Austerity Needs a Follow-Up Strategy

Published in the Telegraph-Journal 9th October 2012

When policy fails to achieve its objectives, a debate can emerge over whether the correct response is the intensification of the existing path or a new direction because of changed circumstances. In New Brunswick we can expect such a debate to take place over the aggressive fiscal management that government has made a core principle of its economic strategy.  The heart of this debate will not be whether government should continue to forcefully pursue its eradication of the fiscal deficit and drive down the government’s debt in the near term. The centerpiece of discussion instead will be to define at what point there will need to be a substantial reversal of course from near-term expenditure management and fiscal consolidation to widespread support for the structural transformation of almost every element of this province.

There are likely to be heated objections to any suggestion that we should ease back on attacking the debt and deficits. Most of these objections will be predicated on the view that reversing course on the government’s aggressive fiscal management would undermine its credibility and potentially backfire by risking a spike in capital costs. These views are consistent with those of critics of government spending that maintain that we risk disaster if deficits and debts became unsustainable.

There is a near-consensus of the view that the fiscal debt today constrains government’s options. Only limited changes are possible if government’s deficits and debt are not brought to a manageable level. Precisely what constitutes that manageable level is worthy of discussion if only to determine at what point government will be able to assert its influence over key areas of expenditure by transforming them. In the absence of major changes affecting health care, education, social programs and physical infrastructure, New Brunswick’s short- and long-run economic performance is likely to deteriorate.

Ultimately, the need for transformation and economic growth is more critical than fiscal management. The behavior of financial markets suggests that it is lack of economic growth, not profligacy that is the main source of concern about creditworthiness over time. In Canada and the U.S., this explains the observed tendency for interest rates to ebb and flow in conjunction with stock market share prices. This is consistent with the implication that the evolving transformation in optimism and pessimism about future prospects, rather than changing views about fiscal policy, drives market fluctuations.

The harsh reality is that the fundamental determinant of fiscal health and stability in New Brunswick over the medium term will be the rate of sustainable growth achieved in the economy. Each additional percentage point of growth maintained over five years would have the effect of reducing New Brunswick’s debt-to-GDP ratio. This achievement should be contrasted with the effects of sustaining fiscal austerity policies that have the effect of impeding, rather than sustaining growth. Beyond the near term when they are necessary to conserve confidence when it is scarce, aggressive fiscal management policies are counterproductive in the narrow sense of increasing debt-to-GDP ratios. Instead, these policies serve to make the unsustainability of debt a self-fulfilling prophecy.

Fiscal consolidation is necessary in the near term. A reversal in the pace of this consolidation is necessary in the medium term for New Brunswick to avoid a lost decade of economic performance. Even this will not be a sufficient condition for economic success. Rather than continuing to forestall productive public investments, we need to bolster confidence by actively planning for structural reforms to change the nature of public consumption expenditures.

Once the need for aggressive fiscal management has passed, the opportunity to undertake fundamental investments in transformation capacity will exist for only a short time. If the fragile economy is to gain strength, the public sector must be fully vested in that expansion.

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Filed under Fiscal Policy, New Brunswick

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