Democracy Briefing: “Why Nations Fail” – how NZ’s political institutions are failing us

Are New Zealand’s political institutions fit for purpose? That’s the question posed by Danyl Mclauchlan in a Listener article this week discussing the work of economists Daron Acemoglu, James Robinson and Simon Johnson, who were recently awarded the 2024 Nobel Prize for Economics. His piece is titled “Why economies fail: Stark lessons for NZ from a 2024 Nobel Prize winner”.

The Nobel prize winning authors have published numerous papers and several best-selling books, including Why Nations Fail and The Narrow Corridor examining the relationship between political institutions and economic success. They find that the key factor behind the success or failure of a nation lies in inclusive institutions and a lack of political patronage (corruption). A society should succeed if its institutions deliver equitable access to property rights, the rule of law, competitive free markets and accountable democracy. But there is always a strong temptation for elites to use political power for “rent-seeking”, economist jargon for extracting wealth from others rather than creating it themselves.

To prevent economic reform, elites capture the regulators that are supposed to constrain them, and politics becomes exclusive. Mclauchlan argues that New Zealand is a case-study in this process. Here’s his main point, suggesting that although on the surface New Zealand looks like a highly democratic and transparent political and economic system, major problems exist:

“But we have a very concentrated political system dominated by two large, centrist parties, neither of which seems to stand for very much. Our laws around lobbying and political donations are a joke and – lo and behold – monopolies and cartel-like behaviour are endemic across our economy. The recent price surges in the wholesale energy markets and subsequent closures of companies that could no longer afford to operate are textbook cases of how oligopolies destroy economic growth. Our governments are accountable via the electoral cycle, but the wider public sector is not. The recent report into abuse in state care demonstrated that public agencies can literally torture children and the entire system will cover it up and no one will be held accountable. Vast sums of taxpayer money disappear into complex bureaucracies, much of it flowing to private sector providers, and it’s hard to see the value from all this spending.”

He is not the first to make the connection between New Zealand and Acemoglu et al. The economist Geoff Bertram has published a number of papers drawing a comparison between the model of extractive economies with exclusive political institutions and the state of New Zealand’s political economy since the sweeping reforms of the 1980s and 90s.

Bertram argued that instead of transitioning to a competitive free market economy the Labour and National governments of that time shifted from a state-dominated economy to a rent-seeking economy, writing “the effect of the changes was not so much to eliminate pre-existing problems of capture and rent seeking as to reinvent New Zealand as a case study of those pathologies in action, only under different management.”

A number of recent news stories illustrate this phenomenon. The electricity market is often described as an oligarchy in which the four “gentailers” who generate power and then sell it to business and consumers are widely suspected of profiteering. By limiting the amount of power generated they increase its price, maximising their profits.

The obvious way to introduce competition into the electricity market is to break up the gentailers. But that solution has already been ruled out as an option for the task force investigating the sector. The consequence of surges in winter energy prices has been the closure of two paper mills that cannot afford the high wholesale prices, with the loss of hundreds of jobs. 

A recent Commerce Commission report into the $25 billion grocery sector found that New Zealanders pay some of the highest grocery prices in the OECD. Many investigations into the supermarket duopoly have found evidence of profiteering and anti-competitive behaviour. Some estimates put the amount of profiteering at $1 million a day. Investigations into the sector have shown that the duopoly has used land banking and land-use covenants to prevent the construction of new supermarkets by potential competitors.

The previous Labour Government refused to regulate the sector, but they established a Grocery Commissioner who recently announced a targeted inquiry to unlock further powers to promote competition – which Act party leader David Seymour indicated he would oppose. 

A recent Ipsos issues survey found that 65 percent of voters supported a capital gains tax, but for the past six years both major parties have strongly blocked such a tax. Like many members of Parliament Prime Minister Christopher Luxon keeps the bulk of his wealth in a property portfolio. He appears to have made approximately $500,000 in tax free capital gains this year from property sales. 

Finally, in a number of articles about the Abuse in State Care report, Newsroom political editor Laura Walters documents the demands made by survivors for the Solicitor General Una Jagose to step down. She cites the Commission’s 2021 redress report, which “laid out the Crown’s aggressive legal strategies – things like using the statute of limitations to try to block survivors’ civil claims, withdrawing legal aid funding, and not being forthcoming with discovery of documents.”

The final report found that “Political and public service leaders spent time, energy and taxpayer resources to hide, cover up and then legally fight survivors to protect the potential perceived costs to the Crown, and their own reputations,” with Walters noting that “While Jagose is ultimately responsible for the Crown’s conduct and how it pursued many of these cases, she was also directly involved in a number of cases, with her name coming up repeatedly in the Royal Commission’s report.” Attorney General Judith Collins has publicly supported Jagose. 

New Zealand has a reputation as a liberal democracy with robust institutions but there’s increasing evidence that these institutions only provide the illusion of accountability and inclusion. Key sectors of the economy are dominated by cartels or oligopolies, the tax system is deliberately structured to exempt the wealth of political and economic elites, and senior officials can abuse their power with impunity. These are all the hallmarks of exclusive politics and extractive economies. To put it simply, the system is rotten.

A key component in Acemoglu et al’s model of prosperity is “creative destruction”. This is more economics jargon, describing the process by which innovation leads to the demise of existing technologies or industries. Incumbent businesses are replaced by new and more efficient ones.

Vested interests will, however, vigorously resist competition. They prefer to use their political power to discourage innovation, block new entrants to market or other forms of economic change. As a result, extractive economies experience low productivity growth. As Mclauchlan notes in the Listener, this has been a feature of New Zealand’s economic story for decades. Again, it’s worth quoting his Listener article on this at length:

“Two of the signifiers of elite capture and extractive economies are low productivity and mass outward migration. There’s little point in bringing new products to market or building an export business if you can get rich via political influence, making sure the government subsidises your industry, creates significant barriers to entry to reduce competition or simply gives you money. This lack of innovation delivers a low-wage economy with high prices. So, if you’re young, qualified and entrepreneurial, your best bet is to go somewhere else with more inclusive institutions and better economic prospects. We’re now into our fifth decade of productivity decline relative to the rest of the OECD, and this is getting worse. Migration of qualified workers – mostly to Australia – is now at record highs.

Mclauchlan subsequently also points out that the reality of this “sclerosis” and decline is somewhat hidden “because successive governments oversaw a massive housing bubble to create the illusion of middle-class wealth.”

The lobbyist and political commentator Matthew Hooton commented on Mclauchlan’s Listener article via his Patreon site on Thursday, calling it “the clearest statement I’ve ever read about why New Zealand’s corporate welfare machine damages any attempts to bridge the productivity gap. Quite simply, since corporate welfare re-emerged after 1999, initially with Jim Anderton’s ‘Jobs Machine’ but made ever-worse by successive governments, the easiest way to make money in New Zealand has been to extract money and regulatory concessions from Wellington. Why genuinely innovate if a minister or bureaucrat will hand you cash or other benefits for pretending to?” 

In The Narrow Corridor, their follow up to Why Nations Fail, Acemoglu and his collaborators argue that for liberty and prosperity to survive there must be a constant tension between the state and civil society. The title refers to the constrained space between a centralised state dominated by political and economic elites and an anarchic, fragmented nation in which cohesion breaks down. It is a perpetual struggle to maintain the equilibrium between the failure modes. In New Zealand’s case, civil society appears to be losing that struggle. 

Dr Bryce Edwards

Political Analyst in Residence, Director of the Democracy Project, School of Government, Victoria University of Wellington

Key Sources

Danyl McLauchlan (Listener): Why economies fail: Stark lessons for NZ from a 2024 Nobel Prize winner (paywalled)

Matthew Hooton (Patreon): Ireland’s history; NZ’s decline (paywalled)

Laura Walters (Newsroom): Survivors call for removal of Solicitor-General