Canada's Economy—Can We Advance Back to Reason?

SIR ARTHUR CHETWYND:

Distinguished guests, ladies and gentlemen: Last week you will recall we were host to an eminent economist from the United States. John Bunting gave us an expert and challenging overview of the immediate future of the economy in the U.S. and in the world.

Today, we are to hear from a Canadian expert about his views of the Canadian economy, both now and in the future.

Whether we like it or not, the seriously troubled state of the economy is or should be on everyone's mind, therefore we felt that this "twinning" of two very knowledgeable speakers on the same subject would be valuable at this unsettled time in our history.

Our speaker, today, Dr. Ian Macdonald, President of York University, is a not unfamiliar figure at this lectern. He served a distinguished term as President of The Empire Club of Canada in the 1969-1970 season. In February 1974, as President-elect of York University, he addressed us on the subject: "Universities: Who Needs Them?"

In that address, while still serving out his commitment as Deputy Minister of the Ministry of Treasury, Economics and Intergovernmental Affairs of the Province of Ontario, he mentioned that his position at that time precluded anything but the most neutral remarks on the fundamental fiscal problems of Canadian Confederation, but he also said that he might well have a comment or two at a later date. I anticipate that our platform has provided that "later date", as he speaks to us on the subject "Canada's EconomyCan We Advance Back to Reason?"

Our speaker is so well known to most of us in this room that I am only going to give a few highlights. He was born in Toronto, graduated from the University of Toronto with a Bachelor of Commerce degree in 1952, heading his class. He was awarded the Cody Trophy as the man contributing most to the athletic life of University College.

Then, as a Rhodes Scholar at Oxford, he obtained his Master of Arts degree-and the following year his Bachelor of Philosophy in Economics. During this time he captained the Oxford Hockey Team. In 1955 he became a lecturer in Economics at the University of Toronto, becoming Dean of Men, University College, and subsequently Assistant Professor of Economics.

In January 1965, Dr. Macdonald was appointed Chief Economist for the Province of Ontario. In addition, he became Deputy Provincial Treasurer and following the reorganization of the Ontario Government he was made Deputy Treasurer, and Deputy Minister of the new and expanded Ministry of Treasury, Economics and Intergovernmental affairs. In this position, he was the senior civil servant responsible for the initiation and development of Ontario's fiscal and economic policy, and for its taxation, debt and investment policy-in short, the management of the government's finances.

Our speaker has had an outstanding career in 'government and continues to have a distinguished career in education. When he left government for the perhaps quieter halls of York University, he announced that two ingredients would be of great importance, openness and mobility, between the various parts of the "new university"--that is, "the broad community"--the sum total of all of those parts which make up what he referred to as the wider "university of the world".

He is practising that mobility in coming back today to focus his attention on the economic state of our Canadian union, at a time when many are questioning and few are able to answer. Perhaps the title of his paper, or that part of it which asks "can we advance back to reason?" seems like a contradiction in terms. But if we can move toward "reason" in these troubled and even hazardous times, I believe all of us would be more than willing to move backwards, forwards or even sideways, as long as it made it possible to see a little light in the shadows of inflation, unemployment and the resources debate.

The well-worn jokes about economists are inescapable. For instance, it is said that an economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today! It has also been said that if all the nation's economists were laid end to end they would point in all directions! These are not my own thoughts, of course. I pinched them from other people.

We can be comforted by this economist who, as the title of his speech indicates, would like to take us back to "reason". For Cicero said that "reason" is the mistress and queen of all things. And Samuel Johnson cautioned us that "We may take fancy for a companion, but must follow reason as our guide." It seems to me that too many segments of our society, most with a rather high degree of monopolistic power, have been courting fancy. Today, let reason have its say . . .

I am most honoured to rewelcome and present to you the President of York University, Dr. Ian Macdonald.

DR. MACDONALD:

Mr. Chairman, ladies and gentlemen: This is the third time I have enjoyed the privilege of addressing The Empire Club of Canada and the first in my present role as President of York University; I hope it will not be the last. However, in a recent discussion with my oldest son, I learned that he considered my job to be rather boring, certainly in comparison with his aspiration to be a racing driver. However, I pointed out that the occupational life expectancy of university presidents was less than that of racing drivers and that it was indeed a life full of surprises and chilling excitement.

Since we have just concluded a rather severe budget, I understand better the story of a mother going upstairs at nine o'clock one morning and saying to her son who was languishing in bed: "You must get up and get along to the university." He replied: "Mother, I just can't face it. You have no idea how miserable it is there. Everyone hates me--the professors hate me, the administration hates me, and even the students hate me." However, his mother persisted only to be told once again how totally disagreeable it was. Finally, in a fit of indignation and frustration and, giving a stern tug on the bedsheets, she exploded: "Get up and on your way to the university--you're fifty years of age and you're the President!"

However, I must report that I have enjoyed my return to the university community immensely and I continue to believe in the particular value of universities for an enlarging culture in Canada. Indeed, I believe it can be argued that universities are more important than ever before in assisting the resolution of so many of the issues that challenge the effectiveness of the democratic system. It is one of those principle issues that I wish to discuss with you today, as briefly as possible, I trust. I recall that the late Sidney Smith, when President of the University of Toronto, described his role as requiring him to be "a ball of fire by day and a bag of gas by night". In view of the current energy shortage, I am doing my best to be conservative in both respects. On the other hand, when I spoke to the club last year, I indicated that I would certainly feel less fettered when the veil of anonymity was lifted from my shoulders upon my departure from the civil service. I have certainly enjoyed my return to "academic freedom".

The Canadian economy today is truly a bundle of paradoxes-the concurrence of inflation and unemployment, job scarcities side-by-side with unfilled jobs, high consumer spending along with high rates of saving, a high level of borrowing even at high rates of interest, and rates of increase in salaries and wages soaring out of sight while our international competitiveness staggers and splutters. Clearly the Canadian economy is out of joint, with the possibility that we could be crippled for a lengthy period. But I believe that we must not accept the inevitability of the crippling disease or resort to a permanent succession of canes and crutches. In that phrase of Bertolt Brecht, "Can we advance back to reason?" Can we assess our condition honestly and begin a course of self-induced therapy to restore our good health?

I believe that we can, but first we must recognize the fact that discussion of public policy in Canada today is totally inconsonant with the reality of our economic and social structure. There are two serious consequences of this fundamental disharmony: first, our economic policy is not equipped to deal with today's realities; and secondly, we have unreasonable expectations for governments in dealing with our economy. As a result, we become frustrated which, in turn, tends to undermine our confidence in the very institutions which we created for the purpose of formulating and administering public policy.

A number of years ago, when teaching monetary and fiscal policy, I was as guilty as any of applying the unitary state world of Keynesian economics to the Canadian federal system. How easy it was to simply sketch in the inflationary or deflationary gap, and then swing the great levers of monetary and fiscal policy into action to exercise a counter-cyclical influence. The correct mix of monetary and fiscal policy would be sufficient to restore equilibrium in the economy.

However, Canada is not a unitary state, notwithstanding the yearnings of some commentators on public affairs and certain citizens with an Ottawa-centric view of the universe. We are a federal state and a highly decentralized one, with immense economic and fiscal powers in the hands of the provinces. Today, the provinces and their municipalities account for what is approaching two-thirds of public expenditure in Canada and about 80% of that highly significant sector-public capital investment. As a result, a determined provincial administration, in conjunction with its municipalities, can exert a significant counter-influence on fiscal policy to that of the federal government and, in conjunction with large agencies such as a hydro-electric power corporation, can have a major impact on domestic capital markets and, through foreign borrowings, on capital flows and exchange rates.

The countervailing influence of provincial fiscal policy is exactly what happened in 1970 and 1971 in Ontario, and I have been surprised that it did not attract more attention. At that time, the federal government was seeking to offset inflation and was practising a policy of fiscal restraint, with particular discretionary attention directed at the urban areas of Ontario. However, in the view of the Ontario Government, unemployment was the more serious threat at the time and a deliberate effort was made, through the 1970 and 1971 budgets, to stimulate the economy, particularly in the basic investment sector. The direct challenge to the Minister of Finance was not lost on him, however, as the 5% investment tax credit, which was the main technique employed by the Ontario Government, was applied to reduce the normal capital cost allowances under the federal corporation income tax.

It should be noted that provincial fiscal policy capacity is largely limited to the size of the deficit or surplus and to the indirect tax field, as was so apparent in the Ontario Budget last week. As a result of the federal-provincial tax collection agreement, the provincial government is not free to alter the direct tax base or the graduated tax rates, although the tax credit system has been introduced first in Ontario, then in Manitoba, as a means of changing the incidence. However, the larger the portion of the direct taxes, the larger the basic budgetary influence, a fact which helps to explain the federal government's unwillingness to turn over a larger share of the personal and corporation income tax to the provinces in exchange for assumption by the provinces of the full responsibility for the large shared-cost programmes.

The provincial, and increasingly the municipal, impact on the economy is not confined to the aggregate sense. Again, in 1971 and 1972, it was demonstrated in Ontario that selective programmes to stimulate employment could have direct and immediate effect. In those instances, the policies tended to be reinforcing rather than countervailing. What that experience demonstrated however was the strength of a federal system when the governments find a way of working together. In that case, the federal financial leverage worked well with the provincial and municipal knowledge of local conditions. The lesson to be derived is that much greater effort must be devoted to designing joint machinery for federal-provincial fiscal policy-making and economic planning.

However, it is not just the existence of the federal system that is the source of current mythology about fiscal policy. There is the basic problem of identifying the phase in the cycle, agreeing about its duration, and then turning the tap on and off quickly enough to have an effect in the right direction. It has always seemed curious to me how blandly we talk about the efficiency of fiscal policy, without examining the record. In fact, there was a highly illuminating commentary in Volume 2 of The Report of the Royal Commission on Taxation in 1966, which examined the record of fiscal policy in relationship to the apparent state of the cycle. For the period 1954-63, the Commissioners reported the following:

"In our view, fiscal policy was approximately in the right direction and of the right magnitude about half the time. In three of the ten years, 1959, 1960 and 1963, we would judge discretionary fiscal policy to be perverse, and especially so in 1959 and 1960.

Looked at in broad terms, fiscal policy in the period under consideration was too expansionary in 1956 and too restricted thereafter. In very few years was there a real problem of choosing between conflicting objectives, although faulty forecasts, and other errors of diagnosis, led policy makers to think and act as though they were faced with such conflicts."

In addition to the chronic problem of adequate data at the right time and proper timing in the application of policy, we must contend with so-called 'fiscal-drag", whereby we build up eventual over-kill in the system and subsequently compound our difficulties. This issue is highly relevant as we struggle today with high unemployment and economic slowdown, whereas, in my opinion, inflation will be back in full stride by early 1976 and will remain the true enemy.

Should the Minister of Finance bring down a new expansionary budget? In view of the extended period before fiscal policy has any impact, as The Royal Commission on Taxation indicated, I would answer that the November 18 Budget last year should have been more expansionary and we would now be enjoying the benefits when we need them. However, an expansionary budget next May or June may only add fuel to the rekindling flames of inflation later this year while taking effect too late to stimulate the productive side of the economy when we need it. We should applaud the willingness of the Ontario Government to extend fiscal policy to the retail sales tax for a short duration. However, even in that instance, the impact would have been better timed if introduced a few months ago. Generally speaking, we need these measures quickly and of sufficient magnitude to have adequate impact. This means that fiscal policy should be much less formalized and the budget cycle less of a master. If the Minister of Finance really felt, as he has been hinting for weeks, that stimulus is required, would it not have been better to bring back Parliament and introduce the necessary tax bill quickly?

Under the present circumstances, with unemployment threatening and inflation persisting, it also seems inconceivable that a strongly based federal government, at this stage of its electoral cycle, would have recommended an increase in the price of oil. The world oil price is not a true market price in the economic sense, but a political price that is bound to come down. It is also extraordinary that the Premier of Ontario should be accused of political posturing in his adamant opposition to the increase. All politicians posture just as all editorial writers editorialize. The real issue is whether the posture is a correct one or not. Timing is of the essence. No one would argue that the price of oil should never change, but it would be the height of folly to do so at this particular conjunction of unemployment and inflation.

That leads me to ponder the concurrence of the two great Keynesian opposites-inflation and unemployment--or stagflation. The role of monetary and fiscal policy in the Keynesian world was to dampen down the economy or to stimulate it with the result that we would achieve full-employment with price stability. However, a number of factors have combined to alter that Keynesian world radically, apart from the issues of federalism and ill-timing:

The decline of the market and the increase of administered pricing.

The growth of unions and union contracts.

The increase of basic government programmes and expenditure as a fixed component of the Gross National Expenditure.

The increase in the service sector component of the economy and the difficulty of finding new productivity gains.

The increase in "buy now, pay later" and consumer credit.

The combination of institutional changes of this nature has set the stage for the major characteristic of today's economy-the tendency for consumer expectations to run ahead of productivity with inflationary potential a built-in characteristic of the modern economy.

Today, unlike any period in the post-war era, we sense deep-seated feelings of discontent and grave uncertainty about the future. It is rather like the cartoon of a man standing in front of the information booth in a department store and saying to the girl in the booth: "Where is it all going to end?" Why, in one of the wealthiest economies in the world is there such widespread social dissatisfaction and striving for more in exchange for less? What is the fundamental source of inflation that is causing such stress in the economic and social system in Canada? Indeed, where is it all going to end?

My simple answer is that your expectations and mine for goods and services are rising faster than our ability or willingness to add to productivity. The task is not diagnosis of the ailment but prescription of the cure and willingness to swallow the medicine. You cannot distribute wealth or enjoy it before you have created it and the simple fact is that productivity is lagging behind our aspirations. Moreover, the problem is clearly of our own making. The suggestion had been made repeatedly that we were importing inflation and had no control over it. However, as the Minister of Finance confirmed at the Conference of First Ministers last week, the fact is that costs are now rising much more rapidly in Canada, particularly in wages and salaries, with serious consequences for our international competitive position.

The Financial Post remarked recently: "Certainly the marked slowdown in output per person employed has been one of the mysteries of the 1970's." It is true that recent increases in output per employed person slowed from 2% in 1972 to 1.6% in 1973, with no effective increase at all last year. But with respect, I do not think it is a mystery. A number of factors combine to explain it, among them:

Massive shifts to service sectors and government where productivity gains are hard to come by.

A general shift to fewer hours of work and less time at work.

The lack of sustained incentives to renew capital equipment.

The declining tendency to worship at the altar of the Gross National Product and a greater concern with quality of life (or the so-called urge to take some of the grossness out of the gross national product).

The chronic uncertainty and instability in intergovernmental relations which has deterred necessary drive and initiative in the private sector.

The complicating factors of food shortages and energy restrictions.

Prices have risen as a result of expectations outpacing economic performance, with the price system now bearing no resemblance to productivity. Although our aspirations have continued to expand, we have moved into a virtual state of "zero growth" and a "steady state" in productivity. As Mr. Turner described it last week: "We are now at the stage where various groups, driven by the desire to catch up with the rapid inflation that has occurred and protect themselves from the future inflation they fear, are making demands upon the economy which add up to more than the economy is capable of producing." At the same time, the diminishing base of the economy that is truly productive is being asked to carry more and more of our public requirements. Meanwhile, we are asking governments to solve problems whose ultimate solution lies with us. What kind of Canada do we want? How hard are we willing to work to achieve it?

Recently, I asked a young friend how he was doing in school and he replied "I'm doin' good. I'm doin' good in reading and in arithmetic and I'm doin' real good in grammar." In turn, I said: "Don't you mean you are doing really well in grammar?" He said, "Oh no, I'm not doin' that good." We would certainly do well if we could do better in our productivity performance.

However, we must also be careful how we use the term "productivity" because, with our increasingly service-industry economy, we require other yardsticks of effectiveness; the assembly-line term productivity may actually mislead us in establishing desirable public policy. Let me illustrate by some comments about the impact of current economic conditions on the state of Canadian universities. It is perhaps curious that, in Ontario, one sector that is being urged to do what the overall economy has not been doing, in terms of productivity, is the university. We are not being told that politicians, professional athletes, or ballet dancers should be more productive, but university professors must be. One of the shortcomings of the term "productivity" is its narrow, quantitative meaning. The term in universities has come to be applied to the staff-student ratio. Quadruple the numbers in a classroom and all will be well, it is argued. However, that says nothing about the quality or effectiveness of the teaching and nothing about research, scholarship, and student guidance and assistance and the countless other activities of professors in a university. What we require then is attention to "productiveness"--a term which employs quality and merit as true yardsticks of effectiveness.

Nor do I like current proposals for reducing admissions to the universities, and the assumption that this will automatically ensure the admission only of the more gifted members of our society. I believe we are far from the ideal goal of equality of educational opportunity in Canada. I am not convinced that sons or daughters of hard-rock miners in Timmins, assembly-line workers in Oshawa, or marginal farmers in Eastern Ontario have the same economic and environmental advantage, nor am I convinced that newcomers to Canada with language handicaps have the same opportunity for getting to university. We must continue to broaden educational opportunity.. At the same time, we should avoid confusion between the terms "elitism" and "merit". Universities should not be elitist institutions, but they must be places of merit. To ensure opportunity to all who can profit from the university experience will help to accomplish that objective.

Other questions are raised by the debate over admissions policy. What is the basic purpose of the university? Are we to continue with mass education or revert to the academy? Are we to provide general education or occupational preparation? Are today's courses designed and taught in the most appropriate manner? For example, should science continue to be more important than the humanities in preparing a person to be a medical doctor today?

As a new university president, I believe that I brought a reasonable degree of objectivity to the preparation of my first university budget. I also believe that we are now in danger of gravely diminishing the basic quality of our universities as a result of under-financing. But I have never taken the view that it was sufficient to blame an uncomprehending public or an unsympathetic government. I believe that we can convince the public and governments, but we will have to work at it.

In 1956, a significant national conference called "Canada's Crisis in Higher Education" was held in Ottawa to discuss ways of preparing for the great bulge of post-war babies that swept like a tidal wave across old and new universities in the 1960's. I believe that in 1975, we require another such conference, a national conference on "The Survival of Universities in Canada" in order that we can chart our course for the Seventies, renourish our declining morale, and provide not only the provincial governments but the federal government with renewed evidence of the social importance of universities.

Perhaps at this stage you are wondering about the connection of this with my main theme about the Canadian economy. Well, in one sense there is none, because I do not regard the justification for education as "investment in human capital" in that unfelicitous phrase of the Sixties. However, I would insist that we will not improve our economic position or enhance our highly favoured social situation without the strong leadership and the wide variety of humanizing influences, which universities can provide. I believe that the universities can still offer that leadership and I would be happy to document the proposition, but that would require another speech on another occasion.

The story is told of an absent-minded professor who lived on Toronto Island. One morning, he rushed down to dockside and saw the ferry about two feet out from the dock. He flung his briefcase abroad and with an heroic leap, landed on board in a heap. Looking up with a benign smile, he gasped: "I made it." To which one of the hands replied: "Yes sir, but why didn't you wait until we docked?"

The Canadian economy labours under no such confusion. It has docked and is not moving! And yet, a magnificent journey still lies ahead for Canada if we can rev up the engines, keep down the price of fuel, encourage the helmsman to steer the smoothest course, and urge the hands to be more moderate in wanting to enjoy the benefits of the promised land before we have arrived. Clearly that involves a wide degree of understanding, and some national goals and objectives. We must all work at the first and we should insist on no less than the second.

Dr. Macdonald was thanked on behalf of The Empire Club of Canada by Colonel E. A. Royce, a Past President of the Club.