We have a spending problem

I apologize, in advance, for a long post full of numbers and charts and economic jargon, but all this ties back to something I said a few days ago: “I am, personally, disappointed that Andrew Scheer has come out as something approaching a big government Conservative. I had hoped that he might put restoring some fiscal sanity at the top of the agenda but it seems that the Conservative plan is to match the irresponsibly free-spending Liberals almost promise for promise. I don’t want my grandchildren paying for this generation’s irresponsibility.

Now, perhaps the fact that I am a septuagenarian who lives on a (somewhat) inflation-adjusted pension and has owned his home, mortgage-free, for many years means that I’m in a tiny minority who can worry about the national debt and deficits, but Bill Curry, David Parkison and Nicholas Van Praet, writing in the Globe and Mail, say that “Voters have lost their taste for government austerity since our last serious Canadian debt and deficit problem. The last time things approached a crisis was a quarter century ago, now a distant memory. Nearly half of the current voting-age population was too young to vote then; 11 per cent hadn’t even been born yet … [but they add] … there could be another reason Canadians tolerate deficits now: a personal financial squeeze that has many feeling that they’re falling behind … [because] … Despite a job boom and an unemployment rate near 40-year lows, wage growth has barely kept up with inflation during the past several years. Meanwhile, rising real estate prices are making homes less affordable.” They offer this graph, prepared by the Good Grey Globe based on StatsCan data to show inflation-adjusted wage changes for the last few years:

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It shows that, on average and after taking the inflation rate (based on the consumer price index) into account, wages in Canada have only grown by slightly more than ½ of 1% since Justin Trudeau was elected. Wages have, in fact, been stagnant … so it’s no wonder that ““A lot of Canadians don’t feel like they’ve been getting ahead,” says Craig Alexander, chief economist at Deloitte Canada. “And because they don’t feel like they’re getting ahead, they’re looking for governments to offer them more.”” That certainly explains why Andrew Scheer is making spending promises that disappoint me and why Elizabeth May, Jagmeet Singh and Justin Trudeau are making promises that scare me to half to death.

But the Globe and Mail says we should all be worried because of seven factors:

1. It’s not all about federal deficits. Provincial debt is ballooning

Justin Trudeau’s Liberals like to gloat that Canada has the best balance sheet among the Group of Seven countries. Not true … [because] … That statement leaves out the provinces, whose combined debts, at slightly more than $700-billion, are roughly equal to Ottawa’s debt. That has to be considered in the overall picture of Canada’s financial health, because it’s the provinces that are responsible for big-budget services such as education and health care – services whose costs will only explode in the years to come … [and] … Canada’s aging population is going to put a lot of pressure on the medical system, and provincial governments don’t have the fiscal capacity they need, Mr. Alexander says. “I’m worried that health care is going to turn into a black hole that Screen Shot 2019-10-05 at 08.00.54consumes all provincial resources,” he says … [that’s something that has worried me for a long time, and I have just returned to it recently, and] … Canada has the biggest portion of subsovereign debt among a dozen other countries with triple-A credit ratings, according to Moody’s Investors Service. More than half of all general government debt in this country (about 58 per cent) is at the regional and local level, pushing up Canada’s gross government debt-to-GDP ratio to almost 80 per cent, Moody’s says. And the financial markets and credit agencies have long believed that in a crisis, the federal government would backstop any provincial debt – so, it’s overall government debt that really matters.

2. Big government is making a comeback.

The Trudeau government has done more than just reintroduce the notion of routine deficits. It has re-introduced big government – or, at least, bigger government. The spending proposals in its campaign platform would give the government its biggest non-recessionary footprint on the economy in 25 years … [while] … The typical gauge for a government’s size is its program spending as a share of gross domestic product … [and] … That shrank dramatically during the deficit-slashing era of the mid-1990s – from more than 16 per cent when the Chrétien government took office in 1993, to less than 12 per cent in the early 2000s. It remained between 12 per cent and 13 per cent during Stephen Harper’s

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prerecession years … [but] … the Liberals have reversed that course – modestly, but unmistakably – since taking office in 2015. And their campaign spending proposals would take it further … [and, now] … In last spring’s budget, the Liberal government envisioned program spending peaking in the 2018-19 fiscal year at 14.6 per cent of GDP, declining to 14.3 per cent this year and continuing to gradually decrease to 13.8 per cent by 2023-24. But under this Liberal platform, program spending now looks set to rise to 14.7 per cent of GDP in 2020-21 and changing little throughout the next mandate; by the 2023 election, it would still be at 14.5 per cent … [but] … Outside of a couple of years around the Great Recession – when the Harper government injected a massive fiscal stimulus – Canada hasn’t a run of sustained spending-to-GDP that high since the mid-1990s. And unlike Harper’s recession stimulus, these aren’t temporary measures … [because] … “Much of [the Liberals’ increased spending] has gone into social spending – which is an annual thing, and it becomes entrenched,” says Joe Oliver, who, as finance minister in the Harper government, was the last finance minister to present a balanced budget, in 2015. “There’s nothing harder in government than cancelling a program – it’s excruciatingly difficult” … [and] … that’s even if governments stick to their plans, which they don’t. According to a study released over the summer by the C.D. Howe Institute, Canada’s federal, provincial and territorial governments routinely overshoot the targets they set in their annual budgets. Since 2000, they’ve spent $91-billion (some $2,500 for every Canadian) more than they budgeted and raised $142-billion (almost $4,000 for every Canadian) more than they budgeted … [but] … Without the rigour of a zero-deficit framework, spending can quickly snowball, C.D. Howe president Bill Robson says. “When governments start to spend very freehandedly, pretty soon you start getting stories about people expensing packets of gum and $15 glass of orange juice or subsidies to profitable companies and handouts that appear to be very calibrated to swing ridings. Over time, I think people’s tolerance for that is diminished.”

3. Just how big a debt burden are we taking on?

One key factor that makes deficits and debts more manageable today is also, conversely, what made them so dangerous in the 1990s: interest rates … [because] … In 1991, the interest rate on 10-year Government of Canada bonds was more than 11 per cent. As a result, the cost of servicing federal government debt – of making the interest payments annually – was a whopping 6 per cent of GDP. In the mid-1990s, Ottawa was spending more than 30 cents out of every dollar it collected in revenue just to pay the interest on its debt … [but] … Today, with 10-year bonds at just 1.25 per cent, federal debt-servicing costs are a shade over 1 per cent of GDP. The interest on government debt consumes just 7 per cent of the budget:

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Many economists argue that such low borrowing costs not only make deficits and debt easier to bear – they may even make them desirable. This could be the best time in history for governments to borrow to finance long-overdue infrastructure projects … [and I would agree IF we were spending on long-overdue infrastructure projects, but that’s not what Team Trudeau is doing] … “This is a very good time to do infrastructure spending. It’s not just the short-term interest rates that are really low, but the long-term interest rates are extraordinarily low. You can do a long-term project and you know you’re going to be locked into a very low-interest-rate environment,” says Queens University economist Don Drummond … [and] … The other mitigating factor is that our debt-to-GDP ratio is manageable. Indeed, debt-to-GDP has emerged as the preferred benchmark … [amongst Liberals and Liberal friendly economists, because] … As long as the economy is growing enough, the conventional wisdom goes, we’re alright managing our debt … [and] … “Should we be leaving debt to our kids?” the University of British Columbia economist asks. “The answer is ‘So long as debt-to-GDP is going down, we’re not'” … [but] … If you accept the notion that going into debt is fine, however, the next question is how much borrowing is okay. And the answer isn’t clear. Moody’s does not have a specific threshold it considers dangerous, for example … [and] … “One of the great failings among many of the economists in public finance is we’ve never nailed down what is an appropriate level of debt-to-GDP ratio,” Mr. Drummond says.

4. We’re spending to buy votes, not promote growth

The 2015 Liberal platform promised short-term deficits that would primarily be used to pay for increased spending on infrastructure. “Now is the time to invest,” the party promised. Yet, in government, the Liberals struggled to meet their own infrastructure spending targets. Government-wide program spending still rose though, to $330-billion last year – a nearly $50-billion spike from the year the Liberals came to power. The size of the public service grew 12 per cent during that time … [but] …For 2019, the Liberals and the Conservatives are both promising across-the-board tax cuts that would reduce federal revenues by about $6-billion a year. The Conservative campaign followed that up with a long list of more targeted tax cuts aimed at seniors, parents, homeowners and others. The Liberals are also targeting the same groups with promises of new tax breaks and benefits … [but, and this is a key point, related to Item 3, above] … Neither party has so far announced major new infrastructure spending, although large long-term spending increases on infrastructure are already part of federal spending plans approved in recent Liberal budgets. The Liberal platform promises $56.9-billion in new spending and tax cuts over four years, to be paid for with $25.4-billion in tax increases and spending cuts as well as $31.5-billion in new debt resulting from larger-than-planned deficits. The Conservative platform has not been released, but the party says it can cut taxes and still balance the books within five years … [therefore] … The question is whether any of the spending will build the economy, improve productivity and create the conditions for robust growth … [not likely] … Former deputy finance minister Scott Clark says deficit spending can be justified if it is a true “investment” that produces long-term benefits, such as spending on infrastructure or education. Yet, he’s been struck by the speed, volume and size of the Liberal and Conservative campaign promises, and says they do not fit that bill … [but, he says] … “These are just attempts to buy people off,” he says. “I don’t think of tax cuts as investments” … [and] …Queens’ Mr. Drummond shares the view that deficit spending should benefit the younger Canadians who will inherit that debt“You still, at a minimum, have to justify passing on a burden to a future generation: Are you generating a benefit?” he says.

5. Cutting now could cost us more later

When people talk about investing in things that pay off for the economy and generate economic growth, they often mention hard infrastructure such as roads and ports. But economist Jesse Hajer of the University of Manitoba says the notion of “social infrastructure” is just as important if not more so. By that he means investing in reducing poverty, in things such as enabling the latent potential work force in Canada … [and] … He gives the example of Manitoba’s Indigenous community, which has been socially and economically excluded and underrepresented in postsecondary training and work. Helping them integrate into the work force is a good thing to go into debt for, he says. They are investments that pay off in the long run … [thus, some say] … The bottom line is that it’s dangerous to look at deficits in purely ideological terms. Borrowing is not inherently evil, he says. You have to look at what you get for the spending … [and] … If governments are going to reduce the deficit, they either have to raise taxes or cut social programs. And those who advocate for a lower deficit typically reject tax increases, he says.” Guilty as changed. I recognize that “social infrastucture” is both real and must be built and maintained. It needs to be part of a balanced budget mix, along with defence and foreign aid.

6. This is not what Keynes had in mind

The legendary British economist, John Maynard Keynes, believed governments should use spending to lean against the highs and lows of the business cycle, thus smoothing the bumpy economic path. Although this Keynesian approach to fiscal policy has had its critics over the years, it is generally at the foundation of sound government budgeting the world over … [because] … The idea is that when the economy is slumping or in recession, governments should increase spending, even if that means more borrowing and deepening deficits, to stimulate economic activity. When the economy is strong, governments can ease off the spending throttle … [but, sadly] … The proposals from the leading contenders in this campaign appear to fly in the face of Keynesian logic. Both the incumbent Liberals and, to a slightly lesser extent, the Conservatives, look prepared to maintain or even expand deficits in the near term, at a time when the Canadian economy is running near full capacity … [and] … Critics worry that harper-un-2013-lge-56a0e5913df78cafdaa62b42deficit spending now will use up valuable fiscal ammunition that could be needed to aid the economy in a downturn … [the critics, like me, note that] … The enviable fiscal health restored by Ottawa in the 1990s gave the Harper government the flexibility it needed for major stimulus spending in the financial crisis and Great Recession of 2008-09. Canada emerged without the kind of troubling debt load that saddled other countries who went into the recession with less healthy balance sheets, allowing it to avoid harsh austerity measures that hampered the recovery in other parts of the world … [and] … Even if the government felt it couldn’t afford a major stimulus effort when the next recession hits – a decision that would certainly deepen the damage and slow the recovery – economists say that deficits would balloon regardless. Tax revenues would go down as the economy slowed, while expenses would increase in support programs such as unemployment benefits … [because] … “You can move from a $20-billion deficit to $50-billion in a flash,” Mr. Oliver says.

7. If we don’t learn from the past, we’re doomed to repeat the ’90s

When Jean Chrétien’s Liberals took power in 1993, they inherited a country awash in red ink. The federal government had run a then-record deficit of $39-billion the previous fiscal year. Net federal debt was closing in on 70 per cent of GDP, about double where it was just a decade earlier (and more than double where it is today) … [and] … The budget that year, tabled by the previous Mulroney government, had a smattering of spending cuts, yet they barely kept up with debt costs. Simply paying interest on the debt was costing the government nearly $40-billion a year and climbing. Those costs alone ensured that the debt kept rising, making the problem worse every year … [then, to their a4ced73d-1bb9-42ec-9e46-4febb821c5b6everlasting credit] … Mr. Chrétien and his finance minister, Paul Martin, determined that it was time for tougher medicine … [because] …“The debt and deficit are not inventions of ideology. They are facts of arithmetic. The quicksand of compound interest is real,” Mr. Martin said in his speech presenting the 1995 budget – a radical document that laid the groundwork for the most dramatic financial transformation in modern Canadian history … [thus] … They set about a sweeping restructuring and downsizing of the federal government. They slashed program spending by 13 per cent. They reduced the civil service by 55,000 jobs. They cut transfers to the provinces by 30 per cent … [and] … Within four years, the deficit had been eliminated. The success at the federal level spilled over to the provinces, where budget balancing became all the rage during the 2000s. By 2005-06, every province in the country ran a small surplus.

Back in the 1980s, Brian Mulroney was frightened away from balanced budgets because, as Joe Oliver said, above: “There’s nothing harder in government than cancelling a program – it’s excruciatingly difficult” Prime Minister Mulroney and his finance ministers, Mike Wilson and Don Mazankowski, instead waged a public relations campaign aimed at explaining the perils of unbalanced budgets to Canadians. Their best friend, after they left government, was an editorial in 1995 in the prestigious Wall Street Journal that described Canada as an “honorary member of the third world” and said the Canadian dollar was “the Northern peso.” That really spooked both Prime Minister Jean Chrétien and Paul Martin.

Prime Ministers Mulroney, Chrétien, Martin and Harper all understood basic economics. They all wanted balanced budgets, eventually, they all understood the perils of neverending deficits and debt servicing costs. Unfortunately the same could not be said for Pierre Trudeau (1968 to 1984) nor can it be said for Justin Trudeau (2015-????).

Recessions come and go, we haven’t had one for over 10 years. Most economists agree that there is a “business cycle:”

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The “troughs” are recessions or even depressions. The Great Recession started in 2008. We have been “expanding” ever since. How long can it last? Not much longer say some experts. We should have been looking, five years ago, at how to balance the budget (which Prime Minister Harper did) and at how to keep it in balance so that we could face the inevitable, next recession with confidence (which Prime Minister Trudeau did NOT do). Instead, we are on a long term spending spree, mostly spending on the wrong things because Canadians want to ignore economic realities because, under Justin Trudeau, their wages have hardly grown at all. Canadians are afraid; they’re asking governments for a handout. It’s impossible to resist during an election. But, eventually, the piper must be paid … it will be painful.

In an opinion piece, also in the Globe and Mail, Konrad Yakabuski says that “Not long ago, deficits were verboten in Ottawa. After a hard-fought battle to balance the federal budget in the mid-1990s – after two decades of red ink that had driven Canada dangerously close to a debt crisis – no party dared advocate deficit spending. The federal government did go deeply into deficit during the 2008-09 recession, but it was considered a necessary evil to combat the economic downturn. The Conservative government of Stephen Harper returned the budget to balance by 2014. If the parties argued about the timing of spending cuts, they all agreed the goal of a balanced budget was the right one … [but] … By 2015, however, cracks had begun to show in the balanced-budget orthodoxy. During the election campaign, the Liberals vowed to run “modest” $10-billion deficits for two years and return to balance by 2019. (Spoiler alert: They didn’t make it.) This time, however, the party isn’t even paying lip service to balancing the budget. The Liberals seem to have concluded that not enough Canadians care, while their base of progressive voters thinks deficits are cool … [and, very sadly] … Even the Conservative Party, once the Scrooge of Canadian political parties, has moved away from a hard opposition to deficit spending. The Conservatives do promise to balance the budget, eventually. Just not during the four-year mandate they’re seeking from voters on Oct. 21.

He quotes Paul Boothe, a former associate deputy minister in the Finance and Industry departments during the 2000s, who says ““I am sort of surprised at how fiscal prudence has gone out of fashion these days … [and] … The current generation of analysts and policy makers don’t seem to understand how hard Canada had to work during the [Brian] Mulroney and [Jean] Chrétien years to get back to balance.”

There is a serious risk that the deficits that Liberals once insisted would be small and temporary will become large and permanent,” Mr Yakabuski opines, and I agree, fully, “And that the spending promises being rolled out in this campaign will leave Ottawa with a pernicious structural deficit that undermines investor confidence, putting Canada on track for a painful fiscal reckoning similar to what it faced in the 1990s. Yet no one seems to be talking about that on the campaign trail. Maybe they should … [because] … In July, the economic recovery that began in Canada and the United States in mid-2009 became the longest on record. After a decade of rising asset prices, especially in stocks and real estate, almost everyone agrees the party has to end sooner or later … [and] … Historically low interest rates have left consumers with maxed-out credit cards and massive home mortgages. Meanwhile, a global trade war threatens to push many export-dependent economies such as Canada’s over the edge. A process of “deglobalization” has begun that could radically shrink global supply chains and leave every trading nation poorer than it is now. “None of the parties are talking about any of that,” notes Steven Ambler, an economics professor at the University of Quebec at Montreal. “It is difficult in an election campaign to raise the spectre of a recession. But I would give any party that did so points for honesty” … [indeed, he says, and agree yet again that] …  the next federal government could face fiscal challenges greater than those faced during the so-called Great Recession of 2008-09. With interest rates still treading near historical lows, the Bank of Canada has almost run out of ammunition to stimulate the economy. That could put extra pressure on the federal government pick up the slack if the economy falters.

He concludes and I agree fully, that “The next federal government could face a far darker fiscal situation than any politician on the campaign trail is willing to admit. Screen Shot 2019-10-03 at 14.34.41Screen Shot 2019-10-05 at 10.37.44Their silence may be the most frightening thing about this sleepy election campaign.” It’s a pity than none, not even Andrew Scheer, will admit to that fact because I think the next prime minister will face spending problems that make those being faced, now, by Doug Ford and Jason Kenney seem quite mild, and I know, with 100% certainty, that Justin Trudeau is not up to facing them.

 

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