The blind and the elephant | Press

As in the Buddhist parable, one often examines the public debt like the six blind men who feel different ends of the elephant and who try to get an idea of ​​the beast. However, by renouncing the willful blindness of preconceived ideas, we can get a more complete idea of ​​public finances, damaged by the pandemic.

I was particularly eager to examine Wednesday the latest figures from the International Monetary Fund (IMF) on the indebtedness of countries, measured in a fairly comparable way, regardless of their distribution of responsibilities between levels of government.

We see that Canada’s gross debt, including all governments, jumped 23.1% of GDP due to COVID-19, from 2019 to 2021, more than the average for G7 countries, up 21%, but less than US debt, which grew 24.8%.

This strong stimulus has allowed us to support the incomes of individuals and businesses, and to pay for health care in an economy that fell 5.3% last year, but is expected to rebound 5.7% this year. , still according to the IMF.

Fortunately, Canada enjoyed relatively healthy public finances before this crisis, with a gross debt-to-GDP ratio of 86.8%, compared to an average of 118% for the G7. Only Germany was doing really better.

Today, our rate is 109.9%, against 139% for the G7. So much for the gross debt.

In its international comparisons, the federal government prefers to show net debt, i.e. gross debt less financial assets, where Canada remains the model student in 2021 with a rate of only 34.9%, against 104.1% for the G7.

The big downside here is the inclusion of the assets of the Canada Pension Plan and the Quebec Pension Plan, managed by Investissements RPC and the Caisse de dépôt et placement du Québec. They are deducted from gross debt and often have no equivalent in other countries¹.

Is it sustainable?

“The current fiscal policy in Canada is not sustainable in the long term,” said the Parliamentary Budget Officer (PBO), Yves Giroux, when he takes a bird’s-eye view of all public administrations, in the manner of the IMF.

His judgment is nuanced when it comes down to the level of the federal government – viable in the long term – and the provinces – not viable in the long term – with the exception of Quebec. It assesses that public pension plans are viable, taking into account both assets and liabilities.

The analysis the PBO did at the start of the summer, after all budgets, is not a forecast, but a projection that is based on reasonable, but limiting assumptions. Its exercise assumes in particular that budgetary and fiscal policies will not change. The demographics are easy to predict, but his assumptions about economic growth and long-term interest rates, while plausible, call for caution.

Yes, but…

The “yes but” was analyzed by the CD Howe Institute, under the pen of Alexandre Laurin and Don Drummond, who highlighted the sensitivity of forecasts to small changes in the assumptions made.

In the scenario presented in the last Freeland budget, the federal debt ratio (here the cumulative deficits) would take 34 years to go from 51% of the current fiscal year to 30% before the pandemic.

But in the more conservative scenario of the CD Howe Institute, the debt rather drifts upwards to reach 60% of GDP over the same horizon. If we add the provinces, the country’s debt ratio would reach 140%.

The difference between the two scenarios is the rate of growth of the economy, which must remain higher than the interest rate paid on the debt for the trend to be decreasing, in the absence of a sufficiently large budget surplus.

A slightly less optimistic assumption on productivity gains, which have been disappointing for several decades, would restrain GDP growth. Interest rates are particularly low now, but a small long-term rise is possible if inflation strengthens in the next few years.

In short, it takes little to switch from a downtrend to an uptrend.

The gradual reduction of indebtedness depends on plausible but fragile assumptions, even without taking into account the shocks that are sure to occur, such as the next recession or the next financial crisis.

Stronger for the provinces

The situation for the provinces is more difficult because they have to finance health services, the costs of which are rising faster than the revenues derived from economic growth. The federal contribution, capped at the rate of GDP growth, infuriated the premiers.

The dynamics of provincial debt are also subject to the critical relationship between the growth rate of their GDP and the interest rate paid on their debt. Except that their financing cost is about 1% higher than at the federal level, a serious handicap for the consolidation of their finances.

With the exception of Newfoundland and Labrador, Quebec’s net debt remains the highest among the provinces, at 45% of GDP, followed closely by Ontario at 44%. If the PBO sees it as a viable situation in the long term, it is perhaps because he is comforted by the disciple imposed by the Balanced Budget Act and by reducing the debt ratio, accelerated by the Generations Fund. Economists are meeting this week to reflect on the future of these control mechanisms.

The issue, both federal and provincial, is not the dramatic reduction in expenses related to COVID-19, which will naturally occur in the next year. Rather, it is the pressure to plug the holes that the pandemic has revealed in the health and social security systems, not to mention the wage pressures accentuated by the labor shortage. The risk of losing control of public spending is very real.

We will also have to work on growth, the denominator of the debt / GDP ratio. The key variable here is productivity: working smarter thanks to better equipment and better trained employees. Productivity, particularly in hospitals, would help contain the explosion in costs.

Last year, the IMF urged countries not to cut public spending too quickly. This year the message has changed: Governments’ credibility is at stake in the bond markets, which dictate the cost of financing their debt. It will pay off to reconnect with budgetary discipline with clear guidelines and priorities.

Let’s open our eyes! We took advantage of a good margin of maneuver to face this crisis, it would be wise to reconstitute it gradually.

1. The IMF does not assess the liabilities of public pension plans, even if the promise of an annuity constitutes a real commitment, because the variations between public plans are incredibly complex. In the Anglo-Saxon countries, the schemes are partially funded, while most of the countries of the European Community have so-called pay-as-you-go schemes, where today’s workers pay the pensions of today’s retirees. which is terribly expensive with the aging of the population.

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