Lessons from Current Miseries

MR. STALDER:

Distinguished members and guests, ladies and gentlemen: The Fraser Institute is a philosophical centre with economic objectives. This Institute is geared toward com petitive markets but searches for the most desirable mixture between individual initiative and government intervention. It was founded in 1974. Since its inception, the Institute has greatly contributed to a popularization of economic knowledge at large. It has enabled consumers and the consumers' representatives in legislature to gain a better understanding of complex matters, thus enabling them to take an intelligent and wellinformed stand. No wonder that this organization has had many best sellers amongst its publications. The lion's share of merit goes to our guest of honour who keeps the machine going.

Our guest of honour, Dr. Michael Walker, is a native of Newfoundland. He obtained his Bachelor of Arts in 1966 from St. Francis Xavier University, his M.A. in 1967 and his PH.D. in 1969 from the University of Western Ontario, where he specialized in Mathematical Economics, Econometrics, and Monetary Theory.

He joined the Bank of Canada in 1969 and when he left in 1973, he became head of the Special Studies and Monetary Policy Group which undertook research in a variety of areas related to the conduct of monetary policy. During 1973 and 1974, Dr. Walker was Econometric Model Consultant to the policy branches of the federal Department of Finance in Ottawa. He taught Statistics and Monetary Economics at Carleton University and the University of Western Ontario. He joined the Fraser Institute in 1974 as a founding director and as director, he has written, edited, and contributed to over a dozen books. As well, he has written numerous articles for professional and technical journals.

He is a popular commentator on current affairs in the print and electronic media, a regular columnist in The Financial Post, and a frequent speaker to a wide variety of groups in Canada and the United States. Ladies and gentlemen, please welcome our guest of honour, Dr. Michael Walker.

DR. WALKER:

Mr. Chairman, ladies and gentlemen: I am very grateful to have the opportunity to speak to you today and, with some humility, join the ranks of the illustrious Canadians who have spoken to you in the past. And I must say I was very tempted to seize upon this occasion to set out my platform for economic recovery and to add to the growing list which has received public attention in the last several months, my nostrums. With some extreme difficulty, however, I have overcome that initial impulse. Instead, I will spend the few minutes I have talking with you about some of the lessons we should learn from our recent economic experience. The reason for pursuing this tack is my belief that unless we firmly understand the force of events which has led us to the current pass, we are very unlikely to seize the present opportunity to rebuild a more certain and more prosperous future. It is the case, unfortunately, that many of the suggestions which have recently been made for solving current problems bear a distressing similarity to those which, in application, have been responsible for our current miseries.

First of all, it is interesting to wonder how, with the perspective of history, we will probably view our current predicament. While it will be viewed as a period of social distress, of course, it is my overall assessment that economic historians will study and record the first two years of the 1980s as an unexpected and unique episode in the history of mankind's economic activities. The reason is that this period marks one of the very few occasions in history when major industrialized countries have pulled away from the brink of a hyperinflationary catastrophe.

You have all heard, on many occasions, a characterization of Western democracy which held out little hope that governments would have the political will to take the anti-inflationary medicine. Politicians find it easier and politically more expedient to expand the money supply to create the illusion of prosperity than to lean against the political pressures and pursue a policy of stable monetary growth. Any politician who might have considered halting the inflationary spiral in the recent past has been quickly assured that the inflationary course was in society's best interests because it created jobs--kept the unemployment rate down.

The strongly held view that politicians would lack the support for a counter-inflationary policy was reflected in the prices people have been willing to pay for gold, real estate, and other inflationary hedges. The behaviour of speculators continually rewarded by their pessimistic, cynical outlook gave further credence to the widespread belief that inflation would accelerate indefinitely. And so it was that by 1980, the Western world was in the grip of what has been called "inflationary psychosis."

Many of those who forecast a continuation of this inflationary process did not understand the power of ideas; did not realize that if political leaders truly believed that an escalation of inflation led to more unemployment and not less and that if they could rally a political constituency around them, then they might well bring about a fundamental change in economic policy.

There may be many aspects of the policy which Ronald Reagan brought to the United States with which we could disagree but about one there can be no disagreement. That is his determination to eradicate inflation from the American economy. The same has been true to some extent of Margaret Thatcher in the United Kingdom.

You know, it is often said that this war against inflation is one in which the casualties are our own people--the unemployed. But is that the real cause? Is it the war on inflation or inflation itself which has caused the joblessness of those who left more traditional employment in the 1970s to sell real estate or to speculate in commodities, open art shops, sell old stamps, coins, and precious metals? Was it deflation or the deadly euphoria of an inflationary bubble which caused the overexpansion of many of our industries and the subsequent inevitable contraction? My own view is that it is inflation which lies at the core of our difficulties and not our belated attempt to control it.

Of course, the victory against inflation was important not only in its own right but also because of the reduction in interest rates which it made possible. It is good to remind ourselves that during early 1982, most observers were anticipating that interest rates would increase in the fall of 1982 rather than decrease, as they actually did. Our forecast as early as the fall of 1981 for a decline in interest rates in the fall of 1982 was based on our perception that inflation rates would continue to fall and that this would inevitably bring about a reduction in interest rates. Some of you may have misgivings about the merits of a disinflationary policy because of the evident pain which it produces. However, if you relate a reescalation of inflation with whatever benefits it might have conferred in the short term to the certain escalation of interest rates to above the 20 per cent level, I am sure you will agree that any benefits from re-inflation would indeed have been short-lived.

So, the first lesson which we must learn from recent experience is that inflation can be beaten but that it requires enormous political courage and a more circumspect view of its deleterious side effects. You may be wondering why I am making such a point of this. The reason is that while we can learn from recent experience that inflation can be beaten, that it is purely and simply a reflection of inappropriate monetary policy, this fact is not widely understood. For example, you have had a steady stream of speakers over the course of the last ten years who have told you that inflation is a social disease. You have been told that inflation is a phenomenon of uncertain and inscrutable lineage. We must now recognize that this view of the world is simply incorrect.

Inflation is only a social disease in the sense that if society is mesmerized by a bad idea, then society is capable of inflicting great injury upon itself and this is no less true in the area of economics than it is in other areas. But our current experience should forever banish from public discourse the notion, given widespread support by politicians, that inflation is something thrust upon the economy by external events or caused by the greedy and antisocial behaviour of citizens. Inflation is a disease of the monetary system and it is a disease that only governments can cause--and that only governments can cure.

Of course, the celebration of our victory against inflation is dulled and dampened by the persistence of a high level of unemployment. It is well to remind ourselves, however, that this high level of unemployment is not only due to disinflation. If there had been no disinflation, we would still have had to contend with the normal economic adjustments associated with the passage of the baby boom--a decline in sales of automobiles and housing units. Even if there had been no disinflation, we would still have had to contend with the competition from foreign producers which has rendered much of the steel industry, in the United States in particular, obsolete. The overbuilding of light industrial and commercial establishments in the United States and the consequent decline in their construction would still have produced a reduction in the demand for minerals such as copper and zinc.

It is also useful to remind ourselves that some of the unemployment that we are experiencing at the moment has not been caused by disinflation or by secular structural trends but rather by conscious acts of Parliament. Estimates suggest that even if the economy were operating at so-called full employment, as much as 7 per cent of the current unemployment rate would remain because of the economic framework established by our various legislatures across the country, including the generous levels of unemployment insurance and the high levels of minimum wages.

Another clear lesson from our recent experience is the importance of government maintaining a certain fiscal capacity. As finance minister Lalonde approaches the construction of his 1983-84 budget, perhaps one of the most critical in peacetime history, he is hamstrung at every turn. The deficit, already at $10 billion before the onslaught of the major force of the recession, has grown to unprecedented, almost unmentionable size, and it is still growing. In consequence, the government has little, if any, possibility of increasing social welfare spending at a time when Canadians have every right to expect support from their government. In effect, so many people are using the social welfare safety net as a hammock that there is no room left for those who really need it, and discretionary expenditure and programs have expanded to the point where emergency spending is not possible.

And so the paradoxical and sobering message of our current budgetary dilemma is that whether one believes in the efficacy of government spending or not, one should, during normal times, be in favour of a balanced budget. If you do not believe that government spending is beneficial then you should be in favour of a balanced budget during normal times because a balanced budget is meritorious in its own right. If you believe in the efficaciousness of government spending then you should believe in balanced budgets because that mode of behaviour provides government with a fiscal reserve to activate during periods of economic downturn. Thus, we should adopt a balanced budget principle for future conduct not out of any fiscal religiosity or budgetary rigidity but rather as a means of preserving fiscal flexibility when we need it.

In the same way that the current recession has exposed the impotence of government as a lever out of our current difficulties, it has also served to illustrate the true character of some of our societal institutions. One institution which has emerged with a different image is compulsory union membership. Some years ago, Lady Barbara Wootton, a member of the British House of Lords and a prominent labour thinker, sought to set people's thinking straight on the nature of unions. Wootton courageously asserted that, "It is the business of a union to be antisocial; the members would have a just grievance if their officials and committees ceased to put sectional interests first."

I think that the prevailing view of the union movement in Canada has been quite different.There has been a tendency to import into Canada a class mythology about the role of unions and unions, therefore, are depicted and generally conceived of as a bulwark against the interests of the capitalist class. Working people generally have tended to identify with the purposes and aims of the union movement and, as a consequence, provincial legislators, following their own political interests, have enacted legislation and created extra parliamentary tribunals intended to support this particular institution in our society.

During normal times, it was easy for many of us to forget the essentially self-serving nature of unions. As long as the total employment in the country grew faster than the total labour force and those who wanted work could fairly readily find it, there was no great interest or incentive to focus on the structural impact of the union movement. However, distresses of declining employment and deteriorating employment prospects have revealed the sectional nature of the union movement in a very blunt and unattractive way.

Not only do unions represent the sectional interests of their members, they represent those who are employed at the expense of those who are unemployed. Daily, we are provided with evidence that given the choice between negotiating a wage reduction and a reduction in the number of jobs, unions have selected the latter. Therefore, not only have they driven a wedge between the various groups in our society, but they also are driving a wedge between the employed and unemployed members of their own associations.

Of course, it is easy to understand why union leaders behave in this way. As more than one wag has remarked, you don't need a union to negotiate a wage cut. The lesson for Canadians from our current experience is that union membership may be a liability when the icy finger of recession reaches out to your workplace. The rigidities imposed by unforgiving collective agreements in conjunction with the political requirements of union leaders who face re-election by the majority of their members has, in many instances, meant that those lowest on the seniority ladder have fared less well than they would have without the supposedly benign interposition of the union. Nowhere is the sectional and special interest nature of unionism more evident than in the public sectors across this country. In almost every province, as provincial governments have attempted to reduce their expenditures in keeping with the reduced ability of the citizenry to pay for social programs and other expenditures, it has been the public sector unions which have led the campaign against such economy measures--despite, in many instances, the manifest support for them on the part of the general public and the obvious inability of taxpayers to continue to bear these burdens.

But the most important lesson which must be learned about the relative roles of capital and labour is that these are not descriptions of class in our society but rather of interests which we all share. We are all labourers in the sense that we have an immediate goal to satisfy current needs and wants. We are all capitalists in the sense that we must concern ourselves about our future ability to earn enough income to do so. And, to some extent, the economic problem is one of a constant struggle to maintain a balance between the ability to satisfy current wants and our future ability to do so.

Of course, recognizing the legitimacy of both of these aspirations does not resolve the tension between them and there will always be a conflict between our interests as labourers and our interests as capitalists. But a recognition of the twofold requirements would change our behaviour and our economic performance in a most incredible way.

You know, it is often remarked how efficient Japanese workers are. How often we are told about the thousands of suggestions which management receives from workers about the way in which the workplace can be made more efficient and more productive! The reason, of course, is that Japanese workers have been spared the infusion of the idea of the class struggle and they recognize the absolute necessity of being able to compete on the most effective basis possible. In other words, they see their long-term interests as workers as being dependent upon the survival of the firm and its capital.

The lesson about unionism which we must glean from present difficulties is that the tough-minded labour leaders who make their reputation on the basis of substantial wage gains must be replaced by the union leaders who, out of concern for the true interests of their members, try to ensure that Canadian enterprises are the toughest competitors in world markets.

One of the most difficult lessons that we must derive from our current experience concerns industrial strategy and that is something I am sure many of you will find surprising. Certainly, my opinion is diametrically opposed to those you often hear expressed. The usual view is that Canada's current economic difficulties reflect the fact that Canada is so dependent upon resource development. In consequence, as goes the world demand for raw materials, so will go the Canadian economy. It is often argued that the way out of this problem is to put more focus on manufacturing industries and, in particular, upon high-technology development, as this would make the Canadian economy more recession-proof.

My own view is that this is a misperception of the problem which we face and that the proposed solution will not prove, therefore, to be effective. The problem we face in Canada is not that our economic welfare is derived from the extraction of raw resources but rather that our economic performance is dependent upon the export of these materials into world markets. Notwithstanding our endowment of wealth and our high standard of living, Canada is a small country in terms of its population. In consequence, Canada is doomed to be forever dependent on foreign markets for much of its economic welfare. In the context of current technology, there simply aren't enough people within our country to warrant the kind of scale of manufacturing activity which would enable us to be more independent of world affairs. Our proximity to and dependence upon the United States will always mean, regardless of what mix of products we are exporting, that the demand for our products will be influenced heavily by the movements of aggregate demand in the United States.

Of course, it is true that some products at the moment are in higher demand than raw materials and if we had had the good fortune and foresight to be involved in the production of those products at the moment, we would be suffering relatively less from the world recession than we are. However, there is no class of products which is inherently recession-proof. It is simply a matter of being lucky enough to have produced a product which happens to be in demand as the recession is under way.

Would we be any better prepared to deal with the recession at the moment if we had been more heavily engaged, for example, in the production of producer-durable goods, or jet airliners, or nuclear reactors? I find that highly unlikely in view of the fact that the industries producing those goods in the United States are currently operating in many instances at only half their rated capacity.

Recognizing our inherent long-term dependence as traders to earn our standard of living must eventually bring us to make decisions in a different way than we have in the past. We must be much more progressive in our pursuit of a true free-trading policy and we must begin to tailor our domestic policies and our attitudes toward industry accordingly. And those (and there are many of them these days) who attempt to seduce you by referring to the Japanese model of industrial development, may forget to tell you that Japan is considerably less dependent on foreign trade than is Canada. Trade accounts for less than 14 per cent of Japan's Gross National Product while it is over 25 per cent of Canada's. Moreover, Japan has within its own domestic boundaries a world-scale market for its products which means that it can, in effect, develop technologies and products within its own markets before advancing with them into world markets.

To some considerable degree, the pursuit of a national industrial strategy which involves the enticement of labour and capital into manufacturing and high technology is a fagade for a cynical policy of regional redistribution of wealth. Even if this underlying program of redistribution had no effect on Canada's ability to compete in world markets, it would be regrettable. In fact, the whole orientation of our national policies is hampering us at every turn--and, most often, the handicaps arise from the unanticipated consequence of well-meaning policy.

Let me provide a few examples of what I mean. At the moment, Canada's forestry industry is in great danger. The International Trade Administration's deliberations in the United States hang as a sword of Damocles over the industry as it discusses whether or not to impose a countervailing duty on Canada's exports of lumber to the United States. The criticalness of this decision is, I'm afraid, not well known to Canadians. But the fact of the matter is that the forest industry is one of Canada's leading employers and is singularly dependent upon foreign markets, particularly those in the United States.

People in the industry in Canada are justifiably concerned because there is, in fact, some evidence upon which to base a countervailing duty. The International Trade Administration considers whether or not foreign suppliers are subsidized in their activities. If so, then the statutes in the United States provide that a countervailing duty shall be imposed; and, the fact of the matter is that Canada's forest industry, to some limited degree, has been subsidized. It has been subsidized by the Department of Regional Economic Expansion. It has been subsidized by our nonsensical National Energy Program. The end consequences of these subsidies, as we can now see, is that they threaten one of the country's most important sources of employment and income generation. I am sure that the government ministers and officials who honed the policies of the Department of Regional Economic Expansion and the National Energy Program never gave a thought to the possible future ramifications in the form of this countervailing duty. Nor could we reasonably have expected them to do so. What we can expect is that we can learn from this experience and in the future not put in place policies of an illiberal sort which hamper the natural process of adjustment in internal markets--a process we could not survive without on international markets. If other countries were to pursue the policies which Canada has pursued now for a hundred years in blunting the natural course of specialization and comparative advantage in international trade, Canada would be an economic wasteland. The lesson for the future is that we must adopt the attitude of free trade. We must do unto ourselves as we expect others to do unto us.

A second example, also current, which underlines the nonsense inherent in many current programs, is the furore over the Crow's Nest Pass issue. Let me be very clear at the outset in stating that I am in favour of rationalizing our transportation system and that I am in favour of grain competing on equal terms with other products for the use of our transportation system and that I am against subsidies in general. But when we examine the abolition of the subsidized Crow's Nest Pass rates in the context of other programs and policies of the government, the inherent rationality of it all is somewhat less clear. For example, at the same time as we are eliminating subsidization of grain exports which are obviously a keystone of our long-term development, we are subsidizing the production of aircraft, computers, and textiles. The razor-sharp thinking which prompts us to trim away the fat from our wheat and transportation systems somehow dulls when it comes to cutting a path for clear thinking through the maze of regional politics.

Let me say again that the reason why these inconsistencies, incompatibilities, and threats to our industrial structure arise is because we have not had in the first place a free-trade attitude in constructing national and regional policy.

The final lesson which we must derive from recent experience is about the extent to which we can rely on natural market forces and the extent to which we must rely on government to channel or redirect them. Of course, the reason for interfering with market forces in the first place is the view that the market is imperfect and that government can ameliorate circumstances by intervening with a tax or a regulation or a price ceiling or whatever. We have begun to realize in the last decade that the alternative of government intervention is also imperfect because it is undertaken by the same imperfect, short-sighted, selfinterested human beings who engage in private activities.

In 1973, when the OPEC nations first began to flex the economic muscles which the growth in the demand for petroleum had given them, North American governments had two choices. One was to allow natural market forces to take their course, for consumers and producers alike to realize the benefits and the costs of higher prices. The other was for government to shelter consumers and penalize producers who had had the luck to find themselves with an investment in a now highly valued resource. Well, in the event, you all know the route which was selected. Eschewing entirely reliance on market forces, governments in Canada and the United States (particularly in Canada) maintained an artificial price for petroleum and to all intents and purposes behaved as though they were secret agents of the Sheikh Yamani in sheltering consumers from the brunt of OPEC's price-raising activities.

The result was that the OPEC nations could increase prices with impunity from the natural market reaction of a reduction in demand. As long as consumers did not have to face the reality of higher oil prices, the Arabs did not have to face the reality of lower demand for their product. And, during the interval from 1973 to 1983, many plans, both private and public, were predicated on the continued existence of a shortage of oil which was the signal which the now badly distorted market place was sending out. In 1980, this changed when the United States went to the world price of oil and Canada's oil price gradually began to approach that of the world level. The result was a most spectacular reduction in the demand for petroleum.

Whereas in 1970 the OPEC nations accounted for 61 per cent of the free world's total oil supply, in 1982 they accounted for only 47 per cent--less than the 50 per cent they supplied in 1960. In the case of North American demand for oil, during 1979 the United States imported 47 per cent of its total requirement, whereas today imports account for only 36 per cent. In both cases, free-world oil dependency on OPEC has been reduced to the pre-1970s level. In my view, this reduced dependency, together with continuing efficiency gains, will produce a world oil price which is stable or falling in real terms for the rest of the 1980s.

In other words, once the market was allowed to operate, it began to produce exactly the kinds of reactions which those of us who still believe in the existence of market forces had predicted as early as 1977. 1 have to do a little gloating here. The Fraser Institute in two books, one titled Oil in the Seventies and published in 1977, and the other called Reaction: The National Energy Program and published in 1981, provided very precise analyses of the consequences which would follow from the failure to allow market forces to operate.

It comes as no surprise to us that the world price of oil has overshot its true economic level. It overshot because of the intervention of government in restraining price and artificially elevating demand and thereby sending false signals to consumers and producers. The lesson we must learn from this experience is that the intervention of government does not ensure that the impact of any particular unfortunate event will be ameliorated. From our experience with energy policy, we must now acknowledge that involvement of government can make matters tragically worse than they otherwise would have been.

I think it is high time we recognized that reliance on market forces as a way of solving economic problems is not, as is often implied, naive, simplistic, or stupid. Quite the reverse is the case. Those who propose that we solve our problems by yet another government program, another high-minded but impractical policy--it is they who are being simplistic, naive, and even malicious. The evidence is quite clear--who can deny it? Of all the lessons we must learn from our present difficulties, this is the most important.

The appreciation of the audience was expressed by Michael Meighen, Q.c., a Director of The Empire Club of Canada