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Our place in the post-recessionary world March 25, 2010

Posted by Dominique Millette in Canada, recession, world economy, world finance.
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Because Canada has emerged relatively more unscathed from the Great Recession than its counterparts in the U.S., Europe and Japan, there’s a tendency for some to feel smug. Yet, the recent storm was only a prelude to the gathering demographic tsunami awaiting fiscal policy makers everywhere. That includes Canada.

This was one of the issues to emerge during “After the Meltdown”, the inaugural conference at Glendon College’s Centre for Global Challenges, on March 24 2010.  The panelists: American Nobel Laureate economist George Akerlof,  award-winning Québec economic columnist Pierre Fortin and London School of Economics professor Tim Besley.

Last year, Akerlof published a book called Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. The gist of his argument, and of cowriter Robert Shiller’s, is that market forces are not governed by entirely rational decision-making as conventional economic theory posits. Originally, Keynes was the first to use the term “animal spirits” in economic theory. It describes consumer and business confidence, but also the key factor of trust. This, as Akerlof argued during the conference, goes necessarily beyond the rational. The resulting conclusion of the book is that only the steady hand of government can effectively counter the erratic pull of emotional overconfidence and subsequent panic.

Fortin, for his part, writes for the Québec magazine Actualité, but is also professor of economics at the Université du Québec à Montréal. He’s won the Gold Medal of the Governor General of Canada and has won national prizes and medals for his articles and his column. His contribution to the debate centred around the need for zero-deficit fiscal responsibility to prepare for both further economic disruption and needed social spending. A big part of that is our upcoming demographic winter, specifically the problem of ballooning health care. In Ontario alone, as premier Dalton McGuinty pointed out earlier this month, health-care funding will consume 70 per cent of the budget in 12 years if left unchecked. Today, health takes up 46 per cent of provincial spending. Meanwhile, the 15-64 year-old population will stop growing in 2025, just 15 years from now; and the 65+ segment will explode. Fortin stated that no amount of increase in the birth rate, or immigration, will change the fundamental imbalance.

One of the problems, of course, is that changing health care costs is a titanic struggle. Québec doctors regularly leave the province for Ontario, which pays twice as much, or for the U.S., which can pay even more. MDs in the U.S. make about $200,000, which is between 2 and 5 times as much as doctors make in other countries. The effect is to pressure Canadian provincial governments into negotiating higher fees with its medical professionals. This is one factor which keeps costs high compared to other developed countries; another, argued Fortin, is health care bureaucracy.

If cost-cutting becomes too great a challenge, revenue generation must take its place. This leads to the issue of comparative productivity: Canada and Italy are the snails of productivity in the G7 countries, asserted Fortin. This lag translates into lower fiscal revenues.

Tim Besley then weighed in with his analysis, which he has also brought to bear as External Member of the Bank of England Monetary Policy Committee and as consultant to the English Treasury.  He observed that normally, capital would flow from rich countries to poor ones, while before the recent crisis the opposite occurred. This ought to have given us pause. Besley gave an overview of the policy and theoretical failures underlying the crisis: the emphasis on inflation targeting as sufficient for global stability; the rejection of activist fiscal policy — a view he espoused personally, he acknowledged; the dismissal of economic inequalities as inconsequential; and the spread of globalization limiting the power to tax. A major pitfall, of course, was lack of strong regulation, as demonstrated by the shell games major financial institutions played — Lehman Brothers and Citigroup being only two examples.

Other factors created pent-up pressure for the direction ultimately taken by capital flows. For example, current account balances diverged dramatically in recent decades with Germany, China and Japan producing surpluses while the U.S. and U.K. created deficits. This sent borrowed money flowing out of some economies and into others. There was also strong growth in financial liabilities: in Spain and in the U.K., these grew to 200 per cent of GDP by the year 2000. As a result, there was an increase in securitization and related derivatives, instruments at the heart of the recent crisis. Meanwhile, financial sector wages skyrocketed from 1.5 to 4 times the rate of other non-farm sector workers from 1990 to the mid-oughts, which increased the number of people eager and willing to wade into the trough. At the same time, there was an unusual compression of risk premia: by 2004-05, buyers accepted a much lower compensation for risk, which indicated very high confidence. Too high, as it turned out.

All in all, what emerged from this discussion, and subsequent questions, was that global governance and local oversight are major issues for the G20 today — and Canada has an important role to play, though we cannot afford to be complacent within our own borders by any means.