Thursday, March 12, 2009


"Smart Debt" is really smart

Have you ever wondered why it seems like the Government of Alberta is always in infrastructure catch-up mode?

Part of the problem is that their capital budget over the past 15-20 years has been bouncing like a yo-yo. When the economy is hot and the government is running surpluses, they increase capital spending. When the economy is slowing down, they cut the capital budget to avoid posting a deficit.

This leaves us with a problem. When the capital budget is cut, there isn't enough money to build needed infrastructure. When the capital budget is high during a boom, cost escalations make the projects so bloody expensive that, surprise surprise, there still isn't enough money to build needed infrastructure. Clearly something has to change if we intend to be able to afford the capital projects that we absolutely need to get done.

When somebody buys a house, he or she generally takes out a mortgage. That person can't afford to buy the whole house at once, so he or she uses debt to facilitate the purchase. The same thing is needed with governments and capital projects. They can't afford to pay for an entire freeway within one year's budget, so the construction needs to be broken into chunks. If funding isn't consistent the results are these piecemeal, half-assed infrastructure projects that never quite get done. Would you build your house one room at a time, year after year? That's the kind of constraint that the government has been working under.

One thing that the government has done to try to alleviate this problem is to use public-private partnerships (P3s). The government signs a long-term (30 year) contract with a company whose job it is to design, build, and maintain a piece of infrastructure all in one shot. This has worked quite well for the ring roads in Calgary and Edmonton. The roads are built to full freeway specifications immediately, instead of being stuck with substandard roads with "temporary" traffic lights at intersections that need interchanges. This is only possible because the P3 company borrows the money that is necessary to build out the entire project at once. Guess what: it's debt! The P3 projects involve debt -- they are just a clever way of keeping the debt off the government's books.

Imagine my surprise when I read Ed Stelmach's proposal for a second alternative that is being referred to as "Smart Debt."

The name "Smart Debt" is suggesting a couple of things. First, the debt should be dedicated only toward capital projects that produce assets. Second, the premier's musings suggest that the government's AAA credit rating would give the government's capital account a higher interest rate than the locked-in interest rate on any new debt. This means that the government could make enough money from its cash to pay off the debt's interest and still have some left over. Once the economy heats up, that infrastructure will already be in place and the government can use its surplus dollars to further pay down the principal.

Nobody would dispute that it's a bad idea to borrow money for operational expenses. Perhaps it buys time, but in the end you've got nothing to show for it except for more debt. On the other hand, using debt for capital spending leaves you with an asset that has value. A loan on something with high depreciation isn't a good idea because you end up paying principal plus interest on an item whose actual value is plummeting. For "Smart Debt," this means that items like cars and computers need not apply.

This policy would help the economy in several ways. First, it would provide jobs during a recession. Second, the government would avoid the pain of any cost escalations that occur during a boom. Finally, completing projects during a recession frees up labour to work in the private sector during a boom, helping to alleviate those cost escalations. In summary, if the government's numbers are correct and they only borrow for capital projects resulting in assets that depreciate slowly, I think that this policy is a slam dunk.

Many ideologues abhor deficits under any conditions. The question that I ask is this: Who is more fiscally conservative, the premier who borrows money, locks it in while it's cheap and builds a project while costs are stable, or the premier who only builds during booms and ends up with the project doubling or tripling in cost?

One of those scenarios would help pay off our infrastructure debt without being detrimental to Alberta's fiscal health. The other scenario maintains zero debt, but it wastes money and leaves us playing catch-up in perpetuity.

Some days I feel like I'm in the Twilight Zone. Only recently I was ripping into Stelmach for some stupid remarks that he made about the Heritage Fund. Now I'm lauding him for the economic foresight that this "Smart Debt" plan reveals. Wow. Speaking of yo-yos...


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