America’s fiscal mess offers long-term opportunities for Canada

Posted on July 29, 2011 in Policy Context

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Published Friday, Jul. 29, 2011.    Jeffrey Simpson

Look past the budget negotiations in Washington. Whether or not politicians cobble together a deal before Tuesday’s debt-ceiling deadline, the long-term U.S. fiscal situation will remain grim. How should Canada respond?

In the short term, we can’t remain immune from economic turbulence south of the border: a ratings downgrade, high unemployment, a very weak housing market, reduced growth. Canada, even in the best of all worlds, can’t grow appreciably faster than the United States for a sustained period. Indeed, the loonie could easily hit $1.10.

In the medium term, Canada should get back to a balanced budget as quickly as prudently possible. A strong fiscal position helped Canada survive the recent recession better than any other country. (Thank you, Jean Chrétien and Paul Martin.) It might need that life jacket again, given the uncertainties of the world economy and the messiness of the United States.

In the longer term, the U.S. fiscal mess offers Canada opportunities to improve its comparative position – but only if Canada invests in the minds of its people and its competitive infrastructure.

The U.S., whatever happens in the days ahead, will be shackled by debt for a very long time, unless Americans take serious action of the kind nowhere on the horizon. Whatever the nature of future budgetary squabbles in Washington, big spending cuts are coming, given the antipathy to tax increases.

These cuts have already arrived at the state level, where budgets for K-12 schooling, universities and colleges, welfare, student assistance and many other basic programs are being slashed, and slashed again. So dire is the fiscal situation of many states, and so entrenched is the opposition to raising taxes, that states will have no choice but to ravage government programs and, of course, the wages and benefits of those who work for them.

Nationally, the Congressional Budget Office offers two scenarios. Under the optimistic (and least plausible) one, the debt would rise to 84 per cent of GDP by 2035 from 69 per cent today. With higher interest rates, paying the debt costs each year will be 18 per cent of total revenue.

Under the pessimistic (and more probable) scenario, the debt-to-GDP ratio tops 100 per cent by 2021 and rises to 190 per cent by 2035. This scenario, says the CBO, offers a “more realistic picture of the nation’s underlying fiscal policies.” To avoid it, the country needs “large and rapid changes to put the nation on a sustainable fiscal course.”

Does anyone see an appetite among Americans for “large and rapid changes”? And we haven’t even mentioned that social security, the largest entitlement program of them all, isn’t properly funded. It needs, according to its trustees, some combination of increases in the payroll tax, reduction of benefits, increase in the retirement age or reductions in the cost-of-living benefits. No one in Washington pays attention to the trustees.

The U.S. government will be cutting back, quite likely massively. This will mean less money for research, graduate students, physical infrastructure, food stamps, national parks and a host of other programs for which there’s no private-sector alternative.

The great advantage the U.S. enjoyed over Canada (and many other countries) in its publicly financed universities, research funding, graduate fellowships and faculty hiring will diminish. The K-12 system, where teachers already are paid much less than their Canadian counterparts, will be further assaulted by cuts.

If Canada were smart, it would realize it needs to invest in the things that will make the country more competitive, while we bring down budget deficits by spending less on things that don’t.

So an extra dollar spent on education and research will be a dollar well spent, in comparative and competitive terms, provided the teachers and professors don’t grab most of the new spending. An extra dollar spent, say, on even more health care will do nothing for Canada comparatively or competitively.

Invest in the future, while the Americans de-invest.

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