ENTRETIEN with/avec Q&A A conversation with Jim Flaherty

Finance Minister Jim Flaherty sat down with Policy Options Editor L. Ian MacDonald in the conference room of his Centre Block office for a Q&A on the budget. The wide- ranging half-hour conversation included issues such as deficit reduction, lessons learned from the financial meltdown and Canada’s comparative strengths going into and coming out of the Great Recession, as well as prospects for funding both public and private pensions in Canada.

Le rédacteur en chef d’Options politiques s’est entretenu du budget fédéral avec le ministre canadien des Finances Jim Flaherty dans son bureau de l’édifice du Parlement. L’entretien d’une demi-heure a aussi porté sur la réduction du déficit, les leçons de la crise financière, les atouts comparatifs du Canada avant comme après la récession, de même que les perspectives de financement des régimes de pensions publics et privés.

POLICY OPTIONS: Mr. Flaherty, JIM FLAHERTY: That’s right. all of the big-bank economists, which is thanks for doing this. PO: And your assertion is that you important because you get independent JIM FLAHERTY: A pleasure. can balance the books, in essence, on economists, one here, one there, who PO: First of all, on the budget, the restraining spending growth to 3 per- will have very different numbers and deficit, you seem to have made a strong cent of GDP per year, which is half of use different assumptions and then say, case for your argument that it’s cyclical the average of this government, histori- “Well, you, the government, are way off and not structural, bringing it down over cally, and it seems that you caught a bit in your assumptions and your numbers a five-year period from $54 billion in the of a break in terms of forecasting when are wrong.” Well, actually not our num- fiscal year ending March 31st to $1.8 bil- the fourth-quarter GDP growth was 5 bers. They’re the average of this year 15 lion in 2015, from about 3 percent of percent. That’s a big number. Is it pos- outside private sector economists. Some GDP to one-tenth of 1 percent of pro- sible that these numbers, the consensus are from academia, and some are from jected GDP five years out. Why would- forecast that you have on reducing the the banking sector. n’t you just have gone straight to zero? deficit, are even too conservative? PO: So when some in the media JIM FLAHERTY: Well, that’s not JIM FLAHERTY: It’s possible, and say, “Flaherty’s assumptions could be where the arithmetic took us, and we did several of the bank economists have proven wrong,” they don’t get it. have that discussion about why didn’t we said that since the budget, and when I JIM FLAHERTY: Well, they’re not do some other restraint item that would met with them at the beginning of familiar with the process, which sur- get us to the magic balance of zero. February their prognostications were prises me. This year we went through PO: Because it’s a rounding error in on the upside, which is just the oppo- the trouble of listing them all in the those terms. site of later in 2008 where the numbers budget. JIM FLAHERTY: Well, it is, and I they were giving were weighted to the PO: And bringing them in for a thought we ought not to artificially try downside. So the numbers may be bet- photo op and meeting with them. to create a zero balance. I thought, Let’s ter over time; we’ll see. JIM FLAHERTY: And saying to the just do the numbers the way they are. PO: Is it important that the projec- economists — my assistant deputy We didn’t do small things; we did tions for growth are consensus fore- minister was very clear with them. I big things, and with DND [Department casts by outside consultants and was in the room, and he said, “Will of National Defence], with the foreign financial institutions rather than in- you stand by this 2.6 percent real GDP aid envelope and with the public service, house forecasting by the Department growth average for the next fiscal three large moves, and those moves of Finance? year?” and the consensus was “Yes.” work out to that deficit of about $1.8 bil- JIM FLAHERTY: That’s right, and the PO: Still with the deficit, and the lion, which is a small deficit in 2014/15. Department of Finance has followed US deficit, $1.6 trillion is 11 percent of PO: And no tax increases? Read that procedure since 1994. We used this GDP, and their debt-to-GDP ratio is my lips: no new taxes, right? year 15 outside economists, including reaching 67 percent. It’s getting to be

12 OPTIONS POLITIQUES AVRIL 2010 A conversation with Jim Flaherty Q&A the kind of number where the IFIs went into the recession in a much you’ve addressed some prudence [International Financial Institutions] stronger position than any other around that in urging financial insti- show up and ask for the keys to the car. Western developed economy, and we’re tutions to raise mortgage thresholds When do you think the Americans are coming out stronger than any of the from 5 percent to 10 percent down going to be as concerned about their others. There really isn’t much room to payments. Is there a point where we leave the housing boom In the first three years of our government we paid down and move to the cusp of a about $38 billion worth of debt. Thank goodness we did housing bubble that you’re that, because we went into the recession in a much stronger concerned about? Do you position than any other Western developed economy, and have any US-style con- cerns here? we’re coming out stronger than any of the others. There JIM FLAHERTY: really isn’t much room to move in some of the economies like Certainly nothing of the the United Kingdom and the . magnitude of what the United States went through. deficit and debt as the rest of the world move in some of the economies like the We have to make sure that the mort- is on their behalf? Have you talked to United Kingdom and the United States. gages that are out there that are [US Treasury Secretary] Tim Geithner PO: Or Japan. insured are of good quality. We know about this? JIM FLAHERTY: Or Japan or Italy, that they are of substantial quantity. JIM FLAHERTY: Yes, and in fact I and then there are the worrisome So far they are of adequate quality, but talked to him very recently about this countries, not just Greece but some we’re watching, and I work closely and to [Fed Chairman Ben] Bernanke, others in the EU that have very sub- with Julie Dickson, the Superintendent and [Bank of Canada Governor] Mark stantial sovereign debt problems, and of Financial Institutions, watching not Carney and I have been talking about it this is a lesson to sovereign nations only household mortgage credit but as well, and I was at a meeting recently not to get themselves in a position also household credit in a broader with several of the US senators and with where they are going to have to take sense, credit card credit, the degree to Phil Gramm, who used to head the drastic steps to stay afloat. which people are extending them- Senate Banking Committee, and there’s PO: So there’s certain sovereignty selves, and there are some concerns a lot of concern in the United States issues around that, aren’t there? there that we’re seeing some tenden- among people like the ones I just men- JIM FLAHERTY: There are, and cies to extend credit. tioned about that, the level of the deficit. through the United States and China; PO: So, too much household debt. We’re talking about trillions of dollars. China holds a great deal of American JIM FLAHERTY: Yes, but as I say, it’s PO: We’re talking about a current paper. not a bubble. There’s no evidence that deficit of $1.6 trillion, the equivalent PO: Over a trillion dollars. we have a housing bubble, because of the annual output of Canada, and JIM FLAHERTY: The United States you’d have to have low quality in we are a G7 nation. has the consumer power to buy a lot of terms of the mortgage securities, JIM FLAHERTY: Right. American Chinese manufactured goods, which is which we do not have, but we all politics are complicated. They’re hav- important, but consumer demand in know that interest rates have nowhere ing a lot of difficulty with both the United States is weak. to go but up, and regrettably, some Houses. Their midterm elections are PO: Just to finish with the deficit, people seem to act as if that is not an coming up in November. This is not a your position is that about nearly half of inevitability. good situation in the United States. I it is in stimulus that is ending after the PO: Well, part of this housing know that Tim Geithner wants to next fiscal year, and the rest of it can be boom is obviously due to cheap liq- move towards a more realistic debt-to- obtained through these kinds of efficien- uidity that you guys pumped into the GDP ratio. And I hope that he lays out cies as in the expenditure review that system in the fall of 2008 and subse- a plan sooner rather than later. [Treasury Board President Stockwell] quently in the budget of 2009, PO: What’s your sense of the kind Day’s going to be conducting as well as Carney on the monetary side and you of shape Canada is in coming out of normal economic growth, right? on the fiscal side. But as you just said, this recession, thanks to the virtuous JIM FLAHERTY: Yes, and of course some of these liquidity issues aren’t cycle we had going into it and pru- the spending restraint we brought in going to continue going forward, and dence in our financial institutions? with respect to those three big items, Mr. Carney’s embargo on interest JIM FLAHERTY: Well, in the first DND, the foreign aid envelope and the rates is fast approaching on the 30th three years of our government we paid public service. of June. down about $38 billion worth of debt. PO: Now, we’re experiencing a JIM FLAHERTY: Yes, and there are Thank goodness we did that, because we housing boom in this country, and some other developments that’ll hap-

POLICY OPTIONS 13 APRIL 2010 Jim Flaherty ENTRETIEN pen this year, including the introduc- money, albeit taking on dangerous agreed at Iqaluit, which I said pub- tion of the HST in and British risk, will take on dangerous risk and licly, that as a matter of principle, if Columbia on July 1, which will have will try to make that easy money, and financial institutions contribute to a some market effects. We also hope to that means that government has an crisis in the financial system to the see some moderation in the housing important role to play here, that when extent that they do, they should bear market as a result of the few steps that we regulate we have to not just have the cost of that, and not taxpayers, we took recently. regulations; we have to have effective and it’s a question of how one does PO: Looking ahead to the G8 and regulations and enforce them. And I that. G20, which Canada is hosting this made those points recently at a bank- PO: I want to come back to fiscal year and obviously you’re playing a ing reform conference in the United frameworks, and particularly fiscal fed- leading role there, what do you think States, and it was very well received, eralism, because there may be a couple we’ve learned from the meltdown of because the big institutions that failed of big trains coming down the track. the fall of 2008 and the deepest reces- in the United States, Lehman Brothers, One is the renewal of the $41-billion sion in our lifetime? Have the banks Bear Stearns and so on — well, Bear health care agreement in 2014, and the learned in Europe and America, do you Stearns was bought, basically; it was other is the question of the sustainabil- think? What’s your sense of that? going to fail — were regulated. These ity of equalization payments going for- JIM FLAHERTY: Well, unbridled weren’t unregulated institutions, but ward. I know you’ve promised the greed is a dangerous thing. You know, they were poorly regulated. provinces to maintain them at 3 per- lax lending standards are dangerous. PO: So where does moral hazard cent growth rates, but looking down PO: And things like derivatives meet moral suasion in all of this? Is the line, what kind of debate do you see and the commodification of financial there a way of putting this into a G8- there in federal-provincial relations? instruments? G20 communiqué? JIM FLAHERTY: Well, the health JIM FLAHERTY: Yeah. High lever- JIM FLAHERTY: Yeah, I think so. I spending is going up at 6 percent per age is dangerous. Irresponsible bor- think we’re making progress. I hope year, as agreed; the Canada Social rowers are dangerous, and I see that we will end up with some sort of Transfer at 3 percent a year, as agreed, dangers always in a systemic sense that contingent capital fund for financial Equalization at the rate of growth of the system is fully capable of collaps- institutions globally. Everyone has to the economy. ing. The history of Lehman Brothers is dance on this, and if everyone’s not PO: Do you see any red lights very instructive, and at the end of the on the dance floor, that means that flashing there? day in Lehman Brothers, there was no capital will just go to the place where JIM FLAHERTY: Well, I see it on buyer, and the United States did not it is not regulated, as it will be in the health care. I mean, health care costs have a choice at the time. I had discus- other places. So Canada will do its at the provincial level are growing at 7 sions with [then US Treasury Secretary] part. We’re against a capital tax. percent or 8 percent per year, depend- Hank Paulson at the time, and despite We’re against a tax on capital transac- ing on which province one looks at, frantic efforts they had to let Lehman tions. We disagree with [British Prime and I think the provinces are going to Brothers go under. The Europeans then took great The lesson to me from all of that is that financial institutions, issue with the Americans, when they see other financial institutions making relatively and I was in the meeting easy money, albeit taking on dangerous risk, will take on when that happened, about letting Lehman Brothers go dangerous risk and will try to make that easy money, and that and displaying a chart from means that government has an important role to play here, the European banks show- that when we regulate we have to not just have regulations; ing that credit spreads had we have to have effective regulations and enforce them. gone wild after the demise of Lehman Brothers. As I pointed out Minister] Gordon Brown on that. I’m have to look at how they make their to the German minister at that meet- not quite sure where the Obama systems more affordable. ing, he had banks levered at three to administration is on that. Tim PO: And we have the largest one and four to one in Germany, and Geithner was against it when we had cohort in world history approaching here he was pointing his finger at a G20 finance ministers’ meeting in retirement age. Lehman Brothers and the American November in St. Andrews, and so was JIM FLAHERTY: Yeah, but probably administration. So the lesson to me I. We both said so publicly. I’m not the healthiest, which is an interesting from all of that is that financial insti- sure whether the Obama administra- thing because it cuts both ways: live tutions, when they see other financial tion may be rethinking that position, longer but live healthier, with fewer institutions making relatively easy but we are in agreement, and we all demands on the system, although we all

14 OPTIONS POLITIQUES AVRIL 2010 A conversation with Jim Flaherty Q&A

Policy Options Photo: Annette Robertson Jim Flaherty and Policy Options Editor L. Ian MacDonald in conversation at the Finance Minister’s Parliament Hill office in the afternoon of March 9. know that the greatest demands on the decision in this budget this year. PO: On competitiveness and inno- system are in the last six months of life. We had to make a big 35,000-foot vation issues, which is a major themat- So yeah, I think the provinces will have decision. We went through the ic of the budget, obviously, where do to look at that. I tried to deal with it in usual way of doing budgets, of look- you see some of the challenges for Ontario when I was finance minister ing at individual items, all the trees, Canada in terms of how you can tweak there, and it’s a tremendous challenge, and at the end then we looked at the system with budgetary measures because regardless of the degree of eco- the forest and went up at 35,000 and some of our comparative advan- nomic growth, health care costs will feet, looked at the forest, and I did tages, notably on corporate taxes and march along growing at 6 percent, 7 per- not like what I saw, because it would new investment and taxes on the cent, 8 percent, 9 percent per year in the have been a lot more spending and investments? absence of any rational containment of it would have been very difficult to JIM FLAHERTY: Well, we’re starting health care costs, and it would be not get to balance in the medium term. to have tax advantages. We already do, good for the federation, for the provinces So we had to resolve that we would and there will be even more. I mean to just try to dump excess health care do a different kind of budget, have the Americans, when I describe our costs on the federal government, because the least amount of new money system to them, are just in awe, quite the federal government doesn’t have the spending in more than 10 years in frankly, of where we’re going on cor- tools to control health care costs because Canada, do a few large things to porate taxes and that we can afford to it’s not our direct jurisdiction. control the rate of growth of spend- do it, because they’re in no position to PO: Nor for you to download on ing going forward and then be do it. President Obama faces serious them, on the provinces, as Paul Martin resolved that we would do it with challenges in terms of the revenue he’s did in 1995. modest economic growth expecta- going to need to find. JIM FLAHERTY: Yeah, that’s tions, which is how we ended up PO: There’s one of your hot charts right. You know, it’s an important with the budget that we did. in the budget papers that’s quite strik-

POLICY OPTIONS 15 APRIL 2010 Jim Flaherty ENTRETIEN ing on comparative Canada-US and problem. We’ve had discussions feder- to the federal government to lead on G7 taxes on new investments. You ally, provincially on this. There are pension reform. We’re working close- have the US at 34 percent and Canada basically three areas. There’s the ques- ly together, as I say, with most of the having reduced from 32 percent when tion of whether we would expand the provinces on this issue. I don’t see any you took office to 16 percent when CPP mandatory system, or expand the tendency in any of the provinces to fully implemented in 2012. That’s a CPP to take on a voluntary system, or want to be a renegade on this. I think major source of comparative advan- use the private sector with a voluntary we all realize the mobility of pension tage, is it not? system, or do some combination of plans in Canada is essential for eco- JIM FLAHERTY: It is, and our person- those three, or do none of the above. nomic growth. al income taxes have been coming That’s basically what we’re looking at. PO: A big part of the rescue of GM, down. And a lot of poorer people or British Columbia’s quite interested. in fact, was Ontario putting up the lower-income people are off the tax rolls Quebec has been quite interested too, money for the pension plan, right? JIM FLAHERTY: Yes. The provinces and territories tend to look to the federal PO: And what would government to lead on pension reform. We’re working closely you tell a Nortel pensioner together, as I say, with most of the provinces on this issue. I who had spent his whole 35 don’t see any tendency in any of the provinces to want to be years, 40 years of his life working out here in Kanata a renegade on this. I think we all realize the mobility of or someplace else in the sys- pension plans in Canada is essential for economic growth. tem and ends up at the end of the day facing retirement altogether, so all of that is good. We can following along, conscious of the shortchanged? Who does he see about still run the government and substantial needs that’ll be expected from the that? I mean other than saying, “I feel programs. Then you continue to build Quebec Pension Plan, and Ontario’s your pain,” what can be done for the military and rebuild the military. So involved as well. So we have a lot of them? we’re still able to do a lot with a fairly the governments in Canada that are JIM FLAHERTY: Well, I have to strong tax base in Canada. going to participate in the public con- state the obvious, that they’re a PO: We put out an issue of Policy sultations we’re going to do in the provincially regulated pension plan, Options last month on Canadians and next two months, and then the not federally regulated, but I think you their pensions and whether they’re finance ministers are meeting again need to look at alternatives there, and going to be available going forward, toward the end of May, and I hope by we are. whether there will be some funding that time we’ll be able to look at the PO: This is your fifth budget. Are issues. Clearly there’s a lot of anxiety options quite closely and start narrow- you still a happy warrior? out there about Canadians wondering ing the options. JIM FLAHERTY: This one was more whether their pensions, both public PO: Is it fair to say that the tiresome. and private, are going to be there when CPP/QPP’s in better shape, though, PO: More demanding? we need them. Is this a coming nation- than social security in the US going JIM FLAHERTY: More wearying al conversation that we need to have? forward? than any of the others. As the Prime JIM FLAHERTY: It’s a current JIM FLAHERTY: Vastly better Minister said, we had to say no a lot, national conversation. Ted Menzies, shape. I mean our Canada Pension and it’s my job to be the naysayer, so my parliamentary secretary, did some Plan is one of the most solid, stable in some of my colleagues are not consultations last year, and we made the world, and actuarially stable going thrilled with not getting anything, some regulatory reforms last year, but on at least 70 years. because we had to make that deci- that was more directed toward the cri- PO: Even Kevin Page would settle sion, as I say, after looking at it from sis we had had with some of the for that. 35,000 feet to say no to almost defined benefit pension plans, where JIM FLAHERTY: Yes. Yes. Dear Kevin. everything. they could not pony up and meet their PO: And in terms of defined bene- PO: Right, and finally, the ques- capital obligations because of declines fits, the private pensions, the feds, as I tion on the minds of all Canadians: in the stock market. Now Air Canada understand it, regulate only about 7 Where did Flaherty get that pom- would have folded had we not inter- percent of the equity, right? padour? vened last year and the same with JIM FLAHERTY: Right. JIM FLAHERTY: One of my col- another Canadian entity, which I PO: So you’re not the major player leagues, who’s a woman cabinet minis- won’t mention. So we made those in this space? ter, said to me in the House today, reforms now in cooperation with the JIM FLAHERTY: We’re not, but the “Now you know what it’s like, Jim, unions, and now we have the broader provinces and territories tend to look about women and their hair.”

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