economic policy: can we manage the economy any more?

Canadian Public Policy

Economic Policy: Can We Manage the Economy Any More?Author(s): H. I. MacDonaldSource: Canadian Public Policy / Analyse de Politiques, Vol. 2, No. 4 (Autumn, 1976), pp. 553-561Published by: University of Toronto Press on behalf of Canadian Public PolicyStable URL: http://www.jstor.org/stable/3550192 .

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Economic Policy: Can We Manage the Economy Any More?

H.I. MACDONALD I President, York University

The early drafts of this paper were prepared prior to the May 25 Budget presented by the federal Minister of Finance. In company with many others, I have been pondering its message in the intervening days. In addition, I have been wondering whether it is not the most effective answer that could be provided to the question put to us today: 'Economic Policy: Can We Manage the Economy Any More?'. Judging from the performance in the Budget, the answer must be 'no.' That is not intended to dismiss the Minister's efforts or good intentions, but rather to ask the question whether 'the budget,' as a single instrument, can really do the job today that was assigned to it in the pure world of Keynesian ideals.

The basic issues are not issues of economic management, but rather of political determination and social objectives. The modern economist is por- trayed like the philosopher of old: a blind man in a dark room looking for a black cat that is not there. In fact, the real problem is our inability to agree upon national objectives and to find the political means of achieving them. And so, the question in the title contains a large presumption. Have we ever 'managed the economy' or achieved that degree of direction that disciples of Keynes believed to be possible? I believe we have not, for a variety of reasons, and we should be careful to analyze those reasons if we hope to do a better job in the future.

There are numerous possibilities: a) the theory of economic management is defective; b) the theory cannot be applied institutionally in our particular situation; c) the application of the theory is mismanaged; d) the problem of controlling leads and lags in timing is insurmountable; e) data is deficient or defective.

In the case of Canada, I believe there is evidence of shortcomings in each of these departments. However, one further point of caution is required before commenting on the process in detail. Economic policy has become a highly elastic term by no means confined to the basic levers of monetary and fiscal policy. It includes policy for regional development, transportation, man- CANADIAN PUBLIC POLICY-ANALYSE DE POLITIQUES, II: 4 autumn/automne 1976 Printed in Canada/Imprim6 au Canada



554 / H. I. Macdonald

power planning, energy and even immigration policy. Today, land-use planning and agricultural arrangements can be important components in terms of strategy for growth and the relief of bottlenecks. And what about wage and price controls? Have they a respectable place in the lexicon of economic policy or are they merely shock tactics in economic policy warfare?

Economic policy in Canada has always laboured under the difficulty of reconciling mythology with reality, but never more so than today. I say 'mythology' because I believe that current discussion of public policy in Canada is totally inconsonant with the reality of our economic and social structure, and nowhere is this more true than in the field of fiscal policy. There are two serious consequences of this fundamental disharmony:

i) our economic policy is not equipped to deal with the realities; ii) we have unreasonable expectations for governments in dealing with our

economy. As a result, we become frustrated which, in turn, tends to undermine our confidence in the institutions which we created for the purpose.

The real problem is the failure of orthodox monetary and fiscal policy analysis to fit the Canadian scene. A number ofyears ago, I suppose that I was as guilty as any when teaching monetary and fiscal policy of applying the unitary state world of Keynesian economics to the Canadian federal system. How easy it was to simply sketch in the inflationary or deflationary gap, and then swing the great levers of monetary and fiscal policy into action to exercise a counter-cyclical influence. The correct mix of monetary and fiscal policy would be sufficient to restore equilibrium.

However, Canada is not a unitary state, notwithstanding the yearnings of some commentators on public affairs and certain citizens with an Ottawa- centric view of the universe. We are a federal state and a highly decentralized one, with immense economic and fiscal powers in the hands of the provinces. Today, the provinces and their municipalities account for what is approaching two-thirds of public expenditure in Canada and about eighty per cent of that highly significant sector - public capital investment. As a result, a determined provincial administration, in conjunction with its municipalities, can exert a significant counter-influence on fiscal policy to that of the federal government and, in conjunction with large agencies such as a hydro-electric power corporation, can have a major impact on domestic capital markets and, through foreign borrowings, on capital flows and exchange rates.

The countervailing influence of provincial fiscal policy is exactly what happened in 1970 and 1971 in Ontario and I have been surprised that it did not attract more attention. At that time, the federal government was seeking to offset inflation and was practising a policy of fiscal restraint, with particular discretionary attention directed at the urban areas of Ontario. However, in the view of the Ontario Government, unemployment was the more serious threat at the time and a deliberate effort was made, through the 1970 and I971I budgets, to stimulate the economy, particularly in the basic investment sector. The direct challenge to the Minister of Finance was not lost on him, however, as the five per cent investment tax credit, which was the main technique employed by the Ontario Government, was applied to reduce the normal capital cost allowances under the federal corporation income tax.



Economic Policy / 555

It should be noted that the provincial fiscal policy capacity is largely limited to the size of the deficit or surplus and to the indirect tax field. As a result of the tax collection agreement, the provincial government is not free to alter the tax base or the graduated tax rates, although the tax credit system has been introduced first in Ontario, then in Manitoba, as a means of changing the incidence. However, the larger the portion of the direct taxes, the larger the basic budgetary influence. This certainly explains the federal government's unwillingness to turn over a larger share of the personal and corporation income tax to the provinces in exchange for assumption by the provinces of the full responsibility for the large shared-cost programmes. In my opinion, through operating fiscal policy at the margin of tax changes, the federal government could retain adequate fiscal policy capacity with 40 per cent of the personal income tax and 67 per cent of the corporation income tax. However, as the debates of the Tax Structure Committee demonstrated in 1966 and again in I969, the federal government feels that its hold on fiscal policy is already sufficiently tenuous.

The provincial and, increasingly the municipal, impact on the economy is not confined to the aggregate sense. Again, in I971 and 1972, it was demonstrated in Ontario that selective programmes to stimulate employment could have direct and immediate effect. In those instances, the policies tended to be reinforcing rather than countervailing. They also demonstrated the peculiar strength of a federal system when the governments find a way of working together. In that case, the federal financial leverage worked well with the provincial and municipal knowledge of local conditions.

However, it is not just the existence of the federal system that is the source of mythology about fiscal policy. There is the basic problem of identifying the phase in the cycle, agreeing about its duration, and then turning the tap on and off quickly enough to have an effect in the right direction. It has always seemed curious to me how blandly we talk about the efficiency of fiscal policy, without examining the record. In fact, there was a highly illuminating com- mentary in Volume 2 of The Report of the Royal Commission on Taxation in 1966, which examined the record of fiscal policy in relationship to the appar- ent state of the cycle. For the period 1954-63, the Commissioners reported that:

In our view, fiscal policy was approximately in the right direction and of the right magnitude about half the time. In three of the ten years, 1959, 1960 and 1963, we would judge discretionary fiscal policy to be perverse, and especially so in 1959 and 1960.

Looked at in broad terms, fiscal policy in the period under consideration was too expansionary in 1956 and too restricted thereafter. In very few years was there a real problem of choosing between conflicting objectives, although faulty forecasts, and other errors of diagnosis led policy-makers to think and act as though they were faced with such conflicts.

In addition to the chronic problem of adequate data at the right time, we have the issue of'fiscal drag' to contend with, whereby we build up over-kill in the fiscal system and subsequently compound our difficulties. The pity is that we appear to recognize these facts, but to behave as if they were not there. As




I look back at public policy in the post-war era, it is remarkable how much good analysis has been done and how little impact it has had on national policy. This is particularly true in the case of The Royal Commission on Taxation. Because the basic philosophy was not acceptable, the rest of the work was also quarantined. I believe it would be extremely useful to have some public dialogue on Volume 2, 'The Use of the Tax System to Achieve Economic and Social Objectives,' which has some highly significant commen- tary.

I turn now to a third problem and that is the concurrence of the two great Keynesian opposites - inflation and unemployment - or stagflation. The role of monetary and fiscal policy in the Keynesian world was to dampen down the economy or to stimulate it with the result that we would achieve full- employment equilibrium with price stability. However, a number of factors have combined to alter that Keynesian world radically, apart from the issues of federalism and ill-timing, as follows: - the decline of the market and the increase of administered pricing; - the growth of unions and union contracts; - the increase of basic government programs and expenditure as a fixed component of the Gross National Expenditure; - the increase in the service sector component of the economy and the difficulty of finding new productivity thresholds; - the increase in "buy now, pay later" and consumer credit.

The combination of institutional changes of this nature has set the stage for the major characteristic of today's economy - the tendency for consumer expectations to run ahead ofproductivity, with inflationary potential a built-in characteristic of the modern economy. The source of our difficulty then, is the structural characteristics of our economy and the behavioural pattern of our society. Those of us who found ourselves driven to recommending a technique for achieving a 'pause' did so largely to underline the fact that some fundamental decisions were required about values and objectives, without which our economy was becoming truly unmanageable. Enter wage and price controls!

In recent weeks, the public debate about the future of the Canadian economy has taken an interesting turn. Whereas wage and price controls were introduced as a temporary measure designed to arrest our seeming inexorable slide to the edge of the precipice, recent developments have heightened the fear that they may indeed be here to stay. This issue conceals a deeper uncertainty - a basic concern about the future course of the Canadian economy and Canadian society. As far as government policy is concerned, the debate has an additional dimension, concerning the extent to which 'Galbraithian economics' has become an article of faith within the Govern- ment of Canada. I have no way ofjudging if that is the case or not; on the other hand, in the last few weeks, both the former Minister of Finance, John Turner, and the former Deputy Minister of Finance, Simon Riesman, have suggested that the controlled economy is indeed an ingrained feature in the Prime Minister's thinking and in that of many of his principal advisors. If this is so, the remarks which the Prime Minister made at the beginning of the year about the future of the market certainly take on an interesting connotation.




I believe that we must answer two fundamental questions before consider- ing the route which we should follow in the immediate future. First, will our main effort be directed at living with the controls and all that they imply for managerial and entrepreneurial behaviour? Second, to what extent are we able and willing to devise a new, fundamental economic strategy for Canada? I find it encouraging indeed that so many Canadians are speaking out and asking basic questions about our future goals and objectives. What kind of society are we seeking? I believe the answer is important because without clear direction our efforts will merely result in a purposeless existence.

I recognize that these are highly philosophical questions, but I believe they have deeply-rooted practical consequences for each of us in our daily lives and for the lives of our children and our grandchildren. Let me therefore begin with the following statement. I agree with the Prime Minister's analysis and his assertion that we are entering into a new social and economic order, but I do not agree with his conclusion, nor with his implied suggestion that we have lost control over the outcome and that we must expect a higher degree of regulation and government intervention in the future direction of the economy. I say that I agree with the analysis because I believe we are trying today to live under some basically incompatible conditions. It seems to me that three factors are undeniably true:

I. We have been experiencing no real economic growth recently and zero increases in productivity. Recent increases in output per employed person slowed from 2% in 1972 to 1.6 per cent in 1973, with no effective increase during the past two years. This can be accounted for by a number of factors, among them the following: a) massive shifts to service sectors and government where productivity gains

are hard to come by; b) a general shift to fewer hours of work and less time at work; c) the lack of sustained incentives to renew capital equipment; d) the declining tendency to worship at the altar of the Gross National

Product and a greater concern with the quality of life (the urge to take some of the grossness out of the gross national product);

e) the chronic uncertainty and instability in inter-governmental relations which has deterred necessary drive and initiative in the private sector; and

f) the complicating factors of food shortages and energy restrictions. The recent recession, therefore, is not merely a temporary aberration in the periodic ups-and-downs of the business cycle, but it is rather a deep-seated situation, reflecting a basic change in attitudes to work, productivity, and economic growth. 2. We have a relatively recent and accelerating concern to conserve resources and to enhance the environment. This has, in turn, become a major factor operating against the economic growth ethic. 3. In the face of these two characteristics, the first factual and the second its partial explanation, individuals continue to have aspirations for a higher level of consumption both of private and of public goods. I recall, a number of years ago, writing a review of J.K. Galbraith's book on The Affluent Society and suggesting that he was mistaken in believing that economic scarcity was no longer a problem and, therefore, we could transfer an increasing proportion of




our output to the public sector. Now, nearly twenty years later in his latest book, Money, Galbraith admits that he underestimated the force of rising aspirations for consumer goods and services. I would add that he also over- estimated our ability or willingness to sustain growth and production. Indi- viduals demonstrate a continuing desire to increase their individual standard of living and, when translated into a desire for more public goods and social welfare measures, we experience an increase in the growth of government and, more recently, in government deficits. I would say that Mr. Riesman's recent contention that the accumulated demand created by monetary and fiscal expansion is the main source of inflation is technically correct. How- ever, that does not change the fact that the expansion has come in response to a desire on the part of people for a higher level of government services and public goods.

The fact remains that these factors are incompatible, and we will continue to have a chronically high rate of inflation unless we find ways to reduce individual aspirations or ways to increase economic growth. One thing is certain: unabated inflation can only result eventually in the destruction of social democracy as we know it. What is really interesting today is that this proposition is not the preserve of either the free-enterpriser or the conventional socialist. Indeed, the leading left-wing candidate for the leadership of the British Labour Party, Michael Foot, identified precisely the same issue as the most endemic threat to the future of social democracy.

The real question is whether we wish to continue to follow the path of economic growth that has sustained us for the past thirty years, or whether we wish to accept a reduction in the rate of increase of our standard of living (or even an absolute reduction) and can agree upon the means of doing so. For the past thirty years, as the product of hard work and high productivity, we have been able to achieve an unsurpassed level of social services and to continue with a program of more equitable redistribution of income. Either redistribution cannot continue, with the result that many individuals will be frustrated, or redistribution of income will continue to the extent that those who are on the giving end increasingly become figures of despair.

Given that choice, I suspect Canadians would still opt for a higher standard of living. The prerequisites for economic policy and economic management would then resemble the following:

I. It would be necessary to make economic growth our main objective, although this need not be a matter of pure materialism. Economic growth can consist of a variety of goods and services and it can add to a richer, more meaningful, more sophisticated life, but without economic growth, we cannot begin to fulfill any of the aspirations we would continue to have.

2. In order to be successful in that objective, policy should be designed to liberate once again the forces of initiative, enterprise, innovation, and competition in the market-place. I do not think that the current debate about the market per se is very helpful. I do not believe that the main problem is the one Galbraith identifies as that of the monopolistic power of large corporations and trade unions. Nor do I believe that this factor is unimportant in our current economic condition. Rather, I believe the




answer is to be found between the two extremes. It will be interesting to see the results of the Bryce Commission, for example. It would also be interesting to see a similar assessment made of the large and powerful trade unions. To be concerned about that point, it seems to me, is not to be anti-labour but rather to be concerned about the prospect of any large group exercising undue power over the individual in our society.

3. We should survey the whole realm of government legislation and public policy in order to find ways of rewarding those factors of initiative, enterprise, innovation and competition.

4. We should concentrate major effort on more efficient use of resources, on the avoidance of waste, on the conservation of resources. This is the most appropriate role for government planning.

5. Not only to increase economic growth, but to conserve resources in the process, we would require a massive attack on methods of increasing productivity. Nor can this be done by business, labour or government alone. Rather, we require a commitment to a joint enterprise, bearing in mind that the service industries and government itself are prime candi- dates for this effort.

6. We would then seek to reassure everyone that to be modern Luddites is not a sensible policy. We should not attempt to withstand the force of technological replacement of particular jobs; indeed, we should encourage it. However, we cannot do so at the price of unemployment and idleness. Rather, we would need to rethink our whole eduational process so that 'adaptive education' became our guide and retraining and rehabili- tation of human resources our pre-eminent concern.

7. We would also require a careful look at the role of government in our society. The problem with the growth of government is not so much a problem of size per se, but rather of the conditions that accompany it: (a) the difficulty of adaptability in changing circumstances where government programs and attitudes become fixed and difficult to dislodge; (b) the draining away of valuable human resources from the private sector where they are badly needed and often in scarce supply; (c) the overriding of government interference with individual initiative and economic fron- tiersmanship.

8. We would require major consideration of the problems of specialization in order to survive in the international world. It is becoming increasingly clear that Canada's competitive position is threatened in a variety of ways.

9. We will require an urgent and major assessment of how the problems of energy shortages, increasing transportation costs, and decreasing agricultural land may affect the pattern of growth. Situations change very quickly and we must be careful to avoid fighting the last war. During my own years in government service, I was particularly concerned about the growth of large metropolitan areas and the need to decentralize people and economic activity to other parts of the country and of the nation. I still believe that is a preferred course in human terms and that decentralization is always to be preferred to excessive centralism. However, is it not possible that the problem of energy shortages, transportation costs, and




scarce agricultural land will begin to reverse the process and encourage, once again, economic concentration? I hope this will not be the case, but I would urge serious consideration of that possibility by government plan- ners.

Io. Finally, we would require renewed consideration of how the new fron- tiers of the north and the west might stimulate major economic revival. Canada is at a low point in the long economic cycle of growth and change, which is normally characterized by major investment booms and economic discoveries. There is still the potential in the north and the west to provide that stimulus which, in the past, has been provided by the railway, the seaway, and such other historic developments. Not nearly enough attention is being paid to that long-term historical process.

However, if we are not successful in a massive attack directed at more efficient use of resources and higher productivity, or if we should prefer a lower standard of living, it is difficult to imagine the market mechanism surviving undiminished. Controls, corporate statism, or some such label becomes a real possibility. In choosing our future course, we should give careful consideration to the 'economic management apparatus' that would accompany it. If'limits to growth' are around the corner, or even more limited growth, then so is Galbraith.

I suggest that we have a serious discussion about the options. The economy is still manageable, but our problem is to decide on the kind of economy we wish to manage. And this is the key difference between the worlds of Keynes and Galbraith - the one designed to use government to salvage the market and the other to control the market.

In the process, let us not be side-tracked into secondary debates about economic theory and its effectiveness. The economics of John Maynard Keynes has not worked well, monetary and fiscal policy has not always been effective, and it certainly was not designed for a highly decentralized federal state like Canada. Nor does Galbraith's analysis of the modern industrial state in the United States fit the Canadian conditions. We have something to learn from all the theories - classical, conventional and non-conventional - and much to lose by slavish adherence. For example, the debate about interest rates is futile if overly-generalized. If we first agree on economic growth as an objective, then monetary policy should direct money at attractive rates into the capital investment sector rather than into short-term consumption. In that way, lower interest rates need not be inflationary. However, timing and the total mix of policies is, at all times, crucial. That requires judgment and perspective - the real essence of good economic management.

And so, what of the future? Last summer, I was one of those who urged some form of wage and price controls, in order to break the cycle of expectations and the inflationary slide. As I indicated at that time, I would have preferred something in the order of a ninety-day freeze to the immediate introduction of a complicated, bureaucratic exercise. However, I also urged that the main purpose should be to create a pause, within which we recon- sidered the basic economic future of the country. What I believe we require is a similar process to that which went into the establishment of 'the recon- struction plan' for Canada in I946. At that time, we were coming out of a



Comment

Comment

GIDEON ROSENBLUTH / Department of Economics, University of British Columbia

Of course governments can govern. It takes remarkably little wisdom, skill or even luck to maintain a reasonable level of law and order and keep the economic system from collapsing. In western industrialized nations there appears to be almost no limit to the incompetence in its chief executive that such a system can tolerate without breaking down. When we ask whether governments can 'manage the economy' we are setting a much more ambi- tious standard of performance. We are asking whether governments in a western capitalist economic system, and more particularly in Canada, can maintain full employment, rising living standards, increasing equity, and (if we want to count it separately) a rising or at least not declining 'quality of life,' without 'undue' inflation. The verdict of history is that governments have achieved these objectives for only limited periods. Their patent failure to achieve them now has brought on the current spate of conjecture.

The analysis of government performance still, with some few exceptions, consists of conjecture rendered plausible by means of anecdotes. Let us hope that we will progress to more rigorous formulation and testing of hypotheses.

I find some of Ian Macdonald's conjectures difficult to accept. I do not believe that the existence of a federal system has to frustrate the pursuit of Keynesian fiscal and monetary policy by the central government. The central government must view provincial and local governments as independent agents whose behaviour it modifies by its policies, just as it views business

561

depression followed by a war, and the concern was that Canada might not find a way to withstand heavy unemployment and economic dislocation. In fact, we embarked upon a thirty-year period of growth and development of unpre- cedented character. Now, I believe we need to stand back and look at the fundamental direction of Canada and our economic future, and to consider the options available to us today.

In conclusion, I believe that we can manage the economy - at least as well as we have ever managed it although not without a great deal of difficulty. The real issue, as always is:

i) to identify our goals and objectives; ii) to agree upon the appropriate and most effective economic policy as a

means of achieving those objectives; iii) To ensure that we have the skill to apply that policy and the determination

to do so. The first must be a task for the people and the politicians, the second a challenge to the professional economist, and the third principally the responsibility of the public administrator. However, much greater effort is required to ensure that each understands the other and in that process of communica- tion and translation lies our greatest challenge.



economic policy: can we manage the economy any more?

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