Industrial policy

Micro-managing the economy: a failure

Since the beginning of the twentieth century, most Western industrialized nations, including Canada, began to take a more active role in the economy, primarily through aggressive industrial policies. Initially, governments invested heavily in infrastructure projects, provided tax incentives, and put in place high tariffs to protect Canadian businesses and jobs. Over time, however, governments adopted a more interventionist industrial policy. Today, the primary aim of most industrial policies is to allow governments to "select certain industries, technologies, and/or firms whose advancement is of critical importance for the economy as a whole, and accord selective incentives, whether through subsidies, import restrictions and/or special efforts to promote exports" (Mihlar 1994). The evidence, however, suggests that when the government begins to pick winners and losers in the market, the costs often outstrip the benefits.

Government intervention in the economy has not been the panacea that it was thought to be. Indeed, government intervention has not promoted efficiency but rather has encouraged inefficiency. Command-and-control regulations have often impeded innovation and enterprise (Wolf 1993). Moreover, the growth of a government bureaucracy with an agenda of its own has encouraged rent-seeking behaviour (Niskanen 1971). Activist industrial policies have protected inefficient firms and have channelled millions of dollars into politically motivated projects with very few economic benefits (Mihlar 1994; Walker 1984). In addition, regional economic diversification programs serve no efficiency objective (Savoie 1990). In light of this evidence, the optimal industrial policy for the state should be to minimize regulation; that is, the state should enforce contracts and provide the framework of laws necessary for all market participants.

Corporate welfare

In the free market, the success of firms is based on their ability to raise sufficient funds to cover the cost of production by selling goods and services at prices that consumers are willing to pay. Firms that meet the expectations of the consumer will profit and remain in business; firms that fail to do so, will inevitably be forced out of business. As Professor Walter Block wrote, the problem with governments assisting firms financially is that the "entire market process becomes short-circuited. Corporations are able to obtain from the public--through the tax-subsidy system--funds which consumers were unwilling to give to them through voluntary sales" (Block 1990). Supporting a business through government handouts (e.g. subsidies, loans, and tariffs), mainly for political purposes (e.g. employment and re-election), creates a cycle of dependency that ultimately does more damage than good.

In 1981, for instance, the automobile manufacturing industry in Canada secured Voluntary Export Restraints (VERs) on Japanese cars. The intent was to protect the three largest North American automobile manufactures, General Motors, Chrysler, and Ford, from increased competition arising from the entrance into the market of the more efficient and productive Japanese automobile manufacturers. The result? Capital investments by the North American automobile manufacturers decreased from $972 million in 1981 to $440 million by 1984. Investments in research and development declined from 0.28 percent of shipments in 1981 to 0.20 by 1984 (Mihlar 1994). Placing the protective arm of the VERs around General Motors, Chrysler and Ford removed incentives upon them to innovate or improve productivity. Furthermore, a study conducted by Mansfield and Switzer found that for each dollar of tax credit for research and development received, these firms increased their expenditures on research and development by only 30 percent to 40 percent, and pocketed the rest (Palda 1992). In Alberta, the $2.67 billion spent on economic diversification programs between 1980 and 1995 have largely been ineffective (Mihlar 1995b). In short, offering subsidies to businesses or putting up protective barriers (tariffs) results in disincentives to invest, creates a cycle of dependency on government handouts, and forces individuals to fund with their taxes firms that they have already freely chosen not to support.

Industrial policy in British Columbia

The government has largely pursued an interventionist industrial policy. Since coming to power in 1991, the NDP government has spent millions of dollars, mainly in the form of tax credits and subsidies to business, to encourage economic growth and employment in British Columbia. The evidence suggests that the government's industrial policy has largely failed to produce the desired (positive) outcomes. For instance, it has been noted throughout this report that job creation and economic growth in the province has continued to decline since 1994. What the government has failed to recognize is that the best prescription for economic growth and job creation is following the right macroeconomic principles: reduce taxes, eliminate restrictive labour laws, and repeal excessive government regulations on business (Gwartney and Lawson 1997). Instead, the government has continued to help corporations with the tax-payers' dollars.

For example, the government recently spent close to $329 million on the Skeena Cellulose plant in Prince Rupert, hoping to prevent the company from going bankrupt (Beatty and Fong 1998). In October 1997, it purchased 52.5 percent of the company from the Royal Bank of Canada in spite of the fact that the company continues to lose money and that, on several occasions in the past few years, it has almost been forced into bankruptcy (British Columbia Ministry of Employment and Investment 1998; Beatty and Fong 1998). Furthermore, the government's 1998 Budget forecast that the company's debt load will increase from $120 million this year to $245 million next year, representing a 104 percent increase (BCMinFinCorpRel 1998a).

The government announced in May 1998 that, in addition to its investment in Skeena Cellulose, it would be pouring $8.1 million into the J.S. McMillan fish-processing plant also located in Prince Rupert. Like Skeena Cellulose, J.S. McMillan has remained unprofitable throughout the 1990s. Furthermore, in 1997 the government gave the company $5 million, expecting to recoup about $3 million of that money from restructuring initiatives (Beatty and Fong 1998).

These latest bailouts, however, are only a reflection of the many subsidies, tax incentives, and government agencies that are in place to protect unprofitable firms in the province. Following is a sample of these many programs and agencies.

• Job Protection Commission
• British Columbia/Alcan Northern Development Fund
• Small Business Venture Capital Tax Credit
• Mineral Exploration Tax Credit
• Quick Response Training
• Power for Jobs

In keeping with its interventionist industrial policy, the government recently passed the Northern Development Act, which will, among other things, create a new Ministry of Northern Development and provide for a northern development commissioner. The commissioner will be responsible for making recommendations to the Minister of Northern Development on job creation and economic development in northern British Columbia (Readshaw 1998).

In conclusion, in spite of empirical evidence that suggests that interventionist industrial policies are clearly the wrong strategy for promoting job creation and economic growth, the government continues to micro-manage the provincial economy.

Recommendations

So that British Columbia will be governed with a more economically sensible industrial policy, we suggest that the government of British Columbia adopt the following policy recommendations.

1. Eliminate all direct and indirect subsidies to business
   Evidence suggests that providing subsidies and tax incentives to business is clearly the wrong approach to creating jobs and fostering economic growth. In fact, most economists have found evidence to suggest that business subsidies have had very little, if any, real effect on innovation and economic growth in Canada (Lippert 1994a). Hence, the government should eliminate the direct and indirect subsidies and tax incentives it provides to businesses in the province. Instead, the government should concentrate its efforts on creating the right business climate, allowing firms to create real jobs and generate economic growth.
2. Repeal the Northern Development Act
   Simply creating another layer of bureaucracy will not bring more jobs and economic growth to the province of British Columbia. The government has stated that the mandate of the new northern development commissioner "will be to promote job creation and economic development in northern British Columbia" (Readshaw 1998). When governments begin to aid one region over another--picking winners and losers--often the majority of people come out on the losing side. Instead, the government should allow consumers in the north, through their own preferences for goods and services, to create the jobs and economic growth in their region without relying on government handouts.
3. Work towards reducing interprovincial trade barriers
   In the past, the government of British Columbia has been reluctant to reduce interprovincial trade barriers, particularly when it concerns Crown corporations and government procurement (Lippert 1994a). Clearly, this strategy works against the government's goals of creating more jobs and economic development in the province. In fact, interprovincial trade barriers cost Canadians almost $6.5 billion a year in lost income (Palda 1994). Therefore, the government should work with the other provinces to reduce these trade barriers. Allowing more competition between firms across Canada, in the absence of trade restrictions, will force firms in British Columbia to innovate, create more jobs, and to contribute to the economic development of the province.

Conclusion

The strategy of the provincial government for creating more jobs and economic growth in British Columbia has largely been a failure. In fact, evidence shows that job creation and economic growth in British Columbia have continued to decline since the NDP government came to power in 1991. Through the use of subsidies, loans, and tax incentives to business, the government has attempted to create the right climate for such growth. However, in doing so it has ignored the large body of evidence showing that such strategies do not work. The government should be cutting taxes, reducing regulation, and allowing for a more flexible labour market rather than giving welfare to companies who fail to perform to the expectations of the consumer. Therefore, for pursuing a discredited industrial policy, the government of British Columbia deserves an F.

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Last Modified: Wednesday, October 20, 1999.