The Feds on the Right Fiscal Path

Parliament_Building,_Ontario,_Canada

Published in the Telegraph-Journal 16th November 2012

Finance Minister Jim Flaherty recently informed Canadians that the economy is growing more slowly than had been forecast.

This announcement could not have come as a surprise to anyone. Commodity prices are down, the euro zone remains a mess, the U.S. economy has not yet rebounded and some forecasts have the global economy growth prospects deteriorating in the near term.

All of this is a predictable consequence of the financial crisis that has continued for more than four years. Mr. Flaherty has responded to these realities by moving the federal government’s target for returning to balanced budgets from fiscal year 2015-2016 to 2016-2017.

Mr. Flaherty noted in his announcement that “despite the weak global economic environment, the government is on track to meet its commitment to return to balanced budgets over the medium term.” Many other nations would be thankful to have this bad news.

In the context of massive uncertainty and euro basket-cases, Mr. Flaherty’s announcement sounds eminently reasonable. So why are critics crying that Mr. Flaherty’s fiscal message represents nothing less than the end of the Conservative Party in Canada? And why is it that Conservatives are the harshest of these critics?

One answer comes down to party politics and looking ahead to the next federal election. Fiscal hawks in the Conservative caucus have been pushing for deeper and faster reductions in the federal deficit. The reasoning ostensibly is to give the party ammunition with which to campaign on a balanced budget in the next election. But federal government expenditure management has been more moderate as the economy’s growth waned.

While the objective of reducing the size of government remains a fundamental principle of Conservative ideology, its implementation has stalled. Reductions in departmental spending have eased and decreased transfers to the provinces are on hold, and no longer appear to be the highest priority in Ottawa. This means that Conservative hopefuls in the next federal election will not be able to wield a balanced budget as a weapon against their opponents.

To Conservatives who have subscribed heavily to the idea that fiscal austerity should be a hallmark of the party’s philosophy, compromise may propagate a credibility crisis. These Conservatives worry that they would have greater difficulty distinguishing themselves from Liberals and New Democrats.

The other answer is that Mr. Flaherty’s critics have an idiosyncratic perspective of the dynamics of the Canadian economy, the role that government plays in supporting growth and employment and how interdependent Canada is on its trading partners.

New job creation and growth depends largely on the private sector, where government’s function is deregulation and ensuring that government spending does not create an obstacle to that growth.

Restoring jobs lost by firms in industries that are in transition or temporarily under pressure is important as creating new jobs in new industries. In Canada, many of the companies experiencing slow growth – or no growth at all – are in the commodities sector, where prices are under pressure. These firms have experienced slower growth because of weakened global demand conditions, a decline in consumer incomes and low asset prices.

A prudent fiscal policy emphasizing a measured and gradual approach will help prevent the economy from falling into deeper or a more prolonged recession even if it does not please fiscal hawks. Macroeconomic stimulus also serves to preserve jobs in existing industries, which in turn serves to support new business formation.

While the economy remains weak, as is the case in Canada today, excessive austerity will delay growth and serve to act as a damper for job creation.

Mr. Flaherty is right to have chosen a moderate fiscal path.

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Filed under Euro Zone, Fiscal Policy

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