How to build back better (and how not to)

Roger Partridge
NZ Herald
2 March, 2023

Building back better was a common catch-cry as the country looked ahead to the post-Covid economy. And why not, you might think. Who would want to build back worse?

Unsurprisingly, building back better is a prevalent plea in the aftermath of this year’s catastrophic weather events. No one should quarrel with this. Cyclone Gabrielle showed shortcomings in New Zealand's infrastructure resilience which are both plain and painful to see.

But planning for better and more robust infrastructure like roads, rail, and essential utilities is one thing. Planning a better economy is another thing entirely.

Indeed, the idea of centrally planned economies was soundly discredited by the end of the 20th century. A simple comparison between West and East Germany, North and South Korea and North or South America provides reason enough.

Yet, in the 21st century, state planning has become fashionable again. In its new guise, the state does not so much take over the means of production. Instead, it picks winners by guiding investment and fostering innovation.

A cheerleader for the new statism is Mariana Mazzucato, an economics professor at University College, London.

Mazzucato’s 2013 book, The Entrepreneurial State, and its sequels have been music to many politicians’ ears. Her clever repackaging of old-fashioned “industrial policy” into “state entrepreneurship” has unleashed a new generation of interventionism. Any government of any political persuasion looking for an opportunity to “do something” need only point to the Italian-born economist.

Tax subsidies for the film industry. A billion dollars or ten on pumped hydro. Green bond investments from the central bank. Which politician or public servant wouldn’t want to try their hand at being an entrepreneur? Especially when they have Mazzucato’s imprimatur and the taxpayer to underwrite their experiments.

Not surprisingly, Mazzucato’s hands are all over our own Government’s building back better efforts. Googling “Mazzucato” and “MBIE” reveals a litany of worthy-sounding reports. From MBIE's  “Discovering New Zealand’s areas of (economic) strength: A literature review” to “What would it take to mobilise investment to achieve New Zealand’s climate goals,” Mazzucato’s fingers are firmly entwined in government policy development.

Despite their popularity, Mazzucato’s views are not new. Her theories are little more than a repackaging of ideas that became fashionable among economists in the 1930s. And the ideas held sway until the late 1970s or thereabouts.

The theories then largely fell from grace. And for good reason. Harvard professor Josh Lerner’s book, Boulevard of Broken Dreams, contains countless examples of unsuccessful state-led business and innovation policies around the world. They range from abandoned science parks in Malaysia to EU funds distributed so widely through political deliberations that they could not make any difference.

In New Zealand, the Muldoon government’s disastrous early 1980s “Think Big” energy investments were responsible for severely curtailing the state’s attempts at entrepreneurship. Muldoon’s policies cost the country billions and left it straddled with debt taxpayers took more than a decade to repay.

But a lack of originality is not the biggest problem with Mazzucato’s ideas. A series of international studies suggest they are fundamentally flawed. Perhaps most notable among them is a major interdisciplinary research programme conducted between 2013 and 2018 in Sweden. The Financing of Innovation study combined detailed quantitative modelling of all Swedish companies with a large number of case studies.

Rather than state-led investment, the study showed that creating a favourable environment for private firms to operate in is most important for advancing innovation.

Three factors were found to be critical. First, improving the supply of human capital through a better-functioning education system and more flexible labour markets. Second, reducing the regulatory burden, including the tax burden, faced by firms and entrepreneurs. And third, focussing on infrastructure bottlenecks and shortcomings.

The results of the Swedish study are not surprising. And they echo numerous other overseas studies.

This may be a disappointment to politicians and bureaucrats keen to place themselves at the centre of something as exciting as guiding innovation and entrepreneurship. Far from leading innovation as Mazzucato advocates, the evidence suggests the state should focus on removing obstacles to innovation.

Getting into the nuts and bolts of micro-economic reform may not be as sexy as funding the next Hollywood blockbuster, but it is what really matters.

If our Government is serious about building back better, there is much to do.

In the short-term, relaxing immigration controls that have choked off supplies of skilled labour will provide an immediate boost to the economy.

Longer term, fixing New Zealand’s broken state school system is critical. The country will never have an innovative, highly productive, highly paid workforce if it does not have a well-educated one.

Reversing labour market reforms introduced over the last 5 ½ years, including the harmful Fair Pay Agreements Act, will help ensure the flexibility of New Zealand’s labour markets.

Together, these reforms will address the human capital needs of an innovation economy.

On the regulatory front, reducing the quagmire of planning laws (rather than adding to them, as Environment Minister David Parker’s reforms will do) is critical. Reforming our incoherent and restrictive foreign investment regime to free up supplies of offshore capital and accompanying know-how may be a close second.

Subjecting the country’s stockpile of other regulations to thorough cost-benefit analysis and discarding or modifying those that don’t measure up should also be high on the list.

Hand in hand with these reforms, the country’s infrastructure shortcomings need to be solved. These were acute prior to the cyclone. In its wake, they are cruelly exposed.

Part of the solution is prioritisation. Now is not the time for costly, misguided luxuries like Auckland’s light rail.

Another part is removing red tape. The country cannot afford the customary interminable wait for Resource Management Act approvals. Nor for the Commerce Commission to approve electricity transmission upgrades. Consenting processes must be fast-tracked.

Nor can the country afford to exclude the private sector from infrastructure financing. Where private sector partnerships are possible, they should be pursued. Options for user-pays, especially toll roads, should also be explored. But the Crown should not hesitate to use its own balance sheet to finance the rebuild. Nor to fund other infrastructure needs that pass a rigorous cost-benefit assessment.

Finally, a word on tax policy. It may be tempting for the Government to increase taxes in response to the cyclone. It should pause before doing this. The Swedish study found that long term, lowering taxes on entrepreneurship and personal incomes did more to increase capital for innovation than any type of state subsidy. If the Government wants an innovation economy, lower taxes on innovation and personal income is best.

Building back better is a worthy goal. But it is not an excuse for “anything goes”. Even in times of crisis, policy must be driven by evidence. And the evidence shows Mazzucato’s promise of an entrepreneurial state is a myth.

If the Government really wants to build back better, it should pave the way for the real innovators and entrepreneurs to succeed.

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