William Robson is president and CEO of the C.D. Howe Institute.
Last fall's federal election campaign, and the new government's announcements since, have left little doubt about the overall shape of next week's federal budget. The Liberal platform promised billions of new spending, and Finance Minister Bill Morneau's fiscal update last month prefigured billions in deficits. So we will see a major attempt to spend, and borrow, the country richer.
Maybe it will work. The government, and plenty of pundits, say it will. But what if a fresh splurge of credit-financed consumption fails to boost growth? The key question then will be whether this is a one-time mistake – whether the government will realize that saving and investing, not borrowing and consuming, are what Canadians need to achieve durable increases in their living standards.
Hardly anyone asks that second question, because so many people insist that fiscal stimulus will work. A generation of commentators, business people and economists have learned that you get GDP by adding up household consumption, business investment, government spending and exports, and subtracting imports. Therefore, the pundits say, more government spending makes for higher GDP – an instant and infallible economic cure.
That's a pretty proposition, and not just because the math is easy. Plenty of people want governments to give them stuff – that's why elections feature big promises. And with so many client groups, businesses and government employees lining up for more, you only have to say "yes."
Moreover, if Ottawa's fiscal boost sufficiently juices GDP – and tax revenue – we needn't worry about deficits, debt and interest payments. The budget will "balance itself."
So the proposition is pretty. But is it right? Too many people assume the problem is that all those things going into GDP don't add up to enough. They say demand is too low relative to Canada's productive capacity. But what if we're already producing about as much as our work force, plus our invested and natural capital, can sustain? In that case, adding up consumption, investment and so on tells us nothing useful about helping the economy grow.
Take a longer view of increases in output and living standards, and the limits of this short-run adding up become clear. Suppose someone claimed to explain the 2.2-fold increase in Canada's real GDP since, say, 1981 by saying it happened because of a 2.3-fold increase in consumption, and a 2.5-fold increase in investment, and a 4.1-fold increase in exports, despite a 4.8-fold increase in imports. The numbers are right, but as an explanation of why we're better off than we were in 1981, it's nonsense.
We eat better now than then, not because we have bigger appetites, but because we produce more food. We get better health care now than then, not because we want it more, but because we produce superior treatment, medical equipment and drugs. And we produce more food, health care and everything else because growth in our work force, in the physical and natural capital we work with, and in our knowledge and ingenuity, added to our capacity.
Which puts our current situation in a different light. Maybe our economy is sluggish not because of deficient demand, but because our productive capacity has taken a hit. Work-force growth has slowed. And lower oil prices have rendered part of our invested and natural capital at least temporarily useless.
So there may be less slack in the economy than the pundits claim. Unemployment is up with the dislocation in the energy sector, but wages are outpacing inflation – which is itself spot on the Bank of Canada's 2-per-cent target. Capacity utilization in manufacturing is at a nine-year high. Canada has a current-account deficit, not the surplus we would expect if anemic demand was drawing in few imports.
If demography and a hit to national wealth are holding us back, we need to boost our productive capacity if we want to grow faster. Although the new government has talked about investment, Ottawa does very little capital spending itself: Most of the budget's new spending will be either federal consumption or transfers that will mainly finance consumption by households and other governments. And borrowing for consumption absorbs saving that would otherwise fund investment in productive capital – machinery, equipment, structures and technology – that could boost output and living standards in 2017 and beyond.
That is not the thinking that will drive the 2016 federal budget. Next week will be about big spending and big deficits. Those who add up consumption, investment and government spending will nod approvingly, and predict larger GDP as a result. Perhaps they will be right. But if they aren't – if saving and investing, not borrowing and spending, are the key to future prosperity – we will need a very different focus in Mr. Morneau's second budget.