How Ottawa Spends, 1992-1993: The Politics of Competitiveness 9780773591677

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EDITED BY FRANCES ABELE

Carleton University Press Ottawa, Canada 1992

(P

Carleton University Press Inc. 1992

ISBN 0-88629-165-8(paperback) Printed and bound in Canada Carleton Public Policy Series 9 Canadii Cataloguing in Publication Data

The National Library of Canada has catalogued this publication as follows:

Huw Ottawa Spends 19831992-93ed.: The politics of competitiveness Each vol. also has a distinctiw title. Prepared at the School of Public Administration,

Carleton University. Includes bibliographical references.

ISSN 0822-6482 1. Canada-Appropriations and expenditures-Periodicals. I. Carleton University. School of Public Administration.

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Acknowledgements Carleton University Press gratefully achawledges the support extended to its publishing program by the Canada Council and the Ontario Arts Council.

Chapter 1 Chapter 2

Preice The Politics of Competitiveness Fmnces Abele

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Chapter 3

Reconst~ctingFiscal Federalism . Allan M. Maslow

Chapter 4

The Department of Finance and the Bank of Canada: The Fial and Monetary Policy Mix Fanny S. Demers

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Capital PlanningICapital Budgeting: The Future of Canada's Capital Katherine A. Graham

Chapter 6

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Jobs.. .Job.. .Jo.. J.. The Ccmsemtives and the Unemployed Robert M. Campbell

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Chapter 5

vii

79

125

Responding to the Challenges of the Global Economy: The Competitiveness Agenda Michel Demers

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Chapter 7

Chapter 8

Touching Us All: International Context, National Policies, and the Integration of Canadians with Disabilities Michael J. Prince

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191

New Actors, Old Script: Technology and Broadcasting Policy C Leigh Anderson

241

Chapter 9

Staff Relations under the Conservative Government: The Singers Change but the Song Remains the Same Gene Swimmer with Kjerstine Kinaschuk 267

Chapter 10

Chapter 11

Federal AIDS Policy for the 1990s: Is It Too Early for "Mahstreaming" in Canada? Evert A. Lindquist & David M. Rayside

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313

JohnnyGreen-Latelies: The Mulroney Environmental Record G.Bruce Doern

353

Appendices:

Fiscal Facts and Trends Subscribers The Authors

Preface The purpose of the How Ottuwa S p e d series is to promote informed consideration of-and debate about-federal government policies and practices. This thirteenth edition considers general and specificresponses of the Progressive Conservative government to Canada's economic difficulties, and to the deep challenges of our economic future. Appropriately, the contributors have achieved informed consideration of these matters, but by no means consensus. The School of Public Administration at Carleton University produces How Ottawa Spends. Many people's efforts have contributed to this edition. All of the authors worked under impossible time constraints, with integrity and good cheer. On behalf of the authors, I would like to thank the traditionally anonymous government officials and staff of non-governmental organizations, who have given generously of their time and their knowledge. Special thanks are due Caroline Andrew, Leigh Anderson, Laurie Beachell, Manfred Bienefeld, Guy Bujold, Richard Buninsky, Ehsan Choudhri, William Coleman, Henry Enns, Katherine Graham, Michael Hicks, Vaughan Lyon, Allan Maslove, Chris Maule, Henry Milner, Herb O'Hemn, Les Pal, Susan Phillips, Ian Sadinsky, Lawrence Schembri, Murray Smith, Wayne Stryde, Donald Swartz, Gene Swimmer, John Taylor, Brian Wharf, and Stan Winer, who provided comments, criticism and advice to authors and to the editor. Research assistants Carolyn Chisholm, Peter Chaves, and Terry Milne worked effectively and creatively through times of trouble and ease. Terry Milne, under the direction of Allan Maslove, also produced the appendix, Fiscal Facts and nerds. Martha Clark, the School's superb Administrator and in-house bilingual copy editor, managed the production. Iris Taylor industriously converted a set of variable manuscripts into a pleasing and accurate text. Carleton University PreSs staff, Michael Gnarowski and Steven Uriarte; copy editor Shelley Henderson; desktop publisher Judy Melanson; and translators Sinclair Robinson and Nandini Sarrna extended superb professional support. For more personal support and intellectual companionship, I thank my husband and friend, George Kinloch. Frances Abele Ottawa

April 1992

The opinions expressed by the contributors to this volume am the personal views of the authors of the individual chapters, and do not reflect the views of the editor or the School of Public Administrationof Carleton University.

THE POLITICS OF C

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Frances Abele R&umC : S'il n'y a jamais eu d'wque oh les Canadiens ont pu ignorer les vicissitudes de ISBconomiepolitique mondiale, win ob ils ont pu se scntir en s&urit&panni le-a pays exportateurn dc p d u i t s manufactutes, il n'en reste pas moins que I'on peut soutenir quc l'dpoque 8ctueUe a vu l'influencc des tbrces internationales Bur I'hlution des politiques interieures atteindre un nivtau sans pdddent. Dans ce chapitre, nous nous penchons sur &ins uccmples @cis en puisant dans tous les autres chapities et en nous concentrant sur le t h h e dc am@tivitd mondiile.~Ce dcrnier concept--d&i d'habitude camme le besoin qu'a le Canada de devenir plus cornp6titif-a ett a s s a ma1analyst5 I1 s a t quand meme de plus en plus de pivot B la plitique bnomique, socialc ou meme constitutionnelle de8 Consemtern. I1 va sans dire que Ie contexte internationale sans cesse changeante et les tendances mondiales affectant I s ~ n o m i c canadienne dcemitent de toute urgencc une snalyse soignee d c&ivt. A cdte fin, le dossier des Conservateurs s ' d r e indgal, contradictoire et pdenticllernent vouG B 1'6chec. cumme le montre le budget de 1992, par exemple.

Abshck Although there has never been a period when Canadians could ignore the vicissitudes of the world political economy--or even count upon finding a secure place among the world's manufacturing e3tpoxtcrs--the present period is arguably one in which international brces shape the domestic policy agenda to an unprecedented degree. This chapter explores some specific ways in which this is occurring, drawing upon all of the other chapters and fbcusing on the theme of 'global competitivene8s." The concept of global competitiveness-usually expressed as the need b r Canada to become mom competitive-has been rather poorly analyscd. Yd, it has been increasingly the Wcrum of Progressive Conservative economic, social, or cven constitutional policy. There is no quation that the changing international circumstances and global trends affecting the Canadian economy urgently q u i r e a caefbl and creative analysis. In this purpose, the Tories* record is uneven, contradictory, and potentially selfdefmting, as illustrated in the 1992 budget.

Since the embattled long march to the 1989 Canada-United States Free Tride Agreement, the need for Canada to become more "competitive" has been a prominent article of faith in Progressive Conservative economic policy.1 The pressure to enhance competitivenesshas also strongly influenced social policy. Various domestic policy initiatives, for example concerning labour force training, the reduction of the deficit, and drastic measures to

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reduce the rate of inflation, have all been identified as measures to improve Canada's competitiveness. The imperative to become more competitive wen affected major parts of the government's post-Meech Lake constitutional proposals, such as the provisions that would create a more integrated domestic market and others that would redefine the mandate of the Bank of ~anada.?Most recently, muscular injunctions to 'compete to win" apparently formed the major thinking behind the 1992 federal budget. Yet the Government has nowhere elaborated the meaning of, or the case for, enhanced competitiveness. Canada's economy, labour force, and educational system have been unfavourably compared with those of other nations, but there has been scant examination of the sources of the identified problem. Certainly the Government has offered no anulysis of the historical context of Canadian economic performance that points clearly towards any particular program, strategic targets, or wen a list of likely-tosucceed competitive niches. While it seems clear that a new world economic order is emerging along with the new political order, there is little scholarly or other consensus about what the nature ofthe new order will be. Nor is it obvious which trends will affect Canada most powerfully, or, least of all, what the appropriate federal response should be.3 What analysis underlies the federal reliance upon competitiveness within a (slowly fonning) North American or hemispheric trading bloc? What are the other options? Does competitiveness imply becoming 'leaner," 'smarter," more 'targeted," or more integrated? Most importantly, will enhanced competitiveness relieve growing poverty, ameliorate the disparities in the regional distribution of costs and benefits in Canada, or maintain the present standard of living for all Canadians? Very little research or even sustained analysis has been published by the federal government to indicate that carehl thought lies behind the current measures advanced in the name of competitiveness, though there is no shortage of documents and speeches exhorting Canadian business and labour towards this goal. The elimination of the Economic Council of Canada and the

me Politics of Competitiveness/ 3 Science Council of Canada-bodies h m which such sustained critical analysis axid evaluation of current policy measures might be expected to emerge-will only make matters worse. The major federal initiative meant to fill the analytical vacuum is the $18 million Prosperity Initiative, which has produced no research to complement public consultations now under way. The authors in this year's edition of Haw O # m Spends were all asked to consider the extent to which external influences affected or shaped the particular domestic policy field they were each examining. Several chose to consider directly the federal response to global economic changes. Their analyses differ in many respects, but m e r g e on some important matters. In this introductory chapter, I will introduce the 10 chapters that follow with some general observations about apparent trends in global affairs. After a review of the contents of each chapter, there is a discussion of some useful common themes, then a discussion of the 1992 federal budget. This leads, finally, to comments conceming the sources of Canadian economic policy and fuave prospects.

CAN WE ALL BE MORE COMPETITIVE? [The] crisis is widely understood and has been fbr at least 10 years. Its labels-post-iudustrial, post-modern-are fitmiliar enough, and so are the process they represent: the decline in manuficturing, the growth in services, the rise in unemployment, the changes in the global division of labour, the phenomenon of "jobless" growth and the retreat of the welhre state....

Somehow this understanding hasn't been brought into any day*-day contact with politics in Western countries, which go on as if national economic sovereignty, something like fill employment, and a generous welhxe state were still norms, soon to be restored. It is just a question of being more competitive, of getting back jobs other countries have taken, or bringing the market into w e l h provision.. 4

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British journalist Martin Woollacott made these remarks in passing, as he developed an analysis of the sources of racist and xenophobic election campaigning in France, the US, Great Britain, Italy, and Germany during the uncomfortable spring of 1992. Canada is not on Woollacott's list, nor is it likely that "foreigner bashing" will be a prominent feature in the next year's federal election.' It is obvious, though, that Canadians confront the same dimensions of economic restructuring and the same dilemmas in economic and social welfare as do the other relatively well-to-do industrial societies. Each nation fBces a similar range of horrible effects and possible opportunities.6 The elements of the changing international situation go beyond the symptoms listed by Woollacott, but it is probably true that the most arresting new elements are: 1) eroded national sovereignty, especially with respect to states' capacity to regulate; 2) permanently high levels of unemployment, through both booms and busts; 3) enormous, long-term pressures on the welfare state and the package of social safety net measures introduced in all but the poorest countries since the Second World War; 4) in many relatively wealthy countries, the growth of a permanently poor underclass, often of a different ethnic composition than the general population (examples include Blacks and Hispanics in the United States, and Arabs in France). These changes have prompted a general revulsion against the neoconservative enthusiasms of the 19809: what remains is some consensus that the roles of public power and of markets must be rethoughtO7With the disintegration of the Soviet Union and the Warsaw Pact, strategic and military policy is in disarray in most nations. Soviet aid has been withdrawn from the Third World even while the new nation-states of the h e r Warsaw Pact are claiming a considerable portion of capital assistance from Western donors that was once available to non-Communist developing countries. With a few exceptions in the newly industrialized countries of Southeast Asia, the nations of the Third World continue in extremely difficult economic circumstances. It appears that nations are formingsemi-permeable trading blocs that exclude the poor countries and that will have an as yet indeterminate political salience. The current recession

7he Politics of Competitiveness/ 5

deepens and spreads everywhere, creating a mirror image of the widening global gap between rich and poor within the world's richest natiom8 At the same time, certain environmental problems appear to be reaching the crisis point. All nations now navigate perilous and unknown waters, though the hardship is not evenly experienced. The circumstances just described point towards a new economic order, in which the extreme vulnerability of societies to international pressures and threats of all kinds is striking. What is not new is Canada's extremely exposed position. Confederation itself was the result of another period of major global restructuring, also trade led. Always small and open, the Canadian economy was shaped by economic interests emanating from first one imperial power (Great Britain) and then from another (the United States). Canadian politics thus have been distinctively those of a small polity whose citizens lived amidst abundant natural resources mainly by selling what they could in order to sustain a comfortable and peaceful life.' For most Canadians, most of the time, this has meant a willingness to use state power to intervene in markets; commitment to the development of a social welfare system that attenuates the worst eficts of poverty; and constitutional provisions that acknowledge the salience of collectivities as well as individuals. Although there has never been a period when Canadians could ignore the vicissitudes of the world political . economy--or even count upon fmding a secure place among the world's exporting manufitcturers-the present period is arguably one in which international forces impinge upon the domestic policy agenda to an unprecedented degree, not least because of the pressure on national state structures being felt everywhere.

THE TORIES' RECORD All of the authors in this volume were asked to consider the extent to which external forces shaped a particular policy field, or to draw comparisons between the response in Canada to particular challenges, and the responses of other governments. They write from many different academic perspectives and have sometimes

6 /How Ottawa Spends

defined little common ground. That is appropriate, given the prevailing uncertainties and the many open questions about the empirical circumstances to which states must now respond. For a similar reason, neither federal policy-makers nor the federal cabinet should be criticized too heavily for the current disarray in the economic policy field. A particularly difficult feature of the present period has been the persistence of painfully high levels of unemployment and all the personal and social disruption that this condition entails. Three chapters consider the sources of this problem and ponder various remedies. O

Robert Campbell compares the Tories' efforts to develop a consultative and institutional response to the recession and continued high unemployment to governmental responses in healthier, "low unemploymentn economies. He finds that the Labour Force Development Strategy, the Canadian Labour Force Development Board, a d the Prosperity Initiative will be seriously constrained by lack of institutionalized commitments from the neceaary stakeholders, limited fimding, and the isolation of these enterprises h m the Conservatives' mscroeconomic policies.

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b y Demm examines the institutions and direction of h a 1and monetary policies, tbcusing on the sources and implications of high debt-to-gms domestic product ratios. She finds that policy choices made in the 1970s and 1980s dictate Ottawa's current policy of "fiscal prudencen-the pursuit of lower deficits, and l m r and stable rates of inflation. Gwemmeut spending controls and care h r a credible monetary policy by an independent Bank of Canada are therefbfe essential, though they may not be sufficient, particularly if the constitutional crisis is not sati&ctorily resolved. Using a very wide-fixus lens, Michel Demers addresses Canada's place in an emerging new world order that he finds is characterized by an unprecedented level of intenrational interdependence. He argues that Canada must seek improved productivity in certain sectors (natural resources and specialized "nichen products); gain access to larger international markets; strengthen the economic union; and improve levels of labour hrce training and innovation.

7be Politics of Competitiveness/ 7 W o other chapters examine the federal response in two policy fields that intimately affect the social and economic well-being of people with particular needs. People in this position are most vulnerable in "competitive" times.

* Federal policies Tor disabled Canadians are examined by Michael Prince. Arguing that Canads has long played an important and progressive role in promoting policies to aid disabled people internationally, he finds also that domestic policy in this a m has been paurefilly influenced by deve1opments abroad, particularly in the United States. In light of their other domestic initiatives, the Progressive Conservatives' policies on disability incorporate welcome &rms and modestly increased expenditures, though these latter may be undercut by broader based program restraint, h r example, in the Canada Assistance Plan.

" Evert Liidquist and David Rayside evaluate Ottewas responses to AIDS during the 1980s. They are critical of politicians' reluctance to address the "sensitive" issues associated with this disease and bureaucrats' failure to see beyond the medical model to develop an effective response to the disease that maximid the benefits fiom available community resources. There was some institutional learning, huwever, that ultimately produced the National Aids Strategy. While finding much to criticin, they see a "silver lining on the AIDS cloud" which "bas pushed officials and activists to find new ways to deliver health care and to work with individuals and communities burdened by disease. "

Prince, and Lindquist and Rayside fmd a complex reciprocal relationship between the policy process in Canada and events abroad, and all note the need fir creative responses in a time of growing need and shrinking resources. A similar questioning appears in the chapters by Allan Maslove and Leigh Anderson, each urging reconsideration of principles once taken for granted in past Canadian pol icy.

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Maslove opens a cunstructive discussion of the specific dimensions of universality in Canadian social policy. He probes the widely acknwledged hilure of federal-provincial arrangements fbr fimding health care and education (through Established Programs Financing). Without urging abandonment of public commitment to

8 /How Ottawa Spends programs that make health care and education available to all, he argues fw a reconsideration of the view that the fkderal government shouldplay a leading role in maintaining national standardsin health care and only a limited role in post-secondary education. Finding cause for a stronger fkderal presence in funding education, Maslwe sees the need for a new approach incorporating clear, shared objectiva; separate fiunding regimes for health care srPd education; public awarenessof Meral spending; and greater financial security fir the provinces, which are the direct spenders in these areas. O

New te!chnologies in broadcasting, Leigh Anderson argues, create the need for a re-evaluation of regulatory instruments previously used to protect and promote Canadian cultural development. She sees a continued role fir Canadian broadcasting but supports abandonment of Canadian content regulations. These should be replaced with market-based techniques that exploit the new opportunities that are created by technological change for production of various and higher quality programs. Anderson suggests that .regulators should shift from a defensive to a promotional posture.

Anderson and Maslove both seek new policy instruments to respond to new economic and technological times. In considering

three other, very different policy areas, Bruce Doern, Katherine Graham, and Gene Swimmer complement this wide reconsideration of state capacity. O

Bruce Duern reviews the Progressive Conservative record m environmental policy, fiom the bad start made in 1984 to the emergence, in the early 19905, of the muchdelayed and fiscally strapped-but still quite ambitious--Green Plan. Doem considers the potential of the Plan to succeed, as an approach to environmenta1 problems and as a nation-building project. He finds its usehhess fbr emirmental protection hampered by the Tories' puzzling fkilure to make use of markets and market instruments in the Plan, while serious engagement with environmental problems might well be divisive rather than unifying.

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Katherine Graham explores the role and image of Ottawa as a capital among other capital cities of the world. Under the Tories, the National Capital Commission's budget has been slashed, while

The Politics of Competitiveness/ 9 effbrts tawards decentralization have led to the transfer of jobs and offices elsewhere. Further, Graham notes that no considerationhas been given to the future form and guwemance of the national capital, either in light of the great changes under way in the w r l d or to prepare br any of Canada's possible constitutional futures. She urges that there be some brave and imaginative attention given to the symbolic and other roles of the capital in the new national and global circumstances. O

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TheProgressiveConsemtives' mixed record on public service staff relations is assessed by Gene Swimmer. Swimmer argues that, although public sector wages did not cause the deficit and the mtraint of wages would not solve the deficit problem, h r political reasons the Tories attempted a strategy of "public servant bashing" that largely hiled. The dically negative e&t on public sewice morale and efficiency caused by this political strategy wershadm some positive measures These include Public Service 2000, a negotiated workforce adjustment policy, master agreement bargaining, and more equitable pmcedurts h r designating essential employees (those who do not have the right to strike). In a better climate of staff relations, all these measures might have enabled the kind of institutional developmentnecessary to respond to changing domestic and international challenges.

C O M M O N THEMES,C O M M O N SOLUTIONS? Although the authors of the chapters just reviewed do not share a common political philosophy, academic discipline, or set of prescriptions, their analyses do yield some provocative and promising common themes. First, many authors found it necessary to examine specific institutional arrangements, both as causes of a current problem and as potential solutions. Lindquist and Rayside, Prince, Fanny Demers, Campbell, and Doern were all impressed by the reciprocal impact of state and society and by the importance of institutions fot shaping the state-society relationship in the policy fields they sought to understand. The willingness of all the authors to abandon old policy implementation methods in favour of new instrumentalities is striking. For example, Doern argues that the

I0 /How mawa Spends use of market-based techniques would strengthen the implementation of environmental protection measures, finding it unusual indeed that the 'Ibries, among all other governing parties, would overlook the appropriateness of these techniques. Faced with ineffective policy instruments, Anderson and Maslove seek to achieve the old Canadian goals of equal access to health care and education, and promotion of Canadian cultural industries through new means, appropriateto new times. None accepts, however, that simple application of "market discipline" or market principles will be sufficient to achieve public policy goals. Second, most authors recognize the 'spoiler" effect of the Progressive Conservatives' commitment to deficit reduction. This commitment (and, of course, fear of the rising Reform Party on the Tories' right flank) led to the shattering deterioration in staff relations that prompted the long public service strike and plummeting public service morale. Spending cuts in honour of the deficit mitigate many otherwise promising policy initiatives, in, for example, policy related to disabled persons. Perhaps most fhr-reaching of all are the dampening effects of spending cuts upon all initiatives to reshape the Canadian economy in response to the dramatic changes in the global economy in recent years. If "competitiveness" is defined as an economy composed of well trained, flexible, and retooled workers, successive cuts to the programs that would promote such a development are alarming indeed. Finally, considered together in all their diversity, the chapters in this wlume do indicate how complex, difficult, and as yet ineluctable are many of the issues involved in understanding Canada's current economic circumstances. They suggest that more scholarly research is urgently needed, and that much more public debate should occur concerning various specific policy questions. The way forward is simply much more obscure than the simple nostrums of prime ministerial speeches, finance ministers' illustrative statistics, and the undefended assertions in the few government documents that address economic matters.

Ihe Politics of Competitiveness/ 11 The government perspective is presented in overview in Rwsperity lltmugh Compedtiwness (PIC), a consultation paper

produced as part of the Prosperity Initiative. This document sounds all the familiar themes of economic measures that have been announced and those that have been implemented. The consultation paper cwers: the need to adjust to new times; the importance of education and training in this process; the importance of science and especially technology in supporting the adjustment process; the importance of sustaining a good climate for investment; the need to establish an attractive (profitable) domestic market; and the need for cooperation among business, labour, and other groups. What is lacking is supporting analysis. What are the specific reasons for pressing fbrward in these areas? How are they linked, in practice? Who is responsible for concrete action? And most importantly, in view of the scarcity of resources, is there a realistic priority among measures that has a chance of producing results, in the form of economic recovery and lower rates of unemployment? A defender of the document might observe, with justification, that answering these questions is too much to ask of a consultation paper, and that supplying "answers" would preclude effective consultation. In hct, very little that has been produced by Cabinet, including budget statements, is more specific than the analysis in PIC. Various budgets and speeches contain piecemeal explanations-such as those cited in the discussion of the 1992 budget below-but there is no indication of any consideration of concatenating impacts and longer term trends. On the contrary, as several chapters in this volume suggest, the imperative to deficit reduction appears to undercut other measures identified as necessary by the Government, such as labour force retraining and policies for special needs groups, such as people with disabilities.

THE 1992 BUDGET Canadians want realistic, lasting solutions to our economic

problems, not quick fixes that lead to long-term breakdowns or further burdens br the taxpayer. They are ready to w r k together to help Canada compete and win in a tough, uncertain

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Spends

economic world. They know that when Canada wins, Canadians win. lo

Since the 1989-90 conclusion of the Canada-US free trade debates, at least, deficit and debt reduction have been linked explicitly to 'concern in the international community about the competitiveness of Canada aud its attraction as a+placeto invest,"" and counter-cyclical measures have been obviated by determined expenditure control. Minister of Finance Don Mazankowski's first budget was consistent with this trend, leading once again with a commitment to 'substantially reduce the deficit" (by about $4 billion, to $27.5 billion in 19~-93).12The Expenditure Control Plan introduced in the 1990 budget, and extended in 1991, was further elaborated in 1992. The goal of the Plan is to cut federal government spending (exclusive of major transkrs to the provinces) by $1 billion in 1992-93 and by $7 billion over five years. This will be achieved by a number of measures, including:l3 O

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a $2.2 billion reduction in debnce spending;

a reduction in the non-wage opemting budgets of departments by 3 per cent (expected to generate $150 million in savings);

elimination of first-class travel for members of Parliament, senators, and sehior public servants,and reduction in international tmel (no estimate of potential savings provided); a cap on the gmwth in spending on social housing, at 3 per cent; various expenditure restrictions expected to generate $70 million in savings; a cut of $100 million from the Canadian Jobs Strategy; and savings of $75 million in reductions to departmental communications budgets.

The cuts to departmental communicationsbudgets will make it more difficult for departments to communicate directly with

me Politics of Competitiveness/ 13 citizens, and ultimately hamper citizens' efforts to learn of govemment initiatives. The communications budget cuts also reinforce another measure taken in this year's budget. h a startling action announced under the rubric of "[s]treamlining government and improving service," 46 government agencies were eliminated, deferred, privatized, or merged with other entities, including such successful and important agencies as the Economic Council of Canada and the Law Refbnn Commission. 'bken together, these steps suggest a government drawing in upon itself, or at least gathering the powers to inform and to persuade more tightly towards the political centre (the Prime Minister's Office), the better to start the pre-election campaign. There are a number of provisions in the 1992 budget that move beyond simple expenditure constraint. All are billed as measures that will sustain economic recovery in the medium term. All are also clearly intended to puff up consumer and investor confidence, which has been sorely deflated by the recession, the failed recovery, and several yean of government spending restraint. The moderately counter-cyclical-or in some cases merely symbolically counter-cyclica114-measures included reductions to the personal income tax surtax, modification of the regulations governing registered retirement savings plans to allow them to be used for purchasing homes, corporate tax reductions in manufacturing and processing, reductions in the withholding tax rate on direct dividends, tax incentives fbr research and development, "targeting" of the lifetime capital gains exemption away from real estate investments, and various small-scale measures to promote small businesses and venture capital formation. There were, in addition, some proposed and some actual changes to child benefits, replacing the (still nominally universal) Fdmily allowance with an earned income supplement and increasing the dependent child tax credit.

Comments on the Budget The oft-repeated political commitment to assist in the process of economic restructuring so that Canada may be positioned to

14 /How Ottawa Spends

succeed in the new world economic order appears not to impinge upon the overriding desire to reduce the deficit. Instead, these pillars of economic recovery are invoked: O u r economy is poised fbr a sustained recovery on its own fhdamental merib; a reowery that draws on the strength of a dramatic impmment in interest rates, inflation and production costs. Inflation has come down dramatically over the past year. It is nclw running at an annualid rate of less than 2 per cent, its 1 m t level since the early 1970s.. Wage settlements also shaw how inflationary p~ssureshave eased. For the last quarter of 1991, public sector settlements averaged 2.4 per cent, d m from an average of 6.4 per cent in the first quarter of last year. Private sector settlements have Mlen to 3.3 per cent.... Interest rates have dropped sharply, down by about seven percentage points since the spring of 1990.''

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This is a particularly fascinating passage in the budget speech, for it follows very closely conclusions reached by representatives of the International Monetary Fund (IMF)in their February 1991 evaluation of the health of the Canadian economy.l6 The IMF shares Cabinet's lack of interest in a positive labour force policy, or any other measures that might shape the economic recovery towards full employment or high value addedlhigh wage national economic strategies. Such measures, among many others, were being explored by the Economic Council of Canada, one of the 46 government agencies axed in this Budget. The question is raised concerning the extent to which Canadian economic policy is actually being made for an audience of international lenders of capital, rather than for and on behalf of the people of Canada. A further question is, who benefitfl The continued emphasis on expenditure control in this federal budget was otrset, somewhat, by some mildly countercyclical provisions. Overall, however, this was a budget that continued the Progressive Conservatives' emphasis on federal expenditure restraint while attempting to exhort and otherwise encourage a private sector driven recovery. Even so, savings for

Ihe Politics of Competitiveness/ I S 1992-93 are estimated to be $1.05 billion, less than half the swings projected in last year's budget ($2.3 1 billion) tor the same period. In addition, expenditures saved as a result of the Expenditure Control Plan are now expected to be less than half what was projecv, in the 1991 budget, at $7.29 billion rather than $14.82 billion. Some of the agency victims of "strearnliniig" no doubt needed to go. Activities at the Veterans Land Adminiitration, for example, have no doubt been winding down as the veterans who took advantage of the loans offered through this agency have aged and died. Similarly, the change in the administrativestatus of the International Development Research Centre, to that of departmental corporation, is probably appropriate. On the other hand, the outright elimination of some other arm's length agencies amounted to destruction of valuable intellectual capacity and capital. Both the Economic Council of Canada and the Science Council embody the reflective, research and analytical capacity of the federal government. Somewhat more specialized, but equally respected and influential analysis was generated by the Law Refonn Commission and the Canadian Institute for International Peace and Security. Together these bur agencies cost a total of $24.3 million. This is a tiny proportion of federal spending, especially when it is taken into account that each agency "leveraged" its impact by contracting with (otherwise maintained) academics and independent researchers to prepare policy-relevant studies. It is interesting to ask why Cabinet would eliminate such cost-effective sources of policy advice at a time when the need for informed policy analysis was never greater? Certainly, the policy analysis agencies were not redundant. The nature of the public service, especially after more than a decade of restraint, is such that this sort of policy advice will rarely be available from within departments: resources are stretched too thin, and analysts are too close to the everyday fires that must be fought. Some observers have argued that eliminating "think-tanks" is an easy gesture towards potential Reform Party supporters among the Tory fold, who are unimpressed by government-supported research bodies

16 /How Ottawa Spends

and always pleased to see the size of the state reduced. Others note that Cabinet's political life is easier when there is less informed criticism and commentary. It is also possible that the leading lights of Tory cabinet have become so obsessed with their gloomy political prospects and unpopularity that they have no interest at all in the process of policy development and analysis, especially should analyses point towards difficult or ideologically distasteful measures. More positively, the Tories may have placed genuine faith in the public consultations organized under the Prosperity Initiative to generate well-considered alternatives,'* or in the capacity and motivation of private sector research institutions to carry out comparable research. Although public consultation is valuable, and although the interventions of interest groups are more useful if they are supported by good research, neither of these sources of information is a substitute for publicly funded independent research. Public consultation often produces abstract, "motherhood" statements-since opposed interests must typically be accommodated. lg Privately funded research legitimately pursues private objectives, with no brief to represent all classes and interests in society fairly. Whatever the real reason or reasons for Cabinet's puzzling choice to abandon the resources embodied in the arm's length agencies, it is true that none of the economic improvement measures proposed in the various chapters of this volume will be as easy to explore, elaborate, or evaluate in the absence of such crucial sites of federal policy advice. As if to underline Cabinet's lack of interest in any sort of positive labour market strategy or even in relief for structurally unemployed workers, the Canadian Jobs Strategy was again used as a source of demonstrable economies in government spending.20

PARTING WORDS This edition of How O t t m Spends evaluates the Progressive Conservatives' performance in the area of economic policy,

The Politics of Competitiveness / 17

broadly defined to include taxation and social spending as well as more narrowly conceived economic measures such as fiscal policy. This kcus has led necessarily to a less-than-balanced evaluation of the overall mandate. Last year's edition discussed the important process of public constitution-building that has occupied Canadians over many months. The differing foci of this edition and last year's edition of How O m a Spends are deliberate, since not all important topics can be covered with equal care each year. Yet it is necessary to note in passing the remarkable and positive developments on the constitutional front during 1992. The federal government recovered from the Meech Lake Accord debacle, finally, in the elaboration of a many-sided process for focused and structured public discussion of concrete constitutional proposals, presented in clear but detailed language. As this book goes to press, the outcome of the long public encounter with constitution-building is uncertain, but two things seem clear. First, hwing had their say and a solid national discussion, many Canadians seem prepared to withdraw from the field. As a result of the now better informed provincial premiers and Weral politicians, public consultations will proceed with publicly acceptable elite accommodation to reach a settlement. Second, early fruit of the public participation process has been the nearly unanimous support for entrenchment of the inherent right to Aboriginal self-government in the Constitution. This measure alone may well be sufficient to maintain the support of Aboriginal peoples for a new constitutional deal and represents one solid side of the felicitous constitutional triangle necessary for peace. It remains for the other two sides (the West, seeking Senate Reform, and Quebec, with a list of minimum powers) to be added. Of course there is a potential danger in the current federal emphasis on process rather than substance. Log-rolling among provincial interests seems to be particularly well-advanced. The stronger provinces and interests seek various measures almost cemin to weaken the federal power, whatever else they may achieve. Federal strategists will acutely feel the need to reach "a

I8 /How Ottawa Spends

deal" after so much negotiation and consultation in the preelection period. The result may be a Rube Goldberg-equeconstitutional arrangement that satisfies everyone mildly in the short term, but that cannot withstand, in the medium term, the pressures of the international environment. Beyond consensus, there must be the capacity to implement the com etitiveness program, or to develop and activate another strategy.8 A major theme of this edition of Hnu O # m Spends is that it is essential at this moment in world history to lift our analytical gaze from the immediate miseries of the continued recession, the anxiety about the economic fuhlre engendered in the deindustrializing areas of south-central Canada, the oil-bust in formerly prosperous Alberta, and the hardships in other prairie economies and Atlantic Canada. 'Ihe minutiae of federal budget construction and the intricate constitutional negotiations now nearing completion are intimately affected by global trends. No one knows whether the world will actually form rival trading blocs, what will happen to the Third World and thus to north-south relations should this happen, and least of all whether an emphasis on enhanced competitiveness and attentiveness to the economic advice of the International Monetary Fund will show the way. As all of the authors in this book illustrate, now is the time for searching questions and thoughtful debate.

NOTES My colleagues Katherine Graham, Susan Phillips and Gene Swimmer immeasurably i m p d this chapter with incisive and level-headed comments. Carolyn Chisholm and Terry Milne responded to challenging feseanh taskswith intelligence, alacrity, and accuracy. Naturally, none should be blamed fbr this analysis or for any remaining errors. 1

A very comprehensive study of the free trade debates and com-

peting analyses is Bruce Doem and Brian Tomlin, Faith and Feat.= Ihe Free M e Story (Wonto: Stoddart, 1991). For a general critique of the extent to which the "competitivenessn argument has shaped even labour-oriented and leftist analysis, see Sam

me Politics of Competitiveness/ 19 Gindin, "Putting the Con Back in the Economy," 7his Magazine, vol. 25, no. 8, (May 1992). 2

Canada, Constitutional ProposaLr, Part III (Ottaw: Minister of Supply and Services Canada, 1991) and Canada, the Report of the Special Joint Committee of the Senate and the House of Commons, Joint Chair: Gerald Beaudoin and Dorothy Dobbie. A Renewed Canada, February 28, 1992.

3

One of the earliest attempts to come to term with what the new times might mean h r Canada was David Wolfe, "The Rise and Demise of the Keynesian Era in Canada: Economic Policy, 19301982," in Michael S. Cross and Gregory S. Kealey, Modern Canada 1930-1980s (Toronto: McClelland and Stewart, 1984). Later studies have elaborated the concepts b r comprehending the current global changes developed by the French "regulation school." A leading figure in this project has been Rianne Mahon, whose chapter "Post-Fordism: Some Issues for Labour" appears in a collection with many interesting approaches to simlar questions: see Daniel Drache and Meric S. Gertler, (eds.), Ihe hrew Era of Global Competition: State Policy and Market Power (Montreal and Kingston: McGill-Queen's University Press, 1991). Contrary views are hund in Michael Porter, Canada at the Crvssmadr: the Reality of a NAV Competitive Envimnment (Business Council on National Issues, and Ottawa: Minister of Supply and Services Canada, 1992); Manfred Bienekld, "A Trade Strategy for a Social Democratic Canada," in Simon Rosenblum and Peter Findlay, (eds.), Debating Canada's Futum: Views j b r n the Left (Toronto: James Lorimer and Company, 1991); and Michael Trebilcock, The Political Economy of Economic Adjustment (Toronto: University of Toronto Press, 1986). For the federal government analysis, see Notes for a Speech by Prime Minister Brian Mulroney to the Empire and Canadian Clubs, Toronto, Ontario, October 25, 1991; Canada, Ihe Prosperity Initiatiw: A S m ' y , Pamphlet (Ottawa: Minister of Supply and Services Canada, 1991); Canada, Prosperity Secretariat, Learning Wll Living Wll, Consultation Paper (Ottawa: Minister of Supply and ServicesCanada, 1991); Canada, Prosperity Secretariat, Prosperity Thmugh Competitiveness,

...

20 /How Ottawa Spends Consultation Paper (Ottawa: Minister of Supply and Services Canada, 1991). 4

Martin Woollacott, "Bashing fmigners mn't work," G ~ a r d i ~ Wekly [London], March 22, 1992, p. 7.

5

Daiva Stasiulis, "Symbolic Representation and the Numbers Game: Tory Policies an 'Race' and Visible Minorities, " in Frances Abele, (ed.), Haw Ottawa Spendc lhe hlitim of Ragmentation 1991-92 (Ottawa: Carleton University Press, 1991). Stasiulis praises the federal Tories h r not pandering to racist sentiments to imp- their popularity against the Rehrm Party, a position that has held despite continued low gwemment approval ratings in the polls and the evident spread of Refbrm support across the country.

6

The situation is of course much worse in many parts of the developing wwld, particularly in sub-Saharan Africa. For example, while actual gross domestic product per capita rose by 19-24 per cent in South Asia, East Asia, and the Pacific during 1982 to 1989, it fell by 44 per cent in sub-Saharan Afiica and by 8 per cent in Latin America and the Caribbean. The Wbrld Bank, WrU 32rbZe.s 1991(Baltimore: Johns Hopkins University Press, 1991). The grrrwth in world economic activity wasjust 1 per cent in 1991, the lwest level since 1982. There was 1.5 per cent gnrwth in the industrial nations in 1991 compared with an overall 0.5 1 per cent decline in the developing world. International Monetary Fund, Wrld Economic Outlook, (October 1991).

-

7

"The practical politics of the h r e are less likely to xekr to Theodor Bayek and Milton Friedman than to scholars who seek to m r k Keynesian analysis in light of the new conditions of the 1990s." (I w e this insight to my colleague Katherine Graham.)

8

For a pclwerful analysis of the elaboration of this phenomenon in just one American city, see Mike Davis, "Los Angeles: Civil Liberties betwen the Hammer and the Rock," N m L@ Rdew 170, (August 1988).

9

Among the varying interpretations of Canadian economic history that have developed this theme, see Harold Innis, Essays in Canadian Economic History (Toronto: University of Tomnto Press, 1956); W.T. Easterbrook and Hugh Aitken, Canadian Economic History (Toronto: Macmillan, 1%3); Glen Williams,

me Politics of Competitiveness/ 21 Notfir Expot.. k r da Political Economy of Canada 's A mfed Industrialitation, 2d ed. (Toronto: McClelland and Stewart, 1986); Daniel Drache and Meric S. Gertler, op. cit. Don Mazankowski, Ihe Budget, February 25, 1992, (Ottawa: Department of Finance, 1992), pp. 1-2. Katherine Graham, "Tracking the Second Agenda: Once More W~thFeeling?" in Katherine Graham, (ed.), How Ottawa S'pendr 19W-91: %eking the SecondAgenda (Ottawa: Carleton University Press, 1990), p. 7. Don M d o w s k i , 171e Budget, February 25, 1992, p. 2.

Ibid., p. 25. Some early analyses suggest that the tax breaks and other measures will be more symbolic than real in assisting especially poor Canadians. See, for example, National Union of Provincial Gwemment Employees, me 1992Fe&ml Budget: Lies I Told My Mother, March 1992. Don Maaukowski, Ihe Budget, February 25, 1992, pp. 7-8. Format of quotation changed by author. The summary of the XMF condtation on Canada was obtained by Eric Beauchesne of Southam News, through an access to information quest. Treasury Board of Canada, 1992-93 Main l3timates: Highlights by Minkq, February 27,1992, (Ottmm Minister of Supply and Services Canada, 1992), pp. 12 and 13, and n b l e 2.4. Launched with considexable hfiue, the Prosperity Initiative has consisted to date in the publication of hw discussion papers (see note 3 above), one substantial but not new and the other, on qmpetitiveness, rather slight; a series of meetings of a highprofile national advisory council; a d some very low-profile community meetings. See Michel Demers, "Responding to the Challenges of the Global Economy: The Competitiveness Agenda," and Robert Campbell, "Jobs.. Job. ..Jo J... The Conservatives and the Unemployed," in this volume. Clearly, wide public

.

...

22 /How Onmva Spends consultation is desimble and often essential in a democracy, but it is rarely a substitute for sustained research. 19

A good example of what emerges h m stakeholder consultations is the definition of "competitivenessn that is offered in the Prosperity Initiative consultation paper, pt.Osperiry Zhmugh Competifiwness: creating an economy and a society able to sell goocls and servicesin the wrld market in such a way that business makes a profit, pays f i r wages, provides secure jobs and good working conditions, and respects the environment." Readers will not be surptised that this definition was produced without the advice of most of the organized labour mwement in Canada, who chose not to participate. Thanks to Susan Phillips For her assistance in developing this point.

"...

See Robert Campbell, "Jobs.. .Job. ..Jo.. .J... The Conservatives and the Unemployed," chap. 2 in this volume; Michael Prince and lames Rice, "The Canadian Jobs Strategy: Supply Side Social

Policy," in Katherine Graham, (ed.), How Ottm Spends 198990..7h.eBuck Stops Where? (Ottawa: Carleton University Press, 1989); Rianne Mahon, "Adjusting to Wm?The New Tory Training Initiative," in Katherine Graham, (ed.), How Ottawa Spends 1-91: %ding the Second Agenda (Ottawa: Carleton University Press, 1991). More generally, a rich source on the history and importance of Canadian institutional development is Keith Banting, (ed.), Ihe State and Economic Intetrests and Royal Commission on the Economic Union and Development Prospects fbr Canada: Collected Research Studies (Toronto: University of Toronto Press, 1986). 21

Katherine Graham stimulated this line of reasoning.

.. ...

JOM. JOB JO... J... THE CONSER'VATIVES AND THE Robert M.Campbell R&um4 :Mat@ la &cession et un taux de ch6mage de plus de 10 p. 100, la stradgiem a c ~ n o m i q u du e gouvernement reste inchan&. Celui-ci reconnait cependant que l'approche ndo-conservatrice n'a pas eu les effets micro~onomiquesnkessaires pour relever le d6fi de la mondialisation. Le gowernement Mulmney a donc inaugd des consultations et des changements institutionnels afin de produire un consensus national pour la transformation des march& du trrrvail et a h de g6drer un secteur priv6 plus innovateur. I1 n'en reste pas mobs que la Commission canadienne de mise en valeur de la main-d'oeum, la S t d g i e de mise en valeur de la main-d'oeuvre et 1'Initiative de la pmspkid smnt restreinks de firpn importante par le volontarismede mi appmches, leur financement limit6 et leur isolernent kce aux politiques macmBconomiquea des conservateurs. Cela d & e la persistance du projet de contr8le du gficit et de restriction dm d 6 p s e s tel qu'il a &S fix6 en 1984. Le gowernement continue de choisir de contdler l'inflation plut8t que de s'attaquer au ch8mage. n u t mmrne lea gouvemements canadiens prMdents, il rehse de considker les changements institutionnels et pogtiques n h s a k pour poursuivrc unc politiqut dc plcin mploi, tellc que cellea qui ont &6 intmduites par des pays 2i taux de cMmage peu 8ev6 comme I'Autriche et la SuMe.

Abstrack Despite the tecession and an unemp10yment rate above 10 per cent, the government's macroeconomic strategy d n s unchanged. The Government recognizes that the neoconsemtive approach has not had the microeconomic effects q u i d to meet the globalition challenge. The Mulroney government has thus initiated consultations and institutional changes to forge a national consensus b r transtbrming labour mark& and to generate a more innovative private sector. The Labour Farce Development Strategy (LFDS), the Canadian Board (CLFDB), and the Prosperity Initiative will Labour Force De~~lopment be seriously constrained by the vloluntarism of tiwe approaches, their limited finding, and their isolation from Conservative macroeconomic policies. This reflects the persistence of the deficit controling and expenditute restraining course set in 1984. The Government =mains biased towards controlling inflation rather than towards dealing with unemployment. Like previous Canadian governments, it is unwilling to countenancethe institutional and policy changes quired to pursue a full employment policy, such as those initiated by law unemployment countries like Austria and Sweden.

24 /How Ottawa Spends

Canadians experienced grim economic times in the winter of 1992. The official unemployment rate rose to over 10 per cent in 1991 and promised to stay there through 1992 and 1993. The number of discouraged workers-those not looking for work after losing their last job or being laid off-grew to a monthly average of 737,000. The 'real" unemployment rate approached 14 per cent. Despite tightened eligibility requirements, there were 3:9 million unemployment insurance (UI) claims for 1991-1.3 million a month on average-totaling an unprecedented $17.7 billion. The rise in unemployment, the record-breaking number of 75,773 bankruptcies, and the growth of part-time employment to over two million2 increased the ranks of the poor. Their numbers had reached 3.8 million in 1990, over one million of whom were children (17.4 per cent of children). Christmas was especially grim, as record numbers flocked to food banks and social agencies struggled to provide Christmas dinners and hampers for thousands. Montreal had a 12 per cent unemployment rate and 615,000 poor people, with one of four residents on unemployment benefits. Despite 1.5 million unemployed Canadians, the second deepest postwar recession, and social services stretched to the breaking point, the Mulroney government has stayed its neoconservative economic course. As reviewed in this year's volume: the Conservatives continue to rank containing inflation, and controlling expenditures and the deficit as their macroeconomic policy priorities. These are seen as necessary conditions for creating a competitive economy in the era of globalization.

'

Numerous reports, however, have undermined government claims that the deficit cutting, inflation controlling, tax reforming, free trade, deregulation and privatization agenda would move the economy on to an efficient and competitive footing. These reports suggested to the Government that Canada's poor employment record reflects two particular domestic weaknesses: a poorly trained workforce and a low-innovation private sector, both illprepared for competitive change. The studies also suggested that addressing these weaknesses requires the collaboration of labour,

me Conservatives and the Unemployed / 25 business, and other social groups if effective and acceptable policies are to be devised. Given the government's acceptance and understanding of the globalization paradigm, a poorly trained workfbrce and a low capacity for innovation must be alarming. The Government has thus initiated institutional policies and approaches in tao areas in particular: labour market policy and consultative, collaborative exercises. The policy results have included the Labour Force Development Strategy (LFDS) and the initiation of cowensusbuilding processes and institutions such as the Canadian Labour Force Development Board (CLFDB) and the Prosperity Initiative. But these policy initiatives will be seriously constrained by the perpetuation of the Conservatives' broader neoconservative strategy. Deficit reduction will limit the amount of funding assigned to labour market efforts. Most collaborative exercises will remain voluntary and informal, given the government's marketcentred ideological orientation. And, these ef%rts will be limited as a result of being divorced from, and in conflict with, the government's overriding macroeconomic strategies. This chapter proceeds in three sections. First, it will review the unemployment situation and compare the Canadian record with that of other countries. Second, recent policy innovations will be tracked and characterized. Third, these actions will be compared with the experiences of low unemployment countries to illustrate the limits to, and weaknesses of, the government's initiatives. The chapter will conclude by suggesting policies to be considered if the unemployment situation is to be addressed successfully.

FULL EMPLOYMENT POLICE CANADIAN AND COMPARATIVE EXPERIENCE Full employment is an axis around which a country's economic, social, and political health can revolve. Economically, the full use of human resources contributes to economic growth and

26 /How Ottawa Spends

prosperity, generating the wealth that finances social programs. Socially, unemployment causes tribulations of both an economic and existential sort, which lead to social problems and damage to community life. Employed citizens are more capable of lookiig after themselves and of developing a sense of identity and wrth through the access to the world and the sense of contribution to society that employment brings. Full employment presents the State with a less daunting policy agenda, a more stable and content society, and a tax-paying public less cranky about carrying the burden of income security measures. Canadian economic policy has evolved in a direction opposite to the goal of full employment. In absolute terms, 'unemployment in Canada has shown a steadily rising trend in the three decades since 1960, with the average for each decade surpassing the average for the previous decade.n4The unemployment rate averaged 4 per cent in the 1950s and 5 per cent in the 1960s. As nble 2.1 indicates, this rate doubled in the 1970s and 1980s. The recovery of the mid-1980s saw increasing, rather than decreasing, rates of unemployment in certain regions. Since 1980, for example, unemployment reached 12.2 per cent and 18.6 per cent rates in Quebec and Newfoundland. A 10 per cent unemployment rate can be anticipated for much of the 1990s, as upturns after recessions have had a decreasing impact in reducing unemployment. In relative terms, Canada is a "high unemployment country," compared with 'low unemployment countries" such as Sweden and ~ustria.' lhble 2.1 shows that Canada's unemployment rate has been high and above the Organization for Economic Cooperation and Development (OECD)average. This higher level of unemployment has been accepted 'passively* (and made "tolerablen via income maintenance expenditures), while low unemployment countries have actively attacked unemployment through higher expenditures on training.6 At the same time, nble 2.2 indicates that Canada has been relatively successful in containing inflation, suggesting an ongoing policy bias towards that goal.

Ihe Conservatives and the Unemployed / 2 7 Why have some countries sustained full employment while Canada's unemployment rate has been persistently high?' The proximate answer lies in countries' different institutional arrange men&and processes-in the ways they translate citizens' preferences into policy. Institutions can constrain or help realize political aspirations and shape expectations about what is possible. The low unemployment countries have institutionalized the full employment goal, reflecting the value their citizens place on it. Theirs is a history of experimentation, learning, and hard choices among alternative arrangements and processes. Canada has experimented periodically, half-heartedly, and ineffectively in this way, and these experiments were followed quickly by disillusionment and cynicism. 8 Table 2.1 @=J@g@ 1960-69 1970-79 1 9 W 2.0 2.8 N ~ Y 1.6 1.7 2.5 Japan 1.8 2.1 2.5 Sweden 2.1 1.4 3.3 Austria 2.3 2.4 6.8 Gennany 3.4 6.2 Unitcd States 6.0 7.2 6.9 6.8 9.3 Canada 4.5 7.4 OECD Average 5.0

1990 5.2 2.1 1.S 3.3 5.1 5.4 8.1 6.1

1991. 5.1 2.2 2.8 3.5 5.0 6.7 10.3 7.1

1992+ 4.5 2.3 3.6 3.8 5.1 6.3 10.1 7.1

Source: Organization for Economic Cooperation and Development, Historical Statistics, 1960-89; Economic Ouhok, various years.

Note:

* The figures h r 1991 and 1992 are pmjections, with the exception of Canada 1991, which is actual.

With globalization threatening to dismember labour markets and whole industrial sectors, the low unemployment countries have institutional arrangements and processes in place. These are intended to encourage consensual policy trade-offs and adjustments, and-ultimately-to ensure that international competitiveness is not attained via rising unemployment. Their experiences

28 /How Ottawa Spends

suggest that a fragmented, dispersed system of sharing power in a collaborative policy process can effi?ct difficult but important policy changes. This, finally, is an approach that globalization seems to have thrust on the ~onservatives,9insofar as they have initiated a number of collaborative arrangements and processes. But these initiatives are distant from the consensual approaches used in the low unemployment countries, so their impact will be limited. Table 2.2

@==ww) 196068 3969-78 1979-89 8.3 6.9 8.3 N ~ Y Japan 5.7 2.5 2.5 Sweden 6.8 7.9 7.9 Austria 4.5 3.8 3.8 GcmtMy 3.5 2.9 2.9 United States 5.1 5.5 5.5 5.6 6.5 6.5 Canada OECD&mPb 6.3 6.7 6.7

1990 4.1 3.1 10.5 3-3 2.7 5.4 4.8 n/a

1991' 3.8 2.3 9.5 3.8 4.0 4.0 5.6 da

1992" 4.5 1.9 3.7 4.0 4.2 3.6 3.4 da

Source: Organization fbr Economic Codperation and Development, Hktorical Statistics, 1960-90; &onomic Outlook, krious years.

Notes:

The 1991 and 1992 figures are projections, save for Canada 1991 which is actual.

a

Organization for Economic Cooperation and Development average for 1990, 1991, and 1992 not available.

CONSERVATIVE POLICIES, OLD AND NEW

The Macroeconomic Framework The essence of Conservative economic policy remains that which was enunciated in November 1984 in A New Directwn jbr Canada: An Agenda fir Economic R ~ W . lo The Government has persisted in an agenda comprising: cutting the deficit; limiting

The Conserwulves and the Unemployed / 29 spending and programs; deregulating the economy; privatizing crown corporations; reforming the tax system to encourage incentive and efficiency; and containing inflation. Budgets since 1985 have remained true to this agenda, even after the onset of a recession in the second quarter of 1990. International factors and the size of the deficit have limited the room for policy manoeuvres, particularly in reducing (but not eliminating)the scope for 'Keynesian" counter-cyclical measures. Conservative economic policy has been onedimensional in its pursuit of price stability. Interest rates at record levels above US rates and a high exchange rate exacerbated the loss in employment brought on by the recession. The 1990 budget admitted that the 'unemployment rate will rise," but Finance Minister Michael Wilson proposed a two-year control program to limit expenditure growth below the rate of inflation. The 1991 budget extended the program, made more cuts (including cuts to job training), froze public servants' wages, and increased unemployment insurance premiums. A national inflation target was announced jointly with the Bank of Canada, with the aim of lowering inflation to 2 per cent by 1995. The 1991 budget bcused on deficit reduction and control of inflation. It introduced no direct measures to reduce unemployment, which had reached 10.6 per cent in February. Minor tax changes were financed by $1 billion in spending cuts (including another $100 million cut to job training). The Conservatives remain sceptical about the capacity of government to lower the unemployment rate save indirectly, via creating price stability and an efficient market environment. The Govemment has moved to imtitutiondize this orientation. The 1991 budget proposed the establishment of mandatory limits on annual program spending for the following five years. In the economic component of the latest constitutional package, the Government proposed to limit the Bank of Canada's mandate to fighting inflation (precluding the Bank from considering objectives like lowering the level of unemployment). l3 Neither unemployment nor the globalization challenge has affected the Mulroney government's broad monetary

'*

30 /How Ottawa Spends

and fscal policies-both of which remain divorced from countercyclical or employment-generating goals.

Microeconomic Initiatives On the microeconomic level, the globalization threat has prodded the Government to devise policies to increase Canadian productivity and competitiveness. Cabinet has acted to improve labour market policies, particularly training, and build a consensus for these and other structural policies. This has culminated in two recent initiatives: the Labour Force Development Strategy-which includes the Bill C-21 revisions to the Unemployment Insurance Act and the creation of the Canadian Labour Force Development Board-and the Prosperity Initiative, which also includes a national consultative exercise. In their first term, the Conservatives made more efkctive training programs a policy goal. They reviewed existing programs in September 1984 as well as through the Nielsen "kk Force exercise; they made a broad commitment in the November 1984 Throne Speech; they presented a Cbnsdtation Poper on Paining in December 1984 which led to public discussions-the resulting document, Preparing Canadians for a Better Future, was presented at the February 1985 first ministers' conference; a formal policy commitment was made in the March 1985budget.14 This process culminated on June 28,1985, when Employment and Immigration Canada (EIC) Minister Flora MacDonald announced the Canadian Jobs Strategy (CJS). The U S made training, rather than counter-cyclical job creation, the government priority. Expressing a changed policy orientation, the U S had distinct limits. As nble 2.3 indicates, the U S maintained the level of the previous government's spending in this area at around $1.5 billion, a level which persisted into the 1990s. New programs were financed by the cancellation of old ones. The goal was to stimulatejob training and creation through the private sector. The overall objective was rather less to increase workers' training preparedness for an increasingly competitive

I)re Conservatives and the Unemployed / 31

world than to direct training resources to those most in "need."'' Labour market policy in this period was determined by two broad orientations: deficit cutting (which limited the funding available), and the emphasis on creating employment and job training through the private sector. Economic expansion drove the unemployment rate below 10 per cent in 1987 and to the 7-8 per cent range in 1988, pushing employment and training off the policy agenda. The 1986, 1987, and 1988 budgets expressed contentment that a revitalized private sector had created job opportunities. The Budgets maintained deficit reduction and expenditure control priorities, so that expenditures on training persisted at the $1.5 billion level (i.e. declining in real terms and as a proportion of government spending).16

Globalization and Policy Change The Free Trade Agreement (FTA) thrust job creation and training back on to the policy agenda. Prime Minister Brian Mulroney responded to critics of the Agreement by promising help to those displaced or affected by the FTA. He established the Advisory Council on Adjustment, which submitted a report in early 1989. Adjusting to Wn was one of a number of reports to recommend changes to the content of labour market policy as well as to its formulation. It did not challenge the government's macroeconomic framework, proposing a market-centred strategy of tax incentives and assistance to increase private sector competitiveness. But it insisted that improvements be made to training policy, to meet the challenges of globalization. It called for a national effort to create a "training culture," through increased business and labour collaboration in designing labour market policies. It noted a Statistics Canada survey which showed that business spent only $1.4 billion on training and that only one in four firms engaged in the training of their employees. On a per employee basis, the United States spent twice as much, the Japanese five times as much, and the Germans eight times as much. The report urged the Government to go beyond a policy of exhortation to get the private sector to do more training. It

32 /How Ottawa Spends

proposed tax incentives and a training levy system to create a $3 billion fund, and the more 'active" use of the Unemployment Insurance Fund for training purposes. l7

l%e Labour Force Development Sfmtegy A few months later, Employment and Immigration Minister Barbara McDougall presented the Labour Force Dwelopment Strategy. The policy "aimed at preparing Canadians for the labour market of the 1990s, so as to ensure that they will be able to adapt to an evolving world economic environment." The accompanying policy document, Success in the Hbrkr, declared that "Canada's competitiveness now depends less on (natural resources) advantages and more on. the skill we bring to our work. "I8 The LFDS marked the beginning of the Conservatives' exercise in consensual economic policy fonnation. As outlined in Success in the W r . , the Government aimed to "mobilize a national effortw to increase Canadians' skills and asserted that "these challenges must be dealt with cooperatively by business and labour.. .. A much greater participation in, and responsibility for, labour force upgrading by business and labour is a major objective of the Labour Force Development Strategy." McDougall proposed a National Skills Development Advisory Board to provide guidance to Employment and Immigration Canada. She initiated a consultative exercise-the lhsk Forces on the Labour Development Strategy-to generate recommendations from business, labour and others on how to implement a better training system. Seven task forces were established, to be managed by the Canadian Labour Market Productivity Centre (CLMPC). The aim was to bring "the private sector-business and labour-together to set the course for each sector and industry."1g The consultation exercise reflected the Conservatives' market orientation: "The primary responsibility for the skills training of employed people rests with employers and workers."20 Thb government's broad fiscal and ideological goals would shape any changes: private sector initiatives would be voluntary and extra funding would not be available. The Government rejected the Advisory Council's levy scheme to finance a training fund.

lk Conservatives and the Unemployed / 33 Instead, the policy aimed to stimulate the private sector to increase its employee training by $1.5 billion by 1994. Instead of increased public funding, McDougall proposed a series of changes to the funding and operation of the unemployment insurance system that would be incorporated in Bill C-2 1: O

O

O

The Unemployment Insurance Fund would be banced entirely by the private sector, ending the government's contribution of around $2 billion a year. Eligibility requirements were to be tightened by increasing the number of qualifyingweeks, limiting the number of benefit mks, and increasing penalties tbr quitting a job, getting fired or refirsing a job; expected savings wwe $1.29 billion.

Ten per cent of the Unemployment Insurance Fund-$1.3 billion-was to be redirected, $800 million of which was to be spent on training. The task force exercisewuld determinehaw this would be used.

These changes were designed to change the UI logic "from one of passive support to an active response built around training and job readiness." While $1.3 billion was reallocated from the UI Fund, training expenditures would be maintained at the existing U S level of $1.8 billion (see 'Ihble 2.3).21 The redirected $800 million for training was assigned to the US. There would be no net increase in "government" spending on training in the following years. An increasing prtion would originate from the Unemployment Insurance ~und. The LFDS was slow to be implemented. Bill C-21 was delayed in the Senate and not promulgated until November 1990. The task forces reported only in March 1990, their major recommendation was made in July, and this was acted on in January 1991-when the Canadian Labour Force Development Board was created (it was not operational until May). The LFDS thus had a negligible short-term impact on unemployment.

34 /How Ottawa Spends

Table 23

Expenditures onHuman ResollreeDevelopment Crn b b ofdolhm) Total (29 Ur' 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92b 1992-92

.90 1.10 1.60 1.70 1.57 1.67 1.64 1.96 2.08 2.57 3.45 3.43

nla n/a n/a nla .65 1.55 1.53 1.59 1.66 1.97 1.95 1.62

nla nla n/a nla n/a nla nla .37 .42 .60 1.50 1.80

Source: Employment and Immigration Canada, Estimates, Part III, Expenditure Plan, various years (OtCawa: Minister of Supply and Services Canada). Data h r 1981-2 to 1984-5 am from

Michael J. Prince and Jim J. Rice, "The Canadian Jobs StAtegy: Supply Side Social Policy," in Katherine A. Graham, How Ottawa Spends 1989-XI.

Notes:

CJS expenditures began in 1985-86, while the changes to UI were implemented in 1988-89. a

The 1991-92 figures are breasts; the 1992-93 figures am estimates.

The CLMPC submitted the task force reports in March 1990. The reports contained a number of common themes regarding strengthening national training standards, promoting lifelong education and training, improving basic skills, enhancing local input into the delivery of labour market programs, and improving human resource planning. Three key themes stood out:

The Conservatt*vesand the Unemployed / 35 O

O

The task facts "recognized that the efktiveness of training and labour programs will be limited in the absence of a healthy and vibrant economy conducive to change and vigorousjob a re at ion."'^

"IBsk F o m expressed strong support for the expanded use of unemployment insurance fwds for income support during training (but) took the position that unemployment monies, financed by wrkers and employers, should be used exclusively for income support for individuals, including income support fm training."24

...

O

Business and labour should play an expanded role in labour market policies, in a new national mechanism.25

However, the tight macroeconomic policy increased unemployment and Bill C-21 W e r r e d UI funds to purchase training courses and pay fees. Only the third issue was embraced, as will be seen presently.26 There was, in addition, one critical area where a consensus was elusive, l[he ?tisk Force on Human Resource Planning issued separate labour and business reports regarding whether private sector training should be financed in a voluntary or mandatory way." As is typical in these exercises, where there is no consensus the status quo prevails-and the "voluntarist" training system has persisted.

Tiro Crrndkn Labour Force Development Board In July 1990, the CLMPC presented a follow-up report to the seven task force reports. Guided by their concern "that real labour market refbrm ...-would not be possible without institutional change," a National Training Board &s proposed. It would function as an "effective and authoritative forum for establishing broad standards of access to training while ensuring the quality of the programs ... [and] forg[e] a broad consensus on national training priorities and strategies." Independent of governments, the Board would comprise 22 members, eight appointed by labour and business organizations, respectively; two representing the educational community; and four representing women, visible minorities, Aboriginal peoples, and the disabled. It would have three functions: to serve as an advocate for increased, higher quality, and more accessible training; to advise governments on all aspects

36 /How Ottawa Spends

of training; and to make recommendations on a number of trainin issues, including the links between income support and training.

dl

The Government accepted most of these recommendations, but named the new institution the Canadian Labour Force Development Board. Chair, and Deputy Minister of Employment and Immigration Canada, Arthur Kroeger described the CLFDB as "much more than your run of the mill advisory board." It was to be "a new way in which governments and major partners ... will work together in dealing with training and human resource issues." The social "partners" would take on increased responsibility for skills training, while ugovemments must be pre ared to relinquish gradually some control over policy matters.w2BThe Board is expected to mobilize private sector efforts in skills training and encourage the development of a training culture. It will determine the annual expenditure plan for the developmental uses of the Unemployment Insurance Account. Its mandate will be limited at first, but "will evolve as it gains experience." By 1994, 60-75 boards will be established at the prgincial and community level to reflect local priorities and needs. All of this was established in an informal way. The Government proposed not to legislate the CLFDB's existence until it had gained experience. The Board is to be assigned no independent funding, but will be supported by a secretariat, research staff, and other resources from EIC. While having no formal authority "to the extent that the parties are capable of reaching agreement and making the difficult trade-offs involved ...the Minister of Employment and Immigration is prepared to act upon the consensus of the ~oard."~' The co-chairs of the CLFDB were announced on April 19, 1991: Gerard Docquier (National Director of the United Steel Workers of America) and Laurent Thibault (outgoing President of the Canadian Manufacturers Association). They in turn announced the other members on May 7.32 The CLFDB had issued three reports by early 1992: a response to the federal government's constitutional proposal to recognize exclusive jurisdiction of the provincial governments with respect to labour market training; a proposal to establish a

me Conservativesand the Unemployed / 37 series of local labour market development boards; and a recommendation on the use of unemployment insurance funds for This last has been its most important training purposes in 1992?~ action. It recommended that developmental uses of the Fund be increased fiom $1.4billion to $1.8 billion in 1992.The CLFDB insisted that, in making this recommendation, it was not prejudging the issue of whether unemployment insurance money should be used only for earnings replacement (of the $1.8 billion, about $1.5 billion would be directed to training-$ 1 billion for income support and $500 million for the cost of training). It chose the $1.8 billion figure as that level 'that would make the total estimated cost of Unemployment Insurance in 1992 the same as what it would have been had Bill C-21 not been introduced." Employment and Immigration Minister Bernard Valcourt accepted the recommendation. There were continuing concerns that the unemployed were being squeezed to pay for training. The Government increased unemployment insurance premiums twice in the past year, and cut $100 million from the Canadian lobs Strategy in each of the 1991 and 1992 budgets.34

The Prosperity Initiative The Government addressed the broader globalization agenda-including issues such as technological change, innovation, research and development-in its Prosperity Initiative. This policy is characterized by the same strategic orientations as the government's labour market policy: the broad macroeconomic strategy is to be left intact, initiatives will be private sector driven, and increased collaboration will be encouraged. In the February 1991 budget, then finance minister Wilson asserted that Canada's 'fundamental problem" has been that 'our underlying ability to compete in the world marketplace has been falling behind that of our trading partners." As the "key to our prosperity is to increase our productivity ... in an increasingly competitive world," he proposed a review of the adequacy of investment in infrastructure, education, research and technology, and so on. No policy recommendations were made to this end.

38 /How Ottawa Spends Rather, 'to help assist our future prosperity the government will launch a national effbrt to build a new partnership for prosperity that d m s fully on the talents and efforts in every sector of economic life." A discussion paper was promised to guide the consensual e%rt to meet the globalization challenge.35 Spring arrived and no discussion paper was released. The Government had difficulty starting the process. The May 13,1991 Throne Speech reiterated the budget's initiative. The Government made no concrete proposals, instead inviting Canadians "to participate in fashioning a new agenda for prosperity ... to reach a national consensus on performance, goals, partnerships and priorities."36The ground was cleared for the government's launch of the Prosperity Initiative when the Porter Report was released on October 24. Caw& m the Crossroads-7k Reality of a New Competitive Environment, jointly commissioned by the federal government and the Business Council on National Issues (BCNI), was produced by competition guru Harvard Professor Michael Porter and his research team. The report presented the familiar argument that competitiveness was now related less to the comparative advantage gained by natural resources than to innovation, productivity, and skills. The report issued numerous recommendations to increase Canadian competitiveness and innovative capacity. It also invited labour and business to collaborate with the Government to this The government's Prosperity Initiative was finally launched on October 29, 1991, eight months after it had first been disclosed.38The Minister of Industry, Science and Technology (IST) and International Trade, Michael Wilson, repeated the government's productivity mantra, declaring that Canadian companies and individuals were not i~ovatingenough to meet the globalization challenge. He insisted, though, that 'the underlying cause of this state of affairs is far beyond the capacity of government to turn around." Instead, Wilson launched a consultation process "to elicit from all sectors of Canadian society the solution to the challenges now confronting us." David Robert McCarnus (President of Xerox Canada) and Marie-Josee Drouin (Executive

...

Vte Conservatives and the Unemployed / 39 Director of the Hudson Institute) were named co-chairs of a private sector steering committee that would guide the consul~~ tation exercise and present a report by the summer of 1 9 9 2 . The delayed launch-and a potentially fatal flaw in the initiative-was partially due to Wilson's inability to convince the Canadian Labour Congress (CLC) to participate. In an October 15 letter, CLC head Shirley Carr expressed the view that there was too strong a "political emphasis" in the initiative, and the fear that her organization was being co-opted into supporting the government's wider economic agenda-which was not open to discussion.40 A discussion paper, Rvsperriry through Competitiveness, was issued to k u s the process (a paper on education and training was also released, Leaning Mll ... Living Mil). The hvsperity document was remarkable in a number of ways. First, it contained no specific government intentions. Familiar issues were "rerehearsed," and the public was invited to discuss broad questions like: "Why does Canada's private sector training effort lag behind that ...of our major trading partners?" and "What specific actions and mechanisms would promote an enhanced role for traditional industries in the knowledge-based economy of the future?" Second, the responsibility for Canada's low competitive capacity was assigned to the private sector: for ranking 20th of 23 industrial countries in employee training, 15th in research and development spending, and 19th in taking out patents. The education system was broadly criticized, particularly for not encouraging Canadians to study science and technology. In the education and training paper, the Government criticized Canadians for not giving learning a high priority (an ironic comment in light of the federal government's cut in transfer payments to the provinces for higher education). In contrast, the government's own policies were cast in a positive light. Deregulation, tax reform, privatization, the FTA, deficit reduction, containing inflation, and so on were presented as having prepared the economy for globalization. The Government did not consider whether these policies had any relationship to the economic weaknesses it had reported and that globalization had exposed. Regardless, the paper asserted that issues like monetary policy and fiscal policy were not open for

40/How Ottawa Spends consultative dis~ussion.4~ On matters open for discussion, the Government continued to avoid recommendations, limiting itself to setting national targets for job creation, inflation, spending. education, and personal income. "Action based on consensus," it maintained, "will be more effective than unilateral action." Canada's ability to compete "depends on our willingness to co-operate amongst ourselves. " The consultation exercise is to unfbld at three levels. Nationally, the McCamus-Drouin steering committee will consult business, labour, and other social interests. The other members of the committee were named on December 18, 1991." Sectorally. cabinet ministers will consult with their clients. At the community level, a 30-person Prosperity Secretariat will oversee up fo 175 meetings in communities across Canada. Physically in IST but separate from it, the Secretariat has been funded by EIC and IST with a budget estimated to be $18.1 million (including $3 million for town hall meetings and $5 million for advertising). It is jointly responsible for the "Yes We Can" advertising campaign, a Participaction-type strategy designed to persuade Canadians to be more competitive. The steering committee will pull together the results of the three consultation exercises in a rt to be presented to the Government in the summer of 1992.??'

CONSERVATIVE INITIATIVES: CHARACTERISTICS AND LIMITS The LFDS, the task force exercise, the CLFDB, and the Prosperity Initiative are directed to the collaborative development of adjustment policies to meet the challenge of globalization. Analysis suggests, however, that these initiatives are distant from the consensual approaches used in the low unemployment countries. Their impact will thus be limited. First, the Conservatives insist that they will not act directly to reduce unemployment. This position will limit the extent to which the initiatives can produce interesting results. Without a macro-employment guarantee, it will be difficult to construct

7he Onsen,atives and the Unemployed / 41

consensual innovations that might displace jobs. The absence of job-generating economic conditions will also limit the impact of whatever labour market policies might be developed. Second, the consultation processes have stria limits. Fiscal

and monetary policies remain off limits to collaboration. The mildly collaborativeEconomic Council of Canada was axed in the 1992 budget. This calls into question the authenticity of the government's commitment to consensus-building. 'The lack of macroeconomic collaboration will hinder the possibilities of collaboration on microeconomic matters, as the capacity for making crucial trade-ufi is limited. In any event, the Government does not anticipate successes similar to the partnership models of Japan, Austria, and Sweden: "Given that regional and cultural diversity is such an important characteristic of Canada, a full consensus on all issues is not realistic or required."44 Third, deficit and spending controls have limited labour market funding. The Unemployment Insurance Fund-a fund now financed exclusively by increasing private sector premiumsbankrolls training. This calls into question the authenticity of Conservative actions and weakens social commitment to the collaborative process. Fiscal restraint also limits the "greasew required to smooth the building of consensus through trade-offs. Fourth, the processes are informal and can be terminated by

a government which has chosen to not "legalize" them. In contrast, anti-inflationary policy and spending limits are to be institutionalized. The Government is not obliged to accept recommendations, unless there is an overwhelming consensus. Given no obligation and limited inducements to fmd a consensus, there will be footdragging in key areas. The voluntarism of the approach-from creating community labour market boards to increasing business training-will slow and limit pay-ofi. Fifth, labour's tenuous involvement will constrain collaboration. It has not benefited much from these processes to date, hence its non-participation in the Prosperity Initiative. Numerous unwanted changes to the UI scheme have been imposed: increased

42 /How Onmva Spends

premiums, tightened eligibility requirements, the end of the federal government's contribution, the use of UI funds for purposes other than income support. Labour's call for a mandatory training scheme has not been accepted. It faces a 10 per cent unemployment rate and a government committed to staying its macroeconomic course. Labour will not participate wholeheartedly in consensus-building exercises under these conditions. Sixth, these exercises will not make a serious short-term impact on the unemployment rate. It took hkro years for the LFDS to be put into place, a year for the Prosperity Initiative to unfold, and it will take a few years for the community labour development boards to be developed. Persistent unemployment will increase the strain under which the processes function, undermining the authority they require to be efkctive.

Institutional Characteristics of Full Employment Policy The procedural arrangements of the low unemployment countries have been more consensual and e c t i v e than the Conservative initiatives, mainly because political power in these other countries has been genuinely fragmented and dispersed. Pbwer is shared by parties within coalition governments, and gwemments disperse and share this power with actors outside of the formal channels of government. This extends gwemments' "co~ectedness" with society (increasing the potential legitimacy of its actions) and leads to increased social involvement in the formulation and execution of policy (increasing policy impact and effectiveness). To develop effective, consensual policies, the Conservatives' experimentation would have to be pushed into deeper collaborative waters, in the following ways:" O

Collaborative approaches to policy-making wwld have to be

extended to the gmrnmental process itself. O

A formal commitment to full employment should underlie the collaborative processes.

The Consemtives and the Unemployed / 43 0

O

The institutional capacity br, and hrmality of, social collaboration must be increased. The setting of macroeconomic and micmeconomic processes must be collaborative and linked.

Consewative collaboration has not been applied to the governmental process itself. This remains majoritarian in character, limiting the impact that collaboration might have. The Conservatives exercise exclusive political authority, despite being elected by far less than 50 per cent of Canadians and being supported currently by less than 20 per cent. The majoritarian, winner-take-all electoral system makes many citizens suspicious of a government they did not elect and to which they hare little access. Government actions are thus distanced from those affected by them and whose response can undermine policy effectiveness. The politics of parliamentary opposition in turn poisons the discussion of issues and smothers attempts to build consensus. Low unemployment countries have pursued consensus in a different way. Their electoral systems are all a variant of proportional representation. Political parties are forced to be more open and connected to society to win seats. Required to build and animate coalitions after the election, the parties encourage a closer connection between government and society. The political necessity and experience of power-sharing has created the basis for a wider social ethos of collaboration. Consensual policies require the fragmentation and sharing of political power within the formal political process. Full employment, for example, has had greater policy resonance in Canada at times of minority govemment. In 1963, political expectations led the minority Liberal government to declare that 'any Canadian ... who wants a job must be able to find one." A veritable explosion of institutional and policy activity ensued, from the formation of the Economic Council of Canada and the Atlantic Development Board to the acceleration of manpower policies and a variant of economic planning." Under the close scrutiny of the NDP, the minority Liberal government in 1973-74 experimented with a variety of tax innovations and

44 /How Ottawa Spends

stimulated monetary policy to diminish the level of unemployment.47 Second, a h a 1 employment guarantee underlies the low unemployment countries' consensual politics. If collaborative exercises are to work, full employment must be predictable. In contrast, globalization has licensed the Conservatives to diminish the inflation rate via crude macroeconomic policies which have swollen the ranks of the unemployed. This approach undermines social willingness to collaborate in difficult adjustment traded&. An institutional roadblock is required to constrain governments from seeking price stability and competitiveness through rising unemployment. This could take the form of making unemployment 'illegal"-for example, by making access to a job or efkctive training a Charter ri ht-or making it extremely polititally unattractive to pursue. A legal prohibition or guarantee would force governments to consider alternatives or devise policies that prevent unemployment. The Conservatives have embraced a 'legalist" approach with regard to price stability, by proposing to narrow the Bank of Canada's legislative mandate. If price stability is to be institutionalized through an autonomous agency, then full employment should also be given this status and assigned mechanismsto realize it-if collaboration is to work. The Ontario government's proposal for a social charter expresses this sort of Third, other countries' consensual experiences have a formal permanence and thrust which the Consemtive initiatives lack. The collaborative participants themselves lack the capacity to build up consensus positions. Labour is organizationally decentralized and even business lacks the peak associations to speak and act with authority. Labour, business, and other social interests should be given institutional, legal, and financial support to strengthen their collaborative capacity. Labour codes could be made more supportive to foster unionization, lest the businesslabour relationship remain asymmetrical.s0 If efforts to build collaborative capacity are to be undertaken, inducements are required, such as the formalization of the

The Conservatives and the Unemployed / 45 full employment goal. More importantly, the Government can be obliged to take these collaborative efforts into account when devising policies. This might require the establishment of firma1 social institutions-national organizations of business, labour, and other sectors-which would meet internally and with each other at set times each year to develop consensus or options. The Government would be obliged to base its policies on these positions. Institutional certainty would assure participants that their consensual efirts would not be futile. Fourth, collaborative exercises have been limited by the divorce of macroeconomicpolicy from microeconomic initiatives, each devised in a difirent manner by different people. Even with expanded job training, there is little incentive for labour to sanction job-sacrificing technological innovations without assurances that unemployment will not result. Those who design microeconomic policies must have access to the formulation of macroeconomic policies, if the brmer process is to have any thrust. In the consensual countries, this approach has allowed the development of an implicit incomes policy. Where labour or business feels confident that "restraint" is rewarded in the form of full employment or competitiveness, low but real wage gains and price increases andlor tight fiscal and monetary policies are often supported. The process is directed to the development of more inspired micro policies. Recommendations for a tight ftscal policy or industrial changes are more likely if complemented by guaranteed, predictable actions in labour market policies. The quality and character of labour market policies can be enhanced substantially, in the context of a full employment commitment and fuller, more formal, and equitable collaboration among business, labour, and other social groups. These policies are Fdl less "wluntaristic," more predictable and better funded in the consensual countries.

CONCLUSION Since the failure of the Meech Lake Accord, the Conservative government has appeared anxious to develop policy initiatives in a manner perceived to be open and collaborative. The

46 / How Ottawa Spends

globalization challenge has also encouraged this development, with consensus now seen as required to initiate far-reaching adjustment policies to increase efficiency and competitiveness. The gcwernment's collaborative initiatives have had a number of interesting features, including the recognition of the relationship between policy consensus and efkctiveness, the decentralizing of labour market policies down to the community level, and &e inclusion of social groups in the consultation exercises. The Canadian Labour Force Development Board is a positive collaborative innovation which, in conjunction with the Canadian Labour Market Productivity Centre, could develop interesting policies and extend the collaborative ethos. At the same time, the collaborative initiatives have been tentative and are likely to have but limited success. The 'Consewatives' ideological orientation has set distinct limits in this regard: they remain committed to a neoconservative macroeconomic strategy and antagonistic to 'legalistic," fbrmal, or mandatory approaches that interfere with market processes. Yet, the experiences of the consensual countries suggest that collaborative exercises do not necessarily increase state power or extend political inteerence. Rather, they increase the legitimacy of the State ahd its effectiveness, by increasing social groups' power and their impact on public policy. Extensive, permanent, and authoritative institutional experimentation of this sort increases the opportunities for public education and comprehension of economic realities. Informed social groups and individuals, with increased mutual understanding and insight about economic realities, are more likely to have the self-discipline and understanding required to comprehend and accept difficult policy tradeoffs. In the final analysis, the development of impmed and effective policies will depend on the existence of an infonned and experienced population.

NOTES 1

According to the Canadian Labour Market Productivity Centre, the rate wuld be 14 per cent if discouraged wrkers, those on temporary lay-off, the underemployed, and part-time workers

Ihe Clonsey~ativesand the Unemployed / 47 w r e taken into account. 7he Gazette (Montreal), January 11, 19%. 2

There w r e 2.02 million people with part-time jobs in 1991, a 45 pet cent increase from the 1.4 million in 1980. Full-time jobs grew by 10.7 per cent in this period. The proportion of jobs that were part-time grew from 10.7 per cent in 1980 to 16.4 per cent in 1991.

3

See FrancesAbele, "The Politics of Competitiveness," in Frances Abele, (ed.), Hav Ottawa Spends: me Politics of Competitiveness 1992-93 (Ottawa: Carleton University Press, 1992).

4

Judith Maxwell, in Sumdm Gem, (ed.), Canadian UnempIqyment (Ottawa: Economic Council of Canada, 1991), p. xi.

5

Goran Therborn, Why Some Peopk me Mom Unemployed Than of G m ~ and h Unemployment (LonOthers: m e Stmnge Pa& don: Verso, 1986). Other high unemployment countries include Belgium, Holland, Britain, and Denmark. Other low unemployment countries include Switzerland, Norway, and Japan.

6

In 1987, of the 2.2 per cent of GDP which Can& spent on labour market programs, 75 per cent was devoted to income maintenance; the comparable Swedish figures were 2.5 per cent of GDP and 30 per cent on income maintenance. See Economic Council of Canada, &od Jobs, Bad Jobs (Ottawa, 1990).

7

See Robert M. Campbell, The Full Employment Objedw in

Canada Historical, C;onceptual and Comparative Pempectives (Ottawa: Economic Council of Canada, 1991).

8

Ibid., pp. 32-36; Pierre Fournier, "Consensus-Building in Canada: Case Studies and Proposals," in Keith Banting, (ed.), m e State and Economic Interests (Toronto: University of Toronto Press, 1986).

9

On this general point, see Susan D. Phillips, "How Ottawa Blends: ShiAing Gwernmental Relationships with Interest Groups," in Frances Abele, (ed.), How Ottawa Spends: The Pblitim of Frag-

mentation 1991-92 (O#awa:Carleton University Press, 199I), pp. 185-87.

48 / How Ottawa Spends 10

Michael Wilson, A New Direction for Canada.-An Agenda for Economic Renewal (Ottawa: Department of Finance, November 8, 1984).

11

Michael Wilson, Budget Speech, February 20, 1990, February 26, 1991.

12

Don Mamdcawski, Budget Speech, February 25, 1992.

13

The current wording directs the Bank to: "regulate credit and currency in the best interest of the economic life of the nation to mitigate by its influence fluctuations in the general level of production, trade, prices and employment.. "

...

..

The Government proposes that "the rekrences to mitigating fluctuations in production, trade and employment and other objectives should be eliminated.. " Govenrment of Canada, Canadian Feakmlism and Economic Union: Pmtnetshipfor hsperity (Ottawa: Minister of Supply and Services Canada, 1991).

..

14

Flora MacDonald, Consultation Paper on maining (Ottawa: Employment and Immigration Canada, 1984). A consultation process resulted in Gwemment of Canada, Empbpnent Opportunities: Pmparing Canadiansfor a Better Future, First Ministers' Conkrence, Regina, Saskatchewan, February 14-15, 1985. It asserted that responsibility h r training rests with workers and employers. Michael Wilson, Budget Speech, May 23,1985. While arguing that "our priority goal (and) this budget is about jobs" (5014, 5021), the Gwemment proposed to encourage private investment to create jobs and assist the process of the private sector's training of workers. Michael J. Prince and Jim J. Rice review these developments in "The Canadian JobsStrategy: Supp ly Side Social Policy," in Katherine A. Graham, (ed.), How Ottawa Spends 1989-90: 7he Buck Stops Where? (Ottawa: Carleton University Ptess, 1990).

15

See Zhe Globe and Mail, "New Jobs Program Focuses on Training," June 29, 1985; Employment and Immigration Canada, Annual Report various years (Ottawa: Minister of Supply and Services Canada); Michael J. Prince and Jim J. Rice, pp. 255-75. See also Rianne Mahon, "Adjusting to Win? The New Tory Training Initiative," in Katherine A. Graham, How OttawaSpendr

me Conservativesand the Unemployed / 49 199691: ?lacking the Second Agenda (Oltawa: Carleton University Press, 1990).

16

See Michael Wilson, Budget Speech, February 26, 1986, February 18, 1987, Febmry 10, 1988.

17

Adjusting to Win= Report of the Advisory Council on Mjwtment ( 0 t h Minister ~ of Supply and Services Canada, 1989). The report concluded that special FTA adjustmeat assistance wuld discriminate against those whose economic difficulties were not created by the FI'A. In any event, it concluded that it was impossible to distinguish one group from the other.

18

See the statement by Barbara McDougall in Canada, House of Commons, Debates, April 11, 1989, pp. 3 17-18 (Ottmw Minister of Supply and Services Canada, April 1989), p. iii.

19

Barbara McDougall, Canada, House of Commons, Debates, April 11, 1989, pp. 317-18, 2674-78; Success in the U6rks-a policy paper: a labour krce development strategy fbr Canada (Ottawa: Minister of Supply and Services Canada, April 1989), pp. iii, 2, 13; "The &us was similar to the Advisory Council's: collaboration, private sectordriven training, 'active' use of the unemployment insurance system," Zk Gbbe and Mail, June IS, 1989. The Canadian Labour Market Productivity Centre was established in 1984 to kilitate direct cansulfation between business and labour on a variety of social and economic matters, including labour market policy and productivity. See What is the CLMPC? (Ottawa: Canadian Labour Market Productivity Centre, October 1991).

20

Success in the M 6 r . a policy paper: a labour hrce development strategy h r Canada, op. cit., p. 3.

21

Of particular importance is s. 26 of the Unempluyment Insumnce Act. In 1991-92, $1.19 billion of the total relates to incomesupport to full-time trainees taking courses under C I S programs. The figure includes $480 million under s. 26.1 fbr the cost of courses and allowances.

22

Success in the Wrh-a policy paper: a labour hrce development strategy h r Canada, op. cit.; Employment and Immigration

50 /How Ottawa Spends Canada, Annual Report, 1989-90, 1990-91. See also Rianne

M a h , pp. 85ff. 23

Report of the CZMPC ntsk Forces on the Labour Force Development Strategy (Ottawa: CLMPC, 1990), p. 4.

24

Ibid., p. 1.

26

Ibid., pp. 1-8. See also A Fmework for a National Daining Board. l%eReport of the Phase II Committeeon the Labour Force Dmlopment Strategy (Ottawa: CLMPC, July 1990).

27

Business characterized its activity as "already substantial," and rejected a compulsory scheme as too bureaucratic and complicated, and open to abuse. It opted fbr a voluntary system,backed by tax incentives and voluntary initiatives such as individual training accounts, a Registered Skills Development SavingsPlan, and expanded education leave and training loan programs. Labour asserted that the voluntary approach was not wrking and was biased to short-term business needs. It proposed a National Training Fund based on a 1 per cent payroll tax, guided by a National Workers Education and Training Council, run jointly by business and labour. Both business and labour we represented by particularly authoritative figures on this task t h e : Tom d'Aquino of the Business Council on National Issues and Bob White of the Canadian Auto Workers.

28

Ibid.

29

Zhe Globe and Mail, January 15, 1991; Emplayment and Immigration Canada, Canadian Labour Force Development Board (Ottawa, 1991).

30

Ibid.

31

Ibid.

32

The other Board members are: Fmm Bwiness Anne Stewart (Cam Operations)

Ihe Conseivatives and the Unemployed / 51 J.T. (Jake) Thygesen (Fuller and Knowles Co. Ltd.) Thomas R. Hall (Stora Forest Industries Inc.) Jim B e ~ e t(Canadian t Federation of Independent Business) Robert V. Wilds (B.C. Maritime Employers Association) John Keenan (Falconbridge Limited) Jean Bernard (Bell Canada)

Fmm Labour F d Pbmemy (Communications and Electrical Workers of Canada) James A. McCambly (Canadian Federation of Labour) Nancy Riche (Canadian Labour Congress) Les Hollaway (Maritime Workers' Federation) Basil Hargrove (Canadian Auto Workers) .. Susan Giampietri (Public Service Alliance of Canada) Diane Wood (B.C. Government Employees Union) F b m Education and lhining

Susan Harbii (YMCA) Thomas Blacklock (Universalis)

Fmrn Mmen 3 Gmups Marcy Cohen (Independent Consultant) h m the Aboriginal Community Roy Mussel1 (Sto:lo Tribal Council)

Fmm the Disabled Community Sandra Carpenter (Independent Consultant) Fmm Visible Minorities Navin Parekh (Consultant, Trainer and Researcher) 33

lRe Federal hposalsfor Constitutional Change With Respect to Labour Market 7hining (Ottawa: W D B , December 10, 1991). It is concerned that the federal proposal wuld compromise its ability to ensure national standards, labour mobility, and an integrated system of labour hrce development. A Proposal to Establish Local Labour Force Development Boards (Ottawa: CLFDB, December 1991). The CLFDB proposes to establish 60-75 provincial and community boards, to decentralile design and delivery as much as possible within the broad context of the setting of national standards: "the practical decisions concerning

52 /How Ottawa Spends training and human resource development requirements are best made by those most afkcted by them" (p. 2). They are to ewlve on a voluntary bas'=, by 1994. Quebec will nut participate, and has set up its own centralized labour market mechanism, the So&& qdbecoise de dtkloppement & la main d ' o e m . m e Globe and Mail, January 16, 1991; l?ze Gatette, ~ o n t ~ e a l ] December 10, 1991. Report on the 1992 budget jbr the Dewlopmental Uses of Unemployment Insumnce (Ottawa: CLFDB, Nwember 1991). 34

l?ze Ilbmnto Star, February 28, 1992.

35

Michael Wilson, Budget Speech, February 26, 1991.

36

Canada, House of Commons, Debates, May 13, 1991, pp. 3,4.

37

The report cost $1.2 million, $400,000 of which was paid by the fkxkral government. It applied the model developed in Michael E. Porter's best selling lhe Competitive Admntage of Nations (New Yo&: The Free Press, 1990). Recommendations included: increased investment to raise productivity, more innovation, improved and incmsed training, national standards and increased practical content in education, specialization of universities with funding tied to increasing competitiveness, global market strategies, increased processing of raw materials, improved inFrastructure, increased research and development, and social security with greater incentives. Michael E. Porter and the Monitor Company, Canada at the Cmssmadr l%eReality of a NAY Competitiw Environment (Business Council on National Issues and the Minister of Supply and Services Canada, 1991).

-

38

It was reported that the delays were the result of disputes between the departments of Finance, Industry and Employment wer the m'son d Vtre of the initiative, who would control the initiative; and what its message was supposed to be. me Globe and Mail, January 29, 1992.

39

Canada, House of Commons, Debates, October 29, 1991, pp. 4129-3 1.

40

Wilson bad ofired a $400,000 research fbnd as an inducement to participate. Internal CLC divisions aver participation were

lhe Conservatives and the Unemployed / 53 resolved in the gwernmentt's treatment of the public sector strike as well as the absence of a guarantee that cha~~ges in economic policy uould be brthcoming to ease the level of unemployment. me lbmnto Star, October 17, 1991. Co-Chair David McCamus was approached to take the position only by Friday, October 24,1991. The initiative was launched the b l l w h g Wbdnesday, but no practical details or procedures were in place. me Globe aruf Mail, October 30, 1991. 41

Government of Canada, Prosperity mrough Competitiwness, Prosperity Initiative, Consultation Peper (Ottawa: Minister of Supply and Services Canada, 1991).

..

Gwemrnent of Canada, Learning WIl . Living Wll, Prosperity Initiative, Consultation Paper (Ottawa: Minister of Supply and Sewices Canada, 1991). There was a third discussion paper issued by the Department of Industry, Science and Technology, Industrial Comperitiwness=A Sectoml hspectiw (Ottawa: Minister of Supply and Services Canada, 1991). 42

Andd Chagnon, President, Group Vidbtron Lt6e Marshall A. Cohen, President and CEO,The Molson Companies Joseph D'Cruz, Faculty of Management, University of Toronto Gordon Cunningham, President and CEO,London Lib Insurance Eric Geddes, Edmonton Council of Advanced Technology Donald Glendenning, Glendenning Associates David Johnston, Principal, McGill University Veronica Lacey, Director of Education, North York Board of Education Marilyn Lister, President, Consumers' Assaciation of Canada James McCambly, President, Canadian Federation of Labour Bill McLennan, CEO, Atlantic Institute of Biotechnology Jack Munro, President, IWA-Canada Lucille Pacey, Vice-President ,Knuwledge Network Penelope Rmw, Community Services Council, St. John's, Nfld. Donald Savoie, Executive Director, Canadian Institute h r Research on Regional Development Kenneth Thomas, President, Saskatchewan Indian Loan Company William bags, Past President, Canadian Port Council

54 /How Ottawa Spends 43

7he Globe and Mail, October 30,1991;m e 2bmntoStar, November 26, 1991; interview with G. Cosgmve, Prosperity Secretariat, January 8, 1992. The advertising and promotion budget has been controversial. There have been substantial expenditureson public opinion polling, public ~lations,marketing, and media monitoring-which the Opposition has decried as promoting and impming the government's image. See Ihe Globe and Mail, January 29,1992.

The community consultant format was tested in Bridgewater, NS on July 30, 1991 and in Orangwille, Ont. on August 6, 1991. The first sessions w r e held in Kentville, NS and Mterton, Ont. on November 13, 1991. Up to Christmas 1991, 58 community consultationshad taken place in all pruvinces and the Yukon, with 2,000 participants. Another 120 sessions are planned up to the end of March 1992. Community IbbFeedback, vol. 1, January 1992 (a newsletter produced by the Prosperity Secretariat). 44

hsperity Through Competitiveness, p. 40.

45

Recent constitutional discussions have included pmposals fbr a social charter in the Constitution, which wuld include prutectim fir fir11 employment, basic income, universal health care, education, and the necessities of lik.

46

For a fbller exploration and compatative analysis, see Robert M. Campbell, The Full Ejnpbyment Objective in Canada Historical, Conmptual and Comparative Pempectiws (Ottawa:Economic Council of Canada, 1991).

47

See Robert M. Campbell, Gmnd Illrcsions: The Politics of the Kkynesian Experience in Canada, 1945-75(Peterborough: Broadview Press, 1987), pp. 143-54.

48

Ibid., pp. 177-84.

49

The Ontario government's constitutional proposal for a social charter addresses this concern. It proposes that the goal of social and economic security be guaranteed constitutionally so that Canada's social program could not be dismantled. The proposal does not, though, include a guarantee of employment. This

me Conservatives and the Unemployed / 55 approach was given substantial support at the Montreal constitutional conference on the federal government's economic proposals, with Claude Castonguay and the CD. Hawle Institute President, Tom Kierans, giving considerable support to the idea. Ihe Globe and Mail, February 1, February 3, 1992. 50

See Pierre Foumier, "Consensus-Building in Canada: Case Studies and Proposals," in Keith Bating, (ed.), Zhe State and Economic Intemts (Toronto: University of Toronto Press,1986); William D.Coleman, Business and hlitics:A Study of CoIlective Action (Montreal: McGill-Queen's University Press, 1988).

Allan M.Maslwe -

R h m C :Le Financement des programmes hblis (FPE) passe maintenant, aux yeux des provinces et du gouvernement f&&ral, pour un programme qui a hhoud, mais pour divmes raisons. Panni ces raisons, mentionnans : 1 le caracthe ext&mement vague du programme; 2 la liaison, dans un seul programme, des soins de santh et de l'dducation, domaines de politique impliquant des questions t r h diffkntes; 3 I'incapacitk de donner au gowememat f&hral, dans ces domaines de politique, une visibilith correspondant lt l'engagement financier de celuici; 4 un manque de st?curite fmancitm pour les provinces. Cc chapitre examine les raisons possible8 d'une intervention fadrale dans chacun de ces secteurs de politique et soutitat, qu'en g M d , le FPE sert ma1 les objectifs nationaux. I1 n'en reste pas mains que la ndgociation de nouvelles ententes eatre les provinces et Ottawa risque #&re difficile vu les questions substantielles soulevt?es par celles-ci et en raison des environnements fiscaux d constitutionnels actuels.

Abstract: Established Programs Financing (EPF) is now clearly seen by both the

pminces and Ottawa as a failed pmgram, though for d i f f m t reasons. Among the reasons b r its failure arc: 1) the excessive vagueness of the program; 2) the linking of health care and education, policy arcas that involve vcry different issues, in one program; 3) its inability to provide the federal government with visibility in these policy artas commensuratewith its financial commitment; and 4) a lack of financial security for the provinces. The chapter examines possible rationales for federal intavention in each of these policy fields and argues that, for the most part, EPF poorly serves national purposes. Haw~ler,the negotiation of new arrangements between the pmvinces and Ottawa is iikely to be diffcult because of the substantive issues involved, and because of the current fiscal and constitutional environments.

A central component of the Canadian fscal federalism structure has been severely strained in recent years. The existing arrangements for Established Programs Financing (EPF) are included in the Federal-Praincial Fscal Arrangements .and Fedeml Pbst-Secondary Educution and Health ContibutionsAct, which came into force in 1977. The EPF arrangement is now so seriously flawed that it must be replaced or completely restructured in the coming years.

58 /How Ottawa Spends

In many ways this could not be occurring at a worse time. Governments in Canada, both federal and provincial, are close to being overburdened by the demands of coping with deficits and accumulated debt loads, by external trade pressures and structural changes in the economy, and by the turmoil created by trying to address constitutional r e h in an impossibly tight timetable. The need to revamp an important element of the federal fiscal system in this environment is indeed unfortunate. Aside from the simple problem of being able to allocate to EPF the attention it requires, the issues at stake impinge on all of these other problem areas, creating an uncertain atmosphere for the future of these fiscal arrangements. The purpose of this chapter is to discuss the issues at stake in the EPF arrangements themselves and their relationship to the larger policy environment. I argue that EPF is a failed program. What replaces it should be substantially different than the current arrangements, but the prospects for an improved outcome are uncertain at best.

A BRIEF OVERVIEW OF EPF The Established Programs Financing fbrmula came into effect in 1977. It replaced a set of programs under which the federal government helped the provinces to finance medical care, hospitals, and post-secondary education (PSE) on a shared cost basis. Under each of these older programs, Ottawa paid roughly 50 per cent of the provinces' costs. These arrangements were replaced in 1977 because they met the needs of neither the federal nor the provincial governments. Ottawa was dissatisfied because a large chunk of its spending was essentially beyond its control as long as it was tied into an open-ended commitment to pay half the provincial expenditures. In addition, Ottawa was not satisfied that the provinces were spending hgally in the shared cost program areas, because the prwinces were spending 50-cent dollars. For their part, the provinces objected to what they saw as the efkcts of undue federal

'

Reconstructing Fiscal Federalism / 59

intrusion in provincial poli domains and the distortion of provincial government priorities.

Y

Given the complementarity if not the convergence of the federal and provincial complaints, the parties agreed in 1976 to the new EPF arrangements, which came into effect April 1, 1977. In the first five-year agreement, the EPF transfer was composed of two more or less separate components: a tax transfer of personal and corporate income tax points, and a cash transfer amounting to about one-half of provincial expenditures on health care and post-secondary education in 1975-76. The program was structured so that in the first year, a province would generate approximately the same revenues from its tax points as it received in cash from Ottawa. The cash transfer was to be increased annually by the increase in per capita GNP and the population of each prwince; the revenue from the tax points would increase along with the personal and corporate tax revenues the province already received. The popular term given to these arrangements was "block funding." The key innovation of EPF compared with previous arrangements was that it broke the link between the levels of provincial spending in the two policy areas and the amount of federal grants. While the federal government deemed that about two-thirds of the EPF transfer was to support health care and one-third was for PSE, the flexibility of the arrangements allowed each province to treat these revenues in the same way as any other general revenues and allocate resources as it saw fit. Indeed, the EPF money f l ~ e d into the general revenue fund of each province just like any other general operating revenue the provincial gwemment received. This difference in interpretation between the two orders of govemment created friction almost immediately. In 1982, at the time of the five-year renewal of EPF, the funding h u l a was changed. One of the important changes was that total entitlement h r each province was determined fbr the base year, and escalation fhctors for GNP and population growth were applied. From this total the amount of revenue generated by the tax points was subtracted, with the remainder being paid by

60/How Ottawa Spends Ottawa as a cash grant. The cash component of the EPF trans& thus was determined as a residual, and that remains the situation today.

In the years since 1982, Ottawa has unilaterally made a series of changes that have affected the operation of EPF in fundamental ways. In 1983-84 and 1984-85, as patt of the "six and fiven anti-inflation program, the escalator for the PSE component (as Ottawa interpreted the transfer) was limited to 6 per cent and 5 per cent, respectively. This measure reduced the base of the EPF transfer and it therefore has had a continuing effbct on subsequent transfkrs because the escalation fBctor for each year is calculated on a smaller base. In the Budget of May 1985, the EPF escalator was reduced by two percentage points for 1986-87 and thereafter. In April .. 1989, the escalator was reduced by an additional point beginning in 1990-91. In the Budget of February 1990, the GNP escalator was h z e n for two years (1990-91 and 1991-99 and limited to GNP minus three percentage points thereafter. Finally, in the February 1991 Budget, the freeze in the GNP escalator was extended to 1994-95. The Budget of February 1992 introducedm further restrictions, fw the first time in four years. The cumulative effect of all these measures has been to limit the growth of the total EPF entitlement of each of the provinces. Given that the tax points transfer continues to generate more revenue from year to year, the residual cash transfer is diminishing and is projected to approach zero in the not too distant ti.~ture.~ Why is this significant? The Canada Health Act of 1984 spells out five principles relating to the operation of the health care system. These principles will be described below. For the moment, the most important consequence of the declining cash transfer relates to the Act's provision giving Ottawa the authority to withhold the EPF cash payments on a dollar-fordollar basis from any province that permits additional charges, in order to discourage reliance on extra-billing and hospital user fees. As the

Reconstructing Fiscal Federalism / 61

cash grant dwindles, so does Ottawa's ability to enforce its ban on fee for service type charges.

EPF IS A FAILED PROGRAM The frequency of cut backs Onawa has imposed on the EPF program over the last decade is symptomatic of serious underlying problems with the program. In short, EPF is a failure from both the federal and provincial perspective, and it has been for some time. Several factors can be cited in describing this failure. From Ottawa's perspective, EPF falls far short of generating the visibility that should accompany such a large expenditure of resources (over $22 billion in 1992-93, tan points and cash combined). In an atmosphere of high deficits, fiscal restraint, and taxpayer resistance, the federal government regards this large expenditure as politically inefficient because voters are generally unaware of the role Ottawa sees itself playing in the funding of health care and post-secondary education. EPF thus becomes a natural target for federal dissatisfaction, tinkering, and financial cut backs. From the provincial perspective, federal changes and restraint measures are seen as insecurities in one of their more important revenue sources. This is especially the case for the smaller and less well off provinces, for whom stability in flows of federal cash has, in the past, been viewed as a counterbalance to the volatility which their own revenues often experience. Both orden of government were able to take advantage of the excessively vague provisions of the EPF program to express their dissatisfaction in the politically most effective ways. In the process they cultivated even more confusion. For example, provinces sometimes argued that the moneys transferred to them under EPF were untied, that is, they could be allocated as provincial governments saw fit; at other times they argued that cut backs in the EPF transfer would damage provincial health care and postsecondary education systems because Ottawa was reneging on its

62 /How Onawa Spends

commitments to support provincial spending in these areas. Ottawa, for its part, sometimes emphasized its role in the provision of these services, and at others times argued that there was no reason why cut backs in the EPF transfer should unduly a&t healthcare and PSE. It was not until the Budget of February 1991, that a federal cabinet minister explicitly acknowledged that EPF money was not tied to provincial spending in the two policy areas.' As was noted in the previous section, with the projected end of the cash transfer component of EPF, Onawa loses its lever to enforce the provisions of the Gznada Health Ao. Its intention is to withhold other cash payments that would otherwise be made to

the provinces. While this may be legally possible,6 the need for the federal government to resort to such measures simply highlights the failure of EPF to serve federal goals. Perhaps the most fundamental problem with EPF, however, dates from its very inception. EPF brings together, in essentially the same financing model, two very difkrent policy areas. m e substantive issues involved in health care are different from those in PSE; the underlying demographic factors are dramatically different; the administrativeldeliverymodels are different; and the nature of the national interest in these two fields is different. Yet EPF treats them essentially the same in terms of Ottawa's participation. Moreover, as a result, health care and PSE are often 1inked together in pub1ic perceptions and discussions. But, if there is a national interest in these policy fields that transcends provincial interests, a basis for federal programs exists. If the nature of this national interest is not the same in these two areas, the brm of that federal participation should reflect these differences. In the next two sections I explore what these national interests might be and suggest what they imply for the forms of federal participation.

Reconstructing Fiscal Federalism / 63

HEALTH CARE What is the nature of the national interest in the medicare system? The most explicit federal statement of such a national interest is in the 1984 Canada Health Act. Five principles are enunciated. First, health care coverage should be comprehensive in tenns of included services. While coverage is comprehensive across the country, it is wrth noting that in the current arrangements, complete uniformity does not exist. At the margins, eligible services do vary from province to province and within a single province from time to time? Second, coverage should be universal, that is, all residents of a province must be insured. Third, coverage should be portable. This condition is met; however, some interprovincial frictions arise when a resident of one province consumes services in another where the fee schedules for the services are higher. The providing province wants compensation at its higher rate, while the province of origin wants to pay compensation at its lower rate. The fwrth condition is that services should be accessible without user fees. We have already noted how this accessibility objective has been enforced by Ottawa since 1984, and how this condition may shortly be threatened. In addition, it should be noted that two provinces-Alberta and British Columbia-assess premiums, which some would argue is inimical to the principle of accessibility (exemptions for low-income families aside). Finally, administration of the components of the health care system is to be carried out by a public agency on a not-for-profit basis. Here again it should be recognized that the current system has not prevented public hospitals from experimenting with contracting out some functions or from attempting to finesse provincial financing systems, raising a question of the assumed cost advantages of public delivery of services. The question remains. In what sense do these conditions articulate a national interest that would not be met without Ottawa's involvement? And what form should that involvement take? A1tematively, when individuals and groups speculate or charge that lack of a strong federal presence will result in a

64 /How Ottawa Spends

balkanized and diminished health care system, what do they mean?' The argument about the divergence between provincial and national interests becomes an argument that different medical care provision outcomes will be generated at the two levels of govemment. Several specific points arise when one attempts to disentangle these general assertions. At one level, the argument that Ottawa must be there to protect the health care system is an argument that provincial governments would dismantle or at least diminish their systems despite the opposition of their electorates. In its simplest form,this implies a degree of non-representative provincial politics that is not credible. In its more complex form, the argument is that interprovincial economic competition will lead provincial gwemments to impoverish health care systems (as well as other social services) to minimize tax burdens. However, such arguments ignore the contributions of these services to productive and attractive societies. If public medicare can be delivered more eficiently than private market systems, a province could become more competitive by providing high quality service? In any event, there is Canadian and international evidence that could be marshalled to support either position. Another political argument is that voters express different preferences when casting ballots at the federal and provincial levels. While people not uncommonly vote for different political parties at the two levels, they presumably have consistent demands fbr services such as health care. It does not seem reasonable that they would vote to maintain (or increase) health care provision at the federal level and vote to reduce service at the provincial level. Voting for different parties, assuming it is done for strategic reasons at all, is more likely to reflect a strategy of how best to attain a desired set of demands. There are several economic reasons why provincial governments might opt for significantly different health care systems without federal standardization. First, income levels vary widely

Reconstructing Fiscal Federalism / 65 across provinces and .,provincial fiscal capacities reflect these differences. Thus, poorer provinces may not be able to provide the "standard" model for simple affordability reasons. If this is a factor, however, the federal policy response called for would be the amelioration of interprovincial fiscal disparities. The fiscal equalization program does this and, in the absence of EPF, it probably would be necessary for Ottawa to allocate more resources to the equalization program. Second, cost structures may differ among provinces. Factors such as the concentration or dispersion of the population, economies of scale, and the market power of health care deliverers could affect costs. For example, it is less costly to provide a given level of service to a population concentrated in an urban area than to provide the same service to the same population when it is widely dispersed. Similarly, if a particular health professionals' union is able to exercise greater bargaining power in one province than another, costs will be correspondingly higher. In these instances, the province with the higher cost structures may rationally choose to provide fewer or diminished services. One may then argue for federal participation to maintain a national standard level of service. However, it is important to note that if cost differences were the motivation for fkderal action, the appropriate response would be to remove or compensate for the higher cost hctors. This would entail treating provinces differently to achieve a standard outcome. The EPF program does not do this. It treats all provinces essentially the same by providing the same per capita grants.'o A third type of economic consideration that may lead provinces to diverge is a pattern of demand differences. Demographic differences (e.g. age distribution) may lead to differing lwels and types of service demands. The 'national interest" in this case would not be to prevent health care systems from varying across provinces; presumably variation reflecting demographic differences would be desirable. The national issue is whether single provinces should bear the extra costs associated with high demand/need patterns. Here again, however, if the case were

66 / How Onawa Spends

made that national equity demanded a sharing of the additional costs, a non-standard treatment across provinces is implied. A provincial health care system may also turn out to be inadequate because of interprovincial spillwen or economic externalities. If individuals who consume health care services in one province carry the benefits to another (in tenns of productive activities, for example), an externality exists that may lead provinces to provide less than the optimal amount of health care." It is not obvious that these spillovers are serious, but if they are, a federal role to compensate for them may be required.

Another type of externality consideration is what economists refer to as a "merit good" argument. The point is often made that Canada's medicare system serves a broader non-health purpose. It is one of the elements that defines Canadian national identity; it is our statement to one another about our attitudes towards community responsibility and caring. In order to fulfil this aspect of its mandate the medicare system must meet certain minimum standards, and it is the role of the federal government to assure these standards on behalf of the national community. If one accepts some version of this argument, it again leads to the conclusion that the federal presence should be accompanied by some effective policy levers. The current EPF system has one such important lever: the withholding of cash transfers to enforce the desire not to impose user fees. However, as we saw earlier, this lever is rapidly becoming weaker and will soon cease to exist within the structure of EPF itself. In the end, reasonable people might reach different views about the nature of the national interest in health care and the appropriate federal presence that is called for to maintain the medicare system. A strong interpretation of the national interest might lead to the conclusion that Ottawa's intervention is required to ensure the attainment of all five of the publicly stated goals of medicare. If so, consideration of internal and external provincial factors that might lead to the breakdown of these five goals leads to the conclusion that Ottawa must have effective levers to ensure

ReconstruCtr*ngFiscal Federalism / 67 their maintenance. In particular, what is called for is a program that is more conditional than is EPF. Alternatively, one might adopt a weaker view of Ottawa's role in protecting the national interest; provincial interests are not dramatically different from national interests, and for the most part there is no reason why provinces would begin to dismantle the key elements of medicare. One might also argue that there is nothing wrong with interprovincial diflkrences and experimentation. Some provinces, for example, are beginning to consider the redirection of resources to preventive measures, environmental and public health programs, and to community clinic models of service delivery. A national health care system would exist as long as some minimal conditions were met, perhaps portability and universal coverage. In this case, a much less interventionistfederal role would suffice, and a program not unlike EPF would be appropriate as long as a significant cash component to the transfer continued to exist.

POST-SECONDARY EDUCATION The second policy area to which EPF supposedly applies is post-secondary education. The nature of national concerns in this area is quite different than in health care, as will be argued in this section. First, however, it is worthwhile noting that the current arrangements include no explicit national standards comparable to the five goals enumerated in the Cam.& HeaZth Act. Nevertheless, a 'nationalw system of PSE does exist. For example, institutions do not assess an out-of-province tuition fke that is higher than the in-province fee; this is really the PSE countecpart to portability in medicare. Similarly, recognition of de rees and certification from other provinces is standard practice!2 The hct that desirable properties such as these have been maintained by the provinces without any intervention by Ottawa is noteworthy; it at least raises questions as to whether the removal of federal levers in health care will inevitably lead to deterioration of national standards in that field as some commentators have argued.

68 / How Onmw Spends

EPF is the latest of several models of federal participation in PSE that do imply a national interest in this field. What is the nature of this national interest and is it well served by EPF? There are really two national interest arguments that can be advanced. The first is the commonly expressed view of post-secondary education and training as an instrument of ecommic development. Increased productivity and enhanced ability to compete internationally, we are told, are dependent on the developmentof a skilled workfbrce. In economists' terms, we must invest more in human capital. l3 In this context, the question to ask again is: what is the national interest that may not be met without the involvement of the federal government? How might the pattern of PSE actively be different and deficient) if the provinces are left to their own devices?' $ In most discussions of this question, externalities are an important consideration. In this regard there is a parallel with the earlier discussion of health care. In the case of PSE, the externality problem arises when individuals who are educated in one province migrate to another, taking their newly acquired human capital with them. Thus the province that makes the investment is not the province that reaps the benefit. The public investment in an individual's training or education is in the form of the subsidy on tuition fees; actual fees paid by students are often about 20 per cent of actual costs. The direct benefits or returns to that investment that the provincial government would ideally gain are in the form of higher tax receipts from the individual, which reflects his or her higher productivity or income-creating capacity. As well, there is a less direct contribution to the general economy of the province. If the individual migrates to another province after completing his or her education, the receiving province rather than the investing province realizes these benefits. Thus, provinces may rationally choose to under invest in human capital. nble 3.1 provides some information on the magnitude of interprovincial migration. It analyses interprovincial migration retrospectively, and shows the probability of individuals with

Reconstructr*ngFiscal Federalism / 69 Table 3.1 Migration ~ates*by Age and Highest Education Level (pereentag@ Education Lev$

Less than Grade 9 All a es 15-2fyrs. 25-44 yrs. 45-64 yrs

.

Total

Male

Female

1.424 3.702 2.513 1.007

1.515 3.428 2.828 1.048

1.341 4.087 2.203 0.968

3.222 3.558 4.249 2.179

3.297 4.104 4.452 2.208

3.074 2.958 3.890 2.093

4.71 1 5.083 5.762 2.641

4.743 5.001 5.786 2.571

4.680 5.153 5.738 2.705

5.969 5.506 7.621 3.404

6.123 5.292 7.790 3.841

5.815 5.715 7.450 2.961

Grades 9 to 13 All ages 15-24yrs. 25-44 yrs. 45-64 yrs

.

Trades certificate or diploma All ages 15-24yrs. 25-44 yrs. 45-64 yrs.

Other non-university education All ages 15-24 y n . 25-44 y r ~ .

45-64yrs.

University without degree All ages 15-24yn. 25-44 yrs. 45-64 yn

.

University with bachelor's degree oihigher All a es 15-2f yn. 25-44 yrs. 45-64 yn.

Source: Calculated from 1986 census data (Statistics Canada 93-108 and 93-1 10). Note:

Migration Rates indicates the percentage of individuals in each category who have moved from one province to another in the previous five years. Only individuals aged 15 and over are included.

70 / How Onmva Spends

various levels of education moving from one province to another in the five-year period ending in 1986. It indicates that mobility for both men and women increases steadily with levels of education. Individuals with the highest education attainment (bachelor's degree or more) are about six times more likely to move interprovincially than are those with the least education (less than Grade 9). These data are not ideal measures of the externality phenomenon. The base is the total population at each age and education level, not the number completing that level within the province. 'Ihere is also no allowance for the number of individuals who pursue post-secondary education outside their home province. Nevertheless, the table does suggest that the mobility of individuals with post-secondary education, particularly under the age of 45, is potentially large enough to affect provincial government decisions on PSE expenditures. Given that possibility, the pattern of migration becomes interesting. Appendix 3.1 shows that for the three highest education groups (which roughly correspond to provincial PSE institutions), Ontario and British Columbia are the only provinces that clearly are net recipients of migration. Nova Scotia and Prince Edward Island experiencesmall net inflows, though for the highest group they are net exporters of human capital. All the other provinces experience significant outflows. In terms of absolute numbers, net migration out of Quebec is the highest. Alberta, while experiencing a net outflow overall, does have a net gain at the highest level (university degree or more). It would appear then that migration flows of highly educated men and women across provincial boundaries are not offsetting. That is, some provinces are net importers of human capital while others are net exporters. One of the conclusions that might be drawn from these patterns is that the highly educated labour market is national rather than provincial in scope. If so, then policy issues relating to this market are appropriately addressed by Onawa rather than, or in addition to, the provinces.

Reconstructing Fiscal Federalism / 71 A second, and related, economic development consideration may also provide a rationale for federal intervention in pursuit of the national interest. National considerations may include a desired distribution of economic activity as well as views about the pace of economic growth. Canada's long, if somewhat uneven, history of regional development initiatives suggests that this is indeed the case.

The location of capital investment, and of attendant economic development, is determined in part by the education and research Fdcilities of regions. This is especially true of investment that creates much desired, high, value added employment. If the federal government wishes to play a role in influencing the regional distribution of this type of activity, working through the provincial PSE systems may be an attractive vehicle for doing so. Social policy considerations may be another reason for Ottawa to play a role i'nprovincial PSE systems. In addition to

playing a role in economic development, post-secondary education is an instrument of social equity, for the creation of equality of opportunity. If one defines the society in national rather than regional or provincial terms, one opens up the possibility that the federal government has a role to play in the pursuit of social equity

via this route. In summary, it would appear that on the grounds of both equity and efficiency there is a strong role for Ottawa to play in the area of post-secondary education. Moreover, if the mobility of labour is increasing aver time, as is popularly perceived to be the case, then the national interest will increase correspondingly.

CONCLUSION The point of the foregoing discussion has been to demonstrate that

the considerations that enter into substantive discussions of federal-provincial cooperation in the areas of health care and post-secondary education are quite different. Moreover, the current EPF arrangements do not serve the needs of either area of

72 /How Ottawa Spends concern particularly well. The EPF arrangements treat the two policy areas in essentially the same way and treat all the provinces the same. Certainly, it is difficult to see how any one program could simultaneously advance national interests in both areas. And, as we have also seen, most articulations of the national interest would suggest that provinces be treated differently in recognition of differing circumstances. Whatever the substantive requirements of each policy area, however, two other sets of considerations are likely to intervene. The negotiations to renew or replace EPF are beginning in an environment of fiscal restraint and constitutional uncertainty. Both the federal government and the provincial governments are currently facing large deficits. In Ottawa's case, while the deficit has declined relative to the size of the economy and in real terms, it has remained at about the same nominal dollar value fior several years. The provincial governments have come under fiscal deficit pressures largely as a result of the current recession and the restraint on transfer revenues imposed by Ottawa. In all cases, these gwernments feel themselves to be seriously constrained by their fiscal situations, and negotiations over federal transfers are likely to be heavily influenced by Ottawa's need to constrain spending and the provinces' need to protect and (they hope) to increase revenues. The constitutional considerations introduced even more difficult constraints. Both health care and education are within provincial jurisdiction. In the current environment of decentralization, it is difficult to see how Ottawa could make any headway if it were to argue that it had a significant role to play in either area in the name of the national interest. For example, the constitutional negotiations appear to be moving in the direction of weakening the role of the federal government in training and education, exactly the opposite of what was suggested in this chapter. In short, one cannot be very confident that direct considerations in the areas of health care and post-secondary education will carry much weight in determining new federal-provincial arrangements. Fiscal concerns and constitutional negotiations are likely

Reconstructing Fiscal Federalism / 73 to be overriding hctors. What may emerge, therefore, may well be even less suited to support our health care and post-secondary

education systems adequately than is the current EPF arrangement.

Appendix 3.1 Net Interprovincial Migration by Age and Highest Level of Education Total All ages

15-24ym. 25-44yr~. 45-64yte. Less than Grade 9 All ages

15-24ym. 25-44ym. 45-64ym. Grades 9 to 13 All ages

15-24ym. 25-44yrs. 45-64yr~. Trades certificate or diploma All ages 15-24yr~. 25-44yr~. 4544yr~.

w

%

0

BC

ALTA

SASK

MAN

ONT

QUE

NB

NS

PEI

NFLD

9,785 -3,835 1,130 8,455

-20,825 14,220 -30,835 -4,265

-2,880 -3,075 800 10

-2,125 5 -1,155

85,020 21,100 53,320 7,110

-55,775 -15,210 -23,420 -10,600

-1,965 -3,345 545 425

5,305 -75 3,380 1,555

1,070 -340 1,050 270

-15,170 -9,710 -4,475 -895

555 -85 -320 690

-2,060 -10 -1,615 -755

335 130 190 60

-220 -90 130 20

3,185 815 1,265 240

-2,270 -185 5 -720

885 35 265 370

595 50 265 270

250 10 120 60

-845 -620 -160 -105

510 -2,955 -815 2,980

-8,865 6,225 -13,825 -1,505

-295 -1,010 1,115 -95

150 255 760 -525

29,870 10,230 15,990 2,505

-15,955 4,415 -3,890 -3,425

-585 -1,145 475 -10

2,045 -195 1,455 570

400 35 320 65

-6,445 -5,000 -1,155 -280

615 110 60 280

-1,575 80 -1,400 -275

75 5 140 -20

25 10 75 -70

1,940 270 1,250 420

-1,160 -420 -210 -355

110

355 35 180 105

1 45

-400

30 95 10

-140 -220 -35

-

100

-5

.

s

Q

ss

ALTA

Appendix 3.1 Net Interprovincial Migration by Age and Highest Level of Education (cont'd) SASK MAN ONT QUE NB

Othernon-university education All ages 2,105 -1,110 15-24~1s. -310 25-44 YIS. 2,325 45-64ym.

-7,570 4,745 -10,990 -1,100

-255 -1,130 830 120

325 835 -325

21,155 4,345 14,855 1,335

-13,755 -4,180 -5.865 -2,370

University without degree All ages 2,025 15-24 yr~. 55 435 2544 yrs. 45-64yr~. 1,045

-2,120 2,040 -3,520 -445

-700 -525 -55 -30

-700 -130 -430

12,565 2,695 8,270 1,160

-8,355 -2,105 4,055 -1,605

BC

university with bachelor's d c p or higher All age8 15-24 yn. 25-44ym. 45-64ym.

Source:

605

-90

NS

PEI

NFLD

-40 -645 570 15

2,135 10 1,570 500

265 -120 325 30

-3,940 -2,465 -1,265 -190

-985 -900 -155 30

730 45 500 135

145 -120 200 70

-2,140 -1,100 -825 -145

1 3

3.

Y oc

2

3,975 155 2,075 1,130

1,350 1,135 510 -195

-2,040 -550 -1,420 -15

-1,985 -375 -1,370 -165

16,305 2,745 11,690 1,450

-14,275 -1,900 -9,400 -2,125

-1,350 -685 -705 20

Calculated from 1986 census data (Statistics Canada 93-108 and 93-1 10).

-555 -25 -585 -20

-130 -175 -5

40

-1,395 -380 -850 -135

8 '?

& 8

a

1' \

2

76 /How Ottawa Spends

NOTES I wish to thank Peter Chaves for research assistance in support of this chapter. 1

The fi.xferal gweinment did have the authority to audit provincial records to enswe that payments r e f e d to eligible services. H w e r , that did not provide Ottawa with the power to regulate or limit spending in these areas. The audit authority was the source of considerable irritation to the provinces.

2

For a more complete review of the antecedents of EPF, see Alistair Thornson, "Federal Support for Health Care: A Background Papern (June 1991, for the Health Action Lobby), and Allan M. Maslave and Bohodar Rubashewsky, ""Coperation and Confrontation: The Challenges of Fiscal Federalism," in Michael J. Prince, (ed.), Haw Ottaw S ' n d r , 1986-87(Toronto: Methuen, 1986).

3

Total provincial entitlement in these tsw years grew only with provincial populations. These measures, along with a pmision to limit Canada Assistance Plan (CAP)payments to the three provinces not receiving equalization payments (Ontario, Alberta, and British Columbia) were contained in Bill C-69. Seveml provinces challenged Ottawa's right to limit the CAP payments unilaterally, arguing that a contractual agreement with the provinces was being violated. Ultimately, the S u p m e Court ruled (August 1991) that an agreement betmen governments could not limit the authority of Parliament to change the agreement.

4

See the Association of Universities and Colleges of Canada, Statement to the House of Commons Standing Committee on Fiance,May 16, 1990, and statement to the Standing Senate Committee on National Finance, December 20, 1990, and the National Council of Welhre, "Funding Health and Higher Education: Danger Loomingn (Spring 1991). Federal cash payments to Quebec could reach zero by 1996-97. The healthier the economy, the more wenue will be generated by the tax points and the more quickly will the cash transfkr hll to zero.

5

Michael Wilson, Ilhe Budget, February 26,1991 (Ottawa: Department of Finance, 1991), p. 63. "Since block-funding began in

Reconstructing Fiscal Federalism / 77 1977, provinces have been able to use the money according to their own priorities, rather than in the more restricted way mquired by the pxwious costaharing arrangements." 6

Bill C-20, wbich received Royal Assent in December 1991, permits Ottawa to withhold any other money it would otherwise owe to a prwince if that province's cash payment under EPF is less than the dollar-hrdollar withholding called h r by the Crrnada Health Act when the province permits extra-billing andlor user b.Thus Ottawa could withhold the EPF cash payment plus other b d s to equal the amounb being paid by individuals in user kes and extra-billing. Given the logic of the Supreme Court on the challenge to Bill C49 (see Note 3, above), one might expect that any challenge the prwinces might launch against the federal government over Bill C-20 would he lost.

7

Thus, h r example, debates occur in provinces from time to time as to whether a wince's medicare system will cover the costs of therapeutic abortions. Procedures that one might argue are optional or cosmetic in nature are fiom time to time added and removed from a provincial list of eligible s e ~ c e s .

8

See, for example, National Council of Welfare, op. cit.

9

For example, a Canadian-style health care system is being publicly debated in the US, at least partially on the strength of the argument that the Canadian system is more cost efficient. Also see Zhe Ubrld CompetitivenessReport 1991, World Economic Forum (Geneva).

10

To a very limited extent, minor finrding difirences do exist across provinces. They are, however, not at all related to cost differences.

11

A particular vetsion of this phenomenon is the case where individuals live and work in one prwince and then upon retirement, after which health care consumption tends to increase, mwe to another province. This approach is essentially another way of describing the demographic differences referred to above.

12

Universities do have policies and inter-institutional agreements with respect to transferability of courses and recognition of degrees. The point to be made is that this was s o d out among institutions rather than being imposed by provincial gwemments.

THE DEBOF FINANCE AND THE BANK OF C A N ' : THE FISCALAND MONEI'ARY l9LICY MIX Fanny S. Demers RbumC :Une politique fiscale inappropride depuis la fin des a n n k 1970 et le manque de ddtermination de la part du gouvernement de s'attaquer plus t8t au dbficit budgthire a e m W C le gowemement de se s e ~der la politique M e aux fins de la stabilisation d u m t la p r h n t e n?cession. Vu le d&cit bid ainsi que le rapport dl& ddte-produit indrieur brut, il est m?casaire d'adopter une politique misant sur la .prudencefiscale, en pmant des mesures afin d'assunx, h I'avenir, un meilleur contr6le des d6penses h tous les paliers de gouvernemmt. La dduction des ddficits ainsi qu'un taux d'inflation bas et stable sont des conditions sine qw nun afin de promouvoir la comHitivit6 de I'hnomie canadienne. Ce chapitre traite de la politique monetaire et fiscale canadienne et considere le coot des dkficits budgetaim importants, la signification des rapports dette-produit inerieur brut ainsi que l'objectif de la stabilitk des prix. Lea propositions constitutio~ellessur la dforme de la Banque du Canada et sur I'harmonisation fucale sont bgalement analysh. Abstract: Inappropriate frscal policy since the late 1970s led to an accumulation of debt, and the lack of resolve in tackling the deficit problem sooner forced the Canadian government to forgo the use of fiscal policy as a stabilization tool in the current recession. In view of the high Canadian deficit and debt-tu-pss domestic product (GDP)ratio, it is neocssary to pursue a policy of 'fiscal prudence." Measures to control spending at the provincial and federal levels of government are needed to ensure better overall deficit performance. The pursuit deficits and of low and stable ratcs of inflation is a sine qua non for of 1-r achieving greater compditiveness. This chapter addmses the conduct of fiscal and monetary policies in Canada, considering the costs of large budget deficits and the significance of high debt-to-GDP ratios, as well as the goal of price stability. The federal constitutional proposals regarding the reform of the Bank of Canada and fiscal policy harmonization are also examined.

On February 25, 1992, Finance Minister Don Mazankowski presented his first budget to the House of Commons. Despite the unexpected tenacity of the recession, the Finance Minister resisted the temptation to abandon deficit control and resort to extensive fiscal expansion. The deficit had grown to $31.4 billion,

80 / How Ottawa Spends overshooting its target for the 1991-92 fiscal year (as indicated in the 1991 budget) by only $0.9 billion. This relatively small increase in the deficit is consistent with a stabilization of the debt-to-gross domestic product (GDP)ratio in the medium term. Thus the deficit appears to be almost under control, the recession notwithstanding. The control of the deficit was designed to reassure financial markets and avoid an increase' in the risk premium on Canadian debt, thus allowing interest rates to remain at low levels and, in the best case, continue their downward trend. The Budget contained selective spending cuts amounting to $1 billion, accompanied by targeted tax credits and subsidies including some measures allowing households to use their registered retirement savings plans (RRSPs) to purchase homes. These measures may provide some very mild stimulus. More specifically, in view of recent polls indicating persistently low consumer confidence1 and in view of high consumer indebtedness, they may improve consumer confidence and induce the purchase of housing and other consumer durables that may help, in turn, to start a recovery. The recession is still unabated. The unemployment rate reached 10.4 per cent in January 1992 and the gross domestic product declined by 0.8 per cent in 1991. The persistence of the Canadian recession can be explained in great part by the length of the US recession, which has now spread to the European Community-Canada's second biggest customer after the US. The Canadian economy is highly sensitive to economic conditions in the US as well as in its other major trading partners. Exports account for 26 per cent of the GDP, with fully threequarters of exports going to the US. Figures for the first few months of 1992 seem to indicate that a recovery may be under way in the US. While the unemployment rate in that country was 7.3 per cent in February and expected to rise further, some leading indicators seemed to provide more encouraging signs. In particular, sales of new houses increased by 13 per cent in January and private housing starts were 27.4 per cent higher than a year earlier. Retail sales were also on the rise.2 A recovery in the US would translate

Fiscal and Monetary Policy Mix / 81 into increased demand for Canadian products and could lead us out of the recession. In this chapter, it will be argued that inappropriate fiscal policy since the late 1970s led to an accumulation of debt, and that the lack of resolve in tackling the deficit problem sooner forced the Government to forgo the use of fiscal policy as a tool to stabilize the business cycle in the current recession. It is important to recognize that fiscal and monetary policies have a direct effect on the competitiveness of a country. Since greater competitiveness is directly related to increased productivity and growth, monetary and fiscal policies should be geared towards providing an environment that is conducive to greater productivity. As is explained below, high budget deficits have a detrimental impact on the rate of investment and thereby reduce the growth potential of an economy. High rates of inflation, in addition to their welfhre costs, also induce an inefficient allocation of resources. Economic growth is again adversely affected. The pursuit of lower deficits and of low and stable rates of inflation is a sine qua nun for achieving greater competitiveness. In view of the high Canadian deficit and debt-to-GDP ratio, the above argument points to the necessity of pursuing a policy of "fiscal prudence." Measures to control spending are needed to ensure better deficit performance. In this light, the legislated spending limits adopted by the federal government may be seen as a move in the right direction. However, certain improvements in accounting practices may be necessary to ensure that this measure has its intended effect. There should also be mechanisms to bring about intergovernmental cooperation to limit overall public sector deficits.

This chapter addresses the conduct of fiscal and monetary policies in ~ a n a d aThe . ~ discussion will focus on the costs of large budget deficits, on the significance of high debt-to-GDP ratios, and on the intimate link between fiscal and monetary policies. In addition, the goal of price stability will be assessed, and an evaluation of the federal constitutional proposals regarding the

82 /How Ottawa Spends

refonn of the Bank of Canada and tiscal policy harmonization will be provided.

THE DEFICIT Since the 1989 budget, the Government has taken a variety of measures, such as the 1990 Expenditure Control Plan, in order to stabilize the debt-to-GDP ratio. The goal has been to achieve a reduction of 50 per cent in the deficit by 1994 (from $30.5 billion in 199&91 to $16.6 billion in 1993-94), leading to a reduction in the debt-to-GDP ratio! As stated in the 1991 budget, By 1996, Canadians, under this scenario, can achieve an economy with no g w e m e n t sector deficit, no current account deficit, no net reliance on fbreign savings, and lw inflation.'

This sanguine outlook was partly due to predictions that the current recession would be of much shorter duration and depth than it has actually turned out to be. In fact, in its 1991 budget, the Government predicted that '[tlhe current recession will last until mid-1991 ... profits are expected to remain nearly flat in 1991 before rebounding in 1992. Unfortunately, the recession is still with us in the first half of 1992, and profits have plummeted to such an extent that a 28.4 per cent decline in corporate income tax revenues relative to 1990-91 is predicted. According to the 1992 estimates, a $2.6 billion shortfall in corporate income tax and a $2.7 billion dollar shortfall in personal income tax are expected relative to the 1991 budget estimate.'

"'

In total, the 1992 budget predicts a revenue shortfall of $4.4 billion for 1991-92 and of $7.5 billion in 1992-93 relative to the revenue estimates of the 1991 budget. On the other hand, total budgetary expenditures for 1991-92 were lower than those predicted in the 1991 budget, in spite of the higher than expected unemployment insurance payments which are estimated to exceed last year's budget projections by $1 billion. The two components of total budgetary expenditures, program spending and public debt charges, were both substantially lower, the first due especially to

Fiscal and Monetary Poliq Mix / 83 year-end budget freezes and the full funding of public pensions, and the second due to the lower than expected interest rates. Some respite has come from the substantial decline in interest rates which permitted debt servicing charges of only $41.5 billion, $1.7 billion below the government's 1199 estimate. As a result, the budget deficit for 1991-92 is $31.4 billion-$0.9 billion in excess of the 1991 prediction-while the 1992-93 budget deficit estimate is $27.5 billion or $3.5 billion higher than predicted in last year's Budget. The deficit will, therefore, remain at 4.6 per cent and 3.8 per cent, respectively, of the GDP in these two years. At 61 per cent, the debt as a percentage of the GDP will also be higher than expected, and its decline would start one year later than predicted in the 1991 budget-in 1994-95 instead of 1993-94. The deficit predictions for 1993-94, 1994-95, 1995-96, and 1996-97 are $22.5 billion, $14.5 billion, $8.5 billion, and $5.5 billion, respectively. While these figures indicate some slippage in the government's effort at deficit control, it would not have been desirable to adopt more restrictive policies than the present ones given the high unemployment rate of 10.4 per cent (in January 1992)~and the necessity to maintain the income support programs during the recession. It is important to keep in mind, however, that these budget predictions depend upon the interest rate, the rate of inflation, and the rate of growth of the real GDP that are expected to prevail in the next few years. Thus, for example, the government's estimates on debt servicing charges in 1992-93 (and the years following) are substantially lower than those indicated in the 1991 budget. These estimates are based on expectations of relatively low nominal interest rates. The interest rate is expected to be 6.9 per cent in 1992 and 6.5 per cent in 1993, and to stay on average at 6 per cent per year during the following three However, even if the rate of inflation may be expected to remain approximately at the targeted levels, nominal interest rates may turn out to be higher, partly because demand pressures on world capital markets exerted by the East European countries and the former Soviet republics

84 /How Ottawa Spends

are leading to higher real interest rates. Another factor is the current election year policy stance of the US government. The US deficit is likely to remain high and may exert additional upward pressure on real interest rates. 'Zbese fhcton could easily drive up the estimated public debt charges and derail the deficit projections of the Government. Similarly, the Budget estimate of the real GDP growth rate, which in turn determines the growth of future government revenues, is also somewhat optimistic. While the 1992-93 growth rate of 2.7 per cent is in line with the projected 2.9 per cent growth rate on average for Organization for Economic Cooperation and Development (OECD) countries during the same period, there are indicationsthat none of the OECD countries will experience as high a rebound from the current recession as they did in the aftermath of the 1981-82 recession. Therefore, the projected 4.5 per cent GDP growth rate announced for 1993-94 may not be totally realistic. All these hctors seem to indicate that the deficits ahead might be higher than expected. The important lesson to be drawn is that future governments should pursue a policy of controlling expenditures very tightly and not yield to the temptation of increasing budgetary deficits in the future. With the exception of Italy, Canada has the largest debt-toGDP ratio among the group of seven most industrialized (G-7) countries.'' From a postwar low of 18.2 per cent in 1975, the debt-to-GDP ratio has risen steadily to reach 54.9 per cent in 1990. From 1978 to 1987, thftebt-to-GDP ratio increased by 3.3 per cent per year on average. It is only since 1988 that there has been a significant change, with the debt-to-GDP ratio increasing by only 0.3 per cent per year on average, especially due to recent federal govemment attempts to reduce the primary bud et deficit, which in 1990 reached a surplus of about $9 billion. I f The current government only truly started to attack the deficit problem in 1988, instead of during the relative periods of boom that the economy enjoyed from 1983 through 1987.'~ Moreover, while the increase in the debt-to-GDP ratio was substantially lowered in 1988, the Government did not seize this

Fiscal and Monetary Policy Mix / 85 opportunity to undertake more substantial reductions in the deficit. Reflecting on the 1988 budget, Neil Bruce and Douglas Purvis note: The trajectory b r the debt ratio is unchanged from the previous budget-this of course is a mssuring change fiom the sequence of past budgets where the pesk was moved successively higher and hrther into the future. Nevertheless, it is less reassuring to note that, at a time when the economy is relatively buoyant, the guvernment saw fit to use the "fiscal dividend" from unexpected higher tax rwenues and lower program outlays to fund new spending rather than to further reduce the deficit. l4

The debt-to-GDP ratio indicates the ability of a govemment to honour its debt by raising taxes. Since the level of the GDP is an indication of the taxing potential of a government, a very high debt-to-GDP ratio may in principle lead to fears that the Government may default on the debt. While there is no doubt about the solvency of the Canadian government, in recent years financial markets have reacted to an increase in the Canadian debt-to-GDP ratio by attaching higher risk premiums to Canadian debt, thus contributing to higher interest rates. Recalling that increasing the rate of inflation through money creation is one way of at least partially defaulting on the debt," a high debt-to-GDP ratio may also influence inflationary expectations if the public starts to believe that the Government can no longer contain the increase in the deficit. l6 Since long-term debt is particularly vulnerable to the possibility of partial default through inflation, the Government would have to fsvour short-term wer long-term debt in order to restore the confidence of its lenders. l7 However, this emphasis on short-term debt prevents the Government from adopting the optimal risk characteristics for its debt which would require holding debt of all maturities.'* It is commonly agreed that the desirable conduct of fiscal (and monetary) policy should be determined by focusing on medium- and long-term e f f m rather than on short-term effects. This view is motivated by the difficulties involved first, in

86 /How Ottawa Spends

establishingthe source of economic disturbance; second, in determining the most appropriate policy response to counter the disturbance if the latter is identified; and third, in implementing the chosen policy given the large lags involved in the adoption of a policy, in its implementation, and finally in the response of the economy to that policy. Fine-tuning of the economy is really impossible. Instead, longer term objectives should be pursued. In particular, large budget deticits and high debt-to-GDP ratios should be brought down to sustainable levels since high levels of debt-financed government deficits are damaging to the long-term growth prospects of the economy. Yet, the very high government budget deficits and high levels of debt in many of the OECD countries (among them Italy, Belgium, Canada, and the US) seem to run counter to this view. Traditionally, the mode of financing government expenditures depends on when the benefits of those expenditures are expected. Thus,in the case of expenditures involving, say, investment in infrastructure where the returns are expected in the future, it is logical to defer payment to the future by running a deficit financed by borrowing from the public. If, instead, the benefits of the expenditures are expected in the very short run (for example increases in unemployment insurance benefits), then it would be more appropriate to use taxation as a means of financing this expenditure so as to assign the costs to the generation that also receives the benefits rather than to shift the burden to a future generation by using debt-financing. In practice, it is also desirable to have deficit spending in years of depression which is then offset by running surpluses in years of expansion. The underlying logic is that budgets should be (at least approximately) balanced, not on a year-to-year basis but wer the business cycle. However, in recent years many industrialized countries, among them Canada, have been deprived of considerable flexibility in their attempts to bridge the current economic downturn due to a high level of indebtedness. Large deficits and high debt-to-GDP ratios have prevented these

Fiscal and Monetary Policy Mix / 87 countries from using somewhat more expansionary policies, such as greater spending, to mitigate the recession. Why did governments depart so significantly from the general logic, outlined above, about the timing of deficits and surpluses, on the one hand, and on the matching of "the term structure" of benefits and costs of government expenditures, on the other? Throughout the 1980s most govemments of developed, as well as less developed, countries have been undertaking more government expenditures than they could pay for through the tax revenues they were raising. Given their unwillingness to reduce spending, govemments faced three choices in financing the difference between expenditures and revenues: a) increasing taxes; b) increasing the rate of growth of the money supply; or c) increasing government debt by selling bonds to the public and to foreigners.

Tlvr financing of the deficit, apart from being a very unpopular and often a politically unacceptable choice, also came under attack in the early 1980s from "supply-side" analysts. According to the supply-side argument, increasing taxes had the impact of reducing the incentive to work, thus leading to afhll instead of a rise in government revenues. Thus, a cut in taxes (when the latter are too high) could potentially lead to an increase in total tax revenues. l9 An important additional fictor limiting the capacity of governments to raise taxes has been the growing integration of world markets. Multinational firms, especially in high technology industries, have become increasingly "fwtloose. " A relative decline in transportation costs has permitted these firms to choose the location of their production facilities according to the economic environment (including the government policies) that they find most propitious. In this context, a country can no longer choose its policies unilaterally, but must take into account the policies of other countries that are potential competitors in terms of attracting new investors or even maintaining those that are

88 /How Ottawa Spends

currently located in that country. Having higher taxes is certainly a handicap in this respect. Governments have thus been forced into a situation where they have to compete among themselves in terms of the policies they adopt. International tax competition motivated the tax reform package proposed by the Canadian government in October 1986. This tax reform proposal, introduced with the Blue paper entitled 'Guidelines for 'hx Reform in Cariada," was a response to the adoption of the 1986 US Xu ~ c t . ~The ' final tax package that was adopted in Canada included features similar to those in the US package. Personal and corporate income tax rates were lowered, income tax brackets were reduced to three, and the tax base was broadened.?' The failure to introduce such a refirm would have put Canada at a competitive disadvantage. These various considerations, in addition to the political costs involved in raising taxes, have forced governments to resort to means other than taxation in order to finance their expenditures.= The second mode of financing, which increased expenditures by increasing the money supply, was also not seen as a viable alternative in the aftermath of the highly inflationary mid-1970s. The high rates of inflation of the late 1960s and 1970s-the result of monetary expansionism compounded by the oil and food shortages of the 197th-had destroyed the credibility of gwemment promises to fight inflation. These earlier inflationary policies had a substantial cost in the 1980s. Inflationary expectations, which led to even higher actual rates of inflation, could be kept low only if the Government could credibly commit to low rates of gmwth of the money supply. Convincing the public of the government's resolve to fight inflation and taming inflationary expectations necessitated the adoption, both in the US and in Canada, of more stringent deflationary policies than would have otherwise been required. Since money-financing was ruled out, the only remaining choice for governments that persisted in increasing their spending levels was to resort to financing their deficits by issuing debt. 'Ihe 'easy money" policy of the 1970s was replaced by easy fiscal

Fiscal and Monetary Policy Mix / 89

policy in the 1980s. Perhaps the seeming lack of concern about the possible impact on the economy of continuous debt-financing, may, in part, be attributed to the influence of the so-called Ricardian view on the effects of bond-financed budget deficits, which reaches conclusions contradicting the more traditional view. Traditional analysis indicates that debt-financed government deficits lead to greater expansion in the GDP than tax-financed deficits, in the short-term." It is, however, the medium- to long-term eficts that are detrimental to the economy. Consumers who purchase government bonds regard them as claims to a stream of future income. Their expected lifetime wealth is increased. Given that consumption increases with lifetime wealth, individuals consume more and, hence, save less. The fall in savings in turn leads to an increase in the real interest rate, an appreciation of the currency, and a current account deficit." The increase in the real interest rate leads to lower rates of capital accumulation (i.e. investment) and hence to lower the burden of current profligate consumption levels is shifted to future generations, leaving a legacy of debt26 and thereby also reducing the growth potential of the economy. By contrast, according to the Ricardian view, which was revived in the mid-1970s by Robert ~arro?' budget deficits have no impact on the economy. Consider a reduction in taxes accompanied by an increase in borrowing to finance the resulting increase in the deficit. If individualstook into account the fact that taxes will eventually be levied in the future to pay for the interest as well as the principal of the current bond issues, then they would realize that the discounted value of the tax exactly ofiets the discounted value of the revenue stream provided by the bond. Hence, they would not consider the bonds as net wealth and they would nbt increase their current consumption, so that savings as well as the interest rate would remain unchanged. In short, the debt-financing of the deficit would have no real effects on the economy. The Ricardian scenario involves an increase in the deficit caused by a cut in taxes rather than an increase in spending

90 / How Ottawa Spends

as has more characteristically been the case for most countries considered. How would consumers in a Ricardian world react to a current debt-financed increase in spending? They would expect that the Gwemment wwld eventually have to increase taxes in the future in order to repay the debt plus interest. Therefore, they would immediately reduce their consumption and increase their savings in anticipation of the future tax. Thus, according to this view, financing a current increase in spending by a current increase in taxes has &actly the same impact on the economy as financing it through debt with an increase in taxes in the future. As Paul Krugman suggests, The point is not that what the government does is unimportant, but rather that the decision whether to tax naw or later, to run a deficit or raise taxes immediately is irrelewant.. In practice, one does not hear Barro's views expressed directly in [the] comdors of power. But they do play an important role in maintaining a climate of doubt about whether the budget deficit is really a serious

..

The Ricardian view is, in general, not very strongly supported by the d a d 9 The current "mainstream" view is more in line with the traditional view described above, which prescribes fiscal prudence as the logical path to take in order to avoid the dam ing implications of high government debt fix future growth? in formulating government policies, at least one reason for expressing scepticism with regard to the Ricardian view and its implication that the size of the debt does not matter is that the economy would incur great costs in the future should this view turn out to be wrong. The Canadian govemment has also more recently-although belatedly-adopted a philosophy in fiscal matters that supports fiscal discipline. The 1992 federal budget indicated the government's determination to pursue its medium-term goal of reducing the deficit and of stabilizing the debt-to-GDP ratio, in spite of the recession, and to resist the temptation (certainly

Fiscal and Monetary Policy Mix / 91 present in a preelection period) to follow more expansionary fiscal policies. Several other OECD countries with high debt-toGDP ratios and large 'sustainability gaps"31have also been forced to adopt policies to counter the effect of 'automatic stabilizers," which tend to increase the debt during a recession?* Since automatic stabilizers are in place precisely to counter the decline in aggregate demand and alleviate the hardships of the recession, the need to neutralize them for the sake of stabilizing the debt is an additional cost of not having attacked the deficit problem during the period of economic ease in the mid-1980s. The legislated spending limits proposed in the 1991 budget were intended to limit the growth rate in program spending to 3 per cent per year for the next five fiscal years starting from 1991-92, as compared with the 4 per cent growth rate in effect since 1984-85. The draft legislation was submitted to the Standing Committee on Finance in July 1991. Following the Committee's report in November 1991, several changes were made to the legislation. The revised draft legislation on spending limits, presented to Parliament on February 14, 1992, now excludes the major self-financing programs-such as unemployment insurance, agricultural commodities stabilization accounts, the gross revenue insurance plan, and the crop reinsurance plan. 'This move is certainly appropriate: since these accounts tend to vary widely over the cycle, they would cause wide swings in spending and could potentially derail the goal of reaching the stipulated spending limits. First, as the Unemployment Insurance Fund is now financed by the contributions of employers and employees, it is not threatening to escalate the deficit. Furthennore, one would expect this Fund to display a significant amount of cyclical variability. In fact, the Fund would go from a deficit position during a recession-as benefits increase-to a surplus during a boom. The income stabilization programs for farmers entail sizeable but temporary expenditures when world markets are depressed, as is the case in 1991-92. The high variability of expenditures in these accounts would require complicated carryovers from year to year. As a result, it would be difficult to detect whether the spending limits were in fact being respected. The

92 /How Ottawa Spends

removal of these programs from the spending limits permits better accountability and transparency of the government's practices.33 In the same spirit, the draft legislation has also brought about a reduction in the number of years required to compensate for overspending in a particular fscal year: whereas the 1991 budget vaguely stipulated that 'the spending excess must be deducted from the maximum authorities for the succeeding fiscal years in such proportions as the Minister of Finance shall determine,"34 the Spendng Control Act specifies that any overspending in one year must be recovered in the following two years?S The possibility of reallocating spending excesses to other years in this manner provides the needed flexibility to preserve credibility: unexpected events (such as an unexpectedly lengthy recession) could potentially lead to spending that exceeds the indicated limit for a given year, thus endan erin the credibility of the announcement of fiscal restraint. 6 The spending limits are also expressed in dollar terms, with a total budget of $615.3 billion from 1991-92 to 1995-96. One concern with this specification is that the spending limits are fixed in nominal (current dollar) terms as opposed to real (constant dollar) terns. With high rates of inflation, a 3 per cent nominal increase in spending may constitute a severe constraint. However, if the inflation rate remains low, at 2 per cent, a 3 per cent increase in spending may be excessive. It would therefore be preferable to express these limits in constant dollar terms." Another problem stems from the accounting definitions used to differentiate increases in expenditure f'rom tax cuts. For ex-

ample, should the new child tax benefit-a tax credit-be counted as a reduction in tax revenues or as an increase in public expenditures. In general; this tax credit will benefit low- and middleincome families who are likely to spend rather than save most or all of this incremental income. In terns of its economic impact, it would therefore seem more appropriate to count this tax credit as an expenditure rather than as a reduction in revenues. Yet the hrmer route increases spending, while the latter does not. If the latter route is followed, spending would be underestimated. At the

Fiscal and Monetary Policy Mix / 93

same time, there are other instances where spending may be overstated due to inappropriate accounting. This was the case with the "tax backs" of old age security pensions and of family allowances in recent years: whereas these were in fact expenditure reductions, they were counted as increases in revenues. In each case, the exact accounting practice followed will affect the success of the Government in meeting the spending limits. A clarification of accounting practices is therefore necessary to ensure accountability and transparency?* The legislated spending limits have also been criticized as being non-binding, devoid of content, and ineffective in a parliamentary democracy such as Canada's. According to Frances Abele, Under the Canadian system of government, a government cannot pass laws that are binding on its future legislative capacity or the legislative capacities of firhue gwernments. The new legislated spending limits are constitutional nonsense.39

Furthermore, Abele argues that, Such a legislated spending cap makes mom sense in the United States, since their system h r expenditure management incorporates significant checks and balances, and significant negotiation and struggle behwen the legislative and executive branches. Canada's fusion of executive and legislative p e r in the Cabinet operates on just the opposite principle, with Parliamentary oversight and public debate providing the comparable "check.

In the US, the counterpart to the legislated spending limits is the US Balanced Budget and Emeqency Deficit C o m l Act (also known as the Gramm-Rudman-Hollings (GRH) Act), adopted by the US Congress in 1985with the objective of reducing the federal deficit to 0 per cent in the 1991 fiscal year. Across the board, budget cuts were to come into effect if the deficit targets were exceeded. Although it could be argued that the US system of government checks and balances would have made such a deficit

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control plan effective, the alldominant influence of interest groups on the US Congress has made it impossible to make significant headway towards eliminating the deficit. The GRH Act had many loopholes. First, it targeted only the profected deficit. But typically the economic forecasts used by Congress have been overly optimistic, thereby justifying greater spending. Second, supplementary budgets were adopted during the fiscal year to provide for additional spending. As early as 1987, it became clear that the 1988target for the US deficit would be exceeded. New deficit targets were set for the years to come, but these were not met. Since little progress was being made towards reducing the deficit, the Budget Enfbxement Act of 1990 was adopted to control spending instead of the deficit. Short of having a constitutional amendment to set limits on deficits, the success of deficit control rests on the political determination of the elected representatives. In this regard, it could even be argued that the American system makes deficit reduction more difficult than does the Canadian system, given the diffusion of authority in the US (between the presidency and Congress) and given that the US Congress is a captive of interest groups. While the Canadian legislated spending limits have some important (though remediable) deficiencies in their current form, and they are certainly not as binding as if they had been introduced in the Constitution, the fact that they would be imposed through legislation is a move towards fucal responsibility. A detraction from these limits by this Government or by a future government will require further legislation, making the act very visible to the opposition, the electorate, and financial markets, in contrast to a routine increase in budgetary expenditures, something to which everyone has grown accustomed. This is a way of at least partially committing a future govemment to the spending limits through political pressures. Another measure adopted in the 1991 budget that has received wide criticism is the establishment of a Debt Servicing and Reduction Fund that will collect GST revenues, net

Fiscal and Monetary Policy Mlx / 95 privatization proceeds, and gifts to the Crown to service and eventually reduce the debt. me establishment of this Fund has been criticized as a' purely cosmetic gesture" and as 'smoke and mirr~rs."~'Thus, in spite of the appearance of a move towards 'trust fund accounting," which involves the earmarking of tax proceeds for certain expenditures." this measure has mt truly created a trust fund. Instead, as Abele points out, 'Once the revenue is collected, there is no way to tell 'GST dollars' from other tax income or from foregone expenditures."43 The macroeconomic effkts of fiscal policies at the federal level can be offset by budgetary actions taken at other levels of government.* The provincial govement, local government, and hospital (PLH)sector, which experienced a temporary surplus in 1988, has accounted for almost half the increase in the general gwernment deficit in 1989 and 1990. A major contributing fkctor has been the increase in spending in the province of Ontario to counter the effkcts of the recession, which was particularly severe in that province. However, the threat of a downgrading of their bond rating on financial markets imposes a fiscal discipline on the PLH sector. There are nevertheless issues of overall spending restraint or deficit control that need to be addressed in collaboration with other levels of gwernment. These issues will be discussed below in the context of the constitutional proposals on fiscal harmonization.

MONETARY POLICY The federal government did not have any fiscal margin in which to manoeuvre during the current recession. What about monetary policy? As it turns out, the overly lax fiscal policies of the 1980s have forced the Bank of Canada to put too much emphasis on monetary restraint in its fight against inflation. Only more recently, in response to the effbrts towards deficit reduction, has monetary policy eased somewhat. In 1990, overly tight monetary policy could also have been motivated by excessive concern about the depreciation of the

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Canadian dollar. The slower growth of M1 (a monetary aggregate composed of currency and demand deposits) since 1988 had resulted in lower inflation in 1990. However, in January 1990, the Canadian dollar began to slide in reaction to a fall in interest rates of 0.25 per cent. Reacting to this observed instability of the Canadian dollar, the Bank of Canada took action to prevent the Canadian dollar from losing value against the US' dollar. As a result, according to several indicators, the Bank pursued too restrictive a monetary policy in 1990; for example, M1 actually fell in the fmt three quarters while M2 (which includes deposits and personal term deposits in addition to currency and demand deposits) rew at a much slower rate than in the first three quarters in 1989.4 f This contributed to an earlier recession in Canada than in the US. In fact, the GDP fell at an annual and seasonally adjusted rate of nearly 5 per c z t in the fourth quarter of 1990 and in the first quarter of 1991. Thus, it appears that monetary policy could have been somewhat more expansionary in the early 1990s if the Bank of Canada had not paid as much attention to the exchange rate.47 Yet, in spite of this episode, as Peter Howitt points out, current monetary policy has in fact been less tight than it was between 1980 and 1984.

Inflation Targets The 1991 federal budget contained an important policy announcement. In an unprecedented move, the Minister of Finance and the Governor of the Bank of Canada made a joint announcement regarding future inflation targets. They made a commitment to lower the increase in the consumer price index (CPI)(excluding food and energy) to 3 per cent by the end of 1992, to 2.5 per cent by the middle of 1994, and to 2 per cent by the end of 1995, '. .. and to making further progress toward price stability thereafter."" The target rates are regarded as midpoints of a target inflation band with a 1 per cent margin on either side. However, it will be the midpoints that will be the objective of monetary policy, and corrective action will be taken in case of deviations from the target rate so as to meet the inflation target during the following period. It is important to note that temporary

Fiscal and Monetary Policy Mix / 97 adjustments will be made to the inflation target in case of large changes in indirect taxes in order to accommodate the first round effects of these taxes on the price level. One of the goals of this announcement is, clearly, to indicate the support of the Department of Finance for the bank's pursuit of "price stability." The announcement permits a mutual reinforcement of the credibility of both fiscal and monetary policies. The Bank's promise of maintaining low inflation rates would calm inflationary expectations, thus leading to lower rates of interest and, thereby, l w debt servicing charges-an essential factor if budget deficit targets are to be met. At the same time, the endorsement by the Finance Department of the inflation targets further dampens expectations of inflation by reassuring financial markets that the Government will not succumb to the temptation of monetizing the debt and of inflating its way through the recession by inducing the Bank to accommodate a higher money growth rate. Clearly, in a democratic setting, this joint statement has no binding efkct on future governments or future budgets. David Laidler suggests that this move may lead to a crisis should a fuhlre government decide to depart from the announced targets." In that case the Minister of Finance of the new government could issue a directive to the Governor asking the Bank to abandon its policy. If the Governor complies, the Bank of Canada's independence and credibility would be undermined. Alternative1 if the Governor refirses to comply, he would have to resign? Financial crisis could result in both cases. An alternative scenario leading to the same result would occur, according to Laidler, if the Bank continues to pursue tight monetary policy even though the inflation rate blls below the target of 3 per cent. Then, faced with the pressures of an election year, the very government that endorsed the inflation targets could legitimately ask the Bank to pursue an easier monetary policy given the lower than necessary rate of inflation. However, it would seem that given the current mandate of the Bank of Canada, and given that the latter's accountability to

98 /How Ottawa Spends the electorate is maintained through the directive power of the Minister of Finance, the above scenarios are always possible should dissension arise between the Gwement and the Bank. The joint announcement made in the Budget should not, in and of itself, make such an outcome any 1ikelier. Legitimate concern could be expressed with regard to whether the Bank would continue to pursue a tight monetary policy even if the targets were met. This mwe could be motivated by the fm belief of the Govemr that price stability should be pursued in the literal sense of a 0 per cent inflation target. The Bank of Canada, right from the outset, has left no doubt as to its own interpretation of the goal of price stability: in his Eric J. Hanson Memorial Lecture, Governor John Crow indicated specifically that any target other than 0 per cent inflation would simply not be a credible one to pursue.s1 Alternatively, continued pursuit of an overly tight monetary policy could be motivated by a desire to prevent (or reverse) the depreciation of the Canadian dollar.'* There is a need to carefully distinguish between the costs of high inflation rates (above 4 or 5 per cent) and the costs of and stable inflation rates (2 to 3 per cent). The next section briefly outlines the Costs of high inflation. Thereafter, the notion of price stability is discussed.

The Costs of Inflation There are substantial ben&ts to achieving low rates of inflation. High, or even moderate, rates of inflation have important co~ts.5~ Inflation tends to redistribute income from lenders to borrowers; it induces "bracket creep" such that individuals are pushed into and those on higher income tax brackets simply due to inflati~n?~ fixed nominal incomes (such as old-age pensioners) suffer, as their buying power is eroded. Moreover, several tax measures such as tax deductions and depreciation allowances are set in nominal terms. Therefore inflation increases the burden of taxes fbr both individuals and firms. Some of these efkcts can be avoided

Fiscal and Monetary Policy Mix / 99

through full indexation of all tax measures. Full indexation is not typically observed, however, and may not be desirable in some instances. To the extent that we have only partial indexation, most of the costs of inflation will be borne by the public. Thus high rates of inflation, even if anticipated, have welfare consequences and that cannot be entirely alleviated income redistribution &ts through partial indexation. In addition, when inflation is high it tends to be more variable and, hence, more difficult to forecast.5s Finally, high rates of inflation also induce relative price variability, thus impairing the efficient allocation of resources? At the same time, it is also widely recognized that in the long run, monetary expansion can neither increase real output nor lower the rate of unemployment, while, again in the longer run, uncontrolled monetary expansion has a detrimental impact leading to high rates of inflation and to high nominal interest rates." Unanticipated increases in monetary growth, leading to unanticipated inflation, may temporarily reduce the rate of unWhether it does or not, as well as the extent of its impact, depends on the particularities of the economy (for example, on the length of contracts). However, this temporary reduction does not affbrd an argument in h u r of the use of monetary policy as an active stabilization tool, that is, as a policy tool for smoothing out fluctuations in economic activity. The reason is that surprise inflation also leads to anticipationsof higher future rates of inflation and to a belief among economic agents that the monetary authority is not committed to maintaining an economic environment with a stable inflation rate. These inflationary expectations, accompanied by an erosion of the credibility of policy announcements, will tend to further increase the acncal rate of inflation as these expectations are incorporated into contractual agreements. What is even more striking is that, thereafter, the same reduction in the rate of unemployment can be achieved only by continuously surprising agents with ever-higher rates of inflation while the benefits in terms of reduced unemployment will be of ever-shorter duration (and ever-smaller m nitude) as the public becomes accustomed to escalating prices.9;

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Such behaviour has been observed in countries with traditionally high rates of inflati~n.~'In such a climate, it will be very difficult to redress the situation since claim on the part of the monetary authority that it is committed to fighting inflation will simply not be believed by the public. Thus, monetary policy cannot really achieve a stabilization of output or employment in any meaningful sense.

Redefining Price Stability While price stability is a desirable goal for monetary policy, in my view the goal of price stability should be interpreted more broadly as a low and stable rate of inflation (perhaps in the 2 to 3 per cent, or even 3 to 4 per cent range) rather than literally as a 0 per cent rate of inflation as is the current stance of the Bank of Canada. This is not a minor quibble, since the latter interpretation of price stability as a 2 to 3 per cent stable rate of inflation would mean that the objective has been almost reached, and that further monetary contraction is unnecessary. In hct, while the average yearly inflation for 1991 was 4.1 per cent, the annualized threemonth rate of increase in the consumer price index fell to 0.6 per cent over the fourth quarter. In January 1992, the year-on-year rate of increase in the CPI was 1.6 per cent. While these figures reflect the dampening effect of the recession on the price level, they also indicate that the actual rate of inflation for 1992 may well be at, or even below, the announced target inflation rate of 2.5 per cent for 1994, two years ahead of schedule. Several reasons can be given to support the notion that a less strict interpretation of price stability as low and stable inflation might be preferable to a literal interpretation as 0 per cent inflation. First, if inflation is regarded as a tax that generates some the further reduction government revenue through seigniorage:' of a low inflation rate will lead to some loss of revenue for which the Government will have to compensate by increasing other existing taxes or imposing new ones. According to a recent study done for the US, increasing other taxes could lead to a sizeable

Fiscal and Monetary Policy MLr / 101

welfare loss.62 One must take into account how the revenue shorthll will be made up before arriving at conclusions about the net beneMs of reducing the rate of inflation Second, a small positive rate of inflation may, in fact, be a more credible goal than a 0 per cent rate of inflation? Given the short-term stimulus that is provided by some small increase in the rate of inflation, there will always exist the temptation for a government to inflate, especially prior to elections. This will make it difficult to persuade the public that the rate of inflation will remain at zero as initially promised. On the other hand, govemments are less likely to indulge in increasing the rate of inflation beyond some small positive rate given the high cost of high rates of inflation and the difficulty of reducing these rates back to acceptable levels once inflationary expectations become entrenched. Third, there are some activities, such as black market and other illegal activities, that can only be taxed through inflation. Thus, for example, in Italy where the "shadow economy" is very important, inflation has been the only means of reaching this sector for taxation purposes. Finally, if, as some theories suggest, there may be longer term effects of deflationary policies, caution would suggest a careful weighing of possible costs against perhaps doubtful benefits of further reductions in inflation below 2 or 3 per cent.

Central Bank Independence For monetary policy to be credible, it is essential to have a central bank that is independent of the political influence of the executive or legislative branch of Government. Especially in the presence of very high budget deficits, there is an ever-present temptation for any government, especially in politically crucial periods such as pre-election time, to attempt to monetize the deficit, i.e. to finance deficits by money creation. This mode of deficit financing will be easier, and will also be perceived by the public as easier, with

I02 /How Ottawa Spends increased p e r of the fiscal authority over the central bank. These arguments imply that expectations of higher rates of inflation may accompany large dacits if the central bank is seen essentially as the revenue-generating arm of the fiscal authority. More strikingly, as Thomas Sargent and Neil Wallace have argued, in the presence of a large debt tight monetary poliey may lead to higher rates of inflation today (through expectations of higher future inflation) if the public anticipates that the executive branch of the Governgent will eventually force the central bank to monetize the debt. In hct, the 1986 Brazilian Cruzado Plan provides an example of this effect? A drastic disinflation program was undertaken by the Government of Brazil without any measures to reduce the massive government deficit; the result was a total failure of the program and a subsequent incmse in the rate of inflation. Rudiger Dornbusch indicates that the circumstances surrounding the Irish stabilization program of the 1980s also bear a resemblance to the Sargent and Wallace scenario.

''

This scenario would be less likely the more independent the central bank is in setting the course of monetary policy. On the contrary, an independent central bank could impose f ~ c aresponl sibility on the Government. Ranking the central banks of various industrialized countries in terms of their degree of independence reveals that the Bank of Canada is among the relatively more independent ones. However, there still are some countries, such as Germany and Switzerland, that have even greater central bank independence." (It is interesting to note that these countries also have low rates of inflation, low deficits, and low rates of unemployment.)@ These are countries whose central banks have a reputation that can only be achieved by a track record of persistently low inflation, so that the public attaches a very low probability to a deviation from that course. They do not need to have explicitly stated mandates or rules in order to be believed. By contrast, the central banks of countries that have very often deviated from the pursuit of low inflation need to establish their credibility. 'lb achieve credibility, authorities must commit themselves to a particular policy rule, hence the

Fiscal and Monetary Policy Mi*/ 103 interest in entering into binding commitments such as a constitutional law. Yet the Bank of Canada, or for that matter any central bank, cannot be entirely and completely independent. Given that it is a it must be ultimately acbureaucracy in a liberal dem~racy.7~ countable to the public's elected representatives. This is of course desirable. However, it also implies that central banks cannot be completely independent, and even the most independent central bank will remain somewhat vulnerable to political pressures. This indicates that preserving central bank independence to the extent possible, given the constraints imposed by a democratic system, may be a necessary condition for achieving a credible monetary policy; but it may not be a sufficient condition. Since it is the presence of high budget deficits that may provoke a lack of credibility, pursuing fiscal prudence is also at the heart of achieving a credible monetary policy.

REFORMING THE BANK OF CANADA In its constitutional proposals, the federal government has suggested a number of reforms,to the Bank of Canada that would change the governance of the Bank and restrict its mandate." The Government proposes to restrict the mandate of the Bank of Canada to price stability. As argued by Laidler, the current mandate is vague and contains multiple-and sometimes even conflicting-objectives. An important benetit of changing the mandate is that it would enhance the accountability of the Bank of Canada because one could evaluate its performance, not relative to a mandate that is vague and imprecise (and that it may not be able to fulfil), but relative to a simple, clear, and distinct assignment. Changing the mandate may also enhance the independence of the Bank of Canada. The conduct of monetary policy is mainly the responsibility of the Bank. However, if the Minister of Finance disagrees with the bank's policies, according to the principle of

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"dual responsibility" the Minister may issue a directive to the Governor asking that the Bank pursue an alternative policy. A requirement is that this alternative policy be consistent with the bank's mandate. Therefore, a simpler and straightfbnuardmandate would make it more difficult fbr the Finance Minister to h c e the Bank to pursue monetary policies that may be polin'cally more advantageous, if these are not consistent with the miindate.

An alternative approach would be to adopt price stability as the main (but not only) objective of the Bank of Canada. This is the approach of the central banks of Germany and New Zealand (since 199Q), and the Drap 7katyJbr Eumpean Economic and Monetary Union, which defines price stability as the primary goal of the future European Central Bank. Several measures were also proposed to reform the governance of the Bank. The Government proposes to consult with provincial and territorial governments before making appointments to the board of directofl and to establish regional consultative panels to advise the board. Peter Howitt favours the establishment of such regional consultative panels which, as he points out, have improved discussion of monetary policy in the United Greater regional representation among the directors has been suggested in order to convey to the different regions of Canada that their concerns are being heard during the adoption of policy deci~ions.'~The directors should be chosen from a list of candidates proposed by provincial governments in particular regions. This will give, it is hoped, greater legitimacy in the public's mind to the conduct of monetary policy. While regional representation is desirable as an attempt at creating a climate of consensus, it may falsely generate the mistaken impression that, somehow, different monetary policies can be conducted for different regions. This is obviously impossible in a country with a single currency and with a single very well integrated financial market. In this light, clarifying the mandate to free it from its current vagueness may be important.

Fiscal and Monetary Policy Mix / 105 The Government also proposes that the appointment of the Governor of the Bank of Canada be ratified by a reformed Senate. Yet, the experience in the US with Senate ratification has indicated that partisan squabblin tends to dominate, thus diminishing the value of the pmcess.7kGiven uncertainty in Canada about the future character of the Senate, it is difficult to gauge the impact of this suggestion. While some of these reforms may be desirable, there seems to be a nation-wide consensus that they should not be part of the constitutional discussions. As a result, they were omitted from the final re ort of the Beaudoin-Dobbie Committee on constitutional retbrm.

e6

CONSTITUTIONAL PROPOSAL FOR FISCAL HARMONIZATION In a federal state, the provincial governments have autonomous fiscal powers. With the provincial government, local govemment, and hospital sector spending amounting to 60 per cent of total government outlays, provincial governments (also constitutionally responsible for local jurisdictions and hospitals) exert an important fiscal influence on the economy. This raises the possibility of provincial fiscal policies working at cross purposes with federal fiscal and monetary policies. For example, the overly expansionary fiscal policy of the Ontario govemment during the boom of the 1980s has led to inflationary pressures that have forced the Bank of Canada to adopt a more restrictive monetary policy.77Furthermore, since-as has been argued above-in the presence of very high budget deficits, a policy aimed at pursuing low inflation will be in danger of not being entirely credible, it is also necessary to adopt certain rules or legislation towards limiting the magnitude of budget deficits not only at the frderal, but also at the PLH,level. In the fall of 1991, the federal government made a constitutional proposal to harmonize the fiscal policies of the federal and provincial governments. Proposal 16 provides for the sharing of

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infbnnation and the coordination of policies. As will be argued below, while the informational aspect is valuable, some reservations may be expressed about the fiscal coordination aspect. First, the Government proposes a fixed budget cycle for the federal and provincial governments. In recent years, the federal gwernment has delivered its budget in the spring and so have the provinces. In Australia, a similar idbrmal coordination has taken place. The federal budget is delivered a fwv weeks after the beginning of the fiscal year, and states present their budgets two months later. In the US, the administration introduces its budget to Congress after the State of the Union Address early in the year. However, there is no coordination with the states as they do not necessarily have the same fiscal year as the federal government or the same budget cycle-for example, the state of Virginia has a .two-year budget cycle. Thus, the current Canadian system is not at odds with the practices of other major federations around the world. Furthennore, since the electoral cycles at the federal and provincial levels are not coordinated, a fixed budgetary cycle could potentially be in conflict with electoral cycles. Instead of formally establishing a fixed schedule for introducing federal and provincial budgets, since the present informal arrangement seems to have worked well, it may be preferable to stick to the current practice. The Government also proposes to have fixed, annual prebudget meetings of finance ministers and of the Governor of the Bank where they could discuss their forecasts of the W e course of economic activity, the future course of monetary policy, and how they intend to implement fiscal objectives. Such an exchange of information would be useful and may lead to improved decisionmaking as is the case when similar practices are adopted in other countries. Making fiscal policy more open would lead to better planning. For example, the provinces could better plan their budgets if they knew well in advance the amounts of federal transfkrs, and the federal gwernment could better set its fiscal stance if it knew provincial intentions. In Australia, there exist annual meetings among premiers (and finance ministers) where

Fiscal and Monetary Policy Mix / 107 the discussion focuses on the magnitude of Meral transfers that the states may expect in the coming year. The states may then present their case for higher transfers. In Germany, the Business Cycle Council-composed of the federal finance minister, one representative from each state (or each Lund),four representatives from the municipalities, and representatives from the Bundesbank (the German central bank)-seeks to harmonize fiscal policies between levels of government. It meets twice a year and serves as a forum to voice differing viewpoints about the economy. For example, in 1989-90 the Council issued a plea for all governments to decrease the subsidization of new housing in order "to cool the overheated housing sector.

"'*

The proposed adoption of the same accounting principles and the same format for provincial and federal budgets would improve the assessment of the fiscal performance of all governments. According to Irene Ip, at present, "comparing provincial perfbrmances is ... impossible from the bud ets or even the public accounts of the provincial governments."5 Furthermore, the absence of a common system of public accounting has led to an inappropriate treatment of fixed capital investment. As mentioned before, it is often proper to fund capital investment by borrowing. However, the cost should be amortized over the lifk of the asset in order to capture replacement and maintenance costs, something which is typically not done. An independent monitoring agency, modelled on the Organization for Economic Cooperation and Development and the International Monetary Fund, could be set up to report on the fiscal behaviour of all provincial and federal governments. However, it might be difficult for this agency to provide fully independent advice since its funding would depend on these governments. Tbming to the coordination aspect of the proposal, the federal gwemment proposes to develop legislated guidelines for fiscal policy that would be adopted in federal legislation, subject to the approval of seven provinces representing 50 per cent of the population. Three provinces could opt out. This approach appears

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to be contrary to the approach of other Meral states such as Australia and Germany, where the emphasis has been on developing a political consensus, rather than extending federal powers over the fiscal autonomy of the states (i.e. provinces). As defended by the Regmupement &ommle et Corntitutbn (a Quebec business association in favour of renewed federalism), a statutory annual meeting of first ministers is more likely to achieve coordination than federally legislated If one were to opt for annual meetings of the first ministers on the state of the economy, should the focus be on fiscal coordination or, instead, fiscal prudence?81

One should first observe that coordination does not imply that each government should adopt the same fiscal policy. Given the presence of regionally differentiated disturbances, expansionary fiscal policy may be appropriate for one province but not for another if these two provinces are in different phases of the boom-recession cycle. Fiscal policy coordination could be valuable if the sole aim of fiscal policy were to stabilize the business cycle. The implicit assumption is that governments can do better if they cooperate, because the spillover effects of one province's policies on the others can be taken into account. The conduct of fiscal policy, however, is often motivated by political considerations unrelated to business cycles. There are also a ~ m b e of r other difficulties. First, it may be difficult to determine whether interprovincial spillovers are positive or negative in the presence of regionally differentiated shocks and less than perfect interprovincial capital mobility. Given that policy interventions may be ill-timed or inappropriate, a concerted and well-coordinated, but flawed, federal-provincial fiscal action could be potentially more destabilizing to the economy than the flawed, but isolated, intervenFinally, by inducing greater tions of only some cooperation, one may lose the benefits of intergovernmental competition which also enables citizens to better compare the fiscal performance of various governments.83

Fiscal and Monetary Policy Mix / 109 Rather than harmonizing fiscal policies, one should devise means to improve deficit performance by imposing spending controls or by restricting the size of budget deficits over the cycle. This has been the approach in Australia and Germany. In Germany, the Stability and Grnvth Act of 1967 requires that public borrowing in each five-year financial plan by each government not exceed its public investment, except in times of crisis. The Financial Planning Council, an institute of intergovernmental cooperation with a membership similar to that of the Business Cycle Council, is concerned with the appropriate levels of borrowing and public spending. Since 1982, it has coordinated etrorts to limit growth in total government spending to 3 per cent. Although l is not bindingthe Financial Planning Council's f ~ c aguideline since states enjoy fiscal autonomy-it has been generally adhered to. Since German reunification, the Council has primarily focused on the level of public bornnuin emphasizing that the federal deficit should be reduced rapidly.%4 In Australia, there exist voluntary fiscal guidelines which focus on borrowing by the public sector. A global limit on state borrowing is discussed and adopted each year at a Loan Council meeting, which is held at the same time as the annual premiers' conference. The borrowing limits adopted since 1984 were effective in achieving a reversal from a net borrowing position by the federal and state governments of 6.8 per cent of the GDP in fiscal year 1983-84to a surplus of 1.2 per cent of the GDP in fiscal year 1989-90.85 In the US, even though the federal deficit is very large, all of the states except Vermont have either a statutory or constitutional balanced budget requirement. While these restrictions are not a1ways binding, most states have traditionally had budget surpluses. Furthermore, in states where a deficit is allowed, it has to be c6rrected in the next fiscal year.86 Finally, in the European Community the creation of a monetary union by 1997 is explicitly tied to fiscal discipline. 'Ib participate in the future European currency union, a member state will need to satisfy several requirements: a debt-to-GDP ratio not

110 /How Ottawa Spends

exceeding 60 per cent, a deficit to GDP ratio not in excess of 3 per cent, and an inflation rate within 1.5 per cent of the lowest rate in the European omm mu nit^."

CONCLUSION This chapter addressed the conduct of fiscal and monetary policies in Canada. The discussion focused on the costs of large budget deficits, on the significanceof high debt-to-GDP ratios, and on the intimate link between fiscal and monetary policies. 1have argued that inappropriate fiscal policy, which led to an accumulation of debt from 1975 on, and the lack of resolve in tackling the deficit problem sooner have forced the Government to hrgo the use of fiscal policy as a tool of stabilization of the business cycle in the current recession. In contrast to the 1982-83 recession, Canada may emerge from the current recession with a debt-to-GDP ratio that will not have increased substantially but instead will have been brought under control. Ironically, what could not be accomplished during seven years of expansion could be achieved during the recession. In recent years, the federal government has attempted to reduce its deficit by disengaging itself from several joint federalprovincial programs, such Established Programs Financing and the Canada Assistance Plan. The current constitutional discussions may afford an opportunity to redesign the federation so as to eliminate the current fiscal imbalances between levels of government and to get at the heart of the federal deficit? An important unknown may have serious implications for fiscal and monetary policies in the coming year: Canada's constitutional crisis. Due to the high degree of worldwide mobility of financial capital (for porrfolio imrestment especially but also for direct foreign investment), uncertainty about Canada's future-in particular about the prospect of a possible disintegration (and about the type of association that would remain between an independent Quebec and the rest of Canada)-could lead to very

Fiscal and Monetary Policy Mix / 111

high-risk premiums on Canadian assets and seriously jeopardize the recovery at a time when the country may start to come out of the recession. If the crisis is not resolved, and national unity is not preserved, much rougher times may await all Canadians.

NOTES I am grateful to Frauces Abele, Ehsm Choudhri, Lawrence Schembri and, especially, Michel Demere h r very helpful comments. I also thank Huntley Schaller br a very useful discussion. 1

Organization for Economic Cooperation and Development, Economic O u t h k 49 (Paris, 199l), p. 2, chart A.

2

"The Economy: Spring in the Air," l k Economist [London], Marzh 14-20, 1992, p. 31.

3

Traditionally, the central bank of a country is identified as the authority in charge of conducting monetaty policy, that is, decisions regarding the management of the quantity of money in cimulation. The Bank of Canada is the financial agent of the Government and has the exclusive right to print money. "Monetary policy is the process whereby a central bank affects the economy through its influence wer the expansion of money and credit." (See "Memorandum on Bank of Canada Functions and Responsibilities," Bank of Canada Review ( O t w Bank of Canada, Nwember 199I), p. 23. The executivebranch of Gmmrnent is the authority in charge of executingJiscalpolicydecisions, i.e. decisions regarding government spending and the collection of tax revenues. An excess of guvemment expenditures wer its revenues creates a budget deficit which can be financed either by borrowing-that is by issuing new bonds-or by increasing the money supply (printing more money). This latter means of financing the deficit is also rekrred to as a monetization of the debt.

4

Michael Wilson, m e Budget, February 26,199 1 (Ottawa: Department of Finance, 1991), p. 94, table 4.

5

Ibid., p. 53.

112 /How Ottawa Spends See Don M d m k i , Ihe Budget, Febnrary 25,1992 (OtCawa: Department of ~ k c e 1992), , p. 111, table 3.15. See "Economic and Financial Indicators,"

7he Economist

[London], March 7-13, 1992, p. 115. Don Mamkowski, 7 h Budget, February 25, 1992, p. 53. The group of seven comprises Canada, France, Gennany, Italy, Japan, the UK, and the US.

These figures are on a public accounts basis. See Department of Finance, Quarterly Economic Review.- Annual Reference Tables (Ottawa, June 1991), p. 93. The primary budget deficit, also called the operating budget, is the deficit excluding interest payments on debt. See Department of Finance, QuarterlyEconomic Rm0ew:Annual Refemnce Tables (Ottawa, June 1991), p. 107. For a similar view, see William Watson "The Budget in the Medium Term: Staying Which Course," in Martin F.J. Pmchowny, (ed.), Policy Forum on the February 19SO Federal Brdget (Kingston: John Deutsch Institute for the Study of Economic Policy, Queen's University, 1990), p. 16. According to Watson, "A stronger attack on the deficit in those years--which after all wre a time of robust economic gmwth-would have increased the number of budgetary choices available today and in the next kw years." See Neil Bruce and Douglas D. Purvis, "Implementing a Prudent Fiscal Strategy in the Medium Term," in Jack M. Mint and Douglas D. Purvis, (eds.), Pblicy Forum on Mampolicy Issues in the Medium T m (Kingston: John Deutsch Institute b r the Study of Economic Policy, Queen's University, 1990), p. 43. Bonds are nominal liabilities; that is, their return is denominated in current dollar terms. Therebre, an increase in the rate of inflation beyond what the bond holder expected at the time of purchase will lower the real rate of return on bonds (in constant dollar terms) below its "promised" level. In this setting, when new bonds are issued, the buyer will require an "inflation

Fiscal and Monetary Policy Mix / 113 premium" in order to compensate fbr the higher rate of inflation. This will lead to higher inkzest rates. Bond purchasers also requim a risk premium whenever there is political uncertainty or high budget deficits. See, fbr example, Maureen Famw and William R. Robson, "Building a Constituency fw Deficit W c tion," Fiscal Policy Monitor, no. 1 (Toronto:C.D. H o w Institute, April 1989); and Rudiger Dombusch and Mario Draghi, hblic Debt Management: lheory and History (Cambridge: Cambridge University Press, 1990). 16

This point was initially made by Thomas J. Sargent and Neil Wallace, "Some Unpleasant Monetarist Arithmetic," Federal Resene Bank of Minneapolis Quarterly Rm'ew, (Fall 198I ) , pp. 1-17.

17

See Robert E. Lucas and Nancy L. Stokey, "Optimal Fiscal and Monetary Policy in an Economy without Capital," Journal of Monetary Economics, wl. 12, (1983), pp. 55-93; and Mats Persson, Torsten Persson, and Lars E.O. Svensson, "Time Consistency of Fiscal and Monetary Policy," Econornetrica, MI. 55, (1987), pp. 1419-31, who discuss how the policy-maker can choose the maturity structure of the debt in order to assure the public of its commitment not to defirult on the debt.

18

In k t this applies to both indexed and nominal bonds of all maturities. See Mats Persson, Torstem Penson, and Lars E.O. Svensscm, op. cit. Probably hoping that it had established its credibility vh4-vis the public with respect to its resolve to reduce inflation, the Bank of Canada has recently issued 30-year bonds fbr the first time. See Bank of Canada, 1990 Annual Report (Ottawa, 1990), p. 41. What the Bank of Canada has hiled to do is introduce indexed bonds so as to truly enhance its credibility and at the same time reduce the inflation premiums attached to Canadian bonds in capital markets. See Douglas D. Puwis, "Summary Remarks," in Martin F.J. Prachowny, (ed.), Policy Forum on the February 1990 Fedeml Budget, p. 77, and John McCallum, "imovations in the Budget: Inflation Targets and Legislated Spending Limits," in Martin F.J. Prachmy and Douglas D. Puwis, (eds.), 13reFebruary 1991 Federal Budget (Kingston: John Deutsch Institute fbr the Study of Economic Policy, Queen's University, 1991), p. 21.

114 / How Ottawa Spends 19

This is the "Lafir-curve" argument. In fact, there is no conclusive empirical evidence on this issue.

20

See W. Irwin Gillespie, lhx, B o w and @end: Financing Fedeml Spending in Canada 1867-199Y) (Ottawa: Carleton University P m , 1991), pp. 202-9 fw a compehhensive hisbry of fiscal policy in Canada.

21

This package constituted the first stage of a more comprehensive tax reform involving the introduction of the GST in the second stage. The revenue shortfitll resulting from the first stage rehrms was initially covered by increases in the manuhcturing sales tax (MST), but ultimately wuld be covered by the replacement of the MST by the GST. See W. Irwin Gillespie, Tm, B o r n and Spend, p. 203, h r a detailed account.

22

In firct, in Canada as early as the 1970s, the Gwemment adopted policies that have led to a reduction in effective tax rates, leading to a revenue shortill. See Allan M. Maslwe, Tax Refonn in Canadw ?k h c e s s and Impact (Halifax: Institute b r Research on Public Policy, 1989), pp. 21-23; and W. I d Gillespie, 22ur, B o r n and Spend, chap. 10. This revenue shortdid1 was unhrtunately not accompanied by measures to concomitantly reduce spending, thus giving rise-first in the mid- and late-1970s-to high rates of inflation as the Gwemment resorted to moneyfinancing and then, once money-financing was abandoned, to the large deficits and accumulated debt of the recent years.

23

Under some circumstances, bond-financed deficits may be even more expansionary than money-financed deficits. See Alan Blinder and Robert Solow, "Does Fiscal Policy Matter?" Journal of Acblic Economics, vol. 2, (1973), pp. 319-37. This analysis indicates that, in the short run, starting from a situation of beluw capacity production and unemployment, the increase in the deficit will lead to a stimulation of demand and thereby increase output and employment, as well as the interest rate and the price level. Hmver, as had been pointed out earlier by Carl F. Christ, debt-financing could also lead to instability in the long run. See Carl F. Christ, "A Simple Macroeconomic Model with a Government Budget Restraint," Journal of Political Economy, vol. 76, (January/February 1968), pp. 53-67; and Carl F. Christ, "Some Dynamic Theory of Macroeconomic Policy E&ts on Income

Fiscal and Monetary Policy Mix / I 15 and Prices under the Gwemment Budget Restraint," Journal of Monetary Economics, vol. 4, (1978), pp. 45-70. 24

The current account balance is the sum of the merchandise trade balance (i.e. exports minus imports), net investment income,and net tnmskrs. It is the second of these elements which is responsible fix the Canadian current account deficit. Foreign indebtedness involves the payment of interest (investment income) on government debt held by fbreigners, and thereby contributes to higher investment income payments than mceipts. See Organization for Economic Cooperation and Development, Economic Swvqs: Canada (Pais, 1991), pp. 30-32. For the calendar year 1991, the Canadian current accouut deficit was $23.4 billion.

25

It also leads to a l m r steady state capital stock. See Franco Modigliani, "Lag-run Implicationsof Alternative Fiscal Pblicies and the Burden of the National Debt," Economic Journal, vol. 71, (December 196I), pp. 730-55.

26

That is, there occurs an inequitable tran&r fmm the firture to the current generation. To the extent that taxes will be higher in the futum relative to today, this impairs the ability to smooth the burden of distortionary taxes through time, leading to a loss of welfiire.

27

See Robert J. Barro, "Are Government Bonds Net Wealth?" Journal of Political Economy, vol. 82, (NmmbertDecember 1974), pp. 1095-117. This idea had been expressed much earlier by several economists, most notably in the early nineteenth century ky David Ricardo. Hmver, it is the more modem treatment of this hypothesis by Robert J. Barn in 1974that has put it at the centre of economic debate.

28

See Paul Krugman, me Age of Diminished Expectatiom: US. Economic Policy in the 1990s (Cambridge, MA: MIT Press, 1990), p. 73.

29

In hct, since the Ricardian view wuld not hold in the presence of distortionary taxes and of imperfbct capital markets, what is truIy surprising is that there is not strong evidence against it! For evidence against this hypothesis, see Douglas Bernheim, "A Neoclassical Perspective on Budget Deficits," 7h Journal of Economic Perspectives, vol. 3, no. 2, (Spring 1989), pp. 55-72;

116 /How Onmva Spends and Douglas Bernheim, "Ricardian Equivalence: An Evaluation of Theory and Evidence," in Olivier Jean Blanchard and Stanley Fischer, (eds.), NBER Macroeconomics Annual I987 (Cambridge, MA: National Bureau of Economic Research, MIT h, 1987), pp. 263-303. For evidence in b u r of it see Robert J. Barro, "The Ricardian Approach to Budget Deficits," Ihe Journul of Economic h p e c t i v e r , vol. 3, no. 2, (Spring 1989), pp. 37-54; and Robert J. Barn, and Xavier Sala y Martin, World Infemt Rates, in Olivier Jean Blanchard and Stanley Fischer, (eds.), NBER Mameconomim Annual I 9 N l (Cambridge, MA: National Bureau of Economic Research, MIT Press, 1990), pp. 15-61. For a study that analyses the Ricardian equivalence hypothesis fbr Canada, see Paul Bodhe and Bradhrd Reid, *Asset Returns and Government Budgets in a Small Open Economy: Empirical Evidence for Canada," Journal of Monetary Emnmia, vol. 23, no. 1, (1989), pp. 65-78. 30

A consensus along these lines seems to exist in Canada as wll.

See, h r example, Neil Bruce and Douglas D. Pwvis, "Implementing a Prudent Fiscal Strategy in the Medium Term," in Jack M. Mintz and Douglas D. Purvis, (eds.), fblicy Forum on Mapoky IssSuesin the Medium T m (Kingston: John Jhutsch Institute for the Study of Economic Policy, Queen's University, 1988), pp. 28-51. A sustainability gap is the gap between the level of non-interest receipts that wid be required to stabilize the debt-MDP ratio and the current level of receipts as a percentage of the GDP. As a result of the current recession, the projection fbr Canada's sustakbility gap has increased from -0.4 to 1.5, a positive sign indicating that a spending decrease andlor a tax increase is required to prevent an increase in the debt-to-GDP ratio. See Organization for Economic Cooperation and Development, Economic Outlook, (July 1991), p. 20, table 6.

+

32

During a recession, "automatic stabilizers" lead to a shrinking of the tax baseand to an increase in transfers, thus adversely afkting the deficit.

33

See Irene K. Ip, "On the Draft Spending Control Legislation," Brief to the StandingCommitteeon Finance, September 17,1991.

34

Michael Wilson, lb Budget, February 26, 1991, p. 80.

Fiscal and Monetav Policy Mix / 117 Don M d o w s k i , 27te Budget, February 25, 1992, p. 102. For an opposing view on this point, see John McCallum, "Innovations in the Budget: Inflation Targets and Legislated Spending Limits," in Martin P.J. Prachmy and Douglas D. Purvis, (eds.), lhe February 1991 Fedeml Budget, p. 24. According to McCallum, the government's proposal, while in the right direction, lacks credibility as it stands. A crucial requirement is that interyear reallocations be disallcwed."

"...

See Irene K. Ip, "On the Draft Spending Control Legislation." For a similar view, see ibid. See Frances Abele, "The Politics of Fragmentation," in Frances

Abele, (ed.), How Ottawa Spends: l k Politics of Fragmentation 1991-92 (Ottawa: Carleton University P m , 1991), p. 19. Ibid., p. 31, cote 30. Ibid., p. 8, and Douglas D. Purvis, "The Budget, the Economy and the Nation," in Martin F.J. Prachuwny and Douglas D. P u ~ s , (eds.), lhe February 1991 Federal Bdget, p. 80. As Robert E. Lucas has pointed out, "Disciplines like thesemonetary standards, budget balance, trust fund accountingformed parts of what James Buchanan and Richard Wagner (1977) have called our unwritten 'fiscal constitution.'" See Robert E.

Lucas, "Principles of Fiscal and Monetary Policy," Journal of Monetary Economics, vol. 17, no. 1, (1986). pp. 117-35. The rebrence in the quote is to James Buchanan and Richard Wagner, Democracy in D@cit (New York: Academic Press, 1977). See Frances Abele, "The Politics of Fragmentation," in Frances Abele, (ed.), How Ottawa Spe& l k Politics of Fragmentation 1991-92, p. 8. Irene K. Ip emphasizes this point in Big Spenders: A Survqr of Rvvincial ~ n u n e nFTnances t in Canada (Toronto: C.D. H m Institute, 1991).

118 / How Ottawa Spends 45

See Ban&of Canada Mew (Ottawa: Bank of Canada, Nwember 1991), p. S20, statistical table A1

46

David E.W. Laidler and William Robson, "A Rough Re-entry: A Comment on Recent Bank of Canada Policy," Commentary .(Toronto: C.D. H m Institute, Nwember 1991), no. 34, p. 2.

47

See Peter Hwitt, 'A Skeptic's Guide to C a d a n Monetary Policy," Commentary (Toronto: C.D. H w e Institute, December 1990), no. 25, p. 11.

48

Michael Wilson, lh Budget, February 26, 1991, p. 14.

49

See David E.W.Laidler, "Inflation Targets and Coordination with the Bank of Camch Qualms about Inflation Targets," in Martin F.J.Pnrchowny and Douglas D. Purvis, (eds.), lb February 1991 Fedeml Budget, pp. 35-36.

50

The directive was introduced into the Bank of Cbnada Act in the a h m a t h of the Coyne affiir of 1%1. At the time, the Diefenbaker government entered into a conflict with the Gwernor of the Bank of Canada, James Coyne, over his conduct of monetary policy and attempted to pass a bill in order to mmwe him from his post. The Bill was passed in the House of Commons but was dehted in the Senate. Nevertheless, Governor Coyne resigned. Subsequently, the procedure of the directive was introduced into the &utk of Canada Act as a means of avoiding similar conhntatians in the hture. According to this procedure, the Minister of Finance-to whom the Governor is ultimately responsible-could issue a directive requesting &at the G m m o r change the current stance of monetary policy and adopt instead an alternative course. This alternative course suggested by the Minister (and backed by the Cabinet) must, huwever, be in line with the Bank's mandate. Even though it is not explicitly stated in the Bank of Canada Act, there is an implicit understanding, based on a statement issued by Gwernor Louis Rasminsky on August 1,196 1, that the Governor would resign should a directivebe issued. See David E. W. Laidler, Hau Shall W W r nthe Governoc A Critiqueof the Gomance ofthe Bank ofCanada (Toronto: C.D. H m Institute, 1991), pp. 5-6 and fbotnote 2.

.

Fiscal and Monetary Policy Mlr / 119 51

See John Craw, Zhe W k of C d i a n Monetary Policy 7he Eric J. Hanson Memorial Lecture (OtCawa: The Bank of Canada, 1988), and Charles Fmdman, "The Goal of Price Stability: The Debate in Canada," Journal of Money Ckdit and Banking, wl. 23, (August 1991), part 2.

52

David E.W. Laidler and William Robson indicate the difficulties inwlved in a transition period from higher to lower inflation, but nevertheless note that the Bank has been werly mstrictive in its control of MI. See David E. W. Laidler and William Robson, "A Rough Re-Entry: A Comment on Recent Bank of Canada Policy." Others argue in fintour of controlling broader aggregates such as M2. See Peter Howitt, Monetary Policy in %mition (Toronto: C.D. H m Institute, 1986), and Peter Howitt, A Skeptic's Guide to Canadian Monetaq Policy.

53

See Peter Howitt's discussion of the costs of inflation. Peter Howitt, "Zero Inflation as a Long-Term Target h r Monetary Policy, * in Richard Lipsey, (ed.), Zem InjWon: The Goal of Rice Stability (Toronto: C.D. Huwe Institute, 1990).

54

See h r example, Irene K. Ip, "Strong Medicine: Budgeting for Recession and Recwery," Fiscal Policy Commentary (Toronto: C.D. How Institute, January 1991), no. 27, p. 4.

55

See b r example, Dennis E. Logue and Thomas D. Willet, "A Note on the Relationship between the Rate and the Variability of Inflation, " Economics, vol. 43, (1974), pp. 151-58; Arthur Okun, "The Mirage of Steady Anticipated Inflation," hokings Papers on Economic Activity, vol. 2, (1975), pp. 485-98; and Alex Cukiennan, Inition, Stu@ation, Relative Prices and Imperfect Information (Cambridge: Cambridge University Press, 1984), pp. 170.74.

56

See Daniel R. Vining and Thomas C. Elwlertowski, "The Relationship between Relative Prices and the Relative Price Level," American Economic Review, vol. 67, pp. 851-66, and Alex Cukierman, op. cit., chap. 6.

57

This is knuwn as the Fisher efkct. The nominal interest rate is equal to the real interest rate plus the expected rate of inflation. Domestic monetary expansion initially leads to lower nominal

120 /How Ottawa Spends interest rates in the short run. In the longer nm,hawever, it leads to an increase in both the actual and expected rrrtes of inflation and, themby, to an iucrease in nominal interest rates. Therefbre, while easier monetary policy temporarily reducesnominal interest rates, it leads to even higher nominal rates in the long run. "In the long run when all adjwtrnentlr have occurred, an inmase in i m i o n is @ected fir& in nominal intmst Nominal interest rates rise one-for-one with the increase in inflation (emphasis in the origiaal). Rudiger Dombu&ch, Stanley Fischer, and Gordon R. Sparks, Macrveconwnics.- lhirrl Canadian Eaition (Toronto: McGraw-Hill Ryemn Limited, 1989), pp. 552-53.

..."

58

For empirical evidence on this point, see, among others, Robert J. Barro, "Unanticipated Monetary Growth and Unemployment in the United States," American Economic Review, vol. 67, (1977), pp. 101-15; Robert J. Barro and Mark Rush, "Unanticipated Money and Economic Activity," in Stanley Fischer, (ed.), Rational Expectations and Economic Policy (Chicago: University of Chicago Press, 1980); C.L.F. Attiield, David Demery, and N. W. Duck, "A Quarterly Model of Unauticipated Monetary Growth, Output and the Price Level in the UK 196378," Journal of Monetary Emnomics, vol. 8, pp. 33130.

59

This is dated to the so-called "sacrifice ratio." See, for example, Organization for Economic Cooperation and Development, Economic Sunqs: Canada 1990-91, p. 67.

60

One study has established that a given unanticipated monetary expansion had a simble short-term impact on the GDP in countries where the rate of inflation had previously been traditionally law (so that inflationary expectations were also law) but almost no short-term impact in countries whee the rate of inflation had been Witionally high (so that inflationary expectations we= also high, as in some Latin American countries). This result indicates that the more often a gwemment resorts to monetary expansion as a means of achieving at least a short-term reduction in unemployment, the less effkctive will these interventions become. Consequently, the short-term trade-off between inflation and unemployment disappears as the monehry authority resorts to inflationary policies. See Robert E. Lucas Jr., "Some International Evidence on Output-Inflation Tradeoffs," American Economic R&ew, MI. 63, (June 1973), pp. 326-34.

Fiscal and Monetary Policy Mix / 121 Seigniorage is the revenue generated by increasing the money su~~l~. See Thomas Cooley and Gary Hansen, "The Mlire Costs of Moderate Inflation," Journal of Money Credit and Banking, vol. 23, (August 1991), part 2, pp. 483-503. According to this study, a reduction of the rate of inflation from 5 per cent to 0 per cent leads to a net increase in wlfirre costs of appmximately 0.5 per cent of the GNP if the revenue loss were compensated by an increase in the labour tax, and by 3.2 per cent of the GNP if the revenue loss were compensated by an increase in the capital tax. This is not negligible. If the same relationship were to hold h r Canada, [Canadian GDP = $667 billion] this implies costs of more than $3 billion in the first case and more than $21 billion in the second! See Thomas Cooley and Gary Hansen, "The Welfare Costs of Moderate Inflation," pp. 498-99. The Bank of Canada maintains that any target other than 0 per cent inflation muld simply not be a credible one to pursue. See, for example, Charles Freedman, "The Goal of Price Stability: The Debate in Canada," Journal of Money Credt and Banking, vol. 23, (August 1991), part 2. See Thomas J. Sargent and Neil Mllace, "Some Unpleasant Monetarist Arithmetic. " See Allan Dnmn and Elhanan Helpman, "Inflationary Consequences of Anticipated Macroeconomic Policies," Reviav of Economic Studies, vol. 57, no. 189, pp. 14744. See Rudiger Dornbusch, "Ireland's Disinflation, " Economic Policy, vol. 8, (April 1989), p. 175. A measure of central bank independence depends on: a) the institutional relationship between the central bank and the executive (or legislative) branch of Government; that is, the way in which the Governor of the central bank is appointed (how ofken and by whom) and whether government officials sit on the board of the central bank; b) the extent of informal contacts between the central bank and the Cabinet; c) whether there exist rules that hrce the central bank to automatically accommodatefiscal policy;

122 /How Ottawa Spends and d) whether the central bank depends on the executive branch h r its financing. See Albert0 Alesina, "Eolitical and Business Cycla in Industrial Democracies," Economic Policy, vol. 8, (April 1989), p. 8 1. 69

See Robin Bade and Michael Parkin, "Central Bank Laws and Inflation: A Comparative Analysis, " Working Paper, University of Western Ontario, 1985; Albert0 Alesina, "Macroecommics and Politics," NBER Macroeconomics Annual 1988 (Cambridge, MA: MIT Press, 1988), pp. 1361; Donato Masciandaro and Guido 'Ibbellini, "Monetary Regimesand Fiscal Deficits: A Comparative Analysis," in H.S. Cheng, (ed.), Monetary Polity in Pac@c Basin Counm'es (Dordrecht: Kluwer Academic Publishers, 1988); Alberto Alesina and h w m c e Summers, "Central Bank Independence and M8croeconomic Independence: Some Comparative Evidence, " Working Paper, H a d University, 1990. See also "Central Banks: America v. Japan: The Rewads of Independence," m e Economist mndon] , January 25-3 1, 1992, p. 19.

70

For an analysis of central banks as bureaus, see Keith Acheson and John F. Chant, "Bureaucratic Theory and the Choice of Central Bank Goals: The Case of the Bank of Canada,"Journal of Money W i t and Banking, vol. 5 , (May 1973), pp. 637-55.

71

In many respecfs, these pmposals hllow David E.W. Laidler's recommendations; see David E.W. Laidler, Haw ShaU W Govern the Governor: A Cn'tique of the Gowrnance of the Bank of Canada.

72

This practice is already in place according b Peter Howitt; see Peter Hawitt, "Refbnnof the Bank of Canada and Harmonization of Macroeconomic Policies," in Robin W. Boadway and Douglas D.Purvis, (eds.), Economic Aspects of the Federal Government's Constitutional PmposaLs (Kingston: John Deutsch Institute, Queen's University, 1991).

73

See ibid., p. 42.

74

See David E.W. Laidler, Hnu ShaU

W Govern the Governor: A Critique of the Governance of the Bank of Canada, p. 23, and Peter Hawitt, "Rehrm of the Bank of Canada and Harmonization of Macroeconomic Policies," pp. 404 1.

Fiscal and Monetary Polity Mix / 123 See Peter Hmitt, "Rehrmof the Bank of Canada and Harmoniza-

tion of Mac~economicPolicies, " p. 41.

See Canada,Report of the Special Joint Committee on a Re& Canada, February 29,1992, p. 89. See Economic Council of Canada, Ransitionfor the SW (Ottawa: Minister of Supply and Services Canada, 1990). See Patrice Muller, "Fiscal Guidelines: A Review of the Experience in hrious Countries," Unpublished, O m , 1992, p. 9. Irene K. Ip, Big Spendern: A Survey of M n c i a l Government Finances in Canada, p. 8. Regmupement Ibonomie et Constitution, Submission to the Special Joint Committee on a R e n d Canada, Ottawa, December 12, 1991. For fbrther discussion on this point see Fanny S. Demers, Michel Demers, and Murray Smith, "Proposal to Strengthen the Canadian Economic Union," Unpublished, Carleton University, 1992. There are dificulties in identifying the exact nature of an economic disturbance, in determining the appropriate policy tesponse and in implementing that policy on time. Short-term policy intenention and fine-tuning are therebre virtually i m p sible. For the view that fiscal coordination could be potentially destabilizing see Peter Hawitt, "Reform of the Bank of Canada and Harmonization of Macroeconomic Policies. " See, for example, Albert Breton, "Tcmards a Theory of Competitive Federalism," Report of the Royal Commission on the Economic Union and Dewlopment hspectsfor Canada, vol. Ill (Ottawa: Minister of Supply and Services Canada, 1985). See Patrice Muller, "Fiscal Guidelines: A Review of the Ex-

perience in Various Countries," p. 10. Ibid., p. 8.

124 / How Ottawa Spends 86

One exception is Louisiana. See Barry Eichengreen, "One Money fbr Europe? Lessons from the US Currency Union," Economic Policy, vol. 10, (April 1990), p. 150.

87

It will also be necessary h r its long-term interest rate not to exceed the lowest rate in the EC by more than 2 per cent and that its currency not be devalued within the European Monetary System h r at least t w years. See "How to Get Good Marks or Ecus," ?he Economist [London], December 14-20, 1991, p. 52.

88

See Irene K. Ip, "Strong Medicine: Budgeting for Recession and Recovery. "

C ; A P I E 4 L P ~ G l ~ BUDGETING: THE FUTURE OF C;ANAaQ9S(liwm4L Katherine A. Graham R&umC :Ce chapitre examine l'hlution de la perspective du r81e et de la place de la &@on dc la Capitale nationale (RCN) aux yeux du gouvemement fMral,

en particulier depuis 1'6lection des o a n s w e u r s en 1984 et au cours des discussions constitutionnelles du lac Meech et celles qui ont suivi. NOUS soutenons que la place et I'image de la capitde du Canada ont M diminuk et d i l u k et qu'une attention minimale a kt&port& A l'avenir de la capitale dans le cadre du gowementent W h l , malgd l'importance des questions constitutionnelles dans la politique fedhle. Que le changement intervemt pour le Canada soit drarnatique ou non, le r81e et la condition de la capitale mteront w e indication importante, peutare d&erminante, de la nouvelle image du Canada, chez nous et h 19&ranger.

Abstrad: This chapter focuses on the federal government's changing perspectives about the role and place of Canada's National Capital Region (NCR), particularly since the e l d o n of the Consenratives in 1984and during the Meech Lake and post-Meech Lake constitutional discussions. It argues that the place and image of Canada's capital has been diminished and diluted and that minimal attention is being paid to the firturc of the capital within the federal government, despite the high profile of constitutional concerns on the federal agenda. Regardless of whether the constitutional change Canada undergoes is dramatic or not, the role and condition of the capital will be an important indication (and perhaps determinant) of Canada's image, both domestically and abroad.

Prime Minister, do you believe in capital punishment?

No, but unfortunately, as Prime Minister, I have to live in ottawa.

The sometimes breathtaking events surrounding the agglomeration and disintegration of nation-states in recent times have affected national capitals in profound ways. Moscow or Minsk? Berlin or Bonn? Where will the real capital of the European Community be? Buried in these debates are important questions about the role of capitals and their place in the national fabric and the

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international order. Should a capital be merely a political centre and administrative headquarters or does it have a broader role in creating and sustaining a cultural sense of nationhood? Should capitals be identified as special places with significant architecture and extraordinary physical design or should they be allowed to evolve without particular regard to their status as capitals? What is the image that a particular capital evokes in the minds of its country's citizens? What image should it evoke? Does the role of the capital change as a country's circumstances change? If it does, how does its role change and why? It is important to think about Canada's capital in the context of the emergence of the so-called new international order and the evolution of capitals in various parts of the world. This is more than an academic exercise. The current constitutional discussions hold out the prospect that the structure of the country may change findamentally or, at the very least, the structure of the federal system as we know it may be modified. Regardless of whether the change the nation undergoes is dramatic or not, the role and condition of our capital will be an important indication (and perhaps determinant) of our new self-image. This will have implications for the role the capital plays domestically and in the international context. This chapter focuses on the evolution of Canada's National Capital Region (NCR). More specifically, it focuses on the federal government's changing perspectives about the role and place of the NCR, particularly since the election of the Conservatives in 1984 and during the Meech Lake and post-Meech Lake constitutional discussions. Over this period, the place and image of Canada's capital has been diminished and diluted. In light of international trends and the potential outcomes of current constitutional discussions, the federal government is advised to think concertedly about the future form and governance of the National Capital Region. Ironically, there is a minimal amount of attention being paid to this issue within the Men1 government, despite the high profile of constitutional concerns on the federal agenda and the importance of nationhood in current political debates. Rather than building on

l'he Future of Chada 's Coptal/ 127 the symbolic and physical investment in the capital by their predecessors, the Coflservatives seem to view the capital merely as something to be cut back. What thinking is being done about "capital questions" is occurring at the local level within the NCR, by municipalities and local interests on both the Ontario and Quebec sides of the capital. As appealing an example of local initiative as this might seem, the bigger questions involved require federal attention and leadership. Before proceeding to discuss what has been done and what should be done, it is useful to think a little bit more about the most basic question on the agenda when one thinks about capitals-what is a capital?

IMAGES OF CAPITALS There are a number of ways to distinguish among capitals. Peter Hall, for example, develops a taxonomy of capital cities based on firnction, locus, and time. He distinguishes among multifunctional capitals, global capitals, political capitals, former capitals, ls.~ ex-imperial capitals, provincial capitals, and s ~ ~ e r c a ~ i t aFor the purposes of thinking about Canada's capital and comparing it with others, it is useful to think about five of these different roles that a capital can play. 'Ib the extent that each role is emphasized, the prominence of the capital in the national ken and the image it evokes are affected. The first role, and perhaps the most basic, is that of political centre. To what extent does the capital serve as the place where representatives of all the national constituencies (whether they are defined geographically or on some other basis) meet, debate, and resolve public policy issues of national importance? One might argue that this role is automatic; but this is not necessarily so. For example, there is at least one contemporary case (albeit at the subnational level) where the political capital has been roving? One could argue that this approach or, alternatively, the physical deconcentrationof national political activity might be increasingly feasible in light of modem communication technologies. In any event, Strasbourg may stand as an example of a political (but not administrative) capital.

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The second role and associated image is that of the capital as the administrative centre fix government activities. In certain respects, this role may suggest a rather minialist perspective on the political role of national government. Ihe capital's role is more to serve and administer, rather than to be the locus of political debate, excitement, and the exercise of state power. In thinking about Beme, Claude Raffestin has suggested, 'n'est' qu'une capitale du consensus: le consensus n'etant jamais qu'un accord sur le mini~num."~ Theodor Hanf describes Bonn in its role as the capital of the former Federal Republic of Germany as a reflection of postwar West Germans' desire for understatement. As a city, Bonn is pleasant, rather than grand, and contrasts with more frenetic and aggressive centres, such as Frankfurt and Munich. Domestically, it provided a soothing forum for the expression of regional and local interests in the federal context. Internationally, Bonn's re1atively somnolent quality offset West Germany's remarkable economic success and perhaps modified international concerns about the rise of the new powerful ~ e n n a n ~ ? The third role emphasized for a capital is its symbolic role as a national monument. In this context, the capital is intended to serve as a physical manifestation of the energy, direction, and prowess of the nation. Brasilia, for example, has been described as "a symbol of the new ~ r a z i l . "Washington, ~ with its formal central plan, grand buildings, and monuments, also fills this function very strongly.

Without necessarily having an elaborately and purposefully constructed physical form, a capital can serve as the heart of a nation. In fulfilling this role, it has a strong cultural and social mandate. As Anthony King notes, "modem urbanism represents a distinctive form of supra-national cultural hegemony. The task of the national capital is to subvert this."' Jose hd-rde argues that Brussels is an appropriate choice for the capital of Belgium because it is "un carrefour culturel, au noeud des deux cultures germanique et latine.

"*

Finally, there is the role of the capital as "The Central Place," the hub from which radiates the political and

administrative power of the State plus the power of private capital and national culture. M obvious examples are London and Paris, both capitals of unitary states and the chief economic metropoles of those states. Much of the literature on capitals suggests that form follows values-in other words, the particular role and image of a capital reflect some basic values in a national society. 'I'm important values in this context would seem to be the dominant conception of the role of the nation-state itself (or in the case of the European Community, the role of the suprastate) and the importance of the national government as an agent for realizing the dominant values and aspirations of society. With this in mind, it is now possible to look at the character and evolution of Canada's capital to see the vision that the federal government has tried to realize at different times.

THE NATIONAL CAPITAL REGION: WHAT IS IT? Most Canadians probably think of the country's capital as simply Ottawa-in some quarters, "the dreaded 0-word." In reality, the National Capital Region consists of over 4,600 sq. km on both the Ontario and Quebec sides of the Ottawa River. The National Capital Commission (NCC) is the federal crown corporation which acts as the lead federal authority over the entire area? However, other federal departments and agencies, by virtue of their facilities in the capital or the instrumental role they play in helping it function, are also important. These include: Agriculture Canada, the Department of National Defence, Parks Canada, Public Works Canada, and Transport Canada. As the lead federal agency in the National Capital Region, the NCC must relate to two provincial governments and 27 municipal governments that provide local services to the various parts of the NCR. These municipal governments represent major urban centres, most notably the cities of Ottawa and Hull, and suburban and rural municipalities on both sides of the river. The NCC also has to relate to two regional governments, la Communaut6 Regionale de

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I'Outaouais (CRO) on the Quebec side and the Regional (RMOC)on the Omario side of Municipality of *-Carleton the Ottawa River. These upper tier municipalities are not insignificant. Fbr example, the 1992-93 annual budget of the RMOC is close to $1 billion, approximately nine times that of the

NCC. HOW DID THE NATIONAL

CAPITAL EVOLVE? The thumbnail sketch of the governance of the NCR given above partly sets the stage for an examination of the recent course of federal policy concerning the role and governance of the capital. But to complete this task, it is necessary to examine the series of decisions which earlier governments took about the role, physical development, and governance of Canada's capital. The capital of the Province of Canada moved to Ottawa in 1865, after a 25-year shuffle (18414 5 ) which saw the province's capital move five times among Kingston, Montreal, Quebec, and d or onto.'^ David Knight argues that Ottawa was selected because the rival Factions h u r i n g other places retirsed to surrender their preference for one of the other major contenders. In his words, 'Ib many, it was the 'best' second choice." Knight goes on to note that the politicians of the day were fully aware that the choice of Ottawa as the capital would give it a symbolic role and prestige as well as tangible rewards.12 Oaawa was chosen, by a close vote, as the capital of the country upon Confkderation in 1867 to avoid revisiting the rancorous political squabbles that had characterized the earlier capital debates and the costs of moving the capital yet again. 13 Since Confederation, selected governments of different political stripes have taken an interest in the capital. In particular, the initiatives of the Laurier, Borden, King, Diefenbaker, and Tmdeau governments helped shape the physical fonn and govemance of the capital.

lk Fmre of Cbnda's Capital / 131 The earliest initiatives were oriented towards beautification of the capital. In 1899, the government of Prime Minister Wilfrid Laurier-responding to local initiatives-established the Ottawa Improvement Commission. The majority of the commission's members were local Ottawa people. Its main achievements were the purchase and development of land fw driveways and parks in Ottawa and the creation of Gatineau Park on the Quebec side of the river. The first comprehensive plan for the capital was commissioned by the Borden government. The so-called Holt plan was presented to the Government in 1916. Momentum for its implementation was lost, however, amid the trauma of World War I and the burning of the Centre Block. In 1927, the King govemment replaced the Improvement Commission with the socalled Federal District Commission and created the first Federal District signifying formally that the capital was more than just Ottawa.'4' Among Canada's prime ministers, it is perhaps Mackenzie King who had the greatest influence on the fonn of the capital. He was also concerned with its beautification.15 His post-World War 11 initiative to hire the prominent French architect Jacques Greber to develop a master plan for the National Capital Region also suggests that King had some sense of Canada's capital in an international context. The Gr&er Plan had five major elements: the relocation of downtown railway lines, the consolidation of Gatineau Park, the acquisition of river shoreline, the development of decentralized federal office sites, and control of urban sprawl through the development of a greenbelt. The St. Laurent govemment began implementing the Gr6ber Plan, and work continued under the Dietenbaker government, which started the purchase and expropriation of land for the Greenbelt. The Diefenbaker government also enlarged the capital territory to its present size in 1958, formally naming it the National Capital Region, and established the National Capital Commission as the agency to oversee developmentof the capital. The NCC replaced the Federal District Commission. The National Capital Act stipulates that at least one member from each province be appointed to the 20-member commission and that Ottawa-Hull and surrounding municipalities should also be represented. The Act provides for provincial and

132 IHow Onmva Spends

local representation by individuals, not corporate representation for provincial governments or for representatives of the local municipalities. All commission positions are Gwernor in Council appointments.l6 The final "watermark" in the history of the NCR occurred during the Trudeau era, as work on implementation ofthe Gr6ber Plan continued. During this period, two key decisions were made. The first was to increase dramatically the W e d presence on the Quebec side of the NCR. The most prominent manifistation of this was the development of two major federal office complexes in Hull. m e relocation of federal employment from the Ontario to the Quebec side of the river was intended to symbolize the new openness of the federal government to French Canada. The second decision was to keep the new buildings for two major national institutions-the National Gallery and the Museum of Civilization-in the heart of the National Capital Region. It was fbrther decided to search for the dramatic in the concept and architecture of the two facilities, one of which would be located in Hull and the other in Uttawa. These museums were under construction when the Conservatives were elected in 1984.

THE NATIONAL CAPITAL AT THE DAWN OF THE CONSERVATIVE ERA It is worthwhile putting the Conservative government's initiatives concerning the capital into context by assessing where the capital stood in 1984 in terms of its role, image, and governance. By this time, the National Capital Region had become the dominant political and public administration centre in the country. One illustration of this is that total federal expenditure in the region had increased from $35.51 million in 1975 to $85.6 million in 1982. The federal government's share of the Gross National Expenditure (GNE)for the same period climbed from 21.5 per cent to 24.6 per cent of the GNE. Over the same period, total federal expenditure minus interest on the public debt and transfkrs to persons and other governments rose from $12.93 million to $28.07 million." According to the 1981 census, 28 per cent of

7he Future of Canada's Capital / 133

the labour force in Ottawa-Carleton worked in the public sector while the figure for Hull was 26 per cent. Approximately 89 per cent of those employed in the public sector worked for the federal government.18 There is also evidence of effort on the part of the federal government to create the NCR as a capital of monuments. The National Gallery and Museum of Civilization are two cases in point. These complement the relatively recent construction of the National Arts Centre and the conversion of the downtown railway station into a National Conference Centre. Finally, with varying degrees of consciousness, previous federal governments had succeeded in creating a capital with some national symbolic value. Geographically, the NCR had developed as a combination of sophisticated urban complex and wildernesssomething of a mirror of Canada itself. In the urban part of the capital, greenspace and amenities such as parks and bicycle paths developed by the NCC contributed to a quality of life that many urban Canadians would aspire to in their own place of residence. The movement of federal employment to the Quebec side of the region in the 1970s had physical implications for the urban design of the capital.19 But equally, if not more, important was its symbolic intent to open the capital and its attendant opportunities to French Canadians more than in the past. If these were the roles that the capital had come to perform prior to 1984, what was the image of the capital in the minds of Canadians? It is possible to suggest that there were at least two dominant images of the capital, one held by local residents and the other by those living outside the National Capital Region. Locally, there was a sense of the capital as a special place with physical attributes, amenities, and a way of life that should be sustained and embellished. Outside of the capital, the prevailing sentiment seemed to be that the capital was both physically and economically remote from the rest of Canada. The conventional wisdom seemed to be that the capital was a 'fat cat" sustained on the endless cream of federal employment and largesse. Ottawa was also the place

134 \ How Ottawa Spends

where federal government policies were made, sometimes to be imposed on reluctant provinces or a querulous public.2o Finally, it is important to have a sense of the state of governance of the capital when the Conservatives came to power. More particularly, what was the state of the NCC? By 1984, the NCC was 26 years old. Its administration was authorized to employ the equivalent of 614 people. The NCC's budget for the 1984-85 fiscal year was $96.67 mil~ion?~ By far the largest share of its revenues came from parliamentary appropriations." Over the fiscal years 1980-81 to 1984-85, the Commission had consistently had a surplus of revenue over expenditure. The practice was for the NCC to retain this surplus for future use? In terms of its real property assets, the Commission owned 48,200 hectares of land (about 10 per cent of the land in the National Capital Region) and 1,300 buildings with an estimated value of $352 million in 1984 dollars. Aside from property acquisition, the NCC had busied itse# since its establishment with implementation of the Greber Plan. This had brought the Commission into a sometimes fractious relationship with area municipal governments. Municipalities on both sides of the river chafed at the restrictions on development on NCC lands. On the Ontario side, there were lively debates about the cost of moving municipal services through the NCC Greenbelt and about the appropriateness of using NCC controlled parkways for public transit. There were also success stories. For example, the NCC collaborated with the Regional Municipality of Otta&a-carleton and the City of Ottawa on a major d&t6wn redevelopment, known as the Rideau Centre. 'Ihe NCC Chainnan from the late 1970s to 1984, Bud Drury, is alleged to have used the financial and land resources of the NCC to placate irate local mayors by building bicycle paths as evidence of good corporate citizenship. Ib some degree, this may have had a salutary effect on the NCC-municipalities relationship. However, the local image of the NCC's approach to implementing its mandate, as of 1984, was that of a somewhat heavy-handed federal agent interested in excessive control of the local environment. At the very least, the

7kFuture of Canada's Capital /I35 NCC was trying to preserve its dominant role in planning for the area. From a local perspective, this was increasingly contentious as the major cities and the two regional governments became more sophisticated and aggressive in pursuing their own plans for development. As the next section will demonstrate, the arrival of the

Mulroney government marked the beginning of the retreat of the NCC from its traditional capital planning activities. The weakening of the NCC in this and other respects has created a vacuum in the federal governance of the capital at a crucial time.

THE CONSERVATIVES TAKE CHARGE Four names loom large when one considers federal initiatives affecting the capital since 1984: Eric Nielsen, Michael Wilson, Jean Pigott, and Brian Mulroney. Eric Nielsen comes onto the stage first, as Chair of the 'kk Force on Program Review. At least two Nielsen Thsk Force study teams looked at the role and activities of the NCC, that dealing with Culture and Communications and that dealing with Real Property. The more important of the two in suggesting the government's agenda concerning the NCC is the report of the Study Team on Real Property. This report observed that the NCC could be folded into Public Works ~ a n a d ahowever, ; ~ ~ it recommended instead that the NCC be retained as a separate entity but be changed from an arm's length crown corporation to a departmental corporation? The Thsk Force also recommended that the NCC change its focus. Specifically, it suggested that the NCC divest itself of lands, buildings, and fscilities-other than those which must be held in the highest national interest-and de-emphasize its land use planning, infrastructure construction, and property management functions. It advocated a renewed and streamlined NCC mandate which would focus on the NCC's challenge "to create a symbol of Canada's strength and unity."** Finally, the 'Risk Force recommended that the NCC undertake its new mandate with a view to reducing its dependence on

136 IHow Onmva Spends

parliamentary appropriations by at least $25 million annuallYF9 In summary, the Nielsen ' b k Force suggested that the role of the federal government in the capital be scaled down in terms of physical and monumental planning but increased in terms of seeking a symbolic role for the capital. All of this was to be accomplished with less money. The second character in the pantheon, Michael Wilson, took the financial suggestions of the Nielsen 'Igsk Force to heart in his position as Minister of Finance from 1984to 1990. One of his first acts as Minister of Finance was to appropriate $30 million from the NCC reserve fund for the general federal treasury. During Wilson's term as Minister, the NCC's parliamentary appropriations were trimmed to the point that they almost met the Nielsen target. In the four years from 1984-85 to 1987-88, the Commission's appropriations fell from $97.06 million to $62.45 million. In 1988-89, the NCC assumed responsibility for Official Residences. As a result, appropriations rose in that year to $103.01 million. However, by tho" fiscal year 1990-91, they had shrunk again to $80.03 million. As of fiscal year 1992-93, the Commission's expenses are forecast to be $110.08 million. Its revenues from sources other than Parliament are krecast to be $18.94 million. This leaves its net cost for operations at $91.15 million. Planned parliamentary appropriations for this year are less than the amount needed to cover this net cost by $11.52 million. This pattern is planned to continue until the 1996-97 fiscal year. The person charged with realizing the NCC's new mandate in the context of the commission's financial squeeze was Jean Pigott. She was appointed to succeed Bud Drury as chair of the NCC shortly after the Conservatives were elected in 1984. Her extended term will end in September 1992. 'Ib a considerable degree, Jean Pigott and her senior staff succeeded in reorienting the Commission in a manner consistent with the Nielsen lhsk Force recommendations. Among the new directions that the NCC has taken during her tenure are: the dwelopment of a new corporate plan that emphasizes programming more than building;

llte Future of Canada's Capital / 137

the identification of those lands and properties that the NCC holds that are fundamental to the national interest and the assessment of options for those that are not; divestiture of some lands and properties; the development of communications and other programs that point to the capital as a symbol of national unity; and manifestation of the ceremonial function of the capital through the cosmetic embellishment of certain streets in the central area. Jean Pigott has also been tireless as a public ambassador for the capital, both within the NCR and across the country.

As a result of the efforts of Jean Pigott and her senior staff, we have today a National Capital Commission that is leaner and less intrusive in terms of the physical planning and development of the capital than was previously the case." While this may suit the federal government's fucal agenda and ease the tensions between the NCC and area municipalities to some degree, the danger exists that the NCC's retreat from its traditional planning function will create a serious void in terms of planning the capital for the longer term future. Indeed, the Auditor General noted in a Special Exumina?ion Report to NCC commissioners in 1987 that the NCC's draft Fedeml LMd Use Plan "by design focuses on the use of the current portfolio of federal lands, not the develoment of the region as a whole or future land requirements...." The potential seriousness of this retreat may be exacerbated by the fact that the NCC appears to have embraced its role as a catalyst for enhancing the symbolic role of the capital without taking on the task of thinking in policy terms about what that role should be in the context of an evolving Canada and the changing international order. Indeed, thinkiig about "What if ..."questions concerning the future of Confederation and the implications of alternative possibilities for the role and form of the capital has been explicitly rejected as beyond the Commission's mandate and unadvisedly provocative. Equally disturbing is the faet that the Commission has had extremely weak links to the central agencies of government (other than Treasury Board) which are coordinating federal thinking about future constitutional arrangements and their implications?4 'This moves the issue of the future of the capital farther from the agenda. One manifestation of this is that there was

138 I How Ottawa Spends

no mention of the capital in the federal constitutional proposals released in the fall of 1991. In short, it appears that little, if any, concerted and constructive thinking is occumng within the federal government about the future of the capital under altered constitutional arrangements. Such thinking is important for more than romantic reasons. 'The National Capital Region contains the fourth largest urban agglomeration in the country. Its population is highly trained and educated. The region itself contains important concentrations of expertise in areas of science, technology, and administration. Much of the activity which goes on in the NCR is "cutting edge," central to the fuhlre of Canada. The implications of alternative constitutional arrangements in tenns of their potential to dilute this national centre warrant consideration. An assessment of the current state of the capital would not be complete without summarizing the Conservative government's broader perspective on the capital. To the extent that we can associate past initiatives with earlier prime ministers, one need only to mention three policy decisions of the Mulroney cabinet to get a sense of its priorities vis-b-vis the NCR. These initiatives are the location of the National Space Agency in the Montreal area and the relocation of the Farm Credit Corporation and National Energy Board to Regina and Calgary, respectively. The Space Agency decision occurred relatively early in the Mulroney era, but the latter two occurred during the past year, as constitutional discussions were heating up. One could justify these initiatives on the basis of trying to revive the government's sagging popularity in Quebec and the West. Further, the immediate economic impact on the region could be considered relatively minor in the sense that the number of jobs lost to date thmugh such moves is slightly over 500 out of total federal employment in the NCR of 99,866 people, not including those employed by crown corporations?5 Nevertheless, popular opinion in the capital and even elsewhere suggests that this could be the start of a trend to strip the federal capital bare to appeal politically and economically to regional interests? Among other things, the fact that only

lhe Future of Chnda's &piid/ 139 a minority of members of Parliament from the region are Conservatives might make this a politically tempting idea. Such an approach by the Mulroney government would have long-term negative implications for the NCR both economically and in terms of its national and international role. It remains to be seen if other interested parties outside the federal government are grappling with this prospect. M obvious interests are found at the local and provincial levels on both the Ontario and Quebec sides of the region.

CAPITAL PLANNING/CAPITAL BUDGETING: IS IT POLITICS, ECONOMICS, OR BOTH? There are concerns on both sides of the Ottawa River about the potential impact of constitutional change on the local economy and political structure. These concerns have manifested themselves differently in Quebec and Ontario. Basically, there has been a great deal more action on the Quebec side of the capital. One important local organization on the Quebec side has been the Societe d'arnenagement de I'Outaouais (SAO), an organization established by the Quebec government in 1969 to 5Jersee economic development on the Quebec side of the NCR. The SAO took a prominent role in representing local interests before the Belanger-Campeau Commission, established by the Quebec government to examine the political and constitutional future of Quebec in the aftermath of the failure of the Meech Lake Accord. Its brief emphasized the need for the Quebec government to ensure the economic diversification of the Outaouais and to renew the structure of governance for the National Capital Region, should Quebec remain part of Canada. Specifically, the SAO recommended that the Quebec government push for the governance of the capital to be under the formal joint authority of the federal government and the governments of Quebec and Ontario, with the participation of regional organizations as well. The SAO was silent on its preferred model of governance in the event of outright sovereignty. In light of this scenario, its recommendations were oriented to sustaining the economic health of the region.

140 1 How Ottawa Spends

Specifically (and hardly surprisingly), it recommended that current levels of public service em loyment in the Outaouais be retained, if separation occurred.3 8 In the aftermath of Belanger-Campeau, the Quebec govemment has been concerned about the potential implications of constitutional change for the Outaouais to the extent that it has established and funded the Cornit6 d'dtude sur l'avenir de I'Outaouais. This committee will examine the impact of three scenarios for the region: a minimal change in constitutional arrangements, significant decentralization from the federal government to all provinces, and Quebec sovereignty.39 The Committee is to carry out its work through the prism of economic analysis, rather than establish desirable political or administrative structures for the NCR. However, its work may well provide a solid basis for the assessment of appropriate arrangements for the governance of the NCR in each case." The importance of this committee's work in the context of discussions about governance received a boost when its Chair, Marcel Beaudry, was elected Mayor of Hull in late 1991. The situation on the Ontario side has kllowed a somewhat

different panern. There is no indication that the Ontario govemment is doing any thinking about the future of that part of the National Capital Region that falls within the province. As one commentator has noted, Ontario has a' provincial administration that treats the city [sic] like a village somewhere near ~ornwll."~'What attention has been paid by Ontario to local governance in that region has been totally unrelated to its status as the capital.42 Locally, there have been concerns about political and economic arrangements affecting the capital in light of constitutional change. On the political front, most notable is the strong desire on the part of the former chair of the Regional Municipality of Wawa-JCarleton to have the NCR created as Canada's 11th province. The economic implications of the decentralization of the Space Agency, National Energy Board, and Farm Credit Corporation and uncertainty about the economic future of the

The Future of Canada's &pita1 / 141

region in the context of changing constitutional arrangements have prompted the RMOC to establish a blue ribbon Economic Development Tbsk Force to develop a strategic direction for the future economic prosperity of the region. The work of that task force continues. Its deliberations about alternative economic strategies and priorities for the Ontario side of the capital is accompanied by some agitation, as various members of the Thsk Force struggle to accept the analytic possibility that there might well be significant change in the structure of the Government of Canada and that such chan e would have a strong impact on the Ontario side of the NCR.2 All of these initiatives, on both the Ontario and Quebec sides

of the NCR, may ultimately contribute to more coherent analysis of the W e of the capital by the federal government. However, looking merely to the two provincial governments with jurisdiction over the territory that makes up the capital or to local municipalities will not be sufficient. Regardless of whether this exercise is undertaken within the NCC or elsewhere, there are some important basic issues which are currently totaIly absent from the federal agenda and which must be addressed. It is perhaps useful to propose a framework and some preliminary ideas concerning how the federal agenda about the capital should be addressed and what substantive possibilities might emerge as important for analysis and debate.

THE FUTURE OF THE CAPITAL: A CONCEPTUAL MAP AND PRELIMINARY THOUGHTS Earlier in this chapter, it was argued that the particular role and image of a capital reflects some basic values in national society. It was also suggested that there is an interplay between the role and the form of governance in place in capitals around the world and that this interplay can be seen in the evolution of federal structures for governance of the National Capital Region up to the creation of the NCC.

142 \ How Ottawa Spends

Discussions about the role, image, and governance of the capital will never (and likely should never) drive the broader discussions about future constitutional arrangements fot Canada. The various broad alternativesfor the future of the country suggest a particular direction for the role of the capital and perhaps for its governance. 'Ib the extent that any of these are realized, a particular image of the capital will emerge into the national consciousness. Ultimately, the W e role, governance, and image of our capital will have implications for Canada's image on the international stage, as well. Options for future constitutional arrangements have been discussed extensively and in a more refined manner than will be presented here." For the purpose of illustrating how thinkii about the fublre of the capital might proceed, it is useful to think about four basic alternative political directions for the country: minimal change in the Canadian federal system as we now know it; significant decentralization of federal powers to all provinces; some form of asymmetrical federalism, with Quebec remaining in Confederation but with different powers and jurisdictions than the other provinces; and Quebec sovereignty-with or without association. Each alternative suggests somewhat greater emphasis on the capital's different roles as political centre, administrative centre, physical monument, symbolic and cultural centre, or as "The Central Place." The analysis also suggests that different issues might emerge as important in dealing with the future role of the federal government in the governance of the capital. The following possibilities are offered for the purpose of sparking discussion and debate:

* If there is minimal change in the Meral system as we now lrww it, the NCR's major role will be as a political and administrative centre. The continuing existence of the Meral gwemment will require a major central venue fir political d e b and the conduct of national political lik. The cmss pressurns fbr centralivltion and decentralizationof the Metal gwemment's administrative activities will continue, perhaps resulting in some further deconcentration of

llte Future of Canada 3 Cqpital/ 143 the fiederal administrative state. Huwever, the NCR will remain the dominant locus of Went1 administrative activity. The major issue with respect to the Meral government's role in the gwemance of the capital will be to sustainthe federal interest in the iace of physical planning and development priorities of local gwernments on both sides of the river. The federal government will have to develop a new institutional relationship with regional institutions, such as the RMOC, CRO, and SAO, in order to achieve f U local understanding of the Meral government's interests in the capihl. In recent years, the NCC has entered into partnership arrangements with regional and local gwemments in the NCR on a project-byproject basis. H-r, permanent institutional membership by the t w regional gwemments in the NCC may be one way to achieve the needed kderal leverage in the i c e of continuing financial constraints and a reduced fbderal land mass.

" Signijcant decentrali~al~~on of fkderal powsrs to the provinces is perhaps the worst case scenario fbr the NCR. Assuming some federal government remains, its role will be substantially diminished. This will result in the diminution of the role of the NCR as a political centre. Perhaps more serious, the role of the NCR as an administrative centre will be significantly reduced as various provincial governments relocate the people they inherit as administrative responsibilities am transferred to the prwinces. Them will be no rationale or support h r maintaining or boosting the NCR's physical form as a manikstation of its status as a capital, nor will it have any particular symbolic claim b r Canadians except as our own Berne, "le minimum." The major issue related to the Meral gwemment's role in the capital region will centre on what initiatives the federal government will undertake to manage the adjustment of the NCR economy and communities to the new reality. The federal government may vest the NCC with an institutional role to deal with this process or it may create another pro tern organization to do sa Regardless, the NCC as we nuw knaw it will eventually cease to exist. O

In the event that some form of asymmetricalfi&mlism should emerge, there would still be a role for the capital as a diminished political and administrative centre. This would stem from the need h r provinces other than Quebec to have a relatively strong central locus of political lik and a relatively strong central bureaucracy to sustain the more fragile federal state. In this context, hmver, there

144 \ How Ottawa Spends wuld be very little justification b r the NCR to be embellished in its role as a physical monument or as a symbolic centre. From a symbolic perspective, the challenge for the federal government uilould be to raise the image of the capital as a place where both elements of the new Canada (defined as Quebec and the rest) could come together and negotiate constructively issues of mutual interest. In terms of the federal government's institutionalneeds visa-vis the capital, this suggests an e d u c e d emphasis on having a neutral federal institution in the capital to kilitate consultation and communication among the Metal gmfnment, Quebec, and the other provinces, as well as with various sectors of Canadian society. This institution would be analogous to the central transmitter in a communications network. O

The prospect of Quebec sovereign@ suggests to David Knight that Ottawa [sic] would become "a forward-capital," one on the periphery of the country." Assuming that it is not decided to mave the capital of Canada elsewhere as a result of Quebec ~ a v e m i g n t y ~ ~ the role of the capital as a political centre will remain very strong, as it acts as the point of political coalescence for the remaining Canada and the point of contact betwleen Canada and Quebec. Quebec sovereignty may, however, result in some dilution of the fimction of the capital as an administrative centre, as the central gwemment tries to heighten its presence throughout the country to reassure Canadians of the immediacy and vitality of the central gwernment. Ironically, Quebec sovereignty may be the one context in which the role of the capital as a physical monument will be enhanced. Depending on the terms of separation and the relations between Canada and Quebec, Canada's capital may be physically modified to take on the symbolic image of "hrtress Canada" or become a physical (and again symbolic) s h a w s e b r the Canada that is a success without Quebec. From the standpoint of gwemance, the alternative of Quebec swereignty offers the most obvious challenges in k m of determining what will happen to fiederal hcilities, pruperties, and personael currently located on the Quebec side of the NCR. Will there be a "capital zone" that encompasses areas of high fiederal presence on the Quebec side? Would such an arrangement be temporary or permanent? What should be the institutional role of the Government of Quebec (and perhaps Ontario) in the governance of such a mne?

lbe Future of -a's

w i t a t / 145

It should be evident that all of the analysis presented here is speculative and needs to be extended in scope and depth. Further, none of the above discussion approaches the future of the capital from the standard institutional perspective of the merits of creating a federal district analogous to the District of Columbia or of turning the NCR into an 1lth pmvince. Such precise institutional prescriptions should be the final product of concentrated analysis regarding the capital's future role and governance. Instead, this analysis has been intended to show that there are some basic and very challenging first principles about the capital that should be exposed to national debate. It has also been intended to assist the federal government and others to join that debate.

NOTES I wuld like to thank Mark Hopkins fbr helping with the background research for this chapter. Frances Abele, Caroline Andrew, and John Taylor provided very constructive suggestions for its impnwement. Finally, I wuld like to thank Jean Pigott and senior staff of the NCC, and senior staff of the RMOC and SAO who provided background material and other types of assistance. Responsibility for any errors of hct and the arguments presented in this chapter rests solely with me. 1

With apologies to the Royal Canadian Air Farce.

2

Peter Hall, "The Changing Role of Capital Cities: Six 'I)pes of Capital City," in Caroline Andrew, Jean Langelle, and John Taylor, (eds.), Capital Cities: An Anatomy (Ottawa: Carleton University Press, 1992), firthcoming.

3

From the late 1960s to the mid-1980s, the Legislative Assembly of the Northwest Territories w e d fiom community to community, while the fbrmal capital was Yellowhik.

4

Claude Raffkstin, "h capitales sont-elles des expressions de semiospheres nationales ou des lieu demiseen scenedu powoir?" in Caroline Andrew, Jean Langelle, and John Taylor, ap.cit.

I46 IHow Ottawa Spends 5

Theodor b f , "Berlin or Bonn? The Dispute Over Germany's Political Centre," in Caroline Andrew, Jean Langelle, and John Taylor, op. cit.

6

Jorge E. Hardoy, "Ancient Capital Cities and New Capital Cities in Latin America," in Caroline Andrew, Jean Langelle, and John Taylor, op. cit. Anthony King, "Cultural Hegemony and Capital Cities," in Caroline Andfew, Jean Langelle, and John Thylor, op. cit. Jose bdevoorde, "Capitale-ville, ville-capible, une approche holistique," in Caroline Andrew, Jean Langelle, and John 'bylor, op. cit. It should be noted that the NCC's jurisdiction is limited to the planning and development of federal lands only. These comprise about 13 per cent of the total NCR land mass. In the case of the remaining NCR territory, the NCC works by using moral suasion. Regional or upper tier governments are, in essence, supralevel municipal governments which the governments of Quebec and Ontario (and British Columbia) have established to assume local functions that are thought to be more efficiently and effktively delivered to a group of municipalities. Functions assigned to the regional level have typically included: water supply; sewage tmatment and disposal; solid waste disposal; and, in Ontario, social services, The regional councils in the CRO and RMOC consist of politicianswho are members by virtue of their election as mayor or, in some cases, councillor in one of the local cities, towns, or tawnships that comprise the region. Ottawa was actua11y designated the capital in 1856. H m e r , the move did not occur until 1865. David Knight, Choosing Canadas' Capital (Ottawa: Carleton University Press, 1991), pp. 339-41. Ibid., p. 339. Rowat notes that the creation of a fkderal district was somewhat illusory because it was not a federal temtory, such as the District

The Future of Canada's Capid/ 147 of Columbia, but merely "lines on a map." See Donald C.Ruwat, (ed.), me Gbwment ofFe&ml C'itals (Toronto: University of Toronto Press, 1973), pp. 319-20. 15

Among other things, in the 1930s King hired Jacques Gdbet to plan the "Parliamentary Precinct. "

16

I am particularly indebted to John 'hylot for his comments on this section. For an excellent ovehew of the history of Ottawa, including its evolution as a capital, see John 'Ihylor, Ottawa: An IUustrated History (Toronto: Lorimer, 1988). @NmE= 17

Allan M. Maslove, (ed.), Hav Ottawa Spends 19W me New Agenda (Toronto: Methuen, 1984), p. 6. 18

The Conkmnce Board of Canada, Ottawa-Carleton Economy.= Looking Ahead (Draf)), prepared for the Ottawa-Carleton Economic Development Task Force (Ottawa, September 1991), pp. 22-23. The estimateof 89 per cent is based on the Conkrence Board's figures for the Meral share of public sector employment in the region as of 1991.

19

Some would argue that the physical impact of the two main office complexes constructed on the Quebec side to enable this mwe to take place was brutal or, at the very least, a vulgarization of capital design.

20

These descriptions are obviously not scientifically based. They are extrapolated from the author's experiences in and outside the capital during the late 1970s and early 1980s. With regard to the local perception of the capital, it should be noted that the sentiment on the Quebec side of the river may not have been so rosy. See, for example, Caroline Andrew, "Ottawa-Hull," in Wamn Magnusson and Andrew Sancton, (eds.), City Pblitics in Clznada (Toronto: University of Toronto Press, 1983), pp. 158-60.

21

National Capital Commission, Statement of Operationsfor the Year Ended March 31,1985, p. 25.

22

In fhct, the parliamentary appropriation for the 1984-85 fiscal year exceeded the total expenditure budget. Ibid.

148 1 How Uttawa Spends

a

National Capital Commission, &ztwnents of Operations, 1980-81 to 1984-85, inclusive. A Study Team Report to the Task Force on Program Review

(Nielsea 'hsk Force), Management of Govenunent, Real Pmpm (Ottawa, May 1985), p. 258.

By this time, the NCC had also begun to orchestrate various cultural events in the capital, such as Wmterlude and the Festival of Spring. Op. cit., p. 251. Ibid., p, 252.

Ibid., p. 249. Ibid., p. 255. National Capital Commission, Financial Statements, various yeam*

-

National Capital Commission, Corporate Plan 1991/92 1995/%: Summary, p. 16. All figures are rounded. The rounded net cost is as reported. This is not to suggest that the NCC has become entirely disinterested. Indeed, it has been one of the major parties, along with the RMOC and the City of Ottawa, in developing a plan kt Le Breton Flats, a major tract of vacant land in the core of the parliamentary me. Auditor General of Canada, Special h i n a t i o n Report (Ottawa, September 30, 1987), p. 2. This may change. The NCC's recently appointed General Manager, John Hoyles, has political links with staff in the Prime Minister's Office. Statistics Canada, Employment Section, Public Institutions Division, September 1991.

Ihe Future of Canada's Capital / 149 36

See, b r example, Allan Freeman, "Stripping Ottawa bare is hardly a capital idea," Ihe Globe and MaU, November 14, 1991 and CharlesGordon, "Little p m t s Ottawabeing Canada's ghost capital," me Ottawa Citizen, May 28, 1991.

37

The territorialjurisdiction of the SAOdoes not cornspond exactly to that of the NCC on the Quebec side. Another important organization is the Secdtariat dgional de concertation de I'Outaouais(SRCO), which may nuw be taking o w the lead from the SAO.

38

Soci6t6 d'amhgement de l'Outaouais, Mhoire pour la Commission sur l'awnir politique et constitutionnel du QuJbec (Nsvemh 1990), pp. 19-20.

39

Comit6 d'6tude sur l'avenir konomique de I'Ouhouais, Cornit& Outaouais pmgmmme de recherche (Hull, September 3, 1991), pp. 3-4.

40

There is another set of reports pertaining to the Outaouais which may also help in this regard. From January 1989 to the release of its third report in October 1990, the NCC convened and provided financial support to a group called Outaouais 2050. It consisted of planning p m ~ i o n a l sfrom local municipalities in the Outaouais, plus representatives fiom the Office de planification et de d6veloppement du Qu5bec (OPDQ), the CRQ SAQ and the NCC. This committee began by looking at the physical develop meat of the Outaouais. Huwever, it gradually widened its scope of activities until, by the time of its last report, it was examining various possibilities concerning the social, cultural, and political development of the area. The three wrking papers prepared by the Outaouais2050 committeeare: L'Outaouaik: hblems, Issues and Plreliminary Concepts (January 1990); L 'Outaouais:Dewlopment and Bordering Contat (July 1990); and L'Outaouais: Dewlopent %rids (October 1990). The NCC itself seems to be de-emphasizing the m r k of this committee in its own deliberations; however, the committee does continue on an ad hoc basis.

.

41

Freeman, op. cit.

42

For example, the Terms of Rekrence fbr a review of the Regional Municipality of Ottawa-Carleton, established by the Ontario

I50 IHow O m a Spends Minister of Municipal A f i m in 1987 (the Bartlett Review), contained no 6 m 1 ~ : eto the capital whatsoemr. 43

See, for example, "Haydongoing it alone on 1lth province plan," ?he Ottawa citizen, December 4, 1990, p. D12.

44

Personal observation as a result of a meeting with a subcommittee of this task force, October 17,1991.

45

See, b r example, IUainG. Gagaon, "Ewrything Old Is New

Again: Canada, Quebec and the ConstitutionalImpasse," in Fran(ed.), How O t t @en&: ~ lbe Politics of Ragmentation 1991-92 (Ottawa: Carleton University Press, 199I), pp. 75-83, and Ronald L. Watts, "Canada's Constitutional Options: An Outline," in Ronald L. Mttsand Douglas M. Brown, (eds.), Options For a New Canada(Toronto: University of Tofont0Press, 1991), pp. 25-27. ces Abele,

46

David Knight, op. cit., p. 345.

47

This possibility should not be ignored. Also, its ramifications should be carefirlly thought through by the Meral government as part of its delibemtions about the capital in the context of the current constitutional possibilities.

REWONDING TO THE CXMLLENGES OF THE GLOBAL M3ONOMY: THE C O O AGENDA Michel Demers ROsumC : La ddtdrioration de la productivid de l'dconomie canadienne par rapport au Groupe des Sept, surtout dans le sexteur manufacturier et les ressources naturelles, cornpromet le niveau de vie futur des Canadiens. Dans l'avenir, le Canada devra s'efforcer d'obtenir des gains de productivid dans les secteurs clans lesquels il a un avantage wmpad-les secteurs tditionnels bas& sur les ressources naturelles ainsi que les cdneaux qui q u i k t n t l ' a d de vastes march&. Uamaioration de la cumpt9itivid canadienne n h s i t e des mesum afut de renbrcer l'union Bconomique canadienne, obtenir l ' a d B des march& plus vastes pour les entreprises canadiemes, ainsi qu'amdiorer la qualit6 des ressources humaines et la capacid innovatrice.

Abstract: The productivity of the Canadian economy, especially in manufacturing and in natural resources, has been falling relative to G-7 countries, thereby endangering the future standard of living of Canadians. In the years to came, Canada will need to emphasize productivity gains in its sectors of comparative advantage-the traditional ones based on natural resources and the specialized niche products that q u i r t access to geographicallylarge markets. The improvement of Canada's compditiveness requires measures to strtngthcn Canada's economic union, to seek access to larger international markets for Canadian firms, and to improve human resources and innovation.

The overwhelming message of market globalization is that living standards of countries that seek to resist the tide will decline relative to others, and perhaps even in absolute terms.

'

Since the mid- 1980s, "competitiveness" has become the overriding concern of governments, as well as of political, business, and labour leaders around the world. How can national competitiveness be enhanced? How can national firms successfully compete on the international scene? Most importantly, what kind of "industrial strategy" will favour greater competitiveness? Should governments adopt a "blueprint" or a "framework" approach to industrial strategy? While the blueprint

152 /How Ottawa Spends

strategy Fmoun the targeting and promotion of specific national industries through various subsidies and support programs, the framework strategy emphasizes instead the importance of designing taxation, competition, trade, and macroeconomic policies to provide a propitious environment for firms and individuals. The current government's general approach to competitiveness is in line with the latter, though there have been cases of government support for specific firms or industries, such as the recent attempts to assist Bombardier's takeover of de Havilland and the rescue of Algoma Steel. The main objective of kderal policy has been to foster private sector initiatives. The Government has taken a NOpronged approach, on the one hand, attempting to improve the economic climate in which firms operate, and on the other, adopting some measures to improve the quality of human and capital resources. A number of policies have stimulated competition in the Canadian market and attempted to attract foreign investment. In 1986, competition policy was made more effective by vesting the control of mergers in a new competition tribunal. In addition, several sectors such as energy and transportation were deregulated, and some crown corporations were privatized. Following the 1986 tax reform in the US, a tax reform package was introduced to reduce the tax disadvantage that Canadian finns would have otherwise faced relative to US f ~ r n sThe . ~ goods and services tax (GST) was instituted to remove the bias against manufactured exports inherent in the previous, complex system of indirect taxes. Unemployment insurance (UI) was reformed to reduce the duration of benefits, increase eligibility requirements, and shift the emphasis away from income maintenance and towards training. The Canada-US Free Trade Agreement (FTA) was negotiated to obtain access to the larger US market for Canadian firms.3 Foreign investment rules were also liberalized under the F I A . Earlier, the former Foreign Investment Review Agency (FIRA) had been replaced by Investment Canada whose goals

me CompetitivenessAgenda / 153 were to attract foreign investment and foster joint ventures and strategic partnerships between Canadian and foreign firms. Investment Canada had been instituted to review direct take-overs in excess of $5 million and indirect ones in excess of $150 million. The =A had more liberal foreign investment rules for direct foreign investment than those imposed by Investment Canada: no review requirements for indirect acquisitions from 1992 on and higher limits on direct acquisitions. Only four secton were excluded from the FTA rules: oil and gas, cultural industries, uranium, and financial services. On March 25, 1992, Energy Minister Jake Epp announced further liberalization in the energy sector. Whereas previously energy take-overs in excess of $5 million had to be screened, under the new ruling an American firm would be allowed to purchase shares in a Canadian firm up to $150 million without being subject to review by Investment ~anada?This was an attempt to increase activity in the oil sector and, especially, to find a potential partner in the Hibemia project. Unforhnately, the Government may have surrendered a bargaining chip before the conclusion of the North American (CanadaUS-Mexico) free trade negotiations. In September 1991, federal constitutional proposals were released that included a proposal to strengthen the Canadian economic union by removing interprovincial trade barriers and achieving Meral-provincial policy harmonization. This very significant proposed measure would improve competitiveness by ensuring access to an integrated market for Canadian firms and allowing individual Canadian workers and entrepreneurs unimpeded access to the whole of Canada. The Prosperity Initiative, a broad nation-wide consultative process with the specific objective of improving the innovation and training performance of the private sector, was launched in October 1991. A study conducted by Harvard University economist Michael Pbrter, co-sponsored by the federal govemment and the Business Council on National Issues, was released in January 1992. It identified the Canadian economy's strengths

I54 /How Ottawa Spends and weaknesses and made several recommendations to all levels of government as well as to labour unions and business firms. In addition, the Government has recently taken measures to stabilize the deficit-to-gross domestic product (GDP)ratio and has reduced the rate of inflation. Large budget deficits have been consistently hampering the government's ability to undertake a more active role in promoting competitiveness. Deficit reduction is in itself a measure that enhances Canada's ability to compete? Yet it also precludes greater direct spending on measures that could potentially impme our competitiveness. The 1992 budget reflects in some ways the conflict between the government's attempt to control the deficit, in spite of a prolonged recession, and its attempt to use incentives to promote competitiveness. On the one hand, the manufacturing sector will benefit from some tax reductions and an increase in the capital 'These tax reductions are also expected to rovide cost allo~ance.~ greater incentives for direct foreign investment in Canada. Some of the measures introduced in the Budget will permit small businesses to have somewhat better access to loans. The budget for the Scientific Research and Experimental Development Program will be increased by $230 million to provide for investment tax credits for research and development (R&D). At the same time, however, the Government has also undertaken a variety of steps that restrict spending but are in conflict with the goal of enhancing competitiveness. There have been cuts in the budget of Employment and Immigration Canada in the amount of $177 million, most of which will affect funding for training and worker adju~trnent.~ Since the 1991 budget, the annual increase in funding for all science and technology grants and contribution programs has been limited to 3 per cent, and with the 1992 budget research institutes such as the Science Council and the Economic Council were abolished. In addition, with respect to providing greater incentives FDr direct foreign investment in Canada, the tax reductions granted to manuficturing may not be as effective as indicated in the ~ u d ~ e t . ~

S

l&e CompetitivenessAgenda / 155

THE CHANGING GLOBAL ECONOMY The necessity to be competitive derives in great part from the new international order characterized by an unprecedented degree of international economic interdependence. World trade has increased very rapidly since the end of World War 11, reaching an average annual growth rate of 4.5 per cent in the 1980s, while world output grew at an average annual rate of only 2.8 per cent during the same period.10 ltade is being regarded as the engine of growth not only by developing countries but also by Western economies. The past five years have seen a cementing of the Canada-US trade relations through the Free Trade Agreement and an acceleration of the economic integration process in the European Community (EC), as well as a substantial increase in trade among East Asian countries including Japan. The annual growth rate of world foreign direct investment increased from 10.2 per cent in the early 1980sto 23.6 per cent in 1986-87. Investment and technology are flowing through international borders at an ever-faser rate due in great part to technological advances in telecommunications and information network systems, which have led to the prolifbration of financial linkages across countries. Industry is becoming increasingly "footloose" and decentralized, particularly in the high technology sector. There is no longer a need for fums to locate all of their operations in only one country. Production takes place where costs are the lowest. The important considerations that come into play in the determination of a desirable location for particular business operations include the economic and political climate of the country being considered as a potential site. Thus, the new world economic and commercial order is imposing fierce competition not only among firms in their quest for a lucrative share of markets, but also among states in their attempts to attract highly mobile investment. Firms can easily move their operations if they believe that the environment provided by the state does not permit them to be competitivewhether it be because of high taxes, complex regulation, low productivity, labour market rigidities, or political instability. As

156 /How Ottawa Spends

John Jackson puts it, 'with interdependence has come vulnerability. National economies do not stand alone. Economic forces move rapidly across borders to influence other societies."l In Canada's open economy, exports amount to 26 per cent of the GDP-the second highest of the G-7, after Germany. Maintaining a high standard of living thus requires .the ability to compete in international markets. Given the global environment described above, how competitive is Canada relative to other nations? While Canada is current1 enjo in one of the highest y g look at declining standards of living in the world, a closer growth trends in per capita GDP suggests that less prosperous times may be ahead unless the problem areas are identified and the necessary corrective measures adopted.

X

COMPETITIVENESS AND PRODUCTIVITE THE CANADIAN RECORD An increase in our competitiveness depends on our ability to increase our productivity. 'Ihe two most widely used measures of productivity are labour productivity, which measures real output per worker employed, and total factor productivity, the real output that can be produced with the given labour and capital stock. Total improvement in factor productivity growth captures a qzuzlitatr*~ the production process and/or in the human and capital resources employed." Thus, a better trained and better skilled workforce, the adoption of superior technology, or the implementation of superior managerial and organizational techniques will contribute to total factor productivity gowth.l4 Furthermore, access to a weN integrated domestic market and to the international market permits finns to specialize and increase their efficiency due to economies of scale. Canada's performance, in terms of both the labour productivity growth measure and the total factor productivity growth measure (l'hble 6.1 below), has been continuously declining. While all Organization fDr Economic Cooperation and Development (OECD) countries have been experiencing a general

The CompetitivenessAgenda / 157 slowdown in economic growth relative to the immediate postwar period, Canada has been second last among the G-7 countries (ahead of the US) since the 1960-73 period. Thus, Canada's problem is somewhat more acute than that of Japan and the industrialized European countries. In particular, total hctor productivity figures indicate that the rate of technological innovation and of human resource development has been deficient. Canada has fallen behind the US, Japan, and Germany in labour productivity growth in manufacturing. While labour productivity growth in manufacturing has been slowing down in the 1980s (Appendix 6. I), nominal hourly compensation rates have been increasing at higher rates than in the other three countries, leading to an important differential in terms of manutscturing unit labour costs (Appendix 6.2). The only way of reducing our current handicap in terms of unit labour costs, without affecting wages, is to improve productivity.

Table 6.1

Total Factor Productivity

Labour Productivity

1960-73 1973-79 1979-89 0.8 0.4 Canada 2.0 -0.4 0.4 US 1.6 Japan 5.9 1.4 2.0 1.8 0.8 Germany 2.8 France 1.7 1.7 4.0 2.2 1.3 Italy 4.6 UK 0.6 1.5 2.3 Sweden 0.4 1.O 2.7 -0.4 0.9 Switzerland 2.0 OECD 2.8 0.5 0.9

Some: Organization for Economic Cooperation and Development, ~conomicOutlook, no. 49, July 1991, p. 120.

In addition to the general decline in productivity growth, Canada may be starting to lose its competitive edge in the very sector that has ensured ir; past and current prosperity, the natural

158 /How Ottawa Spends

resource sector. Natural resource-based ex rts accounted fbr " more than one-half of total exports in 1989.I PFrom 1978to 1989, Canada's share of world resource exports rose from 5 per cent to 8.3 per cent. However, Canada may not be able to maintain this share of world resource exports in the future. As a recent study16 indicates, one reason why Canada may lose its current advantage is the threat of depletion, especially for non-renewable resources. Another reason is the threat posed by the development of new, cheaper synthetic substitutes. The development of new, more cost-effective, and environmentally safe processing techniques by competitors may also endanger the future growth of Canada's resource exports if the natural resource sector does not adapt to world trends in innovation. For example, in the case of the pulp and paper industry, the new environmentally safe technique of pulp production known as thermomechanical pulping, introduced by the Swedish firm Sunds Defibrator, permits the production of good quality paper from inferior qualities of wood. This development has led to the rise of important competibors-such as Brazil and Chil e-that have large, though qua1itatively inferior, forest resources that are also renewable at a faster pace than Canada's due to more favourable climates. The types of policies that are best suited to address the competitiveness and productivity challenge depend on the structural characteristics of the industries in which a country has a comparative advantage.l7 In addition to natural resources, Canada has a comparative advantage in industries characterized by extensive product differentiation where several accepted technologies coexist and where both large and small f m s may operate successfully. Industries such as lasers, fibre optics, medical and surgical equipment and precision instruments, specialized telecommunications services and equipment, and specialized fmancial services may be given as examples. There exist a large number of niche markets for these specialized products. The success of firms operating in these types of industries depends on the geographical sue of the market available. In this regard, the preservation of national unity, the reformed Canadian economic union, and the

m e &mpetitiveitess Agenda / 159

FI'A are of special importance in guaranteeing Canadian firms access to large markets.

HUMAN RESOURCES The increased flow of goods and services across international borders puts national labour forces in direct competition. Because of high wages, it is becoming increasingly difficult for Canadian firms (especially those in sectors with low technological input) to compete with their counterparts in the newly industrialized countries, which face only a fraction of the Canadian labour costs. In this respect, Canada's competitive advantage lies in industries with relatively high technological content requiring a highly skilled labour force. Quite apart from international pressures, the Fdst pace of technological change is itself forcing firms, even in more traditional sectors, to restructure and innovate, thereby increasing their demand for skilled workers. Rapid technological change also implies that workers' skills become obsolete at a much faster rate, requiring frequent retraining. Using the new technologies requires that the workforce possess the necessary technical and managerial skills. ls Employment opportunities in Canada are in sectors requiring well trained, well educated, and highly skilled workers: white-collar occupations (including managerial-administrative and engineering-science related occupations) which constituted approximately one-half of the labour force in 1961 and hvo-thirds of the labour force in 1986." All new job creations between 1981 and 1986 have been in white-collar occupations, while there has been a steady decline in blue-collar occupations. Basic literacy and numeracy are essential to all jobs, even those that do not require highly specialized skills.20 Less skilled workers are often confined to jobs with lower remuneration and in receding sectors. Poorly educated and untrained workers are Fdcing an important handicap in the job market and are increasingly filling the ranks of the long-term unemployed.21

160 / How Ottawa Spends

In Canada, as in the US but unlike in the majority of OECD countries, there exist no educational standards at the national level. Since education is a provincial responsibility, this is partly a result of the highly decentralized nature of the educational system in Canada. Yet, in a federation such as Germany, where the states are responsible for education, coordination of eflbrts among states has permitted the adoption of comparable curricula and tests. The National School Achievement Indicators Project, a 1988 initiative of the Council of Ministers of Education of Canada, has attempted to promote the establishment of some national standards. Cooperation of the provinces is essential fix the success of such an undertaking. The May 1991 Speech from the Throne and the launching of the Prosperity Initiative indicate that the Government has recognized the need for joint federal-provincial initiatives to deal with the high student drop-out rate and the low level of literacy among high school graduates. So far, little has been done to remedy the situation, however. In addition, the slower growth in the federal government's transfers to the provinces through Established Programs Financing, a consequence of the federal deficit control program, has led prwinces to cut their education budgets. ?btal federal spending on labour market programs as a percentage of the GDP accords with those of the major countries of Western Europe and is significantly above US and Japanese levels (see 'lsble 6.2 below). Although Canada's rate of long-tern unemployment (more than six months) has remained low compared with OECD countries (see Appendix 6.3)' dislocations caused by the FTA, and more generally by globalization, mean that labour market policy must focus on retraining both displaced workers and the long-term unemployed. However, labour market policies have been used to provide income support for the unemployed and to achieve regional policy objectives rather than to encourage active measures that improve the productivity of workers. Thus,spending on income maintenance was three times as high as that on active labour market programs (see 'kble 6.2). Yet there is some evidence that active measures such as retraining

me Competitiveness Agenda / 161 are more efktive than income maintenance in reducing unemployment: as indicated in 'Illble 6.2, the two countries with the lowest unemployment rates-Switzerland and Sweden-spent up to two and a half times as much on active programs as on income support. Active measures include providing an &cient employment service to the unemployed (Canadian expenditures in this category were 0.21 per cent of the GDP in 1989), and labour market training for unemployed as well as employed workers who may be in a receding industrial sector (Canadian expenditures in this category were 0.22 per cent of the GDP for training the unemployed and only 0.05 per cent for the employed in 1989)." Table 6.2 GovemmettExpenditures m Labour Market Rogmm Percentage of the GDP (avenge of 198690) Active

Total A=B+C

Me~sures

B

Active Support/ Income MaiDtenaace Msi~tt-e C BIC

Income

Canada

us

Japan Germany France Itdy

UK

Sweden

Switzerland Soume: Organization of Economic Cooperation and Development, ~&mrnicSunqs: Canada, 1991, p. 96.

In 1990, the Government began shifting the emphasis towards active measures by reducing the unemployment insurance

funds available for income support. This may help reduce unemployment in the long run since several recent studies indicate that a somewhat lower duration of unemployment benefits lowers the rate of unemployment." In spite of the recent reforms, an individual can qualify for UI benefits after as little as 20 weeks of

162 /How Ottawa Spends work in low unemployment regions and 10 week of work in high unemployment regions. In contrast, France and Japan require a minimum of 26 weeks, while Germany requires 30 weeks during the last year and 52 weeks during the last three years?4 The recent reform of labour market policies did not address the regional subsidies implicit in UI, which reduce incentives for labour mobility to other occupations or to other provinces and thereby contribute to maintaining a high rate of unemployment in depressed areas in the long run. While depressed areas need greater assistance, investing in industry specific infrastructure and promoting training may be more effective means to achieve regional development. The objective of labour market policies should be the reintegration of unemployed workers into the active labour force. 'Ib this end, an increase in UI funds available for training under Section 26 of the Unemployment Insurance Act, and a reduction of the eligibility requirements for training, could lead to a more balanced allocation between active and inactive measures. Yet, according to the 1992 budget, most of the $177 million cut in Employment and Immigration Canada's budget will affect funding for training and worker adjustmentss a measure in conflict with the goal of promoting training. Sectoral collaborative (management-union) approaches to training may provide an effiicient design of training programs leading to the establishment of apprenticeships, a practice that has been successful in Germany, Switzerland, and Austria. The Advisory Council on Adjustment (the de Grandpr6 Council) indicated in 1989 that private sector inmlvement in the design and implementation of training programs may help in developing a "training culture" in Canada that would stimulate increased onthe-job training by the private sector. The Council also suggested that a corporate training tax be imposed that would be fully reimbursed to firms undertaking the desired amount of training. It would be necessary, however, to devise a scheme that would take into account the differing incentives of firms of different sizes and

Ihe Ompetitiveness Agenda / 163 industries. No federal action has yet been taken to follow up on the Council's suggestion. Training is currently a shared provincial-federal jurisdiction. The Special Joint Committee on a Renewed Canada (the Beaudoin-Dobbie Committee) has suggested that trainin should become an area of exclusive provincial jurisdiction?8Such a decentralization, if accompanied by adequate fiscal trader, may allow training programs to be better tailored to specific provincial needs, given that education is already a provincial responsibility. There will, nevertheless, be a need to harmonize provincial policies and to reach agreement on common standards. Furthermore, since unemployment insurance would remain a federal responsibility and in view of the need to shift the emphasis towards active programs, the federal government will need to work in close collaboration with the provinces.27

INNOVATION Innovation involves not only the development of new technologies, but also their application to the production of goods and services. Technology, whether originating from foreign or domestic R&D, is a very important source of economic growth. Edward Denison's work fbr the United States reveals that, from 1929 to 1982, technology was the dominant engine of growth, accounting for 64 per cent of the increase in output per worker." Empirical evidence for Canada also reveals similar results: up to 60 per cent of the changes in total factor productivity growth can be accounted for by investment in technological i ~ o v a t i o n ? ~Yet, slower Canadian total factor productivity growth in the 1970s and 1980s seems to indicate that Canadian industry has been lagging in the adoption and diffusion of new technologies.

The Canadian Record on Innovation The extent of innovation and the translation of new ideas and processes into productive activity cannot be measured directly. The only available indicators are indirect, and they can provide

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only an imperfect assessment of innovative activity in a country. Some of these indicators involve the measurement of inputs: research and development activities conducted by the private and public secton, and the hction of the labour force consisting of scientists, engineers, or graduate students actively engaged in R&D. Other indicators pertain to the ouprrt of the innovation process: the balance of payments and trade in R&D intensive industries. Starting with input indicators, Canadian scientists, engineers, and graduate students actively involved in R&D constituted 0.45 per cent of the labour force in 1988, above the OECD Gross Expenaverage but behind Japan, the US, and ~errnan~.~' ditures on Research and Experimental Development (GERD) as a percentage of the GDP indicate that Canada, with expenditures of 1.33 per cent of the GDP in 1989, ranked below the OECIJ average of 1.6 per cent and was the lowest of the G-7 countries. However, with respect to the percentage of GERD financed by the public sector, Canada ranks above the OECD and G-7 averages and, in fact, substantially higher than Germany and ~ a ~ a nIt. ~is * in privately funded GERD as a percentage of the GDP that Canada's pedrmance has been inferior, a result that is also confirmed by data on the Business Sector's Expenditures on R&D (BERD) as a percentage of the GDP: Canada lags behind the OECD and the G-7 according to this indicator.33 French f m s spend twice as much on R&D as Canadian firms do (defined as nationally owned firms and subsidiaries of foreign parent f m s ) while German, Japanese, Swiss, and American firms invest about three times as much. A look at BERD as a proportion of value added by industrial sectors in 1989 indicates that Canada exceeded the G-7 average in t w important sectors: electronics and computers. Some of the most innovative Canadian firms are in this sector. Among these, CAE Electronics allocates 25 per cent of its sales to R&D, while Northern Telecom was the first to introduce a complete line of digital central ofice switching systems and is a leader in fibre optic technology.34 It is in the low tech industries such as

ne CompetitivenessAgenda / 165 food/beverages, textiles, petroleum, ferrous metals, and pulp and paper that Canada's performance is worse than the G-7 average. The Canadian pulp and paper industry, by far the leader in world exports in this sector, allocates only 0.3 per cent of sales to R&D in contrast to 1 per cent in the US and Sweden, and 0.8 per cent in Japan and inland.^' With respect to private R&D expenditures, the contrast between the electronics and computer sectors, where international competition is fierce, and the low technology sectors, where competition is considerably weaker, strongly suggests that domestic and/or international competition provide the necessary incentives for firms to innovate. In fact, the nickel industry-where Canadian firms face intense international competition--is an exception within the natural resource sector, where R&D spending activity is generally l d 6 In most of the other resource dependent sectors, the industry is not being upgraded and has not extended its competitive advantage to more sophisticated natural resourcebased products. Tbming to ouput indicators of innovative activity, the ratio of exports to imports in technology intensive industries such as aerospace, electrical/electronic machinery, office machinery and computers, and total manufacturing reveals that Canada's imports exceed its exports in all of these categories. These figures may be somewhat indicative as a measure of the d ~ m i o nof innovative technologies (even if these technologies were not developed in Canada). A measure that is more revealing with respect to R&D conducted in Canada is provided by the net technology-related balance of payments: Canadian receipts from abroad for the use of patents, licences, trademarks, designs, inventions, and howhow exceeded payments in 1988. The US was the only other OECD country that had a surplus." While these measures provide some indication of innovative activity, they do not constitutereliable evidence. Furthermore, due to both definitional and measurement problems, international comparisons are somewhat tenuous. Thus, even though low productivity levels signal a deficiency in the application of new

I66 /How Ottawa Spends technology, in the absence of reliable indicators of the specific problem areas, it is difficult to design appropriate policies.

Federal Government Policies to Promote R&D In January 1992, in a joint art, the federal and Ontario governments rescued the commuter aircraff manuikcturer de Havilland, a subsidiary of Boeing, which was in financial difficulty. The aerospace industry accounts fw one-fifth of all R&D conducted in Canada, leading federal Industry Minister Michael Wilson to note that government assistance was given "in recognition of the strategic importance of the industry." By providing a combined $540 million in subsidies ($240 million by the federal and $300 million by the provincial government), the two governments permitted Bombardier, a Quebec aerospace and transportation firm, to acquire a controlling interest in de Havilland. The Government of Ontario invested an additional $49 million to acquire 49 per cent of the firm's equity. Rmporary government assistance to the highly successful and internationally competitive Bombardier, operating in specialized niche markets, may be a fnritful way to improve Canada's com etitivenws by capitalizing on Canada's comparative advantage.3 8 In general, however, there may not be easy criteria for picking winners. In some cases, an approach based on providing tax incentives, engineering training, equity capital, loan assistance, and gwemment sponsored, industry related research services for the diffision of innovative technology may be more appropriate. As Alexis Jacquemin points out, "Such actions create strategic support by offering better information conditions and reducing uncertainties, sustaining organisational change and skill h a t i o n , and encouragin consensus-building among business, labour and government."

...

4

The federal government's funding foc R&D falls mainly into two broad categories: direct grants and investment tax credits. While science and technology policy is an area of shared jurisdiction between the federal gwemment and the provinces, the federal

7be CompetitivenessAgenda / I67 government has been dominant-due to its superior funding ability-with the provinces accounting for less than 20 per cent of total government spending on R&D. Federal grants for R&D are channelled mainly through three programs: the Defence Industry Productivity Program (DIPP), which accounts for about 50 per cent of total grants; the Industrial and Regional Development Program (IRDP), which accounts for about 20 per cent; and the National Research Council's Industrial Research Assistance Program (IRAP), which accounts fix 15 per cent. In addition, IRAP provides advice and assistance in technology diffusion for small and medium-sized firms.Defence related R&D activities have had important applications in nondefence related industry in, for instance, the US; but of the above cited Canadian programs, only IRAP has industrial research as its sole objective. The 1992 budget proposes to rebrm the tax credit system for research and development so as to eliminate some restrictions on the eligibility of some investments that are also used in production. It is estimated that $230 million will be injected into the scientific research and ex erimental development tax credit system over the next five years! In a recent study, Pieme Mohnen has shown that private1 funded R&D is more productive than publicly funded R&DJ1 Investment tax credits constitute an initiative of the federal government to induce greater R&D spending by private firms by reducing the costs of such activities. There is a 100per cent deduction for capital expenditures and equipment and a 20 per cent investment tax credit on expenditures that qualify as R&D. 'lb induce greater regional development, the investment tax credit is 30 per cent for the Atlantic provinces. A study by the Conference Board of Canada, ranking countries with respect to the lowest benetitlcost ratio at which an R&D investment becomes profitable, concluded that Canada's tax treatment of R&D in manuhcturing was the most favourable among eight major industrialized countries." Yet, the complexity and administrative burden of applying for investment tax credits may significantly dilute the benefits of these tax credits. Recognizing the existence of this burden, which may be even more pronounced for small firms, the 1992 budget proposes to undertake a

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'streamlining" of its scientific research and experimental develop." ment

Possible Causes for Poor Performance in Innovation The most important R&D activities are not necessarily conducted by large firms. Several recent studies have demonstrated that small firms are often the most innovative, especially in the engineering sector.44 Some industrial sectors, where a substantial degree of product differentiation occurs and where opportunities for specialized niche markets exist, are characterized by a large number of small firms coexisting with larger ones. Canada's competitive advantage may lie in the provision of very specialized niche products, and it may, therefore, be important to favour the development of small firms. The National Advisory Board on Science and Technology found that the most important problem facing small firms is a shortage of venture capital4* for either start-up or expansion purposes. R&D tax credits cannot be helpful to these firms if they do not have the necessary cash flows.46Total available venture capital in Canada amounts to only $3.3 bi~lion.~' Even for large businesses in high technology and knowledge intensive sectors, lack of equity capital has been identified as an important constraint to growth." The Federal Business Development Bank (which has a venture capital division) and the SmoN Business Loans Act have provided some funding for small firms. Small businesses currently have a lower tax rate (12.8 per cent instead of 28.8 per cent) on the first $26200,000 of business income, a $500,000 lifetime capital gains tax exemption, and a 35 per cent tax credit for research and development. The 1992 budget indicates that the Government will introduce legislation to extend the SmoN Business Loans Act of 1961, which would otherwise expire in March 1993, and to increase the ceiling for loans to small businesses from $100,000 to $200,000. In addition, reviving a program that it had cancelled in 1988, the Government reintroduced a measure in the 1992 budget that would help small businesses in difficulty to obtain loans at reduced interest rates by

me CompetitivenessAgenda / 169 allowing the lenders to treat the interest on the loan as dividends for tax purposes. Since dividends are taxed at lower rates than interest income, this measure pmvides an incentive for lenders to offer their loans at reduced rates. Unfortunately, this is only a temporary measure that will expire at the end of December 1992. Some measures were also adopted in the 1992 budget to encourage the formation of venture capital. The maximum tax credit for investments in national labour sponsored venture capital funds49 will be increased from $700 to $1,000, with a similar increase from $700 to $1,000 in the maximum tax credit that the federal government matches when the credit is provided by provinces." In addition, it will be possible for a single union to sponsor a national venture capital fund whereas two union sponsors were previously required. Furthermore, the firms in which these funds may invest had been previously restricted to those with assets not exceeding $35 million. This limit is now being increased to $50 million. Finally, the move in the 1992 budget to direct the lifetime exemption on capital gains towards equity investment by disallowing its use for real estate investment should increase the funds available for risky investments. There is a need to further increase the supply of venture capital. One of the reasons that venture capital is scarce in a well developed financial market such as Canada's is the lack of industry specific and product specific knowledge on the part of the risk assessors in the loan granting financial institutions. Since they are unable to evaluate accurately the riskiness of the projects presented to them, they reject projects that might have otherwise qualified for a loan. While the lack of venture capital may partly explain the relatively low Canadian investment in R&D, it cannot provide the entire explanation. As has already been discussed, part of the explanation of relatively low R&D activities lies in the extent of domestic and international competition that firms must Fdce. Competition generally spurs f m s to innovate and adopt new processes. Still another part of the explanation may also lie in direct foreign investment in Canada. The type of direct foreign

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investment conducive to innovation is characterized by the establishment of a home base. For example, the Canadian subsidiaries of GM, Chrysler, and Ford conduct only a very minor part of their R&D in Canada, whereas firms with home bases such as the Canadian subsidiary of Pratt and Whitney, IBM Canada, and Du Pont Canada are among the largest investors in R&D. The important issue is not national versus foreign ownership per se, but rather the RBrD strategy adopted by the firm?' There seems to be some evidence that Canadian firms investing in the US may be transferring some of their R&D activities to that country in order to take advantage of the spillover effects enerated In view by the clustering of American firms in some industries! of this analysis, it would seem to be important to favour the formation of similar "clusters" of economic activity in Canada. Interprovincial barriers constitute an important barrier to the h a t i o n of such clusters. In this light, the economic union initiative could have important benefits.

THE FREE TRADE AGREEMENT In many industries the adoption of new, more efficient, but costly, technologies depends on the size of the market to which finns have access. Having the assurance of sufficient demand for their product permits firms to take advantage of economies of scale: by increasing the scale of their production process they can lower the average cost of each unit of the good or servicethey produce. They can also "rationalize" their operations by specializing in the provision of products that they can produce in the most H~cient and cost-effective manner. Signing the Free Trade Agreement with the US was a means of assuring Canadian firms access to the North American market, thus permitting them to specialize and increase their

The dispute settlement mechanisms constitute an essential aspect of the FTA." They provide a means to address complaints of unfair trade practices. They also help ensure that US trade law is not used by the US administration or Congress in such a way as

Ihe CompetitivenessAgenda / 171 to discourage potential ibreign investors intent on serving the whole North American market from locating in Canada. There are two main dispute settlement mechanisms which fall under chapters 18 and 19, respectively, of the FTA? The Canada-US Trade Commission, created under Chapter 18, is chiefly concerned with disputes relating to the interpretation and implementation of the FTA. Chapter 19 establishes a binational panel and deals with the more controversial issue of ensuring 'fair trade laws," that is, preventing trade laws such as countervailing dutiesSS from being used as non-tariff barriers. So far, about one-half of the US decisions brought for review before the binational panel by Canada have been reversed or revised. An important example is the binational panel's ruling against the US decision to impose countervailing duties on Canadian pork. Following the panel's ruling, the US government argued that the binational panel had exceeded its authority and asked an extraordinary challenge committee to investigate. The US move was not successful, however, and the extraordinary challenge committee confirmed the binational panel's decision. The pork countervail episode is a clear indication that the dispute settlement mechanism has worked well for Canada so far. However, two recent controwsies-the case of softwood lumber and the case of Honda Civicsare likely to provide a further opportunity to t a t the success of the system. In 1986, the US Department of Commerce imposed a countervailing duty of 15 per cent on softwood lumber imports from Canada, arguing that pmvincial stumpage f= (fees charged for harvesting the timber) were too low and constituted an unfair subsidy. Under the Memorandum of Understanding of December 1986, Canada imposed a 15 per cent export tax; then the US import duty was revoked. In October 1991, Canada decided to remove its export tax on Canadian softwood lumber. However, given the protectionist mood in the US Congress and the upcoming presidential election, the timing of the government's decision was questionable. In fact, on March 6, 1992, the US Commerce Department imposed a 14.48 per cent temporary duty on Canadian lumber imports, arguing that Canadian exports were

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~ubsidized.'~At Canada's request, a General Agreement on Tariffs and Trade (GAW panel is currently analysing the case of softwood lumber. If Canada were to be unsuccessful at the GA'I'T, the case could be disputed under Chapter 19 of the ETA. In another protectionist move the US has levied a 2.5 per cent duty on Honda Civic cars assembled in Canada, claiming that these cars did not contain sufficient North American content, Canada is certain to take up the issue with the binational panel under Chapter 18of the FIA, and there appears to be a good chance for victory?' The recent protectionist tendencies of the US highlight the importance of Canadian national unity. First, access to the whole domestic market may be important for Canadian firms seeking to specialize in product niche markets, especially when access to the US market can be subject to uncertainty due to protectionist measures. Second, a united Canada has greater influence in the conduct of trade diplomacy than a disintegrated country would have and hence has a greater chance in fighting US protectionism.'*

THE CANADIAN ECONOMIC UNION In the Fall of 1991 the federal government made two proposals to strengthen the economic union. Accordingly, Proposal 14, Section 121 of the Constitution would be broadened to guarantee thefour freedom (free movement of goods, services, labour, and capital) among the provinces and territories; subject to a number of exceptions, all impediments to the four freedoms would be prohibited. The exceptions were federal equalization, regional development, or any other Weral law in the national interest (approved by two-thirds of the provinces representing SO per cent of the population), and provincial laws designed to reduce economic disparities among the regions in that province?9 The second proposal, Proposal 15, suggested a mechanism to harmonize federal and provincial policies. The Canadian economic union is fragmented. In many instances, wittingly or unwittingly, provincial and federal policies

l?te CompetririenessAgenda / 173

hinder the free movement of goods, services, capital, and labour. These barriers prevent some Canadian firms from achieving the economies of scale that are required to attain efficient levels of production and may prevent them from creating a niche fw themselves at the international level. Some of these policies also reduce labour mobility and contribute to higher unemployment by hindering the efficient matching of job searchers with vacancies across the country. There are several examples of interprovincial barriers: 1) local and provincial governments are able to either reject outright any out-of-province bid for public procurement if there are enough local bidders or adopt a 10 per cent prekrence margin for local or in-province bids; 2) federal procurement practices sometimes restrict bids by region;60 3) several practices favour local suppliers; 4) out-of-province products are sometimes excluded, beer being one example; 5) some provinces forbid employment of workers from other provinces (as Quebec does in the construction industry) or adopt a "buy in the provincewpolicy for intermediateinputs (as does Ontario Hydro in requiring the use of Ontario uranium to the detriment of Saskatchewan's cheaper source); 6) public contracts may even require that plants be relocated in the province awarding the contract; 7) skills standards and licensing may not be recognized from province to province (an electrician trained and licensed in one pmvince may have to retrain and obtain new certification before obtaining employment in another pmvince); and 8) some provinces may prevent out-ofprovince individuals and firms from purchasing local companies or properties. These obstaclesto the functioning of the Canadian economic union are due, in part, to an obsolete common market clause (Section 121) in the Canadian constitution that guarantees only the freedom of movement of goods. Canada's antiquated approach to the Canadian common market contrasts with the experience of other economic unions, including those of federal states. In 1901, Australia adopted a broader common market clause than Canada's, forbidding discrimination on the basis of state boundaries. The United States assigned the trade and commerce power to the US Congress, allowing it to abolish any discriminatory

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practice to the interstate movement of goods and services. 'The 7kew of Rome, adopted in 1957, created a European common market guaranteeing the free mwement of goods, sentices, capital, and labour among the member states of the European Community. The elimination of interprovincial barriers to the movement of goods, services, labour, and capital, recommended by, among others, the Royal Commission on Canada's Economic Union and Development Prospects (Macdonald Commission) is of great importance in making the Canadian economy more competitive.61 There have been recent agreements, among some premiers in Atlantic Canada, to eliminate preferential treatment of provincial residents in procurement policies. However, prior to the constitutional proposals of the fall of 1991, no concrete initiative had been adopted by the federal government to strengthen the Canadian union. Estimates of the static gains (that is, once and for all economic benefits due to specialization according to comparative advantage) are of the order of 1 per cent to 1.5 per cent of the GDP, or $67 billion to $100 billion-not a negligible amount! These estimates do not take into account the possible dynamic gains: the concentration of economic activities has spillover effects and increases the overall rate of growth.62 Although the necessity to modernize Section 121 of the Constitution cannot be doubted, Proposal 14 raised several concerns. First, the drafting was imprecise, so that some provincial policies resulting from different approaches to economic and social policy could be perceived as impeding the -cient functioningof the common market, even if they were not inherentIn other words, it is desirable to prevent any ly discriminat~r~.~~ province or territory from overtly discriminating against other provinces or territories, possibly subject to exceptions, but not to eliminate the richness that comes from the variety of approaches taken by different provinces in a federal system. Second, another drawback of Proposal 14 is that it will lead to much litigation, as was the case after Australia adopted a broad common market clause. Any citizen, firm, or government could challenge a

7he Competitiveness Agenda / 175 provincial or federal law deemed to hinder the free flow of goods, services, capital, and labour. In the interim, before the court ruling, individuals and firms would have to operate under uncertainty, not knowing whether a particular legislation or policy would be ruled unconstitutional. Instead, a specialized tribunal, composed in part of technical experts and modelled on the competition tribunal, should be used as a court of first resort. The appealing party would have to demonstrate significant injury caused by a provincial or federal policy. Finally, it may be prefkrable to create a federal-provincial body to closely examine the various discriminatory practices in greater detail, assess their cost, analyse the impact of eliminating such discrimination on various groups, and determine the barriers that should be removed, how they should be removed, and the appropriate compensation for the losers. After such an investigation, intergovernmental efforts could be exerted to eliminate interprovincial barriers during a period of five to 10 years. A strengthened but much more specific common market clause could then be adopted as a constitutional amendment that would become effective in five to 10 years. The second federal constitutional proposal, Proposal 15, is an attempt to harmonize provincial policies in order to achieve a better integrated economic union. The federal government would have the exclusive right to legislate for the eftlcient functioning of the economic union subject to the approval of a council of the federation-more specifically, of two-thirds of the provincial members of the council representing 50 per cent of Canada's population. Any province could choose to opt out for a period of three years. A similar opting out clause has been adopted in the EC with respect to the European Monetary Union which is scheduled to be created in 1997. As the experience of the EC demonstrates, prohibiting the imposition of interprovincial barriers is not sufficient to create a strong economic union (or a single market). There is a need to harmonize policies. Relying simply on non-discrimination will not be sufficient to create a well integrated market. Although the

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Peaty of Rome guaranteed that there would be no discrimination against the so-called four freedoms, the EC filtered during the 1970s and early 19809 with a proliferation of non-tariff barriers among the member countries that indirect& hindered the free flow of goods, services, capital, and labour.64The high unemployment rates and low rates of GNP experienced by most memo bers of the EC during the early 19809, coupled with the fear of American and Japanese competition, fmally led to the Single European Act of 1986. Its objective is to harmonize the policies of the member states by removing, by the end of 1992, all barriers to the free movement of goods, services, capital, and labour.66

In Canada, there is a need to harmonize policies in several areas. For instance, product and environmental standards, financial services regulations, and skills standards and licensing should be harmonid across provinces. As a result of the current lack of harmonization, interprovincial labour mobility is hindered even when there exist mutually beneficial opportunities: a vacancy in one province cannot be filled by a qualified unemployed worker from another province. Firms wishing to operate across Canada may have to satisfy as many as 10different sets of regulations. This may prevent Canadian firms from attaining the scale and specialization required to face foreign competitors in the international market, in short, from creating a niche for themselves. For example, in financial services-a shared jurisdiction between the federal and provincial levels of government-there does not exist a single unified Canadian market. While banks are federally chartered, non-bank financial institutions are provincially chartered and are subject to regulations that differ from one province to another. The Quebec approach is the most open with respect to ownership links.67 There have even been proposals for further liberalizing the financial system in Quebec by allowing financial institutions to own firms in the production sector, as is permitted in France and Germany. In contrast, the Ontario approach is more conservative: financial institutions chartered in other provinces may only operate in Ontario if the ownership procedures (and, in some cases, the operational procedures) in their home province accord with Ontario's.

l'he Competitiveness Agenda / 177

Although the need to have a mechanism to harmonize the policies of provincial governments and the federal government cannot be disputed, the method suggested in Proposal 15 of the federal constitutional proposal is highly questionable. First, in view of the faet that many of the areas that need to be harmonized are of provincial jurisdiction, this power should have been specified as a concurrent one, assigned to both levels of government. More fundamentally, as the European experience clearly suggests, policy harmonization has td be achieved on the basis of a joint decision between the levels of government, and in a manner that is respectful of federalism. In particular, federalism makes it possible to observe a variety of approaches to solve the same problem, owing in part to political parties of various persuasions being in power in different provinces. This leads to healthy experimentation which, if successful in one province can be adopted by other provinces or the federal government.68' Thus, a preferable approach would be to use the political process and rely on Meral-provincial cooperation. One could examine all areas where harmonization would be desirable. Then, one could follow the lead of the EC and adopt the principle of mutual recognition, the major innovation that enabled the Europeans to create a single market. Under the principle of mutual recognition, the regulations and standards adopted by one member state of the EC have to be recognized by all other member states of the ~ommunity.~~ Mutual recognition leads to competition among governments as to the best type of regulation. If one province has more cost-efficient regulations than the others, its firms will be more competitive than those of other provinces. As a result of such economic pressures, provinces with inecient regulations will be forced to revise their practices. Strengthening the Canadian economic union would not only make the Canadian economy more efficient, it would also make it possible to decentralize more powers to the provinces-which may be necessary to solve the national unity crisis-without fearing that this would create obstacles to the hnctioning of the common market.

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CONCLUSION The necessity to be competitive derives in great part from the new international order characterinid by an unprecedented degree of international interdependence among economies. The productivity of the Canadian economy, especially in manufacturing and in natural resources, has been falling relative to G-7 countries, thereby endangering the future standard of living of Canadians. In the years to come, Canada will need to emphasize productivity pins in its sectors of comparative advantage-the traditional ones based on natural resources and the specialized niche products that require access to geographically large markets. The improvement of Canada's competitiveness requires measures to promote competition in the Canadian market, seek access to larger (domestic and international) markets for Canadian firms, and improve human resources and Canada's ability to innovate. This chapter has analysed recent government initiatives to improve Canada's record on competitiveness. In recent years, federal policies regarding taxation, trade, deregulation, competition, inflation, and deficit control have helped create a more competitive environment for Canadian firms.The negotiation of the I T A has guaranteed Canadian firms access to the American market and has provided dispute settlement mechanisms through which unfair trade practices can be contested. Although Canada's long-tenn rate of unemployment (more than six months) remains low compared to OECD countries, the changes brought about by globalization heighten the importance of human resources and the need for the federal government to work closely with the provinces to emphasize vocational training, better quality of education, and a shift of labour market programs towards active measures to favour the reintegration of the unemployed into the wrkfbrce. With respect to innovation, although the effort of the federal government in supporting innovation has been comparable to that of other OECD countries, the response of the private sectat appears to have been inferior. Policy intervention has to take into account the special characteristics of various types of industries.

lbe CompetitivenessAgenda / 179 Measures could be taken to favour access to venture capital for small firms in niche markets. Finally, it is imperative to strengthen the Canadian economic union. Not only is it a prerequisite for an efficient economy, but it may play a crucial role as the quid pro quo for greater decentralization of powers which may be needed to keep Canada united. Preserving national unity may be the most serious challenge facing Canada's competitiveness. Yet, in today's world of emerging trade blocs it may be the most important problem to solve.

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t

i

!

I ! ! !

7he Competitiveness Agenda / 181

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nte CompetitivenessAgenda / 183

NOTES I would like to thank Frances Abele, Chris Maule, Murray Smith and, especially, Fanny Demers for very helpful comments. 1

Fred Bergsten, America in the W r d Economy: A Strategyfor the 1!%WsWhington: Institute fbr International Economics, 1988), p. 61.

2

See W. Irwin Gillespie, lh,B o r m and S p e d financing Federal Spending in Canada 1867-19M (Ottawa: Carleton University Press, 1991), p. 203, and Allan M. Maslwe, Tar Rgom in Canada. lRe h c e s s and Impact (Halifhx: Institute for Research on Public Policy, 1989).

3

Although FIRA rejected only 435 cases out of 6,599, it created uncertainty and delays which may have deterred some hreign investment.

4

Miro Cemetig and Drew Fagan, "Ottawa opens oil fields to breign investment," Zhe Globe and Mail mronto], March 26, 1992, p. Al.

5

h r i n g the deficit contributes to reducing real intemt rates thus stimulating investment.

6

These were: 1) a reduction of the manuicturing and processing tax rate from 23 per cent to 22 per cent in January 1993 and to 21 per cent in January 1994; 2) an increase in the capital cost allowance rate, for eligible manuhcturing and processing machinery and equipmentacquired a h r February 25,1992, from 25 per cent b 30 per cent; and 3) the Government also promised to undertake bilateral negotiations to decmse from 10 per cent to 5 per cent the withholding tax rate (the tax on dividends paid by Canadian subsidiaries to their foreign parents). Once in place, these measures would confkr a 4 per cent tax advantage on Canadian firms relative to US firms, thereby increasing their competitiveness. See Don Mazanlc