How Canada Can Catch up to the U.S. Economic Miracle

Commentary, Public Sector, David Henderson

Canadians often worry, justifiably, that their economy is falling further and further behind the sizzling U.S. economy. Fortunately, economic growth is not zero-sum: even if the gap between Canada and the United States widens, Canadians can do better and better in absolute terms as long as real GDP per capita rises. But why settle for being less prosperous than the United States? Indeed, with some major changes in its economic policy over the next five years, Canada could set the stage for overtaking the United States-on a real GDP per capita basis-within 20 years. To do that, Canada must become the Hong Kong of the Western hemisphere.

Canada as Hong Kong? Before you reject the idea, consider the following facts. In 1960, Hong Kong’s per capita gross domestic product (in 2000 U.S. dollars) was $3,544, which put it not just way below the United States, but also behind Israel, Mexico and Argentina. By the time the Communist Chinese government took over in 1997, Hong Kong’s GDP per capita, at over $29,000 (again in 2000 U.S. dollars), was slightly higher than that of the United States. Why did Hong Kong do so well so quickly? The answer can’t be natural resources. Hong Kong is a rock at the edge of the ocean, and not even a large rock. No. The reason Hong Kong did so well is that it had the closest thing to a laissez-faire economy that has existed in the last 50 years. Tariffs on imports averaged under 1 percent. The top marginal tax rate was as low as 15 percent and never went higher than 25 percent, and the average tax rate was never allowed to go above 15 percent. Government transfer payments and subsidies have stayed around 1 percent of GDP, compared to 17.7 percent for Canada and 13.9 percent for the United States (in 1995). Government regulation was minimal-no minimum wages, no permission required to start a business, few regulations of business in general, and no government-protected monopolies.

Of course, if Hong Kong were the only country that did well by adopting economic freedom, my case would be weak. But it hasn’t been. Serious economists at the World Bank, at the International Monetary Fund, in economics departments at U.S. universities and at Canada’s own Fraser Institute have, in study after study over the last 15 years, reached virtual unanimity on the big picture. They have found that countries with low taxes, low government spending as a percent of GDP, low or zero inflation, respect for property rights and minimal regulation do better than other countries. That’s why, in economic research, the field of economic development has morphed into the field of economic growth. After a disastrous flirtation with heavy government intervention in Third World countries during the 1950s, 1960s and 1970s, economists came back to Adam Smith’s view that poor countries get richer the same way rich countries get richer-through more economic freedom.

Canada is doing well-on two of these five policies. Canada’s inflation rate is now down to less than 3 percent after averaging 7.1 percent between 1965 and 1980. And by and large, Canada’s governments still respect property rights, although there is much room for improvement.

But take taxes. Please. Between the mid-1960s and the mid-1970s, high inflation kicked almost all Canadians into higher marginal tax brackets. The result, as University of Western Ontario economist James B. Davies has found, is that the average marginal tax rate paid by Canadians rose from about 19 percent in 1965 to about 33 percent in 1974, and has stayed high since. High marginal tax rates discourage work, saving and risk taking, keeping economic growth lower than otherwise.

Those high tax rates-marginal and average-have fed a greedy government. Government spending as a percent of GDP, which was comparable to the U.S. level in the early 1950s, reached over 52 percent in 1993 and is still just below 50 percent. And it uses much of this money to hound Canadians from cradle to grave. Compare Canada’s government spending to that of the U.S. U.S. spending grew too, but much less, from about 21 percent of GDP in 1950 to “only” 28 percent in 1999. If Canadians want economic growth, they must put their government on a diet. Money spent on government projects is almost never spent as well or wisely as people spend their own money. And given how profligately the U.S. federal and state governments spend, Canadian spending as a percent of GDP can be cut below the U.S. level.

Finally, Canada has become a regulatory state. Governments at all levels heavily regulate what people may do with their money and their lives. You are not free to open a liquor store and compete with the government’s monopoly. You are not free to compete with the post office. Employers and employees cannot legally make mutually beneficial contracts that specify hours and pay rates different from those the government decrees. The federal government restricts immigration, preventing very productive people from moving to Canada. Of course, governments in the United States also have similarly oppressive and destructive regulations. But that’s my point. Canada could leapfrog the U.S. in economic growth-and, ultimately, economic well-being-by leapfrogging it in scaling back the regulatory state. Both Canada and the U.S. have benefited from the massive deregulation of transportation. The lesson applies more generally. Across-the-board deregulation would make Canada an economic superstar.

But it’s not just about economic prowess. There’s something more important to be gained by freeing Canadians’ economic lives: freedom itself. Canada has always been one of the freest countries in the world. But Canadians are less free than Americans. They are much less free to purchase medical care from willing providers, for example, and this lack of freedom has caused thousands of Canadians to die earlier than otherwise. In one important way, Canada used to be freer than the United States-it avoided the military draft during peacetime and even for most of both world wars. What a glorious example Canada could set by becoming the freest country and therefore, by example, the leader of the world.