The Irrational Fear of Austerity

Activists, students, and public sector workers joined together last Halloween in Montreal and paraded through the streets ghoulish effigies of Quebec Premier Philippe Couillard and Finance Minister Carlos Leitao wielding bloodstained chainsaws to express their disdain for the Parti Liberal du Quebec’s (PLQ) 2014-15 budget. These protests painted a grim picture of the province’s future if the cuts were executed.

Several months later, Quebec’s economy is still functioning and blood is not running through the streets. Protesters have reorganized en masse, however, in an attempt to revitalize the 2012 Maple Spring protests and unions and student groups voted for strikes in the next several weeks. Much of the grievances come in response to cuts to education and the passage of the controversial Bill 3, which reformed public sector pensions to the relative detriment of pensioners.

The PLQ’s approval ratings have fallen sharply once the electorate felt the reality of their budget. Opposition parties, ranging from Coalition Avenir Quebec on the right and Quebec Solidaire on the left, have been taking advantage of the situation by volleying criticisms toward the Couillard government. Nevertheless, Leitao seems to be holding fast to his plan by emphasizing a stable investment environment, productivity growth, and tax reform as the path toward fiscal solvency. The PLQ promised to balance the budget for 2015-16 without raising taxes on Quebecers and their plan appears to focus on cutting evenly across the board, thereby spreading the pain around, while holding the line on spending in the coming years. Following their projections, growth-fuelled revenue should outpace spending growth, which would eliminate the deficit.

Protestors demand an end to or reduction in the cuts to social services and various groups have been pushing for to increase corporate and top-tier personal income tax rates, reduce business subsidies, and eliminate corruption. Lastly, they would like an end to dubious and frivolous spending. In any case, as illustrated recently in a Fraser Institute study, Quebec’s debt is a mammoth problem and it is only growing scarier. Public debt per capita and the province’s debt-to-GDP ratio, for instance, are the highest among all Canadian provinces. Indeed, it is a struggle to find another subnational government in a poorer fiscal state.

Boasting an unusually large debt burden can be disastrous: interest rates, for example, may rise unexpectedly and such a development could jeopardize scarce public funds. As a matter of common sense, Quebec should begin reducing its public debt burden. William Watson even considers the “Grecification” of the beleaguered province to be a possibility.

Considering that Quebec already has some of the highest tax rates in North America, spending control is evidently where the bulk of reform must happen. What is a government to do?

Protestors in Quebec have a right to feel frustrated. Quebecers have grown accustomed to generous social services as government after government spent beyond its means, and thus, they have never had to reap the consequences of such uneconomic behaviour. Provincial governments have also resoundingly mismanaged fiscal matters and corruption is widespread. Naturally, those protesting in the streets have begun looking toward the top percentile of the income distribution to bear the responsibility of balancing the budget. Yet, one wonders if these protesters have an alternative budget in mind that would not require raising taxes to crippling levels.

Much of Quebec’s austerity would have been rendered unnecessary of increases to tuition, daycare, and other government services had been indexed to inflation as they should have been for decades, but those options were unpalatable and remain so. Alas, the debt has stayed put and it has put on a few pounds.

Importantly, as Premier Couillard argues, the proposed spending cuts do not actually qualify as “austerity.” Austerity refers to an attempt at shrinking the state through spending cuts. The PLQ is not proposing this solution to the province’s debt situation. Instead, it is proposed a reduction in the growth of spending, which is mild by all measures of comparison.

But, as previously mentioned, protesters have a right to feel frustrated. Leitao’s budget will increase subsidies to small and medium enterprises, reintroduce the controversial economic development “Plan Nord,” and increase spending in other areas, ostensibly to encourage economic activity. More importantly, perhaps spending cuts should be more specific, as opposed to the provincial government spreading them around all departments. Public sector pension reform was necessary, however, spending cuts in the realm of social services could have been much friendlier. Lastly, one must consider whether it is appropriate to cut spending on education in light of Quebec’s universities performing worse each year in international rankings.

It could be more palatable, and more economical, to replace some of the spending cuts to education and health by eliminating business subsidies and scrapping Plan Nord, which, in particular, is a very expensive and ambitious project dating back to the Charest era to “develop” energy and mining sectors in Northern Quebec. The province would be better served by focusing on fiscal health and tax reform and by cultivating a commerce-friendly environment. Enacting Bill 78­-styled protest repression measures, however, will almost certainly not calm things down.

All said and done, the Leitao budget is a reasonable and effective one for sorting Quebec’s fiscal mess. It is imperfect, but it mostly makes good sense and it is moderate in nature. Thus, the province’s long-term economic prospects depend on its success and, ultimately, protesters will have to join the rest of the province and confront the reality that debt cannot be reduced without everyone taking a haircut.

Leo Plumer is an AIMS on Campus Student Fellow who is pursuing an undergraduate degree in economics and political science at McGill University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

Energy Transportation and Negative Externalities: The Argument for Sound Regulation

On the heels of my analysis of whether Newfoundland and Labrador has become a “petroprovince,” I examine another aspect of the natural resource development: safety and negative externalities, i.e. environmental costs. In particular, this blog post will focus on the rising usage of large oil tankers for transporting Canadian petroleum products overseas.

Because of Canada’s generous resource endowments, it has become one of the largest oil producing countries and exporters in the world. The proposed Keystone XL pipeline appears to be floundering, however, and the shale gas boom in the United States has withered consumer demand in that country for Canadian exports–both of which have encouraged Canadian producers to look for new markets in emerging economies.

Expanding into overseas markets necessarily requires maritime transportation in the form of transoceanic supertankers, and as demand for energy rises in emerging economies, so too will tanker traffic. Citing devastating spills such as Exxon Valdez, however, several individuals and groups have made an effort to ban or heavily restrict such traffic. Yet, there is a serious economic rationale for continuing to develop, and promote, Canada’s energy sector and the more important issue is developing and promoting it responsibly.

Oil spills have astronomical ecological and economic costs and environmentalists who have concerns about them are justified. In a study published recently by the Fraser Institute, however, the authors note that Canadian tanker traffic has increased by leaps and bounds despite accidents declining sharply, which they argue is the result of better safety practices, smarter regulations, and technological innovation. To reinforce the downward trend in accidents, the most effective regulatory regime is one that requires stringent safety protocols such as corrosion-proof lining for supertankers, in addition to rigorous and frequent inspections to ensure that firms meet these requirements, i.e. a first “line of defense.” Furthermore, establishing safe, well-monitored shipping routes would also reduce accident probability.

Incentives matter and, therefore, policymaking must be independent of private sector interests. (Energy companies have a market-based incentive to avoid losses, which encourages them to take precautions, but many firms fail to pay for their negative externalities.) In addition, regulatory agencies can structure their fine schedules to compensate entirely for the externality costs of environmental damage, which would ensure that firms bear all of the potential costs when making decisions about safety. Canada should also maintain a comprehensive and streamlined oil-spill response strategy that would help contain the damage and repair it, i.e. a second “line of defense.” Lastly, Canadian governments could invest in research and development into containment techniques for “dirty” substances such as diluted bitumen. (Note: most of these precautions exist within the Canadian regulatory structure.)

Some stringent opponents of natural resource development, however, posit that spills are never worth the risk. The nightmarish consequences of many infamous spills haunt the collective memories of coastal communities and environmentalists tend to assume the potential costs to the local economy will outweigh the potential economic benefits. Diluted bitumen, for example, has unknown effects in maritime environments and could prove to be very damaging if it spilled in a maritime setting. Ultimately, those who seriously oppose natural resource development and energy transportation argue that disasters are statistically inevitable and, therefore, not worth risking Canada’s fragile ecosystem and tourist “brand” of having a pristine coastline.

There are several problems with the above link of thinking, however, the most glaring of which is the “inevitability” argument. Indeed, oil spills are inevitable, but so too are all accidents. All economic activities carry some risk, whether they are human, environmental, or financial. Air accidents, for example, have steadily decreased in the last few decades, and although additional accidents are inevitable, it would be unwise to ban air travel. In essence, opponents of natural resource development would like a moratorium on tanker traffic. This approach, however, would stymie efforts within the energy sector to develop safer transportation mechanisms and it could encourage alternative forms of transport that are more dangerous such as rail. Most importantly, it would cripple Canada’s economic prospects and damage our living standards. These caveats show precisely why the apparently calm, well-reasoned rhetoric of the anti-tanker movement is simply a knee-jerk reaction that ignores many constructive solutions to a complex challenge.

Leo Plumer is an AIMS on Campus Student Fellow who is pursuing an undergraduate degree in economics and political science at McGill University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

Is Newfoundland a Petrostate? Part Two

It is instructive to use gross domestic product (GDP) as a means of evaluating whether Newfoundland and Labrador (NL) has become a rentier state. Let us compare across countries with firmly established rentier economies and analyze what share of GDP oil development constitutes: Saudi Arabia and Oman with 55 and 42 per cent, Venezuela at roughly 30 per cent, and Russia with close to 20 per cent. In NL, oil production accounts for 37 per cent of GDP. One additional characteristic of rentier economies is the small proportion of the labour force involved in the rent-generating industry, which, in NL, accounts for 5.4 per cent of all jobs.

Revenue derived from a particular rent-generating industry is another metric that one might use to analyze whether rentierisme has afflicted a particular jurisdiction: rentier governments depend heavily on resource revenues to fund programs and institutions. Indeed, the rapid influx of revenue from the rent-generating industry often encourages governments to adopt generous policy platforms. In the four rentier economies listed above, oil royalties as a share of total government revenue is 93, 45, 45, and 52 per cent, respectively. In NL, the provincial government derives 37 per cent of its revenue from oil royalties, reflecting the provincial government’s dependence on natural resource royalties.

These metrics seem to suggest that NL has become a rentier state, however, there are other elements that help determine whether that is the case.

The most common economic phenomenon associated with rentierisme is the deleterious “Dutch Disease,” which I described in an earlier blog post about NL’s experience with resource extraction. According to Kimble Ainslie, however, NL is not necessarily experiencing a “crowding out” of other industries or a decline in manufacturing employment. “Dutch Disease” typically occurs in an economy with a large non-resource sector, but NL’s agricultural and manufacturing industries are relatively small, and much too small in scale to export in significant quantities. (Non-resource sectors in NL account for 15.7 per cent of all provincial exports and 3 per cent of GDP.) Nevertheless, one could argue that NL’s persistent dependence on singular, direct sources of rent has suppressed non-resource growth in the first place.

If NL is suffering not from “Dutch Disease,” it could be suffering from a “resource curse,”–chronic political underdevelopment and corruption associated with resource dependency–which has retarded the province’s political environment over the years. Although the “resource curse” typically affects poor, developing countries, some aspects of it appear in NL. One consequence of lucrative resource rents, for example, is excessive, irresponsible government spending and NL is no exception: government after government in the province is guilty of increased spending habits and expensive social programs, not to mention public sector wage increases, etc. Furthermore, rentier states will earmark large, often dubious, public projects (read: Muskrat Falls).

Crowd-pleasing spending policies are commonplace in populist, single-party resource-rich states. Although a far cry from the petro-populism of Venezuela, the continuous rule of the NL Progressive Conservative Party, whose electoral victory roughly coincides with the beginning of the province’s oil boom, is intriguing. According to Reid and Collins, for example, former Premier Danny Williams used the oil issue in NL for political grandstanding and the demonization of his opponents.

Further to the aforementioned aspects of rentierisme, the most important long-term consequence of a rentier economy is a lack of incentive for diversification and long-term thinking, both of which result in economic vulnerability. Many Gulf countries have found it difficult to diversify away from the oil and gas industry, and with dwindling supplies in many of these states, in addition to the plummeting price of oil, the future looks grim. Thankfully, NL is less dependent on oil revenues, but, in the words of Finance Minister Ross Wiseman, recent budget shortfalls have one reason “… and that reason is oil.” Moreover, the provincial government has paid little attention to establishing a sturdier, more diversified source of revenue and it has had to make serious spending cutbacks.

In essence, although NL is heavily dependent on oil, and historically, single sources of revenue, it is not quite a textbook petrostate. The share of revenue and GDP resulting from resource rents is very high, but the effects of “Dutch Disease,” high levels of corruption and (serious) mismanagement, dysfunctional or authoritarian politics, and other ills commonly found in less-developed countries are less apparent.

Yet, the provincial government walks a fine line. The economy, albeit growing, does not seem to be diversifying. In addition, spending fell to reflecting falling oil prices, but per capita public debt remains the highest in Atlantic Canada, and as soon as rents begin flowing anew, spending will likely rise. In that case, and if government fails to encourage economic diversification–thereby continuing to place all of its proverbial eggs into one oil-slicked basket–the provincial economy faces the serious risk of economic decline.

As a matter of common economic sense, establishing a form of sovereign wealth fund (SWF) would benefit the provincial government in NL, and most importantly, the taxpayers who reside there. Liberalizing certain industries would also help them diversify and a more reserved approach to the oil and gas industry would eliminate the excessive emphasis on offshore oil. Finally, and perhaps most importantly, fiscal discipline is necessary and the provincial government must adopt measures that embrace it.

The future of NL’s aging population, and the younger generation there to support them, depends on the long term sustainability of NL’s economy. There is a lot to learn from the experiences of other countries with undiversified economies and the provincial government should take them seriously.

Leo Plumer is an AIMS on Campus Student Fellow who is pursuing an undergraduate degree in economics and political science at McGill University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies