Stop the ‘Stimulus’ Spending: The Case for Restraint

Niels Veldhuis
September 24, 2009
Niels Veldhuis and Charles Lammam dissect the hard numbers to debunk conventional wisdom that governments should spend more during an economic slowdown – the facts show the reverse is true.

Stop the ‘Stimulus’ Spending: The Case for Restraint

Niels Veldhuis
September 24, 2009
Niels Veldhuis and Charles Lammam dissect the hard numbers to debunk conventional wisdom that governments should spend more during an economic slowdown – the facts show the reverse is true.
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Just prior to the recent G-20 meeting of Finance Ministers and Central Bank Governors, Canadian Finance Minister Jim Flaherty encouraged his counterparts to follow through on their stimulus pledges. According to Flaherty, “What we need to do is continue to implement our stimulus package, not only in Canada, but in other countries around the world.”

Oddly, Flaherty’s push for stimulus comes at a time when we are seeing glimmers of hope that the end of the recession is near. As the economy begins to recover, government stimulus spending will unfortunately compete with private sector investment and dampen the recovery. Rather than continue to roll-out stimulus money, Prime Minister Stephen Harper’s government should tighten the reigns and put forth a plan to reduce the size of the federal government. Doing so will ensure a brighter economic future. Our own history provides the evidence.

Newly released data from Statistics Canada presents an encouraging picture of economic recovery, highlighting a small increase in economic output (gross domestic product, or GDP) in June – the first monthly increase in nearly a year. Furthermore, the Bank of Canada and most major Canadian banks are predicting positive growth in Canada’s economic output for the third and fourth quarters of the year. If the positive data from Statistics Canada continues and these projections come to fruition, the “great” recession of 2009 will be much like previous recessions, and nowhere close to the doomsday situation many predicted.

Interestingly, the economy is showing signs of recovery despite the fact that most of the stimulus spending has yet to be implemented. For example, first quarter (January-March, 2009) real GDP results show that government spending at all levels of government (federal, provincial and local) increased at an annualized rate of 1.2 per cent (compared to 3.3 per cent in 2007 and 3.7 in 2008). Government capital investments increased at an annualized rate of 1.1 per cent in the first quarter of 2009 compared to 6.0 per cent in 2007 and 12.2 in 2008 (Statistics Canada, 2009b). In other words, governments actually slowed the rate of increase in spending considerably during the beginning stages of the recession; hardly what one would call stimulus spending.

While comparable data for the second quarter (April-June, 2009) has yet to be released, the federal government’s June 2009 report to Canadians was intended to outline the progress that the federal government had made on its stimulus initiatives. The report claimed that 80 per cent of the funding measures were either flowing or money was committed to specific projects.

However, money being “committed” is very different from money actually spent.

For instance, the federal government claims that more than 40 per cent of its total stimulus package is being devoted to infrastructure projects, which inevitably requires months of preparation before construction can even begin, and perhaps years before completion. While money might be “committed” to certain projects, most of the funds have yet to be spent and will not provide jobs in time to counteract the recession, which may well already be ending.

Instead, there is a significant risk that a large portion of the stimulus package will hit the economy as it is naturally moving out of recession. As a result, the “stimulus” will be destabilizing rather than stabilizing because the government will be competing with the private sector for scarce resources resulting in increased costs and fewer private sector projects than would otherwise be the case.

In addition, stimulus spending that is financed by deficits will “crowd-out” private sector investment. Since governments will borrow from the market and provide investors with “risk free” government debt, they will directly compete with and supplant the development and financing of private projects which are crucial to a sustained recovery.

Rather than follow through on their stimulus pledge, the federal government should return to the economic policies of the 1990s that made Canada’s economy one of the most vibrant in the developed world. That is, they should put forth a plan to reduce the size of the federal government.

Most Canadians are not aware of Canada’s 15-year track record of reducing the size of government (1992-2007). After peaking in 1992, the size of government in Canada (best measured by total spending at all levels of government as a share of gross domestic product) actually decreased from 53 per cent to 39.1 per cent in 2007.

If the politicians, journalists and activists who claim that government spending creates jobs and increases economic activity are right, these decreases in government spending in Canada experienced in the 1990s should have negatively impacted Canadians and our economy.

In reality, the very opposite occurred: as governments reduced and constrained spending, a greater share of the resources in our economy was controlled by individuals, families and businesses rather than governments. The result was a robust economy with average inflation-adjusted economic growth in Canada exceeding that in the U.S. and every other G7 country from the mid-1990s to 2007.

Since 2007, however, the size of government relative to the economy has increased dramatically, thanks mainly to the economic stimulus packages that the federal and provincial governments have enacted. The size of total public sector spending in Canada is expected to reach 44.1 per cent of GDP by 2010, a level not seen for more than a decade. Unless the federal government enacts an aggressive plan tore to rein in spending, its legacy could well undo nearly a decade of reductions in the size of government.

Implementing a spending plan aimed at reducing the size of the federal government would avoid the crowding out of private sector projects. It would also provide the fiscal room necessary to reduce economically-damaging taxes thus encouraging economic activity and further strengthening the Canadian economy both today and into the future.

There is a long list of potential areas where our governments could reduce or even eliminate spending with no effect on long term economic growth or social progress including regional development subsidies, corporate welfare, agricultural supports, and broadcast subsidies, to name a few.

Rather than encourage his global counterparts to follow through on their stimulus pledges, Finance Minister Jim Flaherty should focus on scaling back his own government’s extravagant spending. Reducing, rather than increasing, the size of government will ensure a faster economic recovery and brighter future for Canadians.

Niels Veldhuis ([email protected]) is director of fiscal studies and Charles Lammam is a policy analyst at the Fraser Institute.

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