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Jim Flaherty’s Keynesian moment, and its mixed results


Former Finance Minister Jim Flaherty will be rightly remembered for the 2009 federal Budget which provided much-needed fiscal stimulus to boost a crisis-ridden Canadian economy and helped set the stage for recovery.

While the government was reluctant to act, domestic political as well as international pressure from the G20 forced even strict fiscal conservatives such as Prime Minister Harper and Minister Flaherty to find their inner Keynes.

Short-term infrastructure projects put many unemployed Canadians back to work, and extended unemployment benefits made a big difference in many hard hit industrial communities. Unlike the United States, however, there was little investment for the longer term in renewable energy and green technologies.

The Flaherty record is much weaker when it comes to dealing with the long-term structural issues facing the Canadian economy and laying the basis for long-term prosperity and sustainability in a changing global economy.

Since about 2002, the Canadian economy has been primarily driven by a household debt driven housing boom, and by the rapid expansion of the primary resource sector. As traditional manufacturing has shrunk due to the high dollar, it has not been replaced by advanced manufacturing and related service industries which compete in the global market via investments in research and development, innovation and skills.

The resource boom and its spill over effects have created jobs, but not enough jobs to restore anything like broadly based prosperity in central and eastern Canada. Unemployment remains above 7.5% everywhere east of the prairies.

Resources have expanded GDP and exports, but we now run a massive deficit in the trade of manufactured goods, especially advanced machinery and equipment, as well as in high end services. This translates into a huge net loss of highly productive, skilled, middle-class jobs.

The near demise of national technological champions such as Nortel and BlackBerry and the very small scale of our renewable energy industries are symptomatic of our failure to seriously build a knowledge based economy capable of competing in global markets.

Report after report from the OECD, the IMF, the Conference Board of Canada and bank economists have flagged Canada's painfully slow rate of productivity growth compared to the United States and other major industrial powers. Much of this is the result of low investment in machinery and equipment, which has lagged behind overall GDP growth in the recovery.

Our record in research and development is especially dismal. Business spending in this area peaked at over 1% of GDP in the early 200s but fell to 0.88% in 2012. This is less than one half of the 2% or even higher level in the United States and other G7 countries.

The approach of Minister Flaherty and the Harper government has been to leave decisions on investment to the market while creating a broadly “business-friendly” climate through deregulation and tax cuts.

In its flagship policy, the government slashed the statutory federal corporate income tax rate, from 22% to 15% as of 2012, notwithstanding the deficit, and watched the cash reserves of non financial corporations climb to over $600 Billion on the basis of near record high profit margins.

To date, this leaves it all to the market approach has clearly failed to build a new economy. The much anticipated rebound in business investment in advanced capital goods, innovation and skills has just not taken place even as profits have soared. And, given the real shrinkage of our innovative and productive capacities over the past decade, there is good reason to question whether it ever will.

To his credit, Mr. Flaherty did modestly expand some more targeted tax measures, such as tax credits for investment in new machinery, as well as funding for university based research. But public investment in the new economy has generally taken a distant second place to fiscal austerity.

The Harper Conservatives have failed to heed the voices of economists like Canada's own Richard Lipsey and Mariana Mazzucato of the United Kingdom who argue that public investment and government leadership in the development and diffusion of of new technologies are absolutely central to private sector success.

As Mazzucato shows, in the United States, defence research through DARPA has played a huge role in the development of innovative capacity in the private sector. And the US government has also played a major role in capital markets, investing in start up firms in Silicon Valley before venture capitalists were prepared to take on the risk.

In some European countries such as Germany, governments have played a central role in creating the technological building blocks for a major transition towards renewable energy and high energy efficiency, creating major new industries and new jobs in the process.

Finance Minister Flaherty saw little room for such public sector entrepreneurship and leadership in building a sophisticated modern economy. That blind spot has cost us dearly.

This article originally appeared in the Globe & Mail's Economy Lab.

Photo: bcgovphotos. Used under a Creative Commons BY-NC-ND licence.