Cablegate: In Several Ways, Labour Government Betrays Reforms

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 WELLINGTON 000342

SIPDIS

SENSITIVE

STATE FOR EB/TPP AND EAP/ANP
STATE PASS USTR-BWEISEL AND DKATZ
COMMERCE FOR ABENAISSA/4530/ITA/MAC/AP/OSAO

E.O. 12958: N/A
TAGS: ECON ETRD PREL NZ
SUBJECT: IN SEVERAL WAYS, LABOUR GOVERNMENT BETRAYS REFORMS
THAT MADE NEW ZEALAND'S ECONOMY STRONG

REF: (A) 04 WELLINGTON 428; (B) 04 WELLINGTON 291

(U) Sensitive but unclassified -- please protect
accordingly.

1. (SBU) Begin summary: Never entirely content with the
market-opening reforms that New Zealand's Labour government
spearheaded in the mid-1980s, the leaders of today's Labour
government have rolled back several of those reforms. Over
the last four years, the government has intervened in the
energy market, restricted competition in the
telecommunications sector, increased state ownership of
business, and taken a "pick-winners" approach to economic
development -- all actions contrary to the 1980s reforms
that were based on the belief that unfettered competition
would strengthen the economy. Labour's actions partly
reflect its desire, especially in this election year, to
reaffirm links with its traditional allies, particularly
labor unions, and with average New Zealanders who feel they
have been left behind by their country's recent robust
economy. Ironically, the recent prosperity -- marked by
strong growth and low unemployment -- was spawned largely
by the dramatic structural reforms undertaken by the Labor
government in the mid-1980s. In the short term, the
turnaround in some government policies is unlikely to
dampen the current economic expansion, which is expected to
slow over the next year for other reasons. However, the
changes could have long-term consequences and hamper the
government's longstanding quest to return New Zealand to
the top half of the OECD. End summary.

A late harvest
==============
2. (U) By the mid-1980s, New Zealand -- with one of the
most regulated and protected economies in the OECD -- was
saddled with rising inflation, unemployment, taxes and
government spending. Its decade-old economic policies of
smoothing out problems with government spending were
unsustainable. The New Zealand currency's fixed exchange
rate was under pressure, and its credit rating was sinking.
Beginning in 1984, the Labour government dramatically
transformed the economy, removing subsidies and most
tariffs; floating the exchange rate; abolishing controls on
interest rates, wages, prices and capital movement; and
privatizing many state-owned enterprises. The reforms
boosted competition in the private sector and placed New
Zealand among the world's most open economies.

3. (U) Two decades later, the reforms undergird five years
of economic expansion. New Zealand's economy has grown at
or above the OECD average, with average annual GDP growth
at nearly 4 percent since the last recession in 1998. In
2004, the economy grew 4.8 percent. The unemployment rate,
at 3.6 percent, is the lowest in the developed world, and
the government has a budget surplus equivalent to 4 percent
of GDP. Inflation has remained within the central bank's
target band of 1 to 3 percent.

4. (U) However, other factors signal the ride may soon be
over. With a forecast fall in the terms of trade,
declining net migration, slower consumer spending and the
lagged effects of high interest rates and a high New
Zealand dollar, economic growth is expected to slow in late
2005 or early 2006.

5. (SBU) While the current Labour government has left the
1980s reforms largely in place, it also has tinkered with
the details. Motivated by a philosophical desire to
protect domestic interests and to redistribute the
country's wealth, the government has made policy decisions
that have decreased competition in the marketplace. Those
decisions complicate the government's goal of returning New
Zealand to the top half of OECD countries in terms of GDP
per capita.

Energy: Un-level playing field
==============================
6. (SBU) The long-term security of New Zealand's energy
supply remains uncertain, with its major gas field expected
to run out by 2007; limitations on its ability to expand
its principal source of electricity, hydroelectricity; and
its commitment to the Kyoto Protocol (ref A). The
government has mapped for itself a larger role in securing
New Zealand's energy future. When the industry failed to
agree on rules for self-regulation, the government in
September 2003 set up a regulator, the Electricity
Commission, and charged it with ensuring security of supply
and reserve generation. So far, the commission has
appeared to be evenhanded in its oversight of industry, but
its most difficult decisions lie ahead.
7. (SBU) In the meantime, the government has intervened in
other ways to favor certain energy companies --
particularly, state-owned enterprises. State-owned Genesis
Energy announced in August that it would proceed with plans
for a new gas-fired power station after the government
agreed to share the risks if it were unable to obtain
sufficient gas supplies.

8. (SBU) Private companies complained that they had not
been allowed to compete for similar government assistance.
Roy Hemmingway, the Electricity Commission's chair, said
that favoring a state-owned company over private
competitors would distort the market and risk driving new
private investment out of the sector. "Investors are keen
to know the government will not intervene on the side of
the state-owned enterprises, and the government has not
provided that assurance," he said. Three state-owned
enterprises supply about 60 percent of the country's
generation capacity; three private companies provide about
40 percent.

Telecom: A local company favored
================================
9. (SBU) In May 2004, the government announced that it
would not order Telecom Corp., the country's former state
monopoly, to open its fixed-line telephone service to
competition (ref A). The decision was politically
motivated and contrary to the advice of Ministry of
Economic Development studies that showed economic benefits
would result from unbundling the local loop. Official
papers also revealed that the decision, based on a
regulatory board's recommendations against unbundling, had
been opposed initially by Minister of Communications Swain.
But, the Cabinet overruled him, and Swain announced the
decision to accept the board's recommendations.

10. (SBU) TelstraClear, a subsidiary of Telstra Corp. of
Australia, is Telecom's land-line rival and would have been
the primary beneficiary of a decision to unbundle the local
loop. As an official from the Ministry of Foreign Affairs
and Trade said, "You didn't expect this government to favor
an Australian company at the expense of (New Zealand's)
Telecom?" The government's go-slow approach to
deregulating the sector thus has abetted Telecom.

11. (SBU) Greater competition in the marketplace was
expected to spur lower prices for telephone services and
increase broadband access in the country, which is among
the lowest in the OECD at 2.7 percent of households.
Prices for mobile, residential and business telephone
services in New Zealand are significantly higher than the
average for other OECD countries. Following the decision
to not unbundle, several companies, including TelstraClear,
announced they would reduce their investment plans in New
Zealand.

Banking: Creating a state-owned rival
=====================================
12. (U) With the acquisition of New Zealand's major banks
by larger Australian institutions, the Labour government
proved amenable to the desire of its coalition partner to
create a locally owned bank. In 2002, the government
bankrolled NZ $78.2 million (US $56.6 million) to establish
a new retail bank called Kiwibank that operates out of the
state-owned postal outlets. Since then, the government has
added NZ $40 million (US $29 million) to support the bank's
capital base.

13. (SBU) The bank, which holds less than 1 percent of the
country's banking assets, contributes little to economic
growth. It competes largely with other small banks and
offers no services not already provided by its rivals. It
did report its first profitable period (unaudited), for the
six months to December 31. But Kiwibank's long-term
viability remains untested. For example, it does not yet
provide business services, which would require another
infusion of government cash. The top four of New Zealand's
16 registered banks are owned by Australian institutions
and account for about 85 percent of banking industry
assets.

Picking winners: The government bets
====================================
14. (U) As part of a concerted economic-growth strategy and
to wean New Zealand from dependence on agricultural
exports, the Prime Minister in February 2002 announced a
plan to focus government assistance on three particular
sectors: biotechnology, information and communications
technology, and the creative industries, including film
production. With this program, the Prime Minister signaled
the end of what she called "hands off" economic management
and the start of "smart interventions to facilitate
economic growth." The government contended that it was
compensating for a market failure by providing investment
in areas where private financing was unavailable or scarce.

15. (U) The program, called the Growth and Innovation
Framework, provides grants for such initiatives as
education, industry training, research and investor
promotion in each of the three sectors. A system of
subsidies for large-budget film and television productions
was added in July 2003. For both local and overseas
projects that meet certain criteria, the government covers
12.5 percent of a project's New Zealand-based production
costs. Essentially, this amounts to a refund of the goods
and services tax.

16. (SBU) This "picking winners" scheme is criticized by a
number of New Zealand economists, who argue that such
government assistance constrains the workings of an open
and competitive market. In an economic survey, the OECD
said the film production subsidies set "an unhelpful
precedent." It added, "Setting an uneven playing field may
not only misallocate resources but would also create
incentives for wasteful rent-seeking."

17. (SBU) New Zealand's auditor-general in December raised
concerns over how the government has administered the
Growth and Innovation Framework. The auditor-general noted
that basic information for some grants was not available,
criteria were not adequately considered when decisions were
made and little effort was undertaken to analyze the risks
of the government's investment. The auditor-general's
conclusions demonstrate that governments may not be best
equipped to decide which sectors would best deliver growth
for their economies.

Labor: Currying favor
=====================
18. (SBU) Current government leaders do share some goals
with their predecessors of two decades ago, particularly a
desire to protect labor. Through legislation enacted in
2000 and 2004, the current government has restored many
benefits to organized labor that were stripped away by the
National government in 1991. It has given workers the
right to strike in pursuit of multi-employer contracts,
required that parties bargain in good faith in a labor
dispute and provided protective measures for workers in the
event of ownership changes. It also has increased workers'
annual leave and holidays. Critics contend that these
measures have raised the cost of doing business in New
Zealand, will deter investment and will inhibit growth.

19. (SBU) Labor's bargaining power also has been
strengthened by a surge in public sector employment -- a 14
percent rise in the last five years -- that has crowded out
private hiring in a tight labor market.

Comment: A reputation frayed?
=============================
20. (SBU) The government's spirited interventions in the
economy arise from a political desire to cement the support
of its bread-and-butter constituency -- unions and the
working class. The interventions also reflect a
philosophical belief in redistributing the country's wealth
in a quest to create a fairer society. We do not know
whether Labour will continue in this direction if it wins,
as expected, a third term in office in this year's
elections, although if it governs in coalition with the
Green Party (a strong possibility), an interventionist bias
is likely. One economist noted that, despite its
interventions, the government overall has maintained
responsible fiscal and monetary policies that have
controlled government spending, put the operating budget in
surplus and decreased net government indebtedness, while
holding inflation in a low targeted range.

21. (SBU) Meanwhile, the government's interventions will
likely contribute little to its goal of boosting New
Zealand's long-term growth. Certainly, the interventions
run counter to New Zealand's reputation for its cutting-
edge liberalizing economic reforms. They also do not
create a conducive environment for business to expand,
create new jobs and improve labor productivity, which New
Zealand's central bank and local economists say is key to
expanding the economy.

BURNETT

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