When the global recession hit in late 2008, economic output and employment fell so steeply in such a short period of time that policy-makers were seriously concerned about the possibility of the downturn growing into a global depression. The sense of urgency led to unprecedented levels of multilateral economic coordination, with stimulus spending rolled out worldwide and significant deficits incurred by nearly all governments.

A year and a half later, we seem to have dodged the bullet of a global depression. Many will agree that what likely saved us is the coordinated global stimulus packages. Others, however, argue that it was all much ado about nothing and the global economy would have bounced back without government spending. Who’s right?

It’s easy to write off the concerns about a deep and prolonged recession once the recovery has began. Unfortunately (or fortunately?), we cannot observe what the global economy would look like in the absence of the massive inflows of government spending, so this debate will not be resolved empirically.

It seems very likely that the governments’ willingness to step in and do what it takes to avert a potential disaster played an important role in boosting business and investor confidence. Without confidence about the future, and without much eased credit conditions and record low interest rate, business investment could have dried up for much longer. Business “investment intentions for 2010 remain modest and largely driven by the public sector,” observed Mark Carney (the governor of the Bank of Canada) in a speech to the Ottawa Economics Association on March 24. Yet, the role of stimulus spending on consumer and business confidence cannot be measured.

Other stimulus impacts are measurable and they provide strong evidence that the stimulus worked, both globally and in Canada. Institutional and government construction remained a beacon of light for the construction industry when commercial and residential construction plans were put on hold during the recession. In addition, the role of the public sector in keeping employment levels afloat cannot be denied. Most of the job creation that we’ve seen over the past six months comes from public sector employment, while the private sector is still shedding jobs. The automatic stabilizers of employment insurance and welfare helped stabilize household incomes to some extent, although they could have done a lot better if it was easier to qualify for these programs.

The federal stimulus package was far from perfect. As we’ve argued on this blog previously, the stimulus would have had a larger impact if it was bigger, less focused on tax cuts, and better targeted to projects with long-term payoffs for the country (think green infrastructure, universal early child care and education programs and poverty reduction initiatives). But without the stimulus, Canadians would have been a lot worse off.

The report earned the scorn of Federal Finance Minister Jim Flaherty, who called it ”poorly done and it’s wrong” in the Vancouver Sun.  His overall assessment?

“You know I just — I’m disappointed that the [Fraser Institute's] work is as shabby as it is.”

Let’s take a closer look at the actual report and examine the claims made and the statistical evidence used to back them up.

To come to the conclusion that “government investment did not contribute to the turnaround during this period [the second half of 2009],” the Fraser Institute researchers engage in a simple growth accounting exercise, breaking down the change of GDP growth in the last two quarters into its four components. Every first year macroeconomics student would be familiar with the growth accounting equation:

GDP = G + I + C + (X-M)

In plain English (for the non-economist readers), this translates to:

Total economic output = Government spending (or consumption) + Investment (both government and business) + Private consumption + Net exports (the total value of all exports minus the total value of all imports)

Statistics Canada measures and reports on each of these four components on a monthly basis, and it also compiles the data into quarterly and annual reports. The Fraser Institute researchers looked at the numbers for the last three quarters of 2009 and found that government spending and investment played a relatively small role in Canada’s economic recovery so far.

On the surface, this seems to make sense – Canada is a small open economy and global conditions (such as commodity prices and demand for our exports) drive our economic fortunes to a large extent. Global forces started the recession and we cannot sustain a strong domestic recovery without an improvement in the global economic conditions.

In fact, I agree with the Fraser Institute’s assessment that the government cannot claim exclusive credit for the speed of the recovery, just like it cannot be blamed for the recession in the first place. Along those same lines, we should acknowledge that the BC boom in the late 2000s was driven by high commodity prices and growing demand for our exports, rather than by the changes in domestic tax rates or the government’s economic management (although you won’t hear the Fraser Institute staff make this argument).

However, while the government did not single-handedly drive the recovery, they can and should claim credit for cushioning the blow of the recession. Both the federal and provincial governments stabilized employment and personal incomes (and thus consumer spending) by maintaining operating expenditure levels despite the reduction in their revenues. The federal stimulus package was arguably too small to make a very big dent and there were delays in rolling out the actual spending, but without it things would have been a lot worse. Note, for example, that almost all of the recent gains in employment have come from the public sector, while the private sector continued to shed jobs in February, according to Statistics Canada’s latest release from the Labour Force Survey. How much higher would unemployment rates have climbed if the government listened to the Fraser Institute’s advice to balance their budgets by cutting spending?

Government spending filled part of the gap opened by the decline in business investment and private consumption during the recession. With public spending at less than a third of Canadian GDP, the government cannot be expected to fully offset the drop in business investment or private consumption. Their job is to smooth out economic fluctuations by spending counter-cyclically and this is precisely what they did this time. The Fraser Institute researchers do not find evidence of that because they do not look. They focus their attention exclusively on the last two quarters of 2009, when recovery is starting to take hold.

There are a number problems with their analysis.

1) They misuse the growth accounting equation to derive conclusions that are beyond the scope of the equation. All the growth accounting equation tells us is how individual GDP components changed each period (i.e. did they rise or fall), it does not tell us why.

2) They assume that contemporaneous correlation equals causation (and this one is a classic concern in social sciences). The Fraser Institute reports looks at what variables change between two quarters and argue that these must be causing the observed change in GDP growth. This simplistic analysis neglects indirect effects that the stimulus spending may have had on consumer and business confidence, for example. The report authors also fail to account for a number of other government interventions which could conceivably explain some of the GDP growth, such as the swift monetary response from the Bank of Canada, which lowered interest rates and eased credit conditions undoubtedly contributed to improving the climate for private investment.

3) Two quarterly observations do not provide sufficient data to derive meaningful conclusions about the drivers of economic growth in BC, particularly so when the numbers fluctuate so widely from quarter to quarter (compare figure 2 and figure 3 in their report).

Business investment contributed 1.0 percentage points to GDP growth between the 2nd and 3rd quarter, but -0.6 percentage points between the 3rd and the 4th quarter, offsetting the previous quarter’s gains by more than half. Similarly, net exports were a drag to the economy in the 3rd quarter but a boost in the 4th. Which way these numbers will go next quarter only time can tell.

Looking at annual data provides very different conclusions. Statistics Canada reports:

Real GDP fell 2.6% in 2009, as exports dropped 14% and business investment in plant and equipment fell 17%.

and later on:

Final domestic demand recorded a 1.7% decline, largely due to a 17% drop in business investment in plant and equipment. Consumer spending edged up, as a result of a 1.1% increase in expenditures on services. Consumer spending on durable and semi-durable goods declined 2.8% and 2.9% respectively. Government current expenditure on goods and services grew 3.0%, and government capital expenditure increased 13%. [empasis added]

It’s clear from the annual data that without the government stimulus spending, the economic decline in 2009 would have been far greater. It’s quite possible that government stimulus spending provided the necessary conditions for increased private sector spending, thus indirectly driving economic growth. For example, both the federal and provincial governments made it very clear that they are prepared to step in and avert the worst consequences of the recession even at the cost of budget deficits. This certainly helped restore business and investor confidence and opened the door for private sector investments that may not have been undertaken otherwise.

The Fraser Institute report finds that net exports were the main economic driver in Canada during the 4th quarter of 2009. Unfortunately, this wasn’t the result of a strong rebound in our export sector – exports continue to suffer from the high Canadian dollar – but of “a slowdown in the growth of imports of goods and services.” Lower imports means weaker domestic demand. This is hardly the foundation for a strong private sector recovery brewing.

Indeed, it’s too early to conclude that the private sector would be able to take off on its own should the stimulus be withdrawn. We need to be very careful about scaling back public spending next year to avoid slipping back into a recession.

I’d love to be able to tell you that the government has come to recognize the multitude of problems of this model of providing public infrastructure (which have been described at length in other posts), but I don’t think that’s it. And while it was the financial crisis which made it considerably more difficult and more expensive for the private sector to secure financing for these type of projects, I think it’s stimulus spending that is killing the P3.

You see, two decades of spending cuts in Canada (and many other Western countries such as the UK and Australia) resulted in chronic underinvestment in public infrastructure. At a time when raising taxes or running deficits amounted to political suicide, it’s hardly surprising that governments would be tempted by the idea that they could provide much needed public infrastructure without having to put the money up-front (by using a P3). This, in my view, was the big attraction of the P3 model for governments.

I doubt that high-level bureaucrats were not aware that P3s cost more over the long-run and that they expose taxpayers to higher risk over the lifetime of complex 30 to 40 year-long contracts, but as long as they weren’t prepared to raise taxes or run deficits, what other options did the government have?

Now that it is once again politically acceptable and even desirable to run budget deficits and to spend public funds on infrastructure projects, the model looks like it has outlived its usefulness (at least temporarily). It’s no longer worth the government’s effort or political capital to have to come up with ways to rationalize the cost overruns and project downsizing that have aroused considerable dissatisfaction with the outcomes of many P3s.

But until the public realizes that there is no such thing as free public infrastructure and that we all have to pay for the roads and hospitals we rely on, governments will be tempted to engage in short-sighted deals like P3s, putting short-term considerations ahead of long-term gains.

The problem with this question is that it allows for two options only, framing the policy decision as a choice between the proposed government investment project or the current status-quo. Yes, spending money on a new Port Mann bridge is probably better than not investing in infrastructure at all, especially during a recession. But the real question we need to ask is what is the best use of these $3.1 billion dollars of public money (the current cost estimate on the bridge construction) and would another project serve British Columbians better.

A recent article in the Tyee highlights the fact that alternatives exist with its provocative title: Want One Port Mann Bridge, or a Light Rail Metropolis. The article reports that Professor Patrick Condon and researcher Kari Dow at the UBC Design Centre for Sustainability have calculated that the money earmarked for the Port Mann construction can pay for

… a 200-kilometre light rail network that would place a modern, European-style tram within a 10-minute walk for 80 per cent of all residents in Surrey, White Rock, Langley and the Scott Road district of Delta, while providing a rail connection from Surrey to the new Evergreen line and connecting Pitt Meadows and Maple Ridge into the regional rail system.

In the end of the day, we need to balance our immediate needs for job creation with our longer-term goals, such as facing up to climate change and building a more environmentally sustainable society. Rushing to throw money at shovel-ready projects simply for the sake of increasing government spending may well be cheating us out of opportunities to restructure our infrastructure system to meet the needs of a future greener economy.

There is no substitute to carefully considering the longer-term implications of the choices we make if we want to ensure that short-term gain doesn’t leave us with long-term pain.

Case in point: as reported in the Sun, the government is announcing a $187 million road upgrade from Fort Nelson into BC’s oil and gas fields. This initiative will create 1,100 jobs, but is a blatant subsidy to the oil and gas industry, the source of 20% of BC’s greenhouse gas emissions (much more if we were to consider the emissions from burning that fuel out of province). Environmental NGOs have long been critical of subsidies to the oil and gas industry, and rightly so. What if the government lived up to the aspirations of its Climate Action Plan and put $187 million into green retrofits of buildings and alternative energy development?

Another obvious case is the $5 billion Port Mann super-bridge (well, $3.3 billion and rising). Its effect will be to create even more suburban communities up the Fraser Valley, locking in an unsustainable form of development for generations, and quite possibly at the expense of some of the best farmland in the province, which we will need down the road. The bridge will create lots of jobs but would we not be better off if we created those jobs as bus drivers by buying more buses to get people over the existing bridge more efficiently?

Economic and Fiscal Outlook

My own view is that the economic picture in BC is worse than what is in the budget. While premised on a 0.9% drop in real GDP in 2009, the budget assumes a rebound arriving in 2010. Given the state of housing starts, commodity prices and the state of export markets, I am more pessimistic and as a result it seems to me that the budget does not do enough.

The budget’s optimism is reflected in the projections for unemployment, which is assumed to average 6.2% for 2009. But unemployment recently surged by almost one full percentage point in January 2009, to 6.1%, and is two full percentage points higher than a year ago. The budget’s estimate of 11,000 job losses for 2009 is one-third as much as we lost in January alone. My best guess is that unemployment will close to year in the 8-9% range, as the job losses pile up.

The government’s economic forecasts translate into a $495 million deficit in 2009/10 and $245 million in 2010/11, before rebalancing in 2011/12. These deficits are relatively small compared to the total budget: the 2009/10 deficit amounts to only 1.3% of total revenues. For a government so committed to fiscal conservatism, this is a small bridge to cross, so you wonder why they bothered convening the legislature early to amend in embarrassing fashion their own balanced budget legislation.

Perhaps because those deficits may be much larger before this is all over. Spending pressures for social assistance could rise much more than currently forecast (see below). A challenge is in interpreting the government’s revenue forecasts. In years past, tax revenues have been grossly understated leading to large “surprise” surpluses at the end of the fiscal year compared to budget time. This year those revenue projections look to be more reasonable, although it will be interesting to see what the final tallies for 2008/09 will be to get a more accurate baseline (we will not know until summer). That said, given the recession, the budget projects an increase in some tax revenues predicated on growing personal income of 1.7% and growing consumer expenditures of 1.9% in 2009. This seems unlikely, and so we could easily see bigger deficits before this is all over. Added to this is the fact that there are no forecast allowances in this year’s budget, because that would make the deficits look larger (it was only OK to make surpluses look smaller).

In terms of stimulus, there is almost none in this budget. BC’s GDP is just under $200 billion. A deficit of $495 million is a mere quarter of one percent of provincial GDP. Because the deficits is due to falling revenues arising from the recession, it is not really a stimulus. Instead, and as anticipated, any stimulus is in the capital budget, up $1 billion in 2009/10 from 2008/09 – or half of one percent in new stimulus. The “new money” in 2009/10 compared to the previous baseline is slightly larger, an increase of $1.4 billion. Total new money for capital spending over the entire 2008/09 to 2010/11 period amounts to an increase of $2.6 billion over previously announced figures.

Capital expenditures get amortized in the operating budget over several decades (the lifetime of the asset in question), an accounting convention that creates an incentive to “hide” spending measures outside the operating budget. The consequence is that we are biased towards bricks and mortar at the expense of funds to provide the services therein.

Getting details on all of this new capital spending is more difficult as there is no list of projects, and much of the detail in the budget lumps old money in with new, and is allocated over multiple years. The province will match the anticipated federal contribution to infrastructure of $1 billion from last month’s federal budget for a total of $2 billion in infrastructure, over three years (technically the federal money is supposed to spent within two years, so it is not clear why this is allocated over three).

These numbers are much lower than the $14 billion touted by the government, as most of the budget is re-announcing old money, not new money. Also in the budget is the new roof for BC Place, at a cost of $365 million (during the Q&A, Hansen argued that future real estate sales will pay this money back). And that entire budget has extremely little in support of public transit, social housing, residential care, areas that are in desperate need of a public boost.

On the other hand, it deserves mention that the new Port Mann Super-Bridge is not accounted for in this budget. This is a $3-5 billion project that will be financed by tolls. Even though the government is putting up one-third of the financing to the private bridge developer (yes, it is that stupid), there is nothing on the books about it. The new PM will create jobs and is an additional aspect of stimulus. But ultimately a dumb one that undermines any lofty climate change objectives the government might still have.

Bottom line: Total taxpayer-supported (excluding self-supporting Crowns) debt-to-GDP rises from 13.8% to 15.2%, and on a total provincial debt basis rises from 18.7% to 20.4%. These levels of debt are very low compared to other provinces and to BC’s own history, so there is not much to be concerned about in terms of higher debt. Indeed, there is much more capacity to make strategic investments than is being let on.

Expenditures

In terms of program expenditures, current year (2008/09) expenditures are up almost half a billion dollars. Our last glimpse of projected expenditures (from the first quarter update last September) put them at $39 billion in 2009/10 and $40.6 billion in 2010/11. The new numbers are $39.3 billion in 2009/10, an increase of $280 million, and $40 billion in 2010/11, a CUT of more than half a billion.

A big story in the budget is $1.9 billion of “administrative and other cost savings” over three years that reallocated to other priorities. This is the “belt-tightening” part of the budget, and it is poorly explained. For example, $589 million in savings are identified in 2009/10, but information is only provided that accounts for $297 million, leaving the remaining $292 million unaccounted for, as well as any information about savings in future years. On top of that there are extra “efficiencies” that need to be found of $125 million in 2010/11 and $250 million in 2011/12.

Health care fares the best of any sector in the budget, with an increase of 5.7% in each of the next two years. Little of this is new money, however – only $25 million is added to the figure tabled in Budget 2008.

K-12 funding has been cut relative to the allocation from last year’s budget, a striking development given recent concerns about budget shortfalls for school districts. Overall, K-12 funding increased by 1.5% in 2009/10 and 0.7% in 2010/11, amounts that are not sufficient to keep up with cost pressures and will thus lead to further budget cuts down the road. The difference seems to have been handed over to the post-secondary sector.

The budget plans for a small increase in social services budget, including social assistance (a rise of $47 million in each of the next two years). Given the downturn and a 50% increase in unemployment over the past year, the budget projects only a small rise in temporary assistance caseload of 6%, and for the total caseload a projected increase of 4.6%. These numbers could easily swell due to the recession, leading to a higher deficit. But the budget increase is only due to the slightly higher caseload; there are no major changes to the welfare regime, nor any new actions to combat homelessness.

Yesterday’s Throne Speech made a big deal about aboriginal reconciliation but the budget shows that the Ministry of Aboriginal Relations and Reconcilation will get a budget cut of about $9 million, or 18% below last year.

The budget for Tourism, Culture and the Arts is cut from $349 million in 2008/09 to $55 million in 2009/10. Presumably much of this pre-Olympic work can be done through Vanoc, which is not covered by the operating budget.

The Ministry of the Environment also received a budget cut, even though it now has new responsibilities for the Climate Action Secretariat. If the government’s green agenda was sincere we should have seen an increase in the MOE budget, and this neglect makes me think that BC’s legislated GHG reduction targets are about as safe as the government’s balanced budget legislation.

Revenues

There are no new tax cuts in the budget, and the carbon tax will continue as previously planned. This will amount to another penny per litre at the pump come July. I was looking for a revamping of the low-income credit, scheduled to increase only by 5% in July 2009, compared to an increase in the carbon tax of 50%. The budget only commits to increase the credit by 10% as of July 2011. The sum total of these moves is that the carbon tax becomes regressive in 2009/10 and thereafter.

The budget also contains carbon tax rebates for local government, worth $15 million over four years.

As mentioned above, the tax revenue estimates seem much more realistic than in previous budgets, although perhaps too optimistic in some areas. Tax revenues rise and fall with the state of the economy, so much will depend on how the next couple of years goes.

The revenue side of the budget is also helped out by a bump of $400 million in 2009/10 in federal transfers compared to previously announced amounts, and almost $500 million in 2010/11.

But, to stimulate the economy, surely we need to invest in both social and physical infrastructure. Lets take child care as an example. A provincial commitment in tomorrow’s budget to begin building a universal, quality publicly funded child care system will create construction jobs – just like other traditional infrastructure investments. But, it will also create jobs for women - who are the overwhelming majority of BC’s early childhood educators. nvestment in child care will also make it possible for parents to work or go to school to train or retrain. And, most importantly, an investment in child care will support children’s development – something that is even more important now that families are stretched and stressed. 

I can’t think of a better way to stimulate the economy and build strong communities.  Can you?