US embassy cable - 05WELLINGTON342

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