[Recorded by Electronic Apparatus]
Thursday, October 10, 1996
.1533 
[English]
The Chairman: Perhaps we can come to order. We're pleased to have so many economic experts from across Canada with us this afternoon. This is the first of our finance committee's public hearings on what should be in our next budget.
We are meeting following the announcement made yesterday by Mr. Martin on what our figures for the past year will be and on what the future deficit targets for the government are going to be as well.
We have with us today, from the Ontario Teachers' Pension Board, Mr. Leo de Bever, vice-president, research and economics. From the University of Western Ontario, we haveMr. David Laidler, professor of economics.
[Translation]
We also have with us, from Lévesque, Beaubien, Geoffrion Inc. Mr. Clément Gignac, Chief Economist and Strategist, and from the Université du Québec à Montréal, Mr. Pierre Fortin, economics professor.
[English]
From Loewen, Ondaatje, McCutcheon Ltd., we have Ms Maureen Farrow, executive vice-president and director of economics and equity strategy. From the Bank of Montreal, there is Mr. Tim O'Neill, chief economist. From the Canadian Imperial Bank of Commerce, we haveMr. Josh Mendelsohn, chief economist and senior vice-president. From the National Voluntary Organizations, there is Mr. Al Hatton, executive director.
We thank you all for being with us.
We need your advice on three important questions.
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First, are the economic assumptions in Mr. Martin's economic update, particularly with respect to interest rates, growth and income, prudent? If not, what should they be for the next year?
Secondly, what should the debt-to-gross national product ratio be in Canada? We raised this issue with the Auditor General, where he recommended in his 1995 report that we as politicians and Canadians in general pay more attention not just to the deficit but also to the debt. Of course, it has a very related topic attached to it: can we or should we now cut taxes?
[Translation]
The third point is our monetary policy. Mr. Pierre Fortin spoke about that. He says our inflation rate is too low and far more jobs could be created in Canada if the inflation rate were higher.
Let me start by answering the first question.
[English]
I would welcome your comments on the economic assumptions contained in Mr. Martin's economic update. Do you feel they're prudent, and what should they be for the next year?
Who would like to begin?
Mr. Leo de Bever (Vice-President, Research and Economics, Ontario Teachers' Pension Board): I suppose as a finance minister you can't really win in making economic assumptions. If you put in what in the business world would be seen as a conservative estimate, you're accused of padding the books. If, after the fact, you're wrong, then you're lousy at forecasting.
It's clear that the expectations for T-bill rates have come out much better than anyone expected. If that kind of difference from reasonable expectation six months ago can occur, then it's equally likely in my estimation that something will happen in the next twelve months that would give us a reversal of that good fortune. So I think it's quite prudent, when you look at the forecast, that it has what I would call a conservative estimate and a high estimate of where T-bill rates might be going over the next twelve months.
I think the same is true for ten-year government bond rates. They are right now at 7.5%, or thereabouts, and the estimation here is 8%. I think that's conservative. The growth estimates are quite in line with what most private sector forecasts in the OECD are looking for. So I think they're quite useful as a basis for budgeting.
The Chairman: Thank you, Mr. de Bever.
Professor Laidler.
Professor David Laidler (Faculty of Economics, University of Western Ontario): I don't have very much to add to that. There is one caveat that hasn't been discussed, but I think it probably ought to be, at least peripherally.
In my view, the Europeans are getting themselves between a rock and a hard place over European monetary union as 1999 approaches. Two things can happen. One is they will decide to postpone it, and if they do, I can imagine some fallout in international financial markets that will waft across the Atlantic. The other is they will decide to go ahead anyway, which means they will have to fudge their fiscal criteria to a considerable extent and run the risk of introducing a not very credible currency. That too carries with it the risk of international financial turbulence.
Monetary shenanigans in Europe are going to be on too large a scale not to have an impact on international capital markets, generally. So I would also be doing a little bit of quiet contingency planning for that eventuality.
The Chairman: Could you explain to us how turmoil in the European Community may cause problems directly for Canada?
Prof. Laidler: There will simply be runs against currencies and from currencies. There will be uncertainties in financial markets driving up real interest rates in the international economy. There will be the type of turbulence we saw when Britain and Italy were run out of the European exchange rate mechanism.
The Chairman: Thank you, Professor Laidler.
Josh Mendelsohn, please.
Mr. Josh Mendelsohn (Chief Economist and Senior Vice-President, Canadian Imperial Bank of Commerce): Just to follow up on Professor Laidler's comments, I have two observations. I don't have any problems on the forecasts themselves, because they are quite conservative. In fact, if I follow up Professor Laidler's comments, one possible implication of this is that these numbers may end up being very conservative. If there is turbulence in Europe, if the European monetary system doesn't go, there will be a flow of capital into the Deutschmark and that will have some implications here. But if there is fudging of the numbers, those countries perceived as not fudging numbers are actually going to benefit. There may actually be a flow of capital to North America, which could bring our interest rates somewhat lower than we originally anticipated.
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At this point, our working assumption is that there is too much political capital invested in the European monetary union for it not to be a go, however they define the rules of the game. But if that were to happen, I think there would be some flow of capital into North America, and it could actually be beneficial from an interest rate perspective.
Ms Maureen Farrow (Executive Vice-President and Director of Economics and Equity Strategy; Loewen, Ondaatje, McCutcheon Limited): I think what Josh has just said is very important. If you go back to when the other turbulence was happening, we also had a lot of serious problems here. We were carrying rising deficits and debt and we were having political discussions on the front burner. We got caught within that. We also had the Mexican crisis at the same time. There were a lot of things going on in the system.
David is quite correct that when these things happen, it's very difficult to measure the fallout and where they're going to come. But because our economic house is getting much more in order, we're going to weather those storms much better and we're going to attract funds more easily.
The Chairman: Thank you, Maureen Farrow. Tim O'Neill.
Mr. Tim O'Neill (Chief Economist, Bank of Montreal): It's going to sound like a bunch of ``me too's'' on this, but I think the assumptions' prudence and the discussion to this point suggest that the likelihood is that we'll actually do better than these assumptions suggest.
What has to be understood, particularly in relation to the points David Laidler was making, is that in Canada we have economic fundamentals that are seen to be, and in fact are, substantially different from what we were looking at a couple of years ago when we were going through the kind of financial market turbulence referred to here. Whether in some views it's too low an inflation rate, we clearly have established a lower inflation rate than our major trading partner and most of the countries with whom we would be doing business. We are now in a position of having an external surplus. It probably won't be maintained on average for this year, but it probably will be for next year. And across the country, not only at the federal level, governments have established a reasonable degree of credibility with their fiscal programs.
Add to that the kind of competitiveness that we have in our cost structure, and you have an economy that from an investor's point of view - whether resident in Canada or elsewhere - is a very good economy on which to make a bet. It's a very good economy in which to make an investment. I think we're seeing some of the impact of that already in the way the fundamentals I've just referred to have led to a strengthening in the Canadian dollar in the last couple of weeks.
Ms Farrow: There was a significant inflow into Canadian equity as well over the last summer months. It continues to go on and will continue to go on.
Can I finish so that I've answered the first question?
The Chairman: Yes, please, Ms Farrow.
Ms Farrow: On the economic assumptions, basically I don't think we can fault this finance minister. He learned the lesson that you have to be conservative on these economic assumptions. That means you have higher interest rates than everyone else thinks they're going to be. You can pick up lots of gains and you have lower growth in your numbers so that your revenue line doesn't get out of line in terms of your budgeting.
We could sit here all day arguing whether it's 3 or 2.9 or 3.2, and that's a total waste of time. He's likely to gain in this budget from both of those key numbers you asked us about. Interest rates are likely to be lower and growth is likely to be stronger. That's very good because it means we'll beat the targets again.
I think it's very important that the government stay the course on fiscal retrenchment and not give way before the job is completed. We're planning now for the beginning of the 21st century.
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On these economic fundamentals we put in place we're showing very significant improvement across the board. International investors I talk to every day are looking at Canada as though we've risen from the ashes. It's fascinating. It's the deficit - I think we'll come back to the debt; it is important - the current account, the contained inflation environment, the overall competitiveness, the restructuring of the export sector. We've gained enormous market shares across the board on our export markets, particularly into the Asian markets, excluding Japan.
In terms of the domestic economy, all the population-related sectors now are getting restructured, from government to finance to retail. Once you get all this down, you're going to see the confidence of Canadians rising.
Interest rates are falling, and this economy is set to have a whole new round of confidence-building from the external investor, who'll be putting direct investment into this country, not just equity investment or holding our fixed income securities. It also gives us an opportunity. I think it's very important in this budget for the government to start taking stock of how we walk into the 21st century, having done the business planning that governments are now taking responsibility for. Governments are acting like businesses now, and therefore they should start thinking not just for one year, two years or three years, but also what are the needs of Canada as we go in. This is very important in terms of social planning, demographics and competitiveness, if we're going to retain and build upon competitiveness. Rather than talking about tax cuts, I think we should be talking about overhaul of the tax system and then come to that.
The Chairman: Before we get into that I just want to clear away the question of our assumptions, whether there's anything we're missing, whether we should be more prudent or whether we're too conservative, which you people seem to be plugging as being a very good thing.
Al Hatton.
Mr. Al Hatton (Executive Director, Coalition of National Voluntary Organizations): Thanks, Jim. I guess with everything so wonderful, we'll be here for a very short period of time.
The Chairman: I think there are lots of things to talk about. We have a lot of time.
Mr. Hatton: I think that last point on the economic side is absolutely true. The problem is, going back to the assumptions, we would also agree that tax cuts at this time would be the wrong thing.
Representing a part of the community that's different from perhaps a number of people who have so far spoken, we see also a jobless recovery, that, yes, the big economic indicators are helping certain businesses and a certain part of society, but there's a huge other part of society that is increasingly marginalized. If you look at the futurists who are looking at a different kind of scenario, then the good news in this budget is all the things people have been talking about, and we are also for that. There's a whole other side of this, though, that isn't being addressed. I know it's difficult for the finance committee to address this. On the other hand, if we're going to be balanced and we're going to look at the positive impacts on government and on the economy and on a certain part of the business community in terms of the economic indicators and economic work the finance committee and the department have done, that's great.
On the social side, though, what we're finding is I think the unintended impact of all this, that a lot of the community structures, the structures at the local level, that would have people in fact adapt to this, whether it be training programs, support for children, looking at alternate care besides just maintaining the medical system as it is, and hospitals and the whole structure related to that as opposed to community care... That's a whole other series of issues.
The major departments that are concerned about the so-called social side of all of this are all being cut back. They're also changing, but there's no transition plan. It's all internally focused: How do we cut people? How do we save money?
So I think a whole other series of things here also has to be addressed.
The Chairman: I agree with you. I would like to suggest that we will have a lot of time to go into those other issues, too, because they are equally important to us.
I just wanted to get through some of this boiler plate on the economic assumptions, becauseMr. Martin has asked us to consult directly with you on that issue. So with your permission, I'd like to get through the economic assumptions. For example, are they realistic, and if not, what should they be?
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Then I would really welcome opening up further these other issues you've raised.
Clément Gignac.
[Translation]
Mr. Clément Gignac (Chief Economist and Strategist, Lévesque, Beaubien, Geoffrion Inc.): I feel somewhat awkward saying this, but this time I find Mr. Martin's economic theories too conservative. I think he's merely being too cautious. Let me explain.
As far as interest rates are concerned, he predicts they will be 8% next year for ten-year bonds, which is nearly 125 basis points lower than they are today.
As Canadians know, economic forecasts made by Canadian economists must be taken with a grain of salt because we just follow the American trends.
The difference now is that Canada's interest rates are lower than the U.S.'s and the Bank of Canada's official reserves keep growing. In fact, and this has already been mentioned by some of the other speakers, with a balanced current account, for the first time in 12 years, Canadians are paying off the deficit with their own money.
So we have become financially independent and that financial independence allows us to be a little more realistic, since the minister's economic theories as far as interest rates are concerned are extremely prudent and conservative.
Once we have a 3-billion contingency fund, it is worth asking whether the minister should keep the same interest rate philosophy, since interest rates are currently 125 basis points lower than the rate suggested by the minister, and we still have the highest real interest rate of any G-7 country.
Given all that is happening internationally and at home, when the minister prepares his next budget, I think he should wonder whether it is really necessary to be so prudent, as this could have political consequences. He wants income tax cuts to begin at a much later date. He has been overly pessimistic and cautious with interest rates.
Four years ago, when the minister consulted economists, we suggested - I even did so myself - he adopted a prudent approach. We had always suggested 50 basis points above the private sector, but I see that the minister is now going further than just being the kind parent we suggested he be at the time.
The Chairman: Thank you, Mr. Gignac.
[English]
Mr. O'Neill and Mr. Mendelsohn, please.
Mr. O'Neill: With all due respect, I think the history of budget-making over the last three decades in this country is that when you use relatively optimistic assumptions, chances are you're going to have unpleasant surprises. I think it is appropriate to use cautious assumptions.
On the growth numbers - and I've given you an outlook that you can peruse at your leisure - I don't think it's especially conservative. It's modestly so. The conservatism really is on the interest rate side. Given our experience over the last four or five years and the volatility we've sometimes experienced, that's not inappropriate.
I would agree that we still have real interest rates that are too high and that there's room for those to move down. I expect they will. In our own forecast we're expecting both the three-month T-bill and the ten-year bonds to be at levels about two percentage points below what is given here. But I would remind people that when you're looking at the Canadian economy, the influence of the U.S. economy and U.S. financial markets is something we should not ignore.
There is a real possibility - I'm not expecting it, but I'm suggesting it's a risk - that the federal reserve is going to have to tighten, perhaps significantly, in the next three to six months. In that context it will be very difficult for us to completely avoid the spillover effect into Canada. In that context, then, I think it would be appropriate to be cautious.
If they really have to tighten significantly, then you're looking at a significant slowdown in the U.S., which then hits us on the export side, the real side, of the economy, throwing the growth number into question.
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I have no quarrel at all with numbers that, from my own forecast, look a tad overly cautious. I think that's appropriate and prudent.
The Chairman: Thank you.
Mr. Mendelsohn.
Mr. Mendelsohn: Tim O'Neill echoed a lot of what I was going to say, but I want to build on it a bit.
The notion that the numbers are too conservative, and by implication we therefore have room to manoeuvre...I think we open ourselves up to the volatility and risk we want to avoid.
We effectively have a two-year history of fiscal consolidation. Over a long history of 20 years plus of deficit, broken promises and what not, I think in a world in which the Europeans, for example, are moving towards meeting the guidelines for joining the European monetary union, if we now start to look as though we're backtracking a bit, we do risk seeing the risk premiums on Canadian interest rates rise. In fact, if we go that route, I would go for a more conservative interest rate perspective, because we would risk those risk premiums coming right back to us.
We're doing extremely well today. Most people who looked at this would not have thought we could have 150 basis points negative spreads on three-month treasury bills - and lasting. We expect them to continue, more or less, into 1998 and maybe beyond.
If we start going backwards, we'll start paying the price. I think you have to allow for that, and if we're going to go that route, I would possibly even raise those rates.
The Chairman: Thank you very much.
Lastly, on this issue of the assumption, Mr. Fortin.
[Translation]
Mr. Pierre Fortin (economics professor, Université du Québec à Montréal): This issue of economic hypotheses is quite an important one. I think the minister is obviously being prudent, as he should be. I don't think a prediction of 3% of GDP is too conservative. If you follow the basic principles you learned in Economics 101, the three most important factors that have an impact on Canada's economic growth are American economic growth, pressure on Canada's public expenditures, and thirdly, Canada's interest rates. If you compare 1997 and 1996, you see there could be a slight slowdown, at least in the United States, compared to 1996, as Tim O'Neill just pointed out.
Secondly, if you look at the provincial and federal budget predictions, it is easy to see that there will be as many budget cuts in 1997 as there were in 1996. Expenditures will be reduced by 1.5% this year in both real and absolute terms, and the same is planned for next year.
These two factors do not bode well for next year's economic growth. That does not mean we object to getting our financial house in order and fighting the deficit. It is just that in the short term, if you are trying to predict growth, you have to take that factor into account.
Thirdly, the assumed average interest rate for 1996-97 will be 5.3%, and I think that is fairly conservative. It seems to me that the negative impact of those two other forces will be even stronger and that the central bank will have to maintain a relatively conservative monetary policy for all of 1997.
I really expect average interest rates to be less than 5%, regardless of what happens to short-term American interest rates. I would not be surprised if we reached the minister's 3%, which many of my colleagues find very conservative, in view of the negative forces playing on our economy, besides our monetary policy. The only really influential factor right now is interest rates.
.1600
From a strategic standpoint, then, the is on the right course. I think we may even reach his GDP goals, and interest rates may even be a little lower than predicted.
The Chairman: Thank you. Mr. Gignac, please.
Mr. Gignac: I feel quite comfortable with the minister's approach towards interest rates and economic growth. Mr. Fortin has already said that as far as interest rates are concerned, we recommend a conservative approach, but we do not suggest the minister should be more conservative than he has been in the last three or four years. We would suggest he use the private sector average plus 50 basis points.
In my earlier statement, I wanted to say that I think he has a much more comfortable cushion now, a much bigger one than he had over the past three years, because of the changes that have already been mentioned, but this cushion is due to the fact that Canadians have not seen any tax cuts, and Canada's economy might not be able to flourish if there were an economic slowdown in the United States. I think he should just do what he has been doing for the past three years. I just realized yesterday that he is setting up another kitty that we had never recommended.
[English]
The Chairman: Ms Farrow, please.
Ms Farrow: I have one comment to make on the 3%. I would say this is not sticking with the policy of being conservative.
We've usually been running the budget documents with about half a point less growth than the average of the forecast on the street. The forecast on the street is 3.1% according to this document, and this is a 3% number.
The risk in this budget, so to speak, may be that although we've got very conservative numbers on the interest rate side, we're not being conservative enough on the growth side of the economy - the real side of the economy.
I think we should be concerned about that because we've had a really long cycle. We hope we have an extended cycle in the U.S. We hope our exports are going to hang up around the world and the consumer here will kick in. There are risks with all that. The balance sheets of Canadians are not in good shape.
A lot of us are thinking there will be a forward momentum of growth. I would have liked to have seen a two point something number there - 2.5 or 2.7. I felt very comfortable about the assumptions.
The Chairman: Thank you.
Are there any members who want to ask questions of our panel on this issue of our economic assumptions, or should we go on to the next question?
Mr. Bélisle.
[Translation]
Mr. Bélisle (La Prairie): My first question is for Mr. Mendelsohn. You said the predicted inflation rate was lower than that of our main rival, the United States. Our chairman asked you whether we should allow the inflation rate to increase to stimulate demand and economic growth. What is your view on that?
The Chairman: I was under the impression that that was the third question you had asked every expert on inflation rates and job creation. That is what professor Fortin thought. With your permission, perhaps we could take...
Mr. Bélisle: All right, Mr. Chairman. If I may, I will ask another question. One of our witnesses said something quite different from the others and raised an interesting point. That was Mr. Hatton.
He said something quite interesting. I think he was saying there could be an economic recovery without job creation. He also said there is another aspect to this which has not been discussed, namely the social dimension of the issue. My question for Mr. Hatton is the following: could you expand on the points you feel the Minister of Finance has forgotten about, namely the dimension you were alluding to?
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[English]
The Chairman: Just very briefly, Mr. Hatton, because we'll be coming back to these major issues about jobs afterwards.
Mr. Hatton: Then I'm comfortable waiting. If we're going to get into it, let's get into it and not skim across the surface. I think that's more appropriate. I will answer your question, sir.
[Translation]
Mr. Bélisle: Mr. Chairman, I think that I will let you get on with the meeting. I have two or three other questions and you have told me that these will be dealt with a little later on. I will let you go ahead.
[English]
The Chairman: I would like to leave the questions to our experts on the question we asked them: are our economic assumptions correct? Then we'll go on to the second question, which deals with the amount of the debt and tax cuts. The third question will be the thesis raised by Professor Fortin, monetary policy and its impact on jobs. Then we will open up to any other issues that people want to ask about.
In conclusion then, we've heard Mr. Martin's economic update is generally thought to be prudent. There are a number of unforeseen possibilities on the horizon coming out of the European Community. There's also the United States interest rate increase, a decrease in our access to the U.S. market, and the dampening effect that expenditure cuts in Canada may have on our economy, including the fact that growth may not hit the 3%. Therefore, yes, it's acceptably prudent but there's still room for caution.
May we go on to our next question, which was raised by the Auditor General in 1995, that parliamentarians and Canadians in general should place more emphasis on the amount of the debt as opposed to just the deficit. We still have an extremely high debt-to-GDP ratio, one of the highest of the G-7 countries. We have the highest ratio next to Italy. How long can we live with this? Is this a proper measure to look at in our future deliberations? What is the impact? What about tax cuts now?
Josh Mendelsohn.
Mr. Mendelsohn: I think the arguments in many cases are well known. There are both long-term and short-term arguments for focusing on the debt. The whole issue of the deficit really revolves around the need to stabilize the debt ratio and to bring it down. The key long-term issues are intergenerational transfers of the burden of carrying this debt.
If this debt had been accumulated and is being accumulated to build up a capital structure that would allow future generations to be more productive and have a better standard of living, I would say fair enough because the future generations do have an obligation to pick up some of that cost. But most of this debt, if not all of it, has been accumulated as a result of maintaining current consumption. What we are doing is burdening our future generations with that debt load. We're in fact burdening current generations with it, because you can see some of the generation X group, the post-baby-boom generation, even the late baby boomers, paying some of the prices on some of the very issues that were raised around this room today on educational costs and the things being cut in an attempt to stabilize the situation.
Second, there is a great deal of debate within this country and in all industrial countries about the aging profile of populations. They are going to put enormous pressures on governments and the working population to meet the needs for pensions and health care and related aging issues. All of these risk ballooning the debt structure unless we bring it down substantially today to prepare ourselves to deal with it in the future.
Third, we had the discussion here before about something being able to go wrong in the short term, such as that which happened in Mexico. There are questions about Malaysia's credit quality because of current accounts, debt loads, and the like. Indonesia is another one. We already went through this process with Mexico, and Canada got caught in the wake because we had this huge debt structure as part of the process. There were other things as well.
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So I think that even for the long term there is really not much of a debate. We do need to fix it, and that is the real issue. But even from a short-term perspective, I think we need to focus on it because of the risk it poses: we may fall into the trap other countries have fallen into and lose our credibility.
Finally, on the notion of a tax cut, let's assume for the moment that we're all wrong here, that in fact the economy is going to zoom ahead by 4% and the interest rates are going to be lower. My contention would be that I appreciate there are clearly costs we have paid and are paying in getting this situation in place - we took a long time to start dealing with it. So there are going to be costs.
More important, if this issue can be stabilized sooner rather than later, while we still have public support to do that, and once it's done we can then look beyond and look at the possibilities and the prospects of tax cuts and of taking other measures - because we are in the process of bringing down the debt ratio - then I think we're actually ahead of the game and better off.
Why drag it out if in fact we can control it more quickly?
The Chairman: Thank you, Mr. Mendelsohn.
If I might just interrupt, we have been joined by three other experts on our panel. From the National Anti-Poverty Organization we have the executive director, Lynne Toupin; from the Royal Bank of Canada, the senior vice-president and chief economist, Mr. John McCallum; and from the Fraser Institute, the director, Dr. Michael Walker.
Welcome, and thanks to the three of you for being with us.
John McCallum, I saw your hand up.
Mr. John McCallum (Senior Vice-President and Chief Economist, Royal Bank of Canada): First of all, Mr. Chairman, my apologies for being late. I was in Quebec City this morning and discovered the only way to get here was to drive. I did that, but I arrived a bit late.
I would like to make three points on this issue very quickly. First, it seems to me that the very substantial interest rate reductions we've had in the last year or so could not possibly have happened in the absence of the federal government's core fiscal plan.
As we've argued in a report I've circulated, those lower interest rates are likely to create jobs in the hundreds of thousands in the next couple of years. So one would not want to jeopardize those hundreds of thousands of permanent jobs by a fiscal stimulus that would bring benefits measured, at best, in the tens of thousands of jobs.
Secondly, as to permanent versus temporary tax cuts, I think a permanent, sizeable tax cut would represent a U-turn for the core fiscal plan, and hence should be rejected.
There might be a case, however, for a modest, temporary income tax cut, but the problem with that is that a huge amount of research indicates that temporary income tax cuts get about the least bang for the buck in terms of job creation.
So if the priority is jobs, you wouldn't get much from that, and it might be better to go for a UI premium reduction.
My third and final point is the inter-generational argument. It's the baby boomers and the seniors who are the prime beneficiaries of the build-up of the debt. We haven't even quite turned the corner coming down. The baby boomers who are in the prime age of their careers would be the major beneficiaries of a major tax cut.
So I think it's a bit unseemly for these older Canadians to be pushing for a huge tax cut that would benefit them; they have benefited from the run-up of the debt.
We would run the risk that we wouldn't bring the debt ratio down, and we would leave the younger Canadians even further in the lurch. It seems to me, looking forward five years or more, as that debt ratio comes down, that there will be ample time to have affordable tax reductions for the younger people who by then will be more in the prime of their working lives.
So I would certainly think it is essential to bring down the debt ratio. And any kind of significant, permanent tax cut at this time would be counter-productive, not only because of inter-generational fairness, but also because it would risk representing a total U-turn in the fiscal plan of the government, which has been so critical to the lower interest rates.
The Chairman: Thank you, John McCallum.
Michael Walker.
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Dr. Michael Walker (Executive Director, Fraser Institute): Thank you very much,Mr. Chairman. I apologize that my paper is not yet here. I faxed it from the airplane, but it has to be reproduced and will be here momentarily.
Some of the comments I have to make would be more transparent, if we had the tables and the chart to which I would like to refer. I think that until the paper is here, I will retain one of the comments that I would have made, because it really can't be made without the chart.
However, on the issue of the point that, as I understand it, is now on the floor - namely, what are the standards by which we should measure fiscal conduct - it seems to me that the finance minister is really putting to us and the committee the consideration of the appropriate standards that should be looked at in trying to assess the government's overall position.
That leads us back to a general question of assessing where the government is at the moment, before we go on to talk about what might be desirable to do in creating standards for the future.
It is important for us to remember that the reason Canada looks so good in 1996 is not because Canada is absolutely doing all that well fiscally. It's because we're being compared against the ``gruesome seven''. If we compare how we are doing to the G-7 countries, we look fairly good, and certainly we look good by comparison with our past. But we don't look well according to other standards one might suggest. For example, we don't look good according to the top performers in the OECD. We don't look good by comparison with New Zealand. We don't look good, even by comparison, with a country that has so many travails like Chile.
We look good relative to the G-7, and we must remind ourselves and not confuse our comparison here. There's an old expression on the street: you shouldn't confuse brilliance and a bull market. To some extent, we are simply being beneficiaries of bad performance by other countries.
The second point that needs to be made is that there is an obvious standard of comparison, against which we might hold the federal government's current fiscal position, and that is, the actual performance of our provinces. Many of them have been doing very much better than the federal government in its overall fiscal position.
At the Fraser Institute we construct an index of spending, a revenue index, and a deficit and debt index. We published that a few weeks ago. In that index, on the spending side, the federal government scores in the third position. The score on the revenue side - that is to say, in effect, how much it has relied upon revenue enhancement to achieve its deficit reduction goals - shows that the federal government falls in exactly the last position amongst the eleven jurisdictions. In the deficit and debt index, the federal government falls in the second-from-last position.
Overall, in comparison with its provincial counterparts, that gives the federal government a third-from-last position in budget performance.
So, in responding to the minister's request for guidance as to what kind of standards should be adhered to, we should not simply be content with arithmetic. We should rather construct some demanding standards against which to compare federal performance.
When we switch to the question of what sort of arithmetic we should be doing, here also we can provide some insights and, as economists, some suggestions to the minister and the committee.
About 18 months ago, the Fraser Institute published what we called ``The Generational Accounts for Canada''. ``The Generational Accounts for Canada'' attempt to look - just in an arithmetic sense - at the future implications of current fiscal positions, including the current debt position, the promises that have been made to pay under the various social programs and the tax burdens that are associated with those. This generational accounting exercise produced the horrific conclusion that simply to maintain the existing system would require a tax increase of 68%.
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These results have been more or less confirmed recently by another study of the same kind done by the Institute for Research on Public Policy, also using a generational account mechanism.
I would suggest that the really innovative piece of arithmetic the committee should send back to the minister for consideration is that he include not just current and projected four-year or five-year figures, but rather that the government begin to look at the ultimate implications, as it were, of the current fiscal status.
I might say that the government itself, in the activities of Mr. Dussault, the government's chief actuary, has already made a start in this direction by compiling the present discounted value of the future obligations under the Canada Pension Plan and its various social security programs.
The Chairman: Thank you, Dr. Walker.
David Laidler, please.
Prof. Laidler: Earlier some people remarked that the fundamentals are in place. I don't believe they are, because I believe the debt-to-GDP ratio is the fundamental ratio by which you should be judging fiscal policy.
I would argue that the main indication you get from that ratio is your ability to borrow for stabilization purposes the next time the economy turns down. I would say that was a rather more urgent thing than burdens upon future generations.
In the light of that, the numbers we have do not look good. I have some data from the Bank of Canada review for the summer. If you combine the federal government and the provinces, for 1995-96 it is 103.3% of GDP, and the forecast for 1997-98 is 103.1% of GDP.
If you get a U.S. slowdown in the next few years, and that coordinates with monetary turbulence in Europe, it's not clear to me that with a debt-to-GDP ratio like that we can look forward to a capital inflow that will drive our interest rates down. So I think we're in a very precarious position.
Moreover, as Mike Walker says, you have to consider the provinces as well as the federal government when you're looking at these ratios, and provincial debt-to-national-GDP ratios are between 29% and 30% of Canadian GDP.
I know this is not the place to air it at any length, but I have serious reservations about the stance of economic policy in Ontario. It seems to me to be very lax. The debt-to-provincial-product ratio is still increasing there because of tax cuts that, I believe, were ill-advised.
I can't help but believe that is likely to weaken the credibility of Canadian debt instruments in international markets, if there is any turndown in the United States, because that's going to hit Ontario harder than anywhere else.
I conclude from this that there's no room whatsoever at the moment for tax cuts, and indeed I wouldn't advocate tax cuts when the economy is expanding and is forecast to expand. I would save that for the time when the economy turns down, and just buy that little extra fiscal leeway. I would start worrying about future generations when perhaps the debt-to-GDP ratio was on its way down to 70% or 60%, and we're an enormous distance from that.
The Chairman: Thank you, David Laidler.
Lynne Toupin.
Ms Lynne Toupin (Executive Director, National Anti-Poverty Organization): I have one comment and then a question. First of all, I think it's very clear, from the point of view of our organization and many others, that we are very much in agreement with what Mr. Martin said yesterday in relation to not wanting to cut the tax rates.
I think he was right on the mark yesterday when he said that in fact this leads to a reduction in revenues, and which programs are we going to cut?
So we want to go on the record as saying we are very much in favour of not looking at a tax cut, for what it does to revenues - and therefore to programs - as well as for the disproportionate impact it actually has on the different class levels.
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The question I have is more in relation to the debt. If we are going to start biting into the debt, I would like to know which way we would propose to do that. It would seem to me that you can only go so far with interest rates. Conversely, you can look at increasing revenues, or you can look at more cuts to programs.
It would be important for us to know if you are in fact going to go beyond deficit reduction into actually going into the debt. I would assume we will want to cut into programs, and I would like to know at what point...what are the kinds of programs we should be cutting into if we want to go that far. What is left for the federal government to go...if we're going to continue to bite into the debt?
The Chairman: That is a very important question. Those of us on this side of the table would love to know the answers.
Tim O'Neill.
Mr. O'Neill: I want to follow up on a couple of points that have been made about the importance of the debt-to-GDP ratio. I don't know what the right number is; maybe it's not the ``gruesome seven'' average. Certainly we'd want to take Italy out of that one, but we'd want to keep Japan in.
Clearly, with a debt-to-GDP ratio some four times larger than that of Japan, and half as large again as the other four members - leaving Italy, ourselves and Japan out of it... If you want to use that even as a starting benchmark, we're clearly some considerable distance away, as David's numbers suggested, when you take the debt of all the jurisdictions together.
When you're over 100%, that is not a position you want to maintain. In fact, I'd remind all of us that it wasn't that long ago that we were sitting around in groups like this and getting questions like, when - not if - is Canada going to hit the wall?
I went to New York about three years ago and sat around a group of people from Wall Street. There wasn't a question about whether it would happen, but simply when it would happen. Now, we've come some distance from that.
I would agree with David that the fundamental in fiscal policy is the debt-to-GDP ratio. The fundamentals I was talking about were more what kind of fundamentals we have to maintain some stability in financial markets, but for the longer term this is the issue that has to be dealt with.
It's clear that one of the costs we've paid in maintaining this high debt-to-GDP ratio is that we have real long-term rates that are higher than they would otherwise be. If that is going to change, then we certainly have to move in a direction of significant reduction, however we may chose to do that.
The second point is that the debt servicing costs now are taking up roughly 35% to 36% of revenue. So if at any point the government wants to have more flexibility - whether we may agree about whether there ought to be new spending programs, tax cuts or actual debt reduction - the point is that there isn't any flexibility now. As David suggested, there is no flexibility to engage in counter-cyclical fiscal policy. Leave aside the question of whether it's desirable - we can argue about that - it simply isn't possible now.
I would suggest that as far as the tax is concerned, I'm sure we're going to have more debate about this. The goal at the end of the day here is dealing with this debt-to-GDP ratio.
In terms of getting just to a balanced budget, we are approximately half the distance, if you compare where we were three years ago with a $40 billion plus deficit at the federal level. On the basis of the estimates given to us yesterday, we'll be about halfway there at the end of this fiscal year.
If you're running a marathon, you can't see the goal line. You know where it is and you know what it is, but you still can't see it. You're not sure what kind of weather conditions are going to hamper your running strategy. You don't stop to eat lunch.
I would suggest that a tax cut is exactly a pause for refreshment that we don't need at this point in the fiscal program. It's very clear that we have to at least get to a point where we're balancing the budget.
Then the issue of what may be done with the fiscal dividend... We certainly don't have one yet, if we're sitting with a deficit of over $20 billion and, for this past year, of almost $30 billion. We don't have any dividend to spend or utilize; that's a long way off.
The Chairman: Thank you, Mr. O'Neill.
Josh Mendelsohn, please.
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Mr. Mendelsohn: First of all, just what I'm hearing around the table sort of reinforces the argument I tried to make, and that is, if we're fortunate enough to accelerate the process because the economy is stronger, or whatever, then we're better off for it. Let's not give it away too soon.
I'd like to bring up two anecdotal indicators here. It might respond a little to Lynne Toupin's question in terms of how this debt-to-GDP ratio is going to be brought down. Is it necessarily going to require some further program cuts?
The evidence from some of the countries around the world is that it is not necessarily the case that you have to keep cutting. I'm just going to give two examples, and they both come out of the 1996 annual report of the European Economic Community.
One example is of Denmark, and if I may be permitted just to quote a little here:
- Over the period 1982-86 Denmark transformed a deficit of 9.1% of GDP into a surplus of
3.4%...an improvement of 12.5%... The credibility of the policy shift was reflected in a halving
of the level of long-term interest rates and a marked fall in inflation. Rather than plunging the
economy into recession, fiscal adjustment was accompanied by a strong economic expansion.
- And it goes on from there.
In various situations, the pain in the early years may be more than in others. But the general point is that when you get your fundamentals in place, if you keep your wits about you, you do get the economy growing. Ultimately, if you want to increase and improve the well-being of your population, the only way to really get at the problem is to grow out of it. But you have to get the fundamentals in place to grow out of it. That's what I wanted to point out with these examples.
The Chairman: Thank you, Mr. Mendelsohn.
Maureen Farrow.
Ms Farrow: I wanted to pick up on a number of these points. The first is that the debt is the central issue, for all the reasons David and some of the other speakers were saying.
It has to be a focus of the government and of all Canadians that they are willing to stay the course and to get this debt-to-GDP ratio falling, and also back into line.
If you look at page 10 of the document from yesterday, you can see the federal net debt as a percent of GDP from 1946 to date. We're now at around the 70%-odd number that David was saying at the federal level, and we have about 20% to 30% at the provincial level.
At the federal level - that's really what we're talking about here - you have to aim at what it was in the late 1970s or early 1980s, and that's around 40% or 50% of GDP.
Now, I'm not saying that you do that through cuts, because I think what Tim and Josh were saying is quite right: as we get these economic fundamentals in place, we do get the economy growing. We don't go and just waste all the money - just go spending it willy-nilly - or have tax cuts across the board that don't make sense.
We will find that we do slowly bring this down. That's very important for dealing with two things. One is that we're going to get more recessions. In a global economy we're going to have to do more restructuring over the next 20 years. We might think it's behind us, but there's going to be more to come. There's also the inter-generational question.
I'm absolutely adamant in saying to this committee that we cannot afford tax cuts right now. I would also urge that as a nation we can't afford either to go for tax cuts, without first of all going through a very thoughtful process, which is really on what kind of tax system we need for this society.
There's an inter-generational set of issues here. There's also a set of competitiveness issues so that we can keep the economy rolling. It's not just where we spend it; it's what we are going to need to spend against when we look demographically into the future. Otherwise, we're going to do exactly what we did in the early 1970s. Let's have these programs - we don't have a deficit - and then we're going to find that the debt-to-GDP ratio is not 100%; it's at 200%.
The Chairman: Thank you, Maureen Farrow.
Ms Farrow: It's very important.
The Chairman: Clément Gignac.
[Translation]
Mr. Gignac: Since I work in the financial sector, you will not be surprised to hear me say that it would by far prefer to see a debt-to-GDP ratio gain plan in target, namely, that it would prefer to see efforts to bring down the debt.
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When the government was elected four years ago, it set a target of 3% of the GDP. We were thinking primarily about Maastricht at that time and we forgot to mention the other side of the equation, namely the debt-to-GDP ratio. I'm delighted that we are dealing with this now. If the minister wants to set a new target, I would suggest that he shoot for 60% of the GDP, like Europe.
Although I am an economist, I am also concerned about the moral side of the issue and therefore I do not think that the committee should consult only economists on this matter. Let me explain myself. We will have to make a trade-off between the debt-to-GDP ratio that we want to reach over the next five or ten years, and fiscal competitiveness, tax reductions. Obviously, it is not really necessary to reduce taxes in the next budget in order to encourage economic expansion at that time. However, I believe that the committee is consulting us about what will be happening in three or five year's time, and therefore for a period which goes beyond the next six months.
Given the current situation where the unemployment rate is 9.5% compared with 5% in the United States, where the Canada Pension Plan premiums will have to be increased, where UI premiums are high and should be increased as well - except for the symbolic measure that the minister adopted today - in a situation where payroll costs are consistently increasing for the employer whereas the cost of capital has plunged to a 30-year low, I'm asking myself some questions. Do you not think it would be appropriate to hold an important debate to determine whether or not we should, over the next year or two, once the government's borrowing requirements have been eliminated, restore our fiscal competitiveness, namely, bridge the gap that exists between the American fiscal burden and ours?
[English]
If I summarize, of course, we think it's welcome to have a game plan to reduce the debt-to-GDP ratio, but in the short term we have a trade-off. Is it better to reach that target first, or, given the fact that 40% of the Canadian economy goes to the U.S., to have a more competitive fiscal side, because right now we have never seen this kind of situation? We have a huge gap in the unemployment rate, the cost of labour is very high, and the cost of capital is very low.
Maybe I would suggest that the minister consult with other groups. Maybe when we have eliminated the borrowing requirement 18 months or 2 years from now... It's better before to attack the debt-to-GDP ratio. As a first step maybe...reduce our fiscal burden to U.S. labour, because 40% of the economy is there and we have free trade here.
So Europe, of course...but our major partner is very important...to be more competitive.
To conclude, the financial market is not against tax cuts; the financial market is against wasteful spending, gaspillage. So we think that if you maintain a very serious plan on the spending side, very efficient government, and reduce duplication, the market will not penalize you, because you reduce first your tax to be more competitive with the U.S., then reach 60% like Maastricht.
Merci.
The Chairman: Merci.
Michael Walker.
Dr. Walker: Mr. Chairman, heart-warming though it is to have somebody from the Fraser Institute have such universal agreement about the importance of the debt, I think there is a danger that we miss one of the key points about why we're concerned about the debt and why we're concerned about the level of government expenditure.
I'd like you to turn to the handouts you got. There's a chart that shows Canadian per capita economic growth performance over the period 1931 to 1991. That's the line that has the more irregularity to it. The second line that goes straight up towards the right-hand corner is the size of government's share in the economy.
I think it's important for us to focus on this, because clearly we would not want ourselves, as economists, to be saying that if we ran a surplus of, say, $5 billion, and the size of the government sector were to remain at 50% of the economy, this would be the same outcome as if, for example, we were to run a small deficit and at the same time reduce the size of the government in the economy from 50% down to 45%.
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Really the latter has to be our target. The reason we have had such poor growth performance in Canada is that overall the government is so large. The balancing of the budget only ensures that the high level of government expenditure is also matched by a high level of government taxation. Ultimately this is not the desirable situation. Ultimately our target - and the setting of government policy - has to be to reduce the size of government within the economy, or else we aren't going to get a growth dividend. We aren't ultimately going to be very successful in getting the debt-to-GDP ratio down, because we won't have that strong economy diluting, as it were, our past indebtedness.
The Chairman: Are you asking us to cut taxes now?
Dr. Walker: Well, I'm suggesting that cutting taxes, binary cuts in taxes and expenditures, would be a very intelligent policy.
I'm not suggesting that we should give up the deficit target, but I am suggesting that if you look at this chart and you bear in mind what it is we came into the swamp to do in the first place, it was, after all, to reduce the drag of the tax burden on the private sector.
Nothing about economic theory that I know suggests that simply changing the form in which we finance government expenditures will have any effect. It's the level of government expenditures, or the height of government expenditures as a fraction of the economy, that is the debilitating effect, not how we finance it, i.e., whether it's through taxes or through deferred taxes.
The Chairman: Well, that's interesting. We're going to have a little controversy here.
Dr. Walker: I hope so.
The Chairman: One person has called for a tax cut and, I'm sure, will be called to account by Lynne Toupin to find out where those concomitant cuts are going to come in spending programs to finance it.
John McCallum.
Mr. McCallum: In one respect, I think there's a certain amount of excess gloom around the table. I certainly am in favour of attaching a very high priority to getting the debt ratio down, and I'm dead against any significant tax cut at this time.
But in answer to Lynne Toupin's question, I don't think we need to cut programs at all to get the debt ratio down. If we just stay on the present course, according to the government's conservative projections, by the year 1998-99 the operating surplus as a percentage of GDP will be 4.8%. That's a huge number.
The arithmetic of debt will then set in. Even under conservative assumptions, if you just keep spending and tax is going up with GDP, with an operating surplus that big, the debt ratio will come down. Then indeed, as we look into the next century, not only will spending not have to come down, but spending could increase, or taxes could come down, depending on your politics.
A final point. In 1998-99 program spending by the federal government is forecast to be 12% of GDP, the lowest level since 1950. So the point is that if we stay the course... The point is, don't cut the taxes now, because then the fiscal dividend won't come up.
But if we simply stay the course, the vicious circle will become a virtuous circle. The debt ratio will come down, and over the next decade or two there will be very large fiscal dividends. Then it will be debated in the political arena whether we use these for tax cuts, for higher program spending, or some combination of the two.
Mr. Grubel (Capilano - Howe Sound): Or paying down the debt.
Mr. McCallum: But are we coming down? Because the interest payments on the debt will be coming down, that will free up those resources.
The Chairman: I have a lot of interventions. Lynne, you wanted to come back on this, because you're the one who raised part of this question.
Ms Toupin: I just want to ask a question of clarification to John.
Using that assumption then, are you also saying that for next year's budget we still need program cuts, or if we stay the course, if we have all the assumptions in place, do we still need more cuts next year?
Mr. McCallum: My assumption in the statement I just made is that we have all the cuts that have been prescribed -
Ms Toupin: That's right.
Mr. McCallum: - to date by the federal government, but no more.
Prof. Laidler: That includes cuts next year.
A voice: That's the idea!
Mr. Gignac: That excludes provincial government -
The Chairman: The three previous budgets have outlined every cut that has to be made, ifMr. Martin's projections are correct.
Mr. de Bever.
Mr. de Bever: This debate about the tax cut is like you've just landed on the beach in Normandy and you've already declared that the war is over. We're still at $25 billion.
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The other argument against the tax cut is that the government may find itself in the same situation that a lot of private companies found themselves in. If you impose a tax or you give a tax cut, you will have to cut that much more to get to your targets. Cutting under duress is not the most efficient way of doing things. What has happened in the private sector is that a lot of the cuts that were made, in retrospect, turned out to have been inefficient.
So I would argue that we try to do this on the same level. Let's do it the way in which it was originally outlined and not start counting our chickens before they're hatched, because the minister in some sense may have been too successful. He has already created the impression that this problem is solved, and it isn't.
The Chairman: Thank you.
Pierre Fortin.
[Translation]
Mr. Fortin: To begin with, I would like to go back to the principle of reducing the debt in national revenue. That is the first question that you asked.
The principle is based on the fact that economic growth is first and foremost stimulated by a society's savings, that the more savings we have to use to fund government deficits, the less we will have in the private sector to expand the economy. Our economy could grow all the same, but we would be obliged to go outside the country to borrow and, when that happens, foreigners get wealthy and we don't. We are working to fill the pockets of foreigners.
According to this basic principle, this need to increase savings in our economy is what justifies a by-the-book fight against the debt, namely a tireless fight to reduce it gradually. I don't think that anyone can argue that this is a fundamental objective that the government must pursue.
Your second question is a practical one. What precise target should we be setting for ourselves in terms of eliminating the debt, or as a debt-to-GDP ratio? We can give ourselves all kinds of very complicated objectives - and there are certainly enough people sitting around the table who could talk about some very complicated things - but I think targeting a zero deficit would be the simplest rule to follow, and the one most easily understood by all. That is therefore the recommendation that I would like to make to the government.
With a zero deficit, federal or provincial governments could, every year, if the GDP growth were sitting at 5%, namely 3% of real growth and 2% of inflation, reduce the debt load from 70 to 66, to 62 and then to 58%, year after year, and after 10 years of zero deficits, the debt would be down to 40%.
Practically, and not only theoretically, I would suggest that we try to achieve a zero deficit as quickly as possible and that we maintain the course to the extent possible. It will not be possible to do this every year, because unforeseen things happen. There may be some international disturbances and all kinds of phenomena which may cause us to miss our target. We have to allow for some flexibility, but basically, the government must follow Keynesian policies, namely, it must seek to attain a zero deficit and gradually reduce the level of debt, in my opinion.
In order to hurt our citizens as little as possible in terms of the tax burden and in terms of government spending cutbacks, we must of course ensure that Canada's economy recovers as quickly and fully as possible.
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As far as our economy is concerned, right now we are making scant use of our resources, which means that at least $10 billion of the current federal deficit can be attributed to the fact that the Canadian economy is still in a deep slump. If we had a recovery that brought the unemployment rate to about 7 or 6.5%, because structural unemployment has decreased since we have reduced unemployment insurance by 40% over the past five years, this would be quite easy, in my opinion, without the need for further budget cutbacks.
What should our tax burden be sitting at? At present, it is about 37% compared with 30% in the United States. In Canada, we have been saddled with expenses that we did not all agree to.Mr. Walker would like to see a minimalist State, whereas Ms. Toupin would like to see a State which does not necessarily provide a maximum level of service but at least maintains the entitlements that our grandparents fought for over the past 40 years. We could adjudicate bearing in mind the principle pointed out by Clément Gignac earlier, namely, that we have to pay very close attention to our fiscal competitiveness compared to the rest of the world. I would imagine that the Mintz Committee will make recommendations to the government about the business tax system, at least as far as this aspect is concerned.
Consequently, we should try to attain a zero deficit as quickly as possible, without making changes that go beyond what has already been set out in the current expenditure reduction program. Next, let's maintain the tax burden and adjust it wherever necessary, but on a selective basis, exactly as the minister said. As far as that is concerned, I completely agree with him. In my opinion, the strategy followed by Quebec and the federal government, which consists in achieving a zero deficit before tackling the tax issue, is much wiser than Ontario's strategy, which is more or less based on what I refer to as belated "supply side-ism", a bit like the crackpot schemes we saw in the 1980s, which would take us dangerously close to where Reagan took the American budget at the end of the 1980s, namely, a very dangerous slump.
[English]
The Chairman: Thank you, Pierre Fortin.
Al Hatton.
Mr. Hatton: Thanks, Mr. Peterson. I'm just going back to Michael Walker's chart and the comments he made. Maybe I don't understand, but it seems to me that this implies there's just one role for government, and that has something to do with the economy. I think it's kind of misleading. I also notice that it stops in 1991. I don't know if that's just because it's out of date. I'd say that now it's going to start to go down and the other will start to go up.
The other thing I note is that in fact the role of government is changing, and government is trying to understand and be very specific about what its role is going to be. In a sense, I was left with the impression that this thing is just going to go right off the chart and keep on going. In 1991 that was the case; in 1996 it's very different. Maybe I'm misunderstanding something, but I wouldn't want the committee to be left with the impression that... There's kind of an implication here that the problem in the economy has to do with government.
The Chairman: Michael Walker is absolutely thrilled that you mention his name, because it gives him an excuse to get back on our panel, but we'll wait for just a second if you don't mind.
David, would you like to...?.
Prof. Laidler: I really want to pick up on some remarks that Mike made. He said that economic analysis said that the way in which government expenditure was financed doesn't make any difference. There are indeed such models - Ricardian equivalence models - in which there are no marginal costs to raising taxes. Those models have shortcomings. That is why it does make a difference whether government expenditure is financed by taxes or by borrowing, and that's why we're concerned with the debt-to-GDP ratio.
The second thing I would like to say is that it seems to me to be just extraordinarily misleading to take some number - 50% - for the share of government and national income. What is that? Is it revenue? Is that net government cash outlay? Is that government expenditure on goods and services? Is it government expenditure on goods and services plus transfers to individuals? All of these programs have different effects on the economy.
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There seems to be a view, which I've heard many times outside this room, that we need to be competitive in our taxes with the United States. If we're competitive in our taxes with the United States and we don't like deficits, we're going to have to be competitive in our social programs with the United States as well. This isn't the place to debate it, but I had a choice as to where I would immigrate, and I came here. There was a reason for that.
The Chairman: Michael, you'll get a chance to respond to that right now.
Dr. Walker: Thanks very much, Mr. Chairman.
To go back to the question of what the chart shows... First of all, the chart goes up only to 1991, because it was done from an aircraft and I didn't have the other data. The other data would probably be slightly different, but not very different, from the impression that is given.
I think what it does is sound a cautionary note, one that incidentally is now being sounded by almost all of the theorists and empiricists who are active in the area of economic growth. The more recent economic growth models are putting in variables like this to try to explain, in addition to the education of the population and the amount of investment and technology the economy has, that the activities of government seem to be a crucial variable that explains the residual that these economic models had not been able to explain until these kinds of variables were put in. They're commonly referred to as economic freedom variables, or something along those lines. The overwhelming evidence from all the schools I'm aware of that are impinging on this area is that this is in fact a very important variable.
If you're concerned about the rate of economic growth and the terminal level of our incomes in Canada, you had better be concerned about the size of government, because it has a very important effect on it.
David, what are the numbers in the chart? They're the numbers that people like Bob Barro, Jeff Sachs, and people like that who are doing the economic growth analysis these days are putting in their models to try to capture the effect of the role of government within the economy.
Prof. Laidler: Yes, but what are they? What is that 50...?
Dr. Walker: This is just the total of expenditure plus transfers.
Prof. Laidler: Does that include expenditure and interest on the public debt?
Dr. Walker: It includes all expenditures of government, plus transfers. It's a measure of the overall extent to which the resources of the economy are being siphoned through the public sector, something with which we ought to all be concerned if the evidence from the growth work and our own work is accurate.
I think to simply suggest that we should just ignore this chart because government has important functions to play in the economy... I'm not suggesting that government doesn't have important functions to play. I'm just suggesting that the implications of government's involvement in the economy on growth are real.
I just returned, for example, from Scandinavia, to which I was invited to go and share with them our work on these kinds of measurements in a broader context, in which we measured the performance of 103 countries. I can tell you that they're very concerned about the size of government in Scandinavia. In Sweden they're very concerned about the fact that they're up at 60%. Its economy is doing quite a bit worse than our economy is, and the prospects for improvement are just not there.
If we ignore the level to which we've gone in our country and forget about the fact that it has real implications, I think we will pay a very big price for it. We won't get the growth that Pierre Fortin talked about that will liquidate our debt over a period of time. We won't get the wonderful dividends that John McCallum talked about to dissolve our problems.
The Chairman: Thanks, Michael.
Maureen Farrow, then Josh Mendelsohn.
Ms Farrow: I want to come back to something that Pierre was saying that I don't think we really spend enough time on at any of these meetings. That's the savings function and the role of saving. I think we should be thinking more about it, for all the reasons that Pierre was giving, so I won't go back over them.
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But we should also be looking at how we develop the savings mentality in this country. Because we live next to the U.S., we kid ourselves that we save a lot, but our savings rate has been falling. We also don't save anywhere near as much relative to other nations. This is a very important matter. If we're looking at the budget, we should start to look at how to develop a much more robust savings function in this economy as we go forward.
I'd also like to say a few words about selective tax cuts. I don't want to disagree with the minister, because in some ways I don't disagree with what he did in the last budget in terms of selective tax cuts and credits. I think it is a vehicle to support various groups in the caring society that we like to think we're in, and we should think we're in and should try to work towards. But I'm not in favour of selective tax cuts as a norm.
I think we got scared by what we did with tax reform in the 1980s. We did a lot of thinking and then messed up the delivery of the set of measures by dividing it into two pieces, with the provinces coming in between, etc. It was a complete foul-up of the delivery of tax reform. I would much sooner urge us not to go for tax cuts this time, or credits - they're the same as tax cuts - but to really start thinking about what this tax system should look like, both from the competitiveness perspective and, very importantly, what we need to do in terms of programs for the kind of society and the demographics that we have going forward.
We are at a stage where we must think about this, and I'd like to put it back on the table. We get sucked into selective tax cuts and before we know it we'll have changed the system again.
The Chairman: Maybe we could bring up this idea of the demographics and the impact on the budget process in our last session today.
Josh Mendelsohn.
Mr. Mendelsohn: Maureen put it very well. That's one of the problems with coming after half a dozen speakers who have gone into the issue. The comments I heard around the table ranged all the way from ``let's scale back government'' to ``we will be able to keep programs going once we have the situation in place''. I think the key issue, as Maureen was saying, is that every program, just like every bit of the tax system, needs to be re-evaluated on an ongoing basis.
I must have been asleep at the switch at some point, because what I understood the finance minister to say with the first budget and then the second budget was that it wasn't just a matter of cutting the deficit and bringing down the debt load. It was also looking at how we do it and how we restructure government to make the entire economy work not only more efficiently, but more effectively. To me, that's part and parcel of the exercise, but we keep talking about the numbers.
There is clearly something to what Michael Walker is saying. In many countries with large governments there is also stagnation in some sense because there is an ossification of the process. But at the end of the day, I assume that we've been talking all along about dollars and cents as well as the structure of programs and the tax system. I'm hoping this doesn't disappear and they focus on just the numbers. It doesn't deflect from that.
The Chairman: Do any of the other panellists want to intervene briefly on this point? There may be members of Parliament who would like to ask you questions in this area.
Dr. Walker: Mr. Chairman, may I introduce one empirical effect. Everybody knows the case of New Zealand, and everybody thinks that New Zealand first reduced its debt. It didn't. It first reduced the size of government by 20%, and then it went about cutting the debt. In fact, the actual debt went up in the first five years following the transformation. Now, I'm not suggesting we increase our debt, but it's important to remember that the countries that have gone through major transformations have first cut the size of government so as to increase the size of the private sector.
The Chairman: Tim O'Neill.
Mr. O'Neill: There were other things New Zealand did as well, one of which was to open up its economy. We have a far more open economy than New Zealand had at that time, so let's be sure we're comparing apples and apples.
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Obviously, on the issue of what share the government has of the economy and how one measures that, we could endlessly debate on the precise numbers we ought to use. What isn't necessarily captured in here, of course, is the degree of regulatory restraint that various types of governments have imposed on their economies? It may not show up in the dollar numbers, but may show up in very different ways in influencing the behaviour of that economy. That's not really captured here.
Dr. Walker: We published a report two weeks ago that showed its worth about $80 billion in Canada.
Mr. O'Neill: If you looked at the per capita income growth number that this chart shows, for virtually any industrialized country over the same period, I would argue you would find a similar pattern.
One of the major things that happened after the early 1970s, of course, was the significant decline in productivity growth. All of the industrialized countries faced this. That is the major factor in per capita income growth. So we have to be a bit careful about taking two numbers, putting them on the chart, showing the lines cross, and assuming that one means something profound for the other, just on the face of it. There are other important factors important here.
The Chairman: Thanks, Tim O'Neill.
[Translation]
We will now ask some questions. Nic Leblanc, please.
Mr. Leblanc (Longueuil): I have heard many things. You have painted a good picture of the current situation. Everyone agrees that we have to reduce the debt to zero as quickly as possible. We cannot increase taxes because we already pay enough and we cannot increase programs because we don't have the means to do so.
In particular, I would like you to tell me how we can increase economic growth. Earlier you mentioned that we had to first of all increase savings if we wanted to one day stimulate the economy.
The Chairman: I apologize for interrupting, but this question on the means to obtain economic growth will be dealt with later on. I would like us to finish our discussion on Mr. Martin's second question contained in the book that he published yesterday on the debt-to-GDP ratio.
Mr. Leblanc: All right, I will ask a question about the GDP and the debt. The Minister of Finance says, for example, that the deficit must not exceed 2% of the gross domestic product. If one country has a lot more debts than another, we must not compare the deficit and the GDP.
Earlier, you said that most European countries had a debt of approximately 60% of their GDP. Here, in Canada, we know that it is about 100 and 105% when you include the provinces. Consequently wouldn't this ratio be minus 2% of the deficit surplus with respect to the GDP? It seems to me that there is a relativity that we often forget. Perhaps we should be thinking about our debt with respect to the deficit that we should or should not be acquiring.
Mr. Fortin: I said that my figure was zero. Not two; zero. The federal government, like the government of Quebec, has already announced that it intends to achieve a deficit of zero. It should be striving to achieve this level, with some flexibility to allow for the economic situation.
We must distinguish between two things in terms of growth. Firstly, we must bring our productivity back up to the level where we are once again working at capacity, something that we are not doing right now. Only 92 or 95% of our resources are being used in our economy and that is reflected by a very high unemployment rate, which is sitting above 9% in Canada.
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Once the unemployment rate has been brought back down to a more reasonable level, to about 7 or 6.5%, for example, we will be able to give some thought to more effective ways of accelerating growth and accessing savings as a result of the government not having to borrow so much.
This is what I was advocating as the government's main tool for stimulating economic growth. Growth comes from new ideas that are associated with the new technologies, with the new organization of labour; but that requires investments funded by savings. The investment is the Mercedes and the savings are the gas. The more gas you have the farther you go.
Mr. Leblanc: When do you think we're going to be able to go farther?
Mr. Fortin: In five years, we will be able to reduce our deficit to zero and, if we are smart enough to maintain interest rates at a very moderate level, we will be able to experience a complete economic recovery. You will see that this will be a Formula 1 competition. Canada will be like Villeneuve, who, as we all know, will win the Japanese Grand Prix next week.
The Chairman: Thank you, Mr. Fortin. Mr. Gignac.
Mr. Gignac: Minister Paul Martin has taken an excellent approach over the past four years. In the past, governments have all too often set unrealistic targets. We had three or five-year time frames and we never reached the target.
This moving two-year approach, and now with an announcement being made concerning 1% of the GDP, is the more credible approach to take. Having worked in a bank, I can tell you that credibility is important. The same thing holds true for financial investors.
Consequently, I personally believe that within two years and not within three, four or five years, the federal government will have brought its deficit down to zero. It is preferable to operate asMr. Paul Martin has done. When he came into power, the interest rates were much higher than those in the United States, and yet inflation had for quite some time been lower than that of the United States. We now have lower interest rates than the United States because of the current government's credibility in the eyes of international investors. Consequently, he was wise to use targets and, asMr. Fortin said in his concluding remarks, he was wise to have a specific target tending towards zero. This is the most credible target and we support it.
The Chairman: Thank you, Mr. Leblanc.
[English]
Ms Whelan, please.
Ms Whelan (Essex - Windsor): Thank you, Mr. Chairman.
[Translation]
The Chairman: Perhaps you could give Ms. Whelan a chance to ask a question and after, you could ask as many questions as you like.
[English]
Ms Whelan: I just want to follow up on something Mr. McCallum said earlier. When you talk about the debt, I'm wondering if anyone has considered what's going to happen to the debt in longer-range forecasts, in five to ten years, when the baby boomers have started to retire and we've gone from the boom to the bust. There will be potentially fewer people in the workforce, so I'm assuming we'll also talk about lowering taxes five or ten years down the road. Is it realistic to lower taxes at the same time as we need to reduce the level of debt?
It's much more important to reduce the level of debt in this country to a manageable level. I'm just wondering if staying the course is going to be enough in five or ten years, when I see great changes coming.
Mr. McCallum: I think if one can stay the course, the basic story is a happy one.
There are two ways of staying the course. One is you get to a zero deficit in, say, three years, or whatever, and keep it on average zero. That way the debt ratio will be coming down quite substantially. Over time it also means that, as the debt ratio comes down, you will have a gradual fiscal dividend that can be used to lower taxes, to have higher health care spending if the older generation needs it, or any number of things.
An alternative way to do this would be to get to 1998-99 with the operating surplus of 4.8%, hold that constant, and just let spending and taxes go up with the economy. The debt ratio would come down faster that way.
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Either way you do it, you will have a debt ratio coming down, let's say, to 40% within a decade, and that would liberate a fair amount of resources.
The last point I would make is where the caution comes in. We're already starting to talk about permanent tax cuts today when we haven't even reached the peak of the debt ratio.
So all of these nice projections that Pierre Fortin and I are talking about presuppose that we stay the course. If you start having tax cuts today on any significant scale, the debt ratio will start to go in the wrong direction.
Ms Farrow: When you talk about this demographic thing going forward, you really do have about ten years before the front end of the baby boomers reach this critical stage.
The first of the baby boomers only went through fifty on January 1 this year, so you have ten years. If you do what Pierre is saying, you aim for zero on the deficit. Over each business cycle we keep it at zero. We can then pay down the debt, as John is saying, or pay off a lot of it and get down to the 40% or 50% debt-to-GDP ratio.
We have a moment in time. If we don't use that moment in time now to put the right policies in place and keep on course, we will have very serious problems when we come back to talk about this in five years' time, because there will be no window left. It's very important. That's why I raise the demographics.
Dr. Walker: Ms Whelan, thank you for raising this issue, because it's precisely what I was referring to when I talked about the generational accounts and the importance of not ignoring the big swell in expenditures and the big swell in taxes.
We haven't talked about the fact that there is an enormous implicit increase in the tax burden, associated with currently existing programs, simply because of the aging population.
In that regard, on page 47 in the minister's publication, he shows the Canadian expenditures relative to the G-7. We are now nearly down to the average of the G-7. But this is a very distorted picture, because most of the countries in the G-7 already have much of their aging population behind them. They've already ramped up expenditures on social security; they've ramped up their health care expenditures. That's true in most of the European countries, for example, whereas we have not yet faced that kind of ramping up.
The OECD did a study and asked what the implications would be for the tax rate in the future if the expenditures were ramped up. They found that if you put Canada and the other EU countries on the same basis, for example, Canada's tax rates were already one percentage point higher than they were in the EU. As I said, we haven't already had to face this problem of financing the increased health and social security expenditures and so on.
I think there is nothing more important for the government to do than to begin doing these generational accounts on an annual basis and to keep careful watch over what the implications in the future are for current changes in policy.
Prof. Laidler: I have a remark concerning demography. When these issues are raised, I don't understand why people do not consider immigration policy as a tool for dealing with demographic problems. This needs to be looked at seriously.
Mr. Grubel: It doesn't work.
The Chairman: I'm glad you raised that.
Mr. Grubel: Mr. O'Neill said we shouldn't be talking about what the optimum level of the spending is. Mr. McCallum obviously likes the current $106 billion of program spending, and he believes that is optimal.
If we eliminated the deficit in two years using the prudent assumptions of the University of Toronto for revenue growth and for interest rates, we would have to cut program spending to$95 billion. By my calculations that would bring program spending to GDP ratio to where it was just when Mr. Trudeau went on his spending binge.
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The question is, where do we get another $10 billion? The fact of the matter is, as I learned yesterday from questioning the minister, in program spending, other than in transfers to the provinces, this government in its tremendous spending cuts has reduced its own spending by$2 billion a year, less than 2%. I believe there are many people who can see there is still a lot of fat to be cut from the kind of bloated government we have here in Ottawa. That $10 billion to get us to zero in 1998-99 could be found rather readily.
The Chairman: I think Lynne Toupin wanted to volunteer you a couple of billion, Herb.
Ms Toupin: We have been talking about debts and wanting to reduce the debt at some time. I just want to caution people to start looking at the combined impact of the reduction in deficits at both the provincial and federal levels and what it is doing to people. It's not negligible. If you want some information on what those impacts are, we have preliminary studies available from a range of communities and organizations. We cannot continue without being mindful at the very least that these have impacts on real people.
That's the only caution I want to instil here. While we're talking about this and agree that the fiscal houses of this government and all governments have to be put in order, at what price and how far do we go?
The Chairman: On that point, I would encourage you to ask those people to bring these studies forward to us in our pre-budget studies. We expect we'll meet a great number of them as we travel across this country. We look forward to that.
John McCallum.
Mr. McCallum: In a sense this is a point of order. My friend and former colleague Mr. Grubel says it's obvious that I think the 1998-99 spending level is optimal. I don't know how he came to that conclusion, because I never said anything of the kind.
All I said was that under current policies, if we stay the course, we could get into the situation of a declining debt ratio with no further actions beyond what has been in the Martin budgets. Then I said as the debt ratio came down there would be a surplus, which could be used to cut taxes or expand government spending, or you could still cut government spending and reduce taxes by even more.
I think how you use the fiscal surplus is mainly a political question. I was just saying that given the plans, that fiscal surplus will emerge. The division between spending and tax cuts is a matter for the politicians to debate. I'm not offering any opinion on that topic.
Mr. Grubel: I beg your pardon, but there is still a political decision as to what level of program spending we're going to get at this blissful stage. I agree with you. That is an issue, whether we reach it earlier or later, be it in 2001 as you suggested or two or three years earlier. You cannot say these are unimportant. We have a lot of program spending, such as overlapping jurisdictional expenses on fisheries, forestry, and all kinds of things, which would bring us to that kind of a level without having to touch the programs that Lynne Toupin is worried about.
Mr. McCallum: My point was a purely technical one. We're working on a study of this, Herb. I'll send you a copy.
Mr. Grubel: We're working on that study, too.
The Chairman: John, I can answer your question very clearly. Herb thought your declaration, which may have been tacit, that the numbers were optimum, was based on his great deal of respect for you as an economist.
Members and panellists, we have been at this an hour and 55 minutes. I'm in your hands as to how long we go. There are light refreshments for us, and people may want to take a very brief break before we come back to it.
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Maybe we could end very quickly this round dealing with the debt and deficit and then come back and deal with what we should be doing in the future, including monetary policy, including jobs. I'm in the hands of members.
Mr. Leblanc.
[Translation]
Mr. Leblanc: Earlier, we talked about the effects of inflation on the relative debt and about getting citizens to quicken the pace somewhat as far as debt-to-GDP ratio is concerned.
The Chairman: The question of inflation will be dealt with later on by Mr. Pierre Fortin.
Mr. Leblanc: The chairman has quite an iron grip on things.
The Chairman: I apologize, Mr. Leblanc, but I said at the start that we would be dealing with three questions and that the issue of inflation would be dealt with by Mr. Pierre Fortin.
Mr. Leblanc: I will therefore talk about interest rates. I know that interest rates are very low and that this is a good thing. We tend to think that we should lower them even more. However, the current interest rates, even if they were to drop further, will not improve economic growth. The low rates do not appear to have had any impact on economic growth for some time.
I saw what happened here in Ottawa, in 1989, when the Conservatives caused the interest rates to rise slightly and the economy just about came to a complete halt within a few months. Is there not some danger in reducing interest rates by too much? If we were then to increase these rates suddenly by 1 or 2%, perhaps consumers and investors would react just as strongly as they did back in 1989. This concerns me a bit.
Mr. Fortin: No one in the world disagrees about the major effect that an expansionist or restrictive monetary policy can have on short-term economic growth in relation to the potential of the economy, namely, it will widen or reduce the gap between potential and achievement of this potential.
There may be some differences in the mechanisms by which monetary policy influences the economy, and you have mentioned one which is full of common sense; namely that the economy may react too quickly to a rise in interest rates and take more time to react to a drop in interest rates. Such asymmetrical results are possible with a monetary policy.
I would say that, right now, the main reason why the economy appears to be so slow to respond to the falling interest rates of the past 12 to 15 months, is because at the same time there has been a slowdown in the economy caused by the budget cutbacks themselves. It's just like we're on a moving sidewalk. For the time being, the sidewalk is winning.
Obviously, once the budget cutbacks are over and done with, you are going to see that the effects of interest rates conducive to a return to full employment will be felt very strongly. Moreover, we saw this happen in 1994. We had interest rates under 4% and, at the same time, strong economic growth in the United States. In addition, the impact of budget cutbacks was yet to be felt. The economy got off to a very strong start in 1994.
At present, the reason why it's not yet clear is because there are factors that offset the favourable impact of the monetary policy. You should have no difficulty understanding that the drop in interest rates will stimulate the economy to return to full employment. This is a truly inevitable proposal.
The Chairman: Is that it, Mr. Leblanc?
Thank you very much.
[English]
Is there any other commentary on that before we break? Otherwise, I suggest we come back here in about 15 minutes and pursue things we should be doing in the future.
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To conclude this part of our program, it seems to me the consensus was that the amount of debt we have is really critical to our economic future. It was mentioned that Canada is nowhere near the master target of 50% to be able to enter into the common currency, when you consider that combined federal and provincial debt is 103% of our gross domestic product and that every year we are paying because of it close to $50 billion, which is more than twice what we spend on our next biggest expenditure program.
We have heard, except from Michael Walker, that we cannot afford at this time a tax cut. It was put very forcefully I thought by Mr. de Bever, who said, we've only just landed in Normandy; we can't claim victory.
With all due respect to Mr. Walker, he suggested that we should have a tax cut accompanied by additional spending cuts. If, in the ensuing discussion, people want to provide suggestions to us as politicians on where those spending cuts should be made, we would welcome the advice.
Could we take a break for 15 minutes? I would appreciate it very much.
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The Chairman: Could we return to order? We've come to the third, not necessarily final, but at least penultimate aspect of our hearings today.
I have asked Professor Pierre Fortin to start off. I don't think it's published yet, but I have seen a copy of his paper dealing with Canada's monetary policy. He has made a direct link between a tight monetary policy and job losses. He suggests that we should increase the inflation rate, or else relax our monetary policy in Canada, in order to help us create more jobs. This committee has an open mind and is always ready to listen to new ideas.
Professor Fortin, you've indicated to me that you would like about seven or eight minutes to outline your thesis. Then we'll go to discussion.
I would also ask our panellists to feel free to comment on any other aspects of what we should be doing in this next budget, or in future budgets, in order to try to create the type of Canada that we want.
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It is now 6 p.m. Perhaps we could wind this up by 7:30 p.m. at the latest. I'll certainly remain in your hands, and the hands of members, because I know there will be a lot of questions.
[Translation]
Mr. Fortin: I would like to begin by explaining why, at the outset, I wondered about the relationship between unemployment rates and inflation rates. This comes from my having observed the performance of the American economy in comparison with that of the Canadian economy over the past 30 years.
In the 20 years before 1990, the employment rate, that is the proportion of those with a job in both countries, was about the same, it increased in both countries and the job performance stayed at the same level. Suddenly, at the beginning of the nineties, a recession took place in the United States. The employment rate in the United States did drop by 3% from 1990 to 1993 but as of 1995, a recovery brought about a return to the 1989-1990 level. And even now, there's talk about an overheating of the American economy, which in my view is not too far from the truth, with an unemployment rate between 5 and 5.5%.
In Canada, on the contrary, our employment rate dropped by 7% from 1990 to 1993, which means that in 1993 our economy was operating at 7% below its capacity.
In 1994 there was a fairly good recovery but it only lasted a year. We're now at 6% below our employment level at the beginning of 1990 but since 1994 growth has been stagnating. So in 1996, we're still at 6% below the 1989-1990 employment rate when the Americans are back up to the previous level. The question is: why?
At the same time the unemployment rate and the inflation rate in the United States are 5% and 3% respectively. Instead of tartetting an inflation rate of 1%, Mr. Greenspan aimed for 3% and at the same time succeeded in bringing about a recovery of the American economy and achieving an unemployment rate of around 5%, which is considered to be practically full employment in that economy. Anything below 5% would probably mean a very significant inflationary push.
We on the other hand chose 1%, but for the past four to four-and-a-half years we have been unable to bring down our unemployment rate to below 9%. So according to my hypothesis, there is a relationship between the 3% inflation rate in the United States and their ability to achieve a full employment economy and our 1% inflation rate and our inability to reduce unemployment to below 9%.
In 1989, at a time when the estimate of the central bank, my own estimate or those of researchers was that the minimum full employment unemployment rate that we could tolerate was between 7.5 to 8%, unemployment insurance payments were cut back cumulatively by 40%, resulting in a reduction of the structural unemployment rate in Canada by an additional percentage point.
So the unemployment rate that we could achieve in a situation of full employment in Canada is probably below 7% at the present time.
Why is there this relationship? The reason for this unforeseen phenomenon is that an attempt was never made in Canada to achieve an inflation rate lower than 3% at a time when the productivity growth rate was as low as 1 to 1.3%.
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This is something we managed to achieve in the 1950s or 60s, but productivity was growing at such a rate then that wages were increasing at an annual rate of 5%. It was uncharted territory, so to speak. It's as if our central bank decided to make a gamble and ended up losing.
I then asked myself why the fact of setting a 3% inflation rate would result in an 7% or less unemployment rate in Canada when a 1% rate would make it impossible to go below 9%. I think I've come up with the answer by observing how businesses behave.
In a normal year there are always some businesses that outperform others as well as businesses that underperform.
If the inflation rate in the economy is 5%, the more successful businesses can afford to increase wages by more than 5% whereas the less successful ones can only increase wages by less than 5%. That is normal. That is how the markets work.
When you give a 2% wage increase to your employees when the average raise is 5%, that amounts to a 3% difference but there is no requirement for an absolute cutback in wages. But if the average wage increase is only 1% and you wish to make a similar 3% reduction in relation to the average, you'll have to cut back wages by 2%.
Now companies do not want to make a wage cutback for fear of an employee backlash affecting productivity and morale. They are also afraid of an effect on employee turnover with their best workers leaving them.
This means that in a situation where the inflation rate is very low, companies will be unwilling to cut back on wages except in cases of extreme financial distress. They will keep on paying wages that are too high and in order to survive financially, they'll have no choice but to lay off people. Thus, keeping the inflation rate at 1% means that there will be more unemployment than maintaining inflation at 3 or 4%. This is the basic reasoning.
Looking at the data from collective agreements in Canada, I noticed that there were very gradual and normal wage increases in Canada when the inflation rate was at 5 or 6% but when it was at the levels of 1993 or 1994, in the private sector alone half of the collective agreements brought wage freezes into effect.
So there was an absolutely huge reduction to zero in the distribution of wage variation. There was a drop to zero. This is positive proof of companies' great resistance to absolute wage reductions.
This argument is not a new one. It was developed in a statement made by President James Tobin in 1971 and published in the 1972 American Economic Review. At that time, however, it was simply an hypothesis since inflation rates had not been observed at such a low level. It is still conjecture, because a great deal of economic research is still going on.
My conclusion is that an attempt should be made, insofar as possible, to maintain the inflation rate at the lowest possible level, but at a level that also makes it possible to maintain the unemployment rate at the lowest sustainable level. In my view, that would appear to be the case in the american situation where the inflation rate - and I don't have very precise figures - seems to be around 3% as in Canada.
If we are adamant about maintaining a 1% inflation rate, every year we will find ourselves facing a deficit of 500,000 jobs in Canada indefinitely.
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This does not amount to saying that the costs behind us are past, present and future. We will constantly be facing a deficit of 500,000 jobs with an unemployment rate of 2 to 3% above the current 6, 5 or 7%, which is the present structural unemployment.
That is the argument. It is an argument based on conjecture, but also on a growing number of observations of the situation in both Canada and the U.S. What I am suggesting will not have an immediate restrictive effect on the government of Canada and the Bank of Canada since the present inflation rate is very low. We were actually experiencing deflation in the first quarter of this year. It was for this reason that the central bank took action to set the interest rates at a much lower level.
The danger will occur in two years, when the unemployment rate may go to 8 or 8.5% and the inflation rate will be about 2%. The risk we run is that at that time, the central bank will panic and hike up interest rates from 4 to 8, 9 or 10% to prevent inflation from rising, whereas our unemployment rate will still be 1.5% above what we are capable of having with a permanent inflation rate of 3%. That's my argument. It's a simple one.
My proposal is that the current inflation rate range of 1 to 3%, which is in force until the end of 1998, be brought up to 2 to 4%. This certainly won't lead to hyperinflation overnight. It's simply an adjustment to the reality that means that the cost of job loss for Canadians is immeasurable compared to the advantages of maintaining inflation at 2% rather than 3%.
The Chairman: Thank you, Professor Fortin. The issue of unemployment is very important to all members around this table and for all Canadians. It may not be fair to ask the opinion of other experts here because they have not had an opportunity to examine your proposal in depth, but I will ask their views.
[English]
David Laidler.
Prof. Laidler: I have read Pierre's presidential address, and I have read the article in Brookings Papers on Economic Activity, which has had a considerable amount of publicity, written by George Akerlof, George Perry, and a third author whose name I forget. I've also read Paul Krugman's piece in The Economist, and so on, because I anticipated that this topic might come up this afternoon.
The way I would put matters is as follows. We talked before the break about the fundamentals of the Canadian macroeconomic policy and how fragile they are. One of the things that's looking good is borrowing costs. Nominal interest rates are low by historical standards. They've come down across the board. I looked at my Financial Post this morning and saw that you have to go out seven years now, I think, before Canadian nominal rates are actually above U.S. rates. This is an enormous turnaround.
I believe the reason this is in place now is that Canadian macroeconomic policy is gaining credibility in capital markets. That's partly a matter of fiscal policy, but it's also very much a matter of the stance of monetary policy. We have in place inflation targets, and the Bank of Canada has shown it can stay within those bounds in a way in which I think many professional economists doubted, frankly, a few years ago.
As Pierre Fortin has said, those targets are to be reviewed in 1998. I believe they should be reviewed. There should be a long and very careful discussion about what we have learned from this experience. In the light of that discussion, we should decide whether one to three, zero to two, two to four, or what have you, is the appropriate stance for monetary policy over, shall we say, the next four or five years.
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If we change those targets ahead of schedule and change them in an upward direction, I fear we run the risk of undermining the credibility of Canadian macroeconomic policy and losing rather rapidly those low interest rates unless we have a really good reason for doing so, a reason the Bank of Canada could give to capital markets and have the explanation accepted.
Pierre Fortin has pointed to the relatively poor performance of the Canadian labour market as compared to the United States. I have no quarrel with that. We all must agree that the Canadian labour market has not performed very well in the last five or six years. That's a great puzzle. But the particular explanation he's advanced is based on some of James Tobin's conjectures of 25 years ago, which, as he correctly said, couldn't be tested. There were conjectures about how an economy would behave in conditions of low inflation, and we haven't had low inflation for 25 years.
I find there's an uneasy and discomfiting monocausality about Pierre Fortin's explanations of what's going on in the Canadian labour market at the moment. I can give you a list of reasons why the Canadian labour market might be behaving badly at the moment. First, though I've praised the Bank of Canada, I've also in my past writings blamed them for being too enthusiastic about getting inflation down, for getting it down too quickly, and for keeping inflation too close to the bottom end of the target too frequently, because I have no doubt that's had an effect on the average unemployment rate in the economy.
Moreover, building on some past work of Pierre's, which he hasn't brought up, I'm convinced that if you hit the labour market hard enough and drive up the unemployment rate far enough and fast enough, you are going to temporarily shift up the so-called NAIRU. To put it in technical terms, I'm convinced there is partial hysteresis at work in the Canadian labour market.
That means if you overdo tight monetary policy as a matter of tactics, not as a matter of strategy, you slow down the speed with which you can allow the unemployment rate to recover while keeping inflation down. I believe that tactical error in monetary policy in Canada has done harm to the behaviour of the labour market in the past. And I'm not saying anything new. I've said this many times before.
We can also talk about the credibility of fiscal policy. Canadian fiscal policy has not been credible until very recently, and that's pushed a premium into interest rates. The Quebec situation has undoubtedly put a premium into interest rates. I'm not blaming the performance of the Quebec economy alone here, but I'm suggesting that this has affected the whole of the Canadian economy by putting a risk premium into Canadian borrowing costs.
We have reformed the employment insurance and income support systems, and that will help, but these reforms are fairly recent. I think there are ample reasons that enable me to explain the poor performance of the Canadian labour market without having recourse to Pierre Fortin's explanation.
The Chairman: Thank you.
Prof. Laidler: I haven't finished, if you don't mind. I would now like to address his explanation.
Pierre refers to evidence on the Canadian labour market. My colleague at the C.D Howe Institute, Bill Robson, took Pierre's own data and decomposed it. I have some charts here that perhaps I should pass around.
The data to which Pierre is pointing deals with wage settlements, not with wages in general, in the Canadian economy. The wage settlements in question are dominated by public sector. About 60% of the settlements in Pierre's sample are public sector settlements, although only about 20% of the Canadian labour force works in the public sector.
.1820
Moreover, 90% of the wage freezes, in round numbers, which he reports, are public sector wage freezes. This is the period 1992-1994, when you've got the Ontario social contract.
What I would suggest is that Pierre's data - though very interesting and the best we've got - may well be very unrepresentative of the average behaviour of the Canadian labour market.
One final remark on the broader evidence. The study that everyone cites as Akerlof and Perry and the third author - this study has been widely distributed. I had one or two reporters call me up about it. They have read the article, but they haven't read the discussants' comments. I therefore took the liberty of making copies of those discussants' comments.
The reason I have done that is that the two discussants are Robert J. Gordon and Greg Mankiw, two fully paid-up members of the Brookings-Keynesian mafia, if you like. They are anything but monetarists or fans of the Bank of Canada or anything like that. They are extremely critical of the conclusions of Akerlof et al. Let me just read a couple of quotations. This is Gordon on page 62:
- ...I question the relevance of the evidence for the paper's broader macroeconomic conclusions.
Of course nominal wage reductions are rare in a macroeconomic environment in which
inflation is positive and nominal wages, on average, grow at or above the rate of inflation.
- And further down the page:
- The authors' attempt to reason from evidence on nominal wage rigidity in an environment of
rapid positive average nominal wage change to a hypothetical situation of zero average nominal
wage change is subject to the Lucas critique.
Greg Mankiw, a paid-up MIT Keynesian, page 69:
- Let me turn now briefly to the broader policy question that motivates this paper: should
downward rigidity of nominal wages deter policymakers from pursuing a policy of price
stability? The answer, in my view, is no.
- My first reason for this judgment is one that I hope the authors would share: Tobin's idea that
inflation greases the wheels of the labor market is still more an intriguing conjecture than a
well-confirmed theory. This paper moves us in a direction of being able to evaluate the
conjecture empirically, but there is still much to be done before an impartial observer will be
convinced that downward wage rigidity has important macroeconomic effects.
- In addition, even if there is downward wage rigidity in our economy, it might well decrease in a
regime of price stability.
The Chairman: Thank you, Professor Laidler.
Prof. Laidler: Thank you.
[Translation]
The Chairman: Mr. Fortin, would you like to respond to Mr. Laidler?
Mr. Fortin: I would simply like to say that there are many points that deserve special attention, but since the discussion is degenerating into an economics department seminar, I will ask Mr. Laidler to wait one week before I give him a definite answer.
With regard to the criticisms that were expressed following the article by our colleague George Akerlof, they say essentially that the analysis of the American economy and of US inflation is based on forecasts about the evolution of wages in the United States if there was a zero inflation policy or something close to 1%.
That's the case for the American data, but not for the Canadian data. The problem is that they say that in the United States, zero inflation or 1% inflation has not been observed. Therefore, Akerlof may have made forecasts which will not be confirmed when the American economy is at 1%. We have it here in Canada and we can see a very high concentration of wage increases.
.1825
The second point I'd like to raise is a factual question. I took the data from the sheet distributed by Professor Laidler just for 1993 and 1994 and I looked at the private sector only. Between 45 and 50% of collective agreements in the private sector provide for wage increases, whereas the data he reports include many public sector collective agreements negotiated in 1992. I cleaned all this up and I arrive at exactly the same conclusion. In fact I wish to thank him for pointing this out. It's very kind of him and it allowed me to make that distinction.
The Chairman: David Laidler.
[English]
Prof. Laidler: I have one question about the 1994-95 data. My understanding is that in your original paper, the contracts you classified as involving a wage freeze included multi-year contracts in which only the first year was a freeze. Is that still true of the 1994-95 sample?
Prof. Fortin: Yes.
The Chairman: Tim O'Neill.
Mr. O'Neill: This reminds me of my 16 years in university teaching. It feels very much like a seminar.
The Chairman: Tim, do you mean you understood it?
Mr. O'Neill: I have to admit I did.
Some hon. members: Oh, oh!
The Chairman: It's part of the Lucas syndrome.
Mr. O'Neill: The Lucas critique; there is a different syndrome.
Nobody disagrees that if you have, as David said, restrictive monetary policy, you are as a consequence going to have a negative impact on the economy. Nobody denies that. The issue is whether it's permanent or transitory when you get down into low levels of inflation. There is no debate when you're at higher levels of inflation about whether you can reduce the real returns or the real wages workers get. You can do that simply by having a nominal wage increase that's less than the rate of inflation. Nobody assumes there's a misconception on the part of workers about what's really happening. But when you get down to low levels of inflation, there is a rigidity there. That's the fundamental argument, and that it's permanent and immutable in essence.
I hope I'm not grossly oversimplifying, Pierre.
Prof. Fortin: You're simplifying nicely.
Mr. O'Neill: Part of the problem is that if you haven't had a long period of time operating in low inflation, you don't really know whether you've captured appropriately the behaviour of employers and employees in setting wage contracts.
Secondly, the evidence on wage settlements tells you what happens with major wage settlements. It doesn't tell you anything about what happens to those people who have lost jobs, moved elsewhere in the economy and found jobs at lower wages. They've accepted a lower wage, and there are a lot of those people. I'm sure Lynne and Al can tell us about a large number of them.
The fact of the matter is that the evidence at this stage is not compelling that there is more than a transitional problem when you have tight monetary policy. That's a totally separate issue from whether the Bank of Canada moved too aggressively or too quickly or set targets too low. We can debate that. The fundamental policy issue we're faced with now, in Krugman's work and others', is whether having reached low inflation we ought to go back up to a 3% or 4% rate. That's a very different kind of argument. If we take Pierre's view, then we should, because we have a permanent problem. I would argue that the evidence doesn't suggest that yet.
We then have to ask the question of whether there are any benefits here. Pierre has talked about the costs. Are there any benefits from low inflation? David made reference to credibility. Let me just make the point that one of the benefits of credibility is that if you do have an unexpected shock to a system that temporarily causes your inflation rate to go up, you don't suddenly have all those people in the market assuming that you're now going to have a higher rate of inflation in the country so that you then have to start paying inflation premiums in your interest rates. They know, because of the credibility established by the monetary authority, that this is not going to happen.
.1830
One of the things that would be a real concern here is if we seriously took the argument that the Bank of Canada ought to re-inflate. Then the credibility that David referred to might be very much put at risk, and I think we're back into some of the volatility that we've seen earlier in financial markets.
Ms Farrow: The first thing I'm going to do is endorse exactly what Tim's just said. I think he's absolutely right that we don't know if it's permanent and entrenched. There are benefits, and we are going to be seeing those benefits, which is that inflation dividend we've been waiting for.
I think we would lose all credibility if these inflation targets were allowed to drift. We started discussing two to four or three to five; anything like that. Not staying the course on the fiscal side is exactly the same argument on the monetary side. These inflation targets are in place. They have to stay in place, and we should not be talking about drifting away from them. I think if we start that discussion too early, they become built in. That's the expectation.
I would also like to come back to something that I believe is very nice.
I haven't got the academic credentials of Pierre and David, but -
Prof. Fortin: But you have enough common sense.
Ms Farrow: - I live in the real world. In the real world, when you look at North America, there are really two economies here. They have had two very different faces, which Pierre talked about, in terms of the unemployment rates.
I would like to put forward that I think the unemployment improvement, or the great job creation that we saw in the United States, comes about not necessarily just from this difference in the inflation rate, but because of something else. I think it's because the U.S. was faced in the middle of the 1980s with massive import substitution in their domestic economy. They do not rely on exports to deliver economic well-being to their people. They live on keeping imports out.
What really happened in the 1980s, when that got eroded, was that they had to start really looking very aggressively at making themselves competitive within their domestic economy. As a result, there was massive restructuring from the late 1980s. They got the benefits much sooner because it was a more pervasive restructuring.
They're number one in automobiles now. Back in 1987, when we were talking about free trade, they thought they were going to lose the automobile market. Well, they had lost it.
Now in Canada, we signed the FTA, but what did we concentrate our restructuring on? It was the export sector. As 40% of our GDP is linked to exports, that makes a lot of sense. That's what we should have been doing.
Only in the middle of the 1990s have we gotten around to the domestic economy.
So I think we have enormous gains on the employment scene still to come in the last part of the 1990s. You're going to see - John, you were talking about this - an enormous amount of jobs.
So I would disagree with Pierre in the sense of saying it's the argument of the Phillips curve that we should be talking about. I think there are arguments in there, and the targets are going to be important in redefining, but let's not just think that employment is created in that manner.
Dr. Walker: I think this needs to be said. Pierre, it's only people of enormous courage who put themselves out for the kind of leadership position that you have and who take the kind of abuse you're getting here.
Having said that, I'm afraid I'm going to get a piling-on penalty nevertheless, because I think the points that have been made are all accurate. I agree with David Laidler's starting position, which is that we have to maintain the monetary target.
.1835
But in responding in specific terms to your paper, I think the main problem with it is that it addresses a problem that was there before 1991.
In 1986 - I know Herb Grubel will be too modest to mention this - the Fraser Institute published a book entitled Why is Canada's Unemployment Rate So High? We analysed very specifically the kind of structural reasons why Canada's unemployment rate was so high.
We didn't have at that time, frankly, the kind of monetary policy to which you're now pointing to blame for this kind of occurrence. Rather, Herb found in his book that there were structural reasons to expect Canada's unemployment rate to not only be higher than that of the United States, but furthermore, to diverge from that of the United States as time went by. So you were faced with the problem that there was both the existence of the problem you focused on and an explanation for it before the Bank of Canada's policy came along.
To that, I would like to add one further point, because there have been some developments since Herb's book was written. I think we need to focus on this. It relates to the level of government expenditure and the things we choose to do in the public sector.
One of the most surprising differences that you'll find between the structure of employment in Canada and that of the United States at the moment is the fact that nearly 2% more of the U.S. labour force is employed in health care. If you combine that with the fact that the savings rate for elderly people in the United States is typically lower, what you're simply seeing is the fact that they have chosen - this is by spending the accumulated savings, in some cases, of their elderly population - to have more expenditures on health care. It's about 14% of GDP, whereas we're spending roughly 10.5% of GDP on health care. As a consequence of that, they're getting more employment in their health care sector.
Why am I raising this separately? I take it as a separate issue and I am raising it because unless we take some action to change the way in which we organize our health care system, we're going to see a further development of this as our populations age, with widening gaps of opportunity in the health care sector for employment.
So quite apart from all of the other structural features that Herb Grubel identified in his 1986 book, we have a fundamental problem with regard to how we're organizing a key aspect of our economy. In fact, the health care sector is the most quickly growing aspect of our economy. So I think that is something we also need to turn our attention to.
Mr. de Bever: Pierre, I heard you make the argument about the employment-to-population ratio a month or so ago when you were in Kingston, and I've looked at some of the numbers.
It is true, as you point out in your article, that this employment ratio in Canada and the United States has diverged since 1990. It's also true that it has done that in every business cycle prior to that. For instance, in 1970, the difference between the two ratios was 3%, which meant that the U.S. employed 3% more people per 100 than we did.
I would suggest that, yes, monetary policy probably had something to do with the reason why it is so high right now. It's probably also true that fiscal policy had a lot to do with it in the sense that when you look at the period of 1975-1990, there was a time of rapid government expansion in Canada that created a lot of jobs. But they were not sustainable jobs. As a result, in 1993, 1994 and 1995, we've seen a retrenchment in private sector employment. In fact, I think the difference between total employment growth and private sector employment growth is about 100,000 jobs this year.
So here's what I'm suggesting. I guess I'm making the same point that David Laidler is making. This is not a monocausal problem. There are so many strands to this that could make you end up with a good explanation of what's happening that I think we have to be careful that we don't confuse correlation with causation.
.1840
I guess one implication I don't like of the theory you're positing is that you're essentially saying you need to fool workers into accepting real wage declines to inflation, rather than point out to them this is what's happening and they had better get used to it.
You're talking about money illusion. In other words, people are not willing to take a wage cut through a nominal wage cut, but they are willing to take it by having inflation impose a real wage cut on them.
The Chairman: Thanks, Mr. de Bever.
John McCallum.
Mr. McCallum: Thank you. I don't think my comment is in disagreement with Pierre's, although he may disagree with that. There are three logical possibilities for the Bank of Canada's inflation targets: they can keep them unchanged at one to three; they can go up to, say, two to four; or they can go down to, say, zero to two.
I don't think Pierre is necessarily recommending an immediate move upwards in the targets, but it seems to me that any move up in the targets tomorrow or in the near future would be a very bad idea for two reasons. First, we don't need it. Assuming Pierre is right, inflation today is at 1.4% or something like that. We have a large output gap, and most of us don't think inflation is going to go up that much in the next couple of years.
Prof. Fortin: This is what I said.
Mr. McCallum: Okay, maybe we agree. So we don't need to move the targets up in the near future.
Second, it would be highly counter-productive if we did because of this effect in the markets. I suggested earlier the importance of lower interest rates for job-creating purposes. Well, if you were to suddenly announce tomorrow higher targets, there is no doubt in my mind that some of the interest rates would go up quite a bit.
Therefore, (a) it's not necessary, and (b) it would be counter-productive to do this any time soon, and I think everyone can agree on that.
The question then is, should it go down to zero to two? There are some that would favour that. Pierre's argument doesn't settle the issue, because, as you've heard, there's a lot of debate and there are unresolved issues, but it is an argument that, if true, would make a pretty good case against going from zero to two.
I think Pierre's a politically savvy person, and I don't think he really thinks we're going to have higher targets, but the effect of his message, if following further research it turns out to have merit, might be to make it less likely that we'd have a ratcheting down of the inflation targets in the future. It seems to me that is the real issue.
The Chairman: Thanks, John McCallum.
[Translation]
Clément Gignac, please.
Mr. Gignac: How can one accept the proposal put forward by Pierre Fortin and at the same time disagree with the idea of increasing the targets now or a bit later, that is agree with Maureen and John, especially since I'm car-pooling with Pierre to go back to Montreal?
I will therefore begin by surprising you. I work in the financial sector as a strategist and economist. I could tell you, hoping that this will not harm my credibility with foreign investors, that if the inflation rate - and I will provide arguments for Pierre Fortin from the standpoint of financial markets - in Canada was on the order of 2.4 or 2.5% right now instead of 1.3 or 1.5%, interest rates wouldn't be much different.
I'm sure that many people will be surprised. Let me explain. I was a great defender of the Bank of Canada and I continue to be one. No major political events have taken place in the last three to five months, there has been no significant event or significant decrease in the inflation rate in the last three to five months and yet, the risk premium on debt instruments or on Canadian Bonds, or rather the gap in interest rates on 10-year bonds in the United States and Canada has disappeared. The gap used to be 120 basis points and now it's 20 basis points. So in five months, we've had a 1% decrease in the gap regarding the cost of money on 10 or 30-year instruments, between the United States and Canada.
One of the main reasons for this situation is not a change in inflation, in the perception of inflation, but rather the fact that all of a sudden, we have a balanced current account and we're financing our public finances ourselves for the first time in 12 years.
.1845
I asked foreign investors what their vision of inflation was. All the foreign investors I met with claimed that, over a 10, 20 or 30-year period, Canada, 40% of whose economy is determined by the United States, will have approximately the same rate of inflation.
Therefore, over 10, 20 or 30 years, people are projecting a Canadian inflation rate somewhat similar to that of the United States, with everyone agreeing that in the next three to five years, the inflation rate may be slightly lower.
However, when the time comes to invest in 10, 20 or 30-year bonds, we don't take the current inflation rate compared to the United States, or two-year projections, but rather, we use long-term projections.
If we had to do over again what did three, four or five years ago under Governor Crow, we would undoubtedly encourage him more to use targets or to have a monetary policy with a vision of inflation that is much more similar to that of the United States, which is what the Bank of Canada is aiming for right now, since the dividends would not be very different from the standpoint of the financial markets.
Having said that, the past is past. I even think that the Liberal government is managing rather well with the Bank of Canada's targets right now. From the viewpoint of the financial markets, I think it would be a major tactical error at a time when all the G-7 countries are aiming for price stability to send out a contrary message.
Pierre Fortin's research is very interesting from an academic standpoint, although, of course, there is some controversy in the financial markets. I did indeed say that if the inflation rate were 1% higher than it is right now, interest rates would not be much different. However, this would be a very negative message to be disseminating right now, when we have a debt that represents 100% of our GDP; we should not all of a sudden become very lax in this regard. That would be a very major strategic and tactical error.
In closing, Mr. Chairman, I suggest that you closely follow the work of Mr. Fortin and the debates concerning the federal reserve. If the federal reserve lowers its targets to 2%, we should continue to target 1 to 3% with 2% as a median, as Mr. McCallum has proposed. We should maintain this monetary policy as long as we don't see future developments by the US federal reserve.
The Chairman: Thank you, Mr. Gignac.
[English]
Mr. Mendelsohn: I'm not going to go through all the litany. I think I would agree with virtually everything that's been said in criticism. I would ask just one question, and that has to do with...
We're talking about the rate of inflation in Canada being one-third, one-half the rate of inflation in the U.S., yet there is a debate going on within the U.S., within the Federal Reserve Board even, let alone in the research institutes, the Congressional Budget Office, the Joint Economic Committee, and the National Bureau of Economic Research, on just what the rate of inflation is in the U.S.
I've seen reports and studies that basically argue the rate of inflation in the U.S. could be as much as one-half to one and a half percentage points lower than the actual, reported numbers. If that's the case, and I don't know what the answer is...but the work is there and there is a conviction that it is certainly lower than the measured numbers. If it is one or one and a half percentage points lower, we're not talking about that much difference between Canada and the United States.
The second point is that it is absolutely imperative that if we try to push something like this, we keep in mind the credibility of the Bank of Canada. The bank's ability and the bank's need to raise rates more in the event of an accident or some event that puts pressure on the Canadian inflation rate is much reduced when its credibility is intact than when you shift the targets around a fair bit.
I agree with Mr. Gignac. If the inflation rate were up at 2% or 2.5%...I don't think much would happen to interest rates. It's within the target range. So long as they don't deliberately go out there and say our new target is 2% to 4%... If it were up at 2.5%, it's at the upper end of their 1% to 3%, but that's fine, because their credibility is still intact. If you were to shift them, however, you've got another problem.
The Chairman: Thank you, Josh Mendelsohn.
Lynne Toupin.
.1850
Ms Toupin: I have a couple of points. I guess I'll start by steering people in a different direction, and then we'll get back to this issue.
Maureen said a little earlier that she expects lots of jobs will be created, and that's good news.
One statistic was left out of the mix here, so far today and yesterday, and I want to bring it back to the table. Although we say three-quarters of a million jobs have been created, another number, which is not there, is that we have had 700,000 more people living below the poverty line over the course of the last three years.
So that number, in and of itself, does at least beg the question of the kinds of jobs being created and the nature of those jobs. Clearly, the 700,000 more Canadians who are living in poverty today as opposed to three years ago are not all working-age adults; some of them are kids. I think as we discuss the issue of job creation we also have to pay some attention to the nature of the jobs being created.
I think you are hearing a number of people who have concerns about easing up on inflation. I think we have to reiterate that the Bank of Canada's mandate is not just price stability, it is also employment. As far as we know that hasn't changed, so we shouldn't forget it.
I would ask the question: if we do not move at all in the direction that Mr. Fortin is proposing and if we do not deal with inflation as a measure to create jobs, I would like to hear from others as to what the other mechanisms are for active job creation.
I ask this because I think - and somebody said it previously - there's a very clear sense out there by the public that the deficit is in fact under control. I think the government has done a good job of saying it's doing this if it stays the course. We've heard this now. But the attention will turn now to job creation as the major preoccupation, and I would think in the next budget you will have to have credible answers on that one.
So from a practical perspective, if you don't go with a change in or easing up on monetary policy, what are the other active measures we can take to ensure we do deal with the employment problem in Canada?
The Chairman: Lynne, before we ask our experts to respond to that question - and I would definitely ask them to - perhaps we should give Pierre Fortin a chance to respond to those who either agreed or disagreed with him concerning his thesis.
Prof. Fortin: Great guys.
Mr. Chairman, I first want to remind you that the last time I was here was December 1994 and then it was also 15 to 1 against me. What I said at the time was that my simple-minded economics 101 principles were telling me that with the U.S. economy falling like a rock, with the public sector spending cuts being phased in at a very quick pace, and with interest rates in Canada going up from 4% to 8%, there was an enormous danger that in 1995 the good growth we had in 1994 would fall like a rock to the bottom of the water. Of course, I was entirely derided by the rest of them - I mean, it turned out to be 15 to 1 - but guess who was right at the time?
The Chairman: I remember that very well, and that's one of the reasons we asked you to come back with us not only this year but also last year.
Prof. Fortin: But why did you ask those guys to come back?
Some hon. members: Oh, oh!
Ms Farrow: Because you don't want to be on your own.
The Chairman: Because we knew you wouldn't come unless you had some worthy opponents.
Prof. Fortin: I think a very good reason is that progress and knowledge come from confrontation, not unanimity.
I would say two things. First of all, I think it's very important for a central bank and for a minister of finance to be credible internationally, but sometimes you have to change your policy. If the policy you're now following is credible with them and if the credibility of what you're doing becomes an absolute, you're never going to change, even if the circumstances require it for the welfare of your own domestic economy.
What I'm asking is credibility for what? It's true that I'm quite ready to discuss the strategy and tactics of changing the inflation target from 2% to 3% at one point. I would not advocate that we discuss this very loudly; it could be a very discreet and soft decision made at one point by our very energetic Minister of Finance, which -
.1855
The Chairman: I know that he's listening to every word you're saying tonight.
Prof. Fortin: Yes, right.
The objective of macro-policy is to get both full employment and as low inflation as possible. My argument is that 1% or 2%, which is the range in which we're holding inflation here, is too low to achieve 7% unemployment. If we don't adjust the target upwards...also subject to further study and further examination of all those ideas, I think we would be seriously doing damage to our economy and be taking a lot of risks with the lives and welfare of our people. This is essentially my argument.
If it takes one or two months of disturbed international markets and a temporary fall of the dollar from 77¢ to 72¢, there will be a point at which it will be realized that the Canadian inflation target is exactly the same as the U.S. inflation target. Don't tell me the U.S. monetary policy at this time is anything but credible in international markets.
We are now credible with between 1% and 2% inflation. Why can't we be credible at exactly the same level as the U.S. level? This is my argument. I'm asking credibility for what, and I'm asking whether we should let credibility override any possible change in our macroeconomic policy for a better balance between our pursuit of both low inflation and low unemployment.
My practical worry is that when our unemployment rate is down to 8.5% or 8% one or two years from now, after some time of low interest rates, and once all the spending cuts have filtered through, the inflation rate will indeed increase above 2%. Then what John McCallum realizes is not a constraint now will become a constraint. Then the government and the Bank of Canada will have to decide whether to let the inflation rate in Canada rise to the same rate as that in the U.S., around 3%, without the Bank of Canada panicking and suddenly raising interest rates from 4% to 9% as it did in 1994-95. That is exactly the question we have to worry about now.
I completely agree that my intervention is totally ill-timed because that target range is not a constraint. But we're being asked to be foresighted in a sense. I'm foreseeing that we will have a problem down the line in achieving full employment, which I would place at around 6.5% or 7%.
By the way, Herb Grubel signalled a problem with the Canadian unemployment rate in 1975. He's the guy who taught all of us that UI could have an upward effect on the unemployment rate. Actually, this has been confirmed by recent research showing the main difference between the U.S. and Canadian labour markets. When U.S. workers are non-employed, they are much more likely to be out of the labour force and therefore not counted as unemployed, whereas Canadian workers are more likely to be in the labour force and therefore counted as unemployed. That is the reason for the big difference.
There is a strong correlation between this fact and the differences in the parameters of the UI regimes in the two countries. That difference has now been almost obliterated, according to recent studies by the Department of Finance. The level of generosity of the UI system in Canada is just about the same as that in the median U.S. state.
.1900
So there is no question that if we had, let's say, a two percentage point structural difference with the U.S. unemployment rate in the mid-1980s, that difference is now almost obliterated.
The Chairman: Are there any other panel members who want to deal with this specific issue? I know that Mr. Leblanc aimerait discuter de cette question, but before we close out I know there are other issues. We also want to come back to what Lynne Toupin said and deal with jobs.
Michael Walker, do you have a comment on this last issue or do you want to go on to another?
Dr. Walker: I want to correct a minor point or to express perhaps a point of variance with what Pierre said about the differences between our unemployment insurance regimes.
One of the great puzzles has always been why, with parameters almost identical, the unemployment system in Canada has produced so much higher levels of benefits than the system in the United States has.
When I say so much higher levels, Mr. Chairman, let me remind you that at a point when our unemployment rates were the same, Canada was spending 65% as much in total dollar terms on unemployment insurance benefits in an economy that is one-tenth the size, and it was not possible to describe that difference by looking at the parameters of the system.
We published a special edition of the Journal of Labour Economics about four years ago, in which we very carefully looked at the unemployment insurance system in both Canada and the United States.
Prof. Fortin: Not carefully enough. I'll explain to you afterwards.
Dr. Walker: What do you mean?
Prof. Fortin: I'm simply saying that with the same unemployment rate, a much lower percentage of American unemployed received UI, and one of the main reasons was that a lot more Canadian unemployed had access to UI, had qualified for it, because our work requirement is only ten weeks whereas theirs was -
Dr. Walker: But, Pierre, that's exactly the point I'm making.
The Chairman: Michael, we're going to be having another hearing on the question of the difference between the U.S. and the Canadian unemployment rate, and maybe I could invite both of you to come back then.
Dr. Walker: Wonderful.
The Chairman: I'd rather not deal with it now.
Herb, do you have an intervention you want to make on this issue?
Mr. Grubel: It relates both to what Pierre said and what Lynne said.
When you look at the trend figures on the difference in the unemployment rate between Canada and the United States and the regression that took away the generosity parameters, there has always been a huge time trend, 1% per year. What it reflected was a development of institutions and social norms of behaviour.
You cannot, suddenly, when you change the measurable parameters that went in there, reverse those. It comes back to what Lynne was saying.
Consider, for example, Lynne, that we have an enormous subsidy we're giving to seasonal and certain types of other industry - fishing, forestry, construction, recreational industries. They receive six times the amount of money they pay in premiums.
Now, just imagine if these industries were without such subsidies. They would be much smaller. So anytime a census enumerator would knock on the door in this world that I've just described and ask if you are unemployed...well if these industries weren't seasonal, the unemployment rate would be much lower, immediately.
Secondly, we would have considerably lower unemployment insurance premiums. The cost of labour would be down by 7% in terms of the employer who has to make those contributions. We know with lower labour costs the incentive to substitute capital for labour would be much smaller and there would be much more work for people earning the same income.
You can see why the OECD, in a path-breaking report called the Job Study, has concluded that these are the explanations for why the unemployment rates are in the double digits in Europe when the American rates are around 5% or 6% and ours are somewhere in the middle.
My answer to you is, we should look at those determinants, identified by the OECD, as being a cause of our high unemployment. If we think we would rather have all of those people in the seasonal, fishing, and forestry industries subsidized heavily, I would say we have to accept higher measured unemployment rates.
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Ms Toupin: With all due respect, Mr. Grubel, when you go knocking on doors at the next election and you give that as a response to people who are unemployed, it's not going to cut it. I think this is going to be a primary role of the finance committee in the months to come. It's not an issue that's going to go away. While you may want to explain it structurally or any other... I'm still coming back to my question here. What mechanisms are you going to use? You're going to be asked that.
The people out there have agreed that they should take some pain on this. Let's be quite honest here. Most of us in this room have not had to endure the pain of the cutbacks. But now the time has come, with a deficit that seems to be well under control - and we've talked about this earlier - that we have to come back to the question of job creation.
I'm sorry, but your answer does not satisfy the seasonal worker. It does not satisfy the single mother. It does not satisfy many people who will be asking that very question in a few months.
Mr. Grubel: I fully understand this problem, but we are not here now running for election. As people who are setting the long-term parameters of where government is going, they can find enough public advisers on what to do in order to win the next election, and they will.
Mr. Campbell (St. Paul's): We'll win the next election.
Mr. Grubel: I'm acting here as an intellectual, somebody who feels much more comfortable on the other side. I'm telling you, in response to your questions, what we should do over more than just the horizon of the next election cycle. If we really care about the people whom you care about, we will not give them the insecurity and all those problems that are associated with the solutions we have had, because they were dead-end streets. They have not solved the problem.
The unemployment rate is now higher than it ever was before. It creates more dependency than ever before. We have to look at it in a more fundamental way.
The Chairman: I think Nic Leblanc wanted to ask a question on this issue. Then we'll go to the panellists.
[Translation]
M. Leblanc: My questions will also be to Mr. Fortin. The main principles are employees and employers, incentives and disincentives. Employees are motivated by salaries. If employers cannot motivate their employees, they lay them off. I think I understood the basic idea.
In addition, inflation is a little higher, which means that unemployment is lower and employability is increased. I think there is another factor. I spent most of my life investing in real estate and in business. There was another motivating factor for us. Sometimes it felt like we were richer when inflation was higher - the next year we were worth a little more than the previous one. That was a source of motivation, even though it was not real. Not all business people are economists.
Mr. Fortin: We had mortgages at 4% when inflation was at 10%.
Mr. Leblanc: Yes, it was a very good deal. I still have some connection with business people. I think there are other reasons why inflation can stimulate job creation. Everyone is encouraged to invest, either in business, commerce, industry or real estate, because people understand that after a certain number of years, they will be worth more and thus better able to pay off their debts.
When inflation is higher, it is easier to pay back a long-term debt. In the case of the manufacturing sector, the residential sector or office buildings, there is some incentive to invest when inflation is running a little higher.
The same goes for the government. If inflation is at 3%, it is easier for the government to pay off a debt of 6 billion dollars than it would be if inflation were 1%. So that must be taken into account as well.
You are right when you say that we need a reasonable rate of inflation. However, I think it is a mistake to try to keep inflation at 0 or 1%,because a slightly higher rate of inflation means that we can pay off our medium and long-term debts. I have some trouble understanding the Bank of Canada's phobia about inflation, and its desire to keep it at zero.
.1910
I'm not a financial expert, and I'm not familiar with all the ramifications of this issue, but I do know that low inflation rates discourage many people. We are not all economists, are we? We need only look at what people do in business to realize that when there is some inflation, they are encouraged to enter into transactions, and this in turn creates jobs. If there are jobs, unemployment is lower, and when unemployment is lower, the cost to the government is less. So this become something positive for the economy.
The Chairman: Is that all, Mr. Leblanc? Would you like to comment, Mr. Fortin?
Mr. Fortin: Mr. Leblanc's comments are very important and very profound. We cannot say with assurance that he is completely right or completely wrong. We must determine whether interest rates go up so much that they eliminate the advantage brought by higher inflation. Our current experience with inflation makes it rather difficult to answer this question. We are still checking on this.
I would just like to add one brief comment
[English]
for Josh, who's yawning a bit.
The matter of whether we do measure inflation correctly is a very important question in itself, but it should not intervene in the discussion of what the target of inflation... For inflation we should have, whether in Canada or in the United States... The reason is that if we mismeasure inflation in the United States, we also mismeasure it in Canada. Therefore, if we make an adjustment for the U.S. inflation rate, we should also make one for the Canadian inflation rate.
The other aspect of it is that if we want to use the true measure of inflation... If we subtract 1% because our upward bias is one point from the CPI inflation rate and we say that's the new target, I would agree that 1% to 3% is okay. I wouldn't have any problems with the target range being defined as the CPI inflation rate minus one. On the other hand, that would mean that productivity growth would be faster to that extent and that wage growth would be faster relative to inflation.
The Chairman: Thank you, Pierre Fortin.
Barry Campbell.
Mr. Campbell: Thank you, Mr. Chairman. I have a couple of points to make, and then I have a question. First of all, Mr. Grubel mentioned the OECD job study - that important and path-breaking study - which I recall did address itself to the issue of tax cuts. If my memory serves me well, it suggested that if you were going to do any tax cut, you would do it at the lowest levels to encourage people to make the transition from unemployment to employment.
The second point is really in response to Ms Toupin's point about jobs. I hear much more encouragement around this table than you do on that very important question of what all this means for jobs for Canadians. I heard most people here say that staying the course is the prescription for more jobs and that there is light at the end of the tunnel. None of us underestimates the pain and the concern people have had, but I heard many people around this table say that jobs will continue to be created, and in fact will be created at an even greater rate than has been the case thus far. So there is some encouraging outcome from the efforts that have been made and that will come from staying the course.
My last comment before a very brief question is in response to the question as to whether or not Paul Martin is listening. Not only is he listening, Mr. Chairman, but Professor Lucas would understand that he's already taken into account everything he thought people were going to say and has acted on it.
Some hon. members: Oh, oh!
Mr. Campbell: I think that qualifies as a ``Lucas'' critique.
The question really concerns this difference between Canada and the United States. I may be out of order here, Mr. Chairman. As you indicated, we will look directly at this question on another occasion.
.1915
Maybe some of the comments earlier dealt with this, but I wonder whether anybody wants to comment on the issue of labour mobility and whether that isn't a fundamental difference. To some extent it's clearly affected by the programs we were talking about and the differences between those programs, but it may also be a cultural difference that may predate those programs. I don't know. Does anybody want to comment, Mr. Chairman, on the issue of labour mobility and that major difference between the two economies?
Dr. Walker: I would comment, not on regional labour mobility as such... I'll tell you about a very interesting study that we're doing at the institute at the moment, which follows up on a study done at one of the regional federal reserve banks in the United States. The study is the impact that so-called right to work legislation, which just means a more competitive labour market, has on the rate of employment in the States. What they did find is that 80% of the total manufacturing job creation in the United States in the last decade has been in those 21 states that have that kind of legislation on the books.
This is not a unique experience. New Zealand, which we've been talking about before and which made tremendous changes in its structural policies and adjusted the level of government expenditure in getting at its debt and all that kind of thing, didn't have a fundamental change in its labour markets until it adopted the Employment Contracts Act, which effectively introduced competitive labour markets in New Zealand as well. So I think there is a sense in which mobility is important, but I think it's mobility within the labour market.
In the United States it was from those states that didn't have right to work legislation to those that did - a well-identified pattern. But I think what we have to be concerned about is the fact that we have so many of these rigidities throughout our labour market and don't really have a segment in which we have this kind of labour market flexibility.
The Chairman: Thank you.
David Laidler, then Pierre Fortin.
Prof. Laidler: I would add a footnote to what Mike Walker said, and it really follows what Herb Grubel said as well. The U.S. is much less prone to use the labour market as a means of trying to combat poverty, and I think it's generally true that if you try to use legislation about how the labour market functions to combat poverty, you create a lot of unemployment and the poverty that goes with it. To this extent, then, I'm on side with Mike Walker and Herb Grubel.
I'm not sure whether Lynne Toupin will like what I'm about to say. It seems to me that the right way to go is to stop using the labour market to fight poverty. In the Canadian context, use the GST credit and the child tax credit as a basis for a much more widely based negative income tax that uses redistribution to deal with the real problem, which is poverty. In the longer haul you'd like to have fewer low productivity workers. Then this wouldn't matter this much. The way to deal with that is surely nursery and primary education above all.
Child poverty, in my view, is the major social problem in Canada. We have just about wiped out poverty among old people, and we visit it upon children. That is a catastrophically stupid thing to do, because old people die and poor young people grow up to be poor working age people.
The Chairman: Maureen Farrow.
Ms Farrow: Lynne has so many times asked us about employment, and we've really sort of gone off into macroeconomics a lot of the time. I think she's very right when she says that, in the next election, the job issue will be front and centre - and rightly so. It should be.
I think I would endorse what David has just said. I think we have used our policies inappropriately, and we could do a lot of cleaning up, but I think we have to look at it very differently. We have a short-term, real problem, and part of that is going to go away. That's what John and I were talking about with lower interest rates, those interest-sensitive industries, the housing sector, etc. Those are all going to start creating jobs, so we should let that play out.
I will say straight away that I do not want to see another infrastructure program. I don't want to give you examples of how bad the last one was, but if you want me to, I will, and I'll be here all night.
The Chairman: Don't bother.
Ms Farrow: We do not need another infrastructure program.
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Mr. Grubel: Yes, Ms Farrow - tell, tell.
Ms Farrow: The next thing I think you have to start looking at is the series of unemployment problems we have that are age-related, skill-related and region-related. Big macro-policies to deal with them are not going to work. You will have to work together federally and provincially to target these areas.
I agree with David; I do not understand. The biggest inter-generational shift in wealth has been that we look after the aged, but the children, who are the future, are being cut out. That's because they can't vote. It's simply because they can't vote. We have to do something about this with education, with day care. The first three years of a child's life are what's important. I feel like a mother now and not an economist, but that's very important.
The second thing you have to do is education and training. We have to start talking about that in very specific ways. We are beginning to talk about standards, training, skills sets. Look at New Brunswick. I expect they've made a leap into the 21st century with this program to put a computer in every house. If you want to spend some money and take people as a nation into the 21st century, you had better start making sure this whole society is computer literate. That goes back to education. It goes back to how you can use multimedia training programs, how you can change the cost of training. We must start looking at this. I think the federal government should take a lead - not set national standards, but start looking at a very specific need.
There is one age group that unfortunately, because we messed up the education system, may be a major problem to us. They are those young people who have dropped out of school and have not been trained. In this society they are unemployable, and we cannot desert them. Again, it comes back to what you're talking about: we will have to revisit and see what can be done, and it's not giving them welfare for the rest of their lives.
Those are some of the policy issues I think you have to address, but for the longer term. It's not having an infrastructure program in the next budget; that's a long way away from what I'm talking about. I really think you should think about this. It goes with the demographic theme I started off with.
The Chairman: Thanks, Ms Farrow.
Mr. Grose.
Mr. Grose (Oshawa): I'm rather a simple fellow so I ask simple questions. My only experience with economics is running my own business for 35 years.
I've heard everyone from governments through central banks to the manager of the local convenience store take credit for getting inflation down. That begs the question of how you get inflation up, how you get it stopped at a desirable level. Then when you accomplish that, who the heck wants to take credit for it anyway?
Prof. Fortin: Essentially it's by monetary policy. If you want to raise the level of inflation, you lower interest rates. If you want to lower the rate of inflation, you increase interest rates. This is put very simply; it's a little more complicated than that.
Mr. Grose: It's not working at the moment.
Prof. Fortin: I want to say something concerning labour mobility. I'm going to say a very strange thing: you can have too much labour mobility as well as too little. Too much labour mobility creates enormous problems of turnover for firms, and they always have to retrain a new labour force.
I'm associated with a manufacturing company. We sell 80% of our output to the United States. We have five plants in Quebec, in Canada, and two in the United States; therefore, we have a lot of experience with the U.S. as well as the Canadian labour force. We observe that our Canadian labour force gives us a turnover rate of about 8%, whereas our U.S. labour force gives us a turnover rate of about 25%. That was also true even when the U.S. unemployment rate was much higher than it is now; it's not just a reflection of the current lower U.S. unemployment rate.
.1925
So I'm not certain that all of our policies to foster labour mobility... Maybe we should have more of that in Canada, but we should also be conscious that it's not because it's high in the United States that they are always better than we are. Once in a while I would like to hear that in Canada we sometimes do something better than the U.S. does. Our manpower in Canada is much more faithful, much more ready to learn, and to stay with the firm, and that's a great asset for our companies, and raises our profits, by the way.
The second point I want to make is that there have been many studies in the last three years. I am not going to explain all of them, but I see Riddell and Jones, Amano and Macklen at the Bank of Canada, Card and Lemieux at the University of Montreal, Baldwin at Statistics Canada, and Crémieux and Van Audenrode at Laval University. All of those studies, which use very different methodologies, come to exactly the same conclusions: the level of employment adjustment costs and the degree of wage rigidity in Canada and the United States are not significantly different enough to explain more than 1/100th of 1% in the unemployment rate difference between the two countries, basically.
The Chairman: Thank you very much.
Prof. Fortin: I'm exaggerating a little bit.
The Chairman: No. Could I beg your ideas. We could expand our time.
You have not all had an opportunity to respond to the question that Lynne has posed to all of us: how do we go about trying to ensure that we have more and more Canadians employed, which is the major preoccupation of all of us? Everything we've been talking about today - monetary policy and fiscal policy - is simply a goal to try to make it possible for more Canadians to get back to work. I'm sure that each one of you has some other ideas on this question, and it would be of tremendous benefit to us to hear them. We could have a special round on that or I could ask each of you to take two minutes to make concluding remarks. I know I was going to recognize Al Hatton before we did this, but during your concluding remarks, maybe you could touch on not only an answer to Lynne's question but anything else that you wanted to bring before us. How would you like to proceed?
Prof. Fortin: Two minutes each.
The Chairman: Does anybody feel they need more than two minutes?
Al, before you get your two minutes, I want to recognize you.
Mr. Hatton: I will forgo my two minutes, because I want to respond to what Lynne raised. When I opened my remarks I talked about the other side of the agenda, in terms of the social contract, the social union. In fact, that is where our sector is going. The committee probably thinks we're still in the space where we want to get back the money that was lost during the cuts. That's not the case. We are also living in the real world. I've just visited 65 CEOs and executive directors in the last four months, the biggest charities, across the whole sector, right across the whole country, and it's very interesting; we are reinventing ourselves.
The problem is that the government is not connecting with us - and I have to use this opportunity to say this, because it's the finance department and Treasury Board that have set up the program review and the targets that we have all talked about. We accept those targets; we're living in the real world. The problem is that the unintended impacts on all of the front-line ministries - HRDC, Heritage, Health, CIDA, Environment; I could go on - are going through massive change.
All of the things, Maureen, that you raised about education, dealing with child poverty - not giving more welfare but dealing with child poverty - dealing with families and the new nature of families, dealing with health policy that's based on prevention and promotion, and investing in the sector that is outside the system, the community-based system of volunteers and staff who are working to attend to people for a very little tiny bit of money at the local level across this country... All of that now is up for grabs, because those front-line departments that I'm talking about are absolutely fixated with cutting costs, saving jobs, and devolving services to the provinces.
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That's the reality; that's the unintended by-product of all the good work we have talked about today. We are for what you're talking about. It makes no sense to send 35¢ on the dollar overseas or into investors' pockets that could be used to reinvest in either Canadians or other programs. We're on that same wavelength; we have been for a long time.
But the fact is that what we are getting rid of is the infrastructure at the community level. I've been around. National organizations are cutting back their staff - the same process that's going on in the federal government. You have the provinces saying, give us everything now and everything will be fine. The same thing is going on at the local level in the voluntary sector.
That is a serious problem, coupled with the fact that provinces now are doing exactly the same thing, because their interpretation of the downloading that you've laid on them is, oh, we'll do the same thing because the feds got away with it and everybody loves it. But the long-term impact of this is going to be far more critical.
So all the nice things we've been talking about in terms of what's going on in the economy, which I think is true, and we would buy, and we're trying to do it within our own sector - we're absolutely being ravaged in terms of a process to get back to doing many of the things Maureen touched upon, whether it be environmental education, international development education, or whether it be working on child poverty; whatever.
I'm sorry to go on a rant, but when I look at the future of this country, when I look at national unity, when I look at the way in which people are starting to try to deal with the cynicism and the loss of credibility at the political level - it seems that what we're gaining back on the economic side, we're losing on the social, cultural, environmental side.
In addition to jobs being the question at the next election, so is the future of civil society. If we want to have foresight, if we want to look long-term, if we want to start using the by-products of the success on the economic side, we have to start reinvesting in a brand-new way, which means a new partnership. It means that the experts here, large corporations, and leaders in government have to interact with our sector. Help us. Let's work together. We don't have the solution, but we have some of the instruments into the community. You have some of the instruments to help us, either at the macroeconomic level or at the political level. We have to do it together.
We have to stop paying lip-service to partnership. We have to say we all have something to contribute, and then in a sense we are transforming the instrument that the finance committee and the finance department have used to get us back on track on the economic side to help us as well on the social side.
The Chairman: Thank you very much, Al Hatton.
We'll continue with the two-minute summaries. Dr. Michael Walker.
Dr. Walker: Thank you very much, Mr. Chairman.
If you mean a summary of the overall position, I guess I would say that I'm in favour of the Bank of Canada maintaining its policy as its stands. I'm in favour of judicious reductions in taxes and spending to stimulate economic growth.
In specific response to the question that has been raised about jobs, I think there are two aspects to this problem. One is the structural features of the labour market. There are well-identified and well-known problems with our labour market in Canada that need to be dealt with. They relate in part to the framework legislation and in part to the incentives that people are given, which Herb Grubel mentioned before.
I think for us to sit around this table this evening and ignore the fact that the government sector in the United States is 20% smaller than the government sector in Canada, and to suppose that our relative growth performance and our relative employment performance are unrelated to that fact, is a delusion. Unless and until we begin systematically and seriously reducing the size of government, we're going to continue to have problems. In ten years' time when we have this meeting we'll talk again about how we are going to get job growth and how we are going to get the economy back on the rail.
The Chairman: Thank you, Dr. Michael Walker.
Tim O'Neill.
Mr. O'Neill: Sorry for jumping out of line - I have to catch an 8:30 flight to Halifax, which is the very last one this evening, and I will suffer dearly if I don't make it. I have a family still there, so...
.1935
Two or three points. I may disagree with Pierre about the proper targets that may be set, about whether we need higher inflation to achieve a more pronounced positive environment in the Canadian economy, but I would not disagree that right now we need and should be getting lower interest rates. I think there's room for that to happen. Our real interest rates are still very high, particularly given the size of the output gap, or the slack we have in the economy.
The longer-term problem, which is the other issue being raised here, is that once you've closed that output gap with whatever inflation is appropriate to do that, what then do you do about improving the total factor productivity growth of the Canadian economy?
That's really what these issues are about. It's about innovation, it's about skills development. The question raised here about the role of government, I think, is what precisely is that role?
We have argued that, on the fiscal policy side, stick with the program of getting the deficit down to zero and ensuring that the debt-to-GDP ratio comes down. But there's obviously a potentially broader role we have to be talking about. Governments are involved in education. They are involved in health care. They are involved in transfers. We've talked about some of the business end of problems in the welfare system, the disincentive problems there may have been in various regulatory structures in the labour market. So let's deal with those.
Let me make two very simple points. It's clear that whatever role on the spending side the government is going to have, it should be tilted more in the direction of investment than consumption. That investment may be in physical infrastructure, not certain recreational facilities, but real, potentially effective productivity-enhancing infrastructure. There's a lot of literature on what that might be.
The other even more critical infrastructure is the human capital infrastructure. How that's done, the precise way in which we adjust the kinds of expenditures we engage in, in education and in supporting research and development, I don't think we need to get into here, but certainly for the long-term benefits of Canadian workers and Canadian employers that's certainly one area.
The other area is to increase the effectiveness of whatever expenditures, whatever programs, we are engaged in, and health care is one that I think sorely needs that kind of restructuring.
The Chairman: Tim O'Neill, thank you very much. Run and catch your plane. We appreciate your having been here.
Leo de Bever.
Mr. de Bever: I want to use my two minutes to talk about jobs and what might be done there.
I've spent most of my career in macroeconomics, but I've come to the conclusion that a lot of our job problems in Canada are not amenable to pumping more money in certain directions, or lowering interest rates. When you look at the structure of the unemployed, I would argue that you would find a disproportionate number of people who are poorly trained and who probably cannot be retrained in any reasonable amount of time at a reasonable cost.
That creates a dilemma. Again, when you look at the minister's statement, it talks a great deal about creating interesting, good jobs, but I think the fundamental reality is that you can't turn people who have been in a dead-end job for 40 years into computer programmers.
The same problem exists with the incentives or the programs that have been built up for venture capital and small business creation. There are lots of people in Canada with good ideas, but I find there's a real shortage of people who can run a business that has a good idea and make money at it. That's a problem. That's not a money issue. That is a structural, educational issue of a particular kind.
We've talked about what government is going to do for us. First of all, I don't think the government, in the end, is going to provide the major part of the component of the answer to that. What they may be able to do is something on training and education skills at the managerial level and at the low-skill level as well, trying to find jobs that fit the skills of people who need jobs. Otherwise you're going to be pushing on a string in a different direction. If you're going to throw more money at a sector that requires high skills when your need is for low-skill jobs, you're going to create more pressure on the labour market in that high-skill component.
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The Chairman: Thank you, Mr. de Bever.
David Laidler, please.
Prof. Laidler: The macroeconomic fundamentals look good, but they're fragile. So please, no tax cuts just yet, or indeed in the medium term.
As to monetary policy, there is a deadline of 1998. Let's respect it and let's have a debate about what should be put in place in 1998.
In terms of job creation, the macroeconomy over the next 18 months will take care of some of that, but it's not going to take care of the problem that I think underlies Lynne Toupin's concerns, which is not so much a jobs problem - it's a poverty and low-productivity problem. You deal with poverty and low productivity in the immediate term by being much more vigorous in income redistribution. Unlike Mike Walker, I regard income redistribution as a fundamental role of government. In the longer haul you create productive workers by providing children with the proper environment, and we know what that means.
The Chairman: John McCallum.
Mr. McCallum: I'll use my two minutes to give a very quick summary of the paper we wrote, bearing on Lynne's question directly and answering it partially.
We refer very briefly to structural things. I would agree with just about everything David and Maureen said earlier on the structural side, but we focus mainly on the macro-levers.
I think it's important to stress that lower interest rates are going to make a very big difference to jobs. Most people around this table might agree, but there are some out there who say that monetary policy and lower interest rates are not working any more, that money is like pushing on a string. I think those ideas have been disproved in a very important way through 30 years of research in different countries. It's probably the most researched subject. I think David would agree with me, so I'm just entering a plea. If people tell you that, I don't think it's right at all. It's very important to stress the importance of maintaining conditions that keep those interest rates low in order to have the jobs in the future.
On the fiscal side, there might be room for temporary, fairly modest measures. We tried to estimate the job impact of three of those. The temporary income tax cut has the lowest jobs per dollar. The infrastructure program has the most. The UI premium reduction has the middle amount.
As others have said, infrastructure programs definitely have other problems. The ideal, if one could do it, and I'm not sure one could, is to marry some kind of infrastructure idea with a more focused approach, along the lines that Maureen described, and then you would get the best of both worlds. If one can create some more jobs in the next 12 months, before the full impact of those lower rates has come to pass, it would certainly be a positive thing.
The Chairman: Clément Gignac.
[Translation]
M. Gignac: We would like to congratulate Mr. Martin. We are pleased that the government intends to further reduce the deficit over the next few years. We are also pleased with its intellectual evolution on this matter.
At this stage, I would say that since the long-term rates in Canada are almost the same as those in the US, the advantage of having budget surpluses in order to reduce the debt would have a minimal positive impact on interest rates.
On the other hand, I think that in two or three years, the fact that the Canadian dollar is very undervalued could give our businesses a considerable competitive advantage. When the dollar is trading at 80 cents or 82 cents, there will be much less of an advantage, and at that point, it will be much more evident that our tax burden in Canada is much greater than that of the U.S.
So in practical terms, I would recommend that the minister, given that he seems to announce targets before meeting with us, should start by dealing with our tax burden over the next two years to make it more competitive with that of the U.S. He should do this before reducing the debt significantly, given that this will have a minimal positive impact on interest rates.
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Finally, on a technical point, your consultations last year included the amount in the unemployment insurance fund. I mentioned a figure of $10 billion.
I see now that the government wants to go much further. It would be rather unfair to all the provinces if the federal government were to build up such a big fund given that it has to increase the contributions to the Canada Pension Plan at the same time.
It is making unemployment insurance and the pension plan into a tax on employment. It should take care not to tax employment more, if it wants to reduce unemployment. Thank you.
The Chairman: Thank you, Mr. Gignac.
Mr. Fortin.
[English]
Prof. Fortin: I would start by reminding you that the great American economist Paul Samuelson is reported to have said that the Lord gave us two eyes, one to watch supply and the other to watch demand; one-eyed economists have no future and one-eyed countries have no future.
One of the big problems is that we spent most of the 1960s and 1970s discussing only demand, propelling demand all the time, and inflation was the result. Then in the last 20 years we've discussed only supply. In my view it's not a coincidence that we see high unemployment in Canada as a result. It's very important to keep a balanced view. My complaint about Canadian macro-policy is that it has been too extreme on either side, depending on the decade.
It seems very clear that we have the potential to employ over 800,000 Canadians at this time, thereby reducing our unemployment rate to below 7%. That is why it seems to me to be the emergency of the times to encourage the Bank of Canada to maintain low and stable interest rates for many years to come. If we're operating our economy at 6% below potential, it means it would take at least three years of 5% real growth to recuperate what we lost since 1990.
Otherwise, I would also be very strong on the supply side, as many people have argued. I would also have a soft spot of concern about what we're going to do with our social safety net. We've already reduced our UI payments by 40% at the given unemployment rate. If the government deficits that have been generated by the economic crisis and high interest rates had not been there, we wouldn't have gone so far.
It's very dangerous that we do things to our society, Americanizing it so to speak, so that we access a point of no return. By unloading cuts to the provinces, they do the same for the social safety net. We have a big experience with this in California, where they now spend more on prisons than on education.
Those supply side measures remain very important, but the urgency is on the demand side - low and stable interest rates and zero deficit.
The reason everyone is always against me is that the left thinks I'm too much of a fiscal conservative and the right thinks I'm too much of a monetary expansionist.
The Chairman: That's why we have you seated right in the centre of the table. Thank you very much, Pierre Fortin.
Maureen Farrow.
Ms Farrow: Mr. Chairman, I think the most important thing to get out of tonight is that we should not waste the gains we're beginning to reap, and they've been very costly for everyone in Canada to obtain. This means the fiscal side and the fiscal policy must continue to stay the course. No tax cuts right now - I wouldn't want to see any tax cuts at all until we've decided what we're going to do as we go into the 21st century. What are the needs? From the competitiveness and the social demography sides, we have to take stock and I would urge us to do that.
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On the monetary policy side, I think the Bank of Canada, as Pierre has just said very eloquently, needs to have low, real, stable interest rates. I think the Bank of Canada, in order to achieve that - I think it's right within our grasp right now to get that - should keep to these targets and not spook the international market.
I think we have to go to a zero deficit. Then we have to start working on reducing the debt-to-GDP ratio. The number I picked was... Okay, let's get back to the late 1970s, early 1980s, which was a number around 40% to 50%. I think that's quite doable over the next few years.
We've got a window of about ten years before the baby boom really causes a lot of problems on the fiscal side. Let's make sure we understand what we can afford. Let's build the expectations so that we don't disappoint people. Also, let's make this a very fair place.
On jobs, I think you are going to have to answer in this budget. As Tim said, I think you have to err on investment. Keep thinking investment. Investment in humans, human capital, is possibly our biggest asset, so let's invest in it. Let's make sure they're trained and that they have the skill sets.
Let's not waste this money in terms of this regional mobility stuff we've done in the past. Let the interest-sensitive side of the economy really take care of what is going to be quite some big game. Don't mess it up. If you mess it up now, all those small businesses will not be creating those jobs. I think you need one of these sessions to come back to these bigger issues of demographics over the next ten years and where you should be directing policy. We avoid it.
Mr. Mendelsohn: What is there to say that hasn't been said? I think I'll keep it down to one minute, actually. We got ourselves into this mess because we focused on the short term. We focused on the next election. We focused on what special interest groups all wanted.
What we need to focus on is the total society and the future, which was said by many people around this table. What we need to look at is the strategy that improves the well-being of every Canadian and their future prospects in a globalized and increasingly competitive economy that's going to be increasingly harsh. That means you don't look out for the next six months; you look out for the next five or ten years, as far as you can, and you program on that.
I want to come back to something that Al Hatton said. It is a frustrating process when you look around and see measures that could be introduced that could be workable in various areas, yet the bickering at the various levels of government prevent an efficient implementation of some of these things. It's not a question of getting into national unity. At the end of the day, either we all hang together and make it work in whatever fashion it takes or we're all going to hang together.
The Chairman: Mr. Hatton.
Mr. Hatton: Invest in our sector. We can create thousands more jobs. That's all.
The Chairman: Just to remind our viewers, Al Hatton is involved with National Voluntary Organizations. It's obvious that we have to look at what you said.
Last, Ms Toupin.
Ms Toupin: Just very quickly, agree to no tax cuts now or later. Ease up on inflation. While there may not be much support for Professor Fortin's position here, the alternative federal budget has a list of about a hundred economists who have come on side in relation to his proposition.
Keep interest rates low and stable. I think I would challenge the government as well. You've set targets for deficit reduction, and it looks like you're on your way to doing them. It would be interesting to see if you can set targets for reducing the unemployment rate in the same way you did with the deficit and look at all of the mechanisms you can put in place over a mid- to long-term period of time. I think it would be a strategy that you should consider.
I'm glad you at least touched on some of the issues relating to social programs, demographics, and making sure that we are not just looking at the economic side, but at the social side as well.
There's one statistic that's going to be coming out soon that just astounds me: 44% of families in which the head is under 30 are now living below the poverty line. That has real implications for investing. We talked about investing. I'm glad we're using that term. It has implications.
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We need to invest in those children and in their families, because the long-term prospects of not doing anything to almost half of those young families is going to be pretty astounding. We may not pay the price now, but I'm sure we're going to pay it later.
The Chairman: Thank you, Lynne Toupin.
This is the first of our pre-budget consultations. We deliberately invited some of the foremost, most highly respected economists from academe and the private sector to be with us tonight to deal with the framework questions: fiscal policy, monetary policy, and the macroeconomics of where we're going, which is, in many ways, the framework for the building and critical to it.
But it doesn't involve all the questions, which is why we had people here like Lynne Toupin and Al Hatton. They just remind us that the reason we're constructing this edifice - we want it to be right - is for the people who are in it.
It is obvious that we did not select you as experts tonight because of unanimity of agreement. You were selected because of your outstanding reputations. You have been an incredible help to us.
I want to thank you on behalf of all of us as we try to meet this incredible challenge of taking what we have now accomplished and looking forward five and ten years, because we know that what we will do today will impact profoundly on future generations. With your help, maybe we have taken a couple of steps toward getting it right.
I couldn't be more grateful to you. I know how busy all of you are and the other demands on your time. On behalf of all members, I thank you.
The meeting is adjourned.