The federal government’s return to surplus is good news. The outlook for Canada’s economy, and Canadians’ confidence in the future, will be better if it stays there.
The federal government announced last week that it has balanced its budget ahead of schedule. After a deficit of $5.2 billion in fiscal year 2013-14, Ottawa posted a surplus of $1.9-billion in 2014-15.
Good news? Not everyone thinks so. Balancing the federal books has hurt Canada’s economy, said some critics. We even heard calls for a return to deficits.
If asked, some of those critics might acknowledge that deficits are dangerous. Committing to cover all spending with taxes sets a higher bar. Want another dollar in programs? Okay, justify taxing another dollar. Want tax relief? Great, just show the offset. Borrowing lowers that bar – one reason why deficits easily become chronic.
But, those critics would say, we’re not advocating chronic deficits. It’s about “fiscal drag.” The Canadian economy had a pretty flat first half. Maybe if the feds had taxed less, and spent more, things would have been perkier.
We can’t replay history to see if that’s right. But we can imagine what would happen if, in a quest for fiscal stimulus, Ottawa were to reverse course, recording this one surplus, then plunging back into deficit.
Let’s start with some straightforward arithmetic. When people talk about the impact of fiscal policy on the economy, they usually have in mind its effect on total spending – GDP, expressed as the sum of consumption and investment, plus exports, minus imports. These days, that’s about $2 trillion a year.
Suppose the federal government were to undo the progress of the last fiscal year, switching from a $1.9 billion surplus back to the $5.2 billion deficit recorded the previous year. That’s a $7.1-billion swing. $7.1 billion is a little short of 0.4 percent of $2 trillion. What impact might that almost-0.4 percent swing have on the economy?
It partly depends on how the feds go about it. They could aim at a quick boost to private consumption, cutting personal taxes or boosting transfers to individuals. But people would not spend all their new disposable income at once. And some of what they did spend would be on imports. So it’s quick, but “leaky.” Which is why many stimulus advocates prefer governments to spend the money directly.
So let’s look at government consumption. The federal government alone spends some $60 billion on consumption annually. They could consume more: hire more bureaucrats, make them buy more Canadian paper, and burn more Canadian fuel to make their buildings warmer. But only hard-core deficit advocates push for consumption that’s effectively waste.
Let’s turn from consumption to investment, then. Stimulus advocates regularly urge governments to spend on infrastructure. But for Ottawa, the math is awkward. Federal capital investment of all kinds currently runs around $8-9 billion a year. Another $7-billion in a year means almost doubling it. That’s impossible. Even trying would guarantee waste – and worse. Anything realistic would phase in the increase over a number of years. So that’s a fiscal boost of, at most, 0.4 percent of GDP, minus some imports (even governments can’t buy everything domestically), several years from now. No jolt for a listless economy there.
Perhaps, rather than invest directly, Ottawa could subsidize investment by provinces and cities. Provincial and local capital outlays now run around $70 billion a year, so the increase would be a less preposterous 10 per cent. But that would still take time, even if the money were transferred instantly, which it wouldn’t be. So we’re still talking about less than 0.4 percent of GDP (again, minus imports) over several years. Not the stimulus advocates imagine.
So much for consumption and investment. That leaves the trade balance: exports minus imports. Could the government engineer an increase there?
Exports are no help. Yes, Ottawa could subsidize them (and irk our trading partners). But that just substitutes government spending for what foreign importers would otherwise have paid. No boost to GDP from that.
And as noted already, imports, however vital to our wellbeing, don’t help the math: they subtract from GDP. Since part of any increase in spending, whether consumed or invested, by households or governments, inevitably goes to imports, they make the 0.4 percent skinnier yet.
One lesson from the simple math, then, is that we can only get near that hoped-for quick 0.4 percent-of-GDP stimulus if the government spends it all, and largely wastefully, and if it is domestically produced goods and services that are being wasted.
The simple math, moreover, misses things. Thinking further about exports and imports, for example, it matters that going into deficit means issuing more federal debt. Unless Canadians suddenly raise their saving enough to buy all of it — which would erase any intended stimulus — foreigners will have to buy some. For that, they will need more Canadian dollars. The increased demand for Canadian dollars will push up the exchange rate. Result: fewer exports and more imports — shrinking that hoped-for 0.4 percent yet further.
At this point, stimulus advocates will object that the simple math misses positive things as well. What about the spin-off effects? Wouldn’t new government spending inspire greater consumer and business confidence, in turn triggering more private spending? What about the famous multiplier?
True, the economy is more complex than the simple math. Those things might happen. So might other things that are less helpful to confidence and spending.
If Ottawa reverses course and starts borrowing again, some people will worry. They will fear the long-term consequences for interest payments and taxes. A minority, but an influential minority, know that federal financial reports paint too rosy a picture – understating the cost of federal employee pensions, for example – and will lament missing a key opportunity to fix things. Others know that provincial governments are collectively deep in the red, and seemingly stuck there. For them, a return to federal deficits would materially darken the national outlook.
Could the confidence-sapping impact of a new federal deficit hurt private consumption and investment enough to push whatever is left of that 0.4 percent of GDP down to zero, or even below it? Perhaps. Because, to go back to where we started, many people know what too many critics of the federal surplus neglect: That deficits relieve supporters of looser fiscal policy of the obligation to cover their commitments. Which undermines fiscal discipline. Which time after time, in place after place, has turned temporary deficits into chronic ones.
So the federal government’s return to surplus is good news. The outlook for Canada’s economy, and Canadians’ confidence in the future, will be better if it stays there.
William Robson is president and CEO of the C. D. Howe Institute.
Published in the National Post on September 22, 2015