Debate heats up about Ottawa's stimulus strategy

As the debate heats up in Ottawa and across Canada about how to fix the economy, politicians and policy thinkers are faced with a series of nagging questions without any obvious answers:

• How do you boost an economy ravaged by plummeting commodity prices and a declining manufacturing sector?
• How do you pump up the economy after the Bank of Canada cut interest rates to one of the lowest levels on record?
• And how do you get business, labour and individual taxpayers to believe in your plan when they seem to expect the government to perform miracles? 

"A significant majority of our (members) support budgetary deficits if they are necessary, as long as the benefits are balanced over the long term and investments are made to stimulate the economy," the Ontario Chamber of Commerce said in a recent pre-budget submission.

With a budget and stimulus plan due Jan. 27, a senior official has said the federal government will run a $34-billion deficit in the coming fiscal year and a $30-billion deficit in the following year.

About that walking on water trick ...

In the stimulus debate, people talk about infrastructure. Some have also zeroed in on various corporate tax breaks. Then there is the crowd that figures a personal tax cut might be the ticket to an economic upturn.

'Almost every economist will tell you the stimulus has to be massive in order to have any real impact.' —Robert Reich, former U.S. labour secretary under Bill Clinton

Finally, a group of industry bailout types want the money spent in distressed sectors, such as automotive manufacturing and forestry.

A Compas Inc. poll of Canadian CEOs in December found that these corporate captains liked the idea of government spending on infrastructure, cutting corporate income taxes and lowering personal tax rates, in that order.

That "all things to all people" thinking is common among U.S. companies and individuals as well.

One recent Gallup poll suggested that 78 per cent of Americans want Washington to spend money on infrastructure, 75 per cent want the government to chop corporate income taxes and 72 per cent want personal taxes lowered.

Most groups say they do not expect government to solve the economic recession but, if Ottawa has to choose an approach, it might as well follow the path that solves their particular problem.

In economic terms, however, it all comes down to where to spend precious government dollars to get the biggest economic bang.

Back to school

To get a handle on where the government should spend its borrowed cash, it is important to understand the concept of an economic multiplier.

Technically, what most Canadians think of as a multiplier is actually the "Keynesian multiplier" because the idea tumbled out of the writings of famed British economist John Maynard Keynes.

Keynes and others argued that money borrowed and spent by government is then re-spent a number of times by different consumers and companies. Thus, a new dollar spent equals a couple of bucks in financial activity to the overall economy.

"Economists use the 'economic multiplier' concept to symbolize the continual, but diminishing, number of times each dollar spent cycles through the economy," wrote Marie Easley in a 1998 publication of the Federal Reserve Bank of Atlanta.

Critics point to out all sorts of theoretical and measuring difficulties with the idea.

But, as the Canadian and American economies wallow in a recession, the notion of spending money you do not have to create more activity has made a comeback, like a freight train speeding down a narrow track.

By using its good name to entice banks to lend it cash, the Canadian government wants that money to go to the best possible use.

For borrowed money to work its supposed magic, however, people need to spend — not save — the extra funds. And they need to buy goods made in Canada, not products manufactured in the United States or some other country.

Thus, saving, while a good idea to teach a teenager, is not what policy thinkers have in mind when they want to boost an economy.

Spending vs. tax cuts

If you believe the Keynesian multiplier approach, cash spending by government is a far better way to generate economic activity than a tax cut.

"A portion of any tax cut will be saved, not spent. Therefore, it does not provide an immediate economic stimulus," said one academic.

And governments, whether the new Democratic administration of Barack Obama in the United States or the Conservative government of Stephen Harper in Canada, want people to spend the cash they are given.

Saving the money or paying down corporate or personal debt, while laudable goals, do little to stimulate economic growth.

While former George Bush adviser Greg Mankiw recently reignited the debate by arguing tax cuts provide more stimulus than government spending, most political types appear to have come firmly down on the side of Nobel Prize-winning economist Joseph Stiglitz.

"Tax cuts have increased our national debt. …Spending on infrastructure, education and technology create assets. They increase future productivity," Stiglitz said in a January editorial.

What taxes?

Even though many groups are calling for Ottawa to spend more on roads and other bits of infrastructure, the Harper government might still look for some way to cut taxes to boost economic activity.

There are plenty of pitfalls, however.

Companies currently face the toxic combination of falling equity values, shrinking profits and burdensome debt obligations.

Experts say they are driven by the expectations from their shareholders to boost earnings or reduce debt, again laudable goals but neither very useful in terms of short-term stimulus.

Worse politically, the Conservatives might reduce corporate tax rates, a policy they undertook previously, only to find the same firms cutting payrolls in the first and second quarters of 2009.

Lower taxes for voters

Ottawa could make hay among Canadians by knocking down the tax rates for individuals, especially in Harper's much-touted middle class. 

The politics work here, but the economics stink, economists say.

Something close to 55 per cent of the government's tax revenue comes from the personal side. Thus, chopping the rate could result in a larger-than-expected revenue drop but a less-than-optimal stimulus quotient.

Consumer confidence is at record lows nationally. And more and more people are worried that they will end up in the jobless queue in the near future.

Again, saving, while a decent goal for individuals, will hurt any government stimulus plans.

GST cut redux

The other obvious option for individuals is a possible sales tax reduction.

That cut would go directly to spending since the only way an individual can get the break is by buying some item.

Once policymakers rip the wrapping paper of off this fiscal gift, however, they face two daunting issues:

• Consumers have already reined in their spending as a result of the recession. Knocking a penny or so off the goods and services tax might not provide a sufficient incentive to get these people opening their wallets once again.
• The Conservatives chopped the GST to five per cent from seven per cent in past budgets and received a spanking from parliamentary budget officer Kevin Page for exacerbating a revenue shortfall.

What spending?

Taking the extra expenditure route, possible spending increases fall into two broad categories:

• Infrastructure.
• Industry-specific assistance.

Politicians and policy types alike are drawn to infrastructure spending because, not only does the extra expenditure create jobs, you are left with a useful asset — a new bridge, a better road, an expanded airport — at the end of the process.

In addition, Canada produces many construction materials and uses a lot of local muscle-power, all factors that boost the economic payoff from each infrastructure dollar.

The equation is the same in the United States.

"Construction jobs are good jobs, circulating income in communities while leaving behind the transportation, education and energy systems our nation needs to compete globally," said Terry O'Sullivan, general president of the Laborers' International Union of North America, which represents 10 million U.S. construction workers.

Unfortunately, industry-specific assistance might not receive the same glowing reviews.

The Canada Auto Workers union has argued that the country's auto sector has too many linkages and employs too many people to be allowed to fail.

"The auto industry is a crucial part of the Canadian economy. Every job in a major auto plant supports 7.5 jobs in the national economy," says the CAW's website.

But, so far, Canadians are not that keen on this kind of policy. An Ipsos-Reid poll in December found that 58 per cent of respondents said it was "unwise" for government to bail out the auto sector.

In addition, from a strict assessment of its stimulus potential, sinking a dollar into the car sector might not pack as much as a short-term wallop in the economy as a buck spent on infrastructure.

Where would money flow?

North America's three domestic automakers, for instance, already have their hands out with the threat that they might not be able to continue in this country without new cash.

Any help could well flow to their bankers, not to hiring back workers, bailout opponents noted.

Thus, government help would play a part of keeping the assembly sector alive.  But, in terms of economic stimulus, the results would lag behind the infrastructure alternative.

Like Washington, Ottawa is likely to do a bit of everything — some targeted personal tax cuts, something on the corporate side, infrastructure spending and some industry-specific help — in the Jan. 27 budget, insiders say.

Covering all the bases makes sense for a minority government that needs to scrape for every vote.