Chasing prosperity? Or votes?

Why is a balanced federal budget like a picnic? Because neither is responsible for what their promoters promise—be it economic well-being or a sunny, summer day
By Ian McGugan

Finance minister Joe Oliver’s choice of budget-day shoes: well-suited for the campaign trail

Balanced budgets are what pass for sexy among a certain swath of the electorate—most notably the part that votes Conservative. Hence it’s no big surprise that the federal Tories pulled out all stops this spring to announce their first balanced budget in seven years. For good measure, they promised to introduce legislation that would deter future governments from running deficits.

The one obvious conclusion from all this frantic activity is that the Conservatives must believe a balanced budget will be a potent vote getter in the federal election slated for this fall. What’s not so clear, though, is why they or anyone else think the issue is suddenly so important. Balanced budgets aren’t particularly prudent or growth enhancing. Those who believe in the innate superiority of a balanced budget should check their faith against the facts.

The usual rhetoric insists that balanced budgets are a necessary prelude to prosperity. But that’s emphatically not the case. For much of its history, Canada has run a deficit. Year after year, in more decades than not, we have operated in the red. Despite those chronic deficits, however, Canada built one of the world’s most prosperous societies. The same holds true for the United States and the United Kingdom. Anyone who wants to argue that debt is poison has to explain how many of the world’s most successful economies managed to succeed so brilliantly despite decades of near-constant deficits (see adjacent chart, showing Canada’s annual federal budgetary deficit/surplus levels).

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Look at the historical numbers and you find that the link that Ottawa currently wants to build between surpluses and prosperity has things backwards. Rather than surpluses leading to prosperity, it’s prosperity that leads to surpluses.

The most recent patch of budget surpluses began in 1997, as Canada’s economy surged in tandem with the U.S. boom that accompanied the dotcom bubble. To be sure, the Liberals’ tough line on spending was essential to creating the surplus, but the reason that Jean Chrétien and Paul Martin were able to restrain government spending without sinking the economy was that the U.S. was running red hot and that Canada was in an excellent competitive position because of a cheap loonie. Prosperity came first, then came the balanced budget.

The Liberals’ quest for a balanced budget received enormous help from an outside source: falling interest rates, which slashed the cost of servicing the national debt. But again, note the direction of causation: interest rates plummeted between 1990 and 1996, then came the surplus in 1997. It wasn’t balanced budgets that brought about lower interest rates; it was lower interest rates that helped bring about balanced budgets.

One way to think about budget surpluses and prosperity is to picture them as picnics and nice summer days. Picnics usually accompany nice summer days. However, picnics don’t cause pleasant weather. Understand that this is no criticism of picnics: we can and should enjoy them whenever appropriate. But we also shouldn’t expect that having a picnic on a frigid February afternoon will do anything to warm up the weather.

In the same way, a balanced budget can often be a welcome sign that unemployment is low, growth is rapid and the economy is producing at capacity. That doesn’t mean, however, that it’s smart to insist upon a balanced budget at a time—like now—when unemployment is relatively high and growth is disappointing. With interest rates at historic lows, there’s a strong case for Ottawa to borrow money to invest in infrastructure projects and the like. Federal government spending could help boost aggregate demand and spur the economy.

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To be sure, accumulated debt has the power to drag down an economy if it surges to excessive levels—say, 100% of gross domestic product or more. Greece and Puerto Rico demonstrate what can happen when debt hits such lofty heights. But Ottawa is nowhere close to the danger point. The federal government’s net-debt-to-GDP ratio is now only about 32%—less than half where it stood in the mid-1990s (see adjacent chart).

We don’t gain any particular advantage from further whittling down the debt, at least not when the economy is in the doldrums. Those who obsessively worry about excessive debt should spend a few minutes contemplating the other extreme. Needless austerity hampers recovery and condemns people to suffering. Look at Europe since the financial crisis. Across much of the continent, a refusal to engage in stimulus spending has resulted in miserably slow growth and high levels of joblessness.

So what is the right level of debt for Canada? One market-based answer begins by looking at our federal government bond yields. They are at record lows, showing that borrowers here and around the world approve of our current debt levels. Since the economy, as measured by gross domestic product, typically grows by at least 4% a year in nominal terms (2% inflation and 2% real), it seems that we could safely count on increasing our accumulated debt by 4% a year without disturbing anyone. That would keep our debt-to-GDP ratio constant while still providing some economic stimulus.

Of course, anyone truly concerned about the state of Canada’s finances has to look beyond Ottawa. Today’s biggest public spending challenge is dealing with the healthcare needs of an aging population—but that is primarily a responsibility of the provinces, not the federal government. Healthcare spending has been growing at an average pace of 6.1% a year since 2000, according to the Conference Board of Canada, and now occupies 40-45% of provincial budgets.

It’s no surprise that provincial budgets have been under strain in recent years as they struggle to keep up with healthcare demands and other issues. That’s why focusing simply on the federal deficit shows only a partial picture. Budget hawks should turn their attention to the provinces’ struggle to put a lid on healthcare costs, not on Ottawa’s largely symbolic pursuit of a balanced budget.

Ian McGugan is an award-winning business journalist in Toronto and the founding editor of MoneySense magazine. E-mail:

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