Yes, I was here with Professor Mintz when you had the last public meeting. Let history record, by the way, if it's true that we'll never be shaking hands again, that the last human being I shook hands with was Mr. Julian, after that meeting.
I'd like to take this time to address two subjects: looking back at how Canada dealt with past fiscal crises, and then looking forward on whether this is the appropriate time to restructure the economy. Using the projections from the PBO, federal spending is jumping from 15% to about 26%. Together with lower revenues, this inflates the deficit from 1.1% of GDP to 12.7% and raises outstanding federal debt from 31% to about 48%. The actual outcome is likely to be larger, but these estimates provide a good baseline for understanding the fiscal consequences of this crisis.
The most obvious comparison is with World War II. Federal spending initially jumped from 10.5% to 22.8% by 1941, with annual deficits hitting nearly 5% of GDP. Starting in 1942, the increase in government spending became enormous, hitting a peak of 48% of the economy in 1943 and boosting deficits to over 20% of GDP every year between 1942 and 1944. Despite sharply higher taxes, the federal debt soared from 22% to 160% of GDP during the war.
How did Canada cope with such a high level of debt? Initially, the government ran surpluses for six straight years after the war, as spending almost returned to pre-war levels but taxes did not. While some surpluses were sizable, averaging 3.6% a year from 1946 to 1948, equivalent to about $72 billion today, they totalled only 13.4% of GDP. Instead, most of the reduction of the debt load from 160% of GDP to 70% in the post-war decade reflected unexpectedly rapid growth as GDP nearly tripled in one decade.
Today, the prospect of a comparable surge of income growth seems remote. Instead, the model for lowering today's deficit is the austerity adopted after the 1994 debt crisis and the 2008-09 recession. Three-quarters of the deficit reduction after 1994 was achieved by lowering program outlays. The rest was from raising revenues. After the recession ended in 2009, the $43-billion federal deficit was eliminated entirely by reducing program spending.
Most economists advocate deficit reduction through spending cuts and not tax hikes. A recent IMF review of the literature found that spending cuts boost business investment while tax hikes dampen spending. By relying mostly on spending restraint, economic growth was sustained after both 1995 and 2009.
This year's extraordinary increase in government spending and deficits apparently does not deter some from seeing an opportunity to restructure Canada's economy. After all, it is tempting to ask, if we can command the huge resources needed to contain the pandemic, why not use the occasion to make fundamental changes to our society?
However, this thinking is flawed and undemocratic. The vast deployment of government resources in response to the pandemic was intended to preserve the economy as it was. The 11-point hike in government share of GDP was to replace household and business incomes, which collapsed almost overnight. This temporary income support was meant to keep labour and capital in place so these industries could resume normal operations as soon as the virus subsided. Making the increase in government spending permanent by financing programs such as a guaranteed annual income or green energy infrastructure projects would be counterproductive to this short-term goal and would harm long-term growth.
Restructuring the economy is problematic no matter what course the virus takes. If it does subside, either on its own or due to a vaccine, we would expect Canadians to resume spending on personal services. If on top of this we had a substantial increase in government spending, soon the economy would surpass its capacity limits. While not at full employment before the crisis, Canada was not several points below it either. The Bank of Canada estimated that the output gap was about 1% late in 2019.
On the other hand, if the virus disrupts spending for a long period, Canada faces a very difficult transition for its labour and capital. People little versed in economics warn of stranded assets in our fossil fuels, but that would pale by comparison with the hundreds of billions potentially stranded in aerospace, urban transit, hotels and commercial and office buildings. For workers, as widely noted, income and job losses have been concentrated in service industries with low levels of skill, education and pay. Restructuring would be a painful and costly exercise at a time when the economy is still struggling with the pandemic.
A more basic question is to ask whether Canadians want an economy restructured along these lines. In the short term, higher government spending is replacing some of the record decline in household spending, especially on services that form the basis of much social activity. However, humans are inherently social beings. Canadians spend substantial amounts on restaurants, hotels and the like, preferring a large variety of these activities at low prices. It is unlikely that people will permanently give up this network of social activities to finance a guaranteed income, green energy infrastructure or more health care.
At a minimum, plans to rebuild and restructure our economy need to be transparent so that Canadians can decide if they accept this trade-off on a permanent basis. A temporary willingness to make sacrifices during a crisis should not be confused with a permanent shift in preferences. In past crises, Canadians postponed consumption for the common good, but not forever. As World War II ended, a weariness with sacrifice resulted in the defeat of Winston Churchill and the near defeat of Mackenzie King. People wanted to spend on their personal well-being after two decades of pent-up demand. Similarly, austerity programs are best implemented quickly, before people lose the motivation for shared sacrifice.
Unless Canadians choose to lower their consumption for more government spending, plans to impose a restructuring look like another elitist attempt to tell ordinary people how to live. The pandemic supposedly made us more aware of the contribution of blue-collar workers, but the contempt of many for blue-collar consumption choices remains just below the surface. Even worse than slowing economic growth by diverting resources into less desirable activities, imposing such a choice undermines democracy.
Thank you.