Business

Mister Prudence

JOHN GEDDES,MARY JANIGAN August 31 1998
Business

Mister Prudence

JOHN GEDDES,MARY JANIGAN August 31 1998

Mister Prudence

Business

JOHN GEDDES

MARY JANIGAN

Finance Minister Paul Martin has a knack for turning bad economic news to good political effect. When he was planning his assault on Canada's deficit in early 1995, the financial meltdown in Mexico threw markets into turmoil, driving down the Canadian dollar. Martin used that crisis to persuade reluctant Liberals that deep spending cuts were needed to restore international confidence in the economy. This year, grim economic news from Asia and Russia, coupled with renewed worry over the Canadian economy’s slowing momentum, has again undermined the loonie, which closed last week at 64.74 U.S. cents, another record low. Again, Martin is using the unsettled climate to help manage expectations. With a multibillion-dollar surplus mounting on the books, the appetites of many politicians have been whetted for new spending. Martin is countering that clamor for cash with caution. ‘When something like the Asian crisis comes along, yes, it’s going to affect our numbers,” he told Maclean’s. “But because we were prudent, we’re OK. I never believed that we were going to have these huge surpluses that people were talking about.”

Martin’s predicament is that he faces increasingly insistent calls for more cash and large tax cuts at a time when slowing economic growth may erode federal tax revenues. Most private economists are still predicting large federal budget surpluses, starting in the current 1998-1999 fiscal year and growing through the rest of the government’s mandate, which ends in 2002. Although Martin’s officials do not deny that there will be surpluses, they warn that many private forecasts of the size of the surplus, which range up to $10 billion in 19981999, may now be overly optimistic. They will not, however, provide their own estimates. Political insiders are acutely aware of what Martin is attempting, and the tightrope he must walk. “It clearly serves Paul Martin’s interests to dampen expectations,” says Toronto-area Liberal MP John Godfrey. “On the other hand, he can’t overdo it. If he were too gloomy, that would have a self-fulfilling prophetic quality. The dollar wouldn’t hold up.”

BUDGET PLANS

Maclean’s has learned that Finance Minister Paul Martin is considering the following proposals for presentation to the cabinet:

>No mini-budget this fall.

>New spending in the 1999-2000 budget would focus on only one area: health. Ottawa is prepared to give the provinces more money in return for a promise to spend it on basic care.

)► Postponement of plans for a federalprovincial home-care program.

>Renewing his commitment to pay down the $583-billion federal debt.

>No across-the-board cuts in tax rates. >An increase in the basic personal exemption, now set at $6,456.

>Adjusting tax brackets so people can earn higher income before paying more of it to the government.

Prudence, finance officials say, is the watchword. In his interview with Maclean’s, Martin touched on the need for spending in health, education and research but put more emphasis on the need to shrink the size of the $583-billion debt in relation to the size of the economy and on the need to bring taxes closer to lower U. S. levels. “We have got to get that debt-to-GDP ratio down substantially,” he said. ‘We have got to get ourselves more competitive from a tax point of view.”

To that end, Maclean’s has learned, Martin wants to limit any major new spending in his budget for 1999-2000 to health care—despite demands for more funds from almost every ministry. He is unwilling to offer across-theboard cuts in personal income taxes—because it might be almost impossible to raise taxes again if need be. Instead, with backing from Prime Minister Jean Chrétien, Martin is considering an increase in the basic personal tax exemption—now $6,456—or increases in the amount that taxpayers can earn before they move into higher tax brackets. Insiders add that the continuing turmoil in stock markets will not push Ottawa into such precipitous action as a fall budget and a dose of economic stimulus from large tax cuts. “There is a great fear now that expectations will outweigh the government’s ability to deliver,” warned a finance department insider. “That is more true on tax cuts than it is anywhere else. We have got to get those expectations down.”

Martin clearly sounds like someone beset by contradictory pressures. In his remarks to Maclean’s, he carefully balanced every expression of confidence in the economy with an on-the-other-hand warning about the need for caution in light of the economic situation in Asia. The confident upbeat side is aimed squarely at financial markets, which have traded down the dollar. The more cautious side appears to be directed at politicians who are demanding higher spending. That caution was reinforced by more bad news last week. The CIBC and Canada Trust raised mortgage rates for the second time in three weeks and Statistics Canada reported that corporate profits, a key indicator of economic health, fell for the second consecutive quarter. Meanwhile, the Alliance of Manufacturers and Exporters Canada warned that economic growth may slip to 1.5 per cent next year from this year’s 2.8 per cent.

FEELING THE ILL EFFECTS

Financial markets have been in turmoil this summer as the economic crises in Asia and Russia take their toll. Finance Minister Paul Martin spoke recently to Maclean’s Ottawa Correspondent John Geddes about the effects on the economy, the dollar and the next federal budget. Excerpts:

Maclean’s: How is the Asian crisis changing your thinking about where the economy is headed?

Martin: No country, certainly not one that has 40 per cent of its gross domestic product dependent on exports, is going to be unaffected by things that happen in the world’s secondlargest economy, Japan, and in what was the fastest-growing region, essentially Asia. The United States trades with these nations more than we do, and when the United States catches cold we get the sniffles. A third thing is the effect on commodity prices.

There is a perception that Canada is much more dependent on commodities than we really are. They account for less than 30 per cent of our GDP. Asia will affect us because we are a commodity producer. But it is very important to understand that Canada is a much more diversified economy than the world thinks. Maclean’s: How do you respond to those who suspect your warnings about the impact of Asia are another example of how you downplay expectations?

‘I never believed we were going to have huge surpluses’

Martin: Nobody abolished the business cycle. Anybody who plans on no ups and downs obviously hasn’t lived much longer than about two years. Would I have predicted Asia or Russia two years ago? No, but you are bound, in an interdependent global economy, to have regions of the world that are affected by one thing or another.

Because of the prudence we have built into our budgets, our targets are not going to be affected. When something like the Asian crisis comes along, yes, it’s going to affect our numbers. But because we were prudent, we’re OK. I never believed we were going to have these huge surpluses people were talking about.

Maclean’s: Given the problems of the Canadian dollar, do you have to be cautious in the next budget not to spook financial markets?

Martin: I will not comment on the dollar. What I will say is thank heaven that Canada did what it did over the past five years. But clearly the job is not over. We’ve got to get that debtto-GDP ratio down substantially. We’ve got to get ourselves more competitive from a tax point of view.

GROWTH MATTERS

Slower economic growth will reduce federal revenues and result in smaller government surpluses. Forecasts prepared by the Royal Bank show the effects. (Surpluses include $3 billion annually that Ottawa sets aside for contingencies.)

Lower economic growth has a direct effect on government finances. The finance department reckons that a one-per-cent drop in nominal GDP—measured without adjusting for inflation—costs Ottawa $1.3 billion in lower revenues in the first year. That less-than-catastrophic effect bolsters the arguments of those who believe that Martin’s fiscal caution is born less from economics than from a political desire to push back demands for big spending increases and large tax cuts. The department’s own survey of private-sector economists recently found that the consensus forecast for nominal GDP growth next year had been reduced—to 4.1 per cent from 4.9 per cent. That change would cost Ottawa about $1 billion.

Ironically, Martin’s past success threatens his strategy of diminished expectations. Although he announced last February that his 1997-1998 budget was balanced, he will probably show a surplus of about $4 billion, including his $3-billion contingency fund, when he finalizes those figures in October. Last week, even as his officials warned that tax revenues would decline over the fall and winter, figures for the first quarter of this fiscal year showed a whopping surplus of $5.8 billion.

Such numbers make it more difficult for Martin to proclaim that the sky is falling. They also increase the skepticism of private forecasters who do not share his sense of cautious conservatism. Peter Drake, deputy chief economist at the TD Bank, says that Ottawa should post a surplus of $7 billion to $10 billion in 1998-1999. Next year, the bank expects that the so-called fiscal dividend—which is the amount of extra revenue that Ottawa will have above the amount that it requires to pay for current programs— will hit $12 billion to $15 billion. “On the face of it, there are some very large potential spending numbers,” says Drake.

Such estimates have triggered a furious private sector debate over the size of the surplus and the need for immediate tax cuts. Nesbitt Burns chief economist Sherry Cooper argues that Martin should cut personal income taxes in a fall mini-budget to stimulate the faltering economy. That in turn would allow the Bank of Canada to make a moderate increase in interest rates to shore up the dollar. Although Cooper puts the size of the fiscal dividend at $30 billion over the next three years, she has already scaled back her 1998-1999 forecast to $6 billion from $10 billion—because of the slowdown. In contrast, John McCallum, chief economist at the Royal Bank of Canada, argues that substantially higher interest rates could trigger a recession—and that “panicky moves to cut taxes substantially and immediately would probably do more harm than good.” Noting that the economy has already slowed, he calculates that the 1998-1999 surplus will likely be closer to $6 billion—instead of the $9 billion he once predicted. “We are heading into a world which seems to have more downside risk, more turbulence,” he says.

Seemingly undeterred by the prospect of a slowdown, provincial and federal politicians have been flooding Martin with spending requests. At their annual meeting this month, the provincial premiers asked for the restoration of up to $6 billion in their annual cash transfers for health care. Nearly every federal department has plans for big spending. Industry Minister John Manley wants funds for high-tech infrastructure while Transport Minister David Collenette wants money for roads and railways.

Despite those requests, Martin and his strategists will try to maintain tight control in the debate over what to do with the expected bonanza. Early this fall, the House finance committee, chaired by Martin loyalist MP Maurizio Bevilacqua, will tour the country for prebudget hearings. Martin’s traditional economic statement in October—and his officials’ own adept behind-the-scenes remarks—will be used to manage expectations. Political pressure from the opposition remains muted because of internal bickering in the Reform party and the Conservative leadership campaign.

As for the voters, many are still enjoying the last days of summer, relatively detached from the debate. Brampton, Ont., MP Sarkis Assadourian says he has received only 11 complaints about the falling dollar in the past three weeks—out of more than 750 calls. “More people still see the benefits of a lower dollar— except those who travel overseas,” he says. But he adds: ‘When the prices of imports start to rise, pressure will mount.” Bad news for many, perhaps. But for Martin, a case of the economic jitters could set in at just the right time in the budget-making process.