DON’T BE SCARED OF DEBT
Fiscal prudes are warning of runaway provincial debt, but economic stagnation is the bigger risk
Joe Oliver, the former finance minister who oversaw Canada’s plunge into recession last year, is a mere citizen of Ontario now. The debt bogeyman who haunted him in Ottawa appears to have followed him home. “Ontario is the largest subnational debtor in the world,” Oliver proclaimed from the comment pages of the Financial Post at the end of December, as if that (unsupported) fact carried profound meaning.
Canada’s provinces are now the focus of the fiscal prudes. Stephen Gordon, the widely read Laval University economist, highlights the fact that provincial debt surpassed federal debt for the first time in 2015. The Fraser Institute, the Vancouver-based think tank that favours low taxes and small government, tallied the combined debt of Ottawa and the provinces and came up with a total of $1.3 trillion, compared with $834 billion eight years ago. Governments will spend more on interest this year ($26 billion) than former prime minister Stephen Harper spent on defence in 2015 ($24 billion), the Fraser report said by way of showing the “displacement effect” of fiscal indiscipline.
But austerity in a time of economic stagnation has displacement effects too. One of the reasons the provinces are facing such diff iculty is that Oliver based his response to the downturn on the economic equivalent of old wives’ tales. He refused to acknowledge that thinking about debt and deficits had changed. What Oliver should have done was backtrack on Harper’s pledge to balance the budget, recognizing that the collapse of oil prices would cause private investment to disintegrate. He and his former boss were punished for their stubbornness.
And yet, Oliver is back, trying to scare people into thinking it’s 1993 again, when a debt-rating agency temporarily snatched away the federal government’s AAA credit score. He warns us that history is about to repeat itself in Alberta, Ontario, Quebec, and most of the rest of the provinces unless they rediscover the religion of balanced budgets. Rubbish. Alberta and Ontario have suffered downgrades, but other rating agencies left the two provinces’ scores unchanged. Firms such as Standard & Poor’s and Moody’s lack the influence they once had: The U.S. dollar and stocks rallied after S&P downgraded the United States in 2011. Alberta’s borrowing costs barely changed after the same company dropped its rating of the province’s debt to AA+ from AAA.
The authors of the Fraser Institute report sought to introduce tension by citing the work of economists Carmen Reinhart and Kenneth Rogoff, whose historical analysis of sovereign defaults suggests a debt-to-GDP ratio of 90% or greater heralds trouble. This conclusion is controversial. James Dean, an economist at Simon Fraser University who has studied sovereign-debt crises in Latin America, Asia and Europe over four decades, says one of the great paradoxes of sovereign debt is that countries can manage heavy burdens for a long time. Japan’s debt-to-GDP ratio has been in excess of 100% since 1996, and in excess of 200% since 2009. The country’s economy is stagnant, but there are too many variables at work to blame only public debt. Japan sells most of its debt at home, allowing it to finance impressive infrastructure that improves the productivity and quality of life of its citizens. Japan has high debt; it also has bullet trains.
Canada’s provinces shouldn’t try to emulate Japan. The federal government’s debt-to-GDP ratio brushed 100% in the early 1990s, and soon after the wall caved in. Ontario’s debt is 40% of the economy—reason to be alert, but hardly reason to panic. Ontario has set out a target to balance the budget within a few years, as has Quebec, whose debt burden is slightly heavier. The trick is ensuring the money the provinces borrow is put to productive use. Another of Dean’s debt paradoxes is that sometimes the best way to shed the burden is to borrow more. As long as the provinces’ spending is generating economic growth at a faster rate than their cost of borrowing, they are doing the right thing.
As long as spending generates economic growth faster than the cost of borrowing, governments are doing the right thing