The Rising West

February 2006 Alex Black

The Conservative victory in the Canadian national election was hardly decisive enough to guarantee a serious shunting toward the right but nevertheless many Canadians are anxious to see what Canada’s new prime minister, Stephen Harper and his government will bring to the table. As ever with Canada, the concern is over a political schism that threatens national unity. This time however, the discord emanates from the West.

In many ways, this election result represents a westward shift in Canadian demographics and politics. One of the clearest signals of a changing geopolitical map in Canada was the Conservative’s election promise that British Columbia would receive greater representation in parliament, but Mr. Harper himself personifies the westward shift. Mr. Harper will be the first elected prime minister to come from outside Quebec since Joe Clark in 1979 (Kim Campbell was only filling in for Brian Mulroney and was never elected in her own right). Born in Ontario, Mr. Harper’s ideology was nevertheless forged much farther West, in Calgary. He was an early disciple of Reform party founder Preston Manning and University of Calgary professor Tom Flanagan, who remains one of Harper’s closest advisors. Both of these figures represent the far right of Canadian politics, and in the case of US- born Professor Flanagan (his book “First Nations, Second Thoughts” questioned the legitimacy of Native Canadian’s land claims), he would be considered far right in the US as well. Aboriginal groups aren’t the only ones worried about the closeness of Professor Flanagan to Mr. Harper: pro-abortion groups, gay-rights groups, all have much to fear if Mr. Harper decides to listen to his old Reform party’s hard-line social conservatives. Mr. Harper has conceded that he will put before Parliament the decision on whether to revisit gay marriage, but he would be well advised to try and avoid issues where there exist very active polarized minorities but toward which the majority of Canadians are agnostic. Mr. Harper has, however, never been too vocal or conservative on social issues (he was one of only two Reform MPs to favor the gun registry) and has himself a background in economics. Much of his political transformation has consisted in distancing himself from his Reform roots and re-branding himself as a Conservative of old: concerned with an overabundance of federal government and prohibitive taxes. It is on these issues that Mr. Harper found wide support throughout Canada during the election and it will no doubt be on these issues that he will find a large and attentive national audience.

The Conservative’s successful platform was centered around reducing corruption and improving government accountability. This was obviously a hot topic in Canada following the scandals that rocked and eventually toppled the Liberal government. Few in the opposition will argue against the need for a more efficient government, and passing the much-touted Accountability Act is both a clever and practical first foray for Mr. Harper’s minority government. If Mr. Harper intends to make the government leaner and meaner he may run into strong opposition from Atlantic Canada and Quebec if his approach involves cutting back on government subsidies. Many in the West are opposed to Ottawa’s constant kowtowing to Quebec in order to pacify the separatists and Harper has been quoted as saying, “There’s unfortunately a view of too many people in Atlantic Canada that it’s only through government favors that there’s going to be economic progress, or that’s what you look to.” How far will Mr. Harper go in curbing Ottawa’s handholding of Quebec and the Maritimes? One has to keep in mind that much of Mr. Harper’s popularity in Quebec came from promising increased provincial autonomy but what if he takes away with the other hand? With only a minority government to work with, he runs the risk of being very divisive but accomplishing little. He has therefore signaled his intention to pursue the more popular route of tax cuts, taking advantage of the favorable fiscal situation to buy himself both time and possibly votes. Mr. Harper has pledged to cut the GST by 1 percent immediately, followed by another 1percent reduction in roughly a year’s time. Other tax cuts have been contemplated, with perhaps a reduction in the capital gains tax or the inheritance tax. Economically, we would rather see a reduction in the income tax, as we are skeptical as to whether encouraging consumption in an already highly leveraged economic system is a good long-term idea. Mr. Harper’s biggest critic might be his own fiscally conservative mentality which ought to frown on reducing government revenues while simultaneously increasing spending — which he’ll have to do if he wants to come through on some of his other campaign promises such as lowering crime and reducing hospital wait times.

Mr. Harper must obviously walk a fine line between not letting the social conservatives in his own party hijack his platform and not forcing an early no-confidence vote by promoting budget cuts and reallocations. His real ally is Canada’s strong economic position and fiscal surplus, which should afford the prime minister some room to maneuver.

Another prospective outcome of the conservative government’s election will be a rapprochement with Washington. Lately, Canada-U.S. relations have been strained because of the lack of common ground between the Republican White House and the Liberals in Ottawa. A new ambassador in Washington and a shared conservative mindset ought to strengthen cross border ties. As the U.S. absorbs about 85 percent of Canada’s exports, this promises to be beneficial for the economy as trade disputes are more likely to reach satisfactory conclusions.

So what effect will the Conservative government have on the economy? At the most basic level, increased fiscal spending and lower taxes should provide a boost to the economy. As the Canadian economy has already been growing at a brisk pace due to robust commodity prices, we would also expect monetary policy to remain restrictive in order to attempt to keep a lid on inflation. Both the fiscal and the monetary factor put together suggest a further short-to-medium-term strengthening of the Canadian dollar. In fact, since most of the fiscal spending announcements were made during the campaign, a portion of this impact may be already priced into the market. The caveat is that increasingly the economy depends on commodity prices. Certainly more than any fiscal measure, the direction commodity prices take over the next several years will effectively dictate Canada’s economic health. Much of the westward shift in Canadian politics can be linked to the equally westward migration of economic power. Oil-rich Alberta has obviously played the most important part in this shift, but a host of other commodities such as uranium and gold have been displacing the balance of power away from the traditional manufacturing centers of Ontario and Quebec (auto parts makers and manufacturing enterprises like Bombardier have suffered accordingly). We certainly don’t believe Mr. Harper, with all his Alberta connections, will attempt to restrict Canada’s dependence on commodities. But is commodity dependence a sustainable and wise economic formula?

At first glance, the most basic underlying fundamentals for commodities suggest further long-term price appreciation. The global population is increasing and the average person consumes ever more natural resources. Additionally, the global stock of natural resources is fixed and therefore diminishes with additional extraction. Conversely, the balancing factor has always been human achievement and ingenuity: people learn to be more efficient and productive and therefore reduce raw material consumption. Historically, the Malthusian argument has been wrong. As far as Canada is concerned, there is a certain safety in the competitive advantage associated with being a resource country. Global resources are not equally distributed and Canada’s sheer size and substantial good luck mean that it will invariably be in a position to provide primary products to other countries. However, commodity prices are highly volatile and long-term movements notoriously unpredictable. An inevitable short-to-medium-term correction in a long-term bull market would leave Canada reeling regardless of where commodity prices ‘finally’ end up. Furthermore, the question is rather whether being heavily resource-dependent will leave the Canadian economy competitive enough to ensure Canadians of the highest possible standard of living.

The benchmark for developed country growth is still the US. Overall Canada lags the US in GDP per capita ($32,800 to $41,800) and in overall growth rates (2.8 percent to 3.5 percent — based on constant PPP dollars).

The historically high rates of productivity growth coming out of the US in the past decade have been somewhat mitigated by the strengthening of the Canadian dollar, but nevertheless the US is a more productive economic model. The US, of course, does not rely nearly as heavily on resources and instead has achieved remarkable success by creating a more balanced diet highlighted recently by highly productive value-added service industries. Striking a careful balance between different types of industry is probably the safest long-term bet and Canada ought to be careful not to neglect these alternatives. If commodity prices retreat, Canadians may be left wondering why their economy is so unproductive compared with that just south of the border.

Capital markets have reacted positively to the Conservative victory and if Mr. Harper can deliver on his campaign promises while holding together his minority government there will be good reason to celebrate. Our cautionary note is that whether or not Mr. Harper proves to be a competent prime minister, Canada’s economic fate may not be in his or in any other Canadian’s hands and therein lies the true danger. Depending on opaque cantankerous commodity prices is a risky way forward.