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The Progressive Economics Forum

Fiscal “Crisis” In Context: Two Indicators

With all the predictions of doom and gloom coming from the austerity camp, one would think that Canada was already about to hit the famed (but never seen) “debt wall.”  Before we get too carried away, however, with the scary debt stuff, consider these two indicators of the fundamental fiscal fragility/stability of Canadian governments.

The first figure shows the net financial debt of the federal and provincial levels of government, measured as a share of GDP.  This is total outstanding net financial liabilities.  Federal net debt reached almost 70% of GDP in the mid-1990s, fell back steeply to below 30% by 2008, and since has bounced (modestly) to 34% as a result of the fiscal consequences of the meltdown and recession.  It’s interesting to note that the federal debt burden has already levelled off (meaning that nominal net debt has been growing no faster than nominal GDP).  You don’t need to strictly balance the budget in order to stabilize the debt burden (measured, appropriately, as a share of GDP).  At the current level of indebtedness, so long as Ottawa’s annual deficit is less than about $20 billion the debt burden will still decline (since nominal GDP grows fast enough to absorb that new debt, in absolute terms, within a falling debt ratio).  Future deficits would be smaller than that even without the Harper government’s cutbacks; moving forward, the federal debt burden will now start to fall significantly, long before the budget is balanced.

Of course, Canada is unusual among countries in having significant amounts of sub-national debt, mostly with the provinces — whose fiscal situation has been undeniably worse than Ottawa’s.  The red section of the figure layers on provincial debt as a share of GDP.  The rise and fall of the larger federal debt burden still sets the overall shape of the figure.  Provincial debt rose to 27% of GDP by the mid 1990s, falling almost in half by 2007.  It has since bounced back to over 20% — and unlike the federal debt, still grew modestly last year as a share of GDP.  Nevertheless, even on a combined basis, federal and provincial net debt (now equal to 55% of GDP) is far lower than most other OECD countries, has increased by only 10 points of GDP since the financial crisis started, and is already leveling off.  Big cuts in public spending are not necessary in order to stabilize and gradually reduce public debt in Canada.

If anything, I suggest this figure overstates the true “debt” of government because some of those liabilities were issued to pay for real (non-financial) assets which have enduring (and in many cases tradeable) value.  If government capital spending were accounted for on an accrual basis (as makes sense, since this is how companies treat long-lived capital assets), then the true increase in the net debt burden since the recession would be even smaller.

An even more interesting indicator is provided in the next figure, which shows total public debt servicing charges (again as a share of GDP) for both the federal and provincial governments.  This is from CANSIM Table 380-0022; I think (but am not 100% sure) that it is a gross number: that table does not separately report interest income for governments, but it does report a broader category called investment income … so it is likely that the data in this figure overstates the problem (by counting only interest expense, and not adjusting for interest income on the governments’ own financial assets).

According to this figure, not only has government debt service expense declined dramatically as a share of GDP since the bad old 1990s (when it peaked at close to 10% of GDP).  Moreover, debt service has continued to decline despite the (modest) rebound in debt resulting from the recession.  Debt service costs for all levels of government fell below 4% of GDP since the recession.  How could debt service costs decline, even while the debt burden (modestly) grew?  Because average interest costs have declined.  Like home-owners, governments have been able to refinance their debt to take advantage of today’s ultra-low rates.  (Remember, even fiscally pressed provinces like Ontario can still borrow money today for 10 years at real interest rates not much above zero.)  As older bonds come due and are refinanced, governments reduce their interest costs dramatically.  Those savings have more than offset the incremental debt service costs associated wtih additional debt.  So the claim that rising debt service costs are squeezing out more useful forms of public expenditure (not that conservatives support those programs, either) is empirically false.

Running up public debt for the sake of running up debt makes no sense.   There are costs associated with debt, and limits to how much debt can rise.  But there are benefits associated with debt-financed spending, too.  That includes the productivity of long-lived public capital assets that can be financed with debt (just like companies or households prudently finance long-lived assets, from factory equipment to homes, with debt).  In a demand-constrained macroeconomic context, another benefit of debt-financed spending is the positive spillover effect on overall employment and income that results from that spending (even when it’s on current services rather than public capital).  Based on the preceding graphs, Canadian governments are far from any meaningful constraint on their ability to borrow.  Hence, we should make a rational decision as a country regarding how much new debt is optimal, rather than being dominated by an initial quasi-religious assumption that “all debt is bad.”

In short, choosing today to slash spending on useful public programs very much reflects a political choice, not a fiscal necessity.  In the long run, we can and should pay for the public services we need by putting Canadians back to work.  In the meantime, there is clearly ample capacity for governments to continue to carry the cost of these programs.  Since governments can borrow at near-zero real interest rates, even as companies and households are beginning to deleverage, it is counter-productive to impose austerity in the public sector on top of the other painful economic challenges we are facing.

Comments

Comment from Richard
Time: July 12, 2012, 6:04 pm

My response: http://canadiantrends.blogspot.ca/2012/07/re-fiscal-crisis-in-context-two.html

Comment from duncan cameron
Time: July 13, 2012, 2:54 am

These figures show that Canada has room to make new productive public investments to reduce unemployment, and inequalities, and create needed public services at the same time. This should be the focus of economic policy debate. Which areas should be the priority for public investment? A national transportation company producing equipment for light urban transit is one project worth exploring.

Comment from Thomas Bergbusch
Time: July 13, 2012, 7:32 am

What “limits are there to how much public debt can rise”? I can see how this might make sense at the provincial level, but how can Canada face solvency problems when it is a currency issuer?

Comment from Barry Cameron
Time: July 13, 2012, 8:58 am

Jim, what if Canadian GDP, nominal or otherwise, continues to decrease – something I expect to happen since we appear to be in a aggregate no growth global economy for who knows how long. Won’t the ratio of debt to GDP change and with it both the net and absolute amount of debt to be serviced?

Comment from Roy McPhail
Time: July 13, 2012, 10:17 am

As per our recent guest, Steve Keen, an analysis of Canada’s situation that ignores the run up of private sector debt, with house mortgage debt at all time highs, misses the trigger for our Minsky Moment.

Comment from Larry Kazdan
Time: July 16, 2012, 6:16 pm

Further to the comment by Thomas Bergbusch, here are two unpublished letters.

Re: The debate over the state is getting stale, Jeffrey Simpson, Jun. 29 2012,
http://www.theglobeandmail.com/commentary/the-debate-over-the-state-is-getting-stale/article4377628/?cmpid=rss1

Today, no one can present the Canadian government with a dollar bill and demand a fixed amount of gold or foreign exchange. As a consequence, there is no operational restraint on our government which has the power to issue Canadian currency at will. There are of course real limits to the productive capacity of the economy, so government must spend wisely. But to answer Jeffrey Simpson’s question about the deficit, it need not be paid down because the federal government can never run out of its own money and can never be forced into bankruptcy. To serve the public purpose, government should spend on targeted employment an amount sufficient to assure that anyone who wants a job can get one, which also has the effect of stimulating the private sector. With no idle resources in the economy, the deficit will adjust to its proper level, and will not, as it does under austerity, keep rising because of plummeting tax revenues and soaring welfare costs.

Larry Kazdan

Footnote:

Bill MItchell:
Even the most simple facts contradict the neo-liberal arguments
http://bilbo.economicoutlook.net/blog/?p=11345

Re: The NDP’s new attack ad on Harper distorts and offends — but it might just work, Marni Soupcoff, Jul 11, 2012
http://fullcomment.nationalpost.com/2012/07/11/marni-soupcoff-the-ndps-new-attack-ad-on-harper-distorts-and-offends-but-it-might-just-work/

When NDPers accuse Harper of creating “the worst deficit in Canadian history”, they straightjacket themselves with neo-liberal ideology that will inevitably lead to the same service cutbacks and austerity proposed by Conservatives. Canada’s problem is not one of financial ratios but of inadequate demand in the economy that inhibits private sector expansion. Government must fund jobs and infrastructure programs that put people back to work. At the end of WWII Canada’s debt was over 130% of GDP, but golden years of prosperity followed, and the deficit gradually receded. Take care of employment, and the deficit will take care of itself.

Larry Kazdan,

Footnotes:
Revisiting Deficit Hysteria
http://www.google.ca/url?sa=t&rct=j&q=&esrc=s&source=web&cd=10&sqi=2&ved=0CG0QFjAJ&url=http%3A%2F%2Fwww.historycooperative.org%2Fjournals%2Fllt%2F54%2Fchorney.html&ei=ByD-T-zMKMOVrAGzmNCLCQ&usg=AFQjCNERya6OSuKAK5Te9w1jQ6itMu7tpw&sig2=4TTk6V5jCdm_EGsHtgoc5w
H. Chorney

Furthermore, deficits during World War II reached over 20 per cent of GDP and the level of debt to GDP climbed to over 130 per cent in Canada and the United States and over 200 per cent in the United Kingdom without any harm being done to these economies.

Neo-liberals on bikes …
http://bilbo.economicoutlook.net/blog/?p=20176
Bill Mitchell

Comment from Brian Dell
Time: July 18, 2012, 3:32 am

The absence of constraints on the ability of Canadian governments to borrow isn’t necessarily a green light because bondholders can still be confident they will be repaid while at the same time the general public should be concerned about whether additional borrowing would create additional debt servicing costs that could squeeze out social spending in the future. States south of the border are facing serious problems (see http://www.statebudgetcrisis.org) yet bondholders know that they are priority creditors as a matter of law and accordingly you don’t see the “bond vigilantes” active.

Comment from William Lidstone
Time: July 18, 2012, 7:48 am

If the debt is paying functionally zero the that capital isn’t functioning for its owners and ‘growing’ to produce more investment. Govts are shutting g down new capital formation to feed today’s needs. Has to have an effect somewhere down the road.

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