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Questioning the underpinnings of modern economies

Economic orthodoxy is a hard habit to break.

But with the global economy at risk of a second recession in three years, the euro zone on the verge of foundering and the United States staring at a jobless decade, maybe the same-old policy ideas are getting a little tired.

This isn't the recovery most experts expected. And yet it just may be the recovery we deserve, given how the world's rich countries are managing their economies.

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Canadian economists Dan Ciuriak and John Curtis argue in a provocative new study that maybe we have "everything all wrong" about how the global economy works. They've identified a series of anomalies that "call into question the basic understanding of economics that underpins policy formulation today," in their paper, What If Everything We Know About Economic Policy is Wrong?

Flexible labour markets, massive unrestrained capital flows, floating exchange rates, and tax breaks for investors and businesses to drive production of goods and services were supposed to bring prosperity.

But three decades of these supply-side policies have produced the same economic problems they were supposed to fix, including stagnant growth, high unemployment, deflationary pressures and piles of public sector debt, according to Mr. Curtis, a fellow at the Centre for International Governance Innovation in Waterloo, Ont., and Mr. Ciuriak, former deputy chief economist at the Department of Foreign Affairs and International Trade.

And now with the world awash in goods people can't afford, the solution of choice in many countries is to spur even more production and to slash transfers to debt-burdened families.

There's an inherent contradiction in the model. Those policies are causing household incomes to fall, making consumers less able to buy things, and driving inflation lower. The recent sharp plunge in the prices of oil, wheat, copper and other vital commodities suggests that's exactly what's happening.

Second-guessing supply-side economics is more than an academic exercise. Some of the prescriptions now on the table to get the world out of this mess may actually be hastening another recession.

A fierce tug of war is under way among global policy makers, pitting those who would impose stricter fiscal austerity on already ailing economies against those focused on keeping the spending tap on.

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Even U.S. Federal Reserve chairman Ben Bernanke now admits his "enormous efforts" to push down interest rates aren't working to ease what he says is an unemployment "crisis" in the United States. Mr. Bernanke is all but begging the Republican-controlled Congress to get over its new obsession with deficit reduction and adopt President Barack Obama's costly jobs plan.

Consider another anomaly. The United States prides itself on having one of the most flexible labour markets in the world (meaning it's easy to hire and fire workers). And for decades, that system kept long-term joblessness low and delivered unemployment rates that were consistently lower than in Canada and other developed countries, where the safety net is more generous.

Not any more. Median U.S. household incomes are falling, nearly half of the 14 million jobless Americans have been out of work for more than six months and economists are predicting years of high unemployment.

"This is unheard of. This has never happened in the post-war period in the United States," Mr. Bernanke said during a question-and-answer session following a speech in Cleveland last week.

A similar debate is raging in Europe, where Germany and other wealthy countries are demanding strict budget-slashing measures as a precondition for continuing to bail out their poorer neighbours, even though doing so will cause many euro zone economies to shrink – making it harder for them to pay down debt.

It's also being fought in Canada, where Prime Minister Stephen Harper is trying to stickhandle a pledge to be "flexible" in the face of economic weakness, while simultaneously following through with the government's spending cut targets.

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Mr. Ciuriak and Mr. Curtis highlight several other flawed tenets of economic orthodoxy:

* Floating exchange rates have produced record global financial imbalances and wild currency gyrations, rather than stability. Too often, markets are proving to be neither stable nor rational.

* Too much investment in goods production is crowding out the kind of public infrastructure needed to make economies more competitive, including roads and health care.

* Canada continues to offer one of the richest research and development tax regimes in the world even as it falls further behind in the global innovation race.

Accepted beliefs can, and do, change. Today's orthodoxy can become tomorrow's heresy.

It's certainly worth asking the right questions so we avoid repeating the same mistakes.

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