NEW ZEALAND'S LANGE TILTS AT ECONOMIC PROBLEMS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T00590R000200250002-5
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 16
• Document Creation Date: December 22, 2016
• Document Release Date: December 10, 2010
• Sequence Number: 2
• Publication Date: May 1, 1985
• Content Type: REPORT

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Directorate of Confidential
Intelligence
New Zealand's Lan e Tilts at
Economic Problems
Confidential
EA 85-10086
May 1985
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Unauthorized Disclosure,
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and queries are welcome and may be directed to the
Chief, Southeast Asia Division OEA
Confidential
EA 85-10086
May 1985
Directorate of Confidential
Intelligence
New Zealand's Lan e Tilts at
Economic Problems
This paper was prepared by Offic
of East Asian Analysis, with contributions from
Office of Central Reference. Comments
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New Zealand's Lane Tilts at
Economic Problems
Key Judgments Although ANZUS and the denial of port access to US ships have
Information available dominated press coverage of Prime Minister Lange since he came to office,
as of 20 April 1985 we believe the electorate ultimately will judge the Labor government by its
was used in this report.
progress in dealing with the country's serious economic problems. Thus far,
a modest economic recovery since Lange assumed office in July 1984 has
allowed the Labor Party's conservative team of economic technocrats to
begin sweeping reforms designed to improve New Zealand's international
competitiveness and to regain its declining share of world trade:
? Devaluing and later floating the New Zealand dollar.
? Removing price and interest rate controls.
? Liberalizing restrictions on international flows of capital.
? Lowering import barriers.
? Reducing farm subsidies.
? Raising taxes and charges for government services.
The reform agenda also includes limiting the power of the trade unions and
overhauling the tax system.
The government's economic policies underscore the fundamental philo-
sophical differences that separate Lange's approach from that of many of
Labor's traditional supporters-who favor protecting indigenous industry
and jobs and increasing spending on social welfare. Nonetheless, we believe
Lange has gained a breathing space in the party caucus and a free rein on
economic policy matters because his strong antinuclear stand far exceeded
the expectations of party leftists.
Lange appears to be having more serious political difficulties outside the
party. Farmers and pensioners, traditional supporters of the opposition
National Party, are particularly disgruntled with Labor's harsh November
budget. Public opinion polls show that the National Party's popularity has
steadily increased since then, and in April it edged ahead of the Labor Par-
ty by 2 percentage points.
We do not expect Lange to stand firm on continuing his economic reform
program during the remainder of his three-year term. We believe only
sustained economic growth on the order of 3 to 4 percent annually-an un-
likely prospect according to our analysis-would deter union leaders and
leftist party ideologues from demanding a return to policies of stimulating
the domestic economy, despite the risk of accelerating inflation. If the
economy sputters, as seems likely, and the Labor government is blamed,
the National Party would be in a good position to return to power in the
1987 national elections.
Confidential
EA 85-10086
May 1985
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New Zealand's Lane Tilts at
Economic Problems
Lange's Political Mandate
Although foreign policy issues-chiefly ANZUS and
the denial of port access to US naval ships-have
dominated press coverage of Prime Minister David
Lange's first nine months in office, we believe that the
electorate will judge the Labor government on the
basis of domestic issues, chiefly the economy. Lange,
we believe, fully appreciates this economic imperative.
Labor's election rhetoric stressed economic growth
and hit hard at former Prime Minister Muldoon's
expensive social welfare policies.' Moreover, when
Lange took office last July he immediately acted on
his campaign theme of "Bringing New Zealand
Together" by calling for an economic summit, which
was held in September. Business, labor, and govern-
ment representatives-invited to participate in formu-
lating the new government's economic policies-pro-
vided Lange a media extravaganza. Soon after the
election he also assembled a respected team of techno-
crats, giving the finance portfolio to Roger Douglas,
his most conservative Cabinet minister, and appoint-
ing two other members of Parliament with economic
and financial expertise to assist the new Finance
Minister.
Lange's ability to continue his economic reform is
closely bound to his strength as party leader. Al-
though he has always had problems with the left
wing-which opposes market-oriented reform initia-
tives-his position in the Labor Party parliamentary
caucus has improved since August.2 We believe the
principal reason for the improvement is Lange's for-
eign policy: his uncompromising ban on port calls by
nuclear-weapons-capable warships has satisfied one of
the left wing's primary demands. This has won Lange
a breathing space in economic policy making-al-
though, in our judgment, such a tradeoff is unlikely to
satisfy the left much longer.
The Road to Moderation: First Steps
Lange's progress thus far has been impressive. The
Labor government's first economic objective upon
taking office was to end the ruinous speculation
against the New Zealand currency that had developed
in the second quarter of 1984. It immediately de-
valued the New Zealand dollar-a move Muldoon
had resisted for months. At the same time, the
government eliminated Muldoon's tangled web of
interest rate controls; that, together with the devalua-
tion, sparked a dramatic resurgence in capital inflows,
as New Zealand government and private securities
began to look attractive to overseas investors.' To
entice investors from New Zealand's two leading
trading partners the government also sponsored show-
case tours for Japanese investors and lifted the Mul-
doon government's embar o on Australian private
investment.
When he announced the 1984-85 budget in early
November, Finance Minister Douglas served notice
that the new government was about to push for real
change in New Zealand's economic structure. The
budget attempts to combine Douglas's conservative
economic principles with the Labor Party's tradition-
ally liberal aims by addressing three primary goals:
? Reducing the budget deficit.
? Restoring export competitiveness.
? Extending the safety net of social welfare programs.
The Labor government, in our view, has made impres-
sive progress putting the government's finances in
order. On the revenue side, the budget raises the
average income tax, closes several cherished tax loop-
holes, taxes fringe benefits, places a surtax on high-
income pensioners, and increases the excise taxes on
' Devaluation resulted in an immediate reversal of domestic
liquidity conditions. Trading bank reserve assets, reflecting the
large postdevaluation inflow of funds, rose by more than US $460
million during July and by early August reached a record of about
US $1.4 billion, according to the Reserve Bank of New Zealand.
Labor parliamentarians supported Lange, while 24 supported left-
wing leader Jim Anderton and six were nonaligned. Several first-
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Lange's Economic Triumvirate
Finance Minister Roger Douglas is a maverick within the Labor Party because of
his "growth first " economic views. A successful businessman, the outspoken
Douglas has clashed with party leaders in the past but is on good terms with
Lange, who admires his innovative ideas. An accountant by training, Douglas is
48 years old.
Associate Minister for Finance Richard Prebble is a close adviser to Lange and an
excellent pro-Lange coalition builder. He is also a harsh critic of past Labor
Party leadership. Energetic and aggressive, he holds transport-related portfolios
and is Minister for Pacific Island `airs. A lawyer, he is 37 years old.
about 35 years old.
Associate Minister for Finance and Minister of Trade and Industry David
Caygill was once a supporter of the radical-left faction of the Labor Party but is
now a full partner in Lange's economic planning group. He believes New
Zealand's industrial base must be redirected away from noncompetitive activities
and toward highly sophisticated technological products. A lawyer, Caygill is
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Lange's mandate to restore the economy to health
and to streamline the maze of ad hoc policies left by
Muldoon provides him with a major challenge. Since
1955-when New Zealanders had the third-highest
per capita income in the world-moves by a series of
25X1 protectionist governments have helped to lower the
country to about the 20th position, where it has
hovered in recent years, according to the World Bank.
such as dairy products.
Especially during the Muldoon years (1975-84), New
Zealand avoided putting its resources where they
could earn the most in the world economy. When
cheaper Asian-manufactured goods began to flood
home markets during the 1970s, for example, Mul-
doon developed import-licensing and export-subsidiz-
ing schemes that effectively protected New Zealand
manufacturers but directed resources toward indus-
tries where New Zealand had no competitive edge,
such as automobile and electrical equipment assem-
bly. When world agriculture prices dropped, New
Zealand added farm subsidies, which over time have
distorted the pattern of land use and have led to
increased production on marginal land of commod-
ities that are already in surplus in world markets,
Muldoon's critics accused him-correctly, in our
view-of treating the symptoms of New Zealand's
ports.
alcohol and cigarettes. It also requires government-
owned enterprises such as an oil exploration firm and
the post office to return more of their earnings to the
government and raises user fees for roads and air-
On the expenditure side, the budget ends consumer
subsidies on goods such as coal, gasoline, and electric-
ity. The largest chunk of budget savings, however,
comes from reducing the subsidies that have support-
ed farmers and traditional export industries for years.
Douglas, according to press interviews, is convinced
that expensive subsidies are bankrupting New Zea-
land and encouraging inefficient business ventures.
His approach is aimed at reducing both the deficit
malaise rather than its causes. Under Muldoon,
Wellington "solved" the problem of high inflation
with price controls, the problem of high interest rates
with interest rate ceilings, and the problem of high
wage settlements with across-the-board wage in-
creases that were more moderate but ignored market
demand and, later, with wage freezes. To make
matters worse, Muldoon resorted to an erratic fiscal
policy. Real government expenditures invariably rose
during election years, while real revenue collections
fell; after elections, the process was reverse
In perpetuating the welfare state, Muldoon commit-
ted the government to providing more goods and
services than it was prepared to tax the public for.
Food, transportation, postage, and hospital care have
been subsidized for decades. Under Muldoon, howev-
er, social welfare programs expanded rapidly to
include a new national retirement scheme and a more
liberal unemployment insurance program. Thus, over
the last 15 years government expenditures have risen
more than tenfold, and, in the last year of Muldoon's
leadership, government expenditures exceeded 40
percent of gross domestic product while the govern-
ment deficit reached nearly 9 percent of GDP.
and government intervention in the marketplace. Be-
sides outlining a plan to reduce the tariff structure
over several years, the budget immediately increases
import license allocations to allow more competition
in the domestic market
Lange's policymakers have also exhibited consider-
able political savvy in dealing with labor, in our
judgment. Knowing the government would face wage
negotiations in December 1984-at the end of a
three-year wage freeze-Douglas at budget time tried
to preempt one of the unions' major arguments for a
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Figure 1
New Zealand: Polling the Public on Politics
Devaluation of
the New Zealand
40 Jul Aug
1984
12-14 September
National economic
rNatii
28 November
McLay replaces
Muldoon as head
US nuclear-capable
ships denied port
call
Jan Feb Mar
1985
50
40
30
20
10
0 Jul
1984
Jan
1985
Labor government
Government economic
policy
Labor Party
National Party
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large wage increase: that low-paid workers were
unable to support their families at current wage rates.
His family care package, therefore, gives about $5
weekly to low-income working families.' Together
with hikes in social security and other payments, the
benefit package will result in a 9.2-percent rise in
budget expenditures, but the 15-percent increase in
receipts predicted by the government is supposed to
shrink the deficit.
Public Reaction
Despite the pinch of higher gasoline and import prices
resulting from devaluation, the public has given the
government credit for acting decisively in its first
months in office. Pollsters recorded a significant
increase in support for the Labor Party during the
weeks following the election, and after the September
economic summit both the Labor government and
Lange received their highest popularity ratings (see
figure 1).
Since then, the road has been rockier. Reaction to the
long-awaited budget, for example, was sharp, immedi-
ate, and mostly adverse. Although opposition to the
budget has been tempered by the widespread realiza-
tion that the Muldoon government left the country
with serious economic problems, every major interest
group-ranging from farmers to retirees to union
leaders-has complained about particular provisions.
The offended groups include voters in both major
parties. Editorials, letters, and public opinion polls
have registered particular discontent among tradition-
al supporters of the opposition National Party. Even
among Labor Party stalwarts, however, the govern-
ment's budget has ruffled feathers. Many union lead-
ers have complained that the government's policies
require taxpayers rather than business profits to
provide aid to the needy. They had expected, we
believe, Lange and Douglas to provide tax relief for
all wage and salary earners in exchange for the
promises they made at the September summit to
demand only moderate wage increases in the Decem-
ber negotiations
As Santa Lange came to town with his
bag of budget goodies, the pouting began.
The Crusade Continues
Lange's government appears determined to press on,
despite opposition from key political constituencies,
and the next target will probably be the wage-setting
process. The US Embassy reports that, after recently
studying work force dynamics in the United States,
Douglas has concluded that the primary reason for
the almost total absence of new job generation in New
Zealand during the last two decades has been the
inflexibility of the work force. Indeed, government
coercion in the wage-setting process has all but ruled
out corporate- and industry-level collective bargain-
ing. High across-the-board wage settlements in the
1970s resulted in minimum wages that are too high
relative to the skills required in many jobs, according
to Douglas. He says unemployment compensation has
been too liberal and many workers are simply unwill-
ing to take low-paying jobs
Douglas already has had partial success in imple-
menting labor market reforms. Union and business
representatives have approved a new, more flexible
framework for wage negotiations:
? Encouraging enterprise- and industry-level
bargaining.
? Taking into account supply and demand for particu-
lar skills and changes in job content or technological
levels which result in greater productivity.
? Reducing the government's role and increasing the
roles of the Arbitration Court, employers, and local
union organizations.
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ment's overall economic program.
In December, however, union leaders' disappointment
with the government's budget threatened the first
trial of the new system. Because union and business
leaders were unable to agree in advance upon a wage
increase target, Lange acted in a "Muldoon-like"
manner, imposing on negotiators a wage-increase
target of 4 to 5 percent and hinting about wage fixing
if bargainers ignored it. Political observers predicted
bitter disputes: the Federation of Labor endorsed a
minimum settlement guideline of 9.6 percent and
employer representatives stated they would return to
their original offer of 2 percent. Although these
disputes never materialized, wage settlements have
averaged about 7 percent, and we judge that Lange
will face a serious challenge from unions when the
next round of wage negotiations begins in Septem-
ber-primarily because inflation is increasing again,
but partly because the wage round will be a conve-
nient time to express displeasure with the govern-
may limit such cuts.
Also on the government's agenda is a major overhaul
of the entire tax structure to incorporate some of
Douglas's ideas. As recently as two years ago Douglas
suggested reforms considered radical by New Zea-
landers, including abolishing personal and company
income taxes and replacing them with a flat rate
payroll tax (on wages, allowances, and "perks"), and
taxes on some business inputs, gifts, retail merchan-
dise, and wealth. According to Douglas, the present
system of relying heavily on personal income taxes
with steep marginal rates discourages productive in-
vestment and risk-taking and leads to tax avoidance.
It is also ineffective in collecting revenue because a
great majority of the New Zealand work force has an
income close to the average annual wage of $11,500
and few individuals pay the high marginal tax rates.
Douglas took the first step toward implementing his
ideas in April 1985 when he introduced in Parliament
a bill for a broadly based value-added tax. He has
promised to follow up with a large across-the-board
cut in income tax rates, but spending requirements
25X1 The government apparently will implement many of
Muldoon's ideas for export marketing, including the
creation of a new Department of Overseas Marketing
to develop a global export strategy. On the other
hand, Labor's energy policy questions the value of
New Zealand: Cost Estimates for Million US $
Major Projects, February 1984 a
Project
Marsden Point oil refinery
expansion
Motunui synthetic gasoline
plant
Petralgas chemical-
methanol plant
Petrocorp LPG-to-fuels
plant
CNG auto conversion
(150,000 vehicles over 5
years)
Petrocorp gas treatment
plant
Kapuni ammonia urea
plant
Ethane processing plant
Other projects
Construction
Period
Cost
3,780
2,410
1980-84 b
780
1982-85
620
Completed
455
1983-85
220
1979-84 b
130
1983-85
80
Completed
60
Late 1980s
NA
1,370
a Cost overruns and construction delays, especially at the Marsden
Point refinery, have discouraged the Labor government, according
to press reports. Moreover, falling world oil prices make the energy
projects seem less necessary, and there have been rumblings in the
press, supposedly originating within the government, about discon-
tinuing the more costly and less complete parts of the "think big"
program.
b Extended.
Muldoon's "think big" energy development projects-
designed to substitute domestically produced synthet-
ic gas and gasoline for oil imports (see table). Future
projects, says Douglas, will have to operate without
government subsidy-a move that assures higher en-
ergy prices.
Assessing the Short-Term Economic Costs ...
Although reform eventually will improve internation-
al competitiveness and growth, the next two years will
see upheaval as Labor's moves begin to take their toll
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Money, Credit, and Debt:
New Zealand Down, but Not Out
The Labor government faces its most critical problem
of economic management in matters of money and
credit. Public-sector debt is reaching $15.6 billion,
with overseas obligations totaling about $9.1 billion,
according to the US Embassy. The ratio of debt to
GDP has placed New Zealand on par with such debt-
ridden nations as Brazil and Mexico, and its credit
rating has been lowered twice since 1982 by interna-
tional rating services. The high cost of debt service-
15 percent of government expenditures or 20 percent
of revenue-limits Labor's monetary and fiscal policy
options.
each providing a full $1.4 billion.
Beginning with devaluation of the New Zealand
dollar in July, Douglas has introduced a series of
measures to strengthen the financial sector by build-
ing up foreign exchange reserves, freeing interest
rates, liberalizing barriers on international flows of
capital, and allowing an increase in the number of
foreign exchange dealers. Partly for this reason, New
Zealand has had no trouble arranging foreign financ-
ingfor a current account deficit that, according to the
US Embassy, increased by $330 million to reach $1.4
billion in the year ending in December 1984. Its
imaginative debt rollover in September impressed
many foreign economic analysts; one long-term and
three short-term borrowing options were created,
on less efficient businesses. The manufacturing sector,
we believe, will grow only by fits and starts. An
industrial shakeout and the curtailment of large subsi-
dies will inevitably lead to job losses, and, in the
uncertainty surrounding economic reform, new em-
ployment opportunities are not likely to be created in
sufficient numbers to absorb displaced workers
Lange publicly has acknowledged that labor-
management tensions are inevitable in a climate of
rapid change such as he is attempting to instigate.
New Zealanders, however, are usually not very toler-
ant of strikes-apparently the main reason they ac-
cepted Muldoon's reversal of the policy of compulsory
Volatile trading of the New Zealand dollar onfinan-
cial markets in February 1985 possibly caused by
fear of US trade sanctions in the wake of the ANZUS
port access crisis-encouraged Douglas to announce
on 4 March the float of the dollar he had been
preparingfor months. Because the float has produced
no marked revaluation of the currency in trading
since then, Douglas has been able to fend off criticism
that it would harm exporters and risk external
manipulation of the exchange rate. The float will
allow the Lange government greater flexibility in
controlling inflation-which economic analysts had
forecast to reach an annual rate of 14 percent by June
1985-and in managing foreign debt financing.
Moreover, we believe Douglas could continue impos-
ing his conservative economic policies on the often-
fractious Labor Party caucus if he succeeds in moder-
ating inflation and achieving modest growth. The
party's left wing has charged that monetarists have
overtaken the Labor government and overturned long-
standing Labor Party priorities. The left, we believe,
is anxiously awaiting the right moment to demand a
return to traditional policies of regulating financial
markets, stimulating the domestic economy, and
protecting jobs
unionism. For this reason, we believe the Labor
government, which has reinstated compulsory union-
ism and can less afford to offend the union movement,
may be persuaded to reintroduce some subsidies and
import barriers to quiet labor protests if the public
complains.
In the agricultural sector, Labor's subsidy cuts almost
certainly will eliminate marginally profitable farms.
New markets such as China and reasonably good
world prices will bring profits to New Zealand wool
and beef producers again this year, but a potential
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price war involving US and EC dairy products threat-
ens New Zealand dairy farmers. In addition, farmers
continue to be concerned about US trade sanctions
following Lange's port ban policy-a reasonable fear
since the United States is New Zealand's largest
overseas customer.
... and the Political Fallout
Fundamental philosophical differences clearly sepa-
rate Lange and his finance team from many of
Labor's traditional supporters, and we believe this will
prove to be Lange's Achilles' heel. The government's
policies presuppose that the New Zealand economy
should be export led and must, therefore, be competi-
tive in world markets. Union leaders have consistently
opposed this point of view, charging that it requires a
low-paid labor force and exposes New Zealand to the
vagaries of demand and inflation of the global econo-
my. They contend that the best course for New
Zealand is to stimulate the domestic economy and
continue to protect indigenous industry and jobs.
Thus, their argument runs, the government should
have a key role in directing domestic investment and
in regulating the economy.
With economic growth slowing this year to less than I
percent-probably to be followed by two or three
years of little or no growth before the government's
reforms reinvigorate the economy-Lange must ex-
pect a serious challenge from the Labor Party's rank
and file as well as from union leaders.' Party leftists
will continue to be Lange's biggest worry, exasperated
by his forsaking of the party's traditional interven-
tionist, job-protective, and welfare-oriented approach
to economic policy.
Outside his party, Lange also faces increased pres-
sures from a refurbished National Party. The Nation-
al Party deposed leader Muldoon last November-
despite his efforts to retain party leadership. Since
then, the National Party's popularity has steadily
increased, and in late April public opinion polls it
moved ahead of the Labor Party, 44 to 42 percent.
Furthermore, polls indicate a sizable drop in support
for Bob Jones' free market New Zealand Party, with
many of its supporters drifting back into the National
camp.'
Political observers have come to consider National the
"natural" ruling party in New Zealand because not
one Labor government has won a second term since
World War II. Moreover, farmers are generally a
National constituency and about half of New Zea-
land's jobs are still in the agricultural sector. Lange
rightly says that farmers must cut costs and diversify
if agricultural exports are to remain New Zealand's
primary source of foreign exchange earnings. As in all
industrialized nations, however, many New Zealand
farmers will be forced to find new careers. The
potential political backlash is not a happy prospect for
Lange-who publicly admits knowing little about
farming.
If the economy sputters-an outcome we deem like-
ly-the loss of some Labor supporters plus the return
of businessmen, professionals, and disgruntled farm-
ers to the National Party could cost Lange and the
Labor Party its control of government in the 1987
election. We believe a variety of indicators will be
available in the months ahead to gauge the outcome,
including:
? The regional Labor Party conferences. Dissension at
the first of six conferences in March underscores
Lange's tenuous hold over economic policy making.
Party members passed resolutions-which are pre-
liminary drafts of party policies-against the
government's proposed goods-and-services tax and
its market-oriented budget. If moderates fail to curb
leftwing demands at the remaining conferences, it
6 The New Zealand Party was formed in 1983 to offer an
alternative to what its leader, Bob Jones, called the socialist and
interventionist policies of the National Party government under
Muldoon. In addition to free market economic policies, it advocates
the dismantling of the nation's defense forces. In the July 1984
elections, it garnered 13 percent of the popular vote, drawing away
from the National Party many businessmen, professionals, and
farmers disenchanted with Muldoon's welfare-state approach to
product exports are expected to fall.
' We believe the economic growth of nearly 4 percent that New
Zealand registered in 1984 is unlikely to be repeated because it was
primarily a response to the world recovery-export earnings rose
for wool, nontraditional primary products, forestry products, and
manufactures. Moreover, the devaluation and domestic deregula-
tion brought in a surge of new capital in the last half of the year
that is unlikely to be repeated. This year, the export volumes of
most products are not expected to increase dramatically, according
to New Zealand and Australian economic analysts, and dairy
economic management
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would be a major setback for Lange, because subse-
quent rounds of policymaking will be influenced by
the left through its control of the party machinery.
Resolutions passed must be approved at several
levels before they become party policies, but the
parliamentary caucus is obliged to implement party
policies and may convert them into law.'
? Defense spending and taxation. Military spending
must rise-"more than 1 million but less than 1
billion" New Zealand dollars, according to Lange-
to cover the added costs of maintaining an adequate
defense without US cooperation under ANZUS.
Although lowering the overall tax burden and mak-
ing New Zealand's tax system more equitable have
been Douglas's primary aims, increased defense
spending will probably force him to use tax reform
to increase revenue. Douglas's plan may therefore
be of marginal benefit to the New Zealand economy
while creating a public backlash.
McLay has been ineffective in his attempts to
embarrass the Lange government over ANZUS and
has offered no appealing alternative to Labor's
economic policies. Among National supporters,
moreover, former Prime Minister Muldoon contin-
ues to rival McLay in popularity. National will
become a serious threat to Lange only when McLay
exerts stronger leadership and focuses his attack.
have disproportionate influence in the party organization, and are
therefore able to skew the regional and national party conferences
toward more radical positions than the Lange faction would prefer.
' Although Lange has managed to keep leftwing parliamentarians
out of his Cabinet, they are very vocal in the caucus, continue to
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Confidential
Confidential
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