Friday, August 04, 2006

The Third Way & Prosperity

Canada's latest employment figures, released today, further confirm already well-known facts about the state of the Canadian economy.

First, the composition of Canada's economy is changing drastically. Overall, 5,500 jobs were lost; at the same time, manufacturing lost 33,000 jobs, mostly from Central Canada. That means a net gain of 27,500 from other sectors. An even more drastic example of this trend has played out over the past half decade. Since 2004, 224,000 manufacturing jobs have been lost, but unemployment has been creeping down, not up.

Manufacturing in central Canada is declining. As the Canadian dollar appreciates vis-à-vis the U.S. dollar, the costs of exporting manufactured goods to our largest trading partner increases. At the same time, industrialization elsewhere in the world means that manufactured goods can typically be produced more cheaply, as in East Asia.

What will replace these manufacturing jobs? Natural resources will continue to play a major role. Alberta's job market is in obvious disequilibrium, as the labour market there absorbs tens of thousands of new migrants for its ever-growing petrochemical industry. Elsewhere in Canada, mining continues to play a major role in the economy. And no one can forget the importance of the lumber to the Canadian economy. In many of these cases, rising prices globally makes them increasingly lucrative, and the stronger dollar has not significantly hurt exports yet. But are these sources of revenue sustainable?

Without the development of alternative industries that will be sustainable in the long-term, Canada risks, over time, following the path of certain Middle Eastern countries, whose dependence on fossil fuels makes them vulnerable to fluctuations in the global market and may ultimately expose them to economic hardships as petroleum supplies dwindle. Most of Canada's resources, plentiful though they may be, are not renewable. Even many of those that are renewable may not be sustainable at their current levels of production.

Canada must instead focus on further developing emerging industries, including its high-tech sector, biotech, and the service sector. For the foreseeable future, these types of jobs will provide stability and super-normal profits and wages. These jobs, however, require skilled labour.

As Canada's economy changes, it must invest heavily to ensure that these changes result in prosperity rather than decline. Education is exceedingly important, both for new entrants to the labour force as well as re-training programs for the unemployed. Canadians who lose their manufacturing jobs must not be condemned to employment insurance or welfare, but rather they must be confident that the acquisition of further skills will make them sought-after skilled workers in another industry.

Public investment in R&D is also absolutely necessary. As the manufacturing sector shrinks and natural resources appear vulnerable (in the long-run if not the short-run), the social value of government expenditures on research and development will far outweight the costs. The private sector will certainly fund much R&D, but the short-term private return may be well below the optimal long-run social return, meaning that public investment will be necessary to ensure the optimal social level of research spending.

The Conservative model of cutting taxes in order to stimulate investment will increase R&D spending, up to a point. As long as the social return remains above the private return, however, there will always be a place for public spending.

The Liberals must engage this further, for it represents one of the most important challenges Canada is facing. The Liberals' record on this in the 90s wasn't exactly stellar, with Canada R&D spending (as a percentage of GDP) much lower in Canada than in most of the developed world. Similarly, funding to universities increased, but only somewhat.

In contrast to their record of the 90s, the Liberals must recast themselves as the party of prosperity. Middle-class Canadians are looking to Harper's conservatives for financial success, and they have seen it in the form of tax cuts and various credits. This must change. The party that balanced the budget in the 90s must once again be seen to be working in the interests of all Canadians.

To this end, the Liberals must also promote tax cuts and credits, but not quite as far reaching as those proposed by Conservatives. They must stand on the side of credits for R&D work and for education expenses. At the same time, they must also increase public funding to both, since there will be cases where credits will not provide the necessary incentives to spend the required money.

To cut taxes and increase spending, the Liberals must also recognize that cutting taxes is not a mantra, as the Conservatives believe; tax policy must be designed to yield socially optimal results. Thus, Liberals must not shy away from such taxes. Examples of such taxes are those which are simply meant to internalize externalities, such as a carbon tax.

When Michael Ignatieff spoke of a carbon tax, he initially received much criticism, but many ultimately voiced their agreement with the plan. Bob Rae and Carolyn Bennett both expressed qualified support for it, and the government of Quebec has been supporting such a tax for some time. Indeed, a carbon tax (on, as Rae qualified, pollution, not production) is both just and fiscally repsonsible.

Thus, the Liberals must be the party of sound, long-term economic development. They must support the private sector while recognizing the role of fiscal policy and tax policy to accomplish desired ends.

The European welfare state may not be a viable social model in the long-term, but neither is libertarian society in which government fails to even provide public goods, regulate externalities, and manage industrial and competition policy. A third way is necessary, and the Liberals must walk it.


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