Late 2008 brought Canada’s most serious political crisis in decades. The government is challenged to prepare a fiscal stimulus package acceptable to the opposition parties in Budget 2009, scheduled for Jan. 27. If the economy needs a boost from new tax cuts and/or spending, how much, when, why and in what form?
Canada is probably in a mild recession now, which will continue through the first quarter of 2009. We expect a recovery — a weak one — in the last half of next year. With interest rates still low, the dollar still in the 85¢US range and the U.S. economy picking up, we expect above-average growth in 2010 and 2011. But that doesn’t mean the economy should soldier forth unaided. Employment growth has already come to a halt, and it will remain flat for another year, while the unemployment rate will rise to just over 7% a year from now from just over 6% today. Many families will suffer layoffs and weak income growth.
Any country’s first line of defence against a downturn is monetary policy. The Bank of Canada has been doing its part, but the economy needs some supplementary help. Fiscal policy can supplement monetary policy in trying to keep the economy on an even keel. Unfortunately, deliberate attempts to stimulate the economy with tax cuts and/or new spending often prove “too little too late,” or are otherwise ill-advised. To be effective, fiscal stimulus must be three things: timely, targeted and temporary.
Regarding timeliness, we need stimulus from mid-2008 to mid-2010 — a period that is already about one-third over. Any stimulus still in effect after that might fuel inflation or be frustrated by tightening labour markets. Ideally, fiscal stimulus should have been initiated several months ago.
Fiscal actions must be targeted to promptly stimulate consumption and/or investment. They should also increase productivity over the longer term. The fiscal actions should be temporary. Even if they are, and don’t affect the deficit a few years out, they will still leave us with more debt and higher debt charges. If initiatives are sustained too long, they can lead to upward-spiralling, longer-term deficits.
There are two additional considerations. The total amount of stimulus should be sufficiently large to make a noticeable impact on falling economic growth and souring consumer and investor sentiment. Roughly speaking, this would require the fiscal stimulus package to be about 1% of nominal GDP. For Canada today, the sum would be about $16 billion. Finally, any new spending must be cost-effective. It cannot be so rushed that it risks giving taxpayers poor value for every dollar spent.
Given those criteria, what kind of stimulus is appropriate? Accelerating the implementation of relatively small infrastructure projects, which would have otherwise started in 2010 or 2011, is our best bet. This would include municipal infrastructure, road repairs and small bridges.
Other fiscal options may seem attractive at first blush, but there are plenty of ways to foul up. Increased social spending is too hard to make temporary. Reductions in income taxes can be effective, but they risk not being converted into increased consumption and are difficult politically to reverse. Temporary tax cuts or accelerated spending might just move the recession from this year to the next. While the auto sector is certainly in trouble, a focus on training and relocation to more promising labour markets should be the principal focus, as well as a possible joint Canada-U.S. deal with the companies.
Canadians cannot expect any new fiscal stimulus in Budget 2009 to save us from the recession currently underway.
Meeting all the criteria for effective stimulus isn’t always possible. Under the circumstances, I think it would be difficult, and probably not advisable, to introduce a fiscal stimulus package as large as the 1% of GDP threshold. Regrettably, I doubt there are more than $10 billion worth of small infrastructure projects that could be successfully moved into the critical period and still meet the other criteria. Trying to rush larger, multibillion-dollar projects under these conditions might well mean cost overruns and sloppy work — and might also prove too late to address our current economic troubles.
Canadians must be wary of politicians and organized groups who push their favourite spending projects in the guise of necessary economic stimulus. In considering any fiscal actions, we must always be mindful that we — and quite likely our children — will have to pay for them when the economy improves.
Dale Orr is managing director of IHS Global Insight Canada.