Category Archives: Fiscal Policy

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

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

2013 May Not See a Recovery

euro parliament interior

Published in the Telegraph-Journal 14th December 2012

For more than three years, business scribes have been musing about green shoots, economists have been reporting rising output and investors have been realizing sizable returns on their equity portfolios. Aggregate statistics had it that the recession had been beaten and economies were on the upswing even though, for many households, this good news seemed like it was happening somewhere else. Millions of jobs have vanished in the U.S., many permanently. Home-loan defaults piled up and ongoing corporate restructuring rendered the future of many workplaces uncertain. On the eve of 2013, many are asking if the recovery that started in the last months of 2009 will bring more stable relief in the coming year.

The answer may be not be a simple one. It’s true that a temporary lift beginning in 2009 provided some relief. But there were two sources of this upturn. Factories that idled when global demand collapsed sparked to life to replenish inventory. Massive amounts of government monies were partial compensation for weak private sector investment. In conjunction with public spending increases, taxes were slashed and central banks dramatically reduced interest rates. These were band-aid solutions, but they kept the recession from being even more cruel.

In the waning weeks of 2012, warehouses are fully stocked. Production essentially is on hold and waiting for signs that a fulsome demand for appliances, cars and clothing can justify a return to full production. But there is little chance of that happening until nervous consumers reduce their debt and re-establish some optimism. This seems less likely as long as unemployment remains high. In the interim, governments will not be able to fund the recovery much longer. The financial system has been flooded with cash as many central banks have cut interest rates to or near zero. While public spending can remain high, in most countries further increases would not be practical. So 2013 may not be the year of recovery that many are looking for.

Some economists see a much darker potential future that may involve the dissolution of globalization. The euro zone is at the heart of this bleak picture. The euro zone’s GDP is forecast to move forward by less than 0.5 per cent in 2013 with Germany and France barely advancing. The economies of Greece, Spain and Portugal have been shrinking for more than four years. One consequence of this global disaster is that anger continues to mount with political leaders, even in those countries not directly experiencing the harshest elements of the recession.

“The really worrying thing is a 40 percent chance the euro zone might break up altogether…over the next couple of years or so,” said Robin Bew, editorial director and chief economist at the Economist Intelligence Unit.

European banks have traditionally been the source of approximately 80 per cent of trade financing in emerging markets. In the shadow of the financial crisis, Europe’s undercapitalized banks are being forced to repatriate that capital. It is not clear that U.S., Japanese or Chinese banks are in a position to fill the gap. Capital scarcity combined with the need for banks to retain more capital is inhibiting global trade financing. This in turn threatens to accelerate the process of deglobalization.

In the U.S. economy, these adverse conditions do not provide the economic environment necessary to achieve the level of robust growth required for full employment. More disturbingly, the increase in economic and political stress resulting from the weakening of globalization serves to increase investor uncertainty. The increase of investor nervousness has made the financial environment even more risk averse.

Globalization, with all its faults, drawbacks and shortcomings, has been at the centre of prosperity creation for more than thirty years. There have been suggestions that the globalization model may already be obsolete in the United States, where exports are less than 15 per cent of total trade and where rapid Chinese wage inflation, automation, robotics, new software-based cost-cutting manufacturing technologies and the precipitous erosion of the power of organized labour has created conditions not yet fully understood. This phenomenon should set off alarm bells everywhere. Globalization is at risk of destruction, with no replacement in sight.

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Filed under Economics, Euro Zone, Fiscal Policy

We Need More Debate On Fiscal Issues

fiscal drawing

Published in the Telegraph-Journal 27th November 2012

Coming soon

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The End has not Arrived for the Recession

Lehman Brothers

Published in the Telegraph-Journal 23rd November 2012

Coming soon

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Filed under Finance, Fiscal Policy

What Are the Limits of Government Spending Cuts?

higgs big photo

Published in the Telegraph-Journal 20th November 2012

Coming soon

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Filed under Economics, Fiscal Policy