Justin Trudeau’s spending plans will be threatened by higher interest rates and looming recession, report says

HAMILTON—The federal Liberal government’s budget plan to grow the economy and get the public books in order is “unlikely” to work, given its evolving ambitious political promises, higher global interest rates, and the “high likelihood of a more severe recession in 2023,” says a new report.

The report, written by former Bank of Canada governor and deputy finance minister David Dodge, and Robert Asselin, former finance policy adviser to the Liberal government now with the Business Council of Canada, comes as the Trudeau cabinet meets to strategize about the coming months in Parliament.

At the top of cabinet’s agenda over the next three days is to take a hard look at the fiscal and economic picture facing Canada, at looming big-ticket changes to annual health spending, and at tough upcoming public sector contract talks with unions threatening strikes if Ottawa doesn’t meet demands for double-digit pay raises.

The economic outlook Dodge and Asselin produced for Bennett Jones and the Business Council of Canada looks at several scenarios, but mainly it paints a pessimistic picture of the road ahead, and the sustainability of public finances in the face of Canada’s debt, lagging productivity and government revenues, and the Trudeau government’s desire to boost health-care spending, tackle climate change and spur a transition to a stronger digital economy.

It says the Liberal government last year set out budget projections based on “a plausible but optimistic set of assumptions.” Dodge and Asselin foresee the need for an additional $60 billion to achieve the government’s goals. “If anything, even more spending and borrowing may be required for the government to deliver on the policy objectives,” it said.

Ahead of arriving at the cabinet retreat, Prime Minister Justin Trudeau touted his government’s efforts to boost digital innovation and Canada’s high-tech sector, announcing $40 million for Toronto-based Xanadu Quantum Technologies to build and commercialize what Trudeau said is the world’s first photonic-based, fault-tolerant quantum computer, and create 530 high-paying tech jobs.

Trudeau said Monday the federal government would continue “to invest” in such projects, citing the impact that quantum computing can have on automotive and battery design, modelling climate change, or on the development of “new life-saving medicines and technologies.”

“We need to keep looking to where the puck is going; strategic investments like today will set us up for success in the years and in the decades to come,” he said.

It’s all part of a new year push to highlight what the government’s doing to secure so-called “jobs of the future.” Trudeau spent last week during stops in Saskatchewan, Quebec and Ontario pumping up Canada’s efforts to build value-added supply chains in the critical minerals and electric vehicle and battery sectors.

But even as it makes big-spending promises, the government’s fiscal track — how it squares its tax and spending plans with the ongoing need to responsibly pay down debt — faces real risks, say Dodge and Asselin.

Dodge told reporters, “The government is dealing with terrible conflict between priorities, and we’re not the only government but as a small economy, it becomes particularly difficult.”

Dodge and Asselin said the federal government has underestimated what would be required to deal with the “issues they claim to be targeting,” including transfers to the provinces especially for health care, income support and employment insurance, enhanced national security and defence, improved infrastructure, and transformation to a low carbon economy.

Dodge said $60 billion in additional spending would be needed to deliver on “what they’re trying to do, so it’s not insignificant.”

All G7 countries and many advanced western economies face similar problems. Canada is willing to encourage higher levels of immigration “which helps in the short run” to offset the demographic challenges of an aging workforce and lagging productivity.

But Dodge said governments are grappling with higher interest rates globally, growing debt, and declining free trade as countries seek to address international supply chain crunches through subsidies to support domestic industries “under the always perennial guise of national security. I think it is quite worrying and it ends up being particularly worrying for a small country like ours.”

He said governments in Canada, the U.K. and Europe confront competitive challenges because of the Biden administration’s massive Inflation Reduction Act which earmarks $370 billion for U.S. efforts to boost its clean energy and critical mineral production.

“We seem in the western world, basically, to have got ourselves into a box, where the only way we can deal with things is through subsidy,” Dodge said.

However, he added, “the issue goes back to how long can you go on borrowing, how long will markets — either national or international — be willing to finance ever-increasing debt? And that is the classic global debt challenge that we face.”

Kevin Page, head of the Institute of Fiscal Studies and Democracy at the University of Ottawa and a former parliamentary budget officer, said in an interview the fiscal outlook for 2022-23 “is so much better than it was a year ago.” Yet inflation is still running at about six per cent on a year-over-year basis. Many economists expect it could drop to about three to four per cent in the summer, he said, but it is likely to remain “sticky.”

There is a “huge amount of uncertainty” in the economy, Page said, despite a strong third quarter last year, and a strong labour market recovery since the pandemic. And there is a “growing possibility of a recession in 2023” that the government will have to get its head around, Page said.

Inflation has meant real wage losses, household debt is “skyrocketing,” and “that’s really going to put the brakes on consumer spending,” meaning the overall picture of what “fiscal choices” to make is “complicated” for governments, he said.

In the case of the federal government, there is another thorny problem to confront: several public sector unions are in contract talks that have bogged down.

The largest — the Public Service Alliance of Canada — is seeking a 13.5 per cent increase over three years (or 4.5 per cent a year) for some 155,000 federal workers without contracts since 2021. The union says its demand is slightly lower than the cumulative and forecast inflation rate of 13.8 per cent over the same relevant period. The federal government’s offer is a 2.06-per-cent yearly increase over four years.

A senior government source said PSAC’s demand of nearly 14 per cent over three years is “just not on.”

PSAC spokesman Michael Aubry said in an interview the federal government is the largest employer in Canada and “if they don’t set a trend for workers in Canada to stay in line with the cost of living, what they’re saying to Canadians is everyone should take a real wage cut year over year.”

Outside of Hamilton’s convention centre where the cabinet retreat had not yet gotten underway, about 150 undocumented immigrants, farm workers, domestic workers, current and former international students and refugees protested, and called on the Trudeau government to grant them permanent resident status.

Also yelling from the sidelines were several anti-government protesters carrying “F— Trudeau” flags and hollering at a line of security vehicles that were part of the prime minister’s entourage.

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