Minister McKenna should re-consider plans for stimulus
Catherine McKenna, our federal minister of infrastructure, recently said the Trudeau government is thinking about stimulus measures and hopes to have a plan in place this fall. Minister McKenna suggested stimulus efforts would focus on improving economic growth. However, empirical evidence and past experience demonstrate that stimulus packages are largely ineffective at achieving this objective.
Generally, fiscal stimulus refers to additional government spending and/or temporary tax relief used in an effort to mitigate the impact of a recession and speed up economic recovery. The theory assumes that stimulus influences people to spend more, which creates a positive ripple effect throughout the economy.
Infrastructure spending is a common form of stimulus, which is often thought of as a way to improve economic growth and create jobs during a recession. Governments frequently assert that “shovel ready” infrastructure projects in particular will help meet this objective. Indeed, infrastructure spending is likely to play a prominent role in the new federal stimulus package.
In reality, however, even infrastructure projects that are “shovel ready” take significant time to plan and implement. There are delays associated with permitting, environmental assessments, reaching agreements between stakeholders, and obtaining regulatory approvals that can significantly postpone the start of these projects. The long planning process means that actual spending on infrastructure usually starts after the economy has already recovered, which means government spending competes with the private sector for resources, especially skilled workers, resulting in increased costs and fewer private-sector projects—impeding economic recovery.
Consider the experience of the 2008-09 recession. The federal government implemented a two-year $47 billion fiscal stimulus package that relied heavily on infrastructure spending. A 2010 study analyzed economic data from Statistics Canada to determine the success of government stimulus and found that government spending and investment in infrastructure had little to no effect on economic growth during Canada’s recovery. Instead, the data demonstrates that private-sector investment and increased net exports drove the economic turnaround.
Research from University of California, San Diego professor Valerie Ramey and Harvard University professor Robert Barro emphasize issues with stimulus spending more generally, using a concept called the “fiscal multiplier.” The fiscal multiplier shows the impact that each additional dollar of government spending has on the economy. A multiplier greater than 1.0 indicates a $1 increase in government spending will increase overall economic output by a value greater than $1—in other words, it indicates that stimulus works.
Their results, however, demonstrate that the multiplier is likely below 1.0. Put differently, their research indicates that stimulus spending actually crowds out private economic activity that would otherwise have occurred. which is the exact opposite of what Canadian businesses and our economy need coming out of this recession.
Additional evidence from late Harvard University professor Alberto Alesina demonstrates that increased government spending can result in lower economic growth. His research found that a 1.0 percentage point increase in spending relative to the size of the economy produces a 0.75 percentage point reduction in economic growth. Put simply, stimulus measures may hinder the Canadian economy rather than help it.
Instead of spending billions on stimulus measures in the hopes of kick-starting the economy, the federal government could improve Canada’s investment climate, tax competitiveness, and lower the regulatory burden on businesses to get the conditions right for the economy to thrive.
The empirical evidence is quite clear that stimulus spending generally and, infrastructure spending more specifically, are ineffective policies in kick-starting the Canadian economy. Minister McKenna and the federal government must consider the evidence and instead pursue policies that actually improve economic growth.