Don’t Blame Auto Bailout for $50 b Deficit

In all the kerfuffle around Finance Minister Flaherty’s $50 billion deficit projection, the cost of the joint federal-Ontario support for the restructuring of GM and Chrysler has been getting a lot of attention.

But while that restructuring support is an important and expensive undertaking, there’s no way it should be fingered as the major cause (or even a leading cause) of Ottawa’s quick slide into the red.

First, the financial support that will be given to the two companies is being delivered (the two governments announced earlier this spring) in the form of commercial loans from a federally-owned bank: the Export Development Corporation (EDC).

It’s a loan, not a bailout.  And like the $200 billion in loans and asset swaps which the Bank of Canada delivered to Canadian banks in recent months, it should not show up on the federal books as a direct “expenditure.”

When EDC loans money to auto companies, it does exactly the same thing that private banks do when they loan money to their customers: it creates new credit.  That’s not an “expense”, or a “deficit.”  It’s an investment.

Now, fair enough, the EDC had to have its mandate expanded in order to do this (and EDC is now expanding further into other lines of lending associated with other troubled industries in Canada, ranging from auto parts producers to airlines, as part of its public policy mission to address the consequences of the freezing up of private credit).

A federal government contribution to enlarging the capital base of EDC, to allow it to undertake these broader and riskier loans, would show up somewhere on the federal books — more likely as an investment, than an expense.  (And, of course, this investment in EDC would have implications for cash flow and financing — just as the emergency financing facility for private banks did — but that’s an entirely different matter than the deficit.)

Another way the auto restructuring could show up on the federal books would be if the government decided to book a “loan loss provision” of some size, on the expectation that not all of those loans to GM and Chrysler would be repaid (creating a loss for EDC, and hence a loss for the owner of EDC — namely, the federal government).  That is a matter of acounting and business judgment.  They’re certainly not going to book the whole thing as an expected loan loss today (although some of the plan’s critics, of course, no doubt think they should!).

Some of the restructuring finance may flow in the form of equity investments in the companies, rather than loans.  This, too, should be treated as an investment, not an expenditure.  Again, judgments regarding the prospects of receiving a return on that investment can be made — but it’s clearly not reasonable to assume immediately that the value of the investment is zero.

What is clear is that the financial assistance being delivered to the companies is not a “handout from taxpayers,” it is (mostly) a loan from a federally-owned bank.  To claim (as both critics and defenders of the government have done) that these loans explain most or much of the fast deterioration in the overall federal deficit is factually wrong.

There’s a second, more compelling reason why the deficit has little to do with the auto restructuring.  The reason the federal government (despite the ideological predispositions of the Harper crew to staying away from this sort of thing) has decided to participate in the restructuring is because the fiscal cost of not keeping the auto industry going in Canada would be enormous — much worse than the cost (however it is accounted for on the books) of letting GM and Chrysler just collapse.  Prime Minister Harper said as much in Calgary the other day — and on this point he is correct.

A December study from the Centre for Spatial Economics (C4SE) in Milton, Ont., authored by Robin Somerville, estimated the broader economic and fiscal impacts of a collapse of the Detroit Three automakers in Canada.  He estimated two cases: a 100% elimination of the Detroit Three’s operations here, and a 50% reduction.  Together, GM and Chrysler account for about three-quarters of the Detroit Three’s assembly and employment here, so it’s reasonable to assume that what’s at stake with the restructuring effort is a scenario halfway between Somerville’s two cases.

The C4SE report estimated that a 100% elimination would produce an ANNUAL fiscal loss for Ottawa (counting all the direct and indirect effects) averaging $13.1 billion over the next five years, and an ANNUAL average loss over the same period for Queen’s Park of $4.0 billion.

In the more moderate 50% case, the estimated average ANNUAL fiscal loss for Ottawa was $7.4 billion, and $2.3 billion for Ontario.

By interpolation, then, we can assume on these numbers that the collapse of GM and Chrysler (three-quarters of the Detroit Three in Canada) would cost Ottawa about $10 billion per year for at least the next five years, and Queen’s Park about $3 billion per year for at least the next five years.

Far from costing taxpayers $10 billion (even if the financial assistance was treated as a direct government expenditure, which it is not), therefore, the restructuring effort will actually (assuming GM and Chrysler do continue producing here — which the governments are wisely requiring as a condition of the loans) reduce the cumulative federal deficit by tens of billions of dollars between now and 2014, below what it would have been otherwise.

I have the C4SE study in pdf form and would be happy to pass it along to anyone who wants to see it.  Just contact me at stanford@caw.ca.

5 comments

  • Hi Jim,

    Just a couple words.

    There is a large tendency for people to look at these short run restructuring costs and public loans as some kind of demonic hellion ravaging the economic landscape.

    I have never seen such anal behaviour in my economic life. An article today in the globe pegs each job saved in the auto sector at 1.4 million.

    What phracking joke. I can’t believe the short sighted media, feeding the taxpayers such swill.

    The benifuts that the auto sector has built up within our country over the past many years have brought forth extreme amounts of wealth, and established for the first time a legitimate industrial strategy within the havens of resource dependent economic singularity that was once our economy. Diversity is the key that the auto sector brought.

    I find it quite odd that somebody such as yourself has to reach far into the economic chest to even compare what the country would be like with out an auto sector. We have actually become that moronic within our complicated economic decision making. How can we even fathom our economy without an auto sector.

    No modern economy can actually stand on its feet without an auto sector, and for those people quantifying these fictions in such a manner, attempting to raise the specter of banishing the auto sector should be declared enemies of the nation. They are creating a very dangerous ground swell.

    There is quite bright future for the auto sector. We need leadership to get us there, and I feel the CAW and the UAW have made the best of the situation.

    the whole concept of a car is being rethought, and who better to do that then the biggest in the world. Wealth will need to be poured into new wealth generating assets. We need the leaders of these big three to forge a new way through.

    We need the big three to deliver, but they have to be here before they can do that.

    Yes they are too big to fail, and it is not just the jobs direct and indirect that are important here, it is the future of the economy. No study can fully quantify just how much wealth is driven by building autos in ones economy and the future economy will always be about transportation. So even listening to these nay sayers is about as pathetically mind numbingly a task as I can think of. I guess it sells papers.

    Sad really that somebody like yourself has to spend time defending against such ideas, a dreadful waste of time.

    Sure I am not a big fan of saving capitalism for the capitalists, as that is precisely what we are doing at this point in history, with the auto sector but it has got to be done. Amazing how nervous the capitalists become when the government starts getting involved.

    The discourse is invented on the spot and then screamed. The one I like right now, being touted by the business press, it is fine for Obama to help the auto sector, but what exactly is his exit strategy? I thought that was a military term? They don;t even want for a moment to discuss the prospects of public ownership. The discourse has slithered around that concept like a nasty old python and choked the publics throats for those words.

    Nasty stuff, give a man a media spotlight and it is so amazing to witness the ideology in action.

    hang in there Jimbo.

  • “They’re certainly not going to book the whole thing as an expected loan loss today.”

    Apparently, that is exactly what they did.

    Maybe the question is why to they want to deficit appear higher then it needs to be? It could be because they want to take credit for a dramatic drop in the deficit next year, but there is a good chance they won’t be in office then. Maybe just to discourage called for more stimulus.

  • Well the CBC is reporting today that, according to the federal govt, the bailout “will account for the greatest part of the increase in the federal deficit.” And Dwight Duncan said today that the Ontario deficit will hit $18.5-billion with the GM bailout blamed for jump of $4-billion. So clearly either the politicians are backstabbing you in the PR war or your argument is dubious, Jim.

  • On a more general note, I find it astounding that anyone can call him or herself an economist and defend monopolies, which clearly include labour supply monopolies that oppose competition. How can that possibly be efficient? If efficiency just doesn’t matter, fine, but call yourself an activist, not an economist.

  • Kelsey Kirkland

    @Brian Dell, The Free market espousing financial institutions employed economists ask for State intervention in the form of Bankruptcy protection and bailouts to save them from self-created crisis because they wanted hands off from any regulatory oversight by the State. These “Intellectually Dishonest” economists did not protect their investors or clients or warn them of looming crisis until it rolled down like an avalanche. Either that or they were simply Inefficient despite the unrestricted free nature of the capital markets.

    I am astounded that people look for the textbook definitions and disregard the reality that is happening around them.

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