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Business Commentary Tories need to rethink a balanced budget, focus on economic stimulation

Economist with Unifor, Canada's largest union in the private sector.

The evidence is mounting that Canada's economy may already be in an outright recession. Recent data on investment, exports, building permits and retail sales all paint a gloomy picture, and Friday's jobs numbers – the private sector shed 49,000 jobs in June, partly offset by public-sector hiring – added to the pessimism. Through it all, however, federal Conservative leaders return again and again to their favoured touchstone: Never mind the economy, we balanced the budget, and that's what really matters.

Indeed, they go further: Not only should deficit elimination still be the top priority, even in a weak economy – but the mere act of balancing the budget will itself spur economic recovery. Finance Minister Joe Oliver put it this way, in a recent interview with CBC Radio: "We have a solid fiscal situation, and that's why we continue to believe we're going to see solid economic growth this year."

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The prospects of Canada experiencing anything remotely resembling "solid growth" this year are non-existent, and Mr. Oliver knows it. The economy kicked off 2015 with four consecutive monthly declines in GDP. Statistics Canada will report whether we're in an official recession (defined as two consecutive quarters of negative growth) on Sept. 1. The economy suddenly would have to surge spectacularly just to meet the ho-hum growth assumption underlying Mr. Oliver's most recent budget. More likely, GDP will finish the year about where it started, if not lower.

But the more puzzling aspect of Mr. Oliver's view is his treatment of "balanced budget" and "strong economy" as virtual synonyms – with the one automatically implying the other. The budget balance tells you whether government is taking in more than it spends. Growth, on the other hand, depends on whether the whole economy (85 per cent of which is in the private sector) is producing more or producing less. They are totally different concepts.

So precisely how does eliminating a government deficit ensure more production? Fiscal hawks are very vague on the "transmission mechanism" that might link these separate indicators. Some hope that business confidence will be bolstered by a balanced budget, and hence companies will finally open the taps on their investment spending. Don't hold your breath. Free-market purists argue that any resources sucked up by government "crowd out" resources would otherwise be used (with greater efficiency) in the private sector. That's especially hard to swallow in the face of mass unemployment. Mr. Oliver himself provided another explanation: The government should balance its budget now so it has room for extraordinary measures in the event of more serious trouble down the road. This convoluted logic hardly inspires optimism.

In day-to-day economic reality, a deficit does not have any direct impact on the state of spending power, hiring, production or growth. And if deficit reduction is accomplished through big spending cuts (as has been the case for Ottawa), then it clearly inhibits growth. When growth is strong, the deficit tends to shrink automatically, and vice versa when times are weak. But the deficit is the follower, not the leader, in this relationship.

The Conservatives need to dust off their first-year college macroeconomics textbooks. Overall economic activity is determined by the spending power available to buy what we collectively produce. There are four major categories of spending, and hence four main engines that can potentially lead growth: business investment, exports, consumer spending and government.

Unfortunately, the first three are all currently headed in the wrong direction. Business capital spending was sluggish even before oil prices fell (despite large corporate tax cuts) and now it's shrinking fast. Exports have fallen steadily through the year, producing record trade deficits. And consumers, finally tapped out after years of record debt, are sitting on their wallets: Retail sales fell in April. At any rate, consumers can't usually lead the growth parade, anyway, since they need jobs before they can go out shopping.

In the face of such multi-dimensional weakness, what good does it do to eliminate a deficit in the remaining sector of the economy? In a best-case scenario, absolutely nothing. And more likely, the austerity imposed to attain balance (for the federal government, this includes $15-billion annually in cumulative spending cuts and nearly 50,000 lost jobs since 2011) only further undermines demand, both directly and indirectly, by further chilling consumers.

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Mr. Oliver's budget isn't really balanced, anyway. His apparent triumph was achieved through accounting gimmicks: reallocating contingency funds, selling off public assets, raiding the EI surplus, even prebooking the value of expected cost savings from labour contracts that haven't even been negotiated yet. Now, with growth falling well below his 2-per-cent budget assumption, another multibillion-dollar hole has opened up in his budget.

But even if that balance was more genuine, it would be a hollow victory. Federal spending cuts are only exacerbating a startling decline in private-sector employment and output. Mr. Oliver's government claims to have won the deficit battle, but it's clearly losing the economic war.

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