Monopoly Money The Cost Of Corporate Welfare Since 2008

Description
The bounty to the white-herring fishery is a tonnage bounty and is proportioned to the burden of the ship.

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MONOPOLY MONEY
THE COST OF CORPORATE WELFARE SINCE 2008
Jim Rose
2
AUTHOR
Jim Rose has worked at the Ministry of Business, Innovation
and Employment, the Department of Labour, the Ministry of
Social Development, and the New Zealand Treasury, and in
Canberra for the Productivity Commission, the Department of
Prime Minister and Cabinet, and the Department of Finance.
Jim has Masters degrees in economics and in public policy
from the Australian National University and from the National
Graduate Institute for Policy Studies in Tokyo respectively. He
blogs at www.utopiayouarestandinginit.com.
Copyright © 2014 James Rose
All rights reserved. This book or any portion thereof may not be reproduced or used in any manner whatsoever without
the express written permission of the author except for the use of brief quotations in a book review or press release.
Printed in New Zealand, First Printing, 2014 ISBN 978-0-473-29492-2
The bounty to the white-herring ?shery is a tonnage
bounty; and is proportioned to the burden of the ship,
not to her diligence or success in the ?shery; and it has, I
am afraid, been too common for vessels to ?t out for the
sole purpose of catching, not the ?sh, but the bounty.
– Adam Smith
3
Contents
Author 3
Contents 4
Table of ?gures 4
List of tables 5
Abstract 6
Foreword By Michael Barnett 8
Foreword By Stuart Nash 9
1 Introduction 10
1.1 What is corporate welfare? 10
1.2 Methodology for identifying corporate welfare 10
1.3 Plan of the paper 10
2 Key Findings 12
2.1 Corporate welfare in the national government budgets 12
2.2 Corporate welfare in the last labour government budget 14
2.4 What is the value for money for the taxpayer? 15
3 The Minister Of Finance 16
3.1 Government as company doctor 16
3.2 The social cost of subsidies 17
3.3 Capitalism is a pro?t and loss system 18
3.4 Crowding out business turnaround specialists 18
4 The Minister Of Transport 20
4.1 State-owned enterprise welfare 20
4.2 When will KiwiRail turn around? 21
4.3 Soft budget constraints 21
5 The Minister For Economic Development 23
5.1 Government as superior entrepreneur 23
5.2 Subsidies for the ?lm industry 25
5.3 Export promotion and information spillovers 27
5.4 The trade balance must balance 28
5.5 But the exchange rate is too high/too low? 29
4
5.6 A pretense to knowledge 31
5.7 Coping with ignorance 32
5.8 The infant industry argument 33
5.9 Spillover bene?ts and industry targeting 34
5.10 The services sector as the wall?ower of corporate welfare 35
6 The Minister Of Science And Innovation 36
6.1 Government as oracle 36
6.2 It’s tough to make predictions, especially about the future 37
6.3 Market-tested innovation 37
6.4 The survivor principle and efciency and innovation as emergent processes 38
6.5 Product life cycles and public subsidies 39
6.6 Government as co-investor in innovation 39
6.7 Too much of a good thing? 40
6.8 The success of the private sector in picking winners 42
7 The Minister For Primary Industries 44
7.1 Government as agribusiness developer 44
7.2 The nature of the farm 45
8 The Minister For Communications And Information Technology 46
8.1 Government as ICT entrepreneur 46
8.2 A market-tested supply and demand for fast broadband 46
8.3 Ultra-fast broadband is not the ?rst network industry that was the face of the
future 48
8.4 Build and they will come? 49
9 The Minister For Tourism 51
9.1 Government as a publicist 51
10 Concluding Remarks 52
References 53
Table of Figures
Figure 1: Corporate welfare, Budgets 2008/09 to 2014/15 12
Figure 2: Corporate welfare, Budgets 2008/09 to 2014/15 by Vote 13
Figure 3: Distribution of total corporate welfare across votes, 2008/09 to 2014/15 14
5
Figure 4: State-owned enterprise welfare, Vote Transport and Vote Finance (KiwiRail),
Budgets 2008/09 to 2014/15 ($million) 20
Figure 5: Corporate welfare, Vote Economic Development, Budgets 2008/09 to 2014/15 23
Figure 6: The exchange rate efects of an increase in exports 28
Figure 7: Balance of goods and services, New Zealand 29
Figure 8: Corporate welfare, Vote Science and Innovation, Budgets 2008/09 to 2014/15 36
Figure 9: Farm welfare, Vote Primary Industries, Budgets 2008/09 to 2014/15 44
Figure 10: Corporate welfare, Vote Communications, Budgets 2008/09 to 2014/15 46
Figure 11: OECD broadband penetration and GDP per capita 47
List of Tables
Table 1: Corporate welfare in Budgets 2008/09 to 2014/15 ($million) 13
Table 2: Corporate welfare, Vote Finance excluding KiwiRail,
Budgets 2008/09 to 2014/15 16
Table 3: State-Owned Enterprise welfare,
Vote Transport and Vote Finance (KiwiRail), Budgets 2008/09 to 2014/15 21
Table 4: Corporate welfare, Vote Economic Development,
Budgets 2008/09 to 2014/15 23
Table 5: Film industry subsidies, Budgets 2008/09 to 2014/15 ($million) 25
Table 6: Corporate welfare, Vote Science and Innovation,
Budgets 2008/09 to 2014/15 36
Table 7: Farm welfare, Vote Primary Industries,
Budgets 2008/09 to 2014/15 44
Table 8: Corporate welfare, Vote Communications,
Budgets 2008/09 to 2014/15 46
Table 9: Corporate welfare, Vote Tourism,
Budgets 2008/09 to 2014/15 51
6
ABSTRACT
Under the current National-led Government, corporate welfare – subsidies to business – ranges
from $1 billion to $1.4 billion per budget. About a third of this corporate welfare is for KiwiRail.
The major growth areas in corporate welfare under the National-led Government are ultra-fast
broadband and R&D grants for commercial ventures in science and innovation particularly in the
primary sector.
Corporate welfare in the last budget of the last Labour-led Government totalled $1.751 billion,
comprised principally of $700 million planned for the New Zealand Fast Forward Fund and
$577 million for KiwiRail.
This report will serve as a wake up call for taxpayers - the per household cost of the corporate
welfare detailed in the report equals between $600 and $800 every year. The amounts
may be justi?ed - if the Government is a better investor than private citizens. The economic
evidence, however, suggests that governments, politicians and bureaucrats do not have the
market disciplines to be better investors on a consistent basis. Private investors that make bad
decisions quickly run out of money. There is no similar hard discipline on politicians when they
invest public money in business.
Taxpayers and politicians from all sides of the political spectrum should ask whether the public
gets value for money from these business handouts.
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7
For every dollar spent
on corporate welfare, it
is a dollar not available
for education, health,
and investment by the
taxpayer who earned it.
8
FOREWORD BY MICHAEL BARNETT
When it comes to economic development I have always
believed that there are stages in development where business
will not invest because the risks are too high. Often these risks
are associated with local government and relate to zoning
and consents and require local government to intervene and
remove the risks in order that development opportunities
can occur. This has always seemed a legitimate role for
government when managed well.
Corporate welfare on the other hand is diferent – this is
more often manipulation that occurs with an intervention
from government using tax or ratepayer money in a way that
bene?ts some players in a sector and disadvantages others. It
seldom represents a good or fair use of tax and
ratepayers’ money.
Money always has alternative uses. One of the great claims made by governments is that
money “invested” by them is stimulating business and will provide a return to Government and
bene?t society generally. Rarely does this occur.
Governments have no special ability to pick which businesses will succeed and which will
fail, or even to pick which sectors of an economy will do better than others. The information
governments use is no better than that available in the market. Few people ever claim that
public servants are better entrepreneurs than those who put up their own capital to start a
business, or that they are smarter than those who back entrepreneurs with their own savings.
So why have successive governments persisted with the concept that governments can do
good and foster prosperity by investing money on one sector rather than another? In terms of
rational economics I would suggest that the results over time speak for themselves.
A possible answer could be that political support is obtained by investing public money
on certain sectors of the economy, or by spending public money on selective pet projects.
Irrespective of how these projects are chosen taxpayers are entitled to ask where is the
evidence that shows an economy will bene?t from this investment that uses public money on
projects that private money will not support.
As this report shows, the amount of patronage successive New Zealand governments have
given and continue to “invest” is signi?cant. The report also shows that the evidence of
substantial bene?ts is scant and limited.
The production of this publication is a timely opportunity for all politicians to re-examine why
governments invest tax and ratepayer money and where, what bene?t it truly delivers or if it is in
fact corporate welfare.
Michael Barnett is Chief Executive of the Auckland Regional Chamber of Commerce & Industry.
The views expressed do not necessarily re?ect those of the Chamber.
9
FOREWORD BY STUART NASH
As elected representatives of the people, politicians are
stewards of taxpayers’ money. It is up to Members of
Parliament and their parties to articulate their vision for the
country and, if elected to the Treasury benches, channel
this tax revenue to projects that are intended to provide a
nationwide social or economic bene?t.
As a Labour MP, I believe the government has a very important
role to play in stimulating economic growth through ensuring
the market variables that determine optimal outcome are set at
the right level.
As a former Labour Revenue Spokesman, I understand the
power of the tax system to drive growth; but also to destroy it
(or certainly limit it).
The tax system has two purposes in a modern economy: to
gather revenue and to in?uence behaviour. One way to in?uence behaviour is to distribute
revenue into areas that drive growth. I have, however, never believed in providing government
grants to businesses that should be able to raise money from the market. In fact, by giving out
taxpayer money to companies that have the ability to raise capital from either public markets
or private investors, one could argue that the government is having a negative impact on the
growth of our rather shallow capital markets.
This report suggests that a signi?cant amount the tax we pay is being channelled into corporate
welfare. How is this fair to the thousands of small businesses which are the backbone of our
economy? And is it really the best use of scarce resources at a time of record government
debt? I personally don’t believe it is.
The current National Government’s economic vision appears to consist of little more than crony
capitalism. This does not drive the type of sustainable economic growth needed to create long
term economic wealth and opportunities for all New Zealanders; but rather subsidises the very
companies least in need of taxpayer-funded largess. The diference between National’s political
rhetoric and reality could not be more striking. This report shows that rather than working hard
to get the books back into shape and investing in a more prosperous, fairer New Zealand,
senior National Party Ministers appear to be delving into the country’s cofers to dole out money
to their favoured businesses and industries.
Given that politics is a contest of ideas and vision, any government spending on the scale
identi?ed in this report should be transparent and open to public scrutiny. I therefore welcome
the Taxpayers’ Union’s eforts in this area.
While my own politics and that of the Taxpayers’ Union difer signi?cantly, I commend them on
this report. It allows readers to think about the relative values and priorities from the spending
the report outlines.
Stuart Nash is the Member of Parliament for Napier.
10
1 INTRODUCTION
1.1 WHAT IS CORPORATE WELFARE?
Corporate welfare is subsidies for businesses. Corporate welfare runs against the notion that
businesses should make a pro?t or go out of business. The term implies that businesses need
as much, or more, support than the poor. Supporters of corporate welfare often justify these
subsidies as a remedy for a market failure. A kissing cousin of corporate welfare is farm welfare.
In the economic literature, corporate welfare is increasingly used interchangeably with crony
capitalism; however these terms have diferent meanings:
Crony capitalism is a system where companies with close connections to the
government gain economic power not by competing better, but by using the
government to get favoured and protected positions (Becker 2006).
The focus of this report is not crony capitalism. It is not suggested that the items listed as
corporate welfare in this report are a re?ection of cronyism.
If a business is losing money, they should try better, do something diferent or go out of
business. Losses are not a reason for a taxpayer bailout. No business should be premised on
subsidies:
This is a pro?t-and-loss system, and the loss part is even more important than the
pro?t because it helps get rid of badly managed, poorly operated companies
(Friedman 1979).
The purpose of the capital market is to direct investment to businesses that have a future
and take away support from failing ?rms that do not improve and regain customer favour. The
entrepreneurs and investors who are not as good as their rivals in picking winners and avoiding
losers go out of business.
1.2 METHODOLOGY FOR IDENTIFYING CORPORATE WELFARE
The aim of this paper is to collate publicly available information on corporate welfare.
Corporate welfare is computed from each Parliamentary ‘vote’ based on the most recent
information available on The Treasury’s website. Where relevant, policy advice underpinning the
administration of the corporate welfare is included in the computation. This policy advice would
not be required but for the corporate welfare.
1.3 PLAN OF THE PAPER
A summary of aggregate corporate welfare by budget and by portfolio is in the key ?ndings
chapter. The subsequent chapters tabulate corporate welfare by spending portfolio. A small
amount of corporate welfare within Vote Commerce, mostly the $5.782 million in funding for
the Retirement Commissioner, is not discussed. The ?lm subsidies administered by the Minister
for Arts, Culture and Heritage are discussed in section 5.2, which discusses the ?lm subsidies
overseen by the Minister for Economic Development.
What is a Vote? When Parliament considers legislation
relating to the appropriation, the appropriations are grouped
within “Votes”. Generally, a Vote groups similar appropriations
together. For example, Vote Health includes all health-related
appropriations administered by the Ministry of Health. Ministers
can administer more than one Vote within the same Ministry.
11
For people who are risking their own money will of course risk
it foolishly and recklessly, whereas politicians and bureaucrats
who are risking other people’s money will do so only with
the greatest care and after long and profound study.
Naturally, the businessmen who have earned the money have
shown that they have no foresight; but the politicians who
haven’t earned the money will exhibit almost perfect foresight.
The businessmen ... whose success depends upon the degree
to which they satisfy consumers, will of course have no concern
for ‘the general social advantage’; but the politicians who keep
themselves in power by conciliating pressure groups will of
course have only concern for ‘the general social advantage’.
Henry Hazlitt (1959), The Failure
of the ‘New Economics’
12
2 KEY FINDINGS
2.1 CORPORATE WELFARE IN THE NATIONAL GOVERNMENT BUDGETS
Corporate welfare has ranged between about $1 billion and $1.4 billion per year in each of the
six budgets presented by the current National-led Government ?rst elected in 2008 – see
Figure 1. This is about $1.18 billion on average – see Table 1. The annual cost varies between
$600 and $800 per household.
If the corporate welfare identi?ed in this report was abolished, enough money would be saved
that, based on Treasury ?gures, the corporate tax rate could be lowered from 28 per cent to
22.5 per cent. If applied to personal income tax rates, that saving would allow the 30% and 33%
income tax rates to be lowered to 29 per cent. Alternatively, the 10.5 per cent rate (applicable to
the ?rst $14,000 of income) could be reduced to 7 per cent.
Figure 1: Corporate welfare, Budgets 2008/09 to 2014/15
Source: Budget Papers 2008/09 to 2014/15.
Notes: The $690 million for the purchase of Toll NZ Ltd’s rail business and associated costs are not included in 2008/09
data. $700 million for the New Zealand Fast Forward Fund is included in Vote Primary Industry despite its cancellation by the
incoming National-led Government.

Table 1 and Figure 2 are summaries of corporate welfare under the National-led Government
by ministerial portfolio and the last budget of the Labour-led Government, defeated in the 2008
general election. The major player in corporate welfare in National budgets is KiwiRail ($2.425
billion) through the Minister of Transport in Vote Transport. One-of state-owned enterprise
welfare was bestowed on Solid Energy ($195m) in the 2013/14 Budget by the Minister of Finance
in Vote Finance.
2000
1800
1600
1400
1200
1000
800
600
400
200
0
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15
Year of Budget
$

M
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n
13
800
700
600
400
300
200
100

0
$

M
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l
l
i
o
n
2008/09 budget
2009/10 budget
2010/ 1 1 budget
2011/ 1 2 budget
2012/13 budget
2013/14 budget
2014/15 budget
Table 1: Corporate welfare in Budgets 2008/09 to 2014/15 ($million)
Source: Budget Papers 2008/09 to 2014/15.
Figure 2: Corporate welfare, Budgets 2008/09 to 2014/15 by Vote

Source: Budget Papers 2008/09 to 2014/15.
08/09 09/10 10/11 11/12 12/13 13/14 14/15
Grand
Total
Arts, Culture & Heritage 3.27 10.91 18.89 10.49 29.23 3.69 4.06 80.53
Commerce and
Consumer Afairs
6.13 5.78 05.78 5.78 6.82 6.96 5.78 43.04
Communications 25.40 39.00 149.56 178.35 204.88 204.53 801.73
Economic Development 372.46 419.45 446.28 379.46 331.96 284.29 287.16 2 521.06
Finance 594.00 44.27 3.11 108.12 15.00 210.00 974.50
Primary Industries 700.00 0.25 13.50 42.72 64.81 126.48 947.76
Science and Innovation 4.20 112.10 178.91 295.21
Tourism 75.50 93.73 119.45 113.00 97.55 124.44 123.69 747.36
Transport 529.85 375.76 510.15 680.00 118.85 208.75 2 423.36
Total $ million 1 751.00 1 134.00 1 022.00 1 277.00 1 382.00 1 130.00 1 139.00 8 835.00
Per household $1 042.00 $668.00 $598.00 $741.00 $797.00 $646.00 $645.00 $5 138.00

14
After KiwiRail, the Minister of Economic Development has been the main source of corporate
welfare in National budgets. Corporate welfare in Vote Economic Development has been in
decline in recent budgets because one-of support for mega-events such as the Rugby World
Cup and the Shanghai Expo are in the past. There was also a $108 million contribution to the
Rugby World Cup in Budget 2011-12 by the Minister of Finance in Vote Finance.
The subsidies to Crown Fiber Holdings Ltd to develop ultra-fast broadband are making Vote
Communications a major new player in corporate welfare over the last few years. Vote Tourism
has been consistently handing out $120 million a year for promotional work which, arguably,
businesses should do for themselves.
2.2 CORPORATE WELFARE IN THE LAST LABOUR GOVERNMENT BUDGET
Corporate welfare planned in the ?nal budget of the last Labour-led Government was $1.751
billion – see Table 1 and Figure 1. The main components of this were state-owned enterprise
welfare ($582 million) for KiwiRail from Vote Finance and $700 million planned for the New
Zealand Fast Forward Fund in Vote Primary Industry that was cancelled by the incoming
National-led Government.
2.3 CORPORATE WELFARE BY PORTFOLIO
Figure 3 summarises the percentage distribution by portfolio of corporate welfare over both the
six budgets of the National-led Government and the last budget of the Labour-led Government.
Over the last seven budgets, state-owned enterprise welfare in Vote Transport was the single
largest item, taking up 34 per cent of all corporate welfare over the seven budgets. The next
largest source of corporate welfare was Vote Economic Development with 29 per cent of all
corporate welfare 2008/09 and 2014/15.
Figure 3: Distribution of total corporate welfare across votes, 2008/09 to 2014/15
Source: Budget Papers 2008/09 to 2014/15.
15
2.4 WHAT IS THE VALUE FOR MONEY FOR THE TAXPAYER?
What taxpayers need to ask of all these business subsidies is: what do they get for the money?
What is the problem that has been solved? Could this problem be solved by market process
on its own, at its own pace? Why is it not better to have the businesses subject to hard budget
constraints, competition in the market place, the threat of innovation, and continuous updating
of the knowledge available to the entrepreneurial decision-makers by changes in prices and
pro?ts (or losses)?
A central notion of capitalism is the that normal market system runs itself. Each business pays its
own bills or goes out of business. Government intervention should be the exception and only
after careful scrutiny.
It is not the purpose of this paper to draw ?nal conclusions about the merits of speci?c
subsidies. Instead it is to quantify the amount of corporate welfare and let taxpayers judge for
themselves whether any particular subsidy is justi?ed, or is an unwarranted use of their hard
earned dollars.
A business has a soft budget constraint if it has a reasonable expectation
that should it start to lose money or otherwise get into trouble, it will be
bailed out in some way by the government. Such bailouts could come in
the form of direct subsidies, cheap loans or other concessions; any loans
may not have to be paid back or will be continually rolled over. If a rescue
operation was mounted, losses and growing debts may be unpopular with
the shareholding ministers but they were not a life-or-death matter for the
?rm.
When there is a soft budget constraint, the incentives to contain costs
and innovate are much less because there is no threat of insolvency and
bankruptcy. Unless they are politically favoured, private businesses are
subject to a hard budget constraint. If a private business does not at least
break even, they will soon go out of business unless their investors or
bankers think the business has a bright enough future that makes it worth
their while to tide that business over a rough patch, but their patience is
usually rather limited.
The existence (and preservation) of a competitive
situation in private industry … frees the state from the
obligation of adjudicating endless, bitter disputes among
persons as participants in diferent industries and among
owners of diferent kinds of productive services.
– Henry Simons, Economic Policy for a Free Society (1947)
16
3 THE MINISTER OF FINANCE
3.1 GOVERNMENT AS COMPANY DOCTOR
Our review starts with the oldest form of corporate welfare: bailouts for failing businesses. There
is no ambiguity here. No externalities. No market failures. No infant industries. Not even picking
winners. The subsidies under the hand of the Minister of Finance prop up losers.
This is old time industry policy: slowing down the evolution of industries, not speeding it up on
the basis of correcting market failures or capturing externalities. The only justi?cation in most of
the examples listed below in Table 2 appear to be political, not economic – the desire to avoid
job losses.
Table 2: Corporate welfare, Vote Finance excluding KiwiRail, Budgets 2008/09 to 2014/15 ($million)
Source: Budget Papers 2008/09 to 2014/15
Note: the $690 million for the purchase of Toll NZ Ltd's rail business and associated costs is not included in the 2008/09 data.
All other spending on KiwiRail is discussed in the chapter on the Minister of Transport.
Solid Energy ($195 million) and New Zealand Aluminum smelters ($30 million) were failing
because their international competitors were better at serving their customers and keeping
costs down. The efect of this corporate welfare under the patronage of the Minister of Finance
was to prevent the market from working as it should every day, which is weeding out high cost
businesses, and favouring low cost businesses.
State ownership of Solid Energy does not in any way excuse the corporate welfare for that
company. Solid Energy has a duty under section 4 of the State-Owned Enterprises Act 1986 to
be: … as pro?table and efcient as comparable businesses that are not owned by the Crown.
Bailouts for state-owned enterprises are no less of a loss to the taxpayers than any other
bailout. Bailouts of state-owned enterprises are a bad precedent for other state-owned
enterprises. Thanks largely to the losses sufered by KiwiRail, the state-owned enterprises
portfolio comprising of about $20 billion in assets, is currently returning only $20 million in net
annual dividends to the taxpayer. This 0.1 per cent return on equity strongly suggests that the
portfolio of state-owned enterprises needs more discipline, not less.
2008/09
budget
2009/10
budget
2010/11
budget
2011/12
budget
2012/13
budget
2013/14
budget
2014/15
budget
Solid Energy New Zealand Limited - Loan Facilities 15 130.00
Solid Energy New Zealand Limited - Redeemable
Preference Shares
25.00
Solid Energy New Zealand Limited - Redeemable
Preference Shares Impairment
25.00
New Zealand Export Credit Ofce 2.227 2.87 2.925
Payment in respect of Export Credit Ofce
Guarantees and Indemnities
0.186
Rugby New Zealand 2011 Limited 4
Rugby World Cup 2011 - Crown share 108.12
New Zealand Aluminium Smelters - Electricity
Agreement Incentive Payment
30.00
Public Trust Capital Injection 30
Hawke's Bay Airport Equity Injection 8 7.4
Industrial Research Limited Equity Injection 4.5
Invercargill Airport Suspensory Loan 1.5
Total 16.2 44.3 3.1 133.1 15.0 185.0 0.0
17
3.2 THE SOCIAL COST OF SUBSIDIES
Subsidies destroy wealth by encouraging the growth in activities that have a cost larger than
their bene?t to society and to consumers who buy the subsidised product.
A subsidy incentivises the relevant industry to grow to a size that is not supported by the
consumer’s willingness to pay for its output (McCloskey 1985). The choice by each consumer on
whether to pay the prices charged by the industry or a particular ?rm is made after considering
all of the options they have before them in a free market. The resources used to expand the
subsidised industry are valued more highly by consumers in all other uses in New Zealand.
Subsidies therefore move assets from higher-valued uses to lower-valued uses — the wrong
direction for wealth creation.
An economy is efcient if all assets are employed in their highest-valued uses. Subsidies
undermine entrepreneurial pro?ts and losses as the driving forces of the market process. As
Froeb (2014) explains:
Making money is simple in principle—?nd an asset employed in lower-valued use,
buy it, and then sell it to someone who places a higher value on it.
The art of business consists of identifying assets in low-valued uses and devising
ways to pro?tably move them to higher-valued ones.
The idea behind efciency in a normal economic system is that the goods that are worth more
than they cost to produce are produced; the goods worth less than they cost to produce are not
produced (Friedman 1990, 1996). Firms pay the value of the inputs they buy from their owners
in wages, interest, dividends and rents and then receive the value of what they produce when
they sell. If a good they produce is worth more than it costs to produce, the entrepreneur makes
18
a pro?t; if the good is worth less than it costs to produce, they take a loss and rethink their plans
(Friedman 1990, 1996; McCloskey 1985).
There is no value for money for the taxpayer in slowing down the market process of competitive
selection, industry evolution and the perennial gale of creative destruction:
The opening up of new markets, foreign or domestic, and the organizational
development from the craft shop to such concerns as U.S. Steel illustrate the same
process of industrial mutation—if I may use that biological term—that incessantly
revolutionizes the economic structure from within, incessantly destroying the old
one, incessantly creating a new one. This process of Creative Destruction is the
essential fact about capitalism (Schumpeter 1942, p. 83).
3.3 CAPITALISM IS A PROFIT AND LOSS SYSTEM
Losses and bankruptcies are fundamental to the success of the market economy. Losses are a
clear signal that businesses such as Solid Energy and New Zealand Aluminum Smelters needed
to either restructure, cut costs or go out of business. The corporate welfare paid to these ?rms
postponed those difcult choices.
A subsidy that stops Solid Energy and New Zealand Aluminum Smelters from shrinking in size
or closing undermines this evolutionary process of competitive selection that, through trial and
error, favours lower cost, more innovative ?rms. New Zealand should follow the lead of Sweden
in 2009 when General Motors threatened to pull out completely from Saab unless it received a
government subsidy. The response of the Swedish Enterprise Minister Maud Olofsson was:
… they wash their hands of Saab and drop it into the laps of the Swedish taxpayers.
We are very disappointed in G.M., but we are not prepared to risk taxpayers’
money. This is not a game of Monopoly (Lyall 2009).
Failing ?rms do not need any more breathing space than the capital market is willing to
supply them.
3.4 CROWDING OUT BUSINESS TURNAROUND SPECIALISTS
Some entrepreneurs specialise in turning around failing businesses. A prime impetus for
mergers and takeovers is when one ?rm takes over another it judges to be under-performing
but can do better if restructured by new managers hired by new owners (Manne 1965; Jensen
and Meckling 1976; Fama and Jensen 1983a, 1983b; and Easterbrook and Fischel 1991).
Tumbling share prices and other signs of business decay are untapped opportunities for more
alert entrepreneurs, as Henry Manne explains:
The share price, or that part re?ecting managerial efciency, also measures the
potential capital gain inherent in a corporate stock.
The lower the stock price, relative to what it could be with more efcient
management, the more attractive the take-over becomes to those who believe
that they can manage the company more efciently. And the potential return from
the successful takeover and revitalization of a poorly run company can be enormous
(Manne 1965, p. 113).
The share prices of merger and takeover targets spike an average of 30 per cent in anticipation
of these higher pro?ts from better management by the eventual new owners (Eckbo 2009;
Betton, Eckbo and Thorburn 2008). This market process of business renewal is not perfect
nor without upheaval and disruption, but it is the best of the available institutional options, as
19
Edmund Phelps explains:
Granted, enterprises in the private sector are prone to making mistakes in
deciding to develop new products – since feasibility, cost and market reception
are all unknown.
The difculty with a national industry policy is that it places those decisions in the
hands of government ofcials who are remote from the local expertise and insights
that companies draw on for dynamic innovation. It is hard enough for venture
capitalists and early-stage investors to make the right choices (Phelps 2013b).
In the case of failing ?rms, investors back their entrepreneurial judgments with their own capital.
If these entrepreneurs are not consistently good at identifying troubled businesses that can
be brought back to life through a restructuring, they themselves are quickly weeded out of the
market process. They exhaust their own capital and will be unable to win further investor and
bank backing.
A fundamental aspect of business turnarounds, mergers and takeovers is trial and error. A large
number of entrepreneurs back their hunches about the future of failing businesses. Private
investors face hard budget constraints. It is only through competition and experimentation in the
marketplace that the successful venture capitalists are identi?ed. Entrepreneurs are continually
turned over as new players enter the ?eld and the more established operators lose their edge.
Playing company doctor is a high risk business. Mergers and acquisitions have about a 50 per
cent success rate. Many mergers and acquisitions are underdone by later divestitures (Klein and
Klein 2001).
The common rule of thumb is that of 10 start-ups, only three or four fail completely.
Another three or four return the original investment, and one or two produce
substantial returns (Gage 2012).
The lesson for New Zealand taxpayers from the limited success of mergers and takeovers is
not to play company doctor. If the purpose of playing company doctor is to help a fundamentally
sound company through a bad patch, taxpayer support should be in the form of a loan, not a
subsidy. These loans should be sold in a secondary market to obtain a judgment of the private
sector on whether they were good deals.
One great invention of a private enterprise system
is bankruptcy, an institution for putting an eventual
stop to costly failure. No such institution has yet
been conceived of in the political process, and an
unsuccessful policy has no inherent termination.
Indeed, political rewards are more closely proportioned
to failure than to success, for failure demonstrates the
need for larger appropriations and more power.
– George Stigler, The Government
of the Economy (1968)
20
4 THE MINISTER OF TRANSPORT
4.1 STATE-OWNED ENTERPRISE WELFARE
KiwiRail has been a constant thorn in the taxpayers’ side. Since this rail business was acquired
in 2008 for $665 million, Crown investments have totaled $3 billion, $2.4 billion of this under
the National-led Government – see Figure 4 and Table 3.
In addition to the KiwiRail subsidies discussed in this report, KiwiRail has also caused write-
downs in the Crown balance sheet of an incredible $9.8 billion since it was repurchased
in 2008 (Bennett 2012). We have chosen not to include that ?gure in our measurement of
corporate welfare, but arguably, as it is a cost to the Crown, the taxpayer has sufered a loss
equivalent to $5,610 per household, in addition to what is detailed.
This is more than the total spending on police over the same period. The total cost to taxpayers
for the bailouts to KiwiRail under the current National-led Government amounts to $1,359 per
household over the last six budgets.
Figure 4: State-owned enterprise welfare, Vote Transport and Vote Finance (KiwiRail), Budgets 2008/09 to 2014/15 ($million)
Source: Budget Papers 2008/09 to 2014/15.
800
700
600
500
400
300
200
100
0
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15
Year of Budget
$

M
i
l
l
i
o
n
21
Table 3: State-Owned Enterprise welfare, Vote Transport and Vote Finance (KiwiRail), Budgets 2008/09 to 2014/15 ($million)

Note: $690 million for the purchase of Toll NZ Ltd’s rail business and associated costs not included in 2008/09 data.
4.2 WHEN WILL KIWIRAIL TURN AROUND?
KiwiRail has a 10-year Turnaround Plan to make its freight business commercially viable. The
current network of 4,000 km is to be reduced to 2,300 km for the company to break even. The
Treasury advised that this massive and painful restructuring was required before KiwiRail was
purchased.
The taxpayer must ask what they are getting for these regular half-billion dollar annual bailouts.
If not for these bailouts, government revenue would have been enough to have cut the
company tax by two percentage points from 28 per cent to 26 per cent.
Bill English, Minister of Finance, said it all in terms of value for money for the taxpayer in March
2009:
The Government is now the owner of a business which probably has no value, in
fact negative value, having just eight months ago paid almost a billion dollars for it
(Swann 2009).
4.3 SOFT BUDGET CONSTRAINTS
The unwillingness of governments to walk away from failing businesses it owns is an ongoing
risk to taxpayers. Entrepreneurs have no choice when they exhaust their retained earnings and
banks and private investors will no longer support them. As George Stigler (2000) explains:
The competitive industry is not one for lazy or confused or inefcient men: they will
watch their customers vanish, their best employees migrate, their assets dissipate.
It is a splendid place for men of force: it rewards both hard work and genius, and it
rewards on a ?ne generous scale. The success of a competitive enterprise is not
the least uncertain if its employees are able and diligent and its leadership sane
and courageous.
Firms that successfully serve their market ?nd it easy to obtain capital to stay in business and to
expand; unsuccessful, inefcient ?rms of course go out of business.
2008/09
budget
2009/10
budget
2010/11
budget
2011/12
budget
2012/13
budget
2013/14
budget
2014/15
budget
Grand
Total
Rail - New Zealand Railways
Corporation Loans
405.00 55.00 250.00 107.50 10.75
KiwiRail Turnaround Plan 20.00 250.00 250.00 250.00 93.85 198.00
KiwiRail Equity Injection 322.50 25.00
Rail Network and Rolling
Stock Upgrade
104.85 70.76 10.15
New Zealand Railways
Corporation Loans
55.00
New Zealand Railways Corporation
Increase in Capital for the Purchase
of the Crown Rail
376.00
Crown Rail Operator Loans 140.00
Crown Rail Operator Equity Injection 6.77
Total 577.77 529.85 375.76 510.15 680.00 118.85 208.75 3001.13

22
A hard budget constraint is a de?ning characteristic of a well-functioning market economy.
KiwiRail, Solid Energy, and other state-owned enterprises and businesses supported by
subsidies have increasingly soft budget constraints. Kornai (1986) explains:
… the softening of the budget constraint occurs when the strict relationship between
expenditure and earnings has been relaxed because excess of expenditure over
earnings will be paid by some other institution typically by the State. A further
condition of softening is that the decision maker expects such external ?nancial
assistance with high probability, and this probability is built ?rmly into his behavior.
The bailouts for KiwiRail and Solid Energy signal to all state-owned enterprises that they have
a soft budget constraint. When they get into trouble, there will be subsidies and bailouts
forthcoming. The link between pro?ts, innovation, cost control, and good customer service are
all slowly broken when a soft budget constraint creeps into a business environment.
The strongest argument for free enterprise is that it prevents anybody from
having too much power. Whether that person is a government ofcial, a trade
union ofcial, or a business executive, it forces them to put up or shut up. They
either have to deliver the goods, produce something that people are willing
to pay for, are willing to buy, or else they have to go into a diferent business
– Milton Friedman, “The Tyranny of Control” in Free to Choose (1980)
T
A
X
E
S

G
O

U
P

T
O

F
U
N
D

S
U
B
S
I
D
I
E
S

T
O

F
A
I
L
I
N
G

F
I
R
M
S

O
W
N
E
D

B
Y

T
H
E

G
O
V
E
R
N
M
E
N
T
C
H
A
N
C
E
23
500
450
400
350
300
250
200
150
100
50
0
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15
Year of Budget
$

M
i
l
l
i
o
n
2008/09
budget
2009/10
budget
2010/11
budget
2011/ 12
budget
2012/13
budget
2013/14
budget
2014/15
budget
3D Digital Graphics Cluster 2.00 2.00
Analysis and Development Services for
Firms
19.93 18.22 20.45
Depreciation on the temporary Rugby
World Cup showcase and festival building
on Queens Wharf
2.00 4.90 4.90
Enhancing Small Business Capability and
Performance
0.22 0.22 1.23
Enterprise Development Fund 2.77 0.60
Enterprise, culture and skills fund 1.55
Establishment and operation of the Food
Innovation Network New Zealand
0.35 13.00 4.00 4.60
Film New Zealand 0.75 0.80 0.83 1.13 1.13 1.30 1.30
Growth Services Fund 5.93
Identi?cation and Coordination of
International Market Opportunities
68.92 73.59 80.41
International Biotechnology Partnerships 0.73
International Business Growth Services 0.00 101.66 101.26 104.63 111.01
5 THE MINISTER FOR ECONOMIC
DEVELOPMENT
5.1 GOVERNMENT AS SUPERIOR ENTREPRENEUR
The $280 – $450 million in corporate welfare under the patronage of the Minister for Economic
Development over the last seven budgets is peppered across industries – see Figure 5 and
Table 4. The two big spending items in the portfolio of the Minister for Economic Development
are trade promotion by New Zealand Trade and Enterprise and ?uctuating subsidies for the
New Zealand ?lm industry.
Figure 5: Corporate welfare, Vote Economic Development, Budgets 2008/09 to 2014/15
Source: Budget Papers 2009/10 to 2014/15.

Table 4: Corporate welfare, Vote Economic Development, Budgets 2008/09 to 2014/15 ($million)
24

Source: Budget Papers 2008/09 to 2014/15.
Note: policy advice within Vote Economic Development is included as corporate welfare because this policy advice would be
redundant if the corporate welfare had not been dispensed.
International Growth Fund 9.84 20.33 25.83 30.03 15.73 29.71
International Investment Facilitation
Services
16.03 15.21 13.61
Investment Fund Management 2.59 2.33 2.33 2.33 2.33
Investment Fund Management 2.33
Large Budget Screen Production Fund 47.80 52.48 127.00 91.66 50.56 40.56 57.65
Louis Vuitton Paci?c Series 0.75
Louis Vuitton Trophy Series 3.50
Major Events Development Fund 4.50 7.85 8.35 13.53 15.08 10.00 10.00
Management Development Fund 0.28 0.30 0.50 0.22 0.76 0.76 0.76
Market Development Assistance Fund 44.94 40.77
Negotiation and Completion of Stadium
Projects
40.77
New Zealand Trade and Enterprise 2.00 0.60 0.15 0.17 0.17 0.17
New Zealand's Participation at Expo 2010
Shanghai, China
9.38 26.45 10.58
Policy Advice - Economic Development 10.45
Policy Advice - Sectoral Leadership, Firm
Capability, and Regional Development
15.76 19.85 27.01 25.66 13.26 18.45
Policy Advice - Small Business 1.73 1.54 1.23 1.42 1.33 1.45 1.23
Promotion of New Zealand Associated with
the America’s Cup
2.00 19.75 1.68 5.00
Purchase of Queen's Wharf, Auckland 20.00
Regional and Industry Development Fund 1.76 1.03 0.60 3.90 1.15 0.80 0.40
Regional and Sector Development Services 47.16 47.51 31.37
Regional Partnerships and Facilitation 9.34 11.82 4.56 4.56 4.49 4.56
Rugby World Cup 1.80
Rugby World Cup Free-to-Air Broadcasting
Right
0.64 1.60 0.96
Rugby World Cup Leverage and Legacy
Programmes
5.75 7.70
Sector Strategies and Facilitation 1.50 1.50 1.20 1.20 1.20 1.20 1.20
Sectoral Leadership, Firm Capability, and
Regional Development Operational Policy
Ministerial Servicing and Crown Entity
Monitoring
5.77 9.58 0.00
Seed Co-investment Fund 13.76 3.00 8.00 7.60 16.23 7.25 7.58
Services to Develop Business Capability 11.71 13.75 13.44
Services to Support Sector Development
and Special Events
31.09 32.81 31.87 31.07
Services to Support the Growth and
Development of New Zealand Businesses
13.18
Stadium Development 27.87
Standardised Training and Advisory
Services
15.19 15.17 11.41
Temporary Rugby World Cup showcase
and festival building on Auckland's Queens
Wharf
8.00 1.80
Transformational Initiatives Fund 2.47 3.99 3.00
Venture Investment Fund 33.70 1.00 10.35 13.67 29.26 15.00 10.38
Total 372.46 419.45 446.28 379.46 331.96 284.29 287.16
25
5.2 SUBSIDIES FOR THE FILM INDUSTRY
Initially, ?lm subsidies were for local productions as part of fostering New Zealand arts, culture
and heritage. New Zealand is now the host to what the Directors Guild of America and the
Screen Actors Guild of America de?ne as runaway productions; motion picture productions
that are:
Intended for initial release/exhibition or television broadcast in the US, but are
actually ?lmed in another country.
This may have little to do with promoting our own culture, telling our stories, or hearing our
“voices”, as originally intended.
New Zealand is a major bene?ciary of the growth in internationally mobile ?lm productions
combined with Sir Peter Jackson’s unique creative and entrepreneurial talents and
determination to ?lm The Lord of the Rings. Part of the location decision of any commercially
minded ?lm producer is what the competing national or federal, state and local authorities are
willing to do for them for the privilege of hosting their ?lm production. This preferment can be
for location shooting as well as for pre and post-production.
Table 5 incorporates the ?lm industry subsidies administered by the Minister for Economic
Development with much smaller subsidies by the Minister for Arts, Culture and Heritage. Table 5
shows that ?lm subsidies have been as high as $146 million in 2010/11 and as low as $44 million
in 2013/14 depending on whether a big budget production is in New Zealand. The past is no
indicator of the future. It depends on the success of New Zealand in that race to the bottom that
results from a global market for ?lm subsidies.
Table 5: Film industry subsidies, Budgets 2008/09 to 2014/15 ($million)
Source: Budget Papers 2008/09 to 2014/15
New Zealand’s ?lm subsidies have evolved into the country becoming a player in the rather
expensive global subsidy market for ?lms. These ?lms can be about any country, any story and
any era and might be ?lmed in New Zealand for the right subsidy because of modern digital
technology and the variety of backgrounds that allow New Zealand locations to look like any
place in the world.
Extreme uncertainty is pervasive in ?lm and television show production. Producers learnt right
from the start that audiences demanded novelty and innovation – they wanted to be surprised
again and again. Many famous ?lms and TV shows succeeded because the producers made
something that audiences did not know they wanted to see. Their success surprised everyone,
including the producers. Subsidies for the ?lm industry are a high risk for the taxpayer. The ?rst
law of Hollywood economics is:

2008/09
budget
(Labour
Party)
2009/10
budget
2010/11
budget
2011/12
budget
2012/13
budget
2013/14
budget
2014/15
budget
Total
(National
Party)
New Zealand Screen Production
Incentive Fund
3.27 10.91 18.89 10.49 29.23 3.69 73.20
New Zealand Screen Production
Grant - New Zealand
4.06 4.06
Large Budget Screen Production
Fund
47.802 52.481 127 91.66 50.56 40.56 57.65 419.90
51.07 63.39 145.89 102.15 79.78 44.25 61.71 497.17
26
Nobody knows anything … Not one person in the entire motion picture ?eld knows for a
certainty what's going to work. Every time out it's a guess and, if you're lucky,
an educated one (Goldwin 1989)
Big budgets, star power and large marketing budgets do not reduce ‘the terror of the box ofce’
and ?lms involving stars often run over budget. There is no typical movie – industry pro?ts
depend on the rare blockbuster: 78 per cent of ?lms are unpro?table (Walls 2005; De Vany and
Walls 1999). Every ?lm is unique but competes with many ever changing imperfect substitutes
(De Vany and Walls 1997).
Studios and ?lm investors respond to these entrepreneurial uncertainties with a portfolio
approach. They invest in a range of ?lms and in both established and new talent (Sedgewick
2005). New Zealand taxpayers cannot diversify their risks through this global portfolio
approach. The taxpayer is providing subsidies but recoupment through extra tax revenues on
?lm pro?ts is highly uncertain (and we are generally not an equity partner).
The poor returns to the taxpayer are well-known in terms of spillovers and spin-ofs. The
Treasury estimated the current subsidy scheme had delivered net economic bene?ts to New
Zealand of just $13.6 million from 2004 to 2011. This is an annual rate of return of less than one
per cent to the taxpayer. The large screen production grants from 2004 to September 2013
totalled $472 million. This is no small sum of taxpayers’ money. The Avatar sequels have been
promised at least $125 million in taxpayers’ money in return for agreeing to spend at least $500
million in New Zealand. This ?lm subsidy is twice what was paid in subsidies for making the
?rst Avatar ?lm in New Zealand.The Ofces of the Minister for Economic Development and the
Minister for Arts, Culture and Heritage gave frank advice to Cabinet on the screen production
incentive grant:
Countries that are engaging in using increasingly generous incentives to entice
international business are efectively promoting a 'race to the bottom' mentality.
Taxpayers should ask themselves whether they want to keep investing more and more money
in a race to the bottom in the global subsidy market that will always face ‘the terror of the box
ofce’. As the Ofces of the Minister for Economic Development and Minister for the Arts,
Culture and Heritage noted in the relevant cabinet paper again with an admirable commitment
to value for money:
New Zealand should not simply seek to compete on this basis as in the longer
term this is likely to lead to an economic loss to New Zealand and it will not assist
in building sustainable screen businesses.
Not only is the ?lm subsidy business a global subsidy market where New Zealand is a small
player, but ?lm making is also an immensely risky endeavor. The overseas promoters of these
international ?lms have diversi?ed portfolios of ?lms and other investments. The New Zealand
taxpayer has no such diversi?cation in its ?lm investment portfolio. At best, New Zealand is
backing a poor investment. There is an increase in risk of backing international ?lms that fail
at the box ofce. Whether that will be enough to induce the taxpayer to pull out of this global
subsidy market is a story that remains to be told.
27
5.3 EXPORT PROMOTION AND INFORMATION SPILLOVERS
New Zealand Trade and Enterprise is responsible for about $110 million of spending per year on
what is termed ‘International Business Growth Services’. The rationale for this export promotion
is information externalities (Lederman, Olarreaga and Payton 2010). Private ?rms may hesitate to
spend on research and marketing costs that might bene?t rival exporters. Pioneering exporters
risk developing foreign market footholds and country-speci?c reputations that can be quickly
imitated by rivals – fast-seconds – once they have opened the door (Lederman, Olarreaga and
Payton 2010; Panagariya 2003). These fast-seconds wait for a mature product design to break-
through and then enter the market to ofer a cheaper me-too product that can overtake the
brand name capital of the export pioneers (Geroski and Markides 2005).
Export promotion labours under the misapprehension that exports are good and imports are
bad. Trade is merely a clever technology for turning exports into imports. Exports have no
economic purpose other than earning the necessary foreign exchange to buy imports. Consider
the following by Krugman (1993):
James Ingram’s (1983) textbook on international trade contains a lovely parable.
He imagines that an entrepreneur starts a new business that uses a secret
technology to convert U.S. wheat, lumber, and so on into cheap high-quality
consumer goods.
The entrepreneur is hailed as an industrial hero; although some of his domestic
competitors are hurt, everyone accepts that occasional dislocations are the price
of a free-market economy.
But then an investigative reporter discovers that what he is really doing is shipping
the wheat and lumber to Asia and using the proceeds to buy manufactured goods--
whereupon he is denounced as a fraud who is destroying American jobs.
The point, of course, is that international trade is an economic activity like any
other and can indeed usefully be thought of as a kind of production process that
transforms exports into imports.
Both exporters and importers must search for relevant markets, review the available products
and services and ?nd reliable trading partners. Few, if any, countries have import promotion
agencies. Many imports into New Zealand are high-technology consumer goods, production
inputs and the latest new plant and equipment.
If trade promotion by New Zealand Trade and Enterprise is motivated by concerns about market
failure and externalities, on the face of things, there is a stronger case for an import promotion
agency than there is for an export promotion agency. New Zealand’s exports are notorious for
being low technology and dominated by labour intensive primary products from the agricultural
and ?shery sectors.
Such exports are easier to promote abroad because the individual exporter is supplying
something in the nature of the standard product familiar to the buyer in terms of quality. Imports
into New Zealand include many high-technology products where asymmetric information about
the quality of each import is more likely to arise. The main diference is that most people would
immediately accept that importers have to run their businesses without subsidies because that
is what a normal business does.
As for value for money, in a major review of the efectiveness of export promotion agencies for
the World Bank, Lederman, Olarreaga and Payton (2006, p. 2) concluded that:
28
It should be clear that program evaluation of [export promotion agencies] on
economic welfare grounds is difcult if not impossible. Thus often – if not always–
evaluations of EPAs stop short of an assessment based on welfare grounds, and
focus on the more modest objective of assessing whether exports have increased
or whether new markets have been opened.
Findings that export promotion increases exports are of no value to the taxpayer. If the
government subsidises anything, more is usually produced. Panagariya (2003, p. 10)
suggested that:
Given the past failures of import-substitution policies, often justi?ed on the basis
of unsubstantiated claims of external economies, skeptics are entitled to a higher
standard of proof of the existence of externalities this time around.
Rose and Spiegel (2011) found that the national branding from bidding to host the Olympics or
FIFA World Cup is nuanced. Exports increased by 20 per cent for the nation that won and for
losing bidders as well! The Olympic efect on trade is from the signal a country sends when
bidding to host the games, rather than from actually hosting the mega-event. Bids to host mega
sports events are soon after or in conjunction with major trade and investment liberalisations
such as joining the WTO or the Common Market. Bidding for mega-events is a credible signal
that a country has turned a political corner. This credible regime change towards openness is
what matters, rather than the window of global publicity.
5.4 THE TRADE BALANCE MUST BALANCE
Any increase in exports as a result of subsidies or trade promotion by New Zealand Trade and
Enterprise is ofset by an increase in imports. This is because there is an appreciation of the
New Zealand dollar as the trade surplus increases, or the trade de?cit reduces because of the
increased exports.
Figure 6 shows that the increase in demand for exports increases the demand for New Zealand
dollars in the foreign exchange markets. This increase will cause an appreciation in the value
of the New Zealand dollar in the foreign exchange markets. This appreciation will make imports
cheaper so imports will increase. This currency appreciation and increase in imports into New
Zealand will continue until exports again equal imports.
Figure 6: The exchange rate efects of an increase in exports
29
The size of the traded goods sector will be larger when there are export subsidies or trade
promotion. The size of the trade in goods sector would also be larger if there are import
subsidies. Any subsidy to exports, either directly or through trade promotion will increase
imports in equal measure because the trade balance always balances. By the same token,
tarifs reduce both imports and exports.
For most of the last 25 years, exports have exceeded imports, so the current account de?cit
has little to do with the performance of exports or imports – see Figure 7. The current account
balance is the result of the international trade in savings and the relative returns from investing
at home or abroad. The current account is in surplus when national savings exceed domestic
investment, and is in de?cit when national savings are less than domestic investment (Barro
2007; Humpage 1998, 2004).
Figure 7: Balance of goods and services, New Zealand
Statistics New Zealand InfoShare.
Export subsidies either directly or through trade promotion lead to a reshufing of employment
out of import competing industries into the exporting industries but wages will be lower. This
is because New Zealand is producing more of what is subsidised rather than what is the most
price competitive. In a digital age with e-commerce and internet marketing, the case for a
government agency undertaking marketing on behalf of private companies should be waning,
not growing in size of budget.
5.5 BUT THE EXCHANGE RATE IS TOO HIGH/TOO LOW?
One rationale for export subsidies is that Kiwi taxpayers should dig deep into their pockets to
take on a world of under-valued exchange rates. Under-valued exchange rates mean cheap
imports. It is not obvious that we should object to other countries subsidising their exports to
New Zealand. A good rule in public policy is lower prices are a good thing. There is no such
thing as the scourge of lower prices. Maybe we should just roll with the punches – accept what
we cannot change and make the best of a bad situation. In this case it is foreign countries and
foreign taxpayers subsidising New Zealand consumers through cheap imports.
Those claiming that the Kiwi dollar is itself over-valued or under-valued must de?ne the long-
6 000
5 000
4 000
3 000
2 000
1 000
0
- 1 000
- 2 000
- 3 000
$

M
i
l
l
i
o
n
30
run equilibrium value of the exchange rate. So daunting is that task that it is still the case that
the best available forecast of the exchange rate is whatever it is today. Anyone who knew
any better than that would not tell you. They would be too busy trading on their own account
before their exchange-rate modelling breakthrough is out of date, or even worse, is reverse
engineered by a rival currency trader.
If another country undervalues its exchange rate by running a loose monetary policy, perhaps
with the intention of making products and investment opportunities in the country cheap, any
trade advantage from this undervalued exchange rate would erode as domestic prices adjust
through higher in?ation.
First, because monetary policy ultimately determines only the domestic in?ation rate,
a central bank that wants to engineer a depreciation of its currency must create more
money than its trading partners and thereby generate a higher in?ation rate.
Second, because any resulting exchange rate depreciation will ultimately ofset the
in?ation diferential, a monetary-induced depreciation cannot secure a competitive trade
advantage (Humpage 1998, p. 1).
Most central banks around the world gave up on exchange rate interventions in the mid-
1990s, because several decades of attempts to manipulate exchange rates without loosening
monetary policy rarely worked. These exchange rate interventions, known as sterilised
interventions, become an independent source of exchange rate instability and invite counter-
speculation by currency traders and hedge funds. Every hint that a central bank might intervene
to stop the exchange rate going too high to low invites speculation.
Using the monetary policy to keep the dollar from going “too high” would have ruinous
domestic consequences as the Governor of the Reserve Bank explained last year:
If New Zealand decided to cap the NZ dollar, depending on where the cap is
enforced, similar levels of intervention might be required as global foreign
exchange turnover in NZ dollars relative to GDP is similar to that in Swiss francs.
The OCR would need to drop to zero ?rst in order to eliminate the interest
arbitrage motivation for NZ dollar in?ows.
Any attempt to retain non-zero interest rates by “sterilising” such massive
intervention would be very difcult. In efect therefore a Swiss type operation to
cap the value of the NZ dollar through large scale FX intervention would also
amount to quantitative easing.
As I mentioned, this would be highly in?ationary in the NZ context.
Graeme Wheeler, Governor of the Reserve Bank, 20 February 2013
Monetary policy is incapable of improving the competitive position of New Zealand exporters
through exchange rate manipulation. A looser monetary policy required to induce a
depreciation of the too high Kiwi dollar will inevitably lead to higher in?ation that will erode any
temporary advantage to exporters from the initial depreciation.
New Zealand should make the most of what it has in light of the world as it is. Export subsidies
merely reshufes employment and production in and out of the traded goods sector while
lowering the wages and productivity. Matching foreign industrial and exchange rate policies is
always a recipe for subsidising sectors where there is already excess capacity and low returns
(Krugman 1983, 1984).
31
5.6 A PRETENSE TO KNOWLEDGE
When exports are subsidised or promoted, the government is pretending to know what the
optimal size of the traded goods and services sector is in New Zealand. The government is
further pretending to have in its hand sufcient information, knowledge and computational
power to forecast in a disinterested manner free of politics that optimal outcome well
in advance.
The Government must then have the tools to ?ne tune exports and imports to deliver that
optimal outcome in a rapidly changing world where any rational decision will be out of date very
quickly, often before it is even calculated, much less delivered. A further complication for the
Minister is that any knowledge he has in advance will be rather limited.
Most of the more important knowledge is in the hands of the vast number of people. Hayek
(1945) viewed the market process as a vast telecommunication network that mobilised bits
and pieces of incomplete and frequently contradictory knowledge dispersed across countless
individuals and summarise that knowledge into prices:
The most signi?cant fact about this system is the economy of knowledge with
which it operates, or how little the individual participants need to know in order
to be able to take the right action. In abbreviated form, by a kind of symbol, only
the most essential information is passed on and passed on only to those concerned.
It is more than a metaphor to describe the price system as a kind of machinery for
registering change, or a system of telecommunications which enables individual
producers to watch merely the movement of a few pointers, as an engineer might
watch the hands of a few dials, in order to adjust their activities to changes of
which they may never know more than is re?ected in the price movement (Hayek 1945).
The market process works because as people buy and sell and prices change as a result,
their limited individual ?elds of vision sufciently overlap through these price changes that the
relevant knowledge is communicated to all (Hayek 1945). Neither the Minister nor a bureaucrat
can replicate this telecommunications network that is embedded in the market process when
gathering the knowledge that they will need to review both subsidy applications and
industry strategies.
An entrepreneur simply needs to learn prices and costs that are relevant to their particular
circumstances of time and place, and act quickly before their knowledge and hunches about
how the future might unfold are overtaken by events and more alert competing entrepreneurs.
Changes in prices and forecasts of future prices are the basis on which entrepreneurs
adjust their plans. Through buying and selling in the market, there are constant incremental
adjustments of both price and quantities so that economic decisions dovetail towards the prices
and quantities that clear the market. Entrepreneurs are nonetheless still profoundly ignorant of
most events in the economy:
The chief insight gained by modern economists is that the market is essentially
an ordering mechanism, growing up without anybody wholly understanding it,
that enables us to utilize widely dispersed information about the signi?cance
of circumstances of which we are mostly ignorant (Hayek 1978).
32
5.7 COPING WITH IGNORANCE
A minister or bureaucrat attempting to subsidise or promote the exports of a particular industry
must gather a vast amount of incomplete, con?icting information dispersed across countless
individuals. This information is gathered against a background of constant small changes in
prices, costs and available opportunities and there is a lack of immediate feedback to this
minister or bureaucrat through daily changes in prices, pro?ts and costs. Steven N.S. Cheung
explains the challenge facing the minister:
… economists who propose corrective policies tend implicitly to assume unrealistic
constraints on governments. It is assumed, for example, not only that situations
exist which entail divergences between private and social costs, but also that
some state agency will incur a sufciently low, if not zero, cost in correctly
assessing the values of various marginal schedules, even for complex situations
where multiple uncontracted efects will have an impact on large numbers of
individuals (Cheung 1978, p. 39).
Statistics are the eyes and ears of governments when intervening in the market process
(Rothbard 1960). Most of the important knowledge in the market process is tacit and simply does
not exist in a format that can be summarised into statistics or otherwise conveyed to a central
authority; and much of the rest of the relevant information that can be collated quickly becomes
out of date (Hayek 1945).
The Minister and the bureaucracy stand outside of the market process and are not aided by its
process of communicating knowledge among its participants through prices and pro?ts:
Competition is essentially a process of the formation of opinion: by spreading
information, it creates that unity and coherence of the economic system which we
presuppose when we think of it as one market. It creates the views people have
about what is best and cheapest, and it is because of it that people know at least as
much about possibilities and opportunities as they in fact do (Hayek 1948).
The attempts by the Minister to rectify market failures with government intervention and through
subsidies to manipulate supply and demand curves to take into account social costs and
bene?ts is an example of playing the all-powerful role of the teacher in what Ronald Coase
called ‘blackboard economics’:
… in which with full knowledge of the curves (which no participant in the actual
economic process possesses), we move factors around (on the blackboard) so
as to produce an optimal situation. This may well be a good way of teaching
the tools of economic analysis but it gives students a very poor idea of what
is normally involved in deciding on economic policy (Coase 1964, p. 195).
There is no real-world counterpart of the teacher next to a blackboard moving the curves at
will. Coase (1960, 1974), Demsetz (1969), Cheung (1973) and Barzel (1977) warned of the risk of
moving quickly from the identi?cation of a market imperfection to assuming government can
correct it in reality:
The tax policy of an all-knowing, well-motivated state results in corrective
adjustments for externalities in accord with the economist’s prescription; this
obviates the need for considering alternative assignments of responsibility.
The problem was analysed as if the state is a perfect agent through which the
blackboard plans of economists can be brought to fruition. Ignoring
State-associated costs of error, implementation, and improper motivation,
33
rather than ignoring the cost of using of markets, is the root cause of the asymmetric
approach brought to the assignment of responsibility (Demsetz 1996, p. 567).
The great advantage of real markets is the immense amount of explicit and tacit knowledge that
is summarised in prices. Price tags do not come with explanations attached. They instead are a
signal wrapped in an incentive (Alchian and Allen 1983; Stigler 1987). All the entrepreneur needs
to know whether prices are up or down. If the entrepreneur does not adapt to the latest price
changes, he risks going out of business. If the entrepreneur can anticipate changes in prices
faster than rivals, he stands to pro?t.
The Minister must gather a vast amount of knowledge to make up for the fact that he does
not actually own the asset at stake and is not competing in the marketplace subject to a hard
budget constraint. His soft budget constraint is in contrast to Darwinian evolutionary selection in
the market process where:
… the necessary changes in habits and customs will occur only when those who
are ready and able to experiment with new procedures can make it necessary for
the others to imitate them, with the former thereby showing the way … competition
not only shows how things can be improved, but also forces all those whose income
depends on the market to imitate the improvements (Hayek 2002).
5.8 THE INFANT INDUSTRY ARGUMENT
Most of the justi?cation for government subsidies in the rest of the portfolio of the Minister
of Economic Development boils down to the infant industry argument. A new industry or ?rm
has good long-term prospects but is unable to ?nd private sector investors who are willing to
stake the venture. Governments, however, can see further than the private sector regarding the
existence and riskiness of these long-term prospects.
A heavy burden of justi?cation lies upon claimants for subsidies that are premised on ?xing
gaps in the market that arise from the existence of persistent, known but unexploited
opportunities for entrepreneurial pro?t:
There is no more important proposition in economic theory than that, under
competition, the rate of return on investments tends towards equality in all industries.
Entrepreneurs will seek to leave relatively unpro?table industries and enter
relatively pro?table industries, and with competition there will be neither public nor
private barriers to these movements. This mobility of capital was crucial to the
efciency and growth of the economy (Stigler 1963, p. 54).
The infant industry argument is problematic because if the industry will be pro?table in the long
run, the ?rms concerned should be willing to accept losses in their ?rst few years of business,
treating them as an investment to be paid back by later pro?ts (Friedman 1990). If private
investors are unwilling to accept the losses inherent in establishing any new ?rm, perhaps
the anticipated later pro?ts from the investment are not large nor certain enough as ofcious
observers might think (Friedman 1990, 1996).
There could, of course, be learning by doing and other cost reductions that spill over to other
?rms, which no ?rm takes into account when deciding its own level of output. Too little is
produced. McCloskey (1985, p. 288) called this under-production a ‘leading objection to market
capitalism’. Panagariya (2003) suggested that the empirical relevance of externalities remains
as illusory for infant export industries as it was for tarifs and subsidies for import-substituting
industries in earlier times.
34
Edmund Phelps (2013a) made this argument against subsidies and for grassroots innovation:
The problem is that subsidies redirect the economy’s innovation toward politicians,
who lack deep specialized knowledge, and away from the private sphere, where
judgments are made by ideas men, entrepreneurs, ?nanciers, and market people
who consider whether there are not better initiatives to think about or develop.
The competitive market process selects which innovators are rewarded with pro?ts and which
fall by the wayside because of losses. Subsidies impede this competitive market process of
trial and error and Darwinian natural selection through pro?ts, losses and business failure.
Political processes cannot replicate the outcomes of competitive market selection. Most of the
knowledge about what consumers will buy is revealed down the road as the market sifts and
sorts between competing product options.
5.9 SPILLOVER BENEFITS AND INDUSTRY TARGETING
A common rationale for targeting an industry with subsidies is that it has various bene?ts to the
wider community that cannot be captured by individual entrepreneurs so they are ignored in
their investment plans. The industry is too small because these spillover efects are ignored.
Krugman’s (1983, 1993, 1994) summary of the pros and cons of industry targeting stands to
this day:
• The most commonly cited criteria for industry targeting such as future competitiveness,
linkage industries, high value added per worker or responding to the industry policies of
other governments are misconceived, in some cases disastrously so;
• To the extent there is a valid theoretical case for targeting, this theoretical basis for industry
targeting is too complex and ambiguous to be useful given the current state of knowledge;
and
• It is not easy to evaluate the costs and bene?ts of industry targeting even after the fact that
the criteria generally used are crude and can easily be misleading.
Arguments for a strategic industry policy based on game theory in oligopolistic industries and
externalities from learning by doing in production cost curves:
• It is highly sensitive to the parameters: the cost of R&D, the slope of the learning curve, the
number of potential competitors, and the size and growth rate of the target market – about
which there is very imperfect knowledge;
• The argument is highly sensitive to assumptions about competitive strategies – some
assumptions call for export subsidies but equally plausible assumptions call for export taxes;
• An activist industry policy could provoke foreign retaliation, which makes the venture
unproductive; and
• The decision-making process is assumed not to be captured by special interests (Krugman
1984).
According to Pack and Saggi (2006) for a politician or policymaker to successfully target
industries, they must be knowledgeable in the following:
1. the ?rms and industries that generate knowledge spillovers;
2. the ?rms and industries bene?t for dynamic scale economies, including the path of
such learning and the magnitude of the cost advantage at each stage of the learning
35
process;
3. the sectors that have a long-term comparative advantage;
4. the size of the scale economies of the diferent ?rms in the diferent sectors;
5. their potential competitiveness (the policymaker must have an ability that is superior to
that of entrepreneurs and individual ?rms);
6. the nature and extent of capital market failures as they apply to each subsidy applicant;
7. the magnitude and direction of inter-industry spillovers;
8. the relative amount of learning by the individual ?rms from each other and from their
own experience;
9. the extent to which early entrance into an industry generate bene?ts for future entrants;
10. the extent of heterogeneity in the learning abilities of each ?rm;
11. the potential efects of foreign direct investment to international trade on eforts
to coordinate industry spillovers, including a detailed knowledge of which tens of
thousands of production inputs are tradable; and
12. forecasting which ?rms can create knowledge and discover better production methods.
Taxpayers may not be as optimistic as the government is as to its ability to gather all this
information and process it with sufcient political deftness to escape special interest capture.
The performance of portfolio managers in the sharemarket suggests that few of these well-paid
equity analysts are able to beat the market over any extended period of time. The knowledge
and skills required by the Minister and his advisers to take into account externalities and
spillovers makes this challenge even more daunting. By de?nition, externalities and spillovers
are not priced in the market – they must be guessed.
The purported successes of industry policy icons of the past, such as Japan and South Korea,
fail to stand up to closer inspection (Pack and Saggi 2006). For example, Beason and Weinstein
(1996) found that a disproportionate amount of Japanese industrial targeting was in low-growth
sectors and sectors with decreasing returns to scale. More importantly, they found no evidence
that productivity was enhanced by industry policy measures. Lee (1996) found a similar lack of
impact of Korean industry policies on sectoral capital accumulation and total factor productivity
growth. In both cases, the better explanation of Japanese and South Korean economic success
was a credible adoption of a free market economy functioning under low taxes and openness
to trade and new technologies.
5.10 THE SERVICES SECTOR AS THE WALLFLOWER
OF CORPORATE WELFARE
A major source of productivity gains comes from the reallocation of market shares and
employment from the lower productivity ?rms to higher productivity competitors and to
newcomers. In the manufacturing sector, the sources of productivity gains are about 50 per
cent from within-plant productivity improvements with the rest through reallocation that is, in
turn, evenly divided between new entrants and the reallocation of market shares to lower-cost
incumbents. In the retail sector, nearly all productivity gains arrive through new entrants (Foster,
Haltiwanger and Krizan 2001).
Corporate welfare does not speak to this form of productivity enhancement because it is driven
by loss of market share and business failure. Subsidies would only slow down this process of
reallocation.
36
6 THE MINISTER OF SCIENCE
AND INNOVATION
6.1 GOVERNMENT AS ORACLE
Figure 8 shows that a new player on the corporate welfare block is the Minister of Science and
Innovation. Over the last two budgets, a large number of co-investment grants were handed out
through R&D subsidies – see Table 6.
Figure 8: Corporate welfare, Vote Science and Innovation, Budgets 2008/09 to 2014/15
Source: Budget Papers 2008/09 to 2014/15
Table 6: Corporate welfare, Vote Science and Innovation, Budgets 2008/09 to 2014/15 ($million)
Source: Budget Papers 2008/09 to 2014/15

The main argument for R&D grants is the inability of the inventor to obtain the returns
from their innovation because competitors immediately copy the new product and the
ideas behind the new product. Inventors and innovators will not anticipate a sufcient
return to justify investing in the R&D in the ?rst place. The usual solution to this problem
of appropriating the returns from innovation are patents and copyrights rather than
subsidies. In the case of basic science, where the research output is more likely to not lead
to ideas that can be immediately commercialised, the case for subsidies is stronger.
200
180
160
140
120
100
80
60
40
20
0
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15
Year of Budget
$

M
i
l
l
i
o
n
2009/10 budget
(Labour Party)
2009/10
budget
2010/11
budget
2011/12
budget
2012/13
budget
2013/14
budget
2014/15
budget
Realising the Bene?ts of Innovation 10.50 23.30
Research and Development Facilitation
and Promotion Service
4.20
Repayable Grants for Start-Ups 0.90 14.11
Research and Development Growth
Grants
65.10 96.60
Targeted Business Research and Devel-
opment Funding
35.60 44.90
Total 0.00 4.20 0.00 0.00 0.00 112.10 178.91
37
6.2 IT'S TOUGH TO MAKE PREDICTIONS, ESPECIALLY ABOUT THE FUTURE
R&D grants are a particularly high risk form of corporate welfare. Standard subsidies to industry
at least have the advantage that the New Zealand Government can imitate the successes of
other governments in terms of subsidising industries that appear to be successful overseas.
Most of the knowledge necessary to work out what will be a successful innovation lies in the
future and emerges only slowly through trial and error in the marketplace as many products
enter the ?eld. Most fail and the few that remain are well rewarded by the market in pro?ts and
market share.
6.3 MARKET-TESTED INNOVATION
The information available to private investors must be as least as good as that gathered by
government. The key question is whether ministers and bureaucracies have better information
than private investors, and can they use this knowledge more wisely? Investors are skilled
and experienced in evaluating pro?table uses of the capital – the better ones survive, losses
eliminate the rest.
… The basic problem facing public and private policy [is] the design of
institutional arrangements that provide incentives to encourage experimentation
(including the development of new products, new knowledge, new reputations,
a new ways of organising activities) without overly insulating these experiments
from the ultimate test of survival (Demsetz 1969).
Markets work because of the institutions that shape individual choices. These institutions –
property rights, price signals and pro?ts and losses– are the invisible hand that encourage
success and ?lter out error and failure. The market process does not rely upon either individuals
to be well informed or astute calculators. Property rights, prices and pro?ts and losses are
the institutions that do the heavy lifting (Smith 1962, 2008; Alchian and Allen 1983; Boettke,
Caceres and Martin 2013; and Wright and Ginsburg 2012). People deal with human frailties and
correct errors through specialisation, exchange and learning (List 2004; Epstein 2006a; Glaeser
2006). As Hayek (1945, 1948, 1989, 2002) argued, the price system allows profoundly ignorant
individuals to use the knowledge dispersed across countless individuals about changing
economic conditions without having to possess that knowledge themselves.
Ministers and the bureaucracy have no substitute for price signals and the incentives of pro?t
(or loss). Ministers and bureaucracies must instead collect for themselves a vast amount of
knowledge, much of which is tacit and is not summarised in statistics or any other written form.
The judgments of ministers and the bureaucracy about how to interpret the incomplete and
con?icting information that comes into their hands is not subject to a hard budget constraint,
continuous and often subtle updating by the price system, and changes in the pro?ts and
losses on investments that may result in bankruptcy. Coase (1959) illustrated these institutional
shortcomings of intervention with the government allocation of radio spectrum frequencies:
This "novel theory" (novel with Adam Smith) is, of course, that the allocation of
resources should be determined by the forces of the market rather than a result of
government decisions. Quite apart from the misallocations which are the result of
political pressures, an administrative agency which attempts to perform this function
normally carried out by the pricing mechanism operates under two handicaps.
First of all, it lacks the precise monetary measure of bene?t and cost provided by
the market. Second, it cannot, by the nature of things, be in possession of all the
relevant information possessed by the managers of every business which uses or
might use radio frequencies, to say nothing of the preferences of consumers for
38
the various goods and services in the production of which radio frequencies
could be used
In fact, lengthy investigations are required to uncover part of this information,
and decisions of the Federal Communications Commission emerge only after
long delays, often extending to years. To simplify the task, the Federal
Communications Commission adopts arbitrary rules (Coase 1959, p.18).
Business subsidies are likely to be based on shared expectations, proven solutions and
the conventional wisdom of the time. The bureaucratic process of government neglects
the idiosyncratic and speculative knowledge that give the most successful entrepreneurs
their edge. The market process is at its most creative when entrepreneurs compete by
experimenting in parallel to see which rival idea is best. Learning by results follows where
others imitate and improve on the most successful experiments. As Easterbrook (1984)
explained, market participants do what they do because they survive by doing it but the
reasons why may be less apparent to them and to outside observers:
Wisdom lags far behind the market. It is useful for many purposes to think of
market behavior as random. Firms tried dozens of practices. Most of them are
?ops, and the ?rms must try something else or disappear. Other practices ofering
something extra to consumers – they reduce costs or improve quality – and so
they survive in the competitive struggle the ?rms that use the best practice of
survive.
Why do particular practices work? The ?rms that selected the practices may or
may not know what is special about them. They can describe what they do, why
is more difcult.
Only someone with a very detailed knowledge of the market process, as well as
the time and date are needed for evaluation, would be able to answer that
question. Sometimes no one can answer (Easterbrook 1984, p. 5).
6.4 THE SURVIVOR PRINCIPLE AND EFFICIENCY AND INNOVATION AS
EMERGENT PROCESSES
A challenge for ministers and bureaucrats in deciding whom to subsidise is business vitality and
capacity for growth and innovation, which are only weakly related to cost conditions and often
depend on many factors that are subtle and difcult to observe (Stigler 1958, 1987). To survive
in the market, a ?rm, new or old, must rise above all of the problems it faces such as employee
relations, skills development, innovation, changing regulations, unstable markets, access to
?nance and new entry. This is the decisive (and Darwinian) meaning of efciency from the
standpoint of the individual ?rm (Stigler 1958).
The more and the less efcient ?rms are identi?ed by ascertaining which ?rms and classes of
?rms are growing and which are declining in size (Stigler 1958). Competition between diferent
sizes, shapes and organisational forms of ?rms all vying for sales, cheaper sources of supply
and investor support slowly seeks out the keener priced, lower cost, and more innovative
enterprises (Alchian 1950; Stigler 1958).
If the small ?rms in one industry are currently shrinking or going out of business while medium
and large ?rms continue to survive, the small ?rms are inferred to have higher per unit costs.
If the large ?rms in one industry are shrinking while the smaller ?rms continue to survive, it is
inferred that the larger ?rms currently have the higher per unit costs and the inferior products
(Stigler 1958; Demsetz 1973, 1976).
39
One method of organisation replaces another when it can supply at a lower price (Marshall
1920). The number and size of ?rms in any one industry or market re?ects the rise and fall of
?rms in a competitive struggle to survive with competition between ?rms of diferent sizes sifting
out the more efcient ?rm sizes and product ranges (Stigler 1958, 1987; Demsetz 1973, 1976;
Peltzman 1977).
The puzzlingly large size and productivity diferences across ?rms even in narrowly de?ned
industries producing standard products lead to misplaced doubts about the efciency of
some ?rms and of the market process (Barzel and Kochin 1992). Some ?rms can produce
half as much output from the same measured inputs as their market rivals and still survive in
direct competition (Syverson 2011). This great diversity in ?rm sizes is nonetheless efcient
simply because it survived. The diversity re?ects inter-?rm diferences in managerial ability,
organisational practices, choice of technology, the age of the business and its capital, location,
workforce skills, intangible assets and changes in demand and productivity idiosyncratic to each
individual ?rm (Stigler 1958, 1976a, 1987; De Alessi 1983).
6.5 PRODUCT LIFE CYCLES AND PUBLIC SUBSIDIES
The life cycle of many industries starts with a burst of new entrants with similar products. These
new or upgraded products often use ideas that cross-fertilise. In time, there is an industry
shakeout where a few leapfrog the rest with cost savings and design breakthroughs to yield the
mature product (Boldrin and Levine 2008, 2013). Fast-seconds and practical minded latecomers
often imitate and successfully commercialise ideas seeded by the market pioneers using prior
ideas as their base.
This entire dynamic market process of competitive selection, competition as a discovery
procedure, trial and error and leapfrogging is distorted if one or more of the contending
entrepreneurs secures a subsidy from government to stay in the race for longer than justi?ed
by its competitive merits. The government cannot enable this process because neither the
outcome nor even the direction of the competitive struggle for survival is known in advance. To
quote Thomas Babington (1830):
The maxim, that governments ought to train the people in the way in which they
should go, sounds well. But is there any reason for believing that a government is
more likely to lead the people in the right way than the people to fall into the right
way of themselves?
The ?rms that survive and grow in competition with rival ways of doing business are the more
efcient simply because they survived. What will survive in market competition will not be
known in advance to the politicians and policymakers when he is deciding which industries
and ?rms to subsidise. The results of the competitive market process that weeds out the less
efcient ?rm are known at the end of this long race, not at the start. The politicians/policymaker
faces a knowledge gap about prospective relative efciency that can never be closed.
6.6 GOVERNMENT AS CO-INVESTOR IN INNOVATION
The returns to public R&D may be overplayed. The OECD (2003) when investigating the
sources of economic growth disaggregated R&D into private and public components. It was
expecting a large positive and statistically signi?cant relationship. Instead, it found a statistically
signi?cant negative relationship. The OECD was surprised by this result and attempted to
downplay it:
… at face value [the results] suggest publicly performed R&D crowds out resources
that can be alternatively use by the private sector including private R&D.
40
There is some evidence of this efect on studies of it looked in detail at the
diferent forms of R&D and the interaction between them (OECD 2003).
If the OECD reports of publicly funded R&D has a negative return are true, R&D grants should
be viewed with great suspicion. The economic literature has a long history of ?nding that public
R&D grants have poor returns (Davidson 2006). Diamond (2006) found that the citation rate of
chemistry papers funded by the private sector is more frequent than the papers funded by the
government. This suggests that privately funded R&D is more efective in identifying important
and fruitful lines of research.
Importantly, increases in public R&D grants, at least in the short run, mostly increase the wages
of the scientists and engineers undertaking the additional R&D. Goolsbee (1998a, 1998b) who
later became President Obama’s Chairman of the Council of Economic Advisers, found that:
• Much of the bene?t of investment tax incentives does not go to investing ?rms but rather to
the suppliers of their equipment and capital through higher prices;
• The majority of R&D spending is actually just salary payments for R&D workers;
• The labour supply of R&D workers is quite inelastic in the short term so a signi?cant fraction
of the increased spending on R&D goes directly into higher wages;
• By raising the wages of scientists, engineers and other R&D workers to the private sector,
government funded R&D crowds out private R&D; and
• Because of the wage and equipment price rises, the conventional estimates of the
efectiveness of R&D policy may be 30-50 per cent too high.
Goolsbee’s (1998a, 1998b) ?ndings suggest that the main bene?ciaries of R&D grants are
equipment suppliers and knowledge workers. He found that this wage rise efect may have
grossly over-stated the previous estimates of the returns from R&D. The reason that wages
go up sharply when R&D grants increase is the supply of scientists, engineers and other R&D
workers is relatively unresponsive to higher wages in the short run. There is a long training
pipeline in formal education and on-the-job before a new R&D workers gain the necessary
experience to be fully efective inventors and innovators.
Romer (2001) concluded that governments make an error in subsidising the private sector to
hire scientists and engineers through R&D grants. Governments must instead check whether
the education and immigration systems can provides the supply response for these subsidies
to work.
6.7 TOO MUCH OF A GOOD THING?
Why is it that there always seems a need to encourage R&D? There should be no presumption
of under-investment. Remember there was considerable talk of investment bubbles, the ‘dot
com’ bubble and housing bubbles all in the last decade or so.
The Minister must be wary of contributing to the ICT and other so-called investment bubbles.
Government subsidies can intensify these so-called market failures rather than remedy under-
investment in R&D. The Minister cannot pick and choose his market failures, targeting one
for remedy without worrying about intensifying another. Barzel (1968) identi?ed two ofsetting
drivers afecting the optimal timing of innovations.
It is widely recognized that when innovators are unable to realize the full bene?ts
generated by their innovations the pro?t motive may not provide an incentive
strong enough for them to innovate at the socially optimal rate.
41
On the other hand, it has not been recognized that competition between potential
innovators to obtain priority rights (and pro?ts) from innovations can result in
premature applications of discoveries (Barzel 1968, p. 348)
Competition between potential innovators tends to make the amount of resources invested in
R&D too large because of the possibility of the patent foreclosing competition.
If innovations are introduced at their optimal dates, their contribution to wealth
will always be larger than could have been supplied by the same resources
employed elsewhere in the economy. However, competition among potential
innovators may deprive innovations of all their special economic value
(Barzel 1968, p. 349).
Jones and Williams (1998, 2000) discussed two distortions that promote over-investment in
R&D. The ?rst is a negative duplication externality. This stepping on toes efect arises out of the
patent races discussed by Barzel (1968). In a patent race, multiple ?rms run parallel research
programs hoping to ?rst to create and patent a new good or process. This increase in R&D
efort to win the patient race induces duplication that reduces the average productivity of R&D
in the economy and society is poorer for it.
There is also a “business stealing” efect identi?ed by Jones and Williams (1998, 2000). The
R&D aims to redistribute the rents from past innovators to current innovators. There is a risk
of over-investment in research where innovators earn rents on ideas that are not entirely new
or novel. The purpose of the R&D then becomes to repackage existing ideas so that the most
recent inventor is entitled to all subsequent rents for this small increment in the quality of the
underlying product or production process.
R&D subsidies are a subset of the general policy area of promoting innovation through
patents, copyrights, and selective subsidies. The main theme about patents and copyrights in
contemporary policy debates is intellectual property rights overreach rather than whether they
are not a sufcient incentive for innovation and risk taking. Major reforms have been called for
to deal with a wave of predatory litigation by patent trolls that may sti?e cumulative innovation
(Posner 2012; Epstein 2006b). In recent years, Apple and Google spent more on patent
litigation and acquisition than on R&D (Watkins 2014). Bessen and Meurer (2008) claim that:
… in industries other than chemicals and pharmaceuticals, defense against
American patent lawsuits amounts to 13% of R&D spending by defendant ?rms.
Some even call for the abolition or radical curtailment of patents because they are now
counter-productive (Boldrin and Levine 2008, 2013). If patents and copyright appear to be over
rewarding inventors and sti?ing secondary innovation in the difusion of new technologies, the
case for R&D subsidies appears to be weaker in light of innovation perhaps already being over-
The business stealing efect arises when new ?rms produce imitations, and
minor upgrades, of the pioneering products without having to undertake
any of the R&D and initial business risk. One purpose of patents and
copyrights is to ensure that the initial innovator is sufciently rewarded to
make the initial outlay of R&D. When cheap imitations can quickly enter
the market, the initial product is less likely to be invented. Patents and
copyrights ofer some protection but imitation products eventually will
enter undermining the incentives of R&D. Moreover, the R&D behind these
imitation products does not result in genuine new products and production
processes. This R&D duplicates the initial R&D as part of a scramble to
grab the rents associated with being ?rst in the market or a fast second.
42
rewarded by patents and copyrights.
When the innovation is motivated by subsidies rather than the prospect of sales in a market,
there can be premature invention: inventions that simply were not worth the cost of their
discovery at this time. These inventions sit on the shelf, but the subsidies that encouraged their
invention are not recovered.
Subsidising R&D is a far more ambiguous policy choice than might ?rst be thought because
of patent races, duplication externalities and patent trolls that destroy wealth, rather than
create it. Subsidies to R&D in New Zealand risk duplicating R&D eforts overseas for little gain
to the taxpayer and distract attention from designing an innovation policy regime that fosters
technology adoption. That risk should be taken into account by the taxpayer when assessing
value for money from R&D grants.
For a small open economy such as New Zealand, R&D duplication is a major risk because over
99 per cent of global R&D is undertaken abroad. The policy priority is importing and adapting
technologies, not duplicating their invention locally. There are three prongs to
technological change:
1. Invention;
2. Innovation – the development of a technology through to its ?rst marketing or use; and
3. Difusion – the spread of a new technology across its entire potential market.
Jovanovic (1997) estimated that technology adoption costs are twenty to thirty times the costs
of invention in the USA where technology invention costs are about one-half of one per cent of
GDP. Too much efort in science and innovation policy is at the start of the process rather than at
the end:
Although it is generally realised that it is the process of difusion, or use of
technology that creates productive potential and competitiveness, policy initiatives
are largely by-passed opportunities to improve the difusion process.
If this may seem misplaced emphasis, it does in fact re?ect the state of the
academic literature which is wide ranging and extensive as it relates to policies in
R&D, but small and fragmented as regarding policies on
difusion (Stoneman and Diedren 1994, p. 908).
6.8 THE SUCCESS OF THE PRIVATE SECTOR IN PICKING WINNERS
Politicians and policymakers is unlikely to pick winners because the private sector itself backs
a large number of losers before it hits on a few winners with rewards that are large enough
to have justi?ed chancing their arm. For example, Mans?eld et al (1971) found that of 220
R&D projects they studied, 40 per cent were technically incomplete, 45 per cent were never
commercialised, and of those that were commercialised, 60 per cent of these projects did
not earn a positive economic return. Astebro (2003) similarly found that out of 1091 Canadian
inventions reviewed, only 75 of these inventions were commercialised.
1

A few big wins can justify considerable market volatility and a great many failed ventures.
What is left standing after all the bloodletting might be extremely pro?table if only to justify
the ride for those that risked it all to have it all. For example, Eugene Fama estimated that the
many business failures in the ‘dot com’ bubble were justi?ed if about 1.4 more Microsofts were
born as a result (Clement 2007). In other words, many failed start-ups can be justi?ed with the
foundation of only a few successful businesses.
1 See Davidson (2006) for a general critique of publicly funded R&D. This paragraph draws on his references.
43
If this track record is to speak to the current context, R&D subsidies should result in many
failures and a few successes. High risk ventures such as these are better undertaken by the
private sector where entrepreneurs are subject a hard budget constraint rather than political
considerations.
A government could print a good edition of Shakespeare’s
works, but it could not get them written…
I am only urging that every new extension of governmental
work in branches of production which need ceaseless creation
and initiative is to be regarded as prima facie anti-social,
because it retards the growth of that knowledge and those
ideas which are incomparably the most important form of
collective wealth.
— Alfred Marshall, The Social Possibilities
of Economic Chivalry (1907)
44
7 THE MINISTER FOR
PRIMARY INDUSTRIES
7.1 GOVERNMENT AS AGRIBUSINESS DEVELOPER
Figure 9 and Table 7 show that the Government is getting back into the business of subsidising
agriculture with the Primary Growth Partnership. The Primary Growth Partnership (PGP) is
an R&D grants programme for the primary industry sector. There are 18 PGP programmes
underway with a funding commitment from government and from industry combining to $708
million.
Figure 9: Farm welfare, Vote Primary Industries, Budgets 2008/09 to 2014/15
Source: Budget Papers 2008/09 to 2014/15.
Table 7: Farm welfare, Vote Primary Industries, Budgets 2008/09 to 2014/15 ($million)
Source: Budget Papers 2008/09 to 2014/15.
2009/10 budget
(Labour Party)
2009/10
budget
2010/11
budget
2011/12
budget
2012/13
budget
2013/14
budget
2014/15
budget
Primary Growth Partnership 0.25 13.5 36.73 55.81 77.48
Water Storage and Irrigation Investment
Proposals
5.99 9.01 9.00
Crown Irrigation Investments Limited 40.00
New Zealand Fast Forward Fund 700
Total 700 0.25 13.5 0.00 42.72 64.81 126.48
800
8 00
700
600
500
400
300
200
100
0
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15
Year of Budget
$

M
i
l
l
i
o
n
45
As at 30 May 2014, total government funding underway for this farm welfare was $105.58
million. The purpose of the Primary Growth Partnership is to drive:
… the future market success of the primary industries through long-term innovation
programmes that are jointly funded by government and industry. A key goal is to
encourage more private investment in research and development in New Zealand,
which is low by OECD standards (Ministry of Primary Industries 2014)
The Government is pretending to know what the future will hold for the primary industries of
New Zealand in terms of innovation and are then attempting to prefund it.
Figure 9 shows the $700 million in the last budget of the Labour-led Government for the New
Zealand Fast Forward Fund. The expenditure was to be for sustainable pastoral systems,
research and education capability, food innovation clusters, and internationalisation (Clark
2009). In 2009, the incoming National-led Government cancelled this planned spending on
primary industry R&D. The $700 million for the New Zealand Fast Forward Fund is still shown in
farm welfare in Figure 9 and table 7 despite its cancellation because the Labour Party opposed
these spending cuts (Mackey 2009).
7.2 THE NATURE OF THE FARM
R&D grants for primary industries are particularly risky because this sector is a highly
decentralised industry. One of the reasons why farming is so highly decentralised is the
moral hazard arising from seasonal and random factors such as weather and pests afecting
the productivity of individual farms, parts of farms and the performance of individual tasks by
workers in the production process (Allen and Lueck 1998). This is why farming never evolved
into large-scale corporate business: there are very limited gains from specialisation and scale
economies in farming. The family farm provides the best work incentives in light of all the
unobservable and localised random factors afecting productivity:
Although the organization of industry has generally followed a transition from
family ?rms to large, factory-style corporations, farming remains a last bastion of
family production. Production stages in farming tend to be short, infrequent, and
require few distinct tasks, thus limiting the bene?ts of specialization and making
wage labor especially costly to monitor. Only when farmers can control the efects
of nature by mitigating the efects of seasonality and random shocks to output does
farm organization gravitate toward factory processes, developing into the large-scale
corporate forms found elsewhere in the economy (Allen and Lueck 1998, p. 379).
R&D grants to a sector prone to moral hazard and limited gains from specialisation and
economies of scale cast a further shadow of the likelihood of a good return to the taxpayer.
The bits and pieces of frequently contradictory and incomplete knowledge the politician must
somehow collate across countless situations that will be unusually dispersed in comparison to,
for example, those who specialise in a particular industry.
The ?rst question has to be: ‘If we didn’t get this bribe [the subsidy],
would we do this as part of our business strategy?’ If the answer
is ‘no,’ don’t do it however tempting the bribe. It will be a costly
failure. Even if the answer is ‘yes’, it is almost certainly wise to say
‘no’ to the profered bribe. All experience – and there is plenty of
it – indicates that, one pays and pay heavily for accepting bribes.
– Peter Drucker
46
8 THE MINISTER FOR COMMUNICATIONS
AND INFORMATION TECHNOLOGY
8.1 GOVERNMENT AS ICT ENTREPRENEUR
The National-led Government is a major investor in fast broadband infrastructure. Ministers
are pretending to know how one of the most dynamic, innovative and unpredictable industries
will unfold. The National-led Government has committed $817 million in total to broadband
investment. Table 8 and Figure 10 show that these investments have been rising over the recent
budgets.
Table 8: Corporate welfare, Vote Communications, Budgets 2008/09 to 2014/15 ($million)
Source: Budget Papers 2008/09 to 2014/15
Figure 10: Corporate welfare, Vote Communications, Budgets 2008/09 to 2014/15
Source: Budget Papers 2008/09 to 2014/15
8.2 A MARKET-TESTED SUPPLY AND DEMAND FOR FAST BROADBAND
There is a straightforward explanation as to why fast broadband has been slow to come to New
Zealand. New Zealand consumers are yet to earn the wages that are necessary to be willing to
pay the cost of installing fast broadband. Richer countries have faster broadband because this
is one of the bene?ts of being rich – richer countries can buy more of everything – see Figure
11. As Chorus (2013) has noted:
250
200
150
100
50
0
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15
Year of Budget
$

M
i
l
l
i
o
n
2009/10
budget
2009/10
budget
2010/11
budget
2011/12
budget
2012/13
budget
2013/14
budget
2014/15
budget
Total
(National
Party)
Fibre Drop Costs 4.664 13.35 4.88 4.53
International Connectivity 2.397
Broadband Investment
(Crown Fibre Holdings Capital Costs)
25.4 39 142.5 165 200.00 200.00
Total 0.00 25.4 39 149.561 178.35 204.88 204.53 737.325
47
• New Zealand’s growth in ?xed broadband uptake remains in the top 10 in the OECD; and
• all of the countries with higher ?xed broadband uptake have higher average incomes.
Put another way, despite the political rhetoric that slow broadband is holding our economy
back, it is more likely that New Zealand’s poor economic performance is the reason our internet
is behind. The demand for internet services rises with income.
Where fast internet services are most required, and with customers willing to pay, such as
New Zealand’s major cities, ‘ultra-fast’ broadband infrastructure already existed, or was at least
planned, before the Government’s market intervention.
Crown Fibre Holdings Limited is a Crown-owned company set up to manage the roll-out of ultra-
fast broadband. The ultra-fast broadband network is being built by private contractors such as
Chorus. The taxpayer, through Crown Fibre Holdings, is taking on an investment risk that private
investors in the telecommunications industry saw no merit in accepting given the risks of losing
their own money.
Figure 11: OECD broadband penetration and GDP per capita
Ministers are pretending to know better than professional investors what level of ultra-fast
broadband infrastructure New Zealand consumers are willing to pay for in the immediate future.
Ministers are backing these entrepreneurial hunches with the taxpayers’ money. Unlike private
investors, ministers do not have to sell cost projections, budgets, risk analysis and market
growth projections to private investors subject to hard budget constraints. There is no reason to
assume that private entrepreneurs in New Zealand and abroad would leave money on the table
if ultra-fast broadband was viable in New Zealand.
If New Zealand consumers were willing to pay prices high enough to justify an investment in
ultra-fast broadband, there are large pro?ts in prospect for entrepreneurs alert enough to be
the ?rst to grasp this untapped new opportunity. Private entrepreneurs must persuade bankers,
private investors and the capital market to back them with a business plan that has credibility
when evaluated by investors with plenty of alternatives, hard budget constraints and a real risk
of going bankrupt if they choose unwisely.
50
45
40
35
30
25
20
15
10
5
0
100 000
90 000
80 000
70 000
60 000
50 000
40 000
30 000
20 000
10 000
0
Fixed broadband penetration
(subscribers per 100 inhabitants, June 2013)
GDP per capita (USD PPP, 2011)
GDP per capita, USD PPP, 2011
Simple correlation = 0.63
Source: OECD
48
8.3 ULTRA-FAST BROADBAND IS NOT THE FIRST NETWORK INDUSTRY
THAT WAS THE FACE OF THE FUTURE
Broadband access is the latest in a succession of telecommunications and other network
technologies that politicians thought everyone must have as soon as possible.
In just about every country, telecommunications policies promoted universal service for the
old-fashioned telephone. Politicians believed that every business and household, urban or rural,
should have a telephone line if they wanted one. Cross subsidies for telephone installation
and usage were common so that everyone paid the same price, and had the same bene?ts of
bringing the future forward. But as Crandall (2010) explains:
There is remarkably little evidence on the efectiveness of these universal service policies.
Recent studies of the United States policies are not encouraging, for they ?nd little impact
on subscriptions or prices despite the great cost of these programs.
Despite this lack of evidence and even adverse evidence on the efect of traditional
universal service policies, there has been a groundswell of support for a new universal
service policy directed at broadband services.
The advocates of such policies generally rely on the older populist notions of providing
everyone with equal-priced access to a valuable new service, even if they have little
evidence that such policies have worked in earlier, simpler times.
The political demand for universal-service subsidies for broadband is generally based on
simple notions that broadband facilities are a form of essential infrastructure that promotes
economic growth.
Such is the clamour for an early harvest of the economic growth dividend from fast broadband,
the notion that an unsubsidised private market could provide broadband services at a pace that
is a reasonable chance of recovering its cost is dismissed out of hand.
In their day, the private toll roads and canal ways (of the early Industrial Revolution), the
telegraph, the railroads, electricity, oil and gas pipelines, the telephone, the highway systems,
the airline industry, VCR formats, and even PC operating systems were all infant network
industries. Each were seen as indispensable to bringing the future forward when they ?rst
started. Private provision of all these networks services were common.
Governments took over many network industries for reasons ranging from the market failure
of blackboard economics to the old-fashioned suppression of competition in favour of political
insiders. When network industries were in public hands, or under public supervision, costs
were high, quality of service was low, and cross subsidies were rampant. The priority of these
industries changed from innovation to lobbying.
Much of the privatisation and deregulation in New Zealand and overseas in the 1980s and
1990s was in response to the conclusion that these government or privately own monopolies or
regulated cartels provided a low quality service at a high cost. Governments across the Western
world gave up on the pretence that they can tell a good monopoly from a bad monopoly.
Imagine if subsidies were introduced into the PC industry in the late 1980s and early 1990s
to bring forward the development of this vital network industry. It is likely politicians would be
subsidising use of WordStar, Lotus 1-2-3 and Netscape. The Netscape browser used every
regulatory trick in the book against Microsoft Internet Explorer until both were swept aside by
Google. Younger consumers may not remember these forgotten pioneers and faded giants who
all temporarily had the ear of ambitious politicians wanting to be near winners and cameras.
49
Netscape is no more. Change is the only constant and even if a government could accurately
assess the prospects of a company, it cannot forecast future innovation by third parties.
8.4 BUILD AND THEY WILL COME?
The airline industry and ultra-fast broadband have much in common. Both are network
industries, both have expensive new technologies that carriers can buy. A major part of
international trade and domestic shipping is air freight. The tourist and business advantages
of having well-run domestic and international airline industries is well-accepted. There is also
the general requirement that airlines run at a pro?t and make sensible investments in light of
demand and cost conditions in their respective markets.
No one suggests that Air New Zealand or any other airline should buy the latest new aircraft
from Boeing or Airbus ahead of the market. Every airline must balance the massive cost of new
aircraft with the need to have a market that is large enough and rich enough to ?ll the seats.
The latest wide-bodied or long distance aircraft are bought when the individual airline forecast,
as entrepreneurs must, that their individual markets are suitable.
As with ultra-fast broadband, the richest and densest markets were the ?rst to be served by the
latest wide-bodied or long distance aircraft. Many national airlines, especially those that were
government owned, got into ?nancial difculties by buying shiny new aircraft that were simply
not supported by the passenger and air freight markets they served.
No one is surprised when the ?rst of the wide-bodied aircraft or new long-distance aircraft
are bought ?rst by airlines serving a tourist hub or the densest domestic and international
passenger and freight markets in the largest countries. No one is surprised that these
expensive new aircraft slowly difused to other international and domestic airline carriers as
their respective markets grow to a size to serve them at a pro?t with the new aircraft.
A leading reason behind the multi-decade delay in any new technology moving from use by 10
per cent of an industry to 90 per cent use are the complexities of mastering new technologies.
The initial incarnations of new technologies and new products are often expensive and bug-
infested. Skilled and seasoned operators are needed to oversee their introduction and testing.
Later versions are usually more reliable and much cheaper to run. (Greenwood 1999). The later
adopters of the mature versions of electrical and electronic products expect to do little more
than switch it on and go from there with few complications.
Jovanovic and Lach (1997) found a 15-30 year lag from 10 per cent to 90 per cent use for the 21
innovations they reviewed. Even for transformational technologies ranging from electricity to
the Internet, a host of secondary innovations had to be invented, adopted and mastered over
several decades before the most was made on their potential. There is little point having ultra-
fast broadband if New Zealand consumers and businesses are yet to ?nd it pro?table to invest
in the software and products required to make the most of it.
The true value of any technological improvement is uncertain. Investors adopt a new
technology after forecasting the likely productivity of the new technology. Entrepreneurs invest
gradually in new information and communication capital to learn more about the underlying
technologies that they embodied. These new information and communication technologies
were productivity improvements of a major but uncertain scope (Li 2007).
The eventual productivity gains come from two complex sources - from adopting the new
technology itself and from its interface with existing capital and expertise. Because both
productivity gains are veri?ed only by experimentation and learning by doing, it is entirely
possible that entrepreneurs can invest ahead of consumer demand (Li 2007).
50
There was a sharp decline in US investment in 2001 with large accumulations of unused capital
in some sectors. About 90% of the optical ?bre laid in the US in the 1990s was unused in the
years that followed. Entrepreneurs discovered the optimum investment level by investing past
it and then revised plans (Li 2007). Investors in other countries learned from the US experience
as a technology pioneer and invested less freely because more was known about the true
potential of the new technologies after the overbuild in the USA.
The aircraft industry provides a nice parallel with fast broadband in terms of the risks and high
costs of premature investment in new technologies that are yet to mature. Greenwood (1999)
discussed the development of the DC-8 to illustrate learning by using in technology difusion.
The DC-8 was subject to major improvements after it entered the market and experience was
gained with its use. Engines and wings were upgraded to reduce fuel consumption and reduce
drag. The plane was stretched from an initial 123 seats to 251, reducing operating costs by 50
per cent. As experience was gained with operation, reliability improved and maintenance costs
fell as compared to the early versions. Within a decade of its introduction, maintenance costs
of the DC-8 dropped 30 per cent from their initial level. The winners of this ‘wait and see’ game
are likely to adopt much cheaper and more reliable products.
Build and they will come always turns out poorly for the taxpayer. As another analogy, there
is a large literature in the United States on municipal investment in sports stadiums (Siegfried
and Zimbalist 2000). Competing cities spent billions of dollars building new stadiums to attract
or retain teams. Externalities and bringing forward future competitiveness were always the
rationale. The usual result was local communities were saddled with huge municipal debts they
struggled to service with the attendance receipts from half-empty stadiums.
Laissez faire has never been more than a slogan
in defense of the proposition that every extension
of state activity should be examined under a
presumption of error.
– Aaron Director, The Parity of the
Economic Market Place (1964)
51
9 THE MINISTER FOR TOURISM
9.1 GOVERNMENT AS A PUBLICIST
The Government is particularly generous to the tourism sector in New Zealand – see Table 9.
The Government spends as much on promoting the New Zealand as a tourist destination ($113
million) as it does on promoting all other exports through New Zealand Trade and Enterprise
($111 million).
Table 9: Corporate welfare, Vote Tourism, Budgets 2008/09 to 2014/15 ($million)
Source: Budget Papers 2009/10 to 2014/15
Again, in the era of e-commerce, internet marketing, and online booking, the need for
a government tourism promotion service must be weaker than in the past as a factor in
destination competiveness. Now, any tourism destination can set up a web page at a low cost
with expert advice from marketing consultants. This web page can be found by any interested
party in the world. There are a large number of aggregators that specialise in alerting tourists to
destinations to their particular interest. The taxpayers must ask themselves why in the Internet
age that such a traditional form of business subsidy as government promotion of the tourism
sector has survived and is growing.
Because the purpose of business is to create a customer, the
business enterprise has two–and only two–basic functions:
marketing and innovation. Marketing and innovation produce
results; all the rest are costs. Marketing is the distinguishing,
unique function of the business.
– Peter Drucker
2008/09 budget
(Labour Party)
2009/10
budget
2010/11
budget
2011/12
budget
2012/13
budget
2013/14
budget
2014/15
budget
Marketing of New Zealand
as a Visitor Destination
75.501 84.00 93.93 83.86 83.85 113.35 113.35
Tourism Growth Partnership 1.60 6.29 7.99
Marketing New Zealand As a Visitor
Destination through
Joint Venture Partnerships
5.00 18.36
Implementation of the Tourism Strategy 1.68 1.20 0.80
Tourism Facilities Development Grants 0.27 0.05
The National Cycleway Fund 0.60 4.60 27.24
Management Support of the
National Cycleway
2.19 1.31 1.10
New Zealand Cycle Trail
Incorporated Seed Funding
0.35
National Cycleway Fund - Extension 12.10 4.79
Maintaining the Quality of the Great Rides 2.00
Total 75.50 93.73 119 113.00 98 124.44 123.69
52
10 CONCLUDING REMARKS
The National-led Government is paying out about $1.0 - $1.4 billion on corporate welfare every
year. The last Labour Party budget in 2008 planned to spend $1.751 billion on corporate welfare.
The preceding chapters have argued that hard questions can be asked about the value for
money of these corporate indulgences to the taxpayer. The question the taxpayer must keep
asking themselves is old:
To widen the market and to narrow the competition, is always the interest of the
dealers…
The proposal of any new law or regulation of commerce which comes from this
order, ought always to be listened to with great precaution, and ought never
to be adopted till after having been long and carefully examined, not only
with the most scrupulous, but with the most suspicious attention.
It comes from an order of men, whose interest is never exactly the same with that
of the public, who have generally an interest to deceive and
even oppress the public, and who accordingly have, upon many
occasions, both deceived and oppressed it (Adam Smith).
Over one-third of the corporate welfare in any one year is bailouts for failing businesses – old-
fashioned bailouts such as for KiwiRail and Solid Energy. The rest of corporate welfare is very
much about government being midwives of the future. Picking winners and bringing forward
winners. A central premise of capitalism is governments lack the knowledge to pick winners,
and lack the incentive to use that knowledge wisely even if it could be acquired (Coase 1977,
Stigler 1976b; Alchian and Allen 1983).
The new frontier for corporate welfare in New Zealand is government as oracle. R&D grants
for the primary industry sector, for science and innovation, and for industry in general are on
the rise. Taxpayers should keep a watchful eye on these expenditures because their value is
suspect. The evidence is growing, rather than weakening, that R&D grants ofer a poor return to
the taxpayer.
It is through market competition that ?rms discover the best ways to run their businesses and
what is pro?table to supply. Hayek (1974) suggested that the role for government is similar to a
maintenance squad in a factory: its role is not to produce any particular service or product itself,
but rather to keep the (legal and tax) mechanisms that regulate production in a good working
order. The speci?c products of the well-maintained machinery in each factory is decided by
those who own it in light of their costs and the anticipated strength of demand of those who
might buy its products and other competing products. Corporate welfare undermines the central
role of competition in this discovery procedure.
Almost every businessman is in favor of free
enterprise for everybody else, but special privilege
and special government protection for himself.
– Milton Friedman
53
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