Federal Spending as an Economic Engine

Canada's highest productivity growth was during WWII

I want to start with two charts.

The top chart is the spending by Canada’s federal government relative to GDP. The period I want to focus on is the spike during WWII. At its peak, government spending approached 45% of GDP. More than 80% of that was on goods & services with the remainder split between transfers and interest payments.

The bottom chart is the annualized growth rate of Canada’s output per worker, measured by price-adjusted GDP. In other words, it measures the growth of Canada’s labour productivity.

It is very difficult to miss that the highest growth coincides with the highest federal spending.

Obviously this spending was largely devoted to the war effort. But it precipitated a much larger increase in Canada’s productivity than any subsequent period. I believe the wartime spending was also responsible for the elevated growth through the 1950s and 60s. My suggestion is that wartime expenditure by the government expanded and transformed our productive capacity, which catalyzed a burst of spillover innovation.

This fact must be part of the current conversation about how Canada can weather Trump’s trade war.

I want to point out two other facts.

1. Spending on goods & services, which includes the wages paid to federal employees, is just over 20% of total federal expenditures. Transfers to households, other levels of government, and businesses are almost 70%. That means cost-cutting aimed at government services will do little to reduce total expenditure.

2. The massive burst of interest payments from the early-1980s through the early-2000s was the result of the Bank of Canada drastically increasing interest rates in the early-80s. It made a huge contribution to unequal wealth concentration because rich people own much more of the public debt.

The federal government must lead the effort to sustain the Canadian economy in the coming years. That will require putting money behind the effort. Looking to the last federal election, the NDP platform had the highest planned expenditures, while its deficits were effectively the same as the other parties. The Conservatives have said they plan to make major cuts to federal spending. The leading contenders for Liberal leadership have signalled deficit reduction among their priorities. These comments were largely before Trump’s tariff threats. However, they make clear that neither the Conservatives nor the Liberals grasp the scale of the the climate crisis or the threat posed by high and rising wealth concentration.

Done right, federal spending can protect Canadians from the worst impacts of Trump’s trade war, but also turbo-charge our productivity, transform our economy, and greatly improve wealth distribution. But the federal government has to stop trying to “incentivize” investment by the private sector with tax cuts. And it does not have to borrow the money from rich people, which will just make them even richer.

The federal government can create all the capital needed to invest in the Canadian economy. Once added to the economy, that money will not only mobilize the necessary labour and material, its impact will multiply as it gets spent again. Every person’s expenditure is another person’s income. Of course, more money in the economy carries the risk of inflation. But less discussed is that it also tends to trickle toward concentrated wealth at the top.

As the public-created money flows through the economy, it will become the revenue of businesses. A portion of that revenue gets claimed as profit or paid as interest. Just like the public debt, the rich own most business debt and equity. That means they will receive an outsized share of the profit and interest.

A much more progressive tax system is needed to reduce this unfair accumulation of wealth.

During WWII, JM Keynes acknowledged that spending on the war effort would induce inflation unless proper steps were taken. Strategic price regulation has to be one of the tools used. But another should be a form of Trade War Victory Bonds. This not only reduces the amount of money in the economy, reducing inflationary pressure, it also ensures that everyone will share in the benefits of the post-war economy.

Our current political leaders, and those who aspire to lead, are all singing from the same economic songbook. But those songs—cutting the public service, cutting taxes, offering tax credits—won’t work. They never worked. That’s actually part of the reason we’re in such a dire situation and so vulnerable to Trump’s threats. Thankfully, there are other songs. They start with using the unrivalled power of the public sector to coordinate and orient our economy where it needs to go.