Editor's notes

IT IS A UNIVERSAL TRUTH THAT each new year provides us with a tangible nudge to stop, even if briefly, and reassess our projects and goals. Because we all know and expect that of ourselves and others, a new year is also a good time to introduce change.

So with the above in mind, the Institute has changed the outward appearance of Fraser Forum. Inside, the articles remain of approximately the same length, by authors you have come to respect. However, the change in cover design to a more serious, formal look reflects the fact that a high percentage of Fraser Forum is original research--often presented for the first time. Some of the articles you read here go on to form the basis of further research which then may become an Institute book or Critical Issues Bulletin.

We take our work seriously, and want to appropriately reflect our attitude in the way our publication looks. I hope that you will approve of the change.

Have a happy, prosperous 1994!

January's quotation

As the Swiss political writer Felix Somary observed, there is a sort of inverse ratio in governing: the more the state concentrates on inessential functions, the worse it will perform its most basic duties. You may be mugged on your way to the government-subsidized opera house.

National Review, May 5, 1989, p. 14.

January's solution: some principles to guide spending cuts

Isabella Horry and Michael Walker ^Note

What principles?

THERE SEEMS TO BE WIDEspread agreement across Canada that the primary way in which governments must adjust to persistent deficits is by reducing expenditures. Within that consensus there is a wide variety of opinions as to which expenditures should be cut. The problem for governments bent on economizing is to determine a set of principles to guide the down-sizing effort to ensure that the objective is obtained.

Principles or politics?

Of course the response of some to such an assertion is that the reduction of expenditures is not a matter of principle, but rather a matter of politics, and that the only way to determine the appropriate cuts in expenditure is to survey the populace or in some other way to determine the cant of public opinion on this particular issue. While it has the ring of authenticity, this response is not correct, nor would such an approach lead to an appropriate program of expenditure restraint. The reason can be seen quite clearly from table 1 and figure 1 which show the distribution of benefits from current federal government expenditure and the taxes that are paid by families ranging from the very lowest to the very highest income.

Click here to view Table 1: Federal Government Spending and Tax Paid Per Family by Income Group, 1990/91 (dollars)

"We the people" don't want to solve the deficit problem

These calculations, which are derived from the forthcoming Fraser Institute book Government Spending Facts 2, show that for a very wide range of income levels the benefits received by families exceed the current taxes the family faces. It is also true that a very significant fraction of the population, 47 percent of the electorate, are net beneficiaries of the current system of taxation and expenditure. ^Note A survey of all families, therefore, would probably lead to a majority of support for retaining those programs which yield a gross benefit to these families. This political problem is complicated by the fact that many of the costs of the benefits received are not being financed at all by current taxpayers but are deferred, through deficits, to future taxpayers who would not be represented in any survey of opinion. This latter fact also explains why such a large fraction of the population can be net beneficiaries of the tax and expenditure process.

The problem is even more complex than this, however, and is revealed in table 2, which shows the percentage of all program expenditures going to those whose incomes are in the top three deciles. As can be seen, certain expenditure items such as health care, education and culture go disproportionately to families whose incomes are in the top deciles, and while these families are net payers overall to the system, they are net beneficiaries from these particular programs and would resist any attempt to cut them; they certainly would not be in favour of major restraint being exercised against them. ^Note

Click here to view Table 2: Percent of Federal Government Spending Benefit Going to Bottom 30% and Top 30% of Income Earners, 1990/91

In other words, the distribution of benefits from current government programs is such that a survey or referendum of taxpayers could not be relied upon as a means for determining which spending to cut. Any such survey would be swamped by the special interests of the direct beneficiaries. At a more prosaic level, determining the pattern of such cuts by a survey of taxpayers would be akin to a firm in a down-sizing effort determining which employees should be subject to layoff by conducting a survey of the employees. The reality is that government spending programs generate their own "fan clubs" in the form either of the beneficiaries or of those who administer the program. It is these fan clubs that generate the opposition to any change in programs and particularly the opposition to cuts in benefits.

A potential source of a principle to guide spending cuts

What one might hope for from a survey of taxpayers, were it not for the fact that such opinions would be hopelessly skewed by special interest posturing, is a determination of what Canadians think is important for the federal government to do and therefore what priorities they attach to the various programs that the federal government undertakes. Are there other ways in which one could determine such priorities? Fortunately there are. One is to simply look at the historical distribution of expenditures to examine the way in which it has changed and ask whether this changed distribution reflects simply a change in the needs of the population, whether it reflects a change in values, or whether it reflects the extension of government into an increasingly wider array of services that were not historically undertaken (services that are not responding to a changed or increased level of need, and are therefore in some sense a lower priority than expenditures which have historically been part of the government services bundle). In other words, the process of winding back the size of government can be conceived of as a process of going back in time to a level of service and program which was then adequate and is now necessary.

A matter of priorities

Table 3 provides some guidance as to the way in which the distribution of federal government spending has changed over the period since 1970. In order to highlight the choices which have been made over the period the table shows the expenditure on each program area expressed as a percentage of total program expenditure excluding interest on the public debt. (The total also includes the Canada Pension Plan which is not included in the federal government budget but is, of course, an aspect of federal government spending broadly considered.) The implicit priorities which have been assigned are revealed by whether the expenditure item in question takes a higher or lower fraction of total program spending in the most recent period compared to the base period of 1970.

Click here to view Table 3: The Distribution of Federal Government Spending, 1970 and 1990 (Total Program Spending Excluding Interest on the Public Debt)

Looked at from this point of view, we find that the federal government has placed an increasing priority on expenditures on culture and recreation, on the environment, on foreign affairs, on housing, on labour markets including immigration assistance, and most of all on social welfare transfers, which have increased from 33 percent of program spending in 1970 to 40.4 percent of program spending in 1990/91, the most recent year for which data on this is available. At the same time a declining priority has attached to education, ^Note which fell from 7.8 percent of the total in 1970 to 4.0 percent by 1990/91; to the general service provision of government which fell from 8.8 percent to 6.8 percent; health care, which fell from 10.9 percent to 7.6 percent; protection of persons and property, including defence, the courts and the federal penitentiaries, which fell from 14.9 percent to 12.3 percent; resource development expenditure which fell from 8 percent to 5.0 percent; research establishments which fell from 2.8 percent to 1.2 percent; and transportation and communication which fell from 5.4 percent to 3.4 percent. The latter category includes the development of the Trans-Canada Highway, the subsidization of railways and other infrastructure projects of a related kind of the federal government.

Over the period since 1970 there has been a gradual transformation of government away from the maintenance of fundamental services such as defense, the maintenance of law and order, and the provision of infrastructure in both physical capital and knowledge capital, and a movement toward the provision of entitlements or income support of different kinds. There has also been a demonstrated preference for cultural and recreation subsidy and subsidization of foreign affairs including external aid, while federal research establishments have been cut to less than half their 1970 support level and expenditure on protection of persons and property has shrunk by more than 2 percent of the total.

Overall, expenditure on human and physical infrastructure by the federal government has fallen from 50 percent of overall expenditures in 1970 to 35.3 percent in 1990/91.

Back to basics--reconstructing the federal infrastructure

This historical analysis of the changing priorities manifested in government program spending suggests a principled approach to expenditure reduction which ties in very well with a theme that the current government found to be popular in the recent election campaign, namely, the notion that the federal government should be involved in infrastructure development. Infrastructure broadly considered includes education, the system of national defense, the courts, the prison system and transportation and communication. It also includes public health and those expenditures which would be required to maintain a high level of basic health care standards. ^Note

Whether one takes the historic proportions as a system of preferred priorities, or whether one simply takes the view that those programs which have grown most rapidly must be those which will bear the greatest brunt of the adjustment, it seems as though the transfer programs have to be a principal concern of a government bent on restraining its expenditures. It is our strong belief that unless the government adopts and articulates to the public a clear principle to guide the process of expenditure restraint, it will not occur. One potential principle would be to aim to return infrastructure expenditure gradually to its historic level of about 50 percent of the federal budget. Such a principle would also suggest that in the current expenditure reduction program there be an attempt to hold fast on the infrastructure aspects of spending and focus the expenditure cutting on the other programs, principally the transfer programs which have grown so rapidly both in absolute terms and as a fraction of overall spending.

Who should bear the burden of spending cuts?

Having decided on a course of action and the areas of expenditure that must be cut, the next question is how the burden of such expenditure reduction can be best shared across the population. There are two aspects of this distribution of burden. First, how shall the burden of the adjustment be spread across the provinces? Secondly, how will it be spread across the individuals who are the beneficiaries of the programs that are to be cut?

Which provinces benefit from which federal programs?

Table 4 presents an analysis ^Note showing the distribution of government expenditures of various kinds throughout the provinces. Thus, for example, the first figure in the first column shows that 2.8 percent of total federal expenditure on culture and recreation goes to Newfoundland. The sixth figure in the first row shows that 37 percent of culture and recreation spending goes to Ontario. The last two rows in the table report the distribution of total federal government spending across the provinces. The second last row reports the total of federal government spending while the last row reports total federal spending excluding interest payments. Interest payments to Ontario, for example, reflect the concentration in Ontario of financial institutions which are receiving interest payments for debt held in pension funds, and for other reasons, that belong to people across the country. It therefore seems incorrect to include interest payments in a series distributing government expenditures. Moreover, since the interest payments here are virtually identical to the interest costs of the public debt in the government budgetary framework, the last row in effect represents total program spending by the federal government in each of the provinces.

Click here to view Table 4: The Distribution of Federal Government Spending Across the Provinces, 1990

There are a number of ways in which this data can be used in the attempt to discern an appropriate distribution of program cuts. First of all, it is interesting to note by comparing table 4 with table 5 that while there is some variation amongst the individual programs in the percent of federal spending in the provinces, the total amount of program spending in each of the provinces seems to have remained remarkably stable over the last 20 years. In the case of Newfoundland, Prince Edward Island, Nova Scotia, New Brunswick and Manitoba the percentage of total federal program spending going to those provinces is roughly the same now as it was in 1970. Those provinces which have changed--Quebec, Ontario, Saskatchewan, Alberta and British Columbia--have changed only to a very minor extent and that largely reflects the shift in the share of the population, with increases in Alberta and B.C. and small reductions in Quebec and Ontario.

Click here to view Table 5: The Distribution of Federal Government Spending Across the Provinces, 1970

Which provinces would lose what from spending cuts?

While the comparison over time of the priorities expressed in the fraction of total federal spending going to different programs provides some guidance as to the principles to be applied in expenditure reduction, there seems to be no clear guidance in the historical analysis of the shares of the spending amongst the provinces which seems to have been relatively unchanged. However, table 4 can be used in a different way to provide insight as to the impact that reductions in federal expenditure will have. For example, the last line in the table shows what will be the provincial distribution of the impact of an across-the-board one dollar reduction in federal government program spending. Thirty-four cents of every dollar cut would come out of Ontario. Twenty-three cents would come out of Quebec, eleven cents from British Columbia, eight cents from Alberta, four cents from Saskatchewan and so on.

Table 4 also shows that certain program expenditure cuts, for example, an across-the-board cut in military spending, would have a disproportionate impact in the tiny provinces of Nova Scotia and New Brunswick because they are at the moment significant beneficiaries of expenditure on this particular program area, getting respectively nine and seven percent of military spending, while their shares of other program spending are respectively six and four percent.

In the preceding section we found that social welfare services grew disproportionately as a portion of the total budget over the period from 1970 to 1990/91 and that they should therefore be targeted for special attention in the program expenditure rollback. It is interesting in table 4 to observe the provincial distribution of such cuts because indeed the impact is not particularly in those provinces that one would expect. The big losers from a significant cutback in social service expenditure, if that were done across the board, would be Quebec, which receives 28 percent of total social welfare expenditure while receiving only 23 cents out of every dollar on average spent by the federal government. In other words, Quebec is a disproportionate recipient of these kinds of payments. British Columbia would also pay a higher fraction of the total expenditure reduction if social welfare programs were to be targeted since British Columbia receives 12 percent of total social welfare payments but only 11 percent of program spending overall.

Who should bear the social welfare cuts?

Earlier this year ^Note The Fraser Institute conducted an extensive analysis of the federal government's social welfare expenditures, with the intention of discovering who received these benefits and what therefore might be an appropriate approach to reducing the amount spent on these programs. We were able to determine, for example, the extent to which high income families are the recipients of social welfare spending in the form of Unemployment Insurance, Old Age Pensions, Canada Assistance Plan payments and Canada Pension Plan payments. This study is currently being updated.

The study's essential point was to establish a uniform principle of fairness that must be applied in the reduction of social welfare transfers. The principle proposed was that families with incomes below the national average ought not to be affected when social welfare programs are restructured. The paper shows what would be saved if those families that had incomes above the average had all of their program benefits "clawed back." The revised version of the paper calculates these average income levels on a province-by-province basis and shows what could be saved if the provincial average income rather than the national average income were used in making such retrievals of social welfare spending. From an economic point of view the fact that Unemployment Insurance, for example, pays enhanced benefits in low income provinces distorts the economic structure even more than would be the case if the level of benefits were geared to the average income in the province. From the point of view of serving equity we believe that it may be important to key the income clawback not to the national average income level but rather to income levels in the targeted province. This is to avoid to the extent possible the current anomaly where frequently families receiving Unemployment Insurance have higher annual incomes than continuously working residents of the province who pay the UI premiums supporting the Unemployment Insurance program. (In Newfoundland, the overall provincial average income of families receiving Unemployment Insurance is higher than the overall average income of those families which do not receive it.)

"But I'm only getting back what I paid in"

A criticism which has been levied at the approach to social welfare spending reduction outlined in our March 1993 study is that two of the programs, Unemployment Insurance and Canada Pension Plan, are actually contributory programs in which people are simply getting back what they paid in. Therefore, the government really has no right to remove the income from these programs because they are more in the nature of private sector insurance and/or pension arrangements than they are like government programs. As a matter of fact, this characterization of these programs is simply incorrect.

Take, for example, Unemployment Insurance. At the moment a person who is a regular recipient of unemployment insurance--and nearly half are ^Note --who earns the maximum insurable earnings and works the minimum qualifying period, would pay UI premiums of $643.68 (of that amount $459.77 is actually remitted by the employer but economists normally reckon that the worker pays the whole amount either directly or in reduced wages). Having paid that amount into the program, a person is then entitled to receive maximum total payments of $17,425. In other words, regular and extended recipients of Unemployment Insurance receive up to 27 times in payments the amount that they have contributed. This relationship between costs and benefits for the user of the system is illustrated in Figure 2. This will come as no surprise to most Canadians since the antics of regular Unemployment Insurance recipients are well known in folk lore and because of casual general contact with such recipients.

Little is it known, however, that the same sort of situation exists with respect to the Canada Pension Plan. A recent study by the Canadian Institute of Actuaries ^Note points out that a current recipient of CPP is not receiving simply what they paid in, but in fact is receiving seven times the amount they paid. The difference is of course borne by current taxpayers. Owing to the fact that the Canada Pension Plan is indexed to income, high income pensioners who are receiving Canada Pension Plan payments get a higher multiple of their contributions than the average recipient. Figure 3 shows the relationship pictorially.

Accordingly, a clawback of income from either of these programs geared to the recipient's income would, if partial, simply reduce the multiple of the premiums paid. In fact, it would be possible to gear the clawback so that both Unemployment Insurance and Canada Pension Plan payments would be reduced to no less than the total amount that the individual had paid in, including interest. It may well be that the very best way to explain to the public the clawbacks on social welfare payments is to discuss them in terms of reducing the multiple of contributions paid to the recipient--particularly if the recipient is both a multiple repeater and living in a family with relatively high income.

Cutting back the direct spending

While politically the most difficult area for cutting back is undoubtedly the social welfare transfers, it is possible to establish a principle for such cuts based on income, which therefore has the characteristic of ensuring that the burden of the cutbacks is not unduly borne by those of modest means. It is somewhat more difficult to devise a principle to be applied in the reduction of other program spending areas. However, The Fraser Institute, as part of its ongoing study of government spending, has produced a category of such expenditures which may be helpful in dealing with this problem.

As noted earlier, we have compiled a distribution of government program spending benefits by income group. This distribution shows that some government program spending disproportionately benefits higher income groups. For example, expenditures of the federal government on post-secondary education deliver the majority of the benefits to families whose incomes are above the national average. Expenditures on culture and recreation similarly benefit higher income families more than lower income families. Surprisingly, health care expenditures also seem to have such an incidence pattern.

While the distribution of expenditures in table 2 shows that there is an opportunity to reduce expenditures by cutting back on the receipt of benefits by higher income families, it is not evident how this should be done since the program expenditures in question are typically received by individuals who benefit in a circuitous fashion through the institutions which are actually funded by the government spending. So, for example, a high income family which receives a disproportionate share of health care spending does not actually receive the money spent. Rather it is received by the physicians, by the hospitals and other health care providers. The money is spent on behalf of the high income family. Similarly, the high income families who benefit from federal funding of universities do not receive that funding directly but get it in the form of lower tuition fees that are made possible by the federal funding.

The approach to retracting benefits from high income families will have to be different in each program area, but considerable research has been done in many areas indicating how it might be accomplished. For example, in the case of federal spending on higher education, an approach which could be followed and gradually implemented is to insist that all universities which receive funding adopt a full-cost tuition schedule and provide support only to those students whose family incomes are below a certain cutoff level. Gradually implemented over a period of years, such a program would have a number of beneficial side effects on the allocation of educational resources apart from reducing the overall cost of spending on post-secondary education.

In the area of health care, a clear way to retrieve program spending from high income users of the health care system is to require that they add their health care expenditures to their taxable income as a benefit. A recent Fraser Institute calculation shows that a medical care tax scheme with a lower income cutoff of $20,000--that is that no family earning less than $20,000 would be taxed in any way by this provision--and with a ceiling of 10 percent of income, would retrieve about $1.2 billion in total tax revenue. ^Note In addition, there would be a saving of an estimated $867 million as current users of the system are deterred by the knowledge that they will have to pay a "co-insurance" fee in the form of the increased taxation.

Reducing the costs of government operations

We have left until last the easiest area for reduction in government spending--that is, overly lavish spending on ordinary items and services. The Fraser Institute has for the last two years conducted a contest encouraging Canadians to submit ideas about how the costs of government might be reduced without reducing the level of service provided by the programs involved. We have had an extraordinary outpouring of ideas--some 1,500 in total, of which 79 have made it through a strenuous judging process to become finalists in the contest. These finalists' proposals have been presented to the federal Department of Finance each year, and the ideas have been circulated amongst government departments for their consideration. While some of the ideas appear to have been adopted, for the most part the attitude of the reviewers of the proposals has left something to be desired and certainly could not be characterized as "receiving the ideas with open arms." Perhaps that is to be expected, given that in many instances the program expenditure reduction involved would require significant modification in the way things are done. It is not difficult to understand why there is a reluctance to adopt such ideas, but in an era when significant change is going to be made to all of the government's programs it is unclear why such obduracy is permitted to persist. The recent discovery that the bureaucracy has closed ranks to actually undo the implementation of one of the 1991 finalists' ideas regarding government moving services is something that particularly requires the attention of the ministers responsible.

In any event, we tender to the government herewith the seventy-nine ideas that have been submitted in the Prize for Economy in Government. They do suggest some important ways for reducing expenditures and in the spirit of pursuing every possibility for expenditure reduction they should be more seriously considered than they have been to date.

Harcourt hits a three! Rae boots the ball!

"Dr. J." Robson

"Here comes the fast break! The NBA streaks across the continent. The franchise is driving for the net! NO! They've kicked the ball out to Mike Harcourt, the man they call 'The Premier.' I don't think he was expecting that pass, but he corrals it neatly, steps back across the three-point line, and lets fly! It's good! A rain-maker! Nothing but net! The crowd goes wild! It's good for three!"

"Meanwhile, down in Ontario, they bring the ball up slowly and go into the set offense. They swing the ball around the outside, now to Bobby Rae. Oh oh, he wasn't paying attention. The ball slips through his hands, bounces off his head, and it's going out of bounds. That's an ugly turnover, folks, and the crowd isn't pleased."

THE ISSUE, OF COURSE, IS professional basketball franchises in Toronto and Vancouver, and the refusal of the league to issue them if they are to be the object of betting. In both cases the government currently makes money from sports lottery betting on basketball. But where Premier Harcourt has said that his government is prepared to do what it takes to secure the franchise, Premier Rae has said the opposite. ^Note

In both cases the revenue is quite small--about $20 million in Ontario and $500,000 here in B.C. ^Note --but the issue is big, and Harcourt is on the right side of it. To begin with, it is clear that economically a professional basketball franchise is worth a huge amount to a city. Basketball players may be lean, but their wallets are so fat that they stick out into traffic. And they spend at least some of their money in the city where they play.

More fundamentally, the reason these athletes get paid so much money is because what they do is valuable to citizens. People pay money to consume basketball, hockey, and baseball, so we know they value them. Admittedly some misguided folks don't value the product, but the market has spoken. Many people do like basketball a lot, and feel that having a franchise in one's city or region enormously enriches one's life. And when enough people feel that way, it means by definition that a basketball team creates wealth, in huge amounts. It also spreads it around. The value generated on the court is so high that it can pay the athletes and coaches, and the team support staff, it can rent the hotel rooms and limousines, it can build and run the stadiums and pay the peanut vendors, and so on. Basketball adds hundreds of millions of dollars a year to a community. And the sports lottery clearly doesn't, quite apart from the fact that government lotteries generally pay out at a rate (about 66 cents per dollar bet in B.C.'s sports lottery) that would shame Las Vegas (the gambling houses there must, by law, pay out at least 75 percent).

Doubtless, in fact, the net gain to the provincial coffers from a basketball team would far outweigh the lost revenue from gambling.

But that's not the point.

The point is that sports are vital in a community. Sports bring people together, occupy their conversation, become the focus of their hopes and dreams. Even a bad team can unite people. A good team elevates them. When the Toronto Blue Jays won their first World Series, my neighbourhood across the country in Vancouver erupted with hollering and yells of triumph. When is the last time strangers ran out onto their balconies to send up a joyous noise together over an act by government? When is the last time you saw a small child wearing a jersey with a politician's number?

If you believe that government exists to protect the right of citizens to live the good life as they see fit, not the other way around, then as Premier you would want to create the conditions in which a sports franchise could flourish, not block one over a pathetic little dribble of revenue (and among other things this whole business shows the undesirability of financing government through a bizarre, arbitrarily structured set of taxes and other revenue measures, such as lotteries, rather than through low, flat, non-distorting taxes plus user fees where appropriate).

Citizens should not be lightly deprived of things they value. When Premier Rae attended this year's World Series ceremonies, and was warmly booed by a vast throng, he had a chance to see vividly the damage the opposite view is doing to the fabric of our society and the resentment it is generating. But if he thinks that was bad, just wait and see what happens if the NBA announces that, because of him, no team will be coming to Toronto.

As the cheering crowd carries Harcourt from the arena in triumph, Premier Rae should also see that the ball he has booted may be on its way out of bounds, but it hasn't yet gone out of play. If he sacrifices the body and dives for it, he can still bat it back to the league, who can feed it to the franchise for an easy layup. And that's the kind of gutsy, team-oriented effort the crowd would appreciate.

January questions and answers

Isabella Horry

Q: What is the present federal debt per capita and how large will it be by the end of this fiscal year?

A: The gross public debt is estimated at $500 billion and the net public debt (gross federal debt minus federal assets) at $463.6 billion for the fiscal year 1992/93. In per capita terms, these totals amount to $17,610 and $16,324 in gross and net public debt respectively. If the 1993/94 fiscal year's deficit reaches $46 billion dollars then net public debt per capita will rise to $17,722 by the end of March 1994.

Q: How much is paid in interest charges?

A: $40.5 billion was paid in interest charges during the fiscal year 1992/ 93. This corresponds to $0.33 out of each dollar paid in taxes or $.25 out of each dollar spent by the federal government.

January graph

Isabella Horry

Click here to view January Graph

Well done, John Crow

Michael A. Walker

WHILE IT SCARCELY SEEMS possible, it's been seven years since John Crow assumed the leadership of the country's most important financial institution--the Bank of Canada. Crow was chosen after an extensive search process by the executive committee of the Bank of Canada and by the "still wet behind the ears" Conservative government of Brian Mulroney. After having extensively considered all the usual suspects in the private sector and, rumour had it, having been turned down by a prominent francophone banker, the committee and the government settled on John Crow, a long time Bank of Canada employee but one who was relatively unknown outside of narrow central banking circles.

Having worked with Crow at the Bank of Canada in the early 1970s I was led to expect a business as usual approach to the conduct of the Bank's activities. I was quite wrong in that assessment and indeed I think it is fair to say surprised by the untypical and in some respects extraordinary performance which the new governor displayed.

It is well first to remember that when Crow took office the inflation rate in Canada was nearly 5 percent, treasury bill interest rates were above 8 percent and the federal government was, in spite of loud claims to the contrary, continuing to pursue an irresponsible expansion of the public sector financed by large deficits. Some analysts, including those at The Fraser Institute, had drawn public attention to some of the implications of large continuing deficits, particularly for the interest rate structure in the country and for the relative dependence of our financial policy on the attitudes of foreign investors. Unfortunately, our warnings, and those of others who subsequently joined the chorus, were ignored. The government continued to add huge dollops to the increasing mound of the public debt and therefore to put excruciating pressure on financial markets for accommodation and of course in the end upon John Crow who was charged with maintaining the stability of the value of the Canadian dollar.

The connection here may be less than obvious to the casual observer but the point is that one easy out for governments faced by a large financing requirement and concerned about the fact that their increased demand for financing is increasing interest rates, is to print the money necessary to finance their expenditures. The role of a truly independent central bank and central banker is to resist the government's tendency to take this route. Now while there is never any outright demand by the government of Canada for the Bank of Canada to print the money to finance its deficits, the widespread view that interest rates were too high was essentially a demand that John Crow relent and print the money necessary to fund the government's borrowing. For you see, by resisting the government's urge to accommodate its need for financing, John Crow forced the full brunt of the adjustment of the public sector deficits onto financial markets, which of course caused interest rates to rise. For these high interest rate consequences of government deficit financing not the government but John Crow bore the blame.

And did he bare blame! Never in the history of the Bank of Canada, even during the celebrated James Coyne affair, has any governor of the Bank taken so much abuse from so many ill-informed and politically motivated people from so many areas of public life in Canada. Through it all John Crow simply grew in stature, carefully explaining time after time why the Bank of Canada had to pursue its policies of monetary stability and why in the end finally with the enthusiastic public support of the government itself, the Bank was pursuing a policy of eliminating inflation from economic decision-making in Canada. Only such a policy, he noted, would ultimately produce the low interest rates that well-meaning but misdirected people were clamouring for.

And what has ensued? Interest rates currently stand at less then 4 percent. Inflation has been almost completely eradicated in Canada. Indeed, if you take into account the increased Canadian prices caused by depreciation of the Canadian dollar, prices on Canadian production have actually been falling.

Now I would have expected, given this gigantic public experiment in which the positions on both sides were so well defined, that one would have seen in the latter days of 1993 a certain celebration of John Crow. An acknowledgement that he had been right. That he had persevered and achieved in extraordinarily difficult circumstances a public policy goal of lower inflation rates and lower interest rates. One would have expected more notice of the fact that he had recently, for the first time for a Canadian, been elected to the chairmanship of the Central Bank governors of the G-10 countries--the world's ten largest economies. Or that he had been invited by the German central bank, of all institutions, to lecture to them about how to get rid of inflation and low interest rates at a time when the federal government is experiencing increased deficits.

In spite of a lack of public adulation, there is widespread professional recognition of Crow's policy accomplishment. At the recent meetings organized by the Minister of Finance of top Canadian economists, I asked those present to indicate whether they supported the reappointment of John Crow, and 79 percent of those who were willing to express an opinion indicated that they enthusiastically endorsed John Crow's reappointment. Only six of the economists I surveyed said they would not support his reappointment. Even those who abstained from the voting (9 of the 38 present at the meeting) indicated that they had enthusiastically supported the policies which John Crow offered but had some difficulty in publicly supporting John Crow himself.

The reason for this queasiness has also been reflected in much of the public commentary about Crow in recent days, namely the fact that he was abrasive, that he was dogmatic, that he was too arrogant in his approach to Parliament, that he was insufficiently sensitive to the broader political landscape in which monetary policy unfolds.

While there is no question that John Crow has been dogmatic, that he has been firm, that he has been unpolitical and unswerving in his approach to monetary policy, it is my opinion that it was only by taking such a position that John Crow could successfully accomplish his monetary policy objectives. These have been tough economic policy times in Canada. Fiscal policy was running diametrically opposite to the interests of the country and to the direction which the welfare of the country demanded that John Crow conduct his monetary policy. Pursuing the course he did required a tough and single-minded leader and we certainly found him in John Crow. But perhaps, as Margaret Thatcher has recently demonstrated, it is not the karma of great leaders also to be popular. If I were John Crow I'd pay more attention to the fact that the overwhelming majority of his critics in the economics profession now accept that he was right in his policy course and that he accomplished his policy goals.

As a footnote, one must point out, as indeed financial markets have already demonstrated, that if Crow's enemies thought that by getting rid of him they would also get rid of his policies they had better take a closer look. Dr. Gordon Thiessen, Crow's successor, has been cast from a very similar, though Canadian, mould and will, in my opinion, carry on the tradition which John Crow has established. In the end, perhaps that is the finest tribute which we can pay John Crow.

Democracy or the underground economy?

Filip Palda

THE GROWING UNDERground economy is a sign that our democracy is not working as it should. In a democracy people use their vote to discipline their leaders and tell them how to behave. When people believe they have no say over high taxes and government inefficiency, they try to leave. Some leave the country, but many simply ignore government and work outside the law. If Canadians had more control over their leaders the underground economy would be smaller.

Governments do not like to give their people choices. People's ability to leave weakens a government. When citizens can move to another country with lower taxes and better services there is little a government can do but compete with neighbouring governments by keeping its taxes low. The East Bloc avoided such competition by drawing an iron curtain around itself. Captive citizens had no choice but to produce for the state. In the end East Bloc citizens "escaped" by putting most of their efforts into the underground economy. The East Bloc collapsed and corrupt regimes had to mend their ways because too many people evaded the state.

The growth of the underground economy in Canada may one day force our governments to reform in the same manner that East Bloc regimes have had to. Government will have to lower taxes or deliver better services for the tax dollars collected. Reform will come when our leaders realize that the underground economy is a problem created by government. So far our leaders have been happy to declare they will spend more money on tax audits and police patrols. Their former counterparts in the East Bloc learned that such repressive measures do not work for long.

Even though the underground movement may force our politicians to reform, this reform will come at a price. Certain goods and services go underground because taxes in those areas are easy to avoid, not because people want more of these goods and services. This means that the industries that thrive underground may not represent the best use of our economy's resources. Evading the government is also an expensive activity. The time and energy people spend in evasion adds no value to the economy. Perhaps the largest cost of the underground movement is that it forces an ever smaller proportion of the population to bear the tax burden. It is a central principle of economics that high tax rates applied to small tax bases distort the economy more than low tax rates applied to wide bases. High tax rates discourage effort and consumption and should be avoided wherever possible. The growing underground economy forces governments to follow the worst possible principle of a high tax on a small base.

If Canadians had had a more finely tuned way of choosing their leaders than they do now, the underground movement might never have started. Referendums, recall, and a more decentralized federal government are only a few of the simplest things we could do to give people more control over their leaders. U.S. Professor John Matsu-saka has suggested that states that hold referendums are more fiscally conservative. It appears that referendums impose discipline on inefficient governments. Canadians would be served better if politicians submitted to the open discipline of a revived democracy rather than to the crude and inefficient discipline of an underground revolution.

References

Matsusaka, John G. (1993). "Fiscal Effects of Direct Legislation: Evidence from the Last 30 Years." Working paper, Department of Business Administration, University of Southern California.

Get your two cents in, and $25,000 out

John Robson

It's back! The 1994 Fraser Institute Economy in Government Competition is officially under way, and we are looking for anyone with ideas for cutting government costs without cutting services. Readers of Forum are all too aware of the parlous state of our nation's finances, and the recent conference held by Finance Minister Paul Martin only underlines the need for us to tap into the creative ideas of all Canadians. So if you wished you could be at that meeting and get your two cents in, this is your chance, and it may be worth a lot more than two cents. Someone is going to win $25,000. Why not you?

You have until March 4, 1994 to send us--in 1,500 words or less, or it will be disqualified--a summary of your idea: what should be restructured and how, what sort of savings might be available, and what obstacles, political, legal or other, would need to be overcome and how. Finalists will be selected by our panels of judges and will be asked to complete considerably more detailed action plans, to be submitted by May 13th. From these winners will be chosen of the top prize of $20,000 for the best overall idea, of $5,000 each for the best idea in each of three areas--federal programs, provincial programs, and the internal operations of government--and of runner-up prizes of $250. Preliminary entries will be evaluated by two panels of judges: one for English and one for French language entries (we regret that entries in other languages than these cannot be accepted). The completed finalists' proposals will be evaluated by these two panels jointly.

We want to express our particular appreciation to the business advisory firm of Price Waterhouse for their assistance with the logistics and with the judging, both last year and this. For a more detailed description of the contest and its conditions please contact Dr. John Robson at the Fraser Institute, at (604) 688-0221, ext. 1301 or fax him at (604) 688-8539.

Letters

Yes, we definitely make good use of equipment donations!

The Fraser Institute is completely dependent upon the generosity of its supporters for its continued existence. For the most part this support comes to the Institute in the form of financial contributions. However, from time to time members make donations of equipment or supplies which are equally useful. ServiceWorks Inc., one of Canada's leading distributors of computers and printers, has been particularly generous to the Institute and many of our researchers do their work on computers they have provided. Recently, ServiceWorks gave the Institute three laptop computers, one of which was used to write this article. Another is used by our Events Department to contain a portable registry of attendees at our events.

On November 8, this portable registry proved very useful to attendees and to staff at the luncheon addressed by Margaret Thatcher. The following letter illustrates the use to which the laptop was put. Our thanks to ServiceWorks for making us look good and for helping us to better serve the needs of our customers!

Dear Sirs:

I purchased two tickets to the Margaret Thatcher luncheon and inadvertently left them behind on the day of the luncheon.

Your staff on the door were most helpful and very kindly replaced the tickets for me at the door after making a quick check on their laptop computers.

I was most impressed with their efficiency and courtesy and wish to extend my sincere thanks.

The original tickets are returned herewith.

R. G. Hortop

Mississauga

Author too modest

Dear Michael Walker:

You are too modest! I half expected to read a "See, I told you so . . ." in the November issue of Fraser Forum.

In your "Canada's Conservative Government: Proposals for a Mid-Course Correction" you prophesied

I can claim no expertise as a political analyst, but I can't help but venture the opinion that the government will pay a political price for its deliberate philosophical promiscuity. I think that Canadians are tolerant of differing political views but intolerant of the kinds of hypocrisy that playing both ends of the political spectrum against the middle must eventually entail.

In the 1988 election the Conservatives were "saved" by the free trade issue but this time around there was no issue to save them; hence two elected members.

That prophesy came true as Canadians, in large part, voted by their philosophical belief--more government or less government.

Ronald Beer

Okotoks, Alberta

Correction

Dear Editor:

Some words were deleted from the printed version of my letter including a quote by Adam Smith in Fraser Forum, November, 1993. I include the corrected quote [missing words italicized]:

All of them find it for their interest to employ their whole industry in a way in which they have some advantage over their neighbours, and to purchase with a part of its produce, or what is the same thing, with the price of a part of it, whatever else they have occasion for.

I hope that you will print a correction.

James C. W. Ahiakpor, Professor,

School of Business and Economics,

California State University

Hayward

Vladimir Zhirinovsky: Lord of the Flies

John Robson

THE PEOPLE OF RUSSIA SEEM to have confounded the pundits by voting for a savage moron. This was not supposed to happen, because conventional wisdom says that progress in human affairs is natural and normal. Absent deforming influences like, say, Stalinism, countries and communities are supposed to traverse a smooth path that leads to the modern, hyper-democratic welfare state. The last thing in the world anyone thought the Russians would do is vote for Vladimir Zhirinovsky.

Make no mistake about it, the man is quite mad. He has promised to restore Russia's empire in Eastern Europe, by among other things, threatening the West with nuclear annihilation if it objects. Not only are his methods mad, but so are his goals. Imagine being willing to risk a global holocaust over the shattered economies of Eastern Europe!

And yet a hard-headed analysis suggests that the outcome of the Russian vote is not at all atypical, and should not have surprised us. Russian history has until now been a series of misfortunes piled upon misfortunes. One could conclude that nothing good will happen there unless its history takes a dramatic turn, a turn that comes from without. Some external event must persuade Russians, fully and completely, that "We cannot continue to live like this."

The reason for Russia's intractable problems is not demons. Nor is it the failure of the West to shell out billions to Gorbachev and then to Yeltsin. The basic problem is that it is a very poor country, and not just in terms of its physical capital. What is really missing there, and always has been, is human capital. And anyone who took realistic note of the stock of human capital in Russia prior to the election would have anticipated, if not this precise outcome, then one equally bad.

Human capital consists of knowledge of how to do things that are useful. While it is important to know how, for instance, to make gunpowder, tie a fishing lure, drive a truck, or make a road that won't wash away, what is really important is to know how to cooperate with one's fellow citizens. In the West we tend to take this for granted. But it is not something people are born knowing, and the consequences of losing it are extremely severe. We would do well to observe certain key gaps in Russia's human capital.

First among these is the fair treatment of strangers. As Richard Pipes so eloquently argued in Russia Under the Old Regime, the peasants who made up the bulk of Russia's population before 1917 were warm and spontaneous with those they knew, but surly, untrustworthy, and even vicious toward strangers. This attitude pervaded the culture. The peasants did not trust anyone; neither did the nobles, the tsar or anyone else. To give you an idea how bad it was, at the Congress of Berlin in 1878 the Russian foreign minister blatantly substituted a forged map for the real one, and when caught betrayed no shame or embarrassment. A culture that does not prize honesty is one poor in human capital, one in which people lack the tools to do useful things on any kind of scale. Mobility is highly problematic in such a culture, and so is the exchange of ideas.

This problem of honesty toward strangers in Russia also meant that there was no tradition of commercial honesty. Markets in prosperous countries are about trust, about building long-term, reliable relationships, about knowing that if a purchase is in some way unsatisfactory the seller will replace it, whereas in impoverished countries every transaction is winner-take-all, with the very costly uncertainty that entails. ^Note If you doubt me, go and watch any stock market operate: millions of dollars, yen or marks change hands, and no one is signing anything. It's a gigantic honour system. Russia never had that, nor does it now. Some recent Russian visitors to the Institute joked that the problem with Moscow's street markets is that the only thing Russians know about capitalists is the Stalinist caricature, and so Russian entrepreneurs act like that caricature. But Pipes is right that the problem was just about as bad before 1917 as after 1989. It's not that something went wrong, but that it never went right.

Finally, this problem of a lack of skills for getting along with people you don't know manifests itself most egregiously in Russia's civic tradition. Again drawing on Pipes, it is most significant that whereas in Western feudal societies, the distinction between the monarch's personal estates and those held in trust as monarch was eventually resolved in favour of the whole nation, small pockets aside, falling into the latter category, in Russia it was resolved in favour of the whole nation falling into the former. All Russia was the tsar's personal estate, effectively. Add to this the scattered nature of feudal holdings below the tsar, and the history of Vikings, Mongols and other overlords who thought only of plunder, and the extinction of the free cities under Tsar Ivan III and so on. The effect was that no sort of bond ever evolved between people and public figures. In Russia there was no sense of common interest and no set of tools for working on problems of common interest, ever.

What we in Canada should conclude from all this, is that the fundamental economic problem in a society and in a polity is not physical but human capital. A very poor society--say, Japan after 1945--can rapidly acquire physical capital if it has human capital, if its people are skilled at getting along in markets and, when they must, politically. Even a very rich society--say, Argentina in 1900--will stagnate or lose physical capital if it does not have, or fails to renew, its human capital. Peronism was a terrible curse to Argentina, but as Nobel Prize Winner Gary Becker's analysis of Sweden illustrates, even a society with deeply ingrained habits of honest labour can lose them in a generation if it creates the wrong structure of incentives and so discourages their cultivation.

Just as physical capital deteriorates over time, so does human capital. People with extensive human capital die, and people with none are born. We must be sure that the skills of the former are invested in the latter. We must teach habits of civility, honesty and civic virtue.

We have created, and are creating, a society in which it is prudent, from a self-interested point of view, to be shrill and hapless, to collect welfare while protesting in Clayoquot Sound, to burn Bob Rae in effigy, to storm through the streets of Calgary screaming abuse at Ralph Klein, to dive into some oppressed minority group and demand redress, to scream at Bill Clinton because medical science can't cure viruses, and to bicker about helicopters not in terms of national defense needs but in terms of regional pork-barrelling. We holler about our social programs without performing elementary mathematical calculations, let alone discussing the propriety of coercive redistribution.

We are creating a society in which the hard-working, self-supporting good citizen is a chump, and in which the less you produce, the stronger your claim to what others have produced. People who resent the undoubted scams connected with native self-government and "traditional" hunting and fishing with polyfilament nets, snowmobiles and high-powered rifles would do well to consider that the blockades and the demands are in fact a form of assimilation to our highly politicized, aggressive and disruptive elite culture.

Common people seem to be realizing this. The latest poll showing massive hostility to government-sponsored mosaic multiculturalism reflects not hatred of brown people or a desire to mock ethnic accents, but a feeling that the avid multiculturalists neither knew nor cared how to get along decently with their fellow citizens, but are simply engaged in a highly rhetorical grab for the old wallet. ^Note In short, official multiculturalism, like the welfare state, erodes rather than enhances human capital.

Of course we are a long way from pogroms and a Zhirinovskishchina in Canada. But when we consider the horrifying course of Russian history over the last millennium or so, or even the brutal and discouraging tale of Latin America through most of the twentieth century, surely we should conclude that it is time to stop whining about how social conventions deform our inner child, and start talking calmly about how to be good family members, honest tradespeople, and good citizens. We need to accept that, as P. J. O'Rourke has written, "Ignorance is a renewable resource," that indeed it is renewed with each new generation. ^Note

We need to accept that the scariest renewal of ignorance, the point where the young must urgently learn from their elders, is not in how to do things but in how to cooperate to do them, that our most crucial inheritance is human rather than physical capital. Ultimately a bad attitude destroys a good computer chip, and we'll never meet the "challenges of the twenty-first century," or of daily life, if our primary skill is pinching other people's wallets, selling them sand packaged as caviar, or holding our breath until we turn blue if they don't scramble to meet our "needs." This is what we should learn from the strong electoral showing in Moscow of the Lord of the Flies.

Promote economic liberties

Walter Williams,

John M. Olin Distinguished

Scholar, George Mason

University, Fairfax, VA

MONIQUE LANDERS IS A black 15-year-old high school student in Wichita, Kansas. With assistance from the National Foundation for Teaching Entrepreneurship (NFTE), she started "A Touch of Class," a small business washing and braiding hair. With family members and friends as customers, she was able to earn about $100 in profits per month. She was so successful that she was called to New York to be honoured as one of the five Outstanding High School Entrepreneurs.

That's just one story about NFTE's successful program aimed at ghetto youth. Founded by Steve Mariotti and now in 10 cities, NFTE teaches youths how to develop a business plan and market a product or service. Under its auspices, businesses started by at-risk youngsters include stereo component installation, desktop publishing, magic shows, and baby sitting. The kids are excited, energetic, enthusiastic and are learning practical lessons. I know. Earlier this year, I addressed 300 proud students, parents, and teachers in NFTE's Wichita program.

You'd think everybody would say, "Great show, Steve Mariotti. Somebody needs to be on the ground helping impoverished youth find a better way. Let's find out how to produce some more people like Monique Landers!" Think again. When the Kansas State Cosmetology Board heard about Monique's award, they sent a letter warning her that it was illegal for her to touch hair for a profit without a license, and that if she did not immediately cease her practice, she would be subject to "a fine, or imprisonment in the county jail, or both." Nancy Shobe, the board's director, says Monique should take a year-long cosmetology program at a certified school to become licensed. First, there are not that many cosmetology schools that teach hair braiding. Second, tuition ranges from $2,500 to $5,500 for a nine-month course. Furthermore, the minimum age is 17.

Since hair braiding involves no use of chemicals, there is no public health issue. The customer's hair is washed, and the braider spends anywhere from two to eight hours weaving intricate patterns. The real issue is monopoly. According to a story in the Wichita Eagle, more than 100 licensed cosmetologists complained to the Kansas Board about Monique's lack of a license. What do you think was of greater concern to those cosmetologists: the welfare of Monique's customers, or the loss of business to Monique? Most definitely the latter.

Monique's experience is simply the tip of the ugly occupational licensing iceberg that cuts off the bottom rungs of the economic ladder. It is cruel that we sanction these collusive laws. Would we be more satisfied if Monique were having babies, getting welfare and doing drugs? If she were, you can bet the authorities would not be nearly as relentless in their pursuit of "corrective" action.

In countless ways, poor people who are motivated are denied the routes out of poverty that were available to them in the past. Instead of opportunity, they are given welfare. And it's not just enterprising kids. Houston, Texas, stopped a former taxicab driver from providing jitney services. New York and other cities periodically harass street vendors. More and more states legislate against private, unlicensed, small-scale day care services. Civil rights organizations and black politicians are silent and often support denial of opportunity. But they beg for handouts.

Monique's plight highlights the importance of the Washington-based Institute for Justice. The District of Columbia's licensing board tried to run Cornrows & Company, another braider, out of business. The Institute represented its owner, Taalib-Din Abdul Aqdah, and won. Wouldn't it be great if civil rights organizations focused attention on economic liberties instead of on constantly looking for more money?

Speeches

Fraser Institute staff recently gave the following presentations:

•Presentation to the public servants participating in the CAP program in Ottawa

•Presentation to the U.S. Senate regarding the extent of rationing in the Canadian Health Care system

•Panel debate: "Business and labour perspective on B.C. economy and government directions re labour relations" for Human Resources Management Association in Vancouver

•Speech on the impact of the election to Terminal City Club in Vancouver

•Speech on "Reasons for Economic Optimism" to the Real Estate Board in Vancouver and to Friesen Financial Services in Surrey

•Speech on the "Nature of Entrepreneurship and Free Enterprise" to BCIT Chapter of American marketing Association in Burnaby

•Radio interview with Rafe Mair on the subject of education and school vouchers

•Speech on NAFTA to international business students at Capilano College, North Vancouver