the income distribution, but it has certainly changed the position of individuals within the distribution. There are winners and losers, both in terms of individuals, groups within society, and regions within New Zealand. The costs are likely to be concentrated on relatively small groups of workers, while the benefits are more diffuse. A key question is: are the losers permanently disadvantaged, or is the dislocation a relatively temporary one? If labour markets adjust rapidly, through people moving or retraining or both, the effect of the shock will be temporary. Government may still want to consider temporary assistance to help people cope with the effects of integration. For some the shock may be permanent and they may not be able to recover. We need to study more closely mechanisms of labour market adjustment in order to know what sort of policy response is appropriate. In the case of regions there is a tension between helping the people (which may imply assisting them to move to other areas where there is employment) and valuing the place in and of itself (which may imply some form of regional assistance). Summary: Income Distribution Income distribution in New Zealand has widened over the past two decades. Part of this may be due to increased economic integration, although it is very difficult to disentangle from the many other factors influencing income distribution. International evidence has attributed perhaps 5 to 20 percent of the change in the distribution of earnings to trade. Although the effect of integration on the overall distribution of income is unclear, trade liberalisation is likely to change the position of individuals and groups within the distribution, and result in winners and losers. Consumers will benefit, through access to lower priced goods. Costs are likely to be concentrated on relatively small groups of workers in sectors that are no longer competitive. A key question is: are the losers permanently disadvantaged, or is the dislocation a relatively temporary one? If labour markets adjust rapidly, through people moving or retraining or both, the effect of the shock will be temporary. Government may still want to consider temporary assistance to help people cope with the effects of integration. For some the shock may be permanent and they may not be able to recover. We need to study more closely mechanisms of labour market adjustment in order to know what sort of policy response is appropriate. 61 restrictions on foreign investment.65 These restrictions reflect the concern New Zealanders have about some types of foreign investment. They also remind us that we do have some control here: if the concerns about foreign ownership outweigh the economic gains of FDI we have the option of limiting it. Of course it is unclear just how much concern New Zealanders actually do have about foreign ownership. New Zealanders’ actions can contribute to their own loss of sovereignty. When New Zealanders choose to buy imported goods, or to sell their assets to foreigners, or to buy overseas assets they are exercising their individual sovereignty but, one could argue, losing control over production in the process. This indicates a revealed preference for individual sovereignty over national sovereignty. Inflows of people resulting from open labour markets can also provoke fear and opposition. However, unless immigrants arrived in such vast and cohesive groups that they had a major impact on parliamentary political outcomes, the issues of open labour markets are not primarily sovereignty issues.66 It is feared that immigrants will take jobs that should be filled by New Zealanders; this relates to distribution issues, discussed in Section Five. It is also feared that immigration will change and threaten our culture and what makes us New Zealanders; this relates to issues of national identity and will be discussed in Section Seven. How realistic is this fear that capital inflows will result in loss of our productive resources to foreigners? How much foreign investment would it take? That is a difficult empirical question about which this paper can offer no view. The interesting issue for us is the relationship between resources and sovereignty, because whether or not foreign ownership reduces sovereignty depends on the degree to which decision-making power and independence requires control over assets. One view is that political authority is more important than resources: as long as you have a parliament and an executive you can always legislate, regulate and tax.67 However resources give you real choices. Is sovereignty worth anything if you do not have the economic clout to back it up if threatened? The cynical view is that, to have genuine decision-making power as a nation, you need enormous resources. Under this view, a very few politically and economically powerful nations have true sovereignty; all other nations have sovereignty, in effect, by permission of the powerful. To exercise sovereignty you need power; the more power the more sovereignty. 65 See Plater and Claridge for further discussion, and Chapman for a thorough description of the rules governing FDI in New Zealand. 66 Clearly inflows of people have altered the power balance in nations: New Zealand Maori and native Fijians, for example, have lost sovereignty to newcomers. However within modern parliamentary democracies controlled immigration is less likely to have such dramatic political effects in short time frames. 67 At the extreme, you could even nationalise strategic assets. 62 6.1.2 Sovereignty and political decision making International market forces have raised concerns about national sovereignty because they appear to limit domestic choices. We have argued that sovereignty does not entail limitless choices. Nations have always operated within the parameters of the options actually open to them and the pressures upon them. In a changing world those options and pressures have changed. This may require some adjustment, but it is a mistake to view it in terms of loss of sovereignty. A more serious threat to national sovereignty, however, may be the increasing trend toward international decision-making. Governments have attempted to manage the tensions between global forces for integration and national autonomy by international co-operation. Over the past few decades there has been a proliferation of multilateral organisations and agreements. These include functional groupings devoted to particular issues (eg, IMF, ILO), regional arrangements (eg, EU, NAFTA, APEC), semi-global co-ordinating organisations (United Nations, WTO, OECD) and innumerable bilateral relationships (eg, CER). International organisations and agreements tend to set parameters around the actions of nation states. The concern is that this represents a transfer of power and decision making from nation states to international organisations and therefore harms sovereignty. Types of agreements reached, ranging in order of their departure from national autonomy, include mutual recognition, monitored decentralisation, coordination, explicit harmonisation and mutual governance.68 68 See Kahler, pg xxii 63 Does signing up to international agreements limit sovereignty? One view is that it does not. No parliament can bind another. While a nation still has its parliament it can retreat from international commitments at any time. Joining an international organisation merely raises the costs of bailing out in the future. In the end, adherence is voluntary; nations cannot be compelled. The principal distinction between national and international law is in the area of enforcement. National laws have courts to watch over them. The WTO, however, is not a court. It has no power of enforcement. If a member refuses to comply with the rules it previously volunteered to follow, all the WTO can do is approve a request by the complaining member to impose sanctions. This is an option that member governments have always been able to wield unilaterally. Failure to comply with a panel ruling does not result in expulsion from the WTO. The Face of Discontent A particularly high profile focus for concern over loss of national sovereignty is the World Trade Organisation. This is often played out in the arena of environmental protection. One function of the WTO is to help members settle disputes under rules they all agreed to follow. WTO rules place few constraints on a member protecting its environment against damage from domestic production or from the consumption of domestic or imported products. Members can also pursue non-protectionist regulatory objectives that restrict trade as long as there is either scientific evidence supporting the measure or the measure is a provisional response during a period of scientific uncertainty. Environmentalists consider that the WTO encourages governments to converge to international standards because uniformity reduces the incidence of trade disputes. If these standards serve as ceilings, not floors, the incentive for governments to experiment and become genuine pacesetters in environmental law is reduced. The dispute over beef hormones illustrates this tension. In 1998, the WTO found that while a country has broad discretion in choosing levels of biosecurity, the ban on hormone-produced meat by the EU was not rationally related to the risk assessments performed. The EU did not comply with the ruling. After a period of negotiation, in 1999 the dispute panel authorised the USA to suspend tariff concessions to the EU equivalent to the annual harm to U.S. exports resulting from the ban: US$ 116.8 million. Has sovereignty been violated? Environmentalists might say yesinternational pressure was bought to bear on the EU for a decision about their own environment, which affected domestic and imported products alike. Others would say no – the WTO is a club the EU freely chose to join, agreeing to abide by its rules. And what’s more, despite the costs, they maintained the ban. 64 Another view is that, while it may be technically true that nations can change their minds, the reality is somewhat different. Although international law generally provides a mechanism for nations to back out of commitments, there is wide agreement that governments should keep their promises. The costs of withdrawing from some international commitments are extremely high. Where commitments are reciprocal others, who were the beneficiaries of our commitments, may withdraw some of the benefits of commitments they have made to us. Although New Zealand could choose to pull out of the WTO on sovereignty grounds, the economic and diplomatic cost of this course of action makes it prohibitive. We normally think of choices as viable options, not merely technical ones.69 Entering into international agreements, therefore, does effectively limit domestic behaviour. However, as argued previously, sovereignty does not entail that all options are open, that we could reasonably change our minds at any point, or that we are completely independent. We generally consider that individuals are able to enter into contracts without loss of autonomy. In fact a contract could be seen as an expression of autonomy, since it will be entered into because the individual expects the agreement to increase their welfare. Individuals in the nation state have permanently limited their personal freedom via a ‘social contract’ with the state because they reap the benefits the state provides.70 Nations too, often find it in their best interests to subject themselves to a contract or external constraint in the expectation of even greater benefit.71 69 In the sense that if someone was holding a gun to your head you could choose not to give them your wallet, but this is not what we would consider a genuine choice. 70 Nations arguably have more autonomy in the WTO than individuals do in a western democracy. 71 Again, the degree to which this is consistent with individual sovereignty depends on the degree to which the government mandate is the result of democratic political processes. More Sovereignty and Economic Integration Too Since the break-up of the Soviet bloc, we have witnessed the formation of a great number of new nation states. In Eastern Europe the political unit is getting smaller – nations states built on greater cultural and ethnic homogeneity are emerging. At the same time almost all of these Central and Eastern European nations are queuing up to join the European Union because of the economic advantages they perceive in doing so. While the political unit is shrinking, the economic unit appears to be enlarging. Pursuing economic integration is consistent with increased sovereignty. A similar theme is apparent in the case for Scottish independence. The movement believes they will have more sovereignty as part of a bigger unit centred in Brussels. Why be a disadvantaged region of the United Kingdom when you can be a sovereign nation in the EU? 65 Discussion of international agreements and organisations simply in terms of sovereignty is therefore not particularly useful.72 Signing up to international norms sets parameters on national policy. It will therefore only be undertaken for a greater expected benefit. This may amount to a loss of sovereignty (in the same sense that signing a contract limits an individual), but the real question is whether the benefits outweigh the costs of signing. 6.1.3 The way forward – thinking about costs and benefits Assessing the benefits and costs of signing up to international agreements is no easy matter. Many factors will enter into our calculation of national interest. These include likely economic effects (the implications for growth, jobs, living standards etc), impact on other social goals (sovereignty, identity, the environment, etc), as well as a myriad of pragmatic ‘tactical’ considerations (effect on our negotiating position in other areas etc). Some of these have been discussed at a general level in this paper; others are outside its scope. When considering particular international agreements all these factors come together and difficult judgements must be made. There is a high risk of making mistakes.73 Furthermore, even if in principle the benefits are calculated to outweigh the costs if a particular area is liberalised, the devil is in the detail. If the agreement designed to implement the liberalisation is badly formulated, requiring high compliance costs or leading to bureaucratic and legal battles, then the agreement will deliver bad outcomes for New Zealanders. So how do we avoid badly designed treaties? There will be general principles and questions we can ask ourselves that might guide our assessment of costs and benefits. • How does the proposal support domestic policy priorities, both economic and social? • What are the dynamic impacts? • How does it cohere with the rest of our international commitments and relationships? • The possibility of maintaining sovereignty over time depends on democratic involvement and voice in the system. To what degree will New Zealand have a voice in the institutions that result? • Are the processes transparent? • How reversible is the commitment? • To what degree is the declaration worth the resources being put into it? 72 And in fact some objections to international cooperation on sovereignty grounds may be less about sovereignty and more about not liking the decision or policy. People employ any argument that supports their general position, making them hard to disentangle. 73 Consider the original New Zealand Australia Free Trade Area (NAFTA) negotiated in the 1960s, which effectively locked into place all the barriers that existed in both countries. 66 • Is the agreement outcomes based? It is preferable to give nations the freedom and flexibility to choose the means by which they achieve standards. In New Zealand, the power to take treaty action rests with the Executive. However the Government has recently decided that all multilateral treaties that have been considered by Cabinet must be presented to the House before formal steps of ratification, accession, acceptance, approval, withdrawal or denunciation can proceed.74 The Minister of Foreign Affairs and Trade may also decide to present major bilateral treaties of particular significance for consideration by the House. The Government will not take any binding treaty action until the relevant Parliamentary Committee has reported, or until 15 days have elapsed since tabling. Treaties presented before the House for consideration must be accompanied by a National Interest Analysis. This sets out reasons for New Zealand to become party to the Treaty (or denounce/withdraw), advantages and disadvantages, obligations resulting from signing, economic, social, cultural and environmental effects, costs, the possibility of any future protocols, implementation implications, and provisions for withdrawal or denunciation. It is prepared by the lead Department in consultation with others. 74 CAB (97) M 46/11G(1) and CAB (00) M 5/1E(1) Trans Tasman Mutual Recognition Agreement The Trans-Tasman Mutual Recognition Arrangement (TTMRA) came into effect on 1 May 1998. The objective is to mutually reduce regulatory barriers to the movements of goods and services between Australia and New Zealand. The Agreement means that: • if a good can legally be sold in New Zealand it can be sold in Australia (and vice versa); and • if a person is registered to practise an occupation in New Zealand then they are entitled to practise that occupation in Australia (and vice versa). There are currently 25 product standards, information standards and product bans that are not immediately capable of mutual recognition, which are covered by a special exemption. The TTMRA include a process for working through outstanding items with a view to recommending mutual recognition, harmonisation or continuing exemption. The TTMRA is a unique agreement that recognises the mutual confidence that Australia and New Zealand have in each other’s regulatory settings. It facilitates integration while providing, through the exemptions, for retention of sovereignty in areas that are of particular importance to one or the other nation. 67 The National Interest Analysis is the key vehicle through which costs and benefits of international co-operation with respect to a particular area are set out, debated and worked through. It is also the key document that many Ministers and parliamentarians will read and base their discussion on. It is therefore crucial that this analysis is robust and that consultation is well executed. We need to be very clear about what we are giving up and what we are gaining. This calculus runs well beyond the policy area traditionally thought of as ‘external policy’ and it is therefore vital that agencies undertaking the analysis are thinking broadly about the issues and liaising effectively with all relevant parties. Although assessment of the costs and benefits of international cooperation must ultimately be carried out on a case by case basis, a useful area for further work might be the development of a framework or taxonomy for how we think about these issues. Questions of regulatory cooperation and Trans-Tasman harmonisation have been raised as particular areas worth addressing in more detail. Summary: Sovereignty National sovereignty is the decision making power of nation states. There is a concern that the independence and sovereignty of nation states is diminished in an increasingly integrated and global world. As cross border flows of capital and labour increase there is concern that domestic policy options will be reduced. The fear is that world financial and labour markets, and the risk of outward flows that openness creates, generate economic pressures that place limits on domestic policies. There are also fears that inward flows will reduce sovereignty through foreigners buying assets and reducing domestic choice and control. To some degree global capital markets do limit choices. This may not be a bad thing if it supports domestic policy and binds commitment from successive governments. More fundamentally, sovereignty does not require limitless choices. Nations have always operated within the parameters of the options actually open to them and the pressures upon them. In a changing world these options and pressures have changed. This may require some adjustment, but the idea that we had sovereignty and now we are losing it is largely illusory. A more serious threat to national sovereignty may be the increasing trend toward international decision-making. International organisations and agreements tend to set parameters around the actions of nation states. The concern is that this represents a transfer of power and decision making from nation states to international organisations and therefore harms sovereignty. Thinking about international decision making in terms of sovereignty, however, isn’t very useful. Signing up to international norms sets parameters on national policy. It will therefore only be undertaken for a greater expected benefit. This may amount to a loss of sovereignty (in the same sense that signing a contract limits an individual) but the real question is whether the benefits to New Zealand outweigh the costs of signing. Developing a framework or taxonomy for how we think about the costs and benefits of international cooperation is an important area for further work. 68 6.2 New Zealand the region: questions of levels of governance Discussions of sovereignty are very much based within the perspective of New Zealand as a nation state. The issue is then about when it is in New Zealand’s interests to give up some sovereignty in order to reap the benefits of cooperation with other nations. However, in Section Three, we introduced a second conceptual window – that of viewing New Zealand as a region within a larger area. Under this view, decision making location can be seen as a series of concentric circles: decisions can be made by individuals, local governments, nation states, international organizations and at many other levels in between. It is clear that different decisions need to be made at different levels. Nations decide on the punishment for burglary, local governments decide which day is rubbish day and individuals decide what to wear when they get up in the morning. There may also be decisions that are most sensibly made at a supranational level. By taking the emphasis off the nation state the issue is opened up. Rather than trying to decide when New Zealand should give up some of its sovereignty to international fora, the question can be recast as an issue about at what level of governance should decision-making be carried out. There is no presumption that it will necessarily be the nation state, and increasingly we are seeing states devolving to lower levels of government as well as cooperating internationally with higher levels. Of course, often the nation state is the optimal level of governance, but by looking at the question in a different way we might pick up things we’ve missed. The discussion that follows is intended to stimulate thinking on the kinds of situations in which governance at international level may be optimal.75 There is a long tradition in Western democracies for individual autonomy.76 People should be free to pursue their own choices consistent with the preservation of similar freedoms for others. The default is for the state to stay out of the lives of individuals unless there are good reasons for interference. There are good reasons for interference however, if it can be established that the benefits of intervention outweigh its costs. Economics points to the establishment and maintenance of property rights, public goods and commons, externalities and information failures. Political theory argues over how much state intervention is justifiable and for what purpose, but even proponents of the most minimal state acknowledge a role for the state in such things as law and order77. Once it is established that there is a role for government the question of which level of government remains. The principle of subsidiarity78 argues for governance and decision-making to be located at the lowest level possible, unless there are reasons why it should be located at a higher level. Devolved decision-making allows for better private 75 For another cut on this question see Lawrence, Bressand & Ito. 76 Kant, Hume, Mill, Rawls, etc. 77 eg, Nozick’s ‘night watchman state’ 78 I believe this term originally came from the Roman Catholic Church, to describe the appropriate jurisdiction of the church in individuals’ lives! 69 preference revelation and respects diversity in preferences, conditions and values. The smaller the decision-making unit, the better preferences are reflected in decisions. Furthermore, devolution increases government accountability. It preserves autonomy and aids communal solidarity and identity. Devolution allows utilisation of local knowledge and promotes experimentation. This would create a presumption for local government over national, and for national government over international. Like individuals, nations should be sovereign over their own affairs unless there are good reasons why not. Nevertheless, there are many cases where nation states will choose to give up some control over domestic policy because there are greater gains to be had. Theories of fiscal federalism assert that the jurisdiction of decision-making should correspond to the jurisdiction of effects.79 Kerr, Claridge and Milicich80 have further developed this idea. They identify three principles and criteria for determining optimally efficient levels of decision-making and cost bearing. 1 Balanced decision-making: decisions should be located, where possible, with the jurisdiction of effects and costs. People who make decisions should be those who receive benefits and bear costs. This will avoid interjurisdictional externalities that could lead to under or over provision of a public good. 2 Informed decision-making: good decisions reflect all the relevant subjective and objective information. Those who experience the effects should make the decisions, since it is they who have subjective preferences about the issue. People with the skills and resources to access objective information should also be involved in decision-making. 3 Cost effective decision-making: when costs of decision-making are high and preferences are relatively homogeneous, decision-making at a higher level can save on duplication costs. Local decision-making is therefore likely to be optimal when: • There are no externalities; • Objective information is held locally, or is unimportant; • Subjective preferences are important and vary; • Costs of decision making are low. Central decision-making is likely to be optimal when: • There are externalities; • Objective information is held centrally and is important; • Subjective preferences are homogeneous; • Costs of decision making are high. 79 Oates, (1999) 80 Kerr, Claridge & Milicich (1998) 70 Sovereignty is mentioned briefly; Kerr et al acknowledge that if decision-making in itself is something that people value strongly then this will weigh in the balance. In spite of the many arguments in favour of centralised decision making and implementation we may still bias toward devolving decision making to local communities if the social importance of local identity and control outweighs the social choice and efficiency benefits of more centralised control.81 Kerr et al have applied these principles to issues of devolution within nations but they also give clues as to when decision-making might be better carried out between nations.82 6.2.1 Balanced decision making Provision of a public good or avoidance of a ‘public bad’ will be optimal if decisions are made by the people who feel the effects, and these same people also bear the costs. Balanced decision-making will avoid interjurisdictional externalities. Externalities and public goods may be international in scope. International cooperation is therefore important to internalise international spillovers and provide international public goods. Let’s consider some examples. Environmental concerns are a classic example of an area that has long been regarded as appropriate for international cooperation. Without co-ordination, pollution will be overproduced because the producer does not bear the costs of negative externalities to other nations. In a simple two-country situation Coasian theory would suggest that this problem could be resolved and the optimal level of pollution reached if the party without the property rights compensates the other. However, because pollution generally affects many countries, free rider problems are likely to arise making more explicit coordination necessary. International environmental agreements and fora aim to enlarge the decisionmaking jurisdiction to include all those affected and so provide a mechanism for affected nations to express preferences.83 81 Kerr et al, (1998) pg 5 82 The major difference, when applying the framework to international decisionmaking, is that in the local/national devolution case we are optimising for the national level, whereas in the national/international case we only care about what is optimal for our nation, not the whole planet. Furthermore, there isn’t a strong trans-national forum equivalent to ‘central’ decision making in the central/local case. The closer analogy would be if local regions within New Zealand were deciding when it was optimal for them to club together. This difference changes some of the analysis. For example, it makes issues of interjurisdictional spillovers more difficult because no overarching government has the mandate to take the interests of all those affected into account. It also makes redistribution largely voluntary – coercion is more difficult (we may not think this is a bad thing!). Nevertheless, the general principles provide a useful way of thinking more deeply about these sorts of decisions. 83 Another example would be enlarging the jurisdiction of financial risk externalities, through the IMF. 77 policy integration is feasible, and with whom. The arguments canvassed in this paper about the benefits of integration are not sufficient for further integration. In a democratic system high levels of policy integration can only occur to the degree that people feel comfortable with it; when they feel that there is a community of sentiment between current New Zealanders and future groups we might cooperate with. 7.2.2 Identity is not always threatened by integration Although identity is important, it is a mistake to see all steps toward integration as threatening to identity. There will not always be a trade off. We have discussed the way market integration in the goods or labour markets might cause concerns. But there will also be aspects of integration that allow us to maintain what matters of identity. The effect on identity of policy integration will vary case by case. The relationship between identity and sovereignty is important to consider. Identity is currently strongly linked to the nation state, and also to sovereignty. However these links are neither necessary nor universal – they are a relatively recent phenomenon. The age of nationalism began in Europe with the French Revolution. Prior to this social organisation was based on agrarian social structures that were both smaller than nation state units (city states, feudal principalities) and larger (empires, both secular and religious). The imperative that boundaries of political units and cultures converge is a thoroughly modern notion. This implies that identity is possible without sovereignty and without nation states. The fact that it is possible to retain a strong national identity while integrating political structures is already evident in the evolution of the European Union. 7.2.3 Identity is dynamic Identity may be important, but it is also dynamic. The whole idea that we have a clear ‘national identity’ that can be threatened and undermined is rather odd. It assumes a very static view of who we are: that our identity is fixed to one point in time, often claimed to be the present, or some golden bygone age. Preserving national identity therefore means freezing history. But why is 1950’s New Zealand any more privileged than 2000 New Zealand, or 2050 New Zealand? No one time is the ‘real’ New Zealand. 78 The Real India91 The sari – a classic and unique symbol of Indian culture. Right? Yes and no… The contemporary wedding sari is machine embroidered and hand beaded. Machine embroidery is common throughout India but designs can be heavily influenced by textile traditions from Europe and England. Beading was introduced into India in the nineteenth century from Africa. Parsi saris of the nineteenth and early twentieth centuries used Chinese silk and motifs. The Chinese origins were attributed to trade. The ‘kalga’ motif was derived from floral patterns, developed into a fertility symbol (since it was shaped like a mango), was adopted by the English in the nineteenth century, made famous in textile mills in Paisley, Scotland, and developed into the paisley designs common in Europe and the US. Cultural influences can absorb others and be absorbed. Just because aspects of the sari came from Africa, China and Europe doesn’t make saris any less Indian. Just because sari motifs were transformed into paisley doesn’t make saris less Indian. Or paisley more tasteful… Cultures are dynamic, evolving and changing over time with each new force or influence. In stable periods of history cultures may remain unchanged for long periods and when cultural change happens it occurs gradually and organically so that we scarcely notice that customs and values are combining and assimilating and evolving. In periods of transition and rapid change the evolution of culture troubles us more. It’s less clear that all those in our borders share a community of sentiment. Traditional life is disrupted and this sense of dislocation often results in even stronger calls for the preservation of national identity, as people search for stability. Rapid change unsettles us because we don’t know who we are anymore. In the west, the past century has seen unprecedented social change reaching fundamental parts of our lives. The changing role of women, and their movement from private to public domains, has had huge implications for the way women and men define their roles and identities in the family and society. We are very much in a time of transformation and adjustment: the old certainties about ourselves and our relationships are increasingly less relevant, and we are struggling to develop new ways of thinking about ourselves. Is it any wonder we are worried about identity? 91 Example drawn from “Colour and Ritual: A Celebration of the Indian Sari”, Dowse Art Museum, Lower Hutt, 15 July – 8 Oct 2000 79 7.2.4 Change is not necessarily bad Cultural change may not only be inevitable, it may be a good thing. Cultural diversity makes us much more cosmopolitan. A multi-cultural society may make us more open and tolerant of difference. Immigrants bring fresh ideas and perspectives, which have economic and social benefits. Many of those who seem to be part of the brain drain in fact return. Travel has allowed New Zealanders to spot enterprise opportunities and to expand the tastes and horizons of those who stay at home. It’s not clear that it is desirable for most of the population of a small country to remain within it. 7.2.5 National identity is not necessarily good Any discussion of national identity needs to include a cautionary note. Some sense of belonging seems to be a fundamental human need and we therefore tend to think of national identity as a good thing. We think, warmly, of the relaxed kiwi lifestyle; of baches and marmite and gumboots and ingenuity (or whatever romantic version of kiwiana that particularly inspires you). However national identity has a dark side: nationalism. National sentiment is a powerful force and when directed against people identified as ‘not belonging’, whether they are within a nation’s borders or outside, can become particularly nasty. In the name of ‘national identity’ people have allegedly been willing to surrender their own liberties and curtail those of others. They have been prepared to trample on the civil and religious rights of ethnic, racial and religious minorities whom the nation could not absorb. … The ideal of the nation, transplanted across the globe from its Western heartlands, has brought with it confusion, instability, strife and terror, particularly in areas of mixed ethnic and religious character. Nationalism … offers a narrow, conflictladen legitimation for political community, which inevitably pits culture-communities against each other.92 Whether national identity is positive or negative might depend on whether it is inclusive or exclusive. 1930s Nazi Germans defined their identity in terms of an ethnically exclusive club and then proceeded to ‘purify’ their nation internally as well as expand externally. Colonial European powers expressed their nationalism through imperialism. Former Yugoslavia has long seen nationalistic conflict, and most recently ‘ethnic cleansing’, resulting from competing cultures in overlapping geographical areas all asserting that they are the authentic culture, and therefore nation, in the land. This contrasts with American national identity which, although passionate, is inclusive and adaptive – people of many ethnic and cultural groups can, and have, become Americans. This is also true of New Zealand. In the end, however, all groups define their identity in contrast to others, so national identity may, at its core, be a fundamentally antagonistic notion. Nationalism has been a powerful force because national identity has been, and continues to be, particularly good at helping us answer the question of who we 92 Smith (1991), 17-18 80 are. It bestows a sense of security and belonging that we value. However nationalism becomes a dangerous force when individuals and governments decide that national identity is the overwhelming policy objective. European experience differs significantly from the situations facing New Zealand. Nevertheless, there are lessons for us. To the extent that the state adopts a role in promoting national identity, it is important that an inclusive and adaptive New Zealand be promoted. Furthermore, the state must be aware of the risk that, even if it promotes an inclusive national identity, not all New Zealanders will interpret these messages in such a tolerant and open way. 7.3 New Zealand as a nation or a region: the challenge Powerful new economic, political and cultural forces are shaping tomorrow’s world. Transport and communication technology has fundamentally altered the world we live in. Mobility of people around the globe is unlikely to cease. The perspective of the world as containing isolated and self-contained nation states has long since ceased to bear much resemblance to reality. This has led some to speculate that we are seeing the end of the age of nationalism. Nation states will be eroded by the twin forces of increasing internationalism and increasing devolution to regions. Others argue that, despite growing global interdependencies, we are a long way from witnessing the eclipse of the nation state. Collective identity at the nation state level will continue to command humanity’s allegiances for a long time to come.93 Whether we continue to operate primarily through the nation state lens, or move to a more regional perspective, we face a challenging future. If nation states decline in importance, and we lose a strong sense of New Zealand identity, we will still be faced with the basic need for answers to the question ‘who am I?’ We may retain a concept of New Zealandness – our identity is in part conferred by our physical isolation, and we will always have this even without the nation state. Alternatively we will look to other aspects of our identity to answer this. We may see the rise of South Island identity perhaps, or Australasian identity, or class-based identity, or others. In this changing world we will need new ways of generating the security and sense of belonging that comes with national cultural identity. In the end all cultures will be left with a challenge: how do we foster an evolving sense of identity in a world of increasing mobility and merging of cultural influence? If New Zealand the nation state retains its primacy in terms of demarcating our community of allegiance, and continues to be able to provide us with a cohesive sense of self, we still have to deal with the effects of mobility and globalisation. One option is that the State step up its traditional role of reinforcing and encouraging a sense of identification with symbols of public culture, through mass education and the media. Although there are likely to be welfare gains through an increased sense of belonging, it will be important to manage the risk of an intolerant or exclusive sense of national identity developing. 93 See Smith (1991) 81 Summary: Identity Identity, a sense of who we are, seems to be important to us. There is a multitude of ways that we define ourselves; national identity is one that has been particularly powerful. To the extent that we value it, national identity represents a limiting parameter for policy. Policy integration can only occur to the degree that people feel comfortable with it. However, not all steps toward integration threaten national identity – there is not necessarily a trade off. Identity is dynamic. Identity and culture have always evolved over time. Change can be beneficial in terms of opening New Zealand to new ideas and different perspectives, which may make us more tolerant as well as innovative. It may be the rapid speed of evolution in culture and identity that causes us particular dislocation and concern. National identity can also be negative. Nationalism has been a powerful and destructive force when directed against those identified as not belonging. It is important that any promotion of New Zealand national identity be inclusive and adaptive. Whether or not the nation-state remains a primary focus of identity, we will have to deal with the effects of mobility and globalisation. The challenge for the future is: how do we foster an evolving sense of identity in a world of increasing mobility and merging of cultural influence? 82 8. Conclusions and Implications for Policy 8.1 Costs and benefits of market integration In order to assess what level of integration is optimal for New Zealand we need to understand the effects of integration on the living standards of New Zealanders. This paper has attempted to identify costs and benefits of integration across goods, services, capital and labour markets in terms of both material, and less tangible, aspects of living standards. Figure 5 summarises the key elements in our analysis. Government is acting in an environment in which its power and influence is limited; globalisation is something that governments can influence only at the margin. Nevertheless, government is not without choices and these choices can make a big difference to New Zealanders’ welfare even in this, largely reactive, field. Being clear about benefits and costs of market integration should help clarify our objectives. That said, there are many things government can’t influence. To a significant degree, thinking about external economic policy should be viewed in the context of thinking about how to manage the implications and consequences of a process largely outside our control. In these areas ‘costs and benefits’ are better thought of as ‘positive and negative implications of integration’ that will need to be managed. Figure 5: Costs and Benefits Benefits Costs Incomes Greater productivity and higher incomes through: better resource allocation; scale, scope and specialisation; technological advance; accumulation of human and physical capital; firm organisation and management practices; and plant/firm turnover. Particularly important for a small isolated economy like New Zealand. Risk that activity will be more likely to locate offshore and New Zealanders remaining in New Zealand will not capture the benefits of greater productivity. Income distribution May contribute to narrower income distribution and less inequality. Access to lower priced goods disproportionately benefits those on lower incomes. May contribute to wider income distribution and more inequality. Costs may be concentrated on particular sectors that are no longer competitive. Some individuals, groups and regions will be worse off. 83 Decision making Opportunity for more efficient governance in some areas. Difficult governance trade-offs to be made. Risk of making mistakes and ceding sovereignty inappropriately. Identity Opportunity for alternative forms of identity less closely linked with the nation state. Dislocation as rapid change disturbs traditional views of New Zealand identity. 8.2 How do we decide the matter? The question this paper has been attempting to address is: how integrated do we wish to be? We have identified key considerations that might influence the answer. However, reaching a definitive judgement about their relative weights is not possible because it involves empirical uncertainties and political judgements. Empirical uncertainties Integration is good for productivity. However, much of the analysis about the productivity advantages of integration hinges on how seriously we view the risk that economic activity will locate offshore as factor markets free up, and how much we can influence this. We lack the data to make a firm judgement. • A particular development priority is work aimed at understanding the nature of capital and labour mobility between New Zealand and other countries. Do firms and people move? What influences their location decisions? How strong are the border effects keeping activity in New Zealand? Other areas that would inform an assessment of the costs and benefits for New Zealand include work on the levels of density needed for various firm activities, and the response of firms to technology – does technology lead to dispersion or further agglomeration? Concerns about income distribution centre on the fact that some will suffer as a result of a changed environment. How much of a problem this is may depend, to a large degree, on the speed of labour market adjustment. This is another area for further work. • How effectively do labour market adjustment mechanisms work after a shock? Is the dislocation temporary or permanent? Do people retrain and/or move within New Zealand in order to find employment? 84 Political judgements At the centre of the analysis lie matters of value. They cannot be resolved by applying economic analysis. They concern the preferences and attitudes of New Zealanders and should be vigorously debated in the public sphere and decided through the political process. What are we optimising for? Who and what do we care about? People or places? Which people? Which places? We have identified mobility of capital and labour as a risk, particularly in terms of outflows. However, how we think about this depends on whom we ‘count’. Those who relocate offshore will presumably be benefiting a lot from openness, whereas those remaining in New Zealand may suffer. If we include the welfare of all New Zealanders wherever they may reside, then there will be distributional effects, but it is less clear that loss of activity is, automatically, a bad thing. • Do we care about the welfare and living standards of all New Zealand citizens, including those located outside New Zealand? Or should our policies be aimed at New Zealand residents? • Do we value the prosperity of ‘this nation’ and ‘this land’ over and above the welfare of New Zealanders within and outside its physical borders? Labour market adjustment may mitigate the ‘winners and losers’ problem regarding income distribution amongst individuals and groups. Their misfortune may be transitional. However, for regions within New Zealand, change is likely to be more serious. • Do we care about places as well as people? Do we value the prosperity of regions within New Zealand over and above the welfare of New Zealand people? If we do, how much are we prepared to forgo to support them? We are witnessing trends of devolution to lower levels of government as well as increasing international cooperation. Political units seem to be getting smaller while economic units are getting larger. Although issues of the appropriate level of governance may be informed by analysis and theory, a large element of this is also a political judgement. • In what areas, and to what degree, is it important to New Zealanders to retain decision-making power? • In what areas, and to whom, are we comfortable with relinquishing some control for a greater gain? Value judgements cut to the heart of our identity. • How do we see ourselves? What does it mean to be a New Zealander? What level of integration are New Zealanders comfortable with, and with whom? 85 • How do we foster an evolving sense of national identity in a world of increasing mobility and merging of cultural influence? • National identity can be a negative as well as a positive force. In a changing world, should we even be aiming to base our identity on a concept of the nation state? 8.3 Implications for policy questions Applying the insights about costs and benefits of integration to concrete policy choices facing officials and Ministers is vital further work. This work will need to draw on analysis of global economic and political trends to determine what might be achievable. An in-depth treatment of policy is outside the scope of this paper. We hope that others will take up the challenge. The following section identifies key ideas that shape the analysis of policy and illustrates them with some current policy questions. It foreshadows more expansive work, combining policy objectives canvassed in this paper with practical considerations, to better illuminate policy choices. 8.3.1 Identify goals and objectives The first rule of policy – be clear about your objectives when formulating policy. This sounds obvious, but it is too easy to become immersed in strategies and policy details and discussions about what we can and cannot do, and lose sight of what we want to do. We need to keep in mind the questions: • What level of integration makes sense for New Zealand in an increasingly open global economy? • On balance, would further integration serve our interests? 8.3.2 Make linkages across policy areas This paper has attempted to approach issues of integration in new and broader ways. We look at integration across all markets rather than just focusing on trade. We look wider than just economic theories of productivity – living standards are about a lot more than this. We take a spatial perspective as well as a traditional ‘nation state’ perspective. It is important to understand the full impact of policy decisions, and drawing out the linkages between policy areas helps us do that in a more explicit way. If we make changes to immigration policy, for example, we need to be aware that it may have effects on the flow of goods and services and capital as well as labour. When formulating policy advice we must ask ourselves: • What are the implications of policy options on the goods, services, capital and labour markets? • What are the implications of policy options on the range of elements that contribute to living standards? • What are the implications of policy options on the location of activity? • Have we taken into account mobility of capital and people? 86 Thinking Broadly In a recent speech94, Hon Dr Cullen mentioned the idea of an “Australia strategy”. This paints a picture of New Zealand thinking about its relationship with Australia across policy areas, and beyond purely economic considerations. It suggests a perspective of New Zealand and Australia as a region sharing a great deal of common ground and highlights the usefulness of co-operating more. 8.3.3 Recognise what we can’t control In many domains further integration is inevitable. Every day individuals and businesses are making decisions and taking actions that cross national borders. The appropriate response from government is to be realistic about what the trends are, and identify what can and cannot be influenced. In the case of aspects of integration outside government control, policy responses are better framed in terms of how to deal with the consequences for, and impact on, New Zealanders. Issues of national identity are a prime example. Identity is something that is subtle, intangible and not at all easily influenced by governments. It is always a fluid socially constructed phenomenon, but rapid change brings dislocation as traditional sources of identity are disturbed. A rapidly changing world is not something the government can control or stop. Disturbances in feelings of identity are also not easy to address, although the government may be able to play a role in trying to ease the transition through, perhaps, signalling a multicultural global identity for New Zealand. It is important to subject policy choices to the following questions: • Do we have any control over what is happening? • For those things that are beyond government influence, what can we do to maximise the benefits for New Zealanders and minimise the costs? How can we capitalise best on the inevitable? 94 Address to Deloitte Touche Tohmatsu & the Council for Economic Development of Australia, Melbourne, 9 August 2000 93 APPENDIX 1: Input Accumulation Galt (2000) finds there is no international consensus about appropriate theoretical models of growth. Various theoretical approaches include: • Neoclassical growth models, which suggest that accumulation of factors, such as capital, labour and human capital, should raise output levels over time but with diminishing returns. In the long term this means any burst in additional factor accumulation will be temporary, even if leading to a higher income level. Growth can be boosted persistently through exogenous factors such as improvements in technology. • Endogenous growth models, which suggest that growth may be able to continue indefinitely, with contributions from phenomena such as technical change being embodied in the capital stock; human capital investments; R&D spillovers; economies of scale or increased specialisation in intermediate inputs. Other theorists suggest that the nature of the institutions and culture in a society; the role and size of Government; macroeconomic conditions and many other matters may contribute to growth performance. This paper has focused on the type of effects described in the endogenous growth literature. These effects are of particular interest as they can lead to consistent long-term growth. Our position, that a focus on productivity is more important, hinges on beliefs that improving productivity will increase growth, incomes and employment to a greater degree, and for longer, than simply accumulating factors of production. Nevertheless, input accumulation has been a significant factor in the initial growth of countries. For instance, many authors regard the East Asian economies as good examples of the benefits factor accumulation can bring in the early stages of development. For this reason this appendix briefly discusses some of the key ideas surrounding the accumulation of labour and capital. The link between the level of productive inputs and the achievable level of output is relatively obvious. In almost any business, productive capacity can be made larger by increasing one or more key inputs. Note that this does not mean increasing any input will increase output – it is only true for the subset of inputs that are constraining productive capacity at that time. These inputs may also need to be of a certain quality. Expanding the stock of labour There is a range of ways to increase the size of the labour force over the longerterm: higher birth rates; lower death, sickness and accident rates; higher levels of labour force participation (for example, of the unemployed or women); and higher levels of immigration. All of these will lead to higher levels of economic output. To the extent that the changes are ongoing (e.g. sickness and accident 94 rates are improved by 1% a year, each year) they will lead to sustained higher growth. It should be noted, however, that in most developed economies it is the availability of high quality labour that constrains productive capacity, rather than the quantity. This is why it is important to focus on the human capital aspect of labour. Education and training approaches are particularly important, as discussed earlier in the paper. Also, while the methods that involve increasing the total workforce will increase the aggregate level of a country's output, they may not necessarily increase the level of output per person (i.e. labour productivity). It is also worth noting that as countries become wealthier, their labour force participation rates can fall (as can the average level of hours worked by those in employment) as some of the higher income is taken as leisure. Accumulation of physical capital The level of physical capital in an economy can be augmented by higher levels of domestic saving and by tapping into the saving of foreigners. Currently in New Zealand domestic saving and foreign saving contribute fairly equally to new investment. Note that the level of foreign saving in the economy corresponds to the current account balance. There are often debates over whether domestic saving should be actively encouraged in order to stimulate growth, and reduce reliance on foreign sources of saving. However, the empirical evidence to date suggests that while higher growth may lead to higher domestic saving, higher domestic saving does not necessarily seem to lead to higher growth. A cross-section view of countries domestic saving rates and growth performance reveals no discernable pattern. For example in the United States, domestic savings have fallen over the past two decades while growth rates and output have steadily risen. In addition there does not seem to be a limit to how long a country can rely on the savings of others. Countries such as Australia and New Zealand have run current account deficits for many years. 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