Category Archives: Austerity

Moving From Debt to Growth

S&P

Published in the Telegraph-Journal 17th May 2013

The recent downgrade of New Brunswick to AA-minus from A-plus underscores the extent to which the global financial crisis continues to cast its shadow on local economies. Standard and Poor’s (S&P) outlook change took place in June 2011 when New Brunswick became the only province with a negative outlook rating.  According to the credit agency, even with the downgrading, New Brunswick maintained a very strong capacity to meet financial commitments.

At the time, S&P explained their downgrading this way: “Credit concerns include our view of the significant deterioration in the province’s budgetary performance since fiscal 2009 , which continued in fiscal 2011. In addition, New Brunswick’s relatively high net tax-supported debt burden, rose further in fiscal 2011 to about 33% of GDP from about 30.6% in the previous fiscal year. The province expects it to rise further to about 36% in fiscal 2012. The negative outlook reflects our expectation that New Brunswick’s budget plan will not be enough to return the province to a balanced budget position in the medium term.”

Although the downgrade has had no immediate impact on the province, the longer-term effects may be more profound, albeit manifested in subtle ways. Some of the effects of a ratings downgrade are straightforward and manageable. The underlying differences in fundamentals — the set of economic indicators, institutions and policy frameworks that shape the economic outlook — between an AA-minus and an A-plus bond arguably are only minor. Prudential regulations restrict some large institutional investors from holding any asset that is not rated A-plus but this is not an insuperable obstacle to investment.

A small change in fundamentals can result in a relatively large change in bond yields. If the change in yields is large enough and the stock of debt correspondingly high, there is the real possibility that the province could suffer a vicious circle of rising risk premiums and increased debt charges with the consequence of deteriorating economic performance.

There is an expectation that New Brunswick eventually will need greater access to capital to play a more active role in its economic renewal. To achieve this, the fundamentals will need to slant in the province’s favour. Government’s solution to the challenge to date has been to reduce government expenses to draw down its costs. It has been unable to engage in more aggressive austerity policies but additional reductions in health care costs will come with increased unemployment and slowed economic growth. The public policies that will support greater efficiencies — and which will provide real solutions to the growing constellation of health care challenges — will be more transformational than incremental. These policies will require budgets and long-term spending commitments, if they are to reduce costs over time.

To reduce the risk to the province, government would need to avoid introducing discontinuities in the set of policy choices in favour of smooth, orderly adjustments. This may require more time to achieve. Ratings agencies have confirmed their conditional confidence in the direction of the province’s finances. To some extent, the expected sequence of events that will eventually lead to the province’s financial health has already relieved some pressure on New Brunswick and delayed the implementation of greater austerity. The success of this strategy will depend in part on the ability of Finance Minister Blaine Higgs to gain traction on his deficit reduction plans. But success will additionally be predicated on economic growth.

This is where the province’s downgrade could have disproportionate and unexpected effects in the longer term. New Brunswick’s credit worthiness is a synthetic composite of risk and expectations about the future. The objective of government should be to move from current conditions characterized by concerns about the speculation of out-of-control deficits and growing debt, to a desirable equilibrium of improved public finances and a return to growth where government is a committed player.

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Filed under Austerity, Economic Growth, Fiscal Policy, New Brunswick

The Great Unwinding

IMF

Published in the Telegraph-Journal 10th May 2013

In an uncharacteristic show of pessimism, the International Monetary Fund (IMF) recently warned that an “uneven recovery is also a dangerous one” for the global economy. The IMF downgraded its growth forecasts for 2013 for a second time, while professing optimism of a substantial upturn in performance late in the year.

There is ample evidence that this pessimism is warranted. In its twice-yearly World Economic Outlook, the IMF outlined high medium-term risks arising from its skepticism about the euro zone’s ability to pull its way out of its crisis and of the ability of the U.S. to adequately reduce its public sector deficits and debt.

The IMF also recognized that some short-term risks have been reduced. Financial markets showed their approval of both the euro zone’s crisis management initiatives in 2012, and the eventual willingness of American authorities to come to terms with limiting automatic and rapid fiscal tightening under sequestration.

The IMF’s most recent downward revision was shared among emerging and advanced economies. The exception was Japan, where the IMF has become significantly more optimistic following the strenuous efforts of Tokyo to defeat deflation by revising its monetary policy.

We are beginning to see an important evolution of the IMF’s perspective over the past two years. Before 2011, it stressed how most economies were recovering at similar rates. But rather than viewing the global economy as a homogeneous entity, the IMF now believes that the world economy is running at three speeds. It views developing economies such as the BRICS as fundamentally strong. And its analysis has the performance of the U.S. improving while the euro zone lags among advanced economies.

This nuanced view of the global economy underscores how growth has always been uneven across economies and even within them. Projections by the IMF have been persistent in their optimism. Each setback has been treated as only a momentary deviation from the normal trajectory of inexorable growth. Rather than settle on an evaluation of the global economy as possessing structural weakness, each of these deviations have been assigned their own unique cause, whether the Greek bailout, falling prices in the wake of the Japanese tsunami or the uncertainty following Standard & Poor’s downgrade of U.S. debt. Optimists have been unaffected by these temporary setbacks and simply revised their forecast for 4.5 per cent world growth. The latest push-back is to 2015.

The central theme of this economic crisis is that it is a crisis of growth. Financial institutions and markets have long assumed that productivity would continue to accelerate at the pace of the late 1990’s. This is the assumption that fostered an asset-price boom that painted over a spectrum of risk to create an illusion of stability.

But the financial crisis served to unwind these artificial gains and in the process caused a great realignment across industries. This process affected regions unevenly and had no respect for companies that might have operated successfully in their markets for years. As demand declined in the wake of the subsequent recession, industries consolidated and retrenched, cutting costs until growth would return. When the recessionary pressures began to lift, new lower-cost or higher-productivity players had emerged. A new blueprint for competition had rendered the old rule-book obsolete. This is one of the chief reasons for the multi-speed recovery that the IMF now recognizes as the reality of the newest economy.

We are faced with the challenge of recognizing that the old rules no longer apply and that the new growth reality bears little resemblance to the old. In spite of this, policymakers have continued to benchmark the prospects of economic recovery to the growth performance of the pre-financial crisis period. The cardinal assumption underpinning this thinking is that we need not abandon the dynamics of past economic growth because they have merely been postponed and they will return. The greatest obstacle faced by policymakers everywhere is that we continue to justify postponing difficult decisions on the need for the resumption of the pre-crisis growth period.

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Troubling Signs on the Economic Horizon

washington

Published in the Telegraph-Journal 3rd May 2013

We didn’t need to review the data to know that the New Brunswick economy has not fared well in recent years. The combined effects of the decline of traditional industries such as the forestry, weakened U.S. markets in the wake of the 2007-2009 financial crisis and cutbacks in government-sponsored construction have resulted in low or no growth across the province.

The output numbers tell part of the story. The province saw GDP fall by 0.6 per cent in 2012 after increasing only 0.2 per cent in 2011. According to Statistics Canada, goods-producing industries fell 3.6 per cent with declines in construction, mining and the energy sector, while manufacturing declined 1.6 per cent. Services output barely rose at 0.4 per cent in 2012 with marginal gains in finance, insurance and real estate services.

Unemployment has maintained a persistently high level and sits at more than 20 per cent in much of the province outside the three cities in the south. Despite the efforts by the Alward government to reduce its costs, the fiscal deficit continues to grow as does the net debt. The latter has climbed to more than $10 billion.

The U.S. is New Brunswick’s most important export trading partner. A particular concern continues to be the American economy which has effectively stalled since the financial crisis.

On the face of it, an American economic recovery seems to be well underway. The U.S. GDP expanded at 2.5 per cent on an annualized basis in the first quarter of 2013, following marginal growth for the previous three-month period. But even this apparently positive figure masks other more disturbing signs that an economy whose recovery has not matched the pace of past expansions could now be facing a deceleration in its own modest growth rate.

In fact, adjusted for those changes due to temporary fluctuations in inventories maintained by corporations, the U.S. economy’s annualized growth rate shows a steady deceleration over the past three quarters, falling from 2.4 per cent to 1.9 per cent to 1.5 per cent. Other economic measures, from retail sales to the index of leading economic indicators, exhibit symptoms of fragility or even outright declines. The alarm has been sounded by numerous investors who are now concerned that the U.S. has entered yet another spring slowdown.

It is possible that the U.S. economy is merely in transition. But this time may be different. First, after adjustment for inflation, wage compensation hasn’t increased since 2010 and in the absence of higher incomes, consumers have been reluctant to increase their purchasing to pre-recession levels, even with record-low interest rates.

The weakened EU economies have made it much more difficult for the U.S. to increase growth by boosting exports. Today export sales are barely growing, and sales to Europe’s hardest-hit economies have actually declined.

In the interim, Washington’s dysfunctional politics has resulted in numerous unproductive policy moves, instead of the reforms that are sorely needed. And while the U.S. federal deficit has been significantly reduced, the sudden contraction in growth will serve to slow the economy even further, reducing growth in America’s economic output this year by as much as 1.5 per cent. That loss in economic activity will equate to 1.5 million fewer jobs.

In spite of the weaknesses in global economies, the New Brunswick government has admitted its spending cuts and the lack of major infrastructure projects on the horizon will impede economic growth in the province.

“Reduced levels of public sector capital spending along with the absence of any new major projects in the private sector will limit the contribution of capital investment to economic growth. As well, fiscal consolidation at all levels of government will serve to weaken overall economic growth.” Mr. Higgs said.

In the circumstances, it is critical for the government to revisit its commitment to what has become a counterproductive push for austerity. The New Brunswick economy shows little capacity for sustainable growth in the short term. It is necessary now to ensure that the capacity of the economy to recover in the medium term is not jeopardized.

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Filed under Austerity, Fiscal Policy, Job creation, New Brunswick, U.S.Economy, Unemployment

The Economy Isn’t Working As Planned

higgs-alward

A substantial amount of public support for fiscal consolidation is predicated on the assumption that profligate government spending has been responsible for fiscal deficits and debt. But New Brunswick is a clear example of how revenue shortfalls, as the result of lowered taxes, have conspired with too-low spending to create a fiscal imbalance. Policies aimed at reducing government deficits and debt accumulation have increased unemployment at the same time that they have been fiscally counterproductive.

Published in the Telegraph-Journal 26th April 2013

Today’s economy wasn’t part of David Alward’s plan. Before taking office in 2010, his campaign pledge was that he would “lower small business taxes, freeze power rates, increase the budgets for tree-planting and woodworkers, and put more decision-making power into the hands of local economic development agencies” to restore the province’s economic health.

Three years later, the health of the economy has scarcely improved. The most stark evidence of this failure is on the fiscal side. Standard & Poor’s Rating Services downgraded New Brunswick’s credit from its A-plus grade to AA-minus over fears of its high tax-supported debt and the long-term demographic trends facing the province. In 2009-2010, New Brunswick had the second largest deficit in Canada as a proportion of GDP and it has been growing steadily. The interest on the net debt reached $643 million in 2010-2011, even with record-low interest rates. The rating agency says the Alward government is on the right track to turn the situation around. But it is clear that fiscal consolidation has become mired in the reality of near-zero GDP growth.

New Brunswickers are acutely aware that things aren’t working as planned. Since 2010, unemployment has risen to over 10 per cent, real wages have fallen and despite record-low interest rates, businesses are not investing. The federal government has made changes to Employment Insurance prompting Premier Alward to call for a moratorium on the new provisions until more study is done on their impact. The response of a record number of New Brunswickers to the moribund economy has been to join those who already have sought more favourable employment conditions in Alberta, Saskatchewan and Ontario.

New Brunswick joins those jurisdictions in which the practices of fiscal consolidation have only worsened an already bad set of economic conditions. Even austerity hawks have begun to reconsider whether the cure is more onerous than the disease. The International Monetary Fund said this month that “it may be time to consider adjustments to the original fiscal plans.” The IMF may have been referring to Great Britain, but the observation is equally relevant to New Brunswick.

The question is what kind of adjustments would work in New Brunswick at this stage. Mr. Alward and Minister of Finance Blaine Higgs blame the fiscal situation on years of profligate government spending. Mr. Higgs has on numerous occasions said that the government plans to stick to the economic course it has set which focuses on reducing government expenditures to kick-start growth.

A growing chorus of economists and policy makers argue that there are some things the government could do to spur growth without risking a large increase in the budget deficit. The simplest would be an injection of investment in infrastructure such as roads, bridges and schools. The logic is that such projects create jobs and generate business investment. They could get off the ground almost immediately, yet would not add significantly to the deficit because they are financed by long-term borrowing. There are a significant number of infrastructure projects across the province that would meet an urgent need, from the building of water treatment facilities to hospital improvement to school repair. Each of these projects eventually will need to be undertaken anyway but with record-low interest rates, these projects today represent a real bargain.

The challenge even to this relatively modest undertaking is that infrastructure development requires government funding. Government however, has borrowed beyond its ability to pay, at least according to the bond ratings agencies that are watching this province closely. This offers the politically partisan opportunity to criticize Mr. Alward and his party but New Brunswick has supported heavy government spending for far longer than Mr. Alward has been premier. New Brunswickers today enjoy the legacy of substantial government spending in health care, education, roads and pensions. But this has occurred at the same time that taxes were reduced to levels that ultimately have proven to be unable to sustain this spending.

Mr. Higgs is right that unbridled spending has been the primary cause for the province’s financial mess. But increasingly, being right may not be enough.

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Filed under Austerity, Fiscal Policy, New Brunswick, Unemployment

Where’s the Recovery?

senate

A key reason that the economic recovery has been unable to gain momentum is that our policies have been doing precisely what basic macroeconomics says we shouldn’t do. By cutting government spending in the middle of an anemic economy, we’ve been engaging in a self-destructive process calculated to increase long-term unemployment. Austerity policies are counterproductive not only from the perspective of growth and employment but even in strictly fiscal terms.

Published in the Telegraph-Journal 23rd April 2013

Just when it seemed that the U.S. economy was finally on the right track, it has again lost momentum. And in the process, America’s wobbly economic performance has shaken confidence in the prospect that the world’s economies could rise above the anemic performance that has characterized them for more than four years.

The year started well enough in the United States. In the face of a sizable tax increase on January 1st, employment, retail sales and housing all improved substantially in January and February. GDP grew at an estimated annualized 3 per cent in the first quarter while stock markets reached new highs.

The bottom fell out in March. Employment growth, reaching an average of 208,000 in January and February, slowed abruptly to register only 88,000 in March. Retail sales declined as did new construction starts on single-family homes. The dip in housing activity is especially problematic since fundamental determinants, such as low mortgage rates and lean inventories, and an increase in the household formation, had been pointing to continued gains.

Predictably, the economic slump in the U.S. has had its impact in Canada. The Canadian economy lost more than 54,500 jobs in March 2013, according to Statistics Canada. That figure pushed Canada’s jobless rate higher to 7.2 per cent and represents the worst month for Canadian employment since February 2009. In addition to January and February job statistics, the latest numbers show that the Canadian economy has lost more than 26,000 jobs in 2013.

Explanations for the American decline ranged from the possibility that government statisticians failed to adjust the economic data for seasonal effects to the impact of different hiring patterns between large and small firms. Neither of these explanations is persuasive and in any event fail to take into account why economists have been so wrong in their job forecasts over the last 18 months.

The likelihood that the sputtering American economy is the consequence of a single or even a concatenation of misfortunes is extremely low. We are better off to blame global incidents such as those in Cyprus or North Korea or the instability of oil prices, though none of these credibly explain the scope and scale of America‘s weakness.

The more likely culprit is austerity. Stalemates in Congress have resulted in the expiry of a payroll-tax cut and the imposition of higher income taxes on the wealthy which will cost American taxpayers $150 billion in higher taxes in 2013. A similar lack of Congressional resolve resulted in the “sequester” which on March 1st brought across-the-board federal spending cuts worth $85 billion in the current fiscal year. Economists who have been critical of austerity, such as Paul Krugman, have remarked that the American economy may now be less resilient in the face of austerity than it was when austerity measures were first imposed.

Despite the stalling economy, the stock market has, in the main, shrugged off the bad news. This further reinforces the claim that the performance of stock markets bear no relationship to the actual economic experience of most Americans. Moreover, there is emerging evidence that large companies are faring much better than small firms. A substantial number of these large firms operate offshore where the benefits of their growth and profitability do not contribute to the health of the American economy directly. That large firms expend far more lobbying dollars on Congress than their small company counterparts will come as no surprise to critics of Beltway politics.

It is clear that the U.S. economy has not shrugged off the effects of austerity. Instead, it still limps along with growth hovering around 2 per cent. At some point, the evidence that austerity has not achieved its stated objectives will become too difficult to brush aside. For millions of unemployed, this moment cannot come soon enough.

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Filed under Austerity, Economics, Income Inequality, Unemployment