Monday, March 24, 2008

Ontario should run a deficit

Given the very real economic reality of falling demand, the Ontario government would run a one time deficit (by adopting the tax reductions that the federal Finance Minister is calling for and I discussed here) while affirming its commitment to long term debt reduction.

What's happening is the opposite. The Ontario government will provide limited fiscal stimulus to the private sector. Meanwhile, the Toronto Star reports that "[t]he Liberals have also introduced legislation that allows part of the annual surplus to be spent ... rather than applying all of it to reducing the debt." This legislation suggests that, going forward, the Ontario Liberals will provide more stimulus when demand is high and tax revenues are flowing in, but less stimulus when demand is low and tax revenues are limited.

Part of the reason why Alberta politics are so frustrating is that many voters seem to be more concerned with "flows" than "stocks". As defined by the infallible Wikipedia, "stock refers to the value of an asset at a balance date (or point in time), while a flow refers to the total value of transactions (sales or purchases, incomes or expenditures) during an accounting period". So long as the "flow" is above the red line, all is presumed well in the land of the Wild Rose. On the "stock" front, however, the value of Alberta's assets is an embarrassment.

As I noted in an earlier post by quoting Wikipedia:

"Crowding out" is most serious when an economy is already at potential output or full employment. Then the government's expansionary fiscal policy encourages increased prices... At potential output, businesses are in no need of markets, so that there is no room for an accelerator effect. More directly, if the economy stays at full employment gross domestic product, any increase in government purchases shifts resources away the private sector.

This is Alberta spending in recent years. It gets worse, however, in that the spending also comes at the opportunity cost of contributing to our net asset position, which would allow us to run a deficit when economic growth is well below potential.

One can actually plausibly argue that the Klein cuts of the mid-90s were economically unwise. Why? Because if Klein had invested in, say, a high speed rail line between Edmonton and Calgary 10 - 15 years ago, we would have paid significantly lower prices then than now. As it was, the accelerated debt repayment of the early Klein years ended up removing the political discipline to restrain spending at the worst possible time. If voters disciplined non-savers like they are inclined to discipline deficit spenders, the 21st century would have been a different story for this province.

At issue is not the size of government per se, but expected return on taxpayer dollars. It is the generally low expected return that argues for smaller government in general. A government could responsibly go into deficit to fund an investment which generates a greater return than its cost of capital. Corporations borrow all the time and the issue for shareholders is whether the borrowing is being used to fund projects that have a "positive net present value" or NPV, not whether they borrow. In my campaign literature during February, I noted that Alberta spends almost 40% more per person than Quebec but then immediately also noted that Quebec has $7 a day child care.

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