by Aniket Bhushan
Published: March 21, 2016
The upcoming federal budget has generated a great deal of debate and expectation.
Much of the debate and indeed what people are most likely to look for (and probably stop there) is the size of the deficit and stimulative fiscal spending. The lead-up discussion and the budget itself, understandably, focuses on domestic tax and spend issues. Global aspects have received less attention.
In two posts we look at: high level areas that should be kept in view to interpret the budget (here below); and specifics on global affairs, development and trade (here).
Public opinion is conditioned and expectations have been raised high
As would be expected, the government has been playing the expectations management game for some time now. The last fiscal update (Feb 2016) set expectations to the upside with the 2016-17 deficit projection placed at over -$18 billion, before adding in stimulus measures, higher than what most observers were expecting.
Public opinion is conditioned – we are a long way from the Liberal platform commitment of deficits of no more than $10 billion – adding in what the Minister of Finance has repeatedly called “transformative investments” in infrastructure (not just hard infrastructure like transit etc. but also social), it is now unremarkable to expect deficits in the range of around -$30 billion.
Ratios and anchors
Any ‘anchors’ – be it in the form of maintaining the low net debt to GDP ratio or deficit to GDP ratio – are also held in abeyance (even double that $30 billion level would be only around 3% of GDP which is no longer unthinkable). Never mind that the oft repeated federal ratios would look quite different if provincial levels – where debt and deficit pictures are not nearly as rosy – were included (net debt at the federal level may only be around $615 billion, roughly 30% of GDP, but the provinces have accumulated nearly $600 billion additional; Ontario and Quebec together around $480 billion).
It is not a stretch to call the budget lead-up a sea change for Canada, and a fundamental turn from years of austerity and (at least the veneer of) fiscal discipline under the previous Conservative government.
It also makes Canada a great experiment for whether deficit spending will work, not only in the sense of the needed short term stimulus but also in engendering the longer term transformation the new government has promised. Initial conditions – a confluence of low borrowing rates with the 10 yr around 1.3%, strong majority government with a clear mandate, internationally popular Prime Minister – are as auspicious as they are not generalize-able, at least among G7 peers.
There seems to be emerging consensus that the burden of stimulus needs to shift to fiscal policy. Monetary policy is pushing on a string with negative rate experiments in the EU, Japan and Nordic countries. More importantly, Canadian monetary policy can only drift so far from the US trend. Coming years in Canada could be a natural experiment in testing this argument. Can governments that really do have some fiscal space use the same to set their economies on a path different than the rest of the world through deficit spending?
Perhaps in a bid to lower expectations, the closer we got to the budget date the more there was a sense that no major surprises should be expected – the PM in New York has been upfront that the first few years of multi billion dollar infrastructure spending will be in ‘unsexy’ areas (maintenance, upgrades), and the government is quick to remind that key platform pieces like the middle class tax cuts are already in motion.
High level areas
Whether implicitly or explicitly the budget should provide insight into the government’s take on simple but quite fundamental questions – just how weak is the Canadian economy, and what form of weakness is it?
Looking only at the headlines one may think this is pretty obvious. Consider the following:
- WTI crude fell from around $107/barrel in June 2014 to $27/barrel in January 2016 – a drop of -75%
- Today (late March 2016) it is around $40 – an increase of over 50% in less than 3 months
- Over 3 short months since the Oct 19, 2015 election to Jan 19, 2016 the CAD/USD exchange rate, already down substantially from parity to around 0.77 cents, fell further dramatically, about 12% in 3 months – a whopping move for any currency
- Since Jan 20, 2016 it is up 12%
- The TSX, a reasonable measure of wealth effect, fell over 20% from mid April 2015 to mid Jan 2016
- Since mid Jan it is up around 15%
- Initially the expected positive effect of a low CAD on net exports was weak, but exports in the last few months have started to pick up
- Employment has been hit hard in oil and natural resources segments of the economy – indicating just how much these matter which is often underplayed given their relatively small share of the labour market
- But employment trends at the aggregate level have been surprisingly resilient – indicating that there is more to the Canadian labour market than resource reliance
The above may be stating the obvious. But some points are worth restating: things can change very quickly. There is a difference between volatility, which generally overshoots both to the up and downside; and structural weakness.
Clearly all this matters as the Finance Ministry has found out in the short time between the November 2015 and February 2016 updates – as indicated by the substantial changes in projections and assumptions they were forced to make.
So, perhaps it is not inconceivable that oil recovers if not to prior levels then to the trend projected in the earlier Fall update? Or US economic recovery – on which Canada is pretty much reliant – begins to strengthen?
What is unclear, and worth reading between the lines in the budget, is which side the government comes out on. Economics suggests wait and watch but be ready to act quick. Politics the opposite – go big now while the leash lets you chase, if it doesn’t work you are spoiled for choice for things to blame.
One indication may be how infrastructure investment is positioned. Is it as shovel-ready? Is it decentralized for this purpose and handled by lower levels of government more directly? Or is it longer-term? Beyond things like transit, does it expand to pipelines? Or is it distinctly aimed at greening the economy (or at least green-washing the brown, quite literally if oil sands clean up and clean tech are part of infrastructure)?
Clearly there is an East West and cross sector balancing act – transfers to Alberta have already been determined but Bombardier’s bail-out yet needs to be finalized (what with the Liberals returning to power thanks in part to a return from the cold in Quebec).
Another ‘tell’ could be the path back to balance. A budget aimed at preparing the groundwork for medium-term large negative numbers (which it could easily come back to beat if things change externally) so much so that deficit levels become a non-issue, would be consistent with the type of fundamental transformation the new government has targeted. On the other hand smaller deficits over a shorter time-frame may neither be enough to move the needle on stimulating the economy or bringing about any fundamental reorientation.
Who favors who opposes?
It is much easier to find supporters of large deficit spending, than detractors.
When you have Bay Street economists on the same side as Leftist think-tanks (who among other things advocate for financial transaction taxes), in supporting large deficit spending, you know that the debate has fundamentally changed in Canada.
On the left, CCPA in its alternative budget calls for the government to ‘not fear big deficits‘ and let it rise to -$38 billion. On Bay street, the chief economist of one of Canada’s largest banks, CIBC, goes even further and makes a persuasive case for why -$40 billion deficit would be ‘most appropriate‘.
Internationally Canada has a great deal of support – the IMF for instance has vocally supported using fiscal policy aggressively.
The other side of the argument is extremely wonky and means you have to buy into the ‘end of growth‘ idea (that we more or less have to accept low growth as the new normal). Or at least accept that things are really not that bad, or put another way, the economy is doing as well as it could. And accept that Canada is and will remain a resource reliant economy, at least for incremental growth.
At least as persuasive a case against the need for deficits can be made as for, if one gets wonkier (here is a great summary): economic multipliers are smaller for a small open economy like Canada’s and any stimulus will be prone to leakage across borders; fiscal policy may have limited efficacy under flexible exchange rates; it is unclear that demand is deficient if you look at quantity (as opposed to price level) indicators.
The detractor’s reactions are pretty well telegraphed. The thing to watch will be whether the unlikely consort of supporters are surprised, impressed or disappointed.
With the two ends of the spectrum stretched as they are the middle ground could not be wider. Even if weakness is imported from external factors beyond control that could reverse just as quickly as they emerged, the government has bought itself near unprecedented license in investing to reorient the economy.
This budget should tell us whether the opportunity makes them nervous or bold.