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Looking the gift horse in the mouth: the impact of federal transfers on Atlantic Canada.

Fred McMahon. Halifax: Atlantic Institute for Market Studies, 1996, 118 pages, (ISBN 1-896928-00-5).

This is a frustrating book. It claims (pp. 9) to present the "full truth" about the impact of federal subsidies on the Atlantic Economy, yet the language is loaded, the economics is suspect, the data are presented in charts not tables, and there are many assertions but limited (or no) evidence to support them. Thus, the reader is left with the sense that this is simply a political tract. It jumps from one argument to another, ignoring the contradictions between them or their inappropriateness to the Atlantic economy.

The frustrations begin with the central thesis of the book, that federal subsidies have harmed the economic growth of the Atlantic region. The book is not about federal subsidies -- the data used are for the net flow of federal funds into the region, the difference between total revenues received and total expenditures made in the region by the federal government. One reason for this strange choice is that "it is very difficult to pick up the macro effect of individual expenditure programs" (pp. 16). That suggests that specific subsidy programs do not have the impacts the report seeks to find, so subsidies have been defined as net flows to justify the interpretation desired.

The implications of defining net federal flows as regional subsidies are quite startling. Canada pension payments are a regional subsidy, expenditures on the navy are a regional subsidy (is Alberta offended?), a successful bid for a federal contract is a subsidy, the purchase of equipment in the region (but manufactured outside the region) is a subsidy. Unemployment insurance is explicitly identified as a regional subsidy program (pp. 47). Of course, many federal expenditures are not subsidies, most of the programs are not regional programs, and many do not even benefit the Atlantic region, although they are all counted as subsidies in

The Gift Horse

McMahon argues that the Atlantic economy has experienced "explosive" growth, except when federal subsidies accelerated in the early 1970s. He claims that "Atlantic Canada's per capita economic growth has strongly and consistently outpaced the rest of the nation" yet his data (Graph 2) indicate that this was not true about 1/3 of the time. He asserts that the "trend in personal income growth appears unaffected by very large changes in the amount of subsidies received..." (pp. 21-22). But why should a trend line reflect short term changes in the subsidies?

The weakness of the book's conclusions are illustrated in the initial graph, showing per capita subsidies and Atlantic per capita GDP as a fraction of the Canadian GDP. The subsidies climb after 1973 and income falters. However, the inverse relationship is not consistent over the 1961-1993 period or even specific segments of it. Nonetheless, McMahon claims that his thesis is borne out with data showing "exactly the expected timing" (pp. 28).

Even if the data were consistent with McMahon's claim, it is subject to different interpretations. 1973 was a significant year -- the year of the first oil crisis and of the rapid acceleration in inflation (and profits, indicating the inflation was not due to energy costs alone). It was also the year that unemployment escalated in the Atlantic region relative to the rest of Canada. Thus, we would expect at least two components of federal subsidies in the region to increase federal expenditures in Atlantic Canada: unemployment insurance and the national energy program. These increases did not cause the economy to falter, as McMahon would have us believe; they were necessary because the economy was in trouble.

Similarly, we can easily infer a different cause and effect for Atlantic unemployment rates. McMahon argues they rise with increased federal spending in the region and the federal spending was therefore counter-productive. He does not deal with the possibility that increased spending led to more jobs which led to even more workers re-entering the job market (or returning home). The expenditures did not cause unemployment; they simply created higher expectations than could be met.

McMahon has two explanations for the claimed perverse impact of federal expenditures. One is related to the Dutch disease -- an inflow of money raises the exchange rate and that reduces traditional exports. Of course, Atlantic Canada does not have its own exchange rate, so the argument is that the expenditures raise wages which leads to a decrease in the quantity of labour hired. But that sounds like a confusion of a movement along the demand for labour curve when the federal expenditures lead to a shift of the demand curve.

The second explanation for rising unemployment rates is that unemployment insurance increased the attractiveness of unemployment, extending search time and permitting workers to "deliberately [choose] leisure over work" (pp. 30). While there is no doubt that people are reluctant to lose their ui eligibility to take short term work, ui has not made the labour force lazy. People desperately want stable, long term employment and they also need support in an economy where many jobs are seasonal. To claim that a program which provides poverty-level support is preferred to work is an affront to Atlantic Canadians and contrary to the facts (Economic Council 1980). To suggest that ui is a major distortion of the economy but to ignore the efficiency and human costs of excessive unemployment is unacceptable. The ui system should not be withdrawn but re-designed to provide flexibility and incentives to work.

The language used is that of a political tract. Regional subsidies are "massive" (pp. 13) but no attempt is made to compare them to subsidies which have helped other regions, such as the $16 billion to the CANDU reactor program (Macdonald 1985: II-99). During the period over which McMahon is most exercised, subsidies under the Defence Industry Program were substantially higher than under Industrial and Regional Development -- $169.2 vs. $102.7 millions in 1982/83 (Ibid.: 102). The Atlantic Canada Opportunity Agency's seven year budget is only twice the half billion tax expenditure given to one family in Ontario (McQuaig 1987: 298). We are told there is a "huge government presence" (pp. 15) from the "bloating of government" (pp. 39) yet there is no attempt to actually detail what government does. The two largest federal programs are education and health, which the report actually approves of. Yet taking the ratio of expenditure to net national income, "...the ratio of personal spending on transportation and communications (8.9%) equals the ratio for public health... [C]ombined personal spending on restaurants, hotels, and recreation (9.1%) was larger than public spending on either education or health care" (Ruggeri and Hermanutz 1996: 44). What was bloated in government expenditures was debt servicing and that reflected policies of cutting taxes and raising interest too far (Mimoto and Cross 1991).

While the report claims to have conducted "econometric tests" (pp. 23), it presents only the results of a few linear regressions. McMahon seems content to assume that correlation means causation, but he may have the linkage reversed. Lynch et al. (1997) raise serious questions about his methodology.

Looking the Gift Horse in the Mouth is not credible research and would not normally merit a review. However, its promoters have drawn considerable public, and therefore political, attention to its conclusions. It is important that its fundamentally flawed character be pointed out.

Michael Bradfield

Department of Economics

Dalhousie University


Economic Council of Canada. 1980. Newfoundland -- From Dependency to Self-Reliance. Ottawa: Minister of Supply and Services.

Lynch, S., W. Locke, and P. Hobson. 1997. Should Our Concern be with the Gift Horse or with the Ideological Bull?. Moncton: The Canadian Institute for Research on Regional Development. Maritimes Series, June 1997.

Macdonald, D. et al. 1985. Report of the Royal Commission on the Economic Union and Development Prospects for Canada. Ottawa: Minister of Supply and Services.

McQuaig, L. 1987. Behind Closed Doors. Markham: Penguin Books.

Mimoto, H. and P. Cross. 1991. "The Growth of the Federal Debt". Canadian Economic Observer. Ottawa: Statistics Canada, June: 3.1 - 3.18.

Ruggeri, G.C. and D. Hermanutz. 1996. "Rethinking Spending Priorities". Canadian Business Economics, Summer: 37-47.
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Publication:Canadian Journal of Regional Science
Article Type:Book Review
Date:Sep 22, 1999
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