The era of big government and industrial policy is here, like it or not

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John Rapley is an author and academic who divides his time among London, Johannesburg and Ottawa. His books include Why Empires Fall (Yale University Press, 2023) and Twilight of the Money Gods (Simon and Schuster, 2017).

In a world economy dominated by big beasts – the U.S., China and the European Union – a mid-sized and trade-dependent country like Canada has little choice but to swim in the wakes of others. So it’s perhaps a bit surprising that in all the talk surrounding last week’s federal budget, little attention was given to events in the outside world.

Surprising, because that world has changed a lot in the past few years. In particular, industrial policy, and with it the era of big government, is back. And Canada, despite the ruling Liberals often being criticized for spending too much, may be spending in the wrong places and not investing enough in spurring growth.

Academic economists have been making increasingly strong arguments for it but the main reason policy makers are reconsidering measures to assist industrial development is a practical consideration: the case study of China.

For decades, the country has used subsidies to nurture the development of a large manufacturing sector, with the country’s share of world output rising from 5 per cent to 35 per cent in the quarter century after 1995.

Initially, the West went along with it. The flood of inexpensive Chinese goods brought down prices in shops, lowering inflation and with that, interest rates. That, in turn, triggered rallies in Western asset markets. Meanwhile, Western firms outsourced production to China, thus boosting their profits and share prices while also securing niches in China’s rapidly expanding market for luxury goods.

But it was bad for workers. As their jobs disappeared, they rose up and supported populist politicians like Donald Trump, who promised to revive their dying industrial towns. Mr. Trump imposed tariffs on Chinese imports during his presidency, a tactic widely seen to have failed.

So when Joe Biden became President, he instead championed the use of industrial policy. His administration is now providing huge subsidies to support industries so that they might better compete with China.

These policies appear to have raised the economy’s labour productivity. Not only does this increase the prospect that the new American expansion will become self-sustaining, but with U.S. competitiveness vis-à-vis Europe and Canada rising, private investment has begun leaving those markets to go stateside. European IPOs (initial public offerings) and trading are down because the U.S. is once again the land of opportunity. In consequence, the American stock market has left all its peers in the dust.

Europe is now feeling the squeeze. As its producers are pushed out of their major export markets, governments will have no choice but to respond with some form of industrial policy. So far, this has taken the form of tax policy, but the Europeans are now looking to join the wave of decoupling by finding ways to compete with Chinese exports.

Of course, industrial policy gets expensive: The U.S. is currently running a fiscal deficit nearly five times as big as Canada’s and its debt-to-GDP ratio is three times worse. However, the alternative to big government may be even worse.

In Canada, although the government has kept a relative lid on borrowing – the government’s debt-to-GDP ratio has risen less than 10 percentage points over the past 15 years compared with the U.S.’s three times that – its household debt has gone up sharply. In the U.S., by contrast, it has fallen.

This isn’t unusual. Private and public debt often vary inversely. But the end result is that overall debt (public and private) in the U.S. is now lower than in Canada. Meanwhile its economy is more productive. That’s because most of Canada’s debt has been used by investors to fuel a housing bubble that is now an obstacle to economic growth.

One could argue that if debt is going to rise, it would be better for the government to take direction of the process and ensure there is some strategy to it. Although U.S. debt dynamics aren’t sustainable, to the extent the country’s industrial policy is creating a self-sustaining boom, the economy may be able to weather the eventual fiscal retrenchment. In Canada, by contrast, the hands-off approach has, since houses produce nothing, brought the economy to a virtual standstill.

So today Canada, with a stagnant economy burdened with private debt and an industrial sector already hard hit by the rise of Asia, faces a world in which the big players are pouring resources into developing the next generation of industrial champions.

This country has tried to copy them, attracting several electric-vehicle projects, including a deal with Honda announced Thursday. Yet Canada’s results pale when compared with other Western countries’ and its policy debate seems narrowly focused on tax and spending levels, as if we were still living in the 1990s.

One can’t help but wonder if the country is unprepared for what’s coming.