...against fictions and other tall tales

Monday, 16 April 2012

Canada's fiscal stimulus: an interpretation

In a previous post, I suggested that Canada's fiscal policy response to the last recession consisted of an effective set of counter-cyclical economic measures.  To support this idea, I highlighted the fact that, as a result of these measures, Canada's level of public fixed investment increased to the highest level in three decades (see graph 1, click on graphs to enlarge).  Also, I suggested that this increase in fixed capital expenditures helped to mitigate the recession's effect on the level of employment.

Graph 1: Consolidated government fixed capital, 1961-2011, Source: Statistics Canada

This view appears to have caught on.  In his recent budget plan, Canada's Minister of Finance, Jim Flaherty, links the labour market's performance during the downturn to the federal stimulus put forth by Stephen Harper's Government after the last recession (see here):
Economic developments since the introduction of the stimulus phase of Canada’s Economic Action Plan underscore its success in protecting Canadian jobs through strong support to the domestic economy.  As a result...Canada has posted the strongest growth in employment among G-7 countries...
[G]overnment investments in infrastructure were key to the success of the Economic Action Plan...
The budget plan includes the following graphs to support the Government's case that its stimulus was effective in mitigating the impact of the recession:

Graph 2: Improvement in employment during recovery

Graph 3: Unemployment rate, Canada and United States, 2006-2011

Graph 4: Growth in real per capita disposable income, 2006-2010

In graph 2, we see that the improvement in Canada's rate of unemployment during the recovery was the highest among the G7 economies.  In graph 3, we see that the unemployment rate fared better in Canada than in the US.  In graph 4, we see that disposable income rose faster in Canada than in the other G7 countries during the recovery.

But is the increase in fixed capital expenditures really the result of federal government action?  In my earlier post, I was very careful not to associate the increase in fixed public investment in recent years solely with the policy measures put forth by the federal government.  Rather, I specified that it was the "combined success of the federal and provincial governments' stimulus measures" which contributed to the effectiveness of Canada's response to the recession.  In my view, suggesting otherwise would be misleading given that the data from the National Income and Expenditures Accounts shows that the largest share of fixed public investment in recent years has come from provincial and local governments (see graph 5).

Graph 5: Public fixed capital, all levels of government, 1961-2011, Source: Statistics Canada

That said, it would be equally incorrect to suggest that the federal government had no role to play in the recent increase in fixed public investment given that, in Canada, a large share of the income of provincial governments consists of fiscal transfers from the federal government to provinces.  As shown in graph 6, federal transfers represent an important source of income for provincial governments.  And interestingly enough, in recent years there has been a considerable increase in the amount of federal transfers to provincial governments.

Graph 6: Provincial government income from federal government, 1961-2011, Source: Statistics Canada

Does this suggest that the Harper Government is justified when it claims responsibility for the boost in capital expenditures in recent years?  It's hard to say for sure, but there is a good argument to be made that the Harper Government is partly responsible given this increase in federal transfers to provinces since the Tories took office.

Better yet, another explanation would be to propose that responsibility for the significant increase in public fixed investment in Canada in recent years rests instead with the fact that, between 2004 and 2011, the governments in power at the federal level were all minority governments, during which "concessions" were made to opposition parties on budget-related matters (i.e., in terms of additional program funding and increased federal transfers to provinces) as a way for these governments to remain in power. 

This view appears to be supported by the facts.  As you can see in graph 7, federal transfers to provinces increased significantly starting in 2005 following the election of Paul Martin's minority government.  The increase in federal transfers to provinces is especially noteworthy given that it resulted in the first significant increase in federal transfers to provinces (viewed as a ratio of total federal expenditures) since the early 1970s

Graph 7: Ratio of transfers to provinces/federal expenditures, 1961-2011, Source: Statistics Canada

Recall that, in 2005, the Martin Government required the support of the NDP to pass its budget, and that the "compromise" budget significantly increased the amount of funding for programs under provincial jurisdiction such as social housing and education.  But regardless of the nature of these transfers, this additional source of income increased the amount of financial resources available to provinces, enabling them to undertake increased investments in infrastructure and other fixed capital projects.

Now, the above is a very rough sketch.  A more detailed look at the data is necessary to get a better picture of the fiscal dynamics underlying these figures.  Still, I think it's fair to say that the increase in public fixed capital investment in recent years is not solely the result of the stimulus measures put forth by the federal government during and after the last recession.  Rather, as I wrote in my earlier post, it is more likely because of the combined efforts of the federal and provincial governments.

Reference

Courant, P., E. Gramlich, and D. Rubinfield. "The stimulative effects of intergovernmental grants: Or why money sticks where it hits", Fiscal Federalism and Grants-in-Aid, P. Mieskowski and W. Oakland (ed.), Washington: The Urban Institute, 1979.

6 comments:

  1. That's fine but shouldn't Harper be getting most of the credit instead of the opposition parties. His party set the agenda, didn't it?

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  2. i welcome the graphics, esp the adjusted comparative on unemployment. premature for govt to take the trophy home for being G7's 'top gun'. the impact of the recent implementation of public sector cuts will be felt soon enough. that'll certainly make it Top Gun.

    i assume you'll follow your excellent prequel to Canada's current economic situation by giving an interpretation of why Canada's disposable income fares best among others.

    you posit merit appropriately and fairly. the Govt is partly responsible for the recent improvement, and i hope it will not be solely to blame for the unfortunate slowdown in the Canadian economy.

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  3. This is a very gutsy perspective on what will become a major research topic in Canadian Economic Policy for many years to come. It will certainly be evoked as a precedent for the success/failure of minority governments. I can pleasantly presume that this post will be a ground-breaking reference for the better historians in our country.

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  4. I received the following link, and presume it may be of imminent interest to you, although you are way ahead (older posts) of its author as to A&A. Nice work on "minority government compromises". Certainly is a well-structured argument to justify the thesis in any jurisdiction.

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    1. OOPS forgot the insert:
      http://bilbo.economicoutlook.net/blog/?p=19050

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  5. I think the stimulus demonstrated a few things. The first is that it challenges the view that federalism inhibits the effectiveness of counter-cyclical measures (ie, the old notion that Keynesian policies are difficult to implement across autonomous levels of government). But, unfortunately, Canada's experience will also show that 'temporary' stimulus measures (the norm these days) are not a panacea. As JH alludes to, one can go from 'hero to zero' quite fast in the area of economic policy. There's little doubt in my mind that the strategy of 'laying-off' will not 'pay off'. It can only make things worse. The multiplier effect associated with these strategies (and its impact on income) runs both ways.

    That said, this piece doesn't address the fact that much of the stimulus was also the result of other measures, such as the home renovation tax credit. I think this program helped in supporting economic activity during the downturn. So to respond to Anon, yes, Harper did contribute to setting the agenda (ie, he had his own). But in regard to fixed investment spending, you can't deny the role played by the provinces in recent years.

    Swells: I'm looking forward to the research into this. I think this is a good case study, which is the reason I'm highlighting Canada's experience. As you can tell, I'm trying to contribute a few hypotheses to help steer the discussion. Perhaps one day Canada's experience will hold a prominent place in a handbook of best practices relating to fiscal policy (to be published by the good folks at the BIS, perhaps - nod to MI).

    MI: I seem to have been a few steps ahead of you!...I commented on Bill Mitchell's blog late on Monday (late on Tuesday, Australia time). Bill's piece is important. I also think the Perotti paper is an important contribution. My paper copy is plenty scribbled and underlined!

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