The free-market hasn’t delivered on productivity

by Alex Paterson. Posted February 23, 2012


In the initial postwar decades, Canada’s economy experienced a historic leap forward, qualitatively and quantitatively. Strong business investment, rapid industrialization, and massive spending on public infrastructure propelled growth and productivity. We went from being poor cousins to our American neighbours, to virtual equals: productivity in the business sector rose from 70 per cent of U.S. levels in 1946, to 90 per cent four decades later. And as Canada built a stronger social safety net and more equal income distribution, the quality of life for most Canadians surpassed U.S. levels.

In the 1980s, Canadian policy-makers became concerned with how to maintain that momentum. The famous Macdonald Commission, influenced heavily by market-oriented economic analysis, made two core recommendations in this regard. Canada’s social welfare programs should be rationalized to reinforce labour market discipline. And we should pursue comprehensive free trade with the U.S., to expose our firms to the full force of competition and eliminate our remaining 10-per-cent productivity disadvantage. The proposals were fiercely debated, but in the end implemented. The Macdonald Commission’s 1985 report heralded a new era of economic rationalism; it might be less “compassionate” than previous policy frameworks, but would surely deliver the productivity goods via the invisible hand of a freed market.

The graph that accompanies this article starkly illustrates the ironic results. No sooner had the Macdonald Commission helped spur a historic turn in Canadian policy, than Canada’s relative productivity began to fade. The more social programs were curtailed, the more we faced global competition, the more sectors were deregulated, and the deeper taxes were cut, the worse Canada’s productivity performance became. Today we’re right back where we started: poor cousins again, with business sector productivity equal to only 70 per cent of U.S. levels, and still sinking.

In terms of innovation, our performance has been even worse: lagging far behind the U.S. and most of the industrialized world. As we focus on extracting and exporting ever-more unprocessed minerals, our capacity to develop innovative products, services, and processes for the world has withered away. The current tribulations of Research In Motion (like Nortel before it) reflect much larger problems: The failure to develop a successful national innovation system, the failure to nurture Canadian-based global champions, the failure to penetrate global markets with anything other than what happens to be buried beneath our feet.

Market-oriented economists struggle to identify remaining residual “barriers” or “frictions” that must explain the failure of their whole policy approach to unleash promised efficiency. But what if the starting assumption of the “rationalist” model — namely, that the unconstrained operation of private markets is the most efficient, innovative way to organize economic activity — is not justified? What if, in fact, markets work more productively and creatively when they are guided, supported, and constrained, rather than simply being unleashed? What if the best approach is to challenge and direct business to more productive and innovative outcomes, rather than coddling and privileging it?

Indeed, the experience of most successful industrializing countries in recent decades suggests a very different idea of how innovation, productivity, and export-led growth actually occur. From Korea to Finland, China to the Netherlands, Brazil to Germany, countries which actively direct and manage growth seem to perform better in productivity, innovation, and global trade. These countries have fostered investment and innovation with focused sector strategies; deliberately favourable capital market, exchange rate, and trade policies; and sophisticated efforts to manage income distribution so that productivity growth visibly translates into higher living standards (unlike Canada where there is no longer any visible link between productivity growth and personal incomes). Intellectual support for the effectiveness of those approaches is provided by recent new thinking in development economics, highlighting the central role of a proactive “developmental state” in attaining qualitative and quantitative economic progress, rather then reifying market forces.

How do you nurture desirable innovation-intensive industries, and national-champion firms to deliver those innovations to the global stage? Using every policy lever in the tool kit: favourable access to capital and technology; close alignment with public training and technology programs; leveraging public procurement to give strategic firms a head start in their home market; actively promoting domestic interests through trade policy (rather than continuing to believe like Boy Scouts that simply “following the rules” will ensure domestic success). That’s how other exporters, even small countries, built and expanded their foothold in high-value global markets.

It’s about time Canada learned some of those lessons. That will require a willingness to break out of the market-oriented straitjacket which has overwhelmingly shaped policy discourse in Canada since the Macdonald Commission. Yet it is under that framework that Canada went from champ to chump, in terms of productivity, innovation, and global trade. Alternative ideas will seem new, even offbeat. Yet they offer considerably more promise than continuing to scrape the bottom of the free-market barrel.

Jim Stanford is an economist with the Canadian Auto Workers, Canada’s largest private-sector trade union.