CHAPTER 1 THE CANADIAN ECONOMY

WHAT IS IT AND WHAT IS ITS FUNCTION?

Updated: Oct. 4 1998

Before we can discuss how to change things, it is important to understand the present system. The purpose of this chapter is to inform you of the function the economy serves in our lives.

What is the economy?

The economy is one of the most important parts of our lives as it is responsible providing the goods and services we need to live in a modern society as well as the means to earn enough income to obtain those goods and services we need.

What kinds of economies are there?

Economies are some mixture of the capitalist and command systems. They range from the almost pure capitalist (Eg. Hong Kong pre 1997 & Taiwan) to the almost pure command economy (Eg. North Korea & Cuba (at least in 1998)as well as the old USSR). The purer command economy is often called communist but no so called communist nation has actually followed pure communist theory in practice. In Canada, we live in a mixed economy pretending to be a capitalist economy in spite of what our business people would like us to believe. The mix between capitalist and command varies all the time and is a matter of great public debate. This mixed economy is sometimes known as a socialist state of some sort.

The role of government

In a mixed economy both private enterprise and government play an important role in the allocation and distribution of resources. Most so‑called "free‑market" or "capitalist" economies today are mixed. The reasons most used to justify the large role government plays are:

‑ The desire to redistribute income and wealth.

‑ The feeling that it is the responsibility of government to deal with the problems of unemployment and inflation.

‑ The perceived need to regulate certain sectors of the economy for the public interest.

‑ The perceived inability of competitive markets to provide such social goods as health care to everyone or to deal with the spillover effects of industry, such as environmental pollution. That is, market economies are not able to provide required goods and services to all. They only provide for those who can pay. The government tries to correct the inability of the market to provide for those who are unable to pay.

It must be noted that governments seldom ever create new wealth and most any time a government has tried to create new wealth, it has failed miserably. Governments are reasonably good at redistributing wealth but it is the enterprise of private individuals and organizations that creates new wealth in the world. The role of the government in an economy is to provide a framework of rules and laws to allow others to maximize the wealth of the country through private initiative.

This framework must include:

‑ means to give a chance to those willing to take the risk to become stinking rich while not harming the overall ability of the economy to generate more wealth.

‑ means to protect the environment.

‑ means to protect the rights of individuals.

‑ means to prevent abuse of the system that would diminish the total wealth of the country though enriching a few.

‑ means to allow those who genuinely cannot provide for themselves to live a dignified though frugal life.

A Brief History of Economic study

One of the acknowledged authorities on economic matters The Economist magazine. They published a book in 1986⁽¹⁾ which acts as a basic guide to economic theory. It includes a number of theories that have been proposed by economists through the years to explain how an economy works.

These start with Adam Smith in the 18th century who felt that countries and peoples would grow richer if free markets were allowed to work with essentially no restrictions. Adam Smith, who authored one of the first great works on economic theory, the Wealth of Nations (1776), was one of the first to understand the true nature of wealth and to recognize the essential role of economic freedom in promoting its growth. The complete text is available at: http://www.bibliomania.com/NonFiction/Smith/Wealth/index.html

The main theme of the WEALTH OF NATIONS is the growth of national wealth. Smith showed that it is not nature but human effort that makes commodities available and creates new wealth. Smith believed that the natural trend of economic development is upward and that this trend is most likely to manifest itself within the framework of an "obvious and simple system of liberty," or perfect competition. His main concern was to maintain the system of natural liberty that would allow the accumulation and direction of capital into employments that are most desirable from the standpoint of maximizing general welfare. The idea is that if businesses are free to seek out the best opportunities for maximizing gains, the most productive uses or resources will be sought out first.

While this theory was seen to be very radical in its day, those who cherish it today are usually called Conservatives⁽²⁾, Reformers or Republicans.

Legitimate areas of government intervention exist, but ideally, the activities in which the state engages ought to be minimal because the labour of government workers were thought to be "unproductive." The incomes they receive are transfers and do not generate wealth. However, Smith failed to consider that today, government workers are the providers of infrastructure without which much wealth creation would be impossible.

For the most part Smith expressed faith in the operation of the "invisible hand". This is the marketplace operating according to supply and demand mechanisms, for bringing about a harmony of social interests in the still mainly agricultural economy of the late 1700s. The later appearance of capital in the form of machinery, and the industrial revolution made questionable Smith's concept that the accumulation and employment of capital would automatically coincide with the advancing material progress of all classes of society.

Later economists like David Ricardo tried to explain the poverty of the masses while Karl Marx carried the argument through to a vision of inevitable revolution.

John Maynard Keynes, responding to the mass unemployment of the 1930s, felt that management of demand for goods and services was needed to sustain growth and jobs. He wrote a very influential book, The General Theory of Employment, Interest and Money (1936). He felt that market forces, in the form of wage and interest‑rate reductions, cannot be relied on to channel all workers seeking employment into jobs or all savings into investment. Full employment results only if the level of aggregate demand is sufficiently high to ensure that the employment of labour and the investment of savings is profitable. This can be held up by the dynamic nature of a modern capitalistic economy, which renders itself particularly vulnerable to uncertainty. This is often made worse by the modern mass media which feeds us a steady diet of doom & gloom.

Inability to predict the profitability of investment in enterprises that create jobs and new wealth encourages the investing class to accumulate assets in the form of money which tends to reduce demand for goods and services and hence reduces the level of employment. Reduction of interest rates may be of no benefit when expected profit levels are very low or even negative. This has proven to be the case in the 1990's where several years of low interest rates have been unable to significantly reduce unemployment in Canada. Where rates of 0.5% have been unable to get the Japanese economy going again. Alternately when great profits can be made through speculation and acquisition, such as in international speculation in currencies, funds are diverted away from investments that can create new jobs and wealth.

A multi billion dollar corporate takeover benefits no one except the shareholders of the company taken over and their investment bankers.⁽³⁾ Neither does the movement of large sums of money, many times a day chasing minor discrepancies in exchange rates at various money exchanges around the world. Few mergers or takeovers actually create any lng term wealth, either for the shareholders or the economy as a whole. If I wanted to own stock in the target company I would buy that stock. I don't need a company in which I bought stock to do it for me.

Direct intervention by government in the form of public works may then become necessary to restore full employment, Keynes wrote.

Economists, from Smith to Keynes to those working today were influenced by the events of their times, producing different intellectual ideas, few of which are completely applicable to the world of today. Some economists have tried to propose very intricate theories with very complex mathematics to explain what happens. The problem is that most of these theories is that they do not and indeed, probably cannot account for things like consumer confidence and the steady diet of doom and gloom fed to us by the media.

The function of the economy

Few, if any, economics books the writer has found actually tell you what the function of any economy is. The writer believes that there are two main functions:

1. To provide means of production to produce the goods and services all the people within a country or trading area require for a comfortable standard of living. To make this happen, the system has to be set up to allow, indeed encourage those with the entrepreneurial fire in their belly the chance to become stinking rich.

2. To produce enough jobs at a decent wage (or provide some other means) to allow all the people in a country the means to obtain goods and services needed for a comfortable living. To make this happen, the system has to be setup to encourage those with the entrepreneurial fire to hire all the rest of the people, the 98% who don't have that fire.

What is a comfortable living? This is very debatable and not the same for everyone. However, it should include the ability to afford reasonable quality housing (preferably to be able to purchase it if desired), to afford a nutritious diet, to be able to obtain required health care, to be able to afford some type of post secondary education for your children and to be able to afford basic transportation, either public or private. This would include yourself and your family and would include freedom from fear of a sudden drop in income.

While our current economy, through the capitalist system, has been very successful at fulfilling the first function, it has only been reasonably successful at fulfilling the second half. When the people who are working part time but would rather be working full time are counted the Canadian economy has failed in the second function for about 25% of the population. Besides failing to provide adequately for many people, this failure is denying the business community a large part of its potential market. This market could be much more profitable to serve as it would be consuming marginal production⁽⁴⁾ if it could. Therefore, the system needs some tuning and maybe some surgery.

Purely socialist systems, especially the late but not lamented communism, were mildly successful with the second part but because the first part was fulfilled rather poorly, it failed miserably. Almost everyone shared equality of poverty. We need to find a middle road that helps all of us to obtain the comfortable living we need while still allowing the opportunity for those few people with that special fire inside to get rich by providing the goods, services and jobs other people need.

How is new wealth created.

Certainly not by punitively taxing it away from those who have been successful. It is only by individual initiative and the possibility of individuals becoming wealthy can we expect the creation of wealth. If a person cannot become wealthy, no matter what they do, there is no reason for a person to try to create new wealth. There is nothing wrong in getting rich by providing goods and services that a nation requires provided that the second function of the economy is also fulfilled.

Please note that trading money in fields like currency speculation and in most fields of "derivative" investment does not create wealth. It merely moves it around. Most all financial market activities except the initial purchase of stocks and the purchase of bonds are not really investing. They are gambling. New wealth is created by people taking unorganized matter and organizing it so that the final result is worth more than the original state. Investing is supplying capital so that the activity in the previous sentence may be accomplished. This comes down to one of the following:

1. Getting something out of the earth. That is: mining, agriculture or fishing.

2. Manufacturing.

3. Investment in Infrastructure.

Governments can do these too but except for the third item, not as efficiently. That was the main reason that communism fell. The role of government in wealth creation is best kept to providing common infrastructure too large for any one enterprise to provide. This includes educating the citizenry and keeping them healthy, providing roads and making sure the natural infrastructure of the country is not being degraded either through careless use of the environment (by enacting environment protection laws) or from internal or outside aggression (by providing police and military protection).

That is, the government should take care of the "commons" and provide those essential services that are not profitable enough for an entrepreneur to provide at an acceptable price.

Services only move wealth around. Most of what our investment community do is mere gambling. Except for Initial Public Offerings (IPOs), the stock market is trading of wealth between investors with no new wealth created. Only actual purchase of commercial bonds or initial offerings of stocks in corporations⁽⁵⁾ can create wealth through real investment in getting an enterprise in motion or in helping an existing enterprise expand.

What does not generate wealth?

To review:

CURRENCY SPECULATION ‑ The trading of currencies, not to balance national accounts as the result of the flow of goods and services, but merely to take advantage of variations in exchange rates to try to make a few fractions of a cent on the dollar. This merely transfers wealth between owners but does nothing to make new wealth. On the other hand it can suddenly deprive a country of capital as happened in Asia in 1997 and 1998 when their currencies fell in value by sometimes more than 80%.

INVESTMENT IN GOVERNMENT SECURITIES ‑ Unless used to fund infrastructure products, the funds raised with these are merely used to repay prior investors. A Ponzi scheme basically.

INVESTMENT IN STOCK INDEXES, DERIVATIVES, ETC. ‑ These are a "zero sum game"⁽⁶⁾.These are not like stocks and commercial bonds where the money invested is used to help a corporation expand its production in order to create new wealth. These are mere gambling, best confined to Las Vegas

INVESTMENT IN CORPORATE TAKEOVERS ‑ While these do make some people wealthy and occasionally result in some greater efficiencies, the net cost to society is negative. Most takeovers are primarily a means of some wealthy people to feed their ego in a hurry.

SERVICES ‑ While these do create economic activity, we cannot count services, in many cases, as actual wealth producing activities. There are exceptions like data processing for manufacturers or repairs that return wealth producing equipment back into service but most services merely result in the redistribution of wealth. When I buy a service, the person I hire is richer but I am poorer by the same amount in money⁽⁷⁾. This is what is called a zero sum game. Banking can be an exception as bank loans are used by many companies to increase their production capacity and to allow people to buy the fruits of production much more easily than they would otherwise (credit cards & consumer loans).

ECONOMIC ASSUMPTIONS

Some assumptions economists make seem quite plausible. This would include the principles that companies try to maximize profits and workers try to maximize wages.

Other things some economists assume are less believable. These include the ideas that wages are elastic and that all unemployment is voluntary. They say this as they feel that the person out of work has merely priced himself too high and need only accept a cut in pay to find work again.

Tell this to someone who lost their job in a company town when the mill closes and there are no other jobs at any pay. Unfortunately the bank still wants the mortgage payment (which the bank is not willing to reduce). Once a person has achieved a certain standard of living, it is very difficult to throw it away and start again at a lower level. Sometimes this must be done, but lets face it, older workers usually have responsibilities and they cannot let their incomes fall with the market when the prices they pay do not fall with it. The average person needs stability and while they prefer their standard of living to rise, they especially don't want it to fall.

A 45 year old worker with children about to enter university and a half paid off mortgage and a car payment would face disaster if they had to reduce their income to one they were quite happy to get at age 25. This loss of spending power is reflected in the loss of the economic activity that person generated as well.

For example, in some places in Canada, the market has bid housing up to prices that seem obscene by standards in many other countries. This is alright as long as people make wages that can allow them to afford those prices. However, now the working people of Canada are being told they must compete with Mexican labour but on the other hand cannot buy housing at Mexican prices. This blows holes in the theory that unemployment is voluntary because the unemployed have priced themselves too high. It is the "system⁽⁸⁾" that has allowed a persons costs to rise so high that they have no choice but to require a certain income. Yet, it is very difficult to emigrate to another country, like Mexico and live like a Mexican if we want to keep our job. Besides, few countries permit much in the way if immigration any more. Canada, the USA and the other English speaking countries are exceptions in this regard. However, it is even quite hard for a regular working guy to follow their job to South Carolina if it ends up there. This inability of the Canadian working person to follow their job to a low wage southern state was an oversight in negotiating NAFTA.

Canada is a high cost place to live and we need high wages to survive. To tell our workers they must compete with Mexican wages but still pay Canadian prices is irrational. For companies to be able to sell in Canada, they must also provide plenty of high wage jobs so that consumers will be able to buy their products.

Most economics theories seem to work on the basis of scarce resources and scarce capital. They produce neat little graphs with curves and letters but seldom any actual numbers. That is because they try to explain the economy by usually taking only 2 variables into account (rarely more than 4). Most theories state the when price for something goes up, demand goes down and when the real price goes down the demand rises until the two strike a balance. This works very well in many cases, for most commodities including labour. For most commodities this balancing act is the "magic of the market" that libertarians feel should be applied to everything. However, people do not like being treated like this and will strongly resist and attempts to reduce their prices (wages) when the supply of workers goes up.

However, this does not always work. For example gasoline in the summer of 1998 in the Vancouver area fell from $0.569 to $0.339 per litre. However, consumption did not rise much as people did not drive any more because if the cut. Also, because we havd no idea how long the cut would last, no sane person would go out and buy a more gas guzzling vehicle because of the cut. In this case, the demand would be said to be "inelastic"

The problem when it comes to wages it does not reverse well. When demand goes up, wages go up. When demand goes down, wages don't go down, at least not in numerical dollars⁽⁹⁾. The problem a first world country like Canada faces is that when demand goes down due either to a recession or to jobs being moved to lower wage countries, wages cannot fall as prices do not fall for most goods as many prices are now determined globally.

Conclusion

While the free market has been wildly successful on the supply side in providing us with enough to buy, it is not suitable for public services or social goods Canadians feel are essential. Take medicine for example. Most Canadians feel that the user pay system the USA uses is almost barbaric. Canadians seem to feel that there are some things best handled in a socialist fashion.

These include medical care, education, transit, highways⁽¹⁰⁾, environmental management, etc. To pay for these services we pay taxes which are funds that are taken out of the economy to supply social goods. It is the function of the economy to provide the services we want and enough funds to pay for them. It seems kind of stupid that there is a demand for these services and unemployed people willing to provide them but the two cannot seem to get together. It has fallen on governments to regulate the economy so that these services will be provided as well as ensure that free markets are in place to provide the other things we need. However it appears that the government, specifically the federal government has lost its willingness to accept its place in managing the economy to the benefit of Canadians as a whole.

Footnotes

1. The Economist Economics by Rupert Pennant‑Rhea and Clive Crook.

2. A "conservative" is defined by many as someone who wants to make consumption grow as fast as possible, enhancing their wealth while conserving as little as possible of the environment. They are conservative only in wanting to return to the economic status quo of the 1890's

3. Corporate take‑overs seem to bad for the economy as a whole as while they enrich a few, they generally cause significant job losses for many. The profits from the takeover go to relatively few while the usually greater cost in lost economic activity from those who lose their jobs is borne by society at large. The buying power removed from the economy as well as the cost in Employment Insurance premiums is usually several times the cost of profits made by the take over artists.A classic example of Privatizing Profits while Communalizing Costs. Besides, I don't know why stock holders allow their companies to do takeovers of other publically held stocks. As Warren Buffet, the most successful stock buyer in the world has stated that if he wanted to own shares in the company being taken over, he would have bought them at market price from his broker instead of at a premium in a takeover bid. If you own shares in a public company doing a takeover of another public company, dump them. They almost always drop badly after a big takeover.

4. By marginal production, the writer means production that would be very profitable as the current market is already absorbing fixed overhead costs. Therefore any additional production will only cost a company the cost of raw materials. The rest would be pure profit which would make this the most profitable part of the market to serve.

5. Mutual funds, as long as they actually invest in actual securities, are a recognized way of investing in real wealth creation allowing smaller investors to hold a diversified portfolio.

6. A zero sum game is one in which for every cent earned by a winner, someone else has to lose the same amount.

7. The GNP does not take into account my enjoyment of the carpet I had cleaned, the use of my resume typed, etc.

8. The use of the term "system" sounds like 60's hippie radical speak but I use it to mean the uncontrolled system we have that turned out this way. I do not imply a controlling force forcing a particular system on us. Merely that the millions of market place decisions made every day by rational people has caused this particular "system" to evolve. That is, unless you believe in Trilateral Commission conspiracies.

9. That is, in the actual numbers of dollars paid. However, wealth available to a worker can still fall due to inflation. Because the number of dollars being paid is fairly inelastic, it is necessary to have a small amount of inflation to erode purchasing power in times that true wages must fall.