Matthew Lau: To Reduce Provincial Deficits We Must Shrink the Public Sector

This is the second of two prize winning essays by Matthew Lau, 1st place winner of the AIMS on Campus 2015 Essay Competition. Here Matthew argues growing provincial debt in Atlantic Canada is a problem in need of urgent addressing, and has been driven by a bloated — and still growing — public sector. 

public sector chart

With the federal government’s daunting $616 billion in net debt hanging over the heads of taxpayers, it is easy to forget that for many Canadians, their province’s finances are in even worse shape.  In fact, of the four Atlantic provinces only Newfoundland and Labrador has a lower debt-to-GDP ratio than the federal government.

Combined, the provincial governments of the Atlantic provinces hold $40 billion in net debt and there is little reason to believe this number will go down.  In 2014-15, Nova Scotia ran its fourth consecutive deficit, New Brunswick its seventh, and Prince Edward Island its eighth.  Newfoundland and Labrador, which will increase its debt by over $1 billion in the 2015-16 fiscal year, doesn’t plan to balance its budget until 2019-20.

A primary reason for the dismal financial state of affairs in the Atlantic provinces is the excessive cost of government.  Newfoundland and Labrador spends more per capita on government programs than any other province – in fact, its program spending per capita will exceed the thriftiest province’s, Quebec, by 70% in the 2015-16 fiscal year.

Overspending isn’t isolated to just one Atlantic province, unfortunately.  Program spending relative to GDP ranged from 20.2% to 26.0% in the Atlantic provinces in 2014-15.  For the other six provinces, it ranged from 14.3% to 19.4%.

While some have suggested that a lesser ability to take advantage of economies of scale (for example, in the area of infrastructure spending) may account for the poor financial performance of Atlantic provinces relative to the rest of Canada, this cannot fully explain away the excessive costs incurred by Atlantic provincial governments.

A report published in March 2015 by the Canadian Federation of Independent Business, which examined government wages in 2010, found that the average provincial government employee in Canada received a 21.2% premium over comparable private sector workers when both salaries and benefits were taken into account.

In each of the four Atlantic provinces, the premium received by provincial government employees exceeded the national average of 21.2%.  The largest discrepancy existed in Prince Edward Island, where compensation spending on provincial government employees was 28.6% higher than the cost of comparable private sector workers.

The high premiums paid by Atlantic provincial governments to public sector workers is only half of their problems when it comes to compensation spending.  According to the Atlantic Institute for Market Studies, in 2013, every Atlantic province had a higher number of government employees per capita than the Canadian average.  “The Average across Canadian provinces is 84 employees per 1,000 and Nova Scotia has 99 (85 for NB; 95 for PEI and 109 for NL),” noted AIMS president Marco Navarro-Genie earlier this year.

Compensation for government employees is becoming a hot topic in Canada.  Earlier this month, the Fraser Institute found that across all three levels of government in Canada, government workers received a 9.7% wage premium over comparable private sector workers despite enjoying much better pensions (almost all defined benefit), retiring several years earlier on average, being absent much more often, and enjoying significantly better job security.

If politicians in Atlantic Canada are serious about repairing the state of their provinces’ finances, they should take a serious look at compensation spending.  The fact that in each Atlantic province, both the number of government employees per capita and the cost premium per employee is higher than the national average, suggests that there exists a lack of fiscal restraint from Atlantic provinces when it comes to compensation spending.

By Matthew Lau

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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

Is Higher Education Really a Bubble?

Canada’s alleged housing bubble has returned to the media spotlight with full force in recent months. Falling oil prices have slowed housing sales, which has led to speculation that a bust is drawing closer. Bank of Canada Governor Stephen Poloz did not help matters in December when he was widely quoted as claiming housing could be overvalued by as much as 30 per cent. Less quoted was his repeated assurance that Canadian real estate does not qualify as a bubble about to pop. The perennial fear of collapsing real estate values, at this point, has become a form of mass hysteria.

I have wondered lately whether higher education fits that mold. Theories of a “higher education bubble” exist, but mainstream economists almost universally scoff at them, which is understandable because calling student debt a “bubble” is highly misleading as anything more than a metaphor. Yet, it is also worth acknowledging that those who deny the possibility the loudest tend to belong to a knowledge-based class predisposed to uphold the value of university education. The question is not whether higher education has value, though. Rather, the question is whether underlying incentives have caused a misallocation of credit to leverage the wrong kinds of education in the wrong quantities.

The first symptom of a bubble to consider is rapidly rising prices. It is well known that tuition costs have grown significantly above the average inflation rate in both Canada and the United States. In the five academic years from 2010/11 to 2014/15, for example, the average tuition rate in Canada climbed from $5,146 to $5,959, which is roughly 3 per cent annually. During the same period, inflation averaged 1.5 per cent, indicating that tuition increased 1.5 per cent in real terms. Whether this trend is “good” or “bad,” it is not accelerating out of control. In comparison, however, real estate values appreciated by 80 per cent or more between 2001 and 2006 in seven American metropolitan areas. Now that is a bubble!

Student debt, too, is less of an issue and recent graduates are faring much better than is widely believed. The widely-reported number is that students graduate with around $25,000 in debt, but this figure is misleading. In 2012, for example, Simon Fraser University conducted a survey that revealed student debt levels to be roughly $24,600, yet, what is often missed is that this average excludes those who graduate debt free. The average drops to $14,500 when debt-free students are included as part of the analysis.

Bubbles are not just fast growing prices or debt loads, however, but prices that are not connected to market fundamentals. In Canada, rising tuition fees clearly reflect three fundamental forces: 1) demand rising faster than supply (the ratio of students to faculty has increased from 17 :1 to 25:1); 2) higher administrative costs; and 3) a shift in the balance of cost-sharing. Government funding, for example, once comprised more than 80 per cent of Canadian university operating revenues in 1990, but is today closer to 57 per cent percent on average.

Perhaps, then, Canada’s postsecondary education is less like the US housing bubble and more like our own “overvalued”–but not out of control–real estate. The analogy matches quite well. Rather than being driven by easy credit and speculation, our real estate boom is mostly confined to regional markets where the supply of housing is constrained and immigration is high. Low interest rates might have caused some overleveraging and modest mismatching, but it has not been enough for a big bust. In the same way, Canada’s model of postsecondary education leads to modest malinvestments in human capital: too many people with arts degrees, too few in vocational programs. These malinvestments almost surely decrease productivity and lead to labour market mismatches, but they do not portend a catastrophic implosion.

One final possibility is that our public model of university funding transfers the risk to taxpayers, which would mean that our student debt, while not at bubble proportions, is also not the full story. A substantial share of public debt must be considered as well. If that is the case, the question is not one of student solvency but provincial solvency. That, however, is a debate for another time.

Samuel Hammond is an AIMS on Campus Student Fellow who is pursuing a graduate degree in economics at Carleton University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies