[Recorded by Electronic Apparatus]

Thursday, November 9, 1995

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[English]

The Chair: Could we come to order. The finance committee of the House of Commons is continuing its pre-budget consultations, and we're very pleased to have with us today a group of distinguished economists who are going to help us with the question of where our economy is going in terms of growth, interest rates and other significant economic aspects.

With us today we have Mr. Peter Dungan from the Institute for Policy Analysis, University of Toronto; Mr. John Clinkard, senior economist, CIBC; Mr. Don McIver, the chief economist for Sun Life; Clément Gignac,

[Translation]

chief economist and strategist with Levesque Beaubien Geoffrion;

[English]

Steve Tanny, chief economist with Ernst & Young; Mr. Frank Hracs, chief economist, RBC Dominion; Robert Fairholm, principal chief economist, DRI/McGraw-Hill; Mr. Rick Egelton, vice president and deputy chief economist, the Bank of Montreal; Mr. John Johnson, deputy chief economist, Royal Bank of Canada; and Mr. David Rosenberg, senior economist with Nesbitt Burns.

We appreciate very much your presence here. Might I suggest that we start off with opening statements of a maximum of five minutes, and then we could turn it over to discussion among yourselves and with members of Parliament.

Would you like to start, Mr. Dungan?

Professor Peter Dungan (Institute for Policy Analysis, University of Toronto): Thank you very much for inviting me. I'll try to be very brief.

You have a handout in front of you, which is a forecast that we completed in fact only yesterday, post-referendum and post, I should mention, some other events of the world that have occurred, too.

I suspect I'm to one side of the group of economists here in more ways than just the seating arrangements, because our outlook has been and continues to be relatively optimistic in anything but the very short term. Our outlook has the Canadian economy picking up steam starting in the fourth quarter of this year and proceeding at greater and greater speed through 1996 and into 1997 as it recovers from the near recession that we've just undergone.

Maybe it would be better for me to concentrate, in a sense, on the last page of the handout, which is the medium-term outlook. We go out past the year 2000. I suspect I may differ here with many of the other comments, and it may be of less interest to you, but this is where we specialize. It's kind of the medium-term outlook.

You can see that we have real growth in the Canadian economy of about 4% for each of 1997 through the year 2000. That's four years of 4% real growth. In fact, that 4% real growth begins even in the second quarter of 1996 at an annual rate. It just doesn't show up in the annual number because we're left with the baggage of 1995 behind us.

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Why are we so optimistic? What are the fundamental reasons why we have growth like that?

By the way, many other nice things happen with it: the inflation rate stays around 2% on CPI; the unemployment rate comes down; both federal and provincial government deficits are much improved.

I should warn you that in the table the deficit numbers are on a national accounts basis, not a public accounts basis, so they might look very low. The usual rule of thumb is to add about $10 billion or $11 billion at the federal side in order to get the public accounts deficit from that.

We have the deficits coming down quite strongly, and the balance on current account, which is our deficit on trade and services with the rest of the world, is also very much improved. In fact, it goes positive by the year 1999; that is, we get rid of our deficit.

Where does this kind of wild optimism come from? Let me give you some background on that, and it will be the bulk of my comments.

First, we believe our estimates show that the Canadian economy now has an output gap, a shortfall relative to its potential, of between 6% and 8% of GDP.

By the way, I should point out that each of these things that I am going to give you are contentious issues. We will have arguments on each of them. I'm just staking out my side of the argument.

Some people believe that gap is much smaller.

Our number is around 6% to 8%. That means that for the next four, five, or six years we could grow at 1% above our potential with no trouble at all, because we are simply closing up the output gap that we have opened in the last few years, basically since 1989.

The second point for our optimism is that we think the potential growth of the Canadian economy is still in the order of about 3%. Some people will say that number is considerably lower.

There are two contentious issues there.

One of them has to do with the growth of the labour force. The participation rate in the labour force has fallen since 1990; people have withdrawn from the labour force. A question is, have those people backed out because there are no jobs, or have they backed out because there is a change in how people decide to behave? For example, do more women wish to stay home?

We think that at least part of it is what we call discouraged workers, and those people are going to come back into the labour force. That boosts our potential growth.

We also think that productivity growth can be quite strong over the second half of the decade. We have yet to reap the full benefits of the free trade agreement and of the major restructuring of the Canadian economy that has been going on for the last few years. We think that could lead to what we call total factor productivity growth - working better, working smarter - of 1% per year.

Another feature of why we are optimistic is that we think policy is properly set. Fiscal policy is aimed on a course of deficit reduction. There would be a danger of going too fast on that, because it is difficult to absorb people out of the government sector and into the private sector at too great a speed. So far we think the speed is okay - maybe a bit fast, but okay.

On monetary policy, we were greatly heartened by the governor's comments with his release of the monetary report at the beginning of this week. They seem to have it right. They understand that there is a gap. They understand that the proper course at this point is to support growth and that the inflation dangers are not there. So monetary policy will be supportive.

So we have a gap, we have a strong potential, we have policy set properly, and all of those can contribute to four-plus percent growth per year over the next half decade, with no inflationary pressures and with major improvements in all aspects of the Canadian economy.

The Chair: Thank you very much, Mr. Dungan.

Mr. Clinkard, please.

Mr. John Clinkard (Senior Economist, Economics Division, Canadian Imperial Bank of Commerce): My comments are not going to deal with the longer-term view; they will basically be looking at the next year to 18 months.

Before I focus my attention on Canada's prospects for the upcoming year, I think it is necessary to review briefly what happened in late 1994. To paraphrase, ignoring even recent history increases our risk of repeating it.

When world financial markets focused on Canada's fiscal and political problems last year, the currency slid sharply. This of course forced the Bank of Canada to increase interest rates, which in turn short-circuited a long-overdue recovery of domestic spending.

Combined with a slowdown in the U.S. demand for our exports, it caused the economy to shrink in the second quarter.

After a short lag, financial markets recognized that Canada and many of the provinces were making concerted efforts to reduce their deficits by cutting government spending, without resorting to increased taxes. The dollar strengthened. Interest rates declined. By midsummer, domestic demand was showing some signs of strength. Combined with stronger growth in the U.S., the Canadian economy began to fire on all cylinders - but it was not all that fast - by mid-year.

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Entering another budget cycle and looking ahead, it's much too early to measure the effects of the uncertainty generated by the referendum on the economy to date. However, in Ontario, the greater Toronto housing market continued to reflect sustained demand despite Mr. Harris' efforts to rein in the province's ballooning deficit.

Based largely on anecdotal information, the outlook for Quebec appears to have been more adversely affected by the narrow no victory than elsewhere in the country. However, assuming lower interest rates persist and uncertainty about Quebec's prospects dissipate, which should happen, consumer spending and housing demand will probably begin to strengthen in the near term.

This is not to say that events of the past week will have no impact. Companies' longer-term plans to expand in Quebec or locate there will doubtless be affected by recent events and, perhaps more significantly, by the new premier of the province and what she or he plans to do for the remainder of their mandate.

From a national perspective, just as confidence increased in the wake of credible efforts to cut spending and reduce the deficit in the first half of 1995, any perception that deficit reduction was no longer the government's main fiscal priority would, in our view, seriously erode investor confidence.

Coming on top of existing uncertainties regarding the country's political stability, this loss of confidence would likely lead to a weakening of the exchange rate and higher short-term interest rates, despite the fact that we have very low inflation. Just as what occurred less than a year ago, domestic demand would probably stall, employment growth would stop, and higher interest rates and slower growth would, of course, slow growth.

However, assuming this does not happen and financial markets remain confident in Canada's fiscal commitment to reduce its debt-to-GDP ratio to 3% by 1996-97, the uncertainty regarding the nation's political stability should steadily diminish over the course of the year.

This would maintain investor confidence, thereby helping to strengthen the currency against the background of low inflation. With ample excess capacity in the system, monetary policy is likely to remain expansionary, which is a development that would be reinforced by developments in the U.S.

Looking outside Canada, while the U.S. economy appears to have retrenched slightly in the fourth quarter, its prospects for growth in 1996 remain quite healthy. Although the back and forth negotiations about the U.S. budget are presently capturing the attention of financial markets, there's a high probability that there will be tax cuts and cuts to capital gains that will stimulate growth there in the first quarter. Thus, a combination of lower taxes and lower interest rates should stimulate U.S. growth in the first quarter.

Turning to the components of domestic demand, we expect lower interest rates in Canada to stimulate consumer spending. A number of indicators point to stronger growth in housing. Affordability in all parts of the country has improved. We would look at housing starts in the neighbourhood of 140,000 next year, compared to an estimated 108,000 this year.

Investment would be another area in which we would see slower growth than this year, again, with a pick-up in non-residential construction at the possible expense of some slowing in machinery and equipment investment. We have seen machinery and equipment investment growing by over 10%. That's not sustainable, in our view.

Despite the heightened level of uncertainty related to the referendum and the continuing efforts to downsize the public sector, employment has continued to grow in the past three months.

Moreover, following a brief hiatus in the second quarter, the major portion of employment growth has been full time. This suggests that the effects of lower interest rates in the second quarter, and stronger export demand, are having a positive impact on job creation.

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In our view, the impact of the referendum will slow employment growth during the remainder of the year. Help wanted advertising is down in the last four months. However, next year stronger foreign sales plus a complementary rise in domestic spending should cause employment growth to strengthen. Even though we expect an increased participation in the labour force - we recognize there's a significant number of discouraged workers out there - the slow growth in the 15 to 29 age group, the prime source of new people for the workforce, is not likely to be all that strong in the next five years, for example. So consequently we would see the unemployment rate moving steadily down over the next two years.

I don't really need to talk about inflation because I don't see it as a real problem over the near term.

In summary, there are very significant risks to Canada's short-term economic outlook if an erosion of investor confidence forces the Canadian dollar down sharply and causes the Bank of Canada to raise interest rates. However, recent experience indicates that international concerns about Canada's ability to achieve its fiscal policy objectives have by and large outweighed other concerns.

Having said this, the prospects for reasonably strong growth of GDP in the range of 2.5% to 3% accompanied by low inflation, 2% to 2.5%, and stronger employment growth, around 2%, remain good. As well, given the outlook in North America for relatively stable low inflation and moderate growth, growth in Canada should remain in the range of 2.7% through 1997.

The Chair: Mr. McIver, please.

Mr. Don McIver (Chief Economist, Sun Life of Canada): I think after you've heard from most of us you'll be likely to conclude that real GDP will grow by about 2.5% in 1996 and that inflation will be low. I've made available a copy of our own forecast, which is roughly in line with that.

That may appear to signal a benign environment; however, the message that I'm most anxious to promote today is that this information should be used and interpreted with great caution when preparing the next budget.

Consider the following. We can't tell you when, but most economists will attach a high probability to a recession occurring between now and the year 2000. The fiscal plan must anticipate that.

Economists have a poor record of forecasting turning points. In November 1989, of 22 economists surveyed, none, not one, predicted the decline in 1990, and I can give you details of that. Even 12 months later, in November 1990, when the economy was already in recession and had been for three quarters, 14 out of 18 economic forecasters were forecasting GDP to rise in 1991. It fell 1.8%.

A point estimate of annual GDP growth is a crude shorthand, which can obscure a multiplicity of different economic environments. Again, in 1990 GDP fell for three out of four quarters but declined only two-tenths of a point on the year. In 1991 it fell in only one quarter, but dropped 1.8 points on the year.

Even if the GDP forecast is right, the link to revenue and expenditure prospects is complex and has frequently been poorly predicted. I can give you details of that, as well. The same overall GDP growth rate can obviously be generated through different patterns of sectoral behaviour. As a single example, in recent years strong export demand has produced acceptable GDP growth but GST revenues have been much lower than if growth had been domestically led.

Please be clear. In the past, even economic assumptions that in the event have been proved to have been prudent have been associated with substantially lower than forecast revenues. Especially in the context of recent political developments, it should also be clear that interest rates and debt servicing costs can be predominantly determined by factors other than real growth and inflation.

For these reasons and for others I urge you to frame your own approach to an appropriate budgetary stance without undue reliance on economic serendipity. I think the markets will accept nothing less.

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The Chair: Thank you, Mr. McIver.

[Translation]

Mr. Gignac.

Mr. Clément Gignac (Chief economist and strategist, Levesque Beaubien Geoffrion Inc.): Good morning. I'd like to thank you for your invitation. Like my colleagues, I'd be happy to give some suggestions later on in the meeting concerning other topics of great importance, including setting a new target for deficit reduction other than the modest equivalent of 3% of GDP.

I'd like to start with my view of the economic forecast. In this respect - and I intend to give you only three or four figures - , we are moderately optimistic. We foresee economic growth of around 2.5% next year, following this year's level of 2%. With respect to short-term interest rates on treasury bonds, our forecast is 5.5% and as far as long-term rates are concerned, we expect approximately 7.5 to 8%.

What are the reasons for my optimism? We are working under the assumption of an extended economic cycle. Our vision is a prolonged economic cycle in the United States and this is very good news for Canada because with the present state of our public finances, we need a prolonged economic cycle in United States if we want to be sure of turning the corner.

The reasons are as follows. After five years of growth in the United States, inflation and wages are relatively under control. After five years of growth, it is quite unusual for inflation to be lower than it was when the growth began. This leads us to conclude that interest rates will remain low in the United States.

Secondly, my optimism about relatively low interest rates in Canada results from my rather less encouraging interpretation of domestic demand and consumer attitudes. Consumers have seen their purchasing power reduced over the past five years because of a larger tax burden and the wage freeze due to the restructuring of our economy and this along with the lowest savings rate we have seen in the past two decades means that consumer demand will not be the engine it was in the previous years.

At the very least, consumers should expect the tax burden to be frozen at its present level in the next federal and provincial budgets. As to a further reduction of the interest rate differentials, I would like to say as a Canadian strategist that the good will expressed by the Governor of the Bank of Canada will not suffice.

In order for this to take place, the government must take steps to reassure both Canadian and foreign investors that in spite of the present economic circumstances, it will put its financial house in order and adopt more ambitious targets with respect to deficit reduction and balancing the budget, as is the intention in the United States. It should be noted that most provinces have already reached or are in the process of attaining this objective.

To conclude on a somewhat more structural aspect, I will repeat here the optimistic remarks that I made to our European clients last month who were worried about the situation in Canada. They were afraid that Canada would become the next Mexico within the G-7. It must also be said that they were disappointed as well with the performance of Canadian securities in the past several years.

I do not think that the Canadian economy is on the verge of bankruptcy because for some years now important structural changes have been undertaken. We have put into place a cure that may be hard to swallow but will nonetheless be effective in the mid-term, namely price stability - that's something that's already been done - , we also have free trade and there is deregulation, privatization and a more rigorous control of public finances.

At the same time, I'd like to shade somewhat the optimism of my colleague Peter with respect to medium and long term economic growth. International experience has shown that generally, when the decision is made to put one financial house in order and swallow the bitter medicine, and this the sensible approach, five to six years elapse before such policy begins to pay dividends. So I'm optimistic for the medium term but we're going to have to wait a number of years to see the results.

Lastly, on the political side, as the only economist from Quebec this morning, I'm in no way qualified to quantify the impact of the political climate on Quebec or Canadian economic activity. I would encourage my colleagues to be prudent because over the past 15 years, as a Canadian economist, I've always found difficult to quantify the economic consequences of a particular political scenario. Those who have not been careful, and I'm thinking of the Royal Banks' studies following the No to the Charlottetown Accord, have certainly paid the price in terms of credibility.

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I do not have the necessary expertise. Anyone who have reached the age of majority knows full that political uncertainty can result in some degree of turbulence or volatility in financial markets and entail a certain risk premium. However this is very difficult to quantify and experience shows that it is temporary. I do not have any particularly expertise in the matter although I've have been assigned to Quebec. I think that there may be some impact but generally such an impact is both temporary and difficult to quantify.

One thing is sure and I think that the Governor of the Bank of Canada said so: the growing debt of our governments will result in a permanent increase of the risk premium for Canadians' securities.

The Chair: Thank you, Mr. Gignac. Mr. Tanny, you have the floor.

[English]

Mr. Steve Tanny (Chief Economist, Ernst & Young): Thank you. I'm pleased to be here with you this morning.

You've already heard from five of my colleagues, which means you've probably heard the entire gamut of economic views possible on the coming year. What I'd like to do is briefly remind you of where we've come from, give you some suggestions from my perspective as to where I think we're going, and highlight what might be some of the key questions we'll face over the course of the next 12 to 18 months that you should be thinking about as you prepare your recommendations.

The first point is we've been in recovery or expansion for more than four years. This has been the slowest recovery/expansion on record, post-war. Total output has grown by roughly 11% over more than four years, which is roughly 50% slower than what would be typical for a recovery period of this length of time.

Job growth has been even worse. Job growth has only been about 6% over the course of that period of time, and indeed it took us almost three years just to recover the jobs lost in the recession.

Both of those things are key elements in thinking about the way the economy behaves. We have a relatively more slowly growing economy in terms of the past four years, with very little job creation associated with that growth.

At the same time, we have had a very significant increase in machinery and investment spending, despite, by the way, the poorest profit picture we've seen in decades. That machinery and equipment spending has been really out of necessity. It's not necessarily because companies wanted to spend but because they had to spend to stay in the game.

That has led to better productivity growth over the course of the last couple of years than we had seen in the preceding period of time. It's also led to major gains in exports, and indeed we've seen the recouping of our market share in foreign markets.

Those have been the main strengths over the course of the past few years. The weaknesses have been the consumers and government spending.

Those strengths we've seen in the past are the strengths that are likely to carry the economy through the next year or two. To my mind, both investments and exports are going to continue to grow and grow strongly. We have the opportunity to continue to penetrate foreign markets, both to recoup share we've lost in the past as well as to perhaps make some share gains as a result of our better productivity performance and our lower-valued Canadian dollar.

At the same time, the investment spending is likely to continue because profits are now starting to get back to more reasonable levels relative to national income, and in addition because the urgency of continuing to invest in enhanced productivity continues. There is simply no way companies can maintain a competitive place in the market without continuing to invest strongly.

So the key questions facing the economy right now are what's going to happen to consumers and what's going to happen to government spending?

On the consumer side, we can only hope to see some improvement in confidence as a result of recent political developments. Unfortunately those political developments don't leave us with a completely clear message as to what's going to evolve, but let's have some hope that maybe there will be some increase in confidence as a result of the developments that have taken place to date.

In addition, there have been some cumulative job gains over the past year or year and a half, and more recently there is the prospect of continuing job gains, which is likely to improve confidence and lead to improved wage gains.

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We need consumer spending to improve. Right now, consumer spending is about roughly 60% of the economy, or slightly more. If that doesn't grow very quickly, neither will the economy.

The best we can probably hope for is consumer spending growing in the neighbourhood of 2% in real terms, simply because savings rates are already low and consumers can't run down their savings. They can only continue to spend if they can continue to earn. The chances are that real disposable income will only be growing in the 1% to 2% range.

That means there is basically not much hope for the economy to grow at more than 2.5% to 3% in the incoming 12 to 18 months. For that to take place, one will need at least vigorous continued growth in both exports and investment.

What about on the government side? Governments have promised continued restraint in some areas. The federal government has done this. I think that, to the extent the promised restraint takes place, it will naturally act as a drag on the economy.

Having said that, this is, unfortunately, a time when budget deficits have to sort of be addressed. Therefore, we're sort of in the position that the economy will continue to grow slowly because consumers haven't got the income to spend very quickly, nor do governments have the wherewithal to stimulate the economy, as has been the case in the past. The extent to which provincial governments add to the restraint will therefore add to the general drag on the economy.

From your perspective, therefore, it seems likely that the economy will grow at a modest pace over the course of the next 12 to 18 months. A reasonable estimate would be something around 2% to 2.5%.

Looking further ahead, I think the prospect for somewhat faster economic growth is a reasonable one. We have made good gains in foreign markets and productivity. There is no reason not to believe that those will ultimately be translated into a better performing economy. A range of 3% to 4% might make sense.

From your perspective, in the interests of being particularly prudent in terms of advising how the government should make its budgetary plans, it would seem to me that one would want to rely on the more cautious side of that growth, namely, something in the order of 3%.

The Chair: Thank you, Mr. Tanny.

Mr. Hracs, please.

Mr. Frank Hracs (Chief Economist, RBC Dominion Securities): Thank you, Mr. Chairman.

I guess in light of some of the previous comments, maybe some generalization would be useful. I think when we look at the economy we have a few basic parameters that are in place. I think essentially we have a history of chronic imbalances, especially on the deficit and debt side of the economy, and also on the trade side, especially with regard to the current account deficit.

So these background parameters have essentially nullified the benefits we probably should have achieved by moving to this lower level of inflation. We have higher interest rates than are desirable or necessary with this level of inflation.

Also - this is probably equally important - Canada remains subject to these sporadic swings in interest rates that are extremely destabilizing to the economy. At any given time, rates might not be that high, but the swings slow the economy down. It takes time for the economy to regroup. This is all slowing down what should be a better pace.

We have a moderate slowdown in the U.S. economy this year. This is really resulting in a near recession in the Canadian economy. So that's an indicator, we think, that these imbalances have to continue to be addressed.

Fortunately, on the trade side, we've seen major progress in the last couple of years. We have essentially doubled our merchandise trade balance. That was a very exceptional contributor to GDP growth in 1994, but you cannot continue doing that kind of multiplier on trade. So that's something that did happen in 1995. Even though trade generally has been maintained - the balances have been maintained - the rest of the economy remains essentially stagnant.

So that's a good start. We also think it is no surprise whatsoever that after quite an aggressive budget in the spring, the following five or six months have seen almost record levels of foreign buying of Canadian bonds. I think that's the kind of verdict you get when you address the fiscal situation with credibility and commitment.

We tend to think that this process has to be maintained to keep interest rates stable and sort of develop the kind of prospects in which rates remain stable. That's the only way the economy will develop really any kind of continuous head of steam.

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As we go ahead, we think we've been lucky that the U.S. economy so far has only slowed down moderately in 1995. As you know, last year rates were increased there to cool off quite an exceptional growth pace. Fortunately interest rates there have cooled off, and that's given a cushion to what could have been a deeper slowdown in the U.S. economy. So we've benefited from that.

As we head into 1996, the U.S. economy also remains fairly lethargic, and that is bad news for Canada. So even though our economy can only look better in the context of where we're coming from earlier this year, we probably will have difficulty posting growth stronger than 2% or 2.5% on a quarterly basis.

That is not the kind of economy we would like to have. However, that is the global parameter. Internationally most countries have had the peak intensity of their business cycle, so we're all settling into something around a 2.5% growth.

All we can do here, perhaps, is try to put conditions in place that minimize interest rates and minimize distortions in the currency. That is the recommendation we would have.

Thank you.

The Chair: Thank you, Mr. Hracs.

Mr. Fairholm, please.

Mr. Robert Fairholm (Chief Canadian Economist, DRI/McGraw-Hill): From my perspective, the economy is like a drunken sailor on the night before and on the morning after. On the night before, the sailor has too many drinks, the economy during boom periods grows excessively, spending gets carried away, and inevitably there's a hangover the next morning. In economic terms it's called a recession or a major slowdown.

This year we've had what many would call a soft landing. A soft landing is when the economy slows down but doesn't fall into recession, which is two consecutive quarters of decline. From my perspective, it has been a not-so-soft landing this year, because we had a contraction in the second quarter, but I'm optimistic about where we're headed because of the U.S. rebound and because interest rates are headed down. However, I do believe the ultimate descent in Canadian interest rates will be inhibited by our fiscal and political concerns, so we'll have a higher floor than we would have had otherwise in terms of how far interest rates can fall.

Because we've had a soft landing now, I believe the next major risk for a deep recession has been postponed towards the end of this decade. In the meantime, I believe the Canadian economy will undergo a rebound, but that rebound in terms of aggregate GDP will be well below average. This is because of the debt overhang for our economy. Governments are cutting back, consumers have a heavy debt load, and we'll have a more modest rebound of consumer spending than we typically do during the recovery phase after a slowdown.

I've provided some handouts. The charts help explain the story.

One of the basic reasons we have a business cycle in Canada is that our biggest trading partner, the United States, has a business cycle, and we swing along with their economy. This is shown in the first chart in the handout.

In recent years the Canadian economy has tended to swing farther down than the U.S. economy has and then eventually bounce back farther than the U.S. economy does, in part because our interest rates tend to swing around more than U.S. interest rates do. But clearly the pattern of the past will continue into the future; we'll continue to have a business cycle. That's very important when we take into consideration the government's fiscal position.

In terms of aggregate GDP growth, we see this cycle being well below average, as is illustrated in the other chart in the handout. The basic reason for this is that governments are cutting back.

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If you look at this chart, you'll see that after a soft landing, which is the dotted line on the chart, there's a shorter duration of the rebound because you've essentially opened up less of a capacity gap or output gap then you do during a deep recession.

This implies that the next major risk of a slowdown starts coming into play through 1998, into 1999 and on to 2000. This is very evident when we take a step back from aggregate GDP and look at just the private sector. In other words, it's total GDP but taking direct government spending out of the calculations.

From this perspective, the current situation has truly been a soft landing. We've slowed down less than in the past. This is the basic difference between this chart and the previous chart. In terms of the slowdown, for total GDP, we've slowed down more than usual in a soft landing because, before this time, governments would be contributing to growth; now they're taking away from growth.

We think that from the standpoint of the private sector we'll have a typical rebound after this slowdown, which is the same pattern we've exhibited in the past, basically speaking. Again, this points to the next major slowdown, or recessionary risk, for the economy being some time around 1999 or 2000.

This is very important for the government. If we look at the government's budget situation and look ahead at a trend situation in which there's no economic business cycle, then we will achieve a balanced budget, given the existing policies. It'll take until around - in our estimate - 2002. However, if there is a typical business cycle in which government expenses go up, revenues go down, and the difference is added to the debt, which adds to the permanent deficit situation -

The Chair: Excuse me, you said if we continue with no further fiscal measures -

Mr. Fairholm: With current policies, ultimately, you'll hit a balanced budget that will be past the end of this decade.

The Chair: That's assuming no recession.

Mr. Fairholm: That's assuming a trend pattern in the economy in which the economy continues along a trend path of roughly 3% - -

The Chair: It's 2% growth or 3% growth or what? What's the percentage of the growth rate?

Mr. Fairholm: It's roughly 3% growth.

The Chair: Thank you.

Mr. Fairholm: This is a usual trend pattern as shown in the forecast. However, economies don't go along trend lines; they go in cycles. This is very bad for the federal fiscal position.

This is illustrated on the chart. We see that if we put the economy through a typical business cycle, then by 2001, our deficit-to-GDP ratio is roughly 3% of GDP. So essentially you're back to where you're aiming to be in the next fiscal year, even though we've had all these cuts. To get the situation stabilized in terms of the budget balance, it would require another package of similar size to what we experienced last February. That's essentially $11 billion of spending cuts over three years.

The Chair: Thank you, Mr. Fairholm.

Mr. Egelton, please.

Mr. Rick Egelton (Vice-President, Deputy Chief Economist, Bank of Montreal): Thank you very much. Our outlook isn't substantially different from that of those who have spoken before me, but I'll couch my remarks by saying that I'm an optimist on the Canadian economy concerning the next year or two, but that's subject to two very important caveats.

First, there's the political uncertainty in the Canadian economy. Although I would agree that it's extremely difficult to quantify the financial and economical impacts of political uncertainty, I think most of us would agree on the direction of that impact. That has meant higher interest rates and poor economic performance. The continuation of political uncertainty can only hurt, as opposed to help.

Second, I think it is absolutely crucial for governments to maintain a commitment to fiscal restraint. That's because if there is any backsliding on that front, I think they will be punished very aggressively by the markets.

I'll turn to that later, but I'd like to go over five key points that I see as underlying why the Canadian economy is being poised to experience a period of reasonably strong growth with very low inflation.

First, the external environment coming from the U.S. will be very positive. Inflation in the U.S. has been well-behaved. There is very little likelihood, at least in the near term, of a rise in U.S. interest rates. We think the U.S. economy will grow probably at about 2.5% over the next year or two, which will provide an expanding market for Canadian exports.

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Second, more importantly, I think Canada is very well poised to take advantage of stronger U.S. growth. The combination of the low value of the Canadian dollar and the excellent unit-labour-cost performance we've realized in Canada over the last number of years makes Canadian firms extremely competitive. They're perhaps more competitive than at any time in our history. So I think we're very well positioned to take advantage of a growing external economy.

Third, I think inflation and labour cost performance will continue to remain very strong over the next year or two. That's basically because there is still a substantial amount of excess capacity in the Canadian economy. Also, I think people's inflation expectations have been ratcheted downward quite considerably.

Fourth, the easing of interest rates we've seen since the beginning of the year will have an important impact on stimulating intra-sensitive expenditures over the next year. Mainly housing, consumer durables and business investment will not be growing at outstanding rates, but will be important contributors to growth, along with exports, over the course of the next year.

Fifth, I think the stable or lower interest rate climate will help improve consumer confidence. I think having a more balanced Canadian recovery is very critical for the consumer to get back into the picture.

Those are the factors that I see leading to fairly solid growth next year. The third quarter will have around 1.5% to 2% growth. We think that growth will accelerate into next year. We're looking for growth on an annual average basis next year of around 2.8%. On a fourth quarter over fourth quarter basis, which means from the end of this year to the end of next year, we're looking at around 3.5% growth. We see CPI inflation falling probably to around 1.5% at the end of next year, which is quite an outstanding performance for Canada.

Turning to risk, I indicated there are two important risks. One is on the fiscal side. Clearly, we need to go beyond a 3% deficit as a share of GDP if we want to make meaningful progress in terms of reducing the debt-to-GDP ratio. The debt-to-GDP ratio now puts us well above most of our G-7 colleagues. I think it's an important element of why long-term interest rates in Canada are so high, given our strong inflation performance.

The minister has indicated that the 3% deficit-to-GDP target is only an interim goal on the path to a balanced budget. I think it's very important that, in this next budget, the federal government show its resolve toward getting there.

I think the next federal budget may well be one of the most important federal budgets we've had in years.

There are two reasons. First, it will show how strong the government's commitment is toward getting to a balanced budget and how quickly it will try to achieve that goal.

But, second, we're at the stage now in the political cycle at which I think cutting in a February 1996 budget is going to be easier than in a February 1997 budget, which will be easier than in a February 1998 budget. So the task is only going to get more difficult. I think it's very important for the government to show a strong commitment on that front. If they don't, and if markets are disappointed by the budget in February, you could see a quick back-up in short- and long-term interest rates. I think that could just take the footing out from under the optimism just described by me and most of the people here.

Last, of course, is Ontario and Quebec, which are the two provinces that have been lagging behind on the fiscal side. I think they need to show some leadership and should join the fight in terms of getting their fiscal houses in order.

I think Ontario has started to make those initial steps. I think that's been positive. To the extent they follow through on that, I think the markets will respond quite positively.

I think the same can be said for Quebec. I think markets will be looking at Quebec very closely to see where it plans to go on the fiscal front.

Those two provinces are very important for the total debt burdens of the entire nation.

As I indicated earlier, political uncertainty will continue to play a role. I have to believe that the political uncertainty that we have now plays a role in the level of long-term interest rates in Canada. If the uncertainty diminishes, I think we can see declines in longer-term interest rates. That will facilitate better economic performance. The converse is the case if political uncertainty increases. It's hard to say exactly how large those increases in the rate of deterioration of performance would be, but I think we can speak pretty confidently that rising political uncertainty is not good for markets, and that's not good for the economy. Thank you.

The Chair: Thank you, Mr. Egelton.

Mr. Johnson.

Mr. John Johnson (Deputy Chief Economist, Royal Bank of Canada): Thank you. Good morning. It's hard to say anything new and not sound repetitive at this stage. But what I'd like to do is try to put things in a little more of a global context.

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What we see in the global economy is a situation in which global growth is slowing a little, but the global economy is continuing to grow, even if at unspectacular rates. What we see is fairly steady non-inflationary growth across the global economy.

That's a plus for Canada in terms of what it will do to commodity prices. Also, one benefit we and other debtor nations have is that it's very difficult to conceive in the current global environment that we'll see any major increases in interest rates over the next 24 months. We may see some upward pressure in 1997, but the outlook in the near term, certainly over the next 12 to 18 months, is for fairly flat interest rates globally. That's a good environment for debtor countries like Canada to work through some of their problems.

Closer to home, the U.S. is of critical importance. It looks to us like the U.S. will grow at a roughly 2.5% rate. It's pretty hard to justify a faster pace of growth right now. At the same time, a lot of the things that economists would look for to signal a risk of recession aren't there. We're working through the inventory problems. U.S. inflation hasn't picked up. Most U.S. recessions start off with a build-up in inflation and a big increase in interest rates. What we see is fairly steady inflation, and interest rates look like they're going down, not up. So that's a constructive backdrop for Canada.

When we look at the Canadian economy, we see growth picking up, turning positive in the third quarter - 1.5% to 2% sounds pretty good - and at close to 3% in the fourth quarter. We look for the rough trend in the growth rate in Canada of about 3% on a fourth-over-fourth basis through 1996, and maybe a little stronger in 1997.

We think exports will pick up, and we think growth will become more evenly balanced with domestic demand picking up as well. We look for government spending to continue to be a drag on overall economic growth, which is what keeps us close to 3%.

As for inflation, we're in the 1.5% to 2% camp. We do acknowledge that the risks are more toward 1% and 1.5%. So the inflation environment is very constructive. Certainly it's superior to that of the United States, which will help our competitive standing against the U.S.

What that translates to as a financial market forecast is an outlook for slightly narrower Canada-U.S. interest rate spreads. Once again, the political and fiscal environment will condition what happens there.

So we look for generally Canadian interest rates to fall slightly through the end of 1996, with maybe a little upward pressure in 1997, which will mainly come from the United States. The Canadian dollar will be a little stronger than at present, but nothing that we would be concerned about to undermine our competitive standing.

We have three key assumptions underlying this forecast. Certainly one is the outlook for the U.S. The second is what happens on the political front. We're assuming political unity. Third, we're making further progress on the fiscal front at all levels of government and looking for the debt-to-GDP ratio to be on a downward track. It would not just flatten out, but move downward.

That's all I have as comments. I have a report, which I'll hand to you at the end.

The Chair: Thank you, Mr. Johnson.

Mr. Rosenberg, please.

Mr. David Rosenberg (Senior Economist, Nesbitt Burns): Thank you very much.

I'll just start off by mentioning where exactly we're coming from. I think it was mentioned before that we were practically in a borderline recession in the first half of this year. Growth was essentially stagnant. Nobody I saw last year was calling for such a dismal economic performance 12 months ago.

The signal here is to the Department of Finance. It is laudable that they had taken on a very cautious - they called it prudent - and conservative set of economic assumptions. We got broadsided by an unexpected slowdown in the U.S. and the fallout from what happened in Mexico, which of course spiked our interest rates up in the opening months of the year.

These were unforeseen events, but of course these were events that I think suggest that the Department of Finance should continue to take on below consensus growth forecasts and an ongoing, prudent set of interest rate assumptions. It certainly was a laudable development to take on in last year's budget.

I think I'm in general agreement with my colleagues that we will probably see growth pick up. We're already starting to see it in the third and fourth quarters. I'm more or less in the 2.5% growth camp on an average annual basis for 1996, which is about in line, I think, with where Finance had it in last year's budget.

The problem again - I think it's been beaten to death here - is the consumer sector. It's still going to be beset by interest rates that will continue to be higher than they probably should be, with tepid wage gains, soft employment growth certainly coming out of the government sector, and low savings rates.

The problem here is that if you can't get the consumer sector turned on for a sustained basis, it's very difficult to get GDP turned on, considering that the consumer is 60% of the economy.

I think again that this will be very much an export-led expansion, as it has been since we came out of the recession in the early 1990s. I think the positive signs out of the U.S. are a key factor. I think Mr. Greenspan has managed to pull off his much sought after soft landing, which we haven't seen clearly since 1986.

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Keep in mind that, at that time, the U.S. expansion had another three years left in it. I would be optimistic that, although you should never ignore the risk of recession, as long as the U.S. economy chugs along, as I think it will, it will mean very good news for our exports.

Here are a couple of other things to keep in mind. The first is the fiscal policy in the U.S. The focus is on a tough budget coming out of Congress in a few weeks.

Keep in mind one thing. In 1996, although there will be spending cuts, they'll be back-end loaded. The first thing Americans will see is the tax cuts. That will be positive for the U.S. economy. Of course, the fact that interest rates have already come down quite a ways will ultimately give a renewed boost to the demand sector in the U.S., which of course will be again good news for the Canadian export sector.

I agree with Rob Fairholm in terms of his international views. There's the fact that Germany has eased policy, and continues to do so. Japan is moving to reflate. If they are successful in reigniting a demand internationally, then that will mean good news for commodity prices and additional good news for our export sector. Again, I think this will be very much an export-led growth, but we'll see growth nonetheless.

This is the way I see North America. What ultimately brings recessions or expansions to an end is inflation. Ultimately, it's inflation that causes central banks to tighten monetary policy so aggressively that they push interest rates above bond yields, the yield curve reverts, and we fall into a recession. This is the historical pattern.

Yet, what we saw this spring was inflation that peaked in the U.S. at 3.2%, while inflation in Canada peaked at 2.9%. These are levels of inflation that you've not seen hit on a cyclical basis since the early 1960s.

The fact that inflation is coming down is in fact a development that is ultimately going to help prolong this business expansion on both sides of the border. I would just leave my economic comments at that.

I would add one thing on the fiscal side. I'm looking toward 2000. Say that's the government's ultimate goal. Of course, we only know the two-year, scrolled-up deficit forecast, but the government was planning to balance the budget by 2000. I was just doing some back-of-the-envelope calculations.

It would pretty well have to cut program spending on an average annual basis by around 4% per year, first, to offset what will continue to be higher interest costs and, second, ultimately, to balance the budget. That, under a fairly reasonable set of economic indicator assumptions, is what you'd be looking at.

Look at the program spending cuts that were forecast in the budget for let's say 1995-96. It would mean essentially maintaining that same pattern of program spending cuts of 4% per year.

Of course, we've seen a lot of restraint already. Keep in mind one thing: we talked a lot about program spending, but it's total spending that ultimately matters when it comes down to straight dollars and cents. In fact, by 1997, according to the government's own numbers, total spending will be $159 billion, which is exactly what it was in 1994.

Essentially, we're planning to cut program spending by $12 billion, which is strictly being siphoned off to pay off interest on a higher debt-service charge.

So look at all the improvement that's really going to take place, according to the government's own numbers, which I'm not going to dispute. Getting the deficit down to, let's say, $20 billion and change by 1997 is all going to come out of the revenue side, basically.

That's what we're dealing with here. I think those are the program spending cuts. It means maintaining the sort of plan that is already in place. Let's look ahead and say this is toward 2000.

I would have to say at the same time that all of us have to do a much better job selling fiscal restraint to Canadians at large. I don't think anybody would disagree that after we were downgraded by Moody's earlier this year and in the lead-up to the Quebec referendum, if we didn't have the fiscal restraint package in place, then there was a very good risk that interest rates would have been a lot higher than they ultimately were.

Certainly the fiscal restraint being put into place has gone a long way toward at least restoring foreign investor confidence in this country, and it's a key factor that has helped contain interest rate pressures. If it hadn't been in place, financial market conditions could have deteriorated a lot more than they did.

That's it.

The Chair: Thank you, Mr. Rosenberg.

Just picking up on what you said, if you're looking at a zero deficit or a balanced budget by 2000, that would give us three additional years from our target date of 1996-97, when we will be at 3% of GDP, at about $25 billion in deficit. It would give us an additional three years to get down to zero. Are you recommending to us to try to target for zero by the year 2000? I suppose that would mean we would have to go to 2%, 1% and 0% in 1997-98, 1998-99 and 1999-2000 respectively.

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Mr. Rosenberg: I wasn't recommending when you should balance the budget. I would like to see it done by the year 2000, or certainly before. I was just laying out a parameter for you. Let's say that in the back of your mind what the government should really be looking at is balancing the budget by the end of the decade. The sort of program spending cuts required for that - that's how I'm phrasing it - would be in that order.

The Chair: We have our target of 3% or about $25 billion for 1996-97. If we're going to set the next year's target, could each of you tell me what the subsequent year's target should be?

Mr. Rosenberg: Subsequent....

The Chair: Since 1996-97 -

Mr. Discepola (Vaudreuil): It's 1997-98 -

The Chair: For the year 1997-98, we would go from 3% or $25 billion to what in terms of our deficit target?

Mr. Rosenberg: Again, we're talking about the stated deficit, about what the underlying deficit really is, because there are contingency reserves built in. If, for example, they're ultimately not used, the $25 billion is lower than that.

The Chair: That's assuming our accounting is on a consistent basis.

Mr. Rosenberg: If the government maintains its commitment to cut spending by an average of 4% per year, I think the deficit would probably come in at somewhere around $14 billion in 1998, under my interest rate economic assumptions.

The Chair: So according to you our subsequent target should be $14 billion.

Mr. Johnson.

Mr. Johnson: The political cycle and the fact that the economic expansion is late on its legs suggest that you might want to move sooner rather than later, for something closer to two than three as a percent of GDP for 1997-98.

The Chair: You're saying 2%, which would take us down to about $16 billion, $17 billion.

Mr. Egelton.

Mr. Egelton: Two percent for 1997-98 is a bare minimum. I think the 3% target is a very modest target indeed. I think it can be met without a tremendous amount of difficulty. For 1997-98, I'd say 2% at a minimum, and preferably 1.5% of GDP.

The Chair: Merci.

Mr. Fairholm.

Mr. Fairholm: I think there's something to be said for publicly stating that you'll follow the five, four, three, two, one, zero pattern. It's very simple and easy to understand, especially for the money market people. They can latch onto it. They like simple headline types of items.

While stating publicly that it is the bare minimum you need to follow, I think it would be prudent to attack the deficit more quickly and follow a pattern of three, one and a half, zero.

The Chair: Thank you very much, Mr. Fairholm.

Mr. Hracs.

Mr. Hracs: We would run with something no higher than 2%. I think you also have to split the trend down. We don't know what projections are going to indicate in terms of a baseline. For example, if the government does nothing in terms of new measures, you will have some level of projected deficit.

I think that's part of the way there. For example, if you end up at $20 billion, that is lower than where we're coming from, but I think you also need to attach continuing fiscal restraint to that with measures that speed up the structural decline of the deficit. I think you need those two aspects. Of course, if the underlying deficit is perhaps stabilizing where it is, you need to face deeper cuts. You need the combination of those two things.

The Chair: Thank you.

Mr. Tanny.

Mr. Tanny: To begin with, you should be enunciating a clear commitment to a balanced budget at some fixed point in time. It would be preferable to have that take place very close to or within the mandate of this government so that even if it didn't actually occur, it would be seen to be almost occurring. Therefore I think one would want to eliminate the deficit no later than the last possible fiscal year in which the government would be -

The Chair: Which is 1997-98 -

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Mr. Tanny: No. I mean 1998-99. It's a possibility in the sense that the election could be held late in that fiscal year or at least halfway through it.

The Chair: So we have to go from $25 billion to zero within two years.

Mr. Tanny: I would argue for two years.

The Chair: That would probably be 1.5% and 0%.

Mr. Tanny: That's right.

[Translation]

Mr. Gignac: Assuming that the minister will maintain the same prudent approach in his economic forecast along with the 2.5 billion dollar contingency reserve in his calculations, I share the consensus of my colleagues, namely that 2% of GDP for the following year is a good objective.

Why 2% and 1%? Since financial requirements are $8 to $9 billion lower that the deficit, there is not really a lack of consistency, in setting such levels at 2, 1 and 0 because it would mean that before the present government's mandate is over, we would be able to stabilize the debt. Therefore, since there would no longer be such financial requirements, there would be an advantage resulting from the reduction of the risk premium required by financial markets if our objectives of 2, 1 and 0 were achieved.

The Chair: Thank you.

[English]

Mr. McIver.

Mr. McIver: I will reiterate what Dr. Tanny was suggesting. The most important thing is to get a credible path in front of the financial community, a credible path without any accounting trickery. It must be transparent. It must be clear that it's the stated, intended purpose, and it's probably going to have to be in the order of something below 2% for the first year and something approaching 0% for the second year of that forecast.

The Chair: Merci.

Mr. Clinkard.

Mr. Clinkard: Given that in the next two years and indeed in the next years we are probably going to see slower growth.... For a cycle to last more than seven years is quite unusual. We will see government revenues start to decline in 1998. I think that's a reasonable guess at this point. It could be in 1997. Obviously those risks are very strong. I emphasize that you must make the most significant reductions in the near term, in the range of 1.5% to 2%, hopefully towards the lower end. I definitely agree with the 0% by the end of the mandate.

The Chair: Thank you.

Mr. Dungan.

Prof. Dungan: Let me add an extra point. In some senses it's the fiscal health of all the governments in Canada that needs to be kept in mind.

I'll give you two recommendations. It's 2% if you do not further cut transfers to the provinces or the more ambitious 1.5% if you are indeed cutting transfers to the provinces. In other words, the point is not to simply download the problem to other levels of government whose deficits might then, at least in the short term, go up or cause further disruption.

The Chair: Thank you very much.

[Translation]

I suggest we have a two minute break and then we can start our questions. All right?

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The Chair: We now start our questions.

Mr. Loubier.

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Mr. Loubier (Saint-Hyacinthe - Bagot): Thank you for coming here this morning and presenting your very enlightening analyses. I'd like to give particular thanks to Mr. Clément Gignac from Levesque Beaubien Geoffrion Inc. for his clarification relating to the matter of political uncertainty and the evolution of large economic aggregates.

He was smart enough to point out - and this applies to a number of his colleagues - that political uncertainty cannot be quantified. There is a number of factors that are even more important than political uncertainty as far as their influence on large macroeconomic aggregates is concerned.

My second remark - and this complete my thanks to Mr. Gignac - relates to his observation about the real problem being our debt and the evolution of our medium term debt. Moody's came to the same conclusion in January when the firm decided it would monitor the Canadian Minister of Finance before the tabling of his budget.

That being said, I have a question for anyone who might like to answer it: we talk about targets, and it's great to have targets of 3, 2, 1 and 0% - everybody should aim at a balanced budget - but given the problems we've had reaching even 3% of GDP, where could we cut, when could we find new ways of achieving this balanced budget in the medium term?

I would remind you, as did the Minister of Finance last year, that Canada's Department of Finance has estimated this structural deficit at some $25 billion dollars. So how could we bring this structural deficit down to zero in the next four years without reforming the system considerably and exercising stringent control over spending?

The Chair: Who will begin? Mr. Gignac.

M. Gignac: Thank your for your acknowledgments. This is the idea: since servicing the debt has become more expensive over the past 20 years, going out from 12 cents per tax dollar sent to Ottawa to 35 cents or more, we have to admit that we no longer have room to manoeuvre and that we have to do something.

Since our tax burden is already significantly higher than that of the United States, and since the United States already plan to lower their taxes, we should set aside any idea of reducing the deficit by raising taxes.

Even though I am from the private sector, and we haven't always make every effort to help governments put budgets on a sound footing, I am convinced that the so called easy cuts are behind us and that we will now have to cut on the bone itself. We have come to the really difficult cuts.

We have to take another look at what some programs are supposed to be doing and ask ourselves - if we want to talk about efficient federalism - whether they would be best delivered federally or provincially.

In the past 30 years, I have never yet come across a coast-to-coast consensus on the decentralization of powers. Some programs could perhaps be reviewed. I know that one of the first aspects of the up-coming review is Unemployment Insurance Reform. We will have to see where we're at with regard to manpower training. Quebec and some other provinces are already willing to take full responsibility for manpower training.

Future cuts will be very difficult. We've even come to a point where we ask ourselves whether we are willing to decentralize the public sector. Many parts of it have already been privatized.

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We have deregulated as well. Cuts are becoming increasingly political and increasingly difficult. We can't do anything without agreeing with the provinces to avoid duplication. The easy cuts are behind us.

[English]

The Chair: Maybe we could ask two others to comment on the same question, if any of them wish to.

Mr. Clinkard.

Mr. Clinkard: With respect, Mr. Loubier, I think there is some consensus with regard to the recognition of attention to the fiscal situation as being pre-eminent. I don't think there's any discussion here that this is a second issue. This is the first issue. I think we agree with Mr. Gignac that the political situation is a source of uncertainty, but in the recent history it has tended to come and go and it hasn't remained with us, as has the fiscal situation.

As far as the attention and specifics are concerned, I think New Zealand has undertaken some measures to look at some objectives of fiscal programs, has attempted to quantify those objectives, and has looked at what they're getting for those dollars. I think an initiative in Canada to this end might yield some definite benefit.

Thank you.

The Chair: Mr. Hracs.

Mr. Hracs: I guess the point would be the history of why we are here. It has always been difficult to find places to cut. It's not easy now, and it's never going to be easy. But I also think we are here because it is becoming important that we stabilize the deficit. If you don't continue this process now, several years from now it's going to be even more difficult. So I think that is a greater issue.

The Chair: Mr. Silye.

Mr. Silye (Calgary Centre): Thank you, gentlemen, for giving us your forecast and your economic outlook for the future. It has been very interesting. As a businessman, I appreciate having it couched in language that I can understand as opposed to much more sophisticated terms.

As a member of an opposition party, it's part of my job to offer criticism of the government. The government is in charge of our monetary policy, of our spending, and it's up to them to listen to the good ideas that come forth.

For two years we have been constructively trying to criticize this government in terms of attacking their debt, the national debt. The federal debt is of such serious proportions that it hinders economic growth and it adds to instability, obviously.

For two years we have said the targets of this government, setting out on a course for 3% of GDP, are too soft. It's too easily attainable and it's not good enough. Somebody here mentioned that at the end of the day what you have really done is just made sufficient cuts to sustain a level of paying your interest payments on the debt. We're no further ahead, though, because overall spending will be the same at the end of their mandate as it was when they came in. In the meantime, we have made a lot of people suffer along the way.

The other criticism that we have offered is that we felt it was important to get to a balanced budget. The Reform Party presented a taxpayers' budget that set out a zero in three years - 3%, 2%, 0%, or 3%, 1.5%, 0%, whichever way you want to phrase it. I find it encouraging that of the many economists here today, at least five of you have suggested 3%, 1.5%, 0%, and the sooner the better. I think that's a good message to send to the government. It's what we've been doing. We've been criticized for trying to do it too quickly. Now the government is being criticized for doing it too slowly. Is there a balance there? I don't know.

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On the fact of setting targets. The answer we get back from the finance minister when we challenge him to present a balanced budget.... What I'm getting at is this. Which philosophy, from an economic point of view, is better and for the benefit of all Canadians? Is it a philosophy of presenting a target that's achievable or that's met and that restores some confidence? There's no question about it. We've seen evidence of it in the past, but we're still running at 4%- to 4.5%-of-GDP deficits.

Is that a sounder philosophy when compared against presenting a balanced budget over a three- to four-year period, which this government could have done and which I and my colleagues believe it should have done? We all know it's achievable, it's attainable, and the sooner you do it the better. But the government chose to ignore that advice two years ago.

So from an economic point of view, my question is related to - the chairman brought the discussion to this, and I'm glad he did -

The Chair: Thank you.

Mr. Silye: He's focusing on how important it is to get to zero, how soon we should do it, and on the finance minister's revolving deficit target of 3% of GDP, which I'm personally against. I challenged him to present a balanced budget in the House last week, but he gave a non-answer. Nevertheless, I'd like to hear a comment from some of these economists about the need to get to a balanced budget versus just adding to the problem, which is a debt at a rate of 3% of GDP.

The Chair: In other words, is there anybody here who is as hawkish as Mr. Silye?

Mr. Rosenberg.

Mr. Rosenberg: I would answer by saying that I think you have to look at the overall budget, the overall numbers, when you talk about a 3% deficit-to-GDP. The reality is that it will probably come in below that level. It could come in as low as 2.5%.

Keep in mind that the government has built in a significant interest rate cushion for both this year and next year. The interest rate forecast, as it stands right now for 1996, is that yields across the curve are going to be around 150 basis points higher than they are today. I don't know if there is anybody around this table who has that sort of bearish interest rate forecast. On top of that, the government has also built in contingency reserves it probably will not have to use.

So my guesstimate is that you probably will not see 3%; you may see something closer to 2.5%. But that might not even be enough to satisfy you, and I share your concern.

I'll tell you this much, however. At the very least, what has happened or what should happen probably this year or next year is that debt-to-GDP will have stabilized. The twenty-year run-up that we've seen in what I consider to be a very key measure of fiscal stress will at least start to come down, albeit gradually, probably this year. I think that's the measure most analysts and most economists look at. At least there's been a break in that series, so I think achieving a 2.5% deficit-to-GDP is important, looking at it from a debt-to-GDP perspective.

The Chair: Thanks, Mr. Rosenberg.

Mr. McIver.

Mr. McIver: I think the important thing to recognize is that when we're setting targets, the targets are not for the Canadian people, they are for the financial marketplace. In essence they are to provide the financial community, both here and internationally, with some - I was going to say comfort, and let's hope that is so - indication of the commitment of the Government of Canada, of where the government plans to move. With that commitment, if the commitment is strong enough, will come some relief on the interest rates. It becomes to a degree self-fulfilling as long as the commitment is there.

But against that target and against that commitment is the economic environment we've been talking about. Although we're probably fairly unanimous in what we're expecting for 1996, beyond that there is obviously some difference of opinion as to where we might be heading. The risk of a more severe economic condition beyond 1996 makes it all the more important that the target be as hard as possible in order to achieve that credibility.

The Chair: Thank you.

Mr. Egelton.

Mr. Egelton: In a sense, there is nothing magic about a zero balance. I mean, you can have a 1% surplus or a 1% deficit. I think the key is to get the debt-to-GDP ratio on a clear downward trajectory, and on a trajectory that will go through an entire cycle. If we go into another recession we won't end up ratcheting up the GDP ratio, as we did in 1980 and 1988. Fifteen years ago the debt-to-GDP ratio for the federal government was around 20%. Now it's 72%.

So I think the risk of making errors.... You can say zero in two years is too fast, it's too slow, it's this and it's that. The risks are asymmetric. If we miss and we go too slow, I think we'll be punished quite severely. If we're going to be wrong, let's be wrong on going too fast on the deficit.

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In that respect, I think Mr. Martin was setting up targets that he would meet and that markets perceived he would meet. I think that is very positive. He has now established a track record of credibility in that he can hit these targets. He can now translate that track record into some real gains by continuing to move aggressively on the fiscal fronts because markets are now starting to believe he will meet the targets he sets up.

The Chair: Thank you, Mr. Egelton and Mr. Silye.

Mrs. Brushett.

Mrs. Brushett (Cumberland - Colchester): Thank you, Mr. Chair.

It's been a real pleasure to hear this dialogue this morning. We've talked about and have given some credibility to our place in the global market. I would like to focus on the domestic market for a few moments.

We've heard comments here this morning that the consumer domestic market is 60% of our economy. I'm wondering what we can do, for example, with the GST. If we removed the GST or reduced it substantially, would it stimulate the consumer market to generate that $14 billion that we need in revenue? What can we do here on the domestic front?

Another point I would like addressed is on the job front. We talk about keeping the domestic market moving, yet we have such a great mix and match of skills in our small factories. In our needs here in the domestic economy we have so many people who are mismatched for those high-tech jobs that we have to deal with it here on the domestic front.

I would like some comments on those two points.

The Chair: Who would like to start off?

Mr. Hracs.

Mr. Hracs: On the GST, at the end of the day the consumer is paying the tax, whether it's a GST or it's something else. To us, shuffling it and redefining it will do very little to stimulate the consumer sector. We think consumers have basically adapted to the GST. They're never necessarily going to like it, but it's there and I think it would be a backward step to take away those moneys from the revenue stream and to then struggle to find somewhere else to compensate.

The Chair: Are there any others?

Mr. Discepola: Can you give me any other examples? Suppose you don't find revenue sources elsewhere but you actually reduce GST by 1% or 2%, for example - just take any arbitrary figure. What impact would that have?

Mrs. Brushett: It would kind of generate on its own, and generate those revenues.

Mr. Hracs: You would probably see slightly stronger consumer spending. There are multipliers through the economy. Inflation would be less.

Mr. Fairholm: But you're buying a short-term stimulus with long-term deficit problems. That's not the solution.

Mr. Egelton: You could well resolve it if you were to move unilaterally just to lower the GST rate. That would cause the deficit to go up and you'd get an adverse reaction in financial markets through higher interest rates. That could mitigate against all the good things you're trying to do by lowering the GST rate to get disposable income into the hands of consumers.

Mr. Johnson: The provinces may step in to raise their provincial tax rates as well to offset it.

The Chair: Just for the sake of the record, you'll recall that last year one of the issues before us was that we should scrap the GST entirely, that the positive stimulant effects on our economy would more than outweigh the $15 billion in lost revenue, and that the international capital markets would certainly recognize the supply side economics as being in the long-term interests of Canada's deficit reduction and stability for foreign investors.

Mr. Silye: Mr. Chairman, you forget the other half of the equation. Those Liberal members who made that suggestion also suggested a major tax reform in conjunction with that.

The Chair: Well, anyway, thank you.

Mr. Fairholm.

Mr. Fairholm: From my perspective, a more important route to follow is in respect to employment and the taxes on employment. Payroll taxes kill jobs. If you're going to chop any taxes, chop those. With the reduction in the unemployment insurance rate you have an opportunity to get rid of the gap between what people take home and what employers have to pay. That gap distorts the labour market and kills jobs. So if you want to chop anything, chop back the unemployment insurance rate and don't raise other taxes.

The Chair: Thank you, Mr. Fairholm.

Lastly, Mr. Dungan.

Prof. Dungan: If I could just second that, the work we do with our computer models of the economy does indicate that the most effective tax to cut - the one that would have the highest recapture rate, the one that would have the biggest stimulus on output - is actually the employer contribution. It's the payroll tax.

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So we are hoping - indeed it will obviously be mandated by the way the UI scheme works - that there will be some UI contribution rate cuts coming at the beginning of 1996 and the beginning of 1997. If one is looking for some kind of, in a sense, early tax dividend from the cutting that is going on at the spending side, I would strongly recommend - and I think Rob would be with me - that it's the place where one would look first.

The Chair: The payroll taxes.

Mr. McIver: Yes, the payroll taxes.

[Translation]

M. Gignac: Mr. Chairman, my experience in the last 20 years has led me to be increasingly modest in the conclusions I draw from my reasoning. As economists, our classic models tell us that lowering taxes will stimulate consumption. But I think that in the 1990s, we have to be far more subtle.

If the consumer or household has the impression we are lowering the GST, but the deficit increases faster and faster, that isn't really going to stimulate consumption. Before considering a reduction in the GST, we should aim at putting the budget on a sounder footing, something that would restore consumer's confidence. Last year was probably the first time in eight years that the budget deficit was below the level projected. We should stay on that road to boost consumer's confidence.

The GST is not the only factor influencing decisions. We shouldn't forget mortgage rates. In the United States, mortgage rates are very low; here they could go down further. However, mortgage rates vary with long term security, which themselves vary with the decision and the confidence of foreign investors.

We know that Canada is the country most dependent on foreign capital. In those circumstances, we believe that we should move towards a sounder budget, a budget that would restore the confidence of foreign investors in Canada and in Canadian securities; we would then see mortgage rates fall. This approach is probably preferable to lowering the GST, since in my humble opinion traditional models no longer work the way they did 20 or 30 years ago because of the accumulated debt.

[English]

The Chair: Mr. McIver.

Mr. McIver: I suspect that Mr. Gignac has pre-empted my comments, but basically - with all due deference to you folks - on the ability of government to introduce stimulative policies, whether they be tax breaks or whether they be spending programs, or regional expansion programs, that was a decade ago. The reality now is that we have to pay back for those programs, and I don't think today the government has very many degrees of freedom in which to move in order to stimulate the economy.

The trouble with the consumer is indeed that he is lacking in confidence. The strongest relationship between consumer confidence is with jobs, job creation and job uncertainty, and job uncertainty is one of the elements of fiscal restraint.

So the stimulus has already been undertaken. We have to pay the price for it, and that is going to be very difficult. What we need is stability.

I think if the individual who is employed comes to the recognition...when we reach that stage where he says, yes, I don't think I'm going to lose my job next year, he's going to be more inclined to undertake major spending.

By the same token, the potential homeowner, if he reaches the stage where not only does he believe interest rates are going to be lower but he believes they are going to be reasonably stable, if he's making a wise decision to buy today rather than find that two weeks later the rates are up or down, when that situation arises - and that's going to take some time - that's when we will be back on a more positive trajectory.

The Chair: Mrs. Stewart, please.

Mrs. Stewart (Brant): I've been thinking of what Mr. McIver was saying, that it's possible that the only degree of freedom we have at this point is in fact how fast we make the cuts.

As I hear you speak - and I don't want to put words in your mouth - I feel somewhat optimistic and believe what you've done since the last budget is breathe a sigh of relief because you have seen the international market saying, okay, we think Canada is taking the steps that need to be taken. We are showing a committed effort to spending cuts and a recognition that governments have to control themselves, and that, in effect, if we can continue with a plan of stability, we will be able to retain that degree of freedom of how fast. While we agree that maybe a decade ago it was interventionist policies that the government took to protect the weakest, at this point that may be the only option we have in terms of how fast we move down. Remember also that there are those in society who still do need the support of government in the redistribution of wealth.

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On another thing you spoke of earlier, Mr. McIver - and I'd like to pick up to an extent on my colleague's comments but to focus on the revenue side - you said there is some concern around the revenues that will be generated, given consumers confidence or lack of it, and the revenues we'll be able to pick up through the GST and through domestic strategies, taxation strategies. I wonder, as we look at the spending cuts that will be required - because I'm assuming none of you are saying, let's have personal tax increases or significant measures on the revenue side - how big the cuts will have to be.

We were talking about percentages. I think it was Mr. Fairholm who specifically said he's expecting $11 billion in cuts over three years. Was it you, Mr. Fairholm?

Mr. Fairholm: I said you would need a package of that magnitude to stabilize -

Mrs. Stewart: Then Mr. Rosenberg said at 4%, which - my calculation is pretty faulty - would be somewhere around the same magnitude of $3 billion or $3.5 billion a year. Over three years it would be $10.5 billion or $11 billion.

Those are some specific numbers I heard, but as we think about the impact on the revenue side, are those notions built into your number? Are the notions of what we can expect to collect on the revenue side built into your $11 billion or your $3.5 billion?

Mr. Fairholm: Yes, that's with the basic economic growth as in our outlook.

Mrs. Stewart: As in your prediction?

Mr. Fairholm: That's what would be required in the face of a cyclical future as we've had a cyclical past, what you would be required to do to stabilize the deficit situation in terms of a budget balance.

Mrs. Stewart: And the same, Mr. Rosenberg?

Mr. Rosenberg: Yes, I think you're looking at revenue growth of maybe 3% to 3.5% at best on an annual basis. But this goes back, I think, to a question that was asked before about where do we cut. I think the focus has to be on the program spending cuts.

Even when I say 4%, again, I'd like to get you focused on total spending, because at the end of the day that's what counts. Even when I say 4% - and that's annually - in terms of program spending cuts, when you count in what interest costs are likely to be over the next half decade, total spending cuts amount to less than 1% per year. That's the reality we're faced with.

Somebody asked before about where we're going to cut spending. My answer last year was that's why politicians were elected, to make those tough decisions. But suffice it to say that there will have to be Draconian cuts and a massive downsizing of the federal government.

Ultimately, the move towards giving more power to the provinces, let's say, or questioning why we need a certain department at the federal level that is replicated at the provincial level are things that are going to have to be rethought. But there's no question that's what we're looking at here ultimately: a massive downsizing of government.

I know we'd all like to see consumer spending do a lot better, but the reality is that there's no quick fix here.

If you take a look at what New Zealand went through, it was a full ten years. That's what we're looking at here. This problem wasn't built up overnight, and it's not going to be solved overnight. We can't just look at it on a one- or two-year basis, that, well, it would be great to get consumer spending up and do whatever we can. We have to take a long-term view. Maybe that's one of the faults when you have elections every four or five years. That's the politicians' time horizon. But the reality is, if we're going to take a look into the future at what the fiscal side is going to look like, and at the economy moving into the next century, we have to take a much longer-term view here.

Mrs. Stewart: I think that's consistent with what one of your colleagues said, that we won't reap the benefits of the actions for a minimum of five years, or seven years, or maybe even ten years. That's something we have to build into the understanding of the consumer, I think.

Mr. Rosenberg: Let me just tell you this. We all sit here and bellyache about government debt, but Canadians themselves have a personal and mortgage debt of $450 billion. I think it was mentioned before. It's at a record level relative to disposable income. But what better way, ultimately - it's longer-term - to give something back to Canadians than some control over our interest rate structure?

Half our debt is owned by foreigners. It would be nice to get some of that back. It would be nice to get our balance sheets in better shape. This is going to be a multi-year development.

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But that's ultimately how you can sell fiscal retrenchment. Most Canadian have a mortgage; most Canadians have their credit cards. If you can guarantee them lower interest rates - and that comes through fiscal retrenchment, longer-term - I think that's how it's going to be done. But again, it's going to take a long-term view and a multi-year process.

Mrs. Stewart: But then it becomes a real return for them, in terms of their mortgage payments.

Mr. McIver: I believe it will.

Mrs. Stewart: I have one other quick question. In thinking about our cycles, as I recall, down at this end of the table we were talking about the late years in the century being when we can expect recessionary activity. Looking at the numbers that were presented to us by Mr. Dungan, it's really 1997 and 1998 where you're predicting the greatest growth. What is it that suggests that to you?

Prof. Dungan: If there was an objection to those numbers, it would be that there's no recession, even to the year 2000 or beyond. There isn't one there. I would say actually there is; there's a little one, but I trended it out. I don't know when it will happen, so those numbers may include a new recession something like we just went through this year. That would be offset by higher growth in fact in another year.

There are two views about recessions and the business cycle. One of them is that it is a fairly regular process, and, much like the coming of the seasons, it's driven by something physical almost underneath. You will have a boom, then a recession, and then a boom. We know the timing is not quite so regular.

There is another view, which is that economic events happen and that sometimes they have serious consequences one way or the other.

I have a hard time thinking up what could possibly give Canada as serious a recession as we had - because I think we're talking serious ones here - in 1980-81 or in 1990-92 again in the next decade or more.

Basically those recessions didn't happen to us; they were caused. They were caused by the oil price problems of the 1970s and the reaction of tight money in the United States to bleed the inflation out of the system because none of us reacted properly to that shock. Then the seriousness of our recession in 1990-1992 was in great part caused by misalignments of policy and the Bank of Canada deciding that we needed zero inflation.

Now that we're down to low inflation, with no likely commodity shocks on the horizon, I do not see anything, and I'll be bold about it -

Mrs. Stewart: Do you think we've identified all the possible risks and put them -

Mr. McIver: I don't see anything that could cause that serious a recession again in the next decade. The way I like to put it is, I think governments and central banks have run out of mistakes to make.

Some hon. members: Oh, oh!

The Chair: Mr. Pillitteri.

Mr. Pillitteri (Niagara Falls): Gentlemen, on one side you paint most of us a good picture here, but on the other side I'm a little confused. Some of our colleagues on the opposite side have said to hasten the reduction of the deficit, and most of you are agreeing with that.

But I also hear the word ``more'' in decentralization; I hear the words ``more power to the provinces''.

If I take a look at some provinces in Canada right now...the Province of Ontario has stated that having more tax cuts will stimulate the economy, and yet I hear from you that tax cuts would not really stimulate the economy; it would only be short-term gain and long-term pain. If that was actually given to the rest of...the other provinces would follow suit. As a federal government, what would we have to keep this country together as far as an economic solution for the country?

I'm getting two different feelings here. Do you want to take that on?

Mr. Egelton: I'd like to put the tax cut comment in context. I think tax rates in Canada right now are high. They are sufficiently high that they are impairing economic performance, and I don't think anyone on this side of the table would argue that tax rates sometime in the future shouldn't be lowered.

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We have two problems: one is tax rates that are too high; the other is deficit levels that are too high. Mr. Rosenberg talked about.... You're looking at around - I don't know what it was - $14 billion to $15 billion of spending cuts that you need to balance the budget. If you're talking about a tax cut of $5 billion, then you need $20 billion of spending cuts to balance the budget. So if you're having a hard time finding the $14 billion to $15 billion, then you really don't want to add another $5 billion onto that.

I think the first objective is to put your fiscal house in order. Second, the dividend from that will be lower taxes in the future. But I don't think you can put the cart before the horse and cut the taxes before you have your fiscal house fixed.

Mr. Tanny: I'd like to second those comments. Basically, it's not true that tax cuts don't stimulate; they do stimulate. The problem is that, right now, the short-term stimulative effects of a tax cut would be swamped by some negative effects that would be associated with capital markets worrying that, over time, the deficit would be going the wrong way, the debt problem wouldn't be resolved, and so forth.

If you simultaneously cut taxes and spending, which is an option, one could achieve the benefits of both the stimulus of a tax cut as well as the belief or the credibility that you're in fact on a solid track toward a goal that you're making public, announcing and identifying as being the one with which markets can identify and support.

So I think the option of a tax cut is available. The question of timing, which is when you would time such a tax cut, and how it would relate to any kind of spending cuts that you'd want to undertake would be an issue that you'd want to address. But it's certainly a possible strategy.

However, I'd like to come back to two questions that were raised. Basically, what kinds of spending cuts can you engineer? I won't propose to make those suggestions. You're already being paid the big money to make those kinds of decisions.

But let me suggest, however, that you're quite right when you ask, with quite a degree of frustration and despair: where can I cut now? It is no longer tinkering that is available to you. Most of the easy cuts have been made. Also, the kinds of cuts we're talking about are not really cutting so much as restructuring in a major way, taking a different view, looking at what you've seen, and seeing something you haven't seen there before.

As they say about paradigms ``shift happens''. I think that's really the situation that you're in right now: shift happens, then you have to sort of deal with that.

Coming back to your question about the lack of a recession - I think that's part and parcel of all of this - my colleague Mr. Dungan explained his own view, but let me give you perhaps another view of that.

It's quite possible that you can look at Mr. Dungan's numbers and say, where's the recession? The recession can be hidden in there and modelled in general, which produces for you sort of midpoint kinds of results. They present the kind of generality of what's going on in terms of a trend.

Inside that trend, you could have some sort of a downturn, followed by somewhat stronger growth for the next year or 18 months, or whatever, in order to recoup it. So on an average basis, Mr. Dungan's growth is only looking to be around 4%.

That's considerably slower than the kind of growth Canada experienced, say, in the 1950s, 1960s and early 1970s. It's considerably slower than the seven-year expansion that took place in the 1980s following a very difficult recession in 1981-82.

Unlike my colleague, I have a much more fertile imagination. I can indeed imagine many things that would pitch the economy into a significant recession in 1998 or 1999, or 1997 for that matter.

But even given that, I do believe that the kind of growth he's talking about is not unreasonable and/or unachievable. Canada has been experiencing record levels of investment spending directed at increasing our productivity and our ability to penetrate foreign markets.

Say we maintain that kind of a track and we're able to combine that with the governmental determination to improve the financial picture at the government level, which unfortunately is a debt problem much more than a deficit problem, meaning it's a long-term problem. It's a problem that we can either pass onto our children or help solve for our children. Then I think we would be doing this economy a long-term service.

Indeed, I don't know if Mr. Dungan showed you his outlook past 2000, but one can in fact envision a far more positive economic prospect for Canada if we can set ourselves on the right course over the next two or three years.

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That finally leads to my last point. I think you have to be prepared to make some significant sacrifices for which the benefits may not be available to you during your term of office, if you're already in office. The benefits may not be clearly visible to the electorate, even at the time of the next election, although hopefully, with the right kind of measures, the prospect of an optimistic venue would likely be there at least for those willing to make the effort to look for it.

Mr. Johnson: On the issue of taxes, I think a lot of people want taxes to come down and stay down at the appropriate time. In an ideal world where you don't have debt problems, if people perceive when a tax cut comes in it stays in, that benefits the economy. In that same ideal world, if you get a tax cut that people do not perceive as permanent, you don't get the same impacts.

I think you're referring to Ontario. A lot of people in Ontario, at this point, may not perceive a tax cut as permanent. It's something that could be unwound by the next government, and it may not have the beneficial impact the government is expecting.

Mr. Clinkard: I think we've been focusing on tax cuts as an important stimulus to growth and I think we've been overlooking the fact that interest rates have responded, and I see no reason why they shouldn't respond again.

If we look at the U.S., I think markets are already strongly factoring in a decline in interest rates following the passage of a plan to balance the budget in seven years and include a tax cut. Markets are looking at that positively. I think we should just focus on one side, because interest rates are the greatest tax of all; everybody is affected, not just consumers.

Mr. Pillitteri: I think they are true politicians. None of them want to answer the question about the strength of the central government and the devolution of power to the provinces. That was part of my question. It's much better to have a central government to control the fiscal policies for the whole country, rather than devolving the power to the provinces. Would anybody like to follow up on that?

The Chair: Oh, oh, we've opened up a really big issue here.

In the interest of fairness to other members, Mr. Pillitteri, I'm going to allow just two very brief responses to your question.

[Translation]

Mr. Gignac.

Mr. Gignac: You have broached an interesting topic. I have to admit - and my clients know this, to the extent that 80% of them have established themselves outside Quebec; in fact, most of them are in Toronto - that I tend not to get involved in political issues.

Let me give me my views as an economist. I do not believe that reducing the federal deficit is incompatible with decentralizing powers. Quebec and Ontario do have to deal with high deficits - that goes without saying - and they have been taking their time balancing the budget. We would have some very specific recommendations to make to the governments of Quebec and Ontario.

We must also recognize that, to date, we have seen more decentralization of the deficit than decentralization of powers. To quote a joke made by the Minister of National Defence yesterday - if you can't afford a Cadillac anymore, think about getting a Chevrolet. Could someone please explain to me why, at a time when the federal government has become a minority partner in funding for health and education - its participation in provincial programs is only 30 to 40% - it continues to maintain extremely stringent standards in all these programs?

It is quite true that Quebec and Ontario are being slow in balancing their budgets. But let's not forget that Quebec and Ontario represent the core of Canada's industrial sector, and that they were forced to adapt to free trade and rationalization. I am still not willing to conclude that the decentralization of powers is the right solution. We might believe that some powers are best exercised by the provinces, but the opposite is also true: some powers are best exercised by the federal government.

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We can give examples. That may be a little more political. There are areas which should remain within the purview of the federal government, just as there are other areas that should rather be the purview of the provincial governments.

What we're seeing right now is a decentralization of the deficit, without affording the provinces the flexibility they need. In some provinces, we should perhaps just have a Chevrolet, rather than running a Cadillac because of stringent federal standards. If we did that, we would probably see all public deficits drop.

The Chair: Thank you, Mr. Gignac. Mr. Rosenberg.

[English]

Mr. Rosenberg: That's a tough act to follow. I agree 100% with what Mr. Gignac said. I would just say we've all agreed that we have to cut spending, but the big question is where?

When we're looking at the different items on the so-called chopping block, I think it would be absurd not to look at areas of overlap between lower levels and higher levels of government. I look in the phone book and see there's a federal department of environment, let's say, and there are ministries of environment across the land in the provinces. I think these are the things we have to start looking at. Why is there this duplication? In what areas could we possibly save in terms of reducing that duplication? I think it's very important.

It's very important to start rethinking government entirely. Maybe it's time to go back and think about what government provided for Canadians in the 1940s or the 1930s, when we're talking about providing the essentials, whether it's in terms of national security or infrastructure and the like.

The reality is that to achieve our fiscal goals and reclaim our control over interest rate structures will ultimately mean dramatic reductions in government spending, along a broad spectrum that will include giving more control to the provinces. I think they'll go hand in hand.

It's nice to sit in Ottawa, and as federal politicians you might be reluctant to devolve more powers, but has anybody stopped to think maybe this is what Canadians want? Maybe Canadians want their local politicians, who can serve their communities' needs, to be the ones who ultimately deliver these programs and have more control over them. If that's what Canadians want - and I'm not saying they do - then that would be part and parcel of our plan to ultimately balance the federal budget.

The Chair: Why should we have ten retail sales tax regimes when we need only one, for example?

[Translation]

I'd like to come back to Mr. Loubier, if you don't mind.

Mr. Loubier: I have a comment on decentralization. We have three clues indicating the direction the federal government wants to take. The first clue lies in the two first budgets produced by Minister Paul Martin. We talked about - and Mr. Gignac mentioned this - shoving the deficit off into the provinces' backyard. So in the next few years, the best way to get out of this would again be to cut in transfer payments to the provinces, to transfer responsibility from a government that is not being responsible in its control of public finances.

The second clue came from Mr. Ouellet during the referendum campaign. He said that eliminating duplication and overlap would be the responsibility of the provinces, since they had created the duplication, even though in some areas - like education, social assistance and manpower training - the federal government had been more than happy to invest even though those areas were under provincial jurisdiction.

Yesterday, you heard Prime Minister Jean Chrétien comment about decentralization during his visit to Australia. He stated that it would probably be up to the provinces to make the first move and to withdraw from certain sectors, even though it has not been determined if the provinces are in a better position than the federal government to provide the services in question.

I tell you you're dreaming in colour when you talk about decentralization, unless you are talking about decentralization of the deficit. On that score, I agree with you. That's what the government has been doing for two years.

I have a question for you. The issue of tax reform has been tossed aside in this discussion. This is a crucial matter of primary importance, in light of the growth of the underground economy and the various options opened to taxpayers - when I speak of taxpayers, I'm not talking only about individuals, but about corporations as well - to take advantage of tax loopholes to the tune of about $16 billion in 1992, according to the Auditor General's estimates.

How do you feel about the need for tax reform, something which we have not seen for 30 years, as a means for the government to regain control over Canada's finances?

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The Chair: Do you want an answer regarding decentralization or the underground economy?

Mr. Loubier: My question is not about decentralization. It concerns tax reform.

The Chair: You have made a number of comments and the witnesses are entitled to respond if they so wish. We will begin with Mr. Gignac.

Mr. Gignac: Mindful of remaining politically neutral as I have done for the past 20 years and having kept my views to myself during the recent referendum campaign, I would like to distance myself somewhat from Mr. Loubier's comments.

It was not my intention during my presentation to accuse the federal government of wanting to decentralize its deficit. I said that in the past - and I believe even former Premier Bob Rae said so as well - we had seen some evidence of the federal government attempting to decentralize the deficit. I do not wish to impute any motives. I'm not saying that we will once again be seeing a move toward decentralizing the deficit.

This being said, I merely wanted to point out to you that a double standard is in effect. In an area under federal jurisdiction, such as defence, the government readily admits that it no longer has the means to maintain a cadillac system, but it nevertheless proceeds to employ strong-armed tactics to maintain our gold-plated social safety net. That's what I was trying to say.

With respect to tax reform, we have to remember that we are operating in a free trade environment. This is North America. We are not on a small island in the Pacific. Companies and individuals enjoy considerable mobility. One can always dream about taxing the wealthy, big business and the big banks. I believe they must do their bit and I agree that business subsidies in the 1990s are no longer justified.

We can no longer ask ordinary citizens to continue making sacrifices and, at the same time, continue paying subsidies to businesses. No doubt you are mildly surprised to hear this from an economist and strategist working in the financial sector, but fairness must prevail. If a company is unable to balance its budget in the 1990s without subsidies, it simply shouldn't exist.

At the same time, the committee must guard against sitting up in an ivory tower or indulging in crystal ball gazing by applying a taxation rate out of line with the US rate. A large percentage of the population lives very close to the border and we are operating in a free trade environment.

Mr. Loubier: Let me just clarify my question on tax leakages. It's a fact that the five big Canadian banks have 50 branches in the Caribbean. That's ridiculous. Something's fishy somewhere. We read in the newspaper that businesses are trading tax credits and tax deductions. They sell them to other businesses when they don't need them.

A major overall of the tax treatment of businesses and taxpayers is already underway in the United States. Some interesting ideas have been advanced, for example, the proposal to introduce a flat tax rate, something which one of your colleagues, Pierre Fortin, put forward for discussion this year. It's not a question of taxing businesses at a higher rate than that in effect in North America and the world. As you said, we are operating in a global economy. Capital moves freely. However, I can't believe that nothing can be done to make the tax system fairer and to stop tax leakages, if any. We are seeing this happen in the United States. Why can't we take similar action here? That was the gist of my comment.

[English]

The Chair: Mr. Egelton.

Mr. Egelton: I think we're in a pretty difficult position in commenting on those types of tax measures because I don't think anybody here is an expert on that. There are a lot of things you can look at in terms of the pros and cons of decentralization.

What concerns me about the discussion is it leaves the impression that there's a silver bullet to solve this problem: we have a deficit problem and it will just go away if the rich pay; it will just go away if we decentralize and get rid of overlap and duplication, and then we won't have to cut services to anybody and there will be no problem. I don't think that's a reality.

Whatever level of government is responsible for providing the service, that level of service is going to have to come down, because taxes are already too high. That's the bottom line of the thing. I think there probably are things, maybe tax inequities you can fix at the margin, and maybe there is a little bit of overlap and duplication, but I don't think it's $15 billion to $20 billion worth.

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The Chair: Mr. Tanny, briefly, please.

Mr. Tanny: I'd like to comment only that our fiscal regime has been under constant change over the course of the last ten years. It seems to me we brought in major tax reform only to reform the reform and then to go on to reform the reforms that we've made. I'm not sure I understand why there's any suggestion that we can't or have not been reforming. It seems to me we've been constantly reforming. Indeed, one of the questions was whether we should reform further and change the GST, which was just introduced, and so on. That's my first comment.

The second one is simply that I don't disagree that everybody should be paying their fair share according to the rules as written at any given time, and toward that end efforts to go after the underground economy make sense. One shouldn't overestimate the size of that economy nor the costs in terms of going after it. There has to be a cost-benefit trade-off as to how much effort one should really apply in that direction. But I applaud efforts to go after it.

I think, finally, the third thing is that one should keep in mind that under the present system of transfers in Canada roughly 18% of all personal income recorded in Canada is as a result of transfers. That's almost one dollar in five. We already had a very significantly high level of redistributing income in this country, and we should keep that in mind as we contemplate any further kinds of efforts in those directions.

The Chair: Thanks, Mr. Tanny.

Mr. Grubel (Capilano - Howe Sound): It's always a pleasure to have such a distinguished group of articulate and logical people in our presence here to share their thoughts with us. I also appreciate the honesty that came out when they acknowledged the precariousness of all of these forecasts.

I wonder whether your models show any effect yet of what I consider to be a significant microeconomic policy change, and that is the reform of the UI system by the federal government and the reforms of the welfare system that have taken place in Ontario and some other places. We all know this is likely to increase the labour market efficiency. It should reduce unemployment, increase employment and have a generally stimulating effect, at any rate according to some theories. I'm wondering whether there's something on that.

I have now known the Liberal members of this committee for long enough to know that they have two concerns about spending cuts. One of them is the simple political cost and the cost to the good causes where they believe government ought to do things for the people. But the other one is the cost of vulgar Keynesian effects on aggregate demand and how it would increase unemployment and reduce growth even more.

In regard to the last issue, if we turn to the stories and replies that Mr. Gignac and Mr. Tanny gave to the question about tax cuts, would it not be logical, therefore, to assume that if on the other side you made spending cuts and signified clearly that you were moving towards a balanced budget, that you're getting things under control, it would have an effect, both on investors, domestic and foreign, and consumers, so that the growth rate you have assumed is projecting ahead, without doing so, would be affected by this? In fact, we might be very favourably surprised if we did take incisive action along those lines. Is there any indication in your models, or can you speculate about this, please?

Mr. Hracs: We were speaking earlier about the eventual recession and what that might do to us, but I would postulate that the more we take action now, the more we're going to insulate ourselves from the possibility of recession or from the magnitude of it. I think there is time now to take some steps while the economy is reasonably sound, and I think it's a kind of insurance policy for things that could get much worse later. I tend to think that over the long term, near term, it maximizes our performance.

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Mr. Fairholm: I would like to follow up on that in terms of what our economic model shows.

Essentially, if you have a significant spending cut, you take stimulus out of the economy in the near term. However, because interest rates come down, the economy bounces back, and over the very long term, because you have lower interest rates, you increase the amount of investment in the economy, which pushes up supply; therefore, you have a long-term benefit.

Mr. Grubel: How big is that?

Mr. Fairholm: In our model it goes down for the first year, but it depends on the period over which you are cutting. If you're cutting back over a two- or three-year period, the economy first contracts, relative to how much you cut, then it comes back by about the third or fourth year to be above where it had been before.

Mr. Grubel: But those expenditure cuts are really a tiny fraction of the GDP; they are almost within the error of measurement.

Mr. Fairholm: This is relative to the baseline. You cut spending, go below the baseline, and then get back above the baseline.

Mr. Grubel: I understand, but you said we have to cut out $15 billion to get to zero. If it is spread over three years, that is $5 billion per year. What is the economic growth during this period? If you spread it over all of Canada it is almost negligible, relative to the normal fluctuations in demand coming from tourism, exports, imports, and things of this sort.

I am just trying to pull out of you how significant these are in magnitude.

Mr. Fairholm: Let me put it to you this way. If you take 1% of spending out of the economy there will be a short-term multiplier. Because that impacts economic activity, it spills over to cause a larger than 1% decline or reduction in GDP, compared to where it would have been otherwise. Ultimately, that short-term hit dissipates and you start getting a plus later on. It depends how you want to compare it.

If we are in a situation where the economy is growing by 1% and you reduce spending by 1%, you will have a hit where you will be below zero. If you are growing at 5% and reduce direct spending by 1%, you will go down a bit more than 1%. So instead of growing at 5%, you will be at 3.8%, for example. These are the sorts of orders of magnitude, and ultimately you will be better off.

Mr. Grubel: I understand that. But I'm just trying to put the magnitude of the cuts you have projected into perspective. Is it unusual to have fluctuations in size to get to zero quickly? Are they totally out of the realm of daily observations or monthly observations with respect to fluctuations in exports of forestry products, or fluctuations in tourism with respect to whether we have a good summer or not?

With a whole range of random shocks like these, I am trying to suggest the economy is subject to these random shocks anyway. By the time we have reached this small size, would this not be more or less just like a random shock, rather than a really big hit?

Mr. Fairholm: It would depend on how large this hit is, relative to the size of the economy.

Mr. Grubel: Well, you have cited the numbers.

The Chair: In other words, would a $15-billion cut in unemployment insurance impact adversely on the unemployed?

[Translation]

Mr. Gignac, would you care to respond?

Mr. Gignac: As you know, economics is not an exact science. Obviously, any additional cuts restrict the economy in the short-term.

However, to the extent that indebtedness is a phenomenon of the 1980s and 1990s, the econometric models used over the past 30 to 40 years are no longer valid as a means of assessing or quantifying the impact of such cuts.

Let's take a common sense approach. In the United States, which is moving towards balancing its budget, actual rates, defined as long-term rates minus inflation, which hovered at 5.5 per cent during the 1980s, have now fallen to between 2.7 and 3 per cent. Major cuts have been made to the defence budget. Spending in other areas is also down. Look at the resulting economic growth and expansion! Why is this?

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Because in the medium and long-terms, a country's economic outlook depends more on prospects for investment and lower real tax rates.

In a country like Canada, where 40 per cent of the debt is held by foreigners, the Bank of Canada does not control interest rates by pushing a button. Everything hinges on the perception of foreigners. Therefore, in the short-term, further cuts have to be made, which has a restrictive effect. Unquestionably, if we manage to balance the budget within three years and if there is a recession in the United States, we will feel the effects, to the extent that one-third of our economy is export-based.

However, based on our international experience, we have learned that countries that succeed in balancing their budget are far less vulnerable to interest rates when a recession occurs. They are better able to weather a recession and their currency takes less of a battering.

This time around, I am rather in favour of the federal government's approach, which involves building up a nest egg with respect to the employment insurance fund. The previous government made the mistake of increasing unemployment insurance premiums right in the middle of a recession, thereby making the situation worse. This time, if the government acts prudently, moves to balance its budget and builds up a cushion in the UI fund against the next economic downturn, there will be no need to make the situation any worse by increasing premiums.

Therefore, we mustn't be naive. If there is a recession in the United States, we will be affected, but this won't mean that the exercise to balance the budget has been fruitless. On the contrary, it will have had some positive results. I said that when people are called upon to make sacrifices and to put up with rather unpalatable policies, it can take anywhere from five to seven years before some dividends start to pay off. However, based on the US experience, a reduction in actual rates is the key to a brighter economic outlook and to investments. The ball is in the court of our elected officials and our governments.

The Chair: Mr. Clinkard has indicated that he would like to say something. As well, two other members wish to ask questions. We could then wrap up with a 30-second summary from each participant.

Mr. Clinkard.

[English]

Mr. Clinkard: The point is cuts take time. They don't happen instantaneously. They happen over a period of time, so the shock is diffused.

The response of interest rates tends to be in the short term. It tends to occur more quickly as markets focus on this positive. So in some sense I would agree that for these effects, it's not a straight one-for-one in time. At the end of the year it is, but over time these shocks are absorbed and that diffuses their impact.

Thank you.

[Translation]

Mr. Discepola: Do you believe that the 2.5 per cent growth rate for Canada would also apply to the province of Quebec?

Mr. Gignac: In light of recent economic indicators, it is clear that Quebec is lagging behind in terms of economic growth. My feeling is that given the rather difficult budgetary choices that will have to be made, notably the adoption by the provincial government of the same ``time standard'' as Washington, if you will, there will be a certain economic downturn, or at the very least, economic growth in Quebec will lag behind the national average next year. I trust that answers your question.

Mr. Discepola: My second question goes out to everyone. Why should we believe your projections? Some of you said that in 1990, no economist could have predicted a recession. Last year, the committee heard witnesses testify that the rate of growth would be around 3.8 to 4 per cent, and now, we have economists sitting around this table congratulating our Minister of Finance for having taken the most prudent approach.

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Why should we believe that the growth rate will in fact be 2.5 per cent this year? Should we exercise caution once again this year and, if so, why?

[English]

The Chair: Mr. McIver -

[Translation]

Mr. Gignac: Because economics is not an exact science, economists must guard against making overly optimistic forecasts. We have learned from experience that the Minister of Finance is wise to make cautious projections. Therefore, given the inexact nature of our science, it is totally realistic to project that the rate of growth will be 1 per cent lower than forecast and that interest rates will be 0.5 per cent to 1 per cent higher.

Having said this, why have we not used the Finance Department's forecasts which, admittedly, have been more accurate than private sector projections over the past 10 years? Because financial markets might think that these forecasts are much less neutral and more driven by political pressure. Consequently, I think it is preferable to continue working with private sector forecasts, using guideposts to mirror reality more closely.

Canadians will never criticize you for having tabled an overly cautious budget and, as was the case this year, for coming in with a lower than projected deficit. What we don't want to see is a repeat of the situation observed over the past 10 years.

The Chair: Mr. McIver has something further to add.

[English]

Mr. McIver: It seems to me that economic forecasts are indeed quite unreliable. You go through the exercise to provide some framework, some basis upon which to build a fiscal plan.

By the same token, just as economic forecasts are unreliable, so are fiscal forecasts. The government's fiscal forecasts have been unreliable time and time again. It's not an easy job. You do it within a certain framework.

I will make the suggestion that what would be desirable is not just a contingency plan in terms of a contingency fund when putting that budget together, but a contingency plan that actually takes into account what happens, such as, for example, what happened in 1994 where growth originally forecast to come in at 3% came in at 4.6%, but revenues originally forecast at 8% came in at only 6.3%, notwithstanding a much larger growth in GDP.

I would like to see a plan that says to the Canadian public, if during the year it appears that our revenue and expenditure mix is coming in inappropriately compared to our forecast, we are explicitly prepared to take the following measures or undertake the following changes.

Mr. Discepola: Mr. Chair, I have a question. It will take one second.

The Chair: It's really the quality of your questions rather than the time for them, Mr. Discepola -

Some hon. members: Oh, oh!

The Chair: - and since it's so fine we will allow you to continue.

Mr. Discepola: I want two things.

I have a question for Mr. Rosenberg and for Professor Dungan. You both alluded to decentralization.

The question I have for Mr. Rosenberg is more of a comment. There is something I always get frustrated with, especially during every referendum period in Quebec, which seems to be more frequent. When you talk about decentralization I totally agree with you, but it seems to me that it's always a one-way street instead of a two-way street. In your example about environment, you're proposing that maybe we should have ten ministries of environment instead of one. I caution you when you say that because polluted lakes and rivers and acid rain know no provincial boundaries.

In your case, Mr. Dungan, I wonder if the government had not had a national energy policy in 1980 whether the provinces of Quebec and Newfoundland, for example, would have benefited as they did. Decentralization is going to be easy to do if there's a willingness to do it. So far, I see the provinces always saying, give me, give me, give me. No province is coming to us, such as the Province of Quebec, and saying it is the only province that collects taxes, it will let the federal government do that aspect of it. Do you follow me?

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I hope we'll be able to achieve the majority of decentralization, and I think the federal government is going to have the burden of proof on that.

Here's my last comment. As economists you can talk about figures and you can talk about percentages and interest rates, but we have to remember in our policies that behind each one of those figures is a human being.

I ask you, with a show of hands right now, how many of you are prepared to forego your government pensions when you reach retirement age if your annual revenue is $50,000 or more?

Mr. Grubel: That's totally inappropriate.

The Chair: Look, all of us are -

Mr. Discepola: All of us?

The Chair: We realize that all of us will have to make sacrifices if we're going to achieve our -

Mr. Grubel: It's inappropriate and it's silly.

Mr. Discepola: You're welcome, Herb. We'll grow our way out of it then. Is that what you're saying?

The Chair: Mr. Johnson, did you want to respond briefly?

Mr. Johnson: Yes, sir, very briefly.

I and a lot of my neighbours, friends and colleagues certainly have the impression that there is no pension for us. It's gone.

The Chair: Thank you, Mr. Johnson. Thank you, Mr. Discepola.

Mr. St. Denis.

Mr. St. Denis (Algoma): Thank you, Mr. Chairman, and thank you all for being here.

I'm going to take a little different tack. Yesterday I asked the Governor of the Bank of Canada about productivity.

I apologize for being late this morning, but I'm assuming he didn't cover this general area.

In layman's terms productivity is a measure of our ability to turn natural and human resources into wealth, into increased standards of living, into consumer goods, etc.

I think Mr. McIver mentioned a significant point. In the late 1990s the government has much less ability to have a stimulating effect than it had ten, twenty or thirty years ago.

So this is a two-part question. If we accept that premise, are there non-fiscal things we can do to make an impact on productivity? How does our country compare to other countries, to some of our major trading partners, when it comes to productivity? How efficiently and how well are we using and marshalling those things we are blessed with in terms of human and natural resources for the good of our people?

Mr. McIver: We are doing it much better than we were doing it. That is patently clear, because we're seeing that our competitiveness in terms of cost vis-à-vis the United States is much improved.

With respect to other countries, it really doesn't matter an awful lot because we don't share a 3,000-mile international boundary with Europe; we share it with the United States.

As for what measures we can take other than fiscal and monetary measures, I think there's a great deal that can be done. I'm afraid it comes back to the issue of the federal government and the provinces, because it's the regulatory environment that can be changed.

If we use the example of the province of Ontario and the state of Kentucky, there are tremendous differences in labour regulation in those two markets that have enabled Kentucky and the U.S. sunbelt in particular to improve their productivity and their competitiveness very much more quickly than we have been able to do.

Mr. Tanny: In the long term one of the best things we could possibly do is to turn the society into an educational culture. It seems to me we have an obligation to pass on to our kids the idea that the way to create a highly productive society is to have highly trained individuals. This doesn't always mean university education, although in many cases it will. There are lots of other alternatives.

It seems to me if we could get a culture that focused much more on educational and technical achievements and if we were able to instil that kind of sense of learning, that would create much more excitement among our youth and we would have a much more productive society over the course of the next couple of decades.

The Chair: Mr. Walker.

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Mr. Walker (Winnipeg North Centre): I want to thank the guests for coming here. I think we all appreciate just how difficult the predictions are in the economic forecast, certainly in the Department of Finance, with being off a little bit on a percentage basis. That is well-known to everybody who has to do the forecasting. It is an exact science. I respect your willingness to come here and share some of your thoughts of how you put it together.

I just wanted to return to a couple of points that have been raised here, just to bring a different perspective to it.

To go back to Dr. Grubel's point, there has been a tremendous relocation and dislocation in employment in this country. In the last couple of years, Statistics Canada estimates that there have been about 220,000 jobs lost in the public sector. It's about the equivalent amount in the private sector.

So there's a transformation taking place, but it takes a while for the economy to adjust to people who are public servants being unemployed. Some skills are transferable and some aren't. The cost of that retraining on the unemployment side is, normally speaking, borne by everyone in the private sector through their contributions to UI and the high levels of premiums we have to pay for that over regular UI. The quicker we can get that cost on, the better off we are. But in the meantime, there's a real transition cost as we restructure this economy.

On the question of devolution and decentralization, I would like to say that it's a little more difficult than people sometimes make it out to be. If you look at the transfer arrangement we have with the provincial governments, perhaps the greatest mistake we made in fiscal responsibility was the EPF arrangements of 20 years ago.

We transferred a great amount of money on an annual basis, without any sense of responsibility to it. As well, the provinces built up huge fortresses from which they could shoot spears at us whenever they wanted about any cutbacks we made to them.

The federal government, when it comes to real programming - this is not transfers to individuals, transfers to the provinces, debt payment, or UI - spends about, after our cutbacks right now, $40 billion a year, which is 5% of GNP. You'd be hard-pressed to look around for a central government that spent so little into its economy.

So the economic levers we have available to us are going to be put at risk if you're not careful, because that is a very small contribution in terms of real programming, economic development, and whatever else you want to do.

When you cut off transfers to the provinces, you have one of two solutions. Either you have to give up tax points or GST points, therefore giving up your own capacity to reduce your debt, or else you're assuming that they are going to have to, at least in the short term, increase their debt, because they have union contracts and institutions you have to be able to get rid of.

Generally speaking, the point spread for provinces raising money is greater than it is for the federal government. So in terms of a national economy, you've got to be careful you're not increasing the cost to the nation, because they don't have the capacity.

Quebec is going to be an extreme example by the looks of it. The point spread is quite wide now. In Ontario, it depends how quickly they move as to whether they have a capacity to have a low-cost financing arrangement.

But look at some of the smaller provinces, such as Newfoundland. You put them at risk very carefully, in a practical sense. You don't want to bankrupt the province to prove a point nationally, because people who are watching you closely from a market point of view know what you're doing; you're not kidding anybody.

This is just a series of observations, Mr. Chairman, rather than any particular question.

On the question of the foreign debt, there are really three choices. The first one is the one we prefer. This is to reduce the national debt and therefore the international needs. The second one is the increase in incentives, which means increased costs. Therefore, this is counterproductive to reducing your debt. The third one is, through regulatory regimes, to insist that people invest in Canada, not overseas.

Since many of you are partial to RRSP funds, that 20% rule sticks out there pretty widely. Are you suggesting that we should maybe change that to make sure there's a higher percentage of Canadian savings staying in Canada?

The Chair: We'll take three brief answers. Who wants to go first? Mr. Hracs.

Mr. Hracs: Just on the final point about limiting what we can invest offshore, I think it's a progressive step to allow diversification. It's a benefit to your citizens. Internationally, it's something that is quite acceptable, so I think the consequences of rolling that back would be quite significant.

Mr. Egelton: I have two quick comments. I would agree completely with what my colleagues said here. I think a country that imports as much capital as Canada does, does not want to start getting into the business of making capital movements more restrictive. Anything we can do to make capital flow more freely is for the benefit of Canada in the long run.

Second, there's the point of the transformation that's going on in the economy. I agree that there is a tremendous amount of transformation going on now. People are being transferred from the public sector into the private sector, and there are skill mismatches. But I don't think you want to lose sight of the fact that this is always happening. Think back to the Second World War. From 1945 to 1960, Canada moved about 15% of its population from rural areas into the city, which is just incredible. That just swamps anything that's occurring today.

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I think I agree with you that there are problems associated with that, but they are not monumental by historic standards. In fact, they pale in comparison to what we've seen in the past.

Mr. Clinkard: Yes, I think I agree that there has been significant dislocation, but despite that fact, we saw more than 450,000 full-time jobs created last year, between December and December.

I know we went into neutral for the first half of this year, but since July I think there have been close to 50,000 full-time jobs. These are the jobs that count. This is how we're going to get the confidence building.

Even despite the losses we've seen, people have changed. I think that's what we have to remember: if we create incentives for people, they will change; if we maintain the status quo, forget it.

Mr. Walker: Thank you.

The Chair: We now come to the end of our questions. I've offered each one of you the opportunity to summarize in 30 seconds or less, or to give us words of wisdom.

Mr. Rosenberg: My advice would be to keep the growth assumptions conservative, such as something at 2.5% or below. I would keep the interest rate assumptions that were in last year's budget even as low as interest rates are right now vis-à-vis that forecast. Keep this just as a buffer.

I think the focus has to still be on the cuts in program spending. I already outlined that we have to be looking for at least 4% cuts annually through the end of the decade, which would be to balance the books before 2000.

I think that we all have to, at the federal level, think of smaller government. As small as it has become over the past couple of years, we have to think that it's going to become smaller. I used decentralization before as just one part of an overall strategy. There will still have to be massive, Draconian cuts at the federal level if we're going to be serious about ultimately balancing the budget.

Mr. Johnson: Cutting the budget deficit as we've recommended risks putting downward pressure on our standard of living. I think the message you got from us is that not doing that risks cutting it even more.

Mr. Egelton: The economy is poised to grow fairly strongly over the next year or two. There's one thing that you as parliamentarians and the government can do to aid that process, which is to aggressively move to cut the fiscal deficit further.

Mr. Fairholm: To repeat what everybody else has said, I would continue to attack the deficit through expenditure cuts. I would publicly go after a three, two, one, zero path, but privately, if I were you, I would go after a quicker path. So even if you miss, you'll still retain your credibility.

Mr. Hracs: To us, the fiscal situation remains quite urgent. Deficits have to continue coming down, and be perceived as coming down. We look forward to the next budget.

Mr. Tanny: I applaud your efforts at seeking consultation and urge you to continue doing that in the future. In addition, I think you should be focusing on the medium term by creating a solid medium-term plan, and then working to implement that plan.

Finally, if you'd like to see more suggestions about budget-making, I encourage you to take a look at an Ernst & Young report that was done for the Department of Finance in 1994.

[Translation]

Mr. Gignac: Just as we recommend to our clients that they draw up a strategy based on their fundamental vision of Canada, not on an apocalyptic vision, politically speaking, I invite the members of the committee to pursue the goal of putting the government's financial house in order because, while politics is a challenge in itself, debt and indebtedness are, to my mind, the greatest risk factors in terms of our dependence on foreign capital in this global economy.

The Chair: Thank you.

[English]

Mr. McIver: Go for a balanced budget. Adhere to your target plan. Have a contingency plan.

Mr. Clinkard: Economists generally look through a very cloudy crystal ball, and we don't forecast recessions at all well. However, we do know that they will occur. We do know that we have never, in this country, escaped a recession that was triggered by the U.S.

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Regardless of what happens, there will be one. Count on it. It will probably be within the next three to five years. Plan accordingly.

Prof. Dungan: I'll stick with the optimistic projection, because you've asked me for my best shot at it. But if I were in Finance, I would use a more prudent, if you like, outlook on which to base the planning. I think a rosy scenario like this should be viewed as an opportunity to attack the deficit vigorously and not, in a sense, an excuse to ignore it.

The Chair: I guess I'll take - I'm speaking for myself - a couple of messages out of our excellent meeting today. One was to please err on the side of being prudent. I can assure you that this committee did do that in its report to the minister last year. Our recommendations were followed in the budget. In spite of being off target in some areas, I believe we're still ahead of our deficit target achievements.

I believe we will continue that type of prudence. Thank you for your recommendations in that area.

Here's another thing that struck me. Mr. Egelton said for Canadians, including members of the committee, to not assume there is a silver bullet that will end our economic problems. We are going to have to get out of them somewhat in the way we got into them. It's not going to be easy, we can't do it overnight, and it may take longer than we think.

There was some concern expressed by our panel that we, as politicians, have very short time horizons. We go only to the next election and we might be unwilling to undertake measures that would not produce results until some time beyond some future election. If this is a correct interpretation of what some people might be thinking, I can assure them that it's wrong. We realize that it's going to be very difficult and that we may not see the benefits of some of the measures we've undertaken for five to ten years. We want Canadians to understand that message as well, because I think they realize that it's not going to be easy to get out of this difficulty.

Finally, you brought a great deal of research, expertise, experience and wisdom to us. On behalf of members around this table, I want to thank you for an excellent round table and your very valuable contribution to our pre-budget discussions. Thank you.

The meeting is adjourned.