By almost any economic metric, the Government of Newfoundland and Labrador is bankrupt. Theorists would argue it’s not possible for a government to go bankrupt because they have the power to generate revenue on demand via increased taxation. Besides, governments can borrow whenever they want—can’t they?

There are limits.

When the governments of Zimbabwe, Argentina and Venezuela were no longer able to raise debt outside their borders, they defaulted on their obligations and were forced into ignominious restructurings. Their citizens bore the cost of these failings through reduced government services and an accompanying fall in their standard of living. That is the prospect facing the residents of Newfoundland and Labrador. However, this is not widely recognized as the inevitable result. No doubt this is because of the perception Ottawa will come to the rescue. 

I think that is correct: Ottawa will come to the rescue. In doing so, however, the federal government will have no political option but to extract something in return. While the current Liberal minority holds all the federal ridings in Newfoundland and Labrador, that is not the constituency that will drive this decision. Critics will label any help as a reward for financial mismanagement. Other provinces and government members across the country will demand the provision of support be contingent on a commitment to get to a balanced budget. 

Let’s examine the situation at a more granular level.  Canada’s governments have many sources of revenue. The most material are tax revenues—personal and business taxes and the GST. They collect a variety of other fees from areas like taxes on liquor and cigarettes and for dispensing licenses. The difference between the total of all these revenues and what it spends are funded by the raising of debt. This debt is provided by, in the main, the world’s capital markets.  Rating agencies attribute a credit score to the integrity of these offerings which determines the associated interest rate. Providers of this capital have various restrictions or rules around the quality of the debt they are prepared to buy or fund. At a certain point the cost of borrowing can be so high that the debt is simply unaffordable. 

When the current calendar year began, Newfoundland and Labrador’s finance officials faced an already daunting fiscal picture. Rating agencies warned that the province could not expect to hold onto its existing ratings without increasing revenues and/or reducing expenses (read ‘services’). Then COVID-19 struck and with it a collapse in global demand for oil, leading to a resulting fall in oil prices. This was a double whammy for the province’s coffers. Revenues are in freefall and there is little evidence expenses will decline. I know of no reasonably accurate assessment of what the deficit will be in the current year (maybe $2.3 billion?)  but suffice to say it will be much larger than last year. The province has already been forced to look to Ottawa to support its debt offerings over the last few months. This is not sustainable. 

When countries get into such trouble there are global agencies like the International Monetary Fund or the World Bank to provide help. The cost of this help is not an egregious interest rate but a legal requirement that the offending government carry out significant reforms designed to improve its economic climate. In all cases this includes a cut in the services or expenses of the government. 

In the case of Canada’s provincial governments, the most significant costs are health care and education. Debt service costs or interest on previous borrowings is in most cases another material budget item but these are legally enforceable obligations and not subject to the discretion of the budget maestros. My point is this: health care services, education costs and the size of the provincial bureaucracy, their workforce, will all have to be cut. Any thoughts to the contrary are just wishful thinking. 

So, what to do? Surely the correct response is that we do this in a responsible manner, over time, with as little pain as possible so as to avoid the destruction of thinly populated areas where such services incur their highest costs of delivery. At the same time, we should be doing everything we can to drive up government revenues without taking tax rates to levels such that we discourage business growth or drive people out of the province. In fact, we need to do the opposite: we desperately need to attract more business investment in the province and encourage more people to settle here on our way to achieving a responsible and sustainable level of public spending. I’ll dedicate my next column to exploring options and presenting ideas as to how we can do that. 

The sooner we come to grips with this reality, the better able we will be to manage the solutions.