Strategy

Economic stimulus: The big spend

The Harper government hopes its latest budget will kick-start the economy.

On Jan. 27, Stephen Harper’s Conservative government unveiled its budget for 2009—Canada’s fusillade against recession.

WHAT’S THE PLAN?

In short, it’s to spend a lot over the next two years. Finance Minister Jim Flaherty claimed the budget will stimulate consumer spending, and protect those hurt most, including troubled industries. Highlights:

The big build: The Feds will embark on a $12-billion construction binge, including roads, bridges, railways, harbours, university campuses and more. The idea is to put money in the pockets of construction workers, architects, engineering firms and others, thus driving economic activity. Infrastructure can also improve productivity down the road. Flaherty promised to begin within the next few months.

Credit bonanza: The government worries that financial institutions are less willing to lend, thus threatening spending. The underlying problem is in the credit markets. Securitization is the process of packaging mortgages, auto loans and other debt and selling them off as investment products. It allows banks to get loans off their books, freeing up capital for new lending. But somebody must buy those products, and investors have been unwilling to play along of late.

Enter Ottawa. Last fall, the Feds pledged to buy $75 billion of mortgage-backed securities through the Canada Mortgage and Housing Corp. The budget allocates a further $50 billion. (At budget time, CMHC had bought $41 billion.) The government will also buy up to $12 billion of securities backed by vehicle and equipment loans and leases.

Helping afflicted workers: Among other worker-friendly initiatives, the budget temporarily extends EI benefits to 50 weeks from the current 45, and freezes premiums. It also invests more in long-term training. The government expanded the Wage Earner Protection Program to cover severance and vacation pay when bankrupt employers can’t pay up.

Lowering taxes: The budget includes modest tax reductions. The government will increase the “basic personal amount” — the portion of income it doesn’t tax, as well as the upper threshold of the two lowest income-tax brackets.

Bailing out struggling industries: The Tories have not been enthusiasts of corporate welfare. Still, last year they joined with Ontario to loan $4 billion to America’s troubled automakers. The budget continues this tradition. The forestry, shipbuilding and nuclear industries are among the beneficiaries, and some credit initiatives also prop up sectors such as construction, real estate and financial institutions.

WILL IT WORK?

Nobody expects this plan to slay the recession. “This budget is merely triage to help the hardest hit,” BMO Capital Markets chief economist Sherry Cooper wrote recently. “That’s about as much as Ottawa can do.” But some believe it can help Canada emerge from recession sooner. Glen Hodgson, chief economist at the Conference Board of Canada, said the budget is “exactly what our economy needs” and it should spur a return to growth in the second half of 2009. IHS Global Insight Canada predicts it will “somewhat reduce” job losses and bankruptcies.

Dale Orr, IHS’s managing director in Canada, praises the infrastructure plan. “While it creates some debt that will be paid for by our children, at least we’ll also pass them some infrastructure they’ll thank us for,” he says. We need it: according to Statistics Canada, the average age of infrastructure has been on a steady upward trend. There are hazards, though. Some spending “will probably drift off to politically sensitive ridings,” Orr says. The rush might result in sacrificed environmental and zoning standards. And some worry the intended stimulus will not arrive quickly enough. “There is considerable doubt that so-called ‘shovel-ready’ infrastructure spending is really all that ready to roll,” added BMO’s Cooper.

The Tories seem most proud of the tax cuts, but they’re least likely to stimulate the economy. If they’re to work, consumers must spend the resulting savings — but they might pay down debts instead, or spend on foreign goods. According to the Brookings Institution, a Washington-based think-tank, permanent tax cuts are “especially counterproductive.”

Bailing out failing industries is typically the most unpopular form of stimulus. Though some have accused the government of corporate welfare, others were happy the budget did not contemplate more of it. Says Orr: “They’re focusing on adjustment, rather than trying to endlessly prop up unproductive companies. Thank goodness.”

HOW MUCH WILL IT COST?

The government estimates it will spend nearly $40 billion over the next two years. The International Monetary Fund recommended that nations introduce stimulus equal to 2% of gross domestic product. Canada’s commitment amounts to 1.9% of GDP this year, and 1.4% in 2010, so it falls within guidelines. But it’s relatively more expensive than the measures announced so far in all G7 nations except the United States.

The real cost is mounting debt. Hit by plunging commodity prices, flagging export demand, falling tax revenue and more, Canada would have incurred deficits even had Ottawa let the recession proceed unimpeded. But the stimulus will exacerbate shortfalls. Flaherty predicts a $34-billion deficit this year, and another $30 billion in 2010. Over the past decade, we’ve reduced our total debt by $105 billion, to about $459 billion today. That’s about to be undone. Looking beyond raw numbers, it’s not so bad. At its worst, during the mid-1990s, Canada’s debt-to-GDP ratio hit more than 68%. The government estimates that number is now less than 29%, and believes it will deteriorate to 32% by 2010–2011. “It is simply not correct to say that the hard-won gains of the past 15 years in strengthening Canada’s fiscal position have been undone in this budget,” argued BMO Capital Markets economist Douglas Porter in a commentary.

The real hazard is that deficits could last longer than expected. Flaherty promised a return to balanced budgets within five years. Rather that committing to future tax increases or spending reductions, however, the government essentially relies on projected economic growth to eliminate the deficit.TD has pointed out that the government is counting on above-average growth, which may not materialize. There’s also a political hazard: once granted, “temporary” handouts to special interests often prove difficult to revoke.

The greatest moral argument against deficits is that they often amount to one generation leaving its debt to the next. “The last time the federal government went into deficit it took us 27 years to get out,” says Orr. “Taxpayers in the 1980s and 1990s paid dearly for the high spending of their parents.” By Orr’s calculation, though, history won’t repeat itself. He concludes Flaherty was only “slightly optimistic” on eliminating deficits by 2014. “With political will, deficit elimination is more likely to be just a year later,” Orr said.

CAN WE AFFORD IT?

Yes. The government, various economists, bond-rating agencies and think-tanks broadly agree that thanks to comparative fiscal discipline, Canada is better-positioned than its peers. “The reason we paid down $100 billion in debt over the last 10 years is so that we could provide stimulus during a time like this,” said Hodgson. “This is easily affordable, particularly at current interest rates.” In contrast with Britain and Italy, there is little talk yet that Canada might go bankrupt trying to avert economic catastrophe.

IS IT WORTH IT?

For those who reject Keynesian economic theory, the answer is no. The Fraser Institute, a right-wing think-tank headquartered in Vancouver, says the budget merely transfers taxpayers’ money to special interest groups. “This will not increase economic activity,” Niels Veldhuis, its senior economist, said in a statement.

The emerging consensus, however, is that this recession is so severe that it requires bold, immediate action. Citing empirical studies, University of Delaware economist Laurence Seidman claims fiscal stimulus proved helpful in fighting past recessions. Yet even he and other Keynesians acknowledge it’s tough to pull off effectively. The federal plan seems costly but workable. Its success or failure rests largely on its implementation.