In the long run, we’re all dead Keynesians

By: on October 6, 2017 |

When former Prime Minister Stephen Harper’s Conservative government plunged Canada deep into deficit spending in Budget 2009, then-Maclean’s columnist Andrew Coyne concluded that the Conservatives had decided “to finish off what remains of conservatism in Canada.” With this full embrace of Keynesian economics, wrote Coyne, “the Conservatives’ already headlong retreat from principle has become a rout – a great final leap into the void. Understand: there will be no going back from this, for the party or for the country.”

A majority government, election defeat, and leadership race later, and the Conservatives still haven’t returned to economic conservatism. This year they turned down Maxime Bernier’s invitation to lead the party out of the Keynesian void; choosing instead to champion agricultural cartels over free trade, insist that subsidies for textbooks and children’s sports are tax cuts, and support business hiring credits and wage subsidies even as they claim to oppose corporate welfare.

The Liberals are even worse, pushing for more income redistribution, higher spending, and more interventionist government. They won the 2015 election with promises to turn a balanced budget into “modest” and “short-term” deficits, then promptly tripled them and abandoned any deadline for a return to balance.

During the 2015 campaign the Conservatives tried to portray the Liberals as dangerous spendthrifts, but their credibility was weak. Not only was the public weary of Harper and the Tories after a decade in office, but voters smelled hypocrisy in a party that had been arguing for years that all the money they had borrowed and spent had fuelled job creation and economic growth.

Twenty-five years ago Canadian political parties of all stripes got elected, and delivered, on promises of spending reductions, balanced budgets, and lower debt. Today almost no political party at any level is making a serious case for freer markets and smaller government. How we got from there to here is worth examining, and it starts with this question: Why did the federal Conservatives spend their ten years in office engineering an ideological re-embrace of big government and big spending?

The Keynes-free decade

The fiscal strategy embraced by the Conservatives in Budget 2009 had a name – Keynesianism, named for English economist John Maynard Keynes, whose influential book, The General Theory of Employment, Interest, and Money, published in 1936, carved out a massive role for government intervention in the economy. Keynes argued that free markets were flawed, and that the cure for economic recessions was massive government borrowing and spending to maintain full employment and put idle economic resources to work.

Keynesianism really became the gospel of government in Canada during Pierre Trudeau’s tenure as Prime Minister. The result was more than two decades of uninterrupted budget deficits, first under Liberal Trudeau and then under his Progressive Conservative successor Brian Mulroney. By the time the PCs were decimated in the 1993 election and the Liberals returned to power under Jean Chrétien, Canada was a fiscal basket case with a federal debt-to-GDP ratio north of 70 percent and interest payments consuming one-third of federal government revenues.

Pressure to get spending and debt under control was coming from a variety of sources, ultimately fuelled by growing public support. To the chagrin of many Canadian socialists, the NDP government of Saskatchewan under Premier Roy Romanow led the way with significant spending cuts in 1992. During the provincial election in neighbouring Alberta the following year, the Liberal and PC parties competed to outbid each other over the size of their cuts. Voters handed a majority government to new PC leader Ralph Klein, a former liberal made over into a conservative revolutionary promising a 20 percent spending cut.

In the House of Commons, the Reform Party under Preston Manning, which had vaulted from one seat to 52 in the ’93 election, pushed relentlessly for fiscal responsibility. With the articulate conservative voice of a young Calgary MP named Stephen Harper leading the way, the Reformers’ calls for reining in government were bolstered by think tanks and sympathetic voices in the media. In the weeks leading up to the 1995 federal budget the Canadian Taxpayers Federation held a series of rallies across Canada, in conjunction with local taxpayer advocacy groups. The largest, in Pickering, Ontario, two weeks before the budget, drew more than 5,000 people.

In January of that year a scathing editorial in the Wall Street Journal published labeled Canada “an honorary member of the Third World” due to the country’s debt crisis. “If dramatic action isn’t taken in next month’s federal budget,” according to the editorial, “it’s not inconceivable that Canada could hit the debt wall.”

Dramatic action was indeed taken in the 1995 federal budget, the second delivered by the Chrétien government. Rather than tax increases, it mainly chose spending cuts, especially to provincial transfers, as its primary tool of deficit reduction. Program spending dropped 9.7 percent over two years, and by 1997-98, Ottawa posted its first surplus in more than a quarter century.

The return to surplus and the coinciding decline in public debt allowed the Liberals to undertake substantial tax reductions. As a result, Canada was tops in the G7 in both GDP growth and business investment growth for the decade leading up to the Great Recession. These results were a clear rebuke to Keynesians who advocated ever-growing government as the path to prosperity. Their policies had brought about the debt crisis in the first place, and their predictions that cuts to government spending would damage the Canadian economy were proven wrong.

Resurrecting Keynes

During Stephen Harper’s years as a graduate economics student at the University of Calgary, he was drawn to the ideas of Keynes’s sharpest intellectual opponent, F.A. Hayek. A persistent and eloquent critic of central planning and heavy state intervention in the economy, Hayek rejected the idea of government as economic saviour during times of recession. He insisted that free markets should be allowed to work, arguing they would self-correct without government interference.

Harper’s master’s thesis categorically rejected Keynes’ prescription for government spending as the cure for recessions; his thesis advisor Frank Atkins once said it could have been titled “Keynesian economics is a really stupid idea.”

When Harper made his re-entry into politics as Canadian Alliance leader in 2002, every indication was that he would fight to keep Keynes buried politically. In a 2003 speech to Civitas, a Canadian network of conservative and libertarian thinkers, Harper said that that economic conservatism’s “primary value is individual freedom, and to that end it stresses private enterprise, free trade, religious toleration, limited government, and the rule of law.”

Harper prescribed “deeper and broader tax cuts, further reductions in debt, further deregulation and privatization, and especially the elimination of corporate subsidies and industrial development schemes.” For the most part, he added, the arguments in favour of such policies “have already been won.”

His declaration of victory turned out to be premature. After the initial period of austerity, Jean Chrétien and his finance minister and successor as Liberal prime minister Paul Martin ushered in large spending increases in their final years. Indeed, after a three percent decline in nominal program spending over their first six years, the Liberals increased it by 49 percent in their last six. (Similar backsliding occurred in Alberta, with real per capita program spending increasing 32 percent from 2003-04 to 2007-08.)

The Harper Conservatives came to power in 2006 largely on promises to cut the GST, crack down on crime, and clean up the Liberal “culture of corruption and entitlement”. There was no hint of Hayek in the platform, and plenty of expensive promises.

Spending increased well before the recession began, rising $25 billion in just two years. Andrew Coyne noted in 2007 that the Conservatives were spending, in real per capita terms, “more than the Martin government spent at its frenetic worst, when it was almost shovelling the stuff out the door. It is more than the Mulroney government spent in its last days, when it was past caring. It is more than the Trudeau government spent in the depths of the early 1980s recession.”

In 2012, the Federal Government and the City of Toronto announced a $82.4 million pedestrian tunnel project linking Toronto’s island City Airport to the mainland. (From left to right, Airport Chairman Mark McQueen, Prime Minister Stephen Harper, Toronto Mayor Rob Ford, Finance Minister Jim Flaherty). (Image: Stan Behal)

Expenditures rose another $9 billion in 2008, then a whopping $36 billion in 2009. Initially the Conservatives were reluctant to undertake so much debt-financed spending, but they were a precarious minority government, and did not have a strong opposition clamouring for restraint, as the Liberals did in the 1990s. Instead, they faced two main opposition parties howling for stimulus, and they needed the support of at least one of them to pass a budget – and remain in power.

So the Conservatives loudly announced the resurrection of Keynes in the 2009 budget speech:

Our government will spend what is necessary to stimulate our economy, and we will invest what is necessary to protect our future prosperity.

To finance Canada’s Economic Action Plan, our government is making a deliberate choice to run a substantial short-term deficit.

This temporary deficit is an investment which is necessary to stimulate our economy.

The Conservatives’ embrace of Keynesianism was total. The budget called for a $33.7 billion deficit; the actual deficit that year was $55.6 billion, the biggest in Canadian history.

Harper blamed capitalism for the global financial crisis and Great Recession, telling the Manning Centre Conference that year that “we are, as Conservatives, in response to massive failure in the marketplace, using the public role of government to act… the government must step in to restore confidence, to protect citizens, to stimulate the economy.”

He partly justified the deficit by arguing that due to low interest rates “the cost for government in borrowing is virtually zero.” Harper’s remarks reflected what Jim Flaherty, his finance minister at the time, called “a remarkable degree of consensus” that the government “must do what it takes to keep our economy moving, and to protect Canadians in this extraordinary time.”

There was a consensus, in other words, that Canadians required “protection” from free markets, which allegedly did not have the ability to “keep our economy moving,” hence the need for government “investment” to rescue the economy. The Conservatives became so enamoured of their “Economic Action Plan” that they continued it long after the recession ended in early 2009.

That October the Fraser Institute published an analysis in the Financial Post arguing against continuing the stimulus spending. Jim Flaherty responded almost immediately with an op-ed insisting “it is clear that the recovery remains fragile and it is too soon for governments to abandon the package of measures in place to stimulate economic recovery.”

The Conservatives became evangelists for Keynesianism not only in Canada, but also abroad. Speaking to the World Economic Forum in January 2010, Harper gave a full-throated endorsement of Keynesian economics and urged politicians to keep spending.

“It remains my conviction that fiscal expansion, enhanced government spending and increased fiscal deficits were necessary during the recession,” said Harper. “In fact, with rapidly falling output and employment and interest rates near zero, economic theory was clear – this was the only option.”

Stimulus programs, he stressed, “have been and will remain vital.”

Surely this was not so.

Spending Yourself Rich

The illogic of government consumption as the engine of employment and economic growth had been made plain long before the publication of Keynes’s The General Theory in 1936. In the previous century, French economist Frederic Bastiat introduced his famous broken window fallacy in his brilliant essay What Is Seen and What Is Not Seen.

A boy breaking a shopkeeper’s window results in income for the glazier who is hired to repair the window. One industry, then, is boosted by the breaking of windows. That is clearly seen. But Bastiat goes on to describe what is not seen.

If the window is not broken, the shopkeeper could have bought something else, perhaps a pair of shoes. So the glazier’s gain is the shoemaker’s loss. This looks to be a wash, until we consider that the shopkeeper could have had both new shoes and a window. Clearly, wrote Bastiat, breaking windows does not generate positive economic growth. It just destroys wealth. Bastiat went on to apply this lesson to the public sector:

The sophism that I am attacking in this essay is all the more dangerous when applied to public works, since it serves to justify the most foolishly prodigal enterprises. When a railroad or a bridge has real utility, it suffices to rely on this fact in arguing in its favor. But if one cannot do this, what does one do? One has recourse to this mumbo jumbo: “We must create jobs for the workers.”

Of course, whenever government decides to “create jobs for the workers” it must do so by diverting resources from the private sector. Every job created by government requires confiscation of funds via taxation from private individuals, who then have less money with which to purchase goods or start businesses to “create jobs.”

The central idea of Keynes’s advocacy for massive government spending also flew in the face of Jean-Baptiste Say’s Law of Markets, which held that consumption first required production. Keynes reversed this by arguing that it was consumption that drove production.

By this logic, the spectacular rise in human prosperity since the Industrial Revolution was the result of people suddenly deciding around two centuries ago that it would be beneficial to consume more, to have better medicine and live longer lives, to make use of better appliances and enjoy more leisure, to eat better foods and enjoy greater material prosperity. All of this increased consumption allegedly led them to produce more and earn higher incomes.

But of course, it was the productivity gains during this time that enabled greater consumption, not vice-versa. Indeed, two years before the publication of Keynes’s The General Theory, Patrick Barrington had laid waste to the idea of consumption driving economic growth in his satirical poem I Want to be a Consumer. In the poem, an old Bishop asks a young boy what he intends to be when he grows up.

“I want to be a Consumer,”
The bright-haired lad replied
As he gazed into the Bishop’s face
In innocence open-eyed.
“I’ve never had aims of a selfish sort,
For that, as I know, is wrong.
I want to be a Consumer, Sir,
And help the world along.

“I want to be a Consumer
And work both night and day,
For that is the thing that’s needed most,
I’ve heard Economists say,
I won’t just be a Producer,
Like Bobby and James and John;
I want to be a Consumer, Sir,
And help the nation on.”

Pressed by the Bishop, who insists that “we must all of us have to work” and asks again whether the boy has plans to become a doctor or lawyer, the boy replies, “Why, no!”, and concludes:

“I want to be a Consumer
And do my duty well;
For that is the thing that’s needed most,
I’ve heard Economists tell,
I’ve made up my mind,” the lad was heard,
As he lit a cigar, to say;
“I want to be a Consumer, Sir,
And I want to begin today.”

As Financial Post columnist Peter Foster observed of Barrington’s poem in his latest book: “Nothing could more succinctly have laid bare the notion that you could effectively ‘spend yourself rich.’”

Taking the Tories to Task

In March 2010, the Fraser Institute published a study arguing that the stimulus spending enacted by the Conservatives “did not have a material impact on Canada’s economic recovery. The evidence supports recent academic studies that show that stimulus initiatives that rely on government spending fail to increase economic growth.”

The Conservatives did not take kindly to the study. Jim Flaherty told reporters it was “poorly done” and “shabby.” Harper claimed the report was “completely wrong and quite frankly contradicted by very serious work that’s been done [elsewhere].” Echoing his remarks to the World Economic Forum, Harper argued that “economic theory and history is clear” that stimulus spending was the right course of action, and that “every reputable international study says so.”

Two of the study’s co-authors, Niels Veldhuis and Charles Lammam, countered in the Financial Post that Harper’s claims were “simply not true” before pointing to numerous prominent studies supporting the view that government stimulus decreased, rather than increased, economic growth.

It was a harsh and thorough rebuttal of Conservative claims that governments could spend the economy rich. Summarizing the duel between the Conservatives and the Fraser Institute the next day, columnist Foster wrote:

Stephen Harper and Jim Flaherty must be smarting after being taken to the metaphorical woodshed on this page yesterday by the Fraser Institute’s Niels Veldhuis and Charles Lammam.

The Prime Minister and his Finance Minister had dismissed as “ideological” and “shabby” a report by the Fraser economists that suggested that the Conservatives’ stimulus program had “virtually no impact” on last year’s economic turnaround.

Yesterday, Messrs Veldhuis and Lammam produced a devastating catalogue of research by some of the world’s leading economists to confirm that the theory behind the government’s Economic Action Plan, like all such “stimulus” plans, is essentially a crock.

Others too were taking the Conservative government to task. After blasting the Tories for deficit spending in the 2009 budget, the Canadian Taxpayers Federation said that the government should have scrapped “son of stimulus” – the billions doled out in the following year’s budget even though the recession was long over.

“Son of stimulus” highlighted another failure of Keynesian policies: the timing problem. In Canada’s case, the economic recovery had begun long before the stimulus money was out the door, and the stimulus continued well into 2011, even though the recession had been over for two years. But fat cheques and sod-turning photo ops goosed Conservative poll numbers, so they kept at it.

In the lead up to the 2010 budget, a series of columns called “The Chopping Block” appeared in the Financial Post, identifying ways the federal government could cut back spending. One proposed candidate was corporate welfare.

Stephen Harper had promised in opposition that he would end the practice, but never did so. His government even expanded the network of regional economic development agencies, long derided by Conservatives as pork barrelling of the worst kind. Though automobile sector bailouts drew the most attention, everything from the Loblaw grocery conglomerate to the Diamond Bourse of Canada was on the government dole, prompting the Financial Post’s Terence Corcoran to ask in a February 2010 column: “Is there any economic activity in Canada that doesn’t get a hand-out from government?”

Even after they secured a majority government in 2011, the Tories keep shovelling tax dollars to business. In a 2013 Huffington Post article, Mark Milke tabulated $6.4 billion worth of corporate welfare in the federal budget. He suggested the budget be re-named from “Jobs, Growth, and Long-Term Prosperity” to “Grants, Subsidies, and Eternal Business Handouts.”

It must be said that fiscal policy improved somewhat after the Conservatives achieved majority status. Spending increases were slowed in order to allow the deficit to shrink while revenues caught up. Real per capita spending declined in each year until the budget was balanced in 2014-15. The budget would have been balanced the following year had the Liberals not immediately ramped up spending after their 2015 election victory in order to pretend they had inherited a deficit.

Leadership Race: Market Failure

Following the 2015 election defeat, Stephen Harper resigned as Conservative leader and a leadership race was held to find a new head of the party while Rona Ambrose stood in as interim leader.

Setting aside the bizarre entry and exit from the Conservative leadership race by celebrity businessman Kevin O’Leary, the leadership contest was fought primarily between Maxime Bernier, who offered a marked departure from the Harper era, and “establishment” candidates Andrew Scheer and Erin O’Toole, who promised a similar economic approach to Harper’s.

Bernier had been pre-positioning as a fiscal hawk for years, building a base of support within the party as a critic of stimulus spending. For instance, in a 2010 speech in Calgary, he proposed a permanent government spending freeze to keep expenses from rising above $250 billion. “I’m not saying zero growth adjusted for inflation or GDP increase,” he said. “Just zero growth.”

Eliminating corporate welfare was a major point of Bernier’s leadership campaign. He disowned, at the Manning Centre Conference in 2016, the Conservatives’ corporate welfare legacy of which he was formerly a part.

“I find that we conservatives have not always been keen on openly defending these small-government principles,” he said. “Let’s take the issue of corporate subsidies. Free-market economists unanimously decry them as inefficient and a waste of taxpayers’ money. They’re also grossly unfair.”

Bernier campaigned hard for freer trade and against supply management, and his policy agenda included substantial tax cuts: the elimination of taxes on capital gains, a corporate tax cut from 15 percent to 10 percent, and a significant reduction in income tax rates (though he did not give many specifics on where spending would be cut to generate the fiscal room for these tax cuts).

Scheer channelled the Harper-Flaherty status quo on dirigiste fiscal and economic policy, with a couple of protectionist deviations from their free trade orthodoxy. He proposed, for example, country-of-origin labelling on gasoline, presumably in hope of encouraging consumers to “buy Canadian”. He also took a hard line against free trade with China, warning that it “could devastate our manufacturing sector.”

On supply management, the litmus test for economic literacy in the minds of many conservatives, Scheer made his defense of Canada’s agricultural cartels a centrepiece of his campaign. While Bernier promised to abolish supply management, Scheer and all the other leadership candidates vowed to protect dairy farmers and other supply-managed sectors from foreign competition.

The strategy paid off – Scheer even won a majority of votes in Bernier’s own riding on the final ballot (while Bernier outpolled Scheer in the Conservative heartland of Alberta). In the end the victor’s margin was so narrow it may well have been the Quebec dairy farmers he enlisted as insta-Tories that put Scheer over the top.

Dead in the Long Run

Today’s political environment seems grim for friends of free markets, and Canada’s fiscal history teaches that economic conservatives should not hang their hopes on any politician or party. After all it was the Liberals – led by Jean Chrétien, who sat for many years in Pierre Trudeau’s spendthrift cabinets – who pulled Canada out of a debt hole with austerity in the 1990s.

And Stephen Harper, whose graduate economics thesis scorned Keynes’s ideas, led Conservatives and the country into a national political consensus that massive government spending was the only way out of recession.

Today’s governing Liberals are even more hostile to markets. And where the Conservatives believed in massive deficit spending mainly during recessions, the Liberals evidently think massive deficit spending is permanently required to grow the economy.

Keynes famously dismissed critics who warned of the long-term consequences of his economic theories by writing in 1923 that “in the long run, we’re all dead.” But as Canada learned in the 1990s, in the long run high taxes, spending, and borrowing by interventionist governments leads to a debt crisis – and at least a temporary death of Keynesian economics. It is not a question of if, but when.

 

Editor’s note: For a different perspective on the fiscal and economic legacy of the Harper Conservative government, see the December 2015 Policy Options essay “Ordered Liberty: How Harper’s Philosophy Transformed Canada for the Better”, by C2C Journal contributors Ken Boessenkool and Sean Speer.


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About Matthew Lau

Matthew Lau is a Toronto writer.