Justin Trudeau’s ill-advised deficit promises
Incoming Prime Minister Justin Trudeau was elected promising change. His economic program is, at least in its rhetoric, different from that of the previous government. But it is also a departure from the Canadian debt control achievement of the 1990s that’s cited as a model throughout the world.
Trudeau’s most emblematic promise is indeed to run budget deficits of $10 billion over the next three years, without even the pretense of an economic crisis to justify it. Following through on this promise would be contrary to both the economic facts and economic research.
Deficit promises echo the old Keynesian myth that the economy consists of a series of levers, and that all one needs to do to accelerate economic growth is flip the public spending lever. We know through the Nobel prize-winning research of Robert Lucas, from the University of Chicago, that taxpayers cannot be fooled in this way. They can anticipate that deficits will eventually result in higher taxes, and they accordingly reduce investment and consumption to prepare for these increases. Such public spending will increase activity in the targeted sectors, without producing a stimulus effect throughout the economy, though the government will have to borrow to finance it.
The effect of this increase in public spending could even be to slow down the economy. An influential study by Harvard economist Roberto Alesina and three of his colleagues, published in the American Economic Review, the most prestigious academic economics journal, shows that increased public spending might be even worse for private investment and growth than tax increases. The reason is that public investment crowds out private investment, competing to attract workers and capital. Consequently, the private sector has access to fewer resources at a higher price. And with slower economic growth, the standard of living of all strata of society stagnates, with the middle class and the poor generally suffering more than the rich.
The Liberals promised additional investments of about $60 billion in infrastructure over the next 10 years. Even if infrastructure spending could really stimulate the economy, which we know is not the case, Trudeau’s program actually uses a very peculiar definition of “infrastructure” which includes social housing and daycare centers. Regardless of the social merits that can or cannot be attributed to this type of expenditure, it is clear that they do not generate any economic stimulus effect.
Even with respect to actual infrastructure, the World Forum’s Global Competitiveness Report 2014-2015 already places Canada in 15th place. There is no catching up to do. Research by Marco Percoco of Bocconi University, which focuses on infrastructure capital, even finds that there are too many roads relative to demand in Canada, as in most other countries.
Liberals say that we must take advantage of current low interest rates to invest. But low interest rates do not mean low costs, since we must also consider the cost of raising taxes to repay these loans. Studies unanimously find that raising an additional dollar of taxes costs society more than a dollar. That is to say, we are already long past the point at which a tax increase causes a loss of economic welfare that is larger than the growth of well-being funded by the government’s additional revenues. Recent studies estimate that every extra dollar of taxes costs society as much as $5.00. These costs tend to increase with time and may even cause recessions.
Hopefully the new prime minister, his advisers, and his cabinet come to their senses and base their economic program on scientific research, rather than populist myths peddled by unions and lobby groups seeking grants and public contracts. They should take a page from the budgetary exploits of Jean Chrétien and Paul Martin, who put the Canadian economy on the track of sustained growth by cutting spending in the mid-1990s.
Michel Kelly-Gagnon est président et directeur général de l'Institut économique de Montréal, Mathieu Bédard est économiste à l'IEDM. Ils signent ce texte à titre personnel.