Stop the stimulus; With the Canadian economic recovery likely already underway, more stimulus could hurt the economy

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Appeared in National Post

The New York Times columnist and economist Paul Krugman recently congratulated the Obama administration for helping pull the U.S. back from the brink with its stimulus measures. He went on to declare that much more stimulus is urgently needed to help promote and sustain the recovery. Similarly, Prime Minister Stephen Harper warned his international counterparts at the recent G20 Summit that ending government stimulus measures too quickly risks plunging nations back into recession. According to Mr. Harper, G20 countries need to make sure that the stimulus measures that have been put in place get fully delivered.

Unfortunately, neither Krugman nor the Prime Minister has it right. The private sector, encouraged largely by low interest rates, not government stimulus spending, is the reason for the positive signs in the economy thus far. In fact, the real risk for economic recovery lies in governments continuing to push forward with stimulus plans. As the economy begins to recover, the stimulus spending will compete with private sector investment and dampen the recovery. Rather than continue to roll-out more stimulus, the Conservative government should tighten the spending reigns and let the private market flourish.

Recently released data from Statistics Canada presents encouraging signs of the beginning of an economic recovery. After three consecutive quarters of declining economic output, inflation-adjusted GDP increased in June, the first monthly increase in nearly a year. While GDP in July was unchanged, the Bank of Canada and most major Canadian banks are now predicting positive growth in Canada's economic output for the third and fourth quarters of the year. If these predictions come to fruition, the great recession of 2009 will be shallower and shorter than previous recessions and nowhere close to what many predicted.

In the United States, the recession is expected to end this fall. In fact, Ben Bernanke, Chairman of the Federal Reserve, recently stated that, the recession is very likely over at this point.

Despite the rhetoric from economists such as Krugman and politicians like Prime Minister Harper, the signs of economic recovery are appearing despite the fact that most of the stimulus spending has yet to be implemented.

In the United States, Keynesian economists point to the smaller decline in second quarter GDP (minus 1%) compared to the first quarter (minus 6.4%) as evidence that government stimulus is working. But as Stanford economic professor John Taylor's recent analysis highlighted, of the 5.4 percentage point improvement only 1.8 percentage points can be attributed to government spending. And half of this was the result of increased defence spending (not part of the stimulus package). Professor Taylor concludes that the growth improvement in the second quarter must have been largely due to factors other than the stimulus package.

In Canada, the first and second quarter Canadian GDP results show that government spending at all levels of government (federal, provincial and local) increased by 0.5% and 0.8% in each quarter respectively (compared to 1.4% in the first quarter of 2008 and 1.1% in the second). Government capital investments increased by 2.1% and 3.7% in the first and second quarter of 2009 compared to 4.4% in first quarter of 2008 and 2.8% in the second quarter.

In other words, Canadian governments actually slowed their increases in spending in the first and second quarters of this year compared to 2008; hardly what one would call stimulus spending.

This of course is a very different message than Canada's federal government consistently delivers. The federal government's September report to Canadians, intended to outline the progress the federal government had made on its stimulus initiatives, claimed that 90% of the measures were either flowing or that money was committed to specific projects. Indeed, Prime Minister Harper proudly highlighted that 90% of the stimulus funding for this fiscal year has now been committed to more than 7,500 infrastructure and housing projects.

Money being committed is very different from money actually spent.

The government claims more than 40% of the total federal stimulus package is being devoted to infrastructure projects. Building infrastructure, however, requires months of preparation before construction can begin and perhaps years before completion. Most of the funds will not provide jobs in time to counteract the recession, which may well already be ending.

Instead, there is a significant risk that a large portion of the stimulus package will hit the economy as it is naturally moving out of recession. As a result, the stimulus will be destabilizing rather than stabilizing. That is, the government will compete with the private sector for scarce resources resulting in increased costs and fewer private sector projects than would otherwise be the case.

In addition, stimulus spending that is financed by deficits will crowd-out private sector investment. Since governments will borrow from the market and provide investors with risk-free government debt, they will directly compete with and supplant the development and financing of private projects, which are crucial to a sustained recovery.

Rather than encourage his global counterparts to follow through on their stimulus pledges, Harper should focus on scaling back his own government's profligate and harmful spending. Pulling back the stimulus will ensure a faster economic recovery and brighter future for Canadians.

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