As Canadians prepare to go to the polls Oct. 19, the economy is the campaign's main focus, as it almost certainly will be when the Americans do the same this time next year. What should voters be asking? The basic questions are the same for both countries: Where are we now? How did we get here? What do we need to do as we go into the future?
But the answers in the U.S. are somewhat different, as is public opinion. Canadians perhaps feel better – and Americans worse – than they should. Why? And could that change?
Canada weathered the 2008 crises better than other G-7 nation. It has since lost ground relative to the United States. Why is that? Canada must ask how to best manage public opinion, political leadership and the gap between the policy that is needed and the political will to make it happen.
The meltdown that almost brought the world's economy and financial system to their knees in 2008 began in the United States. How then did the Americans, the primary source of the collapse, get more corrective actions right than any others?
And why, despite this success, do the Republicans have a frontrunner like Donald Trump? He is an oversize bully, a big-time insulter and a shameless self-approver. Yet he currently has almost one-third of the support approaching the primaries, based on his skilful response to public fearfulness and frustration. Given that the post-Lehman United States is so much better off, something deeper is at work.
Diagnosis matters most
My approach to economic questions comes from a 2007 book by a Harvard medical researcher. It's called How Doctors Think, but is really about how humans think. Author Jerome Groopman makes two fundamental points: If the diagnosis is wrong, the treatment will not work; and, if the diagnosis fails to explain every potentially relevant factor, think again until you find the right diagnosis. If our politicians took this approach, they could help both countries get back on the right economic-policy track.
To diagnose where we are and have been, we need to go back to the Great Depression. It was never really overcome, but was supplanted by the Second World War. The lack of economic demand in the 1930s made developing sufficient demand the focus of postwar politics and policy.
So, for 35 years, it was widely accepted (even in the individualist United States) that, after a global depression and war, the focus had to be on jobs and economic security. That changed after 1980, once Ronald Reagan was elected president, and the era of debt and globalization began.
The feeling grew there was too much government, that government was too much in debt, and taxes were too high – that the time had come to shift from demand-side to supply-side policies. Macro-policy challenges tend to shift between demand and supply – from being about too little (Keynes) or too much (inflation) demand, and then to too little (inflation) or too much (recession) supply. However, what works when demand is the problem does not work when the problem is supply. By the 1990s, there was insufficient global demand, too high global savings, inadequate productive investment opportunities, too many workers, and global imbalances.
Many countries were beginning to struggle early in the last decade. The United States remained prosperous until 2008, when the sudden flood of Chinese exports overwhelmed its deeply indebted economy.
For the U.S., the big challenge was fundamentally different from Canada's. It went into a "balance-sheet" recession, which happens when high levels of private-sector debt cause both individuals and companies to focus on saving (paying down debt) rather than spending or investing. Canada did not follow suit because its monetary policy was able to stimulate consumer borrowing. Unlike their American neighbours, Canadian households could still do so.
Now, the situation has reversed: The debt of Canadian households as a percentage of gross domestic product is above the 2008 American level. If a real recession does hit Canada, monetary policy will not be able to generate economic activity as it did in 2008. When Canadian interest rates finally start to rise, they will put pressure on the level of household debt. So would unemployment or lower house prices.
Richard Koo, chief economist of Japan's Nomura Research Institute, is the world's pre-eminent student of balance-sheet recessions. He recently told Maclean's magazine there is a real risk of one happening in Canada, if home prices fall while household-sector debt remains high. Tomorrow's home prices could look like today's oil prices. This is not a prediction but a forewarning.
The Bank of Canada, with its low interest rates, has got us into this threatening situation over the last few years. The reason Canadians feel better today than Americans is that they have adjusted less, and the country lives far beyond its means. This can feel good, while it lasts, and was the Reagan-era experience for America. Canada's huge level of low-interest household debt has not yet been felt. Wages here have risen much faster than in the United States. These gains were made possible by Canada's looser stance on macro-economic policy, and contributed to a loss of manufacturing jobs and capacity because the country was less competitive. Now this loss has been aggravated by the oil-price collapse and generally low global commodity prices. None of these things will change quickly.
Why do Americans, who have their affairs in better balance, feel worse about their situation than Canadians? A mix of unrealistic expectations, impatience and the fact they have been through extended rough times. Wage gains have been well below those in Canada. Now, however, the U.S. is both more competitive in manufacturing and less dependent on foreign energy. This means U.S. growth will help Canada less than before.
Canada's recent economic history can be summarized in three phases. From 1984 to 2006 (the Mulroney-Chrétien era), it ran an increasingly tight macro-economic policy that put the country in good shape for the post-2008 crises. From 2009 to 2011, a balanced use of fiscal and monetary policy got the country through the height of the crises.
Since then, Canadian policy has become increasingly unbalanced, with the emphasis primarily on monetary rather than fiscal measures. Monetary policy is largely about expanding (to help growth) or contracting (to contain inflation) credit for business and households. Fiscal policy is about government borrowing to stimulate demand in the economy, and taxing to contain the economy when demand exceeds supply.
There is, as a result, excessive total debt; too much household-sector debt relative to federal debt; and too much of the debt funded by a big buildup of foreign borrowing, not domestic savings. Working this down to better balance will not be painless.
Canada's major political and policy challenges lie on the economic front. Four issues are immediate:
- We must stop living beyond our means – which have already declined because of the fall in oil and commodities prices and the loss of manufacturing capacity. We must replace those lost means, not increase our current spending or cut taxes. The brake will come initially through higher prices brought on by the lower Canadian dollar and lower wages.
- We must broaden our capacity to supply goods and services that are internationally competitive.
- We must address our challenging transit-infrastructure needs, initially through federal deficits. High-peed rail, in and between large urban centres, is a productive time-saver and globally helpful in attracting the best available people, many of whom are used to very good transit.
- We must figure out a new tax policy that is fair and can power the creation of new wealth – and, through it, new jobs.
A rebalancing act
Over the next few years, the incoming Canadian government will have to begin to rebalance the economy in several ways:
- Stop relying on debt-fuelled domestic demand and focus on building a competitive supply economy to produce exports.
- Aim for a better balance between Canada’s monetary and fiscal policy.
- Reduce household debt. This would require higher interest rates from the Bank of Canada and, if needed, more federal debt to offset the demand loss from less household-sector debt.
- Convince Canadians not to be spooked by the idea of running a deficit to build the country. But right now there are no grounds for fiscal deficits to provide cyclical stimulus. Much of the stimulus we have is going into foreign jobs (that’s what a current account deficit does), so the demand helps them not us. Building the country requires more spending inside Canada, so the jobs are in Canada. The level of household-sector debt is more than enough demand stimulus.
- Address Canada’s current economic weakness through structural change. We are entering an era of huge global structural change. Much which will be negative for Canada.
The American challenge is different from Canada's. The economy is in pretty good shape, but it faces a political threat. Republicans do not grasp the fact that the issue today is weak global demand, not U.S. government debt, and weak U.S. supply. Worse, U.S. political turmoil has raised the barriers to mutual accommodation, both at home and abroad.
Right now, U.S. macro-policy is about right, but a sweep by the Republicans next year could put that policy at risk. As Dr. Groopman might say, they could misdiagnose the problem and prescribe a supply-side, anti-debt ideology at odds with the lack-of-demand reality. If the new president adopts any of the Trump approach to the world, the struggling global economy would confront a stark reality: the only country that is on a strong economic path could be undermined, economically and geopolitically.
Voters decide, politicians lead
The task of political leaders is to integrate what voters want with policies they know are needed. Most of the time this task is the art of the possible. At key moments, it becomes the art of making possible the necessary.
Democracies and free markets depend on myriad individual decisions. If they are to work successfully, the signals must tell the truth. Where those natural signals are interfered with by massive borrowing (which blocks the natural pain warning that all is not well), both voters and the markets will make the wrong decisions.
Politicians are lagging indicators and pain avoiders. If there is pain on the horizon, they tend to try to mask what is really going on. They prefer to keep voters ignorant of reality's pain. Credit excess has become a favoured way to mask unpleasant economic truths. Ideology, based on observation of what works, can be useful in providing direction. If it is applied inflexibly, however, it can do great damage. Some politicians find simple ideological promises a seductive political shorthand to avoid facing the hard measures needed to manage in today's global economy.
For all these reasons, Canada and the United States may not get the political or policy leadership they need in the coming elections. Politics matter, but economics inevitably will dictate a change of course before long. Canada may be able to survive (at a cost) without the political leadership that gets the diagnosis of its economic and financial challenges right. Markets and economic forces will limit how far Canada can go off the rails sooner than the United States. But over time the United States and the world generally will not be able to escape the consequences of U.S. political and policy leadership that gets its diagnosis wrong. With Henry Paulson, as secretary of the treasury, Ben Bernanke running the Federal Reserve and Barack Obama in the White House, the Americans got the post-2008 financial system and economy diagnosis largely right, but the fiscal side was later threatened by the Republican Congress for several years. Right now there is no sign that anyone who leads the Republicans will get either the economic or the financial path forward right.
Canada's unaddressed economic-policy challenges may prove less severe in the short run than those in the U.S. Canadian politics and policy making are not likely to be better, but Canada has less scope for financial misbehaviour than the United States does. Markets will catch Canada sooner than the United States, but at the end of the day, markets and increased geopolitical instability will also affect the United States. If U.S. leadership is not there when that happens, the consequences for the global order will not bear thinking about. The United States may well get through the present dangerous political situation, but Canada should be prepared if it does not. An adequate response will require diagnosis and discussion, not political sound bites.
William A. Macdonald is president of W.A. Macdonald Associates Inc., and has an extensive record of public service. To spark discussion of the country's future, he and associate William R.K. Innes have created The Canadian Narrative Project, with assistance from Trent University. See more at www.canadiandifference.ca.