The Stimulus Didn't Work

The data shows that the money the government pumped into the economy had next to no effect.

(Co-authored by Charles Lammam)

The federal government’s television ads seem omnipresent with their message that Canada’s Economic Action Plan is stimulating the economy, creating jobs, and moving the country out of recession.

But is it really? Did the government’s various stimulus initiatives, wrapped under the banner of Canada’s Economic Action Plan, really do all that the government claims?

There’s little doubt Canada’s economic outlook has improved dramatically from last year with the latest data from Statistics Canada showing that the Canadian economy turned a corner midway through 2009. In addition, the Bank of Canada and major private sector banks are forecasting positive economic growth for 2010.

To gauge whether government stimulus actually had an impact on the economic turnaround in 2009, we examined Statistics Canada data on the contributions of government consumption (i.e., spending), government investment (i.e., infrastructure), and private sector activity to the improvement in economic growth at two critical junctures.

And the data show that government stimulus had a negligible effect on Canada’s economic turnaround. Put simply, the stimulus didn’t work.

Between the second and third quarter of 2009, GDP growth improved by 1.1 percentage point from -0.9 per cent to 0.2 per cent. Of this 1.1 percentage point improvement in GDP growth, government consumption and government investment each contributed only 0.1 percentage points. Private sector investment contributed 0.8 percentage points and was the driving force behind the economic turnaround from the second to third quarter of 2009.

Despite government attempts to stimulate renovations in the housing sector through the high-profile Home Renovation Tax Credit, Statistics Canada data show that investment in residential structures did not contribute to the change in GDP growth between the second and third quarter of 2009.

Similarly, the federal government’s temporary business tax relief to stimulate the purchase of new computer equipment did not account for a significant part of the private sector investment that drove the economic turnaround during this period.

On the other hand, one goal of the federal stimulus package was to stimulate private sector consumption. While increased private sector consumption did contribute to improved economic growth from the second to third quarter of 2009, it was slight.

To the federal government’s credit, the $4.5-billion reduction in personal income taxes contained in its stimulus package likely had an impact on consumption, given the permanent nature of the tax relief. This supports academic research suggesting the government should have introduced widespread tax relief to improve economic growth, not increased spending. Unfortunately, less than 10 per cent of the federal stimulus plan was dedicated to permanent tax relief.

Between the third and fourth quarters of 2009, GDP growth increased by 1 percentage point from 0.2 per cent to 1.2 per cent growth. At this juncture, government consumption and government investment contributed nothing to the 1 percentage point improvement in economic growth. Increased net exports were solely responsible for the improvement during this period.

Most indicative of the government’s stimulus mistake is that before the recession, during the recession, and well into the recovery of 2009, the government’s contribution to GDP growth has been markedly constant. In other words, whether the economy was shrinking, stagnant, or growing, the contributions of government spending and government infrastructure investment to economic growth had little effect on changes in GDP growth.

This, of course, contradicts the government’s claim that “Infrastructure measures in the Action Plan … have contributed to the economic recovery in Canada.” But the actual result is unsurprising given that more than 40 per cent of the federal government’s stimulus package was earmarked for infrastructure initiatives, which take time to plan and implement.

Looking forward, the fear is that spending on infrastructure will occur as the economy naturally begins to grow, meaning the government will compete with the private sector for resources, resulting in increased costs and fewer private sector projects.

Despite the government’s rhetoric, the stimulus package didn’t work and was a mistake that will burden Canadians with a legacy of debt for years to come.