Big government is back in Canada, but for how long?

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Since the coronavirus pandemic forced us to throw out all previous notions about the size of government, federal spending has grown by almost half – with no end in sight to this crisis.

Ottawa had been on target to spend about $375-billion in the 2020-21 fiscal year, according to Finance Minister Bill Morneau’s December fiscal update. Since mid-March, however, the federal government has rolled out about $150-billion worth of direct spending measures to help individuals and businesses affected by the economic shutdowns. Ottawa has also deferred about $85-billion in taxes, a large portion of which will never be collected.

It is quite possible that many temporary measures, such as the $2,000-a-month Canada Emergency Response Benefit (CERB), may need to be extended for months beyond their initial timelines. Federal cash transfers to the provinces, to deal with surging health care expenditures, may also need to be increased. The costs of bailouts for specific companies and industries will explode, as well.

All told, it would not be surprising to see federal spending nearly double this year. At the same time, the size of the Canadian economy is on track to shrink dramatically, with gross domestic product plummeting by more than 40 per cent on an annualized basis in the second quarter, according to TD Economics. And hopes of a V-shaped recovery are receding by the hour.

You know things are bad when the Bank of Canada has no idea what is next. Its latest Monetary Policy Report, released last week, did not even include a base-case forecast for GDP for 2020, given the unprecedented level of global economic uncertainty. Canada’s economy is experiencing a double-barrelled shock. The COVID-19-related shutdowns have been accompanied by a collapse in the price of oil, the country’s leading export commodity.

Public spending as a percentage of GDP is, hence, set to surge to levels unseen in decades, well beyond those which occurred during and immediately after the 2009 recession.

Federal program spending had been projected to remain flat at 14.8 per cent of GDP in 2020-21, according to the government’s December update, with the federal net-debt-to-GDP ratio holding steady at 31 per cent. Instead, federal spending will easily surpass the 17.6 per cent of GDP level it hit during the previous recession; it is even likely to fly past the postwar peak of 25 per cent reached in 1982-83.

Combined federal, provincial and municipal government spending – which stood at about 40 per cent of gross domestic product before the crisis – will account for more than half of GDP in 2020-21. And it could take several years before the private sector is in a position to resume its traditional role in fostering wealth creation and economic growth.

For the foreseeable future, then, Canada’s economy will be a state-led one. The income support measures that Ottawa has introduced on a temporary basis could end up becoming more or less permanent. Proponents of a basic income guarantee are touting the CERB as the basis for such a program that, on its own, would account for a big expansion in the size of government.

Meanwhile, a federal bailout of Air Canada could lead to a partial re-nationalization of the country’s flag carrier. Ottawa, which already owns a major oil pipeline, could also end up owning chunks of the country’s energy sector as private investors abandon the oil sands and offshore oil industry. Industrial policies abandoned during the 1980s-era of deregulation could make a comeback.

Or not. Just how much Canadian governments can spend will be dictated by bond markets. Ottawa’s triple-A credit rating is not expected to survive this crisis. For now, financial markets have taken a benign view of measures taken by the Bank of Canada to buy federal and provincial debt. But that may not last as the size of the central bank’s balance sheet balloons in coming months.

The federal debt-to-GDP ratio stood at almost 110 per cent of GDP coming out of the Second World War. But three decades of heady economic growth – driven, in part, by a young and fast-growing population – helped shrink the ratio to barely 20 per cent of GDP in 1973, according to a 2017 Fraser Institute study by economics professor Livio Di Matteo of Lakehead University.

The federal debt rose rapidly after that to 67 per cent of GDP in 1995. Financial markets decided that was enough, forcing Ottawa to execute a 180-degree turn in federal spending.

Now, combined federal and provincial debt levels are set to exceed the 90-per-cent threshold. The idea that Canada will be able to “grow” its way out of all this new debt may be wishful thinking. The demographics that made the postwar debt manageable are no more. Potential economic growth rates have declined sharply.

This new era of big government won’t be anything like the last one.

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