My son, Max, was born on Sept. 5. Like any first-time parent, I’ve been thinking about the kind of world my child will inherit when he grows up. Probably unlike most, my thoughts have strayed to how our economy will look decades from now, and the role policy will play in shaping it. There are a number of changes I think governments could start making now to improve prospects for Max’s generation. I’d like to propose one in particular, which has the added advantage of not costing our current generation a dime.
Please, start running deficits. No, really.
There is no question that Canadian governments’ restoration of fiscal responsibility through the mid-1990s contributed to the prosperity we’ve enjoyed recently. But as the string of federal surpluses extends into a 10th year, I worry that the avoid-deficits-at-all-costs approach is becoming more a hindrance than a help to Canada’s economic future.
Canada’s net government debt is now below 25% of GDP, by far the lowest in the G7 and down from a peak of more than 70% in 1995. Investors long ago dispensed with any debt-related discount on Canadian assets, as the Canadian dollar’s generational high and the negative Canada-U.S. interest rate differential attest. Effectively, then, reducing government debt has stopped being useful for its own sake, as far as the current economic environment is concerned.
Of course, there is still great value in reducing government debt so as not to leave Max’s generation stuck servicing it. But what if we could do better for Max? What if we could take advantage of generational lows in interest rates, to make the kind of investments whose eventual fruits would more than offset the future burden of the associated debt?
I think we can. I travel abroad and marvel at the investments being made in infrastructure, even in supposedly poorer countries. I look around at home and see ever-more-crowded roads, schools and hospitals. And I note that, as a nation, we spend about 40% less as a share of GDP on public infrastructure than we did a generation ago — and about 60% less than we do on building and renovating houses.
Canadian governments are forgoing economically sensible opportunities to make infrastructure investments in our country’s future. Why do I say that? It’s not like I have secret Finance Department documents with a list of projects that were crossed out due to an unwillingness to borrow. But I know that such a list must in theory exist. Because when the government commits to avoiding deficits above all — meaning that current spending and investments for the future must be funded out of current revenues — then those investments will be made only if they fit under the balanced budget constraint, rather than being properly judged on their own merits. It’s like a company saying it had a fabulous opportunity to boost future profits, but didn’t make the investment because it wanted to hit its quarterly earnings number today. Markets have long learned to punish this sort of short-sightedness. Voters should do no less. Any government forgoing fruitful public investment opportunities simply to avoid current deficits is not, in fact, truly providing the “prudent financial management” it claims to be.
So my more concrete proposal is for governments to exempt capital spending from the balanced budget requirement. Limit current taxes to funding current spending. Let investment be constrained only by whether it makes sense, not whether money is left over this year.
This revised budgetary approach would by definition produce deficits. What’s important, however, is that it would not necessarily result in an increase in the effective burden of government debt, because the size of the economy on a dollar basis — the benchmark for assessing the burden of debt — keeps growing, too (or at least it has every year since records were first kept in 1961). For example, my forecast for nominal GDP growth next year is below consensus, at 4.0%. But I calculate that would stillallow the federal government to run a deficit of about $20 billion without increasing the debt-to-GDP ratio.
Now, maybe there isn’t $20 billion worth of useful infrastructure projects to put that money toward next year. That’s fine — cut taxes to bring the revenue side down to current expenditures, leaving the projects we are pursuing more transparently accountable against the borrowing needed to fund them. Or maybe there really is $30 billion in worthwhile investments out there. That’s fine, too — the debt-to-GDP ratio would tick up, but because we’re applying those funds to initiatives that we think will produce positive returns to the public into the future. That’s a good thing.
The point is that we have earned the flexibility to instruct our governments to make sounder decisions about our nation’s debt than simply “Don’t add to it.”
Some readers may at this point object that today’s flexibility has only come about because we’ve constrained government spending by demanding budgetary balance, and that loosening those constraints would put us on the slipperyslope to the bad old days of spiralling deficits. That is a valid concern, even under my proposal, which retains a rigid revenue constraint on current spending but provides for a looser economic constraint on investment. One could argue that much of what the government does is in fact investment, with health-care and education spending, for example, counting as human capital development. Governments might find it hard to resist reclassifying everything they could as “investment” so as not to have to tax now to pay for much of anything.
Moving to our new budgetary framework would present a number of other challenges. What constitutes a “worthwhile” public investment project, and how do we measure the prospective returns? We know there’s often a sizable gap between well-intentioned cup and well-executed lip when it comes to government projects. Major public investments inevitably require the kind of co-ordination across levels of government that never seems to work as it should in Canada. But these are all just as problematic under the current system, and need to be addressed, not avoided.
It’s also true that now is probably not the best time in the cycle to make the change. From a macro perspective, the economy looks to be beyond its productive capacity. Moving to fund higher levels of investment would represent added stimulus, risking further overheating and inflationary pressure, and almost certainly eliciting higher interest rates and a more expensive dollar. From a micro perspective, resources in the construction sector look stretched at this point, especially out West. Then again, there never does seem to be an ideal time to make structural policy changes. History suggests that by the time we actually saw anything get done, we could be facing very different cyclical circumstances.
But perhaps the biggest question is whether my proposal would be politically salable to an ever-suspicious public. I hope to be able to tell Max, years from now, that today’s politicians had the courage to at least make the attempt.