CANADA NEEDS SOLID PLAN TO INCREASE PRODUCTIVITY
New challenge will involve tackling the debt explosion, Kevin Lynch and Paul Deegan say.
One legacy of the COVID-19 pandemic will be mountains of public, corporate and household debt for current and future generations to deal with. With few palatable options, and massive tax hikes and huge spending cuts not among them, the best way to get out of this debt trap may be to grow our way out, but that will not be easy.
The locking down of economic and social activity by governments to flatten the COVID-19 curve, combined with skyrocketing economic uncertainty and personal insecurity, has induced a global recession of 1930s’ dimensions. To counter this, government policies in this shutdown phase have been geared to supporting business liquidity and sustaining household income. These massive programs are financed by government debt — lots and lots of it. In addition to this public debt explosion, businesses and households are also piling up debt to bridge to the restart of the economy.
For households and small businesses, the implications of escalating debt are daunting. Government supports, while helpful, may not be enough. Unemployment rates are soaring, and a return to pre-pandemic employment levels before 2022 at the earliest is unlikely. Similarly, the slower and weaker the restart, the more firms that will find the additional debt is a bridge to nowhere, and face bankruptcy.
The broader economic implications of the pandemic are easy to see but difficult to quantify. We are in the midst of the worst recession since 1930, with Canadian real GDP falling five per cent in the first quarter and likely to tumble a further 35 to 40 per cent in quarter two. The shape of the recovery is much debated, between “V”s and “U”s, but its actual timing and vigour are highly uncertain (even the Bank of Canada will not provide a baseline forecast for the year, only qualitative scenarios) and depend on the duration and depth of the pandemic as well as the nature of the government restart stimulus measures, which are yet to come.
Assuming the shutdown begins to unwind before the end of the second quarter, and the government injects further stimulus specifically designed to support the recovery, the International Monetary Fund’s baseline projection is for real growth plummeting by six-and-a-half per cent this year in Canada, and by even more in its alternative scenarios. The IMF’S forecast rebound for the Canadian economy in 2021 of four-and-a-half per cent will be insufficient to return the economy to pre-pandemic activity levels until late 2022. And other forecasters are more pessimistic, including the Parliamentary Budget Office, which is forecasting a double-digit decline in growth this year. Not a pretty picture, and the economy will be littered with record bankruptcies and lost jobs for some time to come.
As challenging as this is, and it certainly is, the even bigger question is what the next normal will resemble as we emerge into the post-pandemic world. Few crises change either everything or nothing, and the COVID-19 pandemic will be no different. The rebooting of the economy and society will face a massive debt hangover.
We are in the midst of a debt explosion on a scale that Canada has not experienced since the Second World War. With the automatic fiscal stabilizers responding to the weakest economy since the depression, plus the fiscal measures already announced by the government to stabilize incomes and liquidity during the shutdown, and assuming further measures to help restart the economy, the federal deficit this year could be in the order of $300 billion. If realized, this would be equal to over 40 per cent of all the net debt we have accumulated since Confederation and would push the federal debt-to-gdp ratio to near 50 per cent from 30 per cent last year. Next year, the deficit could easily exceed another $100 billion depending on the strength of the recovery and how quickly the government is willing to ramp down its massive new spending support programs.
Near zero interest rates make this fiscally affordable only as long as they stay low; rising debt-togdp ratios make this fiscally stable only as long as markets have confidence in the government’s ability to manage the deficit and debt post-pandemic. Low potential growth — the government’s 2019 fall update forecast average future growth of only 1.8 per cent and that was before the pandemic — and low inflation both reduce the options for public debt management.
Going forward, we should expect downward pressure on Canada’s triple A credit rating — something only Canada and Germany now enjoy among G7 countries. Any credit watch on Canada will be influenced more by expectations of future fiscal policy than current federal debt ratios (which are still relatively low by international comparisons), by perspectives on provincial debt issuance (which today is the largest sub-sovereign debt stock in the world), and by risks of the sustainability of corporate and household indebtedness coming out of the pandemic.
As the restart shifts into recovery, these same red flags will put downward pressure on the Canadian dollar and upward pressure on interest rate spreads in the absence of a clear and credible debt plan. There will be calls for tax increases, demands for spending cuts, suggestions to make greater use of regulation to address sectoral problems, and pleas to keep monetary policy looser longer.
But fundamentally, just as after the Second World War, strong growth will be key to successfully tackling the pandemic debt legacy. As it becomes clear that Canada’s longer-term growth prospects are even less robust than they were before the pandemic, especially if the energy sector remains depressed, an effective long-term debt plan will be in need of a strategy to raise productivity and our long-term growth prospects in Canada.
The broader implications of the pandemic are easy to see, but difficult to quantify.