By Keith Moen
Businesses are often opened and closed, fortunes won and lost, on the rising and falling tides of market forces such as supply and demand. These forces – which can be simultaneously powerful and fleeting – are the fundamental drivers of free markets. Entrepreneurs and executives need to respond to them to seize opportunity and mitigate downturns.
Supply and demand are not the only forces at work in our economy. Many other factors influence where companies can find opportunity, and these forces are not always obvious. And unlike supply and demand, some other factors can intentionally aim to direct the economy in specific ways.
One of these factors is government policy, which often aims to play the role of Adam Smith’s infamous “invisible hand.” In Smith’s writing, the invisible hand is a serendipitous economic force that directs otherwise free market activity to achieve the most societally beneficial conclusion. Government policy is enacted to subtly – and sometimes not so subtly – influence the market economy to achieve a result that is beneficial for society as a whole, such as by enacting regulations to promote safety in the workplace. Sometimes policies have positive effects on economic growth – and sometimes they do not.
There is no time more appropriate to discuss the effect of government policy on the economy than in the lead-up to an election. During elections, candidates and parties propose many different policies, some of which may not even seem to have an effect on the economy, and voters are tasked with choosing among them. Nonetheless, it is important to understand the full effects each policy will have on the economy because the effects can often be larger than one thinks. The upcoming provincial election in Saskatchewan is no different.
It is important to understand the full effect of policies before they are enacted.
The best of intentions
To understand why it is important to think about the broader consequences of a policy, we can use the Saskatchewan government’s decision to apply provincial sales tax (PST) to construction labour in 2017 as a case study.
In 2017 the Province of Saskatchewan was facing a deficit of over $1 billion due to resource revenues being far less than expected (to make the budget, the provincial government estimates how much it will earn in royalties on the extraction of various natural resources in addition to its other revenue sources). As a result, the government looked for ways to diversify its revenue streams away from the ups and downs of resource industries.
Alongside the rest of the budget, two particular measures were passed: first, to raise the PST to 6% and second, to eliminate the PST exemption that had previously applied to construction labour. These measures meant that 6% PST would now be applied to construction projects in the province that had, until the 2017 budget, not had any PST applied at all.
The intended societal benefit of these policies is clear. By raising approximately $250 million through the increase in PST and over $400 million through eliminating the PST exemption for construction labour annually, the government would stabilize its revenues and be in a position to avoid cutting jobs, salaries, and general spending every time commodity prices went bust. At the time, this was a sensible move that organizations such as the NSBA recognized as necessary, and the changes did ultimately help the province achieve the goal of budget stability.
There were, however, unintended economic consequences that show us why it is important to understand the full effect of policies before they are enacted.
Almost immediately upon implementation of PST on construction labour, the industry began to feel the effects. For example, the extra 6% cost on the sale of a newly built home meant that a family purchasing a home that would have sold for $350,000 without PST would be paying an extra $21,000, which can easily be the difference between qualifying for a mortgage or not. The combination of this increase in the cost of a new home and the federal government’s 2017 adjustment to the stress test – which reduced the value of mortgages that people could qualify for – devastated sales of new homes: the Saskatoon and Region Home Builders’ Association noted that the number and value of residential construction permits – two key metrics for measuring the strength of the industry – steadily declined by an average of 20% year-over-year from 2017 to 2019.
Further, contractors in the industry were reporting that they were being underbid on jobs by companies operating in the cash economy, illegally avoiding collecting and remitting GST and PST on their services. This created pressure on both ends of the spectrum; on one hand there was less work because of the slowing market and on the other hand the work that was there was becoming harder to get.
Ultimately, the end goal of the government policy was not met as planned. While jobs and livelihoods may have been saved in the public service, jobs were lost in the construction sector. The slowdown in the homebuilding industry did not just affect general contractors or homebuilders; all the trades and suppliers that perform work on houses and supply fixtures for them also felt the pinch.
To its credit – it takes strong political leadership to recognize when a policy is not perfect and requires amendment – the government has responded, introducing a policy to mitigate these unintended consequences and achieve the desired result. In the 2020/21 provincial estimates the government introduced a PST rebate on new-home construction of up to 42% for construction values up to $450,000. While it is early days for this policy, the hope is that this measure will re-motivate the residential construction industry. But it is never too early to ask what the full effects of a policy change will be.
As the Saskatchewan provincial election approaches and the electorate is presented with various policy choices, it is important to fully examine how each policy will affect the economy of the province and the jobs and livelihoods of its residents. In the example discussed here, hindsight proved to be 20/20, and while it can be hard to fully understand the ramifications of a policy before it is implemented, we should strive for 20/20 foresight as well.
First published in the June 2020 edition of The Business Advisor.