JANUARY 20, 1972
Crossing the 100 Billion Dollar Mark
AN ADDRESS BY Dr. Arthur J. R. Smith,
PRESIDENT OF THE CONFERENCE BOARD IN CANADA, AND FORMER CHAIRMAN OF THE ECONOMIC COUNCIL OF CANADA
CHAIRMAN The President,
Henry N. R. Jackman
This is the third time that Dr. Arthur J. R. Smith, one of Canada's most distinguished economists, has spoken to The Empire Club of Canada. We have, therefore, had the opportunity of hearing his views at three different stages in his career: First of all, prior to his being appointed Chairman of the Economic Council, secondly, as Chairman of the Economic Council, and today after his departure from the Council and in his new position as President of the Conference Board in Canada.
Our guest received his undergraduate training at McMaster University and went on to Harvard University for graduate work where he received his Doctorate in economics. From 1950-1954 he was an economist with the Federal Reserve Bank in New York. He subsequently became Canadian economist for the National Industrial Conference Board, and held several key positions with the Private Planning Association of Canada.
In 1962 he first spoke to The Empire Club, and at that time referred to the fact that the then Government of the day had indicated in the Speech from the Throne that it intended to set up a new institution to be called the National Economic Development Board. Even then, when the Economic Council of Canada was still very much in its embryo stage, our guest indicated a keen interest in such a body, and his remarks to this Club attempted to promote some public discussion as to the role such an institution might play in this country. Unbeknown to our speaker, his remarks made almost ten years ago, were taken seriously by our political masters and were used to encourage him to accept an appointment as a Director of the Economic Council of Canada in 1963. He served with distinction in this capacity and became Chairman in 1967 when Dr. John Deutsch, the first Chairman, was appointed Principal of Queen's University.
When Arthur Smith came to speak to The Empire Club for the second time in 1970 he appeared, therefore, before us as Chairman of an organization which had been given the responsibility by the Government of making long term economic forecasts which were to be helpful in determining long term policy objectives and in suggesting solutions consistent with the aspirations and traditions of our people. When he spoke to this Club, two years ago, he stressed the point that the magnitude and severity of our economic problems could only be effectively tackled by policies of a long-range nature, and that remedies could never be approached on an ad hoc basis or in a short-sighted manner.
This summer, Dr. Smith resigned his position as Chairman of the Economic Council to accept the equally prestigious position as President of The Conference Board in Canada. There was, a great deal of speculation in the press as to the reason for Dr. Smith's resignation, and to date neither the Government nor Dr. Smith has made comment.
Some have suggested that there was a division of opinion between the Council and the Government over the Government's highly publicized and controversial war on inflation, which corresponded with, or according to some may have aggravated, a serious unemployment situation in our country. Others have suggested that Dr. Smith's approach, favouring long term measures as opposed to sharp and abrupt changes in fiscal or monetary policies, was not consistent with the political realities facing a Government who could only measure its future with certainty until the time of the next election. Whatever the reasons, Dr. Smith's retirement has raised the question as to whether it is possible at all for a semi-autonomous Government agency to engage in long term economic planning and to suggest remedies when the realities of politics may determine other courses of action. There can, however, be no doubt that our guest has made, and will continue to make, an enduring contribution to a discussion which vitally affects us all. When at the Economic Council, his annual reviews spoke of social purpose for Canada, and revealed a concern that all Canadians should share in the promise of this land. He appealed to our higher motives in terms of social objectives of economic policy. We are indeed the richer for his contribution.
It is, therefore, with great pleasure that I present to you, Dr. Arthur Smith, former Chairman of the Economic Council of Canada and President of the Conference Board in Canada.
DR. ARTHUR SMITH:
Canada's Gross National Product will cross the $100 billion mark during 1972. In fact, according to the growth trajectories set out in a number of recent forecasts, this mark could be crossed as early as the second quarter of the year. This would imply that the broader basis of economic expansion that emerged in 1971 would persist in 1972. Such an assumption, I believe, is a reasonable one in the light of past experience which shows that an economic upswing tends to gather sustained momentum in its earlier stages by advancing across a widening range of economic activities. As I will suggest later, this upswing has been showing many of the features of a rather typical Canadian business expansion, in spite of the rather different conditions and circumstances in which it is taking place.
But before taking a closer look at the prospects for 1972, I would like to review a few highlights of business trends over the past year or so.
Perhaps the most striking feature of the Canadian economy in 1971 is that it actually has been performing better than many people think it has. This is not unusual at a time when the economy is beginning to move out of a period of substantial slack. The same situation existed in the early 1960's when cautious views still were being expressed about economic trends as late as 1963--more than two years after the economy had been moving through a period of sustained expansion.
Of course, there are still many aspects of performance that are unsatisfactory--unemployment is too high, many productive facilities are still substantially underutilized, fixed capital investment over the past few years has been running well below the levels required for an early return to high employment, and regional distortions are very evident. Moreover, an unusually troubling series of uncertainties has hovered over the Canadian business scene; and assessments of Canada's economic future, as well as the processes of government and private decision-making, have been adversely affected by a loss of confidence, arising from three basic sets of uncertainties and concerns:
- first, uncertainties about what are the appropriate policies to pursue when high unemployment co-exists with substantial continuing increases in many costs and prices;
- second, uncertainties about the outlook for international trade and payments, with the United States acting to restore balance in its international economic position, and with the increasingly apparent need for more fundamental reforms in international trade and payments arrangements; and
- third, uncertainties affecting a wide range of business policies and practices as a result of a rapid sequence of new legislative initiatives by the federal government (for example, initiatives aimed at basic reforms in the tax structure, competition policy and industrial relations). During 1971, a great deal of the energy and time of senior business executives in Canada has been diverted from other responsibilities to these fields both to understanding and assessing the implications of many of intricate and complex changes proposed in the new legislation, and to preparing detailed briefs to submit to the government suggesting alterations in some of the aspects of the relevant bills.
Against this background, it has perhaps been understandable why optimism has been out of fashion, and why the latest gloomy headlines have generally taken precedence over the more promising economic achievements of the economy. Thus, for example, attention has tended to be focused:
- on the persistent high level of unemployment, rather than on the accelerated growth in employment (in 1971, more than twice as many new jobs were created as in 1970);
- on the significant gap between actual and potential output, rather than on the fact that this gap was beginning to close as actual output grew slightly more rapidly than potential output for the first year since 1966;
- on concerns that U.S. policy actions in 1972 might tend to slow Canadian expansion, rather than on the fact that for much of the year, Canadian real output was growing at about double the rate of growth of U.S. output;
- on the low level of corporate profit margins, rather than on the significant upturn in profits per unit of output during 1971, and
- on the sluggishness of new business investment, rather than on the strong expansion of consumer demand that was beginning to lay the basis for a later investment upturn.
By 1970, considerable economic slack had emerged in Canada. But the relative scale of this slack was less than that of a decade earlier, and it was also relatively less than that which emerged in the United States in 1970-71. The two most important factors contributing to the slack in Canada were the shift towards vigorous demand restraint policies that began in the latter part of 1968, and the U.S. business recession in 1970.
Unlike the United States in 1970, and also, unlike the Canadian experience in 1960, Canada did not have a business recession in 1970 (at least not as economists define recession). If it had, the degree of slack and the level of unemployment would have risen much higher in 1970-71, possibly up to, or even beyond, the levels of a decade earlier (when output fell to about 7 or 8 per cent below potential, as compared with about 4 per cent in 1970, and when unemployment rose to around 71z per cent, compared with around 6" per cent in 1970) .
The main factor that saved the Canadian economy from recession in 1970 was an exceptionally strong export performance to countries other than the United States, accompanied by a decline in imports. Our exports to the United States lagged in 1970, when total real output in the United States actually declined slightly. In Canada, it increased by about 3 per cent. But over three quarters of this growth is directly attributable to a rise in exports relative to imports of goods and services. Moreover, this shift undoubtedly had significant secondary effects supporting various other economic activities in Canada.
After avoiding a recession, Canada has moved into a new phase of expansion in 1971 more vigorously than the United States. In 1971, for example, real output in the United States increased about 3 per cent. In Canada, the increase was about 6 per cent.
While the strong export performance was an unusual factor preventing recession in 1970, the subsequent domestic sources of strength in the current expansion are not unusual. Indeed, they would appear to be quite normal, except for the sharp pick-up in agriculture after the sharp drop in farm output and income in 1970. The shift towards an expansionary monetary policy beginning in the second quarter of 1970, the maintenance of a high degree of monetary expansion in 1971, the shift towards a less restraining fiscal policy posture in 1971, and the business recovery in the United States in the past year (even though the latter was more hesitant than the U.S. Administration had hoped for), have combined to bring about the following sequence of demand increases:
- a sharp reversal towards increased residential construction activity (the first symptoms were clear before the end of 1970, a few months after the shift to monetary expansion, and we have had a whopping 25 per cent increase in spending on new residential construction in 1971);
- a subsequent strong upsurge in consumer spending on durable goods in the early part of 1971, particularly on automobiles;
- a less pronounced, but still substantial, expansion in consumer spending on non-durables by mid-1971;
- an upswing in consumer spending on services by the latter part of 1971; and
- an accentuated rise in government spending after an extended period of "austerity" stretching from the summer of 1969 through 1970.
As in the early stages of many previous business upswings, two of the engines of expansion were not operating strongly in 1971. First, imports rose more rapidly than exports last year, so that the external sector exerted some "drag" on Canada's over-all business expansion. Second, the volume of new business capital investment rose only moderately, with a highly uneven pattern of changes among the major sectors of the economy. A sustained expansion would, in due course, inevitably mean that business investment would become a much more powerful engine of expansion. Indeed, there is a danger here that, as in the early 1960's, increased production could be achieved in many sectors for some time from existing underutilized facilities, but that there could then be (as in 1963-66) another large and distorting investment boom as decisions were reached almost simultaneously across a wide range of activities that a major new round of expansion in productive capacity was needed.
On the external side, "export-led" growth was a prominent feature of the business expansions in Canada in the mid-1950's and over the first half of the 1960's. In particular, a potent set of export-stimulating forces came together in the 1960's to make exports one of the leading salients of growth. Among these forces were large contracts for wheat with the socialist countries, the Automotive Agreement and defense production sharing arrangements with the United States, easier access to foreign markets as a result of multilateral tariff reductions, the impact of very high growth rates in foreign markets generally and, above all, the improved international competitive position of many Canadian producers, arising from the devaluation of the Canadian dollar at the beginning of the 1960's (coupled with more aggressive, confident and effective marketing efforts by Canadians in external markets). None of these factors could have been easily or fully anticipated at the beginning of the decade. And it is by no means inconceivable that new and generally unexpected export-stimulating forces could emerge in the 1970's. But it is also possible that exports may not provide as powerful a thrust to Canadian growth in the 1970's as in the 1960's, especially if we experience an extended period of reform and adjustment in international monetary, trade and other arrangements. In such a case, it will obviously be essential to strengthen domestic growth forces, if we are to have reasonable prospects for maintaining high employment and measuring up well with Canada's growth potentials to 1980.
Two other typical features of business trends in 1971 were the continued relatively high rates of unemployment (even in the face of a substantial acceleration in business activity); and a sharp rise in productivity growth in the course of the business upswing. Unemployment does not tend to decline quickly when an economy comes out of a period of major slack. For example, the unemployment rate was well over 10 per cent in the recession of 1938; even in 1940, during the first full year of putting the Canadian economy on a wartime basis, the unemployment rate was apparently still not far below 10 per cent; not until 1941, did it fall below 5 per cent. Similarly in 1961, the unemployment rate was 7.2 per cent, but it declined only gradually to 6 per cent in 1962 and 5 1/2 per cent in 1963 (that is, after two full years of business expansion). The slow response of unemployment to improved business conditions in 1971 is therefore hardly a surprising phenomenon. In accords with past experience under similar conditions, although the slowness of the unemployment decline on this occasion may marginally reflect some special factors and structural changes in the composition of the labour force.
Similarly, the marked pick-up in productivity in 1971 is a normal feature of the early stages of renewed business expansion. In part, it reflects the delayed impact of earlier decisions to increase efficiency under the pressures of weaker markets, reduced profits and rising concern about how to achieve cost reductions. In part, it also reflects effective exploitation of opportunities to use labour, capital and other productive inputs more fully and efficiently as markets strengthen and output can be increased again.
However, one of the features of the past year that has been less typical of past experience has been the continued high rates of increase in average wages, salaries and fringe benefits, and in some other forms of incomes. Similarly, price increases have continued to be a source of concern. The experience of a decade ago suggested that the emergence of substantial slack in the economy could be a major factor moderating prices and cost increases. Recent experience has raised questions about this view.
To be sure, consumer price increases did moderate significantly in the latter part of 1970. But this appears to have been the result of a number of special and, to some extent, temporary factors going beyond the build-up of economic slack. Among these were: the lagged impact of Canada's accelerated implementation in mid-1969 of all the remaining tariff reductions which Canada had agreed to undertake in the Kennedy Round; the effects of the exchange rate appreciation in mid-1970, especially those tending to lower the price of imports; lower food prices resulting partly from a "price war" among various Canadian food chains; the operation of a voluntary price restraint program under the auspices of the Prices and Incomes Commission; and the absorption of higher business costs through sharp reductions in profit margins in most industries. The slowing of price increases in 1970 has, of course, made the comparisons of price levels in 1971 with year earlier levels look favourable, especially through the earlier part of 1971. But, in fact, advances in general price levels during 1971 have been fairly high for much of the year, at least in comparison with the experience since the mid-1950's. At the same time, in international comparative terms, Canada's recent price performance has been good. In fact, in 1970-71 Canada has had one of the lowest rates of general price increases among all of the world's more industrially advanced nations.
Now let me turn to the prospects for 1972. At the outset, it is important to emphasize that we have moved into 1972 with a much more favourable set of underlying and prospective economic conditions than those with which we entered 1971. Three deserve special attention:
(1) The first is simply the fact, already outlined in my earlier remarks, that business expansion has already been under way in Canada for about a year, that a broadening range of economic activities are becoming involved in this expansion, and that this expansion is already developing considerable momentum as it proceeds. Moreover, with business inventories (especially in manufacturing) having been fairly stable over the past two years--in fact, with declines in inventorysales ratios in various industries--it is likely that growing demand will feed back quickly to stimulate production. This is already suggested by the lift-off of total industrial production into a clear expansionary path, after sitting for well over a year on a flat plateau. Indeed, as expansion proceeds, increased inventory demand could well be added to growing final demand to generate accentuated requirements for increased output of many types of goods. Thus, housing, consumption, government and inventory demand could all continue to advance relatively strongly in 1972 and be mutually reinforcing.
(2) Second, the U.S. economy is expected to advance considerably more rapidly in 1972 than in 1971--and perhaps across an even broader front of expanding economic activities than the Canadian economy. The forecasts are still coming in. But it is already clear that U.S. forecasters are more bullish about the economic outlook for 1972 than they were for 1971. A year ago, U.S. forecasts for 1971 were largely concentrated in the range of 6% to 8 percent increases in the current dollar value of GNP for 1971--with accompanying ranges of M to 3'2' per cent increases in real output and H to 5 percent increases in prices. In retrospect, these forecasts were fairly good. The actual results for 1971 are for an increase of slightly over 3 percent in real output and slightly over 4N percent in prices. This year, it appears that the forecasts for 1972 are likely to be concentrated in the 8 to 9 percent range, with projected increases of around 5 percent in real output and around 4 percent in prices. Indeed some of these forecasts, including some of those presented at the Economic Outlook Forum of The Conference Board a few weeks ago, suggest highly favourable contours for the U.S. economic outlook in 1972 -with simultaneous achievement (and I would like to emphasize simultaneous achievement) of faster productivity gains, reduced unemployment, smaller year-over-year price increases, and some strengthening of the U.S. balance of payments position. If these projections are anywhere near the mark, the U.S. economy will grow by close to $100 billion in 1972. This implies that it will add to its output of goods and services an amount approximately equivalent to the entire Canadian output of goods and services in a single year. The last year in which this happened was 1966. And there is little doubt that in the event of any such strong economic expansion in the United States in 1972, there would inevitably be a very wide variety of strong "spill-over" effects on the Canadian economy. Elsewhere, however, the external economic environment may be less favourable to Canada. The Japanese and many European economies have recently been encountering less buoyant expansion than they had generally experienced through the 1960's, and at least at this point of time, very few of them anticipate the resumption of a dynamic new round of expansion in 1972. But, as has obviously been the case in the past, it is U.S. economic developments that constitute the predominant external economic influences on Canada, and it is the U.S. outlook for economic prosperity in 1972 that should weigh most heavily in appraising the external setting for Canadian economic progress in the coming year.
(3) Third, Canada entered 1971 with a highly restraining overall fiscal policy setting, and an expansionary monetary policy setting. Undoubtedly, the monetary expansion in 1970 (especially from the second quarter onwards) contributed, with its not unusual long lags, to the faster growth of the Canadian economy in 1971. In contrast, fiscal policy--as reflected in the substantial high employment budget surplus for all levels of government together--undoubtedly acted as a partial drag on the business recovery in 1971. In contrast with the situation a year ago, we have entered 1972 after a further full year of exceptionally strong and sustained monetary expansion. And we have also entered 1972 with fiscal changes made during 1971 that have greatly eased the previous degree of fiscal restraint. Again, given the typically long lags with which such major policy changes affect production, incomes and employment, it is probable that much of the stimulating effect of the demand policy settings in 1971 will actually be felt in the economy in 1972. Still further, as we enter 1972, both monetary and over-all fiscal policies still appear to be shifting towards more expansionary settings.
Thus, we now start 1972 with a generally sound basis for sustained economic expansion. Canadian economic forecasts for 1972 have recently been ranging from conservative views of an 8M or 9 per cent increase in GNP (5 per cent volume and 3 1/2 to 4 percent price increase) to more "optimistic" views of a GNP growth of "10 percent plus" (over 6 per cent in volume and 4 per cent or more in price increase).
A 6 percent increase in real output in 1972 would be great enough to permit some reduction in unemployment perhaps to a rate under 6 percent for the year as a whole. It would be a large enough expansion to permit some further narrowing of the present gap between actual output and potential output. It would undoubtedly be accompanied by a continued rapid increase in corporate profits, and by especially high growth rates in some other incomes (such as government revenues flowing from income taxes). And it could probably be accommodated without general excessive pressures on existing productive capacities--in short, there are likely to be few physical bottlenecks to impede an expansion of this order of magnitude.
At the same time, if expansion were to occur on such a scale, and on a fairly sustained basis through 1972, some very important questions would arise for decision-making during the year. Indeed, even with this kind of possibility in prospect, questions are already beginning to arise:
- about early decisions that may need to be made to expand productive capacity in various industries (especially since there is a long lag in many cases between such decisions and the actual efficient flow of new production from new or enlarged facilities);
- about moderating the rate of monetary expansion (especially now that such a relatively large degree of liquidity has been created in the economy); and
- about steps to assure timely access to increased manpower of appropriate qualities (especially now that we are in a decade in which we will be short of experienced manpower of many types).
In any phase of strong business expansion, the two basic aspects of economic performance requiring closest attention are price increases and the balance of payments. These are both matters that will undoubtedly be the focus of considerable interest in 1972.
In the case of prices, such interest will be sharper than usual. Generally, in the past, inflation has become a serious problem only in the later stages of expansion, after unemployment has declined substantially, after demand has begun to press on available supplies and productive capacities in various markets, after a major investment boom has been generated, and after belated shifts to expansionary policies have been carried to a point where lagged expansionary effects are inevitable for a considerable time. But, on this occasion, we are moving through the earlier stages of a business expansion with relatively larger price increases and, what is more, expectations that they may continue, if not accelerate--than in comparable earlier periods. Moreover, we are also moving forward against the background of the huge monetary expansion of the year--the kind of expansion which, according to a growing segment of professional economic views, could help to set the stage for a subsequent acceleration of price increases. Similarly, high rates of price increase have become a general, world-wide phenomenon, and we are likely to have less favourable external conditions for maintaining reasonable price stability than in the early stages of any previous business upswing in the past twenty years. (I make this statement, incidentally, with full recognition of the efforts being made in the United States to curb rising prices and incomes. But in the United States, as has invariably happened with scores of other experiments around the world with controls and incomes policies aimed at economic stabilization, the combination of economic inefficiencies and social inequities which such policies tend to produce, are apparently already beginning to erode the basis for their effective, continuing role as substantial restraints against increasing prices and incomes over any very extended period of time.) The fact is that inflation is a complex process. There are no simple, easily identifiable villains. And there are no simple cures for it. But we will undoubtedly continue to be deeply troubled by general price and income increases in 1972.
Regarding the balance of payments, the general past tendency has been for imports to rise more rapidly than exports during a phase of business upswing, but for increased capital inflows to sustain equilibrium in the overall balance of payments. But, on this occasion, even with a floating Canadian dollar that should help significantly to reconcile domestic expansion and international payments viability for Canada, there is an unusual set of uncertainties concerning Canada's international payments situation, including:
- the lagged effects (which have by no means been fully reflected yet in Canada's trading position) of the appreciation of the Canadian dollar since May 1970;
- the effects of the December 18th agreement about significant international currency realignments;
- the adjustments in trade barriers being negotiated between the United States and its major trading partners, including Canada, and the possible implications of the U.S. DISC legislation;
- the complex and uncertain consequences of expansion of the European Economic Community;
- the question about whether the United States will, in fact, achieve a substantially improved trade balance during the coming year (and, if not, what next?);
- the obvious need for more fundamental reforms of the whole postwar basis for international monetary, trade and other arrangements;
- the anticipated announcement of Canadian policy regarding foreign investment in Canada, and the increasing mood of economic nationalism in public debates about commercial and industrial policies in Canada; and
- the possible effects of Canada's new tax legislation on various types of transactions affecting the balance of payments.
In summary, 1972 will be a year with its own plentiful supply of uncertainties and controversial issues. But from the present vantage point, perhaps the most important thing about the economic prospects for 1972, is that these have already largely been determined by the conditions, policies and decisions that now lie behind us. Barring major unexpected events, the main features of the economy's performance--on growth, employment and unemployment, prices and costs, trade and payments, and even regional trends--cannot be greatly affected by evolving conditions or major policy actions during 1972 itself. These will have their main effects in 1973 and beyond. This important matter of long lags is still not as widely understood or appreciated in Canada as it should be.
I believe that the die for 1972 has already been essentially cast, and that economic decisions can now be made with reasonable assurance that the economy is moving into a period of generally more favourable performance than we have experienced during the past few years.
Dr. Smith was thanked on behalf of the Empire Club of Canada by Mr. Peter Hermant.
EDITOR'S NOTE: Dr. Smith's remarks perhaps represent the most complete review of Canada's current economic condition ever given to an Empire Club audience. His basically optimistic forecast for 1972 was substantiated by events, business improved, and as suggested in the title of this Address, Canada's gross national product for the first time crossed the 100 billion dollar mark.