Avoid the zombie thinking of major cuts to federal spending

TORONTO—A zombie is a bad idea that refuses to die. The latest is the idea that the fate of the middle class depends on whether the federal government makes an immediate and huge cut in federal spending—otherwise the country will spiral into decline, and the middle class will be faced with a massive credit rating problem. While there is clearly much more room for smarter spending and a guardrail on debt, the zombie thinking that massive tightening of monetary and fiscal policy will put us on the path to stronger growth is not well connected to the new realities of the world in which we live. This latest zombie has been given new life by the Business Council of Canada, which is calling on the federal government to match the clampdown on the economy from higher interest rates with “an equally big shift on the fiscal front." The planned $15-billion cut in federal spending is dismissed as insignificant. The council wants much bigger cuts. The council, a lobby group for Canada’s biggest corporations, doesn’t tell us by how much the spending should be cut, nor what actual federal spending should be cut. Instead it takes the easy road out, accusing the government of engaging in a deceitful shell game, and charging it with grave irresponsibility that will inevitably lead to the erosion of future incomes and the prospect of future tax increases. Cheap diatribes solve nothing. The real issue, as an array of experts at the recent Jackson Hole Economic Symposium—organized by the Federal Reserve Bank of Kansas City—discussed, is how we restore declining growth prospects the world faces. As Christine Lagarde, president of the European Central Bank, underlined, we are living through profound changes in the world economy, including changes in the labour market and the nature of work, the massive process of an energy transition, and a deepening geopolitical divide with rising protectionism. “Past regularities may no longer be a good guide for how the economy works,” she said, going on to warn that “there is no pre-existing playbook for the situation we are facing today—and so our task is to draw up a new one.” For example, as one financial group analyzing the symposium suggested, getting inflation back to two per cent may be too costly, and a three per cent target may make more sense. The steep increase in global debt, for example, is a matter of serious concern. But in a presentation at Jackson Hole, Serkan Arslanalp of the International Monetary Fund and Barry Eichengreen of the University of California, Berkeley, argued that “high public debts are not going to decline significantly for the foreseeable future. Countries are going to have to live with this new reality as a semi-permanent state.” In their view, engineering large budget surpluses to wind down debt are not possible, since the public support does not exist for the spending cuts or tax increases that would be needed. At the same time, it will be hard to engineer faster global growth, they say, adding that while AI and other emerging technologies may hold great promise, it will take a decade or longer to see what they can do. Nor is it possible to inflate our way out of high debts, as past policies, such as capping interest rates, can no longer work in a world of much greater financial liberalization. “Fast growth is the painless way of solving debt problems,” Arslanalp and Eichengreen said. “Unfortunately, such high growth rates in the advanced economies are not in the cards today.” Looking forward, the two argued, “the challenges are daunting. Given aging populations, governments will have to find additional finance for health care and pensions. They will have to finance spending on defence, climate change abatement and adaptation, and the digital transition." They will also have to be ready to provide much more support to the world’s poorer countries. The big challenge is how to improve innovation-led productivity so that we can generate future wealth to meet these challenges A recent World Bank report showed that there has been a steady decline in the average annual growth rate in total factor productivity—a proxy for the rate of innovation—among the advanced economies, with prospects for further decline between now and 2030. From 2000 to 2010, productivity rose at an average annual rate of 0.9 per cent. In the 2011-2021 period it fell to 0.7 per cent, and the World Bank recently forecast that it will decline further to 0.5 per cent in 2022-2030. Moreover, as economists Yueran Ma and Kaspar Zimmermann told the Jackson Hole symposium, tightening monetary policy will mean a lower rate of innovation, with declines in research and development spending, a fall in venture capital funding, and a lower rate of patenting, with a longer term impact on the productive capacity of the economy. In another Jackson Hole discussion, economist Charles Jones argued that new ideas to boost productivity are becoming harder to find, with a need to invest ever-increasing resources into R&D just to maintain constant rate of economic growth—we have to run faster and faster to stay in the same place. One hopeful sign is that China and India, each with much larger populations, are becoming much better at R&D. The danger is that the world seems headed in the wrong direction. Participants in a panel discussion on globalization, for example, agreed that rejecting globalization comes with high costs, including higher consumer process and less growth-enhancing international trade. The embrace of so-called 'friendshoring'—Finance Minister Chrystia Freeland is a fan—which divides the world into competing blocs, is a new form of protectionism. As Lagarde told the symposium, research by the European Central Bank has shown that where world trade fragments along geopolitical lines, real imports could decline by as much as 30 per cent globally, and “could not be fully compensated by greater trade within blocs.” In a much-changing world of new and complex challenges, the last thing we need is more zombie thinking. David Crane can be reached at crane@interlog.com. The Hill Times