Don’t Panic: Debt Can Build a Better World

Posted by himelfarb on November 19, 2020 · 9 Comments 

This is an updated version of an article that first appeared in Alberta Views (December issue).

COVID-19, this microscopic bug, seems to have upended just about everything. History provides no perfect analogy for what has turned out to be a global health, social and economic catastrophe. Not since the Depression have we experienced such a devastating economic decline. 

In just a few months this virus has altered our lives and shaken us out of our normal ways, forcing us all to weigh what matters most and exposing and magnifying our collective strengths and, with sometimes fatal results, our collective weaknesses. It continues to test our trust of one another, of our governments, of science. It is testing the robustness of our institutions and exploiting their frailties. 

It seems, so far at least, that we have done some things right. We have seen bursts of solidarity as Canadians made sacrifices to protect themselves and one another. For a while, governments at all levels and of every stripe stepped up in ways we haven’t seen for decades, spending borrowed money to save lives, provide relief to households and buy time for businesses, forestalling even more devastating deflation or depression. A vaccine may be available sooner than expected.

But it’s too early to grade our performance. The virus doesn’t yield easily, Covid fatigue has set in, and some of our governments seem to be running out of steam or reverting to type just when what’s needed is strong public leadership. For starters we will have to continue to invest in protecting Canadians from the resurgent virus and to ensure that, once approved, vaccines and treatments are universally available with highest priority to those on the front lines and to the most vulnerable. No doubt some of the “temporary” relief programs will have to be extended, some perhaps made permanent. Senior levels of government will have to do more to help finance our municipalities. Canada’s cities are on the front lines in the fight against the pandemic but are, as a result, running a combined budget shortfall in the tens of billions of dollars, and lack the fiscal tools to close the gap without making damaging cuts to local services.

Recovery, whatever shape it takes, will require yet more active government and more public investment. With record high private debt, economic insecurity and uncertainty about the future of the virus, we should not be looking to hesitant investors and wary consumers to drive recovery. Some sectors of the economy will be slow to come back, and many small businesses will not come back at all. Governments will have to take the lead. Yes, they have already borrowed and spent a lot, but they are going to have to borrow and spend yet more—depending on our ambitions, possibly a great deal more. 

If Canadians wish to build back something better than we had, and forestall or at least be better prepared for the next crisis, we will want to draw lessons from this pandemic, not simply to congratulate ourselves for what went well but to face up to what did not and who bore the costs. 

Elderly people have been hardest hit, but the pandemic has also devastated black and other racialized people, migrant workers, people with disabilities, prisoners, the homeless and the poor more generally—that is, wherever there were pre-existing health, social and economic inequities or where working from home, sheltering in place, social distancing or even handwashing could not be taken for granted. It has preyed on and magnified social and economic inequities and exposed cracks in the system: our lack of preparedness, the tragedy of for-profit nursing homes, the human costs of prison overcrowding, the failure to eliminate chronic homelessness, the constant exposure to risk and danger in public-facing work where employers offer little or no protection. The relief programs put in place were, without question, necessary to contain the contagion, but they are also testament to the inadequacy of our existing social protections and stabilization mechanisms. Employment Insurance in particular covers too few of the unemployed and covers them inadequately. 

This recession is unique, most obviously because it comes with a death toll. It’s also the first we’ve experienced in which the service sector was hardest hit, affecting most those people in low-wage, precarious work, many without paid sick days that might have better protected them and those they interacted with. The pandemic made plain that these are essential workers, even if undervalued and underpaid. It’s also the first recession in which women have been hardest hit, economically and in multiple less visible ways. And of course the bigger crises around the corner—climate change and nature loss—have been put on the back burner, or even further back than before.

All this to say that we have the opportunity or, better, the responsibility not to lock in what was but to build a more just, resilient and sustainable future, to invest in ways that will help get the economy going but also going in the right direction. We have important choices to make about what comes next. Two decades of tax cuts and fiscal restraint narrowed our sense of what’s possible, making it seem like big things were out of reach, unaffordable. But for these last few months we’ve seen that big things are possible and active government can be a force for good. At this critical moment we cannot allow our decisions about what comes next to founder on misplaced fears about public spending and debt.

For several months, as Canada’s governments were first taking on the pandemic and the economic shocks emanating from it, we witnessed something of a fiscal truce. Gone were the calls for restrained spending, small government, balanced budgets. Across the political spectrum governments were spending borrowed money. And across the political spectrum, observers of government—including many who had been lambasting the federal government for its pre-pandemic deficits and its lack of plan to get to balance—were for this brief moment welcoming or at least tolerating active government, deficit spending and increases to the public debt. 

But that truce seems to be coming to an end. The trigger for a new round of deficit worry was the July federal “fiscal snapshot,” which confirmed what we suspected: The economic impact of the pandemic has been more devastating than anything Canada and, indeed the world, has experienced since the Great Depression.

That report projected that our economy would shrink by 6.8 per cent this year. A week later the Bank of Canada projected a 7.8 per cent decline. We may well expect more such revisions. The economic hit is already twice as bad as the one that followed the financial meltdown of 2008. Between February 2020 and April 2020, over one-third (36.1 per cent) of workers in Canada lost their jobs or had their work hours cut by half or more. Those losses pushed the unemployment rate to 13.7 per cent in May—the highest level in the history of our modern labour force statistics—from a pre-crisis low of 5.5 per cent in January. While the job market has been rebounding since June, it has a long way to go. At the time of writing, Canada still had over one million fewer jobs than before the pandemic, and over 700,000 of those with jobs were working fewer hours than normal. Statistics Canada indicates that unemployment rates remain highest for women and people of colour. The recovery may already be flagging and most economists agree that the path to recovery will be slow and bumpy. 

The result, of course, is a huge federal deficit—that is, spending in excess of revenues—greater than anything we had seen since the Second World War. Accumulated debt—that is, the sum of all deficits measured in dollars and as a percentage of GDP—is projected to grow from $717-billion, or 31 per cent of GDP, to over a trillion dollars, or 49 per cent of GDP. Most of that is because of the approximately $228-billion in support that the government is providing to individuals, businesses and other levels of government. Another $80-plus-billion was added to the deficit largely because of lost revenue, with huge chunks of the economy in an induced coma. That figure would have been much higher had the government not stepped in as it did. We can expect the relative debt to creep higher for the next few years. The provinces add yet more red ink. 

Predictably, the deficit hawks have started to hover. Most headlines following the fiscal snapshot asked just how worried we should be about deficits and debt—and many pundits concluded plenty worried. “No way to put a shine on this,” said one; “Dire” said others; “Time to start winding down” said a few. And, following the age-old principles of “Misery loves company” and “What’s better than a race to the bottom?” some are calling for cuts to the public service and public service wages. Let the market do its thing as soon as possible, they’re saying, and start scaling government back down again. 

The Liberal minority government seemed to resist these calls in its Speech From The Throne, setting out what it characterized as a bold blueprint for a just and green recovery. Some of the commitments: creating 1 million “green jobs”, setting more ambitious emissions reduction targets and stepping up climate action, building a national childcare system, pursuing universal Pharmacare, reforming Employment Insurance, strengthening protections for elderly Canadians, improving income support for Canadians with disabilities, and taking long-awaited action to tackle racism. The promises, some old, some new, are pitched at a general level – one might say vague – and will only take on shape and become real when the government puts its money where its speech is. Between now and budget day, the government will be under considerable pressure to water down or back off its proposals. Indeed, the next election, whenever it may come, may well turn not so much on what we need as on what we can afford, a referendum, in other words, on deficits and debt.

Disagreements about deficits and debt reflect more than differences among economists (of which there are aplenty); they highlight deeper ideological disagreements about what kind of country we want and the role of government in getting there. It’s important, then, to sort through the politics of deficits and debt. We need to explode the myths that have for decades stunted our political imagination, making us doubt whether we can afford what needs doing and convincing us that austerity, cutting spending and reining in government, is our only option. Austerity means squeezing essential services such as healthcare, education and welfare and foregoing or delaying public investment when all the evidence tells us that this is exactly the wrong way to go.

First of all Canada is in good fiscal shape. It was in good shape before COVID-19 and it is in good shape now. This is a global recession so all countries have been spending and all are grappling with what comes next. As the IMF has projected, Canada has been and continues to be in an enviable position relative to other rich countries. Those countries with much higher debt than ours must and will be increasing their spending. Why in the world wouldn’t we?

Predictably, though, we are nonetheless hearing the old fiscal scold standards: We must, like every household, live within our means, debt will bury us, and it’s a moral imperative that we not pass it on to our children. But governments are not households. The analogy would be more apt if the people who comprise a household could live for hundreds of years, issue their own money, impose taxes and sell bonds to their members, friends and neighbours. Governments do. Households don’t.

But even putting all that aside, households don’t hesitate to borrow. In fact, household debt is much higher than public debt. Most households understand that borrowing can be smart. Saving up for years and years to buy a house outright may not be the wisest choice in terms of lifestyle or finances, so we usually take on mortgage debt. We borrow for other key purchases that improve our quality of life or increase our earning potential. In tough times we sometimes borrow to bridge until things turn right. Businesses of course borrow routinely to make investments that will over time contribute to their bottom line. 

Borrowing often makes sense or may even be necessary for households and businesses, and that’s even more true and far less risky for government. And given the depths of this recession and the challenges ahead, if not now, when? 

Most mainstream economists would agree that, in tough times, public deficit spending is necessary. Even in relatively good times borrowing can make sense so long as it’s for investments that contribute to growth. That leaves lots of room to argue about what constitutes an “investment.” If it’s inclusive and sustainable growth we want, “spending” on health and social infrastructure, green infrastructure, public housing, attacking poverty, inequality, colonialism, and racial injustice may well be the best investments we could make. And as economist Armine Yalnizyan has made clear, no recovery is possible without access to safe childcare.

So how much debt is too much? At what point will the sky fall and chaos be unleashed? For a time after the financial meltdown there seemed to be a simple answer. Influential research by two highly respected economists, Carmen Reinhart and Kenneth Rogoff, purported to show that if debt grew to 90 per cent of GDP, economic growth would be put into reverse. Not surprisingly their work, and the notion of a debt tipping point, found its way into speeches and policies of conservative leaders anxious to reduce government’s footprint. Their research reinforced the view that deficits and debt are the problem, some version of austerity the solution.

Not long after, three economists from Amherst University took apart the Reinhart and Rogoff study and found numerous errors, large and small, and when the data were adjusted it turns out that there is no magic debt threshold, or if there is, it’s somewhere well north of 90 per cent. The corrected data continued to show a relationship between debt and growth but not as strong as previously thought. Even countries at 90 per cent or higher showed some growth. Nor do their findings allow us to assume causality—does debt slow growth or does slow growth increase debt?

Perhaps most telling is a series of studies by the research arm of the IMF, the organization that arguably did most to champion austerity. We can draw three broad conclusions from its research. First, the economic costs of austerity—putting aside for the moment the human costs—were far greater than the IMF had anticipated. In the years after 2010, when many countries, including Canada, opted for “fiscal consolidation”—reducing deficits and debt almost exclusively by cutting spending—the effect was in fact to slow growth, which in turn reduced government revenues, which in turn meant more deficits and debt.

Second, the economic benefits of tax cuts and other policies of the so-called free market agenda were oversold. The IMF research found that the promised growth never materialized, inequality increased, and the endless tax cuts contributed to higher deficits and debt, leading to more austerity (see my first point).

And finally, yet another IMF study found no clear relationship between debt and economic growth. In fact, for advanced economies in good standing, like Canada, the study comes to what it describes as the “unpalatable” conclusion that there seems to be no limit to how much debt a government can issue. The study found that over the long term, interest rates were lower than the economic growth rate, and this meant carrying charges on the debt were affordable. It’s probably worth mentioning that Japan’s debt, which stands at about 250 per cent of GDP, hasn’t stopped them from spending more to deal with the pandemic—and they are not in chaos. 

The study does offer a number of cautions and caveats. Certainly, taking on a lot of debt has costs and risks, especially because of short-term interest rate volatility. The central bank’s purchase of government debt reduces those risks. And of course it matters greatly what the borrowing is used for. But it seems clear that our deficit and debt phobia does more harm than good.

As for our current record-beating debt levels, because interest rates are so low, the government will pay $4-billion less in debt charges for this fiscal year than had been forecast before the pandemic. With the need for more public spending, and with borrowing being pretty much free, it would be, arguably, irresponsible not to borrow. Rising public debt is entirely manageable if interest rates remain low and the Bank of Canada continues to buy federal and provincial bonds to fund the new spending. It has been doing this at the rate of $5-billion a week and has indicated that it will continue to do so as long as necessary though at a slightly reduced rate. (Check out Andrew Jackson on Modern Monetary Theory and the central bank.) 

Our experience after the Second World War—when our debt level was over 100 per cent of GDP—shows that we can tame such a debt over time without cutting spending and come out much stronger for it. Of course, circumstances were quite different after the war; taxes were much higher, for example, and economic growth much stronger, partly because governments were expanding health and education infrastructure to keep up with the demographic pressures triggered by the baby boom. Nonetheless, as long as we borrow in our own currency, and largely from ourselves, we are in good shape. With even modest economic growth our relative debt will start to shrink. Nor, when we borrow from ourselves, do we “burden our children’s generation,” as they will both pay the interest and receive the interest payments.And if we’re smart about it, we’ll issue long-term debt to lock in the low interest rates, which is what the IMF advises and what Canada’s then finance minister signalled in the fiscal snapshot.

Years of DDS (Deficit Derangement Syndrome) have severely narrowed our sense of what is affordable and therefore what is possible. Numerous polls show that we generally want the same things we’ve always wanted: a secure job, a living wage, access to healthcare, childcare, a good education and training, help when we are in trouble, a secure retirement, safe and livable communities, a healthy environment, and a fair and inclusive democracy. What has changed is that we are, it seems, less convinced that such a future is affordable. 

Canadian economist Jim Stanford has been leading the charge to open wide our window of possibility. He has been making the case that what’s needed right now is a level of ambition much like what we saw after the war, with strong federal leadership supported by an active central bank. What’s more, he argues, we can indeed afford to build the economy and society we need. Not only should we stop worrying about deficits, we should, he says, celebrate them: “Yes, deficits will be huge in the coming years…. Public debt will soar past 100 per cent of GDP within a couple of years. Indeed, anything less than that would be a sign that government is literally not doing its job to protect Canadians from this crisis.”

To ensure that what is being built is sustainable and that the costs and benefits are allocated fairly, we will sooner or later have to look at tax increases as well. In the midst of a recession we must tread carefully, but some tax measures could actually contribute to growth. For example: finally plugging the leaks and collecting what is already owed under existing tax rates, implementing an excess-profits tax to get at those companies, especially the “digital giants”,  whose profits soared during the pandemic while most people suffered, and putting in place a wealth tax on the very rich as has already been proposed to, though sadly rejected by, Parliament. In any case, essential to a just and green recovery will be fundamental tax reform to fix what’s broken, to reflect our changing world, and to ensure that those who benefit most from how things are pay the largest share for making things better. We need a tax system that serves as the foundation for a more equal and sustainable Canada.

We can expect—in fact we ought to have—serious debates about the shape of the post-pandemic recovery, about the future we want, about the role of government in building that future. We have an opportunity to learn from this pandemic, to address the inequities and cracks it revealed, to better prepare for the next crises. Important proposals for a feminist response, a “green new deal” and renewal consistent with reconciliation and Indigenous rights and racial justice show us what our future could be. We cannot afford to have those debates short-circuited by paranoia over deficits and debt. 

I give the last word to political scientist Thea Riofrancos:

“The coming months and years are crucial. They will shape not only politics but also, as the climate crisis intensifies, the very conditions of life on this planet. That’s a huge challenge. But it’s also a historic opportunity to make a better, more equal and more just world. We must not pass it up.” 

Filed under fiscal policy, Post featured on front page · Tagged with Armine Yalnizyan, austerity, COVID-19, deficit and debt, excess profits tax, fiscal snapshot, IMF, Jim Stanford, recovery, Reinhart and Rogoff, Speech From The Throne, Thea Riofrancos, wealth tax