A new growth theory drives Labour's policy

The Clark-Cullen government is not just tweaking the 1990s market-led policies. It is mounting a frontal assault — at least in theory.

In behind its policies is a “new growth theory” which argues that the private sector can’t always pick winners and governments must be involved.

Some of this, as reworked by Michael Cullen’s former economic adviser Peter Harris and adopted by Cullen himself, lies behind the recent move to expand the state-owned enterprises (SOEs).

This is not pre-1984 heavy-government development economics, which marooned many emerging economies and, in a home-grown version, drove this country’s economy up a cul de sac out of which we had to reverse with much pain in the 1980s.

The new theory accepts, in the words of one of its gurus, Dani Rodrik of Harvard University, that “markets do better than central planning and trade is better than autarky”.

But, Rodrik argued in a paper in 2003, “it takes a huge leap of faith to go from this to the conclusion that one can’t go wrong by privatising, liberalising and opening up as much as possible” — the so-called “Washington consensus”.

Rodrik said South America has done less well with Washington consensus policies than China and South Korea with “heterodox” policies.

Rodrik agreed there are “universals”: property rights, the rule of law, alignment of incentives with costs and benefits, macroeconomic and financial stability (with debt sustainability, prudential regulation and sound money). But “diverse” institutional arrangements and policy prescriptions can deliver these “universals” and even to some extent substitute for them, at least temporarily.

“Given the policies in place in China, Vietnam and India … it would have been easier to explain their performance if these countries had failed abysmally instead of succeeding,” he argued in another paper in 2004. It was not enough to say that failure in Washington-consensus economies was due to not having gone far enough — a familiar argument here.

In another 2004 paper Rodrik argued for development policy based on “an intelligent intermediate stand between the two extremes” of state planning and public investment and pure Washington consensus market.

“Market forces and private entrepreneurship would be in the driving seat of this agenda but governments would also perform a strategic and coordinating role in the productive sphere.”

This is not taxes and subsidies and the like but “strategic collaboration between the private sector and the government to uncover where the most significant obstacles lie and what type of interventions are most likely to remove them”.

This is not “picking winners” — and in any case, the private sector has difficulty picking winners, too. If an enterprise picks a loser it carries the full cost of developing the failure and if it picks a winner other firms imitate it and dilute the returns.

If this makes businesses cautious, potentially profitable ventures go unexploited. So innovation — the driver of higher productivity, economic policymakers’ holy grail — is below potential. So the theory goes.

Moreover, some initiatives are not viable unless there are complementary investments such as storage, marketing facilities, quality assurance and transport services.

So, the theory says, to overcome these inadequacies of the market if left to itself, the government and businesses need to work together to discover options for profitable development. That requires coordinated, sector-identified, whole-of-government action across each business sector. This was exactly what Jim Anderton started with the forestry sector in 2000 — before the theory was developed.

The idea is that firms and countries discover what they can do competitively and then master the production processes. The private sector leads and the public sector encourages and supports it. An important element is the recognition that innovation is seldom a one-off but is cumulative and often involves more than one contributor (a recent Treasury study agrees).

The government’s challenge is to ensure its encouragement and support is adding value and not crowding out private activity. So Ministry of Economic Development policy, as detailed in a cabinet paper in 2004, is that government engagement should not reallocate resources to favour one sector against others and should focus on better implementing existing policies and programmes and improving the quality of regulation.

A number of otherwise apparently disparate government third-term initiatives fit into the “new growth theory” framework.

* Commerce Minister Lianne Dalziel has launched an ambitious programme to improve the quality of regulation.

* Telecommunications Minister David Cunliffe is in his industry boots and all.

* SOE Minister Trevor Mallard is gingering up SOEs to partner with innovative enterprises and expand in the hope that that will retain and exploit intellectual property in this country and not leave it open to “plunder” by foreign-owned companies, as he complained in a speech last week to 50 local and Australian CEOs of foreign-owned companies.

* As Minister for Economic Development, Mallard has also set out to sharpen New Zealand Trade and Enterprise’s business assistance programmes.

Mallard included some of Harris’s thinking in the cabinet papers underpinning the SOE initiative. And he argued last week to the foreign company CEOs that innovation is a “connected system with feedback loops. Instead of ideas looking for markets, we need to think of markets looking for solutions” — which is where he sees foreign companies fitting in the government’s new scheme of things.

This is a government that wants action. And now it has a theoretical base to back its instincts. Stand by for more.