ADECADE AGO, New Zealand was at the forefront of cutting-edge liberalizing economic reforms, an agenda that was pursued by both the country's main political parties. First, the left-of-center Labour party, elected in 1984, deregulated, privatized, cut industry and agriculture welfare, and pushed through a major switch from an income to a consumption tax. It ended up proposing -- but not enacting -- a 21 percent flat rate tax. Then, in 1990, the right-of-center National government took up the reform baton with steep cuts in welfare programs and the most radical shake-up of labor law outside Margaret Thatcher's Britain. The economics worked: 4 percent growth in the mid-1990s and the fastest growth of employment in any OECD country.
But now the reformers are to be found at the margins of New Zealand politics. The current Labour government led by Prime Minister Helen Clark -- containing some of the politicians most opposed to the Kiwi reforms -- was reelected in a 2-1 landslide in July 2002 after three years in power. What happened? In fact, the New Zealand case is part of a pattern. Bill Clinton and Tony Blair reaped what Ronald Reagan and Margaret Thatcher sowed. In central Europe, reformers have been replaced by their opponents -- Vaclav Klaus as prime minister in the Czech republic by Milos Zeman, and the author of Poland's Balcerowicz plan by former communist Aleksander Kwasniewski.
New Zealand's experience is instructive for free-market reformers around the world. On these South Pacific islands of a little under 4 million people has been distilled the political dynamics of market-based reform and the countervailing forces opposed to it. Does reform create or consume political capital? To what extent is reform reversible, or does it create new constituencies and permanently change the terms of political debate? Has reform reached a natural frontier at the fortress gates of big-government social welfare programs?
The economics of reform
NEW ZEALAND HAS a palpable sense of economic underperformance -- of a country that has come nowhere near testing the envelope of what is possible. Its stock market has yet to recover its pre-October 1987 highs. In Auckland and capital city Wellington, it has urban areas that, given their natural setting, should be two of the most magnificent waterfront cities in the world. But neither compares to Sydney across the Tasman Sea, to San Francisco, Hong Kong, or even Seattle. Their architecture seems trapped in the 1970s, more like Santiago de Chile or Warsaw.
There aren't enough people in New Zealand. Indeed, it is one of the most underpopulated countries in the world. Take away Australia, with its vast interior deserts, and countries such as Canada, which extends into the Arctic, and New Zealand has the lowest population density of any country in the OECD. In terms of land area, New Zealand is 50 percent larger than Washington State but has just over half the population. New Zealand should be one of the fastest-growing countries in the world, a magnet for ambitious people looking for a better life. The change in migration flows with Britain illustrates the problem. From 1974 to 1980, both New Zealand and Australia were net importers of people from the UK. While Australia has continued to be a net importer, New Zealand started to lose people to Britain. Since the election of the current Labour government in 1999, the country's talent drain has worsened.
New Zealand entered the twentieth century as one of the wealthiest countries in the world in terms of income per head. On the eve of World War 1, per capita income was higher than in the UK and within 3 percent of the United States. It maintained its ranking through the Depression years, and in 1950 per capita income was still 88 percent of that of the U.S. But the tightening grip of protectionism and corporatist policies remorselessly pushed New Zealand down the international rankings. …