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Balanced budget legislation will be disastrous for Canada

Photo: Benedikt von Loebell/World Economic Forum/flickr

Finance Minister Joe Oliver's latest musings about introducing balanced budget legislation represent the worst policy for Canada, and will doom us to European-style crises and rob future generations of prosperity.

While the details of the specific plan are not yet available, the very idea of forcing governments in good or bad times to have a balanced budget is one of the worst economic ideas this government has had in its nine years in office. To wit, such a policy has never worked in any of the places it was adopted. It never leads to growth, and in fact depresses economies.

I am currently lecturing in France, where I see every day the disastrous consequences of austerity and of forcing governments to avoid deficit spending in times of crises. As a result, the government is unable to help young people find jobs, with the youth unemployment rate at 25 per cent; elsewhere in Europe, youth unemployment is more than 50 per cent. Governments are introducing difficult cuts to social programs that are leaving Europeans considerably worse off.

And in Canada, a mere week after Bank of Canada Governor Steven Poloz announces that first quarter growth in Canada will be "atrocious," the government is forging ahead with plans to bring in balanced budget legislation. This is insensitive. The government seems simply oblivious to the hardship of so many working Canadians, yet at the very same time, introducing income-splitting policies that will benefit the rich, and doubling the annual contribution limit for Tax Free Savings Accounts, which will largely benefit once again, Canadians who have the luxury of saving roughly $1,000 a month. How many Canadians, especially among those working two jobs simply to make ends meet, can save $1,000 a month?

But it also smacks of hypocrisy: for two-thirds of its time in office, the Harper government had deficits. In a very important way, imagine what Canada would look like today had this law existed in 2006? The recovery, no matter how weak it is, would never have taken place. It would have doomed us to several more years of crisis.

Not only is it bad economics today, balanced budgets will also doom future generations of Canadians -- your children and theirs -- to depression-style economics. Why? When governments spend, there are two types of expenditures -- what we call current account spending (imagine spending on pencils, desks and government employee salaries; in other words, government's current spending on goods and services to satisfy current needs) and capital account spending. This latter category is essentially spending on our infrastructure (imagine spending on roads, bridges, sewers, electrical grids and other vital areas); in other words, this type of spending is investment in our future.

This distinction is well established in national accounting, and with good reason. Capital spending (also called gross fixed capital formation) is an investment done by the government on behalf of the population, to meet the future needs of Canadians. When the government builds a bridge or new roads, the costs are borne out today but the benefits will span several years and even decades.

But the federal government does not distinguish between current spending and capital spending: it's all lumped in together. Therefore forcing balanced budgets will lead to considerable underinvestment in our infrastructure: it will grossly depress an already depressed commitment to infrastructure spending in Canada.

So imagine a government wanting to upgrade health care, or our sewers, or electrical grids, or improving our roads and bridges, or increasing social security. Well, under the current proposed legislation, governments won't be able to deficit spend to improve our infrastructure, unless it drastically offsets the whole amount of the investment. So what will it do? Only two possibilities: 1) nothing; 2) introduce draconian cuts in other areas, like social services, to offset the full amount of the investment. This will have one of two consequences: 1) allow a further deterioration of our infrastructure; or 2) the eventual elimination of our social safety net.

Worse even, it could force the government, in the name of cutting expenditures, to push onto provinces some of the existing federal programs. If provinces don't want to run deficits because of these extra costs, they will be forced to increase taxes.

If the government insists on carrying out this myopic policy, the least it could do is to propose to balance current spending over the business cycle. An argument can be made that governments should not overspend in buying goods and services for current needs, over the entire business cycle. This would at least leave governments with the ability to respond in times of recession, and to cut back spending when the economy is growing. But constraints should never be placed on capital spending: this is a gross misunderstanding of economics and national accounting.

This policy is one that opposition parties must denounce at once; they must vow to scrap this legislation once they take office in October. Otherwise, this policy has the potential of doing more harm to Canada's economy, and to push us into European-style crisis for decades to come.

Special thanks to Nick Zorn and Pablo Bortz for some useful comments.

Louis-Philippe Rochon is associate professor of economics at Laurentian University and founding co-editor of the Review of Keynesian Economics. Follow him on Twitter @Lprochon

Photo: Benedikt von Loebell/World Economic Forum/flickr

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