Hot! The Canadian way to rein in debt

TheGlobeandMail.com – news/opinions/opinion
Published Monday, Jan. 10, 2011.   Kevin Lynch

Governments in most G20 countries are currently focused on how to restore balance to their “fiscal books,” which were ravaged by the combined forces of the global financial crisis and recession and unprecedented fiscal stimulus. Compounding this challenge is a recovery with less vigour, more volatility and greater uncertainty than in the past. This has prompted policy makers to seemingly bog down in debates about the relative risks of too rapid a withdrawal of stimulus taking steam out of the recovery, versus too slow a withdrawal permanently increasing public debt burdens.

Canadian fiscal experience offers useful insights into this seeming quandary. Canada demonstrated over 27 consecutive years of deficit that postponing fiscal restraint until a more propitious moment does not merely delay the day of reckoning, it exacerbates the problem through compounding debt accumulation and rising interest costs – just like a household caught in a debt spiral. Countries like Greece, Ireland and Portugal are providing real-time examples of the dangers of unsustainable fiscal situations and the consequences of too little, too late fiscal responses.

In the mid-1990s, Canada faced serious questions about the sustainability of its fiscal situation, including rising spreads on government debt. Canadian policy makers came to the right conclusions: that fiscal gradualism was being swamped by debt dynamics; that growing out of the deficit neglected the inconvenient truth that servicing debt was a structural, not cyclical, problem; and that the greater loss of confidence came from inaction, not from resolute fiscal actions.

Disconcertingly, U.S. government debt as a share of the American economy is fast approaching Canadian debt peaks, which reached almost 70 per cent of GDP. And, with no clear U.S. fiscal exit strategy in sight, the International Monetary Fund projects that it will grow toward 90 per cent of GDP by mid-decade.

Concerns about a weak U.S. recovery are legitimate – every recovery after a financial crisis has been a long slog as balance sheets are rebuilt and financial systems deleveraged – but this is not something an expansionary fiscal policy can remediate. Indeed, at some point, more debt, not less stimulus, will pose the greater threat to expansion.

Even Canada will experience a $171-billion increase in federal debt, according to the federal government’s fall 2010 update, more than offsetting the $105-billion in debt reduction achieved over a decade of fiscal surpluses. The interest costs of supporting this additional debt will add to whatever deficit emerges from our restructuring domestic economy, weaker U.S. export markets, substantial loss carry-forwards and any ongoing stimulus initiatives.

In looking at possible areas for restraint, past Canadian experience again illuminates the ineffectiveness of across-the-board cuts to government operations, which typically starve capital and recruitment, and attacks on waste-and-inefficiency, which has proved the fool’s gold of many restraint initiatives through the years.

What has worked is transparently eliminating or reducing programs, with commensurate reductions in budgets and employment, and tackling inefficient tax expenditures, which are no different than ineffective programs. Credibility and confidence are enhanced by legislating multiyear fiscal restraint plans with built in contingency reserves.

What should also work well today is restructuring the “back office” of government by abandoning outdated processes, investing in technology solutions and shifting to a smaller, more IT-enabled work force. What is needed further is a strong commitment to more public-private partnerships, in both infrastructure and service delivery.

In all this, we should be careful not to confuse the size of government with the fiscal challenge before us. Prior to the onset of the recession, federal government program spending (everything but interest payments on the national debt) averaged just under 13 per cent of GDP for a decade – the lowest federal government spending share of the economy since the 1950s. Similarly, the government revenue bite out the economy was 14.5 per cent of GDP, a decline of more than two percentage points since 2000 while maintaining fiscal balance.

The risk going forward for Canada is complacency. At both federal and provincial levels, it will be politically appealing to postpone the concrete and durable restraint actions required to achieve an early and sustainable return to fiscal balance. The arguments will be tempting – the recovery is still modest; such actions will be publicly unpopular; we are in better fiscal shape than most of our trading partners. None justifies a tepid and short-term fiscal response by any Canadian government.

Kevin Lynch is vice-chair of BMO Financial Group and a former deputy minister of finance.

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