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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New Brunswick’s Fiscal Challenges and the Argument for Public Sector Restraint

New Brunswick Premier Brian Gallant announced recently that he is voluntarily reducing his pay by 15 per cent and members of his cabinet will endure a 10 per cent reduction in their wages. He also officially opposed any recommendations to increase the pay of elected officials.

Gallant’s promise is a good sign for the province, which is in desperate need of leadership, particularly in light of the economic issues facing the region. Despite the provincial government’s willingness to examine the salaries of its highest ranking employees, Danny Legere, who is the President of the New Brunswick Canadian Union of Public Employees, says he and his members will not consider wage reductions. Furthermore, he warned that the provincial government “will get the strongest possible resistance if they try to roll back wages in the public sector.”

In New Brunswick, wherein economic and political problems have plagued the province for quite some time, average public sector compensation increased 20 per cent between 2009 and 2013 (as per Statistics Canada), while inflation averaged roughly 8 per cent during that same period. In comparison, average private sector compensation rose 9 per cent between 2009 and 2013. Yet, the labour movement refuses to accept its role in public finance issues in Canada. Data available in the CANSIM Table 383-0030 shows that public sector spending in New Brunswick averages roughly $4.5 to 4.7 billion annually. Additionally, sub-national government sector employees comprise nearly 19 per cent of New Brunswick’s labour market. One thing is clear, therefore, which is that the federal government and its provincial counterparts are not spending less on the public sector. In fact, public sector salaries constitute the largest expense for every government in Canada.

There must be some consensus among New Brunswick’s elected officials if the province is to emerge from its economic woes. Moreover, the provincial government and the province’s labour representatives must cooperate if both parties wish to stimulate the provincial economy. It might be true that some members of the Canadian Union of Public Employees cannot make ends meet, as Legere claims, and although that is unfortunate, they are ultimately beholden to the provincial government, and more importantly, the province’s taxpayers.

Rationalizing the public sector is another option available to governments in Canada that wish to reduce their expenditures and align them with current economic realities. Although this process may entail eliminating public sector positions that are redundant and unnecessary, reducing public sector employment rates through attrition is a more palatable alternative. Since 2010, attrition has resulted in 10,000 less public sector positions annually and, in a growing economy, prospective employees should be able to identify other opportunities in the private sector. (In economics, the “crowding out” effect explains how reducing the public sector, or government involvement in the market, can create new job opportunities in the private sector.) Importantly, however, as argued frequently by former Nova Scotia Finance Minister Graham Steele, attrition is an imperfect solution because some departments will have much larger outflows of retirees and simply eliminating those positions would be incongruous with departmental demands. In any case, although this solution is less than ideal, it is a step in the right direction.

Aligning benefits, wages, and pensions with the private sector is another positive step forward. In New Brunswick, on average, federal, provincial, and municipal employees earn 43, 25, and 34 per cent more than their private sector equivalents when calculating both wages and benefits. The Canadian Federation of Independent Businesses has also calculated that New Brunswick defined benefit plans have unfunded liabilities of roughly $500 million. Lastly, the average retirement age for public sector workers is 60, whereas in the private sector it is 63, and for the self-employed it is 66–and the government actually provides early-retirement incentives.

Recent developments in New Brunswick pertaining to public finances are positive. Premier Gallant is positioning himself to reduce government expenditures and place the province on a sturdy foundation from which to grow the economy. Although he will still receive nearly $152,000 annually, down 15 per cent from $164,000, his gesture demonstrates a serious willingness to consider deep reforms for the sake of New Brunswick’s future.

Corey Schruder is an AIMS on Campus Student Fellow who is pursuing an undergraduate degree in history at Cape Breton 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