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

The Economics of Amalgamation

Small municipalities in Nova Scotia are asking tough existential questions. Earlier this year three towns voted to dissolve within a five week window: Springhill, Bridgetown, and Hantsport. Hantsport’s decision came as surprise, given their relatively healthy municipal finances, but as one supporter of the motion put it, the decision to amalgamate represented a “forward-looking” and “strategic” choice for the councilors. The trends foreseen by Hantsport come down to basic economics. In particular, two interrelated economic concepts stand out to explain why so many of Nova Scotia’s small towns are facing increasing cost pressures.

Economies of Scale

The kind of services provided by municipalities are all subject to economies of scale to varying degrees: as the scale of service grows, average or per capita costs fall until reaching a sweet spot, beyond which more scale creates rising average costs. Economies of scale are key to understanding the differing levels of market concentration by industry, and is similarly applicable to analyzing the size and concentration of political units.

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A simple way to demonstrate economies of scale in municipalities is to look at how per capita costs of basic services differ depending on scale. For example, providing a town in Nova Scotia with police and fire services, along with other administrative and counsel expenditures, costs on average $683 per capita annually. Scaling these same services up to the county level reduces the per-capita costs of every category, and cuts the annual total nearly in half to $350 per capita. Costs begin to rise again for CBRM and HRM, but never reach the highs of the town average.

These trends align with the academic literature on the subject. Most studies of Canadian municipalities find that economies of scale are mmaximized for police and fire services between a population of 20 and 50 thousand. Out-migration is, therefore, especially damaging to towns below this population range.

The Cost Disease

The cost disease is a concept that was first observed in connection to the arts. The economist William Baumol noted that musical performers were becoming more and more expensive to hire, despite little to no improvement in their productivity. One had to pay more in order to entice the musically skilled away from high productivity growth sectors of the time, such as manufacturing.

The cost disease is a defining feature of our times, as creeping changes in relative cost, and in particular rising costs of labour, force old practices and structures to break down. For instance, having home servants was once commonplace, but today is associated with luxury. For a similar reason, it’s often cheaper to buy a new home appliance than to call in a technician. In schools, teacher salaries continue to rise without matching productivity growth, too, leading to the infeasibility of the small school model and driving organizational consolidation.

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Residential Tax Burden = Total residential tax revenue ÷ Total dwelling units

The cost disease leads to similar consolidation pressures for municipalities. Nova Scotia’s municipal districts tend to have the fastest growing residential tax burdens for two reasons. First, relative to towns, they have smaller tax burdens to begin with, so a given increase implies a faster growth rate. In absolute terms, towns have the largest tax burdens by a long shot. Second, municipal districts have more mandatory expenditures, such as the education contribution, that they have little control over.

There are no short cuts to fighting the cost disease. The options can be grouped into two types: we can either accept much higher proportions of GDP going to cost diseased areas or we can find ways to adapt to changing cost structures by restructuring organizations, boosting labour productivity and finding labour-saving technologies.

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

The Importance of Growth

Of the current issues facing the Canadian economy, the biggest of them depend on how Canada’s trade negotiations with other countries settle. The Comprehensive Economic and Trade Agreement (CETA) with Europe, for instance, creates enormous potential for Canada’s export-oriented industry to expand. In Atlantic Canada, however, there could be severely negative consequences if the provinces fail to take steps that bolster economic growth and attract new talent to the region. The new method of determining health transfer payments, which focuses on population and GDP, is just one illustration of how important economic and demographic development is in Eastern Canada.

Canada’s economic success is rooted in exports, and the export-industry, which is composed primarily of natural resource extraction, has an opportunity to not only supply other countries with raw materials and manufactured goods, but also value-added products. Reducing and eliminating barriers to trade with the European Union (EU) will likely benefit key economic sectors, such as energy, manufacturing, and seafood, and freer trade between Canada and Europe will encourage domestic economic activity, as it expands the market available to Canadian industry. The EU is currently Canada’s second-largest trading partner–behind the United States–and, in 2012, exports to Europe totalled $41 billion. However, it is critical that Canadian industry remains competitive in foreign markets and focuses on value-added products, as well as supplying factors of production. In fact, CETA eliminates protective barriers that currently prevent Canadian industry from exporting value-added products into Europe, and vice-versa, which levels the competition, in addition to providing an opportunity for Canadian-EU businesses to produce the most desirable products.

CETA also creates enormous potential for the Atlantic Provinces to expand the agriculture and seafood sectors into the EU, but they face significant demographic challenges that could restrict new prospects. In the last several years, Atlantic Canada’s population has declined and the average age has increased dramatically. In 2011, roughly 16 per cent of Atlantic Canada’s population was aged 65 or above, compared to 14.4 per cent of Canada’s entire population, and by 2036, Statistics Canada expects it to be around 29.1 per cent (compared to 23.7 nationally). Furthermore, Canada’s labour force increased by 1.1 per cent between 2012 and 2013, however, Atlantic Canada’s increased by half that amount, which is due in large part to an outflow of young individuals and families and an influx of retirees. As a result, the region is not equipped to attract large-scale industry, especially compared to British Columbia, Alberta, and Saskatchewan, and has contributed much less than other regions to Canada’s GDP in recent years. This is an important caveat, considering the federal government will begin calculating the Canada Health Transfer using population and GDP in 2018. If the Atlantic Provinces fail to generate economic growth and attract newcomers, they will receive less than other provinces to fund their healthcare systems, which will become more cumbersome in the future due to an ageing population and declining tax base.

In coming years, these two developments–freer trade and the new healthcare funding mechanism–will play a large role in determining Canada’s economic prosperity and the viability of its healthcare system. Canada’s export sector and healthcare system are rooted historically in the country’s history and it is unclear what changes will materialize because of modifications to them. In any case, the Atlantic Provinces need to take measures that bolster economic growth and attract new talent, both of which will allow them to take full advantage of CETA and other free trade agreements and create a sustainable source of funding for their healthcare systems.

Rachel Lowe is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute