The big spending myth. Terence Corcoran,

In the lead up to this week's throne speech and a coming fiscal update from Finance Minister Chrystia Freeland, Prime Minister Justin Trudeau's government has been advised by all and sundry to spend more money. Be careful not to overdo the deficit funding, mind you, but increased government spending is seen as the only way to raise the Canadian economy from its current COVID-19 comatose state.

Even the deficits are downplayed on the grounds that with interest rates near zero, the cost of raising total government debt to $1.2 trillion can be kicked down the road. Tomorrow is another day, when the debt can be paid off as the economy blossoms from massive distributions of government fertilizer.

Those are the arguments. As one pair of political thinkers put it, “We are at one of those pivotal moments. This is a time for stimulus — not austerity — but stimulus that is well-designed, leverages the private sector and is focused on growing the economy.” Another spending advocate, Mark Wiseman, chair of Alberta's $118-billion pension and investment fund, said, “We need to spend because the pandemic has put us in that situation. There's no other option. We need to make sure every dollar we spend is shifted to growth and rehabilitation. If you can spend the money and create the growth from it, you grow your way out of the problem.”

That's the theory. But where's the evidence? Many studies show government spending does not boost the economy. On the contrary, numerous economists over the years have warned that previous increases in government spending have led to declines in economic activity, including a steady deterioration in national economic performance.

Research into the role of government spending in boosting (or not) national economies is filled with contentious claims and deep theoretical and mathematical contortions beyond the brainpower of the average nuclear physicist, let alone a media columnist. But policy must be examined, and the evidence that high levels of government spending, with or without deficits, generate economic growth remains highly questionable.

Economist Valerie Ramey at the University of California, San Diego is one of the more prolific economists on the subject of fiscal stimulus. In a paper this year titled, “The Macroeconomic Consequences of Infrastructure Investment,” Ramey concluded that infrastructure spending can boost growth — if done right. If there are no implementation delays and the actual project adds genuine productive elements to the economy, then government spending can boost long-run growth, assuming it doesn't crowd out private investment.

In another paper reviewing the impact of U.S. government stimulus spending following the 2008 financial crisis, Ramey essentially concludes that the economics profession needs to do more to nail down the real impact of massive government spending binges on the economy.

The idea that government spending spreads through the economy and generates growth via “multipliers” remains a technical and theoretical morass. Ramey notes, for example, that “there is evidence that government spending multipliers may be negative” in countries with a government debtto-GDP ratio above 60 per cent. In that case, government spending can have an “impact multiplier of 0.” Canada this year is in that 60-plus territory, heading for 120 per cent.

In addition to Canada's debt being a drag on growth, the sheer size of government may have a larger impact.

Livio Di Matteo, a professor of economics at Lakehead University, sees the size of government (not just government debt) as a “potent long-term determinant of economic growth.” In a major paper for the Fraser Institute, “Measuring Government in the 21st Century,” Di Matteo wrote: “All other things given, over the course of a decade, an economy with a public sector the size of 30 per cent (of GDP) could see its per capita GDP grow by over one-third, while an economy with a public sector size of 40 per cent would see smaller per capita GDP gains of only one-fifth.”

Which brings us to Canada, where the 40 per cent rule has been broken through most of the last 50 years, producing decades of low growth rates.

Since the end of the Second World War in 1945, total Canadian government spending has soared from 25 per cent of GDP during the early postwar decades, to the recent 40 per cent range. The result has been 75 years of steady declines in Canadian economic growth rates (see graph).

In the years immediately following the end of the war, real Canadian GDP growth per capita routinely hit peaks of four and five per cent. In the first 40 years after the war, per capita GDP increased 60 per cent, from $16,000 in 1946 to $41,000 in 1983. But 1983 was the last year Canada recorded a five per cent increase in growth and since then per capita GDP has increased only 30 per cent to $61,000. The average annual growth rate has sagged down to less than one per cent over the last 10 years.

The graphic message is in the trend lines. Canadian economic growth rates have actually never recovered from the spending extravaganzas of the 1970s. Real GDP per capita has risen less than half a percentage point per year over the last decade.

The data and the graph do not prove cause and effect, but it is hard to imagine how the current explosion of government stimulus spending will change the course of the economy and reverse the trend lines that suggest more spending equals less growth.