Subject to an important qualification, Professor McCallum is right about at least one major point in his article entitled "The Deficit Then and Now" in the June 1997 issue of POLICY OPTIONS: the huge federal deficits that began abruptly in the mid-1970s, and the huge debts they are still piling up, are indeed a serious problem for Canada. The seven reasons he gives are essentially valid, bar a quibble or two in some instances.
The important qualification is that it must be clearly understood that the discussion is about UNPRODUCTIVE debt. PRODUCTIVE debt--debt incurred to finance useful capital installations--escapes these strictures, in the public sector as well as in the private sector.
What McCallum is wrong about is in his understanding of the cause of these deficits and debts, and of the proper cure for them. He has evidently accepted at face value the misleading hypothesis endlessly repeated by most of our political and business leaders and by the subsidized propaganda organs of the latter, which masquerade as objective think tanks.
That hypothesis is that the deficits have been caused by extravagant "big spending" governments, and that the cure is "obviously" to cut back ever more severely on that spending.
If any governments in Canadian history deserve to be called "big spenders", it was surely the successive administrations that held power in the first three postwar decades--the administrations that gave us nearly 30 years of growth and prosperity. That accomplishment was due primarily to the evolving techniques of demand management, which used monetary and fiscal policies to fine-tune the nations's spending decisions. Since then, program spending has been steadily cut back further and further.
The prosperity of those decades was NOT fuelled by government deficits. On the contrary, the federal government had a cumulative SURPLUS of $10-billion on the National Accounts basis (which presents the government's financial statements in a form that is comparable to private- sector statements) in the first 29 postwar calendar years; annual deficits were few and small. The entire government sector, including the provinces and their creatures, had a cumulative surplus of $42-billion. Furthermore, most of the output and employment was created in the private sector; official demand management was merely the catalyst that kept the process going.
Much the same was true of the other major industrialized countries, for the same reasons (McLeod, 1995, pp. 146-151). The benefits spread to their trading partners by osmosis and immitation. The world enjoyed three decades of prosperity, buoyant government revenues, high levels of output and employment, strongly rising national and personal incomes, and expanding world trade, the like of which has never been seen before or since,
What started the abrupt rise of government deficits and debts in the mid-1970s was the sudden reversal of demand-management techniques and their Šuse to REDUCE national spending instead of to support it--one might call it "negative demand management". This, too, was not solely a Canadian phenomenon but a world-wide one.
Surprise! Negative demand management has produced just the opposite of positive demand management: two decades (and counting) of a new world-wide DEPRESSION; reduced government revenues, greatly increased safety-net spending to support the newly unemployed and the newly poor, therefore huge government deficits; high and persistent unemployment, stagnant national and personal incomes, stagnant world trade, misery, despair, and untold social ills.
The Ultimate Cause Of The New Depression
Of course, there was a reason for the abrupt change in policies in virtually every country in the mid-1970s--a reason that is crucial to understanding the economic history of the last 20 years, but which McCallum does not even mention.
Price stability was the neglected stepsister among the multiple objectives of economic policy from the first postwar days, and "creeping inflation" was tolerated everywhere. Creeping inflation was at first relatively stable, but in the late 1960s it began to accelerate ominously. By early 1973 the Bretton Woods system of fixed exchange rates had broken down, primarily because it was incompatible with persistently different inflation rates in major member countries. It was succeeded by the regime of fluctuating rates that still persists.
Inflation virtually exploded in the early years of the new regime, because the discipline that international competition under fixed rates imposed on domestic prices was relaxed. It soon reached 32 per cent per annum in Japan, 24 per cent in Britain, 11 per cent in the U.S.A. and Canada, even 7 per cent in prudent Germany.
No contingency plan was available, for no one had foreseen the problem--certainly not those who had long advocated more flexible exchange rates. Drastic action was necessary, and quickly. The best the authorities in Canada, or anywhere else, could come up with on short notice was the traditional pre-1930 inflation remedy, repressive monetary and fiscal measures.
Obviously, this response was incompatible with the role of monetary and fiscal policy in demand management. Nevertheless it would have been quite reasonable as a temporary expedient, till more permanent measures could be devised that would have preserved the accomplishments of the preceding 30 years.
Eventually a number of economists did begin to address the basic problem of finding a means of controlling inflation that would not make unemployment worse (McLeod, 1995, pp. 154-156; 1997, p. 108), but by then it was too late: ultra-conservative interests had succeeded in persuading governments and the public to accept their right-wing prescription of monetary and fiscal retrenchment as an apparently-permanent feature of the economic landscape. To coin a phrase, they succeeded in throwing out the demand-management baby with the anti-inflation bathwater.
Actually, this strategy proved somewhat less disastrous than, with the wisdom of hindsight, might reasonably have been expected, thanks to two mitigating factors. The first was the operation of the automatic stabilizers that had become an accepted part of demand-management techniques: declining government revenues and rising safety-net expenditures tended to maintain the spending stream and to offset the effects of deliberate retrenchment. The second factor was the persistent weakness of the Canadian dollar through most of this period, which stimulated exports and must be credited with much of what real growth the Canadian economy has registered in the last two decades.
Should We Continue With The Present Strategy?
If one accepts McCallum's explicit and implicit assumptions, there is little to disagree with in his basic recommendation--in a word, that we should continue with the present strategy. The same is true if one disagrees with his assumptions, but is willing to give up in the face of the obstacles the present right-wing agenda has put in the way of a more humane solution.
However, McCallum's tacit assumptions about the cause of our debt and other problems are demonstrably wrong. Since the cause was misguided retrenchment, not government overspending, continued retrenchment is not going to effect a cure. Would you treat an alcoholic by prescribing more alcohol?
Nor does the case against "staying the course" rest solely on this rather negative argument. Both the advocates and the critics of the present strategy agree on one thing: the best way to restore sustainable prosperity is to get the economy working at close to its potential capacity again. What they differ on is how to achieve that goal, and how close to potential capacity it is safe to get.
The conservative economic philosophy that now dominates official thinking almost everywhere is a more ferocious version of the laissez-faire concept than has been seen since early-19th-century Britain, before trade unions had been legalized and the first constraints on female and child labour had been put in place. It denies anything more than a bare minimum role for government in the economy, and insists that sustainable recovery must come from "natural" forces in the private sector--primarily, low and stable inflation and low and stable interest rates.
The critics of this philosophy point out that over 20 years of highly repressive monetary and fiscal measures have only reduced inflation to a level the authorities now claim is tolerable, they have not eliminated it. That does not augur well for a speedy and assured return to prosperity.
Second, the critics also point out that "natural" restorative forces have never brought a quick recovery from even a very mild cyclical downturn, and failed miserably to end The Great Depression of the 1930s. It took TWO YEARS of massive FISCAL stimulus, in the form of wartime spending, to get the economy up to full employment; monetary policy played a merely supporting role.
Third, economists have known for generations that new capital spending is the best generator of economic growth. They have also known for 60 years that the key to such spending is not low interest rates as such, but a reasonable EXPECTATION by entrepreneurs that new productive capacity would generate ENOUGH NEW REVENUE to pay the going "real" rate of interest (after adjusting for inflation) on the capital costs they would incur, and still yield a reasonable net return. Such expectations are hard to come by in a depressed economy.
The now-dominant conservative economic philosophy doubts that unemployment can be materially reduced without causing inflation to accelerate--in Canada's case, perhaps not below 8 or 9 per cent of the labour force.
Its critics point to the early postwar decades, when targets of not more than 1 or 2 per cent per annum for inflation and 3 per cent for unemployment seemed realistic goals, and ask why we can not improve on that performance now, given the hard-won lessons we have learned in the meantime.
There Are Alternative Strategies Available
Inflation is clearly the villain; it led to the retrenchment strategy in the mid-1970s, and it threatens to accelerate once more if the economy is allowed to grow at more than a very modest rate. The most promising possibility for restoring prosperity would therefore seem to be to find a way to contain inflation without making unemployment worse, yet that would be compatible with the free-enterprise money-and-market system. That would permit demand management to operate effectively again.
As noted earlier, a number of economists over the years have attempted to devise such a remedy. None of their proposls has yet won general acceptance by the economics profession as a whole, or even by those who reject the new laissez-faire philosophy, but they all contain useful insights that may one day find a place in a new consensus that will succeed in restoring prosperity.
The one thing that virtually all economists agree on is that price controls do NOT offer a viable means of controlling inflation. That opinion is based partly on the disappointing results of past attempts at such remedies, and partly on theoretical reasoning: they interfere with the function of the profit motive in regulating production in a money-and- market economy.
Nevertheless I am rapidly coming to the conclusion that we must take a fresh look at controls, for a similar mix of practical and theoretical reasons.
On the practical side, it must be admitted that the present economic strategy has been far from a resounding success in promoting a good life for all those willing and able to work, let alone for the disadvantaged who are unable to work through no fault of their own.
Also, many of the worst experiences with price controls involved shortages and black or grey markets in wartime applications, when a major reason for their use was to assist in diverting resources from civilian to military uses; such problems should not arise in a normal peacetime situation. Other bad experiences occurred because controls were used as a substitute for needed monetary restraint, or because they were badly designed or poorly administered.
On the theoretical side, much of our belief in the efficiency of the market system in using scarce resources to supply human needs is tacitly based on the model of pure and perfect competition, which is an analytical abstraction that has no resemblance to the imperfectly or monopolistically competitive markets in which most of us sell our labour and buy the goods and services we consume. To cite only one factor, the ability of major firms to manipulate consumer preferences materially weakens the presumption that any intererence with the market's allocations will be disadvantgeous to human welfare.
It therefore seems highly probable that a well designed system of peacetime controls could materially reduce inflationary presures and thereby improve the performance of the economy. It should be possible to avoid most past mistakes, and to incorporate realistic provisions for meeting legitimate problems when they arose. Whatever its remaining faults, it should permit a far closer approach to full employment than the present repressive strategy.
Specifically, whatever else a viable means of controlling inflation without making unemployment worse may contain, I believe it must include price ceilings on the products of all monopolistic firms and industries, but ONLY on monopolistic firms and industries.
Business leaders have often blamed increases in their selling prices on upward wage pressures, but in the last two decades real wages have been stagnant or declining while prices have risen persistently. The implication is that there must be a mechanism that permits firms to raise their selling prices regardless of wage pressures, and textbook models of monopolistic competition clearly suggest just such a mechanism (McLeod, 1997, pp. 108 and 109-110). No anti-inflation strategy can work unless this mechanism is thwarted.
References
McLeod, Alex N. "The Problem Is Inflation-Control, Not Spending-Control", BANCA NAZIONLE DEL LAVORO QUARTERLY REVIEW, No. 193, June 1995, pp.145-156. ___________. "A Critique of Neoclassicism and New Keynesianism", EASTERN ECONOMIC JOURNAL, Vol. 23, No. 1, Winter 1997, pp. 101-112.