Thursday 30 January 1992

Pre-budget consultations

Royal Bank of Canada

Mark Chandler, assistant chief economist, ecomics, treasury and financial markets

Nomura Research Institute, Nomura Canada Inc

Leo de Bever, vice-president and senior economist

Canadian Imperial Bank of Commerce

Tim Whitehead, general manager

WEFA Group

Ernie Stokes, director


Chair / Président(e): Hanson, Ron (Lincoln ND)

Vice-Chair / Vice-Président(e): Sutherland, Kimble (Oxford ND)

Carr, Gary (Oakville South/-Sud PC)

Christopherson, David (Hamilton Centre ND)

Jamison, Norm (Norfolk ND)

Johnson, Paul R. (Prince Edward-Lennox-South Hastings/Prince Edward-Lennox-Hastings-Sud ND)

Kwinter, Monte (Wilson Heights L)

MacKinnon, Ellen (Lambton ND)

Mahoney, Steven W. (Mississauga West/-Ouest L)

Phillips, Gerry (Scarborough-Agincourt L)

Sterling, Norman W. (Carleton PC)

Sutherland, Kimble (Oxford ND)

Ward, Brad (Brantford NDP)

Substitution(s) / Membre(s) remplaçant(s):

Morrow, Mark (Wentworth East/-Est ND) for Mrs MacKinnon

O'Neill, Yvonne (Ottawa-Rideau L) for Mr Kwinter

Owens, Stephen (Scarborough Centre ND) for Mr Hansen

Sullivan, Barbara (Halton Centre L) for Mahoney

Clerk / Greffier: Decker, Todd

Staff / Personnel: Campbell, Elaine, Research Officer, Legislative Research Service

The committee met at 1007 in room 228.


The Vice-Chair: We will get this meeting started today. This is our second day of hearings in the pre-budget consultations. We are hearing from the economists in terms of giving us some idea of their projections and how they think both the Canadian and Ontario economies are going to be for the upcoming year.


The Vice-Chair: Our first presentation today is by the Royal Bank of Canada, Mark Chandler and Andrew Spence. You have about an hour for your presentation. I know all the members are anxious to ask questions, so we ask that you leave some of that time for them to ask some questions.

Mr Chandler: I will talk for hopefully just about 20 minutes on the presentation itself and then we will get down to some questions. After one full day and another day of talk by economists coming up, I believe you would prefer to ask some questions rather than hear what may end up being the same old thing again.

What I would like to do is to start off by giving you a brief outline on how we see things, the major points for Ontario. It is more issues-related. We have a forecast with all the details for all the indicators at the back of the handout I have given out, but I think it is more important to get a grasp of some of the major issues facing the province from an economic standpoint. I will just start by putting out a couple of points.

First, we believe Ontario has had a problem of weak demand and historically high real interest rates, but this is also a problem that is shared, to some extent, internationally. We are not isolated in facing these factors.

The second point is that while we have had cyclical weakness in Ontario, it has been about on a par with what we have seen in 1981-82. That is definitely not the case for the nation as a whole, where it is roughly half as bad as what we saw in 1981-82. Clearly, Ontario is facing a weaker period than the nation as a whole. That is also true if you look at it on an industry-by-industry basis.

We think the weak recovery and the unexpected depth of the recession in Ontario can be tied to a whole raft of events and policies that require adjustment that is costly, so it is not just the cyclical factors; it is also the structural factors.


One other thing to keep in mind is that during a period of upheaval like this there are challenges and opportunities. It is important to keep in mind that when we see job losses, they are net job losses. There are more jobs lost than what is shown and there are also jobs created. In fact, if you look at some studies done by Statscan, they showed that in one of our best years, 1986, one in five workers left his job, and at that point the layoff rate for the nation as a whole was 16.5%. Even in very good times we see layoffs and we see jobs lost. The point is that we also see jobs created and I think that is really one of the important points we should keep in mind for Ontario. Our policies should be directed toward job creation and making sure there is a good atmosphere for creating additional employment in the future. Nevertheless, the way I see things right now is that the groundwork has been laid for sustained economic recovery. We do not look for a very good 1992 for Ontario; in fact it is not as good as Treasury and Economics has put forward. However, we think that if you start looking out beyond, in the medium term we can get solid, low-inflation growth for both Ontario and the country as a whole. This will be matched with fairly low interest rates and decent productivity growth.

What are the appropriate policies for the Ontario government under these circumstances? We agree there should be adequate recognition that disruptive structural change requires accommodation. In this context there should be funds available for job retraining, etc. However, the overall thrust of fiscal policy should not be based towards an aggressive widening of the deficit. The structural problems are not a problem with demand. They are problems that are in the shifting of jobs from one sector to another in the economy.

Once again we feel there is a sound basis being drawn for sustainable recovery. This recovery is threatened if future tax liabilities are deemed to be too high. The federal government has learned some very costly lessons on this front, watching its debt charges take up an ever-increasing portion of the budget at the expense of program expenditures. Ontario should be wary of falling into this same trap.

Those are the key points of the talk.

What I would like to do now is just go through the handout. I believe all of you have a handout in front of you. If we can go through that just on a chart-by-chart basis, it provides some of the support for the points I have made. We will start at the beginning. Chart 1 is essentially what I have just outlined. For the next year or two years some of the key points for Ontario are: What is the pace of the recovery going to be like? What will be the policy environment we are going to see in terms of monetary and fiscal policies? We think cost control is going to be a big factor internationally, throughout the nation and also within the province. Political stability is also a factor. That is not only true with what is happening on our own constitutional front; we also have a US presidential election this fall and the UK election in the spring. Whether we like it or not, these tend to have an effect on our own environment, most directly through financial markets.

Chart 2 shows what has happened in terms of the Organization for Economic Co-operation and Development growth and inflation. It shows that the 24 largest industrialized countries in the world are also going through a period of slow growth, the slowest in about a decade. Ontario is not alone in that sense. It has also been the case that with slow growth in the industrialized world we have seen inflation start to improve. The OECD forecast for 1992 is 2.2% growth, well below what we saw through the mid-1980s but an improvement from 1991. The world as a whole is also facing weak demand and, typically, lower inflation.

If you turn to charts 3 and 4 right now, they also serve to support these points. In particular, chart 3 shows that clearly Canada has had a problem in terms of high interest rates. If you look at real interest rates, though, long-term interest rates, they are not too different from what you see in the other G-7 countries. Indeed, it has been that case through most of the middle part of the 1980s and right up through 1991. We see in other countries, not just in Canada, and in other jurisdictions, not just in Ontario, that they are being faced with a condition of weak demand and, historically, relatively high real interest rates. That is the international setting.

If we now look at it from a cyclical standpoint, how is Canada faring, and does it compare with what we have seen in the US? Chart 4 has a little table that shows what average recessions would typically look like and what this one looks like. What it shows is that for the nation as a whole, in Canada the output loss, peak to trough, is 2.8%. That is about half of what you would typically expect to see in a recession. As I said earlier, Ontario is facing a worse situation than that. In the US it has been a bit of a different situation. They have had a relatively shallow recession compared to previous recessions.

What all that means is at the bottom. We have the amount of slack, if you like, in the economy. The last line in that chart is the estimated output gap, where we are now producing now and where we could be if we carried along in our trend growth rate. Canada is about 6% below potential right now and the US about 3%. We have much more slack in the economy, and that is keeping downward pressure on inflation in Canada more so than in the US. For our outlook, what that means is that as we grow out of this slow period we see that inflation has the chance to re-emerge in the US, but we do not think that will be such a big issue here in Canada.

Charts 5 and 6 show how that has really affected Ontario over this past cycle. Chart 5 shows the path of employment from the peak prior to the recession carried on 24 months into it. For 1981-82 that is shown by the solid line, and the dotted line shows what has happened in the most recent recession. As you can see, in terms of employment we have seen a very similar pattern emerge. I think that is roughly true for the province as a whole, not just unemployment but if you look at other indicators. For us this decline has been about what we saw in 1981-82. It has good and bad points about it. We know 1981-82 was very rough. We also know that we ended up getting out of there to post one of the strongest growth periods in the province's history.

The unemployment rate shows another indication of how Ontario has fared through all this compared to the other provinces. We are now at a point, with the unemployment rate in Ontario at 9.7% and the national rate at 10.3%, where we are not too much different in the nation. That is a big difference from what we saw through the mid-1980s where Ontario reaped most of the benefits of expansion during that period. The other provinces participated, but to a lesser degree. We did very well in the boom period; we are hurting more in the bust period. That is a very cryptic way of putting it.

Charts 7 and 8 show once again what kind of cyclical factors are at play. I focus on this because we all know that Ontario has a very important manufacturing sector that is going through a lot of problems right now. That is typically thought of as a cyclical industry. If you look at what has happened in the nation as a whole in the cyclical industries -- we define those as manufacturing, wholesaling, retail, construction and transportation -- those have not come back with the same vigour that we saw in 1983. Something is wrong there. Our cyclical industries have not responded to the very sharp decline we have seen in interest rates. They have not responded as they did in 1983. The non-cyclical industries have performed about as you would expect through the boom period. They held up a little better than what we expected through the 1990-91 recession.

Chart 8 shows a similar sort of picture, but with numbers. It shows what happened in terms of output loss in 1981-83 in the cyclical sectors and what we have seen in the current recession. If you look for example for the cyclical sectors as a whole, in 1981-83 they lost 13% of their output through the recession period. However, as we headed out into the recovery period, the roughly eight months or so that is shown there, they had already recouped 8.5%. They had come back about two thirds of the way. 1020

We saw for our cyclical sectors this time around that, with the exception of some sectors, they were not hit as badly in 1981-82, but they really have not come back. We have only gained back about a quarter of what we lost. The cyclical sectors are having a hard time getting back up on their feet. The non-cyclical sectors have a similar sort of pattern. We were not as badly hurt in the non-cyclical sectors in the current recession compared to 1981-82 and we have not come back as strongly. We believe, therefore, that a case can be made that there are some structural factors at play.

If you look at chart 9, it shows what has happened in one of the cyclical sectors: manufacturing in Ontario. What happened last time around in the recession and what happened this time around? Once again it reinforces what we saw for employment in the whole province. That is, 1981-82 looks a lot like the current recession. We said there were some structural factors at play. Where are those forces coming from? We think there are at least three or four we can put our finger on. One of them is the effect of the free trade agreement and increased global pressures. That is a bit of a catchword but really what it means is that it is a very competitive environment, tough to get strong sales increases. A lot of companies are focusing on global market share and it is a very tough environment for a lot of businesses out there. The second factor is deregulation and privatization. We have seen that very recently, in the papers this morning. We also have seen it from the federal government in terms of privatization, but we have seen it abroad too. It is unfair to think that will not affect us. I would say there is a good case that deregulation in the United States has affected our trucking industry, for example. These are structural factors that have made it harder for Ontario businesses to compete in and beyond the cyclical factors. Low commodity prices are also a factor. International focus on price stability: we have seen that the world as a whole has very high real interest rates. There have been very strong capital demands through the 1980s. As well, most central banks in the industrialized countries are focusing on a low rate of inflation, so there have been, compared to past times in history, fairly high real interest rates. There have also been a few changes of opinion on environmental issues over the last decade. What we have seen is that this has definitely made businesses have to go through a lot of costly adjustment in terms of what the environmental impact of their business is. It was something that was probably long in coming, but coming as it does right now has added another cost of doing business. Finally, just the relative price change to the GST. The GST came early last year at a time when businesses were facing a condition of weak demand. There was a lot of uncertainty involved with it, a lot of uncertainty in the pricing decision and a lot of uncertainty in terms of how you adjust your books and how you adjust your prices. All these things have served to affect how businesses have been managing over the last year and a half or so.

The rest of these charts just try to support that. If you look at chart 11, it shows what is happening to commodity prices. For Canada, commodity prices are typically very important. For Ontario they are also important. Base metal prices make a big impact in northern Ontario. They have fallen off very sharply from their peaks in 1988-89. There are some signs of recovery. In fact, we think that will continue on for the remainder of this year, but they will not get back to the levels we saw at that period of time: 1988-89. We have seen base metal, wheat and lumber prices start to pick up recently. Livestock prices remain weak. We do not expect a very strong global recovery, so commodity prices in general are likely not to rebound very quickly.

Chart 12 shows what has happened to the share of industrial employment in total employment. This is important because it addresses the issue of why Ontario has lost manufacturing jobs. A short answer to that is that everybody in the world is losing manufacturing jobs. Manufacturing as a percentage of total employment is falling in all the industrialized countries. If you look at the pattern from 1970 to 1990, Canada has actually held up fairly well compared to most countries: the United Kingdom, United States and Germany have all fared worse over this period. Japan is the only one that has fared better in terms of maintaining jobs in the industrial sector as a share of total employment. That is one of the things that is happening in a structural sense.

Chart 13 shows another reason why manufacturing in Ontario is not faring as well as it might have. This shows what has happened to relative cost trends between Canada, the US and G-7 nations over the last decade or so. Productivity growth in Canada has been well below both the US and the G-7 nations: 1.4% versus 3% to 3.8% in the United States and other G-7 countries. At the same time our wages have increased at more rapid rate: 6.8% over this period. Clearly, if you look at unit labour costs, which are essentially the sum of those two, you have unit labour costs in Canada running at an annualized pace of 5.4% over that period, and that compares with 2.1% in the United States, our major competitor, and 2.8% in other G-7 countries.

You could say that if you had a declining currency you could offset that. But in fact if you look, in US dollar terms, at what it has meant for competing in global markets, Canada has had roughly the same 5.4% unit labour cost increase. Remember, we are looking at the period 1979 to 1990, and right now the dollar has gone through a sharp devaluation through to 86 cents and a sharp appreciation throughout. So we missed that cycle.

What it shows on average over that period is that our unit labour costs are considerably higher than our major competitors' if you put them on common currency terms. Clearly that is having a negative impact in terms of the competitiveness of our manufacturing sector.

Chart 14 shows some other problems in one of our cyclical sectors, the retailing sector. It shows what has happened to same-day automobile trips to the United States and related expenditures just of those same-day trips, and that is our own estimate. They have gone up continually from 1987 to 1991. Just recently we have seen a bit of a down-tick and so have the related expenditures. They have averaged 0.7% in terms of total retail sales for the nation as a whole, but that is a little bit misleading. That means a lot of money. If you apply it to retail sales, the average amount in Canada is about $1.5 billion. So it is not a small problem, and in particular it is very much a local and regional problem. If you talked to the retailers in southern Ontario they would tell you it is much more of a problem than shown by these figures here.

Why has that occurred? One of the reasons it has occurred, if you look at Chart 15, is that the Canadian dollar right now, we think, is overvalued compared to where it should be. Our purchasing power parity, the long-run competitive value of the Canadian dollar, we feel, is about 80 cents. Right now it is trading at about 85.5 cents. It is getting toward that 80-cent level. It is getting there in a hurry. Really, it is overvalued. That has hurt our retailers. It has also hurt our manufacturers just in the last five years. We think there is room for a lower dollar but not much. We think the real way we are going to end up getting back on a more competitive footing is for our underlying cost structures to adjust to make that a more realistic value for the dollar, and I will get to that later.

Chart 16 shows another symptom, if you like, of this whole issue of whether it is structural or whether it is cyclical. Ontario layoffs: This chart shows the number of employees laid off in thousands, and this is just for groups of employees of 50 or more. It shows which percentage is permanent, which are due to plant closures. What it shows is that we see much more of the layoffs this time around associated with plant closures compared to what we saw in 1981, 1982 and 1983. Once again, we think that signals that it is not a temporary downturn in demand, rather that there are a lot of structural problems and a very hard time for many manufacturing and other businesses in Ontario competing, given the current cost structure.

Charts 17 and 18 show -- it is a bit of a forward-looking thing -- what has happened in terms of investment relative to the size of the economy: in the United States, Canada and G-7 nations in the top graph and in the bottom graph, Chart 18, it shows what has happened to fixed investment in Ontario relative to Canada.

What the top chart shows is that it has not been the case where Canada has not invested enough over the last several years to get the productivity gains and the improved standard of living we require. In fact, if you compare what Canada has shown over the last decade with what we have seen in the United States, Canada has been investing relatively more, particularly so in investment in machinery and equipment, with the hope that, in the future, that would pay off in productivity gains, lower inflation and a better standard of living.


In the United States, that trend continues to be on the downcourse and I think that was one of the reasons we saw in President Bush's address earlier this week that there was such a focus on what is he going to do in terms of investment tax credits and research and delelopment tax credits and so on. Investment in the United States is a problem. It has not been as much of a problem in Canada.

Chart 18 shows the same thing: Ontario versus Canada. The levels are a bit misleading in terms of how much Ontario has invested relative to the size of its economy, but the trend there is clear. What we saw in 1985 through 1989 was some very good investment in this province with the expectation that it would pay off down the road in some of the things I just mentioned. But since that time, 1988 through 1990, we have started to see some down-tick. Our forecast is that it is going to say fairly depressed to 1992-1993 and really we think this is one area where Ontario should be very concerned. If we do not get the level of investment we had in the past, we are going to see a lack of new job creation. We are going to see an erosion of real incomes, an erosion of standard of living and an erosion of productivity. We view this as a danger sign. The lights are flashing amber.

Chart 19 is a study that was put out by the University of Western Ontario's Paul Bergman. He surveyed Ontario's 2000 largest firms and asked of those that have no plans to invest in Ontario what the reasons were. The top five reasons are listed there. A lot of times these surveys are used as a sounding board and it is an easy way to show a protest vote, so I would not put too much stock in a lot of the results. But he does cover a large sample. Clearly what they are saying is that there are some concerns about future investment related to Ontario's policies as they relate to wage protection, size of the deficit, future tax burden and some of the things that are being done in terms of employment equity. This shows once again that there are some warning signals in terms of what is happening on the investment front.

Nevertheless, where we stand right now is, given the past levels of investment, given the weak demand and so on, we think we are heading into a period of time when we are going to see consumer prices and inflation at very low levels, the kind of levels we saw in the late sixties. As a result, what we expect to follow is considerably lower interest rates. Hopefully that will pave the road for some up-tick in investment in the future. What does that mean for interest rates? We have low inflation. The real component of that is affected by other factors: demand for capital worldwide, the pace of recovery worldwide -- those are all factors that affect the real component of interest rates. We see those coming down from current levels, but really agonizingly slowly. For Canada: a 3.5% real rate by the middle part of this decade. But if you start adding it up -- essentially a 2% inflation rate, 3.5% real rate -- we can expect to see long-term interest rates at 5.5%. If we get that, and the key to getting it is to make sure we have the appropriate policies, then we can expect that investment will start to pick up again and some of the uncertainty in the investment decision will be alleviated. What does that mean in the very short term for interest rates? We think the path is still down. If you look at chart 22, interest rates, we see the prime bottoming out at 7%. We see the one-year mortgage rate going down to 7.5%, the five-year -- still a little slow in improving -- down to 9.5% by mid-year. It could get to 9% if we see the Canadian dollar settle down and we continue to have that very good inflation performance.

Chart 23 shows some of the issues involved in the Canadian dollar. We have seen the sell-off in the Canadian dollar recently. We think it is overvalued relative to its long-run trend, but to be honest, that can happen for extended periods of time. It has happened across other countries for extended periods of time. It has happened across our own country for extended periods of time. If you look at 1985 to 1987, the Canadian dollar was significantly undervalued for an extended period of time, so this is the long-run guide.

What about the long-run factors, though? How are they going to affect the movement of the Canadian dollar? What we see is that if we get a better inflation performance -- and we think Canada will end up being a percentage point better than the United States in terms of inflation and essentially that will mean a narrowing of the interest differentials to zero -- that will allow the underlying competitive value of the dollar -- the level at which we can compete on an equal footing with the United States -- to move up from 80 cents now to 90 cents by the middle part of the decade.

Clearly there is hope that the Canadian dollar, at current levels, can be more competitive. We think a combination of things will happen: The Canadian dollar will stay relatively weak compared to recently -- it stands right now at about 85.5 cents -- and slowly we will get the underlying improvement in the cost structure that will make our businesses more competitive.

The second line, PPP2 on the bottom here, shows what happens if we fall off the wagon and go back to the same inflation performance against the United States we have had in the last decade. That is essentially about 0.5 percentage points worse. If that is the case, then the Canadian dollar can be expected to tumble quite dramatically. That is something to keep an eye on in the future. Once again, our best guess is that the Canadian dollar will stick very close to these levels throughout the next couple of years.

Chart 24 shows our path for growth in the Canadian economy and the United States economy: very weak in the first half, picking up in the second half. Annual growth for Canada this year is 2%, but that masks a pretty good improvement in the second half of the year where we get growth rates in the 3.5% to 4% range -- end growth of 3.8% to 4% in 1993.

The United States follows a similar pattern. We have seen growth estimates from the White House this week that suggest maybe our forecast for the United States is a little more robust then theirs. Once again in the United States we still see a very slow recovery. The White House does not look for it to improve very much. However, the good news is that yesterday Chairman Greenspan of the Federal Reserve is a bit more optimistic on the prospects of growth in the second half of this year.

What about our medium-term outlook? I will just talk very briefly on this, charts 25 and beyond. Assuming a number of things -- preservation of national unity, full implementation of the free trade agreement, continued reduction of debts and deficits -- we could expect to see that Canada, on average, will begin to grow in the 3%-per-year range, inflation in the 2% to 2.5% range. We have 2.6% on our forecast, with unemployment down to 7.2% and interest rates quite low compared to historical averages.

What does this mean for Ontario? We expect Ontario will have a very weak year this year compared to what we saw in the middle 1980s. We are seeing 1.7% in 1992. This is a bit weaker than the consensus, I believe. It will bounce back in 1993 to 3.8%. Charts 27 and 28 show a comparison of our own forecast against those of Treasury and Economics. Real growth domestic product this year: We plug it at 1.7%, they are looking at 2.2%. The inflation picture is much the same. We are looking for a little stronger employment growth, but to be honest I think that is a little optimistic at the moment. We are also looking for a little stronger labour force growth, so essentially our unemployment rate is very much the same as that of Treasury and Economics.

For 1993 we think 4.8% plugged by Treasury and Economics is a little optimistic as well. We are looking for 3.8%, which is still a very good growth rate. Inflation in both cases is expected to be very low. Employment: Once again we think Treasury and Economics is little bit on the optimistic side. One of the reasons is that the structural factors I talked about earlier are still very much in play and will prevent the typical cyclical rebound. So we are a little bit on the pessimistic side, if you like.

Charts 29 and 30 tell the story of what is happening in terms of Ontario's budget surplus and deficit. I will not go through these in detail; I am sure you know the story quite intimately. The point in terms of the budget deficit: We think it is too high. More so than the current year, we think a path has to be set towards getting it down towards a balanced situation in the out years. I think that would go a long way to helping ease some fears in financial markets and the business community -- not the current-year deficit, but that the path towards a lower deficit is in place.

The $14.3 billion came as a shock, I think, to a lot of people. Clearly the financial markets are concerned and it was reflected, of course, in what we saw in the Standard and Poor's credit watch announcement.


Chart 30 shows why we have been there. That is the story in revenue and expenditures. The dropoff we saw in revenues: Treasury and Economics tells us this is the first time it has happened since 1945. A consecutive drop again this year, which they are projecting is an historical first for the province, not one that, I think, they would like to point to with any kind of pride. That drop made it very difficult for the current administration to try and put through the policies it wants, but you have to look at it in context as well. Through the 1980s we had 11% annual revenue growth in this province and that is unheard of. If you compare that with any other jurisdiction, I think you would have a hard time trying to get anything comparable.

We are in a very tough position right now and it really ties our hands in terms of trying to put through any countercyclical policies. We do not want to be in that position the next time this happens, and it will happen again some time.

Charts 31 and 32 tell us about the dangers, of course, if you do this. This shows the debt burden per capita. For somebody living in Ontario the federal government in years past has saddled Ontario individuals with a debt of roughly $15,500 per capita. Ontario's portion of that debt has risen to about $5,000 per capita. People are more forward-looking, perhaps, than we give them credit for. They realize that the debt burden is future tax liabilities, and I think that is one of the reasons we are not seeing the consumer come back as sharply as we could anticipate in this state of the business cycle.

Charts 32 and 33 show what has happened in a competitive sense in terms of tax revenue and expenditures between Canada and the US. This is total government taxes and revenues relative to the size of the national economy. Canada and the US were roughly similar in 1965. A large gap has opened up between Canada and the US. In and of itself that need not be bad if it goes towards very efficient programs put forward by the government sector. If it goes through in building the infrastructure, that is a higher tax rate or tax level; it means nothing if it is done efficiently.

Chart 33, though, shows the problems of having big debts. It has not gone to general spending; it has not gone to social development; it has not gone to business development. The single biggest component and one that totally accounts for that rise in tax revenue has been interest costs on the debt. Clearly this is an old story, but you end up falling into a debt trap where you cannot put forward the programs you want in the future if you are paying for debts put forward in the past.

Chart 34 shows the federal government learned that lesson at a big expense through the 1970s and early 1980s and it is paying for it now. Ontario, on the other hand, because of very strong revenue growth, did not have to deal with that. They will have to deal with it in the future. Other provinces have seen their debt charges relative to revenues rise.

We are getting towards the end right now. What does that mean? In terms of the risk to the forecast -- charts 35 and 36 -- the pace of the recovery is the single most important factor for Ontario right now. Budgetary actions should be directed to keep a good eye on what is happening in investment in the province and what can be done to encourage it. Inflation momentum is down and will remain down. We have a lot of slack in the economy.

Political factors are a consideration. Once again, the constitutional issue, which we have not delved into, is a big question mark. Clearly you can make a very good case that it is having a depressing impact on investment currently.

There are financial strains in the business sector, in government and the banking sector as well. In the US, what we have seen -- of course our interest rates are very closely linked to the US. The Federal Deposit Insurance Corp in the US expects four bank failures a week this year. That is the government institution. Outside estimators suggest it may be as high as eight banks per week this year.

Clearly the banking problem in the US has not gone away and could lead to a restriction in credit down there still, something that once again the President addressed in his State of the Union address, that may retard growth in the recovery period. So it is a question mark to keep an eye on as well.

In summary, we see a sluggish recovery, but a recovery for Ontario and Canada. Ontario comes out weaker than in 1983. I do not know if it is poised for as strong a growth as we saw in 1985 or the middle and part of the 1980s, anyway, in Ontario. In part because the US is coming out of it slowly, the rest of the industrialized countries are coming out of it slowly. Interest rates are down, but interest rates in and of themselves will not pull us out of this, and there is a lot of uncertainty out there. We are seeing that right now with volatility in the Canadian dollar over the last few days and volatility in interest rates. Those, once again, affect the investment decision.

As a final note, I have attached in the back a very detailed outlook from our group in Montreal that puts together the provincial outlook on what is going to happen for specific indicators in Ontario. You can read that at your leisure. There is also a table of key economic indicators from 1984 to 1993 in Ontario and Canada. Finally, on the last page we see the world: interest rates and exchange rates for Germany, Japan, the United Kingdom and a detailed expenditure side forecast for the US and Canada.

I talked for longer than I said I would, but I will turn it over now, if you like, for questions.

The Vice-Chair: We will start with the opposition party. Mr Phillips, you have approximately six minutes altogether.

Mr Phillips: Frankly, you are more pessimistic than the other people we have seen, although kind of in line with the treasury at 1.7%. If I could comment on your employment figures back in 1982, I sense we are in a different kind of recession and that plotting the curves is not going to give us the future.

I am concerned about what fundamentals will pull us out of this thing. You touched on that a little bit in your document, but there are certain things I think we can do, like wage restraints and getting our wages more in line with other nations. There are other things we are going to have difficulty dealing with, perhaps, such as the debt servicing costs.

My question to you in the banking business: Are you seeing any movement towards investment outside the country by people who do business with you? The numbers you have shown us here today in terms of investment are a little different than we have heard from the Premier. The Premier said Ontario's investment is going up and that Ontario is doing better than it has ever done as a proportion of the investment. Those are my two questions for you: Have you any sense, in real terms, of whether investment is leaving Ontario and Canada? Second, what numbers can you give us that would be helpful in determining what investment is going on right now in Ontario?

Mr Chandler: In terms of the first question, what have we heard from our clients and our customers, we have had a lot of talks about them. A lot of them are potentially moving; a lot of them have moved. Where we see it most is the very mobile individuals. To be honest, we have heard from some people in our private banking group of high-wealth individuals who are very worried about the situation in Ontario, have been in Ontario for a long time and are considering moving or have moved. We are hearing a lot of that.

On a very personal and anecdotal basis, I see a lot of young families in the same position. This is not tax policy or economic policy, but there is the quality-of-life argument. One person in our own office is moving out to Saskatchewan. It is a big jump, I guess, from Toronto to Saskatchewan, but once again it is quality-of-life argument: the time it takes to commute, tax burdens and what is available for children growing up in that region.

So, yes, we have heard it on a very anecdotal basis. There are very few good indicators, even for the nation as a whole, in terms of current investment. Statscan does not do a very good job because it is tough getting current investment levels, so it does a once-a-year survey. That survey was not very appealing for Ontario.


Other informal surveys ask, if you look at large company surveys, "Are you thinking, in the next five years, of adding things?" Those are, once again, quite negative. Some of those are in my document.

In the past Ontario has done very well. We have seen it in the mid-1980s with a lot of the car companies putting a lot of money into the Ontario economy for investment, but if you look at what is coming out of the car companies now, they clearly are not as keen to see that same kind of investment proceed in the future. So I have a lot of concerns both on the personal side, in terms of what is happening and the people who are questioning whether it is worth their moving or not, and on the business side. What are we seeing in aggregate investment numbers? Everything I have seen suggests there are some problems out there.

Mrs Sullivan: Do I have any time?

The Vice-Chair: About two or three minutes.

Mr Phillips: Go ahead, Barb. I have one quick one just on where you see the job growth coming, because you are projecting, I guess, an increase of about 65,000 in the number of jobs in the province. In what sectors do you see that?

Mr Chandler: We will see an improvement in the cyclical sectors, so I think there is a chance that you could see manufacturing come back from very low levels. I think there is also a chance that you could see it in some of the finance sectors, although I have put a question mark beside that. I know we are not looking aggressively.

Mr Phillips: Sorry, I wanted Barbara to put a question in here. Thank you.

Mrs Sullivan: Actually, my question follows from those presented by Mr Phillips. We too are very concerned about the confidence in the economy. That is affecting capital investment choices in a highly global market and we see that as a necessity, in fact, in the future for job creation. I wonder what incentives you see as likely to overcome some of the negative factors that might be appropriate for government initiatives.

Mr Chandler: I think one of the first things that always tends to go up is what is going to happen in the labour legislation policy in Ontario. That shows from that survey, but other surveys have shown that same type of thing. People do not mind. A lot of businesses have invested in here knowing it is a fairly high-wage area. They might be disappointed in the trends over the last couple of years. This morning we saw the employment-in-hours figures and they showed that in industrial aggregate jobs, November over November for Ontario, we lost 8.9% of the jobs, and yet our average weekly earnings went up at 5.8%. Those who have jobs are doing okay; for those who do not, there is not much investment giving much hope.

What can you do? Certainly I think we should take the initiative in the public sector that wage restraint is the order of the day. We had a very sharp increase in public sector employment and wage growth in the last several years. We have seen some paring in the private sector and, to be honest, I do not think we have seen it to the same degree in the public sector. So I think that is also another area for initiative.

Keep an eye on what businesses are telling you when you survey them, because if I could add up eight tax rates here and nine tax rates in this state and 11 tax rates in this province and say, "Look, you are better off," but they say, "I don't feel better off," that is the important thing when they invest. So talk to them: "Why don't you feel better off?"

Mr Carr: I was very interested in chart 34, "Government Debt Charges." In your last line you said, "Ontario is in danger of falling into this same trap." I think we have. When you look at the Treasurer's own document on page 14, $4.9 billion was what we do in public debt interest, and his projection, with no change, goes to $6.1 billion. The $4.9 billion is historically very high.

You say at chart 29 that you do not believe government spending is a viable option, although you may have heard the Treasurer today, who is going to speak with the Minister of Finance, saying that is what they should be doing. In all fairness, he is not saying he is going to do it; he is asking somebody else to do it. It is easier to ask somebody else to do it. My question to you is this: Knowing the situation the way it is now, knowing what he thinks, do you think he should run up the deficit in terms of government spending to try and stimulate the economy?

Mr Chandler: I do not think $14.3 billion is right. Personally, I think he went about it the wrong way in the last budget. I think money has to be available for job retraining. Making the decisions to fall on the part of the school boards and the hospital administrations and so on, cutting them back to 1% growth when there is 9.9% in total for the province, I do not think is setting a good leadership example.

But I think where it had to come was in the government employment sector, the 90,000 jobs or so that are strictly Ontario civil service. When times were good, there was a lot of increase in that sector and a lot of bidding with the private sector to fill those jobs. The private sector is hurting a lot. People have lost their jobs, there are risk and return tradeoffs. I do not think the wage structure in the public sector really adequately reflected the risk and return tradeoffs. They are fairly safe jobs, and with that security should come a little bit lower wages. Anyway, I think that is something they could have done.

So what should he do at this stage? I would have liked to see a freeze, point-blank, in terms of the employment part, the wage-salary part of running each ministry.

Mr Carr: Just to go further, as you know, about a year or so ago we talked about doing that, putting a cap on the civil service. They said you could not do it on the backs of the civil servants, and of course a year later they did it anyway. All that happened was that we lost $1 billion, which is what it would have cost. That is $1 billion, with a "b."

Because they have limited the transfer payments to school boards to 1%, for example, what happens is the school boards have already negotiated contracts of 5.6% or 5.8%, depending on the municipality and so on. What we are calling for is saying, "Okay, we only gave you 1%; therefore let's have a provincial wage mandate saying the teachers will only get 1% this year," again falling in line with what you say. Would you advocate that for the government?

Mr Chandler: It sounds reasonable to me. You have to look at all the details, but I think that is the correct direction to go. You are really putting the school boards in a tough situation there. I think this kind of idea about wage restraints has to be shown to be coming across the whole province. You have to be honest. I have heard this figure at second hand, but we pay our teachers in terms that they have a better standard of living than anywhere else in the world, and I am not sure the pupils we put out or the quality of the education we get is the best in the world if you look at objective measures.

So it is not just teachers and I am not picking on them, but I think you have to see some kind of reality set in, in terms of wage structures. A high school principal makes $90,000 a year. That is if you look at the contract settlements and Ontario wage settlements. Maybe that is what the marketplace deems, but I do not know if the marketplace is acting correctly.

Mr Carr: I agree.

Mr B. Ward: Your projections are way off compared to what we heard yesterday from other banking institutions and economists. I guess, in the words of Mr Phillips, we will not know who is right until next year, when we see whether the projections are accurate or not. Somehow I think we may fall somewhere in the middle of what we heard yesterday and what we are hearing from you today.

At chart 29 you mention that Ontario is particularly hamstrung because of the shortfall, ie, deficit. Of course you are aware from reading the Treasurer's document that this number is unacceptable and will be coming down. But it seems that when we look to America we see tremendous debt, tremendous potential for failures in the banking system. I believe their debt is at a postwar high as a percentage of their gross domestic product, and yet it seems economists on both sides of the border applauded Bush's initiatives in trying to stimulate their economy. Some said he did not go far enough, but generally it was felt that there was room for movement in America from a fiscal standpoint. Yet our national debt and deficits and our provincial deficit, in your opinion, do not allow any room for movement. So in your opinion, why is there room for movement in America?

Mr Chandler: I will tell you what the difference is. The difference is, we have spent more in the past. If you look at public debt relative to gross domestic product and if you look at just the federal government sector in the United States, it is about 60%. In Canada it is about 60%. If you add in state and local in the United States, it is still 60%. State and local governments do not run big debts in the United States. In Canada, if you add in all the debt by provinces and local, you have 80% of GDP. The difference between how we fare compared to the United States with regard to our debt level relative to the size of our economy is that we are worse by about 20%. That is the accumulated deficit outside the federal government sector. So I would make the point that we are more hamstrung than they are.


The budget deficit this year for the United States is at a postwar high of around 6% of its GDP. Ours will be about 6%.

Mr B. Ward: That is not what I read.

Mr Chandler: If you take $31.5 billion at the federal level and $14.3 billion --

Mr B. Ward: Which is not what it is.

Mr Chandler: No, we do not think we will get to $14.3 billion, but let's say that was what we ended up with. Then if you look at Ontario, the deficit this year would be 9.7% of GDP. Clearly, by any kind of arbitrary measure like that, we have expanded a lot. We are having fiscal stimulus. We have done more in the past, which makes it hard to do more in the future because of the amount of money we are paying out in terms of debt payments relative to revenues.

Mr Jamison: My question is one that deals with deficits also and projections. This whole session is set up basically so the Treasurer and Minister of Economics can have some further input from other organizations as to which direction the economy will go.

I was here last year and every banker and economic adviser we talked to was simply wrong in his estimation on the duration of the recession and how we would come out of it. Having said that -- I asked this question yesterday and made some comments -- the governor of New York state has just indicated that its operating deficit this year will be $6 billion. That is a state everyone seems to be moving to to do business as far as some people are concerned, and they do not have the social infrastructure and so forth. Your projections are different than others, but you are saying basically the same thing, that we are going to come out of it. What makes you more certain this year than you were last year?

Mr Chandler: I will tell you what we did last year. We had negative growth. We thought we would see negative growth this year, negative 0.6% or 0.8% or something. Can I be more sure this year? No. Will we be wrong? Yes, you can guarantee that we will be wrong because of the state of forecasting. Will we be more wrong than anybody else over any extended period of time? No. This is an exercise in forecasting. For year-to-year GDP or year-to-year employment, a consensus forecast works just as well. But that is not the point. Really we should be looking at what are the appropriate policies for the next five years, not just, "next year, is it going to be 0.2% or 0.3%?" I think that is what we should be targeting for. We think it is going to be weak. If we are wrong and we get surprised, I will not be upset.

The Vice-Chair: We have to cut it off there. I guess in some respects we only hope economists in general have more credibility than some elected officials when it comes to issues.

We want to thank you very much for coming in today. We appreciate your presentation and the detail which has gone into it. I hope the members of this committee get a better sense of some of the analysis that is coming from different directions for the upcoming year in the economy.


The Vice-Chair: The next presentation will be from Leo de Bever from Nomura Research Institute, Nomura Canada Inc. Welcome back to the committee. Again, we will have roughly an hour for the overall presentation, but we would appreciate it if you would leave some of that time for members to ask questions. I believe the clerk is handing out your written presentation, so if you would like to begin.

Mr de Bever: Just by way of background, the front part of this presentation is something I have taken over the last six weeks to investors in Canadian and provincial government bonds in about 13 countries to try to explain to them what is going on. The back part is more particular to the questions at hand. I do not propose to take you through everything in detail, but I think we should look at some pictures and get an overall feel for what is happening.

You mentioned that a lot of economists were not terribly on target on what was happening in Ontario in 1991. I think that reflects in part the professional hazards we face. When you make these forecasts, you do not even know where you are because you do not really know what the recent history was with any degree of accuracy. That may sound like an excuse, but it is a serious problem.

Last year when the budget was put together and when we were putting together our forecast for Ontario, we were working with indicators that showed a considerably more robust Ontario economy than in retrospect it was. Be that as it may, the Canadian economy went through a really bad spot last year, and the Ontario economy by comparison was even worse.

I think there is going to be some light at the end of the tunnel. If you look at the recession in terms of economic growth, on the first page you see a graph that compares this recession with the last one. What is obvious is that last time the decline was much steeper into the trough of the recession and the recovery was much steeper as well. What we see this time around is a very shallow decline and a very weak recovery. That is one crucial difference.

On page 2, I have a graph that shows gross domestic product growth for Canada and the province. Again, it indicates that Ontario tends to be a more cyclical province. When Canada is doing well, Ontario does relatively better; when Canada is doing poorly, it is largely because Ontario is doing relatively poorly.

Given that it seems the decline in interest rates we have seen in the last 18 months is going to have its effect in 1992, because that is usually how long it takes for these things to work, and because 1991 was a year of restructuring for a lot corporations, we are relatively positive on 1992 for Ontario. We think it will be slightly better than the country as a whole.

On page 3 you see some of the differences of this recession compared to the last one. You can see the very dramatic decline in profitability relative to GDP. You can see that profits bottomed out in the first quarter of 1991 and are ever-so-slightly inching up, largely as a result of cost-cutting.

The graph at the bottom of that page is more disconcerting. It shows what happens over time to the proportion of employment in manufacturing. I will come back to that later on.

The next page shows what has been happening to wages. I do not think employees feel particularly prosperous, but as a proportion of GDP they have been increasing their share, largely because everybody else has been doing so much more poorly. One point I am going to be hitting on is that this very cyclical movement of income share and the employment declines that go along with that are something we should be concerned about and perhaps should be the focus of policy action.


In terms of looking at the details of how we see the economy recovering, on page 5 I list the components. If in the 1980s the problem was that we spent too much, in the 1990s we are going to see that consumption is not going to be a big component of recovery. Residential construction in 1992 will be. We have already seen a recovery in housing starts, which virtually guarantees that construction will do relatively well throughout the year.

I also see a relatively bright outlook for investment in machinery and equipment, simply because once you have decided you are going to stick it out in Ontario, you had better invest to the hilt to try to keep the wolves at bay. The rest of the world is not sitting still and it looks like we may have been doing that for the last five years.

Non-residential construction, office buildings, commercial and retail outlets: Forget it. It is going to be a disaster area. There is excess capacity. We built too much and there is not going to be much recovery there.

Government nationally will see some expansion; very little, but there will be some.

I do not expect much in the way of export improvement, but there will be some relief in the sense that prices for export goods should recover proportionally more than volumes.

The disconcerting pictures at the bottom of page 6 again emphasize the difference between Canada and the United States in the behaviour of labour markets over the cycle. As you can see, we have a tendency to have unemployment rates stay up higher for longer periods of time and we have a tendency to have on average much higher rates of unemployment. Both factors have something to do with the way we run some of our social programs and the way the bargaining process seems to work in Canada as opposed to the United States.

On page 7 I start with financial market conditions. The really good news for this year will be that inflation will probably be a lot lower than most economists were expecting even a few months ago. Because of some restructuring that is taking place in areas like the retail sector and because of the generally weak state of the economy, inflation will likely fall under 2% for the first half of 1992 and only recover slightly after that. The main factor, of course, is that the contribution of inflation made by indirect taxes will diminish now that the GST has been in effect for a year.

On page 8 I indicate my outlook for interest rates. Interest rates are expected generally in North America to bottom out some time this year and that is what is reflected in this forecast, both for Canada and the United States. I have a sneaking suspicion we may have some good news coming there because I believe that particularly long-term interest rates are higher than they should be relative to the amount of inflation I envision happening.

I will not get into the constitutional thing. That was there for the benefit of my foreign audience. I think we have all exhausted that topic. In terms of the outlook for Ontario specifically, on page 10 I see a 3% growth for gross domestic product, accelerating to 4% or 4.5% by 1993, relatively strong housing starts, low inflation and a fairly high unemployment rate, for some of the reasons mentioned earlier. What I would like to focus on is why some of these things are happening. When I started working for Nomura I never realized one of the side-effects would be that I would be able to analyse some of the views I have had on this topic for quite some time. I get this feeling from most people who spend time out of the country: When you look at Canada from the outside you quickly realize that although we may be one of the largest countries in terms of size, from the outside we barely register unless we pull together as one nation and speak with one voice. More often than not, that is not the case. That is the reason I really feel constitutional talks are important, because I think these overriding, larger realities are what are going to drive some of the dynamics of our economy.

We are only one half of 1% of the world population, but we are better off than 80% right now, which makes us an enviable target. Most people would more than love to trade places with us. But we waste an awful lot of resources, in fact more than most people can ever hope to consume. As I told you last time, that is one of the reasons I find it ethically wrong that we, with this abundance of resources and high standard of living, borrow to consume even more.

Let us analyse what got us in the current position. We have a great abundance of resources and we have a lot of land. We were able to attract a lot of people to come to Canada after the Second World War. As a result, we grew very strongly in the 1950s, 1960s and 1970s. In the 1980s we sort of got stuck and we coasted along by spending more than we produced and borrowed the rest.

When you go outside you get a much more dramatic impression than from the inside that the world has been catching up with us and that communication and transportation have made it much easier to reach our markets. Industry by industry we are starting to feel competition, to the point where we are now losing jobs in the areas where we originally achieved our standard of living. I think we have reached a stage where we feel threatened by the outside. The outside is entitled to its success, by our own standards of measurement, but it does not mean that we should not try to figure out what is wrong and try to do something about it.

We all seem to blame the same icons: GST, free trade, John Crow and Brian Mulroney. I do not think any of these factors are terribly important in the big scheme of things. Maybe they have some importance, but they are not the real problem. I think the problem is all of us collectively as workers, managers, politicians, consumers and students have not done the things that are needed to make a stronger economy. I would not call us lazy, but we certainly have been taking it easy.

I think one response to that can be that you build a fence around the country and try to keep out foreign influences and save jobs by not buying foreign products. In a few cases some of that protectionist sentiment might make sense, but in a lot of cases it does not. Even with the best policies in the world, I think we are going to lose certain sectors, particularly in manufacturing. Because this is important, I will take you through it.

Look at page 12. The top two graphs show that from an employment perspective this recession is about as bad as the last one in terms of job losses. The bottom one on the left shows that there is a pattern to the kind of proportional job losses in manufacturing. During recoveries the manufacturing sector holds its own because everybody is making money and even manufacturing does not have too much of a problem. The problem occurs at the tail end of the business cycle when profits get squeezed and the only way out is for people to lose their jobs, and those jobs are not coming back.

Why is that? It is not just a Canadian thing. On the bottom right, you see that the same thing is happening in the United States. I could show you graphs for the United Kingdom, Germany or any number of other countries where the same thing is true. The reason that is true is on the next page. If you assume for the sake of argument the economy is growing on average by 3%, then you find that on average the demand for goods and services is roughly growing at the same rate of 3%. Productivity in manufacturing is around 3% or better; productivity in service is 1% or less. So when you do the calculation of what you need to produce the kind of demand you are generating, you come up with the conclusion that employment in manufacturing will grow on average not at all and employment in services will grow about 2%.

I made a statement like this 10 years ago, saying that by 1991 there would not be any more Canadian manufacturing jobs than there were in 1981, and everybody took shots at me. I am making that prediction again for the year 2000 because I think it is just inevitable. I am not saying that you should not try to generate more jobs in manufacturing; what I am saying is you have to be realistic about what you can achieve and you have to pick and choose what you are going to defend.

The one thing that was really driven home to me over the last few weeks when I spent time in the Far East is how other countries have recognized the problem much more clearly than we have. I went out there to try to explain what Canada was all about. I do know whether I helped them, but they certainly helped me understand some of our problems.

I was in Europe just before the end of the year, at the time when they were having their big summit on union. It was amazing to watch, particularly given that I grew up there in the 1960s when this whole issue was sort of dead, to see how they were groping for union, common market clearance and more efficiency. That was one way of doing it. If you think we have a third option to cosy up to the Europeans instead of the Americans, forget it; they do not have the time of day for us.

Then early in the year I went to the Far East. I went to six or seven countries that are somewhat less in terms of standard of living than we are now, but they are making tremendous strides. The one that struck me, by example, is Taiwan. They had been growing at close to double-digit rates for the last 10 years. Their productivity has improved. Their standard of living has improved. As a result, their currency has strengthened. Their response has been very pragmatic. Their response has been that they feel they have to learn to adjust to change, that they have to keep on shifting people from one industry to another to stay competitive. Now they are in a position where they can do things like buy out 40% of McDonnell Douglas to get to the top of the technology heap.


Two things stick in my mind as common denominators of all those countries: They have far more discipline to achieve a common goal, and they are willing to enlist both savings and education in the process of achieving that goal. The positive historical correlation between savings and growth is an old one. It is not news. The emphasis on education is one that we purport to share. The first budget this government announced was big on how to create human capital, but as I indicated to you last time there is not really a clear understanding on how we are going to achieve that, other than to say we are going to spend X amount of dollars.

Most aging governments make no bones about the fact that their only resource is people. Their first goal is, as I put it, to teach people how to learn, because they have gone from intellectually realizing that multiple career changes will be common to planning for it. I think that is where we, in education, should put our emphasis.

Turning to fiscal and labour policy. I heard the tail end of discussions that went on and unfortunately I am hearing many of the same things. The recent Fiscal Outlook was not very well received, and I know what the Treasurer said, I know what the Premier said -- that $14.3 billion is not what you are shooting for. But that is the only number that hit the headlines and that is what hit you in the financial markets. So I think at the very minimum you have a marketing problem.

The additional problem I see is that there have been a lot of articles recently in the foreign press that have not only been critical of the deficit but have also highlighted what are conceived to be hostile attitudes towards business and inflexibility in labour relations. Again the government may not agree with that characterization but that is the image being projected and I think that is where you are going to have to start if you want to change the minds of foreign investors.

A lot of these articles miss the point in that they do not focus on what has been happening in 1991 to improve the situation. In particular in the labour area I urge you to take another look at the proposals you have there, because I really believe they are not going to improve things; they are going to make it worse.

The proposed amendments to the labour laws seek to protect workers against what they implicitly call abuse by employers, but the proposals themselves go far beyond that. I think they continue to view the economy too much as a battleground between employers and workers and they focus on making it harder to shut plants down, but they do not make it any more attractive to keep them open.

I have read a lot of reports that the government is surprised it was able to place as much debt as it did following the last budget. It is true that at the right price I think Japanese and Far East and European investors will continue to buy your bonds, but the price will get higher the more often you come to market. The next test will be when Ontario floats a new issue. My guess is that, again, you are going to see your spread, relative to Canada's, increase.

There was also some notion that the drop in interest rates has given the province some options to spend more money because it is cheaper to finance it. Please remember that inflation is likely to be a lot lower in the future than it has been in the recent past and that real interest rates have not fallen to any extent yet. Lower inflation not only reduces interest rates; it also reduces the growth of revenue so that the real cost of debt service has not really diminished all that much, and that is ultimately all that counts.

Some have suggested that Ontario really has no debt because our assets are bigger than our liabilities and that securities companies would be more than willing to get paid for the privilege of selling your bonds. I work for a company like that. Yes, we are more than willing to sell your bonds, but we do not think it is particularly smart to float as many of them as you have been.

As we have found at the federal level, the higher your debt level rises, the more you become constrained by the need to take into consideration the wishes and concerns of the people who are buying your bonds. As long as you keep an AA rating, you are not going to be in too much trouble, but once you reach below that, you are going to find that many portfolios will not be able to hold Ontario bonds because of credit quality restrictions.

You are looking for budget suggestions. Frankly, I think your ability to affect the near-term recovery of Ontario is limited and that is something that, in a way, is a problem that politicians and economists have created for themselves. I really think that when push comes to shove, the government can set the stage for changes in the economy, but it cannot really determine the rate of growth to any considerable extent. It has to come from individuals, from people, from businesses.

However, if you want to improve both your image and the reality of your fiscal situation, I would encourage you to look at the possibility of extending the freeze you have announced for next year. The reason I am doing that is that this will probably allow you to get away with some reshuffling of your capital expenditures. It makes a lot of sense, given that the depth of the recession has been most serious than was originally anticipated, to shuffle your capital expenses within the period you have set out. I do not see anything analytically wrong with it. The only problem is that you may have a credibility problem, in that people are not going to trust you to lower your spending when the year is out. So in order to do that, you have to tie yourself to some rules that say: "Look, this is what we're committing to. We're going to lower our spending until our revenues catch up with our operational outlays and in the meantime, wherever practical, we're going to try to advance some capital spending."

Also, given that a lot of the sectors affected are going to be in the education and medical areas, I think you have to look at ways to raise additional revenues that are out of non-tax revenues. I see nothing wrong with raising tuition fees. Internationally speaking, they are very low. If you raise them and at the same time make it easier for people to borrow for their own training and education, I do not think that is internally consistent. The benefits of education accrue to individuals, so they might as well pay a large share of the cost of providing the training.

Point five, improving educational efficiency: The cry you hear from the school boards and universities is: "Look, if you restrict our budget we're going to have to lay off people. We can't provide the services." I am hearing more and more voices from people who are closer to this than I am, saying that there is quite a bit of opportunity to make progress in improving the efficiency of the educational system. My wife is a teacher. I look at it from the outside in. I am a parent. I know what goes on in some of the schools that my kids are part of. From a business perspective, I think school boards and school staff still have a lot to learn in terms of how to manage their affairs efficiently.

The same is true for medical services. I think doctors are not particularly good at running businesses. I know we have hospital administrators and we have people who are skilled in that area, but I think there is a still a lot of headway to be made. There is also the basic observation that if you make something free, people overconsume it. I know that is a touchy area, but we have to find some way to impress some people, that when they consume medical services, it costs. I would be the last one to say that if they need medical services, they should not be able to get it, but I think there is a fine line there. There is a consumption element to some of these services that previously we may not have been willing to acknowledge.

I would also focus on ways to speed up structural change. This runs exactly counter to what has been happening in fact. Most industrial policies run in a rearguard action that tries to slow down the rate of change. Algoma is a case in point. Instead of trying to analyse the problem head on and make some drastic changes and move, we tend to drag it out over a longer period of time. I think that is wrong and in the long run it is not going to help you.

Now for a technical suggestion. I know this business of capital spending and its treatment in the budget is near and dear to the NDP's heart. The first thing any decent analyst does is to change the numbers to something that he is used to looking at, because what you are doing is really quirky and it does not fit in with what the rest of the world does in terms of analysing these things.

One of the features of our economic system is that during the recession people stop spending, not just because they lose their jobs but because they are afraid of losing their job. The way our labour market works tends to encourage that kind of thing.

I think that public policy should, in part, be geared to providing more flexibility to adjust compensation to the state of the business cycle. I am not saying you should cheat workers out of income, but what I am saying is that if I had a choice, if I knew that everybody in this room and everybody in this province would give up 5% of their income, I would be willing to give up 5% of my income to see everybody employed, or at least everybody who by economists' definition is really unemployed. The bottom 4% or 5% is commonly characterized as frictional unemployment. I think this was highlighted again this morning by the numbers that came out on wages. What we have is, people who have jobs have wage increases that are way too high and as a result, given the profit squeeze, you end up with a lot more unemployed than you would if you were able to moderate that rate of increase.

Longer-term, I think our focus should be on the practical aspects of facilitating structural change. It is a very difficult topic, but I think it has to be done. If countries like Taiwan and Hong Kong and Singapore and Malaysia can get it right, we can get it right too. I think the government's goal of creating a higher rate of human capital formation is laudable but you have to have some practical ways of doing it without breaking the bank.

When I appeared last before this committee I pointed out that this government has somewhat different priorities, but I did not believe that the fiscal or other policies it proposed were going to achieve the results it was hoping for. On the whole, I still feel that. I see some change, some more appreciation of certain economic and other realities, and I think that is positive. But I do not see enough of it yet. I realize it is difficult, because a lot of people in this government do not have a financial-economic background. But please seek out advice, not just from people who agree with you and who are mostly in the academic sector, but try to deal with people who have met a payroll, who have run a business and have some economic expertise.


The Vice-Chair: Thank you very much for your presentation. We have roughly about nine minutes per party, so who would like to start?

Mr Sterling: Thank you very much for coming again in front of our committee. I really enjoyed your remarks last year and I must say that I have enjoyed them again this year. I do not find much to argue with. I do not know what political label you wear or whether you wear one, but you probably are close to where I sit on most issues.

Recently we saw President Bush come out, and they are talking about a $400-billion deficit in the United States. We are talking at the federal level of $30 billion to $32 billion and about $10 billion this year here, and it looks like higher next year.

In your travels around the world, how do the other nations deal with their fiscal problems in terms of what seems to be a political will of the people, regardless of the politicians who are in charge? It seems that we have all bought into -- and I am saying this in a corporate sense, regardless of party -- this idea of spending people's money in the future and feeding overconsumerism in a lot of ways by using up services and resources without paying our own way. In other countries, is it a different view of the electorate, or is it a different style of politics? How do they deal with it?

Mr de Bever: In a lot of countries I find that there probably is a lot less individualism and a lot less attention being paid to grass-roots politics. As a result, the ruling élite, whatever it may be, has a better ability to force through things that in a more populist country might be more difficult to achieve. I think the problem really is that most Canadians -- and most Americans, for that matter -- do not really understand fiscal policy. I saw a Gallup poll that says that most Canadians think that businesses make 35 cents on the dollar. I think things are a lot less prosperous than that. So you start from there and then you look at people's perceptions of how many rich people there are to tax in a given country and who the rich are. I find that people's perception of reality and the true reality are very different. So I think the fact that we are a country where we have to get elected to form a government and then have to go out and implement the policies that we just promised is a handicap. The only thing you can do there is train people how to be better economists -- economists in the sense not of forecasting the economy but seeing the dependence between ways and means. That is a really tough problem. I have done my bit to try to do that in various forums, and inevitably you start out and people totally disagree with you. After a while, they start saying, "Maybe there is something here." I think the fraud we have perpetrated is that somehow governments can do things differently than households, that we can spend ourselves into oblivion indefinitely without consequences.

If you go back to Keynes, who started this whole thing, that was not the intent of the exercise. The exercise was that at times government can spend more than it takes in if at other times it spends less than it takes in. The second part has been forgotten. Over the last 30 years we have always been running deficits. Maybe the country is getting ready for that now. People are starting to see that we are coming to the end of the road and that we are becoming more restrictive by what we are doing.

I go back to 1981 again, when the Ontario government organized a conference that said, "Do deficits matter?" One study by the Institute for Policy Analysis showed that you could finance large deficits way into the year 2010 and the debt-to-GDP ratio kept on going up and somehow you could pay the interest on that stuff.

My question was, and I was asked to review that: Do you really want to do that? What do you think is going to happen when you have all that debt? Do you not think the people who hold the bonds are going to call the tune as to what you can do? I think that is where I have my opposition and we are getting to the point where we can get a hearing with the population for that notion.

Mr Sterling: You are very much experienced in the bond market, and Nomura, I think, is the largest investment business in the world in terms of the amount of money that you control.

One thing I do not understand is that as the Ontario government, Ontario Hydro, goes out for more and more money, how well known is it that its demand in the bond market is increasing rapidly? Does that make a great deal of difference? Does it make a great deal of difference when they go from $100 million to $1 billion, or is it from $1 billion to $10 billion? How do you measure that in the bond market?

Mr de Bever: This is the way portfolio management works. In a foreign country they have a certain allocation they can give to foreign bonds -- for the sake of argument, say 10% or 15%. Within that foreign allocation Canada usually has a very disproportionate share because we have very high interest rates. Within that share, credit quality matters a lot. What happens is that you can load up on a bond for a while because the proportion in the portfolio is small, and as long as the credit quality stays high you can extend the holdings on that basis for some period of time.

Then two things happen. As the market calls it, they get tired of hearing the name. Ontario is at that stage. People in the market are getting tired of hearing the Ontario name, meaning that you are coming to market too often. The Kingdom of Denmark did that a few years ago and for a while they were sort of the pariah of the bond business. We have the additional problem that we are getting downgraded and as a result some portfolios will say: "This credit quality is no longer sufficient. Sell." Selling pressure means that your spreads relative to, say, Canada's go up. Those are the mechanics. In terms of people realizing what is going on, in countries like Japan they are very well informed, in Britain in particular they are very well informed, in Germany they are, and less so, for some reason, in France, I found. In the smaller Asian countries Hong Kong and Taiwan are very well informed because of the immigration ties with Canada.

You do not get much grace. If things turn bad, people catch on real quick. So yes, there is going to be, not a limit to what you can sell -- at some price people will buy your bonds -- but the price is going to be very high.

Mr Carr: I am very impressed with that. I would like to send a copy of the Hansard to both the Premier and the Treasurer. I take it that because you are on public record, you would be in favour of that. Have you ever met privately either with the Treasurer or the Premier to discuss these issues? They do not seem to be listening to us. What you are saying I think is bang on. Have you ever had a chance to speak with them?

Mr de Bever: No, I have never had the opportunity. I have dealt with various civil servants and I have testified before the Ontario Energy Board, but that is about as far as it goes.

Mr Carr: Thank you.

Mr Jamison: You talked about the Far Eastern countries really concentrating on their people and so on. I think that is a very interesting point. The training, retooling, reskilling of the workforce is very important.

You also mentioned the infrastructure, that the capital spending end of things is something that you are concerned about. With Ontario being positioned where it is geographically, within the range of the brunt of the United States market, what do you see happening if in fact capital spending is not kept up to a pace where our roads and our schools and our hospitals are kept intact at least?


Mr de Bever: You are going to face the same problems the American states are facing as well. Their infrastructure is falling apart. I am not advocating that we abandon the infrastructure investment. What I am saying implicitly and explicitly is that we need to maintain a reasonable level of infrastructure investment, but we need even more other investment; 75% of all investment is replacement investment in the private sector. If you start losing the will of companies like General Motors and Ford to invest in Ontario, you can have all the infrastructure in the world and it is not going to help you. That is what I am concerned about.

Your point earlier about the US being in trouble is a correct one, a valid one. The contrast between Canada and the United States is that I think a lot of the states undertax for the services they provide and that is why they are getting into trouble as well. That does not offer any excuse. It just says that Canada and the United States share many of the same problems. It does not say to everyone else that they are doing terribly well.

Mr Jamison: It is interesting that you should say that. On one of the Buffalo stations last night the results of a survey of business people in New York state was presented; 72% are thinking of relocating elsewhere.

Mr de Bever: I have seen similar studies for the US.

Mr Jamison: Again, the problems we see in the industrialized world are relative to each other. I guess the point is that there are new directions that are needed, that we are seeing a structural change here.

Mr de Bever: Structural change has been with us for 20 years. It is unfortunate that our collective memory is so short. As I showed you in the numbers, 1982 was as bad from an employment point of view as 1990. We put different labels on it but in actual fact the reality is not that different. It may be caused by developments in different industries this time, but the aggregate impact is the same. You are getting productivity growth not just here but elsewhere. You are getting competitive pressures and you have to respond to it. Our response so far I think is relatively inadequate. The fact that the Americans are not doing any better in many ways does not really help our people very much.

Mr Jamison: I understand that. The other point you made, and I think you are very correct in your thinking, is that in the manufacturing sector the numbers of jobs really will not increase. I tend to agree with you for a number of reasons: technologies, the combination of skills that are taking place in each workforce to make that competitive approach to the globalization of production and markets. Certainly if that were not to happen I would think that the average wage would be forced down, because the unemployment numbers do relate to that.

I just want to make the comment that I believe you are right on. It has been proven so far to be and I can tell you that this is happening. Most large manufacturers and industries are heading that way. The technology has to be introduced, and along with that technology a combination of skills and things of that nature is taking place right within those manufacturers. I see no change in that, again.

Mr B. Ward: Thank you for your presentation. Your wages as compared to GDP apparently projected to a peak -- or I guess now it looks like you are projecting a lower -- do you foresee that trend to be coming down in 1993 and 1994 as GDP growth occurs?

Mr de Bever: It will have to. Just on that point, let me make a point that always frustrates me. Take the auto industry in the 1950s, 1960s and 1970s. We had some industries which were state of the art, top of the world. There was no competition, and relative to the economy as a whole they saw their wages increase and they assumed that this was the standard that from then on would be prevailing. Unfortunately those days are over and I think that in a lot of sectors we are going to have to accept it, and "good" jobs are not going to be quite as good. In other words, the margin relative to average wages that we built up in some sectors of manufacturing may disappear all or in part because of the levelling of competitiveness worldwide.

Mr B. Ward: That is a strong component of our unit labour cost.

Mr de Bever: It is.

Mr B. Ward: So that would help our productivity, if you are projecting, and I assume you are by the look of the line, that as the years progress, wages as a percentage of GDP will be coming down.

Mr de Bever: It will have to come down to somewhere around 55% or 54% again, I would think.

Mr B. Ward: Would you say that is the median?

Mr de Bever: If you go back to 1947 you will see that it rose very strongly up until about 1982. That is mostly because the economy shifted to a more service-oriented economy. The proportions are not changing as drastically any more, so it would be levelling off in equilibrium, I would think, if there is such a thing, to about 55%.

Mrs Sullivan: I too am impressed with your presentation, not only on this occasion but I was impressed with your presentation to the committee last year at about this time and I concur with your conclusions.

Mr de Bever: Thank you.

Mrs Sullivan: I would like to ask some specific questions relating to your projections for the economic outlook in Ontario.

If I can extrapolate from your Canadian projections, you are looking for moderate change in consumer expenditures, negative change in business investment, no change in inventories, with exports up and imports down, yet I see your GDP growth projection for 1992 for Ontario specifically is 3%.

Where do you see that growth occurring? In which sectors? Other than the change in ideology, I suppose, which we are not going to be able to do an awful lot about, it seems to me, unless there is a resignation that I am not expecting, where do you see the kinds of government actions that could increase the confidence to ensure new business investment and where would that business investment best be placed?

Mr de Bever: First, to answer your question about the sources of growth, as I pointed out Ontario has a lot of very cyclical industries which right now are operating at very low levels of capacity. In areas like autos and steel and construction, even a small bounce from the bottom is going to give you, little by little, enough to give you this 3% that I am forecasting for the first year. That is really the one thing that strikes me about this recovery: that there is no one leading sector.

Last time we had autos just roaring out of the chute and just pulling everybody along. It is not happening this time because the auto industry is a much more competitive industry, although it is one industry where I think with a bit of innovation you could do a lot of things. We talked about Bush trying to sell 20,000 cars in Tokyo. I think that is a dumb idea. If you are going to sell 20,000 cars, you should sell them in North America. There is an easy way of doing that.

If North American producers were able to get together and produce the kind of warranty Nissan is producing, I think it would be easy to sell 20,000 extra cars. Why are they not doing that? I could see, from a public relations point of view, if Bob White and the chairman of Ford or whatever would get on TV and say, "We feel that we're as good as the Japanese and we're willing to put our money where our mouth is and this is the guarantee we offer you and we'll jointly guarantee that guarantee and that's why we want you to buy cars," instead of saying, "You owe it to us to buy a Canadian car or an American car because we are auto workers and we live here," you would get that sector moving a lot faster and you could grab a market share from the Japanese. We have been losing market share and we have been losing it at a terrific clip. There is no reason for that if we are indeed improving quality at the rate that is being indicated.


Where the government can help, I think, is in facilitating this kind of thing, in shortcutting the kind of stuff that happened at Algoma. Is it not ludicrous that one month we have people trying to get a 7% wage increase and the next month they go bust after they get it? There has to be some way for government and labour and business to try to iron out these kinds of nonsensical situations, which are extremely costly from an overall point of view.

The one image from that Algoma thing that sticks in my mind, by the way, is the necessity of going into this training thing. I remember this man who had been working at Algoma for 25 years and he said, "What am I going to do now?" That question should not have to be there. He should have the skills to say: "Well, okay, this is tough. I'm going to need some time to adjust, but I'm going to make it in some other place." The fact that people do not have that confidence, I think, is in itself a problem.

Mr Phillips: Two or three questions. On the manufacturing side, the problem I have with your conclusion is that I think that accelerates the loss of manufacturing jobs, that we accept they are going to decline.

In my mind, they are declining for three reasons. The innovation, the technology, is doing it. That is one reason; there is no doubt about that. I think a number of the manufacturing jobs have actually gone to the service sector, because they used to be in-house employees and they are there now. I think we are losing it elsewhere. I have looked at the numbers very carefully over a long period of time, and my question to you really is: In Ontario, how important is the manufacturing sector to our future economy and how do we slow the rate of decline in that?

Mr de Bever: First, I take issue to some extent with what you said earlier. I think you can slow the rate of decline in employment, and I think if you focus squarely and head on, it is not going to accelerate the rate of decline.

Why are you losing these jobs? You are losing the jobs because you are not price competitive; you are not competitive on a unit labour cost. If you accelerate the rate of innovation in the manufacturing sector, you reduce your unit labour requirement. You also reduce your price, so you increase your market share. That is the way these things work.

I had this argument in 1981 with the research director of the Canadian Auto Workers. At that time he called me something like a "disciple of a defunct economist" for suggesting what I am suggesting today. The last 10 years have borne out that my notion that the more technological change you can get, the better off you are to preserve jobs has been correct. The sectors that are losing the fastest are the ones that have the weakest productivity growth, not the ones that have the highest productivity growth.

Mr Phillips: I agree with all that. I am just saying that to read your conclusion literally, you say: "Listen, manufacturing is on the way down anyway. Focus on the service."

Mr de Bever: No, that is not what I am saying. What I do not want people to say is, "We're going at all costs to keep manufacturing employment at this proportion of employment." What I do urge you to do is to look at the sector and say, "Okay, in which areas is there absolutely no hope?" Throwing good money after bad money is not going to do us any good. I would suggest that very low value added sectors -- leather, textiles, some components of those sectors -- are probably a lost cause.

Within the auto sector, I think there is a great deal to be said for discriminating between low value added and high value added and then trying to find partners in Mexico and places like that to help you produce the low value added stuff and concentrating on the high value added stuff. That is how other countries do it. I think that is the way we should do it, because our labour force is highly paid but also, on average, more highly skilled. We cannot compete with low wage workers in low value added industries, but we can compete with them in the high value added area because they do not have the average productivity relative to wage that we do.

Mr Phillips: I have a second question. My observation in talking to an awful lot of people in the business community is that everybody says there is a huge problem in the Canadian economy, but everybody says it is somebody else's fault. Mr de Bever: That is exactly what I am trying to say here. It is not somebody else's fault. It is our fault, all of us, and unless we stop blaming each other it is not going to get fixed.

Mr Phillips: Is my sense right? I talked to a lot of CEOs and very few of them are looking at lower levels of remuneration. Do you think they are prepared also to look at --

Mr de Bever: If there is one area where I agree with Premier, it is that one. I think it is absolutely scandalous that in the compensation of executives, Mr Iacocca included, there is no relationship to the performance of their organizations.

This is an old question. I came across something by Socrates talking about what the ratio ought to be between executives and workers. Five was the number, I think. I do not know what the number is, but I am sure it is not what we see in some of these large corporations.

I do not have any quarrel with you there and I do not have any quarrel with the fact that management blames labour and blames government and so on to a larger extent than it should. I think we all should look inside our own area much more closely, because I think we all share the blame for what is happening here.

Mr Phillips: I think we are getting close to that. My last question is: What is the technical suggestion you have on treating capital?

Mr de Bever: I have forgotten.

Mr Phillips: Remember, you said on the bottom of page 16 -- how would you recommend we treat it?

Mr de Bever: I would suggest that you simply do it the straightforward way. There are two straightforward ways. One is that you go down the way the budget does in terms of operational deficits and you say, "This is my capital expense and this is my total deficit." That is one way of doing it. The other straightforward way is to treat depreciation as an expense.

Mr Phillips: I agree totally with that, and that would get around your issue of -- in tough times you could spend twice as much on capital, and in good times half as much. We could not persuade the government to do that. I believe you are absolutely right. Everybody will look through the numbers and say: "Don't try and fool us. We know what your real deficit is, and we are kidding ourselves on that." But we lost that. Both the opposition parties voted against it, but it is through.

Mr de Bever: The point is, if no one in the world sees it the way you do, why do you want to keep doing it that way? It does not gain you any points anywhere.

Mr Carr: It does with the public.

The Vice-Chair: Do they get fooled? How do all the other provinces do it? Do they do it according to these international standards?

Mr de Bever: Yes, on the whole they do. They take one or the other. The public accounts usually treat capital expense as just another expense but they do it after the operational side. The national accounts do it the way we suggested earlier. They treat it as depreciation.

Mr Phillips: I agree with you totally. I think it is designed to understate the deficit so that they get away from the embarrassment of saying it is $14-billion or $12-billion deficit.

The Vice-Chair: If I may, just one question before you go. Some of the comments you made in answering questions in general and in your presentation seem very consistent with some of the things that came out of the Porter report. Have you had a chance to look at that document?

Mr de Bever: I have seen the reviews of it but I have not looked at it in any detail. I found it interesting that Mr Porter said a lot of things to a lot of people in Canada that I have been saying for years, but somehow the fact that an outsider said them seemed to carry more weight. Or maybe it was the fact that we paid so much money for it.

The Vice-Chair: Maybe that was it. Well, it was interesting, because I thought a lot of your comments were similar to things he was saying in specific areas.

Again, thank you very much for appearing before the committee today. We appreciate your giving us your outlook for the country and for the province and for taking the time out of, I am sure, a busy schedule to help us get a better understanding of what is happening.

Mr de Bever: Thank you.

The committee recessed at 1158.


The committee resumed at 1406.


The Vice-Chair: Since we have all three parties here, we might as well get going. We have with us Mr Tim Whitehead, general manager and regional economist for the Canadian Imperial Bank of Commerce. He has handed out a brief, which the clerk has distributed. Perhaps you would like to begin, Mr Whitehead.

Mr Whitehead: I want to begin by just saying thank you for inviting me and asking me to give my opinions on the economic outlook and the future of the Ontario economy.

I spent the last week out in Calgary at a constitutional conference where everything I said was viewed in terms of a white male from southern Ontario, so I am very much aware of coming here and speaking to you as an economist and a banker and having my thoughts and my musings interpreted in that light. I want to assure you that I have tried to produce my comments independently of those biases.

I should also mention that while I am clearly a representative of the CIBC, my comments should be taken as more independent than that. The marching orders I got from the bank were to the effect of, "Go and give your best piece of advice and don't worry about the fact that somebody else in the bank will be giving different advice and different comments on what the government should be doing." In fact, if you get another representative from the CIBC, you will probably get a different outlook and a different prescription. So with those caveats, let me start off.

I want to talk about the economic outlook to begin with, and then I want to talk generally about my perceptions about the economic environment and some budget considerations -- general policy directions, I guess -- and finally I want to make some specific suggestions.

On the economy, I have very little problem with what the Ministry of Treasury and Economics has put out in its forecasts, particularly the one contained in the January 21 update. They are looking for something in the order of 2% growth. We are pretty much in the same sort of category in terms of our growth outlook for Ontario. That translates into a fairly difficult economic environment in the sense that you are still going to have unemployment averaging above 9%. I am slightly less optimistic about housing starts than the Treasury and Economics people are. In the release of December 10, they were looking for something like 73,000 starts in Ontario. I think that is quite optimistic. I think 60,000 is probably more realistic.

On the inflation side, we were certainly in the ballpark. They are talking about 2.3% for this year and I think it is going to be about 2.6% for the CPI increase. On the exchange rate, I have a little difficulty because they did not update their exchange rate forecast in the January 21 forecast, so we are somewhat more optimistic, if optimism means a lower dollar. We would be looking for something in the range of about 85 to 87 cents for the average for this year. Correspondingly we would be looking for a lower prime lending rate than Treasury and Economics included in its budget forecast of December 10. They had something well below 9%. That was as specific as they got. We would be looking for something closer to 7%, maybe even getting lower than that by the end of the year.

In general terms, at least in the macroeconomics component, the overall measure of these things, I do not see a big difference between what the Treasury and Economics people are saying right now and what we would be saying is an outlook for the Ontario economy.

I have some problems with the analysis contained in their handbook in that they tend to be somewhat more optimistic about investment growth and I am not quite so sanguine about non-residential investment in Ontario in the coming year. I think you may see somewhat stronger consumer spending, but the investment side I think will continue weak for another year at least.

Perhaps a more substantive problem I have with the tan book, and this leads me to my first recommendation, is that I am a little concerned that the analysis they put in there is somewhat slanted in that they attribute all the faults in the Ontario economy to the Bank of Canada policy or the free trade agreement or high interest rates or the high Canadian dollar. I think, particularly as we look at the investment side, there is room to believe that perhaps some of the policies of the Ontario government have contributed to the weak investment outlook. I am not suggesting it is entirely the fault of the Ontario government, but I suggest the business reaction to the deficit and to labour legislation, proposals such as that, have weakened the investment outlook. To the extent that the tan book glosses over or ignores that completely, I am a little concerned it may not be always the best basis for discussion.

Consequently one of the first suggestions I make is that perhaps there is room for production of these forecasts by an independent body. This is a proposal that was contained in the federal government's constitutional proposals, that you have an economic body that can pass comments and make an independent review of economic outlooks and budget policy. It is also in line with the practice in the United States, and that is the Congressional Budget Office, which produces relatively independent economic forecasts and comments on costing and a whole range of issues related to public policy.

The key thing here is that I am not in any way criticizing the forecasting effort of the Treasury and Economics people, because it generally has been fairly good. By that I mean it generally agrees with mine. My sense is that in the writing up of their document they tend to be suffering under some, one might say, political constraints. They are not new ones. I think they have always suffered under them under successive governments, but it is a problem that perhaps could be addressed.

Let me turn next to some general policy directions. The key thing here is that when I was looking at it and discussing it with other people, we clearly identified that the biggest problem for the Ontario economy is jobs. We need jobs in the worst possible way, obviously. We are looking at unemployment remaining high for the next couple of years anyway. The key thing is jobs; not necessarily the high-paying jobs, but jobs. I think that is an important point that should not be lost. We would like high-paying jobs, but we really need jobs. Jobs will come about through economic growth. I am not advocating economic growth for any other reason than creating jobs. It is a very important social and economic dimension in the economy.

The question then is, how do we create this growth, how do we foster this growth? Under economic theory, at least as it stands today, the key things you want are a skilled workforce, capital investment and technological development. The fourth point, which is sort of only recently being incorporated into economic theory, is that you have to use those things in the most efficient manner possible.

That leads me to suggest the government can help stimulate this growth that is going to lead to sustainable jobs in the long term by helping develop a skilled workforce. This means education, job training, promoting job training, whether it does it directly itself or promotes it in the private sector.

Second, it should promote capital investment. Things the government does that discourage private investment, discourage capital formation. Since capital formation is a big component of technological advancement, discouraging capital investment discourages technological development.

The fourth component and the third area where they think the government can play a significant role, and one the government has already identified, is trying to bring labour, business and government together so that they can work more effectively. Maybe this is part of labour legislation. Certainly the suggestions on labour legislation are aimed at trying to get the collective bargaining process developed such that there is more democracy and more effective use of resources in the private sector. I think this is a really important thing and it is a track the government should follow.

Let me turn now to some specific suggestions, and I have split them up into short and long term. The first is that I am very sceptical about the government's ability to stimulate the economy in the short run. I am very pessimistic about pump-priming. I think the Ontario economy is a very small, open economy; not small in the Canadian sense but small in the world sense. It is a very open economy, so that money spent in stimulating or in tax cuts -- deliberate spending -- tends to get lost before it has a significant impact on the economy. You do not get the large second-round or multiplier effects.

The second point is that in trying to stimulate the economy you are more or less deliberately increasing the deficit. I am concerned that a deliberate increase in the deficit over and above what may be anticipated for next year actually may weaken the recovery in that large deficits may at this point have a negative effect on consumer confidence; that if we start pumping the deficit up here in a deliberate attempt to stimulate the economy, we may in fact cause consumers to sit on the sidelines, because they see this large deficit and they say: "Things must be really bad out there. I'm not going to spend, because my job is going to be lost in the near future."

At the same time, there is a body of opinion that argues that large deficits are seen by the consumer superrationally, if you will, as being taxes that they are going to have to pay down the road, and they start saving as a consequence. I find that stretching the point a bit. I am more concerned about the impact of a large deficit on consumer confidence.

One short-term suggestion I would make is that the government consider privatization of some of its assets. I know the Suncor announcement was yesterday. I would suggest that Ontario Hydro, GO Transit and perhaps some others might be considered at the same time. I recognize these are big institutions and have predominantly been seen as a major portion of government policy in the province. I would argue there are benefits to be received from privatizing either one of these institutions. I will just talk about Ontario Hydro and GO Transit.

To the extent that you could privatize Ontario Hydro, the government would receive a fair amount of money and could use that to pay down some of its debt and ease up some of its financial burden. I would argue that Ontario Hydro in the private sector is really not much different from Ontario Hydro in the public sector. There are certainly regulatory mechanisms in place to control rate increases, to make sure it is environmentally friendly and that sort of thing. I would also argue that should the government consider privatizing it, it should make every effort to make the people who buy it the consumers of Ontario Hydro. The pattern I would suggest here is British Gas in the United Kingdom, where in privatizing the effort was made to make consumers of British Gas the buyers of its shares. There are a number of reasons for this and I have sort of touched on them in my document.

Similarly with GO Transit, I would say that if you could make the people who actually ride GO Transit the people who buy it, you could offer inducements in the sense of a discount on their monthly pass or something of that nature. What I am aiming at here is not so much privatization for the sake of privatization, but rather the argument that you could turn GO Transit into something more of a co-op, so the people who own it are the people who use it and they might be a bit more receptive to the fare increases that would be necessary to reduce some of the loss at GO Transit. I am concerned that in privatizing GO Transit you might increase the fares so much that you would cause people to use automobiles instead. But I think that can be circumvented if you try to encourage ownership, and that can encourage people to use the resource, as opposed to using their cars.

Let me turn briefly to long-term issues, because as I have indicated I am pessimistic about the government's ability to provide significant stimulus to the economy or to provide employment to the economy in the very short run. In the long term -- and I recognize some of these suggestions may not be entirely palatable -- what I would suggest is that the government harmonize its provincial sales tax with the GST. This has a number of positive economic effects. I understand it is politically difficult for a number of reasons, but there are a number of reasons why it would be good for the economy.

Certainly it would reduce the cost of capital investment in the province and that would be a stimulus to the capital formation we need to create sustainable jobs. I would not suggest harmonizing the PST with the GST without considerable tax breaks or improvement to social assistance so that low-income groups would not be hurt by harmonization. Sticking with the provincial sales tax as currently constituted means you have a big portion of your tax revenue on a base that is declining relative to the overall economy over the next 10 years or so. Moving to the broader base, harmonizing the GST would put the province's financing on a better footing.


I also suggest as a longer-term thing, and in line with trying to create a more skilled workforce, a tax incentive for businesses to invest in human resources or job training. This has been tried in Quebec and I cannot honestly say I know how well it has worked. They have had it there for a couple of years and I have not seen any reports on how well it has worked.

I am not suggesting this as a tax break for business. I suggest you might also consider raising taxes on business and offsetting it with a tax incentive to invest in human resources, but it is perhaps the most efficient way for the government to get businesses more involved in job training.

A third suggestion I would make for the long term is considering the idea of community development bonds. This has been used in Manitoba and Saskatchewan. Basically groups borrow money from individuals. That borrowing is guaranteed by the province and the money raised in that way is used to invest in small enterprises that have the potential to grow and are predominantly community based.

Clearly this involves borrowing on the part of the government because it is guaranteeing -- if not borrowing on the part of the government, at least an increase in the continued liabilities. Studies elsewhere -- and I am thinking of Saskatchewan here -- suggest that the cost per person-year of work created through the community development bonds in the final analysis is about $1,000. To my mind, if those numbers can be replicated in Ontario, $1,000 per person-year is certainly an attractive proposition.

I would not be a banker if I did not advocate expenditure restraint. I would say, however, that it would be very difficult to employ in the short term. The expenditure restraint I would advocate would be in the medium term and in this regard I would say the fiscal outlook of January 21 included a continuation of a suggestion about a continuing fiscal review of expenditures and ways to deliver services more efficiently and cost-effectively.

I think this is a very good idea and is probably the best way to get out of the situation we are in right now. I would advocate, however, that the government should consider giving it a higher profile. Perhaps it could be done through committees composed of individuals outside government, making the reports public so you could give it a higher profile, putting more emphasis on it and convincing the taxpayer that the government is serious about imposing these reviews and looking for more effective ways of doing things.

I was struck by the Ontario Fiscal Outlook, the January 21 document, in that there are about 12 pages of ways to raise taxes and about four pages of ways to hold spending. That perhaps reflects reality, but I was concerned that the document was comparing tax rates in Ontario versus tax rates elsewhere and saying, "We are low here; hence there is room to increase." That may be true and clearly there is a role for that sort of analysis and trying to figure out just how to tailor our tax system. I think it would be better if the government and budgets concentrated on trying to focus on how much of our provincial economy is going to the government in taxes.

We are looking at about 15.5% now if you take total revenues of the provincial government and compare that to the gross domestic product. I expect that is probably going to increase over the next while, but it is perhaps far better to target that and use it as a policy variable than try to look at individual tax rates. I argue that because there is an erroneous assumption that you can pinpoint taxes and say, "This group is undertaxed. You can hit them." In fact, tax incidence is a considerably more complex thing than that. The key thing to look at is the burden of taxes on the economy overall because it is the key component in determining how much our taxes help or hinder our competitiveness.

That might be a double-edged thing, by the way. The business community has an idea that Ontario is heavily taxed right now and that it is going to get worse. I think they might find other provinces in Canada are more heavily taxed if they take the total revenues as a proportion of GDP. On the other hand, it might make the effects of tax changes at the government level a little more transparent so that an overall increase in taxes may be a little harder to hide.

Finally, and this might seem paradoxical given the current economic environment, I suggest the government consider the creation of stabilization funds. This has been used, not terribly effectively I might add, in other provinces, but the idea would be to state in your budget what your revenue projections and expenditure projections are. Should you exceed your revenue projections -- I would argue there is a possibility that growth may be stronger than the 2% the government is anticipating -- that money should be put into a fund that can be drawn upon in years when the revenue projections are not achieved. Similarly the same can be done on the expenditure side. If expenditure savings are achieved -- that is, they come in under what the government projected in its budget -- that money could be put in a stabilization fund and called upon in future years.

This would not only get around the problem where governments in the past have seen windfall revenues come in and spent them almost as quickly as they have come in; it might also reassure investors and people looking at buying the province's bonds that the government is serious about trying to get its financial situation in order. Let me stop there.

Mr Johnson: That sounds like Keynesian economics; is that what you are suggesting?

Mr Whitehead: No, not so much Keynesian economics. It is really the government's own accounting.

Mr B. Ward: I found your presentation very informative. The concept of community bonds: Could you expand on that a little bit and would you have any more information you could provide to the committee on that particular concept? I find it very interesting.

Mr Whitehead: I will explain how I understand it works. I have some more material but I have not brought it with me; I can certainly get that to you.

Mr B. Ward: Could you provide it? I think it would be very useful.

Mr Whitehead: The material I have comes from the Saskatchewan government. It was instituted by the previous administration, but apparently the new government is also looking at it favourably. The way it works is that community groups are set up. They can incorporate themselves; groups of individuals in the community can get themselves together, and subject to approval by the government, issue bonds that will be sold more or less in their own neighbourhood, their community or whatever.

The government would guarantee those bonds with a five-year horizon to it. The group would then use the money raised to invest in local initiatives that might create employment, but basically are intended to be commercially viable efforts. While they might be community located, they could be almost any sort of endeavour -- anything that exports or whatever -- but basically they would be located within the community.

The government's guarantee works in the following way: The bonds are guaranteed but the government will not pay out for five years, so even if the company and the endeavours the community group invests in fails the day after it is set up and everything is lost, the government will not pay out for five years.

At the end of five years, the holders of the bonds have the option to either bail out and ask for their guarantee to be effected -- the guarantee is really only applied against principle, not interest -- can ask for the guarantee to be imposed and get their principle back, or they can say, "I will convert my bond into equity in the underlying institution." The key concept is that the government is only minimally involved in trying to figure out where to create the jobs or where to create the companies. It is really on a community basis. In a sense, I view it as community empowerment. People in the community can put their money into the community and help to create jobs.


Mr B. Ward: They would know what is best. I would appreciate it if you would provide me with the information.

Mr Johnson: That was a very interesting presentation. I was wondering if you had an opinion on whether the province should be collecting taxes that presently the federal government collects on behalf of the province. One of the positive aspects is that apparently there could be some administrative savings, as I understand it, and also an opportunity to know exactly how much revenues are coming in. There is a delay, as I am sure you know, when dealing with the federal government. I was wondering if you had an opinion on that.

Mr Whitehead: We are talking particularly about income taxes.

Mr Johnson: Yes.

Mr Whitehead: Personal income taxes. I am not so inclined. There are advantages to having a relatively common personal income tax system across the country. Obviously Quebec is an exception to that, but I think it is perhaps best for the working of the Canadian economic union if there is a relatively standardized personal income tax system.

There would be advantages to the province, however, in a sense. I do not know that there would be that great an administrative advantage in terms of the cost of collecting the tax. On the surface, I suspect you would be duplicating things and I do not see the saving there. You would have advantages, though, in the sense that you would be more involved in trying to forecast it. It is clear the province would have the same situation as it is going to have this year or next year. You would have the bigger advantage, however, in that you could tailor certain policies to try and direct things the way the province sees fit. For example, you could make more incentives to particular investment-type activities or more community-based activities or you could make the tax system more progressive, if that is your wish. There is certainly an advantage in terms of affecting policy there, but I am sceptical there would be much administrative saving, and I would argue that there would be some cost in terms of a non-uniform personal income tax system.

Mr Johnson: You mentioned in your document that jobs are important, whether a lower-paying job or a higher-value job; Nevertheless, a job is important. The system we have right now for general welfare assistance pays an amount we would like to think is appropriate for the needs of individuals on that. There is also a statistic that one would suggest is a standard of living, and if you make more than this you have attained -- I cannot remember what the term is. For example, to be above the poverty line a family of four needs to make at least --

Mr Whitehead: The poverty line is the usual term, yes.

Mr Johnson: Do you think the poverty line -- whether it is a real figure or not, I suspect there is some arbitrariness to it.

Mr Whitehead: Yes.

Mr Johnson: Do you think that would be reduced in some way if people were to become employed on a large scale in lower-paying jobs?

Mr Whitehead: I have not given any thought to that. I am not sure that is the case. My argument for jobs is more directed to the fact that when you are unemployed, it is not only an economic problem in the sense that there is a drain on government resources, that you are not creating anything and it is a wasted resource, but also that there is sociological damage to society, that there are a lot of sociological problems that arise from it. I think it has to be one of the most disheartening things in society today. It is far better to have somebody employed, even in a low-paying job, than to worry about really attracting only the higher-paying jobs. I do not know if that answers your question, but I am explaining at least the basis for it.

Mr Johnson: Yes, that is fine. The question was not couched as well as it could have been, either. Thank you very much. Mr Phillips: In the short term, you essentially agree with the Treasury people in terms of the economic outlook for next year. My question is around your longer-term suggestions. The government has already, I think, indicated what it is going to do in terms of economic recovery. They touched the same things you do, but they will be announcing, as they already have, how they are going to handle training, their creation of capital pool and the use of pension funds for capital. They are tackling the things you are suggesting, but with different vehicles. Have you any comment on those things?

I think there will be about four or five elements to their economic renewal plan. One will be taking probably about $2 billion of training and retraining funds and putting them into an arm's-length, perhaps crown, corporation jointly managed by the unions and business. I am sure you are familiar with that.

Mr Whitehead: Yes.

Mr Phillips: The second one will be the thing that was in the paper the other day, the union-managed venture capital funds, where you invest $3,500 and you get 90% tax credit on it. I think that will be the way they will develop the funds for the capital investment, then use the public sector pension funds for further investment, along with the labour relations changes.

Those will be, I think, four of the key elements of the economic renewal plan. They are different from your recommendations, but they tackle the same thing. Are those appropriate as solutions? Are they things you think will work?

Mr Whitehead: Maybe I am bringing a bias here. I am sceptical about government having a heavy hand in trying to direct things. Inasmuch as they are trying to set up these funds, perhaps they are trying to distance themselves and let business and labour manage them in varying degrees. I think it would be far better if you just left it in individuals' hands and let them try to figure out where they want to put their savings, rather than trying to heavy-handedly direct them through tax incentives or whatever, force them to put it in money that is going to come into Ontario.

On the education training fund, I think it could be done more cheaply if you try to encourage firms to make that sort of investment through a tax credit. The problem with firms making this sort of investment in job training is that they are always worried they are going to train somebody and he is going to leave. Hence, all the money they put into that has been lost.

You can overcome some of that problem about externalities, as economists call it, if you give them some sort of incentive, and that may be enough to overcome the worry about the probability that the employee will leave. Consequently the government ends up paying maybe 15% of the cost or 20% of the cost, but you get the same sort of effect. Moreover, the private sector is the one that determines which particular job training would be appropriate and what is most needed at that time. I worry about large bureaucracies, whether they are managed by business and labour or government. I worry that they tend to be inefficient. I am much more concerned with trying to get more community-based and back down to the micro level.

Mr Phillips: But that is already under way now, the setting up of that jointly managed board. As I said, it will have probably a budget of a couple of billion dollars. Has the bank commented on that at all?

Mr Whitehead: No, not that I know of.

Mr Phillips: We were supposed to be dealing earlier this week with Bill 150, which is this thing here that is out on the market.

Mr Whitehead: Yes.

Mr Phillips: Has the bank commented on that?

Mr Whitehead: No.

Mr Phillips: I guess you have not commented on the pension-based fund thing yet.

Mr Whitehead: No.

Mr Carr: Thank you for your presentation. I enjoyed it very much. One of the things we talked about this morning is that what happens with governments is that if one level reduces taxes, the other level says, "Oh, boy, here's a chance to put our foot in and jump." Hopefully as a result of what is happening on the Constitution, there will be some clear lines on that although I am not too confident that will happen.

One of the things that happens, for example, is that when we limited the transfer payments to school boards to 1%, all that will mean is higher property taxes, because 80% of school boards' expenditures are salaries. They already have agreements of 5.6% with the unions, so 80% of your costs are going to go up 5.6%. The money that comes from the Ontario government is only going up 1%, so you are going to have to increase the property taxes. That is what happens with one level doing it.

One of the proposals made is that when you limit transfer payments to 1%, you should then say to the school boards, using them as examples, "We will mandate that teachers will not get a raise above 1%." Do you agree with that? What would be your comment on that? It works, of course, with hospitals as well.

Mr Whitehead: I guess I would have a problem with that, again along my philosophy that you have to give a fair amount of freedom to community-based responsibility. Perhaps a better way of approaching the same sort of thing is not to give a huge increase one year and then cut it back to 1% next year. The individual groups at lower levels of government build in expectations of continuing funding. If you make clear, as the government has done, that it is going to be one, two and two, then I think the local groups may immediately respond with higher property taxes. But as long as they get a clear picture of what they are going to face in the future, then I think there is an opportunity, as the Treasurer expressed, for us -- the local groups, the hospitals, the community groups -- to start building in those funding expectations. I would view that as the responsible way to handle it.


Mr Carr: I was interested in your comments about the private sector. I agree. I do not think there will ever be enough money to fund our hospitals and our schools if we get involved in, for example, housing, where the rent bills drive the private sector out and the public sector jumps in with non-profit housing. Day care would be another example, where they believe the government should run it, so they put $100 million into it. That is where we have some problems with the government saying, "But the deficit would rise no matter who did it." When you look at the housing figures, what we are going to spend on housing over the next few years, we are talking about billions.

I was interested in your comments about the privatization. With regard to companies like de Havilland that we have now bought -- of course all governments have done this, ie, Suncor was bought and now sold, and now we have jumped in with de Havilland -- the argument has been that they need to have some government involvement, otherwise they would not get off the ground. Would you like to comment on whether governments should be involved in things like Bombardier-de Havilland, and if so, how should they work it?

Mr Whitehead: There may be an argument in a case like de Havilland that if the government did not step in, nothing would happen, but I view them as very expensive jobs. There may be an argument that you had to protect a particular industry that would have been lost otherwise, but still in terms of spending to create jobs those are very expensive jobs.

What I guess concerns me about the de Havilland deal, from the public purse point of view, is that the downside, if you take in all the guarantees, is fairly expensive. On the upside, I do not know how it is structured in terms of at what point Bombardier is going to buy out the government's equity.

Mr Carr: If it makes money, they can buy them out.

Mr Whitehead: Yes. I worry that every time the government gets involved with this, and it is not any particular government or any level of government, they always have a considerable downside and very limited upside. Maybe that is the way it has to be, and maybe that is the way it had to be in the case of de Havilland, but clearly it is an expensive proposition.

Mr Carr: It is not unlike what you had on page 5 when you talk about jobs when the government creates them. The figures are probably even a little bit higher in the de Havilland deal if you look at the number of jobs. Of course, we do not know the number of jobs that are going to be saved because we have just lost a few hundred more.

In regard to taxes, we have talked about how one government lowers and the other one jumps in sometimes, and so on. We have this overlap and duplication. Clearly, not specifically by the province, but people feel overtaxed and I think rightly so versus some of the other jurisdictions.

If you were going to have your chance to explain to the Treasurer what you think should be done with regard to taxes, what would you tell him? As you know, he has been very coy saying that he has not ruled it out, but there are a lot of people who say he is going to have to increase some taxes to meet the deficit projections. If he does have to increase any, which I do not think he does, where would it be? How would you handle it? A higher provincial sales tax? Corporation tax? What would it be if you had to?

Mr Whitehead: Whatever he is doing with taxes, there is a built-in assumption in the business community that they are going to go up and are going to go up an awful lot. I think there would be considerable benefit to spelling out what the tax plans are for maybe two or three years down the road. I do not know whether that is possible and I am not sure it is. The uncertainty in that in the business community is probably as much a problem as anything else.

If there were no choice except to increase taxes, I guess my preference would be to broaden some of the tax base, particularly I mentioned converting the PST to the GST. But I am not sure even there, because I think a necessary softening of that blow on the lower-income groups would mean that a lot of that extra revenue would have to go anyway. I view that as a much more acceptable approach than raising income taxes, for example.

Mr Carr: I was interested in your tax credit for training. Community bonds were one of the things in the new directions you outlined a couple of weeks ago. There were some ideas that were used in other jurisdictions. With regard to the tax credit for training, how do you see that working specifically? If I am an employer of 10 employees and I want to do some training, how would I take that tax credit? What do you think is the best and most efficient way to do it? Everybody is telling us we need more training, more education and more workers. How can we do that very practically and simply?

Mr Whitehead: I would try to structure it in a certain way. I would make it a tax credit against all taxes, capital taxes and income taxes. I would set up criteria so that you do not just have fly-by-night or other expenses being categorized as job training expenses. I would work out some mechanism to make sure they are bona fide training efforts. I might also be inclined to scale them so that the biggest benefit from those tax credits would go to the smallest firms. Larger firms, and I would include banks there, have fairly well-developed job training programs. What you want to do -- the biggest bang for the buck -- is to encourage it at the smaller firm level, which typically and historically has had less involvement in job training and perhaps could do a better job of it. I would certainly make a sliding scale aspect of it too.

Mr Carr: You heard the Treasurer speak the other night as well, a week ago or whatever it was, with regard to the deficit situation. On page 5 you talked about the tremendous problem we have with the deficit. You are talking about not increasing taxes. You heard, and I mentioned this morning, that the Treasurer is going to meet with the other finance ministers. He is saying that we should stimulate the economy, although he is not saying Ontario should do it; he said the federal government should do it. When somebody else is paying, I guess you can say that. I do not think we have got through. We have turned him in a lot of areas. He still believes he has to do something. What would you tell him with regard to government spending and running up the deficit to create jobs? How would you simply tell him that he should not do it?

Mr Whitehead: I would just say that you are not getting a big bang for the buck. In fact you may be negating some of the economic recovery, because as I indicated, I think if you get a big runup in the deficit you are really going to scare the consumers out of the market. The government is a big component of the market, but consumers are a far bigger component.

Right at the moment we have 10% or close to 10% unemployment in this province. There are very good reasons why consumers are not spending. I think a lot of it is psychology. Consumers are scared. They do not see anybody else spending and they are not prepared to spend. I would argue that if a whole bunch of things do not happen, if we do not have another runup in interest rates, if we do not have a breakup of the country and if we do not have a huge increase in the deficit, consumers will come back to the market, probably in about the second half of this year. They could provide a considerable stimulus to the economy, far more than what the government could do spending by itself.

Mr Carr: Just with regard to the spending cuts, as you know the big portion of it, give or take 75%, is the colleges and universities, social, health and so on. What has happened is that historically governments of all political stripes have not touched that, for a lot of political reasons, I think. If you were to take a look at it, realizing we do have to make some expenditure cuts, where in those areas would you look? This is a million-dollar question, because this is the big challenge for the Treasurer. Have you any suggestions for him in those areas that he might be able to get a bigger bang for his buck?

Mr Whitehead: It is a matter of exclusion. When I look at social assistance, I say there may be abuses to it, but I do not buy a lot of what Diane Francis writes in the paper. The key thing in terms of social assistance is that you have to reaffirm to everybody that it is money spent on those who need it. I do not believe you are going to find an awful lot of savings there, but you might, and I think you should make every effort to find savings there so that you reassure people it is money well spent.

In the other areas -- health and education -- my cursory examination when I have been in schools or hospitals is that it seems to me these are areas that spend quite heavily on administration. Maybe savings could be achieved there. We are driven into a very hard corner here. We are looking at three sacred cows that make up 70% of the expenditure. Of those, I would tend to concentrate more on the health sector and education sector rather than the social assistance, but I would look at all three of them, perhaps in that order.

Mrs Y. O'Neill: I appreciate your comments and I am sorry I was late for the beginning of the presentation. I think your assessment of the inability to pinpoint taxes is very accurate. I am not really sure this present administration fully appreciates that. If I just take the gas tax for example, your document and others that have been presented to us indicate there does not seem to be a hospitable environment for investment. I think what you say about "psychological" is a spinoff of that.

I am interested in what you said about the training inasmuch as that seems to indicate to me that you do not think there should be business subsidies. I am now going back to the Ontario capital cost allowance, for instance, and that kind of thing. Do you feel there is still a role for some kind of business subsidy, or should the business people be willing and have to take the risks and provide whatever professional development is there?

Mr Whitehead: I would argue there is perhaps some role for the government to try to encourage business. I would try to make it tax-neutral in the sense that if you offer some incentive for human resources development you should at the same time -- I am not arguing for a tax break for business; I am arguing to try to put a little bit of incentive to offset what firms look at as an externality, that if they train somebody, he leaves. If you can offset that perception by giving some incentive there, then that perhaps is a good thing.

This is my reading of the business community: they may cry out for all sorts of things, but they would be far happier with some sense of certainty in the outlook, what taxes are going to be like and what their operating environment is going to be like, rather than have some sort of incentive to go out and spend right now. That would be far more important to stimulating investment than almost anything else.

Mrs Y. O'Neill: So it ties in with the psychology-mentality-atmosphere idea.

Mr Whitehead: Yes.

Mrs Y. O'Neill: It seems not to have really been deeply appreciated how important that is until this particular -- if we want to call it that -- recession. I guess we were into another mode of thinking; that things were always going to get better. Now we really have to turn our thinking around.

The Vice-Chair: Are there any other questions? Seeing none, I would like to thank you very much for coming in this afternoon and participating in our discussions on the pre-budget consultations and more particularly on the outlook for the year and presenting some options to mull over, actually some new options that we have not heard from some of the other groups.

Mr Whitehead: I enjoyed it.

The Vice-Chair: I believe our next group is just arriving, so we will take a five-minute recess while we wait for them.

The committee recessed at 1453.



The Vice-Chair: We will get started with our next group. I believe we have with us Mr Ernie Stokes. You are from WEFA, which stands for --

Mr Stokes: WEFA does not stand for anything.

The Vice-Chair: It is not a short form?

Mr Stokes: No. It used to be, but it is not any longer.

The Vice-Chair: What did it used to stand for?

Mr Stokes: It used to be the Wharton Econometric Forecasting Associates but there was a merger between Chase Econometric and Wharton and they just kept the acronym.

The Vice-Chair: It is just so we know the history. At any rate, welcome to the standing committee on finance and economic affairs. We appreciate your willingness to come and give your presentation today. If you would like to begin, we have one hour altogether and we hope you will not take the full time so there can be some time for questions.

Mr Stokes: Thank you for inviting WEFA. We appreciate the opportunity to come and discuss our views.

I assume you have heard lots of economic forecasts. The handout I have has the economic forecast of WEFA. I do not plan on talking about the forecast a lot. What I would like to talk about instead is policy, and in particular, where we have been and where we are going. One of the most important sources of growth or changes of growth, in our view, is what policy does to the economy. What I would like to do is concentrate on that today, and I will concentrate on what role policy has played over the last few years and what it could play in the future.

What has happened? If we look back to 1988 in Ontario, we were on top of the world. We had the most rapid growth in the Ogranization for Economic Cooperation and Development, one of the lowest unemployment rates, inflation was not bad and we were in very good shape. In 1991 we suffered almost the most severe recession in the OECD, had the highest unemployment rate and pretty high inflation as well. What has happened?

I would like to explain it by two major sets of factors. Economic forecasters always look at these sets of factors when they try to describe what is going to happen. You also use the same things when you look back. You can break them down for Canada into international developments and what I call domestic policy developments. Particularly in forecasting, international is important. But when we look at Canada recently, domestic policy has played a very important role in what has happened here.

On the international side, what has happened since 1988 is that the economies in the world have slowed down significantly. All of our major trading partners have slowed down. We are not the only ones. What happened is that in 1988 there were severe inflationary pressures in the world. The world economic growth in 1988 was very strong. Many countries raised interest rates to slow the economies down to reduce inflation and this is where we are now.

WEFA predicts, for example, that in 1991 the world economy actually declined for the first time in decades. It has never done that for years and years since the Depression. The OECD countries are doing better than the former Soviet countries. What is causing the world economy to decline is mostly the Soviet Union and the Eastern European countries. They are in terrible shape. But the OECD is also in very bad shape, so the rest of the world is not doing very well either. We are not in this alone.

We are a small, open economy. By that I mean we depend heavily on trade for what we do. We have to rely on what is happening in Europe and the United States and so forth, and generally if they are not doing well, we are not doing well.

If you look at the charts I gave you, on the third page there is one on Canadian and United States economic growth. What you will find out is that the two economies tend to move pretty well together. If you look at inflation, which I also present in there, you can see that our inflation rates tend to move together. If you look at interest rates, we also tend to move together on interest rates. That is what has happened since 1988.

But there are some important differences. We have had a bigger slowdown, ie a deeper recession. We have had higher interest rates than the United States and many other countries and our inflation has been going in the wrong direction. Theirs has been going down and ours has been going up. To explain this, we have to look at the domestic scene and the domestic policy environment. What I want to look at in this area is two sets, again. One is what we call "stabilization policy" and one is what we call "structural policy".

Stabilization policy is the sort of year-to-year changes in revenues and expenditures that governments make in trying to manage the economy. Structural policy is things like changing tax systems, free trade, the GST and so forth. There are two different sets of policies and they will have different impacts on the economy. One set of policies, ie the structural ones, are trying to improve the underlying strength or growth capabilities of our economy. The stabilization policies are trying to manage the economy so it does not grow too fast or too slowly so we do not get inflation or a too-high level of unemployment.

It is our view at WEFA that the major reason for the slowdown in Canada has been mismanagement with respect to stabilization policies. We think there were big mistakes made. I have worked in the policy business before for government so I realize it is difficult, but there have been some big mistakes made and I want to talk about that today.

When you look at what is happening in the economy from a stabilization point of view, what you are trying to do is manage demand and supply. We know that if demand exceeds supply, you are going to have inflation. If demand is less than supply, you are going to have high unemployment. So the role of stabilization policy is to manage demand and supply so that we go through the middle. We call the middle the concept of "potential output" or "potential GDP."

Potential GDP is the amount of gross domestic product we can produce in the economy using our capital and labour and resources at average rates of utilization, ie they are not overburdened or underburdened. If the economy grows faster than the potential GDP, we get inflation. If it grows more slowly, we get rising unemployment. The job of stabilization policy is to try to get us to follow potential GDP.

What has happened in the last few years is that we have not done that. If you go back to 1988 -- and I have included a chart here if you want to refer to it -- it is called the "real GDP gap". There is actually one for Canada, which is the first one, and if you look two pages back there is one for Ontario. This measures the percentage difference between actual GDP and potential. If you want to, think of it as the difference between demand and supply in a sense.

If you look at the Canadian one, you can see that in 1982 when we had our big recession GDP was way below potential, so demand was way below supply. You can see what happened as we went through the early 1980s. We got to 1986 and we were operating the economy at potential, so our resources just met what we wanted. Then we went above potential, that is, excess demand, through 1988. Then we came back down again and were in what we call a recession.

If you look at Ontario, you can see that in 1981, 1982 and 1983, we were operating with excess supply and we had very high unemployment rates. What has happened since then, however, is that we have gone in the other direction and at present we are back where we were in 1982. Many people say the recession now is worse than it was in 1982 in Ontario. I do not think it is. Based on these graphs, it is not any worse; we just forget. That does not mean it will not get worse, but up to this time it is not worse. It could continue and be worse. We are not necessarily worse off than we were before. That is the first thing I would like to point out.

The relevance of this chart for policy is that, as policymakers, you are supposed to keep us on the zero line. If you get us going too high, you cause inflation; if you get us going below the line, you have unemployment. If you look back, that is exactly what has happened. When you go back to 1986, we were just where we thought we should be. What happened? We had a worldwide boom in 1986-87. The whole world started growing very quickly. Consumer spending went up and we had an investment boom. Business investment went up in Canada.

You all know what it was like in Ontario in 1988-89. We were overheated like crazy. I moved here from Alberta and I could barely afford a house. That is what I call an inflationary gap. That is what the above-potential GDP is called, an inflationary gap, and when you get below-potential GDP it is called a deflationary gap. So above you get inflation, and below you get inflation, coming down and high unemployment.

In 1987-88, governments were spending money like crazy. What you are supposed to do with stabilization policy when the private sector is growing is get out. You are supposed to make room. This is the old style Keynesian economics. The way it is supposed to be done is that you are supposed to get out and make room for the private sector. Governments did not make room for the private sector in 1987, 1988 and 1989. This is at all levels of government. It is not just Ontario that is accused of doing it. The feds did it and everybody else did it as well. I am not blaming Ontario by itself, but Ontario clearly was growing too quickly. The policymakers should have got out then.

What happened was that all of a sudden the policymakers figured out what was going on. They saw all this inflation coming up, the market was overheated and what they did was put on the brakes.

The Bank of Canada is not exempt from heating up the economy either. In 1987, because of the so-called stock market crash, it raised the money supply growth very sharply, which means lowering interest rates more than it should. This was an expansionary policy just when we did not need it. Fiscal policy and monetary policy were extremely expansionary, which led to this boom. Of course, what this is going to lead to is very high inflation. That is what happened in the 1970s and it would happen again.

The policymakers said, "We can't allow this to happen," so what did they do? They reversed course. They said, "We're putting on the brakes." Up went interest rates, spending growth started to slow down, taxes went up and boom, we were in a recession. That is what happened in this economy, quite simply. We should not have had the growth we did in 1987 and 1988. The gap in Ontario was about 4% or 5%. That means the economy was growing 4% or 5% too much then. Everybody was bragging about how great Canada was doing, that we had the strongest growth in the world. We should not have had that growth.

What has happened? We have simply taken it away. In 1988, we had huge growth above potential. What are we doing now? We are taking it away. Stabilization policy is supposed to keep those cycles very small. We had got unemployment rates down very low. What was the unemployment rate in Toronto, 4%? That was way too low. I know we would like the unemployment rate to be very low. I am not saying we should not have it low, but the problem is it got there not because of structural changes in the economy but because the economy was overheated. Wage demands went way up and inflation started. Housing prices went crazy.


The point is -- and this sounds stupid -- the reason we have had such a poor time now is that we had such a good time before. It is quite simple. One of the implications of this for the future is that we spent too much trying to get the economy going. We stimulated it too much. We boosted the economy when we were already in a boom.

Think about what we are doing now. Everybody is saying, "Cut back, cut back." What we are going to do is go in the opposite direction again. In the boom, we all stimulated. Now in the bust, we are going to contract. All we are doing in this economy is making the economic cycles very volatile. Some economists call this procyclical policy, which means you increase spending and expansion in booms and you contract them in recessions.

Stabilization policy is supposed to do exactly the opposite. We are doing stabilization policy backwards in this country. What does that do to the economy? We call it destabilization policy. It destabilizes the economy. It causes booms to be bigger and recessions to be bigger. We are talking about cutting government spending now. That may be a worthwhile long-term goal -- I think it is, because I like to pay less taxes -- but I am not sure we should do it now, simply because we are going to destabilize.

For the private sector to grow and for potential output to grow, you have to have investment. You have to have people learning about their jobs, productivity etc. If you continually go through boom-bust cycles like this, people do not invest. It is too uncertain. Business people do not like to invest when it is uncertain. People do not like to spend when it is uncertain. Why is consumer confidence low? Because they think they are going to lose their jobs.

By using stabilization policy in this direction, we are making business cycles worse, not better. The idea is: "Let's just take it easy. You don't have to spend so high." For example, in the future, when we start getting the deficit or when the economy starts to grow again, will the Ontario and federal governments, because their revenues go up, spend money again? When you have it, you spend it. That is what we are doing. The same thing is going to happen all over again. If you spend money when the deficits come down, you are going to cause this to happen again.

When people start blaming free trade, the GST and so forth for the poor performance of the economy, let's just think about this. We simply had to come down. We could not keep growing like that. That is a very important point.

Second, while we had to slow down this time because of these problems, why do we have to slow down so much? Everybody else was doing the same thing, but we have had a worse performance. The reason we have had a worse performance gets into the structural aspects, and there are a number of policies here that are causing trouble.

One of the biggest ones is called zero inflation. Zero inflation would be nice to have. The lower inflation, the better. However, when nobody agrees we should have zero inflation, the only way you are going to get it is by clobbering people. What has happened over the last three years is that the Bank of Canada has said, "We want zero inflation," and everybody says: "No, we don't want it. We want high wages and high prices." How does the Bank of Canada get inflation down? It causes a recession. It creates a deflationary gap, that big negative in the chart. That is the way we get inflation down in this country. We run big unemployment rates, big deflationary gaps. Not only did we have to get rid of our inflationary gap by slowing the economy down; the Bank of Canada said, "We want to go to zero inflation." Nobody believed them and nobody cooperated, so they have hammered us. That has made our recession extremely severe.

We have just been finishing a study on why the economy's performance was so poor. Quite frankly, it is attributed to monetary policy and zero inflation. It is not free trade. In fact, one of the reasons we wrote the paper is that people were dumping on free trade, saying it is the problem. If you look at what monetary policy does, it looks just like a trade policy. Tight money has the same effects as putting tariffs on or taking them off. What happens when you raise interest rates in this country relative to those in the rest of the world is it causes the dollar to go up. What does that do to our products? It is like putting a tariff on them, so people buy less of them. Also, it acts like a subsidy on imports, because imports all of a sudden become cheap. What monetary policy does is it taxes exports and subsidizes imports.

Why do we have cross-border shopping? It is so much cheaper to go down there and buy it, because of the monetary policy. The dollar has done it. The dollar has gone up 25%, ie, the prices of imported goods are 25% cheaper than they were five years ago. That is what does it. Just think about it. Would you cross-border-shop if the prices went up 25%? I doubt it. There may be service elements in there, but a lot of this can be explained by the type of policies we are initiating.

Anyway, my point is that everybody has done studies on free trade and nobody has really come up with a good scientific study that shows it is as harmful as the people said it was in the paper today. We have not lost 460,000 jobs in manufacturing since the recession started. I do not know where they get those numbers from.

I believe you should have low inflation. I am not criticizing the Bank of Canada fully in this. I think we needed lower inflation. However, what I would like to say is that we should change our policies on it, that we should all try to agree with the policy. If all of us go along with tight money, it is a zero cost. Everybody lowers his wages, everybody lowers his prices and there are no problems. The problem is that nobody gets along, nobody cooperates on policy, and everybody is fighting each other. That is what many people have criticized Canadian policy for. Why is Japan doing so well? They all cooperate. Why is Canada not doing so well? We have an adversarial system. It is as simple as that.

We do forecasts for business people and governments and so forth. We go in there with an inflation forecast of 1% in five years. "Does anybody here believe that is going to happen?" They do not. Neither do you. Well, we may get it next year. But the point is that the reason you do not believe it is why interest rates have to stay high. It has been very costly to go this policy now.

The reason I bring this up is, let's not blow it after we have invested in it; ie, policies in the future. We have invested in thousands and thousands of lost jobs to blow the inflation now. What I am saying is, do not go back and stimulate the economy and do crazy things to get it overheated, because all of the 300,000 manufacturing jobs we have lost will just have been a waste then. At least let's get something for our money, or our lost money. That is another reason why we have had tough times.

Another thing I think is relevant for the future in understanding what is going on is that there has been too much going on. We have had free trade, GST and tax reform. We have zero inflation. We also have a desire to reduce the size of government. I do not disagree with any of those. I support every one of those policies. However, they were all introduced at once they were not explained properly and there are no adjustment packages to go along with them. It is a mess. We do not know whether people are losing jobs because of free trade, GST, tax reform, whatever. We have no idea.

When the federal government introduced the free trade agreement, it said it was going to phase it in over 10 years. At the same time they are going to go to a zero inflation policy. What the Bank of Canada did in one year was to raise the price of Canadian goods by 25%. Who cares about tariffs? They just wiped out all the adjustment. There is no adjustment. You adjusted, boom, like that. You did not adjust over 10 years. It was a joke. It is a coordination problem in policy. We have to get our act together on policy. We cannot be going off in one direction or another direction. It does not work.

I think what we should have done is probably what a lot of people have suggested: Let's go a little bit easier. Maybe we should have gone easier into zero inflation. I think it is worth while to do it. Maybe we should not take such a drastic approach, especially when we are trying to introduce free trade.

The GST is unfortunate. I think it is a good policy, but it is unfortunate it had to be introduced in the middle of a recession. From one point of view, it is unfortunate because it hurt the economy. From the other, it is good because it was not inflationary permanently. It hit it all at once and you got through.


What has happened is that people are extremely confused as to what is going on. They are starting to blame policies that are good for the economy and are saying those should be eliminated. You have people saying free trade should be eliminated. I do not think free trade has really hurt the economy very much. Free trade was oversold. The average tariff rate in Canada and the US was around 3% or 4%. Who cares? Really, it is nothing. The exchange market, like I just said, damaged the trade sector much more than any free trade agreement did. In certain industries there were high tariffs, but not very many. I really think that was oversold but I think it is a good policy. The GST is going to help business.

The important thing to look at here is not actual gross domestic product; it is potential. These policies were implemented because Canada had such poor productivity growth in the 1970s. The Conservatives, in fact the OECD, the whole world was getting into this. They said: "Productivity has been terrible in the 1970s. What is wrong?" They came to the conclusion that it was because governments were messing up the private sector. Governments subsidized things and put tariffs on. What they did was to make the resource allocation in the economy based on government decisions rather than economic efficiency. What was profitable to produce was not based on economics; it was based on what industries government wanted to go. The goods and services tax is a prime example of eliminating that.

The federal sales tax was introduced when there were not many services around, so it was taxing goods. Do you think it is fair to tax goods and not services? Not only is it unfair, but it also causes resources to be allocated from goods production to service production. If it is cheaper to buy services you will buy more services than goods. When you take off the federal sales tax and put on the GST, you remove the bias. Those sorts of things will increase efficiency and the potential GDP. You may like the FST or you may like tariffs as long as they increase economic growth, because we are not going to get any more economic growth in this country unless we increase productivity.

The solution in the early 1980s by the Conservatives, and even the Liberals when they started, was to get these structural policies put in place -- tax reform, free trade etc. These policies were to improve the efficiency of the economy, so I think we need those. The question of how they are introduced is a different issue.

Where are we going? Our forecast is not very optimistic. We see two years of pretty slow growth. Why a weak recovery? For one thing, as I mentioned before, the rest of the world is not doing very well and we do not do very well when the rest of the world, particularly the United States, does not do very well. We are not going to get much support from the United States, so we do not expect that to help us. I think another reason why we are going to have a slow recovery has to do with policy. Fiscal policy is doing what I just said it was. It is operating backwards again.

Monetary policy is still tight. You may think interest rates have come down, but just remember that the difference between interest rates and the inflation rate is a measure of how tight monetary policy is, not the absolute level of interest rates. When the inflation rate comes out at 2% for January and short-term interest rates are still around 7%, the difference is about 5%. That is like it was two years ago. Inflation has come down but interest rates have not; not enough. That is not good for growth. I think that is still a problem.

On the fiscal side, I made up a chart for Ontario here near the back, on your government deficit, and call it the budget surplus. I think it is important to look at this for your decision-making in the future. This is not the official government data. Statistics Canada publishes what is called the Provincial Economic Accounts. They create their own measure of the deficit or surplus and that is what it is. It is slightly different. Lately it has been about $1.5 billion less than the Ontario government's estimates. It is a different accounting system. Anyway, they do move in the same direction.

What I want to show you here is simply what happened to the deficit and how much it is due to the recession. There are two measures of the deficit. One is called "cyclically adjusted" and one is "actual." This is actually the surplus. When you go down it means a bigger deficit. When you look at the cyclically adjusted deficit it takes out the fact that we are in a recession. Where would the deficit be if we were operating at potential output, if you remember my potential output measure, if you are operating at sort of full employment or full capacity?

What you can see is that the actual deficit went from a surplus in about 1988 to about $9 billion in 1991. I understand it may even be revised now. The cyclically adjusted one, ie, if the economy were operating at full employment, is about $2 billion. I should mention that higher welfare payments are included in there as well as higher capital expenditures, so there is some non-cyclical stuff in the expenditures. Anyway, what I have done here is to adjust revenues.

What has happened is that because of the recession, the deficit has gone up by about $7 or $8 billion, so everybody is panicking. You look back and you say that in the previous recession we had just as bad a decline in the economy, but the deficit did not do as badly. How is that possible? You should ask some of the Treasury people to look that up. I worked it out. It has to do with the fact that you are looking at absolute deficits rather than as a share of GDP, ie, the bigger the economy gets the bigger the deficit is going to get in the circumstance.

The reason is that when you increase spending over time, expenditures get bigger and bigger and you have to keep raising tax rates to match those. If you are going to have a policy where you want to increase the size of government, you also have to increase your tax rates, your sources of revenue. As well, over time the economy gets bigger, so what happens here is that when you go into a recession, in this case when you are getting higher tax rates and higher expenditures, when the economy gets bigger, you get bigger deficits. It is called "inflation illusion."

The reason I am mentioning this is that you think it is a lot worse than last time. I do not think it is a lot worse than last time when you adjust for the size of the economy, Ontario's GDP going into the 1981 recession compared to going into the 1990 recession. The nominal GDP was 250% higher in this recession than it was in the last one. Your amount of revenue out of GDP -- your revenue base is GDP, essentially; it is income taxes etc -- gets higher. So you will see your deficit collapse.

When you worry about policy, do not look at actual deficits. Adjust them for the size of the economy. I did not do that here. If you look at that potential chart, the GDP gap chart, what is going to happen here is that when the economy picks up again this is going to disappear just like that. I am telling you that it is falling. Look how far it fell just because of the recession. If you get your gap closed, which we call your output gap, that is going to disappear really quickly.

If you start raising taxes and cutting spending it will help in terms of getting the deficit down, but if your economy ever gets going again you will end up running huge surpluses. Maybe that is good, but what I am trying to say here is to watch out for these big numbers. They are generated by the fact that your economy is bigger and your tax rates are higher than they used to be. You are relying more and more on the economy to finance your expenditures. The bigger your expenditures get, the more your tax rates have to go up and you become extremely vulnerable to cycles.

This is another reason I suggest you watch your stabilization policy if possible; it is not all up to you. This is going to happen to you. It happened to Ottawa in the early 1980s and it is happening to it again, massive changes in its deficits, and a lot of it has to do with the fact that it is just a simple cycle. If the economy can pick up again, you are going to see this deficit disappear fairly quickly. That is one year it did that. It is unbelievable, but the economy fell -- the growth rate was very big -- a big decline.

People were telling you yesterday to ease up, I understand from the radio. I would recommend easing up for two reasons. One is this pro-cyclical problem you are doing -- maybe you are not doing it but whoever it was before was doing it -- and the fact that you can get rid of this deficit when growth picks up. You have lost a lot of jobs in this province. That is a lot of tax base. You have lost a lot of profits. The deficit was not in bad shape three years ago. It has got worse because of the recession. Your deficit was virtually zero on a provincial accounts basis and it was slightly bigger on a public accounts basis.

I think once you get the economy going again, provided you do not go on a -- one of the things you will notice is that what I call "cyclically adjusted" has gone from a surplus to a deficit. That is due to policies implemented by the latest government. They are trying to stimulate the economy with higher investment spending and so forth. Their spending growth is very large. That is why we have gone from a cyclically adjusted surplus to a deficit. The previous government raised the thing to a surplus and then it collapsed again, but once we get the economy going we are not going to have this big deficit problem.

In the meantime, the economy is going to be weak and people here are worried about that. They are worried about the deficit. The federal government is worried about the deficit. It raises UI payments and other taxes to cut spending. I think it is going to make things worse; I do not think it is going to make things better. If it is part of a long-range plan to cut expenditures, that is okay; I agree with that, but why do you not do it in a boom?


We missed the golden opportunity in 1987 and 1988. We could have increased taxes dramatically then and we would have made the economy better off, not worse off, We would have avoided what we are into now. It is hard to believe but it is true. You cannot grow faster than your resources. It is impossible; you cannot do it.

What we see in the future is everybody still worried about this problem, and it is going to cause the recovery to be weak. One of the problems I think we are going to have, and you really cannot do anything about that in this government, is the conflict between monetary policy and what has happened to the Canadian dollar. The Bank of Canada has reduced inflation in this country through one source mainly and that is dollar appreciation. A rule of thumb on the Canadian dollar and inflation is that for every 10% appreciation of the currency you get about 2.5% lower inflation.

This is why the bank is worried about the exchange rate falling. If the exchange rate falls 10% the inflation rate in that year will go up 2.5%. For example, if this year we are running at 2% inflation to start with and the dollar goes down 10%, we will be running a 4.5% inflation. That is why the bank is petrified of the currency coming down.

Of course the dollar has gone up 25%. If you apply my rule to that you realize that much of the disinflation we have had over the past year has not come from workers and firms; it has come from import prices coming down. Our import prices are affected by the currency. They have come down 25% and that is translated into lower domestic inflation.

What the Bank of Canada has to worry about now is whether the rest of us will reduce our demands on the economy. They do not want the dollar to fall, which is necessary, we believe. If you look at the very last chart in my handout you will see what has happened to the current account deficit. It is plotted there as a percentage of the GDP. Again, I use the GDP to take into account the size of the economy. It is the worst we have ever had in the last 30 years. We have never had this bad a current account and the main reason is the dollar. The Bank of Canada was fighting inflation through creating large trade deficits. This is an unfortunate side-effect, but this is what has happened.

What has to happen for the economy to improve is for us to change our cost-competitive position. Cost competitiveness is something everybody talks about. Our view is that the dollar has to come down or wages and costs have to come down to solve the problem. A measure of competitiveness for manufacturing that we come up with shows that since 1986 the Canadian manufacturers' competitive position has deteriorated by about 50%, ie, their costs have increased relative to US costs by 50%. Some of that is because of the dollar, a little more than half, some of it is because of high wage settlements in Canada relative to the United States and some of it is because of our lower productivity. You have seen these charts before.

What has to happen for our trade balance to improve -- and it has to improve; it is terrible -- is that either we have to get the exchange rate down or our costs have got to come down. In WEFA's forecast we are going to have tough times in the next two or three years because the Bank of Canada is resisting lowering the dollar to improve the economy and that is what is necessary. If you do not have the dollar come down, you have to have our costs come down. If we want to go back to the old position, if we want to eliminate that 50% reduction in our competitiveness, that means the dollar has to come down 50% or our costs have to come down 50%. The Bank of Canada would like to see the costs come down 50%. How likely do you think it is that we can get wages down by 50% in this country?

Our view is that the dollar is going to come down and wages are going to come down. Inflation is already coming down. The only problem with that is that as long as the bank wants most of it to come through costs and as long as we do not want it to come through costs, the unemployment rate is going to stay above 10% because what the bank has to do is beat us into submission. It has done that for three years and it will continue to do that until we get our cost structure in line. It is an unfortunate position. Our view is that the dollar is going to go down below 80 cents within three years because we as Canadians cannot accept those sorts of wage declines and we will not get productivity growth. That is another reason why we think we are going to have a weak recovery.

When we look to 1994-95, if the currency comes down and if wage settlements come down somewhat -- not as much as the bank would like to see -- I think we will be okay. Our forecast for 1994, 1995 and 1996 is 3% or 4% growth. But we have two or three years to adjust to the GST, the free trade agreement, tax reform, zero inflation and lower government spending. We have to adjust to these. There are adjusting costs for all these policies and we are going to have to incur them. Unfortunately that is going to hurt us. Hopefully we will benefit in the last half of the 1990s. I think we will. That is our forecast, that we will, but none of us believe these things and therefore we fight them. The more we fight them, the worse it is. I am optimistic, but not for this year and next year.

Mr Phillips: Thank you very much for taking the time to be with us. I do not know where to begin. You are predicting what kind of growth this year in gross domestic product for Ontario?

Mr Stokes: For Ontario, about 3%.

Mr Phillips: And in 1993?

Mr Stokes: About the same.

Mr Phillips: Your advice to us is that we cannot be particularly tough on the spending side at this stage.

Mr Stokes: My advice is simply do not overdo it. I am not saying to increase spending. What I am saying is do not panic and start trying to cut, because one thing you cannot do with fiscal policies is eliminate a deficit. The way the economy works is that for every dollar of spending you cut, you will not get a dollar on your deficit. It has to do with the economic multiplier; that is, if you increase spending by a dollar, the deficit does not go down by a dollar and vice versa, because some of it leaks out. What you will do if you cut spending by a dollar is somebody will get laid off and you will lose some of your tax base. That is in the short run. In the longer run that can change, but in the short run that is what is going to happen. If you cut the deficit by $1 billion, you will not get it back. If you reduce spending by $1 billion, you may only get $800 million, so you are not going to get it anyway. You will not get the full $1 billion. It does not work that way. It never has and it never will.

All I am saying is please do not continue with pro-cyclical policies. Do not make things worse when they are bad and do not make things better when they are good. If you want to cut spending, great. I love that, if you downward trend spending over time. When the economy was strong, you could have grabbed a whole bunch of money out of the economy, no problem, because we were growing too fast anyway. But do not try to grab it when everybody is down and out, because we do not have the capability to give it up.

Mr Phillips: The challenge with your recommendation is that you are looking at real growth in the next four years averaging maybe 3% or something like that.

Mr Stokes: Yes.

Mr Phillips: That translates to revenue increases of less than 3% each year, unless you increase taxes. If you leave your taxes at the same rate, your revenue growth will average less than 3%, so your prescription here is for perpetual deficits. If you are looking for ways of getting the economy rolling again, I think you are saying you have to get your fiscal policy in balance. The challenge with your recommendation is your prescription is for deficits that never begin to trend down.

Mr Stokes: No, I am not saying that. What I am saying is the optimal time to reduce your deficit is not at the bottom of the cycle. Eat the deficit for a couple of years. You can still try to reduce it a bit. You can cut back, but wait until the economy is growing. When you get the economy growing at 3% for a couple of years, then raise taxes or tax spending.


Mr Phillips: We have a different opinion of how much cash that throws off. You said that will look after the deficit.

Mr Stokes: A lot of it will. What you need is to get Treasury to do a good analysis of this.

Mr Phillips: They have. I think there is a well-accepted model that the revenue goes up at 90% of the gross domestic product increase. That is a well-proven model that has been used and has stood the test of time for 20 years.

Mr Stokes: Yes, but you have to remember I am not saying to cut spending. By cutting spending, I mean do not increase it faster than you should. I am saying static spending. I am not saying to cut spending. The difficulty with evaluating this is you have some view of where spending is going in the future, and if you think that is 5% a year, I am telling you that is crazy. If your forecast is 5% expenditure growth per year for the next few years, then you are way out of line with the inflation targets of the Bank of Canada. What I am saying is, given what spending is now, do not try to reduce it. If you kept zero real growth on expenditures, what would happen over the next few years?

Mr Phillips: The deficit would go down by about $1 billion a year.

Mr Stokes: Without your revenues?

Mr Phillips: That is with your increased revenues, based on your economic forecast. So your deficit would go from $9 billion to $8 billion to $7 billion to $6 billion. Of course I am not taking into account the increased costs of servicing the debt.

Mr Stokes: That will come in, but what you have to remember is if interest rates remain low, that debt servicing cost gets a lot lower too.

Mr Phillips: That is what we all thought, but next year I think the debt servicing cost will probably --

Mr Stokes: The problem is that when you look at your expenditure growth, it is 13% or 14%.

Mr Phillips: No, I used your model of zero increase.

Mr Stokes: What I am saying is that is what has happened. When you have a 13% increase in expenditures, your deficit is bound to go crazy. I am not saying to cut spending. Well, if you assume it is 5% a year, then I am saying to cut spending, ie, keep growth in your expenditures low relative to your GDP. If your GDP grows 3% a year in real terms, keep your spending at zero.

Mr Phillips: I am assuming you do that. I am just saying to you that you make very little dent in your deficit numbers because your revenues go up less than the gross domestic product increase.

Mr Stokes: I have not looked at Treasury's economic model, but I would like them to explain to me how we fell so fast then. There was a 2.5% decline in the economy. How far did the revenues fall?

Mr Phillips: The reason is that last year when the budget came out there was a general acceptance we would be looking at real inflation rates running in the 3% to 4% range, but there was no recognition of that and so the spending was predicated on continuing with salary settlements in the 5% to 6% range.

Mr Stokes: That is part of what I am saying. I do not understand why the deficit got so big. That is the question to ask. Let's see some accounting. If you use the rule that revenues increase by 90% of the GDP, then revenues should have fallen less than the 2.5%.

Mr Phillips: Revenues essentially stayed the same. They actually decreased because the economy decreased.

Mr Stokes: That is what I am saying. They should only decrease by the same rule as when they increase.

Mr Phillips: They did. That is what I am telling you.

Mr Stokes: So your problem is expenditures then?

Mr Phillips: Yes, exactly.

Mr Stokes: But that is what I am saying. I am saying do not cut spending in that sense. Keep your expenditures at least flat. You can gradually cut them. What I am getting worried about is trying to slash them by 10% or 15% or something like that. I am not talking about that sort of thing, 10% or 15%, but you could just hold your expenditures in line.

Mr Phillips: I think you can go to sleep easily tonight. They will not be cutting by 15%.

Mr Stokes: Okay.

Mrs Sullivan: I want to ask you in particular about your firm, about the kind of counsel you provide and to what kinds of clients. Have any of those clients decided that the corporate world is no longer appropriate for them in Ontario? Are they seeking to move or to cut back on their capital investment?

Mr Stokes: We have clients from big business mostly, large firms and governments. That is our client base: very large corporations and governments. What we see is probably what you read about. Most of our clients are cutting back. We are losing money of course too. They are all cutting back. None of them that we have talked to have talked about moving. They all complain about tax policies and so forth, but they have just cut back like everybody else is cutting back. I do not think the Canadian cutback is much different than the US cutback. There is the world competitiveness issue and everybody is cutting back.

I guess the other question is, has anybody phoned me and asked about moving to Ontario? You are in Ontario and you have a big fixed cost of being here. It is a major decision. I get phone calls from clients in the US. We are an international firm so we have offices all over the world and people ask me what the environment is here. I really cannot recommend to them to invest here right now simply because -- I did not even talk about one thing and that is the Constitution.

Ontario is important, but I think there are other factors as well. There are always general complaints about too much government. I complain about that too, but I do not see any major problems that way. There are people who are worried about the labour legislation and so forth. I think that is a major concern of business right now. I am sure most of them have told you that.

Mr Carr: I agree with a lot of what you are saying in terms of how we sacrifice long-term planning in a lot of cases for political expediency. All parties do that. One of the problems I see when I look at this government is that they said last year that what we needed to do was stimulate the economy and throw $700 million in, and this was the answer. Then of course we zigzagged and it became, "We have to cut now." What happens is many people get cynical. They say: "You don't have any long-term direction. You don't stick to it." That scares people. I think a lot of it is because a lot of politicians do not appreciate the economics.

Just in the broader sense, and excluding the people from Oakville South because this fine gentleman is from Oakville South and we all know those people are well versed in economics, what is your perception of the average person's --


Mr Carr: That is why I got elected, and we will not ask him how he voted. We are talking about a complicated instance and I will give you an example. You talked about free trade. I worked in the customs brokerage industry prior to free trade. You are right that the tariffs were low, but 80% of the product came in without duty. Of course the people opposed to it said they were going to blame every robin that falls out of the tree on the free trade agreement. What I think is part of the problem is that politicians try to muddy the water for political reasons. What is your perception of the general public's grasp of the economic situation? Do they understand it, appreciate it and what can we do to improve it?

Mr Stokes: Quite frankly, I think it is too complicated for most people. I think a lot of economists do not understand it. There are a lot of things going on. The average person does not understand the economics of free trade. The average person does not understand the economics of the GST. You have to have a reasonable amount of knowledge about economics before you can understand those issues and the implications of them.

One interesting thing about economists is that economists are very good at talking about long-term effects of policies, but we unfortunately do not have a very good idea of how we get from here to there. These are the adjustment issues I was talking about. We tend to neglect the adjustment issues at the expense of the long-term goal. If we implement all these policies, we all thought, "Let's just put all of them in the economy and we will see whatever comes out," and that is what we did. They are extremely disruptive, mainly because what they do is change the type of products that are produced, the type of labour that is demanded and all sorts of things like that.

If you look at the GST -- this is why it is going to be complicated -- I talked about a change in the demand for goods relative to services. People who work in the goods industry are going to do better and the people who worked in the services industry are going to do worse.

Under free trade, some industries had high tariffs and some did not have any, so the industries that had high tariffs that were protected are in trouble and unless they make adjustments those industries are going to go out of business. There are quite a few; I think of the furniture industry and a few others. Most of us predicted those industries were going to go out of business.


The early tax reform: Some industries were being taxed at higher rates than others. If you level the playing field, you put some of those out of business and introduce others. You are causing the resources in the economy -- capital, labour and so forth -- to be moved from one sector to another. You are getting three or four different policies that all have different resource allocation implications and you are not sure what is happening. The reason you cannot tell what is happening on free trade is because of the GST, and the reason you cannot tell what is happening because of GST is tax reform or lower government spending. It is all mixed up in there and it is extremely difficult. That is why I am saying the people are absolutely confused.

Mr Carr: I agree, and it is not only the particular issues, it is almost that governments are heading in different directions. One government is heading in this direction because of political philosophy, and we have 10 provinces. What I had hoped would come out about the Constitution is some clear lines because we are pulling against each other in opposite directions. Then, of course, we try to coordinate with finance ministers getting together and political things get in the way.

Your recommendation for the provincial government with regard to the next budget and taxes: Appreciating what you have said, that we have always done it wrong in the past and may have done the exact opposite, looking at the economy as it is right now with Floyd going to bring the budget down in the spring, what would your recommendations be with regard to taxes? I am thinking of the provincial sales tax, the corporate tax and all the various taxes? What would you recommend to him?

Mr Stokes: I would try to be neutral. The stimulated stuff may help somewhat and I guess it depends on how bad the economy really gets. If you are relatively neutral, I think it would be a good policy even politically because everybody will hate you if you go one way or another anyway. If we had done things right we could have stimulated now, but we did not do things right so we cannot stimulate now. How do you get out of this? Probably you would be very cautious about it. Do not cut too much and do not increase too much and sort of try and go through the middle. I know people are going to yell at you because of your deficit size, but we have to remember the feds' deficit went from $10 billion to $25 billion in the last recession.

The Vice-Chair: I am sorry, Mr Carr, I cannot allow you another question. Were you done with your answer?

Mr Stokes: All I was going to say was that the federal government has the same problem you have now. You are going to end up with this big deficit and how do you get out of it? That was your point. You are going to have to work slowly out of it. You cannot eliminate it immediately. You will not get the bang for your buck. If you cut spending or increase taxes you will not get the money back. You will just hurt the economy and you will not get out of it.

Mr Johnson: A most interesting presentation: You are right that many variables have to be taken into consideration when you look at the economy. Having a sincere interest in economics and having actually studied under Sid Ingerman at McGill University -- I did not study there but I studied under him for a short period of time -- I have come to believe in Keynesian economics. It has never been practised consistently, and only in part, by governments. That is the problem. If it were practised consistently through the boom-bust cycles of economies, it would have the levelling effect it is supposed to have, but it has never really happened.

This government has tried to do that or tried to take some initiatives that would suggest Keynesian economics, and that is by going into the deficit we are in. I think that is good. I believe what you have said, that we will come out of this deficit, albeit maybe slowly. One thing you said was that this recession is not worse than the one in 1982, and as I look at your graphs I can see why you would make that comment.

Mr Stokes: I said "as yet."

Mr Johnson: Then the question is, could it not at some later point be determined to be worse because of duration and the rate of frequency?

Mr Stokes: If you look at that GDP gap chart, in 1982 there were only two bottom lines. What you could see is a number of them underneath "potential." What you worry about is the sum of those differences. Your recession may not be as severe in its depth, but if it lasts longer then it is just as bad. In fact, when you want to get into discussing depression, a depression is a recession that lasts longer. That is what I am saying: It has not been determined as yet that it is worse, but if things do not pick up, it certainly could be.

Mr Johnson: What do you think? I will tell you what I think. The government could allow the deficit to become larger. You know what my ideology is. This is not a problem because I think the province has the potential to pay down that deficit over a period of time. I wonder if you could be a little more specific with regard to your opinion on allowing the deficit, in the next year, to go to $15 billion, for example.

Mr Stokes: It would be unfortunate if it had to. I would prefer it if interest rates were to get to reasonable levels and people pick up on their own. Ottawa found out what happened to a cumulative debt problem in $50-billion interest payments. I would hate to see Ontario end up in the same position because you will pass your troubles down to your children and their children. I am worried about that because it limits your ability to change the economy. If you have these big debt-servicing payments -- the federal government now has a balanced budget on its program spending.

Mr Johnson: They did not send us the $3.7 billion they were supposed to.

Mr Stokes: We have a debt stock problem. Our revenues are covering our spending in terms of programs at the federal level; what we cannot cover is the debt payments. What is going to happen to Ontario is that if it does the same thing, its revenues may cover its -- if we did not have this debt payment, we would have plenty of money left over. Tax rates are so high now because of the debt problem.

If Ontario is not careful it will slip into that mess. What made it worse, of course, for the federal government was that it keeps using monetary policy to fight inflation. If you keep using monetary policy to fight inflation with the high-debt stock you are in big trouble. If the monetary policy had been easier, in the study we are doing we indicate that the feds could have knocked $20 billion off their deficit by now if they had used a different policy mix.

If you had slowed the economy down by reducing spending and raising taxes, you would not have had the same problem at all. Even if you cut your deficit it may not do you any good because you do not get one for one. By cutting your deficit more, if you drag the economy down when you are doing it, which you will do -- no economist will tell you, unless you are a supply sider and they were completely wrong. If you do that, you will not get the money out of it. If you reduce spending by $5 million, you will not get it because you will take $5 million out of the economy and you may get $4 million or $3 million back.

Mr Johnson: In a nutshell, what is your best advice to the Treasurer today, given the circumstances he finds himself in?

Mr Stokes: I would just try and be cautious. I would try not to let the deficit get out of control, but not to overreact because then you are getting into the problem I just mentioned. You are making the cycles worse. We are getting impatient. This is what governments do every time: We get impatient. We got impatient to get inflation down in 1981 and drove the prime rate to 22%. It devastated the economy. The Bank of Canada this time was impatient to get to zero inflation and we are in a mess again. We got impatient in 1982 about getting the economy going and we overstimulated it. We are getting impatient about getting the economy going now. What are we going to do?

Mr Johnson: That was my question.

Mr B. Ward: Slow and easy; maintain the course.

Mr Stokes: That would be my advice. You are going to be stuck with this deficit; you have no choice. You inherited it to the extent that you have a huge recession imposed on you. It is really not your fault. You cannot reduce the deficit in a recession.

The Vice-Chair: I want to thank you very much for coming in. I know there are plenty of other questions including some I would not have minded asking, but our time has run out. We want to thank you very much for making a contribution to our discussions on what is happening and certainly for giving us a different perspective on how government finances should be operated.

Unless there is any other business, this committee stands adjourned until February 10, when we will continue pre-budget consultations with specific groups. In the agendas you were given, the ones who have confirmed already -- I believe there were four or five more -- we were still waiting to get confirmation from for those two. Probably a good portion of the Wednesday will be spent on that and then we will have the day on the budget.

Mr Phillips: Do you know when Chairman Ron will be back?

The Vice-Chair: Chairman Ron is in his riding today. I believe he has a special visitor. Premier Bob is down there. That is why he is not here today. He will be back.

The committee adjourned at 1600.