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Canada needs to consider a fiscal Plan B


Canada’s Economic Action Plan is being widely advertised this National Hockey League playoff season, but it is hardly working as advertised. It needs to be rethought in light of new thinking about the costs of austerity.

While the feel-good ads would have us think that the famous “Plan” is generating growth and jobs, last week’s Labour Force Survey showed that we have lost almost 100,000 paid jobs in the private sector since December.

Just what is Canada’s Economic Action Plan? This boils down to a belief that fiscal austerity plus small government and low taxes will promote growth and jobs through high levels of private sector investment, especially in the resource sector.

In a statement before last week’s G8 meetings intended to bolster the case for global fiscal austerity, Finance Minister Jim Flaherty argued that “the most important contribution a government can make to bolster confidence and growth in a country is to maintain a sound fiscal position.” He added that “the way to make Canada an attractive place to invest is by keeping taxes low, cutting red tape and removing barriers to trade and investment.”

However, growth in Canada in recent years has not been led by private-sector investment, which has been notably weak and remains below pre-recession levels. Instead, our relatively strong performance in the recovery from the Great Recession was driven mainly by a housing bubble and a steep increase in household debt to record levels.

As the IMF noted in its most recent country report on Canada, “rapid recovery from the Great Recession was built in part on the resilience of private consumption and residential construction. But with elevated house prices and both residential construction-to-GDP ratio and the household debt-to-income ratio at historically high levels, the prospects for both sources of demand have weakened.”

Contrary to popular belief and the rhetoric of the Harper government, resource-sector exports have not been a major driver of growth and jobs for the Canadian economy as a whole. To the contrary, we have been running a trade deficit of some 4 per cent of GDP because the rise in resource exports has been more than offset by a rise in the manufacturing trade deficit.

It seems highly doubtful that resource-sector investment and exports will rise by enough to offset reduced household spending, given that oil and gas prices seem to have peaked, and given growing domestic and international opposition to further expansion of export capacity in the form of new pipelines.

That takes us back to the issue of fiscal austerity, the central plank of Canada’s Economic Action Plan.

The Harper government has become an outlier in the international debate over the risks of fiscal austerity. The IMF, generally reflective of the mainstream consensus, has begun to take seriously the Keynes-Krugman argument that spending cuts at a time of depressed demand will result in continued high unemployment, lost output, and thus little progress in reducing public debt as a share of GDP.

In last month’s World Economic Outlook it warned that “fiscal adjustment needs to progress gradually, building on measures that limit damage to demand in the short term.” Britain has been warned that spending cuts have gone too far; pro-growth fiscal policies in Japan have been supported; and the United States has been warned of the dangers of cutting government spending too fast.

In its report on Canada, the IMF judged that fiscal restraint by all levels of government is shaving the annual GDP growth rate by 0.5 percentage points. This is more than enough, it can be added, to make the difference between rising and falling unemployment.

Using highly circumspect language, the IMF hinted that Canada, given its strong fiscal position compared with most other advanced industrial countries, might even introduce a new stimulus program.

“If the economy weakened further, the federal and some provincial governments should allow the full operation of automatic stabilizers. In the event of a large adverse shock, the federal authorities could also consider a new temporary fiscal stimulus package, given the available policy space.”

The OECD has similarly said of Canada that “if new shocks were to weaken underlying growth materially, the pace of debt reduction should be slowed.”

The key point is that Canada’s Economic Action Plan is not working as advertised. We should at least be thinking about a fiscal Plan B.

This article originally appeared on the Globe and Mail's Economy Lab.

Photo: bay_dragon. Used under a Creative Commons BY 2.0 licence.