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The budget: Shock therapy

With today's budget, the Conservatives will try to resuscitate the economy with a wave of spending and tax cuts, joining other governments in turning on the taps in an effort to get ailing economies back on their feet

From Tuesday's Globe and Mail

Diehard Keynesians say it should be well above 4 per cent. The IMF is calling for 2 per cent. U.S. President Barack Obama's proposal amounts to 5 per cent.

How much of a country's gross domestic product is enough, and how much is too much?

When Canada's fiscal stimulus spending is announced today in the federal budget, economists expect the package will represent about 1.25 per cent of GDP. That's in line with some big European countries, but falls short of what the Americans and Chinese are spending. It's also well below the level that some big-name interventionists such as Paul Krugman are urging.

The evidence that the world economy is grinding to a standstill - and that no nation has been able to immunize itself from the damage - is now incontrovertible, and still mounting. In a forecast to be released later this week, the International Monetary Fund has shredded its estimate for global expansion this year to 0.5 per cent, down sharply from its prediction in November of 2.2-per-cent growth, according to a person familiar with the report.

Now, Canada is joining the global public spending race. While Ottawa is likely to spend close to $20-billion this year on stimulus, what is not known, economists say, is whether the spending spree fuelled by fears of another Great Depression and egged on by Keynesian economists will rescue the global economy from the abyss. Or what long-term damage this will inflict on public balance sheets.

"We're in uncharted waters," said John Mauldin, a well-known investment adviser who heads money management firm Millennium Wave Investments in Arlington, Tex. "The captains of the ship are Keynesians. We know that. But they're not sure where they're going."

Few voices have risen in opposition to a strategy that seems fraught with risks. Critics of heavy government intervention typically argue that such spending is inefficient, may not cure what ails individual economies and could saddle governments with far more problems than it solves, such as massive long-term debt.

But right now, most economy watchers insist this is no time for governments to be reticent. While the IMF does see growth rebounding to 3 per cent next year, such key economies as the United States, the euro zone countries and Japan will grow only slightly - even once aggressive fiscal stimulus packages have been taken into account.

The unfolding credit and economic crisis suggests that if anything, governments have not been aggressive enough. Already, some economists are saying that governments failed to intervene fast enough to halt the spreading virus last fall and are paying the price now.

"Whenever there has been a financial crisis in the past, something like 5 to 10 per cent of GDP has been spent to turn things around," said Manmohan Agarwal, a senior visiting fellow at the Centre for International Governance Innovation in Waterloo, Ont., who is studying the various responses to the global crisis.

That's more than many countries are spending, apart from China. The country, which enjoys a huge budget surplus, is earmarking an estimated 16 per cent of GDP for job and infrastructure spending. The Obama administration, facing sky-high deficits, intends to spend an estimated 5 per cent of its 2009 GDP, excluding the bank and auto bailouts. No major European government is spending even 1.5 per cent of GDP.

The Harper government's plans line up with the European's. Based on what it has revealed of its intentions so far, the total will be closer to about 1.25 per cent of GDP. When likely provincial spending programs are included, the total will approach the 2-per-cent level recommended by the IMF.

But Canada's spending may still not meet the IMF recommendation that countries with strong balance sheets and budget surpluses, which Canada has enjoyed until now, should be doing even more. Canada should spend "something to the tune of a few percentage points" to spark demand, Mr. Agarwal said.

Like other countries, Canada is steering billions into infrastructure building, but is also cutting taxes. Ottawa watchers say the mix of tax cuts to spending could be even higher than the 40-60 ratio favoured by the White House.

But tax cuts, although politically appealing, do little to spur economic growth unless they are permanent. And even temporary cuts are tough to unwind later, economists say. Tax cuts might be necessary for political reasons, but the fact they are discussed as a stimulus is "a measure of economic ignorance, really," Mr. Agarwal said.

No matter how much Ottawa opts to spend, Canada's recovery depends largely on what happens beyond its borders.

"We have to hasten to remind ourselves that we're not the country that tanked the rest of the world," said Don Drummond, chief economist with Toronto-Dominion Bank. "The rest of the world tanked us. The domestic side of our economy held up a lot longer than it did in other places."

There is another inescapable truth about Canada's economic well-being that can't be addressed by a fiscal stimulus, no matter how large.

"Canadian economic performance isn't driven much by our own fiscal policy," Mr. Drummond said. "It's much more driven by the international climate."

With a file from reporter Kevin Carmichael in Ottawa


CountryStimulus to date% of GDP
United States$825-billion5*^

*All figures U.S. *estimated

**estimated, 2007 GDP

^ excluding bank bailouts

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