The Liberals’ approach to reducing the debt burden from the pandemic has been a go-very-slow approach that counts on economic growth outstripping interest rates over a long stretch of decades, and allows for permanent sizable budget deficits.
That philosophy was on exhibit in this week’s fall economic statement, where the Liberals – handed a fiscal cushion of $126.9-billion from higher revenue and lower program expenses – chose to spend the majority rather than to pare back deficits aggressively. The key measurement of Canada’s debt burden, the ratio of net debt to gross domestic product, is now projected to fall slightly faster compared with the forecasts in the spring budget. But only slightly.
As shown in the chart below, the government is forecasting a steady if unhurried drop in the debt-to-GDP ratio into the latter half of this decade, a projection that would still leave the debt burden nearly 13 percentage points higher than previous to the pandemic.
According to forecasts in the spring budget, it would not be until at least the middle of the century that the debt burden would be pared back to its prepandemic levels. As the second chart shows, without steps to galvanize economic growth, debt levels would still be elevated by 2056. But with spending on child care and other initiatives, according to the Liberals, growth will accelerate, with the relative size of the debt declining more quickly. All that, without the need for spending cuts or tax hikes.
A caveat: The spring projections don’t take into account the improved revenue outlook unveiled this week. But they also don’t include new spending since then, nor the additional tens of billions of dollars that the Liberals pledged during the recent election campaign.
Even the relatively slow shrinking of the debt forecast in the budget depends on a host of favourable assumptions: no new cataclysms, lower interest rates, slower growth in program spending than has been the Liberals’ habit, and a sharp uptick in annual productivity growth that would boost economic growth.
Much of the criticism over the Liberals’ approach, particularly from the opposition Conservatives, has centred over the risk of interest rates rising and driving up debt servicing costs.
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But a recent report from the Organization for Economic Co-operation and Development undercuts the other side of the equation as well. It forecasts sluggish productivity growth over the next four decades, at just more than half the level implicit in Ottawa’s projections of a genteel and painless decline in the federal debt burden.
Economist Don Drummond, a former senior Finance Department official, has pointed out that Finance made overly optimistic assumptions on long-term productivity growth that were inconsistent with Canada’s recent economic performance to arrive at its forecasts.
Canada will be the worst performer among the 38 member countries of the OECD this decade, with average growth in real GDP of just 0.7 per cent, said David Williams, vice-president of policy at the Business Council of British Columbia. What’s worse, the OECD also predicts Canada will be at the bottom of the OECD pack between 2030 and 2060, with average growth in real GDP only slightly better at 0.8 per cent.
It’s a bleak picture, made worse by forecasts of a declining amount of capital stock for every worker. Dr. Williams says statistics indicate a serious problem with the investment climate in Canada. Even that forecast doesn’t capture its full extent, since the heavy investment in and high productivity of the non-conventional oil and gas sector skews any assessment of Canada’s economic performance.
The unconventional oil and gas sector, for instance, adds $1,300 to Canada’s GDP for every hour worked, he says. The natural resources sector as a whole adds far less, $350 in GDP for each hour worked. In turn, that’s far higher than for the entire economy, where an hour of work increases GDP by $54.
The lopsided contribution of oil and gas has been a huge driver of Canada’s prosperity, Dr. Williams says. “They’re the sectors that pay Canada’s bills.”
But will that continue to be the case, as Ottawa moves to constrain the sector’s growth, and cap carbon emissions? Dr. Williams has his doubts about whether green jobs will come close to matching the productivity of the fossil-fuel sector of the Canadian economy. Finance Minister Chrystia Freeland has brandished the government’s increased funding of affordable child care as a game-changer, comparing its potential effect to that of the North American free-trade agreement a generation ago.
Dr. Williams disagrees, saying, “It’s a rounding error as an economic growth strategy.”
University of Calgary economist Trevor Tombe has a less pessimistic view of the trajectory of the federal government’s debt burden, saying Ottawa can return to a prepandemic debt-to-GDP level by 2034 if it slows spending increases to only keep pace with inflation and population growth. Still, Prof. Tombe says, a more aggressive reduction would be preferable in order to increase the ability of the federal government to absorb future economic shocks.
Mr. Drummond sees the same perils as Dr. Williams in productivity trends, saying he is worried Canada is set to repeat the same grievous error that resulted in growing structural deficits in the 1970s through to the 1990s. Then, a combination of external economic shocks and other factors reduced the healthy economic growth rates that Canada and other Western countries had enjoyed in the period after the Second World War.
Policy makers kept assuming that the deceleration in growth was, to borrow a phrase, transitory. It was not.
Not until the 1990s, when the Liberal government aggressively cut spending, did Ottawa come to terms with that economic reality. History may be repeating itself, Mr. Drummond says. “I fear we’re permanently shifting down to yet another lower growth rate, and it’s not being recognized.”
Adding to that burden are the costs of mitigating climate change, and hardening infrastructure against extreme weather, he said. The federal government should be explicit in discussing those future costs, and how they should be paid for, including through tax hikes, Mr. Drummond said. “I think we have to be open that this could be a rough ride.”
Tax and Spend examines the intricacies and oddities of taxation and government spending.
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Patrick Brethour