Reality check—the dangers of debt accumulation

Canada has entered perilous fiscal territory. Total government debt is 107 per cent of GDP with more on the way. Risk from mounting debt casts a shadow on the future.

Former Clerk of the Privy Council, Canada’s highest-ranking civil servant, Alex Himelfarb is one of the most eminent and vigorous proponents of increased debt. But his recent article in Finances of the Nation misrepresents the evidence about the dangers of debt accumulation. His citations are important, just not the way he claims.

After criticizing what he characterizes as the orthodox view that “deficits and debt are the problem,” Himelfarb cites “three recent” IMF reports “each of which challenges the conventional fiscal wisdom” in support of his view that Canada should borrow more. In reality, the citations warn against the course Himelfarb charts (aso does the most recent IMF 2021 report on Canada).

Himelfarb first cites the IMF’s World Economic Outlook: October 2012 report. Rather than challenge “conventional fiscal wisdom,” the report states that the “problem of high public debt existed before the Great Recession, because of population aging and growth in entitlement spending, but the crisis brought the need to address it forward from the long to the medium term.”

That’s hair-on-fire language for the IMF. The report calls for “fiscal consolidation” and “structural reforms to public finances”—IMF-speak for deficit and debt reduction.

Himelfarb’s description of this 2012 report as “recent” is odd, but it’s relevant to Canada’s debt challenge. The report searched history for “successful debt reduction” and found Canada of the mid-1990s. Debt had reached more than 100 per cent of GDP, as it has now. Rather than Himelfarb’s call to damn the torpedoes and spend more, the report praised Canada’s spending cuts as the only viable approach to debt reduction “given the already high level of taxation.”

Himelfarb writes: “Another [study] concluded that the economic benefits of ‘neoliberal’ policies designed to shrink or contain the size of government had been badly oversold.” The article actually says “somewhat overplayed.”

Moreover, the article argues against harsh austerity but does not criticize policies “designed to shrink or contain” government. Instead, it says “high debt is bad for growth and welfare” and calls for containing government spending, “allowing the debt ratio to decline organically through growth.” That’s pretty conventional thinking and distant from Himelfarb’s call to increase debts and deficits.

Himelfarb asserts: “Yet another [study] found no clear relationship between debt and economic growth. In fact, for advanced economies in good standing like Canada, the study comes to what it describes as the ‘unpalatable’ conclusion that there seems to be no limit to how much debt a government can issue.” That’s false.

What Himelfarb cites as the article’s conclusion is actually a supposition it rejects—whether low interest rates mean “governments can safely borrow more.” The study’s conclusion, “The short answer: not by much.” This conclusion is on the page Himelfarb quotes, and the abstract, introduction, econometric results and conclusion. “Not by much” is rather different than “no limit.”

Another oddity. Himelfarb says the article finds “no relationship” between growth and debt. But the article didn’t address that question. Instead, he seems to misinterpret another one of his citations, the 2012 IMF report, which does say “there is no simple relationship between debt and growth.”

The operative word is “simple.” The report finds that countries with debt levels “between 90 and 115 percent of GDP” but which are decreasing debt have economic growth rates an astonishing 0.5 percentage points higher than those increasing debt. This is a striking warning against Himelfarb’s recommended course. Canada’s debt level is exactly in the red zone where more debt stunts growth.

The IMF’s most recent report on Canada is consistent with these earlier warnings. The report worries Canada’s growing debt will undermine fiscal credibility. “The recent sharp rise in public debt increases the importance of clearly specifying a medium-term fiscal anchor [a cap to deficits and/or debt] to guard against a potential weakening of credibility in the fiscal framework.”

The 2021 federal budget has no defined fiscal anchor. We need a sensible debate on getting public finances under control rather than fiscal reality distortion.