January 12, 2011
Archived - Speech by the Honourable Jim Flaherty, Minister of Finance, at a Director’s Forum co-sponsored by the Woodrow Wilson International Center for Scholars’ Canada Institute and the Program on America and the Global Economy
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It is an honour to be here at the Woodrow Wilson Institute.
I would like to say a few words about the economic crisis, the Canadian economy and global economic challenges.
On a very serious note, may I offer the condolences of our Prime Minister, of our government and of all Canadians to the family and friends of the victims of the shootings in Tucson last weekend. All Canadians wish, as I certainly do, as a legislator, a speedy recovery to Congresswoman Gabrielle Giffords.
I am pleased to be here at this center for scholarship. The fact that Canada is a focus here is great news for us in our work with the United States and internationally. I’d like to take a moment to acknowledge my fellow Canadian, astronaut Julie Payette, who is here in the audience today. Julie has accepted an eight-month appointment as a Public Policy Scholar here, joining the ranks of notable Canadians such as Ralph Klein, Benoît Pelletier, Joe Clark and—as he takes pains to remind me regularly—my eldest brother, Professor David Flaherty, who was here in the early 1990s as an expert in privacy and American history.
I would be remiss if I did not acknowledge a connection to Princeton University, where I was in the class of 1970. And as you know, Woodrow Wilson spent 25 years as an undergraduate, as a professor and as the President of Princeton, before becoming President of the United States.
I’m going to talk a bit about where we are domestically and internationally. Here at the Canada Institute the goal, as I understand it, is to “explore one of America’s most important bilateral relationships and the world’s largest trading relationship—one that gets far less attention in Washington than it deserves.” Now that may have been true when the Institute was founded, but today some in Washington certainly are paying more attention to Canada.
Just last Wednesday the Washington Times said, “Talented Canadians have long regarded the United States as the land of opportunity. It may not be long before Americans see our northern neighbour as the land of the future….We could learn a lot from them.” We’ve learned a lot from each other over the years and we’ve certainly learned a lot from each other during the course of the economic crisis these past few years.
Let me offer some context for that. Here in Washington, on a Friday in October 2008, the G-7 Finance Ministers and Central Bank Governors met in the Cash Room of the Treasury Department. This was at the height of the crisis. Lehman Brothers had failed in September 2008, Bear Stearns had failed in the spring, we had frozen credit markets, and some British banks and German regional banks had failed. There was some question about whether the markets would open on the Monday.
U.S. Treasury Secretary Henry Paulson started the meeting of the Finance Ministers and Central Bank Governors by saying, “We’re in a lot of trouble.” There was a response by the Europeans that was fairly aggressive with respect to what had happened with Lehman Brothers and the view that some of the bankers had from Europe, that Lehman Brothers ought not to have been allowed to fail, and they handed out a one-page sheet showing what had happened to credit spreads since the failure of Lehman Brothers.
So there was an unusual discussion for central bankers and Finance Ministers that was fairly acrimonious. We did intervene and pointed out to some of the Europeans that they had banks that had capital ratios of 30 to 1, 35 to 1 and 40 to 1, that this wasn’t simply a situation that applied to some United States financial institutions. The conversation became more reasonable and a little less acrimonious over time.
The practice in international fora is for public servants to prepare communiqués before the meetings. This time we acted differently. We agreed around the room that we would tear up the communiqué, and that we needed a one-page document, something that would help restore confidence. We came up with a five-point plan on one piece of paper, which the G-7 people around the table all endorsed. And fundamentally, the conclusion was that we would not allow any more systemically important financial institutions to fail.
This was an important meeting in the sense that it set the tone for the weekend, and in fact it led to the G-20 becoming the primary forum for the discussion of global economic policy. That was on Friday afternoon. On Saturday morning the G-7 Finance Ministers met with President Bush in the Roosevelt Room. He went out in the Rose Garden and endorsed the five-point plan. The IMFC met that morning and endorsed the plan.
In the afternoon, there were several meetings, including the Council of the Finance Ministers of the Americas—all the Finance Ministers from North America, South America and Central America—who also endorsed the five-point plan. Then on Saturday evening, the G-20 Finance Ministers met. President Bush attended that meeting and the G-20 Finance Ministers endorsed the plan, which led to the first Leaders Summit of the G-20 in November 2008 here in Washington.
All of this was unusual in the Canadian context because we were in the midst of a general election. Governments aren’t supposed to make major decisions in our system during the course of an election campaign, but these meetings started on October 10 and the election was the following Tuesday on October 14. We had to make some decisions with respect to the Canadian liquidity in the Canadian banking system, which we did.
We decided to purchase some insured mortgages, mortgages that the federal government guarantees, to provide more liquidity to our banking system and to guarantee the wholesale debt of our banks. But we did not have to put taxpayers’ money into our financial institutions in Canada. In fact, on the mortgage insurance program we made money for taxpayers.
The next important meeting was the November 2008 Summit here in Washington, where the primary resolution was that the countries around the table agreed that we would stimulate our economies by 4 per cent of GDP over the course of two years. We did that in Canada and we had the support of the G-20, which I think, in fairness, helped convince Canadians that it was necessary, that it was the right thing to do as part of the global response.
Let me turn for a few moments to Canada. No one saw the recession coming in the last quarter of 2008. We did anticipate some turbulence, though, early on when we were first elected five years ago in January 2006. The United States is our major trading partner and we were concerned with the sustainability of the fiscal situation here.
So what does a smaller country do in order to prepare for what is likely to be some turbulence down the road? We ran surpluses and we paid down public debt for three years leading up to the recession that started in the last quarter of 2008. We were concerned, and that preparation helped us.
In May 2006, in our first budget, I referred to one of the major risks being a sudden correction in U.S. house prices. As you know, that didn’t happen until later on in 2007. Our government also released a long-term economic plan in 2006 to protect and grow our economy based on maintaining balanced budgets and using surpluses to pay down public debt and keep our debt-to-GDP ratio well below that of our G-7 counterparts.
In October 2007 we decided that to improve our competitiveness and to spur economic growth we would make some dramatic reductions to personal and business taxes. This was a longer-term program, from the fall of 2007 right up until next year, to reduce our business taxes.
As a result, when the crisis hit later on in 2008 we were able to respond quickly with a substantial stimulus program of 4 per cent of GDP, in cooperation with the provinces and the territories, without creating a structural deficit federally, so that we can come back out of the recession and get back to balanced budgets effectively.
Like others, we faced a credit crunch. The danger was that businesses would face substantial challenges in securing loans, hindering economic growth. To fix this, we instituted a simple market-based program to purchase pools of insured mortgages, which worked well. This liquidity support gave the financial institutions the confidence they needed to continue to lend money to those who needed it. We also created lending lifelines for smaller businesses through a Crown agency called the Business Development Bank of Canada and we gave Export Development Canada, another Crown agency, the power to lend domestically, which had never been done before.
The stimulus plan was mainly capital used to build infrastructure, which has a long-term economic benefit. We did have the cooperation of the provinces and territories, and importantly we had the cooperation of the federal public service. This is not easy to do, as you know, with relatively large governments. It’s hard to turn the government ship around.
This was a government ship that was running surpluses and all of a sudden we’re turning around and creating very substantial deficits. There was a need to spend large sums of money effectively and efficiently and without waste, and to get the money out there, working with the municipalities, the provinces and the private sector so we would not have double-digit unemployment and we would not have a deep and prolonged recession.
The plan worked. All of the jobs that were lost in Canada during the three quarters of recession have been regained and more. Our economy has been growing since the third quarter of 2009—we’ve had five consecutive quarters of growth. All of the output lost during the recession has been recouped. We are the only G-7 country to do so. Our fiscal situation remains one of the strongest in the world, and despite our massive injection of economic stimulus, we remain on track to return to a balanced budget in the medium term.
We built an exit strategy into the stimulus plan at the beginning. It’s always easier to spend in government than it is to restrain, as we all know. Now, we’re into the part where we have to start to restrain—the capital spending would happen over the course of two years, 2009 and 2010, into the first quarter of this year, and then we would move back from the capital spending, so that we can get back to balanced budgets and surpluses in the medium term.
So it’s imperative that we do that. If we do that, as we are, we will reduce our deficit to less than half of this year’s deficit in 2012–13. And by 2015, we will post a small surplus. Now, we’re going to do this by ceasing the capital spending on stimulus. We’ll also announce some targeted measures with respect to limiting the growth of government spending and an administrative review of some of our government spending, because we know that there’s waste within government and we can have some restraint. But the major thing is stopping the stimulus capital spending and restraining the rate of growth of government.
We need to have a balanced approach. The economic recovery is fragile. We have the European situation, which remains dangerous with respect to Portugal and a few other countries in Europe. And this is not an academic point. We’ve been through this in 2010 with respect to Greece and more recently with respect to Ireland. I’ve been speaking with my European colleagues this week again and there’s continued concern about the situation in Portugal, about the need for the creation of an appropriately sized facility that could be used in the European context.
So all of those things are worries that mean, in our fiscal planning, that we need to be balanced and modest as we go forward to preserve what will be relatively moderate economic growth.
I would like to say a few words about housing. I remember Henry Paulson calling me at home on a Sunday afternoon in August 2007. Finance Ministers had been having discussions about the fact that there was too much liquidity in the world and about where this would manifest itself. Well, that Sunday afternoon, we found out it was manifesting itself in something called subprime mortgages in the United States.
In Canada, we have avoided a housing crisis. First of all, we had prudent mortgage lending standards by our financial institutions. They are primarily large retail-based financial institutions through a branch system across the country. They know their customers locally. They don’t sell the mortgages for the most part; they hold most of the residential mortgages that they give out.
We had a sound supervisory system. I know people like to talk about regulation a lot. Most of the financial institutions that failed were regulated, but most of them were not properly supervised. I’d suggest and that’s the key— that we have effective supervision in Canada through the Office of the Superintendent of Financial Institutions. The Canadian Bankers Association’s last survey on residential mortgages in arrears in Canada showed arrears of 0.4 per cent as of October 2010, unchanged from October 2009.
We also have recourse mortgages in Canada so that a person has a continuing obligation financially, even if they walk away from their mortgage indebtedness on their residence. And we do not have mortgage interest deductibility on our income taxes. We do have tax-free capital gains on the sale of a principal residence.
Now I’d like to say a few words about reducing business taxes. I mentioned earlier that this was an important policy decision back in 2007 to help create jobs. We know that reducing business taxes is the fastest way to create jobs because it reflects very quickly in hiring and economic activity. When we took office in February 2006, the basic corporate tax rate federally in Canada was a little bit over 22 per cent, with surcharges. That was five years ago. As of January 1st of this year it is 16.5 per cent. As of January 1st next year, it will be 15 per cent. That’s going from a little bit over 22 per cent to 15 per cent over the course of six years.
This is already legislated despite the fact we’re a minority government. It passed back in 2007–2008, so if someone wants to change that, then they’re going to have to raise taxes in Canada. As a result of these reductions and other tax changes, we now have an overall tax rate on new business investment that is substantially lower than in any other G-7 country. Now, we are a federation, so we need the cooperation of the provinces because the provinces have the power to tax businesses just as the federal government does. So we urged them back in 2007 to join us in this venture, to get their business tax rate down to 10 per cent by 2012–2013. Most of them have taken up that challenge and will be there by 2012–2013.
What difference does it make? It means that we will have a Canadian brand, a Canadian base federal-provincial business tax rate of 25 per cent as of 2012–2013.
So we’ve come a long way from where we were about 20 years ago. Over the holiday, I was interested to see an editorial in the Wall Street Journal. It said, “Twenty-two years ago, we wrote an editorial—‘North, to Argentina’—warning Canada that economic prosperity isn’t a birthright but requires sound policies like free trade. Nowadays, that’s a lecture Canada could credibly deliver to Washington on business taxes.”
We believe in free trade and open markets. We permanently eliminated tariffs on a broad range of machinery and equipment, and we eliminated the remaining tariffs on manufacturing inputs by January 1, 2015. This will make Canada the first tariff-free zone for industrial manufacturers in the entire G-20.
Now I’d like to say a few words about our financial services industry. The World Economic Forum, for three years now, has rated our banking system the soundest in the world. As I say, we did not have to bail out our banks. I give a lot of the credit for this to a strong supervisory regime in Canada and a structure which has the major players sitting around the table together.
So the Department of Finance, with my Deputy Minister, the Office of the Superintendent of Financial Institutions, headed by Julie Dickson, who’s the primary regulator of the financial institutions, the Bank of Canada, headed by the Governor, the Canada Deposit Insurance Corporation and the Financial Consumer Agency of Canada are all responsible for keeping an eye on the macroeconomic situation. It has put us in a position where we are well positioned to transition to the new Basel III standards on capital and leverage for our financial institutions. And we will do that in Canada well ahead of the deadline.
Last year Canada chaired the G-7 and co-chaired the G-20 with Korea. There was an important G-20 Leaders Summit in Toronto in June. The Prime Minister led the discussions and the negotiations that led to a three-pronged approach to fiscal consolidation.
First, advanced economies committed to meet ambitious targets for halving their public deficits by 2013 and stabilizing or reducing their debt-to-GDP ratios by 2016, and agreed that this consolidation should proceed in a growth-friendly way.
Second, countries with large current account surpluses agreed to undertake measures to raise domestic demand and reduce precautionary savings. And as part of this, emerging surplus economies agreed to undertake reforms to enhance exchange rate flexibility.
Third, all members of the G-20 committed to pursue structural reforms that would boost long-term growth.
These are important global commitments. They are ambitious targets but they were agreed to in Toronto.
So there’s some positive signs now in the advanced economies, particularly of late. However, demand in many advanced economies is expected to be modest for some time. Emerging economies are experiencing a significantly stronger recovery, but as you know they are facing rising inflation and the risk of asset price bubbles re-emerging.
So I think the general view, and certainly it is our view, is that rebalancing needs to occur. Governments in advanced economies must return to living within their means. For advanced economies, one key response to this challenge is to set out credible and clearly communicated plans for restoring fiscal balance and reducing debt-to-GDP ratios. Recent and current developments in Europe pose enormous challenges to sound fiscal management, including higher interest rates and borrowing costs, deteriorating consumer and investor confidence and the potential for debilitating financial crises.
Now, fiscal sustainability and fiscal consolidation in advanced economies is not sufficient by itself. It is only one component of the international policy coordination needed to sustain strong, sustainable and balanced growth in the future. Globally, imbalances have begun to widen again and low interest rates across advanced economies have sparked a new search for yield, leading to increasingly volatile capital flows into emerging economies and upward pressure on their exchange rates.
Several countries have responded through unilateral intervention and regulations to restrict capital inflows. These uncoordinated measures heighten the risk of countries introducing retaliatory trade measures and underscore the need for cooperation. They have direct impacts on other countries. Canada, for instance, has borne a disproportionate share of the adjustment in recent months through the appreciation of the Canadian dollar.
From the G-20 Seoul Summit, we now have agreement from G-20 Leaders on a roadmap that we will take over the next year to identify and reduce unsustainable external balances. Large current account balances will be assessed against a set of indicative guidelines, with countries committing to pursue a range of measures to reduce these imbalances. Canada, together with India, has been tasked with leading this work at the G-20 over the next 12 months and work is in progress, although it will not happen overnight.
But what is essential here is that these discussions are being coordinated multilaterally, with all the major players at the table, rather than the dangerous alternative of nations going their own way.
Woodrow Wilson once said, “Life does not consist in thinking, it consists in acting.” Well, we need to do both. If the world’s developed and developing nations can continue to work together just as they did when the global recession first hit us all so hard late in 2008, I firmly believe we can go a long way toward ensuring a solid and sustained global recovery.
I’ve said a lot of nice things about Canada’s economic performance, but we have some significant challenges in order to secure our economic recovery. We have a relatively high Canadian dollar. We are reducing business taxes, which helps alleviate that impact. We are eliminating tariffs on machinery and equipment.
We have ongoing fiscal challenges, in some of our provinces in particular. I’ve been encouraging my provincial colleagues to balance their budgets as soon as possible and we’ve committed to keeping our federal transfers—we transfer substantial amounts of monies every year from the federal government to the provinces—at the levels they’re at through 2013–14. We will not balance our budget federally on the backs of the provinces and territories, which happened back in the 1990s.
We are also concerned with household debt. Like the United States, our interest rates are nearly rock bottom. These conditions have made it logical for Canadians to borrow money and we are cautioning Canadians to use common sense—that interest rates will not stay low forever, they’re going to go up and will you be able to handle your debt obligations when you have higher interest rates? We’ve done more than talk about it. Twice, I’ve tightened the rules on residential insured mortgages in Canada to shorten amortization periods and require larger down payments so that we can make sure that we maintain a solid, stable residential housing market. We also have challenges with respect to productivity and innovation.
Cooperation is vital. We had the honour last year of chairing the G-7 and co-chairing the G-20. Everyone agrees that the G-20 is the premier economic forum. There was some question last year about the role of the G-7. This year, France is chairing both the G-7 and G-20. And I am confident the G-7 part of it will continue.
We did something last year that was unusual. I invited my colleagues, the central bankers, the Ministers of Finance, U.S. Treasury Secretary Timothy Geithner and Ben Bernanke to come with me in February to Iqaluit, Nunavut, in the Canadian Arctic. The whole idea was to get back to the idea of the G-7 originally, which was a fireside chat and not a lot of formality. We got rid of the communiqué as well.
That chat was very important because following that we had the crisis with respect to Greece and the continuing issues in Europe with some other countries, including Ireland. But it helped facilitate that cooperative attitude and that ease of communication that Central Bank Governors and Ministers of Finance need to have.
I think that the work that the G-20 and the G-7 have been doing has served us well over the past few years and I look forward to further cooperative efforts this year to ensure that we move away from this recessionary period and these credit challenges firmly and finally.