Miville Tremblay is an economics reporter at La Presse and a research fellow at the Centre for International Business Studies at the Ecole des hautes etudes commerciales in Montreal.
What's the best way to bob the cat's tail?" a Quebec deputy minister asked me in late 1996, as he was struggling with government spending cuts. "Should we trim it gradually? Or whack it off with one final blow?" The Quebec government has chosen a gradual approach while trying to develop a broad consensus on ways to regain control of its budget. But public sector employees have been under financial pressure for so many years that "everyone now has their claws firmly gripping the carpet," the senior mandarin told me. This defensive attitude, although understandable, might not be conducive to the creative solutions expected of the negotiations. Would it not then be preferable to emulate Ontario Premier Mike Harris and simply slash off the tail with a last, painful blow?
We now have lived through months of protracted and sometimes excruciating negotiations which culminated in an agreement between the government and its public sector employees in March 1977, only a few days prior to delivery of the provincial budget. It seems that Quebec will, after all, avoid the social unrest that plagues Ontario. Why it had to act is no mystery. The Parti quebecois government is working hard to eliminate the deficit for three reasons. First, service charges on the provincial debt are crushing its freedom to act as a responsible, social democratic government. Second, the financial markets have issued dire warnings about any failure to reduce the deficit and the mountain of debt. Third, and by no means a minor consideration for the PQ, putting its financial house in order is part of the price Quebec must pay to become an independent country. The government also opted for consensus building because that is part of Quebec's political culture. It also wants to maintain its pro-sovereignty alliance with the huge and powerful labour federations.
The process did result in a creative solution. It remains to be seen whether it is in the best interests of Quebecers. In the following, I try to explain why Quebec chose a different path and how it did so, and assess the potential--and limitations--of this approach.
Hostage to the financial markets
From the election of the PQ in September 1994 until the referendum in October 1995, I traveled to 20 cities around the world to meet the financiers who decide almost daily whether to buy the bonds issued by Ottawa and provincial governments or whether to sell them. I conducted about 175 interviews with key players. The results of this research I presented in a recently published book, A Country Held Hostage: How the World Finances Canada's Debt (Stoddart, 1996). (1)
We can sketch out the general situation as follows: Canada is twice as indebted as the average major OECD country and, more than any other, relies on foreign capital to finance its debt. Quebec is more indebted than any province except Newfoundland. (2) Like most provinces, it borrows more abroad than does Ottawa. Overall, Canadians finance about 60 percent of their public debt and borrows the rest outside the country. We may now be able to finance our shrinking deficits domestically, but there are still insufficient savings in Canada to finance all of the public and private debt.
Financial institutions that manage German, Japanese, or American savings have plenty of countries other than Canada in which to invest their money. Typically, an insurance company or a pension fund will invest most of its funds in the country of its clients. Of the portion invested abroad, most will be in stocks. Of the part invested in foreign bonds, only about 3 percent will, on average, be put into Canada, because Canada represents only 3 percent of the world bond market. In practice, the proportion of the international bond portfolio invested in Canada may range from zero to 20 percent, depending on whether a fund manager believes the Canadian bond market will perform better or worse than average.
This forecast depends on many factors: the level of inflation (none is best; inflation erodes the value of future payments) (3), the direction of interest rates (declining rates result in capital gains as bond prices rise), the direction of the Canadian dollar (when it goes up, there are foreign exchange gains), and the evolution of perceived risks.
No one I met doubted that Canada or any province would pay their interest charges or redeem their bonds when they come due, whether in 90 days or 30 years. (4) They did, however, raise a problem: any slight increase in risk slightly decreases the value of the bond on the secondary market, and any slight decrease in risk has the opposite effect. These shifts in the value of bonds in a portfolio directly affect their yield and, very often, the bonus that the fund manager gets at the end of the year. These risks are periodically rated by, among others, two influential New York agencies, Moody's and Standard & Poor's. Bond managers constantly try to guess when and what the next rating change will be. They hope to sell bonds before they are downgraded or buy before an upgrade. For bonds issued by rich countries or provinces, it is not so much the absolute level of risk that matters, but the general trend. If the trend is down, that is, if the rating agencies deem that the country or province deserves a slightly lower credit rating, the choosiest investors will place their funds elsewhere, while others will demand a higher rate of interest to lend money to that government. Fund managers are generally a conservative lot, especially about bonds, which make up the stable part of their portfolio. The reason is simple: that's the way we expect them to manage our pension funds.
How do they rank Canada and Quebec? No one I met compared Canada with Mexico or Argentina; only Canadians do that. No one compared Quebec with Bangladesh; only the Fraser Institute does that. Even when our Cassandras were predicting Canada would hit a "wall of debt" or plunge off the proverbial financial cliff, foreign fund managers had a fairly positive opinion of Canada. Nevertheless, they were unanimous in their belief that the country had to reverse its fiscal course immediately: no state can allow its debt to grow faster than its economy for an extended period of time. Their second concern was political...