The return of deficit spending

As the global depression continues, countries like Canada are staring at looming deficits the size of which they have not seen in decades.

These days, federal Finance Minister Jim Flaherty is talking about a potential $50-billion deficit for the 2008-09 fiscal year.

"We are going through a deeper economic slowdown than anticipated … we also have the substantial auto payments that are going to be required," the Conservative Flaherty told reporters outside the House of Commons.

Canada's two senior finance officials — Flaherty and Bank of Canada governor Mark Carney — both underestimated the seriousness of the country's economic fall.

That means they also were short on their estimates as to how much red ink Canada would see in 2008-09 and beyond.

In missing the fiscal tumble, Canadian officials were not alone.

And neither were they alone in terms of running a huge deficit.

The United States, France, the United Kingdom, in fact, pretty well any country one could care to name have all posted large budgetary shortfalls.

Given the enormity of the deficits, most economists no longer argue for a quick return to fiscal rectitude.

"My God. You can run a deficit in your budget or a deficit in your economy," said Atif Kubursi, an economics professor at McMaster University in Hamilton.

Depleted cash

One reason for the return of deficit spending to governmental lexicons is simply the disappearance of revenue.

As economies sag, more people lose their jobs and fewer pay as much tax.

California, for instance, saw its state revenue dip $800 million US for the July-to-October period in 2008 compared with the same quarter a year earlier, $21.8 billion versus $22.6 billion.

California's economy has been slowing as technology companies sell fewer gadgets.

Ontario said it will face a $500 million deficit as the provincial economy slows.

"Today’s economic reality is forcing governments around the world to re-examine their expenditures, adjust their assumptions and respond to an environment where the only constant is uncertainty," Ontario Finance Minister Dwight Duncan said in the provincial government's economic update in late October.

Essentially, government revenues can go up and down, whereas government spending almost always rises — the only issue being how fast. 

Empty quiver

Some analysts argue that elected officials need to prime the deficit spending pump because everything else has been tried to help the economy.

Governments in industrialized countries have already set up facilities to buy up bad debt and invest in banks. As well, these administrations have cut interest rates, including cuts of 75 basis points by Canada's central bank over the last month.

"The only other option might be some deficit financing," said Livio Di Matteo, an economics professor at Lakehead University in Thunder Bay, Ont.

Years ago, politicians and purveyors of the dismal science would have sooner eaten a plate of worms than advocate for governments to spend beyond their means.

The reasons were not ideological in many cases, Di Matteo said.

Instead, they objected because "many governments lack the fiscal rectitude" to keep deficits under control in better economic times, he said.

Dusting off old thinking

John Maynard Keynes, and more recently Canadian economist John Kenneth Galbraith, are the people most often associated with deficit spending.

Their thinking is fairly straightforward: in bad times, the government should borrow to spend money on useful things like bridges and highways or not-so-useful things, such as digging ditches, made famous when U.S. President Franklin Roosevelt used public  money to battle the Great Depression in the 1930s.

By going into debt, the government gets some much-needed cash into the wallets of consumers and companies who in turn spend more and kick-start the economic growth cycle.

Doing a back-of-the-envelope calculation, Di Matteo estimated Ottawa can inject fiscal stimulus equal to one per cent of the country's economy by running a $10 billion short-term deficit.

Good in theory, ugly in practice

Too often, however, politicians forgot the second piece of advice from the fiscally conservative Keynes: pay off the debt in good times.

Once a spending program or tax break is put in place, voters who benefit from this bit of public largesse lobby — more often than not successfully — to keep these provisions in place.

Thus, what started off as a temporary measure to boost employment becomes permanent and a drag on the government's finances.

Worse still, critics maintain, these deficits linger for years, piling up public debt and reducing the government's ability to spend more cash during future crises.

The Canadian government faced the confluence of sagging revenue and rising spending during the early 1990s as the federal deficit peaked at $42 billion Cdn in 1993-94.

By way of comparison, that red ink would total 16 per cent of Ottawa's spending in 2008-'09.

New rules

Some economists and government types see new laws as a way for elected officials to cut programs and repay debt during decent economic times.

Jack Mintz, the Palmer Chair of Public Policy at the University of Calgary School of Policy Studies, argued recently that Ottawa should put a law in place that mandates the shorter-term repayment of new outstanding borrowing.

In his scenario, the government would add cash to the contingency reserve sufficient to repay the new debt over a couple of years.

Such rules serve a political purpose. 

Politicians can duck behind these type of rules to explain to voters the rationale for spending cuts or tax hikes.

Unfortunately, past governments have often ignored such rules. 

In addition, administrations can engage in odd policies in order to meet financial targets. For instance, some U.S. states have closed all public offices and send most bureaucrats home for weeks at a time in order to save cash.