February 24, 2005

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B.C.'s revival: Good policy or good luck?

There is compelling evidence to suggest that government policies can influence the longer-term growth prospects of an economy.

According to most measures of economic activity, British Columbia appears to have finally emerged from almost a decade of economic stagnation.

In his recent budget speech, finance minister Colin Hansen was quick to assign credit for this happy turn of events to the provincial government's wise economic policies.

The government's critics, on the other hand, were equally quick to divert credit to various external factors, such as the fortuitous boom in world commodity prices. At least everyone seems to agree that the B.C. economy is moving again. But who or what deserves the credit for this economic development?

Let me begin with a couple of facts. First, for as long as most people can remember, British Columbia has always been one of Canada's so-called have provinces. Essentially, all this means is that average material living standards in B.C. (say, as measured by real per capita income), have normally exceeded the Canadian average. Second, over long periods of time, material living standards have tended to grow at roughly two per cent per annum, which is fast enough to double incomes every 36 years. Together, these two facts imply that the average British Columbian today is significantly richer than their parents and (historically, at least) significantly richer than the average Canadian.

Of course, in any given year, the economy's growth rate may differ substantially from its historical average. Occasionally, growth becomes negative (incomes are falling) so that the economy is said to be in recession.

But because the economy generally displays secular growth, these episodes are relatively infrequent and short-lived. It is highly unlikely that local government policies have very much to do with the year-to-year fluctuations in growth around trend.

For a small economy like B.C., highly integrated as it is with the world economy, external factors (such as world commodity prices and interest rates) play a predominant role. Sometimes these factors work against the B.C. economy and sometimes they work in its favour. But these factors are largely beyond the control of British Columbians.

On the other hand, there is compelling evidence to suggest that government policies can influence the longer-term growth prospects of an economy. Economists are virtually unanimous in the view that growth in long-run living standards depends on rising productivity.

Productivity depends on technology and capital (both physical and human). Productivity will only rise when individuals in an economy have the incentive to adopt new technology and divert resources to new capital expenditure. The willingness and ability of individuals to undertake such investments can depend critically on the nature of government policy.

For example, a government antagonistic to the business community may adopt a regulatory regime that inhibits productivity-enhancing investments. A confiscatory tax regime may accomplish the same thing by lowering the after-tax return to investment.

Furthermore, while government policy has no control over external factors, its policy structure may influence the nature of the economy's response to any given external disturbance. In particular, a bad policy regime may exacerbate the effects of a negative disturbance, thereby prolonging a recession and delaying recovery. Similarly, a good policy regime may mitigate the effects of a negative disturbance (for example, by facilitating economic restructuring) and enhance the prospect of quick and durable recovery.

It is interesting to note that despite the historical ups and downs in the B.C. economy, it has (until recently) always remained above the Canadian average. But this historical pattern appears to have broken down in the 1990s. Over this decade, British Columbia's economy displayed virtually zero growth - an unusually long period of economic stagnation. In contrast, the Canadian economy as a whole grew rapidly throughout this period. As a result of these developments, B.C. became, for the very first time, a have not province. This transition from have to have not status just happened to occur shortly after the election of Michael Harcourt's NDP government in 1992.

A natural question to ask at this stage is whether B.C.'s dismal economic performance over the 1990s is attributable to bad luck or bad NDP policies. There is reason to believe that it was some of both, but mainly the latter. First, one can hardly blame the NDP (or the Social Credit party) for the recession that occurred in the early 1990s, since this was a worldwide phenomenon. But while the rest of Canada slowly emerged from this recession, B.C. continued on a path of economic stagnation. The reason for this can only partly be attributed to external factors that worked against the B.C. economy. It is hard to believe, however, that these external factors should have manifested themselves as several years of economic stagnation in a well-functioning economy.

The states of Washington and Oregon, for example, were similarly affected by the decline in world commodity prices at that time and yet, both of these jurisdictions fared much better than B.C. This, as well as other evidence suggests that responsibility for B.C.'s transition to a have-not status must lie largely on the shoulders of the NDP administration at that time.

Turning to more recent events, the B.C. economy showed signs of economic recovery late in the NDP's administration. However, while the B.C. economy began to grow, it continued to grow more slowly than the rest of the country. Following the election of the B.C. Liberals, the B.C. economy continued to grow at a moderate pace, which was enough to make it grow faster than the rest of Canada. Official GDP numbers are currently available up to 2003. Current estimates suggest that B.C. continued to grow faster than the rest of Canada in 2004. As well, current forecasts suggest that B.C. will continue to outpace the rest of Canada for much of the near future.

The interesting question here is whether B.C.'s current growth trajectory is the product of good luck or good policy. With recent worldwide boom in commodity prices largely favouring the B.C. resource sector, there is no question that good luck has played a significant role in recent developments.

But good luck cannot last forever and, as I have explained above, the longer-term growth prospects of an economy and how an economy responds to fortuitous events can depend critically on the nature of government policy. It is still too early to measure the extent to which Liberal policies have contributed to our recent boom. But there can be little question that they deserve at least some of the credit, if only for replacing what was viewed by many as an antagonistic, unpredictable, wasteful, and amateurish (however well-intentioned) NDP regime with something relatively more benign.

David Andolfatto is an associate professor of economics at SFU who is currently studying the role of government policies in shaping the historical patterns of economic development among Canada's provinces.

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