Federal Finances in Review

 

The last week has been a chaotic one in Ottawa given the resignation of the finance minister on the eve of the Federal Economic and Fiscal Statement (FES), the turmoil over the Prime Minister’s leadership and the ongoing verbal assaults of President-elect Trump on Canadian sovereignty.  Nonetheless, lost in all of this is that after a considerable delay, there has finally been an update to Canada’s Fiscal Reference Tables (FRT) and Figures 1-4 here provide an overview of both the past (1966-67 to 2023-24) as laid out in the FRT and the future (2024-25 to 2028-29) such as it is laid out in the FES. 

Figure 1 provides a nice snapshot of the federal fiscal footprint – the federal spending to GDP ratio. Over the period of this chart, the federal footprint reached a  maximum of 25.6 percent in 2020-21 during the pandemic. This was of a course an outlier year and if one takes this out, one nevertheless notices that from a low of 13.9 percent in 2013-14, the federal fiscal footprint has gradually drifted upwards notwithstanding the pandemic and in 2022-24 stood at 17 percent.  While not at the level of the 1980s when it exceeded 20 percent, it remains that the federal fiscal footprint both in 2023-24 and going forward to 2028-29 is the largest it has been since the late 1990s and marks a calculated expansion of federal public sector size relative to GDP.

 

 Part of this rising expenditure has been financed via borrowing and in 2023-24 the deficit stood at nearly $62 billion.  From 2023-24 to 2028-29, Canada is forecast to accumulate another $242 billion dollars in deficits bringing the national net debt to $1.549 trillion by 2028-29. Figure 2 plots the deficit to GDP ratio, and it stands at nearly 2 percent for 2023-24 and is forecast to drop to 0.7 percent by 2028-29 – assuming of course that given the deficits projected, nominal GDP growth proceeds at 4 percent annually.  Given the slowdown in the economy that appears to be underway and the likely imposition of US tariffs in 2025, this would appear to be an exceptionally rosy GDP growth forecast.

 

 Figure 3 plots the net debt to GDP ratio, and it began to take a definite upward path starting in 2019-20 when it went to 37 percent from 33 percent the year previous.  It peaked at just over 44 percent in 2022-23 and is only going to come down slowly to about 42 percent by 2028-29.  Now, while up by recent standards, it is nowhere near where it was during the federal fiscal crisis of the 1990s.  Yet, the debt is mounting, and interest rates are higher than they were during the debt and spending spiral of the pandemic and so debt service costs have gone up.

 

 In 2019-20, debt service costs were $24.4 billion representing about 7 percent of federal revenues that year.  For 2024-25 they are anticipated to be more than double at $53.7 billion or 10.8 percent of federal revenues.   By 2028-29, it is projected that annual debt service costs will reach $66.3 billion or 11.3 percent of federal revenues.  As Figure 4 illustrates, we are again nowhere near the numbers of the federal fiscal crisis when well over 30 percent of federal revenues went to service the debt. At the same time, we appear to have settled at a plateau over 10 percent for the foreseeable future and that is money better spent on programs.

 

 In her resignation letter, the outgoing finance minister appeared to have a fiscal epiphany as she noted the need to keep our fiscal powder dry to face the economic challenges coming down the pipeline.  The trends of the last few years suggest that there has been a certain dampness to federal fiscal powder for the last few years that is expected to persist into the future.  While there is still fiscal room to manoeuvre, a large recessionary shock will quickly erode that room given the gradual enrichment of long-term  federal spending via assorted initiatives over the last decade as illustrated by the federal expenditure to GDP ratio. This suggests that dealing with a major recession will be more challenging that it would have been a decade ago.

 

 

Global Aftermath: The Economic and Fiscal Effects of COVID in Canada and the World

 

The write-up accompanying my report on COVID in Canada and the world released today by the Fraser Institute.  The full report is available here.

 

— Published on May 11, 2023 Fraser Institute

The economic and fiscal disruption and associated effects of the pandemic in Canada and around the world were severe and unprecedented. The general effects of the pandemic were to disrupt health, social, governmental, and economic systems. While the impact of the pandemic on Canada and the world was similar, variations in demographics, timing of the spread and response, and other characteristics have meant that the effects on health, the response, and the economic and fiscal impacts have varied across countries.

At 103,874 total cases per million population by June 2022, Canada performed remarkably well: incidence was the fourth lowest among the IMF Advanced Economies. Moreover, of the IMF Advanced Economies, Canada was 27^th out of 38 at 1,103 deaths per million population; Japan was the lowest at 248 total COVID-19 deaths per million population. Canada did not fare as well for crude COVID mortality: its rate of 1.1% is the second highest of the IMF Advanced Economies. As for responses to the pandemic, at 227 vaccinations per 100 population, Canada had the 7^th highest vaccine uptake rate of the IMF Advanced Economies and the 3^rd highest level of stringency in its responses to the pandemic as measured by the Oxford University’s COVID19 Government Response Tracker.

Impact on the economy

Canada’s estimated real per-capita GDP growth was negative and the country ranked 29^th out of 40 IMF Advanced Economies and had the second-worst performance of the G7 countries over the period from 2019 to 2022. Canada, during the first pandemic year, had the second worst employment drop of the IMF Advanced Economies at 5.1%, coming in just ahead of the United States. However, during the rebound in 2021, Canada had the second highest employment growth of the IMF Advanced Economies. Canada’s unemployment rate in 2020 of 9.6% was higher than the world average (9.2%), the G7 average (6.6%), and the average for the IMF Advanced Economies (6.3%). According to the International Monetary Fund’s inflation estimates for 2021, Canada was mid-ranked (19^th highest) amongst the IMF advanced economies. However, a particularly high proportion of Canada’s inflation appears to be linked to demand-side rather than supply-side factors. As well, Canada ranked 9^th out of 30 OECD comparator countries for the size of the increase in housing prices.

Overall, Canada’s performance in controlling COVID-19 incidence and vaccine uptake was good but this was accompanied by lower testing rates for COVID as well as higher crude mortality rates. In terms of economic performance, Canada did not fare well in per-capita GDP growth during the pandemic; employment growth was also low, though this did improve in 2021. Canada was also generally mid-ranked for inflation compared to the IMF Advanced Economies, though it appears to have had a higher proportion of its inflation driven by demand-side factors. Canada’s success in some aspects of dealing with COVID appears to have come at an exceptionally high price, particularly from negative short-term employment effects and weaker per-capita GDP growth.

Impact on the fiscal situation

In 2020, of 194 IMF countries, at an increase of government expenditure of 19.7%, Canada ranked 25^th highest in the world for spending. This increase of nearly 20% was well above the world average of approximately 9%, the G7 average of 13%, and the average of the IMF Advanced Economies of nearly 11%. Canada also averaged a 2.2% drop in general government revenue in 2020 according to the IMF, not as severe as the average drops for either the IMF Advanced Economies or the G7.

The world saw its negative fiscal balance widen from 3.6% in 2019 to over 10% in 2020 before starting to decline to under 8% in 2021 and to just over 5% in 2022. According to the IMF, Canada initially saw a negative fiscal balance of about 11% in 2020 from a balance of close to zero in 2019. The fiscal balance for 2020 was later revised to 11.4%, with a revised forecast of 4.7% in 2021 and 2.1% in 2022.

Globally, from 2019 to 2021, the average gross debt-to-GDP ratio rose from 57% to 67%. All together 161 out of 196 countries—nearly 80%—saw an increase in their gross debt-to-GDP ratios from 2019 to 2021. Canada saw its gross debt-to-GDP ratio increase by nearly 25 percentage points from 2019 to 2021, the 15^th largest increase in the world. It is worth noting that, of the increased government debt accumulated in Canada during the pandemic, much was incurred by the federal government rather than the provincial governments.

Canada’s fiscal response was especially large and driven mostly by the federal response. In some respects, the ability of Canada to ramp up its fiscal response in time of need reflects its long-term prudent fiscal management and resulting low debt-to-GDP ratio achieved in the decades after the federal fiscal crisis of the 1990s. At the same time, the size of the deficit and fiscal response during the pandemic should not be allowed to become a long-term feature of the public finances given the recent rise in interest rates, especially as it limits the ability and fiscal flexibility for responses to future events.