THE "SNAPSHOT" ECONOMIC UPDATE

THE “SNAPSHOT” ECONOMIC UPDATE

Today Canadians learned the costs of the federal response to the COVID-19 pandemic—a projected deficit of $343.2 billion for the 2020-21 fiscal year and a national debt that for the first time cracks the $1 trillion mark. Finance Minister Morneau’s Economic and Fiscal Snapshot revealed that private sector economists expect real GDP to decline by 6.8 per cent in 2020, before rebounding by 5.5 per cent in 2021. The government added that while the worst economic impacts of the pandemic are behind us, the return to normal will be “gradual and uneven,” and slow in sectors such as retail, trade, travel, entertainment, hospitality and tourism. Addressing the transition out of the current pandemic support programs, the Update signals upcoming changes to CEWS, the wage subsidy program, to “stimulate rehiring, provide support for businesses during reopening and help them adapt to the new normal.” Reflecting the uncertainty of consumer and business behaviour as the national economy reopens, the Update limits fiscal and revenue projections to the current fiscal year, and does not present an economic recovery plan.

BACKGROUND

In 2002, former U.S. Secretary of Defense Donald Rumsfeld became famous for his assessment of different dimensions of measuring risk in complex situations.  He said that there are “known knowns”—the things we know we know; “known unknowns”—the things we know we do not know; and there are “unknown unknowns”—the things we don’t know we don’t know.

The advent of COVID-19 and the devastation it has wrought on people and economies around the world is the ultimate “unknown unknown” of our times. While there were advance warnings that something like this might occur, the when, why and how were unknowable.  As our experience with the virus has developed, what we think we know about the virus, how it acts and how best to counteract it, has been constantly evolving. Even among the experts, the value of face masks was first labelled as “illusory” but their use is now increasingly mandatory throughout the country when people are in indoor public settings.

For the federal government and finance minister Morneau preparing today’s fiscal snapshot, the biggest challenge was in the “known unknowns” category.  At what pace will the recovery take shape and move forward? Will a second wave arrive and push us all back to square one?  How should the government extend, amend or phase out pandemic support programs, to aid in the transition back to normal while protecting those who still need help?  How can the billions in debt the emergency spending has spawned be managed and repaid?  As when and how does the government begin to address the policy agenda on which it was elected only last October?

Typically, an economic update summarizes developments and trends since the last budget, presents the latest spending and economic performance data and offers updated multi-year forecasts of growth, spending and revenue, the deficit and the debt.  The many uncertainties caused by the pandemic forced the government first, to cancel the scheduled March budget, and second, to transform today’s update into a “fiscal snapshot” accompanied by some international comparisons.

OVERVIEW

As shown in Table A2.4, federal budgetary revenues will take a hit of $72.2 billion dollars as a result of the pandemic. These reduced revenues, combined with the approximately $240 billion spent on individual and business support programs as a result of COVID-19, result in an annual deficit of $343.2 billion for the current fiscal year.  This deficit will push the projected level of the federal debt to just over $1 trillion, the first time it has crossed the trillion-dollar threshold.

 

THE ECONOMIC OUTLOOK

The private sector economists consulted by Finance Canada expect a decline in real GDP of 6.8 per cent for 2020, followed by a recovery of 5.5 per cent in 2021.  After cresting at above 13 per cent in the second quarter of 2020, the economists foresee a decline in the rate of unemployment to just above 7 per cent by the fourth quarter of 2021.

ANALYSIS

A grim picture 

Most of the numbers contained in the update have been reported before but drawn together, they paint a grim picture of the carnage:

  • 5.5 million people who lost their jobs or had their incomes cut;
  • Savage declines in sectors like hospitality, airlines and services (described as the “epicentre of damage”) that will be very slow to recover; and
  • A stunning drop in GDP (although the private sector average forecast sees most of the 2020 decline reversed in 2021).

The report spends a good deal of time delineating the uneven and negative impact of the crisis on women, lower income and disadvantaged people, Indigenous Canadians and visible minorities. The Gender Based Analysis Plus is extensive and likely sets the table for targeted further support programs.

Canada’s pandemic support in context

There is a determined justification for the massive expenditures that were designed, Finance Canada says, to transfer potential debt from people to the government as they were forced to stay home. The update lays out a surprising piece of evidence that the government support programs to individuals in the aggregate made up for all the lost income suffered through May. The document uses comparative international tables to put Canada’s COVID-19 response in context, much of it positive. The document deals extensively with projected levels of debt – over a $1 trillion – attempting to downplay the long term consequences, including a debt/GDP ratio of 49.1% (well below historic heights including the near 70% in 1995 that led to the severe austerity budget) and laying out the minimal cost of debt service through long-term reliance on leveraging today’s interest rates.

CHANGES COMING TO THE WAGE SUBSIDY

As it reconciles the fiscal numbers, the deficit level projected ($343.2 billion) is significantly larger than had been expected. That is a combination of the economic impact on government revenue aside from support measures ($81.3 billion), the money spent so far on COVID-19 responses and additional funds ($50 billion) being allocated to the Canadian Emergency Wage Subsidy (CEWS). The document promises changes to that program that will increase its price tag by $50 billion to $82.3 billion, far more than has been expended thus far and taking it beyond CERB. The goal is to move people from CERB to CEWS. CERB is not forecast to increase much to $80.6 billion, perhaps signalling that it faces a phase out or a transformation back into the EI program, which received an additional $10 billion today.

The government had asked for stakeholder input on the wage subsidy at the end of May. The results from that consultation are still pending as Finance Canada has sorted through the input to see what changes and adjustments will require legislation. Understanding the concerns from industry which include the extension of the program and whether and how it steps down as the economy recovers, the solutions are not yet ready for prime time and were only briefly touched on in the update today.

One aspect that has been signaled repeatedly is the eventual inclusion of businesses that rely on third party payroll agents, a group that has been ineligible for the subsidy so far. With the political and economic imperative to ramp the economy back up, it’s likely the criteria for CEWS will be broadened and the program extended to fall 2020 to support the economy through a possible second wave of the virus.  The Minister has also signalled significant changes to broaden its scope and duration and to deal with the disincentive in the program caused by the rigid threshold of a 30% revenue loss to qualify. Companies lose their eligibility if their revenue loss drops by just a bit to 29% and that means losing the subsidy they get per employee. So, there is incentive to keep losses at 30% or above, reducing economic activity.

UNCERTAINTY GOING FORWARD

The government’s uncertainty about the future course of the pandemic and the economy emerge clearly in today’s document and it will not do much to meet demands for more clarity and a recovery plan. It explains the government’s reluctance to produce anything more than a “snapshot” and even at that,  the document goes out of its way to emphasize the unknowns and the potential downside risks to economic and fiscal assumptions, saying at one point that trying to forecast a year out is “not possible” under current conditions and might even be ”misleading”.

The look-forward errs on the side of pessimism, presenting possible worst case scenarios driven by consumer fear, business uncertainty, and a likely second wave of infections (although it suggests we should weather that one a bit more easily because of the lessons learned).  Those two scenarios envision much sharper drops in GDP.

As it outlines the three stages of the crisis and government responses, the update projects a move from “containment” to an almost indefinite second period of “controlled reopening,” and suggests that “rebuild and recovery” won’t happen until a vaccine is available.

Finance lays out three obstacles it sees to the restoration of confidence that would lead to increased economic activity. First is the persistent concerns of consumers (“the fear of going out”), second is the general uncertainty about jobs, recovery and the impact of permanent economic “scarring” and third is the impact of business uncertainty on hiring and investment.

The bulk of the document is a look back at the extent of the crisis, the support levels needed for individuals and businesses and the continuing damage done to the hardest hit in the economy.

Perhaps a bit surprisingly, there is a section of the document that deals with the health side of the pandemic, tracking Canada’s efforts at containment and outlining the criteria generally being used by public health authorities to expand reopening.  As part of this section, the government doubles down on the conditions it wants imposed in eight separate areas before it will transfer the promised $14B to the provinces. Thus far there has been no public progress on those negotiations with several provinces saying they will not accept any conditionality at all. The size of federal expenditures thus far and projected dwarf this proposed transfer to the provinces and perhaps create some doubt about just how much $14 billion buys in these new days.

IN CONCLUSION

Finally, throughout the COVID-19 pandemic the government has largely avoided unforced errors. With an unprecedented roll out of new policies and programs, at never seen before volume and speed, the political and communications fumbles have been minimal. However, the political cooperation and collaboration—across parties, and between feds and provinces—is now beginning to fray. The negotiations with the provinces over transfers promise to be a blistering fight and the bungled roll out of the WE Charity Student Service Grant (and the discovery that the PM did not recuse himself from the cabinet decision) has suddenly turned up the political heat as we enter the summer months.