Public sector in for some wrenching economic truths

Stock market recovery, a buoyant housing market and enthusiastic Christmas shoppers lifted spirits as the New Year dawned. But before we declare victory over the new millennium's first global financial meltdown, let's remember that much of the improvement in employment and GDP statistics is being driven by unprecedented, and unsustainable, levels of public spending.

Throughout the developed world, governments have been pumping cash into the economy "like there's no tomorrow." Those who have enthusiastically administered Doctor Keynes' medicine of recessionary deficit spending failed to learn the other part of the Keynesian economic prescription: that governments prepare for the bad times by amassing surpluses during good times. Except for Canada, developed countries now throwing "stimulus" cash in all directions went into the recession with debt and deficits that were already far too high.

At a recent public presentation where I lamented out of control public debt and deficits, a member of the audience challenged my viewpoint with this reasoning: "The United States is running a huge deficit, but the Dow is way up and job losses have fallen, so how can you say that running deficits is a bad thing?"

The question highlights a prevalent lack of understanding about a key reality of public debt: i.e. virtually every dollar (or pound or yen, to name the most overspent currencies) of financial shortfall by governments must be borrowed from someone else. For example, the U.S. deficit is funded mainly by auctioning hundreds of billions in Treasury bills, with China being the biggest buyer. Here in Canada, sovereign debt securities include Canada Savings Bonds. It's no coincidence that those bucolic TV ads advocating their purchase have become more frequent. Our country's recession-battered tax revenue on the one hand and massive stimulus spending on the other is rapidly driving up of our national debt, after years of paying it down. And remember, every dollar of deficit incurs interest, further eating into revenue available for core programs.

Canadians experienced the impact of these realities in the early 1980s, when a combination of sky-high spending and rising interest rates caused a debilitating spiral of debt and deficits that required draconian cuts in social program spending lasting more than a decade. This economic malaise spread to the private sector, forcing businesses to pay interest rates exceeding 20 per cent. Equity markets were devastated because investors could buy lower-risk government bonds with higher yields than even the best company equities could provide. The resulting economic contraction, together with inflation caused by the impact of excessive government spending on money supply, was termed "stagflation" and it thrust Canada into the worst recession since the 1930s. The drop in economic output combined with our enormous debt placed our country in the category of other teetering economies such as Italy and Argentina.

Learning from those hard lessons is what allowed Canada to enter the latest recession in better shape than any other G8 country. But sadly, there are many world leaders who exemplify the adage that those who don't learn from history are doomed to repeat it. The two most prominent of those are U.S. President Barack Obama and British Prime Minister Gordon Brown. Both countries are accumulating debt and deficits so large that it's virtually impossible to develop a plausible recovery scenario. Further damaging his credibility are Mr. Obama's recent comments to the effect that, since the banks got the country into "this mess," they should pay for their mistakes by easing credit restrictions on new lending. In other words, the cure for the easy credit disease is more easy credit. This is an astounding statement from the leader of the country where profligate lending to house buyers with poor credit ratings and runaway shoppers ignited the global economic firestorm.

As in other countries, Canada's government spending has turned this time of private sector bust into a public sector boom. Rather than making tough choices and finding ways to be more efficient, universities and other public institutions have followed the well trodden path of campaigning for even more taxpayer money. While private sector workers lose jobs and worry over uncertain pensions, public sector workers use monopoly strike power to extract higher wages and protect benefit packages most private sector workers could only dream about.

But the tables must and will turn. Private sector recovery will be long and difficult, but the overall direction will be up. On the other hand, financial reality dictates that public sector expenditures must fall dramatically. That challenge is made even more difficult because the costs of Canada's flagship social programs keep on rising. We're past the point where long overdue changes to both the delivery and funding models can be delayed. The most notable example is health care. Well before the recession it was clear that our monopolistic health care system is inefficient and appallingly inaccessible. Yet union opposition and political inertia deferred real change. Now, with provincial debts and deficits reaching crisis levels and a national government determined to rebalance post-recession budgets, real change can no longer be postponed. The private sector has gone through wrenching challenge and change. Now, it's the public sector's turn.

Gwyn Morgan is the retired founding CEO of EnCana Corp.