Too Few Producers: In Britain and North America

BRIG. GEN. LEWIS:

Members and friends of The Empire Club of Canada: Drawing, as the Empire Club does, upon the wide spectrum of professions and occupations for our guest speakers, both national and international, provides this club with a balanced look at the affairs of man and our world. Depending on what our speakers have to tell us, we can leave here, stimulated, depressed, exhilarated, but always with something to think about. Perhaps the more thought-provoking of our speakers are those who come to us from the academic world. I can tell you with a great degree of assurance that that is the case with our speaker today, Dr. Walter Eltis, Fellow of Exeter College and Lecturer in Economics at the University of Oxford.

It was Dr. Eltis, writing in 1975 for the Sunday Times, explaining reasons for the decline of the British economy, who sparked a controversy that continues today among British politicians, businessmen, trade unionists, economists and bureaucrats.

Dr. Eltis has chosen as the title of his address today "Too Few Producers." This is taken from the title of his recent book Britain's Economic Problem: Too Few Producers. The book has received wide attention and acclaim in economic circles around the world and, most importantly for us, it draws parallels between British and Canadian economic problems.

Dr. Eltis has held his present post at Oxford since 1963 and his expertise in his chosen field can be attested to by a quick glance at his curriculum vitae. Amongst other impressive activities and qualifications we see: 1970, Visiting Reader in Economics at the University of Western Australia; 1976/77, Visiting Professor of Economics at the University of Toronto. His current tour of Canada is under the auspices of the Canadian Chamber of Commerce, and in March and April of this year he takes up a visiting professorship at the European University Institute, Florence.

Dr. Eltis has given the Woodward Lecture at Yale University, and he has spoken to many groups in Canada and the United States, such as the National Planning Association, the Rand Corporation and the Washington Chamber of Commerce.

One has the decided impression that our speaker is a pragmatic economist who would give short shrift to the type of statistician who puts his head in the oven and his feet in the fridge and states that on the whole he is feeling fine. Given the concern of most in the audience for the state of the national and indeed the world's economy, we are delighted that Dr. Eltis has found time in his busy Canadian schedule to be here with us today to address us on the subject "Too Few Producers."

Ladies and gentlemen, I am honoured to present to you Dr. Walter Eltis of the University of Oxford.

DR. ELTIS:

There is a growing understanding that the economic difficulties of Britain and North America are fundamentally structural. A most important aspect of the structure of economies is the relationship between the size of the sector of an economy where an economic surplus is produced, and the requirements of those who live off that surplus. Teachers, civil servants, doctors employed by the government, soldiers, policemen and pensioners produce no marketed output but they buy a great deal. The output they buy has to come from somewhere and it comes from the production of companies, whether private or nationalized, and from those who work for them. These produce more marketed goods and services than they buy, and the surplus then goes to those who produce none.

Suppose we have an economy where industry and commerce produce a surplus of thirty per cent while teachers, doctors and civil servants try to buy forty per cent. There is only one place that the other ten per cent can come from and that is from overseas. Hence a country which is trying to spend forty per cent outside the market sector and only has a thirty per cent surplus within it is going to have a trade deficit of ten per cent of marketed output, which is going to cause a collapse in the pound, dollar, lira or whatever its money is called, which is then going to force interest rates higher, and produce all the other effects that result from balance of payments weakness.

The vital relationship is the one between the surplus producing sector, companies, public corporations, banks, and so on, the size of the surplus that they produce, and the needs of the government-financed surplus-using sector. Because this is the vital relationship it does not follow that the surplus-using sector is in any way less significant to the well-being of a society. Health, education, an absence of slums, and an absence of poverty and destitution are of vital importance to societies as rich as ours, indeed to all societies, and it is arguable that they matter far more than extra material production. It is essential to comprehend, however, that it is the surplus-producing sector that makes social welfare possible, and so the viability of the surplus-producing sector is what attention must be focused on. If that sector fails to produce an adequate surplus and to expand sufficiently rapidly, the financing of the social services will be undermined.

The requirements of the government-financed non-market sector have grown very rapidly in both North America and Britain since 1965. In the United States the government-financed surplus-using sector needed 30.7 cents in the dollar in 1965 and 38.5 cents in the dollar in 1977, an increase of eight cents in the dollar. In Britain the government sector needed 35.1 cents in the dollar in 1965 and 44.0 cents in the dollar in 1977, an increase of nine cents in the dollar. In Canada the needs of defence and welfare increased from 33.2 cents in the dollar in 1965 to 43.9 cents in the dollar in 1977, an increase of eleven cents in the dollar. These shifts have produced great strain because the transfer of an extra ten per cent of total output to the non-market sector has had to be financed in economies with quite low productivity growth rates. In these twelve years the average British, Canadian or United States worker has produced only 20 to 25 per cent more and the government has needed a high fraction of this addition to real resources.

In the twelve years from 1965 to 1977 the United States government spent forty-five per cent more in real terms on behalf of each American worker. This left just three per cent extra per head for companies and workers to spend themselves on private consumption and investment. Those who produced the surplus therefore got three per cent more and those who used up the surplus got forty-five per cent more. In Britain those who produced the surplus in industry and commerce got twelve per cent more from 1965 to 1977 while government spending for each market sector worker increased sixty-two per cent. In Canada there was a six per cent increase in these twelve years in the marketed output available for each of those who produced it and a sixty-seven per cent increase in what government spent on their behalf.

These are great discrepancies. From 1973 to 1977 they were partly influenced by the fact of the world recession, and in recessions governments rightly continue to expand their spending even though private sector companies produce less and sell less. If the eight years from 1965 to 1973 which led up to world recession are considered in isolation, it still emerges that spending by the government on behalf of each worker in Canada, Britain and the United States increased over twice as fast as what workers and companies were themselves able to spend.

It is not wrong in principle that spending on education, health, pensions, personal security and the arts should have increased so much in relation to personal consumption. There is a clear trend that as people become richer they spend more in these directions. The wealthy are especially concerned about their health and that of their families, the education of the next generation and adequate provision for retirement. These are provided by government for those who are poorer, and it is right that the provision which is publicly made should grow as fast as those who are free to choose provide for themselves. But there is a vital consideration that must always be kept in mind. What is provided publicly comes ultimately from the surpluses provided by companies and corporations, and if the part of the economy that produces those surpluses cannot function effectively, then there will be nothing to provide the social services that all desire. So it is on the health of the market sector in Britain, the United States and Canada and the surpluses that it provides that attention must be focused. Did the very rapid growth in public services in all three countries undermine the ability of their industry and commerce to function effectively?

The examination will start with Britain where the growth of government expenditure produced an immense increase in tax and social security deductions from the paypackets of the average worker. In 1963 fourteen pence in the pound were deducted from the pay of the average British worker, and by 1975 thirty pence in the pound were being deducted, so an extra sixteen pence in the pound were deducted over these twelve years. With a thirty per cent rate of deduction from paypackets by 1975, the ordinary worker was being asked to pay the taxes that used to be required of a bank manager or university professor. At first workers reacted to the steady increase in taxation that they were expected to pay with great restraint. From 1964 to 1969 they co-operated with antiinflation policies which restricted pay increases to four or five per cent, and there were extremely few labour disputes. In return for this co-operation, what was left in paypackets after all tax deductions took five years to increase just 3.5 per cent.

Workers were not pleased by this, and they began to feel that their unions were letting them down, so there was a gradual change in union leadership and policies. Workers had found that co-operation got them less than one per cent extra a year and after 1969 unconditional co-operation ceased. The unions started to push up wages very much faster and to organize so that their net pay rose even though more and more taxation was being deducted. To achieve this, they chose leaders often from the militant Left who were expected to maximize the bargaining power of their group. The new union leadership had fewer inhibitions about the methods used to obtain large wage increases and they set their sights, not on increases of seven per cent or so which had been regarded as high until 1969, but on increases of well above ten per cent. The rate of inflation increased sharply, but with the new militancy the average worker managed to increase real take home pay fifteen per cent from 1969 to 1973, compared to only 3.5 per cent in the previous five years of co-operation.

But during the period when the workers co-operated there was no damage to the underlying productive structure of the economy. From 1965 to 1969 the government took an extra 2.3 per cent of marketed output and private consumption in the market sector fell by 2.6 per cent of output so the growth in government expenditure was financed entirely from private consumption. Investment and exports both got a greater share of output. Hence, so long as the workers paid for the growth of government, the structure of the British economy became stronger and the country was able to maintain high employment and improving public services.

When the workers started to act militantly from 1969 onwards their extra wages had to come from profits, and from 1969 to 1973 they succeeded in reducing the share of profits in industrial production by something like six pence out of every pound produced. Government was no longer growing at the expense of workers' consumption. As a result of the increase in union militancy and power, workers' consumption increased faster than output despite increased taxation. At the same time government claims rose sharply, by over three per cent of output. As workers and the government both took a higher fraction of output, capital investment and the balance of payments were bound to get less, and this in fact happened. Accompanying the profits squeeze, investment and the balance of payments got 4.1 pence in the pound less in 1973 than in 1969. Investment in job creation suffered. Employment by British companies fell by over 100,000 a year after 1969, and the balance of payments moved towards collapse.

The mechanism by which the workers shifted the National Income away from profits and towards wages and salaries deserves attention. After 1969 the trade unions demonstrated that they had the power to increase money wages very rapidly. The government found it unacceptable that money wages should rise explosively, and so Mr. Edward Heath's Conservative government reached a temporary agreement with the unions in 1972 whereby they agreed to wage restraint on condition that profits would be severely restricted through government price controls. The workers said that they would not agree to wage restraint if companies could price as they pleased. The government then placed companies in a situation where they were not allowed to pass on increases in wage and raw material costs in full, so profits were squeezed, the share of wages in the National Income rose and some other component of incomes had to give way. Hence the key to the workers' higher share of wages was their power to force price and wage controls, unfavourable on balance to profits, onto the government.

There are two ways in which the inevitable consequences for the balance of payments can be explained. On the one hand, once workers were well enough organized through their unions to hold their share of consumption in the National Income, workers' consumption can be likened to one millstone. The government at the same time had the power as always to take all the resources it wanted, because it signs the cheques and because it can print any money it needs, so its claims resemble another unshiftable millstone. What was in between these millstones was bound to be squeezed and in the end crushed, and it was in fact capital investment and the balance of payments. If the government has invincible power to raise its real spending while unions give the workers power to resist any cut in their spending, something else, namely investment and the balance of payments, must take the strain. Profits are of course severely squeezed in this situation and it may be that companies react by investing less. But suppose companies bravely go ahead and invest as much as before, even though they are short of cash. In that case it must be the balance of payments that takes the strain, and as the two millstones move towards each other the balance of payments is bound to move massively into deficit. This results in a large excess of imports over exports. The government cannot face this and once foreign loans and borrowing reach their limit, it has to deflate the economy which persuades companies to cut investment. The sequence is then that the balance of payments is hit first and investment in job creation suffers after that.

That is one way of looking at the difficulty. A more fundamental way returns to the relationship between the surplus-creating sector and the surplus-using sector set out at the start. If, as a result of union pressure, the government introduces price and wage controls which have the effect of squeezing profits, the surplus of marketed output that companies provide will also be squeezed. If the companies provide a smaller surplus and the government takes more, the difference has to come from the balance of payments.

This can be illustrated very vividly from what happened in Britain because it is in fact possible to estimate the surpluses of marketed output that British companies provided each year. From 1961 to 1977 British private sector companies provided a rate of surplus for the finance of social welfare which averaged 35.9 per cent. The nationalized industries or crown corporations provided a rate of surplus which averaged only 11.1 per cent. This meant that if the whole British economy had been run like the private sector companies, Britain could have had a welfare state of around thirty-five per cent which is roughly what Britain in fact had. If the whole economy had been run like the nationalized industries, Britain could have had a welfare state purchasing only eleven per cent of total output. So if the whole economy had adopted the pricing and investment policies of the nationalized industries, pensions would have had to be cut by two-thirds, and two-thirds of the doctors, teachers, soldiers and policemen would have had to be sacked because the nationalized industries were only capable of supporting an eleven per cent welfare state.

The reason for the low rate of surplus of the nationalized industries was first that they invested massively, far more than the private sector, and to a large extent excessively. There was one year, 1975, when their gross investment actually equalled forty-eight per cent of their gross output. In 1972, Britain spent 2.5 per cent of the country's entire production to produce just three per cent of the country's total energy requirements through the nuclear-energy program, which is a rather poor trade-off. The nationalized industries also went through a period when they priced massively below costs of production in an attempt to check inflation. For four years, 1972, 1973, 1974 and 1975 the prices they charged failed even to cover wage costs and in 1975 they sold their output so much below cost that they needed loans or subsidies of fifty-eight pence for every pound's worth of net output they produced. As the nationalized industries produced a very low or even negative rate of surplus, a far larger rate of surplus was required from the private-sector companies, but during the period of price and wage controls the private companies were obliged by Mr. Edward Heath's government to price as if they were nationalized industries. They too were expected to price below cost, and in 1974 the surpluses provided by the private-sector companies were thirteen pence in the pound less than in 1972. The simultaneous fall in the rates of surplus provided by both the private companies and the nationalized industries led to Britain's largest balance-of-payments deficit in 1974, when imports actually exceeded exports by eight per cent of the National Product. An equivalent Canadian deficit today would be a staggering twenty billion Canadian dollars, which is over three times the present deficit. Of course the British deficit of eight per cent of the National Income, due fundamentally to the fact that private sector companies and the nationalized industries were both being obliged by government to provide a much diminished rate of surplus at a time when the welfare state was taking markedly more, led to a collapse of the pound and soaring British interest rates.

The period when all this was happening in Britain was one when the government was not very concerned with the efficiency of its own sector and extremely concerned about the way the private sector was being run. The writings of John Kenneth Galbraith had been very influential, and governments believed that the private sector was full of distortions and inefficiencies which called for action. Those who ran the public sector were in contrast regarded at least by economists as all knowing and capable of taking society's needs as well as private greed into account. It was believed that this complete knowledge of private and social costs and benefits would lead to decisions in the public sector which were bound to be socially efficient. In many countries, including Britain, Professor Flores' statement that, "The private sector can be defined as the part of the economy that the government controls: the public sector is the part that nobody controls," was only too true. The indifference to efficiency of the British nationalized industries has already been described. Two further examples from Britain can be added. From 1965 to 1973 there was a fifty-one per cent increase in hospital administrators in the National Health Service in a period where there was an eleven per cent reduction in the number of hospital beds that they were administering. From 1961 to 1975 there was an eighty-five per cent increase in employment in education, but only fifty-one per cent of those employed in local authority education actually taught pupils. The others administered, served meals, cleaned and did all kinds of things other than teach. The money spent on Mirabel airport is a very clear Canadian example of the proposition that "The public sector is the part of the economy that nobody controls."

By 1973 the growth of the British non-market sector and its inefficiency were severely undermining the productive structure of the economy. Profitability had been severely weakened as a result of the success of trade union militancy that resulted from worker frustration, and there was far too little investment to maintain employment in the market sector. The rate of annual job loss accelerated to over 125,000 a year. The world recession clearly contributed to this trend. At the same time British workers have become still more frustrated since 1973 because the economy is very clearly producing far too little marketed output to satisfy the now far stronger trade unions. Despite some recent tax cuts, the average unmarried British worker had 3.9 per cent less real purchasing power available to him after tax deductions in 1978 than in 1973 while the average married worker had 0.9 per cent less. Workers see some unions achieving increased living standards through the exercise of market power, and press their own unions to achieve the same, to produce the dreadful results that are visible in Britain in the winter of 1978-9. Local authority workers have waited for heavy snowfalls to refuse to grit or sand roads which then had to be closed. Some ambulancemen have said they would not take victims of road accidents to hospital. Gravediggers have been on strike and there have been union pickets outside cemeteries to prevent burials. Lorry drivers closed the ports for four weeks and refused to allow movements of food which caused farmers to slaughter animals they could not feed. That is what can happen where companies and corporations are unable to produce enough marketed output to provide the increased private consumption and improved social services workers desire.

There is one country which has experienced developments very similar to Britain's, but where these have gone still further in some respects, and that is Sweden. Hans Soderstrom and Staffan Viotti of the Institute for International Economic Studies in Stockholm have explained recent developments in the Swedish economy very vividly. In their account, wages rise faster than prices and productivity in the sector of the economy which produces tradeable goods and services--which is predominantly industry. As the real cost of labour rises there, companies find it unprofitable to employ as many workers as before, so they cut employment. As it is widely agreed in Sweden that it is the government's duty to act as employer of last resort, all the people who become unemployed in industry are found some kind of work in the public sector. This puts up taxation--the Swedes finance most of their public expenditure through taxation and not by printing money--and the higher taxes cause the workers to put up wages again. This further rise in wages (and Assar Lindbeck, Director of the Institute of International Economic Studies has pointed out that with Sweden's marginal tax rates it now takes a three per cent rise in wages to recover one per cent of wages lost through higher taxes), gets still more workers sacked from private industry. These extra workers are then absorbed into the public sector which pushes up taxation yet again. As the Swedes form one of the more disciplined communities in the world, and as they have also strongly favoured full employment and public sector expansion, they have managed to push taxation to what must be the highest ratio in the world by this mechanism. In just the six years, 1970 to 1976, average taxation in Sweden increased by twelve cents in the dollar from forty-six per cent to fifty-eight per cent of the National Income. There is no other OECD country where it increased by more than seven cents in the dollar in this period. The tax ratio has continued to rise since 1976 and in 1978 it reached sixty-five cents in the dollar. The Swedes are now beginning to believe that at sixty-five per cent it has reached some kind of limit. Given this, they have started to attempt to reverse the continuing job loss in industry which is due to the fact that profits are too low and wage costs too high. Hence wage costs have had to be reduced and profits increased so that there is sufficient investment to create jobs. If employment does not increase in industry and commerce, still more workers will have to be fitted into the public services which would push up average taxation beyond sixty-five per cent. Alternatively the economy could cease to offer full employment. But reversing the process which has been described is extremely difficult and it involves making workers worse off for a time. It must, however, be reversed. Since taxation cannot be increased every year without limit, the Swedish process of squeezing workers out of industry and then re-employing them in the public services cannot continue indefinitely.

There are clear similarities in what has happened in Britain and Sweden. In both countries the growth of the surplus-producing sector has been gradually undermined through continuing union pressures to raise personal consumption on the one hand, and a growing government share leading to ever-rising taxation on the other. These pressures have left too little in between for investment in job creation in industry and commerce on which the whole surplus-creating capacity of the economy, and therefore its ability to finance social welfare, depends.

Has growing government spending produced similar effects in North America? In the United States the increase in government expenditure has been nearly as fast as in Britain but between two-thirds and three-quarters of the increase has been local and not federal. As a share of the National Income, both the extra government spending and the increased taxation has been predominantly by states, cities and townships.

A second point to note about the increase in public expenditure in the United States is that the increases in expenditure and taxation have been by no means uniform. In the four highest taxed cities, Boston, Buffalo, New York and Milwaukee, total local taxes averaged 15.8 cents in the dollar for a family of four earning $20,000 to $30,000 in 1975. In Houston, Jacksonville, Memphis and Nashville, they averaged 4.7 cents in the dollar at the $20,000 income level and only four cents in the dollar for a family earning $30,000. Those in the Liberal north-eastern Galbraithian states were therefore paying about twelve cents in the dollar more than the southerners. That meant that Americans could opt out of the whole increase in the government sector by simply moving to Houston, and millions have moved from the northeast to the south. From 1960 to 1975 population increased sixty-seven per cent in the four low-tax cities and fell six per cent in the high-tax ones.

The New York/Houston tax discrepancy was in fact one of 13.2 cents in the dollar at the $20,000 income level and 14.6 cents in the dollar for those earning $30,000 and this meant that there were very clear financial incentives for the better off to move south. At the same time, New York social benefit levels were higher so there were incentives for the unemployed and the unemployable to move north. A former mayor of Houston put it colourfully when he said, "Houston is a good place to be if you want to work. If you don't want to work you might get a better deal in New York." In New York City there was a fifteen per cent fall from 1960 to 1976 in those employed in industry and commerce who produced the surplus that financed the city. In the same period the city employed forty-two per cent more to use up that surplus. So you had forty-two per cent more people living off the surplus that fifteen per cent fewer people were producing. This led to New York's inevitable financial crisis and when that point was reached both sectors in New York started to cut employment. The market sector workers continued to leave New York, and 200,000 market sector jobs disappeared between 1974 and 1976. At the same time, New York City had to cut employment once the financial crisis point was reached, and from 1974 to 1976 New York City sacked 50,000 workers. Hence both sectors of New York started to decline once the point of financial crisis was reached and this has had devastating social effects. If we look at the employment of sixteen- to nineteen-year-old teenagers we find that in low-tax Houston it rose from forty-one per cent in 1970 to forty-seven per cent in 1976. In high-taxed New York it fell from thirty to a socially disastrous twenty-two per cent in the same period, and among the ethnic minority groups only one in seven of the teenagers has a job.

The example of New York shows the socially devastating effects of pushing up the costs of the government sector faster than workers wish it to be pushed in one part of a country which workers are free to leave. Those who increased welfare expenditures faster in New York than in the remainder of the United States thought they were increasing welfare. Instead they drove out the taxpayers who finance it, and ended up with social disaster: a large dependent population with too little money to support it, and few employment opportunities for those who wish to work. The attempt to increase welfare expenditures too rapidly has therefore destroyed social welfare.

To what extent has the growth of government expenditure in Canada had effects which parallel those in New York and Great Britain? Government expenditure has increased faster in Canada than in either Britain or the United States, so it is to be expected that it will have had very significant effects.

In fact from 1965 to 1973, the eight years leading into the world recession, the Canadian social services grew entirely at the expense of personal consumption. In 1965, Canadian workers in agriculture, industry and commerce consumed 55.6 cents worth of every dollar they produced. By 1973, largely as a result of greatly increased taxation, they consumed only 47.3 cents in the dollar. This staggering fifteen per cent fall in the proportion of output that the average Canadian worker consumed more than financed the improvements in Canadian social welfare expenditures. It financed higher investment and a better balance of payments in addition. But the price was a heavy one in terms of deteriorating industrial relations.

Because of the greatly increased taxation the average Canadian worker only increased consumption by 0.5 per cent a year from 1965 to 1973. The social pressure from this was partly relieved by the fact that more Canadians in the average family were working. On average in Canada the proportion of the population that has been working has been rising by 1.5 per cent a year. This is mainly because there has been an increasing tendency for wives to work, and to increase their hours of work. Hence, while the average Canadian worker spent about 0.5 per cent more each year in real terms, the average family was able to spend about two per cent more because more members of the family were working. But this only benefited some families, and there is no doubt that the individual Canadian worker's income was growing quite slowly. Hence Canadian unions began to organize like British unions to get a faster increase in private consumption. If the number of days lost through strikes in Canada are examined, these averaged only 1,611,000 a year from 1956 to 1965 but they increased to an average of 5,592,000 a year from 1966 to 1972. Until 1965, Canadian wages increased at much the same rate as United States wages, but from 1965 to 1973 they increased two per cent a year faster than United States wages and from 1973 to 1976 they went up six per cent a year faster than United States wages. Canada then reached the British point of needing price and wage controls in order to restore discipline in the labour market which is something that most of the world's economies have not needed. The fact that Canada like Britain has needed price and wage controls certainly suggests that there was considerable worker frustration about the slow growth of private consumption.

In Britain the worker frustration, leading to increased union power, started to undermine the productive structure of the economy from 1969 onwards. Fortunately for Canada, such evidence as is available suggests that there has not been significant structural damage to the economy of the type that occurred in Britain. Thus in Britain employment in the market sector of the economy fell by 0.75 per cent a year during the world recession. In Canada, in contrast, employment in the market sector, that is in agriculture, industry and commerce, increased by 1.75 per cent a year throughout the world recession.

Until the start of the world recession Canada, of course, increased employment faster than that, in fact at a rate of about 2.75 per cent a year, but if Canada had reached a point of serious structural damage by 1973 then the country could not have continued to expand market sector employment at a rate of almost 2 per cent a year. In both New York and Great Britain employment started to fall at a significant rate once the damage was done.

An examination of profitability in the Canadian market sector tells a similar story. According to the international MacCracken report which sought to compare profits in a number of countries, the share of gross profits in the Canadian National Product increased from 28.2 per cent in 1965 to 28.8 per cent in 1973, and then fell only to 27.2 per cent during the first three years of the world recession. In the United States, in contrast, profits fell from 29.5 per cent of gross output in 1965 to 25.1 per cent in 1976, a far sharper fall than Canada's. If the share of corporate profits in the Canadian National Income is examined, then the share of profits less capital consumption and inventory inflation was 10.6 per cent in 1965, 11.4 per cent in 1973 and 11.6 per cent in 1975.

There are thus two indicators which suggest that Canadian profitability has been maintained through the world recession, indeed that it has shown remarkable stability. Data for capital consumption from 1975 to 1977 is not yet available, but the gross profits share has continued to hold up so there is no particular reason for apprehension.

Hence, the British effects of growing government expenditure, declining profitability and falling market-sector employment have not been shared by Canada. There is, however, one British symptom of deterioration that may merit attention. Canadian manufacturing profits were thirty-four per cent of total profits in 1965, thirty-three per cent in 1973 and only twenty-four per cent of total profits in 1977. So there certainly has been a Canadian profits squeeze in the manufacturing sector and presumably a commensurate relative increase in profits in the mineral and commercial sectors. The reason for this is first that the extra rise in Canadian wages relative to United States wages has been especially damaging to profitability in industry, where Canadian and United States prices must be competitive. The same is not so true of services like banking, insurance and retail distribution, where it is far easier for Canadian firms to pass their higher wage costs on to the consumer. In the second place, Canadian price controls have hit manufacturing especially. The prices charged by banks, insurance companies and shops are not easily controlled by the government but the prices charged for manufactures are controllable. It is therefore reasonable to suppose that the Canadian Anti-Inflation Board which ordered a number of companies to lower prices during the period of price and wage controls damaged industrial profitability. There may therefore be weaknesses in profitability and in the productive structure of Canadian manufacturing industry.

The recent devaluation of the Canadian dollar to $.84 U.S. should however have restored profitability, at least for a time. This has made up for much of the extra Canadian wage inflation since 1965. However, the benefits from a competitive Canadian dollar will soon be lost if the consequent increase in the Canadian cost of living prompts Canadian workers to raise wages far faster than United States wages. In the second and third quarters of 1978, Canadian exports of goods were about twelve per cent higher in volume than in the equivalent quarters of 1977. This indicates that the devaluation of the Canadian dollar is assisting the recovery of Canadian industry, and that a rise in industrial employment and profitability should follow. But if Canadian wages now explode upwards, profitability will revert to the previous low levels and the recovery of industrial production will slow down. This is where the previous growth of government spending makes conditions especially difficult for Canada. Real consumption per worker in Canada was only three per cent higher in 1977 than in 1965. There is therefore a considerable frustrated desire for more private consumption in Canada as in Britain, for the government has taken most of the fruits of higher productivity in the market sector. The Canadian unions are also far more organized than they used to be and here also they have followed Great Britain. It is extremely important for Canada that, despite these difficulties, wage restraint be maintained so that the eighty-four cent Canadian dollar leads to industrial revival rather than to accelerating inflation which could set the scene for further falls in the dollar.

To sum up the present situation, growing government spending has plausibly presented Canada with a frustrated and unionized labour force but so far such structural deterioration in the economy as there has been appears to have been confined to industry, and Canada now has an opportunity to restore industrial profitability and to add considerably to industrial employment.

If Canada has not experienced a British-type deterioration in the profitability and employment provided by the market sector as a whole have there been New York style regional effects? There is one major cause for concern here. Quebec has both higher taxation and government expenditure and lower marketed output per worker than Ontario and the western provinces. It also has a higher minimum wage than Ontario and other provinces, and language regulations that are driving market sector companies out. Like New York, it is persuading many of those who pay its taxes to leave. There are, however, significant differences between Quebec's vulnerability and New York's. Canada equalizes taxation between the provinces to a much greater extent than the United States, and partly as a result of this, in 1978 Quebec taxpayers only paid about five cents in the dollar more in total taxation than Ontario taxpayers at the same income level. The tax discrepancy between New York and Houston was about two and a half times as great at around thirteen cents in the dollar in 1975. In Alberta, total taxation is perhaps ten cents in the dollar less than in Quebec which begins to approach the United States north-south tax difference, but Quebec is probably more vulnerable to a departure of companies and the skilled to Ontario and there the tax discrepancy is not yet very considerable. The situation will however change each year and to Quebec's disadvantage if companies continue to leave. Every such switch will reduce Quebec's tax base and increase Ontario's and so further increase Quebec's relative tax handicap. The public and private sector employment statistics of the provinces will therefore need to be watched with great care in the next years.

What of the future of the Canadian economy as a whole? Why is there such profound concern about the Canadian economy if the structure of the economy has come through the world recession with profitability undamaged and seven per cent more productive jobs than in 1973? Sadly this rate of job creation is insufficient for Canada's long-term needs. International population projections suggest that Canada's population growth in the period to 1985 will be one and a half times as fast as that of the Soviet Union, the United States and Japan, and ten times as fast as the European Economic Community's. Because of Canada's very rapid rate of population growth and the increase in participation rates--more women working each year--the country needs substantially more job creation than other economies. The result is that the 1.75 per cent per annum rate of growth of employment that Canada has been achieving is too slow to prevent unemployment from growing. Unemployment has almost reached nine per cent already and it will rise by a further 0.75 per cent during each year that the prospective labour force rises 2.5 per cent and only 1.75 per cent new jobs are on offer.

Canada must therefore raise the rate of job creation as a matter of the greatest urgency but how is this to be done? Some Canadians are suggesting that expansionist Keynesian policies should be pursued still more strongly than they have been. Canada already has a budget deficit which exceeds five per cent of the National Income and the suggestion is that a still larger deficit should be tolerated. Britain is very familiar with these policies and British experience has been that they no longer work. A high fraction of the extra demand that results from tax cuts or government expenditure increases is spent on imports, perhaps as much as sixty-seven per cent in the British case, and the effect of this has been that the British Treasury has expanded the Japanese and West German economies about twice as much as the British in its Keynesian spasms.

Canada also has a very high import ratio, so there may be a similar tendency for the extra demand that Canada creates to leak out of the economy. What is more serious is that these leakages cause immense deterioration in the balance of payments. Canada's current account is already in substantial deficit, and the dollar is falling faster than the government wishes. Still more Keynesian expansion would produce a still weaker balance of payments and therefore a still weaker dollar and yet higher Canadian interest rates. The fall in the Canadian

dollar to $.84 U.S. gives the country an opportunity to reduce the deficit, but statistical work in Britain suggests that the balance of payments improves after a devaluation only to the extent that the budget is improved. So Canada will sabotage any benefits for exports and for the expansion of industry which should follow from the lower dollar if a still more expansionist budgetary policy is now attempted. So that is not the answer.

Is the answer more government-financed job creation schemes? Statistical evidence from a recent Harvard-MIT study suggests that throughout North America fifty-seven per cent of industrial jobs disappear every ten years, because of international competition, the obsolescence of plant and the development of better products elsewhere in North America. These jobs which disappear have to be made good through the creation of an equivalent number of new jobs. In some parts of North America, namely the south, they are more than made good. In other parts, namely the northeastern states of the United States, they are not made good, and industrial employment declines. The process that is being described is one of creative destruction, in which bad jobs disappear and are replaced by better ones. Britain has made the terrible mistake in the past four years of putting most of such government money as is available to deal with the employment situation into job preservation rather than job creation. Britain has therefore subsidized the continuation of the bad jobs. The country has attempted to stop the fifty-seven per cent from disappearing instead of putting the money towards the creation of good new jobs which can hold their own against international competition. There is no doubt that such money as is available must go to the creation of jobs to produce new products that can win international markets and hold their own against foreign competition in the home market. Such projects are hard to find and it is probable that Canada is doing about as much as can be done in these directions as it is. There is no doubt that trying to defend the old jobs that international competition is undermining is an increasingly expensive Canute-like task from which no long-term benefits can accrue.

There is, of course, no fundamental reason why a resource-rich country like Canada should have to finance all the job creation that is needed without foreign help. The United States was a resource-rich country with high potential for development in the nineteenth century, and the return on capital was higher than in England where the opportunities for growth were judged to be less. Capital therefore flowed from England to build factories, mines and railways in the United States, and the United States in consequence had a large current account trade deficit that was financed by a real capital inflow from Europe.

Canada today is a country with a high potential for development, like the United States in the nineteenth century. So it is right that other countries should invest to create real capital and jobs in Canada and that the Canadian current account of the balance of payments should be in deficit to the extent that other countries are helping to develop the Canadian economy.

Australia is in exactly the same situation, and in 1971-77 Australia's current account deficit was much the same as Canada's as a share of the National Income. But seventy-three per cent of Australia's current account deficit has been financed through the direct investment of international companies in Australia. This has meant that almost three-quarters of Australia's deficit has been financed by the creation of new productive jobs and new productive capital installations in Australia. In consequence Canberra has only had to borrow to finance the other twenty-seven percent.

In Canada's case none of the current account balance of payments deficit has been financed by international capital coming into Canada. Indeed the international direct investment flow has been out of Canada and not into the country, with the result that Ottawa has had to finance over one hundred per cent of Canada's deficit. This has meant that the Canadian government has had to make very large foreign borrowings and a great deal of Canadian fixed interest stock has had to be placed in New York and now other foreign financial capitals. The Canadian dollar slips downwards in relation to the United States dollar in every week in which Ottawa fails to borrow enough, and Canadian short-term interest rates have had to move up with United States rates and indeed to be above them most of the time because of the Canadian government's continuous need to borrow south of the border. If, like Australia, the Canadian government had only needed to borrow to finance thirty per cent of Canada's deficit because international companies were building factories and mines in Canada to finance the rest, then the Canadian dollar would be far stronger, and Canadian interest rates could be significantly lower than they are. The fact that the Canadian dollar has fallen forty-seven per cent in relation to the Australian dollar since 1974 despite Canada's slower rate of inflation underlines the force of this argument.

Why is capital flowing out of Canada? It is puzzling that it should be if the rate of return on capital is fully competitive with the United States as the statistics suggest. One possibility is that these statistics are misleading. In that case there is a straightforward answer. The statistics on comparative profitability need to be looked at carefully and if they show that the rate of return net of all taxes is weaker in Canada, then the simple solution is to cut the taxes that fall on companies. These amount to between four and five per cent of the Canadian National Income so they can be cut quite considerably. The return in Canada will then rise and international capital be drawn in. If, on the other hand, a careful statistical study suggests that the real rate of return on capital in Canada is fully competitive, then what is keeping international capital out of Canada must be lack of confidence in future profits. How drastically price controls can affect profitability has already been explained. Canada is one of the few countries in the world that has had to resort to these. International companies may well take the view that a country which has used these once may do so again, and believe that serious risks are involved in investing in a country where future profits are insecure.

But if present profitability is competitive, and only future profits are in doubt, then Canada's problem is a comparatively simple one. If profitability is currently sound, all that is needed is the expectation that those profits can also be earned in future. If that is true, Canada would have the comparatively simple task of establishing confidence that international companies will be able to act competitively in future and earn such profits as they can in competition with Canadian companies. Re-establishing confidence is a far easier task than altering the structure of production--which is the problem facing Britain.

It is of fundamental importance to Canada to discover precisely why direct investment is flowing out of the country instead of into it as it should be. If international investment starts to flow into Canada again, more jobs will be created, the exchange rate of the Canadian dollar will start its recovery and interest rates will be able to come down. Above all, renewed expansion of the market sector will safeguard the social services where Canada has achieved so much. Like Britain's, these are now threatened by expenditure cuts which can be reversed as soon as a faster rate of expansion of industry and commerce provides a sufficient growth in tax revenues.

The appreciation of the audience was expressed by Harold V. Cranfield, M.D., F.R.C.P.(C), a Past President of The Empire Club of Canada.