New Zealand pioneered economic reform. Now, nearly three decades later, some Kiwis are wondering why there has not been a bigger pay-off. New Zealand real income was above the OECD average in the 1960s, fell to less than 60% of the OECD average by 1990 and since then, despite sustained vigorous reform, it has hardly risen in the OECD ranking.

Is this intrinsic to New Zealand's place in the world: small scale, a long way from anywhere and with comparative advantage in agriculture? Or is there salvation in as yet untapped reform?

Of course, this might be a half-full/half-empty debate.

Compared with Europe, Japan or the US, New Zealand came through the 2008 crisis reasonably well. There were no financial problems. While many thought that the combination of a housing boom with high household borrowing would unravel in a messy way, New Zealand has adjusted rather than collapsed. The economy did slow sharply in 2008-09, but the main problem is that the recovery has been anaemic, leaving unemployment at nearly 7%, a couple of percent higher than before 2008.

It's hard to fault macro policy. Inflation is well contained. Fiscal policy, having recorded 15 years of surpluses, went into deficit to soften the 2008 downturn but is headed back to balance. Government debt is small.

It's also hard to put too much blame on a slow world economy. New Zealand is milk supplier to the world (accounting for 60% of the global milk powder trade), and in particular to the rising Asian middle class. World prices of milk and timber have reflected this strong demand and New Zealand terms of trade are historically high. The Australian market for New Zealand exports has remained strong.

Perhaps the reform process was over-sold. Even impeccable macro policies can be weighed down by small scale, an absence of agglomeration benefits, distance to markets, a wide dispersion of skills in the workforce and natural disasters.

There is, however, another narrative. Despite its admirable reform efforts, New Zealand has a modest saving performance. This may be the key to the main macro-economic complaint: the strong NZ dollar, around 15-20% higher now than in the decades following the 1985 float. A combination of low savings, a readiness to invest in housing and some strong exports (milk, timber) push up the floating exchange rate. This stronger exchange rate means that other exporters (most vocally, manufacturing) are squeezed, perhaps out of existence.

Housing provides the other element of this story. After a couple of decades of net emigration, since the late 1980s there has been substantial net immigration and population growth of around 2% per year. These new arrivals need houses, putting upward pressure on demand and inflation, necessitating consistently higher interest rates

Averaged out over the past two decades, New Zealand's interest rate has been 3.5% higher than US rates. This attracts volatile carry-trade flows to fund the current account deficit, making it hard for the country to do well because it borrows a lot overseas and pays high interest rates. Then it uses the borrowed money to build more and better houses, which is not unimportant, but not the best way to boost productivity and move up the OECD pecking order.

With both the interest rate and the exchange rate high, investment in the export sector is discouraged. While most countries have increased the share of exports in GDP over the post-World War II period, this ratio has hardly changed for New Zealand.

Where to break into this low-performance circle? If New Zealand saved more, the current account deficit would be smaller and interest rates and the exchange rate lower, thus giving better incentives to exporters. Surprisingly absent in the reform agenda is compulsory saving or strong tax incentives for saving. KiwiSaver is an example of a small savings incentive, but is not enough to make much difference.

The high unemployment rate suggests something else seems to be wrong. New Zealand is the country that transformed Chinese gooseberries into kiwi fruit, persuaded the world that grassy sauvignon blanc was palatable wine, taught the world how to sail in the America's Cup, invented economic modeling with the hydraulic Phillips Curve machine, bred the best race horses and film actors, conquered Mount Everest, turned the Lord of the Rings from a fable into an industry, and may have invented the pavlova. The country seems to have lost its zing.

New Zealanders are a long way from throwing in the towel and accepting the offer we made them, more than a hundred years ago, to join in the Australian federation. But consistent sub-par performance encourages good people to shift overseas. There are half a million New Zealanders living in Australia.

More seamless integration across the Tasman is one sensible response. The Closer Economic Relations trade agreement is still being tweaked to reduce the barriers (the day when we can eat New Zealand apples may not be too far off). But sovereignty is a prickly thing. We haven't even been able to unify banking supervision, even though the New Zealand banking system is Australian owned.

Photo by Flickr user wowser.