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Setting the Scene: The Post-WWII Canadian Economy David W. Slater “Canadian history is a success story — an account of coping with troubles and triumphing over adversities. Although the years since 1945 have contained their shares of disappointments, they have been more successful than most.” — Bothwell, Drummond, and English, Canada Since 1945 T he history of business economics in Canada really begins only after the Second World War. Before then, the number of business economists in Canada could almost be counted on one hand.1 The Second World War and the reconstruction period that followed gave a great impetus to the profession of business economics. During the war, economists, although few in number, played prominent, even decisive roles in many wartime operations.2 The main centres of such activity were the small but powerful staff of the Bank of Canada; the even smaller but more powerful staff of the Department of Finance; the economic planners and managers of the Foreign Exchange Control Board and the Wartime Prices and Trade Board; the key Munitions and Supply Department, run by its legendary minister, C.D. Howe; and a small group at the Dominion Bureau of Statistics (as Statistics Canada was then called). After the war, the building and use of the national income and expenditure accounts was an important milestone in the development of economic research by providing a major framework for economic planning and policy. One of the first organizations to use it extensively was the Economics Branch of the Department of Trade and Commerce. The branch evolved out of the efforts of Dr. W.A. Mackintosh, originally a Queen’s University 6 economics professor (and, later, the university’s principal), who had played a key role in the Department of Finance during the war. Mackintosh was given a mandate to establish a major economic research group for the Department of Reconstruction and Supply under Howe. In 1947 the department’s name and function were changed. It became the Department of Trade and Commerce, with Howe as its minister. He insisted that the Economics Branch be retained as an important part of the department. In addition to the key role it played in developing forecasting within the government, the Economics Branch also made business/government linkages a much more important activity than they were before the war. This development was facilitated by the fact that many successful businessmen of the postwar period had served during the war in Ottawa as colleagues of members of the Economics Branch. This business/government interaction was especially important for the development of the many economic and social programs in the postwar years. The rapid expansion of economics in government served as a model for the private sector. With the growing complexity of the rapidly expanding postwar economy, interest in what economics could do for business firms mushroomed. The magnitude of that development is illustrated by the relative growth of the business economics profession. While Canada’s real gross domestic product (GDP) in 1993 was about seven times greater than in 1946, the number of economists in government and the private sector grew much more rapidly during that period. According to my memory of the early postwar years, there were then no more than 100 economists at work, with only a handful in the private sector. By 1993, it is estimated that there were almost 4,500 active Canadian Business Economics Winter/Spring 1997 applied economists, with about 3,500 in government and 1,000 in the private sector (Hoicka, 1995). It would be an exaggeration to credit economists with the country’s postwar economic success, but there is no doubt that they did contribute effectively and importantly to the rational analysis and common-sense policy developments of firms, industries, and the economy as a whole. In addition, they played a key bridging role between business and government in the complex mixed economy of the postwar years. They also served an educational purpose by providing advice and assistance to the judiciary and the regulators who needed to become economically literate. Four Features of Postwar Canadian Economic History In one of the best recent economic histories of Canada, Norrie and Owram (1991) have set out four features of the postwar years: The first ... is ... significant growth and structural change. Today’s economy, when compared to that of 1945, is larger, richer, and much altered. Technology has made it possible to produce ever-greater quantities of grain, lumber, ore, steel and automobiles with less labour. Instead, workers have found employment as retail clerks, data-processors, teachers, nurses, and research scientists. These new jobs are mostly in cities and, relative to the past, are increasingly taken by women and by visible minorities.... Second ... even in the midst of this structural change, much in the economy is unchanged. We remain a small, open society, be it with respect to international commerce or to ideas and ideologies.... Third ... in terms of overall macro-economic performance, the years between 1945 and the early 1980s divide naturally into two distinct periods. The first ran from the end of the war to the early 1970s and the dominant Winter/Spring 1997 characteristics were growth and prosperity. An initial period of uncertainty as postwar reconstruction was underway was followed by more than 20 years of sustained, albeit uneven, economic expansion.... Performance alt e r e d d r a m at i c a l l y af t e r 1 9 7 3 . Economic growth fell off sharply, inflation and unemployment rates rose, and government deficits soared. Was the “golden era” of Canadian economic performance during the first three postwar decades the norm and the subsequent two decades an aberration — or the reverse? The fourth point is that the turnaround in economic performance in the 1970s was accompanied by a distinct shift in attitudes to economic management. Mu ch ha d be en expected of government in 1946. The success in restructuring the economy to meet wartime needs seemed to indicate that it could be similarly engineered to meet peacetime challenges. New Keynesian [policy approaches] promised to even out business fluctuations. Ambitious programs for health, education and income-security were planned to ensure that some of the fruits of the growth and prosperity flowed to the less fortunate in society.... The economic difficulties after 1973 seriously challenged this faith in economic management. Themes Underlying Canada’s Postwar Economic Growth Consider first the “golden era” of Canada’s postwar growth — the period between 1945 and the early 1970s. The standard explanations for the strong growth in that period have been built on three elements. One follows the Innis-Mackintosh thesis about Canadian growth being founded on export staples, which, with minerals and energy, continued to be important after the war. The second element was the stimulatory effect of government and government-assisted megaprojects, such as the Trans-Canada Highway, the St. Canadian Business Economics 7 Lawrence Seaway, the Quebec North Shore and Labrador Railroad, and the oil and gas pipelines. The third was a large inflow of foreign savings into direct investments in Canada. Related to these developments was an intensification of the Americanization of the Canadian economy, brought on partly by capital inflows. As well, despite major efforts at the end of the war to recapture and expand Canadian markets in Europe, trade with the United States became dominant. Canadian tastes and economic institutions became more American. Indeed, even by 1947 it had become clear that in the face of exchange controls and trade barriers in Europe and other overseas markets, Canada was being forced to strengthen its economic relationships with its big southern neighbour. Fortunately, U.S. growth performance was extraordinarily strong during the postwar era. In addition to the above explanation, two factors contributed to Canada’s strong postwar economic performance. First, Canada and the United States were the only two of the world’s major industrial economies whose infrastructures significantly expanded during the war and were not devastated by it. Second, there were strong indigenous forces behind Canadian postwar growth, many of them rooted in Canada’s wartime experience or in its private as well as public efforts at postwar reconstruction and development. The domestic economy was not just an adjunct of the export, megaproject, and foreign investment activities. Domestic forces of economic development were important in their own right. Domestic Economic Growth The Canadian economy changed fundamentally between the beginning and the end of the war. It became more productive and more diversified, and it had a more confident, skilled labour force, as well as a set of institutions that were more conducive to sustained domestic growth. During the war, real output per worker increased by one-third, and total real output by two-thirds; in other words, productivity had increased at a compound rate of nearly 5 per cent per annum and output by 10 8 per cent. Product specialization and the development of new industries were both important elements of wartime economic performance. Canada produced huge quantities of a limited number of goods, thus gaining large economies of scale. Canada also introduced, or expanded from small beginnings, such industries as aluminium smelting and fabrication, and the production of synthetic rubber, synthetic fibres, ball bearings, antibiotics, high-octane gasoline, aircraft frames, electronics, and optical glass. In addition, Canadian steel and truck production expanded greatly. Furthermore, Canada’s productivity levels did not fall off significantly at the end of the war. Indeed, after a pause productivity continued to grow at rates that were high for a peacetime economy, well above their longterm average. Annual growth rates in real output per employed person exceeded 3 per cent. This development was somewhat surprising in view of two potential drags on the postwar economy. The first was the burden of a huge postwar redeployment of the labour force: at the end of the war Canada had three quarters of a million people in war industries and a similar number in the armed forces, out of a total labour force of just over 5 million. The other potential drag was the continuation of the high trade barriers of the 1930s; it was well into the postwar period before these barriers began to come down. For these reasons, many expected the Canadian economy to return to the more diverse, small-scale production patterns that had characterized the interwar period. As it turned out, however, these factors were offset by positive influences. The surprisingly strong postwar productivity performance reflected several factors. Both the military and war production efforts during the war improved the skills of the labour force. Large contributions were also made by the educational programs for veterans after the war. Immigration increased, bringing relatively highly skilled workers into the Canadian labour force. For the first time in the country’s history, there was a fully developed, internal migration network.3 Canada also shared in the cumulation of under-applied technical knowledge inherited from the interwar and war periods. More importantly, it Canadian Business Economics Winter/Spring 1997 was in a better position than most countries to take advantage of these opportunities. Increased productivity was particularly evident in the agriculture industry. The postwar mechanization of Canadian agriculture was part of the reason for an astounding increase in output per agricultural worker and a rapid decline in the farm and rural population. At the end of the war, the employed agricultural labour force was over 1.1 million persons, or more than 20 per cent of the country’s labour force. By 1961 that number had been cut almost in half. In 1945, fewer than a quarter of the farms in Canada had tractors; by 1961 over 80 per cent had at least one. The transition from power furnished by horses to internal combustion engines took place rapidly. Canada had nearly 2.5 million horses at the end of the war, but only half a million in 1961. Other factors contributing to the large increase in agricultural productivity were the increased size and scale of farms; the use of insecticides, pesticides, and fertilizers; and improved transportation and access to external markets. Increased productivity also came from developments in the transportation, housing, and capital-investment sectors. The automobile (and truck) became the dominant mode of transport, except for heavy, low-valued bulk goods. Between 1941 and 1951 automobile ownership increased only marginally; 36.7 per cent of Canadian households reported owning one in 1941 compared with 43 per cent in 1951. But by 1961 the automobile boom was on in earnest; 68.4 per cent of Canadian homes boasted at least one car (Bothwell, Drummond, and English, 1989:142). Automobile registration was about 1.4 million in 1946, but by 1966 it was 7 million. The country’s road systems, both urban and highway, also expanded rapidly in the postwar period. At the end of the war only 17,300 miles of the improved roads were paved; 144,000 miles were gravel or crushed stone, and 420,000 miles were simply earth. Between 1945 and 1960, four times as much building of paved roads took place as had occurred between 1929 and the beginning of the war. By 1975, 149,400 miles of roads were paved, 255,200 were gravel or crushed stone, and only 107,000 were earth (Urquhart and Buckley, 1965). Winter/Spring 1997 One of the greatest scarcities at the end of the war was housing. In fact, the nation’s housing stock was lower in 1945 than it had been in 1929. In the first 15 years following the war, 1.6 million new housing units were built — an increase of roughly 50 per cent in the total housing stock. Moreover, most of the new housing met the minimum standards of the National Building Code. Even with this effort, however, Canada’s per capita stock of housing did not surpass prewar levels until well into the late 1960s. Capital investment from domestic sources was also an important factor in postwar economic growth (Urquhart, 1988). While there were significant net foreign capital inflows in the mid-to-late 1950s and the late 1970s, the dependence on such inflows for the high amount of investment activity that occurred in Canada in those years was much less than during other periods of high investment. To put the matter differently, the bulk of postwar investment was financed by Canadian domestic saving. (Net capital inflows, however, became a much larger factor in the 1980s and 1990s.) To sum up, while resource-based export staples continued to make favourable, though uneven, contributions to Canada’s growth throughout the early postwar period, domestic indigenous contributions were proportionately larger than they had been during the first half of the 20th century. The details of the domestic developments are easy to identify, but what were the fundamental forces and policies at play? What Forces and Conditions Led to the Postwar Burst of Indigenous Canadian Growth? The answer to this question is somewhat speculative because the forces at work involved confidence, attitudes, objective conditions, programs, and policies. Some personal speculations follow: • The strength and diversity of Canada’s industrial contributions to the war effort, as Canadian Business Economics 9 • • • • • • 10 noted earlier, provided momentum for solid postwar performance. The new industries that had been developed and the new plant in older industries were useful and profitable in the postwar period, with few exceptions. Canadians gained confidence in introducing new technology in production. This was particularly noticeable in agriculture. The National Research Council, which had been such an important factor in wartime technological advances, continued to make similar contributions after the war. Innovation — i.e. the introduction of available technologies (foreign as well as domestic) into production processes and marketing — increased significantly. Much richer and more effective networks of suppliers and subcontractors had been built up during the war than existed previously, and these continued to be used after 1945. As noted earlier, the wartime links between business and government were continued under Howe’s postwar Reconstruction and Supply, and then Trade and Commerce, departments. Close relationships also continued between business and the Department of Finance and the Bank of Canada. A generation of Canadian engineers and managers had gained experience and confidence from their wartime activities, which they carried into their postwar civilian roles. Having used industrial incentives, subsidies, and support for infrastructure effectively in the wartime Munitions and Supply programs, the federal government continued to provide help for business after the war. Indeed, in the postwar reform of the corporation income tax, Canada built in much more generous depreciation allowances than existed in the United States (Perry, 1969). Perceived gaps in Canadian capital markets were filled, at the end of the war, by • • • • • the establishment of the Industrial Development Bank, the farm improvement loan programs, and, late in the period, the Export Development Corporation. The revamped and enlarged Central Mortgage and Housing Corporation (CMHC) and its extremely effective participation in mortgage lending and insurance were of immense importance to the postwar Canadian housing program. The National Housing Act was a major contributor not only in improving housing standards, but also in promoting effective town planning and the provision and financing of urban infrastructure. The release of the refundable portions of wartime income taxation was obviously important. The maintenance of the low wartime interest rates facilitated the gradual liquidation of the public’s accumulation of war bonds and aided in the funding of postwar business and personal investment. The successful management of the massive wartime fiscal, monetary, and debt programs provided both to the government and the public considerable confidence that Canada could attain a high and stable level of employment and income. This confidence was reinforced by the White Paper on Employment and Income (1945) and by other postwar plans for reconstruction. Canada systematically pursued a more open and stable multilateral system of international trade and finance, through the International Monetary Fund, the World Bank, and the General Agreement on Tariffs and Trade (GATT). And last, but far from least, was the important contribution made by the rapidly expanding numbers of economists employed in government and industry. To sum up, a conjuncture of circumstances, attitudes, programs, and policies gave a strong thrust to Canada’s successful postwar economic growth. Canadian Business Economics Winter/Spring 1997 Inflation and Disinflation, Slow Growth and High Unemployment Now we turn to the years after the “golden era.” While those years included some years of good economic performance, the overall story has been disappointing in many respects. Inflation rose to double-digit rates in the mid-1970s, resulting in serious trouble for the economy; price and wage controls were imposed for a time; massive monetary restraint was instituted in the early 1980s; productivity and real income growth, fell to historically low levels; unemployment rates grew in each successive business cycle; financial instability increased significantly with the failure of a number of financial institutions; and governments were overwhelmed by growing deficits and debts, thereby weakening the use of active fiscal policy. Why Have the Last 20 Years Been so Different? Despite hundreds of articles and many books examining this question, the jury is still out on the question of why the last 20 years have been so different. The stylized facts, summarized below, are generally acknowledged, but they are not the fundamental explanations. • First, inflation, which increasingly affected the G-7 countries, became relatively severe in Canada during the mid-1970s. In a leap-frog sequence, both business and labour expected to be bailed out of accelerating costs by inflation. Household, business, and government debtors all expected to be rescued from their inflationary actions by more inflation. Central banks, grossly underestimating the expanding liquidity arising from institutional changes in financial systems in Canada and the other G-7 countries, made the wrong moves to counter the large oil price increases of the mid-1970s. Inflation accounting proposals did not Winter/Spring 1997 take hold, either in the practices of individual companies or in public policies. Valuations of earnings and capital were thus exaggerated by accelerating inflation expectations. In all, it is very clear now that when inflation works its way into every nook and cranny of an economy, it will take a long time and great pain to eradicate it. • Second, the golden-era pace of economic growth was incorrectly expected to continue to be the norm. In Canada, the staple industries were expected to provide additional growth and large and increasing economic rents. Megaprojects would provide the basis for future growth, mainly in the resource-based industries. Housing starts, office space, and shopping malls were expected to continue to expand, justified by optimistic growth expectations of Canadian households and businesses. The Canadian financial system believed these expectations and financed the property booms. Unfortunately, many of those expectations were not justified since golden-era economic growth was sui generis, with the average performance of the last 20 years nearer the norm. In many cases, this resulted in heavy job and financial losses. • Third, while no new major social programs have been adopted since the mid1970s, the costs of those already in place have increased more rapidly than GDP. Health care, education, welfare programs, unemployment insurance, and the reduction of regional disparities have all become relatively more costly. The burden on taxpayers increased significantly, but even with steep tax increases, the federal government ran a deficit in every year after 1974 — in fact, a very large deficit in each year of the past decade and a half. The debt burden eventually became so large that cutbacks, with the resulting fiscal drag, became a feature of policy. Program reductions were the norm, and activist fiscal policies became impossible. Even program initiatives or improvements with public support had to be delayed or scrapped. The highway system and the urban infrastructure, for example are deteriorating because of lack of funds. Canadian Business Economics 11 • Fourth, real rates of interest after 1980 have become high by historical standards throughout the world, partly reflecting the trend towards large government deficits. In addition, in Canada the comparatively more rapid growth in government deficits and the increased political uncertainty associated with the possible separation of Quebec led to a widening of Canada/international interest rate differentials. This has meant that for new investments, the hurdle rates for favourable decisions have increased. For governments, with their large deficits and debts, high interest rates have added to the real burden of debt service. No consensus has yet emerged on Canada’s prospects after the painful shake-out that is now under way is completed. Many question marks remain. Among other things, the benefits of the revolution in information technology have yet to be fully realized. The dramatic increase in productivity and jobs from the free-trade agreements have been difficult to document. The years of cost-cutting in business have so far yielded limited gains in productivity and profitability. The barriers to interprovincial trade have turned out to be persistent. Government efforts to reduce deficits and the debt burden will be with us for some time yet, with the resulting drag on growth. If our heavy dependence on foreign capital inflows continues, we will require higher real interest rates than those in other major industrial countries. How, then, can prospective performance be improved? Will low-inflation monetary policy deliver on its promise of increasing real growth? Will governments be successful in reducing their deficits and thereby lessening the fiscal drag that has been plaguing the economy? Will real interest rates fall below real growth rates so that the reduction of governmental deficits and debt-to-GDP ratios will become easier? Can unemployment be substantially reduced? And how can the incipient crises of income and health care for the en- 12 larging proportion of the aged population be met? In coming years, economists in both government and business will be called upon to provide analysis and advice to assist in the favourable resolution of these issues or, alternatively, to anticipate potential problems facing organizations as a result of their nonresolution. Clearly, these dilemmas will provide a huge challenge for the profession. Some Concluding Thoughts The postwar golden era of the Canadian economy was also a golden era in the development and influence of business economists. The last two decades, on the other hand, have been tougher sledding for both. To their credit, business economists were early and persistent critics of policies that were leading to trouble, most notably mounting government deficits. To a great extent, however, their warnings fell on deaf ears. Ironically, they were caught up, to some extent, in the rounds of cost-cutting and restructuring that have resulted. For much of the postwar period, academic economics and business economics grew apart. But more recently, renewed or new work has begun to bridge the gap. The work on economic growth by Richard Lipsey, Paul Romer, and others is based more on the historical record of the real world than on neoclassical growth theory. Long-cycle analysis has had a regeneration. The Lucas expectational models provide a powerful framework for dynamic micro and macro analysis of events, policy, and performance. The rich data bases developed by Statistics Canada and the power of electronic computing have enormously expanded the capacity for analysis. Business economists, therefore, have new ideas and new tools to improve their usefulness. With the formidable challenges that lie ahead, these should help them regain some of the momentum they experienced during the golden era. Canadian Business Economics Winter/Spring 1997 Notes References 1. Douglas Gibson and Gilbert Jackson made a name for themselves at the Bank of Nova Scotia in the 1930s. Before that, in the 1920s, a Canadian, W. Clifford Clark, had become a successful business economist in the United States, where he was the vice-president and chief economist of a major mortgage banking firm. After returning to Canada he became one of this country’s greatest deputy ministers of Finance, serving between 1932 and his death in 1952. But the first business economist to work in Canada was Graham Towers. He began his career in economics with the Royal Bank in 1920. Then, in 1934, he became the very successful founding Governor of the Bank of Canada. 2. For a detailed discussion of the role of economists in Ottawa during WWII, see Slater (1995). 3. Mobility was increased by the experience of the massive movements of armed forces and munitions workers during the war; by the establishment of the National Employment Service; by improvements in transportation and communications; and by increased accessibility of postsecondary education. Bothwell, Robert, Ian Drummond, and John English (1989) Canada Since 1945, revised edition (Toronto: University of Toronto Press). Harvey Perry, J. (1969) Taxation in Canada, third edition (Toronto: University of Toronto Press). Hoicka, John (1995) “Restructuring the Economics Profession: From Specialist to Generalist,” Canadian Business Economics, Vol. 3, No. 2, Winter, pp. 63-74. Norrie, Kenneth and Douglas Owram, (1991) A History of the Canadian Economy (Toronto: Harcourt Brace Jovanovich. Urquhart, M.C. (1988) “Canadian Economic Growth 1870-1980,” Discussion Paper No. 734, Queen’s University, Department of Economics, November. Urquhart, M.C. and Buckley, (1965) Historical Statistics of Canada (Toronto: Cambridge University Press). Slater, David W. (1995) War Finance and Reconstruction: The Role of Canada’s Department of Finance, 1939-46. Winter/Spring 1997 Canadian Business Economics 13