||Down, Resurgent Dismal
by Henry Lackner
So many Canadians are out of work, so many are on welfare, so many businesses fail, the debt is so high, and the economy is growing so slowly, because the Bank of Canada's policies are misguided. The free-wheeling bank with its zeal for zero inflation must be restructured along more democratic lines. These are among the conclusions of Unnecessary Debts, a joint volume by "eight leading Canadian economists". Their strong credentials are detailed in the volume.
Make no mistake; this is not a book For Dummies. Those without at least freshman economics will work hard. There are technical concepts, all defined in a glossary, footnotes, references, numerous charts and tables, and even the occasional equation. Many will be happier with similar material in Linda McQuaig's bestselling Shooting the Hippo; or with the numerous articles in Duncan Cameron's CCPA monitor. But business leaders dismiss such sources, unfairly and too easily, as the work of mere journalists and pamphleteers.
Those who work out with Unnecessary Debts will be in shape. They will be able to take on the heavyweights of commerce, banking, government, and academy who still preach the Dismal Science. The book is worth the price even if one just reads the editors' introduction, which puts the whole volume in context, and their final contribution. Everyone should read this final essay ("Credibility Mountain") and the editors' lucid abstracts for all the others.
"The Dismal Science": that's what Thomas Carlyle called economics in the nineteenth century. For the Reverend Mr. Malthus had preached inevitable poverty and overpopulation, with only war, famine, and pestilence as solutions. The stockbroker David Ricardo produced an "iron law of wages": the more you pay a worker, the more she reproduces. The higher pay becomes subsistence income no less than the lower.
These ideas sprang from Adam Smith's wonderful Invisible Hand, said to co-ordinate price, demand, and supply of goods with an efficiency that made any government interference unthinkable. The laws of the Invisible Hand were thought to govern free markets, even as the laws of physics governed the starry heavens. Mathematicians soon applied similar equations to both fields: economics gained the trappings of a hard science.
Dissenting voices there were, notably Marx, then, more successfully, in the 1920s, Keynes. His macroeconomics dominated the world academic and political scene from the Great Depression until after the Vietnam War.
Then the Dismal Science of classical economics made a comeback. We got "Rational Expectations Theory" and "Real Business Cycle Theory". Unemployment, poverty, homelessness, social breakdown are again seen as inevitable. If people don't have jobs, it's because they refuse to work for low pay. New Dismal Science preachers now dominate both government and academy. They proclaim: "Woe unto those who permit inflation and are easy on the deficit." It was to rebut these preachers that Unnecessary Debts was written.
For such recessions Keynesians recommended fiscal policy including government spending and hiring to take up the slack. They recommended monetary policy: lowering interest rates to make it easier for consumers and businesses to spend.
Batting cleanup for the Unnecessary Debts Keynesian team is the Nobel-Prize-winning economist James Tobin. His essay "Business Cycles and Economic Growth" demonstrates how boom and bust caused deviations from the classical "equilibrium" in this century. He showed how these deviations were explained by Keynesian theory, but not by the classical Real Business Cycle Theory, which tells the government to keeps its hands off the economy. He examines the evidence: unemployment, vacancies, layoffs, excess plant capacity, unfilled orders, delivery delays, and monetary effects on output. He wonders, "Why do so many talented economic theorists believe and teach elegant fantasies obviously refutable by plain facts?"
The other authors zero in on the Canadian economy. Rosenblueth, in "The Debt and Canada's Social Programs", details how lowering real interest rates would liven up the economy to benefit most Canadians. Real interest is reported interest minus the rate of inflation.
"The efficient and equitable way to reduce debt-to-income ratio," he says, "is to cut interest rates and to add other government measures that will combat unemployment and raise the growth rate of the economy..[I]n terms of what the economy produces, we can certainly afford social programs in the nineties at the level of those in the seventies or early eighties." Once adjustments are made for foreign investors, "Canadians [as a group] were better off in 1993, than in 1982 or 1975..[Canadians] have more real income per person now than they had before, even taking into account payment of interest on the public debt, about which everyone complains."
With lower interest rates, Rosenblueth explains, private borrowing costs would go down, so that people would buy more houses and durables; businesses would expand. So GDP (how much is available in the domestic economy) would go up as would its growth rate. Consequently, poverty and unemployment would go down, government income would go up, so that the debt-to-income ratio would grow at a smaller rate.
The lower interest rates would also make Canada less profitable to foreign lenders, who would reduce their Canadian activities. A less desirable loonie would reduce its cost. The less valuable loonie would cut imports, but increase exports, again yielding a higher GDP. Lower interest rates also reduce government borrowing costs, thus lowering the government deficit.
From Osberg's "Social Policy, Macro Policy, and the Debt", we learn how the joblessness caused by high interest rates crunches flesh-and-blood Canadians. Jobless people get sicker, physically and mentally. They divorce more often and they commit more crime. Those with very low pay and insecure jobs suffer similarly. We are confronted with both personal tragedy and government costs. An army of sick, depressed, demoralized, and criminal people is in no shape to take employment even when it becomes available. Unemployment causes unemployment.
Training and motivational programs, explains Osberg, can be futile. With high interest rates, there won't be enough jobs for the "trained" and "motivated" people to go around.
High interest, he writes, is costing Canada $50 billion in potential resources. Suppose the powers that be lowered interest rates enough to take unemployment down to seven percent. Then a twenty percent tax on just the increase in output "would entirely finance the transfer payments required to eliminate poverty in Canada [!]" The remaining funds would slash both provincial and federal deficits, while increasing consumer spending.
At this point the pundits will lecture us about globalization and competitiveness: Canada cannot remain, they say, a small Keynesian welfare island in a sea of efficient though ruthless competition; Sweden, Denmark, Australia, and-a favourite example-New Zealand, all could no longer afford their social programs and had to start dismantling their welfare states; Canada must do likewise.
Quite the opposite is true, as Osberg and Fortin point out in their introduction. By 1988 the Bank of Canada had stabilized inflation at four percent. Canada's policies were as tough but no tougher than the American ones. Had Canada continued with the 1988 policy, as demonstrated by McCracken ("Recent Canadian Monetary Policy"), Canadian unemployment would now be 1.6 percent lower and the Canadian economy would be in better shape.
But the bank, unlike the Yankees, went for zero inflation. Interest rates soared sending the loonie to its highest in a long time against the American dollar. Canada became an island of extremely high interest rates in a sea of lower though still high rates. Canadian unemployment soared above American. Canada "had to" dismantle social programs, but American investors loved the high interest, and moved money north of the border.
To squash this Canadian extremism, Audenrode ("Some Myths About Monetary Policy") wants to peg the Canadian dollar to the American. The loonie riding up and down with the U.S. currency, Canada would no longer need a fancy central bank with its expensive salaries and trappings. The stable exchange rate would favour free trade and Canada would benefit by the rational decisions of the U.S. Federal Reserve Bank.
Osberg and Fortin are at pains to create as broad a consensus as possible against the Bank of Canada's destructive policy. They point out how the three authors-Gillespie, Kneebone, and Fortin-who detail Canada's financial history agree on the historical facts.
The difference concerns policy recommendations. Kneebone (in "Four Decades of Deficits and Debt"), unlike the other authors, opts for government cutbacks. He is convinced that nothing can stop the Bank of Canada from implementing its destructive zero inflation policy in the future.
The Bank of Canada is mandated "to promote the economic and financial welfare of Canada." Why, ask Osberg and Fortin (in "Credibility Mountain"), has the bank not done so, pursuing instead zero inflation with its horrible effects on government revenues, employment, production instabilities, social breakdown, and political restructuring. Could the bank have deliberately embarked on a policy to shift even more income from the "undeserving" poor to the "productive rich"? What a terrible affront to democracy that would be: civil servants arrogantly bypassing elected representatives and open debate, while warning of punishing markets, and promising "light at the end of the tunnel".
The editors prefer to believe the bank miscalculated rather than misgoverned. The all-powerful governor and his people had disregarded most of the evidence, and rejected all perspectives other than their own. How can these functionaries now admit to themselves and to the Canadian people that they mistakenly caused such monumental damage to Canada? The central bankers would be disgraced; stripped of their veneer; turfed out of their fancy jobs. Like the Vietnam hawks who threw so much into the battle, they must now press on, believing the war will eventually be won.
To avoid such mistakes in future, Osberg and Fortin recommend replacing the one bank governor with a committee of governors representing different economic perspectives and all of Canada's regions. "Operation Restore Democracy" would provide open debate on the bank's strategies, balancing Keynesian with classical economics. Each governor, residing in her own region, would maintain her own staff of full-time regionally-based professional economists. Never again would a monetary czar decide unilaterally and without public discussion for zero inflation.
Diagnosis determines therapy. Is Osberg and Fortin's diagnosis correct? As Osberg admits (in a personal communication), it is the rich, the borrowers who benefit from the low inflation policy. It is labour that suffers both economically and politically. Despite the counterindications, many economists, all bankers, and almost all multinational business leaders support the bank's current policy. What if the bank were merely carrying out the instructions of the powerful? According to McCracken (also in a personal communication), the purpose of high interest policy is to dismantle social programs.
He also writes revealingly:
"An alternative hypothesis is that the higher interest rates and particularly the rising value of the dollar were the result of an implicit agreement between Canada and the United States that required a higher Canadian dollar as part of the Free Trade Agreement introduced in 1989. This explanation is supported by the concerns expressed in 1986 by U.S. congressmen and other officials that the Canadian dollar was `too competitive'. Not surprisingly this has, to date, been vehemently denied by all parties. In any case, high interest rates and the high value of the Canadian dollar seem to have led to overcautiousness on the part of Canadian business, allowing U.S. business to move first and most advantageously to take advantage of the expanded market opportunities and options to rationalize production."
The editors prefer to avoid "the political polarization of the debate" and the "exaggeration and semihysteria". They prefer to emphasize the more consensual issue of "democracy" rather than the divisive idea of the "political economy of labour".
The Dismal Science marches on.
Henry Lackner is a Halifax writer and a long-time independent student of the philosophy of science, with a particular interest in heresies.