Dan Ciuriak is a consulting economist and former deputy chief economist at Foreign Affairs and International Trade Canada.
Things are not right in macroeconomic policy land.
When the U.S. Federal Reserve Board raised its policy interest rate in December, it was the first upward adjustment since the economic trough in June, 2009 – 79 months ago. For most other central banks, including Canada’s, the most recent move was to lower rates even further. Several (Sweden, Switzerland, now Japan) have done what used to be unthinkable and lowered their policy rates below zero. Most expansions are over by 79 months, but this one has yet to get off life support.
Things are also not right in microeconomic policy land. Twenty-first-century growth is all about innovation, which drives economic renewal, productivity and trade. At a time of seemingly limitless opportunity, Canada’s performance on all three fronts has sagged. The innovation deficit is the linchpin. Unlike successful innovation economies (such as Sweden, South Korea, Switzerland, Israel, Germany, Japan and the United States), Canada has not conceived a viable industrial or innovation strategy.
A bit of history puts Canada’s headaches into sharp perceptive.
In the 1930s, the global economy suffered through the Great Depression. For Western liberal democracies, including Canada, the eventual economic policy solution was demand-side management – Keynesianism. This worked brilliantly for a while. But after several decades of neglecting supply, a new problem emerged: a combination of slow growth and accelerating inflation called stagflation.
The solution was a suite of policies to expand supply.
The policy transition from demand side to supply side was a radical departure from conventional thinking. Fiscal policy was replaced by monetary policy as the main tool for economic stabilization. Policies aimed at supporting steady jobs were replaced by policies making labour markets “flexible,” which shifted economic risk from capital to labour. Traditional policies for industrial development were replaced by private-sector incentives. Public-sector investment in expanding the “knowledge commons” – investing in knowledge creation that was then turned over gratis to the private sector – was replaced by policies encouraging the enclosure of the knowledge commons, which meant increased patenting in realms that used to be public domain.
It all seemed so right at the time, but after several decades of promoting supply and neglecting demand, a new problem has emerged: a combination of slow growth and the threat of deflation – stagdeflation. It’s the mirror image of the 1970s.
There are many other parallels. The 1970s stagflation was accompanied by other problems, such as fiscal deficits and structural problems such as bloated public sectors. Stagdeflation today is similarly accompanied by a host of other problems: fiscal deficits and structural problems such as waning business dynamism, corporations saving and households borrowing; soaring income disparities; and, more critically, the ineffectiveness of monetary easing.
The supply-side revolution cleaned up inflation but tossed out a few babies with the bathwater. Global per-capita income growth slowed from 2.6 per cent during the postwar demand-management era to 1.8 per cent under supply-side policy. Remarkably, this growth slowdown occurred at a time when some of the most powerful innovations in history were introduced, including the Internet, which should have diffused technology within and across economies to an unprecedented degree.
Canada ought to have seen an impressive growth premium during this period, given its highly skilled labour force. Instead, real per-capita income growth slowed from a premium of 0.5 per cent over U.S. growth over the period 1950-1980 to a discount of 0.1 below since – even though Canada did not experience a full-fledged economic and financial crisis during the 2008-09 U.S. meltdown.
In the past decade, Canada’s economic policy remained resolutely orthodox. On macroeconomics, we doubled down on supply-side policy. And now the results are in. Per-capita income growth virtually stalled. Based on International Monetary Fund data, the economy went from 1.8 per cent above potential in 2005 to 1.3 below potential in 2015. This faltering performance occurred despite massive fiscal stimulus that added $305-billion to the public debt and pushed the structural general government balance from a surplus of 0.8 per cent in 2005 to a projected 1.0-per-cent deficit in 2015. Trade performance struggled and the external balance went from a surplus of 1.9 per cent of GDP in 2005 to a projected 2.0-per-cent deficit in 2015.
As consumption supported the economy, households increased their debt-to-income ratio from 0.95 to 1.63. While the leverage is real, the asset values (mainly house prices) supporting it may be ephemeral. This has increased the economy’s risk profile and created a potential policy powderkeg for the Bank of Canada. On microeconomics, Canada also played by the book and saw a historic collapse of its technology sector, the source of wealth in the 21st-century economy.
So what to do now? To paraphrase Albert Einstein, we cannot solve problems using the same thinking that created them. In the 1970s, pushing the levers that delivered stagflation did not solve stagflation. Today, pushing the levers that delivered stagdeflation is not solving stagdeflation. Orthodox prescriptions are not delivering innovation.
Change is needed, but turning the page may be difficult, just as it was in the transition from demand management to supply-side policy. At that time, schools of economic thought clashed. Victory was declared and Nobel Prizes were distributed like war medals. Anyone in a position of economic policy-making authority today made their career engineering the transition to supply-side policy or refining it.
But the first law of holes says that, when you’re in one, stop digging. Recognizing that orthodox economic policy has resulted in Canada missing the 21st-century prosperity train is the first step to catching up with it.Report Typo/Error
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