Deficit and Debt Phobia

We seem set to go into the next election – which could be in a matter of  days -  with both the Conservatives and Liberals firmly committed to bringing the federal Budget back into balance in a relatively short time frame, with no tax increases.  There appears to be no sign of a break in the conventional wisdom that “exit strategies” from  temporary fiscal stimulus should be pursued as a matter of urgency, and I fear that the NDP may well be pushed in the same direction.

That would leave us with remarkably little to talk about over the course of a campaign.  If we are not prepared to countenance some combination of deficits and tax increases, then there can be no significant increase in public investments in services, social programs or in green infrastructure and jobs.  To the contrary, the only  thing left to have an honest debate about would be where to cut spending (which won’t stop politicians invoking a fantasy world in which we return to strong growth while balancing budgets.)

Widespread Canadian debt phobia has its origins in the fiscal debates of the late 1980s and early 1990s when government debt and interest payments on the debt grew rapidly as a share of GDP. The majority of Canadians were convinced that we were about to hit a “debt wall”, and the Chretien – Martin governments slashed program spending to the bone to bring the federal Budget back into balance and then into surplus.  For all of the Liberal claims to be a centrist or even progressive party, the reality is that they cut social programs and public services much more savagely than did the government of any other OECD country. Few have dared question the wisdom of balanced budgets since that time, and the current deficit has been reluctantly accepted only as an emergency measure.

What some understood in the late 1980s and early 1990s was that the growth of government debt was driven primarily by very high real interest rates.   The dynamics of  debt growth are driven most centrally by the relationship between interest rates and the economic growth rate. If high interest rates depress growth and add hugely to debt servicing costs, then the debt burden will soar… and that is precisely what happened.  The Bank of Canada and its relentless pursuit of price stability via very high interest rates in the midst of a recession was the cause of the fiscal crisis, not government program spending.   (See the book edited by Lars Osberg and Pierre Fortin, Unnecessary Debts, published by Lorimer in 1996 for a detailed analysis.)

Today, the basic elements of our fiscal situation are vastly different. The net financial liabilities of all levels of government combined in Canada are projected to be just 27% of GDP this year, compared to an OECD average of 51%. Our net debt is down hugely from the peak of  71% in 1995.  (See OECD Economic Outlook Annex Table 3.) General government net debt servicing costs stand at an extraordinarily low and indeed almost trivial level of 0.2% of GDP, compare to an OECD average of 1.7%.  The fact of the matter is that we are in great fiscal shape, and can well afford to borrow more and invest much more now that times are tough and public investment is needed to sustain jobs and set the stage for a more productive future economy.

Quite unlike the late 1980s and early 1990s, the stage is set for interest rates to be lower than rates of economic growth for some time.  Long-term government bond rates are now in the range of 3-4%, or 1-2% in real terms.  Even if we get back to only modest nominal GDP growth rates of 4-5% and interest rates rise a little,  the gap between growth rates and interest rates means that we can run modest deficits without increasing the debt to GDP ratio at all.  Increasing that ratio for a few years is not a big deal, certainly so long as the investments funded by borrowing are intelligently invested so as to improve longer term productivity growth and sustainability. It should ot be a huge challenge to think of investments – from child care and early learning, to renewable energy development and infrastructure – which yield a return far in excess of the low costs of borrowing.

But if deficits are judged beyond the pale from the outset, we can’t even have that debate.

14 comments

  • I have really enjoyed CBC News Tonight (8pm on Newsworld) the few times that I have seen it. It consists of in-depth interviews on three or four top stories, rather than the usual TV news collage of ten-second clips on many stories.

    On last night’s National, the Liberal response to the fiscal update was ten seconds of bluster from John McCallum about how Jim Flaherty has no credibility left. But CBC News Tonight featured several minutes of Harry Forestell asking what the Liberals would do differently than the Conservatives to balance the budget and McCallum repeatedly being unable to answer.

    McCallum’s line was that the Liberals had balanced the budget before and should simply be trusted to do so again. He chastised the Conservatives for budgeting much higher EI premiums after 2010, and committed that Liberals would neither raise taxes nor cut transfer payments to provincial governments.

    But how did the Liberals balance the budget last time? They kept EI premiums far above EI benefits and slashed transfers to provincial governments. So, Forestell’s question stands: how would they balance the budget this time?

  • Love the blog, and use it often. Would love a share function to link quickly to facebook and twitter (unless I’m missing it?).

  • “certainly so long as the investments funded by borrowing are intelligently invested so as to improve longer term productivity growth and sustainability.”

    that’s key, as is the irritating fact that the increasing debt has resulted from a) giving more freebies to bankers, for their obscene private profits and further b) borrow from private sources and pay them interest instead of using the Bank of Canada (borrow from and pay OURSELVES back ).

    I hear what you’re saying, that the deficit/debt isn’t much in the context of low interest rates and the relationship with GDP. But honestly we’ve been hearing this line from progressive economists for a long time, with conservative economists/politicians saying the opposite, and it seems that unless we talk about the harder issues people are just going to be confused.

  • further to my last post,
    the entire global economy is structured on debt, leading to questions about;
    1) how useful is this fundamental structure? and,
    2) who gets access to debt, who dishes it out, at whose expense, and who decides what its used for?

    We have continued and expanding use of an undemocratically-regulated electronic casino, ballooning and leveraging unknown amounts of debt products, facilitated by politicians around the world like harperiggy, who mouth statements and continue with this game as usual.

    There is a fundamental contradiction in their claims to concern about debt and their failure to address this largest elephant in the room.

  • What a great post by Andrew Jackson. The NDP must stand up for deficit finance; that is all there is to it. And realistically they have nothing to lose by doing so in the next election.

    Basically, the NDP abandoned efforts to lead a more enlightened discourse over economic policy in this country a little more than a decade ago, with their concessions on two fronts:

    1) The party’s at first tacit (and under Jack Layton explicit) acceptance of neo-Liberal policies of sound finance and balanced budgets; and,

    2) Its willingness to tolerate decentralization (or the end of universality) in national social programs, especially where Quebec and Alberta are concerned.

    Now, the latter is an extension of the former, since the destruction of much of the country’s social infrastructure was effected in the name of getting out of the way of the provinces (who in fact just downloaded responsibilities onto communities, as Hugh Mackenzie and others have shown).

    One understands why the NDP chose this route — it was a gamble, but the thinking was that inroads could be made against the hegemony of neo-liberal politics only by building a coalition of progressive and some centrist forces, including appeals to Quebec sovereigntist forces. The NDP, smarting from the party’s poor showing in the 1990s, determined that it had to be more ruthless in its search for power. I think part of this came out of consultations lead at the turn of the century among party faithful rightfully fed up with the Svend-Robinsonization of the party. I mean by this the tendency of certain elements of the party to content themselves with remaining a pressure group in Parliament that sought to pressure governments of the day into more progressive policies, instead of organizing to take power. Riding associations wanted a winner, which is why Jack Layton was chosen.

    But to my mind, party leadership mistook what it meant to win. What they opted for as electoral strategy was a commitment to making short-term inroads among the electorate by having a charismatic leader from Ontario (Layton), dispensing with deficit finance, and cultivating support among Quebec separatists. This strategy has been successful to an extent but is self-defeating in the medium and long term, since:

    a) in cultivating links with Quebec nationalism and the separatists, it has undermined the trust that many traditional NDP supporters and the public at large had that the party actually wanted to act in the national interest (the December coalition, which I strongly supported, reinforced this impression because of the NDP’s preceding courtship of Quebec nationalists); and

    b) the NDP has become on economic policy essentially indistinguishable from the Liberals (no-one dares disturb the media consensus around neo-classical economic dogma, even though it is thoroughly discredited everywhere else in the world!).

    Almost despite myself, I have to admit that Layton, for all his mistakes on policy, has shown great dedication and self-discipline on behalf of his cause (e.g. getting rid of “smiling Jack” for the last election, tempering his attacks against Dion, or tempering his attacks against Martin over the effects of his cuts on the homeless, which took discipline even as it was wrongminded). He has done what he was asked to do: bring the guile and self-discipline of a professional politician to the NDP.

    In the coming election, however, the party MUST change course. As it did when facing Paul Martin, but could not do when faced with Stéphane Dion, NDPers must outflank the Ignatief Liberals by presenting themselves as the true defenders of pan-Canadian values and programs. To that end, the NDP should:

    1) Come out frankly in favour of deficit finance (and sell it by saying “just as taking out a mortgage on your house makes you wealthier over time, so does deficit spending on daycares and green infrastructure”);

    2) Talk about democratic equality and the values of sharing and social democracy, and public investment — as the most effective ways of supporting entrepreneurs and collective entrepreneurs (such as mutuals and cooperatives, and other employee-owned businesses);

    3) Speak of the necessity to reinforce the Canada Health Act, especially in Quebec (here all attacks should utterly ignore the Bloc as irrelevant and focus on the right-wing policies of the Party Québécois, such as the conditions gagnantes, the tolerance of health care privatization or Pauline Marois’s recent and ignorant comments that the PQ would have to “sanitize” provincial finances because of its stimulus spending). The point is to attack the separatist concensus that a weakened Ottawa means a strong Quebec — instead of waffling on hypocritically about creating an “ouverture” to Quebec, the NDP has to say that Quebeckers have been harmed by the reduced role of the federal government, whether it be in ending shared-cost programs, not standing up for public healthcare, abandoning supports for national labour markets and youth employment, or not ensuring that minimum environmental standards are followed in all provinces (which affects all Canadians).

    4) The NDP has an opportunity now to tell the public, frankly and openly, what they have not been willing to hear: that the austerity of the 1990s actually slowed down debt reduction and economic recovery, that Canadians’ sacrifices to defeat the Mulroney-Crow deficit were for nought and that everything had to be done to ensure that during the current recession and into the recovery there be no equivalent austerity program;

    5) On environmental matters, the NDP should focus less on arcane debates over whether a carbon tax or cap and trade is the better model than on the importance of direct public investment in green infrastructure. Not that market-based models are not useful environmental management tools, but rather that incentivizing behaviour at this stage is less important than a command and control approach to correcting GHG emissions at industrial sources. The argument has to be: this affects us all, so merely scapegoating Alberta and Saskatchewan is not the solution. Just as western Canadian oil revenues have often, via equalization, benefitted Canadians in other provinces, now is the time for all Canadians to band together collectively to share the costs of emissions reductions by the oil patch, for the benefit of us all. Then start talking in Keynesian terms about the need for war-type investment program (in green infrastructure) in peace time.

    6) Finally, in English-speaking areas, bring back the election ads from the late 1980s — the cartoons that accompanied the Tommy Douglas speach about the white cats (LIberals) and black cats (Conservatives) being essentially identical fat cats.

  • Thanks for this very important post.

    I’ll add that while the “EI” fund has been in surplus for well over a decade, income taxes have been falling and that has mainly benefited the wealthy.

    And they took their tax savings and “invested” it in garbage while working incomes were dedicated to reducing Gerald Bouey’s and John Crow’s debt.

    Now that this bullshit “investment” has fallen like a house of cards, governments are going into deficit to keep their economies afloat and raising EI premiums again!

    We should tax the wealthy who demonstrably have more money than they know what to do with.

  • The post and commentary are excellent – reminds me that Canada could be a different place…

    But back to the real world – where the people I know see no point in an election and are really angry about it. The NDP (and Greens) should and could stand up on this point alone. I know they would be accused of “populism” but who cares? They and we have nothing to loose and at this point and it might help to drive a wedge between the working class and the corporate media.

    If the NDP does not stand up for ordinary folks this time around I know a lot of people who simply won’t vote as a form of protest. But perhaps our political elite simply don’t care anymore….

  • “the austerity of the 1990s actually slowed down debt reduction”

    this needs elaboration. please explain the mechanism.

    the analogy provided of taking out another mortgage on the house ‘makes you wealthier’ doesn’t match up with the reality i’ve seen. people out here who are up to their eyeballs in debt often have to sell their houses when they lose their jobs or have other misfortunes, which seems more the rule than the exception these days. on the ground its the people who stay away from household debt who last the longest.

    maybe once the mechanism for the quote has been explained a better analogy will come to mind.

  • In response to Leigh Thomson:

    Obviously, in his follow-up post to the above entitled “Deficit and debt phobia: An addendum”, Andrew Jackson explains far better than I ever could the mechanics of debt and deficit reduction.

    But what I was referring to was my understanding that Gordon Thiessen’s anti-inflationary intervention in 1995 and Martin’s cuts in 1995 and 1996 combined to massively depress aggregate demand, driving the annual change in the CPI below one percent by 1998. As far as I have been able to tell, the resulting contribution of those cuts to deficit and debt reduction was highly questionable. Mr. Jackson indicated in his 1997 chapter “Employment Creation” in Alternative Federal Budget Papers, 1997 that:

    “Massive fiscal restraint – largely driven by direct federal spending cuts and cuts in federal transfers to the provinces, compounded by provincial cuts – reduced real economic growth by an average of 1.5% in each of 1995 and 1996 (according to Wood Gundy). Fiscal restraint already in the system will reduce real growth by 1% in 1997.”

    Given the huge braking effect on growth that the Liberals’ austerity measures imposed on the country, it appears an open question, even if one assumes that the cuts actually contributed to deficit reduction, whether the overall effect on debt reduction was positive. In addition, Pierre Fortin and Lars Osberg in 1998 calculated that the cuts were not necessary to reduce the debt ratio, provided real interest rates were allowed to decline to their historically normal levels. Jim Stanford similarly suggests that the Finance Minister’s original goal of balancing the budget by 1999-2000 could have been achieved without any program cuts whatsoever. In Alternative Federal Budget 2004 Technical Paper #1 he writes that, “under a counterfactual scenario which assumes the federal government only froze nominal program spending at its 1994 levels (rather than implementing the deep spending cuts that began with the 1995 budget)” and “average effective interest rates,” the federal government “would still have beaten its official deficit reduction timetable, and balanced the budget by fiscal 1999 with no cuts in nominal program spending, and no additional increases in aggregate taxation (other than those which were in fact imposed by the federal government).” The additional implication seems to be that, had just slightly lower interest rates been used than those used in the counterfactual example, the budget would have been balanced without spending cuts, which is what Mr. Jackson is arguing with regard to our deficit and debt, going forward no?

  • what you and Andrew and others are focussing on is one of the factors – spending on needed public services- which can influence debt.

    what you’re saying is that spending on public services can REDUCE debt, rather than increase debt, because the spending gives foundational supports and jobs to people, favourably impacting the GDP portion of the critical debt/GDP/interest rate relationship.

    and that this relationship can be further improved with low interest rates.

    Not only is there No Need for radical gov’t spending cuts (because the debt ratio will decrease with a healthy GDP even if interest rates are the same), but Government Spending Cuts Actually Increase Debt, because they negatively impact the GDP and people’s ability to survive.

    so, in the current context, focussing on the debt ratio provides a more accurate picture of how people are able to survive than debt absolute numbers, which are meaningless outside of context.

    its like a kid owing the piggy bank 5 cents when he or she gets 15 dollars for shovelling the neighbour’s drive.

  • “its like a kid owing the piggy bank 5 cents when he or she gets 15 dollars for shovelling the neighbour’s drive.”

    That is really good. But ideally, wouldn’t one would need an analogy that illustrates the dynamic impact of investment on the debt/GDP ratio?

    This doesn’t grap one’s attention as your example does, and is not very environmental, but maybe we need something like:

    A teenager borrows two bucks from his piggy bank to gas up a snowblower so he can clear several neighbours’ driveways at $15 a pop.

  • lemme think about it

  • to extend the analogy, that might be useful if;

    -the machine is made of recycled metals/parts manufactured by unionized workers,
    -the driveways are used for bikes, or to access public transit, or for low footprint cars,
    -first and foremost; the neighbours on the street have ensured that everyone has housing and other basic public services, and that their contributions aren’t getting siphoned off to any fossil fuel, nuke, river damming, and war bandits, but are fully providing clean public power for that machine and other needs,
    – there are enough jobs for other kids on the block, otherwise a lot them pushing shovels might be better employment and exercise..
    – the piggy bank is owned by the neighbourhood.

  • rentier fungicide

    Don’t look now, Layton has just been outflanked on the deficit question by, of all people, Michael Ignatieff. The NDP’S incompetence on this issue makes me want to tear my hair out.

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