Ranga Chand is president of Chand Carmichael & Company. He has held senior positions with the Department of Finance and the Conference Board of Canada
The financial crisis and the ensuing global recession have dealt a crippling blow to public sector finances in the G7 and from which all member countries have yet to recover. As GDP contracted and the unemployment rate surged, government revenues fell and spending jumped in all the major economies but with wide variations (see table below).
As a result of these sharp divergences in government revenues and expenditures, the fiscal deficit has risen in all the major economies. Before the onset of the global recession, only Canada and Germany were running surpluses but by 2009, all the G7 economies were in the red.
According to the International Monetary Fund's latest medium-term projections, over the 2010-2015 period, government revenues are projected to increase at a faster pace than the overall growth in the economy in all of the G7 countries. On the other hand, government spending is projected to grow at a considerably slower pace in all cases (see second chart below). This growing gap is expected to sharply reduce the budget deficits of the major economies. Still, by 2015, only the budgets in Canada and Germany are expected to be in balance. In the rest of the group the deficit, as a percentage of GDP, is projected to be 7.4 per cent in Japan, 5.5 per cent in the United States, 3.1 per cent in Italy, 2.3 per cent in the United Kingdom, and 2.2 per cent in France.
The question, of course, is how realistic are these projections?
The GDP forecasts undoubtedly are the wild card and here the IMF clearly has an optimistic outlook for annual growth in the G7. To put this in context, the IMF is projecting that the average annual growth over the 2010-2015 period will be higher in every single G7 economy compared to the rate of growth that these countries achieved in the 2000s. But, it's worth bearing in mind that the 2000s was a period where budget deficits and debt levels were far more benign than they are today.
The challenge facing the G7 will be in preventing deficits and public sector debt from growing to unsustainable levels. Inevitably, this will mean significantly raising revenues as a percentage of GDP while at the same time reducing spending levels sharply. The difficulty here is that while governments can control spending -- providing there is the political will which, based on past experience, is admittedly a stretch -- the intake of revenues very much depends on the state of the economy.
As fiscal policy tightens and austerity measures start to bite, the onus will be on monetary policy to keep growth going. But, with inflationary pressures mounting across the board in both developed and emerging economies, the era of ultra-low interest rates is drawing to a close. As rates start to move up this too will have a dampening effect on growth and put further pressure on government revenues.
The bottom line is that as governments embark on the long and difficult road to fiscal consolidation and households struggle to pay down debt, economic activity in the G7 countries is slated to remain well below their potential levels for a considerable period of time.