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The question of Election 2015: Can government create jobs and growth? Add to ...

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At some point in late October, after you’ve celebrated your surprising election victory, freed yourself from the speeches and negotiations and cabinet announcements, and paid your visit to the Governor-General, you will sit down in a black leather chair in your oak-paneled office in Ottawa’s Langevin Block, stare through its big windows across to Parliament Hill, and quietly ask yourself the question that has been hanging in the air: “So. Where do I find the levers?”

The levers. During the long months of the election campaign, it was so easy for you to talk about them. Those levers you said you would grasp, and seize, and put into the right hands. The levers you pledged, in vague but evocative terms, to use to shift the economy into high gear, or to restore growth, or to boost employment, or to raise the living standards for the middle class, or to make small business thrive and innovate, or to restore the competitiveness of the manufacturing sector, or to bring back leadership in high technology, or to shift the country away from resource dependency.

So where, Mr. Prime Minister, are those levers? From here at the top, the control panel does not seem easy to reach. But you’re going to be expected to do something significant to change the direction of the Canadian economy, which has not been heading anywhere very encouraging lately. And, besides, you said you would.

And now you find yourself alone, faced with one of the great questions of our age: Just how much can government really change the direction of the economy? Beyond the campaign rhetoric about “job creation,” can government policies and programs actually create jobs? Can they cause significant and lasting shifts in the levels of employment, or economic growth, or competitiveness? Can public-sector decisions make certain industries, or companies, into international winners?

Or is government at best a passive bystander and at worst a clumsy meddler in an economy largely buoyed and tossed by global and systemic forces far beyond its control?

If that question is going to torture the next prime minister, it is because it is the question that is reshaping politics around the world at the moment. The Canadian federal election of 2015 has occurred at a time when the economic role of the public sector has taken on a new and dramatic life. Economists and political scientists are looking at the relationship between the state and the economy very differently than they did before the world economy turned on its head in 2008.

That dramatic change can be seen, albeit sometimes faintly, in Canada’s electoral showdown. It is a campaign that has pitted three distinct responses to that question against each other – a largely hands-off approach with some targeted tax breaks (Stephen Harper); a large-scale, deficit-driven investment plan to restart economic growth (Justin Trudeau); and an attempted strategic shift toward non-resource industries by taxing big business and paying for incentives for tech and manufacturing (Thomas Mulcair).

What is new is that none of these approaches are considered terribly controversial today, by voters or by mainstream economists; if anything, the more interventionist proposals of the New Democrats and Liberals seem surprisingly mild compared with the bold state interventions being employed in the United States, Germany and other strong economies.

That marks a big change. A decade ago, there was a near-unanimous consensus in the political centre that government could not, and should not try to, use large-scale public spending to boost economic growth or “create jobs.” At best, it would waste money on illusory gains; at worst it would distort markets and damage competitiveness.

In Canada, there were good reasons for this reticence: The country has a long history of disappointing or embarrassing government initiatives, at both the federal and provincial levels. Aside from the expensive legacy of directly state-owned airlines and oil companies, there is a mottled history of the practice often dismissed by economists as “picking winners” – the pouring of funds and subsidies into hopeful enterprises such as Nortel (which collapsed – ironically, after Ottawa refused to bail it out – and was sold to Ericsson) or Ballard Power Systems (whose much-touted hydrogen car batteries never materialized). There have been vastly expensive regional-development programs and agencies handing funds to companies that were often created just to attract such funds, and the propping up of local small businesses that ought not to have been saved.

These sorts of experiences have made government investment in the economy a taboo subject, and not just in Canada. As recently as 2012, U.S. presidential contenders Mitt Romney and Barack Obama spent a good part of a national debate trying to outdo each other in denying that they could affect the economy. “Government does not create jobs,” Mr. Romney said, to which President Obama replied: “this notion that I think government creates jobs, that that somehow is the answer – that’s not what I believe.”

But, even if this rhetoric remained alive, the 2008 economic crisis and its dramatic policy aftermath changed a lot of minds. The countries that escaped intact, including the United States and, to some extent, Canada, were the ones that poured public money into stimulus spending and bailouts. That experience shocked a lot of formerly strait-laced economic thinkers into reassessing their view of how governments and economies work together.

“We’re in a very different time,” says Kevin Page, the University of Ottawa economist who spent five years as Canada’s first parliamentary budget officer, after almost three decades managing public spending at numerous federal agencies and departments. “You have no investing happening. There’s been no year-over-year growth in investment in Canada for three years, nothing really getting kick-started in the private sector, and weak aggregate demand… you can’t get interest rates low enough to get people investing. This is not a normal time, so the role of government should have shifted. Now is the time, with record low interest rates, to invest and get the economy going.”

Yet the election campaign has also revealed a distinct lack of boldness among the major parties: All three are discussing, at most, indirect government approaches to the economy: stimulus plans to boost consumer spending, or tax credits aimed at broad sectors or sizes of business. Most of it, viewed from an international distance, looks like variations on what Canada has been doing since the 2008 emergency, with different emphases on levels of taxation, spending and debt.

That’s far removed from the much larger state interventions in the economy that have driven the recoveries of the United States, Germany and Northern Europe – initiatives that include the bailout of the Big Three auto companies, the large-scale subsidies of nanotechnology, electric-vehicle and alternate-energy industries.

Many economists came to realize not only that government intervention bailed many countries out of the post-2008 recession and restored growth and employment, but that the crisis itself may have been caused, in good part, by the disappearance of active government support in the economy – the sort of direct investment and partnership that had existed in earlier decades.

Back in 1944, renowned economic thinker Karl Polanyi described, in his book The Great Transformation, how the world’s most successful market economies had come into being in Europe: “The road to the free market was opened and kept open by an enormous increase in continuous, centrally organized and controlled interventionism.” It was the state that made the private sector possible, not vice versa. And suddenly, after 2008, it looked to a lot of people like this was exactly the sort of interventionism that was needed to get markets working again.

As a result, the past five years have seen a resurrection of “industrial policy” – the old concept of a highly engaged state working directly with corporations as an active investor. The World Bank and the International Monetary Fund, after spending decades disciplining their client countries to get their governments out of the economy, had a change in thinking around 2010. That year Justin Yifu Lin, the World Bank’s chief economist, wrote an influential paper arguing that “government policies directed at affecting the economic structure of the economy” are necessary to restore economic growth and to shift countries out of development traps and resource dependency.

“True, industrial policy still carries a somewhat blemished reputation in mainstream economics and still generates controversy,” Mr. Lin wrote in a 2013 paper co-authored with Nobel Prize-winning economist Joseph Stiglitz, who has been a major champion of the new industrial-policy thinking. “However, things have changed considerably in the aftermath of the Great Recession: it is no longer associated systematically with loss-making nationalized industries.”

Economists began noticing that the great economic boom of the 1990s and 2000s had been a direct product of targeted state investments in specific companies and sectors. The Italian economist Mariana Mazzucato, in her influential book The Entrepreneurial State, chronicled the emergence of the iPhone as a direct product of Washington’s large-scale investments in Silicon Valley – not just through state spending on technology products and tax incentives to high-tech industry, but through the specific choice of Apple, in the 1970s and 1980s, as a company Washington would invest in (though small-business investments that put $2 into Apple for every dollar of private investment). Intel and Compaq were also targets of this active state investment, much as Elon Musk’s Tesla electric-car company is today.

Dr. Mazzucato, in an interview from her University of Sussex office, describes the heavily funded state banks that have allowed Germany, China and the United States to build globally competitive companies – and notes that Canada, despite having earned a fortune in petroleum revenues in the past 15 years that could have created a similar major institution, has nothing substantial of the sort, nor any proposal to create one.

“Canada is interesting,” she said. “It is one of the most skewed countries, not only in terms of sectors – lots of emphasis on the extractive stuff – but also in terms of instruments: It’s very, very indirect. It does most of its government investment through tax incentives. Compare that to the United States or China or Germany, where it’s all direct: If they want to do something, they do it. They directly finance a sector or the most innovative companies, and they create grants or guaranteed loans to do it, not an indirect tax credit. And on top of that, these Canadian investments are not so mission-oriented: At best, there’s a list of sectors to be supported indirectly, but no targeting of specific companies or industries. And then they get surprised when they’re not on the top any more in any of the big innovations.”

Dr. Mazzucato warns that simply trying to invest in technologically promising companies can be folly: There needs to be support for the larger-scale research around them, and the companies need to be focused on real innovation. She points to the Washington’s less successful support of biotech and pharmaceutical firms, which have generally spent their money buying up shares and competitors rather than adding new value to the economy, as an example of such waste (and points out that governments have to be willing to make plenty of losing bets if they hope to support the next Intel or Apple).

But also, she notes, governments rarely create economic successes simply by throwing lots of money into pure, theoretical research, typically by investing in research universities – something that happens in Canada, where private-sector research and development levels are far below those of other well-off countries. In the 1970s, she writes, the Soviet Union spent an incredible 4 per cent of its economy on pure research. Japan spent only 2.5 per cent, but was the country that managed to create the employment and income boom.

“What doesn’t work,” Dr. Mazzucato says, “is when the direct investments are too focused on one part of the innovation chain. The kind of active government involvement that was characteristic of Silicon Valley and places like Denmark – that government involvement has been across the entire innovation chain. Basic research? Yes. Applied research and early-stage financing for companies? Yes. Those countries that think they can just spend a lot on science and a lot on basic research and assume business can take care of the rest, without also having a strong presence in public policy – they tend to fail.”

Canada, in its typically safe and risk-averse way, is far removed from this sort of large-scale investment thinking. That may prove wise: The recent meltdown of China’s stock market and banking system shows the risks of taking state investment in the private economy to its ultimate limit.

But it does show that this election’s great debate over government’s role in resurrecting the economy is far from radical or risky, by international standards: Even the most expensive and deficit-inducing proposals are very modest compared with the state of the art of fiscal thinking today.

And even if it does not create a more competitive private-sector economy, it has produced a surprisingly competitive political battle over the role of government in business.

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Follow on Twitter: @dougsaunders

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