The Real Dimensions of Canada's Contemporary Political Economy

BGEN. ANDRUNYK:

Members and friends of The Empire Club of Canada: A few decades ago, Canada's economic policy was set by a handful of Ottawa bureau crats at the Department of Finance and the Bank of Canada without fear of criticism from the academics. Today these bureaucrats still shape and make economic policy but more nervously. They now face an intimidating array of critics in the universities and from a number of research centres.

Examination of government policy and performance is now being channelled through such research centres as the Institute for Research on Public Policy, the Canadian Institute for Economic Policy, the Ontario Economic Council, the Canadian Energy Research Institute and the C. D. Howe Research Institute.

The latter institute is a private, non-profit research centre that focuses on short- and medium-term economic policy issues, particularly in the areas of budgetary affairs, inflation and unemployment, and international trade.

Our guest speaker today, Mr. Carl E. Beigie, has been associated with the C. D. Howe Research Institute since its founding in 1973--first as its Executive Director and since early 1978 as its President. Born in 1940 in Cleveland, Ohio he received his education at Muskingum College in New Concord, Ohio and at the Massachusetts Institute of Technology, where he carried out studies in economics at the Ph.D. level. Prior to his appointment at the C. D. Howe Research Institute, he worked for the Irving Trust Company in New York City where he became Vice President and International Economist, and for the University of Western Ontario where he was a lecturer in the Department of Economics.

Mr. Beigie has written a number of monographs and articles covering a wide range of topics, including the Auto Pact, Telecommunications Regulatory Policy Issues in Canada, and Energy Problems in Quebec and Canada. His most recent monograph, "Inflation is a Social Malady," has received wide recognition. He is also a frequent commentator and lecturer in Canada on current economic policy issues. Among his other activities, he is a director of Fraser Inc. in New Brunswick, of Zinor Holdings Ltd., and of the Canadian Foundation for Economic Education.

1981 has been an especially significant year in his life. First, he became a Canadian citizen at the first of the year and I know that you join me in offering him our sincere congratulations and best wishes for a full, happy and prosperous life in Canada. Second, he and his wife and two sons moved from Montreal to Toronto this summer where he has taken a one-year appointment at the University of Toronto as the Claude T. Bissell Visiting Professor of Canada-United States Relations.

Ladies and gentlemen, it gives me great pleasure to invite Carl E. Beigie to address us on the subject of "The Real Dimensions of Canada's Contemporary Political Economy."

MR. BEIGIE:

Economics is often referred to as the "dismal science," and my remarks this afternoon are unlikely to alter that perception. Over the next several months Canada is going to be faced with economic policy decisions that are as tough, and as fundamental, as any it has faced as a country during the post-World War II period. The most optimistic prospect I can offer in honesty is that Canada could have a brilliant economic future, but only if it accepts the disciplines of harsh reality and takes the steps necessary in the near term to restore reasonable balance to its economic system. To do so, the role of government must be shifted from the pursuit of political expediency to the pursuit of managerial wisdom and foresight. If this does not occur, the country faces not merely the spectre of a falling value for the Canadian dollar in foreign exchange markets, rising rates of unemployment and below-potential rates of economic growth. Canada also risks a further gradual erosion of individual freedoms as government is looked to for the provision of illusory security as the people give up the responsibilities of democracy because they are onerous.

Six years ago the Government of Canada embarked on a policy of monetary gradualism as a strategy for bringing inflation under control. The tactical instruments of this strategy included the temporary imposition of wage and price controls, restraint on the rate of growth of government expenditures, promises of government playing the role of a good (but not a leading edge) manager in its compensation negotiations with public sector unions, and most importantly, a commitment by the Bank of Canada that it would cut back in a gradual but determined manner on the rate of growth of new money creation.

Given that the basic purpose of this strategy was to bring down the rate of inflation, I believe it fair to

conclude that the conduct of economic policy in Canada over the past six years has been a failure. Inflation in this country is running at a faster rate than it was six years ago. Moreover, and more importantly, an inflation psychology has taken a very deep grip on the public, thereby virtually ensuring that costs and prices will continue to rise at disturbing rates well into the future. With Canadian inflation rates now running significantly higher than those in the United States, the prospects for the Canadian dollar, which was trading at a premium relative to the American dollar in the fall of 1975, and the prospects for Canada's industrial competitiveness internationally are not at all encouraging.

To say that the conduct of the strategy of monetary gradualism has failed in terms of its own policy objectives is not to say that the Government of Canada has made a mess of an easy situation. The economic and political environment at home and abroad for bringing down inflation has not been favourable. In particular, the lack of economic policy steadiness in the United States under President Carter not only left President Reagan with many of the problems he now faces, it also made Governor Gerald Bouey's job of staying on course with the Bank of Canada's tactics very much more difficult.

From the standpoint of an economic policy analyst, what has passed is past, except for the lessons that can be drawn for the future. My own view is that the discussion of this country's economic options would benefit greatly from candour by the federal government concerning what has gone wrong instead of from continued insistence that Canada has been doing quite! well by comparison with other countries in terms of economic performance over the past six years. There have been several bright spots in this performance, but it is time to take an overall perspective and ask if doing better than the worst is adequate for a country with Canada's strong potential.

The basic question facing Canada, as preparations are finalized for a federal budget later this fall, is whether the strategy of monetary gradualism is faulty. Is it the tactical pursuit of this strategy that has been the cause of our current problems? My argument would be that the strategy of gradualism continues to make sense, but there are several constraints on the mount of time Canada has to make it work, particuIarly given the course of policy in the United States under President Reagan. Furthermore, monetary gradualism would have worked much better if the tactics chosen had been applied with much more discipline. The danger that now exists is that the federal government is going to do a policy about-face in its budget that could produce a pointless degree of further disorientation to the economy and the basic economic system.

The implementation of the strategy of monetary gradualism has been plagued with what I regard as errors in political-economy judgement originating, in large measure, from an unwillingness to be tough. For example, the income provisions of the controls program of the Anti-Inflation Board were simply too generous. To bring this point home, I would simply observe that if these provisions had been enforced throughout the period from the fall of 1975 to the present, wages for employees in private sector firms would be considerably higher than they are today, and so, too, would be inflationary pressures. What the AM did, in effect, was to put a floor on wage gains that was set by the rise in the consumer price index, with a one-year lag, plus the historical rise in average worker productivity.

It is my contention that the AM experience helped ingrain in the Canadian public mind the completely misleading notion that equity requires that incomes rise by a minimum of the rise in the cpi, irrespective of the specific causes of the price rise. This contributes to an "indexation mentality" that has a decidedly harmful effect on the essential flexibility of the Canadian economy at a time of fundamental change in numerous basic economic relationships. There is a certain intellectual logic to universal indexation at a time of high inflation. This logic relates to fairness considerations. There is no logic in economics to indexation using an upwardly biased estimate of inflation, namely the cpi. I would be supportive of budget actions that changed indexation from the cpi to a more accurate, and anti-inflationary measure of general price-level changes, an example being an index known as the GNP price deflator. At the same time, I think serious consideration should be given to expanding indexation to areas that have thus far been excluded, such as the calculation of taxable capital gains.

The Canadian indexation mentality will almost certainly aggravate inflationary pressures emerging from the recent oil and gas pricing agreement reached between the federal government and the producing provinces. I have long argued in favour of boosting domestic energy prices even more rapidly than has now been agreed to. Holding prices low discourages conservation and the development of new energy sources. It also encourages wasteful decisions in the use of the country's finite energy base. Canada's energy ' pricing policies have pandered to political pressures to shelter the general public from economic reality. And it has also revealed starkly that relations between -governments in this country run on the basis of confrontation rather than co-operation. If these governments could have come to an agreement reflecting good economic judgement, prices would have moved quickly to their opportunity costs, with the proceeds being used to shield the most severely disadvantaged and to augment Canada's output-generating capital base above the ground to offset the reduction in the base below the ground in the form of non-renewable energy reserves. - .

My main point here, however, is a quite different one. Given the indexation mentality, income earners are going to expect compensation for the agreed rise in energy prices. If the Bank of Canada accommodates these expectations, more inflation is inevitable; if it does not, choosing instead to stick with a policy of toughness, then these expectations are going to contribute to an inevitable recession.

A second tactical feature of the monetary gradualism strategy was to make the total compensation package for public service employees comparable to that provided in the private sector. This tactic was sound in theory, but it has suffered in practice. One of the principal reasons why controls were imposed in 1975 was because of the large spread in settlements between the private and public (particularly provincial) sectors, and while the spread has narrowed considerably, public service compensation remains an issue that cries out for new approaches.

A third tactical feature in the post-1975 economic strategy for Canada was a pledge not to allow the share of the economy taken up by government expenditures to rise. This pledge has largely been kept, but the assumption underlying it has never been seriously challenged within government. That assumption is that governments' share of roughly forty per cent of GNP, a share that had grown sharply in the years prior to 1975, would be compatible with a restoration of overall balance within the economy.

I regard the government share of total Canadian expenditure to be a more serious policy concern than the size of the federal government's budgetary deficit, although I do not look upon the latter as unimportant. A fact that is not widely understood is that if we look at all governments combined in this country, the real level of their deficits--that is, after adjusting for inflation--has been going down recently, as has been noted by Professor Greg Jump at the University of Toronto's Institute for Policy Analysis. Federal borrowing does add to strain on financial markets, however, especially at a time of monetary restraint. I will come back to this point later.

The reason why government expenditure levels are important, at least in my view, is that they tend to reflect excessive consumption pressures on the country's currently available output. I hasten to add that many expenditures by governments are of an invest-. ment, or at least a quasi-investment, nature. They add, either directly or indirectly, to the economy's longterm ability to produce goods and services. Nevertheless, the rise in the level of total government expenditures in the 1960s and early 1970s added to the total amount of current consumption expenditures without there being a corresponding rise in the taxation revenues on permanent income sources. I do not want to become overly technical on this point, but I would ask you to bear in mind that using revenue from resource taxation to finance current operations of government (meaning consumption) is viable only so long as the resources are there to tax. This is one of the difficulties I have with setting off the revenue surplus positions of energy-producing provinces against the deficits of the federal and other provinces and concluding there is little for Canada to be concerned about in the government budgetary area.

The fourth and final tactic in the Canadian monetary gradualism strategy is the Bank of Canada's monetary policy. This has been the key element of Canada's anti-inflation strategy, and Canada's current inflation is a direct result of indecisiveness in the implementation of this policy over most of the period since the fall of 1975. Although the Bank and its chief spokesman, Gerald Bouey, have argued strongly in favour of the steady application of progressive monetary tightening, I would argue strongly that the practice of monetary policy has been far too loose in this period.

The Government of Canada and its agencies have talked discipline since the fall of 1975. But they have practised discipline only in the sense that they have acted to prevent a bad situation from getting much worse. Fighting inflation has not been the principal target of Canadian policy. In fact, highest priority in the economy has been given to maintaining growth and employment. The result of this priority ranking has been more inflation. My summary judgement of five years of Canadian economic policy, from late 1975 to late 1980, is that these years have been wasted.

Since late 1980, however, there has been a change in government attitude toward economic policy in this country. The tactics of monetary gradualism remain the same, but the implementation has been noticeably different. Reducing inflation has become a much higher-ranking policy goal, even to the point of risking a short-term rise in unemployment and a period of very slow, possibly even negative, economic growth.

It is not altogether clear to me whether this change in tone has been intentional or not. The one thing that is clear is that the Bank of Canada has become exceedingly serious in its determination to fight inflation. This has been signalled by its very tenacious fight to prevent the Canadian dollar from falling below eighty cents US. in foreign exchange markets. This has required that Canadian interest rates remain above those in the United States, and this constraint, in turn, has determined the rate of flow of new money that can be allowed into the Canadian economy.

The next six months are going to be an extremely interesting period in the Canadian and in the US. economies. Even though short-term interest rates have been declining modestly in recent weeks, they remain quite high even in real (after-inflation) terms. The longer these rates persist, the more convinced I become that the two economies are heading into at least a short-term recession that could become quite severe. Will that be allowed to happen, or will monetary authorities at the Federal Reserve System and/or the Bank of Canada be forced to ease off in their policies in the face of mounting political pressures? If they are, I am of the very firm opinion that Paul Volcker and Gerald Bouey would, and should, resign as men of strong principle. The coming round of extreme political heat over economic policy has arrived first in Canada. The limitation of mortgages here to a maximum of five years has meant a large number of existing homeowners being hit with the consequences of high interest rates at re-financing time. Another signal of the government's new anti-inflation determination is that it has indicated that it has no intention to provide significant general relief for this problem.

But the most dramatic political crunch still lies ahead for the two governments. Recession means a significant reduction in new job creation, and unemployment is the single most important economic indicator on which the public judges the performance of government. Margaret Thatcher has thus far been able to stand the intense political heat caused by a very serious unemployment problem. Would Mr. Reagan and Mr. Trudeau be willing, and able, to tolerate anywhere near as much heat?

Given that both administrations are still in the fairly early stages of their mandates. they could survive a short, even if quite severe recession. Furthermore, my sense is that Mr. Reagan would, arguing to himself that the short-term pain of recession must be borne to achieve the long-term gain of more stable prices.

The political-economy judgements of leaders in any situation are very difficult to predict, and forecasts of what Mr. Reagan will do are particularly speculative because he has been in federal office for such a short time. It is quite different with Mr. Trudeau, although I find almost everything being written about the prospects for his government's economic policies to be classifiable as speculative.

My own sense is that Mr. Trudeau, as is the case with most Canadians, does not really worry very much about inflation in this country unless it is running well above the US. rate of inflation. He is concerned about the income distribution effects of inflation, however, regardless of what the inflation level is in Canada relative to that in the United States.

This perception leads me to the following conclusion as to what to expect in Canadian economic policy over the near term.

First, the federal budget is likely to be tough in the context of an economy headed into a recession. This is because the government is concerned about the clear trend that has emerged toward a widening in the inflation differential between Canada and the United States.

Second, within a fairly tough overall budget, there is likely to be a further shift in policy aimed at transferring after-tax income (and expenditure) toward the lower income groups in the Canadian society.

Third, there will be little easing away from, and possibly some further moves toward, shielding more and more Canadians from disciplines of the market place. This country has become philosophically dominated by the notion that stability in incomes is a natural right. The result has been a steady move toward turning Canada into a fixed economy, a point on which I will focus my concluding remarks.

Fourth, there will be little easing of interest rates in Canada until it can be done without a lowering of the Canadian dollar and without a widening in the inflation differential with the United States. I expect interest rates in the United States to continue along a slow and erratic, but reasonably steady, downward course for quite some time, and I expect Canada's rates to follow, but more slowly, basically the same path. In brief, I regard any notion that the Bank of Canada will be able, or will even want, to follow an independent "monetarist" course to be an academic debater's dream.

A fundamental reality about Canada, at least as I read this country, is that market-place solutions to economic problems are regarded as the exception rather than the rule. Government intervention is looked to for answers. This attitude could not be more diametrically opposite to the attitude of President Ronald Reagan, who I believe reflects the dominant philosophical orientation of the American people. From the earliest days after coming to Canada more than ten years ago, I have been struck by the logic of this country's suspicions about the marketplace. The market does present a severe challenge to this country's goals of maintaining a separate, individual political sovereignty from the United States and of maintaining a reasonably strong economic viability for each of this country's regions.

I do not advocate market-place solutions to everything, and I think that this country has been on the whole, quite successful in achieving a balance in government intervention in the past. But there are four challenges to this balance that are becoming increasingly pressing on this country's decision-making processes.

First, for the first time in his nearly thirteen years as Prime Minister, Pierre Trudeau is confronted by a President of the United States who is as firmly committed to an ideological philosophy as he is. There is no question, in my mind, of one giving in to the other in the bilateral relationship. Unless some new thinking is given to how the differences in determined, yet diametrically opposed, ideologies can be reconciled among equals, the co-operativeness that is dictated by geographic reality and that is desired by the large majority of both publics will be in serious jeopardy.

Second, effective national policy in Canada is all the more difficult precisely because the easy course of market-place approaches is not really desired in this country. Co-operative federalism in this context is not in any way an empty phrase. The federal government must have the economic power to take a firm lead in this necessary alliance, and this is really what the ends of the current constitutional debate are all about. But Ottawa is allowing the perception to grow outside Canada that national policy means central Canada imperatives. I am convinced that the inability to move quickly on the essence of the constitutional issues is doing serious harm to this country's ability to take full advantage of a very exciting economic future.

Third, I have been impressed with the skill of Ottawa officials in identifying special interest motivations that underlie most of the policy arguments it receives. This skill can provide the basis for strong, balanced policy actions. But it is becoming increasingly apparent that Ottawa has taken on the colouring of being a special interest in itself. It has become far too closed and rigid in its attitude toward outside policy analysis and advice, and error in economic policy during the 1970s is a prime case in point. Unless this attitude can be changed through a top-down commitment, I am concerned that those mistakes will be repeated.

Fourth, and finally, the role of the private sector is essential to the preservation of true democracy in a society, regardless of its attitudes toward the role of markets. Too many voices in the private sector in this country, whether they come from business, labour, or other sectors, have become either transparently obvious in their special-interest pleading or they have been willing to be stilled in return for government discretionary favours. For now, Canada still has the economic largess to keep a quiet, comfortable life sustained without suffering unduly. But a quiet, comfortable life today is going to be achieved at the expense of future generations of Canadians.

The real issues in Canada today are not merely economic. They involve the very essence of democratic freedoms and liberty, and I can only earnestly hope that the private sector in this country can continue to generate people with the foresight and courage to be prepared to sacrifice short-term economic benefit, if necessary, to ensure that long-term individual freedoms will always be a right and a duty of being a Canadian.

The thanks of the club were expressed to Mr. Beigie by Ronald Goodall, Treasurer of The Empire Club of Canada.