Canada managed to escape the initialÂ financial crisis, between late 2007 and early 2009, in better condition than its major global financial partners.Â It did so for a variety of reasons.Â Canadaâ€™s economy is by and largeÂ â€œfreerâ€ than that of the other advanced industrial countries, including the United States and Europe.Â Canada has historically preformed consistently well on the Heritage Foundationâ€™s Index of Economic Freedom.Â Importantly, Canadaâ€™s banking sector did not suffer from a collapse of the mortgage market, meaning that there was not a major disruption of financial intermediation between savers and investors.Â Canada suffered mainly from the ripples originating from countries with which Canadian businesses were interdependent with.
There was an important decline in industrial productivity, and Canadian industry has only begun to recover fairly recently.Â Nevertheless, the hit Canadian production took was not as acute as that of the United States â€” American private investment remains severely depressed, which is the main cause of the stagnation fromÂ which the American economy is suffering.Â While there are some reasons for concern, the Canadian economy is in a good positionÂ to finalize its recovery and grow from there.
There is someÂ fear about the future of Canadaâ€™s housing market.Â In many ways, this sector resembles that of the United States.Â This includes the fact that roughly 90 percent of Canadian mortgages have been securitizedÂ by the Canadian Mortgage and Housing Corporation (CMHC), which is a cause for anxietyÂ when correlating the mortgage disaster in the United States with the role played by Fannie Mae and Freddie Mac.Â The concern is heightened by theÂ knowledge that there is an overconcentrationÂ of banking investment in the mortgage market, much like there was during the years leading to the crisis in the United States (depending on how these assets are being rated, investment in them may even be rewarded thanks to how capital reserve minima requirements have been designed by the Basel accords).
Canadaâ€™s housing market may be in better conditions than some believe, though.Â Comparatively, inflation has been historically low â€” generally, the consumer price index has seen a percentage change of less than three percent month-by-month.Â Cheap credit manifests itself not only in an increase in investment loans (whether business or housing), but also in a rise in consumer credit.Â That the increase in consumer prices remains modest, within this context, is a good sign.Â It should also be considered that the different interest rates governed by the Bank of Canada, including the overnight rate, were fairly conservative until only recently.Â The same is true for general bank rates, as well.Â It was only afterÂ the initial crisis that interest rates began to fall (the general bank rate fell from a high of 4.75 percent to a low of .50 percent between November 2007 and May 2010; they now sit at 1.25 percent).
There is, admittedly, a centralization ofÂ bank investment into mortgage-backed securities, but at the same time there may be less reason to suspect that these securities are as risky as those in the United States.Â NewerÂ investments may beÂ riskier than older ones, and it is certainly true that there may be a shockwave effect if there were even a slight crisis in the mortgage market, but there is reason to believe that the situation is vastly different to that of the United States on the eve of the financial crisis.Â The underlying securityÂ of bank assets may be safer than realized.
Despite all the positive qualities of the Canadian economy, Finance Minister Jim Flaherty has expressed some concern for its relatively poor performance in the most recent quarter and has declared his intentions to push back his budget balancing policy in favor of shoveling money towards stimulus ventures.Â There is some legitimacy behind Flahertyâ€™s uneasiness.Â The Canadian economy is very integrated into the global division of labor, meaning that global economic problems have a considerableÂ impact on its health.Â Flaherty probably intends to use these stimuli as bulwarks against the possible shockwave that may come with the worsening European economic outlook.Â While Flaherty may have some reasons to be afraid, his response could be better.
If there are two things to criticize about the Canadian economy, they are Canadaâ€™s high government spending and the relative lack of freedoms on investment opportunities.Â That is, how Canadians and foreigners can invest in Canadaâ€™s markets is tightly regulated by the Canadian government.Â The result of high government spending and tight regulation on investment is a two-prong attack on any economyâ€™s greatest asset in fighting economic discoordination: the entrepreneur.
It is important to remember that the situation in CanadaisÂ not as dire as some of the language used here may lead to believe.Â Canada ratesÂ highly in business freedom.Â The countryâ€™s financial sector is in order and the provision ofÂ credit to businesses has not become overly tight.Â Investment and production are growing at reasonably higher rates than in other advanced industrial countries.Â These are all positive attributes of the Canadian economy.Â The point being made here, though, is that political policy â€” if there must be any political policy at all â€” ought to strengthen these particular qualities and avoid undermining them.
Reducing government spending is important.Â The less money the government takes from the private sector, the more productive the private sector is.Â I have laid out the theoretical case for this in a previous article, â€œGovernment Spending is Bad Economicsâ€.Â Basically, there are tendencies in the market which help regulate the use of capital in the market.Â Generally speaking, market outcomes are relatively more â€œoptimalâ€ than those which stem from government spending.Â This is because the government operates outside of the market process (i.e. the coordination process).Â If could be summed up in a phrase, it would be: markets economize, governments ration.
Money is usedÂ to buy resources.Â The more money government takes away from the private sector, the more resources the government takes away from the private sector.Â The less capital-goods available to entrepreneurs, the less capital-goods that can beÂ invested into the various production processes which make up the structure of production.Â The end result of this pattern is to decrease the volume of wealth creation.Â We can therefore conclude that government spending comes at a cost.Â The cost is the foregone production of the private sector.
Freedom in investment is also paramount if there is to beÂ any degree of flexibility in an economy.Â An entrepreneur must have the freedom to move capital around from investment to investment, based on his or her assessment of the profitability of different capitalistic ventures.Â If a certain investment is seenÂ as unprofitable, it is preferredÂ to have the degree of flexibility sufficient to cut oneâ€™s losses and re-invest in something better.Â Generally, the more restrictions a government puts on investment, the less flexible the investment environment is.
It could be argued that some regulation is necessary to avoid predatory investment or investment that is â€œobviouslyâ€ bad.Â This could be said, for example, of a statute looking to ban subprime lending.Â Superficially, the case for this type of regulation is clear.Â It becomes more suspect when one begins to realize that the rationale behind these types of investments were not malignant and that their (lack of) security is not as obvious as it may seem in retrospect (in the United States, for instance, there were no investments in the mortgage market rated under AAA â€” the subprime collapse came as a total surprise).Â Regulators tend not take this into account, and the case for this type of legislation is more often than not extremely superficial.
We can also apply the more well-known and repeated arguments that bolster the role of the entrepreneur.Â This includes avoiding monetary intervention through the Bank of Canada, such as interest rate manipulation.Â Credit expansion distorts relative prices, causing a change in investment patterns which may not be sustainable (what Austrians term â€œmalinvestmentâ€).
Why is the entrepreneur so important?Â Wealth production is an outcome of capital accumulation and economization.Â That is, an economyâ€™s productivity depends on its level of savings and the efficient use of these savings in the processes of production.Â The economic agent who directs this type of activity is the entrepreneur.Â The entrepreneur is responsible for investing savings into business opportunities.Â Thus, the last thing that should beÂ done is to limit or remove the means of doing as much.Â In fact, any government policy should beÂ directed at removing pastÂ legislation which may act to hamper the ability of the entrepreneur.
If Canadaâ€™s economy suffers a blow-back from the worsening conditions in Europe, it will be Canadaâ€™s entrepreneurs leading the escape.Â When some business opportunities with Europe become less profitable or no longer available it will be Canadaâ€™s entrepreneurs which redirect their resources towards better investment ventures.Â This economic restructuring will be the key to maintaining a healthy rate of productivity and economic growth.Â Furthermore, in the interest of avoiding major blips, this restructuring should take place as quickly as possible â€” this is exactly the reason why entrepreneurs should have as much flexibility as possible when making their decisions.
Finance Minister Jim Flaherty certainly has reasons to beÂ wary of possible economic ripples making themselves to Canada fromÂ the European crisis.Â Advanced industrial economics enjoy extensive, interconnected division of labors.Â A crisis in Europe will also affect industry in Canada.Â But, Flahertyâ€™s policies to bolster the countryâ€™s defenses against such an event are the exact opposite of those he ought to pursue.Â Postponing the plan to balance the budget only means that more money will be siphonedÂ away from the private sector and essentially wasted on government programs â€” this money will not be economized towards the end with the most perceived utility.
If the Canadian government needs to take action, it ought to do it in the exact opposite direction.Â It should cut spending and legislate only the removal of regulations that hamper business activity.Â In other words, the entrepreneur who operates in Canada shouldÂ be as free as possible to move his or her capital around into those avenues of investment which are perceivedÂ to offer the highest rewards.Â If the market process is allowedÂ to work, Flaherty can be reassured that the Canadian economy will adequately deal with whatever problems come from a European debt and currency crisis.
Canada, in fact, is in the perfect position to take these capitalistic steps.Â It is already one of the most robust advanced industrial economies in the world, since it managed to remain relatively stable after the 2007â€“09 credit contraction.Â The Canadian economy is also one of the freest of the large advanced economies, meaning it has ample precedent to show the value of a free market attitude.
Â The role of capital regulations in the United Statesâ€™ banking industry has been exploredÂ in Jeffrey Friedman and Wladimir Kraus, Engineering the Financial Crisis (Philadelphia, Pennsylvania: University of Pennsylvania Press, 2011).