Thursday, January 29, 2009

The Liberals and the Road Not Taken

In this life, there are times when you have to make fundamental choices. You go one way or you go the other. The Liberal Party had such a choice to make: between the formation of a progressive coalition government with the NDP, or propping up the Harper government. The first choice would have allowed for the presentation of a budget to parliament that really would have offered hope to Canadians in a dark time. The budget would have provided stimulus through direct government spending on the scale needed to deal with the rising tide of joblessness in the country. I believe, and I’ve argued the case in previous posts, that the direct spending would have to be at least $50 billion this year and again next year. Fifty billion dollars amounts to about three per cent of Canada’s GDP. That level of spending would have created about half a million new jobs, perhaps more, depending on the capital intensity of the projects undertaken.

Such spending on carefully chosen projects, many to begin immediately, would have made a major contribution to renewing the nation’s dilapidated infrastructure and would have made our economy more efficient, more productive for the future. (I’ve spelled out my ideas on this in previous posts.)

The Harper-Flaherty budget doesn’t do the job. New spending of about $6 billion this year and again next year, will create about 60,000 jobs. It won’t make a dent in the rising tide of new joblessness that is forecast to engulf Canadian communities from coast to coast. The layoff notices are going out every day. The descent of our economy into deflation is proceeding. Within a few months, the utter inadequacy of the government’s policy will be evident to millions of Canadians.

In the face of this, Michael Ignatieff and the Liberals have made the second choice. They have decided to prop up the Harper government. If I had to speculate about the reason for this, I’d conclude that they are more comfortable with the Conservatives and the business community than they are with social democrats, trade unionists and wage and salary earners.

So be it. This is not a personal matter. Although the media is trying to make it seem that social democrats are miffed because they have been jilted by Ignatieff who is now dating the Prime Minister, it’s really about whose basic interests a party chooses to serve. The Liberals have made things very clear. That’s sad, not for Jack Layton and the NDP, but for Canadians who deserved better.

Over the next six months, at least, we are going to be reading about layoff notices every day. We are going to be seeing families unable to pay the mortgage, send their kids to college, or meet their basic obligations.

For those progressive Liberal MPs who believe their party has made the wrong choice, the alternative is to rise in the House and take a few steps down the floor to join Jack Layton and the NDP.

Wednesday, January 28, 2009

Jack Layton Is Now The Real Leader of the Opposition: Ignatieff Plays Hamlet

Michael Ignatieff began his press conference in the National Press Theatre in Ottawa today by saying that the Harper government’s budget was deeply flawed. For a moment, I thought he was about to do something interesting, to propose serious and substantive amendments to the budget. But then he dropped the clunker. The Liberals, he said, will propose an amendment requiring the government to provide periodic updates on how the budget is working.

There you have it. Michael Ignatieff went away last night, laboured, and brought forth a mouse.

Explaining himself in answer to questions from the media, the Liberal leader was embarrassingly sophomoric. The Liberal-NDP coalition had been useful, he said, because it had forced the government to put many useful measures in the budget. On the other hand, he said the budget remained a “Conservative” budget that likely would not work. Nonetheless, he said he intended to vote for it. Provided, of course, that his “Mickey Mouse” amendment is acceptable to Stephen Harper. By turns, Ignatieff sounded like Demosthenes, thundering down condemnation on a government that has repeatedly failed Canadians, and then like an apple-polishing pupil asking for a report card from the head master. Rule number one in politics: you can’t have it every which way. If you vote for the Conservative budget, it becomes your budget Mr. Ignatieff, no matter what font the government uses to print its reports for you.

In answer to questions that suggested that perhaps he had thrown the game away, Ignatieff could have replied in the manner of Hamlet: “Do you think I am easier to be played on than a pipe.”

Having decided “not to be” as a serious opponent of the Harper government, Michael Ignatieff could consider a career on the stage.

Meanwhile, Jack Layton has become the real leader of the opposition. He showed courage when he reached out to the Liberals to form a progressive coalition that could provide Canadians with the leadership they need to cope with the economic crisis. He tried the option of working with the Liberals. Michael Ignatieff has walked away from that option. Layton has retained his integrity and his clear understanding of what the country needs. Progressives now have one party and one party only available to them: the NDP.

Michael Ignatieff Should Focus on the Economy, Not on the Politics of the Budget

Yesterday, after reviewing the Conservative budget, Michael Ignatieff posed a very perceptive question: "My concerns about the budget are have they underestimated the seriousness of the crisis? That affects all the numbers. If they make that judgment wrong, pretty well everything goes south, including their deficit projections."

The truth is, and I am sure that Ignatieff understands this, the Conservatives have underestimated the seriousness of the crisis. The stimulus, through direct government spending, that is offered in the budget, is far too puny to lift an economy with a GDP of $1.5 trillion a year. Instead of about $6 billion a year in direct spending, Canada needs roughly $50 billion a year this year and again next year.

That’s the hard fact about this budget. It’s what the Liberal leader needs to focus on when he addresses the nation this morning at 11.00 a.m. EST.

Especially in the cloistered environs of Ottawa, it is very difficult for political leaders to remember what is happening to Canadians and their communities during this economic crisis. Surrounded by the jaded, cynical figures of the media in the capital, who have become as frozen as the gargoyles on the Centre Block, a politician can be forgiven for losing track of reality.

In the short-term, enormous pressures are being brought to bear on Ignatieff to support the Harper government budget, perhaps with some amendments. The problem is that as hundreds of thousands of Canadians lose their jobs in coming months and as communities lose their major employers, reality is going to come home to Canadian political leaders. The economic crisis is real, even though the Ottawa media are treating it as though it is a parlor game about which political leader is more strategically gifted than his foes.

If Michael Ignatieff keeps his eye on the country and the actual problems of Canadians, he can get this one right. We’ll see later this morning.

Tuesday, January 27, 2009

This Budget Won’t Lead Canada Out of Recession: Ignatieff Should Defeat It

The Conservative budget, unveiled today in the House of Commons by Finance Minister Jim Flaherty, will not mitigate the effects of the deepening economic crisis for Canadians. Members of Parliament should defeat this budget.

Liberal leader Michael Ignatieff has a momentous decision to make. He will decide over the next few hours whether to support the budget and keep the Harper Conservatives in power or to defeat the budget and form a coalition government with the NDP. Either way, he will set the course for the country for the next two or three years.

When we cut through all the details in the budget, one central fact emerges. The amount of money the government plans to spend directly to stimulate the economy is far too low to save jobs and to mitigate the effects of the recession on Canadians and their communities.

Depending on how you interpret the budget, the government is committing itself to direct new spending of about $10 billion to $12 billion, on infrastructure and housing, over the next two years. Some of this depends on matching provincial and municipal funds, which may never materialize. Much of it depends on how much the government actually spends, a crucial matter since the Harper government has left most of the previous infrastructure money it promised in earlier budgets unspent. At most, the new direct spending by the government amounts to about $6 billion a year.

These numbers may sound big. In fact, they are puny. The Canadian Gross Domestic Product totals about $1.5 trillion a year. Six billion dollars a year amounts to just over one half of one per cent of our country’s GDP. Economic announcements and forecasts tell us that Canada is on track to lose hundreds of thousands of jobs over the next six months. The Conservative government’s planned spending would create, at most, about sixty thousand short-term jobs.

The various tax measures in the budget will be equally ineffectual in stimulating the economy.

Much of the $64 billion deficit the government projects over the next two years is accounted for by the tax cuts the Harper government made before the economic crisis took hold with a vengeance. Some of the rest is as a consequence of proposed new tax cuts. The across-the-board income tax cuts in the budget, which not only benefit lower income earners but all income earners, are undoubtedly welcome to many Canadians. But they will do little to stimulate the economy. A sizeable portion of the cuts will go to paying down existing debts or replenishing lost savings. A further and very large chunk will be spent on imported goods. Canadians import over $400 billion worth of goods a year, close to thirty per cent of our GDP. By way of contrast, Americans import goods equivalent to about fifteen per cent of their GDP. A huge portion of the tax cuts announced by Flaherty will leak out of Canada in the form of additional imports. They may stimulate the Chinese, Japanese and American economies, but they will do precious little to stimulate ours.

The best and most effective way to stimulate our economy to counter the descent into deflation and further job losses is through direct government spending. That spending can begin within a few weeks on infrastructure projects with a price tag of billions of dollars. Beyond that, there should be spending on longer-term projects, to improve public transit, to build high-speed rail systems between Canadian cities and to refit housing for greater energy efficiency. The need to fight the recession should be tied to the opportunity to rebuild our cities, design and build cars, trains, and planes for the 21st century, and to transform our forest products industry to make it sustainable and productive for the long-term. In short, we need an economic plan that is green and that is devoted to increasing Canadian productivity.

When it comes to direct government spending, size matters. Anything less that $50 billion a year in direct spending by Ottawa this year and again next year is completely inadequate. Fifty billion dollars a year or three per cent of our GDP would create about half a million jobs, perhaps six hundred thousand, depending on the capital intensity of the projects undertaken. Because the federal government has paid down a considerable amount of the national debt over the past decade and has dramatically reduced the national debt as a proportion of our GDP, we can afford this level of spending. Indeed, we can afford it much more than the United States can afford the proportionally higher level of spending the Obama administration is planning.

Michael Ignatieff has a crucial choice to make. He will take the country down one road or down another. No compromise is possible. If he chooses to support the budget and keep the Conservatives in power, the Flaherty budget will become the Ignatieff budget.

While such a choice may make some people happy in the short-term, Ignatieff needs to keep in mind that the economic crisis is the worst faced by the nation since the 1930s. Its rapacious, destructive course is continuing. As the layoffs and the shutdowns proliferate, the anger at Ottawa for doing next to nothing will rise.

Ignatieff should think about the millions of Canadians who need serious economic leadership now, rather than about the cynical media corps in Ottawa who have no idea what is going on in the country.

Monday, January 26, 2009

On the Eve of the Budget: The Conservatives Haven’t a Clue

As the Canadian economic crisis deepens with new layoff announcements every day, with the economy shrinking, and with Canadians anxious about their own future and the future of their communities, the Harper government still has not figured out how serious things have become.

Today, on the eve of the budget, we already know enough to say that what the Harper government will unveil tomorrow will not be remotely sufficient to stem the loss of jobs and to put Canada on the path to sustainable recovery.

The Conservatives have announced that over the next two years the Government of Canada will have a $64 billion deficit, $34 billion this year and $30 billion next year. At least half of this deficit flows directly from the tax cuts the Harper government has already made. As for stimulus---the injection of new direct government spending into the economy---we are to have precious little of that.

At a news conference this morning John Baird, the minister in charge of infrastructure, announced that the government will announce at least $7 billion in new infrastructure spending in tomorrow’s budget. The minister broke down the elements of the program as follows: $4 billion for infrastructure projects to be carried out by provinces, territories and municipalities; $2 billion for repairs and new construction of universities and colleges; and $1 billion for green infrastructure projects.

Although he seemed confused about the details, the minister said that this spending is to take place this year and next. If this were to occur---and remember that most of the infrastructure spending announced by the Harper government in its last budget never materialized---we are talking of spending of about $3.5 billion a year.

To put numbers like this on the table to relaunch an economy with a $1.5 trillion GDP is a bad joke. This level of stimulus would do next to nothing to turn the economy around.

Are the Conservatives really proposing to leave it up to the Obama administration to provide the stimulus to pull the Canadian as well as the American economy out of the doldrums? That’s what the puny numbers Ottawa has released so far would indicate.

Tomorrow, when we get the full budget, the key will be the overall number for direct government spending. Without direct federal government spending of at least $50 billion in 2009 and again in 2010 ($50 billion is about three per cent of Canada’s GDP), Ottawa’s efforts will leave Canadians floundering in the worst economic crisis since the 1930s.

Wednesday, January 21, 2009

Obama: Yesterday, the Joy, Today the Hard Economic Reality

Now that Barack Obama is in the White House, his single greatest challenge is to restart the U.S. economy, to turn it away from its descent into depression, toward sustainable recovery. Unlike the period of the Great Depression of the 1930s, when Americans held their ultimate fate in their own hands, they no longer do. Whether he fully appreciates it as he sets out on his presidency, much of the ability of Barack Obama to carry out his economic agenda will depend on the decisions of foreigners.

In sharp contrast to the Great Depression of the 1930s when the United States was the world’s leading creditor nation, the U.S. is now the greatest debtor in the world. This places enormous constraints on the course the United States can pursue to cope with the economic crisis and with the broader foreign policy challenges that confront it.

Two forms of debt are particularly important to the external position of the United States: the U.S. government deficit and debt; and the U.S. current account deficit.

First, let’s look at the effects of the U.S. government debt, which presently amounts to $11 trillion and is set to soar much higher. The Obama administration’s economic recovery plan is driving the U.S. government’s deficit from $410 billion at the beginning 2008 to well over a trillion dollars a year. The administration projects that trillion dollar deficits will persist for years to come. The U.S. federal debt is financed in part by securities held by U.S. government accounts, among the most important, the Federal Employees Retirement Funds, and the Federal Old-Age and Survivors Insurance Trust Fund. At the beginning of 2008, 55 per cent of the debt was held the “public”, meaning those who purchased U.S. treasury bonds. Forty-five per cent of these “public” purchasers were made by foreigners, two-thirds of that total by foreign central banks. By far the most important of the central banks in making these purchases were those of China and Japan. When to the central banks of China and Japan are added to other purchasers from these two countries, about 47 per cent of the purchases by foreigners is accounted for. In total, foreigners have been financing about 25 per cent of the gigantic U.S. National Debt, a percentage that the Obama agenda could drive much higher.

Between them, the central banks of China and Japan hold over a trillion dollars worth of the U.S. securities used to finance the U.S. national debt They don’t buy them because they regard them as a good investment. Quite the contrary. They buy them to save the United States from the crippling consequences of its own internal weakness. This, they do, not as an act of generosity, but to safeguard their vitally important export markets in the U.S. and to prevent a global economic collapse.

Suppose the Chinese and Japanese central banks, along with about eight or ten other central banks, decided to reduce their purchases of U.S. Treasury bonds. The consequence would be a sharp decline in the value of the U.S. dollar against other currencies. A lower dollar would lead to a very substantial reduction of U.S. imports. Keeping exports flowing into the vast American market is what motivates Asian central bankers to buy trillions of dollars worth of U.S. Treasury bonds.

There is a limit to this willingness to serve as lenders for the deeply indebted Americans, however. The biggest money makers in China are foreign multi nationals that set up shop in that country to avail themselves of a highly productive and relatively inexpensive labour force. Those multi-nationals are earning a far higher return on their invested capital in China than the Chinese central bank makes sustaining the U.S. dollar through its purchases of U.S. Treasury Bonds.

The Obama administration will need to sell vastly more (the dollar total could more than double) Treasury Bonds to Asian and other central bankers. This will have two effects. First, it will substantially increase the downward pressure on the American dollar against other currencies. A renewed fall in the value of the U.S. dollar will serve as yet another disincentive in the path of central bankers and private investors buying up the bonds. Buying bonds denominated in a falling currency is a money loser, especially if the interest rates on the bonds are low. To sweeten the pot, the interest rates on U.S. Treasury Bonds will have to be substantially raised, both to slow the decline in the U.S. dollar and to increase the return to the buyers of the bonds.

This, of course, creates yet another problem for the United States. Higher interest rates on American bonds make the cost of financing the rapidly expanding U.S. national debt ever more dauntingly stratospheric. Thus, borrowing immensely more from foreigners to finance the administration’s stimulus program is an exercise that can only be described as fraught. The more expensive the cost of borrowing, the less effective will be the U.S. recovery program.

In principle, there is a way to reduce the volume of additional foreign borrowing. This would be to dramatically reduce the income and wealth gaps between the rich and the rest of the American population, in part by imposing much higher income and wealth taxes on the very affluent. While in theory, this could work, in practice this would necessitate such an enormous shift in the American socio-economic system that it is inconceivable under present circumstance. It remains only a theoretical possibility to be noted. The continuing dependence of the United States on foreign borrowing, and thus on the need to tie much of the world into an American centred geo-political system is rooted in the marked inequality that exists in the United States itself.

Adding to the problem is the rising current account deficit of the United States, which was running at an annual rate of $710 billion in the autumn of 2008. (The current account includes the trade in commodities, tourism, and the trade in services, including profits, dividends, and interest payments between the United States and all other countries over the course of a year.) To finance its gigantic current account deficit, which amounts to just under five per cent of the U.S. Gross Domestic Product of $14.3 trillion, the U.S. is forced to engage in immense foreign borrowing. This can take a number of forms. One of the most important is the inflow of investments by foreigners to acquire assets in the United States. During the 1990s, these inflows were occurring at a time when the U.S. was on the cutting edge of the global technological revolution. It was the age of the boom. Following the crash in 2001, though, much of the flow of new foreign equity into the United States halted. Indeed, over the next few years, if the U.S. dollar should drop significantly against other currencies, foreign investment inflows into the United States would likely be aimed at the acquisition, on the cheap, of American economic assets. This is hardly a prospect that the U.S. government and corporate sector can view with equanimity.

For any country to have a perennial current account deficit that runs in the range of five per cent of its GDP is a perilous exercise. For any country other than the United States to do it is unthinkable. The U.S., as those who believe that America can go on doing this indefinitely insist, has a special role in the global system which allows it the privilege of greater indebtedness than other countries. Among other reasons for this is the fact that the U.S. dollar remains the reserve currency of the world. This means that when the U.S. government borrows money abroad it does so in its own currency, so that even if that currency depreciates against other currencies, Washington does not have to assume the additional cost this would impose on other borrowing governments.

The merit of this argument has declined as the prospects for the further depreciation of the U.S. dollar have increased. The burden to be borne by foreign central banks has simply grown dangeriously large and it is about to become more enormous still.

The U.S. current account deficit---the extent to which the United States spends more abroad than it earns abroad---creates a paradoxical relationship for the U.S. with other countries. On the one hand, there is the vast American market on which China, Japan and other countries, including Canada, depend so much for the profitability of the enterprises based on their soil. (Manufacturing companies, because of the economies of scale they achieve as their sales and volume of production increase---as the ratio of fixed to variable costs falls---make as much as half of their profits on the last fifteen or twenty per cent of their sales.)

It helps to picture the size of the U.S. market for foreigners this way: each year the U.S. offers to foreign suppliers a market more than half the size of the entire Canadian market as a consequence of its deficit. This additional market exists on top of what the U.S. market could offer foreigners if Americans sold abroad as much as they buy. The paradox is that foreigners have to pay dearly to keep this market open and available to them. The bigger the U.S. current account deficit, the more lucrative it is to foreigners. But the bigger the U.S. current account deficit, the more burdensome is the weight of the unprofitable U.S. Treasury Bonds foreigners must buy to keep that market open.

There is an inherent instability at work here. It is the kind of arrangement that could only exist in the relationship between a declining empire, or hegemon, and its clients. When the United States was a rising empire---as it was even in the dark days of the Great Depression in the 1930s---it creditor status, its superior productive plant and ultimately its unexcelled military potential, ensured its ability to invest abroad on its own terms and to dictate its trade arrangements with other countries. Indeed, in the last days of the Second World War, in 1944, the United States, along with its allies established the rudiments of the post-war economic system at Bretton Woods, New Hampshire, placing itself at the centre.

The United States can be likened to a ballerina. When she is young she makes difficult feats look easy. When she is aging she has to settle for making easy moves look difficult.

At what point will foreigners conclude that the game is not worth the candle, that financing the foundering U.S. is more trouble than it’s worth? Since so many factors are at play, including the stresses so evident in the U.S. effort to sustain its geo-strategic position in the world, no precise answer can be given to this exceptionally important question. What is abundantly clear, however, is that the Asian powers and the Europeans could adopt economic strategies in which the role of the U.S. as a market of necessity (much more for the Asians than the Europeans) becomes far less important than it is today.

Although it would confront both countries with large, and quite different, challenges, China and Japan could set out to dramatically reduce their dependence on exports. Because of its immense population and the fact that only about one third of it has been raised above third world conditions (more than four hundred million people), China has a vast internal market to which it can potentially direct much more of its economic output. Instead of propping up the financing of the U.S. state, the Chinese central bank could redirect its energies toward this unequaled internal market.

This would be no simple matter. To date, China has benefited enormously from the investments of foreign firms, their know-how and their access to the mature markets of the West (especially the American market).

The socio-economic transition for China in a shift from exports to the internal market would be a highly stressful one. Wages in the advanced sectors of the Chinese economy, which have been rising could be driven down, as the giant country focused on internal demand. The well-being of the relatively prosperous segments of Chinese society would experience at least temporary dislocation during the transition. Over the longer term, however, the shift would likely lead to even greater prosperity in the advanced sectors since the pressure to keep labour costs low for the purposes of the export orientation would be greatly lessened.

As long as China regards sustaining a huge level of exports to the U.S. as critically important to its economy, Chinese wages have to be held down. As China develops, and the demand for greater domestic prosperity increases, labour prices are bound to rise in any case, and this will further drive the shift away from the concentration on the American market.

Japan’s situation, despite its reliance on exports to the U.S. is markedly different from that of China. Japan has an advanced economy and a high standard of living. The country’s aging population and its reliance on exports have held back the expansion of Japan’s domestic market. To put it the other way round, the failure of its domestic market to develop rapidly has made Japan’s high level of exports a matter of continuing importance.

The U.S. and Japanese economies have been depicted as having a symbiotic relationship. Japan is the saver and lender---it has been the world’s leading creditor nation since the mid 1980s---and the United States is the spender, borrower, debtor and importer. Japan needs the U.S. as an outlet for its surplus capital and a destination for its exports. The United States relies on Japan to help finance its debts, its propensity for living beyond its means and its thirst for high quality manufactured products.

Japan, like China, has been willing to lend enormous sums, at very poor rates of return to the United States to keep this symbiotic relationship alive. But there are limits to the Japanese willingness to bear even higher costs to safeguard the U.S. market outlet.

The scope for the Japanese to focus on the expansion of their domestic market is much more limited than is the case for the Chinese. Japan, however, is quite capable of shifting its lending and the destination of its exports away from the U.S. to India, Europe, Brazil, Nigeria, South Africa and other countries. Indeed, in conjunction with a drive by China to expand its domestic market, there would be an enormous opportunity for Japan to help finance China’s expansion and to shift the focus of its exports to its giant neighbour.

It is a cardinal error to believe that the United States will sustain its present role at the centre of the global economy and that it can continue the virtually unlimited access to foreign borrowing it has enjoyed in recent decades.

Although this has not been widely acknowledged in public discourse, the United States will have to navigate a wrenching economic transition. One cost, that is virtually certain to accompany this is a falling standard of living for the American people. Barack Obama has warned Americans that the road ahead will be a difficult one. Soon they will learn that the pain is much greater than they have yet imagined, a pain that grand speeches down the length of the Mall will do little to assuage.

Monday, January 12, 2009

Ignatieff’s Dilemma: Coping with the Conservative Budget

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.