How to get out of the economic crisis
I delivered the following speech on February 3 before the Toronto Board of Trade. Yesterday, the Financial Post published an excerpt under the title “Give Keynes the boot.”
As you all know it began as a financial crisis caused by a real estate crash in the United States. It then spread around the world and caused a recession. Most governments reacted with ambitious stimulus packages that were added to the high debt levels they already had. It has now transformed itself into a sovereign debt and a budgetary crisis in particular in Europe and the United States.
Some countries in Europe like Greece are close to bankruptcy and need to be bailed out. Others such as Italy and Spain are in serious trouble. Some of them are expected to be in recession this year. Many analysts are saying that this may eventually break the European monetary union.
The U. S. for its part has been accumulating huge and unsustainable deficits for several years.
In Canada, on the contrary the situation is under control. We’ve created more jobs since the recession than we lost during the recession. Canada did pretty good in part because we had sound public finances before the crisis and because our stimulus plan was limited and well targeted mostly on needed infrastructure.
We did not lose control of our spending. We did not create unsustainable deficits. And today we are on a clear path to a balanced budget and unless the international economic situation gets worse sustained growth.
Why is it, that Canada finds itself in a relatively favourable economic situation while our partners are still having serious difficulties? Because our partners follow the economic school of thought called Keynesianism. This theory was developed by British economist John Maynard Keynes.
Keynes did not trust private entrepreneurs and the free market very much. He was a strong believer in government intervention. One of Keynes’s central ideas is that when you find yourself in a crisis or a recession the best solution is to increase government spending.
Government spending will sustain overall demand put everyone back to work and kick-start the economy. Even if you already have a big deficit and a high level of accumulated debt it doesn’t matter. You should borrow and spend.
That’s one of the paradoxes proposed by Keynes the solution to too much spending is more spending. The solution to high levels of deficit and debt is more deficit and debt.
Keynesian economists are saying that the reason why the American economy is still not fully recovering from the crisis is that the American government is not spending enough. For them annual budget deficits amounting to 10% of GDP are not enough. They are calling for even larger budget deficits. To give an idea, our budget deficit in Canada, this year, amounts to less than 2% of GDP.
There is something fundamentally wrong with this explanation. The key question you have to ask is this where does the money that governments spend come from? It has to come from somewhere. A government cannot inject resources into the economy unless it has first extracted them from the private sector through taxes or put us further into debt by borrowing the money.
Every time the government takes an additional dollar in taxes out of someone’s pocket that’s a dollar that this person will not be able to spend or invest. Government spending goes up, private spending goes down. There is no net effect no increase in overall demand.
Government borrowing has the same effect. The private lenders who lend money to the government will have less money to spend or invest elsewhere. Or they will have less money to lend to other private business people. Government borrowing and spending goes up private borrowing and spending goes down. There is no net effect no increase in overall demand.
It’s like taking a bucket of water in the deep end of a swimming pool and emptying it in the shallow end. And it’s definitely not working.
Our Keynesian friends in Ottawa the NDP and the Liberals should understand this.
Let’s look briefly at the country that has pursued this type of policy to an extreme degree Japan. Twenty years ago Japan suffered something similar to what the United States experienced recently. There was a speculative bubble in the real estate sector which finally crashed in 1990. Prices collapsed and this affected the whole economy.
The Japanese government embarked on a series of public spending programs to artificially stimulate the economy. They spent trillions of yen. But the Japanese economy stayed stagnant.
In 1990, Japan’s gross public debt was 68% of GDP. Today, Japan’s public debt is the largest in the world at about 225% of GDP. And they have very little to show for it. You don’t get richer by maxing out your credit card. Yet if we are to believe the Keynesians Japan should have been the fastest growing country in the world during the last 20 years. But that was not the case.
Here are two more examples from history that have turned out differently. Ten years before the Great Depression in 1920 and 1921 the U. S. economy experienced a very severe recession. But almost nobody knows about it today because it did not last very long. The economy went down by 17%. Unemployment went from 5% to 12%. The President at the time Warren Harding did not believe that increased government spending was the way to revive the economy. On the contrary he thought government should get out of the way.
What was his solution? He cut the American government’s budget almost by half. It went from 6.3 billion dollars in 1920 the last year of the Wilson administration to 3.3 billion in 1922. He also cut taxes.
According to our Keynesian friends and the opposition party in Ottawa that’s not at all what a government should do to revive the economy. But that’s precisely what happened. By the end of 1921 the economy had rebounded and grew for the rest of the decade. Unemployment went down rapidly to 2.4% in 1922.
What about the Great Depression itself? Many people believe that the President Roosevelt’s New Deal solved the crisis. But that’s not what happened. Despite all the new spending and new programs the depression went on and on. In 1939 Roosevelt’s secretary of the Treasury Henry Morgenthau made a startling admission and I quote: “We have tried spending money. We are spending more than we have ever spent before and it does not work. After eight years of this administration we have just as much unemployment as when we started and an enormous debt to boot!”
It is also often said that the Second World War ended the Depression. That’s not the case either. Unemployment certainly went down because millions of men were drafted. But the situation did not improve for ordinary Americans. Most basic products were rationed during the war.
The Depression actually ended after the war. That’s when government spending was drastically reduced. Government spending went from 92 billion dollars in 1945 to 29 billion dollars in 1948. That’s a reduction of more than two thirds! That’s when the post-war prosperity started. The consumer society as we know it where the average family was able to afford a fridge, a car, and a house started at that time.
Again if we follow Keynesian logic this is not what should have happened. With these spending cuts, government was reducing overall demand. The economy should have crashed. But the economy boomed because the government released resources that became available to the private sector. Government spending always competes with private sector spending for scarce resources. When you divert resources from the more productive uses that they can find in the private sector to less productive uses in the public sector you will not see growth.
To revive the economy we need to let entrepreneurs keep the means to create wealth. We need to create the best conditions possible for the private sector to become more productive.
This means first of all to restrain spending. That’s what our government is going to do with a clear plan to achieve a balanced budget by 2015. In the coming budget our government will announce cuts in government operations of between 5% and 10%. That’s a concrete way to stop competing with the private sector.
We also need to reduce taxes. Since January 1st corporate taxes in Canada stand at 15% the lowest among G7 countries. They were at 22% when we took power six years ago. That’s a concrete way to leave resources in the private sector.
We need more free trade. Our government has also announced free trade agreements with eleven countries. We are still negotiating with several other countries. We hope soon to be able to announce a very important agreement with the European Union. That’s a concrete way to promote free exchange between Canadians and the rest of the world.
Finally, we need less regulation. Unnecessary red tape is a hidden tax on entrepreneurs and weighs heaviest on those least able to bear it: small business owners. Unnecessary red tape stifles economic growth and job creation, reduces productivity and can crush the entrepreneurial spirit of Canadians.
On January 18, I unveiled the Report of the Commission to reduce Red Tape. It contains 105 recommendations to get rid of regulatory irritants and to prevent red tape from growing again. That’s a concrete way to free the private sector.
We know that sustainable growth cannot be achieved with more government spending, more debt and more taxes. That’s the Keynesians theory. That’s what the opposition in Ottawa keeps asking for. Their only solution to everything is more spending, more artificial stimulus, more debt and more taxes. What they don’t realise is that too much stimulus will act as an economic sedative rather than as a stimulant. We cannot spend our way to prosperity.
The Keynesian solution has been tested and has failed. What we need is a conservative approach witch emphasices the primary role of the private sector in creating wealth and sustaining economic growth.
Free markets made Canada a prosperous country. Free markets will also insure a strong recovery.
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