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Ignatieff’s dilemma: Coping with the Conservative budget

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Liberal leader Michael Ignatieff has been saying lately that the budget the Conservative are drafting, to be presented to Parliament in a few days, is not his budget, it's the Harper government's budget. Fair enough, but if the Liberals vote for the budget, it will become their budget as well. That's how a minority government works. You either support the basic program of the government or you don't. There's no wiggle room.

Ignatieff is in the unhappy position of having to make the most important decision he will make in the next two years in just a few days. He has made clear what he wants to see in the upcoming budget: protection for those most vulnerable to the recession; the rapid creation of jobs through infrastructure spending; and investments in productivity and competitiveness. On the latter point, he emphasizes the need for retraining people to help unemployed workers find new jobs.

This is a good list. But the devil will be in the details. Whether the budget amounts to a little sprinkling of good will on these issues or a genuine plan to counter the recession will depend on how much money is invested in these programs. To counter the savage economic downturn, anything less than one hundred billion dollars over the next two years will amount a sham. Double that amount is what is really needed.

A key to assessing the budget is to understand how the Conservative government thinks about the recession and what its socio-economic goals are. We've already heard in recent days from Finance Minister Jim Flaherty that he wants to make sizeable tax cuts a central element of the upcoming budget.

That's no surprise. Right-wingers, in both the United States and Canada, have a well-developed set of ideas about how to deal with the economic crisis and the descent into deflation which is its critical element.

The bursting of the housing bubble, the failure of financial institutions and the crash of stock markets around the globe, struck investors, the rich, and the well-to-do with the force of a tsunami. The consequence was a sharp decline in the high-end spending of those who had had money and suddenly had less. As in the 1929 crash, the sharp reduction in spending and investing by the wealthy and near-wealthy played a signal role in spreading the crisis from financial markets to the "real" economy.

Layoffs in the retail sector, bankruptcies and bankruptcy sales pushed the economy down the dismal road of sharply rising unemployment and deflation. While most of us have experienced inflation and the falling value of the dollars we hold, very few alive today have suffered deflation, a far more deadly economic affliction. On the surface, deflation, a condition which arises when prices fall, has its attractions. Few motorists in Canada are complaining about the nearly fifty per cent drop in the price of gasoline since the summer of 2008, and few homeowners are complaining about the thirty per cent decline in the price of fuel to heat their houses. The problem with deflation is that it is symptomatic of a severe economic downturn that can last not a few months but for years, crossing the line from recession to depression. Throughout the industrialized world, economic policy makers are grappling with the onset of deflation, whose devastation can be seen, among other places, in the crisis of the automobile industry.

When deflation strikes an economy, the prospects for economic growth are so negative that companies, not only lay off large numbers of employees, they put on hold capital investment projects that are a key to future growth and the hiring of additional workers. For instance, the catastrophic sales declines in late 2008 at the major automobile companies signaled a drastic reorganization of the industry. In December 2008, Chrysler's sales of automobiles in the United States plunged fifty per cent in comparison to the previous December. This left analysts concluding that Chrysler (now Daimler Chrysler) could not long survive as a separate auto producer. Many predicted that what remained of Chrysler would have to be merged with General Motors, which would also have to be dramatically downsized. While the price bargains being offered by the two ailing auto makers have never been better, at the end of the restructuring, the American auto industry will employ tens of thousands fewer workers than it did at the start of 2008. Cities, towns and entire states will be dramatically affected by the lurch of the economy into deflation.

Deflation negates the motivation for business to make capital investments. The reason is quite simple. As consumer purchases decline, the prospect for increased sales diminishes. Rather than making investments, which involves hiring more workers, either by the company itself or through its suppliers, to expand plant capacity, to purchase new machinery, or to design new products, the company reduces production and lays off some of its existing employees. The company sells off its inventory, reducing prices to capture as large a share of the shrinking market for itself as it can. The consequence of this behaviour is that the ranks of the unemployed are expanded. Consumer purchasing power is further reduced, which lowers demand further, driving the system through successive rounds of layoffs and deepening deflation.

The deflationary downward spiral during the Great Depression was not self-correcting as it turned out. Orthodox neo-classical economists and right-wing politicians are wedded to the idea that markets left alone by governments, will work out these problems on their own. They believe that if the price of labour (wages and salaries) is allowed to fall, along with prices, a point will be reached where companies will once again find it profitable to make investments and to increase their production. This way, they insist, the downward spiral, if allowed to work itself out, will reverse to be followed by an upward virtuous cycle.

On this reading, the culprits standing in the way of economic renewal are trade unions that keep the price of labour artificially high, and governments that stand in the way of allowing wages and salaries to fall by paying out unemployment insurance and social assistance to the unemployed. Right-wing orthodoxy insists that the price of labour should be allowed to fall to the point where it becomes profitable to re-hire workers.

In late 2008, in the United States and Canada, right-wingers were quick to make unionized auto workers the poster boys for what was wrong with the auto industry. The wages of auto workers had to drop dramatically, they insisted, for the auto companies to return to viability. Using the same logic, right-wing thinkers and politicians, in principle, are opposed to the implementation of minimum wages, and are utterly against raising them. Minimum wages, they say, are uneconomic. They make the price of labour "sticky" to the downside, and stand in the way of the market sorting things out so that the drive to prosperity can be resumed.

Because right-wingers want to create a more market driven economy, they are basically opposed to bailing-out particular industries, such as the auto industry and the forest products industry. They can be pressured to support bailouts, as the Harper government recently was in the case of the auto industry, but they want government involvement in industry to remain as limited as possible. Long-term government involvement in key industries is anathema to the political right, even when it makes very good economic sense.

All this is not to say that right wingers and their intellectual allies, who populate the business schools of the United States and Canada, are opposed to any public policy measures being undertaken to cope with a severe economic downturn. They favour three types of actions by governments under such circumstances. First, they approve of central banks lowering interest rates to make it less costly for businesses to borrow and invest capital and for individuals to purchase automobiles, other durable goods or to buy houses. Second, they applaud governments making deep tax cuts, on the assumption that this will put more money in the pockets of people and in the coffers of business, which will allow consumer spending to rebound along with new capital investments. Third, they favour sharply reducing government spending, as a corollary to the tax cuts. This, they say, will keep deficit spending by governments to a minimum. It has the additional attraction for them of permanently reducing the role of government in favour of the market, which is an overriding objective of theirs.

The problem with this right-wing agenda, and its individual elements, is that it doesn't work. All of it was tried for years during the Great Depression. The consequence of this dreary experiment was utter failure. The dirty little secret of neo-classical economics is that left to its own devices a market economy can achieve a point of equilibrium between supply and demand that leaves millions of people, a high proportion of the work force, without employment. An equilibrium can exist that leaves economic output far below full capacity.

This is the ground on which the great disputes between the Keynesians and the monetarists were fought out.

John Maynard Keynes made the case that neo-classical economics had not solved the problem of economic equilibrium being achieved without full employment or full utilization of economic capacity, or anything close to it, being realized. He insisted that governments had to play an indispensable role in ensuring that sufficient demand existed to allow the economy to function, at or near, full capacity. (Experience has shown that during a recession, interest rate cuts by themselves do little to generate economic recovery. Interest rates on their own have been compared to trying to push a string forward.) In addition to the stimulus provided by monetary policy, through interest rate cuts, according to Keynes, there had to be the stimulus provided by direct government spending, as well as through tax cuts, not to the wealthy but to the mass of the population.

The trouble with tax cuts for the well-to-do is that, during a recession, the affluent are inclined to use the tax break to replenish their savings rather than to spend. Tax cuts for the majority of the population, those who are wage and salary earners, result in much more stimulus for the economy, because people with lower incomes will be inclined to spend their additional dollars on goods and services.

There is, however, a problem with tax cuts as a way to help Canada cope with recession. The Canadian economy, much more than other industrialized economies, is geared toward the export of primary products (and assembled automobiles) and the importation of vast quantities of finished goods. Much more than most other industrialized countries, Canadians are importers of the end products they consume.

As a consequence, tax cuts tend to promote a huge increase in imports of all manner of manufactured goods. In this way, the stimulus from tax cuts leaks out of the country. It is a far less efficient way to generate recovery than is direct spending by the federal government on infrastructure, whether we are speaking of rebuilding roads, sewer systems, and schools, or undertaking huge new projects in urban public transit or high speed rail systems between cities.

If the budget promises its major stimulus through tax cuts, Michael Ignatieff should understand the dead-end economics and ideology that underlies this and he should defeat it and the government. If the measures he wants to see in the budget don't have a serious price tag attached to them, he should also defeat it.

Ignatieff has a fundamental choice to make. The country will either go down one road or it will go down another. He will have to decide. And he will wear the decision.

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