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Sean Speer: A fiscal reckoning is coming for Canada

Commentary

This week’s Fall Economic Statement is expected to show that this year’s deficit will be higher than the $40 billion that was projected in the March 2023 budget. It may in fact be as high as $56 billion (or 2 percent of GDP) according to one estimate which would be nearly as large as the deficits that were recorded during the 2008-09 global financial crisis in both absolute and relative terms. It also means that Ottawa’s fiscal trajectory is moving in the wrong direction after running a $35.3 billion deficit (or 1.3 percent of GDP) last year. 

This budgetary deterioration raises a bigger question about whether the Trudeau government has manufactured a structural deficit that won’t be resolved merely by a combination of rising revenues and some spending constraints. It will now require more concerted (and possibly draconian) efforts to bring Ottawa’s revenues and outlays back into balance. The budget, in short, won’t balance itself as the prime minister infamously put it

I’ve come to think of the problem in the following terms: federal fiscal policy since 2015—but particularly since the pandemic—has come to reflect Stephen Harper’s tax rates and Justin Trudeau’s spending preferences—and the two are ultimately irreconcilable. Something has to give. 

Figure 1 plots federal revenues and expenditures as a share of GDP over the past fifty years. It conveys a somewhat complicated story. Revenues have bounced around a bit but remained largely stable. Expenditures have changed more significantly in response to major developments such as economic downturns or the COVID-19 pandemic. Annual revenues have averaged 16.1 percent of GDP over this period. Expenditures have averaged 18.8 percent

Graphic credit: Janice Nelson

Over this half century, expenditures have therefore averaged 2.71 percentage points more than revenues. The gap hasn’t stayed constant of course. It has increased and decreased based on different factors including economic trends and fiscal policy choices. But just over three-quarters of the years during this 50-year period have witnessed expenditures exceed revenues as a share of GDP. 

The Chrétien-Martin governments came to office in 1993 with a gap of more than five percentage points. As a result of the Program Review exercise in 1995, they subsequently oversaw eight consecutive years of budgetary surpluses in which revenues exceeded expenditures. Overall, this period was marked by an average gap between expenditures and revenues of just 0.75 percentage points as a share of GDP. 

The Harper government’s fiscal policy followed a different trajectory during its three terms in office: its first term was marked by large-scale tax reductions, its second term involved fiscal stimulus in response to the global financial crisis, and its third term was an exercise in fiscal consolidation to eliminate the deficit produced during the worldwide recession. The net result was that expenditures exceeded revenues by an average of 0.72 percentage points between 2005-06 and 2014-15. 

The main story, however, from the Harper government’s fiscal policy was in hindsight its tax reductions (such as lowering the HST/GST by two percentage points) which lowered federal revenues as a share of GDP from about 16 percent to 14 percent. One must go back to the early 1960s to find comparable levels of taxation. In this sense, the Harper government’s ability to bring revenues and outlays into approximate balance in the aftermath of the global financial crisis is an even more notable accomplishment because revenues were about two percentage points lower than their average over the past fifty years. 

The Trudeau government was elected with a short-term plan to solve for the federal government’s revenue-expenditure gap: borrowing. Its 2015 policy platform envisioned three years of annual deficits averaging $10 billion per year. Although the government predictably failed to live up to this promise and ended up running larger and longer deficits, its fiscal policy in the pre-COVID years saw expenditures exceed revenues by an annual average of 0.84 percentage points. This was broadly consistent with the overall performance of the Chrétien and Harper years. 

The gap, however, reached an unprecedented level during the COVID-19 pandemic. It averaged 9.25 percentage points during the two-year pandemic and has remained elevated ever since. March’s budget projected it to be 1.4 percentage points this year. Tuesday’s Fall Economic Statement is bound to increase that upwards. It may be below the fifty-year average (though the Trudeau government’s fiscal record, including the pandemic, has produced an overall gap between expenditures and revenues that exceeds the historic average by about 0.25 percentage points), but it’s self-evidently trending in the wrong direction. 

What’s the takeaway? As long as we’re living in a world of Stephen Harper’s tax rates and Justin Trudeau’s spending preferences, the gap is likely to grow—especially in the face of various spending pressures such as calls for higher spending on climate change and national defence and the inexorable rise of old-age spending. 

We’re going to have to have a reckoning: are we prepared to pay for the size of government that we want (and some people argue that we need), or are we ready to reset our expectations about the size of government to bring it in line with the rate of taxation that we’re prepared to pay?

There’s little reason to believe that Tuesday’s Fall Economic Statement will answer this question. The Trudeau government’s weak political position increases the likelihood that the gap between revenues and expenditures will grow in the short term. The political incentives to attempt to effectively bribe voters with deficit-financed dollars in advance of the next federal election will be overwhelming.

But this isn’t a sustainable trajectory for federal policymaking. The long-run challenge facing Canadian fiscal policy is rooted in the Harper-Trudeau gap. Some government will eventually need to solve it one way or the other. The arithmetic is going to eventually catch up to us. 

Brian Lee Crowley: Canada is becoming irrelevant on the global stage—and that’s bad news for America

Commentary

On November 14, the Macdonald-Laurier Institute (MLI) launched a new Washington-based initiative: the Center for North American Prosperity and Security or CNAPS (pronounced, ‘synapse’). As a part of the launch event, co-hosted with the Hudson Institute, MLI’s Managing Director, Brian Lee Crowley, delivered remarks outlining the desperate need for an honest, adult conversation between the U.S. and Canada, particularly on national security and energy policy. Brian’s speech is reproduced below with MLI’s permission. 

Ladies and Gentlemen,

I am here, as the head of Canada’s most prominent national public policy think tank, to say to you that it is time for a new era in Canada-U.S. relations, one that is no longer based on comfortable myths we repeat to each other endlessly about eternal friendship, shared history, and undefended borders. Foreign policy is founded on interests, not vague sentiments. And America’s attitude toward Canada fails to serve your interests in two ways. 

First, your unfamiliarity with and complacency about Canada expose you to risks here in the North American heartland that you are managing poorly. You can only fix this by seeing Canada as it really is.

Second, that same lack of awareness about Canada blinds you to how Canada can be the solution to some of America’s most pressing problems, but also that Canada will not solve those problems unprompted. You have to speak up. 

In the short time I have available to me I want to give one example of each of these ways in which America is failing to act on its interests with respect to Canada.

Canada’s declining national security is a continental threat

I mentioned that American complacency with respect to Canada is exposing you to risks here in our shared North American heartland. These risks are not primarily economic but revolve around national security.

The last decade has seen a dawning realization here in Washington of the dangers posed by a resurgent China heading a group of authoritarian revisionists that includes Russia and Iran. These countries chafe under a rules-based international order that thwarts their will and imposes moral, diplomatic, economic, and military penalties on violators, such as Russia following its invasion of Ukraine. They long for a return to unrestrained Hobbesian Great Power competition.

The United States has risen impressively, if slowly, to this challenge. It has provided notable levels of support to Ukraine. It has spearheaded and embraced innovative arrangements, such as the “Quad” (India, Japan, Australia, and the United States) and AUKUS (Australia, United Kingdom, and the United States) in the Indo-Pacific, and bilateral defence cooperation agreements and NATO expansion to deter Russian aggression in Europe. Moreover, it has become the world’s largest oil producer and LNG exporter, providing a lifeline to a Europe compelled to reduce its reliance on Russian gas.  

Canada, in marked contrast, is fast becoming an honourary Third World country from a national security point of view. This is due, at least in part, to a benign neglect of Canada by Washington, thereby encouraging the belief in Ottawa that Canada can embrace China and indulge in domestic diaspora politics with impunity.

Our contribution to joint continental defence, via NORAD, is dilapidated while Russian and Chinese advances in hypersonic weapons systems are making North America vulnerable. After the Russian invasion of Ukraine, Canada announced it would spend CAD$4.9 billion over six years to improve our capabilities but progress is glacial. The will to buy desperately needed new weapons systems is lacking, hence the more than a decade it took us to decide to purchase F-35 fighters. When the leaders of Japan and Germany came and begged Canada to make more of its abundant energy resources available, they were sent away empty-handed.

Canada’s military spending is two-thirds of NATO’s target of 2 percent of GDP, and a fraction of the United States’ 3.48 percent. Our prime minister has privately told NATO leaders he has no intention of meeting the target; in fact, the latest spending review by Ottawa has singled out defence for further cuts. Canada’s top soldier, Gen. Wayne Eyre, lamented recently he doubts our capacity to lead a mooted mission to Haiti, our military being already stretched thin by its modest contribution to Ukraine and leadership of the NATO mission in Latvia. One of our top defence experts at MLI, Richard Shimooka, wrote recently

…political decisions have simultaneously over-deployed the Canadian Armed Forces (CAF) while neglecting to invest in its capabilities. This has upset the fragile sustainment system, leaving its actual operational capability in tatters. The military has become a token force abroad and is even unlikely to be able to provide for Canada’s own defence in the near future. (emphasis added)

This is the view, not of some attention-seeking but poorly-informed junior congressman, but the sober assessment of one of Canada’s most distinguished defence analysts.

Compare this to the renewed commitment of Australia and the U.K. under AUKUS to buy nuclear submarines, embrace unprecedented levels of technological and command cooperation, and to increase significantly their military spending in consequence. Canada’s response to these shifts has been tepid, slow, and condescending. 

Once upon a time, Canada’s absence might have been explained by the political sensitivities of being seen as too close to the U.S. and the need to manage the independence movement in Quebec. Those traditional explanations are now taking a back seat to revelations of the extent of China’s penetration of Canada’s institutions at every level, including the political parties.

Canada’s security services have been sounding the alarm on China’s growing interference and nefarious activities for decades; indifference and hostility were official Ottawa’s response. Recently leaked intelligence assessments that Chinese Communist Party United Front operatives worked actively to influence the results of elections at every level have finally caused the public to take notice of the CCP’s clandestine activities. 

Canada is now so compromised that Canada’s intelligence-sharing allies, particularly in the “Five Eyes” alliance, quietly wonder if it is safe to share sensitive information with Canada, and I am here to tell you that they are right to have these doubts. 

I could go on, but the second half of today’s event is dedicated to a session where our top China expert, Charles Burton, will discuss with Hudson’s Miles Yu the China problem and its significance in the Canada-U.S. relationship.

To close off this first part of my remarks, let me just say that job one for America is rallying the liberal democracies against the depredations of China-led authoritarians. Yet Washington faces the real possibility that its northern neighbour won’t just fail to shoulder its share of the load, but that its institutions may be so compromised as to be unable to act in the interests of the West. It is time for America to start doing its part to arrest Canada’s slow-motion defection by reversing the neglect, complacency, and dismissiveness that helped to create it. As Prime Minister Justin Trudeau likes to say, better is always possible. But better on the Canada-U.S. front will only happen if both sides get more business-like and demanding in this relationship. 

It is to encourage this adult discussion that my think tank, the Macdonald-Laurier Institute, is here today at the invitation of the Hudson Institute, to launch our new U.S. operation, the Center for North American Prosperity and Security, or CNAPS (“synapse”). Before I go on to the second half of my talk, where I look at how Canada can be the solution to some of America’s problems, let me open a small parenthesis here and tell you a bit about my Institute: 

Now I mentioned at the outset of my talk that there were two things going on in the Canada-U.S. relationship that required U.S. attention but aren’t getting it. I talked about ways in which Canada was engaging in a slow-motion defection from the Western democratic alliance, a policy of which America seems barely aware.

 In fact, Washington’s ambassador in Ottawa has recently been defending the current Canadian government’s shameful and indefensible levels of defence spending. This gives comfort to those happy to see Canada inching out of America’s orbit and frustrates those of us pressing Ottawa to live up to its vital commitments to its democratic friends and allies in an increasingly dark and dangerous world. If America’s representative to Canada doesn’t see a problem but merely repeats the Trudeau government’s talking points, it makes it doubly hard to shake Ottawa out of its dogmatic slumbers.

The importance of oil and gas

But I also promised to talk about the ways in which Canada can, often unbeknownst to America, be the solution to some of its most troubling problems. I’ve only got time for one, so let’s talk energy.

Energy is the lifeblood of our economies, and therefore of our security. By a combination of good luck and capitalist ingenuity, North America is perhaps the most energy-secure continent of all. Many of Canada’s biggest energy companies—such as Enbridge, TC Energy, Cenovus, and Cameco—are truly North American companies, and are betting on our nations continuing to grow and prosper together.  

What many Americans do not realize is the extent to which U.S. energy independence is based on interdependence between our two countries. Canada may leave much to be desired in terms of defence spending and telling friend from adversary on the international stage, but when it comes to our joint energy security, Canada makes an outsized contribution and could do even more.   

The two-way energy trade between Canada and the United States hit a new record last year, reaching $190 billion (USD), almost triple what it was in 2020 in the throes of the COVID-19 pandemic, and beating the last high water mark of $178 billion in 2008. 

Most of this trade—over 80 percent of it—flows from Canada to the United States, primarily in the form of crude oil, but with significant natural gas and electricity exports as well. 

The shale revolution changed the American and global energy landscape. You went from the world’s largest importer to the world’s largest producer of oil and a net exporter. You added an entire Saudi Arabia’s worth of production to your tallies. This was undeniably good for the world and good for consumers, and we do not credit cheap American shale enough with the economic growth and low inflation the world enjoyed throughout most of the 2010s until Russia invaded Ukraine. 

As vital as the shale oil revolution has been for American energy security, however, it does not and cannot change the fact that not all barrels of oil are created equal. For example, the U.S. produces virtually no heavy oil, yet many of this country’s refineries, especially on the Gulf Coast, were set up to refine that kind of oil, and some refined products require heavy oil feedstock. Most of the heavy oil that supplies these refineries comes from Canada, and cannot be replaced by shale oil. That explains both why Canada is far and away the largest exporter of oil to America, AND why America can thank Canada for the fact that it is now a net exporter of oil.

But the shale revolution also created difficulties for Canada. We were used to you wanting every drop that we could produce and never bothered to build any export capacity beyond North America. To this day, and until the Trans Mountain expansion pipeline to the West Coast comes online in a few months, about 96 percent of our oil exports go to the United States. Your main response to the flood of new shale oil was to reduce your oil imports from authoritarian states, while Canada’s share has grown. Today, over 60 percent of your oil imports—about a quarter of your total consumption—come from Canada. About 4.5 million barrels a day: more than twice as much as Mexico, Russia, Saudi Arabia, and Colombia combined.

And the volume of oil you need from Canada may well need to grow. Just as shale oil production grew swiftly, it looks like it may decline quickly too. Even if technology prolongs the shale revolution, you still have the problem that shale oil cannot supply a major part of your refining sector. 

All of that gives a special significance to the fact that Canada’s oilsands represent the world’s third-largest reserves, and have hundreds of years of production ahead of them at current rates of decline. Regardless of what happens with shale, American energy independence cannot be threatened so long as it is understood to be North American energy independence. 

U.S. Secretary of State Antony Blinken, right, and Canada’s Foreign Minister Melanie Joly walk together after a group photo session during the Group of 7 Foreign Ministers meetings at the Iikura Guest House Wednesday, Nov. 8, 2023, in Tokyo. Eugene Hoshiko, Pool/AP Photo.

Can you be environmentally responsible and still rely on Canadian oil? Absolutely. ALL heavy oil production, including Canada’s, emits a lot of GHGs. Canada’s largest oil companies are working together to achieve net zero by 2050, however, and have credible plans, based on a projected $75-billion investment in carbon capture, nuclear energy, and other strategies, to achieve it. 

But friends tell friends the truth, and I have to tell you that Canadians have noticed that, although you limited Canadian oil imports when President Biden revoked the Keystone XL pipeline’s permit, you recently eased sanctions on Venezuelan oil. Venezuela too produces heavy oil, but its oil production process is literally the dirtiest in the world. And while you thumbed your nose, allegedly on environmental grounds, at Canadian oil, you were quick to embrace oil from one of Latin America’s most odious dictatorships when prices started to rise at the pump and there wasn’t much room left to draw down your strategic oil reserves. 

This mistake will have to be fixed eventually, and when it is, one of the challenges we will have to confront is how to rebuild confidence among North American pipeline companies that cross-border infrastructure will never again be treated as a political football for short-term gain. 

Next, let’s talk natural gas. The shale revolution not only increased oil, but natural gas production as well, and enabled you to become the world’s top exporter of LNG. We hope to finally join the ranks of global LNG exporters in 2025 when the LNG Canada project in Kitimat, BC is finished.

While your production growth has been impressive, here too your success has been underpinned by Canada. The United States still has net imports of about 5 billion cubic feet of Canadian natural gas per day. This is just shy of the amount Germany used to import from Russia through Nordstream 1. This has helped keep your domestic prices reasonable and provided an important domestic supply backstop as more of your own production is shipped abroad.

Energy and global security

Of course, Canada’s energy potential isn’t only of significance to the U.S. I’ve already mentioned that the heads of the governments of both Japan and Germany were in Canada recently pleading with Ottawa to make its plentiful energy available to them. They were sent away empty-handed. Yet the geo-strategic significance of Canada’s energy can hardly be overstated, and not just for America. 

I met not too long ago with the Taiwanese minister of trade on a visit to Taipei and I asked him if he had considered how Canada could contribute to lessening Taiwan’s number one vulnerability. What is our biggest vulnerability, he asked? Why, the fact that so much of its energy comes in ships that must travel from the Middle East, through the Straits of Hormuz, under the shadow of Iranian missiles, pass through pirate-infested waters and the choke point of the Straits of Malacca and then through the recently militarized South China Sea that is increasingly dominated by China. 

Oil and natural gas from Canada, by contrast, would come straight across the North Pacific under the protection of the U.S. fleet. Something analogous could be said about Canadian energy headed to Japan, Europe, and elsewhere. Autocratic regimes from Russia to the Middle East profit both strategically and economically from Western dependence on their oil and gas, yet America and its allies do too little to press Canada to make available the vast energy resources it controls, resources which could change the energy balance of power worldwide. 

Canada-U.S. energy interdependence

I don’t have time to delve into the vital transborder electricity market, where again American consumption floats on a Canadian buffer that will not survive unless we consciously cultivate it. I will, however, look for a moment at nuclear. Nuclear energy is undergoing a renaissance and offers great promise to enhance energy security while lowering GHG emissions. The United States is already the world’s largest producer of nuclear power, while Canada is sixth. Advances in nuclear technology, with fourth-generation reactors, promise to unleash even more potential, with new applications beyond on-grid power generation that can aid in decarbonizing industrial activities or energizing remote mine sites and communities.  

Canada and the United States have a huge opportunity to be leaders of this renaissance, not only because they are incumbents, but because nuclear is still controversial in many parts of Europe and Australia, and we can assume market share while they dither. Here again Canada is or can be the solution to some of America’s challenges. 

Canada is the second largest exporter of uranium and hosts the world’s richest (highest grade) uranium reserves. Unlike many other critical minerals, the extraction and processing of uranium fuel is being done wholly in North America. Although many Western nations have relied on cheap Russian-enriched uranium, the United States is actively working to enhance its enrichment capacity here. Canadian uranium is the feedstock and Canadian companies, capital, and technical know-how are going to be indispensable to this effort.

“It is time for America to start doing its part to arrest Canada’s slow-motion defection.”

With all this interdependence on the energy front, naturally there is vulnerability too. America needs Canada to be your most reliable supplier of energy. But there are headwinds from Ottawa’s direction ahead that risk tripping up the unwary.  

First among these is the federal government’s proposed emissions cap. Ottawa plans to single out the Canadian oil and gas sector for extraordinarily rough treatment, requiring them to cut their emissions by an eye-watering 42 percent below 2019 levels by 2030. 

Although the oil and gas industry has invested heavily in emissions reductions, and GHG intensity per barrel fell by a fifth between 2009 and 2020, there is no way to meet this new target without cutting production. S&P Global has calculated that 1.3 million barrels a day in output will need to be slashed. Because 96 percent of Canadian oil exports currently go to the United States, pretty much the entire amount will have to come out of American supplies. 

The second is the federal government’s proposed Clean Electricity Regulations, the net result of which will be that we will produce less electricity but consume much more of it. It is hard to see how we can continue to export 60 TWh a year to the United States under such circumstances, and I hardly need to spell out to this audience what the likely effects will be on American electricity consumers.   

All of us here today have a shared goal of ensuring that Canada is a reliable supplier of all forms of energy to the United States. It is a cornerstone of our mutual prosperity, stability, and independence from autocratic regimes who do not share our interests. I urge you to pay attention to what Canada is doing on the energy front and to be much more vocal in ensuring that Ottawa’s decisions take full account of their impacts on North American energy security. Because I assure you that is the furthest thing from Ottawa’s mind at the moment, and I fear the consequences for us both.

To conclude, ladies and gentlemen, that, in a nutshell, is why we believe both Canada AND America need my institute’s new Center for North American Prosperity and Security here in Washington. For good or ill, our national interests are deeply intertwined, but America is too preoccupied with domestic politics and global crises to think strategically about how our shared national interests can be pursued together, whether on defence, national security, the Arctic, energy, critical minerals, intellectual property, pharmaceutical and other health care policies or a host of other issues. 

The importance of partnership

Ottawa, on the other hand, finds that American neglect and inattention give it licence to make decisions that affect us all, driven by transactional and transitory domestic political considerations rather than the strategic advantages that can ensure North America continues to be the envy of the world and the bulwark of liberal democracies everywhere.

It has long been the view of my institute that if you want to change the world for the better, you must not only have a better idea, but you have to attract the attention of policymakers, opinion leaders, and voters to that idea. We work tirelessly to make bad public policy unacceptable in Ottawa, but it has now become clear to us that poor policy in Ottawa is often aided and abetted by Washington’s complacency and unwarranted presumption of knowledge about us. Better policy in Ottawa surprisingly often goes hand-in-hand with a Washington more mindful of the potential of our shared continent and willing to speak up about what America needs from the partnership. 

This is no plea for the U.S. to bully Canada. On the contrary, as a former Canadian foreign minister of the Liberal persuasion said to me recently:

“Countries don’t have friends, they have interests. If you want a friend, get a dog. My belief has always been that Canada succeeds as a middle power by being useful…If we are no longer useful in a strategic sense, then we don’t have a lot to offer other than our resources.”

At this point, we seem to take pride in our inability to talk with key global powers, preferring to wag our moralistic finger and lecture others. That, combined with our chronic failure to meet our defence capability requirements makes us of little importance in DC politics.

We at MLI, and now at CNAPS, believe this to be profoundly true. If Canada wants to have real influence in the world, if we want to have our needs met, we have to be useful to the countries that matter, and the United States matters more to us than the rest of the world put together. Being honest with each other and truthful about what we really need is no dilution of our sovereignty, but the condition for both of us to realize our national interests. 

Washington and Ottawa now have a conduit that will fearlessly tell both sides what the other needs, and why, to ensure our shared continent remains a beacon of security and prosperity to the world. That is our promise to you. It is our deepest hope and fondest wish that Canada-U.S. relations will never be the same again.

Thank you.