A large and growing per centage of Canadian consumers are in three classes today. These are:

1. Unemployed and unable to spend.

2. Employed and too scared for their jobs to spend any more than they must.

3. Underemployed and unable to spend much.

With the number of workers in secure, well paying jobs declining, consumer demand becomes stagnant. Industry is having a hard time to maintain the profit level it needs to survive without substantial downsizing. After all, a company has to maintain its return to investors substantially above the rate of return of T-bills. Otherwise, their capital will flee to safer investments. However, down sizing only makes matters worse for the economy in the long run.

While industrial profits grew very well in the first half of the nineties about all the profit that could be squeezed out of companies through downsizing, re-engineering, re-focusing, returning to core businesses, etc. have been squeezed. Most companies are no longer "fat and happy" or even "lean and mean". Most of them are now "skinny and pissed".

Industrial profits are going to go down substantially in the late 90s or grow a lot more slowly. The DOW and TSE 300 cannot grow much more as all the value realizable in the market has already been squeezed out as has been shown by the "crash" of October 1997. Companies have no more fat to cut. Any damn fool can make profits go up for a short while by slashing the guts out of a company but eventually there is nothing left to cut without killing the company. However, the talent needed to grow a company seems a not rarer. Anyone can do a "Chainsaw Al Dunlap" and make short term profits. It is a lot harder to do a "David Sarnoff" and grow a company.

Investors are going to start taking their money elsewhere, causing many companies to close, throwing yet people out of work. Look as what happened to places like Thailand in the fall of 1997 when investors got jittery about that country. This results in people becoming tax consumers rather than tax payers and the government gets less revenue. This makes government expenses rise. The deficit rises and the government then issues more "safe" investment vehicles that suck more money away from industry.

Each individual company tries to respond to reduced demand by reducing costs and getting more productivity per worker, hoping people will buy if prices are lower. In this case, the best thing an individual company can do is to move the labour intensive part of their operation to a low wage country, like Mexico. Of course, this throws more Canadian workers out of work, reducing overall demand while making the deficit worse.

The problem here is that if one company in an industry moves manufacturing to a low wage country, it has an advantage. However, if they all do, none have an advantage and the economy in Canada is held back as workers cannot buy the fruits of that industry, now moved to Mexico.

Of course, in the free (and getting freer) market we have today, if your competitor moves production to Mexico, you have to move your production as well because not enough people will buy your higher priced goods. Of course, fewer people can buy the goods of industry as a whole as the amount of wages paid in a country is reduced. Therefore, what is good for an individual company is bad for all the companies in an industry as a whole.

The process works in several ways. The first is:

- Less employment in Canada resulting in:

- Higher government cost and lower revenue resulting in:

- For the remaining tax payers, a higher portion of income taken in taxes resulting in:

- Lower disposable consumer income resulting in:

- Lower consumer demand resulting in:

- Downward cost pressure in industry resulting in:

- Industry moving to lower cost countries resulting in:

- Less employment in Canada resulting in:

- Higher government cost and lower revenue resulting in:

- For the remaining tax payers, a higher portion of income taken in taxes resulting in:

- Etc., etc., etc.......

The end result will be a tax payer revolt which, while making the politicians cut our taxes, will only serve to speed up the second spiral as follows:

- Interest payments on the national debt grow resulting in:

- Having to attract money from investors resulting in:

- Less patient capital for industry resulting in:

- Industry having to cut costs to maintain dividends resulting in:

- Less employment in Canada resulting in:

- Lower government revenue resulting in:

- Having to borrow even more resulting in:

- Even higher interest payments on the national debt resulting in:

- Having to attract yet more money from investors, etc., etc., etc.

Eventually it will go out of control and the federal government will no longer be able to service the debt. However, before this occurs, our social programs will be destroyed and the economy will come be seriously damaged. The International Monetary Fund may come in and the result will be somewhat like Argentina where a new currency had to be created, unemployment is high, underemployment near universal and while stable, the average standard of living is far lower that it would have been otherwise.

Basically, the bottom line is that even though Canadians are the potentially richest people on earth we are going to end up poor because:

1. Our federal government overspent during the late 70's and early 80's in order to buy our votes and didn't clean up their act when the economy got better in the mid 80's. They only started in the late 90's but by then it is getting too late.

2. We could not get some numbers in the Bank of Canada's computers to come out right.

These spirals will continue as they are positive feedback mechanisms. For those unfamiliar with control theory, a positive feedback mechanism is one where a certain change results in even greater change. An example, of positive feedback is the Public Address (PA) system in an auditorium. We all have heard loud howl coming out of improperly set up or adjusted PA systems.

How this works is that the sound coming out of a speaker is picked up by the microphone. This sound is then amplified and returned to the speakers at a higher level. This is then picked up by the microphone again, amplified and sent to the speakers at still higher level. Eventually, within seconds, there is a loud howl as the system goes out of control.

Likewise, with the national debt, it increases due to unpayable amounts of interest. This then makes the debt higher the following year which results in even higher unpayable interest due which increases the debt further. This is a positive feedback loop.

The point I am trying to make with this scenario is that if things were left unchecked, by the year 2018 the interest on the national debt would have exceeded annual revenues. See the graph to the left. At this point there is no hope of return. The system will be out of control and the economy will go bust. Decisive action had to be taken before that time. By 2040 100% of expenditures would have been interest payments. There would be no money available for any programs. Your children would be paying their taxes yet receive NOTHING for them!

What control theory requires for stable systems is negative feedback. This is where a change in an input results in a change in the output opposite to the input thus dampening the effect of the changed input. Later, I will propose a number of negative feedback mechanisms to stabilize the Canadian economy and to reduce the amount of instability we all face.

After, that is what we all want. Income stability, with reasonable growth, for all of us, whether a wealthy Bay Street investor of a single mom on welfare is a desirable goal. We have the resources to do this in our corner of the world. We just seem to be lacking the leadership to make the modifications the system needs.

The downward spiral is usually attributed to a lack of demand by consumers. Demand goes down not because people don't want more things. We all want more. Demand falls when people's disposable income drops. This can also occur when income rises slower than the rate of inflation. In Canada, disposable income dropped in the 1980s for two main reasons. The cost of housing and the amount paid in taxes increased faster than people's incomes. Actually, this was not just limited to the 1980s. It started in the 1960s. The effect was not noticed until the late 1980's.

The last recession had some other cause than just an ordinary slackening of demand. Yes, demand slipped and one cause of it is was women. Don't get me wrong. This not sexist drivel. The women are not to blame themselves. The problem is that our families are running out additional members willing or able to enter the work force.

Have you noticed that house prices and taxes have risen much higher than the general cost of living since 1960. Housing is a great investment because housing has had the fastest appreciation rate of any "safe" investment. Well, if the cost of houses rises faster than the raises in the pay of working people, how did we manage to still sell so many at accelerating prices from the 60's to the 90's.

The answer is the continuing increase in participation in the work force of women since 1960. Back in the semi-mythical days of June and Ward Cleaver, most any man gainfully employed in industry, commerce or the civil service could support a family and buy a home. It took maybe 33% of a working man's gross pay to buy a home. Income taxes took less than 20% away.

Since then income taxes now take 40% and payments on a house can easily take 40% of a workers pay. How do people still do it. With the increased participation of women in the work force, families were still able to buy. Each year since 1960, either voluntarily or involuntarily, more and more women entered the work force.

With each married woman (or equivalent) entering the work force, the potential income of a family rises about 50%. This made the difference which allowed housing sales (and prices) to stay at artificially high level while allowing governments to take an ever increasing share of income in taxes.

However, now that the participation rate of women in the workforce has been capped by lack of jobs and by lack of very many more women to participate in work, the economy has to adjust. Unfortunately, we don't want home prices to drop as most of us have our retirement savings tied up in our homes. Also, the government is unable to reduce taxes because of the deficit.

Only the dramatic drop in interest rates in the early 90s kept houses and real estate moving at all in the biggest markets, Toronto and Vancouver. In the rest on Canada most real estate prices have fallen as there are not enough buyers left.

Now, with low inflation, you might think that demand would improve. It has not because of the three growing people categories mentioned earlier. The unemployed have no money. The underemployed workers⁽¹⁾ do not have enough money for anything but the basics. The only ones who can spend are the full time employed but they are too scared. They are saving all they can or are staying in smaller homes and paying them off because they are afraid for their jobs.

It used to be that government workers were secure in their jobs that at least they spent freely. This is no longer the case and it seems that the last group who had good incomes and who could spend freely have been terrorized into not spending.

This results in continuing low demand resulting in low employment in industry resulting in cutbacks by industry⁽²⁾

and government resulting in scared consumers resulting in lower demand. The spiral to a Mexican level economy continues.

What about the attempts by the Liberals to balance the budget. This is an admirable and very necessary step. However, once it is balanced does anyone really believe they have the will power, especially with the demands of aging baby boomers, to run a surplus to pay down the accumulated debt. Even if they have the will power to keep it balanced, we will be paying about $60 Billion per year in interest charges forever while we keep rolling over the old accumulated debt. This is money that will have to be taxed away from all future generations to come. It will be a permanent drag on the economy. The graph assumes the economy will continue to grow at about 3% a year in dollar terms.

In addition there is no indication that interest rates will stay this low forever. Any rise in interest rates means more taxes, more cuts or a deficit again. With fewer workers in future there may well be pressure to raise wages. This will eventually cause inflation which will push interest rates up. The above Liberal Scenario graph will then end up like the Uncontrolled Scenario Graph previously.

The writer believes with the future pressures on medicare keeping the budget balanced will be impossible. This is because most people consume about of their lifetime medical costs in their last year of life and the boomers will start dying of old age by 2010 while at the same time the per centage of the population paying taxes will drop..

While the Liberal's plan is good, the writer believes that additional steps are needed to put things right.

Before we look at solutions though, we have to take a little detour into money. What is it and where does it come from? 

FOOTNOTES

1. These are those who want full time permanent work who are forced to working part time or temporary jobs because there are no others. These are also people who are forced to work below their skill level as there are not enough jobs available at their skill level. 

2. Known as "down sizing", "right sizing", "productivity enhancement", etc.