Recessions and recoveries

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In war font on many a business section, Mark Carney declared the recession over.

More accurately, the Governor of the Bank of Canada stated in the opening statement of a press conference that:

» "Global economic activity appears to be nearing its trough, and there are increasing signs that activity has begun to expand in many countries in response to monetary and fiscal policy stimulus and measures to stabilize the global financial system."

» "However, this recovery is nascent. To sustain global growth, effective and resolute policy implementation remains critical."

» "The Bank has long expected that economic growth in Canada would resume in the second half of this year and pick up in 2010. Indeed, growth in Canada should resume this quarter. The dynamics of the recovery projected in today's MPR are broadly consistent with the Bank's medium-term outlook in April."

That's great news.

If economic growth is indeed on the rebound, it is a good thing that will translate positively into people's lives.

However, that translation may take a loooooong time for people to feel and believe.

The leading indicators of a recovery are all on the uptick.

The conventional wisdom on recessions is that the financial markets are the first in, and the first out. They take a nasty hit early, recover and then grow, with the TSX losing close to half its value before recovering to above 75% of its earlier value over the last few months. These leading indicators are all picking up nicely, and for stockbrokers, retirees living on securitized investments and anyone with savings in the market, this is an immediate benefit.

But the political challenges of recessions tend not to be markets, but unemployment and revenue. And the problem is that both are trailing indicators.

The unemployment rate continues to move upwards, growing 0.2% in June to 8.6%. While there is some optimism to be taken from the fact that unemployment is growing at a slower rate than earlier in the year, that's a bit like celebrating that the water is coming into the hull of the ship a little slower. The ship is still sinking.

From a political perspective, unemployment - or more accurately, the perception of Canadians toward the employment situation - is a major factor driving voting behaviour in Canada.

The Mulroney government was re-elected in 1988 in part because of perceptions of the employment situation, and was defeated in 1993 because those perceptions were reversed.

The Canadian Election Study team did an excellent piece on the 1997 election that shows that it is perception of unemployment, not the unemployment rate itself, that drives voter behaviour. Richard Nadeau found that in 1997 more than 80% of Canadians thought the unemployment situation had not improved (and 40% that it was higher!), despite a significant two-point reduction in the actual rate.

Nadeau and the CES team attribute this to several factors, including:

1) Incremental improvement may not be enough, particularly when the incumbent government was elected on a mandate to create jobs.

2) Absolute levels of unemployment may matter as much as the relative position of the unemployment rate compared to the last election.

3) Voters' retrospective horizons seem to be short. Most of the improvement in employment in Jean Chretien's first term was during the first two years, while the last 18 months were relatively stagnant with a 0.3% uptick just before the election was called.

The CES team estimates that if perceptions of the unemployment situation had been more positive, with half of respondents saying unemployment had gone down instead of just 20%, the Liberals would have increased their vote by 3%, erasing their losses in Parliament.

Ironically, immediately following the election, both the general economic and specific employment situation improved markedly, with a sustained drop in the unemployment rate and a likely corresponding boost in Liberal fortunes in the polls (and an increased majority in the election of 2000).

The point of all of this is that it was seven years after the official end of the 1990-91 recession before politically popular increases in the employment rate were felt, and translated into sentiment toward the incumbent government.

("Jobless recovery" is a cliché now, as both the 1981 and 1991 recessions saw long periods of unemployment rising or remaining high even after the recession was technically over.)

Worsening this challenge for governments is a decline in government revenue that trails the recession by as long as five years.

The culprit here is corporate tax revenue, one of the great mysteries of the budgeting process.

Each year, the federal and provincial governments must estimate their revenue picture based on a wing and a prayer. Stable revenue sources like agency revenues, fees, income tax and sales tax are relatively predictable.They decline a bit in recessions, but in a way that economists can model.

Corporate taxes are a crap shoot to predict because the amount a corporation pays in any given year is optional. Anyone paying income tax - individual, trust or corporation - can offset profits they have made against losses they have experienced. While most individuals don't really have losses - or if they do, don't understand they can do this - corporations hire professional accountants who understand they can move losses as many as five years down the road. As a result, corporations often wind up using a loss in a recession year to offset profits in good times.

Historically, this corporate bookkeeping led to government revenues from corporations booking lower than expected in 1991-96. However, in 1997, corporations were no longer able to use recession-era losses to avoid tax and revenue leapt ahead. Federally, this corresponded with the post-deficit balancing rush in government revenues to create the rolling surpluses of the later Liberal era.

The bursting of the tech bubble in 2000 provided a number of companies with write-offs that slowed this boom in revenue for a few years. But by 2005, the revenue stream was hotter than expected provincially and federally.

Now corporations have a fresh round of significant losses they can use to offset profits during the recovery, delaying any relief to the common treasury until 2012 or 2013.

This is the spectre that governments now face: a "jobless and revenue-less recovery" that will focus attention on employment and fiscal questions.

In that environment, the "job-creating" Single Sales Tax is a more logical tool for political sales than it currently appears. The Harper, Campbell and McGuinty governments are all hitching their hopes to it to some degree.

Another sign of hope may be the aging population and the increasing attention the public pays to the stock market.

In earlier recoveries, a far lower proportion of the public were dependent on the market directly. While the proportion of Canadians who own corporate equities directly remains relatively low, a far higher proportion of Canadians are invested through their corporate pension plan or - most often - through their RRSP.

The same phenomenon is found in the U.S., where half of Americans are equity-owners, up three-fold since the early 1980s when it was just one-fifth.

It is possible that this increased attention paid to the market may place a greater emphasis on the behaviour of the stock market in determining economic outlook for Canadians, increasing the sense of a recovery for more voters earlier than in the 1981 and 1991 recessions.

Regardless, the looming fiscal crunch is a reality.

If it is joined by inflation that necessitates a sharp spike in interest rates, no level of stock or bond market performance will offset paying 15% interest on a mortgage.