COVER

From Pain to Economic Gain

The budget-slashing era is almost over

ROSS LAVER June 9 1997
COVER

From Pain to Economic Gain

The budget-slashing era is almost over

ROSS LAVER June 9 1997

From Pain to Economic Gain

The budget-slashing era is almost over

ROSS LAVER

On the surface, not much has changed: the Liberals are back with a majority, the opposition is fractured. But in one respect, Jean Chrétien’s second mandate promises to be radically different from his first—unlike any, in fact, since the late 1960s. Within the next two years, if present trends continue, the federal budget should cross over from deficit to surplus, a situation that last existed in 1970. The era of tax hikes and spending cuts will be over. No longer compelled to play the role of grinch, the finance minister will confront a new challenge. Should Ottawa cut taxes or raise spending—or both?

If that sounds too good to be true, wait—there’s more. Economic forecasters here and abroad say that, barring any nasty surprises, Canada is poised for several years of robust economic growth, aided by low inflation, low interest rates and strong exports.

Already, the expansion can be seen in increased manufacturing activity, retail sales and housing starts. And before long, the pickup in business and consumer confidence should start to make a dent in Canada’s 9.6-per-cent unemployment rate. An April survey of 1,200 executives by Dun & Bradstreet Canada found corporate hiring expectations higher than at any point since the 1980s boom. Another key indicator, Statistics Canada’s index of help-wanted ads, has risen 17 per cent in the past year, a pace last seen in 1988.

In part, the economy’s strength is an inevitable product of the business cycle. But the positive outlook also owes much to Ottawa’s suc-

FEDERAL DEBT

(% of GDP)

FISCAL PAYOFF

(in billions of 1996 dollars)

Estimated federal - surpluses, assuming no change in spending and taxes

cess in taming the deficit and the consequently improved view of Canada on international money markets, two factors that have given rise to what economists call a “virtuous circle.” As the national balance sheet strengthens, investors gain confidence in the country’s future. That bolsters the dollar and allows interest rates to fall, which in turn lowers Ottawa’s cost of servicing the $593-billion federal debt. Lower rates also promote stronger growth and higher government revenues— causing the deficit to fall even faster.

The turnaround has been dramatic. From $42 billion in 1993-1994, the deficit dropped to $14.8 billion in the fiscal year that ended on March 31. John McCallum, the Royal Bank’s chief economist, expects a $6-billion shortfall in 1997-1998, followed a year later by a $2-billion surplus. If Ottawa then left spending and taxes unchanged—an admittedly unlikely scenario—the accumulating surpluses would be enough to pay off the debt entirely by 2018.

McCallum’s own view is that, once the deficit is eradicated, Ottawa will keep its budget roughly balanced through a blend of tax cuts and higher spending—both of which would fuel economic growth. Based on conservative assumptions—eight-per-cent interest on the debt, two-per-cent inflation and three-per-cent growth in real gross domestic product—McCallum sees the debt declining to 30 per cent of GDP by 2018 from 74 per cent today. All the while, interest payments on the debt would be falling—enough, eventually, to cut personal income taxes in half or increase federal spending by a third relative to GDP. “Politically, we’re entering a very different environment,” McCallum says. “In the past, finance ministers had to convince Canadians to accept pain. In the future, the debate will be about how to distribute the gains.”

What threatens this sunny forecast? The biggest single danger is another constitutional crisis, which would frighten off foreign investors and prompt the Bank of Canada to jack up interest rates to protect the dollar. An inflationary spurt, either here or in the United

States, would also push up bor-

rowing costs, forcing Ottawa to pay billions more in debt-servicing charges. Finally, the U.S. economic expansion, now six years old, is getting a bit long in the tooth by historic standards, and some analysts argue that it rests on a mountain of consumer debt. If the United States goes into an economic tailspin, Canada is sure to be dragged down with it.

Those are the risks, but the overall picture is bright. By the time the next referendum rolls around, Ottawa may well boast a balanced budget and be in a position to start cutting taxes. If so, the prospect of independence—and all the uncertainty that implies— will likely have less appeal to the 30 per cent of francophones whom pollsters call “soft nationalists.” For the Liberals, that in itself is reason for optimism—not to mention the fact that a tax cut at the start of the new millennium would position the party nicely for the next general election. □