Does Government Economic Policy-Making Make a Difference? The Canadian Case

MR. ARMSTRONG:

At this point, Ladies and Gentlemen, I shall ask Mr. C. W Daniel, Chairman of this year's United Way Campaign to favour us with a brief message.

Mr. Daniel reported on the progress of the United Way Campaign and the results to date, asking the support of all segments of the community.

Mr. Armstrong thanked Mr. Daniel and assured him of the support of all present.

MR. ARMSTRONG:

Mr. Minister, Mr. Consul General, honoured guests, ladies and gentlemen. Our guest of honour today, the founder and former Dean of Administrative Studies at York University and former Chairman of the Ontario Economic Council, hails from Teeswater, Ontario, and thereby hangs a tale, or two.

It is alleged that some years ago Dr. Gillies, when in Chicago, went to the railway station and asked a ticket agent to sell him a train ticket to Teeswater. The ticket agent said, "And where, may I ask, is Teeswater?" To which Dr. Gillies responded, "Do you mean to tell me that you don't know where Teeswater is? I am surprised because everyone in Teeswater knows where Chicago is!"

To continue in this vein, one morning in the very early stages of our speaker's campaign, prior to the last federal election, the Mayor of Teeswater, with whom Dr. Gillies had not spoken in about twenty years, telephoned him to say that he heard Dr. Gillies was running for election as a Member of the Progressive Conservative Party and to let him know that a resolution of the Teeswater Town Council had been passed the previous evening, authorizing the expenditure of the town's funds to pay the cost of providing the services of the Teeswater Pipe Band for as long as required during the campaign. The band played at the Don Mills Plaza on several occasions during the course of the campaign, and in light of all the allegations made during and after the campaign concerning its rather high cost, the party workers were in hopes the critics would raise the issue of the cost of the band. To their chagrin the question was never asked. Now it can be told.

Without intending to embarrass our guest of honour further, may I add that on the evening of election day when the election results were being announced on TV within an hour of the closing of the polls, the computer declared Dr. Gillies elected and shortly thereafter his opponent conceded. Our guest of honour decided to telephone to his dear mother, who still resides in Teeswater, and he asked her if she was watching TV. She said, "Yes". Then after a protracted silence he said, "Mother, what programme are you watching?" I am informed that his mother is not inclined to waste too much of her time following the campaign. She likes the old time election pattern where you listen to a couple of speeches and then go to the polls on election day and vote.

Dr. Gillies holds degrees in Economics from the University of Western Ontario, Brown University, and Indiana University. In 1951 he joined the faculty of the University of California, Los Angeles. He served as Vice-Chairman of the Redevelopment Agency of Los Angeles, and as an adviser to the State of California, the Department of Urban Affairs in Washington, and the Organization of American States.

Dr. Gillies is the author of several professional and popular books. He has served on many government and civic bodies and was formerly a Director of several Canadian companies. He is presently a member of the Board of Governors of Humber Memorial Hospital, the Metropolitan Toronto Zoological Society, and is a Director of the Canadian Civil Liberties Association.

Dr. Gillies is Member of Parliament for Don Valley Riding, Co-ViceChairman of the P.C. Caucus Committee on Economic Affairs and Taxation, a Member of the P.C. Caucus Committee on Housing and Urban Affairs and of the Standing Committee on Finance, Trade and Economic Affairs.

Ladies and gentlemen, I am pleased to introduce Dr. James M. Gillies who will speak to us on the subject: "Does Government Economic Policy-Making Make a Difference? The Canadian Case."

Dr. Gillies.

DR. GILLIES:

No one can be sanguine today about the way in which the Canadian economy has been managed over the past few years. In the early 1970's, we had the ignominious reputation of having the highest unemployment rate of any industrialized country in the world-7.2 percent-and now we are experiencing one of the most rapid increases in inflation that this country has ever seen. We have gone from an inflation rate of approximately 2 percent in 1970 to the current rate of over 8 percent. As far as long-term economic policy making is concerned, virtually nothing has been done and the government is making decisions on an ad hoc basis about such critical problems as energy, agriculture, foreign ownership and other items which will determine the future of this country, outside of any framework of how the Canadian economy should grow and develop. Perhaps an even more distressing element in the situation today is the virtual abdication by the government from the responsibility for more effective management of the economy. Shortly after World War 11, the Canadian government specifically stated as the goals of economic policy-making in this country, the maintenance of reasonably full employment, relative price stability, less regional disparity in income, and a lessening of poverty in our nation. And these goals have never been disputed by any government in office since that time. Today however, we have a government actually saying that it can do nothing about the most serious economic problem that the nation has faced in a quarter of a century-inflation. It is incredible for any government not to do something about inflation, and it is in my view immoral for an administration in Canada in the 1970's to suggest that the central government is powerless to do anything about a problem as serious as inflation. Such a position simply states that every individual in this country should try to protect himself as best he can against the ravages of inflation because the government can do nothing. It is destructive to the whole concept that there are tools of economic policy that can be used to direct the manner in which the economy operates. It is as if the clock had been turned back to the early 1930's when, during a period when the world was suffering from high levels of unemployment and depression, governments were saying that nothing could be done about it. It is as if nothing had been learned about economic management in fifty years. Surely we are not prepared to accept for a moment that economic problems are not man-made and therefore not subject to man's control.

Associated with this destructive and dangerous policy of suggesting that we cannot control our economic environment is the recent proposition that we should measure our economic condition in a different fashion. It has been stated that we should accept a new definition for full employment in our economy-that the goal of four per cent unemployment is unobtainable. And equally significantly, it has been suggested that an inflation rate of five per cent is perhaps appropriate in our economy. Only three years ago, a three per cent rate of inflation was considered the most the economy could sustain. It was argued that a rate of three per cent was a small price to pay for getting towards full employment. Now we find the suggestion that perhaps five per cent or six per cent inflation is not too much of a price for the nation to pay for economic growth. Next year will ten per cent be acceptable? Such an approach is inexcusable.

The degree to which one is willing to adopt policies to solve the inflation problem relates to how serious one thinks the problem is. I believe that it is of such overwhelming importance that we must mobilize all the resources of government, business and individuals to bring it under control. We are not talking about a three per cent inflation rate or indeed a five per cent inflation rate, but an eight per cent inflation rate-a rate that could escalate to two figures. What does this mean? It means that probably for the first time in history, the Canadian government is selling government bonds at an interest rate that is less than the inflation rate. Anyone who has bought a bond finds, at the end of the year, even with interest, it is worth less in real terms than he paid for it. How can one seriously talk about encouraging savings in the economy when savings are eroded by current inflation rates? How can one plan any sort of pension that makes any sense, with an inflation rate of the dimension which we have in the economy today? And what about people who would like to acquire a home of their own? At the current rate of inflation in Toronto, the average selling price of a house in 1995 will be $250,000. That is average. If one believes no one should spend more than two and a half times their income on housing, this means that the average income in Toronto in the year 1995 should be $100,000 a year. What does that say about the adequacy of pension programs that are being designed and paid for now? And of course, for people on fixed incomes today, living on pension programs, the rapid escalation of all prices is a matter of incredible hardship. There is no way in which a Canadian government through social security changes can compensate for an inflation rate of current dimensions. It has never been done in the past and it can't be done in the future. Moreover, it has to be a fool's game of the highest order to think that the inflation problem can be dealt with by increasing payments to those people who are most badly hurt by inflation.

There are those who argue that we need not worry as long as the inflation rate in this nation is less than the inflation rates in other countries. This argument is made on the basis that we are a large trading nation and as long as our prices are lower than those of our competitors, we will be able to sell and need not worry. Again, this is a dangerous proposition. Once inflation gets hold, and expectations of inflation continue, it's highly problematical whether or not we can hold our inflation rate below that of our customers. But even if we can, the damage that inflation does domestically cannot be compensated for by trading activity.

Most importantly, even if one is not concerned about the inequities and the difficulties that inflation creates domestically, there can be no doubt that a continuation of inflation leads eventually to recession. When inflation thrives, the amount of income that people have to spend for necessities rises, the amount of discretionary income declines, sales drop and a recession is triggered. A serious recession in Canada now would be of greater consequence than at any time since the end of World War II because, since the end of World War II, we have operated in an international climate of reasonable stability. That is no longer true. The decline in the acceptability of the American dollar as a world currency has created uncertainties in international money markets unlike any which have existed since the late 1920's and early 1930's. The energy crisis around the world is bound to exacerbate problems in world money markets. We cannot depend upon international stability to automatically help us out of any domestic recession that we may create for ourselves.

The evidence of the escalating nature of inflation is everywhere. In spite of the fact that gold is no longer bought by any central bank, its price has escalated. Is it not incredible that gold today sells at $120 an ounce when only three years ago it was valued at $40? The escalation in land prices is evidence of people moving resources into real commodities. For years, the stock market was always thought of as an effective hedge against inflation, but mixed performance suggests that this is no longer true. Inflationary expectations are here.

The position taken by the government today is that Canada is more or less helpless because inflation is a world-wide problem. Let me be the first to say that inflation is a world-wide problem. But let me emphasize that this does not mean we cannot do anything about it. Unfortunately, when it is said that inflation is a world-wide problem, there is an implication that some sort of vague international agency is looking at this problem and eventually will bring it under control. Nothing could be further from the truth. Indeed, at the last two significant meetings of international organizations-the OECD and the International Monetary Fund-the whole emphasis of these agencies was that individual countries have enormous responsibility to do everything they can to control inflation in their own nations, because it is only by nations working on their domestic problems that the worldwide problem can be brought under control. It is intriguing that at the International Monetary Fund meetings, the Director of the Fund urged individual countries to adopt some type of domestic incomes policy and not to use changes in interest rates to affect exchange rates. Equally interesting is the fact that Canada, which has been adopting a posture that it is an international problem about which nothing can be done, has refused to apply any type of incomes policy and indeed has modified its interest rate policy constantly in order not to take adjustments in the exchange rate.

It is simplistic in the extreme to suggest that world-wide inflation is in response to supply and demand phenomena. Of course, prices are determined by supply and demand, but the important question is what determines the level of supply and what determines the level of demand. The trigger for much of the inflation in the world has been some crop failures and possibly some supply policies that have limited production. It is hard to believe that it was only three years ago in Canada that programs were introduced by our government to pay farmers not to grow wheat on the faulty notion that the way to improve farm income was to limit production. Similarly a program was adopted to reduce the supply of chickens in order to force the price of eggs higher.

Similarly demand is influenced by domestic economic policies and there has been a tendency on the part of most governments to stimulate demand over the past few years through expansionary monetary and fiscal policies..

In our own case, there can be no doubt that one of the most inflationary forces in the Canadian economy has been the devaluation of the Canadian dollar. It is sometimes forgotten that when the American dollar was devalued in response to the balance of payments crisis, that we were devalued because we were floating with the American dollar. The Canadian dollar has become cheap in terms of the Japanese yen and the German mark. It is not astonishing that our exports to these countries have risen, given the advantage that has been created for those countries because of devaluation. To say that world-wide demand and world-wide supply is the cause of our inflation is to ignore the fundamental factors that create demand and supply situations within countries.

The simple fact of the matter is that the government is looking at the problems backwards. The question is not how much is world-wide inflation contributing to domestic inflation in Canada, but rather how much is Canada's domestic inflation contributing to world-wide inflation. From 1972 to 1973, on a first quarter basis, the total increase of our price index of imports was 4.05 percent. During that same period, the percentage increase in the price index of our exports was 8.18 percent. In other words, the increase in the index of our export prices has been 100 percent greater than the increase in our import index. Obviously, our export index is influenced by demand pressures in other countries, but it is clear evidence that in world market Canadian prices have gone up far higher than the prices of things that we buy.

Domestic policies have an enormous influence on the rate of inflation and indeed the Canadian government, because Canada is in reality endowed with resources, can probably do much more about domestic inflation than almost any other country in the world.

What have been the factors that have caused the heavy inflation in Canada? There are many. First of all, in an effort to recover from the recession in 1970 and the high levels of unemployment at that time, the government introduced an easy money policy, the equivalent of which has probably never been witnessed in any other industrialized country. The money supply was increased at a phenomenal rate, almost fifty per cent over the last three and a half years, with little relationship to the increase in real production in the economy. I am not a monetarist in the sense that I believe supply of money is the only factor involved in inflation, but there can be no question that this rate of increase had a very significant inflationary impact on the economy. One should not follow a tight money policy in periods of high unemployment, but there has to be some correlation between the increase in the money supply and real growth. At the same time, the devaluation of the Canadian dollar had enormous inflationary impact. And we continued to follow an expansionary fiscal policy long after it was clear that it was having a strong inflationary force in the economy without doing very much about unemployment. In spite of the experience in 1970, when we had very high levels of unemployment and rising prices, the government insists that broad-gauge monetary and fiscal policies can create growth, reasonably full employment and price stability. The evidence is clear that the government still believes that with these broad-gauge tools the economy can be fine-tuned. It cannot.

What should be done? It is essential that inflationary expectations in the nation be broken. It is essential to restore confidence in the Canadian people that the central government can and will do something about inflation. It is for this reason that we in the Conservative Party have argued that an incomes policy should be put into effect in the nation. We have called for a short-term freeze in prices, wages, salaries, profits and dividends-indeed a comprehensive freeze on everything except agricultural products at the farm gate. No one in our party, least of all me, believes that freezing prices is any way to solve the inflation problem. But we do believe that a freeze would restore confidence on the part of the Canadian people that the government is willing to tackle the inflation problem head-on. Secondly, we believe the freeze would provide time to work out the nature of the longer-run incomes policy. We do not believe that there would be serious malallocation of resources during the short period of the freeze nor do we believe that anyone would be frozen into an inequitable position. And what would the incomes policy do? Basically, it would establish guidelines for increases in prices and wages throughout the economy. Increases sufficient to assure the investment of new capital in production activities and the proper share of the increase in productivity to workers would be assured. Primarily, the policy is designed to prohibit strong power groups-whether they be in the field of business or the field of labour or trade associations-to take more out of the economy than they put into it. During periods of inflationary expectations, it is possible for certain groups to take advantage of the situation, thereby contributing to inflation, and this must be stopped.

Some raise objections to an incomes policy and are quick to point out that such programs cannot work. But one has to be careful about such assessments. The fact of the matter is that in 1970 the inflation rate in Canada was slightly over 2 percent and in the United States it was approximately 4 percent. Today, the inflation rate in Canada is over 8 per cent and that of the United States is around 6 percent. I do not like to use international comparisons-I don't think they're relevant-but it's quite wrong when people suggest that the program in the United States had no effect on containing inflation in that country. Certainly, Phase I and Phase II were very successful. Similarly, we have mixed reports from the experience in Great Britain. I have been told that without the incomes policy, one could be expected to have an inflation rate in that nation of almost 20 per cent. But that is something that can't be proved one way or the other. What is a fact is that we must do something about breaking the expectations of inflation in this country. We must not permit groups that are not subject to market forces to use the inflationary situation as an excuse for establishing prices and wages that are far beyond what the economy can support. Again, let me emphasize that it would not be a program, as we visualize it, of tagging all individual prices, but rather of setting broad guidelines for those areas of the economy where market forces don't operate.

Clearly, an incomes policy will not solve the inflation problem in Canada. It has to be accompanied by a monetary policy that ties our rate of increase in the money supply reasonably close to the rate of real growth in the economy, a policy that relates government expenditures more closely to the collection of tax revenue, a policy that stimulates increased economic activity through lowering interest rates. I happen to believe that high interest rates are a cost and are not basically antiinflationary. It has to be accompanied by policies to expand production. Never again in this country must we accept the proposition that the way to prosperity is through restricting production. We have to re-think our exchange rate policy to the extent that we have to be certain that if we are floating, we have a true float, and that we don't have that float affected to our detriment by excessive capital flows. And we have to reduce direct taxes, such as sales taxes, that are inflationary in and by themselves. The application of these policies, with the support of all Canadians, can effectively reduce the inflation rate in this country. Reducing inflation will certainly not be painless, but not reducing it will be tragic.

The current economic problems of course affect us most-and I am quite aware that Lord Keynes said that in the long run we are all dead. But there can be no gainsaying the fact that we are at a cross-roads in the development of the Canadian economy. The change is just as fundamental as the change that took place during World War II.

You may recall that, prior to World War II, Canada's economic activity was based primarily on a three-way trade. We shipped our raw materials to Britain and the British Empire, used the foreign exchange we earned in this activity to buy goods from the United States. It was our famous triangular trade. At the end of World War 11, our policy shifted to one of continentalism. Our economic activity was more and more linked with the United States and our economic policies were evolved in that direction. The Automobile Pact is a perfect example. The integration of our capital markets and the rapid rise in our trade are others.

But the premises under which that policy was made have changed, and we must recognize those changes. The policy was based on the fact that the American dollar was strong in international markets, the economy of the United States was vibrant, and that resources were basically in surplus supply throughout the world. We now know that this is no longer the situation. The U.S. dollar no longer has the stability that it once had, and it is no longer accepted around the world as a reserve currency. The American economy has serious problems with respect to energy, and world resources seem to be in short supply. Any of these conditions may be temporary but then again they may not. The fact of the matter is that we must evolve in Canada an economic policy based on a re-assessment of whether or not Canadian interests are best served by following the policies that we followed in the past, and now is clearly the time to do so. We must determine how we are going to utilize our resources. Are we going to assert our legitimate self-interest over our resources in a way that is not detrimental to any of the parties involved, but which can lead to the greatest benefit for all Canadians? Will we question the philosophy of trade for trade's sake? There is no magic in exports if the net result is no improvement in the standard of living of Canadians. We are a major trading nation and will continue to be so, but we must ask the question what it is we want to export and in what form we want to export. We must have more emphasis on processing our resources in Canada. But this is simply a cliche and an empty phrase if it does not mean that policies will be followed which make it attractive for more processing to be done in Canada compared to other countries. We must have incentives to make such development and production in Canada attractive in world terms. There is no doubt that investors and producers will take their capital elsewhere if they are denied an adequate rate of return for operations in Canada. We must accept as a matter of fundamental principle that we will not limit production output as a means of artificially raising prices but rather will recognize that the real wealth of the nation depends on what it can produce. The world is changing. Canada must change with it. We have the resources, the people, the stability to make this nation the most prosperous, in the best sense of the word, in the world. We are indeed a blessed nation. We have the resources, the people, the stability of government to achieve almost anything that we wish. What we must have is the vision.

In seeing things as they are in Canada today, we can all understand what may have prompted the late Senator Robert Kennedy to say: "You can see things and you say 'why?' But I see things that never were and say, 'why not?"'

We have an option. We can accept the premise that nothing can be done and do nothing. To pursue the present course of action means more unemployment, higher inflation, greater increases in prices and more frustration for those unable to help themselves. Or through government leadership, through discipline and restraint among the various interests within the economy, we can achieve a smooth transition to unprecedented prosperity.

Dr. Gillies was thanked on behalf of The Empire Club of Canada by Dr. Murray G. Ross.