An Economic Agenda for the Next Government of Canada

Three weeks until the end of an 11-week federal election campaign and Canadian voters seem not in a hurry to make a clear choice about the identity of the party they will cast their votes for on October 19th. Over the past eight weeks, the leaders of the three largest federal parties have had many occasions to discuss a variety of subjects including the economy–what observers believe to be the most critical ballot-box issue facing Canadians in the upcoming election especially in the context of an economic contraction and a significant drop in oil prices.

Unsurprisingly, the economic debate presented a few preposterous statements, but what is more interesting in my opinion was the scarcity of key economic ideas tackled by the leaders. Whether this reflects their ignorance about how the economy works, which is a problem, or simply their choice of political reality over economic reality, an even bigger problem, the participants added very little to the real economic debate the country actually needs. None of the leaders so far has put on the table a comprehensive economic platform and, in any event, no one leader’s message on the economy is emerging as the winner with voters as wavering polls show.

With that in mind, here is what I suggest to be the economic agenda for the next government of Canada.

Monetary policy: Although the government has no control over monetary policy which is pursed independently by the Bank of Canada, one must keep in mind that the short-term interest rates are near historical lows. And without ruling out a future rate cut, the monetary policy space to boost demand will be shrinking as rates approach zero. An accommodative monetary policy will start having its own limits at some point, thus the relevance of a countercyclical fiscal policy.

Fiscal policy: The government is neither a household nor a business. Government spending is crucial when growth is weak and labour market fragile because if everybody slashes spending, the economy will deteriorate even more as everyone’s income falls leading to further cuts in spending and so on. Take it from Paul Krugman: “[...] my spending is your income and your spending is my income.” In Canada, given the recent fiscal consolidation gains and low federal debt level, the government should use the available fiscal resources for growth-friendly measures as investing in highly-needed infrastructure projects.

Employment: With the exception of the jobs in the public service, the government does not create jobs and the Prime Minister does not manage the economy. The government sets the rules and create a certain economic and legal environment for other economic agents (household and businesses). The next government should put concerns about unemployment ahead of concerns about deficit. With a nominal GDP of 2 trillion dollars, a surplus of 1.9bn is totally insignificant and so is a deficit of 1.9bn (0.1% of GDP). In the meantime, Canada counts some 1.3 million jobseekers 20% of which are long-term unemployed–that is, people without work for 27 weeks or longer. The implications of long-term unemployment on the potential long-term growth are not to be underestimated by policymakers.

Taxation: In my opinion, the key to create jobs does not lie in cutting taxes for small businesses, nor is it the way to reduce inequalities. When it comes to job creation, size does not matter. In addition, widening the tax rate gap between big and small businesses is harmful for growth. Tax breaks are ineffective if SMEs are simply not willing to hire more people and family businesses can often figure out ways to split their income through their corporations.

There is a need to simplify the tax code instead of adding “boutique” tax credits. Tax expenditures have largely increased during the last two decades. A better and simpler alternative is to cut tax rates broadly–particularly for those in the middle of the income scale–and broaden the tax base.

Inequalities: Inequalities have drastically increased during the last 30 years. The top Canadian earners gained ground far more than the middle and lower earners. This trend is not only bad for growth but is a threat to democracy itself. However, some taxes and transfers may be precisely the wrong remedy.

We need a 21-first-century approach that combines simple and effective tools as taxing activities that generate negative externalities and are paid by the rich (perhaps excessive risk-taking in the financial sector), and targeting government aid to those who need it the most (perhaps cash transfers to poor families aiming at reducing school dropout rates). Further gains can come from eliminating deductions that particularly benefit the rich as well as narrowing the gap between taxes on wages and capital income. Other policy measures that can help reduce inequalities (as opening our markets to competition and dismantling oligopolistic structures) must be seriously considered because tackling rent-seeking behaviour not only would add equity to the system but also efficiency. Immigration and fertility policy can, too, play a role in this regard especially when it comes to inequality of wealth.

Housing and household debt: This is the part where the federal government’s options are limited. Indeed, with 1.8 trillion dollars in household debt, of which 1.3 trillion is for mortgage, additional targeted macroprudential policies are required, especially in hot spots like Toronto and Vancouver. That is, however, no easy task. The problem is that the interest rate is controlled by the Bank of Canada while the land use is a provincial jurisdiction. I cannot think of too many things the federal government can do besides providing subsidies, but that would only bid up home prices. The main risk actually will come from the inability of households to pay off their mortgages if interest rates eventually increase which could reduce household consumption and, of course, slow down the economy.

International trade: Perhaps the most surprising element about this campaign is the near-absence of trade agreements from the debate when Canada is going through a structural economic transformation due to a significant drop in oil and base metals prices. I do believe free trade with the rest of the world makes us better off in the long run, but their downside effects must be addressed in the short run, and they should be implemented gradually. Free trade must also be–as University of Oregon’s Mark Thoma put it–fair trade. While there are many long-term benefits, in the short term some workers will lose their jobs due to shifting production to other nations. The benefits from trade can then be used to help those workers who sacrificed their jobs in the interest of the greater good.

Moreover, the government must abolish the supply management for it is a regressive system that distorts the market by guaranteeing producers a positive return on production, inhibiting competitiveness and, in the long-run, preventing Canada from becoming an exporting agriculture livewire. Canada can, for example, abandon supply management in return for serious concessions from our southern neighbours like opening up the U.S. agri-food market to foreign competition.

Climate change: Just over two months time away from the United Nations Conference on Climate Change, Canada’s reputation is at stake. Canada must start implementing policies that address greenhouse gas emissions on a large scale. The effects of climate change on our economy are significant. Experts demonstrate how climate change is already affecting Canada’s glaciers with all the huge implications for late summer flows used for irrigation water and personal use.

The next federal government must work with the provinces to set targets and keep the mechanisms for reaching them flexible while being open to different strategies in different parts of the country–although I personally advocate a carbon tax at provincial level. But one thing is clear: The current strategy has proven to be ineffective. Canada is in fact a price-taker in the global energy market and imposing sectoral regulation is an implicit price far more costly for the economy than either carbon taxes or cap-and-trade systems.

Moreover, Canada is subsidising fossil fuel by 2.1% of GDP according to the IMF’s (conservative) estimates. Gradually phasing out these subsidies and using the funds in renewable energy and clean technology projects can help both reduce greenhouse gas emissions and create jobs.

Forecasts for economic growth in Canada are getting gloomier and downside risks persist due to the slowdown in emerging economies, China in particular. Cutting spending now will do very little to improve long-run fiscal outlook. In the short run, every little fiscal space must be used while preparing for a fiscal adjustment over the medium run. Most importantly, politicians ought not to forget the importance of macroeconomic policies to support growth and job creation.

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