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The Independent Institute
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Chile and New Zealand—Models for U.S. Reform


Considering the budget impasse between Newt Gingrich, inciting a revolution, and Bill Clinton, staunchly defending the status quo, one might conclude that the welfare state is a tangled web from which no nation can escape. But Chile and New Zealand have shown that big government can be rolled back. By diminishing government, they have reduced their public debt, accelerated their economic growth, and restored their citizens' hopes for a better future.

Since the mid-1970s the Chileans have transformed their backward welfare state into one of the world's most progressive economies. They reduced monetary growth, scrapped trade barriers, and privatized state-owned enterprises, lopping off two-thirds of the public sector. By cutting taxes and cutting expenditures even more, the government has eliminated its deficit, recently running a surplus of about 2% of GDP.

Chile's domestic saving rate has risen to more than 25% of GDP (twice the U.S. rate), allowing a correspondingly high rate of investment, augmented by hefty foreign investment. The economy has grown at 7% per year over the last decade (more than twice the U.S. rate).

In 1981 the Chileans began to privatize their social security system. Like us, they had a government pay-as-you-go system of old-age pensions that had been shamelessly twisted and bankrupted by politicians. In its place the reformers put an arrangement in which private companies known as AFPs compete to manage the retirement savings of workers, who have wide latitude to decide how much to contribute -- from 10% to 20% of wages. (U.S. workers pay 12.4%, counting the employee's and the so-called employer's portion of the OASDI tax.)

Nine out of ten Chileans chose to enter the new system. Now workers own their own retirement accounts. At retirement they may receive a pension from their AFP or purchase a life annuity from a private insurance company. According to José Piñera, the minister who managed the privatization, "workers have not lost a dime," and pensions under the new system are 40 to 50% higher. Because many workers chose to put away more than the minimum, Chile's private saving and investment have soared.

New Zealand is also instructive. After World War II the growth of government steadily choked its progress. Extreme protectionism, high farm subsidies, huge national debt, elevated tax rates, and profligate welfare all contributed. Says John Wood, New Zealand's ambassador to the United States, by 1984 "we were as tightly regulated, protected, and centralized as any East European country, and performing about as well."

To reverse this disastrous course, New Zealanders in 1984 elected a new government that began sweeping reforms. They abandoned foreign exchange controls, deregulated the financial sector, slashed tariffs by two-thirds and opened markets to international competition. Farm subsidies, which had accounted for 30% of farmers' incomes, were virtually eliminated.

By a two-step process, New Zealand sloughed off many of its state enterprises. First, firms were required to operate on a commercial basis and given the flexibility to do so. Second, firms were sold to private owners. Since 1987 the government has sold 21 state enterprises for NZ$12.8 billion. Public employment has been reduced by 59% since 1984.

At Telecom New Zealand, commercialized in 1987 and privatized in 1990, employment dropped from 26,500 to 9,300. Telecom replaced its antiquated technology with a modern digital system and now competes with MCI on long distance and Bell South on cellular service. Formerly it soaked up subsidies; now it earns positive net income and pays taxes.

New Zealanders repealed restrictive labor laws and deregulated labor markets. They reformed welfare, reducing benefits and directing them more precisely to those in genuine need. A law passed in 1989 holds the head of the central bank personally responsible for keeping the rate of inflation below 2%.

New Zealand's economic growth rate recently has been about 5% and its inflation rate below 2%. The government deficit, which was 9% of GDP in 1984, has been eliminated, and a surplus is now anticipated. Public spending has fallen from 41% to 34% of GDP and continues downward. Unemployment has fallen from a high of 10.9% to 6.6%.

The Gingrich-Clinton gridlock suggests that Americans are stuck with our current size and scope of government -- and the lackluster economy that government -- strictures cause. But the economic miracles of Chile and New Zealand demonstrate that, even for nations enmeshed in the welfare state, economic revitalization is possible. All it takes is the political will to slash government and unleash people's creative powers, setting citizens free to cooperate and compete in open markets.


Robert Higgs is Senior Fellow in Political Economy at The Independent Institute and Editor at Large of the Institute’s quarterly journal The Independent Review. He received his Ph.D. in economics from Johns Hopkins University, and he has taught at the University of Washington, Lafayette College, Seattle University, and the University of Economics, Prague. He has been a visiting scholar at Oxford University and Stanford University, and a fellow for the Hoover Institution and the National Science Foundation. He is the author of many books, including Depression, War, and Cold War.

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