Unfinished business: reflections on Canada's economic transformation and the work ahead.

• Author: Mohamed, Rahim
• Position: Essay

A Canadian Century?

For virtually its entire history, Canada has lived in the shadow of the behemoth to its south: the more populous, more economically vibrant, and more globally assertive United States. In fact, it could even be said that Canada's national psyche is marked by a nagging inferiority complex vis-a-vis the United States, a trait captured in the saying "To be Canadian is to be not American."

However, as the twenty-first century approaches its third decade, a well-governed, resource-rich, and xenophilic Canada is beginning to forge its own identity, even surpassing the United States in some areas. For instance, the Luxembourg Income Study of 2014 found that Canada is now home to the world's most affluent middle class (reported in Austen and Leonhardt 2014). Canada's new global relevance is also evident in the enthusiastic response in the United States and elsewhere to the 2015 election of the youthful, telegenic Justin Trudeau as the country's new prime minister. (1)

Canada is also notable for its robust response to the global financial crisis of 2007-8. The effects of the crisis on Canada's financial sector were limited thanks to the stability of the country's prudently managed domestic banking system. (2) In fact, Canada was the only G7 country that did not bail out or guarantee its banks in the wake of the crisis (Farlow 2013, 322). Moreover, it has been one of only two G7 countries (the other being Germany) to maintain a Triple-A credit rating throughout the postcrisis period. Canada's conservative federal government, led by former economist Stephen Harper, initiated a multiyear deficit-spending program to mitigate the most severe effects of the global downturn and subsequently managed to bring the federal budget back to a surplus position just prior to ceding power in the fall of 2015. Put simply, Canada's serene political climate and stable finances make it the envy of virtually every other advanced economy.

Yet Canada's curve-beating postcrisis performance ultimately reflects a set of transformative fiscal-policy reforms implemented throughout the 1990s, dubbed Canada's "redemptive decade" (Crowley, Clemens, and Veldhuis 2010). Such reforms included the implementation of a nationwide value-added sales tax, the finalization of a regional trade pact with the United States and Mexico, the restructuring of federal pension and social assistance programs, and large-scale reductions in public spending. Moreover, a number of intrepid provincial and municipal governments have found innovative ways to reduce the burden of public spending on health care, education, and other public services. To my knowledge, the story of Canada's historic turnaround has yet to be told in its entirety to an international audience.

Accordingly, the purpose of this article is to provide an objective account of that economic transformation and a candid discussion of the problems that continue to hold Canada back economically. I aim to place the hype surrounding Canada's economic governance under closer scrutiny and therein promote a more measured discourse regarding which aspects of "the Canadian model" should and should not be emulated. On the negative side of the ledger, I cover Canada's ongoing problems with productivity, innovation, and the governance of natural resources.

The first section of this article recounts gains made during Canada's redemptive decade, identifying the year 1995 as a critical juncture in the country's history. The second and third sections, respectively, cover what I consider to be the largest obstacles to Canada's continued economic development and diversification: its lagging performance in the critical domains of productivity and innovation as well as political obstacles to effective natural-resource governance, concerning in particular the country's vast petroleum reserves. Finally, I briefly touch on possible policy solutions, although I must stress that my primary aim is to elucidate problems facing the Canadian economy, not to prescribe remedies.

The Year That Changed Everything: 1995

With the benefit of hindsight, the year 1995 stands out as the beginning of Canada's historic turnaround. Yet at the time there were few, if any, signs of the imminent reversal of fortunes. In fact, a widely circulated Wall Street Journal editorial published in January that year named Canada an "honorary member of the third world" and predicted that it would soon need International Monetary Fund assistance. The piece also warned that Canada could face a currency crisis similar to Mexico's peso collapse of late 1994 ("Canada Bankrupt?" 1995).

The editorial's author, reputedly financial journalist John Fund, could hardly be faulted for his pessimism. Between 1990 and 1995, the Canadian economy had suffered its largest contraction since the Great Depression, accumulating 15.7 point years of excess unemployment (3) over this timeframe (versus a 6.3-point year loss in a recession-hit United States) (Fortin 1996, 762). Canada's "Great Slump" was attributable to a vicious cycle of high interest rates and a ballooning public debt (Fortin 1996, 772), (4) which led to downgrades by the global bond-rating agencies. The severity of the downturn sealed the political fate of the country's scandal-plagued Progressive Conservative government, which was left with only two seats in Canada's 295-member Parliament following the federal election in the fall of 1993.

Although elected on a platform of deficit reduction (Liberal Party of Canada 1993, chap. 1), the incoming Liberal government, led by veteran politician Jean Chretien, initially had difficulty breaking old habits. The Chretien government's inaugural budget, unveiled in February 1994, proposed just a one percent reduction of the annual operating deficit and actually increased program spending. The budget was panned in the media and did little to comfort skittish foreign creditors (Crowley, Clemens, and Veldhuis 2010, 72-73; Martell and Palmer 2011).

To make matters even worse, the fragile French-English truce that undergirded Canadian federalism was disintegrating. An ill-advised attempt to reform Canada's Constitution in the early 1990s had galvanized the people of Quebec, and a referendum on its independence was to be held in October 1995. (5) William Keech and William Scarth capture the bleakness of the situation perfectly when they write, "[T]here were two guns at the federal government's head: the one pointed by the international financial bond rating agents ..., and the other pointed by the separatists" (n.d.).

Canada's existential crisis created a well-founded sense of urgency among policy makers and ultimately a window for transformative fiscal-policy change. Paul Martin, Chretien's high-profile finance minister, seized this opportunity when he unveiled the Liberals' second annual budget in February 1995, a fiscal-policy blueprint that grappled more seriously with the deficit crisis. This budget called for an 8.8 percent reduction in program spending over two years ($10.4 billion (7)) and slashed forty-five thousand public-sector jobs (14 percent of total public-sector jobs). All told, spending cuts outlined in the budget outweighed corresponding tax increases by a ratio of seven to one (Martell and Palmer 2011). These figures represented the Liberal government's vision of a "smaller ... smarter government" (P. Martin 1995, 2). Martin encapsulated this philosophy in his memorable budget speech: "The debt and deficit are not inventions of ideology. They are facts of arithmetic. The quicksand of compound interest is real. The last thing Canadians need is another lecture on the dangers of the deficit. The only thing Canadians want is clear action" (1995, 2).

These words were especially poignant coming from a representative of the centrist Liberal Party of Canada, a party that advocated for social justice and celebrated its history as a champion of expansive social policies such as universal health care. Further, Martin's budget for 1995 was supported by the Reform Party of Canada (Martell and Palmer 2011), (8) which made up the dominant right-wing bloc in Parliament following the collapse of the Progressive Conservatives. (9) This uncharacteristic show of across-the-aisle solidarity sent a clear message to creditors: the federal government was serious about cleaning up its finances.

The spending cuts were concentrated in areas where the federal government had overlapping jurisdiction with provincial and local authorities. The federal Ministry of Transportation took the hardest hit, losing more than 50 percent of its funding. This cut reflected a handing-off of the direct ownership and operation of public-transportation systems to lower levels of government. Federal farm subsidies, which disproportionately benefit Quebec and the agrarian prairie provinces, were also slashed dramatically (Veldhuis, Clemens, and Palacios 2011, 22-25). Crucially, the budget proposed a $4 billion (14 percent) reduction over two years in provincial transfers for health, education, and social services. The social transfers were also restructured into block grants, which allowed the federal government to send a fixed amount of funding to each province. Under the preexisting cost-sharing structure, the federal government's level of social spending varied based on what the provinces spent. The move to block grants made social transfers more sustainable and predictable. Although these decentralizing measures would later create problems of their own, (10) they were instrumental at the time in helping Ottawa get out from under the debt burden. They also gave the provinces new flexibility to experiment with their own service-delivery schemes.

The federal government's belt tightening began to pay dividends almost instantaneously. Aided by a booming U.S. economy, falling interest rates, and restored investor confidence, Canada produced a budget surplus within just two years of...