Assessing the Department of Finance s Evaluation of the Economic Action Plan

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1 Assessing the Department of Finance s Evaluation of the Economic Action Plan Prepared for: DEPARTMENT OF FINANCE Prepared by: THE CONFERENCE BOARD OF CANADA February 2010

2 TABLE OF CONTENTS PREFACE INTRODUCTION CANADA S ECONOMY BROUGHT DOWN BY THE GLOBAL RECESSION ESTIMATING THE IMPACT OF STIMULUS MEASURES SUMMARY OF CONFERENCE BOARD S ASSESSMENT

3 Preface This research was undertaken by The Conference Board of Canada (CBoC) for the Department of Finance. In keeping with Conference Board guidelines for financed research, the design and method of research, as well as the content of this study, were determined by the Conference Board. About The Conference Board The Conference Board of Canada is the foremost independent, not-for-profit applied research organization in Canada. We help build leadership capacity for a better Canada by creating and sharing insights on economic trends, public policy issues, and organizational performance. The Board s Economic Forecasting and Analysis division employs more than 25 professional economists, who bring together knowledge across regions and sectors in producing their forecasts. The forecasting group constructs and maintains econometric models of the national and regional economies and a one of a kind, comprehensive quarterly database of the provincial economies in Canada. The Conference Board of Canada was established in 1954, and is affiliated with the U.S. based The Conference Board, Inc. that serves some 3,000 companies in 67 nations. 3

4 1.0 Introduction In Budget 2009, the Government introduced the Economic Action Plan (EAP) and provided an estimate of its expected economic impact. Including provincial and territorial actions, it was estimated that the EAP would create or maintain 190,000 jobs by the end of As a result of additional actions to support the automotive sector and other adjustments to the Plan, this estimate was increased to 220,000 jobs in the Third Report to Canadians. 1 The Department of Finance has requested that the Conference Board provide comments on the Department s analysis on the economic impact to date of the EAP. This report highlights the findings of our review of the document entitled Economic Impact of the Economic Action Plan to Date. Moreover, a summary of our assessment, that can reproduced in forthcoming government publications, is provided in Section Canada s Economy brought down by the Global Recession At the emergence of the financial crisis, the Canadian economy seemed well-positioned to weather the looming economic storm. However, as the financial crisis evolved, it became increasingly clear that Canada would not remain as well-insulated from the global recession as anticipated or hoped. As conditions in the U.S. and other countries with significant exposure to mortgage-backed securities worsened, the global economy became increasingly under pressure as worldwide demand flagged and export markets slumped. Canada, with its significant economic ties to the U.S. and with an economy that had been boosted by worldwide demand for commodities, was not immune to the worldwide malaise. Indeed, Canadian exports fell precipitously over the fourth quarter of 2008 and into Perhaps even more devastating was the impact that much lower commodity prices had on the revenue stream associated with resource sector exports, especially when combined with the effect of waning consumer and investor confidence. These factors a U.S. and global recession, falling prices for oil and other raw materials, and falling confidence in Canada pulled Canada s economy into recession. Real gross domestic output (GDP) contracted sharply for three consecutive quarters starting in the fourth quarter of The data for the third quarter of 2009 revealed a modest up-tick in growth, bringing the recession to an end. Still, real GDP is estimated to have contracted by 2.5 per cent in 2009, comparable to the performance in the United States. The ebbing of business confidence and shrinking profit margins led Canadian businesses to quickly alter the way they operate. These changes included reductions in investment and 1 Department of Finance, Economic Impact of the Economic Action Plan to Date. Forthcoming

5 employment as well as a significant slowdown in wage growth. Overall business investment began to decline sharply late in 2008 and continued to fall through the first half of In the labour market, businesses relied upon temporary and permanent layoffs and other strategies to cut operating costs by reducing the size of their workforce. Consequently, total employment fell until mid In the nine months from the peak of employment in October 2008 to the trough in employment in July 2009, the Canadian economy shed 414,000 jobs, representing a 2.4 per cent decline in employment. Over this period the private sector (defined as the total economy net of public administration) shed nearly 394,000 jobs. More than half of the economy s total job losses have been absorbed by the manufacturing sector which, over the same nine month period lost more than 218,000 jobs. This represents an 11 per cent decline in manufacturing employment while construction and primary sectors also suffered steep percentage declines in employment. In light of the steep global economic downturn there has been strong consensus that governments needed to act quickly in an effort to stimulate the economy and dampen the socio-economic costs of a decline in real GDP and employment. Moreover, the call for public intervention has gone beyond the usual social safety net to include heavy doses of monetary and fiscal stimulus. In Canada, Federal and provincial governments implemented a range of new stimulus measures that included infrastructure spending, tax cuts, and increased employment insurance benefits to counter the recession. 3.0 Estimating the Impact of Stimulus Measures In Budget 2009, the Federal government implemented the Economic Action Plan (EAP) in order to boost confidence and economic growth in the midst of the most synchronized recession since the Second World War. 2 The EAP included personal and corporate income tax cuts, increases to employment insurance benefits, infrastructure stimulus, transfers to businesses and households and other measures. In order to assess the economic impact of the EAP it is important to know the amount and timing of each measure. In particular, the effects of infrastructure stimulus on the economy will depend on the spending patterns of specific projects. The time it takes for engineering plans to be drawn up, the overall length from start to finish of a project and other factors, such as weather for example, can have an impact on the size and timing of peak economic activity and job creation. Moreover, the total impact of the EAP includes sizable contributions from other levels of government the extent to which provincial, territorial and municipal governments participate in the EAP will have obvious repercussions on the overall size of the stimulus. 2 Ibid. pg 4 5

6 Stimulus Measures and Flow of Funds In a series of reports to parliament, the Federal government has been tracking the implementation of the EAP, detailing a wide range of specific tax measures, infrastructure projects and various other stimulus measures. In estimating the impact of the EAP to date, the Department of Finance has relied on various measures and assumptions in order to compute the amount and timing of stimulus funds that have been spent, or are currently flowing, into the economy. Table 1, presents these estimates of total funds spent or flowing up to the end of 2009 and projections up to the end of February The third column presents the total amounts allocated to the EAP, by area of spending, as presented in Canada s Economic Action Plan, A Fourth Report to Canadians. 3 Table 1 Budget 2009 Action Plan - Update Dollars Spent/Flowing Dollars Spent/Flowing as of December 31st as of February 28th (millions of dollars - cash basis) Total Amounts Allocated for Personal and Corporate Tax Cuts 2,361 2,780 3,020 Employment Insurance and Training 1,503 2,651 2,873 Infrastructure 1 6,462 8,888 11,233 Knowledge Infrastructure 1 1,513 2,124 2,736 Other transfers and programs 1 14,749 15,238 16,683 Total 26,589 31,681 36,546 1 Including provincial, municipal and territorial contributions Sources: Department of Finance. Economic Impact of the Economic Action Plan to Date. Forthcoming 2010; The Conference Board of Canada. While the Department of Finance is expecting to revise the estimates of spending as updated project information becomes available, Table 1 suggests that the lion s share of funds made available in the EAP have already been spent or are currently flowing into the economy. Up to the end of 2009, $ billion, or just under 73 per cent, has already been spent or is currently flowing. The timing of tax cuts, transfers and other monetary incentives is calculated in a straightforward method, as flows correspond to amounts paid out or planned as per budget 3 Department of Finance, Canada s Economic Action Plan, A Fourth Report to Canadians. December

7 measures. Estimating the amount of stimulus spending that has occurred on infrastructure projects is more complicated. The Department of Finance compiled a list of infrastructure projects financed through the EAP. The stimulus spending is assumed to flow out in a linear fashion from project start to end date and these project-by-project estimates accounted for approximately 70 per cent of total project-based infrastructure stimulus and one-sixth of the total EAP funding. The methodology used to create the infrastructure investment profiles provide an adequate estimate of the timing and size of the spending for the specific projects reviewed. In addition to the programs and funding highlighted in Table 1, the Federal and Ontario governments, in partnership with the U.S. government, provided support to troubled auto makers. Through loans and other instruments, the Federal and Ontario governments provided $14.6 billion to General Motors and Chrysler. The injection of funds occurred in June of 2009 and is considered in the Department of Finance s report, for the purposes of calculating the overall economic impact of fiscal stimulus measures, as part of the EAP. Estimating the Economic Impact of the Economic Action Plan Quantifying the economic impact of the EAP measures described above is not a simple task. In essence, the Department of Finance relied on its macro-economic model of the Canadian economy to construct an economic scenario for Canada in which none of the EAP and automotive industry support measures are applied. Comparing this hypothetical scenario to actual data has allowed the Department of Finance to quantify the economic impact of the EAP on GDP, employment and other economic indicators. The methodology applied is robust and widely used by Canadian private sector forecasters, including The Conference Board of Canada. Macroeconomic models such as the Department of Finance s Canadian Economic and Fiscal Model (CEFM) are detailed enough to capture the effects that different types of fiscal stimulus have on the economy. EAP measures aimed at households and businesses for example will result in more leakages through imports while direct spending on infrastructure generally requires fewer imports and thus has a larger direct multiplier effect on the economy. The CEFM is an effective tool for capturing the nuances between multiplier effects. Moreover, the model can effectively capture not just the direct effect of a measure but also captures second-round effects. Indirect effects, for example, occur when demand for suppliers to those industries directly affected by the EAP measures is lifted. Induced effects occur, for example, when households spend the extra wages or income and businesses reinvest their profits. Induced effects tend to have a broad impact across all sectors of the economy. A more detailed economic model of the automotive sector was used to estimate the first-round effects (direct and indirect) of the support measures put in place to rescue GM and Chrysler. The Department of Finance relied on Statistics Canada s detailed input-output model of the Canadian economy to assess the direct and indirect jobs maintained by the $14.6 billion in 7

8 support measures. The input-output model is an effective tool to assess the supply-chain for the automotive sector, measured in output or employment. The results of this supply chain analysis suggest that for every direct job in automotive assembly, about 3.6 additional jobs are required in other industries. The Department of Finance assumes that the automotive sector support measures will maintain all of the 14,000 assembly jobs that GM and Chrysler directly employ plus three-quarters of the indirect jobs, for a total of 52,000 jobs. In some respects, quantifying the impact of the automotive sector support measures on Canada s economy is the most difficult component of the economic impact analysis. While the measure of indirect jobs tied to automotive assembly obtained from the input-output model is solid, it is much more difficult to know how the bankruptcy of GM and Chrysler would have affected total automotive assembly jobs in Canada. The Department of Finance assumes that all direct assembly jobs at GM and Chrysler would have been lost if not for the support measures. While this is possible in the very short-term, over the medium-term, it is very difficult, if not impossible, to know how the automotive assembly industry would have progressed in Canada following the bankruptcy of Chrysler and GM. Overall, the Department of Finance finds that the economic impact of the EAP and automotive industry support is large and has a significant impact on employment in Canada. Table 2, highlights their results. Table 2 Estimates of Economic Impact of Economic Action Plan Stimulus Measures 2009Q2 2009Q3 2009Q4 Debember 2009 February 2010 End of 2010 Growth (percentage-point difference in growth rates, at annual rates) Real GDP Employment Level ('000s) Employment Source: Department of Finance. Economic Impact of the Economic Action Plan to Date. Forthcoming Recall from Table 1 that the Department of Finance estimated that $ billion of the EAP was spent or flowing by the end of December Based on the results presented in Table 2, the stimulus measures lift total real GDP by a cumulative 1.4 per cent in the fourth quarter of Employment is boosted by a cumulative 0.6 per cent, or 96,000 jobs, in the fourth quarter of In comparison to the size of the EAP already spent or flowing, the estimated impacts on overall real GDP and employment are reasonable, perhaps even conservative, when compared 8

9 to the economic multipliers from the Conference Board s own national economic model. Furthermore, the total amount of the EAP over is estimated at just over $36.5 billion, providing a significant hit to the Canadian economy. Overall, we find that the Department of Finance s estimate that the EAP will create 220,000 jobs by the end of 2010 is produced using reasonable assumptions and standard economic methods. 4.0 Summary of Conference Board s Assessment In light of the steep global economic downturn there has been strong consensus that governments needed to act quickly in an effort to stimulate the economy and dampen the socio-economic costs of a decline in real GDP and employment. The call for public intervention has gone beyond the usual social safety net to include heavy doses of monetary and fiscal stimulus. The stimulus efforts, coordinated on a global scale, have been successful in pulling the global economy back onto a path of growth. In Budget 2009, the Federal government implemented the Economic Action Plan (EAP) in an effort to boost real GDP and employment. The EAP included personal and corporate income tax cuts, increases to employment insurance benefits, infrastructure stimulus, transfers to businesses and households and other measures. The Economic Action Plan contributed to reducing job losses and lifting real GDP starting in the second quarter of In estimating the impact of the EAP to date, the Department of Finance relied on various measures and assumptions in order to compute the amount and timing of stimulus funds that have been spent, or are currently flowing, into the economy. Moreover, the Department of Finance s use of model based simulations to approximate the impacts of the EAP on the economy are standard methods that are widely used by other governments as well as private sector forecasters, including the Conference Board of Canada. Given the assumptions provided, we find that the Department of Finance s estimates that the EAP has created 113,000 jobs by December of 2009, and 220,000 jobs by the end of 2010, are reasonable and produced using standard economic methods. 9

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