Economist Don Drummond’s report recommends that increases in Ontario’s public health care expenditures be scaled back (from 6.5 per cent a year to 2.5 per cent) for the next five years and, possibly, beyond.
What's the best way, in economic terms, to downsize government? In a major report in 2010 (sensitively titled "Will It Hurt?"), a team of International Monetary Fund economists recommended that governments cut the most politically sensitive things first – and then keep them cut.
More specifically, the economists recommended that governments primarily target pension entitlements and public health care services. It is only by cutting the most politically sensitive things, they said, that the public will find an austerity program credible enough to support.
Without saying so explicitly, the Drummond report on the downsizing of government in Ontario takes essentially the same approach. (The primary objective of the exercise, as economist Don Drummond expressed it, was "to get out of deficits and to stay out.") The report recommends that increases in Ontario's public health care expenditures, the most politically sensitive area, be scaled back (from 6.5 per cent a year to 2.5 per cent) for the next five years and, possibly, beyond.
Here is Ontario Premier Dalton McGuinty's sword-in-the-stone moment. If he fails this test, the entire enterprise – the enforcement of a more limited government – fails, too. It is a simple test of courage, the moral capacity to do what must be done. In short order, Ontario must get out of deficits. In 1990, Ontario's provincial debt equalled 14 per cent of provincial GDP. It now equals 35 per cent. Within five years, it will equal 50 per cent. It doesn't matter what noble things the government does with the loans it takes (doubling net debt to $440-billion in the process). Year by year, the province draws inexorably closer to bankruptcy (or to something that feels like bankruptcy).
The IMF report provides a guide to austerity programs. It concedes that spending cuts will probably hurt, though not nearly as much as many people think. It cites a number of macroeconomic studies that suggest "fiscal contractions" – austerity programs – can actually stimulate growth when they rely primarily on spending cuts (as opposed to raising taxes).
In its study, the IMF drew on austerity programs in 15 advanced economies (Canada among them) with a combined incidence of 170 "fiscal contractions" in the past 30 years. The frequency of austerity programs in the richest economies tells you something you already know – that governments often embark on restraint and then, as the crisis of the moment appears to ease, abandon them. Governments, in other words, have a boom-and-bust business cycle of their own.
The IMF report concludes that a typical austerity program (1 per cent of GDP), combining spending cuts and tax increases, reduces a country's GDP by 0.5 per cent within two years. It increases the unemployment rate by 0.3 percentage points. So a typical austerity program does hurt – in the short term, at least.
Yet the IMF report concludes that countries can lessen the hurt, and perhaps eliminate it, by relying exclusively on spending cuts. It says an austerity program that uses tax increases alone to balance the budget will produce an economic contraction equal to 1.3 per cent of GDP in two years; the unemployment rate will rise by 0.6 percentage points.
On the other hand, an austerity program that uses spending cuts alone will produce an economic contraction of only 0.3 per cent – a number the IMF economists identify as statistically insignificant; the unemployment rate will rise by only 0.2 percentage points.
Further still are the beneficial consequences of what might be called a credible austerity program, of which the Drummond report is a good example. Spending-based adjustments have benign effects, the IMF report said, if they involve cuts to pensions and health care services. These cuts can be deemed not only benign but, perhaps, expansionary: These are cuts that can pay for themselves. The IMF report identifies two countries, Denmark and Ireland, that have experienced "expansionary contractions."
These are useful tips for Ontario, and for all the provincial governments. Cut pension entitlements. Limit public health care expenditures. Don't raise taxes. Do these things and you can generate extra economic growth even amid austerity. It will take time – perhaps the seven hard years of Joseph's austerity in biblical Egypt. But will it hurt? Not much.