Niels Veldhuis, Senior Research Economist, the Fraser Institute – Second Interview

Canada, Equalization, Frontier Centre, Interview, Role of Government, Taxation, Uncategorized

Frontier Centre: When we last spoke two years ago, you shared numbers showing that Manitoba’s public sector was much larger than the Canadian average. Has anything changed?

Niels Veldhuis:Unfortunately not. Federal, provincial and local government spending, in Manitoba relative to the overall economy is still nearly to 50%, which remains one of the highest proportions among Canadian provinces.

FC: What is the relationship between the size of government and economic performance?

NV: That’s an important question, and I urge people to go to the Frontier Centre’s website and look at my 2005 presentation on the subject. A lot of academic research has been done that investigates the relationship between the size of government and a whole host of economic and socio-economic indicators. These academic studies show that there exists what’s known as an optimal size of government that maximizes economic growth, employment growth, and health, education and other socio-economic outcomes. The optimal size of government in Canada has been found to be somewhere between 20 and 35% of the GDP.

FC: Why are there differences in those estimates? Late last fall, we hosted Richard Vedder from Ohio State University, and he says the optimal level is 17.5%. Why are your numbers so high compared to his?

NV:One of the reasons for the disparity is differences in jurisdictions. In places like Canada, where there are large geographical distances between the population centres, more infrastructure is required which obviously requires more money and a slightly higher optimal size of government. The estimates I provided for Canada are historical estimates. With the level of technology we have in place today, the optimal size may well be smaller.

FC: One of the differences in the economic performance of Manitoba that is often overlooked is the fact that we have the highest aboriginal population. Because of special circumstances of law on reserves that negatively impact economic outcomes, that demographic fact drags down our performance and our indicators. How does that affect Manitoba’s standing in the overall numbers?

NV: That may have an impact. It’s not something I have looked at very closely. But in order to maximize economic prosperity, the right environment needs to be created. That applies to the general population and it certainly applies to the aboriginal population. The Frontier Centre has done good work in trying to make people aware of what policies are needed in those jurisdictions to create the right environment for prosperity.

FC: Saskatchewan has an NDP government that, at least on the subject of tax competitiveness, seems to have gotten the message. Manitoba’s tax cuts have been niggling in comparison. Is it inevitable that the next domino is Manitoba?

NV: If you’re living in Manitoba, you would certainly hope so. Saskatchewan finally enacted major business tax reforms in its 2006 budget. I personally hope that Manitoba’s next and joins in what the other western Canadian provinces are enjoying, which is prosperous economies. If Manitoba does want to join that club, it has to reduce its business taxes such as corporate income taxes dramatically, and it has to eliminate its most damaging tax, the corporate capital tax.

FC: How badly is Manitoba lagging the rest of Canada in terms of its economy? Is the divide growing? Are we getting worse relative to other provinces?

NV:In terms of economic growth, Manitoba certainly ranks among the worst provinces, similarly in terms of GDP per capita and disposable income per capita. Manitoba also has the worst record of private-sector job creation.

FC: One of the crucial indicators you discussed today was our low investment levels. Why does that matter?

NV: Unfortunately, Manitoba has a relatively low level of investment relative to the other Canadian provinces. We know that when you have low levels of investment, workers are less productive and, when workers are less productive, their wages are lower. If you create the right environment and get increased investment, you are going to get higher rates of productivity and you’re going to get better wages for Manitobans.

FC: In your talk today, you spoke of two approaches to economic development. Can you summarize what you said?

NV: The first one is creating the right environment, one which gives people the incentives to actively participate in the economy. That means giving people incentives to work, to take risks, to save and invest their money and to act entrepreneurially. The way that you do that is by having an optimally sized government, a competitive tax regime with incentive-based taxes, streamlined regulation and free trade..

The second way is to have an actively managed economy, where the government is heavily involved (as in Manitoba at 50%), where the government favours certain industries through subsidies and tax credits, where trade is not free, where you have a lot of red tape in the economy.

One method of development has the government actively involved in trying to create prosperity – which seldom results in a prosperous economy – and the other is creating the right environment.

FC: What is the new inter-provincial trading arrangement between B.C. and Alberta? Is there any momentum for expanding it throughout Canada?

NV:The Trade Investment Labour Mobility Agreement (TILMA) is an historic agreement signed by B.C. and Alberta in 2006. It basically creates one large economy between the two provinces. By 2009, there will be free movement of goods and services, people and investment. For example, if you are a registered teacher in one province you can automatically teach in the other. A business registered in one province will automatically registered in the other. It’s going to result in a much more dynamic economy because people, labour, goods and services are able to move across borders freely.

Hopefully other provinces will join onto the agreement. I think this is a huge opportunity for Manitoba. If Manitoba were to sign on to this agreement, it would be very beneficial for Manitobans.

FC: We’d have to swallow some pretty severe changes. Some autarchic practices you described today would have to be changed pretty quickly, wouldn’t they?

NV: Absolutely. But B.C. and Alberta are phasing TILMA in over a three-year period. To lessen the impact on some groups of people, Manitoba could look at a similar strategy. But the benefits would be overwhelming. The benefits to most Manitobans in terms of being able to ship goods and services to B.C. alone, particularly because it has large, deep-sea ports able to ship to other places around the world, are substantial. And free movement of labour and investment is something that is absolutely critical to prosperity.

FC: By virtue of its equalization boodle, Manitoba is able to offer basic public services like health and education at a much more expensive per capita rate than the provinces whose people are funding the transfers. Do you think the writing is on the wall? Do you think that should be made part of the calculation of federal equalization transfers?

NV: One of our recommendations is that the equalization be adjusted for the cost of providing goods and services. We know that the cost of providing goods and services, purely by nature of things like property taxes and wage rates, is a lot lower in Manitoba than it is in Vancouver or Calgary. Equalization should be adjusted to account for differences in the cost of living.

FC: One part of the “green wave” sweeping the country is a perceived need to build a national east-to-west power grid. Do you agree that it’s needed?

NV:I can’t really comment on the electricity grid because I am not an energy economist. Many green initiatives proposed by various governments have yet to be costed out. Canadians need to be made aware of exactly what these green initiatives are going to cost their families. If Canadians had accurate estimates of the costs of the green initiatives, I think a lot fewer people would be supporting them.

FC: Do you think we should have legislated limits to the size of government?

NV:I am a firm believer in what is called a “tax expenditure limitation,” which basically takes power out of the government’s hand and puts it back into peoples’ hands. You limit the size of government spending or the growth in the size of government spending to inflation plus population growth, so that real spending doesn’t change. If governments want to spend beyond that, they have to go back to the electorate and get people’s authority to increase spending at a faster rate. If there are surpluses, those surpluses automatically go back to taxpayers. Many U.S. states have these tax and expenditure limitation laws and it would certainly be something for Canadian provinces to look at.

Conversation in PDF