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CAUT Bulletin Archives

June 1999

Link Severed Between Paper Economy & Real Economy

David Robinson

Paper Boom

Jim Stanford, Toronto: James Lorimer & Company Ltd., & Ottawa: The Canadian Centre for Policy Alternatives, 1999; 473 pp; paper $24.95 ca.
Even the most cursory reading of the business pages of any mainstream newspaper would give one the impression that Canada's economy is suffering a split personality. In this bifurcated world, the realm of money and finance has enjoyed unprecedented revenues, profits, and, most importantly, political influence. Stock market records have been shattered, bank profits have ballooned, and the sales of mutual funds and derivatives have reached heights unthinkable just a few years ago.

On the other side of the tracks where most Canadians live, however, the 1990s have been a grim decade, unquestionably the worst since the Great Depression. Personal disposable income, adjusted for inflation, has fallen and despite recent gains, unemployment remains stubbornly high.

All of this begs the question: how do we explain the stark contrast between the astounding growth of finance and the anaemic growth in the rest of the economy? After all, traditional economic theory suggests that the financial sector exists simply to grease the machinery of real production and investment. If finance is booming, then why is the rest of the economy going bust?

That's the central question Jim Stanford tackles in Paper Boom. Stanford, an economist with the Canadian Auto Workers union, has woven together a lively, comprehensive, and critical account of what really ails our economy. Paper Boom tells the story of how the private sector, despite all the concessions it has won in the past two decades, has failed to deliver the goods.

In trying to explain how the boom in finance has not translated into greater prosperity for most Canadians, Stanford concludes the economic link that once joined the 'paper economy' with the 'real economy' has been broken. Despite its enormous political and economic influence, the financial sector's contribution to real economic progress -- to real growth, jobs, and investment -- is in reality insignificant.

The paper economy employs less than five per cent of the total paid workforce. It makes up just six per cent of GDP. It undertakes almost no real investments in machinery, buildings, factories, homes and infrastructure -- investments that concretely improve our material standard of living.

But why has the real economy stagnated? Naturally, conservative economists will say the economy is underperforming because of profligate government spending, burdensome regulations, generous social programs and an unfavourable business climate that is choking off private investment. The best thing governments can do is simply get out of the way -- cut spending, slash taxes, deregulate the economy, and balance budgets. Then the invisible hand of the marketplace can get busy creating jobs and prosperity for all.

By almost any standard, Canada has a more deregulated, free wheeling and business-friendly environment than at any other time in recent memory. For the doubters out there, Stanford provides an exhaustive list of probusiness policy changes enacted since the early 1980s: free trade, public sector cutbacks, privatization, monetarism, corporate income tax cuts, and the deregulation of the energy, telecommunications, transportation, and financial services sector. The kicker is that despite these unprecedented concessions to business, the real contribution of the private sector to economic growth in the form of real investment has diminished.

For Stanford, the reason private sector investment continues to flounder isn't because governments are too intrusive or the marketplace is too regulated. Rather, it's the policies promoted by business that have ironically been their undoing. Using econometric models, Stanford 'tests' a number of variables that might explain the slowdown in real investment in jobs and growth. The main culprit? The economic downturn of the 1990s caused by fiscal restraint and high interest rates.

It's here that Stanford begins to tell a now familiar story. Beginning in 1989, Canada embarked on an untried and ultimately disastrous economic experiment. The Bank of Canada announced its intention to eliminate inflation, raising real interest rates to unseen heights and choking off economic growth and job creation. Consequently, Canada fell into a deep recession and hundreds of thousands of working people lost their jobs.

High interest rates also had the perverse effect of pushing governments further into deficits as the cost of servicing public debts jumped sharply. Governments responded to the crisis in public finance by raising taxes and cutting services. Apart from shifting billions of dollars from taxpayers to investors holding government debt, then, high interest rates also sowed the seeds of tax revolt as Canadians were forced to pay more for fewer public services.

But high interest rates also picked the pockets of businesses in the real economy. Almost all companies carry some form of debt to finance their investments. However, as interest rates skyrocket, the cost of carrying that debt or financing new debt rises substantially. The result is that more corporate income is channelled away from possible investments in the real economy toward the paper economy.

So what's the solution? There's no magic elixir, Stanford contends. Electing governments that enact lower interest rates, more expansionary macroeconomic policies, rebuilding our battered public sector, and regulating finance is a good start. But unlike many other critics of the prevailing economic orthodoxy, Stanford doesn't end his analysis here. He recognizes that any attempt to undo the neo-conservative policy agenda at the ballot box would offend many powerful vested interests. And those who control wealth would most certainly back up their opposition with threats of investment strikes and capital flight.

If Canadians are determined to really win back what has been lost over the past two decades, Stanford contends, then they have to be prepared to step up to the plate and take a swing at creating and investing real capital for themselves. That is, investment must be "socialized."

How would it work? Stanford admits that previous attempts in Canada to build public economic institutions, such as Crown corporations, had mixed results. However, he makes it clear that these shortcomings were not because the public sector is inherently inferior to private enterprise. Rather, Crown corporations were often given unrealistic mandates and insufficient resources.

In conjunction with resuscitating Crown corporations and putting public ownership back on the policy agenda table, Stanford also recognizes the need for a strong public presence in providing capital for real investment. Here, he proposes a detailed and viable plan for expanding the mandate of the Bank of Canada to include that of providing public venture investment funds.

Paper Boom is likely to become one of the most important and controversial economic texts of our time. Stanford not only takes apart neo-conservative economic policy, but also challenges those on the political left to think more seriously about wealth creation and investment. Agree with him or not, Stanford has succeeded in opening anew an old but vitally important debate over how our economy can be structured for the benefit of all, rather than for the private gain of the few.

David Robinson is Director of Public Policy & Communications at CAUT.