The Great Budgetary Pivot: But to Where?
It has been a long two years since Ottawa’s last budget in March 2019, before the Liberals were reduced to a minority government in the fall 2019 election, and a year before COVID-19 struck in early 2020 with devastating consequences all round. “Health and economics are uniquely intertwined in this crisis, and they will be equally so in the recovery,” write Kevin Lynch and Paul Deegan, expanding an earlier analysis in the Globe and Mail, and offering some thoughts on a way ahead. “The key,” they conclude, “is political will and public support.”
What a difference a year makes. We are living with unprecedented economic uncertainty and personal insecurity that harken back to the Great Depression of the 1930s. The deadly, global pandemic was the dominant health, political and economic story in 2020, and continues to be in 2021. Indeed, its aftermath will affect future generations.
Today, we are at war on two fronts— against a virulent pathogen and against a pandemic-induced reces
sion—but not always on a war footing. Canada’s early efforts to contain the virus deserve a passing grade. But our capabilities to test rapidly, to contact trace effectively, to acquire and distribute vaccines reliably, and to actually vaccinate Canadians at scale and with urgency, get a failing grade. Health and economics are uniquely intertwined in this crisis, and they will be equally so in the recovery.
In the economic battle to contain the liquidity shock from the sudden and deep recession, the federal government deserves good marks for rolling out massive temporary income supports quickly. But, while the perfect is the enemy of the good, more attention to the designs of the programs would surely have avoided the moral hazard of excessive insurance—government support replaced more, much more, than 100 percent of lost household income during the 2020 recession. Further, the last Budget was delivered to Canadians in March 2019, projecting a deficit of just under $20 billion–a too-long gap for what is the annual public blueprint of the state of the nation and its finances.
The 2021 federal budget provides an opportunity to begin the pivot from reacting to a two-pronged crisis to planning for sustained economic growth in the post-pandemic era, which will take time; targeted public and private investments in skills, digital technologies, and infrastructure; more agile regulation that eases doing business, and an innovation mindset.
The timing and vigour of the recovery depends almost solely on a novel fiscal instrument: vaccinations. The slower governments are to vaccinate Canadians—and the track record to date is anything but encouraging— the more delayed will be the recovery and the greater the attendant health consequences.
Adecade ago, as Canada and other countries emerged from the global financial crisis, there was a vigorous debate between those who argued for fiscal consolidation to rebuild resiliency and those who advocated for sustained stimulus to reduce excess capacity. Just as then, it is never a simple either-or choice— governments can neither cut their way to growth, nor spend their way to prosperity through unconstrained deficit spending.
Sustainable fiscal management will be crucial to our success in increasing public and private investment, improving productivity and competitiveness, and anchoring business and consumer confidence. It has a number of essential elements.
First, we need to set a clear, credible fiscal anchor to earn the confidence of rating agencies and impose budget discipline within government. A fiscal anchor cannot wait for better days, and its absence is a flashing red light to international investors who do not have to hold Canadian dollar assets in their global portfolios. We are not a reserve currency.
The last Budget was delivered to Canadians in March 2019, projecting a deficit of just under $20 billion–a too-long gap for what is the annual public blueprint of the state of the nation and its finances.
Sustainable fiscal management will be crucial to our success in increasing public and private investment, improving productivity and competitiveness, and anchoring business and consumer confidence.
Fiscal limits are needed now to force governments to make tough but necessary spending and revenue choices. But more than this, the government has to set out a credible path to longer term fiscal sustainability, one that rebuilds our resiliency for the inevitable future shocks.
The C.D. Howe Institute’s Fiscal and Tax Working Group has provided timely advice on the politically difficult but necessary politically choices the budget must address. They advocated four principles for any new permanent spending:
• If this spending is not financed with savings from a review of existing programs, the majority should be met with increased tax revenues.
• To the extent new sources of revenue are required to fund permanent new spending, their design should do as little harm to investment and growth as possible, they should be predictable and reliable, and they should be as broad-based as possible.
They noted that reversing the two percentage points cuts to the GST by the Harper government, combined with a 40 percent increase in the GST tax credit, would raise nearly $15 billion annually—a sizeable contribution towards fiscal sustainability.
Near zero interest rates make new spending fiscally affordable only as long as they stay low, and this is a big risk to the fiscal framework going forward as it ties our fiscal future to the bold assumption that inflation will not rebound and interest rates will remain at record low levels.
Second, we need a debt management strategy that significantly shifts the mix of federal borrowing from shorter term maturities to longer term bonds to lock in today’s ultra-low interest rates, which will not last forever. Those who argue that the massive increase in debt this year is affordable because interest rates are so low should also argue in favour of shifting as much of the new debt as possible to very long-term bonds.
Third, as the economy recovers and unemployment declines, we need to stop the extraordinary levels of spending on the temporary emergency support programs. Today, the block to recovery is not demand or income—household savings are at record levels thanks to government support payments—it is supply constraints due to COVID-imposed lockdowns of businesses. Temporary support programs have to be just that, temporary—Canada’s fiscal credibility and sustainability depend on it.
And fourth, we need to switch more of government expenditure towards investment spending to rebuild our long-term growth potential, which is the only way to manage the mountain of debt we are accumulating. We need more public investments in physical and digital infrastructure, in education, in innovation, and in border fluidity. They all raise productivity and growth. We also need pro-growth policies and investments to increase labour force growth through higher immigration and greater female participation in the work force. And technology is key to meeting our climate change objectives.
But the tough challenge is the need for the government to do less of something in order to do more investing.
The fifth element is to start tackling Canada’s other deficit, the one that few are talking about: the current account deficit. Our declining competitiveness in recent years, exacerbated by weakness in energy prices, has meant a substantial and persistent current account deficit.
We have to get more firms taking advantage of our trade agreements with the United States and Mexico, with Europe, and with the Trans-Pacific Partnership countries. Despite a relatively low dollar, we are racking up large trade deficits with our major trading partners, including the US and China, and this is increasing our foreign indebtedness just as we are rapidly accelerating domestic government and private sector debt.
And the sixth element is a combination of humility and agility in the face of uncertainty about how COVID-19 will reshape the world. In addition to how long the virus and its variants remain a global threat, Martin Wolf of the Financial Times has set out a daunting list of five known unknowns facing political, policy and business leaders in the coming years: acceleration of technology usage in everyday life and work; rising inequality and its economic and political impacts; huge increase in the indebtedness of governments, firms and households; deglobalization with pressures to near-shore and reshore global supply chains; and, political tensions, both attacks on liberal democracy in countries like the United States and others, and worsening geopolitics, particularly between the United States and China.
Canada and its governments have to have the policy capacity, resources and flexibility to respond pro-actively—not reactively—in this dynamic and uncertain environment.
Fundamentally, just as after the Second World War, strong growth will be key to tackling the pandemic debt legacy. Governments cannot solve all problems, but they can help create the conditions to make the private sector more successful. We are at one of those pivotal moments, and this is a pivotal budget. It’s an opportunity to begin rebuilding the Canada brand as an attractive location for investment and doing business. It’s an opportunity to begin the pivot towards strong, sustained, long-term economic growth. It’s an opportunity for government policy to be the recovery’s resilient disruptor, rather than perpetually pandemic-disrupted.
The key is political will and public support – putting short term politics and pain aside for long-term public gain. As Winston Churchill once noted, “It’s not enough that we do our best; sometimes we have to do what’s required.”
Governments in the 1980s, 1990s, and 2000s made tough fiscal and policy choices in very challenging circumstances. Let’s hope Prime Minister Trudeau and Chrystia Freeland follow this approach of sustainable fiscal management and avoid short-termism that passes the buck— and the risks of a massive debt hangover with sharply lessened resiliency—to the next generation.
Temporary support programs have to be just that, temporary— Canada’s fiscal credibility and sustainability depend on it.