The G-20 Meeting and Canadian vulnerability facing the global economic crisis

A missive from CCPA Executive Director Bruce Campbell:

The G-20 the leaders’ meeting in London on April 2 will be a important test of whether the major nations are up to the challenge of confronting this recession and preventing it from becoming a depression.

Will their collective response of monetary, fiscal and financial reform measures be bold enough and sufficiently coordinated? Or will it be a forum for inaction, posturing, and papering over differences? The crisis demands a combination of aggressive monetary, fiscal and financial reform measures implemented as a comprehensive whole.

However, there are major differences among the participating nations. The United States and China are the leading proponents of boosting aggregate demand through fiscal stimulus. The IMF and many influential economists also advocate major stimulus in the order of 2% of GDP.

The European Union is leading the group of countries that think the main focus should be financial stabilization, reform and reregulation.  Most EU countries believe that for the moment they are doing enough (or in some cases as much as they can) on the fiscal side, even though their combined fiscal stimulus measures fall short of the 2% IMF target. In fairness, the EU countries generally have much stronger automatic stabilizers, or built-in stimulus, in their economies than do the United States or Canada.

Canada portrays itself as in the middle supporting both approaches. Harper boasts about the strength of its banking sector, its aggressive monetary policy and robust fiscal policy, claiming that Canada is meeting the 2% of GDP fiscal stimulus target. Neither Canada’s independent Parliamentary Budget Office nor the IMF believe the federal government’s claim.

A draft of the final G-20 communiqué leaked to Financial Times reinforces my view that the consensus agreement will fall short of what is needed given the seriousness of the economic crisis.

On the positive side, it appears that there will be agreement to begin the process of creating a new regulatory architecture for global finance. This would include establishing regulatory frameworks for hedge funds and credit rating agencies; establishing a framework for CEO pay, requiring greater transparency from tax havens, and securing commitments from governments to backstop their banks with capital if necessary.

It appears also that there will be major increase in resources for the IMF, including for a new issue of special drawing rights, the IMF’s own money.  How effective this will be in meeting the severe economic and financial challenges facing emerging economies will depend on the degree of conditionality associated with this finance. The track record of the IMF–notably its penchant for contractionary policies—does not instill confidence going forward

The major shortcoming of this G-20 meeting will almost certainly be the lack of commitment to an aggressive and coordinated approach to fiscal stimulus.  It doesn’t look like the IMF 2% of GDP target will be part of the agreement.  Most major industrialized countries including Canada have fallen short of the target. Canada is singled out by the OECD as one of the countries that can afford to do more, but is  unlikely to  do so.

The inadequate international fiscal stimulus response to date misreads the seriousness of the crisis. The priority now is for Governments to act together immediately to aggressively pursue expansionary monetary and fiscal policies.

As Yale economist Robert Schiller wrote:  “In our current crisis, we need to try to understand the perils we face…The greatest risk is that appropriate stimulus will be derailed by doubters who still do not appreciate the true condition of our economy.” (Schiller, Economic View Mar. 29)

There will be a general commitment not to engage in protectionism even though there is little evidence at this point of a widespread increase in trade barriers. However, there are signs of conflict in the area of exchange rates, as some countries depreciate to boost their exports.

I am concerned that to the extent that other  nations  do  not  pull their  weight  on the economic stimulus front, and are seen to be free riding off the US fiscal stimulus, this will be seen in a negative light in the US and may in fact lead to greater US protectionism.

The lesson of the Great Depression is not that protectionism made things worse (which they did). But rather that the failures of macroeconomic policy created the conditions which made protectionism inevitable. In this context, protectionism was a rational reaction, and it took a long time to reverse.

Canada is better positioned than most to implement an aggressive fiscal stimulus package to cushion the blow of the recession, since we have one of the lowest debt-to-GDP burdens of any industrialized country; though this advantage is meaningless unless it is used properly.

However, by other measures Canada enters this recession in a far more vulnerable state than in past recessions. Why?

First, since the mid-1990s, inequality in Canada has grown faster than in most OECD countries, including the U.S. Median incomes have stagnated while the top 5% have captured the lion’s share of income increases.

For many Canadians, stagnant wages and low interest rates depleted savings and led to the ballooning of personal debt as a way for many to maintain to their standard of living.

As the recession hit and economic insecurity rose, its Siamese twin, consumer demand, plummeted. People, fearful for their future, have cut back spending in order to repay their record debt and/or boost savings. For those in precarious employment and where family members have lost their jobs, the situation is much worse. These families are in survival mode.

For the economy as a whole, this fragile consumer demand situation is worse than it was in the early1990s, making Canada much less likely to pull its economy out of recession any time soon.

Second, and related to the first, is the shredding of Canada’s social safety net, and the overall contraction of the public sector. Cuts to social assistance, unemployment insurance, and other government transfers have weakened Canada’s automatic stabilizers, which kick in during recessions to cushion the blow for vulnerable citizens and help maintain consumer demand. According to the Parliamentary Budget Office, these automatic stabilizers today are only half as large as they were during the 1980-81 recession.

Historically, a large Canadian public sector provided stable jobs and vital public services, making it an effective counterbalance to contraction in the private sector. This stabilizing force in the Canadian economy is now dramatically smaller — down from 50% of GDP in 1994 to 34% of GDP in 2004. Without these supportive mechanisms, the recession will be deeper and more prolonged than in the past.

The third vulnerability is that changes over the past decade in the structure of Canadian production and exports have resulted in a dramatic proportional rise in resource exports and a corresponding decline in manufacturing exports.

Always a trade dependent country (accounting for about one-third of our GDP), Canada is now even more vulnerable to volatile commodity price and volume swings. This vulnerability is heightened by the fact that more than 80% of our exports go to the U.S. In the last six months alone, these exports have fallen by one-third.

Counting on a U.S. recovery to spark a revival of Canadian exports and free-ride our economy out of recession may have worked in the past, but the U.S. is not likely to come out of the current recession any time soon.

Recently, Harper has been peddling an upbeat Hoover-type message that economic recovery is just around the corner, a message that flies in the face of a deteriorating economy.

Acknowledging the growing severity of the crisis would suggest a re-evaluation its existing fiscal plan.  Unfortunately, under this intervention-averse government, such a rethink is highly unlikely, and Canada’s recession will therefore be deeper and more prolonged than it needs to be. Many more people will suffer.  And the cost to the economy will be profound.