An unsustainable proposition

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By Alex Whalen, Operations Manager

My colleague Patrick Webber has already touched on why government spending versus GDP growth is a bad measure for austerity. Here, I will expand on that argument and shed light on another part of the equation not within the scope of the paper but intrinsically a part of our discussion: debt.

The notion that government spending should grow along with the economy, as Brennan suggests, is problematic for a few reasons: e.g. economies of scale, decreasing marginal costs, and practical concerns about limiting the role of the state. However, it is also wrong to suggest that growing along with the economy is what has happened. While it is true that government spending has grown at or about the rate of GDP, rapidly rising provincial debt – not greater revenue – is fueling that spending.

To understand why this is a problem, look at the relationship between spending and revenue. Nineteen of the last 20 provincial budgets in Atlantic Canada (i.e. all budgets in the four provinces over the last five years) have delivered deficits, meaning the government spent more money than it took in. This has led to a significant accumulation of debt.

Critics of our paper would likely agree this is a problem, but would suggest it can be fixed with more revenue, i.e. higher taxes. The problem with that logic is twofold. First, we’re already among the highest taxed jurisdictions in the country – just how much more governments can squeeze out of their populations is dubious. Second, taxing at relatively higher rates has an effect on competitiveness. A government cannot raise taxes to solve every deficit problem: at some point rational economic actors will relocate to more competitive jurisdictions.

In a region trying to create more and better paying jobs, and to retain young people (not to mention labour and capital being more mobile than ever), we must stop seeing deficits as a revenue problem.

Provincial governments have become trained to increase spending yearly without restraint, and perhaps that is why the most modest of cuts seem like austerity.

The other problem with looking at government spending as a share of GDP is the distinct nature of the two items and how they grow. As GDP grows, more wealth is created and people are relatively better off. However, government growth at the same rate has a different set of effects.

There is no theoretical limit to how much GDP a province might want, while there most certainly is a limit on the number of civil servants, provincial departments, etc. Government is not an endless good like wealth. It has limits, and while we may argue over what those limits are, it is nonsensical to suggest that government should grow in an unlimited sense, as we would wish for the economy.

In fact, long-term GDP growth combined with a flat population should demand that government spending go down as a percentage of GDP: the same population receiving the same services and more overall economic activity should be precisely the formula through which government gets leaner and more efficient, not the opposite.

Taking the argument to the full extent, let us say that Nova Scotia was able to drastically increase its GDP. We know that a large chunk of government spending goes toward employing people. If spending grew with GDP, holding population constant, an increasing number of people would work for the government, until everyone did. And if everyone worked for the government, where then would the wealth come from to support such employment?

Ultimately, there is a limit to what government can do, what services it can provide, etc. Growing it in tandem is both ill advised and unsustainable. Growing it with consistent deficit spending, as is being increasingly done, is one sure way to bring on real austerity in the future.

Editor’s Note: This blog entry is Part 2 in a series of four blog posts related to our recent paper “Measuring Austerity in Atlantic Canada” by Patrick Webber. Following misdirected comments and criticism of the study, we compiled this series to clarify misconceptions and to underscore its findings. Read part one here.

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